by Patrick Dahm, consultant at Samuel Seow Law Corporation (via AsiaLawNetwork)
Here’s a harsh truth – when people extend their familiar or friendly relationship to a business environment, corporate trouble beckons, sometimes even disaster. A common scenario is that of family members, friends or fellow students starting a business with great ideas but without great (or any) legal agreements.
As something turns sour, having insufficient (or no) contracts in place to deal with internal feuds and impending fall-outs only complicates matters.
What can you do without a good contract?
Short answer: get one. Easier said than done, but nothing is impossible. If you are facing any of the issues listed below, know that it’s still worthwhile to try to get things right by way of contract and to repair your strained relationship with your business partner.
Here are ten common causes of conflicts within small businesses that arise from not having proper contracts in place that I’ve heard about, and suggestions on how to deal with them.
#1. Your business partner has used his company shares as collateral for a bank loan.
She has done so without your consent. Now she defaults on the loan and the bank is forcing the sale of her shares.
What to do: If you were entertaining the idea of buying out your partner, here’s your chance.
But if you must keep the setup as it is, for example because your partner’s vital contributions, you may have to step in as some kind of white knight to fend off the bank dragon. This doesn’t mean you’ll help your business partner for free. She’ll have to compensate you one way or the other. For example, if you undertake for your partner’s debt, or a part of it, so that the bank will leave the shares alone, you should make sure, by way of a binding agreement, she won’t think this is a freebie for her.
#2. Your business partner is ‘moonlighting’.
Your business partner is spending much more time and effort on his side business or projects. You end up having to deal with most of your company’s affairs on your own.
What to do: If he’s running a side business competing with your business, you might have to toughen your stance. In a market economy, no law will prohibit competition as such. But law does commit some people to extreme loyalty to a company. They are called fiduciaries; the directors of a company, for example, have fiduciary duties. So if your partner-with-a-side-business is a director of your company, there’s a chance.
But let’s assume it’s not that bad. In that case, you should assert to your partner that as he is contributing less to the business, it is only fair that he will receive less of the business’ profits from now on. And no, he can’t have his initial investment back.
#3. Your business partner (the majority shareholder) vs You (the minority shareholder).
You feel your business partner is undervaluing your contributions to the business. She even disrespects your position by taking corporate measures without your knowledge or consent, for example by holding of extraordinary general meetings without invitation and making resolutions at those meetings.
This is serious as it concerns the integrity of your business entity. It is illegal for a majority shareholder to steamroll the minority. Even if your contributions to the business were entirely negligible (not saying they are) and your voting rights are irrelevant, you still have basic rights. For example, the shareholders of a company have the right to take part and hear what’s going on at shareholders’ meetings. The court has the power to vary or even cancel an unfair shareholders’ resolution. As I said, this is serious.
What to do: If your business partner needs to work on his appreciation of your contributions, you may feel like showing her by reducing your efforts for a while. Be careful, this might not be legit under your agreement with her, which is an agreement you might have. Yes, having verbally discussed in the past who will do what may have led to a binding agreement, and so may your implied conduct.
#4. Your business partner is a rolling stone.
Either by disposition or because the job demands it, your business partner likes to move around and seldom spends a long time in one place. You realise there’s a real risk he could make himself scarce in a (legal) dispute.
What to do: You may need a process agent who will accept deliveries on behalf of your business partner no matter where he is. If you ever need to serve anything to him, for example a writ of summons or originating summons, properly serving this document on his process agent will ensure this document is deemed served on your partner.
#5. Your business partner is facing life-altering events.
Major changes in your partner’s life have kept her from focusing on the business. Perhaps she is having a baby, or more unfortunately, fallen seriously sick. As it is, she is no longer willing or able to contribute to the business as much as she used to.
What to do: If your partner’s contributions are crucial to the business, you should encourage her to come back as soon as she can. In the meantime, you may want to draft an employment contract for her to ensure she’ll be available part-time, or occasionally, or on an ad hoc basis.
#6. You want your business partner to leave.
You think that letting go of your partner would be for the best due to his poor work ethic, unprofessional behaviour or any other reason.
What to do: You can provide an incentive for your partner to surrender what he owns of the business by buying him out. You could offer him cash for his shares, but if that’s not an option, you could present him the prospect of sharing, for a while, future profits the company will make without him. Sounds odd, but it can be the price for someone to go away and not bring in his untalent any longer. If deep in his heart he does understand, he’s likely to seize the opportunity. Especially when you won’t allow him to lose face.
#7. Your business partner wants to leave with his industry expertise.
Your business partner has second thoughts about her involvement in your joint idea of running a business together. Unfortunately, her contributions are crucial to the success of your venture.
What to do: If she really wants to part ways, don’t let yourself stand in her way. Isn’t it for your best, too, in the long run? Chances are you can start anew, in the same line of business or another. In many, many cases, an honest separation agreement which provides for a clean break will help commercially.
#8. You want to leave with a key employee.
It’s not your business partner; it’s you. Your exit is complicated by your wish to take with you a key employee, especially someone who was initially scouted by your business partner.
What to do: Legally, this is not a problem if there are no proper contracts in place. You’re not bound by a non-enticement/non-hire clause, and the key employee isn’t bound by a non-competition clause. But beware, is it a moral thing to do? Sometimes it is, sometimes it isn’t. In any case, you always meet twice in life.
#9. Your business partner passes away and is replaced by his heirs.
Your business partner has bequeathed his shares in the company to several heirs. You become the only shareholder in the company unrelated by blood and find your position threatened.
What to do: Threatened? Why? Hasn’t the death of your partner just catapulted you into the position of a majority shareholder? Well, maybe, but that doesn’t mean you have carte blanche. We’ve established that minority shareholders have basic rights and, to put it crudely, many minority shareholders have many basic rights.
You must manage your many new co-owners due to their potential to shake up the business. Set clear expectations on whether they’re supposed to be involved in the company’s operations and whether they’re supposed to have the right to make commitments on behalf of the company.
The law makes it quite clear (co-)owning a company is not the same as (co-)managing its business. But where you’re confronted with a strong sense of entitlement in your fellow shareholders, you might have to bring this message across effectively, ideally without burning the bridges. Beyond that, you may have to inform customers and other stakeholders about who’s at the helm – and who isn’t.
#10. Your business partner passes away and is replaced by his heirs’ heirs.
To make matters worse, a few of your business partner’s heirs have also passed away since, and now their part of the shares is inherited by their heirs. Instead of that one partner with whom you used to run the business, you now have a plethora of partners near and far, some of whom you don’t know (and perhaps never will).
What to do: Consider who among your partners ought to receive invitations to general meetings and how to distribute your business’ earnings among your shareholders. Not easy if no one knows who all the shareholders are, so you should sit everyone down at a meeting and clarify who owns how much of the business.
A solution to problems like these may lie in establishing trust or escrow structures. Of course, it’s preferable to deal with existing, available and identified counterparts. But even where you can’t get hold of your partner’s heirs’ heirs all and sundry, a trust structure or a contract for the benefit of third parties might help. Complicated, but less complicated perhaps than having last year’s resolutions challenged because your company didn’t invite all the shareholders properly.
Let there be no shadow of a doubt: it will always be better to pre-empt or, where possible, prevent the above or similar scenarios by way of clear and distinct agreements among all parties involved. If the opportunity to do so has been missed, it’s rarely the end of the world. As long as you realise this will only be the second-best solution. After saving what could be saved your company will feel different. If it had to shed many feathers, chances are it will look different too. But wasn’t it Odin who said: ‘If you get up one more time than you fall, you will make it through’?
Patrick Dahm is a lawyer and consultant at Samuel Seow Law Corporation. He was assisted in this article by AsiaLawNetwork.com content strategist Joseline Yu.
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