May 23, 2019
It is not uncommon to have a business entity with several co-equal partners each with their own assigned job within the corporation. What is even more uncommon is when the corporation has one or more partner that does not do his or her job leaving the other partners not only disgruntled but having to carry the ‘lazy’ partner. More often than not the disgruntled group of partners will get together to terminate the ‘lazy’ partner’s interest in the company however; they usually do it the wrong way and wind up in court. As a matter fact, even if the partners were to do it the right way they are still going to wind up in court as the issue of valuation of the company’s shares will probably have to be decided by a judge. Nevertheless there are certain things that should be done at the corporation’s formation that could help limit the partners’ liability both financial and legal.
First, all partners within a corporate entity should have a written Operating Agreement for purposes of not only delegating as to which partner does what but also for purposes of eliminating the silent partner to make sure that all partners work. Does that mean the Operating Agreement can force a partner to work? No. However; it does indicate what he or she is required to do for the corporation and moreover it eliminates the non-working silent partner. Should the corporation and or shareholders have to proceed to court and possible litigation the Operating Agreement will serve as a guideline for the Court and eliminate any defenses that the any shareholder may have that they are silent partners and hence not required to work.
A common tool utilized by many business partners to eliminate another partner’s shares is when the disgruntled shareholders transfer all of the company’s assets without consideration to a new corporate entity that does not include the ‘lazy’ shareholder’s assets to the new corporation. Even if the shareholder violated the Operating Agreement and even if the majority shareholders are rightfully disgruntled the aforesaid transfer of shares violates what is known as the Doctrine of Unclean Hands and said action will be undone by most courts with varying consequences. The Doctrine of Unclean Hands provides that a plaintiff (in this case the majority shareholders) is not entitled to justice because the plaintiff acted unethically and or in bad faith. Regardless of what the ‘lazy’ partner did or did not do and no matter how justified the remaining shareholders may feel all minority shareholders are entitled to the fair market value of their respective shares.
Majority shareholders have the burden of proving fairness of the process of the transaction or the price for the minority partner’s shares. Majority shareholders cannot simply argue that it is fair to cut out a minority partner because he or she did not carry their weight in the operation of the company regardless of whether or not an Operating Agreement provides for a silent partner.
If you have any questions about disputes amongst business partners or about corporate formation please do not hesitate to contact the Firm.