Business Partnerships Gone Bad

Business Partnerships Gone Bad
“I own a restaurant with three other people.  Lately, all we’ve been doing is fighting over almost everything.  Now it seems that everybody turned on me.  I have not seen any money from the business.  Meanwhile, everybody else uses the restaurant as their own piggy bank.  What can I do?”

A business break-up can be as stressful and emotionally draining as the breakup of a marriage.  And there is always a child involved….the business.  So when your business partnership has gone bad, you really want to find out where you are standing and what rights you may have vis a vis the other business partners and the business.

The Agreements

Whatever your gripe against your business partners may be, the first question is always: What does the agreement say?  You have to check whether you have an agreement with your business partners and what it says with respect to your problem.   If the business is run as a corporation, check your shareholder agreement;  if it is an LLC, check the operating agreement.

If you do not have anything in writing (like many small businesses, regrettably), you have to look to the default rules of the respective New York laws dealing with your specific entity.     For LLCs, it is the New York Limited Liability Company Law and for corporations, it is the New York Business Corporation Law.  These laws also apply if your agreement is silent with respect to your issues.

The following assumes that your relationship is governed by the default rules and that it is organized as a New York corporation or a New York limited liability company.  So always remember that your particular agreement may have different provisions.

“I just want to leave this behind me.  They should buy me out and  let me go.  I am doing them a favor, because somebody will get hurt if we don’t come to a resolution soon”

Unfortunately, as a shareholder of a corporation or a member of an LLC, you may not be able to convince your estranged business owners to let you go and buy you out.  Unless your agreement provides for some withdrawal/buy-out remedy, you will remain a member/shareholder until the business dissolves or until the other owners agree to buy you out.

“Is there a way that I can force a break-up of the business?  If they don’t want to compensate me for leaving in peace, we should just close shop and call it a day.”

Forced Business Break-Up

Under certain circumstances you may be able to take your dysfunctional business family to court and ask the judge to dissolve the business and then distribute the assets to the owners.   If you can succeed with such a drastic step, depends on the facts of your situation and whether you are a shareholder in a corporation or a member of an LLC.

Forced Dissolution of a Corporation

If you (alone or together with other owners willing to go into battle with you) own  50% of the shares in the corporation, you can petition a court for dissolution of the corporation by showing either one or both of the below:

- management is hopelessly deadlocked; or

- management has been guilty of illegal, fraudulent or oppressive actions toward you.

If your ownership is at least 20%, you can still petition under the second showing above, namely, that the other owners have engaged in illegal, fraudulent or oppressive actions.  But in those cases, a judge has certain discretions and may conclude that the  liquidation of the corporation is too harsh a remedy and that there are other feasible means to give what you are owed and protect your rights.  In that context, a judge may conclude that a buy-out may be a proper remedy for your situation.

Buy-Out Election

If you decide to sue your estranged business owners based on oppression, you may be in for a surprise, because your opponents could force you to accept a buy-out of your stake in the business.  The business corporation law gives your opponents the option to buy you out for the fair value of your ownership share.  But they must make that election within 90 days after you have filed your papers.   What is the fair value of your ownership stake?  Unless you agree on such value, it will be a battle of the experts who follow specific rules and methods established over time.

Forced Dissolution of a Limited Liability Company

Many owners of a Limited Liability Company are surprised to learn that their business break-up rights and remedies are much less defined compared to a corporation.   A minority member of an LLC has limited possibilities to force a dissolution of the LLC and the majority members of an LLC are not able to force the minority member to accept a buy-out.

The only remedy for dissolution of an LLC is in Section 702 of the New York Limited Liability Law, whereby a member can force a dissolution whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or the operating agreement.   The law does not provide for a buy-out election or all the other specific rights in the business corporation laws.  Added to the sparse language of the law is the fact that there are also very few court cases interpreting the state of the business dissolution laws in the context of LLCs. So when can you force a dissolution?  New York’s highest court stated:

…..dissolution is reserved for situations in which the LLC’s management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in the case of a voting deadlock or where the defined purpose of the entity has become impossible to fulfill. . . . Dissolution of an entity chartered for a broad business purpose remains possible upon a strong showing that a confluence of situationally specific adverse financial, market, product, managerial, or corporate governance circumstances make it nihilistic for the entity to continue.”

Yeah, still not very clear, is it?  I guess it is fair to assume that a deadlock over essential decisions necessary for the continued operation and financial success of an LLC would be sufficient for dissolution.   Unlike in corporations, “mere” oppression of the minority member by the minority members is probably not sufficient to justify dissolution.

The reality of many dissolutions fights over corporations and LLCs is that many end in settlement.  In certain situations, a court action towards dissolution may be the right strategic move to convince your business partners that they have to come to the table and negotiate with you, rather than spend a fortune on litigation.

“Short of dissolution, don’t they have to pay me my share of the profits? I have not seen anything in terms of money.”

Right to Profits – Access to Books and Records

Prior to dissolution, you have a right to profit distributions.  If the other members/shareholders pay themselves, most likely, you have a right to a similar distribution, based on your ownership percentage.

“I don’t even know how the business is doing financially and how much they are paying themselves. How can I get access to that information?”

Each shareholder of a corporation or member of an LLC has a right to inspect the books and records of the business.  Write them a letter and demand to see them.  If they don’t let you, you can take the matter to court.

“Can they make all kinds of decisions without my consent?”

When it is just you and one other owner, certain important decisions have to be made by consent of all owners.  For example, the other business owner in an LLC cannot just take in another member without your consent.

When it is you against more than one other business owner, there is the possibility that they can outvote you, even on certain very important issues.  But they have to follow proper procedure and notify you of all decisions made without your consent.  Finally, they can’t just decide to do whatever pleases them.  If their decision is completely lacking any business judgment or just designed to damage you and your stake in the business, you may have a claim against them based on their breach of fiduciary duties against you.

Photo Cosmoflash

About Imke Ratschko


Imke Ratschko is a New York Attorney helping small businesses, business owners and entrepreneurs with all things "Small Business Law," such as litigation, contracts, business owner disputes, shareholder and operating agreements, sale or purchase of a business, investors, and starting a business. You can reach her at 212.253.1027.

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