Litigation among family-business owners often ends with a negotiated settlement agreement instead of a trial and entry of judgment on the parties’ claims. Through a settlement, the parties have the flexibility to agree upon any applicable business terms, including any payment to be made to the claimant and the scope of any release to be provided in exchange for the payment. However, settling parties should document any settlement agreement clearly so they know what rights, if any, are being released and, what rights, if any, they can continue to assert against each other after the settlement is finalized.
Owners of closely-held businesses, including family-owned companies, often agree to restrict the owners’ ability to later transfer their ownership interests to third parties. Such restrictions prevent one owner from selling his or her interest to a “stranger” with whom the remaining owners otherwise would not want to co-own or operate their business. These provisions also frequently require advance consent of the remaining owners before a sale to a third party or provide a right of first refusal through which the remaining owners may match the price offered for a departing owner’s interests before he or she sells to a third party. Transfer restriction clauses also sometimes provide exceptions for transfers to certain family members, such as an owner’s spouse or children, in order to provide continuity of ownership at least among the owners’ families. But what happens when a non-transferring owner does not want to do business with his departing co-owner’s children and refuses to acknowledge a transfer of ownership to them? A state appellate court in Illinois recently addressed such a situation in Kenny v. Fulton Associates, LLC.
In business purchase agreements, including agreements between family members, the seller often retains pre-sale liabilities, such as tax liabilities, while the buyer assumes post-closing liabilities related to the business’ ongoing operations. But what happens when the buyer induces the seller to retain such liabilities through fraud? In Bailey v. Bailey, a U.S. District Court in Texas recently gave its answer when faced with a claim that a son defrauded his parents in connection with his purchase of the assets of their family-owned business.
According to the Court’s post-trial decision, Roger and Shirley Bailey owned an electrical services company. Their son, Jeffrey, had worked in the company for many years. In 2007, Roger and Shirley decided they no longer wanted to manage the company and put Jeffrey in charge. Shirley’s sole remaining responsibility was to control the cash disbursements from a bank account that she controlled as the company’s treasurer. In doing so, Shirley relied solely on requests for funding by the company’s bookkeeper. Continue Reading Watch out for Fraud in Family-Business Purchase Agreements
A family business’ significant commercial relationships are usually reflected in written agreements. But who is authorized to sign those agreements and to bind the company to the terms? Typically, a company’s management will have actual authority to sign agreements. However, the company may give the impression to third parties that other employees (for example, purchasing agents, account managers and IT personnel) that those employees have “apparent” authority to sign contracts relating to their areas of responsibility and thus bind the company to agreements. It is therefore important for family business owners and management to clearly instruct their employees and agents – and to communicate to third parties – as to whether those employees or agents are authorized to sign contracts and other important documents on the company’s behalf.
In a recent decision, the United States Bankruptcy Court for the Eastern District of Massachusetts sent a reminder to practitioners and family business owners that it is critical to maintain corporate formalities in order to avoid unintended liabilities. In the case of In re Cameron Construction & Roofing Co., Adv. P. No. 15-1121, 2016 WL 7241337 (Bankr. D. Mass. December 14, 2016), the Bankruptcy Court applied the concept of substantive consolidation and made the assets of a non-bankrupt related entity available to creditors in the bankruptcy proceeding.
In family businesses, disputes may arise concerning access to company information. Owners who work day-to-day in the business typically have unfettered access to this information, while passive shareholders may feel they are “in the dark” as to the company’s decision-making and performance. Passive shareholders depend on the “insider” owners to provide them with full and accurate information and may become suspicious of the insider owners when the information provided is delayed or incomplete. For their part, the active owners may believe that information requests from other owners are a burden or a distraction to the company’s operation. So, what documents are corporate shareholders entitled to review?
When family business disputes erupt, the parties often end up in court, where a judge or a jury will decide their fates. Litigation of these cases often takes years. In Massachusetts Superior Court, for example, the rules provide for a presumptive 22 month schedule before judgment in a so-called “fast track” case, while an “average” track case has a 36 month time-frame before judgment. Federal courts or other states’ trial courts may have slightly faster deadlines to judgment, but the fact is that litigation in court can be a long, drawn-out exercise. This extended time-frame not only delays the resolution of the dispute, but also can interfere with the ongoing operation of the business during the suit, as management and employees divert their attention to discovery requests, motion practice, and trial preparation over an extended period. Not to mention the strain such a lengthy process puts on already contentious family relationships.
When a family business operated as a limited liability company brings on professional management, the parties typically focus on items in the operating agreement such as capital contributions, allocations and distributions, and governance. However, a recent Delaware Chancery Court case serves as a reminder that all provisions of a limited liability company operating agreement must be given careful consideration, including the provisions relating to advancement and indemnification rights. In Harrison v. Quivus Systems, C.A. 12084-VCMR, the Delaware Chancery Court ruled on cross motions for summary judgment in a case where the plaintiff, the former CEO of the defendant, sought indemnification and advancement from the defendant corporation. The court ruled in favor of the plaintiff, and awarded not only the advancement and indemnification sought, but also “fees on fees” incurred by the plaintiff in bringing the action in Delaware.
John Harrison (the plaintiff in this action) had served as the CEO of Quivus Systems, LLC (the defendant), since its inception in 2007. In 2014, the controlling shareholder of Quivus removed Harrison as CEO, and in 2015 filed suit against Harrison in the Superior Court for the District of Columbia, alleging mismanagement and corporate malfeasance. In response to this lawsuit, Harrison made a demand for indemnification (including advancement of expenses), which was refused by Quivus. After this refusal, Harrison sued Quivus in the Delaware Chancery Court, leading to the ruling issued by Vice Chancellor Montgomery-Reeves on August 5, 2016. Continue Reading Family Businesses Should Carefully Consider Indemnification and Advancement Obligations Included In Limited Liability Company Operating Agreements
Directors of all corporations – including family owned businesses – owe a fiduciary duty of loyalty to the company. This duty requires a director to put the interests of the company ahead of his or her personal interest and not to divert corporate opportunities or assets for his or her own benefit. Many state statutes further address potential conflicts of interest and allow for such conflicting interest transactions as long as the director makes prior disclosure and obtains the approval of all non-interested directors or shareholders before embarking on the transaction. This statutory process protects the corporation from the potential damage of a self-interested deal by one or more directors. It also provides cover for the director when acting for his or her own benefit as long as the director makes the proper prior disclosures and receives the needed approval.
Family owned corporations are subject to the same statutory requirements regarding entity governance as non-family owned businesses. Thus, in order to fully comply with the applicable statute for the state where the business is incorporated, a family business should pay attention to all provisions that require annual or other ongoing action by the company. These include:
- Holding annual shareholder meetings
- Holding formal elections of directors at shareholder meetings,
- Documenting actions taken by the unanimous consent of the directors without a meeting
- Maintaining complete records of the company’s operations and finances
Many companies also have detailed provisions in their by-laws that spell out additional duties of directors and officers, along with shareholders’ rights and responsibilities.