BUSINESS DIVORCES:  Some Common Legal and Business Issues

Each potential business divorce situation involves its own unique set of legal and business issues.  Almost all business divorces, however, share some common concerns.  This post describes some of them.

Governing Documents

The legal instruments governing an entity’s internal affairs are its “Governing Documents.”  Governing Documents of a general partnership include its partnership agreement; a limited partnership, its certificate of formation and limited partnership agreement; and a limited liability company, its certificate of formation and company agreement.

The Governing Documents contain the agreement of the owners regarding, among other things:

    • management of the business;
    • voting and other rights of the owners, including the power to remove the managers; 
    • limitations on ownership transfers;
    • events that cause the entity to be dissolved and wound up; and
    • the authority of the owners to amend their agreement.

The Governing Documents constitute the starting line in any business divorce contest. 

If an entity’s Governing Documents were prepared well, they might control or strongly influence the manner and outcome of a business divorce.  If prepared poorly, they might make a difficult situation worse.  If Governing Documents are missing because the founders neglected to create them, then the conflict is at risk of quickly turning into a free-for-all mess.

Third Party Contracts and Other Entanglements

A company’s agreements with its lenders, landlords, and other non-owners, as well as other third-party entanglements, may significantly affect the course of the business divorce process.

For example: 

    • A bank loan agreement may contain covenants or conditions that restrict or prohibit a change in the company’s ownership.  Violation may be an event of default and may impose personal liability on the owners.
    • A lease agreement may carry similar provisions, entitling the landlord to terminate the business’s lease and recover damages from the company and its owners.
    • Pending lawsuits or asserted claims against the company or its owners may complicate or delay a business divorce proceeding.
    • Absent these obstacles, a creditor or claimant of a company is nevertheless likely to be concerned to see an owner of the company exiting with a material portion of the company’s cash or property.

Continuing Company Operations

Regardless of which owner “wins” a business divorce, the company may suffer.

The owners’ infighting may distract the managers and cause employees to look for more stable job situations.   The prospect that the company’s performance and reliability may suffer may put off customers and suppliers.   Lenders may decline to extend or renew credit to an enterprise that appears shaky.

Competitors sensing the company’s weakness may try to poach employees and customers.

If the dispute is especially emotional or hostile, an owner may be tempted to go public with his side of the story.  He may file a lawsuit or spread negative comments about his fellow owners.  Any of these steps will likely harm to the company.

A Commonality of Interests can Advance Resolution

Concerns like these are not only issues common to different business divorces.  They are also problems shared by all of the owners in any business divorce.

That presents an opportunity for the owners to recognize they share at least some common interests and must cooperate if they and their company are to avoid or manage those problems.  Such cooperation can help the owners realize that resolving their divorce through private negotiation or mediation may be the best course for everyone’s interests.


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