Family-Owned Business Divorce: When Litigation is Your Only Remedy

Stradling Yocca Carlson & Rauth
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Stradling Yocca Carlson & Rauth

Family-owned businesses can be an optimal means for transferring and preserving family wealth. When the family works cooperatively in their respective best interests to run and manage their businesses and assets efficiently, they usually win.

Often, however, family members just don’t get along. According to a Businessweek.com article, only about:

  • 40% of U.S. family-owned businesses turn into second-generation businesses
  • 13% are passed down successfully to a third generation
  • 3% get to a fourth generation or beyond

Recently, a client came to me with a particularly interesting legal challenge infused with complex ownership structures and exacerbated by serious friction throughout the family. The client believed that certain siblings had caused a family-owned manufacturing business to make distributions to certain family member shareholders but not others. Further, the client believes these siblings were not accounting to shareholders and partners in other related family-owned businesses and causing those entities to engage in certain actions to the detriment of other family members. The client’s objective was to be bought out of the family businesses rather than become embroiled in litigation between family members. While this sounds like a straightforward task, it isn’t due to the following issues:

    1. Each of the family businesses is owned by a different subgroup of family members.
    2. Some of the family business are LLCs, some are corporations, and still others are partnerships.
    3. There were numerous transactions between the family-owned businesses impacting the valuation of each business.

In addition:

  • The siblings and family members don’t get along at all.
  • The corporate and accounting records of each of the family-owned entities is sparse.

So how do you begin with a legal quagmire this complex?

We started with collecting all important information regarding what the business has been doing over the past five years. In some cases, this required filing actions to enforce director and shareholder rights to inspect corporate records. We were then able to persuade a representative from each faction of the family to participate in a mediation which resulted in an agreed upon valuation of each of the family businesses, a reconciliation of certain past, unaccounted for transactions and, ultimately, a mutually agreeable buy-out of the client’s interests.

However, having resolved similar disputes such as these over the past decades, set forth below are other possible remedies the client would have had to have considered if a buy-out could not have been reached:

    1. Seek the appointment of an independent board (that does not include family members) for each of the entities to make impartial decisions on behalf of the owners.
    2. Seek an involuntary dissolution of the family-owned entities.
    3. File lawsuits for breaches of fiduciary duties, negligence, and corporate waste against the various board members and officers of the entities to compel resolution = business divorce litigation.

Fortunately, despite the complexity of the family business and the bad blood between family members, they were able to reach a mutually agreeable solution to the problem without filing lawsuits. This likely would not have been possible, however, if the various family factions were not guided by sound legal counsel and had not agreed upon a third-party mediator to assist them in working through the issues. While we are always ready for business divorce litigation, we can also provide valuable guidance and oftentimes necessary assistance to work through complex problems without any litigation as well.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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