So, you and your business partners want to help ensure that all of the time, energy, and money you have invested into creating a successful venture will lead to a fight among yourselves and tens (or hundreds) of thousands of dollars in litigation expenses? On behalf of business litigation attorneys around the nation, we’re flattered! Here are some of the tried and true ways you can achieve that goal.
While litigation can frequently be emotional, it is a near certainty when the matter involves what is often referred to as a “business divorce.” Much like the dissolution of a marriage, when business owners split after years of mutual reliance, the result is often anger, animosity, and resentment, and a fight over custody of a “child”—the business that owners have collectively devoted themselves to developing and growing. If you are a business owner or are thinking about starting a business and you truly want to maximize your legal expenses, here are eight simple rules to help facilitate protracted and costly litigation.*
This is, unquestionably, the most surefire way to set yourself up for problems down the road. After all, if you spend a relatively modest amount in legal fees at the birth of the business, you may end up not being able to spend a whole lot more to help the business die. But, in the event that you decide to pay for the appropriate ownership agreements (whether an operating agreement for a limited liability company or bylaws and a shareholders’ agreement for a corporation), whatever you do, do not sign them. Instead, operate on a general “understanding.”
When owners’ contributions vary—perhaps one owner will provide the financial backing, another the “sweat equity” to run the business, and a third the talent or intellectual property at the heart of the business’ offerings—do not associate financial value to the non-financial contributions. This way, you can help foster an eventual sense of resentment from those who are running the company and growing the business towards the owner who made the initial capital contribution and continues to profit from the other owners’ efforts.
Another great way to achieve this goal of fomenting resentment among owners is to leave open any questions about owners’ compensation. What services are to be performed by which owners? Are some owners entitled to compensation for their services in addition to profit distributions? How are the company’s profits to be distributed? These are all great questions to leave for a fight down the road.
Also be sure to avoid addressing the potential need for additional capital contributions to the business, and whether those contributions might be mandatory and how they might alter ownership interests.
When you clearly document each owner’s interest in the company, you leave little room for the potential fight over ownership, including purported promises of gratuitous transfers, realignment of interests, or distribution of newly issued stock.
This is another critical step that is almost certain to create major problems. By placing restrictions on the transferability of an owner’s interest, you will limit the risk of an owner’s fifth spouse, who does not like you to begin with and does not feel that the company has been run properly, from assuming control over an ownership interest following death, divorce, disability, etc. You will also avoid owners pledging their interests as security for personal obligations, which could result in the owners’ creditors taking control of their interests. And by failing to establish any protocols to force an involuntary transfer of ownership interests, you can be left to deal with the fifth spouse, frustrated creditors, or even a disgruntled owner intent on doing everything possible to undermine the business—all splendid avenues for a major dispute.
Disagreements over critical business issues will invariably arise. If you do want to maximize the work for your business litigation attorneys, you must be certain not to establish any procedure or mechanism for informally resolving disputes among the business’ owners, such as through private mediation. Such informal processes minimize the opportunity for your attorneys—and your business partners’ attorneys—to become enmeshed in the operations of the business.
Another fantastic way to set the foundation for future litigation is to avoid establishing any procedure for resolving voting deadlocks. If all owners are sufficiently firm in their respective positions, you may end up with no choice but to seek judicial intervention to break the deadlock, with the help of your legal counsel of course.
Fortunately, corporate records provide a slew of opportunities to create problems that can lead to major legal battles. Because a corporation is required by law to maintain certain records and owners are entitled to review those records, when the corporation does not maintain them as necessary, a legal battle is virtually inevitable. This is particularly true when the business fails to maintain clear financial and accounting records. (If you really want to enhance the potential for disaster, do not hesitate to intersperse personal transactions among those for the business.)
Similarly, you should take care not to document all significant corporate events, including entering into sizable contracts, financing agreements, leases, or other major financial obligations on behalf of the company.
Another way to lay the foundation for future problems is to modify various agreements and understandings among the owners without documentation. This will help to prevent a consistent pattern of operation that might otherwise be used to establish a framework for an enforceable, implied agreement. Instead, all of the owners should be able to present their own contentions about, and interpretations of, all significant business issues.
This is especially true when dealing with “silent partners” or other owners who are not involved in the day-to-day operations of the business. Withholding information about the financial condition of the business, in particular, can go a long way in fostering suspicion about the business’ operations and the fidelity of managing owners—a sense that is greatly magnified with regard to undisclosed transactions that negatively affect the bottom line or where the business’ assets are offered as security. Once one owner becomes suspicious of the others, the downward spiral into a significant battle between owners typically follows.
As with all relationships, clearly communicating issues and concerns when they arise is much more likely to lead to a resolution than will letting those issues and concerns fester and escalate to the point that they become irreparable. So, if you are a minority owner or have no responsibility for the operations of the business, be certain to remain silent about your concerns. This will not only encourage the other owners to continue to operate the business as they desire without ever addressing your concerns, it will also allow your distrust and resentment to compound.
Take these eight simple rules to heart and you just may end up engaging in emotional, time-consuming, and, most importantly, incredibly expensive litigation with your business partners.
* It should go without saying that the foregoing “rules” noted in this article are meant to be sarcastic and they should not be followed. Nevertheless, the frequency with which even sophisticated business owners follow one or more of these rules is staggering and the consequences can be disastrous. If you are a business owner or are looking to start a business, be sure to engage the services of a competent business attorney to help you minimize the potential risks and maximize the potential for a successful venture.