business partnerships gone bad
(Last Updated On: May 8, 2021)

Business Partnerships Can go Bad.  Picture this:

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 of a business partnership 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 concerning 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, unfortunately), 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 the default rules govern your relationship 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.

Making Bad Business Partners Responsible for their Actions

As business partners, you owe each other and the business loyalty, honesty, and support.  Each of you is held to a higher standard than ordinary people.  This is called “fiduciary duties.”  Business partners cannot steal or embezzle from the business; they cannot grossly mismanage or withhold good deals from the business.  If this is happening, you have a court action for “breach of fiduciary duty.”  This action can take the form of asking for damages or making the bad business partners stop the offending conduct.   In most cases, the damages are being done to the business and not to you personally. Thus, such an action would be in the name of the business.  In other words, you are the plaintiff, but you are bringing the action for the benefit of the business.  So if you win the action in court, the money damages go to the business, not to you personally.  But you are entitled to get your attorneys’ fees back from the amount of money granted by the court before it goes to the business.

Forced Business Partnership Break-Up

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 minority 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.

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. The majority members of an LLC are not able to force the minority member to accept a buy-out.

The only remedy for a forced dissolution of an LLC is in Section 702 of the New York Limited Liability Law. 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 New York Limited Liability Law does not provide a buy-out election or all the other specific rights in the business corporation laws.

However, by now, the courts have given some guidance.

For a dissolution under Section 702 Limited Liability Company Law, “the petitioning member must establish, in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.”

If dissolution is justified, courts have now even granted a so-called “equitable buyout,” whereby an LLC member is allowed to purchase the other member’s interest in the LLC.  This is not really a dissolution, as the LLC continues its existence after the buyout.

Is a deadlock or total conflict between the members sufficient for a dissolution?  Not always.  Courts have held that dissolution is not warranted despite disagreements between the members when the limited liability company can otherwise continue to operate in furtherance of achieving its stated business purpose.

The reality is that many dissolution fights over corporations and LLCs or lawsuits for breach of fiduciary duty end in settlement.  In certain situations, a court action towards dissolution or for breach of fiduciary duty or both 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

Before 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.  The law provides an expedited proceeding giving you the right to see the books and records; sometimes, this gets the ball rolling for serious negotiations and makes the parties come to the table.

Can they make all kinds of decisions without my consent?

When it is 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 critical 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.

Call me to discuss your business partnership gone bad.  We help clients with business partnership disputes.

(Also see Access to LLC Books and Records)

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 or by email.