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The Basics of Business Divorce: the legal and practical issues business partners must consider before getting divorced

Oderah C Nwaeze and Meaghan Geatens

The Basics of Business Divorce: the legal and practical issues business partners must consider before getting divorced
Photo by Charlotte Harrison on Unsplash

Although its origin is unclear, the term “business divorce” applies to the negotiations or legal proceedings meant to end the business relationship between at least two partners or dissolve their privately held entity. Business divorce is broad enough to include disputes that cause business partners to end their partnership, or situations where retirement, sickness, criminal activity, or liability require owners to separate. The term also contemplates circumstances where a business partner wishes to change the composition of management. Business divorces, although occurring in the corporate context, often are just as emotional and disruptive — and at times more complex — than divorces involving spouses. The reason is simple. Most business divorces involve the complication that tends to inflame even the most basic marital divorces — negotiations between parties who were formerly very close. Given that reality, counsel to parties involved in a business divorce must be careful to promote the rational and strategic considerations of a business divorce over the raw emotions of the business partners.

With that in mind, this article explores the considerations of business partners before and during a business divorce, as well as their rights in business divorce and the practicalities of litigation to divide a business.

Issues to Consider Before a Business Divorce

An entrepreneur who wishes to end her relationship with her business partner must consider a number of issues before taking that step. First, is there a simple and efficient way to exit the joint venture? As part of that consideration, the business partners will need to determine whether their business divorce will involve splitting up the company’s assets, including finances and property. If the parties entered the joint venture with a clear understanding of the business assets each owned or is entitled to, that might simplify the business divorce. Consider a situation where partner A built every aspect of the business but needed partner B to operate and grow it. In that circumstance, ejecting partner B from the business might be as simple as entering into a separation agreement and compromising on some form of compensation. Whether that is possible, however, will depend on whether, by virtue of operating the business, partner B can claim entitlement to the company’s real or intellectual property and other assets.

Second, if the business divorce will involve a division of assets, it is important to know what those assets are, and which entity or persons own them. Are the business’s physical assets — such as vehicles, real estate, electronics, or office furniture — owned by the company itself or one of the business partners? Parties contemplating a business divorce also should know whether the company owns any intellectual property and whether that intellectual property is subject to any licensing agreements. Having an awareness of the business’s assets will allow the partners to estimate their respective stakes in the company and to ensure that all relevant assets are considered when the company’s value is calculated. Relatedly, a party considering a business divorce should have some sense of the company’s liabilities, including whether the company is subject to any agreements that must be satisfied as part of the company’s winddown or if the company’s assets serve as collateral for any loan or line of credit. An early understanding of the business’s assets and liabilities might inform the business divorce approach. It is ill-advised to spend $400,000 litigating a business divorce in order to divide $300,000 once liabilities have been satisfied.

Third, since members of privately held entities often are friends, family members, or people from the same religious or ethnic community, business divorces often are as much about the personal relationship as the business one. Thus, an entrepreneur contemplating a business divorce must assess her relationship with her joint-venturer and prepare for the extent to which emotions and personal beliefs will interfere with the parties’ ability to reach a reasonable resolution. Are there cultural or societal expectations or traditions that may influence how much of the company a business partner believes he deserves? Will the opinion of an elder or community leader influence the positions taken by the separating business partners? There are several circumstances where deferring to a judge’s discretion is better than negotiating with a business partner who substitutes logic and rational business approaches for principles and feelings. A party would do well to know whether it was in such a situation because the stress caused by emotion disputes often can cloud the judgment of the best businesspeople.

Rights of Business Partners in a Busines Divorce?

Before initiating a business divorce, business owners should, in consultation with counsel, understand their rights when their company is dissolved. What those rights are will differ based on the type of entity the business is, so business owners should have their counsel review the company’s governance documents, including bylaws, stockholder agreement, limited liability company (“LLC”) agreement, and partnership agreement.

By way of example, governing documents, particularly in the case of an LLC or partnership, often provide for the dissolution of the company in certain circumstances. Some governing agreements include buy-sell provisions that will allow one business partner to buy out another, and some contain requirements for which liabilities or payment obligations should be satisfied first during a company’s dissolution. At times, LLC agreements will eliminate certain fiduciary duties, preventing a partner from being able to bring certain claims against her business partner. It also is common for governing agreements to contain forum selection provisions, requiring any business divorce litigation to take place in a particular court. Ultimately, business owners must understand how the business’s governing documents will impact their rights in a business divorce and whether mediation, litigation, or some other process would be the best option.

Important to that analysis is the impact that relevant state statutes and case law have on the business divorce and the way assets can be divided. For instance, states often have different requirements for voluntary and involuntary dissolutions of a business. In Delaware, for instance, a corporation can be unwound judicially only if the corporation has 50-50 ownership between two stockholders, and one stockholder seeks dissolution. Other than that, Delaware statutes do not provide for the involuntary dissolution of a corporation. Delaware partnerships and LLCs are provided more statutory leeway in seeking dissolution. Both can be dissolved “whenever it is not reasonably practicable to carry on the business” in accordance with the relevant partnership or LLC agreement, though courts only “sparingly” grant judicial dissolution of LLCs. In evaluating whether it is practical for a partnership to carry on its business, courts will seek to “determine the business of the partnership and the general partner's ability to achieve that purpose in conformity with the partnership agreement.” LLC agreements typically are evaluated by borrowing the same standards that courts use to evaluate whether it is reasonably practicable for a partnership to carry on its business. One situation where courts commonly find that carrying on the business is no longer is practicable is when there is deadlock that prevents the company from operating due to a significant business decision, or where the company’s defined purposed was either fulfilled, or impossible to carry out.

Furthermore, it is important for an entrepreneur to be aware (or consult counsel who is aware) of state law because remedies for business divorce-related claims arise under state law. It should not require the significant investment of litigation for a party to discover that the remedies sought are unavailable or less significant than preferred.

Issues to Consider when Litigating a Business Divorce

Ideally, a business divorce can be completed through negotiation, mediation, or some means other than litigation. The consensus is that resolving a business divorce outside of the courts can expedite the process, saving the business owners’ time, as well as financial and emotional expense. If parties to a business divorce conclude that litigation is necessary, they must take a couple of preliminary steps. First and foremost, each party must decide on a goal and how he or she would like to reach that goal — whether that be full separation and dissolution or continuing a revised business relationship. Second, the parties must identify the facts on which they can base their claims in support of the business divorce. Different facts are necessary to prove various theories of fiduciary duty claims including those based on waste, misappropriation of corporate opportunities or funds, failure of board oversight, and minority oppression.

In addition to the claims that may be supported by the available facts, a business owner must consider the length of time it will take to navigate a business divorce through litigation. In Delaware, if the business divorce is uncontested, it might take six to nine months for the business divorce to reach a final conclusion due to the availability of court resources. A contested business divorce, in Delaware, likely will reach trial in 12 to 18 months. The time litigation will take to resolve a business divorce is crucial to consider if the lawsuit is disrupting the business’s operations.

Finally, it is imperative that any business partner considering litigating a business divorce be aware of the cost of litigation. Even uncontested business divorces could result in up to six figures in legal fees. If the business divorce is hotly contested, each party could incur legal fees of $700,000 to $1 million. Thus, when deciding whether to file a business divorce lawsuit, a business owner should assess what financial resources can be devoted to the litigation. That analysis should give special consideration to the value of the business at the center of the business divorce. It is especially important to pay attention to the litigation spend in business divorces disputes because the emotional nature of the matter often leads to overbudget litigation expenses if the parties are motivated to make decisions based on feelings and not strategy.

This article was prepared by the Business Law Section's Business and Corporate Litigation Committee.