Law360 is providing free access to its coronavirus coverage to make sure all members of the legal community have accurate information in this time of uncertainty and change. Use the form below to sign up for any of our weekly newsletters. Signing up for any of our section newsletters will opt you in to the weekly Coronavirus briefing.
Sign up for our Securities newsletter
You must correct or enter the following before you can sign up:
Thank You!
Law360 (May 8, 2020, 3:20 PM EDT) --
 |
| Stephen Brodsky |
In addition, each may have vastly different personal and financial circumstances that may influence, or even dictate, their business decisions.
This article discusses how the current COVID-19 crisis may cause more disputes among the owners of private companies and how owners may attempt to resolve them. A number will likely be unable to do so. In such cases, some will seek to sell their shares and member interests, others will invoke dispute resolution procedures and still others may pursue relief under a governing state statute.
Sometimes, business "divorce" is the only option.
Current Conditions
Regardless of their organizational form and industry, privately owned companies are nearly all facing the same extreme market conditions, including the following.
Decreased Demand
Demand for a company's goods or services may have fallen drastically, whether due to curtailed spending or state-mandated safety measures. Regardless of the cause, consumers are not buying what the company is selling. How can the company adjust, both in the short and long term? Should it lower its prices? Can it change its business model?
Disruptions in the Supply Chain
Supply shortages and delays are likewise affecting companies, often resulting in scarcity and higher costs. Should the company pass costs to customers or absorb them in the hope of retaining goodwill?
Employment Issues
Employment matters of various kinds abound. For some businesses, it is simply not feasible to have employees work remotely while shelter in place orders are in effect. Without question, owners may disagree about employees that are presently not needed and salaries that are no longer affordable.
Nonperformance of Agreements
Many businesses will be unable to perform their contracts or find that others will fail to perform. Purchase orders may be cancelled. Supply agreements will not be honored. Defaults will occur. Each even may give rise to potential liability. When is nonperformance the best alternative?
Fixed Costs
Every company will have certain costs that will remain due and owing, such as mortgages, rent, utilities and insurance premiums. Companies must decide which it should continue to pay. Perhaps for some, defaulting is the better, or only, option.
Liquidity and Financing
Cash and financing needs may have changed drastically. Events may have triggered a default or material adverse change in a financing agreement. Is restructuring debt possible, and if so, can the owners agree to new obligations?
Increased Potential for Disputes
Responding to each of these challenges will require business owners to make difficult, even, critical decisions. The potential for legitimate, good faith disputes is undeniable. Each owner may weigh legal, operational and practical considerations differently.
While one may seek to preserve sales, another may focus on cost. Disagreements may arise over how the same issue. One owner may favor targeted layoffs, while another may prefer across the board salary cuts.
The company's shareholder or operating agreement may require that certain decisions be decided only by unanimous owner agreement. While this provision may have been thoughtfully included at the time of the company's formation, how will that provision play out now? Will it result in a deadlock?
The life circumstances that each owner is experiencing may also give rise to disputes. The influence of each owner's personal financial condition cannot be ignored. For example, one owner with a nest egg may demand that all owners refrain from taking a distribution, while another without such resources may seek a distribution and demand other cost-cutting measures.
Perceived or actual differences in owner performance or contributions to the business may cause still other disputes. Personal matters, perhaps exacerbated by the current pandemic, may be affecting an owner. Examples are marital discord, family obligations and medical issues. Each may understandably result in underperformance.
If the owners' agreement does not adequately address underperformance or inequities, resentment and discord among the owners may build.
Resolving Disputes
Direct Negotiations
Ideally, if all of the owners desire to continue their business, it is best for them to attempt to resolve their disagreements among themselves. It is certainly the least costly route. Trust, open-mindedness and compromise will be key. Such discussions may be either with or without reference to operative terms of their agreement. If their agreement does not sufficiently address the issues at hand, renegotiations among the owners may be necessary.
Owners' Agreement
Regardless of the nature of private company (e.g., a corporation, partnership, or limited liability company), it is best practice for the owners to have a carefully-drafted, clear and comprehensive executed written agreement that set forth the rights and responsibilities of the owners.
This agreement should address, among other things:
- How company decisions are to made; officer or manager roles;
- Transfers or sales of shares or member interests, whether through voluntary dispositions or in the event of an owner's disability, incapacity or death, to third parties, including first-refusal rights of company owners;
- Involuntary automatic sell back provisions given certain triggering events, such as breach of one or more contractual or other duties by an owner;
- How shares or interests are to be valued in each circumstance; when and how profit and other distributions are to be made; and
- Other matters concerning operations of the company and the rights and obligations of the owners.
Such additional terms may include restrictive covenants, confidentiality agreements and indemnity provisions.
Relevant to this discussion is how company decisions are to be made. The owners may agree that decisions are to be made by a majority of votes of owners with voting rights. Or they may vest managers with discretionary authority.
Importantly, the owners may decide that certain major decisions require a super-majority vote or unanimous agreement. The agreement will typically define what constitutes a major decision.
Examples are the hiring or termination of key officers and employees; executing contracts of a certain type or above a particular dollar amount; entering into contacts or taking actions that are not in the ordinary course of business; and any other matter that the owners consider to be sufficiently important to require more than a mere majority vote.
It is reasonable that the decisions companies must make during the COVID-19 pandemic and the concomitant financial turmoil may be major decisions and/or decisions not in the ordinary course of businesses for the company. If the shareholder, operating or partnership agreement includes a unanimous consent rule, the owners may take action if all agree. Certainly, the possibility of deadlock looms.
The agreement will likely include a dispute resolution provision that operates in certain circumstances. It may cover disputes concerning particular matters or it may be triggered upon the occurrence of certain asserted events, such as a contractual, fiduciary or other breach by an owner.
These provisions commonly require arbitration to be used. Some may even specify the arbitral forum to oversee the process and procedures will govern.
Resorting to Statutory Relief
If there is no agreement among the owners or the agreement does not address the issue at hand, an owner may need to seek relief under relevant state statutes. For example, if there is a deadlock among management such that the affairs of the company cannot be continued, a shareholder or LLC member may petition a court for dissolution.
For example, as to New York corporations, Business Corporation Law Section 1104 enables shareholders who own one-half of all votes of outstanding shares to petition for dissolution if (1) the directors are so divided respecting the management of the corporation's affairs that the votes for action required by the board cannot be obtained; (2) the shareholders are so divided that the votes required for the election of directors cannot be obtained; and/or (3) there is internal dissension and two or more factions of the shareholders are so divided that dissolution will be beneficial to the shareholders.
Business Corporation Law Section 1104-a is available to holders of shares representing 20% or more of all outstanding shares and allows for dissolution in the event of illegal, fraudulent or oppressive actions toward the complaining shareholders or property or other assets of the corporation or being looted, wasted or diverted for non-corporate purposes.
Similarly, for a New York limited liability company, LLC Section 702 allows a member to petition for dissolution if it is not reasonably practicable to carry on the business of the LLC in conformity with the articles of organization or operating agreement.
It is possible but, not assured, that an owner in personal financial distress will be able to use such statutory mechanisms to force a dissolution of the company.
Conclusion
To respond in the current pandemic and financial turmoil, companies will need to make difficult decisions. While some owners may seek to continue with the business of their company, others may desire to leave it, for personal or other reasons. Hopefully, all who seek to weather the storm will see their businesses survive.
Stephen L. Brodsky is a partner at Kaufman Dolowich & Voluck LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
For a reprint of this article, please contact reprints@law360.com.
