Preventing Corporate Divorce: Why You Need a Business

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Like domestic marriages, business partnerships can start off well, but for a variety of reasons, the parties involved may ultimately choose to go their separate ways. If your partnership does fall apart, there are ways to spot early warning signs and precautions to take so that you’re not caught in a lengthy and costly legal battle. Below are a few flagged issues to help avoid a complicated “corporate divorce.” Impact of boilerplate language in corporate governance documents If you’re drafting a shareholder agreement, bylaws or operating agreement, you need to consider:

What kind of dispute resolution are you going to have in place? With only two decision-makers, do you want to designate a third person to be a tiebreaker? Otherwise, it’s going to be incredibly expensive to break a tie if you end up going to court or choose arbitration. Also consider, if you’re in a contentious dispute and one person has more money than the other, they can essentially get their way because they have the means to enforce their position, and you could lose simply by not having the resources to fight.

Do you want to designate a trusted third person to break the tie? Be sure you can trust the third person since they will make the final decision. Some choose a friend that’s also a lawyer, others choose a religious figure such as a pastor or rabbi – just be careful who you choose. Ideally, you have three members of the board of directors or managers so there’s never a tiebreaker issue.

Do you want to include a prevailing party attorneys’ fees clause? Attorneys’ fee clauses can change the dynamic of a dispute because there’s a lot more at stake when the loser risks paying the winner’s attorneys’ fees and costs. Once again, if your partner has greater means to litigate, you may lose simply because you don’t have the same amount of resources and end up paying more in the end. However, the existence of an attorneys’ fee provision may help you to convince a lawyer to wage the fight on your behalf.

Importance of understanding corporate governance If you don’t stay current with your corporate governance, you and the company are open to attack. If a corporation doesn’t hold regular shareholder or board meetings, make sure the corporation is designated a close corporation. If corporate formalities are not followed, you risk being an alter ego of the corporation, or your partner could use the lack of formalities against you. If you don’t want to follow all of the corporate

formalities, obtain the correct designation in order to avoid this. Perhaps most important, be sure to document everything.

Be aware that if you are co-managers in an LLC, either manager can make decisions and the LLC is bound by those decisions, and this can be very problematic. Even if the operating agreement requires a unanimous decision, and without it the company can’t do X, this doesn’t fully protect you against third parties seeking to enforce an agreement your co-manager made without your knowledge. The company is still on the hook for a co-manager’s actions. The same is true for corporate executives.

It’s also dangerous to get into an LLC and not have an operating agreement because states have default statutory schemes that apply to limited liability companies. Those laws won’t always protect you in certain situations.

Red flags when negotiating and structuring deals It’s fine for the other party to say they’re not comfortable with something, but pay attention to what they’re not comfortable with. Is it bringing in a third party? This could signal the other person is trying to be in a position to get control. Are they uncomfortable with a prevailing party attorneys’ fees clause? This could create a problem because it may show they can afford to litigate while you can’t.

If something doesn’t feel right in negotiations, don’t be afraid to walk away, even if you’ve invested resources because it could be much worse if this happens further down the road. Consider conducting a background check even if you’ve known your potential partners for years. Most important, invest in getting agreements set up the right way from the outset.

Even if you’re passively involved, keep tabs on financial accounts until the company is making money, and then you can loosen the reins. Don’t assume your partner will perform their agreed portion of the work correctly or at all.

A final and somewhat obvious, but crucial, tip: If you find your potential partner did something questionable in the past, reconsider getting into business with them. They will likely do the same to you – ask questions and trust your intuition.

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Delman Vukmanovic LLP
213.943.1340

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