How Do I Get Out of This? Planning to Avoid the Business Divorce
THE COUNSELOR
Volume 9 • Issue 9 • September 2019
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. This month's issue will discuss planning to avoid the business divorce. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
Owners starting a business are often like a new couple getting married, everything is bliss and no one can imagine a break up will ever occur. While your marriage may not end in divorce, the odds are your business will. Inevitably, and for a variety of reasons, the business owner will begin to ask, how do I get out of this? Many wrongly assume that just because they want out, the other owners must buy them out - or let them out.. This is generally not the case. The answer to that question is another question, what does your agreement say? If you don’t have an agreement, the applicable statute in your state will apply.
No Plan
Unfortunately, many businesses have no agreement at all. In that instance, the state statute governing your type of entity will control. While each state and type of entity may vary, the Revised Uniform Limited Liability Company Act is illustrative of what is included in many statutes as the default rule. That Act provides that dissolution only occurs in a few narrow circumstances:
an event or circumstance that the operating agreement states causes dissolution;
the affirmative vote or consent of all the members;
the passage of 90 consecutive days during which the company has no members; and
the entry by a court of an order dissolving the company on the grounds that:
the conduct of all or substantially all the company’s activities and affairs is unlawful;
it is not reasonably practicable to carry on the company’s activities and affairs in conformity with the certificate of organization and the operating agreement; or
the owners in control of the company:
have acted, are acting, or will act in a manner that is illegal or fraudulent; or
have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the other owner.
These are generally narrow circumstances and can be difficult to meet. If this is the only way out of the business, you may be stuck.
Plan For It
As the saying goes, you should begin with the end in mind. That means discussing and reaching an agreement on how the business is ended or how an owner is allowed to leave prior to the end of the business. The agreement should be in writing and the agreement should be signed. You would be surprised at how often that last step, signing, is missed. Planning for it means putting in place the rules of the game for when an owner wants to leave and whether some, but not all of the owners are required to approve a dissolution. These agreements may be found in an operating agreement, partnership agreement, shareholder agreement, or a buy-sell agreement.
What are some of the questions that should be answered in the agreement:
Is the Company existence for a term of years or perpetual?
What percentage of the owners must agree to dissolve the Company?
What happens when an owner dies?
What happens if an owner becomes disabled?
What happens if an owner gets divorced and a court awards the other spouse an interest in the business?
What happens when an owner goes bankrupt and the court takes possession of the ownership interest?
What happens if an owner fails to perform expected duties?
What happens if an owner wants to retire or otherwise leave the business?
What happens if an owner wants to take a leave of absence for a mission or the like?
What happens if an owner wants to sell to a third-party purchaser?
Can an owner be expelled by the other owners?
If so, for what reason can an owner be expelled?
If your agreement has addressed the above questions, it is not uncommon that in certain circumstances a buyout will be required. If that is the case, has your agreement answered these questions?
Is there a provision for how the purchase price is determined (valuation)?
Is there a provision for how the purchase price will be paid?
Is your agreement adequately funded – i.e. how will a buy-out be paid?
Has insurance been purchased?
Are appraiser qualifications specified?
Is the appraiser selection method specified?
Are spouses bound?
Forced Buyouts
Occasionally, the owners want to be able to force a buyout as a way to end the business relationship. These can be very aggressive positions and it is important to remember that you may be on the wrong end of the buyout. Some common forced buyout provisions include:
Russian Roulette - this can take several forms, but with a Russian Roulette provision, usually one owner serves notice to the other owner offering to purchase that owner’s interest for a stated price. The owner receiving the notice must then either sell all of his/her interest to the other owner at that price or purchase all of the other owner’s interest at that same price.
Texas Shoot-Out - with the Texas Shoot-Out, each owner submits a sealed bid containing their perceived value of the business. The owner with the higher bid buys the other owner out.
Dutch Auction - with the Dutch Auction, each owner submits a sealed bid containing the lowest price for which they would sell their interest. The owner with the higher price buys the other owner out at the lower price.
Now What?
Regardless of what stage your company is at, if there are multiple owners, the failure to address these issues in a written agreement may mean you are stuck in the business or get forced into court in an expensive and messy business divorce. The easiest time to address these issues is when people are still getting along. The more time that passes and as hidden animosities develop, the harder it will be to get people to agree.
As always, the first thing to remember is to work with quality advisors who understand these issues. Next, work toward getting the written agreement in place. Thereafter, have a regular review meeting, at least annually, to discuss the agreement; and act timely in making revisions.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.