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Knock Down Drag Out Fight? The Anatomy of Business Ownership Disputes

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Knock Down Drag Out Fight? The Anatomy of Business Ownership Disputes

Ownership disputes in closely-held and private companies, or “corporate divorces,” are among the most litigious and difficult matters to manage and resolve and can quickly become extremely expensive and damaging to a company. Understanding the technical law in this area is critical to successfully resolving these disputes and potentially avoiding them all together.

Transcript

- [Janel] Hello. My name is Janel Dressen, and I am the CEO, shareholder and an attorney, a trial attorney, at the law firm, Anthony Ostlund Louwagie Dressen & Boylan located in Minneapolis, Minnesota, and our law firm focuses on litigation and trials for businesses. Today, I'm going to be speaking about the anatomy of business ownership disputes and the title of the presentation is, Knock-Down-Drag-Out Fight: The Anatomy Of Business Ownership Disputes. The agenda for today's presentation will include discussing reasons for ownership disputes, some issue spotting when a dispute is in the air, common allegations that are made in these types of disputes, the kinds of claims that you can expect and need to understand and know, the importance of written agreements, remedies. We will talk about four real cases, rules not to forget, and consideration of alternative resolutions. Let's start off by talking about reasons for ownership disputes. Often, if it's a family-owned business and the context in which I will be presenting today is all on private businesses, not public companies, and many private businesses happen to be family businesses passed down from second generation to third generation to fourth generation. And statistically, it's usually by the time of the third generation, and certainly by the time of the fourth generation, that there is high level of disputes. But even with the second generation, we're seeing these kinds of disputes, and that's because the persons did not choose generally, to be in business together, but their parents or grandparents or great grandparents chose by passing the business down from generation to generation. And oftentimes siblings values can be different, their interests can be different, et cetera, so it's ripe for disputes. There's the insiders versus outsiders issue that is some of the owners are passive investors, inactive investors. They may simply just be shareholders, they may not be on the board of directors, they certainly may be where they are not employed, and then you may have those shareholders that are employed by the company. And there can be significant tension between the rights and obligations of insiders versus the rights and the obligations of the outsider. There's oftentimes disputes over emotional issues. Again, this plays more into the family arena, family business arena, but can extend to any kind of business certainly. A difference in values and difference in view of what equality means, whether equality means being fair or whether equality means being equal. There's certainly obviously financial reasons for ownership disputes. And then there's the unforeseen reasons, perhaps death, disability, maybe even early retirement of one of the key persons. And then finally, reasons for these ownership disputes include, liars, cheaters, and stealers. If you have a business partner, a business owner, that is a liar, cheater or stealer, certainly that can be ripe for litigation. Common allegations in these types of disputes. And oftentimes I refer to these disputes as business divorce because ultimately that's generally where these cases end up, is the parties are separated and the parties being the business owners, the shareholders, or the members, if it's an LLC. But common allegations that you will hear in these disputes are squeeze out, freeze out. That is the minority owner claims that the majority or controlling owners are squeezing them out of the business or freezing them out of the business by their actions and conduct. And this can be done in many, many different ways, but essentially not giving information, not providing similar benefits as other shareholders, not involving them perhaps in meetings or decisions, stopping any form of financial benefit that may exist such as distributions or dividends among many other ways. Termination. Oftentimes in these businesses, the owners are employed. And in fact, oftentimes the owners found the companies and they're the founders, and it's their source and oftentimes sole source of income to be employed by the company. If one of the owners is terminated, it's common allegation that they've been harmed, certainly, both on the employment side, but also on the shareholder side. Removal from the board. That can generate a claim here. Providing no say or voice in the operations or management of the company, oftentimes in closely held companies, which is defined differently in different states, but it generally means a small number of shareholders, could be, in some states, up to 35 shareholders, maybe in some states a few more. But in a lot of these cases, you have a 10 or less shareholders, and they expect to have a say of some sort, whether that being on the board, whether they're being shareholder meetings, et cetera. So if that's cut off or they're not provided for that, that's a common allegation. Shareholders often claim they're not being provided no return on capital. Perhaps the capital is being used maybe to reinvest in the company contrary to their value and desire, and/or is being paid out all in compensation to the insiders. A lack of information. Often you see that in almost all of these cases, that there is a misrepresentation about the company, there's a lack of succession plan, certainly a loss of confidence or trust in those that are running and operating the company. Those kind of allegations, you'll see more often when there's a downturn in the market and perhaps business slides or becomes unprofitable, excessive compensation being paid to the officers and/or the insiders, and then certainly personal use of corporate assets. This again comes up oftentimes in the context of the insiders versus the outsiders, where the insiders who are employed by the company use company assets. Could be a private jet, could be a company car, could be tickets to professional sports, you name it. And the outsiders who also are shareholders do not get that same benefit. They will claim that they are being treated unfairly, and/or that there's a, a breach of fiduciary duty. So, thinking about these types of disputes now that we know the common allegations that you can expect to see, what as a lawyer do you do and look for? The first thing that becomes very important to understand is what the company structure is that you're dealing with. Is it a partnership? Is it a corporation? Is it a C corporation or an S corporation? That's a tax issue, but it's important to know. Is it a limited liability company or some other entity under the applicable state statutes? Why is this important? Because this will tell you what set of statutes govern the relationship between the owners of the business. And so that's the first question that needs to be asked. Second question is, what state is the company formed in and the state of incorporation? Why is this important? This is important for a very similar reason because you need to know what statute the owners and their relationship is going to be governed by. And it's gonna be, generally, unless the parties agreed to some other provision, choice of law provision in a contract perhaps, the state of formation of the company is going to apply, and typically the statutes provide specifically for that. And if not, common law would provide for that. The next important topic to tackle is, who is your client? So let's just take, for example, you have a controlling shareholder who happens to also be the CEO of the company come in to see you and they have some issues with a minority shareholder. Are you representing the controlling shareholder as a shareholder, as a CEO, or are you representing the company? And this is required for you to know who your client is under the rules of professional responsibility and for that to be defined and understood upfront. Now, certainly you may need to get some basic information about the situation before a decision is made as to who the client should be. You could consider whether it's proper to have a joint representation, but here is the risk, in some states, if you represent the company, you may have an obligation to disclose your advice to all shareholders. And so you need to know if that's the law in the state in which you are practicing. If that's the case, and you represent the company and you build the company and the company pays you, the conversations and advice that you are providing to the controlling shareholder/CEO can be subject to discovery and could cause very significant problems for your client if your client is thinking that's a privileged conversation vis-a-vis the minority shareholder. Also there's dual roles that clients often play. They may be a trustee of a trust 'cause oftentimes these businesses and the interests are held in trust, particularly with family-owned businesses, and that they may be a trustee or a beneficiary, so you need to know that. They may also be both the trustee and the attorney involved, they may be a family confidant. You need to make sure that if there's multiple hats, what hat and what basis you are representing your client, and if they bring others into the meetings, certainly there's a waiver of the privilege when there's a third party in your meetings, so you need to understand what their role is. For example, if the CFO attends the meeting with the CEO in the example I provided, if you are representing the company, in most states, that would probably still be a privileged conversation. However, if you're representing the CEO as a shareholder in his or her shareholder capacity, having the CFO present may waive the attorney-client privilege, absent some law that would provide that they're acting as an agent for your client. So you have to give a consideration of both conflicts of interest if there's joint representation. Oftentimes, in these cases, having a joint representation is not the right path to proceed when you ask yourself each of these questions because of potential conflicts of interest and/or waiver of privilege considerations. What next? What you next need to talk to your client about to understand these disputes and how to resolve them is ask what governing documents exist. It's not unusual for clients to not necessarily know. They may recall that they signed something or they may bring in a particular single document thinking that's controlling, and it might not necessarily be. So clients need to be informed of the types of documents that you want to look at and understand that if there's any amendments, that they are also extremely important to provide to their lawyer so you can provide the best advice. What kind of documents am I talking about? Articles of incorporation, if it's a corporation, bylaws, shareholder and member agreements, oftentimes it's called the buy-sell agreement, it may be called the transfer restriction agreement. Other may be voting agreements in place. The trust agreements, if the shares of your client are held in trust can sometimes govern the rights and obligations of the parties. If there are employment agreements, employee handbooks. Any sort of document that is potentially a governance document and a contract with the other owners and/or a contract that your client may be subject to vis-a-vis the company. And you need to carefully review all of those documents together with the applicable statutes. The next question to ask is, based upon the facts that your client shares with you, that is why are they there to see you, and what is the issue and what is the dispute, is, are we talking about a direct claim or a derivative claim? And many lawyers and even courts can have difficulty in this area, understanding the difference, and perhaps understanding why the difference is important and can greatly impact how to proceed. So a direct claim involves injury to the individual, a derivative claim involves injury to the corporation or the company. Well, let me give you an example. Client comes in and says, company has stopped paying distributions. The client may say, well, that's an injury to me. However, if it is a decision that applies to all owners of the company, it's not just to the individual, that is potentially a derivative claim because it involves all shareholders equally in the corporation. Another example is an excessive compensation, and this is the most common example. In a claim where an officer is being excessively compensated, that's generally a derivative claim, because if the officer is being excessively compensated, it's the company that suffers the harm. While that harm flows through to the shareholders, because it impacts the financial performance of the company, because it, first and foremost, harms the company, it's a derivative claim. Why does that matter? Well, if you are going to pursue claims, you most likely are better off having direct claims and making sure you understand that you have direct claims, because if you have derivative claims, there are specific rules in the rules of civil procedure, and in many states, there's significant case law in this area as to what you need to do to perfect a derivative claim. And if you have a derivative claim and you properly perfect the derivative claim, that is you get to proceed on it when you recover, if you recover, the proceed go to the company, not the individual. Now, typically there's a basis for attorney's fees in derivative claims, but the recovery does go to the company, which means all shareholders enjoy the benefit of what you may be pursuing as a derivative claim. So generally, clients are much more interested in pursuing relief for them and them alone, so that is a direct claim. You need to understand, do you have a direct claim? There's different strategic approaches that you would take. Now, if you're on the defense side and a derivative claim is made, there oftentimes will be a motion to dismiss because the requirements to meet and perfect a derivative claim are not met. Many lawyers do not understand what requirements exist and/or do not follow the rule of law in pleading the pleading requirements. And in many states, there's what's called the special litigation committee where the company, if they're faced with a derivative claim, either as a demand before it's formally brought in court, or even once it's brought in court, can appoint what's called a special litigation committee to investigate the claims, and in many states, that special litigation committee, their determination, which in some circumstances, or many circumstances the company is overseeing, that is entitled to the deference of the business judgment rule. So that is a significant useful tool from the defense side, which conversely means one of the reasons, if you are considering bringing a derivative claim as a plaintiff you need to be aware of that useful tool for the defense because it may impact whether or not you proceed and how you proceed. So a special litigation committee is usually needs to be appointed by the board of directors and it's one or more independent directors, meaning they are involved in the potential claim. If you can't find independent directors, then they can point appoint independent outsiders to serve as a special litigation committee. Oftentimes you'll find that it's a lawyer or a former judge, and it's just important that they do not suffer from a conflict of interest, and so that they're independent. And then, generally, courts, well, not in every state, but in many states will, well, as I mentioned, give the determination of the special litigation committee business judgment rule. So if the special litigation committee determines it's not in the best interest for the derivative claim to be pursued, oftentimes the court will stamp approval of that and dismiss the claim. All right, so let's now turn to the issues that are, the kinds of claims that you will see, the actual claims themselves. Fiduciary duties, oftentimes there's breach of fiduciary duty claims in lawsuits between business owners. Understand what duties your client has and make sure that your client understands what duties they have. In order to do that, I go back to what hat were they wearing when the action was taken? Were they wearing their officer hat? Were they wearing their director hat? Were they wearing their shareholder hat or their employee hat, or any of the different capacities in which they served? Maybe they were wearing multiple hats. The fiduciary duties that apply depend upon what hat your client was wearing at the time of the disputed action. In many states, but not all, and this is something you need to determine in the state in which you're practicing, shareholders in closely held companies owe fiduciary duties to each other. Certainly, the controlling shareholders owe fiduciary duties to the minority shareholders to act in good faith and deal fairly. There are often exceptions, and this is why I stated earlier you need to see a copy of the articles of incorporation, that limit liability for directors. Typically, you do not see anything with respect to officers. Many statutes do not permit that, but you can find a limitation of liability for directors for certain breaches of fiduciary duty as long as it's not, for example, intentional misconduct or unknowing violation of the law, or conduct in which the director received an improper personal benefit. And anytime a matter is at issue with respect to an allegation of a breach of fiduciary duty, the business judgment rule may come into play. Now, if it's a breach of duty of loyalty, which means acting in conflict of interest or self dealing, or improper personal benefit, the business judgment rule does not apply. But if it's a breach of the duty of care, the business judgment rule does apply, and the business judgment rule effectively, per states, as I mentioned, with respect to it applying to special litigation committees, it provides that, as long as the directors, for example, acted in good faith, the court is going to defer to their business judgment. It's not going to second guess business judgment, even if the court concludes that it was a stupid decision that the directors may have made, it turned out to be a very damaging decision. Nonetheless, as long as they acted in good faith when the decision was made, the court will defer to that, and it will be determined not to be a breach of fiduciary duty. So you need to understand the context of that rule with respect to fiduciary duties. Another claim that you will see is oppression liability. Some states it's called unfairly prejudicial conduct, and some states, this is governed by common law, and some states it's governed by statutes. It can be things such as burdensome, harsh, and wrongful conduct towards your partner, it can be deemed conduct that violates standards of fair dealing and fair play, it can be the same type of conduct that would be considered a violation of fiduciary duty. And in some states, it can be frustration of a shareholder's reasonable expectations. What you need to know from a high level for the anatomy of these claims is you need to know, is there a statute in the state that governs on shareholder oppression liability? And if not, is there any sort of such claim in common law? Now, about one half of U.S. jurisdictions apply a reasonable expectation approach to oppression and unfair prejudice claims. And this is important because lying, cheating and stealing, or any wrongful conduct is not required to prove an oppression claim. A reasonable expectation standard is not fault based. If you think about the no fault divorce, in these kind of cases, it's not to cast blame per se or that somebody did something wrong. The question is, what are the reasonable expectations of the shareholder, shareholders, and were those reasonable expectations frustrated? Now, reasonable expectations, what does that mean? This is an area, obviously, given the breath of what is reasonable, and that's something people fight over in court all the time, this it's based upon notions of an implied contract and the court considers were those rights prejudiced or frustrated. What are the sources and development of reasonable expectations? As I mentioned, I use some analogies to divorce between spouses. Here, you need to think about a business prenup, and this is why getting the governance documents in front of you right away, especially if there's a reasonable expectations, oppression standard in the state that governs, those documents are very important to what a shareholder's reasonable expectations are. Another source is the corporate governance rules. Again, going back to some of my first recommendation about get the articles, get the bylaws, you may even want board minutes to see how board meetings have been handled, copies of shareholder meeting minutes to see how shareholder meetings have been handled. Those can be a source of the development of a shareholder's reasonable expectation. And when do you look at a shareholder's reasonable expectations, 'cause, obviously, they can change over time, and that differs state to state too. Some states look at the expectations as they existed at the inception of the relationship. That is when they became a shareholder or owner of the company. And some states consider 'em both at the inception, and as the expectations develop over time. Obviously, if you enter into agreements at the beginning of the relationship, which is often the case. You throw 'em in a drawer and you never look at 'em again, also often the case, the expectations from then on certainly can change. And that's important because most business owners don't think about it again. They think, oh good, we got documents up front. We're good to go. Not true in this context. In order to be a reasonable expectation, the expectation cannot be based upon a subjective hope and desire. That is, by definition, not objective, meaning not reasonable. It's subjective. So it needs to be an expectation that's been voiced and known to the other shareholders, and essentially that the other shareholders haven't objected and have led the shareholders to believe that that's a fair or reasonable expectation. What do I mean by that? Well, a common example that I will get into in a little bit more detail here is employment. If the expectation is, that I would continue to have employment, and that's how I am making a return on being an owner of the company, and they're terminated, that may be a frustration of a reasonable expectation even though under employment law, they're an at will employee. So with the shareholder backing, there may be a claim for oppression even though there would not be a claim for wrongful termination. Receiving shares by gift or inheritance does not preclude recovery for oppression, but a donor's wishes may shape reasonable expectations. This is another thing that varies by state to state. And so reading the cases on this and understanding what expectations to look to, and whether the donor's expectations, if this is a company where it's been handed down from generation to generation, does the donor's expectations matter or are they irrelevant? Now, development of those expectations, if we're looking at them as they develop over time, there may be additional written agreements. And outside the written agreements, there may be a course of conduct in dealing that implies an agreement. Course of conduct in dealing can be found through many different sources. It can be found in written documents, it could be found these days in text messages, social media chats, can be found, obviously, emails is a big source, in notes of the parties resulting in meetings. It can be unwritten promises made between or among the parties. It does not have to be in writing. And the court's gonna, if there is no writing at all, and some companies and business owners don't have the kind of documents that I mentioned, you should get up front. In those circumstances, the court to determine what the shareholder's reasonable expectations are, may look at what is called associative bargaining, which is, what would the parties have agreed to had they bargained over how their investment would be protected? And that may be a determination of reasonable expectations. And then, of course, complying with fiduciary duties, including their substantive obligations and procedural obligations associated with fiduciary duties is important. Now, as I mentioned, there's employment claims, expectations of an employee owner. Oftentimes, especially if you're very familiar with employment laws and many states have at will employment, you think there's... As long as you're not violating the discrimination laws and retaliation laws, that you can terminate someone. However, if they are a shareholder in a private business or closely held business, you need to know what the law is unreasonable expectations and whether, as a employee owner of the company, is there a potential claim? And the threshold question that the court will ask is if there's a contractual agreement or promise inducing reliance which is breached by the termination? And if companies get employment agreements put in place that specifically say they're at will employee, that is important because if the employee owner signs that agreement, and then later tries to claim that they have an expectation to continued employment or employment through retirement, that would be inconsistent with the employment agreement in which they agree that they were at will. I would say you even go so far as to say that they agree they have no expectations with respect to their employment outside the terms of the employment agreement itself. And then the employment agreement may very well be dispositive of any oppression claim on that basis. If there is no employment agreement, though, then it's a he said, she said, he said. It's, what did the parties say, what did the parties expect? And there are many cases out there where the court has said, the fundamental expectation with respect to the ownership was I, meaning the shareholder, would have employment and there can be a lifetime employment expectation. So be aware. I already mentioned, and I'm gonna briefly talk about it again, but the importance of written agreements. And this is part of planning to avoid these kinds of disputes. The reality is, in these types of disputes, words matter, but written words are easier to prove, of course. So while conversations and what people say to each other and promises that are made verbally are important to these types of claims, written words are much, much easier to prove in court. And people are using email more often. More often have been for many years, so oftentimes in these cases, there's multiple, maybe even hundreds of trial exhibits that are emails to determine what the parties said to each other and how that relates to reasonable expectations. And written agreements are important to the determination, but they may not be the exclusive source, as I've mentioned. And in some cases, the written agreements may not address the issue. So for example, you may have a buy-sell agreement that addresses what happens upon death or disability and retirement, but it may not address termination of employment. In that case, the court's not gonna look to that document as forming a reasonable expectation with respect to termination of employment. The court's more likely to look at the course of dealing and what the parties understood, discussed and so forth. The subsequent conduct of the parties, does it contradict the agreements? Again, did the parties sign agreements, throw 'em in a drawer, never look at 'em, not follow them, and 10 years later, there's a dispute that arises. In that circumstance, the conduct of the parties, if it contradicts the agreements, the court may apply the course of dealing despite what the agreements state. However, owners of businesses are in the best shape by having the written agreements. So despite the fact that there's a risk that the course of dealing can override the agreements, you still wanna have agreements in place. And in terms of protecting against that overriding, ideally, your clients would comply and follow the terms of the agreement, so spending time up front, understanding the intentions on how they operate and that the words on the paper are actually consistent with the intentions and expectations are, is important. Types of remedies in these cases are very wide ranging and broad. In these cases, it's almost always a bench trial. Some states, very few, have jury trials for these types of claims, but considering most states are bench trials, the judges have wide range for equitable relief, and because the court is sitting in equity, damages do not have to be proven. Court could order dissociation, meaning kicking a member out of the company. Dissolution of the company, although that's generally, in every state, the last resort. Fair value buyout is very common and that's what I call a business divorce where the court orders one party or the company to buy out another, and it's usually the shareholder who has been oppressed that is getting the fair value buyout. Fair value, meaning no discounts are applied to the value of their ownership interest, even though they're in a private company, so it lacks marketability, and even though they own a minority interest and do not have control. Injunctive relief, appointment of a receiver, oftentimes these cases provide by statute or case law for attorney's fees and personal liability. If the conduct is harsh, punitive damages can be available in these cases in some states, the remedy of seeking an accounting, or an order for access to records or an award of distributions, perhaps rescision, if a transaction is determined to be a violation and/or a contract, specific performance, damages, of course, employment damages, even again, if you're an at will employee, and breach of fiduciary duty damages. The other important topic to think about in these cases, both as a plaintiff and as a defendant and how you plead your case is indemnification and advances. What is your state statute provide? What are the articles and bylaws provide? Now, do you want to sue, if you're the plaintiff, sue the other directors if they have a right to be advanced their legal fees? You're paying out of pocket, they are having the company, of which you are an owner, pay for their legal fees. That's a consideration that needs to be discussed with their client because oftentimes clients are very surprised by this. They think if, you know, how can the wrongdoers that I'm suing have the company that I own pay for their legal fees while I have to pay out of pocket. And that's because there are indemnification and advances statutes in many, many states and almost all companies put provisions in their articles or bylaws, and sometimes the owner agreements. In order to get indemnification in advances though, there's hurdles to it. They have to be acting in their official capacity. There's other eligibility requirements. Sometimes it's permissive by the company, and sometimes it's mandatory. Again, this is governed by statute in the agreements. And sometimes there needs to be a determination of eligibility. And then, of course, that needs to be reported to the shareholders. The other source of payment of legal fees in these cases can be insurance, can also perhaps cover the remedy if there's a damages. So you need to understand if the company has insurance policies. Again, it's helpful, I think, whether you're the plaintiff or the defendant in these cases, to understand the interplay of insurance and if and where and how that might come in, and if and where and how that may impact resolution of the dispute. So there's many different types of policies that could potentially come in. There's the directors and officers policy, errors and omissions, fiduciary duty policy, umbrella policies, employment practices policies, and then homeowners. And homeowners may be a surprise to many people. I know when I first discovered this it was a surprise to me how homeowners insurance could apply in this context, but a lot of homeowners insurance policies and even umbrella, personal umbrella policies have coverage for defamation and violation of privacy type claims. And in these cases, while that may not be the primary claim in the purpose of the lawsuit, that may be a claim that's being alleged, is defamation and or privacy violation, that could be a trigger for getting insurance coverage. All of that being said, there are, as in any insurance policies, common exclusions to look for. So it's not just simple as, is there a policy and is there coverage? Of course, in any time you're determining insurance coverage, you need to look at the exclusions of which there are generally many. Ones that would be applicable here include the insured versus insured exclusion. Oftentimes, there's, a director's and officer's policy will say, if an insured, that is a director or officer, sues another insured, that is another director and officer, there is no coverage for that type of claim. And in these small businesses and private businesses, because the owners are often wearing multiple hats, the insured versus insured exclusion comes into play more often than you would expect, and certainly tends to come as a surprise to the company. They would not know that that would be the, did not know that was the issue when they purchased the policy. There's deliberate fraud and willful violations, exclusions, personal profits, prior and pending exclusions, which bars coverage for demands and suits against the insured that was pursued or notified before the pending or prior date in the declarations of the policy. And again, there's perhaps many other exclusions that could apply depending on the type of policy. So with that background, I wanna briefly cover four real hypotheticals, and I call them real hypotheticals, which seems like an oxymoron, but I say that because it's real. These are real cases, and I'm going to briefly describe, but it's hypothetical because, of course, I'm just giving you a very limited set of facts, which is unfair to really know the anatomy and how all of this played out is, you can tell from my presentation so far, these are complicated cases with many different layers. So my question's going to be, with each of these sets of facts, does the court order a buyout or any equitable relief in favor of the plaintiff based on these facts? And again are limited facts. Real hypothetical number one. The plaintiff was hired as an at will employee in 1996. The plaintiff was given stock in the company 10 years later in 2006, and signed a stock purchase agreement with a formula value in circumstances in which the company becomes obligated to purchase shares. The plaintiff was terminated as an employee in July of 2010 for creating a hostile work environment and engaging in offensive misconduct in the workplace toward female employees. After termination of employment, he remained a shareholder and a director. And after termination, he, the plaintiff, started working for a competitor. After termination, the company excluded him from shareholder meetings and refused to provide him financial records. So before I give you the answer, think to yourself, does the court order a buy out in favor of the plaintiff on these facts? The answer is, yes, the court does. Now, one might say, how in this circumstance where the plaintiff competing against its own company that's he's owner of, it was terminated for good cause clearly for engaging in hostile work environment and offensive misconduct in the workplace? Well, the court parse that out, and this is back to my teachings, the what hat were they wearing, just because they were terminated as an employee and that employment termination may have been justified and proper does not mean that that the company can ignore and stomp on the rights of the plaintiff as a shareholder. And a shareholder continues to have rights, even if they're not employed by the company, even if their employment was terminated for good cause. Those shareholder rights, of course, include being continued to be invited and notified of shareholder meetings. Oftentimes, continuing to be provided financial records and information. Now, the company's in quite a quandary in that circumstance because plaintiff in this circumstance is working for a competitor. And you can understand why you may not wanna share information, financial information and information that's discussed at shareholder meetings with a person in that situation. And there are protections that you could put in place, protective measures. Perhaps you can have a confidentiality agreement, you can have executive sessions to exclude competitive information that the plaintiff could use to their harm, but you can't stop providing them notice of meetings and completely cut them off from information. All right, real hypothetical number two. Four sibling shareholders each held a 25% interest through trust. The ownership was provided to them through gifting and inheritance from their grandfather and father. One of the shareholders was an employee, CEO and director, and the other three shareholders were inactive. The plaintiff alleged that her reasonable expectations were violated based upon decades of promises and representations to her by the active, the insider, shareholder brother, and that the company would provide her an exit strategy that was fair. In other words, she didn't wanna be a shareholder. And the shareholders in this case had entered into a transfer restriction agreement during the period of the decades of promises that were being made by the brother to the plaintiff and it provided that shareholders must consent to the transfer of stock. This shareholder brought an action, wanting to be bought out, claiming, again, that her reasonable expectations were violated. In this circumstance where there was the transfer restriction agreement, and based on these facts, do you believe that the plaintiff was granted a buyout? The answer is, yes, the plaintiff was. Well, in this circumstances, as I mentioned, agreements are not always dispositive. So while there's a transfer restriction agreement in place that says that shareholders must consent to the transfer, the conduct and actions of the parties, including of the insider brother who controlled the company, demonstrated that these promises were in fact made. That is that an exit strategy would be given to the plaintiff. And it just never was. The promises kept coming, and the action did not follow. All right, real hypothetical number three. Plaintiff was a former shareholder and employee of the company. Plaintiff actually led the implementation of the buy-sell agreement for the company. And the board terminated the plaintiff as an employee and removed him as a shareholder director and officer under the terms of the buy-sell agreement. The board offered to repurchase this plaintiff's stock at what was a very low formula price under the terms of the buy-sell agreement. If I recall, it was about $2,300, and the interest was worth into the high six figures. The plaintiff brought a lawsuit challenging his termination of employment and his involuntary removal as a shareholder officer and director of the company. Does the court order a buyout in favor of the plaintiff in this case? The answer is no, but. And I say no, but because the court, district court granted summary judgment in favor of the company, stating that the buy-sell agreement was dispositive, particularly because the plaintiff led the implementation of it, and under the terms of the buy-sell agreement, while the price was very low for the shares, that's the agreement that the plaintiff entered into. But importantly, the buy-sell agreement did not address the context of termination of employment. It addressed removal as a director and officer, but not with the employee hat. So on appeal, the court of appeals reversed that decision and said, remanded to the district court to determine if the reasonable expectations of the plaintiff as an employee were violated. The case then settled. The lesson to be learned from this is, your agreements need to cover these circumstances that are potentially can be anticipated, and certainly termination of employment is one of those. Finally, real hypothetical number four. In this case, the brothers each owned, there was three brothers that each owned one third interest in the companies, which manufactured and sold luggage and leather products. In 1987, one of the brothers discovered an accounting discrepancy of approximately $330,000. He insisted that the company retain an outside accountant to investigate. That created a whole host of problems with his other brothers. They were not happy with him that he wanted this investigation to occur. The other brothers stepped in and told him that he needed to cooperate, resign, or be fired. And if he did not forget about the apparent discrepancy, his brothers would fire him. He was then ultimately placed on mandatory leave of absence and fired, and he sued. Now, this one, hopefully, after everything I've presented to you, is an easy answer. Does the court order a buyout in favor of the plaintiff? The answer is yes. In this circumstance, the court determined that the plaintiff had a reasonable expectation to continued employment. And in this circumstance, the threats to the brother and the fact that he was terminated because he was trying to do something good for the company did not sit well with the court. So the rules that you can learn from these cases and from the rest of my presentation. Rule number one, know the statute. And on my slides, I repeat that three times, know the statute, know the statute, know the statute, because it's that important. You need to understand the nuances of the applicable statutes in the jurisdiction that applies. And you can't stop there. You need to understand the agreements, the governance documents, and possibly depending upon the jurisdiction and whether reasonable expectations applies, the course of dealing between the parties, and you need to fully explore that course of dealing with your clients. Rule number two, know the outcome. What do I mean by that? How could you possibly, as a lawyer, know the outcome? You can't. However, what you do need to know is judges are not inclined in these kinds of disputes to maintain the status quo. When you have owners fighting and at loggerhead and not getting along, it's not good for the business. And judges are not inclined to say, well, after all this, I'm just gonna keep you together and proceed and carry on as status quo. It's just like in the marriage context, when spouses or one spouse no longer wants to be married, they get a divorce. Courts are inclined to separate the parties if that is the reasonable, equitable, fair outcome, and if it's in the best interest of the business. Rule number three, know your client. You have to get to know your client, you have to get to know their business, you have to get an understanding and full disclosure of how, the history of the relationship between the owners, how it started and how it's developed over time. Does... And you need, as I mentioned, because of the rules of professional responsibility and the conflicts of interest issues and potential waiver of attorney-client privilege, you need to know who your client is. And you need to know that at the outset, and you need to document that appropriately in your representation agreement and act accordingly. And you ask yourself, does the company and the controlling owners or board need separate counsel? The answer is almost always yes. Rule number four. This is perhaps the rule that doesn't have a lot of definition, but is important to think about. Be creative and proactive, right? This is an area because it's an equity where there's lots of room for resolution of disputes, and it's much better for clients to resolve this kind of dispute and not have the court force a resolution upon them. You can be much more creative and avoid risk on many levels, including tax risk, risk with your customers, risk if, with family relationships, it's a family-owned business and so forth. So be creative and proactive to try to get a resolution before these matters end up in World War III in court. One of the ways to think about being creative and proactive is whether your client should get an appraisal of the business, certainly, if they haven't had an appraisal or they don't really know the value of the company. Getting these kinds of disputes resolved without knowing the value of the business is extremely challenging and difficult. Because, if one side's gonna be a buyer from the other's interest, how do you negotiate price and terms without knowing the value of the business? And while certainly a business appraisal can be expensive, if getting a business appraisal resolves a dispute like this, it is well dollars spent without a doubt. So business appraisal considerations. Is the business appraiser independent, as opposed to perhaps biased and/or working for one party? It's usually, you know, it's a third party opinion of value. And the question is whether is it going to be a joint business appraisal or is it going to be one sided? Meaning, might be the company just hires to get the appraisal, or it might mean all the shareholders agree, let's get the business appraised and then decide how to proceed. You need to know what methodologies and approaches that appraiser is going to follow. Is it going to be a fair value appraisal of a certain interest in the company, is it going to be fair market value, or is it going to be some other value? Also important, in many cases is, what's the valuation date? When is the appraiser to value the company as of? Obviously, the value of a company can change depending upon the date it's valued, and all appraisers need to know that valuation date and will stick to it. Will discounts be applied if a minority interest is being valued? either a minority interest discount or a marketability discount as another issue to consider when negotiating a joint business appraisal. And information disclosure. Who's gonna have access to the appraiser? Who's gonna have access to the information that's provided to the appraiser? Who's gonna be interviewed by the appraiser? Who's gets to ask questions of the appraiser? All of these things are things to consider upfront in advance and try to reach an agreement on so it's not another basis for a dispute. And when all is said and done, in an ideal world, the best situation would be that all shareholders have equal access to the appraiser, would be interviewed by the appraiser. Again, if it's a small number of shareholders, that's realistic. If it's a large number of shareholders, it's much less realistic. And that the communications with the appraiser are shared with all shareholders. So there's not some feeling of hidden agenda, hidden information, trying to pull one over that can breed a lack of trust, a lack of confidence, as I stated in the beginning of my presentation. You don't want that to happen in the context of a business appraisal, especially if you're gonna be able to use that business appraisal to resolve disputes. What are alternative resolutions in these disputes? And this is the final topic that I will cover. There are lots of alternative resolutions beyond going to court. And I think it's incumbent upon all lawyers who have a client that comes in with these types of disputes that I've been talking about to consider right away front what are the alternative resolutions. Because litigation can be damaging, it's obviously exhausting, it can be emotional, it can be very expensive. And while I'm a trial attorney, and certainly I appreciate, in fact, love when people go to court and are in litigation, that's how I make a living, is incumbent upon me to try to help my clients avoid that situation because that's in their best interest. And so alternative resolutions to consider. Sale of the company. Rather than having a fight over value, getting an appraisal and so forth, is there interest in putting the company up for sale? The market will then determine the price. Don't need to have a fight about price, don't need to have a fight about who's gonna leave the company, who's gonna stay, do not have to have a fight over the terms and conditions of a buyout and so forth. Well, many owners of businesses do not wanna sell their company, so that's not always an option, but it's certainly something to talk with your client about. Whether you could do an auction between the owners and the highest bidder, if you will, wins. So that's kind of a creative solution as well. You set a base price, that both sides agree the company's worth at least X, and then you actually have an auction between the owners thereafter as to who wants the company at what price. It keeps people more honest. Outside investors. Maybe you bring in outside investors if the company can't afford to buy a disgruntled shareholder out, but clearly a separation is needed, two considerations could be outside and bringing in outside investors and perhaps putting an ESOP, which is employee stock owned program. Having a negotiation period. Maybe instead of rushing to court, let matters simmer down. Having this in your agreements, that before you can bring a dispute there has to be a negotiation period, is a very good provision because as more time passes, smarter, you know, the emotion can be dropped down a notch. So provide for a negotiation period. Maybe it's a 60-day period. Some matters, that's not possible 'cause damage could occur in the interim. But in most cases, having a negotiation period can be important. And the other alternative resolutions, of course, is mediation. Having a mediator, a third party come in and try to mediate a resolution before going to court. I almost always, in almost all circumstances, recommend to my clients, let's try to mediate this before we would file a lawsuit. If I'm on the defense side and I do find myself on plaintiff and defense side in these cases, I certainly talk to my client about talking with the plaintiff to get a mediation scheduled sooner rather than later. And then arbitration. The reason to consider arbitration over in court litigation is for the privacy. Sometimes they can proceed much faster, which is generally in the best interest of the business. So between the confidentiality protections, and you may, depending upon your jurisdiction, not want to depend on courts to be deciding business decisions and business valuation issues, and you much rather hire someone as an arbitrator that's an experienced in those areas. So those are just some of the advantages. There's many other advantages, of course, of arbitration too. So those are some of the alternative considerations for resolutions to consider. With that, I conclude this presentation. Thank you for listening.

Presenter(s)

JD
Janel Dressen
CEO and Shareholder
Anthony, Ostlund, Louwagie, Dressen & Boylan P.A.

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