Over the past 20 years, I have been involved in countless disputes and litigations adversely affecting the owners of small, closely held advisory firms. The purpose of this column is to address some of the primary causes of such conflicts and to provide some recommendations to help mitigate them. To get the answers to these issues, I asked my partner, Scott Unger, who has counseled many advisory firms in ownership divorce matters throughout the country.
Many times, conflicts between the owners are caused by changes in personal relationships, Unger said. Changes in personal relationships caused by misunderstandings, growing apart, or differences in work ethics and opinions have led to strife amongst shareholders, and can, if not amicably resolved, lead to shareholder litigation. Like marriage, the relationship between shareholders requires work. It is unrealistic to expect that shareholders will agree on every decision. The key to avoiding major discord is to work with one another and to listen to the other’s point of view.
An aging or ill shareholder may produce other circumstances conducive to dissension. For example, a shareholder with diminished mental capacities caused by disease or advanced age may be taken advantage of by one of the other shareholders. Moreover, the diminished owner’s weakness may be seized upon and utilized to squeeze out the aging member. In addition, litigation may be caused by an aging shareholder who refuses to relinquish control. Aging founders who are accustomed to running the company their way may regard the corporation as their own property. Sometimes as the founder of a firm ages, he or she may become more tyrannical. That, of course, could lead to discontent.
To avoid problems caused by an aging or ill shareholder, Unger recommends that the shareholders discuss and create clear-cut retirement rules, disability and deferred compensation arrangements, which are put into place when the founder and all shareholders are healthy. If the shareholders are also employees, Unger recommends that you speak with an employment lawyer to make sure that the proposed rules do not run afoul of state or federal employment laws.
In addition, it is important that the aging or ill shareholder’s family know and understand the established rules before their relative is confronted with diminished capacities. So as to avoid potential controversy, if there are any questions related to the capacity of the aging shareholder at the time these rules are established, it is prudent to seek a qualified health care professional who can provide an opinion as to the competency of the elderly or sick shareholder at the time of adoption.
The death of a founder or principal shareholder can also lead to ownership problems. Whenever a shareholder dies, the decedent’s block of shares may be divided amongst several people, which increases the chances of an incompatible shareholder acquiring an interest in the company. The unequal division of a majority shareholder’s stock between the testator’s children may serve as a catalyst for dissension, especially where the terms were unknown prior to the decedent’s death. To prevent dissension caused by the death of a shareholder, Unger strongly recommends that the owners establish a succession plan.
Financial reversals and tough economic times often exacerbate problems that otherwise might not have led to a squeeze-out. Financial difficulties, like those resulting from the current economic environment, often lead to discontent amongst the shareholders. Sometimes this results in shareholders fighting about compensation. Unger strongly recommends owners set parameters for how owners are compensated.
Most importantly, in order to mitigate adversity resulting from the above events, it is critical for owners to establish written procedures for compensation, succession and buy-out that clearly spell out the terms of how to address and resolve any such occurrence.