We are often approached by someone who has fallen out with a business partner. Disputes sometimes arise between friends and family members who went into business together and later fell out over the running of the business. A recent instruction leads us to write this article about the area.
The problem
Often, business partners go into business together without taking legal advice – the thinking is that as they are friends/family they’re less likely to fall out and so why incur the expense? This can prove to be a mistake.
Going into business means new relationships; they are now business partners, directors, shareholders and employees of the business.
Sometimes business partner disputes are easy and quick to resolve, but other times it leads to significant problems.
Deadlock
One problem is deadlock for shareholders of a company. This is when shareholders own equal shares, e.g. 50%-50% and just can’t seem to agree on the way the business is to be run. Typically one partner thinks that they can tell the other what to do, refuse to hold meetings, remove them as a director and even invoke the disciplinary procedure and remove them from the business.
The innocent party may even find that the other is increasing their salary or expenses in order to try to take out more money from the business. And typically one will cancel the bank cards of the other and such action could lead to the bank suspending the business account. it is common for there to be allegations that the one with control over the company’s funds is using them for personal use, i.e. to pay for professional advice on the dispute, when that is a personal, not a company expense.
Resolving business partner disputes
Options include one partner buying out the other, or if that can’t be agreed, selling or dissolving the company. Another option is for one of the partners to walk away from the day-to-day running of the business and bring a court action for ‘unfair prejudice’ to another shareholder.
You may think that the matter is less difficult if the shareholdings aren’t equal – it may seem that that in such a case, the majority shareholder does have the ability to tell the other what to do. In fact, that isn’t necessarily the case. We have seen instances where the minority (49%) shareholder claims that the majority (51%) shareholder holds a (1%) share ‘on trust’ for them or that despite an unequal shareholding they are ‘quasi-partners’ or some other legal technicality. Also, majority shareholders mustn’t treat the minority shareholders ‘unfairly’.
The first thing to check is the articles of the company and any shareholders’ agreement. If the business-owners took legal advice when setting up the company the lawyers would have advised them to put in place mechanisms for resolving deadlocks and business partner disputes, often via a shareholders’ agreement.
One of the best ways to resolve business partner disputes is to have the business valued and for one to buy out the other. It is possible for the company to buy back shares from the shareholder(s). This way, the ‘purchasing’ shareholder(s) don’t need to raise their own funds to settle the dispute.
The difficulty is usually in agreeing on which professional should value the company. Typically one party will need to go so far as to issue proceedings against the other in order to ‘bring them to the table’ to even agree this. However, this can still lead to difficulty as allegations of financial mismanagement may arise and cast doubt over the valuation.
Either way, a valuer will be needed, because the remedy in an unfair prejudice claim is typically for one party to buy out the other at a figure imposed by a judge (who will make decisions on allegations of financial mismanagement).
In more dramatic cases, the court can order a ‘winding-up’ of the company if it thinks it’s ‘just and equitable’ to do so. This means the company will go into liquidation.
Where the shares are equal, voluntary liquidation is a possibility, but this is usually a last resort. If the business is no longer viable because of the disputes, then one shareholder can serve notice on the other to dissolve their partnership. Then, the liquidator will sell the assets to pay off creditors, and divide the balance between the business-owners. This rarely happens where the business is operational and in credit.
Unfortunately, there are no ‘good’ outcomes; business partner disputes negatively impact on employees and customer relationships. Petitioning the court to order a ‘wind-up’ is also no better, as it spooks all concerned, including customers and suppliers alike. The legal fees can match and, in some instances, be more than the business valuation.
Prevention is better than cure
A safety net is always useful, even among good friends. Business partners should have a shareholders agreement in order to resolve any future dispute avoiding court proceedings and to protect the business from turmoil and major disruption. For example, it should provide for how deadlocks are to be resolved, how to conduct valuations and arbitrate disputes. For example the parties should consider:
- Russian roulette clause
This clause allows one shareholder to buy or sell to the other out a pre-determined price – without the hassle over valuation of the business. However, this clause is risky as it does put the financially stronger shareholder in a better position. - Arbitration clause
This appoints an arbitrator who can make the final decision about the dispute between the two shareholders. Usually, this is a lawyer or accountant with professional knowledge and understanding about business needs and can either be named at the start of the business relationship or can later be appointed by a professional body such as the Bar Council or ICAEW. Arbitrators tend to be expensive and their decisions might be legally unsound but unappealable. - Employment contracts
A director’s contract can have a long notice period clause in it, which doesn’t guarantee that a minority shareholder won’t be dismissed but it can provide such large compensation that it makes it less likely. Although the flipside is that when there is more money at stake, it makes an employment tribunal claim for wrongful dismissal more likely if the issues aren’t clear-cut.
The article is not a comprehensive review of the topic and only intended to highlight some of the issues that can arise. Nevertheless, we hope that it explains how taking legal advice at the start of a business relationship can help to resolve disputes later down the line without unnecessary cost and business disruption.
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