Business Litigation

Easily the most common things we see in business breakups is that the parties were not represented by their own counsel in the formation of the partnership. More often than not, the scenario is that one of the partners hires a lawyer to draft the partnership agreement. What the other partners do not realize is that this attorney is not representing them individually.

Depending on how the attorney was hired, he is either representing the partner that hired him or possibly the new potential entity. In either scenario that attorney could not represent the other partners in their individual capacity because there is a conflict of interest. That’s not to say that the attorney drafting the agreement is not capable of drafting a fair partnership agreement, but the other partners must understand that they are going into the transaction not represented.

Of course cost is often a deterrent in not wanting to retain individual counsel from the offset, and that is certainly understandable. But keep in mind, in the event that the partnership does go south, you will have no option but to retain counsel. Representation during the partnership break up will be far more costly than what it would have been had you retained counsel to help negotiate the agreement.

If you choose to go into the transaction not represented by counsel, than you must thoroughly review the partnership agreement and all relevant documents. Do your best to work through the different scenarios in the event things go south and what the best way to amicably resolve the matter would be.

In that Tarrant County Case, although the parties hired an attorney to draft all of their corporate documents. Neither retained private counsel. As a result the methods for terminating their partnership were not very well suited for their particular type of business and did account for certain issues that they faced.

The first thing that always comes to everyone’s mind is to just liquidate everything and everyone takes their proportionate share and moves on. While this may seem like a great idea, it’s never this simple. Winding down a business is very complex and it touches on many different areas of law. First of all, the entity exists separately from the partners. Just because one partner wants to leave the LLC or the LP does not mean he can just force it to shut down. The partner still has a duty of loyalty to the business and the other partners.

Second the tax consequences for liquidating and winding up a partnership or an LLC can be severe. If this is the option that you choose, you must consult a CPA and determine if you can afford the tax liability. If you can afford it, then in many cases this will be the best option to get everything wrapped up so you can move on with your life. Secondly depending on the property that the partnership owns, liquidating a straight liquidation can be tricky.

Another problem that can arise is lots of times the assets aren’t really the kind that can just be liquidated. For instance, let’s say in our hypothetical example that the the partnerships only meaningful assets are service contracts. The partners thought that they could just divide up those service contracts evenly between each other and start their own separate company. The problem that arose was that many of the clients did not like the partner that that they were assigned and were understandably less than thrilled to be in the middle of a nasty breakup. In this situation many of the clients canceled their service contracts and signed with the competitors. Obviously this will cause the value of the business to go down significantly.

The 2011 amendments to the Texas Responsible third party law, while probably well intentioned have created a situation that is clearly at odds with the original intent of the responsible third party statute. Originally the idea behind the statute was to allow defendants the opportunity to have the jury apportion fault to parties who could not be made a party to the lawsuit. Usually these were instances where either the responsible third party could not be located or the Court lacked jurisdiction over the party. Also there are times when a party’s whereabouts are known and the Court has jurisdiction over the party, but there is very little incentive for the Defendant to bring that party in as a co party. These would be situations where the party is essentially judgment proof because the party lacks financial resources or insurance.

Over the years, the responsible third parties have morphed into essentially an unrepresented defendant that is effectively an empty chair for the defendant to point the finger. This is especially a problem when a Defendant designates a responsible third party after the applicable statute of limitations has run. Prior to 2011, if a Defendant designated a responsible third party after the Statute of Limitations had run, the Plaintiff was allowed to bring suit against that party so long as he did so within thirty days of the designation. “Under this scenario, all culpable parties were before the court, defending themselves, and accountable to the plaintiff for their percentage of responsibility,” thereby achieving “a carefully constructed scheme balancing the interests of both defendants and claimants.”

In 2011, the Texas Supreme Court ruled that the statute of limitations laws in Texas trumped the plaintiff’s ability to join a time barred responsible third party. The Court was deeply divided on the issue. The dissenting justices noted the strategic advantages that a Defendant gains by designating a responsible third party for purpose of shifting liability. If a plaintiff is not allowed to join a time barred responsible third party, it is forced to prove the liability of the defendant while simultaneously defending against an empty chair. This would disrupt the balance that the original responsible third party law had sought to maintain.

After the Court’s ruling, the legislature sought to address this issue and implemented a system that allows a for Defendants to designate responsible third party after the statute of limitations, so long as it has complied with its obligations to timely disclose that person as a responsible third party under the TRCP. The Texas Rules of Civil Procedure require that a Defendant must respond to a request from the Plaintiff to disclose the names of all possible responsible third party. Once the Plaintiff has sent the request and the Defendant has responded, the Defendant is under a duty to timely supplement these responses.

Although the new amendment may seem fair to everyone on its face, from a practical perspective it has made the situation worse. Defendants aren’t required to elaborate as to why the party is a possible responsible third party. Thus a wise Defendant will always disclose as many possible responsible third party as possible even if it has no evidence or reason to believe that the party has any culpability. Plaintiff is then put in a binned when the statute is about to run and it must decide whether or not to bring suit against the party listed as possible responsible third party or risk Defendant designated the responsible third party after the statute has run and risk having to defend an empty chair.

For instance, let’s say that a property owner hires a contractor to build an office building. The contractor hires an architect, structural engineer, electrician, a plumber, mechanical engineer, a roofer, and a framer. The building is complete and almost immediately upon taking position the owner notices that there is problems with leaks. The owner continual tries to repair the building and but after about a year and half there is a significant leak in the building that causes significant damage. The owner conducts an independent investigation and after about a month of due diligence the owner determines that the contractor, the plumber, and one of the other subcontractors are at fault and the owner brings suit. In this hypothetical let’s say that the owner filed suit about 22 months after the owner took possession. In construction defect cases like these the statute of limitations isn’t always so clear. Under this scenario it is possible that the statute of limitations begins to run when the owner took possession of the building.

The Contractor names all of the subcontractors as possible responsible third parties. But does not provide a reason. The owner can’t figure out what the other contractors possibly did wrong, so the owner declines to bring them into the suit. Three months later, the contractor designates all of the subcontractors as responsible third parties. Now the Plaintiff has too show liability against the Defendants but also must defend against the empty chair of the responsible third party.

Let’s say on the other hand that the Plaintiff decides to bring them into the litigation, even though he believes that the contractor and the other defendants are truly the culpable parties. Although this scenario is probably better for the Owner, there are obviously problems with expanding the scope of the litigation like this is the exact opposite of what the responsible third party were intended.

There are several ways to end a business partnership. The right method will be different for different situations and different parties.

One popular method for terminating a partnership is a buy/sell clause. In this method one partner will put out a number and the other partner has the option to either buy out the other partner or sell his interest for that amount. This is an effective and equitable method for terminating a partnership. But the problem in this scenario is that often times neither partner can afford to buy the other partner out.

Of course sometimes Court intervention is necessary when there is a break up of an entity or partnership. But it may surprise you to learn that often times a court’s power is very limited. This particularly true, if the business is profitable and still making money despite the fact that the principles are not getting along. A Court will typically not terminate an entity, simply because the partners do not get along.

Another issue that must be addressed in partnership agreements that has to do with the termination of partnerships or other business entities is the withdrawing partner’s ability to start a competing business or work for a competitor. It is important that the businesses have a non-compete agreement for their partners as well as a non-disclosure agreement protecting their confidential and proprietary information. Traditionally non competes were disfavored by public policy. The idea behind them being disfavored is that they hinder competition in the market place. Also Courts want to recognize that the withdrawing partner (for lack of a better term) has the right to make a living. But businesses have the right to expect that partners and high level employees won’t take certain confidential information to a rival business. Courts understand the competing interest at play and recently have showed more of a willingness to give more teeth to non-compete provisions so long as the follow certain parameters.

First of all, for a non-compete to be valid the person must have had access to some type of proprietary or confidential information on which is important to the viability of the business. This can be lots of different things. Obviously it could be something as complicated as a patent or other trade secret but also could be something as simple as a customer or potential contact list. For instance, if Walgreens attempted to enforce a noncompete agreement with a former cashier that recently took a job at CVS, a court would not hold that non-compete agreement enforceable because more than likely that cashier did not have access to any high level information at Walgreens.

Obviously when we are speaking of partners, we are more than likely talking about somebody who has access to confidential information of the business. But it is possible that a scenario could arise where there was a silent partner that was not involved in the operations. If that is the case then it is very well possible that a non-compete would have no effect on him. Regardless it is important that partnership agreements spell out and acknowledge that each partner is privy to certain “proprietary and confidential” information.

Second the clause must be reasonable as to the time and the geographic area. Generally five years for a non-compete is going to be about as long as a court will allow and that may be pushing it. You might be able to find an exception to this here and there but typically that is going to be the long end. I always recommend that the length of time be two to five years. Again at some point in time, the partnership needs to understand that former partner gets to move on with his life and start working again.

Third the clause must be reasonable as the geographic area. A business that primarily serves Dallas/Fort Worth metroplex can reasonably expect to have a non-compete agreement that prevents a partner from competing against them for their business in the metroplex, but a clause that would prevent them from engaging in a similar type of business throughout the entire state of Texas would more than likely get shot down. Generally what I recommend for this is to phrase the clause in terms of preventing the former partner from competing against the business in the same areas that he worked for on behalf of the partnership.

If you have specific questions regarding terminating a business relationship request a free evaluation by calling (817) 877-3303.

Should I have a business termination “prenup” with my partners?

I have had the privilege of working on many different types of cases involving many different areas of law. The most difficult litigation is business break ups.

These types of cases combine the intense emotion and hurt feelings of a divorce and also the complexity a commercial a large commercial dispute. Unfortunately many of these disputes would have been avoided had the parties taken the time to determine what to do in the event that somebody decides it is best to go there certain way.

The most important part of a business relationship or partnership agreement is how to effectively terminate the partnership or what to do when another principal or partner decides to leave.

Unfortunately, this is often the most overlooked clause of the agreement. More often than not, the agreement makes no mention of how to effectively wind down the entity.

When it does make mention, the clause is often boilerplate and the provisions laid out don’t really fit well for the business and do not account for certain foreseeable situations.

It is imperative that those individuals starting a new business thoroughly think through what to do in the event that one of the partners wants to leave the business.

The situation is of course most analogous to that of ending a marriage with an effective pre-nuptial or “prenup” agreement vs a divorce. A prenup is an agreement two people entered into before they get married that lays out how property will be divided in the event that the marriage.

Obviously there are two reasons why most people don’t get prenups. The first being, that when most people get married they are younger and don’t own any significant types of property or draw a significant income, so it is looked at as a waste of money. The other and more common reason is because it is an awkward conversation to have.

Of course, it’s this same awkwardness that is the main reason that business relationships often overlook their termination clauses. Typically at the beginning of any type of relationship all of the parties are full of hope and optimism and nobody wants to acknowledge that there is a chance that this might not work out.

More often than not, the people coming together have a previous relationship which leads them to believe that they will be able to resolve disputes amicably. Sadly, more often than not this isn’t the case.