This is the sixth in a series of articles discussing various issues related to privately-held businesses.
Gerry Dick Inside Indiana Business Editorial Series

Article Five – November 2007

The Business Divorce: Disputes Between Business Owners

The majority owner of a business concludes that his sales manager, who holds a 10% interest in the company, is simply not doing his job. After many unsuccessful attempts to solve the problem, the majority owner fires the sales manager, who sues, claiming that the majority owner breached the fiduciary duties owed between business partners. The majority owner counter-claims, making the same allegation. After many months of costly and distracting litigation, the judge forces the majority owner to buy the sales manager's 10% interest in the company.

Such litigation, which can be distracting and expensive, is becoming more and more common. Similar to a divorce between spouses, business partners often reach a point where they have "irretrievable differences" that prevent them from doing business together. They cannot resolve their own disputes, but they need someone to "undo" their business relationship and divide up the corporate assets (or, to extend the metaphor, the marital estate).

Litigation is a sledgehammer. It should be the last solution, only to be pursued if and when all other efforts at achieving an uncontested "business divorce" have failed. However, the failure of a business relationship, like the failure of a marriage, usually involves hurt feelings, bruised egos and clouded judgments, all of which are barriers to logical business solutions. While litigation is expensive, annoying and time-consuming, it forces owners to obtain legal advice, gives parties access to information, narrows the dispute to genuine factual and legal issues and resolves the parties' claims.

Common legal grounds for a lawsuit between business owners are actions for breach of fiduciary duty, breach of contract (if employment contracts, operating agreements, etc. exist), fraud and conversion of funds. When one owner sues another, it is common for the Defendant to assert his own litany of complaints by filing a counter-claim. As part of such litigation, owners should expect that the books and records of the business will be closely examined by attorneys and accountants hoping to find evidence of wrongdoing. All owners, and perhaps several third parties, will be required to testify, under oath, about how the business operated. Unless a settlement can be reached, a trial will occur. In other words, if either party has any dirty laundry, it will be aired.

If one of the parties proves that the other breached his fiduciary duties, breached the operative agreements, committed a fraud, converted funds to his own use or otherwise violated the law, the judge will determine what relief is appropriate. Usually, a monetary judgment will do little to resolve the dispute, as the parties will remain co-owners of the business. For that reason, courts have devised specialized relief to sever business relationships.

The most common type of relief granted is a forced purchase of the minority interest by the majority owner. In fact, the parties often agree that such a sale should occur, but cannot agree upon a price. In such a situation, the focus of the litigation becomes the value of the minority interest, and the most important debate is between opposing business valuation experts.

Other types of relief are possible as well. For instance, if the parties own equal shares of the business, the court might force them to make a sealed bid for each other's share, and award sole ownership of the business to the higher bidder upon payment of the bid. Also, the court might enter an order requiring that the business be sold to a third party, with the proceeds to be split among the owners pro rata. In this context, judges have wide discretion to craft creative solutions. Thus, while litigation is never the preferred option for undoing a business relationship, a "business divorce" can sometimes be achieved by filing a lawsuit.

Donald Snemis is a partner in Ice Miller's Business Litigation and Environmental Practice Groups.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.