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Knowledge is Power: Know Your Rights and Responsibilities as a Private Business Owner

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Knowledge is Power: Know Your Rights and Responsibilities as a Private Business Owner

In this program, you will learn about the sources of a private business owner’s rights and responsibilities, fiduciary duties and how they play out in real business ownership disputes. We will review the importance (or not) of written agreements, remedies to be aware of, and how to reduce and eliminate liability risk.

Presenters

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

Transcript

- Hello. My name is Janel Dressen. I am the CEO and an attorney with the law firm, Anthony Ostlund Louwagie Dressen & Boylan, which is located in Minneapolis, Minnesota. We are a litigation trial boutique of trial attorneys, practicing in the area of business litigation and representing private business owners, as well as businesses. Today, I'm going to be speaking on the topic, "Knowledge is Power: Know your Rights and Responsibilities as a Private Business Owner". Private business owner will include discussing being a business owner of a closely held company. The agenda for today's presentation includes talking about the duty of care that private business owners owe to one another, the duty of loyalty, the duty of good faith, honesty, and fair dealing. We will talk fairly extensively today about oppression liability, which is also, in some states, referred to as unfairly prejudicial conduct. In that context, we will discuss the importance and sometimes unimportance of written agreements. We will discuss the remedies, indemnification, advances in insurance coverage issues that private business owners should be aware of. I will briefly touch on four representative examples of disputes that have arisen in this area and the resolution to demonstrate how the rights and responsibilities of business owners can play out. And finally, I will end the presentation today to discuss areas in which private business owners should engage in preemptive planning. With that knowledge is power, as I mentioned, business owners often fail to understand their rights and obligations. Starting with educating private business owners to understand what their rights and obligations are undoubtedly will help them fulfill those rights and obligations and avoid unnecessary business disputes. Today, we're going to talk about how emotions can interfere with fulfilling business rights and obligations. There's in this area courts when considering the rights and obligations of business owners, which sometimes are referred to as business partners or often are referred to as business partners. The courts will look at fairness, equity, and make value determinations. Very unusual as compared to standard business disputes. We need to consider the financial aspects of running a business, as well as the financial needs, and desires, and expectations of the owners, including retirement, the lack of succession planning, and the needs and wants of various shareholder groups. There needs to be planning for the unexpected. That includes death, disability, early retirement, and debt as just some of the examples. Discussion should be occurring and planning around change in business plan. The other considerations include spouse and outside influences. And finally, circumstances where you may have a lying, cheating, or stealing business partner. Those are the most obvious situations where you can have business disputes. So let's briefly talk about the sources of rights and responsibilities of private business owners. Anytime I'm meeting with a new client to talk about their rights and obligations and perhaps problem solving with issue among private business owners, one of the first sources that I look to is documents, and then I ask them to provide. In an ideal world, I get the documents before we even meet, so I can get a good understanding of what exists in written form. That would include the articles and bylaws of the company, which generally are the corporate governance documents. In an LLC, it may be called the operating agreement or the LLC agreement. There's oftentimes agreements that relate to voting of shares and/or purchase of shares. There could be a voting control agreement. There can be a voting trust. There could be buy-sell agreement. It's often called buy-sell agreement. It may be called the transfer restriction agreement. It may be called a stock redemption agreement. Any of those agreements are extremely important. It's also important to know if any of the shareholders who are employed by the company have employment agreements, and then finally getting the trust documents if in fact shares are held and trust. Oftentimes in family businesses, when the business is transferred from generation to generation, it's done through trust, in which case, the shareholders are beneficial owners and their rights and obligations could further be defined by the trust instruments, as well as defining who the trustee is. And so ignoring that piece would be a mistake because you do need to understand how that could fit in the picture. And so you do wanna know and sometimes clients don't even know how they hold their shares, whether they hold their shares in the share register and their individual name. Sometimes they may hold it through an LLC or a company they formed, or they may hold it through a trust. And getting an understanding of that upfront is extremely important. Beyond the written documents, though, when I do meet with clients, then I need to understand more because as we will learn through this presentation today, the written documents are not the end-all-be-all. You also need to understand what the course of dealing between the parties has been. And why is that? Well, because oftentimes, what business owners do is they sign their documents when the company's formed, put in place articles and bylaws because it's required. They may sign at some form of shareholder or buy-sell agreement, or maybe some other form of agreements, and they throw them in a drawer, and they never look at them again. And they act completely inconsistently or partially inconsistency with the agreements that they reached. And they do so for a long period of time. In that circumstance, that's going to be irrelevant to a court if there is a dispute. Likewise, before there is a dispute, it's relevant to what the rights, and responsibilities, and obligations of the owners are because the course of dealing can create rights and can create obligations. Ask about other written communications. What have the parties put in writing beyond a formal legal document that a lawyer may have created? Did they put anything in an email? You see more text messaging these days. Is there anything in chats that they've agreed upon? Some clients may think those aren't enforceable 'cause they're not signed. They're not enforceable because they weren't prepared by a lawyer. That's not true in this area. So you need to get that information and understand it, and make sure the client understands that those sort of communications can create rights and obligations. All of the rights and obligations need to be in the box in consideration of whether the business judgment rule applies. And we will talk more about that later in the presentation. And then finally, the applicable statutes. Every state's law in this area may have statutes that may differ from another state. And so you need to ask your client where the company was formed, whether it's an LLC or it's a corporation. Generally, that's the laws that are going to apply to the relationship among the shareholders or business owners. Why? Because that's what the law says. Alternatively, if the parties have reached an agreement maybe in an LLC operating agreement, maybe in a shareholder agreement that they want some other state's laws to apply, typically those are upheld. Of course, there's always exceptions, like there is with everything under the law. But if, for example, the company was formed in Minnesota, but the parties agreed to have Delaware law apply, you need to know that so that when you're looking at what statutes are applicable, you are looking at both. And statutes that can be relevant include, what are the fiduciary duties in that particular state in that type of company? There could be different statutes for an LLC versus a corporation, so you need to make sure you understand. Is your company an LLC? Is it a corporation? There are oppression statutes in several states, not in every state. You wanna make sure you're familiar with that and what the standard is under the particular statute. And then of course, there may be specific liability exclusion statutes that you wanna make sure you understand so that you can consider that and improperly advising your clients. So let's start with talking, dig in a little bit more and talk about the duty of care. The duty of care is the most common fiduciary duty that you hear about often. And it provides that an owner, a business, this would be generally a controlling shareholder. It definitely will be a director, and it definitely will be an officer. Those folks owe the duty of care. And the duty says that you need to act with care that a person in a light position would reasonably exercise under similar circumstances and in the best interests of the company. And certainly, there's a question of, well, what if you are a minority inactive shareholder or investor in a company, do you owe owe a duty of care? Many states would answer that question yes, you still owe a duty of care, that all shareholders owe a duty of care. So you wanna make sure that you understand what the scope of the duty of care is. Now, the duty of care is in the context of the business judgment rule. And the business judgment rule essentially says that courts will defer to the business judgment of the decision makers in the business. Generally, that's the board of directors. Sometimes in some circumstances, it can be officers, and sometimes it can be the shareholders. And so those in control that are making the decisions, the court will defer to the business judgment of the decision makers. And that's so long as they are not violating their duty of loyalty, which we will get to next. And in context, what that can also mean is this next bullet point, which officers, directors, and shareholders can rely in good faith on opinions, reports, statements, and other information as long as the person reasonably believes the information is competent and reliable. To put that in layman's terms, that means that the decision makers can, in fact, and it's highly recommended that they do when they're outside their area of expertise to rely on a third-party consultant or expert, or the people that know the information that relates to the decision that's being made. And if you do that, again under the business judgment rule, the court's going to generally defer to the business judgment and not second-guess what you do, even if it's the wrong decision. And so it is a protective measure for the decision makers again so long as you're not violating your duty of loyalty. Classic example would be, you are setting compensation for officers. Perhaps you are an officer, so you're, in essence, maybe weighing in or setting your own compensation if you're on the board. And in that circumstance, one of the things you could do to isolate yourself from potential liability for breaching duty of care is to seek a fair market value assessment of your compensation and rely on the report of the outside consultant that says, "Here's what a market range is for your compensation." If that were challenged by the shareholders to being excessive, as long as you reasonably relied on that outside expert, it's highly likely that the business judgment rule would apply, and the court would not second-guess the setting of that compensation. Ultimately, the duty of care just stands for the proposition that you need to act in the best interest of the shareholders, not in any self-interest, and you need to do what's right for the company as a whole. The next duty is duty of loyalty. And the duty of loyalty prohibits self-dealing. It prohibits taking advantage of corporate opportunities. And we'll come back to that. It prohibits acting in a conflict of interest position. It essentially says that you are a trustee of the assets of the company. That is, they are not the assets of the company, are not yours, personally. They belong to all of the shareholders, and they need to be protected for the benefit of all of the shareholders. And you shouldn't be using assets of the company to your personal advantage and/or to the exclusion of the other shareholders. And in many states, it prohibits you from competing. Now, there are statutes under the Revised Limited Liability Company Act that specifically state that engaging in competition would be a breach of the duty of loyalty. That being said for both of the points on corporate opportunities and competition, the parties have the right to contract around that, specifically with an LLC or operating agreement. And most companies today are a very high percentage of companies, today are being formed as LLCs versus corporations. In those governing documents, you can specifically exclude and state it's not the parties agree. It's not a breach of the duty of loyalty. If you engage in certain corporate opportunities, maybe you put some conditions to that, such as they have to be approved by the board, or maybe you put a certain dollar amount to them. And similarly, you can state that the owners and members can compete without violating the duty of loyalty. The next duty that we'll be discussing is the duty of good faith and fair dealing. This duty is expressed in many of the LLC Act statutes. It's expressed in some corporate statutes, but certainly you'll find it to show up more often in the LLC Act. Even if it's not in the statutes, however, you are going to find this concept of good faith and fair dealing under common law in most states. Perhaps in all states, there is this concept under the obligation of fiduciary, which is to act in good faith towards your business partners and deal fairly with them. And truly, this is the kind of cornerstone of what it means to be a fiduciary. So in the LLC context, the Revised Limited Liability Company Act would provide that a member in a limited liability company shall discharge the member's duties and exercise any rights under the chapter or under the operating agreement consistently with the contractual obligation of good faith and fair dealing, including acting in a manner in light of the operating agreement that is honest, fair, and reasonable. The light shines on whether you have acted honest, fair, and reasonable, and that is the expectation. And this is at all times. Even if you're in an adversary position, you are supposed to act honest, fairly, and reasonable with your business partners. And note that this provision in the LLC Act that the operating agreement is referenced twice. And why is that? It's because the operating agreement is the centerpiece of a member's rights and an LLC. And so you need to first look at what the operating agreement says. And generally, that the LLC Act in almost all states provides that the parties have a lot of flexibility in setting forth what their duties, rights, and obligations are to one another. Again, like anything under the law, there are exceptions. But making sure that you look to the operating agreement to see if there are exceptions and what the parties have agreed upon is fundamental to understanding a private business owner's rights and responsibilities. Now, under the LLC Act, an operating agreement has a very broad definition in many states. It includes not only written agreements. And this is where clients perhaps become the most surprised because they will say, "Well, we have an operating agreement that says X. And so X is what happens." That's just not true. The definition of operating agreement can include oral and implied agreements. And so that's where I mentioned earlier, when you're speaking with your client, you definitely wanna speak to them about the course of dealing in course of performance that they've engaged in since they entered into an operating agreement. In the context of a corporation, the same can be true. The agreements may only be presumptively valid and can be changed by the actions and conduct of the parties, and as it may change the party's expectations. Now, with respect to the LLC, as I mentioned, most duties may be limited or restricted, but restrictions cannot be what's called manifestly unreasonable. And I recognize that that is not very helpful in being able to advise a client of what can and cannot be put into an operating agreement because manifestly unreasonable is not defined. And any court considering that phrase could construe it differently. And that also will obviously turn on the facts and circumstances. So my view on this, and there's very, very, very little case law on this. Not enough to advise anybody as to clear bright-line rules. And perhaps there may never be any clear bright-line rules on this specific subject. But what I would tell clients is don't overreach. Do what you would want done to you in an operating agreement. And be very careful if you are trying to treat the minority and the majority different, not vis-a-vis their investment 'cause, of course, there's gonna be differences. There may be different classes. There may be voting and non-voting ownership interest. That's not what I'm talking about, but basic fundamental rights to be able to get information, to be able to go to meetings, to be able to understand what their investment is. Don't also, for example, exclude liability for the majority, but minority have liability. The minority have certain obligations that the majority are controlling members have. So the idea is ultimately, you need to be fair and don't overreach. There is, however, virtually, no limit to permissible member protection. So you can provide many protections in an operating agreement against liability and provide them in writing. And generally, those things don't change. So keep that in mind when you're hopefully talking to your clients when they're entering into the business relationship. Now, unfortunately, many times, that's not when we're working with our clients. We are working with them long after the agreements are in place. They haven't ever re-reviewed their agreements. They haven't put in place provisions that will protect them. And now, we have to deal with a set of facts that are outside, or just slightly covered by an agreement. That's when you have to consider and understand oppression liability. And what is oppression mean? Oppression can mean different things, depending upon what state you are in. But generally, it is otherwise referred to as being squeezed out or frozen out of a business. And if you're being treated in some states, it's called, as I mentioned, unfairly prejudicial conduct. Well, what does unfairly prejudicial conduct mean? It can mean, in some states, violation of reasonable expectations. So here, there's examples of how different states have construed oppression liability. In some states, it can mean burden, some harsh, and wrongful conduct. In some states, that's not necessary. It can mean conduct that violates standards of fair dealing and fair play. It can mean conduct that violates the fiduciary duty of utmost good faith and loyalty. And as mentioned, it could be a frustration of a shareholder's reasonable expectations. And so in advising clients here, again in terms of what their rights and responsibilities are, depending upon what side of the coin you're on, if you're representing controlling owner or representing a minority, you wanna make sure you understand under the state's laws that you're advising on, how does the courts treat oppression liability? What is the standard that would need to be proven to establish liability? Importantly, and this is another area where clients seem to be very surprised, lying, cheating, or stealing is not necessary. The most obvious case of oppression liability is if you have a business partner that's lying, cheating, or stealing, or perhaps doing all three. And in that circumstance, you know and your clients certainly know that's not appropriate. And so understanding that that's going to be a breach of fiduciary duty and lead to oppression liability is the easy case, assuming you can prove the lying, cheating, or stealing. But in many cases, lying, cheating, and stealing is not what happened. Even if they're accusing each other of that, it's something less than that. And that does not mean that your oppression liability doesn't come into play. It absolutely does. And this is what clients need to understand. So about 1/2 of the US jurisdictions apply a reasonable expectations approach to oppression, unfair prejudice, or breach of fiduciary duty claims. Understanding reasonable expectations then therefore becomes important. And it's an area that clients generally have no education or knowledge about unless they've ended up in oppression litigation. The inquiry for reasonable expectations is not fault-based. It's not finger pointing, even though oftentimes, that's what happens in these cases. It's not necessary to finger point. It's based upon notions of an implied contract. And so even if there's a written contract, it's the implied contract of where the rights and interests of the complaining shareholder, prejudiced are frustrated. And the way that reasonable expectations develop is what would create the implied contract. So let's talk about that. The sources and development of reasonable expectations. I've thought about this over the years. You oftentimes can hear cases might be called a business divorce. And so think business prenup. If you have agreements and we've talked about that already, that's the sources that you wanna start with when you're meeting with clients and advising them in this area, you wanna think about... Oh, by the way, if you have the luxury of advising clients who are entering into agreements, you want a business prenup. That is you want to set out in the initial agreements what the expectations of the parties are on as many important topics as you can. For example, employment, the ability to sell shares, what happens on death, disability, retirement, employment, resignation, and so forth, rights to information, rights to attend meetings, confidentiality, competition, shareholder distributions, being on the board, being an officer, all of these things. If you can document them upfront, that will be an important, very important source of shareholder's reasonable expectations. Second, the corporate governance rules. That's again the articles and bylaws. There may be other documents that set forth the corporate governance rules. You oftentimes will hear your shareholders say they expected the company and those in control of the company to comply with the corporate governance rules. So has those in control complied with those rules? It's important to do so because they can be a source of developing reasonable expectations. Now, in many states, the courts look at the expectations as they existed at the inception of the business relationship. And in some jurisdictions, they look further as how they develop over time. The develop over time is where the course of performance and course of dealing comes in. Now, to be a reasonable expectation, it cannot be based upon your subjective hopes and desires. That's insufficient to be reasonable. It has to be objectively known to the other shareholders. And the other shareholders have to, along the way, at some point, accepted that as an expectation that you've had. And what that can mean is silence. They don't reject it along the way. So for example, if you have an employment agreement that says you're at will, but for 15 or 20 years, you say, "I expect to work here until I retire," and the other shareholders buy into that, and then suddenly something happens and they decide to terminate you, there will be a fight over whether a reasonable expectation was developed. And in fact, I would say in that very brief, incomplete, hypothetical that the facts are more favorable to the shareholder who is claiming that they had a reasonable expectation developed over time. Now, receiving shares by gift or inheritance does not preclude recovery. But in some jurisdictions, the donors wishes may shape reasonable expectation. Donors wishes oftentimes in these cases is the parents or the grandparents, and they may state what their wishes are with respect to how they see the future of the company and how they see how long you hold your shares, and what you do with your shares. Again, they're not gonna be determinative, but they may play into what your reasonable expectations are because if you take the shares by gift or inheritance with the understanding of what the expectations are when you're receiving those, that can be your expectations, the reasonable expectations at the inception of the relationship. And of course, as already mentioned, they could change over time. But you do wanna ask your clients, "How did you receive the shares?" If it's by gift or inheritance, that can certainly impact reasonable expectations. We've already talked about written agreements, course of conduct and dealing that implies an agreement. There may be unwritten and written promises made between, among, or impacting the parties. That's what I mentioned earlier, which is ask about what's been said in emails and text messages, and voicemails, and chats, and even in conversations where it's not in writing. Somebody might have taken notes, or somebody's gonna testify, "He said I could be employed until I wanted to retire. I realized I have an employment agreement, but we changed that. We reached a different agreement after that." You need to also consider an assessment of the understanding that would be expected to result from what's called associative bargaining. That is what would the parties have agreed to had they bargained over how their investment would be protected. Now, the associative bargaining concept comes into play where there is no agreement has been reached and the parties just have a dispute. And one side wants one thing, and one side says wants the opposite. And there aren't any agreements to govern. The courts are then gonna step back and say, "Well, what would the parties have agreed to had they bargained over how their investment would be protected?" And that's where the concepts of equity and fairness come into play, as well as fiduciary duties. And keep in mind that fiduciary duties include not only substantive obligations, but also procedural obligations. What does that mean? That means not only the decisions. Let's talk about, for example, you make a decision that you are going to terminate someone's employment. And they say they have a reasonable expectation to long-term employment. And the termination itself would be the substantive obligation that would be under scrutiny. How you carry that out, the procedural aspect of it is equally important and equally subject to risk of liability. What do I mean by that? Well, if you are secretly, for example, meeting with corporate council about terminating your fellow business partner and corporate council's being paid by the company, what will be argued conspiring with corporate council to get rid of a shareholder, first by terminating them, perhaps also by removing them from the board, and you're doing that in secret, and you are not being honest about it, and you're using company resources to do it, that can be violating a procedural obligation, having secret meetings and excluding business partners. How about trying to push a shareholder out, squeeze out, if you will, at a very low price at a time when you know they are vulnerable? All of those things can be procedural obligations. And as mentioned, they're equally important as the substantive obligations that we've talked about with duty of care, duty of loyalty, and good faith, and fair dealing. Let's turn now, and we've already discussed this at some length. I've discussed this at some length, but it is important because this is again, where clients and lawyers can go off the rails because they believe that the agreements are the be-all-end-all. I don't wanna underestimate the importance of written agreements. They're absolutely important, but they aren't the end-all-be-all. And certainly, your clients need to understand that their words matter. If they are being degrading, being nasty, so forth, words matter. But written words are easier to prove. So when your clients are putting things in emails and text messages, and/or there's a written agreement, keep in mind that's easier to prove up whether there's been a violation of a duty an/or responsibility of a private business owner. So it's important. Written agreements are certainly important to the determination of reasonable expectations as to matters that are dealt within the agreements, but they're not the exclusive source as I've already mentioned. Now, key here, this happens in many, many cases, matters dealt within the agreements. There are so many times where there is a written agreement, but the issue is not addressed in the agreement. Let me give you a very easy example. Shareholders enter into a buy-sell agreement. It governs death, it governs disability, it governs divorce, but it doesn't govern anything else, such as what happens to the shares upon employment termination if the shareholders are employed by the company. What happens to the shares if the shareholder wants out? Is there a way out? What happens to the shares if one party is in bankruptcy or has creditors? Sometimes that's addressed. Sometimes it's not. What happens when there's deadlock if you have a company that's owned 50/50? Or if you have a company set up with where you have two factions that own equally, what happens upon deadlock? So if the agreements do not address those issues, the court then obviously looks beyond the agreements. And it's going to ultimately determine what's fair and equitable. Now, some states' statutes provide that written agreements are presumed to reflect the party's reasonable expectations. Some states do not provide that. And so, again, that's another issue you wanna look at carefully is, does the state statute on any oppression liability if in fact there is a state statute? And if not, does the common law, what does it say about the importance or presumption of written agreements to the parties? You also wanna consider the subsequent conduct of the parties that may contradict the agreements. How strong is that evidence? And ultimately, are the agreements fair and reasonable? If you an egregious, or as I mentioned earlier, an agreement that has manifestly unreasonable terms, the court is not going to enforce it because again they sit in equity. This is not the typical contract where you're in court and you say, "Enforce the payment provision. Enforce this provision or that provision." The courts often look beyond the agreements. What are common allegations that you should be aware of and beyond alert that can happen in this area? The classic squeeze out, freeze out where you're trying to push out a shareholder by keeping them in the dark, not providing information to them, not having any shareholder meetings, being nasty or rude to them, and doing all that, and then offering to buy them out for pennies on the dollar of what their shares are worth. Termination of employment is a common allegation. Removing me from the board if I'm an owner, they may say, "I expected to, and we discussed, and/or had an agreement that I would always have a seat on the board despite what the articles of incorporation or bylaws may provide, not giving me a say or any voice over my investment." Now, keep in mind, in a public company, obviously, the shareholders have very little say other than maybe being able to cast a vote on who's gonna be on the board of directors each year. In a private business, the expectation generally, and this is an inherent expectation without it ever being expressed is that the shareholders are going to have some form of voice and say. Doesn't mean control, but it does mean the opportunity to be heard and have opinions about significant matters that are happening to the company. You may wanna provide in your agreements that certain owners are gonna be passive, and they're not gonna have a say, and they agree they're not gonna have a say. So you don't have a dispute over this. No return on capital, very common. This would be a circumstance where you have insiders and outsiders. And what I mean by that is you have shareholders that work at the company, those are the insiders. You have shareholders that don't work at the company, they are the outsiders. The outsiders claim that the insiders are paying themselves high salaries. That results in no distributions to the shareholders. Have a distribution plan. And if the company can't afford distributions, you wanna make sure that the insiders compensation is consistent with market, so that you avoid a situation where there's the argument I just highlighted. Lack of information, this is also a very common dispute in this area. For whatever reason, oftentimes, the insiders do not wanna share certain information with the outsiders. And of course, the insiders are gonna have more information. Of course, the board's gonna have more information. If you're an officer of the company, you're gonna have more information. In this area, however, more is more. Give more information to your shareholders, okay? Don't refuse to provide and completely shut down information because that is going to be generally is the start of an ultimately what will turn into an oppression case. There's no reason to shut out your fellow shareholders. In fact, this is their asset. It is their investment. And even if you feel like they've did nothing to earn it, perhaps it was given to them. They don't work in the company. They still have a right to get information about their investment, including financial statements. And if need be from the company perspective, have your shareholders enter into an NDA confidentiality agreement. Misrepresentation, you certainly don't wanna misrepresent information to the shareholders that can create disputes. Lack of a succession plan, this is also very common. How is the company gonna be handed down perhaps from generation to generation? Or if it's not a family-owned business, most people don't wanna be forced business partners with their partner's spouse or their partner's children. And so having a succession plan in place that's also consistent with the owner's estate planning becomes important and definitely should be discussed and planned for. Loss of confidence, loss of trust, this is very common in these areas, excessive compensation which we talked about, and then of course, personal use of corporate assets. And that kind of falls in the context of lying, cheating, and stealing. Those those are common allegations that you will see in this area and that you wanna plan for to try to avoid. So I mentioned that I was gonna briefly talk about some representative examples. And I'm going to do that in some family business disputes that I've personally been involved in, It's the Lance case, Taco John's. Lance, by the way, is a grocery store business. Taco John's is exactly what you would expect, a fast food restaurant. And then RPS Real Estate, it's a family-owned real estate business, and then ABC Corporation, which I've just named it that for confidentiality reasons. Common themes that you'll see in these areas are there... It's the second, third. Sometimes it's the fourth. They make it to the fourth generation. You very rarely do you see disputes arise with the first generation. What does that tells you? If you are moving to the second generation, the third generation and beyond, you need to have even more planning, and you need to make sure that the shareholders can get aligned if possible. Oftentimes, they hold their shares in trust. And so there's a trust structure in place that needs to be reviewed, honored, and understood. There's often insiders versus outsiders as I mentioned. And oftentimes, once you get to the second, third, and fourth generation, the business owners have different values regarding assets and money. And that needs to be considered and planned for. For example, you may have a set of shareholders that believe that the earnings should be used to grow the business. And you have another set of shareholders that believe the earnings should be distributed to the shareholders, put a distribution policy in place. The board can work on that. You can use outside advisors, so you have the protection of the business judgment rule so that you have something that you're working from. And that tends to lessen the dispute in that area. And also, I would say for shareholders that want out, have a path to get them out that's reasonable. So example one, the Lance case, again this was a grocery store business. There's four sibling shareholders that each held 25% ownership interest through trust, handed down to them from their grandfather and father. And it was therefore through gifting and inheritance. One of the four was employee. He was the CEO and a director. The other three shareholders were not employees, officers, or directors. And the plaintiff in this case, Kim Lund. She alleged that her reasonable expectations were violated based upon decades of promises and representations to her by her brother, the CEO, the insider, that the company would provide her an exit strategy that was fair. And the company did not have, the shareholders did not have an exit plan for shareholders if they wanted to leave. And so for 20 plus years, there was discussions about how Kim did not want her asset to remain in the company. She wanted to get out. And in fact, she wanted to use it for charitable purposes rather than continuing to grow the Lund grocery store empire. So that was an example of different values and different beliefs with respect to how the asset that was given to them by their family should be used. The other siblings did not object to this over the years. And in fact, Kim was told multiple times in writing and verbally that she would be given an exit path. The shareholders during this 20-year period did enter into a transfer restriction agreement that provided shareholders must consent to the transfer of stock. Once Kim commenced her lawsuit, the argument the defendants made is Kim does not have a reasonable expectation that the company will provide her an exit from the company, unless all shareholders consent, and we don't consent. The court rejected that argument. And the court said, "You're saying that now in the litigation, but the evidence shows that over the 20-year period, Kim was repeatedly told that an exit path would be provided to her and an exit path was not provided to her. In fact, there was no evidence that a full exit path was ever even put together and offered to her." And so the mistake there was, if you have a shareholder that doesn't want to stay in, don't force them to stay in. It's just like in a marriage. If your spouse wants a divorce, they're going to get a divorce. You should treat and plan for the same in the context of a business, particularly a family business is even more crucial because of all the emotion involved. The second example is the Taco John's case. This Taco John's is owned by two family, 50/50, the Woodson and the Holmes. This dispute was largely among the Holmes family. And it's a Wyoming-based company, which does have an oppression statute. The Holmes parents put together a family voting trust, where they named the voting trustee, their oldest daughter as the voting trustee, which provided that she could vote all the shares of all four children. She did not exercise that voting trust for many years. And while the father was alive, all four siblings in the Holmes family had representation on the board of directors. And the four siblings voted their shares to elect the directors rather than the voting trust acting in any way. After father dies, oldest daughter claims as the voting trustee that she now gets to vote the shares. And she starts removing her siblings from the board one by one or their representation. In some circumstances, it was a spouse. And she replaces their representation on the board of directors with her son and daughter. And she claims that she's allowed to do this because she holds the voting trust rights. In addition, she causes her 95-year-old mom to transfer a general partnership interest in another Taco John's entity to the exclusion of the other three. The other three say that interest was supposed to go to all four of us equally. Now, you've caused our mom who's 95 years old to transfer it just to you. Of course, in that circumstance, you have the three siblings suing their sister and the Taco John's company for shareholder oppression and breach of fiduciary duty. Ultimately, the case was settled before it went to trial. So there was no decisions in the case, but the result was for the three siblings to be bought out of the company. And so, again, the lessons to be learned from this, which are many, but if you have siblings or business partners that have different views that don't get along, if you have a business partner that's going to start removing the other business partners from having a say, you can expect that there's gonna be a lawsuit. You can expect that shareholders expect in a private business to have a say in the company. And while certainly there was this voting trust, the reason the dispute arose is because the voting trust was not used for many, many years. And then when it was used, it was used to exclude the three siblings from having a say in the company. The third representative example, RPS Real Estate. This is a family-owned business that has over a hundred parcels of commercial, residential, and vacant land. It was actually 15 children in this business. It was split into two businesses. One of the businesses, it was owned by seven children. That's the side that ended up in litigation. Two of the seven children were excluded from secret meetings. Documents and information was held from them. The five which they referred to themselves as the fab five were secretly recording board meetings. The fab five knew, the two did not. The fab five were pre-meeting and predetermining decisions that the board would make unbeknownst to the two. And the fab five were giving preferential treatment to certain family members with respect to assets that included employment by the company. And in the operating agreement that the parties agreed upon, there was a provision that said that one owner could get out per year by providing notice. If more than one owner wanted out, they would then roll the dice. And I mean, literally, roll dice. And whoever got the highest that year would be able to be bought out. Now, under the rule, the dice concept, there was a significant discount that would apply to the value of the shares. So the two siblings commenced an action. The defense was, if you want out, you get out with the discount. And the two siblings said, "It's not that we want out, you've essentially squeezed us out by engaging in all this conduct," that I've highlighted. The court agreed. The court agreed that that was oppression. Did not, in that circumstance, apply the operating agreement because it didn't apply in the context of oppression and breach of fiduciary duty, which the court found as a matter of summary judgment. And ultimately, the parties negotiated the buyout price based without applying discounts. The obvious lessons to be learned from that case are, again, this is examples of squeezing out an owner and where it can easily lead to litigation when you are withholding information, you're holding secret meetings, you're secretly recording meetings, et cetera, et cetera. The final example, ABC Corp. There's not a decision in this matter yet. It was recently tried. But this was a business owned by parents, a sister and a brother. The brother worked in the business and the sister never worked in the business. Here, that alone, of course, is ripe with risk and should be best paid very careful attention to and planned for. The parents gifted stock to the brother and sister equally, until at some point, they gave the brother an extra 1.5% of non-voting stock more than they gave to their sister as a bonus to him as being the CEO of the company. This caused a whole host of issues. Sister was extremely upset despite the fact that she had received over $200 million in shareholder distributions. She sued. Ultimately, both the sister and brother wanted separation. So we at least agreed on that. They didn't wanna be business partners. And the company was sold and wound down, but she continued her lawsuit claiming that she should get more and claiming excessive compensation to the brother, claiming preferential treatment with the company assets by the brother. In the meantime, as she's threatening to sue her parents and her brother, her parents, not surprisingly, make changes to their estate plan. And as you can imagine, that resulted in litigation as well. She claimed the buy-sell agreement was unfair. And this would be an example of where planning upfront and getting an agreement when you're going to transfer stock to the company that you're not going to sue over it if I'm gonna gift it to you, that you understand you don't have rights to equal shares, et cetera. Some of these things could have been documented beforehand. I'm not sure in this circumstance, the lawsuit could have could have been avoided. But the documents had they been better drafted, could have made the case easier to be resolved. Now, remedies. There's a whole host of remedies in this area, including dissociation and an LLC, which means a member can be removed. The ultimate remedy is dissolution. Dissolution, meaning dissolving the company. That's usually the last resort that courts will enforce here, but it certainly is a risk, which is why you wanna make sure you understand your duties and obligations and comply with them. Most common relief in this area by courts is a fair value buyout. Fair value buyout means even if you're a minority, even though it's a private company that you get bought out without discounts. Meaning, no minority discount, no lack of marketability discount. There could be injunctive relief against your actions if you're a controlling owner. A receiver could be appointed over your company. There's always a risk of there being personal liability and attorney's fees if you've engaged in bad faith conduct and punitive damages. Oftentimes, an accounting can be ordered or providing access to records and awarding distributions. Rescission, meaning the court could undo a business decision or a bad or oppressive act, specific performance, the court could specifically order specific performance of the agreements between the parties, always can seek damages for breach of the agreements, including employment damages if you have an employment contract, or an assertion that you have lifetime employment as a reasonable expectation, and then breach of fiduciary duty damages. Okay. Another important topic to business owners is indemnification and advances. If you end up in a lawsuit in this area, what are your rights for the company to pay for your defense so that you don't have to pay for it out of pocket? You need to look at your articles and bylaws in the owner agreements to see what the indemnification provides, if any. Is it permissive or mandatory? Generally, business owners want it to be mandatory. Under some state laws, if you don't have an agreement in place under some state laws, it isn't mandatory, it's permissive. And that means if you're on the outs, you may not get indemnification. If you are to get indemnification and advances, advances means you get paid while the action is pending, and you don't have to wait till the end when a decision is made. It's generally only if you were acting in your official capacity, that means director officer could be controlling, shareholder could be employee, and you meet the eligibility requirements. Generally, you have to attest in a written affirmation that you've acted in good faith and not engaged in self-dealing. There will be some sort of determination of eligibility for advancements and ultimately determination for indemnification. And in some states, you may have some reporting obligations if you are indemnified. These are things though that you wanna plan for and make sure you understand. They are very important and something you do not want to fall through the cracks if you should be unfortunate enough to end up in a lawsuit in this area. Another area that you want to make sure you understand is what insurance coverage exists for these types of disputes. Is there directors and officers insurance, errors and emissions and employment practices? Would they cover you as an owner of the business if there was an action by a shareholder? There could be also fiduciary coverage. Your personal umbrella policy may apply in some circumstances, and even your homeowner's insurance may apply, that which can apply to a defamation and privacy claims in many circumstances. That being said, there are many exclusions in this area that you have to be aware of when there is a shareholder versus a shareholder suing, and that's called the insured versus the insured exclusion. Therefore, if you have directors and officers insurance with an insured versus insured exclusion, you wanna make sure you understand the scope of that 'cause that could effectively make your coverage in a shareholder/oppression or breach or fiduciary duty action worth nothing. There is always, in these insurance policies, a deliberate fraud and willful violation, exclusion, a personal profits exclusion, and then of course, the prior and pending if there was prior allegations or demands before the policy was in place. That may or may not be covered, depending upon the types of insurance coverage you have. What can you do? We've talked about this, I've talked about this throughout the presentation. But just as a summary of things, that you want to make sure you're considering and planning for, obviously, you have to consider the specific assets that you have and how you're gonna plan for them in terms of succession planning. You may have differences in how you treat your real estate versus operating assets and so forth. You have to consider the change of intentions. Certainly, owners may change their intentions of how long they wanna operate the business, how long they wanna be in the business. That needs to be considered along the way and how that will be planned for and documented. You always have to consider taxes. You wanna involve your tax council so that when you are planning for these matters, how does it impact tax obligations as well as your estate plan and estate tax? What the agreement is about new owners and new owners coming in, and planning for a change in owners, planning for a change in business plan. You always wanna make sure that you have opt-out provisions. I've already mentioned that. That is you want an opt-out for shareholders if they want out. Dispute resolution mechanisms. Most people don't ever look at those. They're just put a standard provision in. Clients don't pay attention to it, but they are actually very important. Having a comprehensive dispute resolution mechanism in there that's really geared towards getting a resolution before you end up in litigation, requiring mediation, requiring negotiation periods, requiring bringing in outside advisors to help resolve matters can be really helpful as opposed to, again, just having to immediately head to litigation. As mentioned, you wanna prepare for and plan for all of these Ds, which is death, disability, divorce, deadlock, dissension; that is the parties can't get along; dissolution, departure, and debt. And then finally, you want to have business valuation provisions in place for how the business would be valued. Oftentimes, there's a stipulated value, and the owners never do it on an annual basis like they're supposed to. So have a stated method for how the company would be valued in all of these D situations. Is it going to be fair market value? Is it going to be some other formula? The more planning you can do, obviously the better. And in order to plan, you need to make sure you understand your rights and obligations as discussed. Thank you for your time.

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1h 2m 03s

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