Expert: Timmy Chou - 7/21/2010

Question
QUESTION: I am looking for advise on how to end a 50/50 partnership.
Background-
The partnership is based on equal equity in a California S corp
There is no written partnership agreement or documentation, other than the S corporation documents
The partnership and S corp were formed to "take over" an existing business, to which one of the current partners was a partner of. The other partner has no prior equity in the preceding business.
The partners mutually agreed, and documented positions for officers at the time of formation of the S corp, so there is a documented President, and Secretary.
Both partners have agreed that they cannot work together, and that the partnership needs to be terminated.
Both partners would like to buy the other partner out.
The financials of the business are current and well documented, so there are no disputes on any financial issues, or a "fair" division.
The question is, what is a fair way to decide who has control of the buy out decision?

ANSWER: Thank you for your question!

Sorry for the delay, the system just notified me today of your question.

If you have looked at some of my previous answers you may know that I always advise questioners that mediators act as neutral third parties to disputes and never "get involved" in judging the merits of conflict, but merely use special techniques to help the parties decide how to negotiate their own settlement.

I am not an attorney and cannot give you legal advice but can respond from my mediation, management and consulting experience.  I am assuming that your settlement agreements are being crafted "on the fly", and I am also assuming you have not done anything to put you in breach of any written partnership obligation.  Note that this issue may certainly have legal ramifications and you may wish to consult an attorney.

It is best to have as much structure created at the outset of starting or building a business rather than in the middle because there are inevitable assumptions and expectations created by each party.  FYI the area of least development in business creation is in break-up or dissolution contingencies, where partners specify what the rules are in case of problems.

Consider doing the following preparatory and proactive steps right away as a good discussion foundation.  Here are my recommendations:

1.  Document a chronological timeline noting the creation of the business, the promises made and the individual contributed work product, asset contributions, the identification of accounts, or any other contribution.  Also document the rise of the conditions leading to the dissolution and record how this plays out.  You note that there are no written agreements beyond the boilerplate filing articles, however you almost certainly have oral agreements and understandings.  These carry the force of law.

2.  Review your existing documents.  Review whatever written agreements, operating agreements or other governing documents you have for guidance about rules for disengagement, if any.  Again, oral agreements count.

3.  Look at your legal options.  You don't say how much money is involved here but any litigants will incur a large cost to file suit, and you have to count the possible cost to yourself to pay for or defend litigation.  Remember that nearly 90% of lawsuits settle before trial so the question is usually not IF you will settle, but when and at what cost.  Disputing parties would be better off to wisely choose a cheaper, faster mediated settlement.

4.  Go see a lawyer.  The local Bar Association usually has a referral service that will give you access to an attorney for free.  You may wish to understand the legal landscape.  In most states when a company does not have completed organization documents or operating bylaws, the state has standard bylaws of some type codified and these would be the documents you would rely on legally.  You can get a copy and see if they offer any guidance.  

Once you understand where you are and how you got there you are then in a position to work out a settlement.  

In the case of a 50/50 partnership, partners may individually wish to do one thing or another, but cannot compel the partnership outright.  Partners also have a duty to the partnership to not damage it.  Hence, a partner cannot just demand his "piece" out of the middle if it will precariously damage the partnership interests for all.  Once the partnership percentages have been allocated, unless there are rules to the contrary one cannot go back and say that this or that condition gives one partner superior control rights over another.

The stalemate is what it is, and the parties have no other choice but to negotiate.  You should consider hiring a mediator to help manage the discussion.  Mediators have specialized skills that can assist the process and keep it on track.  

These are some ideas.  Feel free to follow up with additional questions.

For your general information, the pros and cons of the types of dispute resolution methods follows.

GOOD LUCK!


Arbitration, Mediation, and Litigation

Arbitration: the referral of a dispute to one or more impartial persons for final and binding determination outside of the judicial system

Benefits of Arbitration:

  Confidential, no public record
  Limited exchange of documentation, information
  Quick, don't have to wait for a court date
  Arbitrators have expertise in the subject matter and are trained in conflict resolution
  Cheaper than litigation
  Preserves business relationships

Negatives of Arbitration

  It's often a compromise, no 100% winner
  Complex arbitration can be costly
  If not satisfied, may litigate the arbitration procedure
  Poor results with an unskilled arbitrator
  Both parties must agree to cooperate in the process

Mediation: the process by which parties submit their dispute to a neutral third party (the mediator) who works with the parties to reach a settlement of their dispute.

Benefits of Mediation:

  Neutral mediator can objectively suggest alternatives not considered before
  Parties are directly engaged in negotiating the settlement
  Can be quicker than litigation
  Less costly than litigation
  Preserves business relationships
  85% of American Arbitration Association cases mediated find successful solutions

Negatives of Mediation

  may not reach a binding decision
  unskilled mediator

Litigation: using the judicial system to resolve disputes

Benefits of litigation:

  a clear winner and loser
  uses a prescribed set of procedures
  more predictable outcomes
  is final

Negatives of Litigation:

  waiting for court dates can do more harm
  usually more expensive than mediation and arbitration
  part of the public record

---------- FOLLOW-UP ----------

QUESTION: Hi Timmy,

From my original question, what I was trying to get advise on, was specifically how to resolve the stalemate. I have already done all of the other things you have suggested, and while there be be points that could achieve legal leverage, both parties want to find a "fair" way to resolve the stalemate.
So, here is my follow up question:
Do you have any examples of a fair way to resolve a stalemate in a 50/50 partner situation?

(We both want to buy the business, we have agreed on a price, and we definitely cannot continue together)

Thank you

Answer
In my experience settlements are typically based on a combination of tangible and intangible elements.  Obviously, one can use various valuation methods to look at the tangibles -- and it sounds like you have both done that and are comfortable with the presentation.  Once this is done, though, the heavy lifting begins if there are still intangible conflicts remaining.  This becomes more of an art than a science whether we are talking about a victim-offender mediation where the offender wishes to provide some sort of restitution to the family of a murder victim (impossible), custody of children where both parents want custody, or a partnership split where both partners wish to buy out the other and operate the business.  

Working through these "Solomon"-like scenarios is where a trained mediator can help you if you choose. There are no transferable examples of resolutions -- except that at some point one party gives up the impossible demand in exchange for something else.  If I were your mediator I would be looking to understand your more fundamental motivations for clues for alternatives.  Why do you want to keep the business?  Is it because you love the work, or is it because you want to make money?  Perhaps other ways can be found to give you creative fulfillment or money that will be satisfactory.  Understanding the underlying motivations can be helpful as tools for resolution.  

Another technique I use is imagining alternatives.  Imagine the business is going to be given by a judge to the other party.  What would be your next best alternative to owning the business do you think?  Helping each side to imagine and think through alternative possibilities is another way to open up flexibility and expand creativity.  

Many other techniques and exercises can be used to explore, discuss, test and finally craft a resolution.  This is not about "fairness" anymore and cannot be reduced to a formula or template, but must be undertaken as a careful, respectful negotiation.

In my experience these resolutions are very difficult to do without help.  There are simply too many obstacles to creativity when investment, emotions and tension is high.

Feel free to follow up, good luck!