Time and again, I am contacted by clients experiencing difficulty with their business partners, or fellow shareholders, and looking for a way out. The conversation usually results in a review of the company’s organizational documents. More often than not, we find the parties adopted boilerplate language in the Operating Agreement, Bylaws, or Shareholder Agreement. Many start up companies do not customize their organizational documents, due to lack of resources, blind optimism, or other reasons.
In most cases, when starting out, the parties sign the agreement, save it in a folder, and don’t look at it again until there is a problem. When they do, they inevitably find that the boilerplate (or statutory default language) that was adopted when the parties started their venture, was not followed, or did not conform to the understanding of the parties. Here are a few common clauses that can cause headaches down the road if they don’t reflect the parties actual dealings:
1. Capital Calls. Infusion of capital at the start of new entity is typically easy to agree upon. But what happens if one party invests more than the other? What happens if the company’s operating agreement has an extensive capital call provision that was not followed? The results may not be what the parties intended. It’s very important not only to understand these provisions, but also that they are clearly and articulately drafted so that they fair not only to those contributing, but also justified according to the agreement.
2. Executive Power. While an agreement may provide broad authority and allow a myriad of powers to the CEO or Manager of an LLC, parties need to be careful and not inadvertently cause a minority shareholder oppression claim. Courts have found minority shareholder oppression claims valid, even where the Executive’s power was specifically delegated for in the company’s written agreements. Ultimately the executive’s duty is owed the Company itself, and the level of authority exercised must be within the scope of that duty.
3. Employment of Shareholders/Members. In a closely held company, employing shareholders of the corporation, (or members of the LLC) is common. This becomes problematic when the shareholders, or members, are contributing to the company in different capacities, with different levels of input or output, or there are misunderstandings regarding compensation, dividends, or distributions. It is helpful to have these obligations memorialized in the Operating Agreement, Shareholder Agreement, or Employment Agreements for each owner. Describing the level of expectations for each owner, what happens if an employee is resigns or is terminated, and how they are compensated can avoid a lot of discord between shareholders. More often than not, I find these issues are not addressed at all leaving us to the default language treating all owners alike.
While it’s easy to look back and say one should have done x, y, or z – that’s the not helpful if you’re in the midst of a dispute. One solution is a review and overhaul of the existing agreements with the goal to modify them so that they reflect how the company is actually being run. Once we review these agreements, and as long as all, or a majority of the members agree (depending on what approval is needed to amend an agreement), documents can be amended to reflect the actual operations of the company.
If the parties are beyond a fix, it is likely inevitable that parties are en route to a business divorce. Consulting with a lawyer to help decipher what the agreements actually mean, and how they will be interpreted with the facts and circumstances at hand, is necessary to find a way out of the conflict.