When formerly friendly business partners start having problems, stop talking to each other, can’t agree on anything, have secrets, and simply don’t cooperate anymore in bringing the business forward, you may wonder what grounds there are to sue your business partner or the business in order to stop the madness or come to some kind of resolution. Here is an overview of the kinds of claims that are the usual suspects in this kind of litigation:
Breach of Contract
Limited Liability Companies may have an operating agreement and corporations may have a shareholder agreement. These are contracts. If any conduct or omission of the business partner or the LLC or corporation is in breach of these agreements, this would be a breach of contract with a claim for damages. Thus, most business partnership disputes start with an investigation of the contracts between the parties.
A request for a declaratory judgment asks the court to make a statement about a right or situation. In the business divorce context, this could be a statement about who owns what in a corporation or LLC or who has the right to vote, or if certain actions by the LLC or corporation were properly approved by members or shareholders. For a judge to get involved, one has to show that there is a legitimate dispute, which means that you have to show why it matters and that there is actually a conflict over the issue.
To be successful in obtaining a preliminary injunction, you have to establish that you would most likely win the lawsuit in the end, that there is a danger of irreparable harm if an injunction is not granted, and that the balance of the equities is in your favor. Courts will only grant you an injunction if you have evidence that is “clear and convincing”.
Dissolution of LLCs
A member of an LLC can bring a lawsuit to dissolve an LLC whenever it is “not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement”, see Section 702 Limited Liability Company Law. This is a difficult lawsuit to win. In most cases, it is not sufficient to base such a lawsuit on deadlock among the members or other internal upheaval or breaches of fiduciary duties. You must show that 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 that continuing the entity is financially unfeasible. If the business is run just fine, but the members are in never-ending fights, that is not enough.
Dissolution of Corporations in cases of Deadlock or Oppression
A 50% shareholder of a corporation can bring an action under Section 1104 Business Corporation Law asking the court to dissolve the corporation because there is a deadlock among the directors or shareholders.
A 20% shareholder of a corporation can bring an action under Section 1104-a Business Corporation Law alleging illegal, fraudulent or oppressive actions or that the property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation. Faced with such a lawsuit, the other members can force the 20% shareholder to sell its shares under Section 1118 Business Corporation Law.
Forced LLC Buy-Out
Many disgruntled business partners wish to be bought out by their fellow business partners or buy out those partners. Unfortunately, there are very few ways of forcing a buyout. Unless the governing contract has any special provisions dealing with partners’ exit opportunities, the possibilities are slim. There is the possibility of having a judge grant an equitable buyout in the context of dissolution, but the road to such an outcome is long and uncertain. “Equitable” means there is no specific law that grants the right, but a judge, after the dissolution of an LLC, finds buyout by one partner of the other a better solution.
LLC Merger Fallout Situations
In New York, majority members can force out minority members by merging the LLC into a new LLC which then excludes the minority member. The laws provide some protections for minority members to make sure that they end up with the fair value of their membership interests. If there is any breach by the majority members of the required procedures, minority members can bring a lawsuit complaining of the breach of their rights. See also “Cash Out Merger – the totally legal way to get rid of a minority LLC member“
Access to Books and Records
As a member of a limited liability company and as a shareholder of a corporation you have an absolute right to review the records of the entity. For a corporation, it is §624(b) of the Business Corporation Law. For an LLC, it is §1102 of the LLC Law. Thus, a common lawsuit is a request for access to the books and records of the business. Often, one or more business partners exclude another partner from such access under dubious circumstances. Before bringing these lawsuits you have to formally ask the corporation or LLC for the records in writing. Then, when they refuse or just do nothing, the lawsuit for books and records can be started.
Breach of Fiduciary Duties
Another common scenario is that one or more partners violate their duties and obligations to the business and the other members. This is called a “breach of fiduciary duties.” Almost all lawsuits among business partners contain a claim of breach of fiduciary duties. Business partners owe each other and the business the utmost duty of loyalty and honesty. Section 409 of the LLC Law expressly states that LLC managers must act “in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances.” This means they cannot embezzle or waste the business assets; they cannot compete against the business; they cannot neglect their work responsibilities and so forth.
Bringing a breach of fiduciary duties claim requires that one carefully distinguishes between direct claims by the disgruntled business partner and claims brought derivatively on behalf of the business. Courts will dismiss causes of actions if a direct claim is brought as a derivative claim and vice versa or if the two are intermingled.
If a breach of fiduciary duty claim is directed at actions that harmed the business rather than the individual business partner, the action has to be a so-called “derivative lawsuit” where the complaining partner sues the misbehaving partners on behalf of the business. If such a lawsuit is successful, the misbehaving partner would owe the damages caused to the business, not the individual partner. An example would be a business partner stealing money from the business. The other partner can bring a lawsuit on behalf of the business, derivatively, against the stealing partner.
Less frequently, the harm may not be to the business, but directly to the disgruntled member or shareholder. For example, if you are frozen out of your management position and are thus unable to manage the business, you would be personally harmed and the claim would be a direct claim by you against the owner committing the breach of fiduciary duties by freezing you out of your rightful position within the LLC or corporation.
Demand for an Accounting
When there are allegations of misconduct, i.e. breach of fiduciary duties, by fellow business partners, you may have a claim for an in-depth accounting of everything that happened to the business financially. This goes beyond merely looking at the books and records. It requires the opponent to really explain what happened and provide all supporting documentation underlying all financial entries. Like with the claim for access to books and records, this action requires that you first demand such an accounting from the people in control of the business prior to initiating the lawsuit.