Mixing family with business is famously problematic, yet it is still quite commonplace. Consequently, so is litigation arising from the family business.
A family divorce can be just as emotionally and financially taxing as a matrimonial divorce. Indeed, family business disputes are plagued by the failure to document ownership rights and are inherently personal and emotional. For these reasons, family business divorces commonly result in protracted, and costly, litigation.
Blood is Thicker Than Water – Not Always!
The Failure to Properly Document the Business Relationship
What we see most commonly in our practice is that the original business deal between the family members wasn’t documented, so when things go awry, the parties have no clear agreement governing their rights and obligations.
Naturally, when a family business is first formed, the parties are excited about their new business and fully trusting of their family member-turned-business partner. However, it is best to proceed with cautious optimism, treating the family business as you would any other business agreement. Unfortunately, once money is involved, blood isn’t always thicker than water.
While a verbal understanding between two brothers might be good for one generation, what happens when those brothers pass their business interests along to the next generation? What was a successful, conflict-free arrangement between the two loving brothers can evolve into a contentious relationship between numerous cousins who all have differing interests, work ethics, and objectives – and no documentation.
Even drafting an agreement as the first generation passes the company on to the next is often difficult. Thus, is is imperative that the family business is formed and organized properly from the start, and that the business terms are properly and fully documented.
Without a formal agreement governing the business relationship, any minor dispute that arises has the potential of becoming a costly legal battle to determine the parties’ rights and obligations. For example, what are the parties’ expected contributions – both financial and “sweat equity”? What are the parties’ roles or job functions? How do profits get distributed if the business succeeds? How do losses get allocated if the business struggles? What if additional financial contributions are required during the course of operating the business? What is the succession plan? These are just a few examples of the issues that could lead to a major dispute between the parties.
While New York law provides certain statutory mechanisms for dissolution of a corporation in the event of a conflict, the grounds for dissolution are far more restrictive for limited liability companies. Therefore, absent contractual rights to rely upon, separating from the family business becomes even more difficult in those cases.
Personal Conflicts and Emotions
Sibling rivalry takes on a whole new meaning when it is part of litigation. Once emotions are involved, even the savviest businessperson may stop thinking logically and instead be driven by feelings of anger, revenge, and spite – all of which add to the already-costly litigation. We frequently wear our “therapist” hat when resolving these matters to help our clients get through the emotionally difficult decisions involved.
Oftentimes, the parties will cut off their nose to spite their face (in a vindictive attempt to cut off their relatives’ nose) in the context of the family business divorce. A straightforward business dispute that might have otherwise easily settled for a nominal cost can be dragged out with years of litigation, costing the parties tens (or hundreds) of thousands of dollars in legal fees, simply because family member A doesn’t want to give family member B the satisfaction of getting their way.
While is is a seemingly impossible task to remove the emotional factor from the family business divorce, good counsel, incorporating basic common sense, and also understanding the psychology of those involved, can save your client thousands of dollars in legal fees.
This article was reprinted with permission from the Suffolk County Bar Association.