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.

Continue Reading Pay Attention to Bylaws When Taking Corporate Actions

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.

Continue Reading Corporate Formalities Matter in the Transfer of Shares of Family-Owned Businesses

A United States Tax Court recently issued a decision after trial that should serve as a reminder to management and controlling shareholders of family-owned businesses that salaries or other compensation paid to family-member employees may only be deductible if the salaries are “reasonable.” In Transupport, Incorporated v. Commissioner of Internal Revenue, the Tax Court conducted a trial on the company, Transupport’s appeal of an IRS notice of deficiency.  In the notice, the IRS had determined that amounts the company attempted to deduct for compensation to four sons of the company’s founder and president were not reasonable.  The IRS also had disallowed the deductions to the extent of the unreasonable compensation and assessed a penalty based on a “substantial understatement of income tax.”

Continue Reading Are you paying your children too much to work in the family business? The IRS might think so.

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.

Continue Reading Carefully Consider the Scope of Releases When Settling Claims between Family-Business Owners

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.

Continue Reading Do You Need to Do Business with Your Co-Owner’s Children? It Depends on the Language of Your Agreements.

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.

Continue Reading Who is Authorized to Bind Your Family Business to Contracts?

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.

Continue Reading Bankruptcy Court Sends Not-So-Gentle Reminder About Observing Corporate Formalities

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?

Continue Reading What Corporate Records do Family Businesses Need to Provide to Their Shareholders?