What Is a Business Divorce?
Business partnerships, like marriages, are complex relationships with highs and lows, challenges and rewards, good times and bad times.
When people start businesses together, they should expect to experience growing pains. However, when differences are irreconcilable and threaten to drag the company down, partners may decide that a business divorce is the only reasonable solution.
It is important to seek help from an experienced business attorney to draft agreements that establish processes to avoid and resolve disagreements before a serious dispute arises and to facilitate partners’ separation in a way that minimizes harm after a dispute arises.
Why Business Partners Break Up
The reasons for business divorces are often similar to why married couples choose to go their separate ways.
The following are some common reasons why business partnerships fail:
Conflict over finances;
Disagreement about the direction and management of the company;
Unequal contributions;
Different working styles;
Lack of communication or transparency;
Misalignment of values and motivations ;
Ego clashes and power struggles; and
Unethical, irresponsible, or illegal conduct, such as minority shareholder oppression or breach of fiduciary duty.
A struggling business venture can heighten underlying tensions and cause partners to scrutinize every move as the prospect of failure increases. However, even a successful business can create friction that puts partners at odds. Increased success may be accompanied by more problems, more pressure, and unanticipated issues that can turn tiny cracks in the partnership into wide gaps.
How to End a Business Partnership
The goal of a business divorce should be the same as when a marriage ends in divorce: keeping the breakup from turning into a long, drawn-out legal battle.
A business divorce can become very costly if it requires litigation. While business partners can turn to the court to resolve their differences, there are several methods to resolve disputes that do not require filing a lawsuit—which is typically viewed as a last resort and may leave partners significantly lighter in the wallet, decrease the company’s value, or worse, lead to dissolution.
Review Agreements
When a business divorce seems imminent, the first place to look for a process for separating is the company’s shareholder agreement, partnership agreement, or operating agreement. A well-thought-out agreement will provide a structured approach to deal with various scenarios the company might face—including a breakup of its partners.
For example, the agreement could contain deadlock-breaking mechanisms, such as a buy-sell provision (i.e., a buyout agreement) that allows one partner to purchase the shares of another partner at a set price and term in the event of a deadlock or some other triggering event specified in the agreement.
In addition, the company may have a prepared exit strategy in the form of a dissolution clause. This provision describes events that can trigger the dissolution of the partnership and the process of settling debts, distributing any assets, and legally ending the business.
Negotiate With a Partner
If no agreement addresses how a business divorce should occur, the partners—with the help of their attorneys—may be able to negotiate an end to their relationship.
Depending on the state of the relationship, an agreement could enable one partner to step back from the business while addressing the company’s value and how its debts and liabilities will be handled. Alternatively, the partners could agree that selling the business or its assets is in their best interests and split the sale proceeds.
If the partners cannot reach an agreement, their attorneys may recommend enlisting a professional arbitrator or mediator to help with the negotiation. Successful arbitration or mediation results in an out-of-court settlement often negotiated by business attorneys and is typically far more cost-efficient than litigation.
Litigation
A business divorce could be resolved in court if the partners are unable to resolve their dispute through negotiations or contractually established processes (e.g., a buyout or dissolution provision). However, once a dispute leads to litigation, the partners lose all control over the outcome.
A partner may turn to the court to seek judicial dissolution of the business. Depending on state law, dissolution may require the party seeking it to prove to the court that their business partner engaged in some type of improper conduct such as breaching their fiduciary duty, that it is no longer reasonably practicable to continue the company’s activities, or other grounds for dissolution under state law.
The grounds and mechanisms for judicial dissolution vary from state to state. In some states, courts can order alternative remedies such as arbitration or a court-appointed tiebreaker (which effectively makes the court a new business partner) to resolve a partner dispute.
Dissolution by court order rather than mutual partner agreement may result in terms that are less than ideal for one or more partners. For example, the dissolution may include a lower value for the partnership interests or business assets than what the partners expected. Needless to say, a dissolved business can no longer generate income.
Protect Your Interests in a Business Divorce
Well-crafted legal agreements that specify an ordered, thoughtful process for a business divorce facilitate smoother and less costly terminations of business relationships. If you do not have a well-drafted operating or other business agreement, please contact us before a dispute arises for help creating an agreement that protects your interests. We can also review existing agreements to ensure their provisions are clear and well-defined and draft new contracts if necessary to protect your interests.
If a business divorce seems unavoidable, our business attorneys can do what is needed to protect your interests as quickly and cost-effectively as possible. We can advise you about related tax liabilities, court filings, and other requirements for ending the relationship or winding down the business. Call us today to schedule an appointment.