Often, disgruntled or departing employees and business partners take trade secrets or propriety information from the company, such as a customer list or a formula.
A business separation agreement should consider economic elements. For example, who will pay the company’s debts?
Most shareholder disputes are avoidable with careful planning.
Tina: I am a minority shareholder and personal trainer of a fitness facility. Recently, the majority owner fired me from my position so that she could promote a family member. The majority owner has also held business meetings without me and reduced the company’s distributions so that I can no longer draw an income from the business. What, if anything, can I do?
Andrew: This is a classic fact pattern for Shareholder Oppression: a business problem that often affects minority shareholders of closely held businesses. Essentially, Shareholder Oppression occurs when the majority shareholder excludes a minority shareholder from the business. In this case, the marjority shareholder is attempting to leverage out the minority shareholder to obtain total control of the company. It is possible, depending on the jurisdiction and type of entity involved, that the majority shareholder has also breached contractual obligations and fiduciary duties that are owed to the minority shareholder, as well. In many jurisdictions, the minority shareholder must negotiate the sale of her interest in the business (“Sell-Out”) or sue the majority shareholder for judicial dissolution or receivership. Other judicial remedies, such as stock repurchase or money damages may also be available. A good valuation is a powerful negotiation tool that will assist the minority shareholder in getting a fair price for her shares.
Tina: What are some signs that I am being oppressed by a majority shareholder?
Andrew: Different jurisdictions define shareholder oppression in different ways. Generally, Shareholder Oppression occurs where the majority shareholder freezes out or leverages the minority shareholder from the benefits of the business. The cases in this area provide many examples: dilution of shares, failure to provide notice of important meetings, termination employment or reduction of compensation, hiring or promotion of friends over the minority shareholder, reduction or discontinuation of distributions, or squeezing the shareholder out through a merger. In some jurisdictions, other factors are considered, such as demotion of the minority shareholder, taking away a parking space, physically locking the minority shareholder out of the building, or through other similar acts.
A good valuation is a powerful negotiation tool that will assist the minority shareholder in getting a fair price for her shares.
Tina: Are valuation or appraisal experts necessary when it comes to the litigation of Business Divorce or Shareholder Oppression cases?
Andrew: Almost always yes. Closely held businesses are not publicly traded and, as a result, are difficult for laypeople to value accurately. It is therefore necessary that the minority shareholder retain a business valuation expert. A good valuation expert can provide testimony that is necessary for the fact finder to determine the damages award, including fair share value, the long term prospects and investment value of the company, its marketability, and, where appropriate, the present value of future earnings.
Tina: As a litigator, what advice do you give to individuals looking for a business valuation expert?
Andrew: One of the most important requirements of a business valuation expert is credibility. A credible valuation expert is more persuasive at trial and throughout the negotiation process. Factors that demonstrate credibility include experience in the relevant industry of the business that is subject to valuation, a lack of bias, and the ability to communicate the valuation clearly to the opposing party, judge, or jury.
Tina: I believe it is time to effect a Business Divorce or sale, at what point do you recommend hiring an attorney and what role do they play in the process?
Andrew: It is advisable that an attorney be consulted very early in the process. Initially, an attorney can help you understand your rights under the company’s Operating or Shareholder Agreement. A thorough understanding of these documents will help your attorney advocate for you during the negotiation process.
Tina: My business partner is selling back her interest in the company and I want to make her sign a non-compete agreement. I do not want the seller to open up a similar business in the same state for at least 10 years. Legally, can I do this?
Andrew: Probably not. Whether you can prohibit competition for any duration or in a geographic area depends heavily on the background facts and nature of the business. Most jurisdictions require that non-compete provisions must be reasonable in time, place, scope, and duration. Also, in other jurisdictions such as Delaware, the non-compete must further the legitimate business and economic interests of the company. In the scenario posed in this question, it is unlikely a court would enforce a non-competition provision for such a long duration and broad geographic area. A non-compete of a more reasonable limitation, such as two years and 50 miles, is more likely to be enforced.
Whether you can prohibit competition for any duration or in a geographic area depends heavily on the background facts and nature of the business.
Tina: I want to sell my interest in my company but do not have the information necessary to determine a fair price. Is there anything I can do?
Andrew: Yes. In some cases, the company’s Shareholder or Operating Agreement provides for the fair value. In other cases, it is possible to obtain the information necessary to make this determination by requesting it from the company informally. Many times, the company will honor the request if it is reasonable and limited solely to the information necessary to serve your specified purpose.
If the company does not cooperate, then most, if not all, jurisdictions provide a statutory mechanism for the interested shareholder to demand inspection of books and records. The process for doing this is highly technical and it is advised that an attorney assist you.
Tina: I am leaving my company to start my own competing business. What concerns should I have?
Andrew: First, you need to understand whether you are bound by a non-compete provision or restrictive covenant that prohibits you from competition. Second, you must be careful to avoid a breach of loyalty to your current company. Often, disgruntled or departing employees and business partners take trade secrets or propriety information from the company, such as a customer list or a formula. That information most often belongs to the company itself and its misappropriation to start a competing venture can result in liability.
Tina: What are the most common terms of a business separation agreement?
Andrew: The business separation process is a painful one. Often, your soon-to-be former business partner is a member of the family or is someone you have known for a long period of time. Regardless, the terms of the business separation must be closely scrutinized. A business separation agreement should consider economic elements. For example, who will pay the company’s debts? How will the transaction be taxed? The agreement should also consider how company assets will be distributed. Who will control the intellectual, real, or personal property? The agreement should also consider the future relationship between the parties. For instance, the agreement may require additional insurance for future claims, indemnity, or releases.
It is important to take the time to read and understand the shareholder, operating, or partnership agreement prior to committing to the business relationship so that your concerns are accounted for.
Tina: Do you have any other tips or advice for anyone who is buying, selling or appraising a business?
Andrew: Most shareholder disputes are avoidable with careful planning. It is important to take the time to read and understand the shareholder, operating, or partnership agreement prior to committing to the business relationship so that your concerns are accounted for. Further, understand your buy/sell rights should you ever wish to withdraw your ownership or if your business partner leaves.