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The Corporate Divorce: Breaking Up (in Business) is Hard to Do

business attorney

Untangling business disputes between owners (a corporate divorce) is often harder than an actual divorce. In a divorce, the law imposes some order on the process. Without a written agreement from a business attorney, you might not be able to end the business relationship with your partner without ending the business. Unfortunately, business owners don’t often go to a business attorney for advice and the necessary contracts. After all, they don’t know if the business will work, so why spend the money? 

You should spend the time and money with a reputable business attorney in Fairfax, VA to set up the business right because of what happens when you don’t. 

Suppose a dispute arises between the business owners. What the dispute is about doesn’t matter. I’ve seen businesses pulled apart because the business is doing well; the business is doing poorly; one owner thinks the relationship is no longer fair; one owner stops showing up to work; or the owners, who are also husband and wife, separate or get a divorce. The reason for the dispute can be positive or negative. At its heart, an owner dispute that blows up a business will be something the owners can’t resolve between themselves. Without a written agreement, options for breaking this deadlock and keeping the business running are fairly limited.

Most states have provisions to dissolve (end) a company or disassociate (kick out) a member if certain conditions exist. State law allows for appointment of a receiver (third party) to wind up (end) the company’s affairs. All these court-driven solutions end with the company no longer existing and are difficult and costly. It is much better for the livelihood of your business that your business partner and you agree on certain procedures and dispute resolution processes before problems arise. 

Let’s look at an example. A husband, Chin, and wife, Dara, owned a business. Chin was the majority shareholder. He also had mental health issues, which caused him to abandon his business and Dara. Dara filed for divorce. The divorce judge allowed Dara, the minority shareholder, to replace the company’s board of directors and appoint a new board of her choosing. Now, there were lots of problems with this from a legal standpoint. First, as a minority shareholder Dara didn’t have the authority to appoint a board of directors. Second, the company wasn’t part of the divorce, so the divorce judge didn’t have jurisdiction over the company, that is, he didn’t have the authority to order the company to do anything. 

Still, sometimes weird things happen in court, and this judge was determined to enter an order affecting the company. To save the company from the divorce court, Chin, who was undergoing treatment once again, filed the very profitable company for a Chapter 11 bankruptcy—also known as a reorganizing bankruptcy. Chin immediately fired the wife’s board of directors. This story had a happy ending. Ultimately, Chin and Dara reconciled, and the business thrived. However, many businesses die when disputes between the owners occur. 

You should have these three types of agreement with your business partner:

  • a shareholder’s or operating agreement (the type you need depends on whether the company is a corporation or a limited liability company),
  • a buy-sell agreement, and 
  • an employment agreement with non-competition provisions. 

Though I say these are three agreements, the relevant terms can, and probably should wherever possible, be included in one written contract. If you opt to make each type of agreement a separate document, be careful to ensure you don’t have contradicting terms. Again, I find it easier to have all the important agreements in one document. Essentially, you want an agreement that sets out who handles what, how decisions get made and how you get out of the relationship if things aren’t going well. The outline below gives you some of the major terms to have in any agreement between business owners.

Considerations for Shareholders’ or Operating Agreements

  1. Governance
  2. Election of specific people to specific positions
  3. Number and allocation of shares
  4. Day-to-day operations:
  5. Who manages?
  6. Who sets the corporate vision/ direction? 
  7. If there is an equal number of managers, how is a tie addressed?
  8. Requirements—majority or supermajority—to alter corporate documents
  9. Shareholder/member rights
  10. Powers
  11. Waiver of partition rights 

 (legal mumbo jumbo that means the right to have property divided into individual portions for the owners)

  1. Duties
  2. Employment
  3. Compensation and benefits 
  4. Termination 
  5. for cause
  6. without cause
  7. Stock issues 
  8. How additional stock is issued
  9. Is dilution possible?
  10. Restrictions on transfer of stock
  11. Sale of stock
  12. Right of first refusal
  13. Inter-member voluntary sale
  14. Compelled sale
  15. Disability sales
  16. Death sales
  17. Termination of employment 
  18. Effect of owner’s bankruptcy or divorce
  19. Effect of creditor’s enforcement against interest
  20. Payment Terms
  21. Contingencies affecting payments
  22. Key man insurance

(life insurance policies designed to pay the company if an owner or other key employee dies to make up for the loss of that individual in the corporate structure)

  1. How to resolve differences
  2. Meet and confer
  3. Mediate
  4. Arbitrate or litigate
  5. Combination of above
  6. Distributions including allocations of profit and loss
  7. When?
  8. Who makes the decision?
  9. Guidelines on what may be distributed
  10. Participation in other ventures
  11. Duty of loyalty 
  12. Liability and indemnification 
  13. Capital contribution calls

(legalese for when a company has the right to request loans or other funds from its owners; failure to pay a capital call can result in a loss of some percentage of ownership) 

III. Restrictions on trade (where allowable)

  1. Non-competition
  2. Non-solicitation 
  3. General Issues
  4. Name rights
  5. Continuation of business after an owner leaves
  6. Major decisions – procedure and definition
  7. Dissolution 

(legal mumbo jumbo for ending the company’s existence)

Still, sometimes weird things happen in court, and this judge was determined to enter an order affecting the company. To save the company from the divorce court, Chin, who was undergoing treatment once again, filed the very profitable company for a Chapter 11 bankruptcy—also known as a reorganizing bankruptcy. Chin immediately fired the wife’s board of directors. This story had a happy ending. Ultimately, Chin and Dara reconciled, and the business thrived. However, many businesses die when disputes between the owners occur. 

You should have these three types of agreement with your business partner:

  • a shareholder’s or operating agreement (the type you need depends on whether the company is a corporation or a limited liability company),
  • a buy-sell agreement, and 
  • an employment agreement with non-competition provisions. 

Though I say these are three agreements, the relevant terms can, and probably should wherever possible, be included in one written contract. If you opt to make each type of agreement a separate document, be careful to ensure you don’t have contradicting terms. Again, I find it easier to have all the important agreements in one document. Essentially, you want an agreement that sets out who handles what, how decisions get made and how you get out of the relationship if things aren’t going well. The outline below gives you some of the major terms to have in any agreement between business owners.

Considerations for Shareholders’ or Operating Agreements

  1. Governance
  2. Election of specific people to specific positions
  3. Number and allocation of shares
  4. Day-to-day operations:
  5. Who manages?
  6. Who sets the corporate vision/ direction? 
  7. If there is an equal number of managers, how is a tie addressed?
  8. Requirements—majority or supermajority—to alter corporate documents
  9. Shareholder/member rights
  10. Powers
  11. Waiver of partition rights 

(legal mumbo jumbo that means the right to have property divided into individual portions for the owners)

  1. Duties
  2. Employment
  3. Compensation and benefits 
  4. Termination 
  5. for cause
  6. without cause
  7. Stock issues 
  8. How additional stock is issued
  9. Is dilution possible?
  10. Restrictions on transfer of stock
  11. Sale of stock
  12. Right of first refusal
  13. Inter-member voluntary sale
  14. Compelled sale
  15. Disability sales
  16. Death sales
  17. Termination of employment 
  18. Effect of owner’s bankruptcy or divorce
  19. Effect of creditor’s enforcement against interest
  20. Payment Terms
  21. Contingencies affecting payments
  22. Key man insurance

(life insurance policies designed to pay the company if an owner or other key employee dies to make up for the loss of that individual in the corporate structure)

  1. How to resolve differences
  2. Meet and confer
  3. Mediate
  4. Arbitrate or litigate
  5. Combination of above
  6. Distributions including allocations of profit and loss
  7. When?
  8. Who makes the decision?
  9. Guidelines on what may be distributed
  10. Participation in other ventures
  11. Duty of loyalty 
  12. Liability and indemnification 
  13. Capital contribution calls

(legalese for when a company has the right to request loans or other funds from its owners; failure to pay a capital call can result in a loss of some percentage of ownership) 

III. Restrictions on trade (where allowable)

  1. Non-competition
  2. Non-solicitation 
  3. General Issues
  4. Name rights
  5. Continuation of business after an owner leaves
  6. Major decisions – procedure and definition
  7. Dissolution 

(legal mumbo jumbo for ending the company’s existence)

Still, sometimes weird things happen in court, and this judge was determined to enter an order affecting the company. To save the company from the divorce court, Chin, who was undergoing treatment once again, filed the very profitable company for a Chapter 11 bankruptcy—also known as a reorganizing bankruptcy. Chin immediately fired the wife’s board of directors. This story had a happy ending. Ultimately, Chin and Dara reconciled, and the business thrived. However, many businesses die when disputes between the owners occur. 

You should have these three types of agreement with your business partner:

  • a shareholder’s or operating agreement (the type you need depends on whether the company is a corporation or a limited liability company),
  • a buy-sell agreement, and 
  • an employment agreement with non-competition provisions. 

Though I say these are three agreements, the relevant terms can, and probably should wherever possible, be included in one written contract. If you opt to make each type of agreement a separate document, be careful to ensure you don’t have contradicting terms. Again, I find it easier to have all the important agreements in one document. Essentially, you want an agreement that sets out who handles what, how decisions get made and how you get out of the relationship if things aren’t going well. The outline below gives you some of the major terms to have in any agreement between business owners.

Foundation documents set the baseline for what everyone believes is a “fair” resolution of specific anticipatable events while everyone gets along. If the parties separate amicably, they can always agree to do more than the agreements require. In the event that the parting is less friendly, everyone knows the minimum result in advance. Having these critical foundation agreements can save not only the business if a later dispute arises but also the relationship between the owners. It’s important to have these discussions with your business partner when you start the company and to document any agreements reached to avoid later landmines.

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