iAs a business trial lawyer representing private company owners and investors in business divorce disputes and civil litigation for many years, my experience teaches that business partners should approach litigation with caution. Specifically, and for the reasons discussed in this post, I would advise business partners to sue their business partners only when it is required to stop wrongdoing or when a partner’s contract rights have been clearly violated.
First, business divorce lawsuits are expensive to litigate because the disputes are fact intensive, the value of the business will be likely be the subject of intense conflict, and a cadre of experts who need to be retained will add to the fees. Second, these cases are rarely resolved by motion practice, which means the litigation will likely go on for two years (or longer) before trial and eventual appeals. Third, courts in Texas have limited powers, and the verdict rendered by the jury at trial may not resolve the conflict. Specifically, Texas trial courts are not authorized to remove a corrupt partner from the business or order the company or majority owner to buy the interest held by a minority partner in the business. Finally, in many cases, the partner who is sued will respond by filing counterclaims, and as a result, the business partner who launches the lawsuit will be required to prosecute and also defend claims in litigation.
For these reasons, a business partner who is considering filing suit against other partners should consider whether there are alternatives to litigation that would resolve the conflict. If the ultimate conclusion is that litigation is necessary, the partner pursuing the action should evaluate what specific goals the litigation is designed to achieve, and work with trial counsel to develop a realistic budget and timetable for achieving those goals.
Alternatives to Litigation
When business partners are in conflict about their views regarding the operation of the business, they may be unable reach consensus on a path that resolves their differences, but they may agree that a business divorce is their best option. The issue then becomes whether they can agree on the terms for a partner buyout. This is where a dispute over the company’s valuation (and the resulting buyout price) may create a roadblock that precludes a business divorce from taking place. This situation arises when the parties have not entered into a buy-sell agreement, and thus the minority investor cannot require either the owner or the company to purchase the minority interest via the terms of the buy-sell agreement.
When the partners reach an impasse in buyout negotiations, my suggestion is for them to consider participating in a pre-suit mediation. For the majority owner, the mediation provides the opportunity to secure a buyout of the minority investor without becoming embroiled in years of litigation. The majority owner can attempt to secure this buyout through a variety of creative strategies. As just one example, the majority owner may be able to secure an agreement to buy some, but not all, of the interest that is held by the minority investor, with the remaining interest converted into a contractual obligation that requires the owner to make a further payment tied to the future performance of the business. Unless the investor is demanding an exorbitant price for the minority interest, the majority owner should strive to secure a buyout that ends the distraction the investor has created, avoids the expense of litigation, and regains the shares for the company, which then become available for sale to another party.
From the minority investor’s perspective, a pre-suit mediation is an attempt to negotiate a reasonable sale price for the minority interest without devoting time and expense to litigation. Moreover, the investor may not even have the remedy of a buyout available in the lawsuit, so the mediation may offer the only path to secure a buyout of the investor’s minority interest. A sober assessment from the investor’s perspective includes accepting the reality that the investor will not be receiving any additional salary/bonuses or distributions from the company as these will all be eliminated by the majority owner. The bottom line is that the investor should be incentivized to strike a deal for the sale of its minority interest on reasonable market terms.
Determine Whether Non-Litigation Options Exist
If the pre-suit mediation is not held or if the mediation is not successful, each side should evaluate if there are any non-litigation options available. The majority owner should be scrutinizing the governance documents to determine if they are subject to amendment. Under the Texas Business Organizations Code, unanimous consent is required to amend corporate bylaws and LLC agreements, but the owners can opt to give a bare majority or a super majority the right to amend. Where amendment is possible, the majority owner could elect to adopt a new buy-sell provision that authorizes the company to buy the interest held by the minority investor. Making these changes may result in litigation by the investor, but the majority should be on solid ground if the changes are consistent with the governance documents.
For the minority investor, it may be possible to sell the minority interest to an interested third-party buyer. In all likelihood, the majority owner will have a right of first refusal, which will enable the owner to match any offer that is made to the minority investor, but which may lessen the investor’s ability to secure a purchase offer on favorable terms. The investor should, however, at least investigate whether a market exists for the minority interest if the majority owner is only offering to buy the interest for a low-ball price. The investor may find that other partners in the business will pay a price higher than what the majority owner offered for the minority interest.
In addition, the minority investor may also want to exercise the right to require the company to provide access to books and records if the majority owner has engaged in any type of self-dealing conduct. Highlighting misconduct by the majority owner is the right thing to do because it will stop the majority owner from continuing to harm the company. The process of investigating the majority owner’s conduct may also help to incentivize the owner to focus on negotiating a reasonable buyout of the minority investor’s interest.
Assess the Strength of Claims and Remedies Available, Including Legal Fees
Certainly there are cases where litigation is not just necessary, but essential, which is the case when a business partner is engaging in misconduct that is harmful to the business. In these cases, the final step before filing suit against a partner is to engage in a pre-suit evaluation with assistance from experienced trial counsel. This process will include evaluating the merits of the claims, analyzing what remedies are available – including whether there are claims that provide for recovery of legal fees – and finally, developing an understanding of the legal budget and an estimate of the timetable for getting to trial.
Regarding remedies, the majority owner may desire to oust the minority investor(s) from the business, but that is not likely to be a remedy the court can award even if the owner is able to successfully prove the claims alleged in the lawsuit. Similarly, if the minority investor is focused on securing a buyout, the court is not permitted in most cases to grant an order for the company (or majority owner) to purchase the shares or interest held by the minority investor. The court can award monetary damages to the minority investor to recover for the harm the company has suffered based on the majority owner’s breach of a fiduciary duty, but Texas courts have never awarded a buyout remedy to an investor based on a majority owner’s breach of fiduciary duty.
Conclusion
Civil litigation can be a powerful tool when one business partner sues another, but this litigation typically involves an expensive and lengthy process, which is unlikely to be positive for the underlying business. For these reasons, business partners are wise to consider whether there are options available that would allow them to achieve their business objectives without filing suit. In many cases, a pre-suit mediation is advisable where the parties can meet and attempt to negotiate mutually acceptable terms for a business divorce.
In those cases where litigation is necessary, the party filing the suit should evaluate the specific claims to be asserted in the case against the other partner(s), the remedies that will be available for those claims in the suit, and the litigation budget for pursuing them. The final point is that the business partner who is filing suit should consider what steps can be taken to mitigate any harm to the business once the suit becomes public. This includes developing messaging strategies to communicate with the company’s employees, clients and key vendors to provide assurances the litigation will not negatively impact the business.
