Business Divorce: Plan Ahead to Avoid the Pain of Breaking Up

by Sue Kern-Fleischer

Business-DivorceLike a marriage, business partnerships don’t always last forever, and lengthy disputes can be nasty. Knowing one’s ownership rights is important, and many business executives make the mistake of not planning well and educating themselves before the partnership is formed.

Pouria Paknejad, a trial attorney and partner with Scottsdale-based Smith Paknejad PLC, sees a wealth of errors in the foundation of businesses and their operations that lead them to disputes, starting with understanding how responsibilities differ in different types of partnerships. “It’s important to understand that the term ‘partnership’ has a different colloquial meaning than its legal meaning and there are different types of partnerships,” he says. Currently in Arizona, no registry for partnerships exists with the secretary of state. In contrast, LLCs are governed by the Arizona Revised Statutes (ARS) Title 29 and corporations are governed by Title 10. Noting that formalities required in governing corporations are immense, Paknejad says LLCs (whose members are called “stakeholders”) can be “fantastically less formal” since the Arizona LLC Act was intentionally drafted by the legislature in the late 1990s to be very broad.

Whereas corporations have bylaws, LLCs have operating agreements. Because LLCs have fewer rules and restrictions, many business executives forego drafting a meaningful operating agreement that will help guide them in running their businesses. “It’s a big mistake not to educate yourself early on, because every step you take thereafter could be creating liability for both you and the company,” Paknejad says.

Neal Bookspan, an equity partner with Phoenix-based law firm Jaburg Wilk, says some business owners, in an effort to save money, use form documents off of the Internet. “It’s worth an hour of an attorney’s time to get some initial guidance. Otherwise, you may take steps you can’t undo and create more issues going forward,” Bookspan says. He also cautions business owners to pay attention to the provisions in their operating agreement or bylaws. “A lot of people sign it, put it in their drawer and never look at it again,” he says. “But people change over time, and real-life scenarios can be game changers. Owners should review these documents at least annually.”

Accounting issues also cause disputes among business owners. Paknejad says undercapitalization is one common mistake business owners make with the formation of LLCs. And often problems arise when one partner starts using LLC funds for personal expenses. “Many times, I’ve gone after companies that treat the LLC as their alter ego,” he says, adding that he has seen friendships break up over failed businesses.

What should business owners do if they suspect a partner of shady dealings? “The devil is in the details,” says Bookspan. “Look at the financial records and bank accounts. Do your due diligence before making an accusation, because once you accuse someone, it’s hard to step back from it. I’ve seen people wrongly accuse others, and it can ruin relationships.”

It’s worth noting that just because a business partner may have done something bad or unethical does not mean his or her ownership rights are taken away. “I’ve been involved in cases where people were defrauded, and they may win a money judgment but the person responsible for fraud is still a corporate shareholder or LLC member. It can make for some strange situations,” Bookspan says.

Sharing, “In my 22 years of practice, I don’t think I’ve ever seen a company actually dissolved through litigation,” Bookspan says what usually happens is one owner, ultimately, buys out the other owner’s ownership interest.

In Maricopa County, litigation for “corporate divorces” can drag out up to two years or more, depending on the judge, calendar and time for discovery. “You can’t control what the other side and their lawyer will do, and that can cause delay and increase the fees and costs,” Bookspan says. Often the bylaws or operating agreement will address how disputes will be resolved, typically through mediation or arbitration. “I think mediation is fantastic,” Bookspan says. “It is the only time where the parties have a role in deciding the outcome. With arbitration and litigation, you don’t know what will happen.”

Paknejad says business divorces can be as emotionally taxing as marriage divorces, if not worse because of the large amounts of money involved and feelings of betrayal and anger. “There’s nothing worse than seeing the joy and celebration of a new business venture turn into the acrimony and pain of a business dissolution … especially when those people were previously good friends,” he says, emphasizing the need to consult an attorney early into partnership discussions. “As my partner, Gary Smith, always says, ‘An ounce of prevention is worth a pound of lawyer bills.’”

Neal Bookspan of Jaburg Wilk is an equity partner who has been helping individuals and businesses manage their legal risks for more than two decades. His practice includes resolving and litigating all manner of contract-based disputes. 

Pouria Paknejad of Smith Paknejad PLC is a trial lawyer and former editor of Attorney at Law Magazine. Ranked this year on Martindale-Hubbell as an AV Preeminent Lawyer by a panel of his peers, he earned a seat on the Maricopa County Bar Association Board of Directors in 2013.

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