May 16, 2021

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Shareholders clauses strengthen business, avoid litigation

Partners often go into business together with the best of plans. But what happens when those plans go awry? Ideas for the business’s future may stray in different directions, partners may accuse each other of self-dealing, or one may give a spouse or family member an ownership stake — and a say in the business’s future.
50/50 disputes, selling or bequeathing of shares or ownership, minority ownership rights, and other such issues are not wholly unpredictable. Yet just like credit and debt, tax liabilities, or competition and market forces, shareholder disputes can have a material impact on the business.

Most shareholder issues should be addressed in a business’s governing documents. If not there from the outset, they can be included as the business matures.

Taking a proactive approach to addressing possible shareholder issues, in addition to shareholders’ reactive rights, can help clarify the business’s response to future possible conflicts. This can help avoid costly and lengthy litigation or judicial dissolution.

A few considerations …

  • Buy/sell agreements. This provision establishes what happens if one party wants to sell their interest and exit the company; transfer ownership of shares, even to family; or bring on a new partner, for example. In an effort to avoid litigation and judicial dissolution, the agreement can force a buyout after an appraisal to establish the business’s fair market or net book value.

  • Tie-breaking mechanism. Organizations with 50/50 partnerships or any even-numbered and equal-stake ownership group need a way to address, negotiate through, or break a deadlock. The corporate documents can require any such matter first go to mediation, or shareholders engage a third party, such as an agreed-upon member of the executive committee, an attorney with no ties to the company, even a mediator, to serve as the tie-breaker.

  • Non-compete clause. Imagine two 50/50 owners are in dispute, and before resolution, one moves to open or join a competitor, or while being paid out his or her interest opens a competitor across the street. While owners have fiduciary obligations to each other, an agreement on the issue can provide certain immediate relief for the company and its owners, like injunctive relief and attorney’s fees. While non-competes are unenforceable in certain industries, the clause could compel partners to consider before acting on the legal and financial implications they may face.

  • Talk to counsel. Whether with general or outside counsel, ask to review the current operating agreement for clauses that protect the company during shareholder disputes. Possibly engage an experienced corporate transactional attorney to put protections in place.

Such clauses can also be useful if ownership is approached about an acquisition. Prospective buyers often review the operating documents before closing to see how the company’s interests are being protected. This can include non-compete clauses or evidence of prenuptial agreements where needed, especially for executives who will remain after an acquisition or for then-existing disputes.

Most importantly, have that hard conversation with your partners. Once in place, clauses protecting shareholder rights can strengthen the business, while hopefully just collecting dust in the file cabinet.

Firm director Henny Lawrence Shomar is an AV-rated attorney practicing in the areas of complex commercial and business litigation, probate litigation, and marital and family law.

For more than 50 years, Tripp Scott has played a leadership role in issues that impact business.

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