Entrepreneurs launching new companies today take on a significant gamble, because statistics show that roughly 30% of all new start-ups fail within two years, and only half survive for a full five years. Many businesses fail due to the owners’ inability to meet the challenges of the marketplace, but some start-ups shut down when conflicts arise within the ownership group. Companies can go under over these ownership disputes even when their governance documents include dispute resolution provisions—if these terms fall short of keeping the business intact.
Given the many business risks that business entrepreneurs face, they should not also have to accept the gamble that a future serious conflict with their co-owners will torpedo the business. This post therefore focuses on dispute resolution terms that are designed to resolve ownership disputes, but which will preserve the continued operation of the business. While not fool-proof, the best mechanism for resolving ownership conflicts in our experience on a prompt, confidential and cost-effective basis is through a set of well-crafted fast track arbitration provisions. These arbitration terms are included in the company agreement (LLC’s), in the bylaws (corporations) or in the limited partnership agreement (limited partnerships), and they are discussed below.
Faster – Prompt Date for Final, Evidentiary Hearing
Litigation will often drag on for months and, in some cases, years, and at great cost. By contrast, arbitration is a dispute resolution procedure that is created by agreement of the parties, and as a result, the parties can choose to adopt a specific timetable in their arbitration provision that requires the final arbitration hearing to take place on a prompt schedule. The manner in which a fast-track schedule for the arbitration hearing plays out is described below.
After one of the parties files a demand for arbitration, the arbitration company, which is typically either AAA or JAMS, will assist the parties in selecting the arbitrator, or if the parties opted for a panel, a panel of three arbitrators, to preside over the dispute. Once the arbitrator or the arbitration panel is appointed, a scheduling conference will be held promptly, and the date for the arbitration hearing will be set at that time. If the parties require the hearing date to take place within a specified period in the arbitration provision, e.g., 60 or 90 days, the arbitrator or panel will enforce the parties’ agreement and adopt the schedule to which they agreed. In short, the parties will get what they bargained for, a prompt hearing with no delays/continuances.
Cheaper – Strict Limits on Discovery and Length of Hearing
The broad scope of discovery that parties are permitted to undertake in civil litigation results in a time-consuming and costly process that includes numerous depositions of both fact and expert witnesses, extensive written discovery and document exchanges and prolonged battles over discovery issues. Following this lengthy discovery process, the parties may face multiple trial settings and continuances and, finally, a trial that can last for weeks.
Arbitration would be just as costly and time-consuming a dispute resolution process as litigation if the parties did not impose any limits, but this dynamic can be changed dramatically if the parties choose to restrict the scope and extent of allowed discovery and also limit the length of the arbitration hearing. Specifically, the fast-track arbitration terms that we propose include all of the following limits: (1) the number of fact witness depositions (just 2-3 per side), (2) the number of experts designated to testify (1-2), (3) the number of written discovery requests that can be served (one set of no more than 15 individual requests for each set), and (4) the number of days that are allowed for the hearing (no more than 3) with each side to have an equal amount of time to present their evidence and argument.
These limits on the scope and amount of the discovery that the parties are permitted to obtain before the arbitration hearing and the restriction on the length of the hearing itself force the parties and their counsel to be efficient in all aspects of the case. Just as importantly, these limits are likely to result in a sizable reduction in the amount of the legal fees and associated costs that would otherwise be incurred in presenting the dispute for decision.
Confidential – Confirm Confidentiality
An important aspect of arbitration is that the parties’ claims and defenses, as well as the underlying facts of the dispute, are filed in a private forum, and they should thereafter be kept in confidence. The private, confidential nature of an arbitration proceeding stands in contrast to a lawsuit in which all of the parties’ claims, defenses and factual disputes are filed publicly and are available for review by the press and members of the general public.
For business owners concerned about the potential negative impact on their business if their claims and disputes with other owners are aired publicly, the opportunity to resolve these disputes in a private forum may be appealing. The company’s governance documents should therefore make clear that, under the fast-track arbitration provision, the parties need to maintain all claims, defenses and other matters related to the dispute in strict confidence and, if desired, the provision can also provide for economic sanctions against a violator of this provision.
Final, Enforceable – No Appeal and Converts to Judgment
The final point benefit resulting from arbitration provisions, including those that are not fast track is that, if the parties’ dispute is not settled in a prompt and businesslike manner, these provisions will result in an evidentiary hearing and, ultimately, a judgment issued and enforced by Texas courts. Moreover, the judgment awarded by the arbitrator or the arbitration panel will be both final and unappealable.
The upshot is that if the claimant does not prevail at the hearing on the merits of the claims presented, the claimant will not be entitled to secure a do-ever through a lengthy appellate process. Instead, the prevailing party has the right to convert the arbitration award into a final, enforceable judgment in court, which will be the case if the claimant is seeking to collect on any dollar amounts included in the arbitrator’s award.
No Perfect Solution
It should be noted that no dispute resolution system is perfect for every situation, and this includes fast track arbitration provisions. For example, if the business founder is already wealthy when the business begins, and the other investors are considerably less well off, the founder may want to require all disputes among owners to be litigated rather than arbitrated in the belief that having deep pockets will allow him/her to win a war of attrition. On the other side of the coin, investors who have little capital may not want to agree to arbitrate any future claims they may have against a wealthy co-owner if they believe the owner will not want to endure the adverse publicity from claims that are made against him/her in a public lawsuit.
These competing strategic considerations must be considered by the business owner and all investors in the company before they agree to adopt any dispute resolution provisions in their corporate governance documents.
The risks of entrepreneurship cannot be denied. Competition is fierce, customers are fickle and the marketplace is always changing. There is one thing that founders can do, however, to mitigate the risk of the company’s failure resulting from future conflicts with their partners, and which will allow for a prompt, cost-effective and final outcome of these disputes. Based on our experience handling ownership claims, the inclusion of fast-track arbitration provisions in the company governance documents provides the most optimal approach for effectively resolving these internal ownership conflicts.