Business Divorce: New Practice Area or Plain Old Commercial Litigation?

About the Authors:

Kurt M. Heyman is a founding partner of Proctor Heyman Enerio LLP in Wilmington, Delaware, where he practices corporate and commercial litigation, including business divorce, in the Delaware Court of Chancery and other courts. He is the co-chair of the Business Divorce Subcommittee of the ABA Business Law Section’s Business and Corporate Litigation Committee, and manager of a LinkedIn group called Business Divorce and Private Company Disputes.

“Business divorce” is a term appearing with increasing frequency in legal circles, including treatises, blogs, law-firm website bios, social media groups, seminars, and even as the name of an ABA Business Law Section subcommittee. It is often used as a marketing tool to describe a particular practice area or type of case.

What is business divorce? Is it really a separate practice area, or is it just old-time rock and roll with a new twist?

Distilled down to its most basic essence, business divorce is the legal separation of the owners of privately held business entities. Each of these elements has specific implications for business divorce as a practice area, which is addressed below, albeit in slightly different order.

Privately Held

One of the primary characteristics of business divorce as a practice area is that it involves only privately held entities. This has two primary implications. Unlike cases involving publicly held companies, these cases usually involve the actual founders of the entity, and they often are not able to litigate their disputes with “other people’s money.”

Given that business divorce cases often involve the actual founders of the entities, or perhaps their children after the death of the founder(s), or even partnerships between family members or friends, they tend to involve a greater sense of personal pride in the enterprise than cases involving publicly held entities. Moreover, given that the owners often are family members or longtime friends, the disputes involve a greater degree of personal animosity and rancor than disputes relating to public entities. Unlike the famous quote from The Godfather, these disputes are “personal, not business.” The business divorce practitioner must be aware of such dynamics in order to represent the client efficiently because they may be more important to achieving a resolution than a simple analysis of the bottom line. The attorney must also be open to acting as an amateur psychologist in these types of cases by encouraging the client to focus on the big picture rather than personal animosities.

The private nature of the entities can also have consequences on the war chest available to litigate a dispute. “Private” does not always mean small; indeed, some business divorce cases can involve quite substantial businesses. Regardless of the size of the entity, however, they often do not have the same access as public entities to other people’s money—whether in the form of capital markets or insurance coverage. In other words, these cases can be cost sensitive, and the practitioner must take care to avoid destroying the value of the entity with legal costs. This is something that should be pointed out to the client as well when he or she wants to go to war over the smallest of disputes.

Business Entities

Business entities are creatures of state law, so not surprisingly, the process of ending a business relationship also is governed by state law. It really does matter if all your exes live in Texas. Equally unsurprisingly, state laws governing the termination of business relationships vary greatly. Complicating matters further, state laws authorize different types of business entities (e.g., corporations and alternative entities), and the laws regarding the termination of relationships under these different forms of entities differ greatly. In other words, with 50 states, there really are 50 ways to leave your lover, or business partner. (Of course, federal and state tax law could also be significant in the division of an entity’s assets.)

Thus, the two most important questions facing the business divorce practitioner are: (1) what type of business entity is involved; and (2) which state’s law applies?

Although states’ laws can vary significantly, generally speaking, the divorce of a corporate relationship will be governed primarily by statute and secondarily by the corporation’s governing documents, including certificates of incorporation, bylaws, stockholder agreements, and buy-sell agreements.

In alternative entities (limited liability companies, limited partnerships, etc.), on the other hand, the divorce of the relationship will be governed primarily by the entity’s governing documents (primarily the operating agreement or limited partnership agreement) and secondarily by statute. Indeed, most dissolution statutes governing alternative entities provide very little guidance, often offering little more than the fact that dissolution is available when it is no longer reasonably practicable to continue the entity’s business in accordance with its governing documents. Moreover, at least some states permit an alternative entity agreement to preclude the owners from seeking judicial dissolution.

Again, the difference in laws governing different types of entities can be significant, resulting in numerous traps for the unwary, including the timing of dissolution and the appropriate point at which to file the necessary papers with the secretary of state. For better or worse (or richer or poorer for that matter), it usually is necessary for the business divorce practitioner to become an expert in only his or her own state’s applicable laws. Many states will not even entertain dissolution proceedings involving an entity created in another state; however, that is not universal, and that principle does not stop a court from hearing matters other than dissolution that may constitute business divorce of an entity created elsewhere.

Legal Separation of Owners

Although it is certainly true that business divorce is not synonymous with or limited to “dissolution” of an entity, it is equally true that business divorce would not exist without dissolution. As indicated above, dissolution is a matter of state law. If the business partners have set forth their wishes regarding how their interests will be separated upon divorce in their governing documents (i.e., a prenuptial agreement), courts normally will follow those agreements, regardless of the type of entity involved. Where they have not done so, statutes usually will govern, again regardless of the type of entity involved. Where the statutes are inadequate to the task, common law will fill the gaps (e.g., equitable dissolution of LLCs in Delaware, which may be available even where statutory dissolution is not).

Although there are different standards and requirements for dissolution under the different state regimes, there are certain generalizations that can be made. Dissolution is more likely to be granted (regardless of the state or entity involved) if at least one of the following factors is present: deadlock between owners or managers over key decisions (particularly, but not exclusively, in 50/50 situations where there is no majority owner, tie-breaking mechanism, or viable exit mechanism); frustration of the entity’s purpose as stated in the governing documents (with a more narrow purpose making it easier to obtain dissolution); and insolvency.

Note, however, that “dissolution” does not always have the same meaning. It can have the literal meaning of liquidating the assets of the entity then distributing the proceeds to the creditors and owners, or more frequently, it can come in the form of a sale of the company, whether to one of the owners or to a third party.

However, what if dissolution is not available for one reason or another? What if the governing documents preclude it (which would be enforceable at least in Delaware)? What if there can be no dissolution because there is a tie-breaking mechanism or because the lawyer is representing a minority equity holder in an entity that has no ability to effectuate a dissolution?

Again, the answer is going to depend on the type of entity involved and the state in which it was created, as well as whether the attorney represents the majority or minority interest. For example, a majority stockholder in a corporation may, by statute, be able to eliminate the minority stockholder’s interest involuntarily though a squeeze-out merger or reverse stock split, subject to the obligation to pay a fair price.

The minority equity holder wishing to end the relationship may have fewer options, but some states do recognize concepts of “minority oppression” or “equitable buyout” to force the majority to buy out the minority. In the absence of such remedies, what the minority often is left with is the ability to agitate—for example, through the exercise of statutory or contractual rights to access books and records of the entity to investigate mismanagement or possibly even bring a derivative suit against the majority on behalf of the entity. Such remedies are crude tools to effectuate a buyout if that is the ultimate goal, however, because that is not relief that can be granted by the court in actions pursuing such remedies.

Self-help—that is, acting unilaterally without agreement from one’s business partner or judicial imprimatur—is something that usually should be avoided in the business divorce situation. One 50/50 owner physically locking out another (yes, this actually happens), or a dissatisfied owner attempting to leave with all or a portion of the business, likely will lead to a court entering injunctive relief against the self-helper based on claims—again, usually under state law—for breach of fiduciary duties, misappropriation of trade secrets, or violations of noncompetition, nonsolicitation, or confidentiality restrictions. (Of course, in employment situations, federal laws may also come into play.)

Conclusion

Ultimately, the business divorce lawyer must be a jack of all trades to be prepared to litigate issues arising under entity and commercial law of numerous and varying stripes. So is business divorce really a separate area of practice such that a client must hire a specialist who has previously litigated such cases, as opposed to an experienced general corporate/commercial litigator? Probably not, but it couldn’t hurt. As they say, breaking up is hard to do.

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