Getting in business with a friend or family member often puts strain on the relationship. Problems arise when the parties are in a “deadlock” in the management of the business. The typical deadlock occurs when:
- The failure of equal members or managers to reach agreement;
- The failure to obtain a required majority vote;
- The failure to obtain a required approval from a member with approval rights; and
- The failure to obtain unanimous consent where unanimity is required.
A deadlock often results in hard feelings, loss of time, and possible mediation, arbitration, or litigation – which may result in the dissolution of your company.
The number one thing that you can do to survive your Business Divorce is to make sure that you have an operating agreement that includes a deadlock-breaking mechanism. You wouldn’t believe how many partners we come across that do not have an operating agreement to begin with. This almost guarantees that the parties will be in court seeking a judicial dissolution when a deadlock arises.
Let me tell you about two brother E & J, who wanted to start a business. E was the older brother and he had this vision of turning a piece of vacant land into real estate development. While J just went along for the ride and had experience with construction.
E & J did everything that they needed to do to get the business off the ground. They met with the City to obtained building permits. They met with the State to obtain construction permits and have their designs approved. They even cashed in their retirement to purchase the property.
J used his construction knowledge to help build the building. After a year and a half of work, E & J were finally ready to open up and start making money. And then the unthinkable happened. J after working in the business for one month wanted out. He was tired and realized that the business required too much of him. So, he began talking to E about getting out of the business.
At this point, E & J were working with a bank to obtain a loan on the building and the business. But now things were changing. E & J met with the business attorney at our office to discuss their options. Since the business attorney (i) drafted the operating agreement and (ii) was familiar with the parties they were able to avoid a costly deadlock. Because J made it clear at the meeting either he was going to receive his money or the business was going to be sold.
Options for Breaking a Deadlock, which should be included in the Operating Agreement.
Buy-Sell Provision – basically, the parties agree to buy out the other party should a deadlock arise. In the right circumstances, a buy-sell provision is effective at forcing parties to find a way to break a deadlock to avoid the potential of one party actually making it happen.
External/Internal “Tie-breakers” – this is where the parties that are deadlocked will refer the decision to a tie-breaker. Although this seems like a great idea, just remember that the decision may be removed from the parties most familiar with the company and its business and placed in the hands of a third party who may not have the requisite insight.
“Rotating/Alternating” Vote Mechanism – this would allow partners to rotate “tie-breaking” when there is a deadlock on a decision, but we recommend against this due to the gamesmanship that frequently leaves everyone unhappy.
“Put or Call” Mechanism – essentially, a triggering event is the action or circumstance that will allow one party to exercise the put or call. These are very effective, if and only if, the provision are heavily negotiated and carefully drafted.
Partition of the Company or its Assets – the possibility of a forced sale of the Company or its assets can compel disagreeing members to find away to resolve their deadlock. Partition can work only in limited circumstances where the assets or business activities are easily segregated among the members without destroying the business model itself and where the values of those assets are equal and division is easily agreed upon by the disputing members.
Let our us help you survive your business divorce by drafting a battle tested operating agreement to protect your business interest. Call us today.