Photo of Ladd Hirsch

lhirsch@winstead.com
214.745.5130

Ladd Hirsch is a solution-oriented trial attorney with more than 30 years experience representing companies and high net worth business clients in complex litigation cases and arbitration matters. Ladd is tenacious and pragmatic for his clients in both the courtroom and boardroom in seeking results that meet their short and long-term business objectives. Read More

Ladd has extensive experience prosecuting and defending complex business litigation matters, including disputes involving claims for breach of contract, business fraud, violations of fiduciary duties, breach of non-compete covenants, theft of trade secrets and business defamation. He has litigated claims arising in all of the following industries: real estate, manufacturing, oil and gas, healthcare, commercial lending, computer software and technology, construction, retail sales, insurance, multi-level marketing, beer distribution, food service, and video games.

Since the late 1990's, Ladd has focused a significant portion of his practice handling Business Divorce disputes and related litigation for majority owners and minority investors in substantial private Texas companies. In these Business Divorce matters, Ladd files and defends claims against fiduciaries (officers, directors, managers, general partners and trustees), including claims for breach of fiduciary duty, breach of the entity governance documents and shareholder derivative claims. In this Business Divorce practice, Ladd works together regularly with family law attorneys and their clients to assist them with a wide variety of business and complex property issues that arise in family law proceedings.

Ladd has tried cases to judgment in both state and federal courts, including federal courts located in New York and Chicago, and he has argued cases on appeal at both the state and federal levels in Texas. Throughout his career, Ladd has represented clients in business cases under hourly, contingent and hybrid fee arrangements. Ladd has also been retained in a number of matters by other attorneys to serve as an expert witness on the subject of recoverable legal fees.

As we noted in a previous post (Read Here), the disruption and dysfunction caused by a bad business partner who holds a substantial minority stake in the company can lead to the ultimate failure of the business.[1]  This is especially true when the company founder has no buy-sell agreement in place that will allow him/her to redeem the minority investor’s interest in the company. When the majority owner has no contract right to force the minority investor to exit the business, the owner’s options are essentially limited to: (i) going out of business and dissolving the company, (ii) selling the business to a third party (iii) or selling the majority owner’s interest to another party who will step into the owner’s shoes and take on the task of dealing with the minority investor.

None of these “end the business” options are likely to satisfy a company founder who worked very hard to bring the company to life. This post therefore considers options for the majority owner of the company to consider when no buy-sell agreement exists with the minority investor who has become a major stumbling block in the path to the company’s continued success.

Setting the Stage for the Exit of the Bad Business Partner

The bad business partner may believe that he/she has the upper hand in negotiations with the majority owner. Specifically, at the same time the minority investor is wreaking havoc at the company, the investor is refusing to be bought out or is demanding a grossly inflated price for the purchase of his/her minority stake in the business. In this situation, the majority owner may appear to be “stuck” with no recourse to force the exit of this bad partner and fix the problems the investor is causing at the company.
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Navigating a successful business exit when a marriage ends in divorce often presents challenges for both parties. Leaving aside the emotional tensions present in divorce, resolving conflicts regarding the ownership of business interests in the marital estate is also daunting. This post therefore reviews options for divorcing spouses to in their divorce proceeding. If couples can ratchet down the emotions and the acrimony, the tools discussed in this post may help allow the couple to optimize the financial outcome of their divorce settlement and preserve the value of the company they own or in which they share a large ownership stake.

The Valuation Dilemma

The most contentious business issue in many divorce proceedings is the value of the business that must be divided as part of the divorce settlement. Valuation is an inexact science, and the divorcing couple can easily spend hundreds of thousands of dollars on expert and legal fees battling it out over the value of one or more private companies included in the marital estate. This challenging issue is not subject to any easy fix. But there are some options the couple may want to consider before engaging in an expensive and time-consuming valuation battle.

(a) Marital Agreements.   Couples can eliminate the private company valuation battle by entering into a marital agreement that specifies what specific assets will be shared on divorce, or what amounts will be paid, and the agreement can also specific how the value of any assets will be determined. While a pre-nup is more common, couples can also agree to enter into a post-nup that details a property division and removes any conflict regarding the valuation of specific assets. Texas statutes set forth strict requirements to follow for marital agreements be enforceable. See Chapter 4 of the Texas Family Code

(b) Designated Valuation Expert. The couple can agree to pre-select and designate a valuation expert they both trust to conduct the valuation for them and to be bound by whatever value is determined by this mutual, trusted expert. Alternatively, there are variations on this approach, which give the couple the right to retain valuation experts if they don’t like the value that is determined by the designated expert and the results of these additional experts will then be averaged to determine the final value. 
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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.  
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It’s my party, and I’ll cry if I want to
Cry if I want to, cry if I want to
You would cry too if it happened to you.
Its My Party, by Lesley Gore

Almost five years have passed since the Texas Supreme issued its decision in Ritchie v. Rupe[1] in 2014 abolishing shareholder oppression as a claim under common law by minority shareholders in private Texas companies.  Specifically, in Ritchie, the Supreme Court eliminated a court-ordered buyout as a remedy for minority investors complaining of oppressive conduct by the company’s majority owners.  The legal landscape remains bleak for minority shareholders, and when the five year anniversary of Ritchie arrives in June, minority shareholders still have no legal remedy to secure a buyout of their ownership interest if they failed to obtain a buy-sell agreement or other contract exit right at the time of their investment in the company.

In this blog post, we will review efforts made to address the problems created by the Supreme Court’s holding in Ritchie, both legislatively and in the courts, consider how the predictions the Court made in Ritchie have played out, and discuss the state of the current legal battlefield between minority shareholders and majority owners in Texas private companies.

No Legislative Fix for Ritchie Has Been Adopted or is Pending

In the aftermath of the Ritchie decision, the Texas legislature took a run at creating a statutory fix to address the Court’s removal of a buyout legal remedy for oppressed minority shareholders.  In 2015, the year after Ritchie was issued, Rep. Ron Simmons, a second-term Republican from Denton County, introduced Bill 3168 in the Business and Industry Committee of the Texas House.  This proposed Bill would have applied solely to closely-held entities rather than to all private Texas companies, and the provisions of Bill 3168 were broader than the pre-Ritchie state of the law.

More specifically, as originally proposed, Bill 3168 would have granted broad statutory powers to Texas trial courts, including the right to appoint a “fiscal agent” to report periodically to the court on the operations of the business.  This new type of statutory agent is different than a receiver and would likely be more akin to a monitor. In addition, the Bill intended to provide the oppressed minority shareholder with more than a buyout right as it authorized shareholders to pursue a claim for a dividend to share in the retained earnings stockpiled by the company, as well as the right to recover damages from the majority owner and/or board members who engaged in oppressive conduct that was shown to be harmful to the minority shareholder.
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In her thoughtful column in the January edition of the Texas Bar Journal titled, “Do You Suffer From Impostor Syndrome,” lawyer coach Martha McIntire Newman, focuses on a topic that has too long flown under the radar.  Ms. Newman describes this condition as “a state of chronic self-doubt that causes lawyers to fear they will be exposed as incompetent even though the evidence of their success is obvious to their colleagues and clients.”  TBJ, Jan. 2019, p. 56. TopLawyerCoach.com   This anxiety causes even “successful lawyers to second-guess themselves no matter how well they perform.”

The Impostor Syndrome discussed in Ms. Newman’s column is not limited to the legal field.  We have encountered many business owners, executives and entrepreneurs who have struggled, at times, with crippling self-doubt.  Ms. Newman quotes former Starbucks CEO Howard Schultz: “Very few people, whether you’ve been in that [CEO] job before or not, get into the seat and believe today that they are now qualified to be the CEO.  They’re not going to tell you that, but it’s true.”  For business leaders who face doubts resulting from the Impostor Syndrome, this post offers three suggestions to consider in addition to the sage advice provided by Ms. Newman.
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Conflicts with business partners are not just a serious distraction for majority owners of private companies, these ownership disputes can be expensive, time-consuming and harmful to the long-term prospects of the business.  The start of a new year is therefore a great time for majority owners to consider whether there are steps they can take to head off disagreements with business partners. Fortunately, the answer is yes, and this post looks at New Year’s resolutions that majority owners may want to consider that will lessen or completely avoid these ownership conflicts.

The Sweat Equity Problem

The first New Year’s resolution majority owners may want to make is to decline to issue  “sweat equity” in the company.  Sweat equity refers to the grant of an ownership stake in the company to employees or outside consultants who provide services to the company, but who do not provide any financial capital for their interest in the business.  Sweat equity is granted most often by new or emerging companies that are short on cash, and they therefore issue stock rather than paying compensation for the services needed.  In other cases, owners provide sweat equity to longtime employees as part of a succession plan.
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When a private equity (PE) firm buys the controlling interest in a private business, the purchase often includes an earn-out provision which calls for the owner to remain active in the business for some period of time. The use of an earn-out provision can seem like a win-win for both parties, because it allows the PE firm to buy the company for a lower purchase price and provides the business owner with the opportunity to secure a substantial additional payment if the company achieves certain agreed financial performance targets after the sale.  The problem with this rosy picture is that earn-out provisions are a common cause of disputes and litigation over whether the earn-out requirements were met after the purchase and whether the owner is entitled to the additional payment.

This post focuses on conflicts that frequently arise between PE firms and owners over earn-out provisions and suggests changes for both PE Firms and owners to consider, which may reduce or eliminate these post-purchase conflicts.  
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In the private company world, the buck stops with the majority owners, who generally hold the reins to running the business.  In our experience, however, it is not uncommon for some majority owners to push the limits of their control by engaging in self-dealing transactions that are for their own benefit.  The self-interested transactions in which majority owners may engage can take many different forms, including paying excessive bonuses to themselves, directing the company to enter into “sweetheart” deals with their other companies, taking company opportunities for their own gain, and using company assets or personnel free of charge.

When minority investors seek legal recourse from abuse of authority by its majority owners, the controlling owners will often point to a little-known Texas statute, which they contend renders them immune from liability for their actions.  See Texas Business Organizations Code § 101.255.  As we say in Texas, that dog won’t hunt.  This post explains why the existence of Section 101.255 does not provide majority owners with a “get out of jail free” card, and why this statute does not validate their improper conduct when they engaged in self-dealing.
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The statistics are grim on relationships remaining intact between business partners.  This month’s edition of Inc. magazine cites Noam Wasserman, entrepreneurship professor at USC’s Marshall School of Business, reporting that 10% of co-founders end their business relationship in less than one year and 45% break-up within four years.  While these statistics are focused on two-person owned companies, break-ups are at least as common among businesses with multiple owners.  Faced with these distressing figures, this post focuses on concrete actions that business partners can take at the outset when their company is formed or when an investment is made, which our experience teaches will improve their prospects for maintaining long-term business relationships.

Operational issues and the vision for the company can definitely lead to disputes, but in many (if not most) cases, the crux of the conflict between business partners comes down to a disagreement over money—how the financial pie will be split.   Our suggestions therefore key on how the company’s finances are handled.  The starting place is to put an exit plan in place at the outset of the relationship —a Buy-Sell agreement that governs any future Business Divorce.  This “corporate pre-nup” will help avoid litigation and a huge distraction for the company when a partner departs.  We have written extensively on this topic in previous posts (see links below), and adopting a partner exit plan is essential.

But the Buy-Sell Agreement only comes into play when business partners are separating.  There are three specific steps that partners can take when their relationship begins, which will help limit their conflicts and, perhaps, avoid the need for a Business Divorce in the future. These steps are: (1) adopt a dividend/distribution plan, (2) implement an executive compensation plan or formula and require annual valuations of the company prepared by an independent business valuation firm.  Each of these actions is discussed below.
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July 2018

A search for the perfect buy-sell provision for use by private company owners and investors may be akin to hunting for a unicorn, because the business objectives of majority owners, on one side, and minority investors in the business, on the other, are rarely, if ever, fully aligned.  But, if this search is limited to focusing solely on the terms of a buy-sell provision that addresses the critical business concerns of both majority owners and minority investors, that task is not beyond the rainbow.   What is clear is that majority owners and minority investors share an interest in putting a buy-sell agreement in place at the start of their business relationship.  This post therefore covers the essential terms that owners and investors will both want to consider in a provision that strikes a balance in a mutually acceptable buy-sell agreement.


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