Advising Clients in Wind-Downs, Separations and “Business Divorce”: How to Use ADR and Other Tools to Steer Business Owners Through a Break-Up of a Closely-Held Business

10 Min Read By: Joseph T. Janochoski

Adversity in business is a frequent occurrence; disagreements arise, personalities clash, and goals diverge as companies grow and change over time.  Sometimes that adversity leads to a need to winddown or separate business interests, which can be a thorny subject for lawyers and their clients.

These so-called “business divorces” typically involve complex legal and personal issues—many of which have not been anticipated by the people involved—that may or may not be the subject of any written agreements between the business partners.  An average business divorce case can include a myriad of issues that touch on subjects like corporate governance, fiduciary duties (and the attendant responsibilities), contractual obligations, fluctuating and varied expectations of owners (particularly in a family environment), employment law issues, trade secrets and sensitive information, non-compete law, business valuation and a variety of tax issues.

As if that were not enough, this whirlpool of issues is often agitated by varied state statutes governing dissolution or buy-outs, which may offer additional remedies (or, in some cases, restrictions) to an allegedly aggrieved shareholder.  Given this complexity, it is often the case that parties facing such a dispute will be well-served by at least attempting to mediate as an alternative to lengthy, expensive—and, frankly, risky—litigation.  Mediation allows parties to craft outcomes that are acceptable, certain, and advantageous in terms of cost and time, and its informal processes permits the use of independent experts, customized resolution of small and large issues (in a less adversarial environment, no less), and potential repair to damaged relationships.  While almost always complex, using the tools of mediation (or other ADR formats) provides attorneys with unique ways to advise their clients in the winddown or separation of closely-held businesses, which in turn allows all parties to the dispute to move on with—and into the next chapter of—their lives and control their future without involvement of a court.

Beyond the usefulness of mediation in general, it is important to remember that is also likely the cheaper option for clients.  As in most business disputes, each side of the case wants to maximize the value of their business interest; in doing so, however, many fail to consider the impact of the cost of litigation (particularly where claims that give rise to indemnification obligations are involved), or the impact of that cost on a potential sales transaction or other business transactions.  By considering those costs—and recognizing that resolution may maintain the value of the business for all parties—the use of alternative dispute resolution methods such as mediation in business divorces can save all parties a lot of time, money, and headaches.

The variety of issues that can arise in a mediated business divorce is impossible to catalog completely.  However, several key considerations (particularly during a global pandemic) are important to keep in mind whenever advising clients in a mediated winddown or business divorce.

1. The personalities of the partiesemotional and family barriers to resolution.

While “big” personalities can exist in other areas of the law, nowhere is that truer than in closely-held business disputes.  Many closely-held businesses were founded by a single individual with sole ownership, or by close friends or family members who shared ownership (sometimes equally, sometimes not).

These individuals often have intense personalities and emotional investment in the dispute (for many, it’s a business they’ve spent their lives working in or around), which means that disputes regarding their closely-held businesses often have an emotionally-charged backdrop to battle.  Siblings may disagree as to who should take over a family business, what ownership interests should be, and who should take over which role in an enterprise that may have been handed down through a family for generations.  Similarly, friends may have a falling out—sometimes over the business, sometimes over other things—and begin to dislike each other.  This, in turn, can impose serious ramifications on the business operations—and even the long-term value—of the business.

One party may feel they deserve a larger share of the business (or higher compensation) or more control to compensate for their involvement in the day-to-day activities of the business, while another may believe their longer-term ownership and contributions of capital entitle them to a majority position or veto rights, despite a lack of day-to-day involvement.  One owner may want to sell the business, while the other may not; one may want to sell off certain divisions or lines of business, while the other may want to take an all-or-nothing approach.  Given the personalities—and intense emotions—that can permeate a closely-held business dispute, any good attorney advising their clients in such a dispute must master not only the facts of the dispute itself, but the character and nature of the personalities in play, all while constantly considering each parties’ goals and desires.

Resolution may only be accomplished if each party feels heard, respected, or at least acknowledged, and understands that in order to resolve a case, emotions must be set aside, and a business deal must be reached.

2. Earn-out and valuation date disputes in a changing world.

In a mediated settlement—particularly one that has only been reached in principle—changing world circumstances may cause the implosion of an otherwise solid deal.  Recently, the COVID-19 pandemic has provided an unprecedented example of just how much can change in a short period of time: in a matter of months, the world’s economy ground to a halt as the virus raged around the planet. New variants continue to pop up, and it is unclear exactly how long the pandemic will have a major effect on the world economy.  The effect such a change can have on a mediated settlement in principle cannot be understated. For example:

  • The parties may have agreed on a particular valuation date or method to use in valuing company interests for the purposes of a buy-out. A massive change like a viral pandemic could necessarily alter the parties’ desires surrounding what valuation date to use; for those selling, the use of a date that results in a higher return on investment is obviously appealing, but for those buying, a date that reflects changes in the true value of the ownership interests they are purchasing is necessarily more attractive.  Of course, the precise industry in which the business sits also plays a role in these kinds of negotiations: is there potential upside because of the pandemic (i.e., a closely-held biological testing business may have a more profitable valuation date during and after the pandemic than it did before), or has an eviscerated business suddenly made a turnaround by capitalizing on a sudden return by the workforce back to an office environment such that an earlier valuation date is still acceptable?  Compromise may be the only method by which such a change can be evaluated and weathered.
  • The financial data informing a business divorce will likely have changed during a pandemic: sales may dry up, assets may need to be sold, and a business might have to restructure itself to avoid significant (or even fatal) losses, depending on the industry. At the same time, some business enterprises may greatly benefit from a pandemic; a buy-out of a restaurant in a pandemic is going to look a lot different than a buy-out of a streaming service.  Moreover, future plans for capital expenditures, expansions, or changes to the company’s financial forecast will necessarily alter the parties’ expectations surrounding a buy-out; a pandemic is no exception and will likely exacerbate those issues.  Acknowledging the need to adjust expectations as the world changes is critical to ensuring a mediated settlement for a buy-out in principle survives.
  • The structure of any buy-out—i.e., will it be a lump sum payment or payments spread out over time, the mechanics of the share transfer, whether earn-outs will exist, and the text of the agreements themselves—must take into account changing world circumstances. Some businesses (see, e.g., movie theaters) likely could not afford to provide a lump sum payment for a buy-out of ownership interests during a pandemic.  A shipping logistics company, on the other hand, might have just had its best year ever, and a lump sum payment would actually be the preferable route to take (where it may not have been before a pandemic).

3. Special considerations depending on which side you represent.

When representing a minority owner in a business divorce, it is important to keep several key factors in mind, including when a mediation is threatened by changing business circumstances.

  • Always remember the purpose behind governing state statutes and common law: to protect and provide adequate remedies to minority shareholders. These statutes often focus on concepts of fairness, reasonableness, and equity, which become even more apparent in the context of changing global circumstances.
  • A changing world means changing goals; you should also remember that the goal of reaching a mediated settlement (or keeping a settlement in principle alive) is to balance the need for a permanent resolution/separation of business interests against continuation of a viable business for the remaining owners. Why pay the lawyers to litigate the separation when you can use those same funds to fund the business divorce?
  • As previously noted, the emotions of minority owners may run high, particularly where a majority owner has acted in a way that either is or could be perceived to be unfair towards the minority owner. Resolution will often depend on removing emotion from the terms of a deal—at least in part—and a good lawyer must also remember to keep their client from getting greedy or overreaching in their demands of a controlling shareholder—i.e., revenge is not usually a financially sound objective.

Representing a majority owner in the same dispute comes with a host of separate, but equally valid and important considerations.

  • Controlling owners will need clear, expansive, rock-solid written agreements that set forth expectations of the parties moving through a mediated deal. This principle is even more important when global events shift economic considerations in a short period of time; the need for certainty in a time of change is often critical to advising an owner that will continue to own and operate a closely-held business after a separation event.  This certainty needs to be present in valuation decisions, as well as decisions on the precise structure—and reasons for the structure—of the deal.
  • In salvaging a potential deal from a mediation that has been impacted by changes to the world economy, remember that the majority owner is attempting to maximize business interests. This requires consideration of methods to ensure as much of a return on investment as possible, while accounting for the need to avoid making lowball offers or using unfair negotiating tactics with the minority owner.  A changing world economy impacts everyone; remembering that point—and helping an otherwise headstrong client understand it—could be the difference in whether a deal succeeds or collapses.
  • Like minority owners, the emotions of a majority owner may also run high. The individuals involved could view minority owners as seeking to fleece the company (particularly where some owners are involved in day-to-day operations and others are not). It is equally critical to work with a controlling owner to set emotions aside as best they can to reach a business deal.

Ultimately, mediation is an excellent medium through which parties can resolve emotionally charged, legally complex wind-down or business divorce disputes, particularly in the context of a rapidly changing world.  Careful consideration of the parties’ emotions, the history of the parties’ relationship, and the subject business’s position in a changing economy all play a part in helping guide parties to an effective resolution.  Moreover, the lens through which a party views a dispute can also change based on whether they are a majority or minority owner; savvy counsel will take the time to help a client focus on the business or practical interests involved, instead of letting emotional weight lead to unreasonable demands, overreaching, or baseless stubbornness.  By considering these issues, a good lawyer can help their client (and, in fact, all parties to a dispute) reach a cost-effective mediated resolution of a business divorce in a changing global economy.

By: Joseph T. Janochoski

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