What Is A Business Divorce?
Marriage dissolutions are often considered the most contentious disputes that wind up in court.
However, this is not the only type of divorce the courts need to resolve. Often just as contentious, expensive, and frustrating, the business divorce.
Shorthand for shareholder and partnership disputes, “business divorce” occurs when one or more business owners claim they were mistreated by a co-owner. The mistreatment can arise out of mismanagement disagreements, accounting issues, fraud, mishandling funds, or any other kind of dispute arising among co-owners. Shareholder disputes commonly happen because there is a breakdown in trust or communication, divergent management style, or disagreement on future business goals. At its essence, a shareholder dispute is a fight for control.
Business divorces are emotional, in fact, sometimes even more so than personal divorces. This can happen because there is literally “no love lost.” The relationship began over money, and the subsequent battle over money can involve a deep sense of betrayal without the mitigating force of prior emotional bonds. What started as just business can turn into an ugly personal crusade.
One of the best ways to avoid or control shareholder disputes is to have a shareholder agreement in place. If a dispute does develop, the agreement serves as a guide for how to resolve it. The agreement usually includes a roadmap detailing what will happen if disputes arise. The agreement can provide a variety of dispute resolution mechanisms. For example, it can require a face-to-face meeting among the disagreeing parties, which may help when communications have broken down. It can require exchange of documents and records, which may assist when there are allegations of accounting or financial irregularities. Another mechanism is mediation, a process in which the parties, guided by a neutral facilitator, try to work through the issues.
If the dispute cannot be resolved by cooperation and agreement, then the shareholder agreement may provide guidance on other resolution options. It may provide terms for valuation of shares and a buyout process. It may establish who resolves a deadlock, or who has control in the event of an even vote.
If the parties do not have a shareholder agreement, then statutes and other law will control the relationship among shareholders. Statutes provide rules for voting and shareholder rights. They determine the process for requesting documents and corporate records. In the absence of a shareholder agreement, it is not a “free-for-all.” Owners must be cautious to comply with applicable laws or they may expose themselves to claims of misconduct.
If the shareholders cannot or will not resolve their differences cooperatively, by reference to a shareholder agreement or following applicable statutes, then the unfortunate next step is usually litigation (or arbitration if the shareholder agreement provides for it). In litigation, shareholders can use the power of the court to force production of financial records, obtain access to other company information, impose temporary restrictions on use of funds, and sometimes obtain an audit. They can sue for compensation if monies were misappropriated or the company value was damaged. If there is an absolute impasse in operation of the business, then a shareholder can sue to dissolve the company by auction or other sale process. The court can appoint a receiver to run the business until the dispute is resolved or the business is sold.
An example of high-stakes shareholder litigation is the Arizona Iced Tea case. The company was established in 1992, and the founders ended up in a New York court in 2008. One founder (the seller) tried to sell his interest in the company to a third party without the consent of the co-founder (the holder). When the holder objected, the seller sued to dissolve the business at which point the holder asserted he could unilaterally buy back seller’s shares.
The seller argued that the company could not block the transfer of his shares to a third party. However, the shareholder agreement restricted the sale of shares to a third party. The New York appeals court disagreed with the seller’s position, ruling the company had the right to buy out his shares. The appeals court said that following seller’s logic would undermine the goal of promoting business continuation. Dissolution is often a “death sentence” for a going concern. Of course, this is why litigation and the threat of dissolution is often a catalyst for an agreed resolution.
After a trial on a number of issues, including valuation, the selling shareholder’s interest was valued at approximately $1 billion, and that is the amount holder paid to buy back seller’s shares. The case was finally settled in 2015. The parties seemingly arrived at the same destination as if they had followed the shareholder agreement, applicable law, or basic logic, but having incurred substantial attorney and expert witness fees. Unfortunately, it sometimes takes litigation to force a reasonable resolution.
Chernoff Law prides itself on its creativity in handling shareholder disputes. While the primary strategy is to try to prevent such disputes and resolve them when they arise, we are prepared to litigate and use all the resources in the dispute toolbox when necessary. If you have questions about ownership disputes or other legal matters, please reach out to us HERE.