The Business Divorce
THE BUSINESS DIVORCE
There are many similarities between business partnerships and marriage.
Both are adventures into the unknown, require mutual trust and respect, involve the sharing money and a high degree of compromise to placate egos but reach common goals.
Some might say that a business partnership is harder to maintain than a marriage.
In 2013 202,387 new companies were registered in Australia.
In the same year 10,746 companies entered external administration or were wound up. Internal Company Disputes A company may need to be wound up because it is insolvent. But in many cases companies are wound up because of internal disputes between its members Common complaints I deal with include scenarios where some of the members: • set up another business in competition; • divert income for personal use; • take secret commissions from suppliers; • misuse confidential information such as supplier lists and client contacts for personal benefit; • force minority members to take on more debt or provide personal security; • steer the company into risky or chartered areas of business; • passively or actively harass bully or intimidate members • make important business decisions without reference to the other members; and • act oppressively and against the interests of the company. A member may feel betrayed by the commercial immorality conducted by the other members and in those circumstances a company bust up is inevitable. Unless there is an agreed mechanism for the orderly sale of the business or the disposal of shares in the business, the process of dealing with internal company disputes is complex. The options available to disputing members are: • selling the shares to the other members; • selling some of the shares to a third party; • selling the company to a third party. Not all options will be available. Some options then present a further set of complications such as:
• determining the share price for the shares; • the release of guarantees and other securities (usually given to a bank or to suppliers); • the practical problems of selling shares to a third party; • restraint of trade; and • maintenance of confidentiality and intellectual property. Winding Up of the Company If a stale mate is reached or if the parties cannot agree on a price for the buyout of shares, then Supreme Court proceedings can be commenced for the winding up of the company. In some circumstances an order can be sought forcing the oppressive member to buy the shares of the others. The Corporations Act 2001 (Cth) provides the Court with the power to wind up the company if the court is of the opinion that: • there’s been oppressive or unfair conduct; or • if it would be just and equitable to do so. Oppressive and unfair conduct might arise if directors breach their fiduciary duties by issuing shares for the improper purpose of manipulating voting power to the detriment of minority shareholders. This avenue may also be available for minority shareholders who feel they are being ganged up on by the other shareholders. Companies have been wound up on the just and equitable ground where: • the mutual trust and confidence of its members has broken down; • a deadlock has been reached; • there is fraud or misconduct in company management; • there is failure of substratum – the activities are being conducted outside the scope of the objects of its constitution or the company is conducting activities it was not meant to do. Advice should be sought from an experienced lawyer in these types of commercial disputes. There are serious consequences to a winding up. A liquidator will be appointed and all parties will effectively lose control of the business. Litigating winding up applications are complex and expensive. A defending member may contest the wind up application and put the applicant to proof of its oppression claims. If it is salvageable, the liquidator will try and sell the business, and a fair chunk of the proceeds will be eaten up in liquidator’s costs. There may be little left at the end of the day. I advise my clients to exhaust all avenues of negotiated resolution before they instruct me to litigate. The Solution: A Shareholders Agreement Like divorces, windups are often messy, expensive and stressful experiences. The emotional strain on some business partners has often led to threats of violence. Stalemates are often reached where the partners cannot be at the workplace together because of the degree of hostility between them. To avoid this situation it is helpful to have a shareholders agreement which sets out the rights and obligations of each of the shareholders of the company. It is like a prenuptial agreement. The shareholders agreement will also contain provisions on how to deal with disputes.
An unresolved dispute may trigger a buyout clause. The clause will then set out: • how a shareholder might exit the business or purchase the interest of the other, • how the share is to be valued: and • the effective date of the valuation. A Shareholders Agreement may end up saving hundreds of thousands of dollars in expensive litigation. Partnerships In a partnership the process of winding up is commenced by serving a Notice of Dissolution. The process of the winding up is usually set out in the Partnership Agreement. But in many cases there isn’t a written agreement. A Partnership Agreement can set out what is to occur with the assets of the partnership in the event of a dispute. It might also contain provisions which provide for one partner to buy the other out for a price determined by an independent valuer. Uncertainties and problems can arise if there is no partnership agreement and a party is forced to apply to the court for orders. 10 Tips for Business Partners and Co-Directors If a business is starting out with two or more members my advice to them is as follows:
1. Share expenses instead of Capital. Don’t be caught by giving up more than what the others are offering.
2. If you are the “ideas” person and the other person has the skill, it is usually a mistake to take on the other person as a partner. Instead you should employ them or hire them as an independent contractor.
3. Have a written agreement with an exit strategy.
4. Many partnerships start out between friends. However do not expect that friendship to transcend winding up. Often the best of friends become enemies when money and pride is involved.
5. 50-50 partnerships sound warm and fuzzy but the reality is the business needs a leader. A ship cannot have two captains if it is to sail in the same direction. Consider a 60/40 split for overall operational control.
6. Ask yourself “what do I need from a business partner?” Ideally you need someone that compliments your skills and personality not someone that you are dependent upon.
7. Obtain a full declaration of your partner’s financial position.
8. Are you and your business partners of the same mind in terms of expectations and commitment to the business? Again the obligations of the parties can be documented in a shareholders or partnership agreement.
9. What is your business partners family life like? Are other parties likely to interfere or are there background issues that need examining?
10. Does your partner have a good business or financial track record? Don’t get involved with rogues or with parties with dubious reputations. They are likely to abuse the business relationship for their own benefit. Some of my clients have discovered that their business partners have taken secret bribes and commissions from suppliers or not shared rebates. Others have been faced with the burden of providing more security than the other parties so that they have more to lose.
For more information please contact Evan Sarinas of Sarinas Legal. This releases not intended as legal advice and all liability is disclaimed for reliance on it.