Small Biz: Breaking up a business is hard to do
Here's some tips on how to avoid a painful "divorce"
By Jean D. Sifleet
A litigation quagmire
A recent Massachusetts court decision shows just how awful the process can be. In Brodie v. Jordan, a minority shareholder (actually the surviving spouse of one of the three founders) wanted her shares bought out. The majority shareholders refused and engaged in a pattern of conduct constituting a "freeze out" - denying the minority shareholder any compensation or benefit from her stock ownership.
The minority shareholder filed suit in 1998, and the case wound its way through the court system for nearly 10 years.
The first court decision ordered the buyout of the minority shareholder based on the corporation's net assets as valued by a court-appointed expert (less than $100,000) plus pre-judgment interest. The decision was affirmed on appeal. On the second appeal, to the highest court of Massachusetts, the decision was reversed. According to the SJC, the forced buyout overcompensated the minority shareholder and unfairly punished the majority shareholders. The SJC "remanded" the case so that the lower court could order a different remedy.
After all those years of litigation, there still was no resolution. According to the SJC, the court should restore the minority shareholder "as nearly as possible to the position she would have been in had there been no wrong doing" - whatever that means!
Faced with yet another court proceeding and substantial uncertainty about what remedy the court would order, the parties finally settled.
An agreement could have prevented this litigation quagmire that continued for years without resolution.
The benefits of a buy/sell agreement
A buy/sell agreement is a contract to buy out the other owners under certain conditions (e.g., death, disability, divorce, retirement, disagreement), on certain terms.
Paradoxically, the process of pulling together an agreement for how to part company actually helps to build a stronger working relationship, reducing the potential for conflict. The process helps to clarify roles and expectations about how money will be spent, decisions made and priorities set.
The agreement is really an opportunity to mutually and explicitly agree about how the business will operate. It's also an opportunity for minority shareholders to protect themselves and make sure that major decisions, such as sale of the business, issuance of additional stock and borrowing money, require more than majority approval. The agreement can specify that certain decisions require a two-thirds, three-fourths, or unanimous approval.
Include ADR in your agreement
After the Brodie case, the last place you want to try and resolve business ownership disputes is in court.
Providing for alternative dispute resolution (ADR) in your agreement is a smart move. ADR runs from informal and non-binding "mediation" to binding "arbitration." ADR is faster and less expensive than litigation, and your agreement can define the valuation methodology and buy-out process.
Because transferring ownership in your business is as inevitable as death and taxes, a buy/sell agreement is essential. The absence of such an agreement can leave you with a nasty "divorce," the resolution of which can be lengthy, costly and destructive. A buy/sell agreement can save you a lot of time and trouble in this lifetime as well as for your survivors after your death. So, don't wait for a special moment of stress before you address the inevitable issue of business ownership transition.
Jean D. Sifleet is an attorney, CPA, three-time entrepreneur and author. As a member of Hassett & Donnelly's business practice group, Sifleet focuses on counseling privately held companies on a broad range of business matters.
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