These challenging times present particular challenges to small business. Notwithstanding efforts to stimulate the economy, the fact remains that many businesses simply can’t function at a sustainable level without open doors and customers who require inventory, raw materials or products to sell. Empirical data supports a substantial downturn in gross domestic production such that the federal government has declined to publish economic forecast data for the summer of 2020. Millions have been separated from employment – either temporarily or permanently. Every business and every businessperson has felt the economic effect of the pandemic.
While small business may never be the same, it is not dead. We all know the United States economy is driven by small to medium employers no matter the media focus on big industry. There will no doubt be consolidation in nearly every sector of the economy from construction to retail. History has proven that, for the savvy businessperson, trying times like these bring opportunity. Taking advantage of opportunity requires strong, focused and forward thinking business relationships.
Much has been made and reported about the federal government’s effort to sustain the economy and assist working families through programs such as enhanced unemployment benefits and the Payroll Protection Plan. AMM has assisted many small business owners in negotiating the application process and anticipating both documentary requirements and potential financial consequences of the available programs. State and local governments have also offered programs to the business community. Bucks County has now announced the creation of a new grant funding opportunity: the “Bucks Back to Work Small Business Grant” program. Availability is limited, however, and the application window is small so qualifying business owners must act quickly to obtain a share of the grant fund.
The coronavirus pandemic has already caused massive financial impacts across nearly every industry in the Commonwealth of Pennsylvania. Unemployment claims have skyrocketed, essentially all physical business locations are closed, and industry is struggling to convert to remote operations. Unfortunately, it appears the financial crisis is just beginning.
As the coronavirus pandemic extends its grip across the Commonwealth of Pennsylvania, its effects are felt throughout the practice of law. The very nature of litigation, the need for witness testimony, advocacy and argument before a tribunal, judge or jury necessarily implicates close personal contact. While measures to preserve the status quo are certainly necessary, the impact on pending litigation as well as potential new litigation, is developing.
The impact of the COVID-19 global pandemic is rippling through the United States economy. Mass cancellations, closures, travel restrictions, containment zones and school closures at every level leave many business relationships interrupted. Goods and services previously planned for and anticipated are no longer required. Buyers are scrambling to cancel. The grocery store shelves are empty and the markets experienced perhaps the most volatile week in history. We are entering a period of great uncertainty.
It’s the hardest advice to give; do nothing. As lawyers, we envision ourselves as problem solvers. It’s our job to take on a client’s problem, real or perceived, and seek to find a solution. We listen, we evaluate, we plan. We apply our knowledge of the law, our experience and our judgment to develop a strategy to best address our clients’ concerns and maximize potential outcomes. We are often type “A” personalities. We are drawn to action.
So it makes sense that the hardest advice for a lawyer to give is to do nothing; to maintain the status quo, to grin and bear it, to forego that argument or claim. Sometimes, however, to do nothing is exactly what a situation requires.
For example, consider the small business with two equal owners both of whom are “involved” but to differing degrees. Each invariably believes the success of the business is primarily the result of their effort as opposed to the efforts of their co-owner. Should they separate? Dissolve the business? Sometimes the answer is certainly yes, but just as often the answer is no. The cost of the dispute, not only in terms of money spent but also revenue and opportunity lost, must be considered. It may even be that the co-owners’ combined respective skills are what drove the success of the business and that combination may be lost forever. Business factors such as proprietary trade secrets or exclusive trade agreements may render separation for value impossible. There is rarely a quick resolution to a business control dispute.
Similarly, when considering litigation, a party must consider whether litigation is actually in their best interest and not an emotional reaction. Whether claimant or defendant, the economics of litigation, success or failure, must be considered. Sometimes, however, the litigation economics form only part of the story. A business owner must also consider the business management distraction that litigation may cause, disharmony or disunity in the work force as employees and management personnel take up sides, or even the impact on customers and clients. A further concern is the question of how that portion of the public which becomes aware of the dispute - or even which must become aware of that dispute for business reasons – might perceive the respective positions of the parties. In some cases, litigation may force clients and customers to become concerned for their own business, thus creating significant stress on the relationship.
Tax reporting obligations are another area ripe with conflict. Often times an analysis of a business control dispute or damages evaluation in litigation will involve analysis of financial and tax reporting. A party must consider whether tax and financial reporting is consistent and that the facts as reported substantiate the position espoused by the party. In the litigation process, we often encounter all manner of tax financial recordkeeping and reporting issues; inaccurately reported income, misdirected payments, mischaracterized expenses and inventory value manipulation just to name a few. The parties to any dispute must consider the implications of public disclosure and avoid “taxicide”.
Many business relationships disintegrate to the point where continued co-existence is untenable and intolerable. In many cases, there are legal mechanisms that can be brought to bear to induce a change. A business owner is wise to consult with experienced professionals so as to evaluate the broad ranging ramifications of a particular strategy before embarking on what could be a dangerous or damaging path. Sometimes it is best to do…nothing.
Many an article or blog post concerns minority shareholder rights, shareholder oppression or shareholder “freeze out”. As business and litigation lawyers, we are always mindful of the rights between and among business owners, what can and cannot be done in furtherance of those rights and the legal mechanisms applicable to the exercise of those rights. We frequently write on the strategies available to a minority shareholder such as examination of books and records, claims of breach of fiduciary duty and the potential for appointment of a corporate receiver or custodian.
This is not that article.
The fact is, being a minority shareholder means that, by definition, there are often things you simply cannot control. A shareholder or member in a business entity who possesses less than a controlling stake must have reasonable expectations as to the rights attendant to such ownership and understand the limits of such rights so as to make informed decisions concerning the investment of time, energy and money in pursuit of the collective enterprise.
Let’s start with who owns the remaining shares in the company. In the absence of an agreement to the contrary, the majority shareholder is free to transfer the majority (said another way; controlling) interest in the company without the consent of the minority. A transaction can result in a change in control such that the minority shareholder suddenly works for someone entirely new. While a minority shareholder can enjoy “dissenter’s rights”, such rights are applicable in very narrow situations specified by statute. In fact, in the absence of a prohibition, the stock in a business entity is readily transferrable, just like on an exchange, if a buyer and/or seller can be identified.
Internally, a minority shareholder can find it difficult to impact the direction of the business. Depending on the by-laws of the entity and, frankly, the will of the majority, a minority shareholder may or may not have a voice on the board of directors and thus may not possess a vote on material decisions such as the persons who will fulfill critical roles in the executive branch of the business such as the officers of the corporation. More importantly, a minority shareholder may not have input on the financial operations of the company including distributions, financing arrangements, major purchases of inventory, equipment or talent. All of which can dramatically affect the annual bottom line.
Even employment is not guaranteed to a minority in interest. In the absence of an agreement to the contrary, the employment of a minority shareholder may simply be at will in the same way as the sales force, the administrative assistants or the custodian. Certainly, terminating a minority’s employment could be one of the factors argued in a freeze out, but in the absence of other factors, termination of employment alone may not give rise to a cause of action. Certain courts have suggested continued employment may be implicit in a “founder” but those situations are few and far between and a plaintiff/minority shareholder must be prepared with more to argue than the end of employment if freeze out is alleged.
In business, like politics, being in the minority means sometimes you are powerless to immediately change the course of the company. Sometimes, a group of shareholders can band together to pool their collective influence for their mutual benefit. Other times, the best strategy is to become the majority even when the acquisition of additional shares comes at an unnecessary or unanticipated cost. Under any circumstances, rights afforded to the majority are not constrained solely because a minority shareholder does not agree with a particular course of action.
As a litigator, I am often contacted by minority shareholders who are frustrated by their lack of control or influence. While the law offers certain protection for holders of such minority interests, those remedies are factually limited and are often unsatisfactory even if granted in full after significant expense in litigation. Certainly an appropriate agreement outlining the respective rights and obligations can change the analysis. Business owners should consider, and plan for, what rights their stake in the company provides.
As commercial litigators, we frequently field calls from counsel in other states seeking to enforce judgments entered in a state other than Pennsylvania against assets of the judgment debtor which may be identified within the Commonwealth. Under Pennsylvania Law, a judgement creditor may effectively transfer a judgment in two ways; the traditional approach of a civil action to enforce judgment at common law or pursuant to the terms of the Uniform Enforcement of Judgments Act. The Uniform Act prescribes the mechanism for transfer of the judgment and the procedures which follow thereafter.
The effectiveness of a foreign judgment is based upon the full faith and credit clause of the United States Constitution and grounded in principles of comity among the several states. Pennsylvania, like many other states, has adopted the Uniform Enforcement of Judgment Act in an effort to streamline the process of transferring a judgment from a “foreign” – meaning a different state – court. The Act merely requires that a certified copy of the judgment and relevant docket entries be filed with the Prothonotary together with an affidavit of last known address of the judgment debtor. That transferred judgment then becomes a lien against the debtor’s real property within the county. Of course, not all arguments are resolved by the simple process outlined by the Act; frequently, the transfer signifies the beginning of a new litigation cycle.
While the full faith and credit clause as implicated by the Act is a very powerful vehicle available to a judgment creditor, the application is not unlimited. Review by a Pennsylvania trial court is for the most part limited to issues of jurisdiction and due process in the issuing court; if the issuing court did not have jurisdiction, or if due process has not been served therein, then Pennsylvania may decline to enforce the foreign judgment. The judgment debtor bears the burden to establish the absence of jurisdiction and due process. A judgment debtor should be expected to file a Motion to Strike the transferred judgment arguing the inapplicability of the full faith and credit clause.
Significantly, the application of the full faith and credit clause extends to the determination of jurisdiction and due process. In other words, if the parties “fully litigated” the issue of jurisdiction in issuing court and the issuing court, even incorrectly, concludes jurisdictional requirements are satisfied, that decision in and of itself is subject to full faith and credit regardless of whether that decision was correct by application of fact and law. A judgment debtor that has not appeared in the foreign action certainly retains the right to challenge jurisdiction and due process if the creditor subsequently transfers the judgment to Pennsylvania, but certainly runs the risk of the entry of judgment by default in the foreign court. Conversely, a judgment debtor that appears in a foreign court where jurisdiction and due process are in any way addressed by such court runs a substantial risk of deference to that court upon transfer to Pennsylvania.
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.
One of the trickiest issues we deal with in business control disputes relates to the impact and management of personal guaranties on the part of the individual shareholders/members. A personal guaranty can be an impediment to a transaction among the shareholders consolidating ownership, an impediment to the withdrawal of a shareholder/member, or even a trigger of default under the terms of financing agreements in place between a business and its bank. Managing the impact and expectations of business owners as to a personal guaranty should be considered in the early stages of any potential transaction.
In nearly every small business banking relationship, the bank requires personal guaranties on the part of business owners. Personal guaranties, often even the more overbearing “spousal” personal guaranties, are the norm. Of course, the purpose from the bank’s perspective is to increase the level of security against repayment. The individual terms of the personal guaranty are governed by the language of the agreements.
The net effect of a personal guaranty is to, in effect, pierce the corporate veil and render the guarantor liable for the debt to the bank (or other creditor party to the guaranty agreement). In this way, not only does the bank obtain another source from which it can recover, but also dramatically impacts its practical bargaining power. Often we see shareholder agreements including and incorporating indemnification provisions which reference those situations in which a shareholder/member has guarantied an obligation to a lender. The value of such indemnification provisions is suspect given that the bank is always going to look to the path of least resistance to recover the extent of its obligation. In a guaranty the company is the primary obligor to the creditor. It is the primary obligor’s default which leads to exposure under a personal guaranty. In that instance, the company is not likely in a position to indemnify as its assets are likely devoted to the repayment of the primary guarantied obligation.
The best and most frequent approach to a personal guaranty in a business control dispute is to secure the release of the guaranty by the bank or other creditor as part of the transaction. Certainly, if the debt is retired in a third party sale, accounts are closed and the issue is moot. Not necessarily so in an ownership consolidation transaction involving a transfer among existing owners or members, or where one or more shareholders/members leaves the business. In that case, the business may continue and banking relationships may remain unmodified. The bank is not required to release the guaranty. Even further, under certain circumstances and agreements, a transaction may constitute an event of default of the credit arrangement. Management of the personal guaranty becomes an important part of the deal.
It is obviously always better to secure a release of a guaranty contemporaneous with a transaction. If that course of action is unavailable, indemnity is the only other option. In such cases, indemnification should flow from both the company and individuals as, if the guaranty is ever an issue, it is likely the Company’s ability to pay in the first place, which gives rise to creditor’s pursuit of the guarantor.