BUSINESS DIVORCES:  The Hidden Partner (or Co-Respondent)

Over the past two months, I have published seven blog posts on the subject of Business Divorces.  So far, I’ve chosen to write about procedural aspects of resolving a Business Divorce, not about the causes underlying a Business Divorce.

I tend to focus on solving problems, not assessing blame for causing those problems.  And I believe from experience that most business divorces — like spousal divorces — arise from internal conflicts between the owners.  

Do not Dismiss the Possibility of an Outsider

Nonetheless, I want to pause here to mention a special kind of “underlying cause.”

In my Introductory post, I noted that a business divorce is like a spousal divorce.  Last week’s article warned that “third-party entanglements” may significantly affect the course of a business divorce. 

Those two statements come together when there is a “hidden partner.”  A “hidden partner” is a third party who is inciting the Business Divorce like a “co-respondent” in a marital divorce who is having an affair with one of the spouses.

Sounds like a Corporate Raider — But that Happens on Wall Street, not Main Street, Right?

Takeover attempts, proxy fights, corporate espionage, and merger and acquisition secrecy.  These items commonly appear in articles on public companies, hedge funds, and billionaire investors.

As I’ve observed in another post series, however, offensive and defensive schemes in the public company world are mirrored in the world of private companies.

An Illustration

A partnership owns raw land suitable for commercial development if and when an adjacent state highway is widened.  A proposal for improvement of that highway is awaiting governmental approval.  A real estate developer wants to purchase the property, but the general partner declines her offer.  The general partner is confident that the value of the land will skyrocket if the project is approved and funded, so he rejects the offer.  The developer identifies some limited partners in the partnership whom he knows would like cash now instead of waiting for a development boom that might, but might not, arrive in a few years.   The developer arranges to provide the funds the limited partners require to generate alleged “disputes” with the general partner.  Those disputes serve as pretexts for removing the general partner and seizing his carried interest in the partnership.  A compliant substitute general partner assists the developer and his limited partner friends in squeezing out the hapless other limited partners.

This illustration reflects a typical and common real-life situation.   Heavily modified, it is based on a matter from my practice involving land valued at around $50 million — before the infrastructure improvements multiplied the value of the property to more $250 million.

The Lessons

In the public company sector, governmental regulation mandates full disclosure of material information relating to a takeover attempt, including the identity of interested parties, their plans, and their agreements with company insiders. Governmental regulation also imposes criminal as well as civil sanctions for false or misleading disclosures.  Government agencies act as referees to monitor the parties’ legal compliance and as prosecutors to punish lawbreakers.

In the private company sector, there is relatively little governmental regulation, no government agency referee, and, except in extreme cases, no government agency to penalize misbehavior.

It is up to the owners themselves — together with their attorneys and advisers — to defend their interests against a “hidden partner and co-respondent.”  A hidden partner is an absent decisionmaker.

To resolve a Business Divorce,  those owners, attorneys, and advisers must flush that hidden partner from the shadows so that the resolution process includes all of the decisionmakers.

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