Thousands of businesses across the United States fall within the definition of what is commonly referred to as “small business”.   Many of these small business are formed by two “friends” with compatible skill sets and both possessing knowledge of a particular industry.  Business owners commonly refer to their co-owners as “partners”.  As the business and its’ complexity grows, deficiencies in performance or capacity on the part of one partner may be exposed. Alternatively, the absence of immediate success can cause a less patient partner to seek other opportunities and abandon the work that is necessary for the collective good.  What starts as a promising partnership can quickly turn sour.  Here are a few tips on moving forward:

1. Agree on material issues ahead of time.  It goes without saying that a written agreement which contemplates and addresses material issues benefits everyone.   Terms frequently addressed in such agreements include the relative duties of the parties, corporate officers, duties of directors and financial matters. If shareholders/partners/members are required to devote substantially all of their time to the venture, the agreement must so state.   Similarly, if shareholders/partners/members can be required to contribute capital to the business, the prevailing agreement must so state.  Agreed upon rights and remedies upon abandonment of functions within the business by a shareholder/partner/member can provide the road map for resolution and expedite transition.         

2. Change terms of employment.  An option which may be available to a shareholder/partner/member is the exercise of corporate power to change terms of employment with respect to the non-performing shareholder/partner/member.  While a founding  shareholder/partner/member may arguably have certain rights to continued employment, such guarantees are limited and may not preclude a change in terms when faced with non-performance or abandonment. Exercise of corporate power does not come without risk and any change in employment terms is almost always alleged as part of a minority shareholder oppression claim.

3. Offer a buy-out.  Certainly the cleanest and most efficient means to end an unproductive arrangement quickly is to acquire the non-performing shareholder/partner/member’s interest in the business by the payment of money.  Of course, such an agreement is not always financially available.  Moreover, a voluntary transfer necessarily implicates that that non-performing  shareholder/partner/member agree.  Issues of valuation, income streams, indemnification and restrictions against competition can complicate any potential buy-out.

4. Sell the business.  Often the solution to a disagreement on partner performance is a sale of the business with a corresponding post sale employment agreement for the performing shareholder/partner/member.  Money is a powerful motivator.  A sale generates money in a lump sum which can induce a shareholder/partner/member to forego the ongoing income stream that results from future operations.  Certainly, control over the sale process, including the legal right to effectuate a sale by virtue of agreement or corporate control, are essential factors for evaluation.  

5. Dissolve and start something new.  As a matter of last resort, dissolution of the entity may be the only way to gain freedom from a non-performing shareholder/partner/member.  The Business Corporations Law provides a mechanism for dissolution.  Provided the requirements can be met, a shareholders/partners/member may seek judicial dissolution of the entity essentially forcing a judicial sale.  An important aspect of dissolution is relief from fiduciary duties owed to the business and minority owners.  Dissolution can be a complicated and expensive proposition and very disruptive to ongoing business operations but remains a viable strategy when business owners can no longer work together but also cannot agree on separation.

Published in AMM Blog

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