Thousands of corporations are established in the United States each year. The majority are closely held, with five or fewer shareholders. Most operate without a formal shareholder agreement, an oversight that can be fatal to businesses that survive their start-up and achieve success worth fighting over.

The Curse of Success
Success can breed disputes. For example, John Inventor conceives of a widget that he thinks will be hugely
popular. Without the resources to develop or market it, Inventor finds Mary Money, a partner to underwrite the project, and James Sales, who will handle marketing and sales. They establish a corporation to collaborate on the project. Cash is limited, and the partners fail to craft a shareholder agreement.

As business progresses, Inventor realizes creative differences with his partners. Inventor, Money and Sales each sit on the company’s board of directors. By a board vote, Inventor finds himself kicked off the board and terminated. Without a shareholder agreement, Inventor has no legal right to force the company or his partners to buy him out. Now, he has lost control of his idea.

Using this scenario, let’s assume a fourth partner, Betty Friend, exists and is aligned with Inventor. The four partners, equal shareholders, find themselves at an impasse. Two prefer the status quo; the other two seek another direction. Under these circumstances, a deadlock arises. The company becomes paralyzed, and the only ways to resolve the dispute are diplomacy or court.

Receivership and Other Formal Consequences
As shareholder disputes escalate, eventually one party files in court various claims including, but not limited to, shareholder oppression, breach of fiduciary duty and/or a petition for deadlock and dissolution. Pursuant to circuit courts’ powers, judges can appoint a receiver to marshal assets and manage businesses pending liquidation, order an in-kind distribution of assets or effectuate another resolution.

In this situation, the company’s fate lies almost exclusively with the court and its appointed fiduciary.

For most small business battles, costs usually exceed the actual amount in dispute and have a catastrophic effect. Prospects are significantly reduced even if the business survives litigation. Matters get worse with deadlock.

If authority is unclear, courts can take the company from the shareholders and appoint a receiver. The receiver acts as an extension of the court, and is typically charged with preserving the company’s assets’ value and overseeing the company’s orderly dissolution.

In most receivership cases, judges appoint lawyers to serve as the receiver. The potential results of receivership and the company’s future are dependent on the receiver’s background and experience.

Good Counsel
Accountants approached by clients involved in such disputes should recommend that clients consider alternative dispute resolution to contain the dispute and costs. Alternatively, the clients could engage a neutral third party to help resolve the dispute and operate the business. While shareholders may be unable to agree on certain matters, they should be counseled on the mutual advantages of controlling the dispute resolution process and minimizing litigation costs.

Disputes are an inevitable part of business, but heading to court to resolve them is not. Shareholders can retain control of their company during the dispute resolution process by selecting a facilitator instead of relying on the court, which will appoint a lawyer as the company’s de facto CEO.

A skilled facilitator will help the shareholders recognize that acts by the majority against a minority shareholder, even if technically legal, are not without consequence. Further, the facilitator can be instrumental in reaching fair and equitable buyouts of a minority shareholder, notwithstanding the fact that a shareholder may not hold the right to be bought out. In a deadlock, the facilitator assists in negotiating an equitable buyout or sale of the company’s resources to maximize shareholder value while avoiding litigation.

The facilitator will assist in an orderly resolution of the dispute with minimal disruption and at significantly less cost than through formal court receivership, while maximizing shareholder equity.

About the Author
Mark M. Snitchler is a partner at Beals Hubbard, PLC, in Farmington Hills, Mich. He practices commercial transaction and litigation, and has served as counsel to numerous corporations.

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