Too often, entrepreneurs (who intend on starting the next IPO) pay little to no attention to their organizational documents. This is quite intriguing, as it is similar to buying a house, and not paying attention to whose name is on the title, or what is in the covenants, conditions, and restrictions or neighborhood association bylaws; or getting married and not discussing prior to such marriage who will pay the mortgage.Continue Reading Business Partner or Spouse? Why Organizational Documents Are So Important
Last week, the Dallas Court of Appeals overturned a $98 million trial court judgment, which was based on a jury finding that BBVA USA (BBVA) had defrauded one of its commercial borrowers. See BBVA, et al. v. Bagwell, et al., Dallas App. Ct., No. 05-18-00860, December 14, 2020).  The appellate court concluded the jury’s verdict had to be reversed because, as a matter of law, BBVA’s borrower could not have justifiably relied on allegedly false statements that had been made to the borrower by a representative of the bank. The Court’s holding and its focus on the element of “justifiable reliance” as a contractual defense to a fraud claim provides valuable guidance for private company majority owners in regard to their relationship with their minority business partners.
In light of the Bagwell decision, this post reviews key provisions that majority owners may want to include in their company governance documents to avoid future claims that may be made against them by their minority co-owners for fraud and/or for breach of the fiduciary duties that majority owners owe to the company acting in their capacity as governing persons. These provisions can be included in the company’s governance documents—in the by-laws of the corporation or in a company agreement for LLC’s—and they concern matters that frequently become the subject of disputes between private company co-owners.
Withholding of Profits Distributions/Dividends
One frequent area of conflict between majority owners and minority investors concerns the issuance of profits distributions. Private companies are typically “pass through” entities in regard to income taxes, which means that the business does not pay any taxes on the income that it generates and all taxes on the company’s income are paid by the business owners based on the percentage of their ownership interest. While majority owners may routinely issue distributions to the company’s owners to cover the amount of their tax liability that is attributable to income generated by the company, majority owners will want to retain flexibility to decide whether or not to issue profits distributions and, if so, in what amounts.
Continue Reading BBVA USA Receives Holiday Gift From Dallas Appellate Court: The Decision Includes Guidance for Private Company Owners
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.
Continue Reading Dispute Resolution for Business Partners: The Arbitration Option—Know When to Hold ‘Em, When to Fold ‘Em, and When to Walk Away
By Brad Monk
People change, and not always for the better. Which leads to the question: what is the best course of action when a trusted business partner turns out to be a rotten egg? The answer is not easy, but usually the best course of action is to promptly remove an untrustworthy partner from ownership in the business and also from participation in the company’s management.
Removal Provisions Need to be in the Governance Documents
The process of removing a bad business partner is often unpleasant and difficult, but it is likely unavoidable. To prepare for this type of risk, diligent majority owners will want to include “removal rights” in the company’s governing documents (the LLC agreement, the partnership agreement, or corporate bylaws) that provide for the removal of business partners who go off the rails. By the same token, minority investors will want to closely review all “bad boy” provisions to insist on changing these terms if they give the majority owner unbridled power that could be used abusively to harm the minority investor.
Continue Reading Be Careful With the Rotten Egg: Removing a Bad Business Partner From the Company is Difficult
Just as an excessively lavish desert can ruin a fine dinner, including an overly broad indemnity provision in a private company agreement can prove to be too much of a good thing for the company. The point of indemnity provisions is to protect company executives (e.g., officers, directors, managers) from claims made against them in the good faith performance of their duties. To ensure the net is broad enough to include all types of claims made against executives, however, these clauses are often drafted quite broadly. But when the provisions are so inclusive they exceed their intended scope, another truism may apply—the cure may be worse than the disease. This post discusses the effective use of indemnity provisions in private company governance documents and reviews potential drawbacks that can result when these provisions are drafted without appropriate limits.Continue Reading Too Much of a Good Thing: Avoiding Unwelcome Results From (Too) Broadly Drafted Indemnity Provisions in Private Company Governance Documents
In the Harry Potter universe (now returned to playing on Broadway), the wizarding world greatly feared the Dark Lord, Voldemort. In the business world, minority investors in private companies should rightly fear the power of majority owners who have the power to amend the company’s governance documents. Minority investors in Texas privately-held companies often assume—understandably, but wrongly—that their equity stake cannot be taken for little value by the majority owner(s). Minority investors further assume, naively, that if the majority owners suddenly changed the company’s rules to take minority investor’s stock or LLC units, the investor would have some sort of legal recourse and a strong claim to pursue against the majority owner.
But, the little-known and alarming reality is that, under Texas law, if minority investors are not careful to limit the “right of amendment” contained in the company’s governance documents, majority owners have the right to effectively pull the rug out from under minority investors. Using this amendment power, majority owners may be able to change the company’s bylaws or revise the terms of the LLC company agreement to remove minority investors as managers, directors and employees, and just as importantly, deprive minority investors of the fair market value of their ownership interest in the business.
Continue Reading The Amendment Power: Voldemort May Not Have Had This Power, But It Is One to be Feared by Minority Investors in Private Companies