Small Business Shareholder Litigation: Breaking Up is Hard to Do

As a business litigation attorney, Dean Mead Shareholder A. Felipe Guerrero sees a lot of business divorces.
Guerrero says a typical situation he sees is a business with two shareholders, one with a majority interest that allows that person to make decisions for the business. They may have come together with the enthusiasm generated by working together at another business and decided to strike out on their own. Over time, however, there are many reasons for one partner, often the minority shareholder, to grow dissatisfied. Maybe they disagree about the direction the majority partner is moving the business in or feel one person does most of the work. The minority partner may want dividend distributions while the majority decides to invest profits back into the business. In some cases, “one person simply loses interest and wants to move on,” Guerrero notes.

Problems Start When One Partner Wants Out

The problem comes when the minority partner wants out. That may be an expensive proposition for the majority shareholder, who will have to buy the other person’s shares and take on debt to do so. Perhaps the business is profitable and humming along, and the majority shareholder has little incentive to work out a separation.

Frustrated by an inability to either influence the course of the business or reach satisfactory terms for a buyout, Guerrero says “the minority partner will begin to push buttons” in an attempt to make the partnership untenable. This often begins with relentless requests for financial records of the corporation. Section 607.1620, Florida Statutes, provides powerful rights for shareholders to demand financial statements, and for the recovery of legal fees and costs. Similarly, section 607.1604, Florida Statutes, allows for the demand of corporate records and the recovery of attorneys’ fees and costs. The minority shareholder may try to force the issue by going to court, and if the records are turned over, the majority shareholder can expect to see every expenditure questioned and perhaps have to deal with allegations of violating fiduciary duty.

The courts generally give broad discretion for corporations to make financial and operating decisions, making it difficult to prove financial impropriety unless there is solid evidence of self-dealing. Making a bad business decision doesn’t violate the law. There also may be questions about whether the plaintiff’s claims are direct, or derivative claims where he or she is arguing that the entity itself suffered damages to be remedied. In worst-case scenarios, one business partner could ask a court for a judicial dissolution of the corporation, which kills the business and may leave both partners in a worse financial position.

Most shareholder or operating agreements do not have any provision for triggering a buyout of one person’s shares, Guerrero says, except for the death of a partner. This is to protect both parties, since a triggered buyout might allow one person to essentially steal the other person’s shares at a below-market price if the business is on an upward trajectory or attracting buyout interest from another company. Operating agreements should be very specific about how shares are valued and redeemed to help avoid litigating those issues.

Takeaways for Your Business Prenup

Like marriages between people, Guerrero says there always will be business partnerships that hit the rocks, and nobody foresees such problems in the beginning of a relationship. Still, if you are thinking of starting a business with a partner, he recommends several steps.

• From the beginning, have a shareholder or operating agreement that addresses everything that might come up in running the business, such as how the parties will choose appraisers, and how the valuation will look, because there are different methods of computing total value. Don’t rely on an off-the-shelf agreement; have a lawyer draw up an agreement that fits your business and concerns.. You’ll need to provide certainty for pricing a buyout.

• As difficult as it may seem in the euphoria of starting a new enterprise, think of worst-case scenarios right from the beginning. For example, you may need non-competition provisions, non-solicitation terms, and non-circumvention clauses. A business litigation lawyer who has seen a lot of business relationships end up in court will have this kind of insight.

• Maintain good financial statements, corporate records, and any other documents required by the operating agreement. Be sure the other shareholder is involved in corporate decision-making to the extent necessary or appropriate, and minutes are kept of meetings. It is easy to become lax when times are good and you are pouring all of your time into operations, but sloppy recordkeeping can be your Achilles’ heel in shareholder litigation.