The last thing I wanted to do after graduating from law school was practice law as a civil litigation attorney. The contentious nature of the litigants and their attorneys, combined with the gamesmanship of it all, makes most rational beings avoid the courtroom like the plague. But, what do I do? I’m a civil litigation attorney, and I cannot think of anything else I’d rather do for a living. However, my clients, understandably, do not share my enthusiasm for the litigation process. For them it equates to torment and reversal of fortune. For many, a victory does not necessarily mean a “win” and even the prevailing party may feel like the loser after considering the litigation costs and emotional strain.
Litigation is society’s way of righting a wrong but, truth-be-told, so many issues litigated today need never have been the subject of a lawsuit. With business litigation, had people just dealt with the “What ifs?” prior to formalizing their business relationships, they would not later have to deal with the “What now?” It’s the “What now?” that ultimately serves as the foundation for bitter litigation. Friendships and families are forever divided over matters that could have easily been avoided if, during the excitement of the proposed business venture, simple “What if” questions were asked and honestly answered by all parties. Some of these “What if” questions are illustrated in this story. 1
Michael, a longtime client, owned a manufacturing company. Michael came to incorporate his business and relied on my legal expertise for his company, vendor, employee, and customer contracts. It was no surprise when he asked me to create the documents under which Andrew, a long time trusted friend and employee, was to become a shareholder.
Andrew and Michael had been working together for over three years and Michael appreciated Andrew’s efforts in helping him grow his business. Both were excited about the prospect of Andrew becoming an owner and wanted the legal “paperwork” completed quickly. As instructed, Michael clarified it to Andrew it was important for him to have separate legal representation because I was solely acting as Michael’s attorney and had to act in his best interest. Andrew agreed and retained an attorney to assist him.
As happens usually, the parties are so excited about the future they consciously avoid discussions which might dampen their enthusiasm or jinx the entire venture. Michael and Andrew were no exception. Michael, however, being a little more sophisticated than many, resisted the temptation to proceed without addressing fundamental “What if” questions and asked Andrew:
- What if Andrew, you or I decide we want to devote less than our “full-time” efforts to this company; how are we to address our respective ownership interest?
- What if the company, needs an infusion of money; are you Andrew willing to obligate yourself on a loan or will you be willing to contribute some of your own cash?
- What if either you or I become sick or incapacitated and cannot work for an extended period; how are we to equitably compensate the burdened shareholder.
- Andrew, knowing I hope to retain the controlling interest; how will we address growth where we might deem it in our best interest to extend an offer of ownership to others? How might we handle the dilution of interest?
- What if one of us should die; how are our families to be treated?
- What if we reach an impasse regarding a business decision; how shall our impasse be ultimately resolved?
- What if one of us, independent of the other, does something that causes the company to get sued? Who will pay for the cost? Who will pay for the increased insurance premiums?
While there are a numerous other “What if” questions, just posing these few can sometimes lead to unexpected revelations. In Michael and Andrew’s case, Michael found out Andrew was not interested in the responsibilities that come with ownership. Andrew decided, after considering the “What ifs”, he would rather be an employee working in another industry. Andrew left Michael’s company and they parted as friends. Had Andrew become an owner, his lack of commitment would have soon become an issue. Just a few months after Andrew left, demand for a product developed by Michael skyrocketed and Michael was forced to infuse the company with over $200,000 to cover production costs. Michael launched his company to the next level and remains the sole shareholder.
Bottom line; business formations, with even just one other person, must be treated with the same care and consideration one would give to the most important decisions of their life. When you consider all the time and money you will spend building your business, in contrast to losing it all because of inadequate agreements and documentation, stellar legal representation at the formation stage is a must. Operation agreements, shareholder agreements, management agreements, buy-sell agreements are expensive but still only a fraction of the cost of litigation.