Let’s say that you and a family member or close friend decide to start a business. You take the necessary steps to form the company. You sit down with your partner to discuss how the company will operate, and you even go to the trouble of hiring a lawyer to prepare the necessary paperwork. It’s likely that the last thing on your mind is “what happens if my partner and I hate each other after we get this business off the ground?”
Nearly every new venture is born out of optimism. But fast forward a few years. You and your business partner no longer share the same vision and every time you meet to discuss the company, things are tense. One morning you wake up to find that you have been locked, literally and figuratively, out of your own business. The locks on the front door have been changed and you no longer have access to the company’s bank accounts and other financial records. What do you do now?
In Colorado, the vast majority of new businesses—like the one described here—are formed as a limited liability company (“LLC”). Because this form of entity can accommodate multiple business types, while shielding the owners from personal liability, it has become remarkably popular. But, too often, when the owners of an LLC realize they can no longer do business together, they have no idea how their separation will play out.
If you find yourself in the middle of a “surprise” business divorce, here are the top five issues you need to address immediately:
1. Where’s the money?
In a lockout scenario, it is simple for one of the owners to declare a financial war by seizing control of the money. This can be accomplished either by terminating the other owner’s access to the bank accounts or by moving substantial sums into an account controlled exclusively by the bad actor. Depending on the terms of the written agreements between the business partners (i.e., the “operating agreement”), it is likely that this kind of monetary lockout violates fiduciary obligations owed the other owners or to the company (or both). If funds have been transferred out of your company’s account, you may have additional claims for conversion and civil theft.
Sometimes writing a strong letter demanding compliance with the terms of your operating agreement will bring a rogue business partner back into line. But, more often than not, an owner who has taken this kind of hostile action will not change course until ordered by a court to do so. If you believe your business partner is unlikely to listen to reason, you should consult a lawyer and do what it takes to regain control of the company’s cash. When you have that conversation, keep in mind that, if the bank allowed your business partner to unilaterally remove your name from the company accounts, you may also have a civil action against the bank for breach of fiduciary duty. Banks do not usually like being dragged into partnership disputes. So, you may be able to undo some financial shenanigans if your bank is at least partially to blame.
2. Who has access to the books and records?
A business partner stealing from the company or otherwise trying to inflict financial harm on fellow owners does not usually make it a habit to share the accounting records. So, if you find yourself in a brewing partnership dispute, ask yourself: “Who has access to Quickbooks?” and “Can I track our customer orders, accounts receivable, cash receipts and other metrics?” If the answer to these questions suggest that you are operating in the dark, you need to change that immediately. And Colorado law may help your cause.
So long as you remain a member of the company, you have a right to inspect some—if not all—of the books and records of the company. Every member in an LLC has a statutory right to demand to inspect and copy those financial records that are reasonably related to their membership interest in the LLC. The company’s operating agreement may also provide additional inspection rights and access to records. A lawyer can help you review the operating agreement to see if you have any additional rights.
3. What obligations have I personally guaranteed and what are the risks?
Banks and other financial institutions often require owners of a company to personally guarantee certain liabilities of the company. Just because you are locked out of your company does not change your obligations under any personal guarantee. In fact, if your business partner controls the finances and has exclusive access to the books and records, your risk of liability on your guarantee may be growing by the minute.
A personal guaranty is a contract with a third party that is enforceable even if your partner has breached their fiduciary duties. As part of a resolution, you may be able to negotiate a release of the guarantee or request a replacement guarantee. But you need to take stock of these liabilities and do everything you can to mitigate your risks.
4. Can I compete with the jerk who just locked me out?
A business divorce typically involves owners who are capable of running the business alone. They can manufacture the product, provide the service and sell to customers with or without a business partner. So, when conflicts start to boil over between the owners, they are naturally tempted to run their own little businesses “on the side.” But competing with a business you own with others is not a risk-free means of escaping a toxic partnership.
Members of an LLC have a statutory duty that not only prohibits them from competing with the LLC, but also from misappropriating an opportunity of the LLC. However, these statutory duties may be modified by the terms of the operating agreement. Specifically, the duties that managers and members owe to the LLC may be restricted, modified, or eliminated by the operating agreement as long as those modifications are not manifestly unreasonable. So, before you run out and start a “side business,” you need to review your operating agreement closely. And you need to call a lawyer who can help advise you as to your next best steps.
5. What is my end-game?
If you jointly own a business organized as an LLC, your ability to navigate a dispute with your partner(s) will depend on your knowledge of the operating agreement. Study that document cover-to-cover. And, if you need advice about what it means, find a lawyer with experience in business divorce.
If you are dealing with a business partner who has already locked an owner out of the company, it is unlikely that the situation will be amicably resolved. In the fields of domestic relations, lawyers call this kind of conflict between spouses “irreconcilable differences.” If that is what you are facing in your business, it usually requires either the dissolution of the company or a buy-out. And you need to start thinking about these two alternatives as you formulate your end-game.
Depending on your situation, a resolution strategy may include:
- Judicial Dissolution. You have rights as a partner and sometimes you need the assistance of the courts to enforce those rights. In addition to any claims that you may have against your fellow owner for violating their fiduciary duties, these cases often also include a claim to judicially dissolve the LLC. When it is no longer reasonably practicable to carry out the business of the LLC, under Colorado law, a member of an LLC may file a lawsuit to dissolve the company. While there is not one dispositive factor the courts consider to determine whether an LLC should be dissolved, the key considerations include whether there is a deadlock between the members and whether the members have clearly reached an inability to work with one another to pursue the company’s goals.
- Alternative Dispute Resolution. Even if one partner initiates litigation in court, many of these cases will resolve without the parties proceeding all the way through trial. Mediation is one option, where you and your business partner meet to discuss your disagreement with a neutral, third party. The parties can participate in mediation before a lawsuit is filed or after the parties are already in litigation. A professional mediator is specially trained to assist with dispute resolution, by facilitating discussions regarding your dispute. In many cases, you can reach a resolution during mediation, however, you are not bound by the process and can still take the matter to court.
No one goes into a business venture expecting it to fail. But if you find yourself in the middle of a brewing business divorce, Chipman Glasser’s attorneys have a depth of experience to help you work through the issues you need to address.