Should I sue my Business Partner?

You are fuming right now about what your business partner is doing to you and/or the business and you are wondering if you should sue your business partner. Before pulling the trigger, understand what lies ahead:

Is there a way to negotiate yourself out of this?

Going to court should always be the last resort. Court actions are costly and time consuming (years not months) and can destroy what is left of your business. While your attorneys will do most of the heavy lifting, you will have to spend much time cooperating with them and gathering relevant evidence. So try your best to come to the table with your partners to negotiate a good outcome before going to court. Give a little, take a little.  And even if you are already well into a lawsuit, consider settling.

What do the Agreements say?

Your decision to sue or settle begins with your business agreement. You, or preferably your attorney, should check whether you have a written agreement with your partners and what it might say about your dispute. If your business is a corporation, there may be bylaws, a certificate of incorporation or a shareholder agreement. If it is a limited liability company, there may be an operating agreement. Each of these documents, and others, may have relevant provisions.

Even if you have no formal documents, other writings could act as agreements between you and your partners. Do you recall all the promises made in email correspondence or phone texts – or on cocktail napkins? Any document showing some sort of consent may be helpful.

If you do not have anything in writing (like many small businesses, regrettably), you need to look to the New York laws dealing with your specific entity: for LLCs, the New York Limited Liability Company Law (NYLLC), and for corporations, the New York Business Corporation Law (BCL). These laws also apply if you have a written agreement that says nothing about the issues behind your dispute.

What are my Remedies?

Your next step is to consider what you might get in court or through negotiation. Obviously, the cure depends on the problem.  But there are certain remedies that often come up in partnership disputes.

Access to Books and Records

You can demand to see the books and records of the business.  If needed, an expedited legal proceeding (meaning it takes weeks, not years) can enforce this right.  The governing law is set forth in BCL 624 and  NYLLC 1102.  Inspection rights of members and minority business owners are not absolute, but any legitimate purpose will likely satisfy the court.  In any event, a demand can signal to your partners that you mean business and may force them to choose good faith negotiation over digging in their heels.

Claim against Partners who damaged you or the Business

You may have a claim against fellow business owners for misbehaving toward you or the business.  Managers and managing members of New York LLCs owe fiduciary duties to the other members (while non-managing members of manager-managed LLCs do not).   Officers and directors of a corporation owe fiduciary duties to the corporation and the shareholders.  Shareholders do not owe fiduciary duties to each other – except in very small corporations or where the shareholders are essentially managing the corporation.

A fiduciary duty is an obligation to act in good faith, to treat co-owners fairly and in accordance with the deal struck, to act in the best interest of the business and its owners, and to refrain from fraud, taking assets for one’s own benefit, wasting assets, competing with the business or diverting clients away from it. If your partner violates this duty, you may be able to sue the partner directly or on behalf of the LLC or corporation.

Fiduciary duties basically mean that they have to act in good faith, treat the co-owners fairly in accordance with the deal struck, act in the best interest of the corporation or LLC and their owners, and refrain from fraud, taking assets for their own benefit, wasting the assets of the business, compete with the business or divert business away from the company.

If there is a breach of those duties, you may be able to sue the person committing the breach directly or, if the breach was more towards the business, you can sue on behalf of the LLC or corporation, a so called “derivative” action.

Forced Break-Up of the Business

Under certain circumstances you may be able to take your dysfunctional business family to court and have a judge dissolve the business and order it to liquidate its assets.  You will first need to ask yourself if this drastic step is really the best outcome. The value of a business lies in its operations and goodwill as a going concern. But sometimes it can be a good idea to bring such a lawsuit anyway because it may force your partners to consider a buyout – and the court may even order one.

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 a corporation, you can have a judge order dissolution by showing that management is hopelessly deadlocked (Section 1104 of the BCL).

If you own at least 20%, you can have a judge order dissolution by showing that management is guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders or that the corporation’s assets are being looted, wasted, or diverted for non-business purposes by the directors or officers or others in control.  In deciding over such a case, a judge has some options under the law and could conclude that liquidation of the corporation is too harsh a remedy and that there less painful means, such as a buyout, to give you what you are owed and protect your rights (Section 1104-a).

So a shareholder with 50% or more has two options, under 1104 and 1104-a.  But the choice needs to be carefully considered, since 1104-a petitioners can be forced to accept a buyout. 1118 BCL gives your opponents the option to buy you out for the fair value of your ownership share. What is the fair value? Unless you agree on an amount, a battle will commence between experts who follow complicated rules and methods established over time.

Forced Dissolution of a Limited Liability Company

Many LLC owners are surprised to learn that their break-up rights and remedies are much less defined than in a corporation.  Dissolution of an LLC is codified in Section 702 of the New York Limited Liability Law.   Under 702, you need to show that management is not willing or is unable to pursue the stated purpose of the LLC, or that continuing the entity is financially unfeasible.   Easy in theory, but difficult in practice.  That management may be hopelessly deadlocked or guilty of misconduct is not generally enough to justify a dissolution under Section 702.

Equitable Buyout

In connection with this proceeding or standing on its own, a court may decide to grant an “equitable buyout”, meaning it is not provided for in the written law, but the court thinks it is a good idea to protect the business and its owners.  An equitable buyout consists of one member being forced to sell his/her ownership interest to the other member.  But don’t rely on this, since this equitable remedy is very new and the requirements a little murky.  It seems that a prerequisite for the equitable buyout is that you can show that you also have a good case for dissolution under Section 702 and that a buyout is really the “most equitable method of liquidation”.  So it all depends on the individual facts.

Do you need legal action immediately?

Many people are anxious to bring injunctive relief as soon as the dispute hits the fan.  Injunctive relief means that a court will relatively quickly put a stop to the rogue business owner’s shenanigans without waiting for a trial, which can take years.  Injunctive relief requires that you can show a high likelihood that you would win after trial and there would be irreparable injury without this expedited relief.  An example would be any action that significantly effects control and management of the LLC or corporation.  Courts have held that such misconduct can have irreparable consequences.  Anything that can be fixed with money damages is less likely to be a candidate for injunctive relief.   However, bringing an action for injunctive relief rather than waiting for the wheels of justice to turn can make or break your litigation strategy.  Even if you have a good case, a lost injunctive relief petition may shift the balance in favor of your opponent.