7 Tips to Avoid Litigation In a Family Owned Businesses in Massachusetts
This guide offers 7 tips for Massachusetts family owned and other closely held businesses to avoid disputes and decrease the risk of costly and sometimes devastating litigation.
Create and Adhere to Strong and Clear Governance DocumentsIn Massachusetts, G.L. chapter 156C governs LLCs, but LLCs are creatures of contract and so the LLC's Operating Agreement may modify and trumps the provisions of the statute. G.L. c. 156D governs corporations, but some exceptions, may be modified by the corporation's governing documents.
In either type of entity, the governing documents are critical and must be carefully considered and crafted for each new business. Form or boilerplate governance documents and agreements should not be used to save time or money.
A non-exhaustive list of important areas for the governing documents to address includes:
-Classes of ownership and shareholder/member voting rights, powers, limitations
-Who will manage the business (Directors/Managers) and their powers, duties and limitations
-How directors or managers are selected, how they may be removed or replaced
-How and for what purpose capital calls may be made, any limitations, and a procedure for making and fulfilling them, as well as consequences to owners who do not participate
-An agreement on when and a formula for how much will be paid out in distributions
-A process for valuing, buying and selling ownership interests and restrictions on transfer of ownership interests
-Provisions for indemnification and advancement
-Inspection and copying of documents
-Definitions of and policies for engaging in related party transactions
-Policies for presenting and pursuing corporate opportunities
-Employment of owners and hiring of family members
-Limitations and amendments to the documents
Of course, it is not enough to create thorough governance documents. The business and all involved must follow them. Otherwise, decisions made and actions taken will be vulnerable to challenge. Failure to follow formalities may also jeopardize the corporate or LLC form and expose owners to liabilities for the entity's debts.
Agree on a Comprehensive Buy/Sell AgreementMany disputes arise when a minority owner wishes to divest itself of its ownership interest and either there is no provision for the owner to do so, or there is significant disagreement about the value of the minority owner's interest (and the application of discounts for lack of marketability/minority interest). Or both.
The best way to avoid or decrease the risk of this type of dispute becoming the impetus for a lawsuit is for the company and its owners to have a clear buy/sell agreement that anticipates a sale of a minority interest, as well as other transfers. The agreement may spell out how and when shares may be transferred, any restrictions, rights of first refusal and, importantly, a method for valuing the interest, including any discounts that will applied, among other things.
Be as Transparent as Possible and Get Owner Agreement for Major Decisions.Owners are often unpleasantly surprised to learn they do not have unfettered access to the company's records and information. Massachusetts General Laws chapter 156C and 156D govern what information a limited liability company (LLC) or a corporation must provide to owners, but governing documents can provide broader rights.
Whatever the governing documents or the statutes require, transparency and inclusiveness will go a long way to avoiding unwarranted suspicions and mistrust from outside owners. If owners are kept apprised of financial performance, business plans and strategy, significant hurdles and opportunities and are included in major decision-making (to the extent possible without jeopardizing the business), management and the company are less likely to be accused of keeping owners in the dark, operating for the management-owners' benefit and to the detriment of outside owners, or other wrongdoing. It also allows managing owners to learn of and address any objections to the extent possible before proceeding.
Institute and Follow Policies for Nepotism, Related Party Transactions and Corporate OpportunitiesThree areas that often trigger lawsuits are nepotism in hiring and promotion, related party transactions and usurpation of corporate opportunities. To reduce the risk of disputes that turn into lawsuits, the entity's governing documents can spell out policies and procedures related to each and require strict adherence to them.
This could include criteria for the hiring or promotion of relatives and friends of owners, policies for the company to engage in transactions with owners and other insiders and a procedure for an insider to present business opportunities to the company and to obtain consent to pursue any opportunity the company does not wish to pursue itself.
Keep Business and Personal Expenses SeparateOne simple rule that protects both the company and its form as a corporation or LLC and also protects managerial owners is for all owners and other insiders to keep their personal and business finances and expenses separate. Also, owners should not lend money to the corporation or borrow from it without giving the same terms and opportunity to all owners and without having and following a clear policy for doing so.
Enter into Employment Agreements with Owners who Work in the BusinessTo avoid uncertain claims of owner's right to continued employment, the company may wish to memorialize terms of employment of owners in an agreement, even if it is an agreement for at-will employment. Expectations for performance and conditions of continued employment, advancement, compensation, bonuses, discipline and termination should be clearly addressed.
Avoid Deadlock or Plan for how to Deal with itIf a company is deadlocked - meaning, decision-making is impossible because the decision-makers are tied 50/50 or otherwise unable to meet the required voting threshold to make a decision or take action, the business suffers.
In Massachusetts, the only statutory fix for a deadlock in a corporation is judicial dissolution if certain criteria are met. Chapter 156C provides for court-ordered dissolution of an LLC upon application of an LLC member "whenever it is not reasonably practicable to carry on its business in conformity with the certificate of organization or the operating agreement."
But dissolution is unlikely to be desired in most cases. If a company is profitable or the owners otherwise wish to carry on the business, the remedies available in the event of a deadlock will be left to the court's equitable powers (in litigation) or the agreements made in the governing documents.
Uncertainty and harm to the corporation can be avoided by including a method to break deadlocks in the governing documents. While owners may sometimes break a deadlock at the director/manager level, if they are unable to do so, other alternatives should be available. This may include agreement on or a process for appointment of a provisional director/manager - a neutral third party who participates in deadlocked decision-making to break the tie.
Other ways to deal with a deadlock include providing for a buy-out by one owner of another, removal and replacement of officers or directors/managers, and/or requiring an accounting with respect to any matter in dispute.
Whatever method is chosen, this should not be left until there is mistrust or bad blood. All involved are best served by dealing with it up front when there is trust and optimism.