Breaking Up Is So Very Hard To Do: The Importance of Shareholders’ Agreements

“Make it easy on yourself”, the hit single by the Walker brothers, not only resonates with love struck couples, it rings true for family owned businesses, because “breaking up is hard to do.”  Just ask the Berkowitz and Demoulas families. They kept lawyers busy for several years while their clients had nightmares.

Even a well drafted shareholders’ agreement for orderly transition of management may not necessarily avoid litigation, but it can be of immeasurable value both to the wrongfully terminated family member, and to the majority who want to squeeze out recalcitrant shareholder. Absence of a shareholders’ agreement often beckons litigation.

States, including Massachusetts, treat closely held corporations like partnerships.  Shareholders owe one another a fiduciary duty of utmost good faith and loyalty, the standard that partners owe each other.  The Donahue line of cases recognizes that majority shareholders in a closely held corporation have an opportunity to oppress, disadvantage, or “freeze out” minority shareholders.  One freeze out tool is to terminate a shareholder’s employment.  But if less drastic remedies are available and not tried first, such as a warning, counseling, or a reasonable opportunity to correct behavior, the terminated shareholder may sue both the company and the majority shareholders for breach of their fiduciary duty.  Courts recognize that employment is the only real source of economic return for a shareholder’s investment in a closely held company.  Termination of employment, therefore, is often the weapon of choice used by the majority which can have drastic financial consequences for the terminated shareholder.  A well drafted shareholders’ agreement may head off litigation by clearly delineating responsibilities, providing due process, and a code of behavior which allows for termination for cause.  Termination of a minority shareholder without cause is likely to precipitate long and costly litigation.

A properly crafted shareholders’ agreement treats the consequences of the death, disability, share transfers, and mid-life crises of the principal owners.  It should also consider involvement or lack of involvement of the founders’ children, alternative dispute resolution (i.e. mediation/arbitration), clearly defined lines of responsibility of the principals, how shares should be valued in the future, and other factors unique to the particular family.

Litigation should be a last resort to resolve disputes.  In addition to a shareholders’ agreement, business owners can make it easier on themselves by listening (and then listening some more) to other family members both inside and outside the family business. Open communication to disseminate and share ideas and information among family members in the business helps to avoid the creation of silos. Silos impede the sharing of information; isolate family members from each other; create suspicion; foster paranoia; and provide launching pads to “attack” when conflict arises.  The result can be MAD (Mutually Assured Destruction) through an unwanted sale, merger, dissolution or bankruptcy with all the rancor and angst that accompany them.

“Make it easy on yourself” and engage a lawyer sensitive to family issues and who knows the value of proper legal documentation for closely held entities. She should also believe that litigation is not the answer, but rather a consequence of a family’s unfortunate dysfunction that could be avoided with more open communication and appropriate legal and organizational structures to motivate communication and avoid silos.

If litigation is the only remaining course, be sure to engage a capable trial lawyer experienced in family disputes, because “breaking up is so very hard to do.”

“Make it Easy on Yourself” was the Walker brothers’ first big hit. You can hear it on YouTube http://www.youtube.com/watch?v=bZTS9H-l5qQ to reminisce about the 60’s, or learn what your boomer parents enjoyed when flower power was stronger than the power of the gun.