When times are good, many business disputes between shareholders, partners, or LLC members tend to work themselves out. If business is strong, the promise of profits brings parties to the table to settle their disagreements. To the extent one party wants out, it’s easier to come up with an equitable division of assets when business is humming. When times are tough, discord more frequently leads to business disruption. Accordingly, it’s in times like these, when the COVID-19 pandemic is wreaking havoc on the economy, that it’s important to make sure that your company’s operative documents are up-to-date and address key issues that may arise if your business experiences distress and the relationship among its owners is put to the test.
The Importance of an Ownership Agreement
You’ve heard the age-old advice before: Get it in writing. It’s imperative for every multi-owner business, no matter its structure, to have a written agreement in place that provides a framework for operating the business, making decisions, and navigating disputes among the owners.
Such an agreement, called an operating agreement, a partnership agreement, or a shareholders’ agreement depending on the business’ structure (this article will refer to such agreements, collectively, as “ownership agreements”), covers a range of important issues, including voting on important decisions, capital contributions to the company, guidelines for admitting new owners, splitting profits and debts, and the manner in which disputes between owners are to be resolved.
When a business is founded, optimism between owners is high and many overlook the importance of having a written agreement in place to address future contingencies. In some instances, owners simply use a form agreement that doesn’t address their unique circumstances.
For many business owners, operating according to a handshake deal or a poorly conceived ownership agreement works fine—until it doesn’t. Business conditions worsen. Relationships between owners deteriorate. Conditions change. And without a clear, thoughtful, and written agreement in place, owners have few means by which to resolve their differences. They are left to operate according to default rules established by state statutes, and often end up in litigation.
An ownership agreement is like an insurance policy—you don’t think you will need it, but it’s irresponsible, and potentially ruinous, not to have one in place to mitigate against risks. Once a dispute about important business issues arises, it’s too late to start thinking about conflict resolution procedures, such as those that are found in a strong, well-crafted agreement. Indeed, without an agreement in place, a dispute is much more likely to devolve into litigation since there’s no clear mechanism for brokering a resolution.
Common Provisions in an Ownership Agreement
It is important for business owners to work with an experienced business attorney to create an ownership agreement or revise an existing one. Doing so helps ensure that the agreement reflects the parties’ intent and the unique characteristics of the business. While every agreement is (or at least should be) customized to cover a business’ particular circumstances, common provisions address issues such as:
- Management of the Business: Who is responsible for the management of the business? How are decisions to be made? An ownership agreement should ensure that the roles and responsibilities of the owners are clearly defined.
- Meetings of the Owners: When are meetings to be held? What rules govern voting? What notice is required? By establishing clear processes and procedures for information sharing and decision making, a business can avoid disputes that often arise when an owner feels that he or she is being left in the dark.
- Capital Contributions and Ownership Division: An ownership agreement should clearly identify how much capital each owner contributes to the business and how ownership of the business is allocated among the parties.
- Profit Distribution: Not surprisingly, many disputes between owners result from disagreements over how and when profits are distributed.
- Transfers of Ownership Interests: One of the most important provisions in any agreement is determining how ownership interests may be transferred. Often, agreements will provide that purported transfers that do not adhere to the ownership agreement are treated as void under the agreement. Many agreements also include buy-sell provisions that determine the process of buying out an owner and how the purchase price for an owner’s interest is calculated.
- Termination of Ownership: Ownership Agreements should detail the terms on which the business can be terminated and how assets are distributed upon termination.
- Resolving Disputes: To help avoid litigation in the event of a dispute, many agreements provide for alternative dispute resolution such as mediation and arbitration.
Is Your Business Ready for the Unexpected?
These are volatile times. It’s hard to run a multi-owner business under any circumstances, and the COVID-19 pandemic has further complicated life for all of us. It’s not uncommon for business owners to experience disharmony, but keep in mind that a dispute does not mean a business breakup is inevitable. A well-crafted ownership agreement can provide parties with a framework for resolving disputes and getting back to business. And if a separation is inevitable, an agreement can allow owners to move forward in an organized and efficient manner, without public scrutiny or costly litigation.
If your business does not have an ownership agreement in place, now is the time to focus on this important priority. If your business has an agreement but it has not been reviewed in years, now is the time to dust it off. We have significant experience assisting clients in fashioning agreements that allow their businesses to run smoothly and help them to resolve disputes without resorting to litigation. For more information, please contact one of the Business & Tax department attorneys.
We have created a response team to the rapidly changing COVID-19 situation and the law and guidance that follows, so we will continue to post any new developments. You can view our COVID-19 Response Page and additional resources by following the link here. In the meantime, if you have any questions, please contact your Fraser Trebilcock attorney.
Edward J. Castellani is an attorney and CPA who represents clients involved with alcohol beverages as a manufacturer, wholesaler, or retailer. He may be contacted at ecast@fraserlawfirm.com or 517-377-0845.