Sunday, December 18, 2011

Benjamin Franklin's Words of Wisdom For Closely Held Businesses

Most of my practice currently consists of representing businesses in disputes with their insurance companies and helping international companies do business in the U.S. However, I started my career as a general commercial litigator, handling everything from banking and securities litigation to product liability cases. Although my current firm represents many larger companies, we also represent many middle market companies and family businesses. One staple in this area is what I loosely call the "corporate divorce." 

Corporate divorces happen when business partners (I use the term in the general and not purely legal sense) no longer get along. Perhaps there is a difference in where to take the business. Perhaps one partner has worked hard and built the business when the other has been content to sit back and share in the profits. Perhaps animosities have built over personal issues that really have little to do with the business. 

Often, these animosities divide life long friends and family members. The resulting disputes can be every bit as acrimonious and destructive as a marital divorce. The primary reason that these disputes develop is because the partners never contemplated that their interests would diverge and consequently never planned for it.

One of the greatest citizens that America ever produced was Benjamin Franklin. Before Franklin achieved success as a civic leader, scientist, inventor and diplomat, he was a successful businessman, a printer by trade. Franklin achieved success by hard work and through developing successful alliances and partnerships. Franklin set up a number of his apprentices in their own printing businesses, seemingly without disputes or disagreements. Here is Franklin's advice from his famous autobiography:

"Partnerships often finish in quarrels; but I was happy in this, that mine were all carried on and ended  amicably owing, I think, a good deal to the precaution of having very explicitly settled, in our articles, every thing to be done by or expected from each partner, so that there was nothing to dispute, which precaution I would therefore recommend to all who enter into partnerships; for, whatever esteem partners may have for, and confidence in each other at the time of the contract, little jealousies and disgusts may arise, with ideas of inequality in the care and burden of the business, etc., which are attended often with breach of friendship and of the connection, perhaps with lawsuits and other disagreeable consequences." (Franklin's Autobiography is in the public domain and is available free in's Kindle store).

Franklin's clear and concise advice rings as true today as it did when it was written over two hundred years ago. While technology will change and new businesses will be started and others will become obsolete, human nature is still the same. If you are in a closely held business, whether it be a start-up, small, medium, or large, Franklin's words are some of the best free advice you will ever receive.

Here are a few other thoughts on how business partners can avoid, as Franklin so aptly put it, "lawsuits and other disagreeable consequences":

1. 50/50 is almost never a good idea. Many friends and family members envision a "50/50 partnership" as the ideal business arrangement. Although it may seem like a good idea when the business is starting and goodwill among the participants abounds, 50/50 partnerships seldom end well. When disagreements occur, which they will, 50/50 partnerships result in automatic deadlock, with no way to move forward. Note that, in my experience, there is a direct positive correlation between the success of this business the the likelihood of a dispute. If the participants are unable to agree on a resolution, the only legal solution is often the appointment of a receiver to take control and run the business and sell it or dispose of its assets. Not a happy result.

2. You need an exit strategy from the get go. If you are involved in any venture with more than one investor, you should have an exit strategy in your operating agreement, shareholder's agreement, or partnership agreement from the very beginning. There are numerous options, but typically such provisions provide for one party buying the other out based on an agreed metric. 

3. If you did not document your business arrangement properly at the beginning, do it now. If, as is so often the case, you started a business venture without documenting the relationship among the participants, and there is still good will among the participants, do it now. Just because things are going well now does not mean that harmony will last forever. View the present cordial circumstances as a second chance to do when you should have done when you started the business.

4. Bring in new "partners" carefully. Often, businesses will want to bring in an individual as a "partner," perhaps as a reward for loyal service or perhaps to provide an incentive to a new participant viewed as valuable to the business. Although the concept of an "equity kicker" may seem like a good idea, keep in mind that it creates an additional level of risk and entanglement. Consider other forms of rewards in the form of structured bonuses, etc. If you do bring in a new partner, have an exit strategy if things do not work out.

5. If there is a dispute, see an experienced lawyer sooner rather than later. If things seem to be going south, see an experienced lawyer sooner rather than later. The sooner that a dispute can be resolved the better. Business people almost always, in my experience, underestimate the toll in time, distraction, and human energy that a dispute will impose on a closely held business. Be careful in selecting a lawyer. If all the lawyer can talk about is the fight and taking it to the other side, that may appeal to your raw emotions, but it rarely makes for a quick or relatively painless resolution. Be open to the possibility of mediation, as it is often the best (and least public) way to resolve disputes.

Saturday, January 1, 2011

A Great New Year's Resolution for Your Business: A Legal Check-Up

By John L. Watkins

One of the best New Year’s Resolutions any business can make is to have a legal checkup. The idea of a legal checkup (sometimes called a legal audit) is to identify potential legal risks and issues and to take proactive measures to resolve or minimize them before they become expensive problems. The nearly universal rule is that it costs less to resolve a legal issue early on - such as through a proper contract prepared with professional assistance - rather than trying to address the issue later, such as through litigation.

The best legal checkups are customized for each business. The legal issues faced by a start-up will be different than those of an established larger business. The legal risks of a trucking company can be quite different from those of a software company.

If a business has in-house counsel, then in-house counsel should coordinate the review, with the assistance of outside counsel as necessary. If a business does not have in-house counsel, it should have a continuing relationship with an outside business attorney, who can handle the work.

Each legal review should be customized, but here are some of the issues to be considered. The items are listed starting with issues that are more frequently faced by small companies and then proceeding to issues more frequently faced by medium-sized or larger companies.

• Has the business properly maintained its registration with the secretary of state or other authorities? Failure to maintain registration (at least in some jurisdictions) can result in dissolution, which can in turn lead to a loss of corporate liability protection.

• Does the business maintain proper corporate or company records? Are corporate minutes and resolutions, for example, maintained and up to date? Failure to maintain proper records may put the corporate liability shield at risk.

• Does the business properly maintain financial records? Are loans from shareholders or members properly documented? Are corporate financial expenditures segregated from personal expenditures? If there are multiple corporations, are separate books and records carefully kept for each company? Again, failure to maintain proper financial records may place the corporate liability shield at risk.

• Does the business have a professionally drafted set of terms and conditions under which it does business? Do the terms and conditions properly limit risks, such as by disclaiming implied warranties and limiting remedies? Have the terms been reviewed recently?

• In addition to customer terms and conditions, are supplier terms and conditions properly documented? Are subcontractor terms and conditions documented? Do suppliers and subcontractors assume an appropriate level of risk in relationship to the transactions? Do suppliers and subcontractors have sufficient financial resources and insurance to back up their obligations?

• Does the business have procedures for protecting confidential information and trade secrets? Are employees who handle the information subject to non-disclosure agreements (“NDAs”)? Do suppliers, contractors, subcontractors or customers have access to the confidential information and trade secrets, and, if so, are they also subject to NDAs? Have the NDAs been professionally prepared and recently reviewed?

• Does the business have other intellectual property in the form of patents, copyrights, and trade secrets? Is the intellectual property carefully managed and protected? Are procedures in place to make sure that deadlines are met and fees are paid?

• Does the company have in place proper security and privacy procedures for its information technology? Has the company determined if there are any special regulatory requirements for data storage, security, or privacy applicable to its industry? Does the company outsource any of its IT, such as to a cloud computing provider? If so, has the company performed proper review and due diligence of the provider’s technology and procedures? Does the contract with the cloud computing provider protect the company’s interests?

• Does the business periodically review its employment and employee benefit procedures? Do key employees have employment contracts with appropriate covenants (which may include, depending on the circumstances, covenants not to compete and non-solicitation covenants)? Have employment contracts been recently reviewed and updated?

Note: There are important changes to Georgia law. Employers in Georgia should, in particular, consult with an employment attorney regarding the changes.

• Has the company carefully assembled and reviewed its insurance coverage? Does the company really know what is covered and not covered? Have the policy limits been reviewed for adequacy? Is there a procedure in place for reviewing endorsements that insurers may add upon renewal that may limit coverage? Have issues such as environmental liability, employment liability, and cyber liability been considered and properly insured? Does the company grant “additional insured” status to customers? If so, has the potential effect on the company’s aggregate policy limits been considered?

• Does the business have procedures in place for handling and documenting potential claims? Are potential claims reported promptly to the insurance carriers? Are claims tracked? Do the carriers and defense counsel provide periodic reports?

Please note that this is not intended to be a complete list, although it should provide a reasonable starting point. If you do not have an in-house attorney, the business should engage a regular outside attorney to learn about the company’s business and serve as a trusted legal adviser. If you do not know how to go about finding an attorney, check out my book, An Insider's Guide on Hiring a Business Attorney, which provides a step-by-step guide for finding, evaluating, interviewing, engaging, and working with a business attorney.