DEALING WITH A NON-PERFORMING PARTNER
May 21, 2015
By James Forrest and Jeff Wolfe
Our clients at the Forrest Firm range from young startups to well-established, long-standing companies, and everything in between. They vary in size, type, years in business, and industry. But no matter the company, many business owners share some of the same issues.
One of those issues, which we get asked about very often, is how to handle a non-performing business partner—or deadbeat, as some put it. Getting rid of an owner in a closely held business can be one of the most difficult aspects of business management. Without proper upfront planning for conflict, there may be few options to remove a non-performing partner without significant time and expense.
Taking Proactive Measures
When we help our clients start their companies, we generally advise them to err on the side of caution and be proactive in executing written agreements regarding owner disputes and buyouts. These guidelines can be part of a corporation’s bylaws or an LLC’s operating agreement.
Another option is to draft a separate buy-sell or shareholders’ agreement and have it signed by all owners. A buy-sell or shareholders’ agreement outlines an owner’s recourse if disputes arise and under what conditions you can force a non-performing partner to sell his or her interest back to the company.
Generally, most business decisions—including one involving a non-performing partner—can be made by a majority vote of the owners. Therefore, if a non-performing partner is impeding the effective operation of the business, a business can still move forward in making decisions without this partner’s consent.
In some cases, however, there is no way to secure a majority vote—such as a 50-50 split in ownership or a specific decision requires an approval threshold that must include the non-performing partner. In addition, even if decisions can be made without the non-performing partner, the other owners may still desire to buyout the non-performing partner’s ownership interest for various reasons.
Staying Out of Court: Arbitration and Mediation
It is often the best choice to try to resolve partner disputes through direct negotiation. If the partners are not able to reach an agreement, you can bring in a neutral third party to help achieve an equitable resolution through binding or non-binding arbitration or through mediation. The differences in these types of alternative dispute resolution are subtle but very important. With binding arbitration, the parties agree beforehand to comply with the award issued by an unbiased third party. The decision is issued at a hearing at which both parties have an opportunity to be heard.
Non-binding arbitration is also conducted by an unbiased arbitrator, but the parties involved are under no obligation to abide by the arbitrator’s award. In this case, the award is essentially an advisory opinion of the respective merits of the parties’ cases. On the surface, this seems very similar to mediation. The principal distinction, however, is that a mediator will help the parties involved find a middle ground where everyone can compromise, whereas the arbitrator remains totally removed from the settlement process. Using a form of alternative dispute resolution to solve your problem can help save time and money, and also prevent the situation between partners from becoming hostile.
Court: The Last Resort
In extreme cases and as a last resort, you may have to file a civil suit to enforce the terms of an agreement. This tactic is normally used only when a partner fails to abide by your company’s written dispute policy or exit strategy. If you don’t have a written agreement, your case will be governed by the default provisions of the business statutes in which your company is located. In most states (including North Carolina), owners of partnerships or LLCs can bring a court action to dissolve the company or force a buyout if the dispute is irreconcilable.
Whether you’re just starting up your business, would like to put a written agreement among owners in place for an existing business, or have an ongoing dispute that needs legal intervention, the attorneys of the Forrest Firm are here to help. Certainly, no one enters a business partnership with the expectation that a dispute will arise. But, as with most legal matters, it’s best to protect yourself upfront or bring in legal guidance to help resolve the dispute.