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.*
- Do not have a lawyer prepare a comprehensive ownership agreement
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.”
- Do not identify each owner’s contribution to the business
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.
- Do not properly document ownership rights
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.
- Do not establish a framework for the transfer of ownership interests
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.
- Do not establish any procedure for resolving disputes among owners
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.
- Do not maintain clear corporate records
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.
- Do not keep all owners of apprised of developments in business operations
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.
- Do not raise questions or concerns when they arise
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.