Family Business Divorce: When Litigation Is Your Only Recourse
Family businesses can be an optimal way to pass on and preserve family heritage. When the family works cooperatively in their respective best interests to effectively run and manage their businesses and assets, they usually win.
Often, however, family members don’t get along. According to a Businessweek.com article, only about:
- 40% of U.S. family businesses are transforming into second-generation businesses
- 13% are successfully transmitted to a third generation
- 3% reach a fourth generation or beyond
Recently, a client came to me with a particularly interesting legal challenge, steeped in complex ownership structures and exacerbated by serious family friction. The client believed that some siblings had caused a family manufacturing business to make distributions to some family member shareholders, but not others. Furthermore, the client believes that these siblings were not accountable to shareholders and partners of other related family businesses and caused these entities to engage in certain actions to the detriment of other family members. The client’s goal was to be bought out of the family businesses rather than become entangled in disputes between family members. Although it seems like a simple task, it is not due to the following issues:
- Each of the family businesses is owned by a different subgroup of family members.
- Some of the family businesses are LLCs, some are corporations, and some are partnerships.
- Numerous transactions between family businesses have had an impact on the valuation of each company.
- Siblings and family members don’t get along at all.
- The social and accounting registers of each of the family entities are sparse.
So how do you start with such a complex legal quagmire?
We started by collecting all the important information about what the company has been doing for the past five years. In some cases, this has required the filing of actions to enforce the rights of directors and shareholders to inspect corporate records. We were then able to persuade a representative from each faction of the family to participate in a mediation that resulted in an agreed valuation of each of the family businesses, a reconciliation of certain unaccounted past transactions, and ultimately a mutually agreeable purchase. – out of the client’s interests.
However, having resolved similar disputes such as these over the past decades, here are other possible remedies the client should have considered if a buyout could not be completed:
- Seek the appointment of an independent board (which does not include family members) for each of the entities to make impartial decisions on behalf of the owners.
- Request an involuntary dissolution of family entities.
- Filing lawsuits for breach of fiduciary duty, negligence and corporate waste against the various board members and officers of the entities to compel resolution = business divorce litigation.
Fortunately, despite the complexity of the family business and the bickering between family members, they were able to find a mutually agreeable solution to the problem without filing a lawsuit. However, this probably wouldn’t have been possible if the various family factions hadn’t been guided by strong legal counsel and agreed on a third-party mediator to help them resolve the issues. While we are always ready for business divorce litigation, we can also provide valuable advice and often the assistance needed to resolve complex issues without litigation.