by Steven N. Malitz
This was published as a Feature Story in the June 2016 edition of SubStance Magazine, which is distributed by the Illinois Mechanical & Specialty Contractors Association.
Jethro and Wally owned Twisted Mechanical Contractors for 20 prosperous years, on a “hand-shake deal.” Jethro started an unrelated, non-competitive business – a plumbing company. Claiming that Jethro deserted Twisted, Wally barred Jethro from Twisted, eliminated his compensation, canceled his benefits and emptied the business bank accounts. Jethro then sued Wally to dissolve Twisted so he could start his own mechanical contracting business, without Wally.
Unfortunately, the partnership agreement for Twisted was oral. 20 years of harmony resulted in disaster. No more combined family parties for Wally and Jethro. Costly litigation may very well have been avoided with the following inexpensive steps taken at the beginning of the business with the assistance of an attorney:
1. Forming a corporation or limited liability company for tax benefits and creditor protection. (Your lawyer can assist you in deciding which entity is right for your business)
2. Shareholders Agreement (for a corporation) or operating agreement (for a limited liability company), with provisions relating to (a) ownership percentage for each owner; (b) buy-sell in case one partner wants to sell, becomes disabled or dies; (c) valuation of the business in case of sale; (d) wind-up/dissolution—who gets paid in what order; (e) fiduciary duties owed by each owner to each other and the business; (f) deciding deadlock An Ounce of Prevention is Worth a Kilo of Corybantic Cure issues if the partners cannot decide on major business issues; and, (g) rights of the partners to engage in other entrepreneurial activities.
3. Stock certificates evidencing ownership and number of shares owned by each shareholder (for a corporation).
4. By-laws setting forth the rights and powers of shareholders, directors and officers, and how those in charge are elected. By-laws also help settle any disputes among the owners.
5. Resolutions or consents reflecting and authorizing the involvement of business owners, in this case Jethro, in other businesses, or otherwise documenting other, general business decisions made from time to time in their construction business.
Although litigation finally resolved all issues between Jethro and Wally, the emotional and financial cost was great. Consider drafting or updating the agreement with your fellow partner. Not only will it help to resolve litigation with less expense, but, more importantly, good documentation will minimize the likelihood of litigation in the first place by letting the business owners know in advance what they are permitted to do and what the consequences will be of their actions.
We would be happy to send you a checklist with the basic terms in any shareholder agreement or operating agreement. Documentation creates business freedom!
Steven N. Malitz is an attorney with the Chicago-based law firm of Arnstein & Lehr LLP. He represents subcontractors, twisted and untwisted, and other business owners. To contact Mr. Malitz, please email firstname.lastname@example.org.