Disputes Among Business Owners – Get Your Operating Agreement Done

• Todd Ellis
• Monday, January 14, 2019

I often tell my business clients that I am jealous of their entrepreneurial spirit and I admire the intestinal fortitude it takes to follow through on their idea to start a new business venture. While I own my law firm, it is not the same as starting up a new business with no license, new partners and the knowledge that the competition is trying to recreate your idea as soon as you launch.

These same business clients that possess the creative skills and business acumen to set a venture in motion are often the ones that are less prepared to have the important discussion on how to structure the relationship with the other owners. The business plan is thoroughly vetted but with little or no consideration for the rights and duties of the owners.

As a litigator and a mediator, I am used to contentious disputes being resolved through alternative dispute resolution or the court system. Some of the most difficult and expensive cases I have worked on in the last couple of years have been between partners or former members of a business venture. The matters are incredibly personal and often the financial future of the business and the partners are at stake.

Many of these cases could have been avoided altogether or certainly narrowed to a more reasonable set of issues to resolve if the parties had worked to craft even a reasonable operating or partnership agreement at the beginning of the venture. Whether the business does very well by year three or is having substantial problems after one year, owner disputes arise under all circumstances. I have drafted operating agreements for clients and have had success in heading off business disputes. However, much of my experience comes from litigating these issues. I advise clients that have more complex business structures to seek a tax lawyer or a business lawyer that more consistently structures these start-ups to do their operating agreements. I can recommend some for you or your clients but the following are a few steps I highly recommend business owners follow at the beginning of the venture:

1. Require the Tough Meeting

It is much easier for business partners to talk creative or development strategy than it is to talk about how their relationship should be set forth in an agreement. I give my clients a broad outline of issues to discuss before coming to see me. Often they have not gone through the tough partnership decisions when they want me to create the entity to begin their venture. If you have to, take them through a common operating agreement when they meet with you personally and require that they consider the tough issues while you take notes. That draft can lead to a much greater chance that they sign an operating agreement.

2. How Do I Get In, How Do I Get Out

Ask your client or partners, how do I get in the venture and how do I get out. Simply starting the conversation about how they see the entity going forward and when a partner can sell his interest will require a discussion about most of the contentious issues. Litigation often comes when a member of the entity did not know there were restrictions on how and when she can sell her interest. Whether they decide that it cannot be sold for a period of time or the partners agree that the interest must be offered to other members before being placed on the open market, these are terms that can set a path for the inevitable change in ownership.

3. Draws, Distributions and Employment Agreements

Many of the disputes I work on relate to vague understandings about what a member has to do, if anything, to earn his interest in the business. The lack of clear cut roles is a trigger for partnership disputes when the business is going well and when it is suffering. Anyone who has an active role in the operations of the business should have an employment agreement setting forth their duties and compensation. Employment agreements and the terms for payment of distributions or earnings in the business will take much of the resentment out of the monthly payroll and annual payouts.

This blog in no way covers all the important issues to be decided to start a business with multiple partners. How the business handles the death of a key partner or employee, how distributions at the end of the year are paid and a partners right to business documents are just some additional matters that should be discussed. The point is you or your clients should absolutely deal with these issues on the front end or someone will be calling a litigator in the future. If I can help you or your business clients with general business counsel or litigation issues, let me know.