An Indiana Court of Appeals recently ruled upon a dispute between a mother and her daughter and son-in-law (and their business) concerning the lease of commercial property and the repayment of loans the mother made on the business’ behalf. The Court began its decision in Wayt v. Maschino (December 29, 2017), by noting: “This case can be added to an unfortunately long list of cautionary tales concerning the perils of going into business with family members.” Continue Reading Court Ruling Highlights The “Perils Of Going Into Business With Family Members”
Disputes between and among owners of family-owned businesses are sometimes unavoidable. When such disputes progress to litigation, they can be extremely costly, time-consuming, and disruptive for the business and its owners. However, most civil lawsuits still settle before reaching a trial before a judge or jury. More specifically, many of those suits settle through mediation. Indeed, judges routinely encourage parties to attempt to settle their disputes, through mediation or otherwise, before setting a trial date.
Mediation is a process through which parties to a dispute select a neutral third-party – often a retired judge or an attorney with subject-matter experience – to attempt to broker a deal between the opposing sides. Mediation sessions are confidential and provide an opportunity for parties to explore a variety of options for resolving their dispute that otherwise may become unavailable once the case is put in a judge or jury’s hands. If done early in the life of a case, mediation can also allow the parties to avoid substantial litigation costs and business disruption.
Family-owned businesses that are organized as limited liability companies typically reflect the terms of the company’s governance, along with the members’ financial rights and obligations, in a written operating agreement. The terms of the operating agreement often specifically include what, if any, payments a member is entitled to if he or she withdraws as a member of the LLC before the LLC dissolves. For example, the operating agreement may limit the right to payment of a withdrawing member to the return of any balance in his or her capital account. An operating agreement may even provide that a member is entitled to no payment whatsoever upon withdrawal. In any case, agreed-upon provisions concerning payments upon withdrawal will reflect the members’ expectations from the outset. Such provisions can also protect the LLC from having to make large and unplanned payments upon a member’s unilateral decision to withdraw at a point in time when the LLC may not have the funds to pay such a withdrawal distribution.
Family members often transfer family-business ownership interests or other assets between each other. Their discussions sometimes progress from informal negotiations to a written term sheet to a final written agreement. However, a term sheet itself can be found to be a binding agreement if the terms are sufficiently definite for a court to determine each party’s obligations and if the parties’ conduct evidences their agreement to perform according to those terms.
In Kunz v. Kunz, a Court of Appeals in Iowa recently ruled upon a claim by one family member against another to enforce a “Settlement Memorandum” which provided for the purchase and sale of stock in the family business, even though the Memorandum contemplated the drafting of later documents to finalize the transaction. In 1973, brothers Richard and Robert Kunz formed Happy Homes, Inc., a company that sold factory-built homes. Richard died in 2007 and his 50% interest in the company was transferred to his wife, Connie. Connie and Robert then began discussing the sale of Richard’s interests and later participated in mediation to aid in these discussions.
Family-owned businesses often employ multiple family members. Even if there is an expectation that employment will continue indefinitely, the company and the family member employees both usually reserve the right, explicitly or implicitly, to terminate the employment “at-will,” meaning at any time and for any reason. The terms of such at-will employment need not be set out in writing, though sometimes they are. However, where the parties contemplate the right and obligation of lifetime employment, they should put the employment terms in writing to avoid the potential application of the statute of frauds.
The statute of frauds, generally, bars a party from bringing a claim for breach of an agreement that cannot by its terms be performed within one year, unless the agreement is in writing. In some states, such as Massachusetts, an otherwise enforceable oral agreement for lifetime employment does not fail due to the statute of frauds, because, the courts reason, the agreement could theoretically be fully performed if the employee dies or the company goes out of business within one year of the contract date. In other states, such as Illinois, an oral lifetime employment agreement is not enforceable under the statute of frauds, because, as the courts reason, a lifetime employment agreement “anticipates a relationship of a long duration – certainly longer than one year.” Courts in those states apply the statute of frauds to such agreements in recognition of the evidentiary concern that memories can and do fade over time and thus become unreliable and in order to protect defendants and the court from “confusion, uncertainty and outright fraud.” Continue Reading If You Expect to Work in the Family-Owned Business for Life, Be Sure to Get It in Writing
All too often, family businesses are run in an “informal” fashion, with insufficient attention being paid to corporate formalities, including requirements set forth in a corporation’s bylaws. The Delaware Chancery Court recently ruled in Rainbow Mountain, Inc. vs. Begeman (March 23, 2017), that even in a family-owned business where all of the parties to a dispute are family members, the bylaws will control corporate actions.
In Rainbow Mountain, the defendant Terry Begeman was a member of the family that had founded the corporation. After a falling out among the family members, the group that held a controlling interest sought to remove Terry from the board of directors of the corporation, and in 2008 voted him off of the board of directors. Terry refused to accept this removal, and in 2014 the corporation filed an action for declaratory judgment seeking to confirm that Terry had been removed from the board.
Shares in family-owned businesses are often transferred between family members, whether through a sale or gift during a shareholder’s lifetime or through inheritance after an owner’s death. The parties to such a transfer should make sure it is properly documented to reflect the intention to transfer the shares. Typically, this is done through the transferor’s delivery of a signed share transfer instrument and the company’s issuance of a share certificate in the new holder’s name. In the absence of proper documentation, the transferee may not have a valid claim to the share ownership. Even worse, the company may find itself in the middle of an ownership dispute if the transferee has attempted to acquire the shares through fraud or deceit.
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
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.