Winding Up Investments Gone Bad From A Business Perspective

December 27, 2012    

BIRMINGHAM BUSINESS LAW BLOG

Sometimes, despite management’s best efforts to make the business succeed, the business fails. Sometimes, because of management’s insistence on personal gain, the business fails. Sometimes, the two are commingled. Regardless, the result is the same. The company does not perform up to par, and the expectations of return need to be adjusted downward or possibly written off entirely. The reasons for business failure are numerous – market failure to materialize, regulatory burden change, lack of capital, partners sleeping with people other than their spouses, completely incompetent management, and/or failure to appreciate the challenges of a new endeavor and increased competition. These reasons and numerous others often contribute to the derailment of otherwise splendid ideas.

If you are the management, go back and review the articles that talked about getting investors. Did you treat your investors in an upright and forthcoming manner? Did you keep your investors apprised of the risks? Did you give them good updates? If so, congratulations. I cannot guarantee that you are going to come through unscathed, but you are starting from a good position. Now is the time when, unfortunately, you need to cash in your goodwill and start again. Swallow your pride and unravel your mess. If you have not been forthcoming or if you have used funds for personal gain, hold onto your hat and get a lawyer because your investor(s) may not be so forgiving.

If you are the investor, then be realistic about the company’s value. Figure out what your rights are from a legal standpoint and proceed accordingly. I am not advocating not holding people accountable or letting people off the hook. However, what I am advocating is making a calculated decision based on a fair value of the company with the inclusion of fees. Money, not emotion, should dictate your course of action. Did you invest more than you could afford to lose in a small private company? If so, you should have known better.

If you are an employee owner, you face a more daunting challenge. The analogy often used in these situations is that of the leaky lifeboat. Three people are on a lifeboat that springs a leak. One of them must get off. The senior partner owns the boat. Does the junior partner or the associate take the jump? In this situation, there are a million different reiterations, twisted story lines, and could haves/should haves, but the situation is almost always the same: the organization cannot support all of the people. These are difficult situations because, inevitably, someone is going to have to changes jobs, possibly even careers. However, if the partners remember that at one point they thought that working together would be better than working separately, and then work to unravel the web that they have woven, they can usually get out of a bad situation.

These events are often referred to as business divorces, and just like martial divorces, they can get ugly and messy. Sometimes, however, just like in martial divorces, if both parties behave themselves, the matter can be resolved quickly (i.e. a no fault divorce). As with divorces, if a business divorce is prolonged typically the only people who win are the lawyers. Rarely do both sides enter into these proceedings with clean hands. Both sides should do everything in their power to avoid a protracted dispute.
More so than in any other area dealt with in these topics to date, maturity in these situations by all parties pays enormous dividends.

There is a role for lawyers in the process. As things go sideways, having an understanding of the legal situation vis-à-vis one another is enormously helpful. Understanding the various clauses, understanding the applications of various duties, understanding the points of possible disagreement, and understanding the relative positions of the parties is essential in order to have an informed choice of which direction to take.

Additionally, as you move forward, if the parties are not seeing eye-to-eye, having counsel to understand the legal impact of business decisions is essential. Can I raise my compensation? What happens if I take on this debt? Can I hire this grossly unqualified person who happens to be my sister? Often, at the outset of conflict in a business, a cause of action for minority oppression does not exist. Only after the conflict has festered does a party take an action that forms the basis for a legal remedy. Involving counsel may not prevent a lawsuit, but it can certainly help identify actions that may increase the likelihood of a fight.
And yes, lawyers can fight for you. At some point, these disputes go to litigation. Indeed, much of commercial litigation surrounds fights with people who have ownership in various entities. While a business lawyer may be able to provide guidance at first, eventually when you go into litigation, you will need a litigator.

That said, and as a final point, I will say that I do hold people accountable for their choice in attorney. These conflicts are often slow moving disputes – not because of a slow court system but because the dispute itself is typically a festering situation. Accordingly, the parties will try to resolve the dispute themselves. Eventually lawyers are brought in. If, at this point, you bring in a scorched earth trial attorney, you are sending one message. If you bring in a business lawyer, you are sending another message. If you bring in your fraternity brother friend lawyer, you are sending another message. You may, for a variety of reasons, want to send that particular message. However, you need to realize that you are sending a message, and you need to make sure you are saying what you meant to say.

Mike Goodrich
Goodrich Law Firm, LLC

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