Preventing and Resolving Business Divorces
Jonathan Hawkins and Halsey Knapp, Jr.
2016’s last Atlanta’s Most Trusted Advisors radio show focused on the topic of business divorces – how to prevent them, how to handle them gracefully and the signs that indicate a split may be necessary (or coming). Bonnie and her co-host, Ryan “Redhawk” McPherson interviewed two attorneys from the business law firm Krevolin & Horst in Atlanta: Jonathan Hawkins and Halsey Knapp, Jr.
The firm represents businesses of all types and sizes, from startups to companies with $100 million in annual revenue, with the unifying factor being that all are closely held rather than publicly traded companies. Their work includes general corporate law, technology, commercial real estate and business dispute resolution; the guests’ focus is on crisis management and business disputes, particularly partnership breakups.
Halsey offered a very succinct piece of advice to business owners, saying that a very effective strategy for avoiding future problems is utilizing the services of transactional attorneys. “Most of things we deal with can be avoided if you visit them first; it’s pretty simple. Whenever you’re organizing a business or you’re contemplating a change or even if you’re seeking a new investment by outside sources that were not in the company originally, those are points where you should revisit whether or not you have a contract, whether or not there’s going to be a buyout, whether your shares will be included in the buyout. If I leave the company, will my warrants still be good? Those are things you want to ask before events happen not after, because transactional attorneys have the ability to reshape the transaction in a way that’ll preserve the benefits that you expect to receive when the transaction is consummated.”
Ryan: So tell us, what are some of those first warning signs a business may be experiencing where they need to get some professional advice?
Jonathan: Business is about relationships and a business breakup is not unlike matrimonial breakup. I mean, you’ve got basically your work partner that you’ve been with for sometimes 20 years or more. And you start to drift apart. People’s visions perhaps change, their place in life. Their ideas about what they want to do change and they start to drift apart. That’s a common occurrence. Some of the worst things we see are one partner decides to start stealing from the other and that’s a whole different set of circumstances. But a lot of times it’s just two folks that find it’s been a great run and one is ready to wind down and the other person wants to keep going strong.
Halsey: The tools to separate should be discussed at the beginning of the relationship but generally are not. When people come together they’re very optimistic about their business, what they’re going to do, the last thing they want to do is spend hours talking to the lawyer about this, what the worst case scenario might look like and how we might value the business or how we might finance each other’s buy out at the end.
And so those are sensitive subjects that need to be taken up on the front end. In today’s world, most businesses form as limited liability companies and those are companies that are controlled by contract rather than the rules created by courts. As a consequence if you don’t on the front end focus on those issues and incorporate your exit strategy into your operating agreement, you then have to fight on the back end with lawyers like us to create a new agreement and a new opportunity for both folks going forward.
Jonathan: And it’s good to consult with a lawyer, and maybe an accountant so you have an independent voice telling you all the things that could go wrong.
Ryan: One of the trends we hear about is arbitration. What are some of the pros and cons there?
Halsey: Well arbitration originally was promoted primarily as a way to have a less expensive and more expeditious resolution of conflicts. And one of its big advantages is you can sometimes get a decision maker who’s has industry knowledge or business knowledge and you can keep the proceeding confidential. And sometimes the allegations that are being made between business partners are not particularly positive, so they don’t want it to be known to the general public that someone’s alleging that they stole things or misappropriated business opportunities with the company. But since trial lawyers have been involved in the process for so long now its changed the arbitration process to be more like litigation, there’s more discovery, there’s more cost, there’s more delay. And frankly one of the frustrations I’ve found in arbitration is that efficiency is being promoted over the search for truth.
Halsey: Exactly. And it’s really a problem because arbitrations have limits as to whether you can interview the other side’s witnesses ahead of time to know what they say or know what the facts are. And once you go through arbitration it’s final. You can’t get it reviewed; you can’t get it appealed. And so the outcome is the outcome and the arbitrator has more latitude in making those decisions than any trial judge has. And most people don’t learn that lesson until it is all over.
Ryan: Halsey, one of your expertise [areas] is in crisis management. What intrigues you the most about working with businesses when they’re involved in crisis?
Halsey: Well, it’s interesting. You evolve into this practice after you’ve seen a lot of disputes over your career. After doing this for 37 years, what I tell clients is that fact is stranger than fiction because what actually happens sometimes is pretty amazing. And through that experience and seeing the turmoil and the expense that litigation creates for clients when crises arise, you can bring some judgment and some wisdom to the table to say there’s a way to get out of this if you take some self-corrective action on the front end and you’re proactive about the process. You need to be the authoritative source of information and you need to, in fact, share bad information as quickly and as thoroughly as possible to regain the public trust or regain the trust of regulators who might be inspecting what’s going on within your business.
That is counterintuitive and something that we as humans don’t like to do. We don’t want to admit we made mistakes. But there’s nothing more powerful than a sincere apology and there’s nothing more powerful than being accountable for mistakes that are made within your organization. There are several very public recent company problems you can refer to for this. Wells Fargo is a huge current example.
Ryan: Yeah, all over the news, headlines everywhere.
Halsey: And I wrote a piece on that. Once this happens you can’t go into defensive mode. Defensive behavior is sensed by a journalist and by regulators and they’re going to continue to pursue you and not trust what you say if you act defensively. You have to take off that veneer, step forward, be candid and disclose to the public and to those that are watching what happened, what your plan is to correct it and how you’re going to hold those accountable for what happened. There’s got to be a reckoning. If there’s no reckoning and limited transparency, you’re not going to come out of this as quickly or as effectively as you’d like to.
Jonathan: So there’s some tension here on the public relations side. For PR purposes, you want to publicly disclose and apologize quickly. But as a litigator who defends potential lawsuits, I know you need to protect yourself too. How do you reconcile the two and how would you advise a client who’s stuck in that position knowing lawsuits are probably on the way?
Halsey: Well you have to decide what your biggest threat is. And more often than not, the viability of the business is the most important factor at risk. And I bet you if you follow Wells Fargo’s financial reporting for the next 18 months you will see whether or not they dealt with their most important element – that is, satisfying their customers. And the second person that you need to be aware of is the regulators. You can win the litigation but litigation is a multiyear proposition and 95% of the cases get settled. So if you make winning the litigation your priority, I would suggest to you your priorities are way off.
Ryan: So make sure to check in the pulse of the culture at your company daily, weekly, monthly. Don’t just assume that all is good within the workforce there and make sure that you have a plan when the business divorce happens. Now one thing that probably comes up a lot, and I know for me it would be a concern when dealing with lawyers, is cost. Cost is always an issue and in this case you can accumulate some heavy expenses. Can you speak to the cost factor a little bit too?
Jonathan: Sure, it can get expensive. And when clients come to me, the first thing we talk about is what are we fighting over, because sometimes it’s about principle or burying the other side…
They usually see the light at some point. But the first thing I ask is what are we fighting over? Does this company make any money? Sometimes it is just not worth it.
Halsey: Cost is a huge element on all these challenges. The thing you look for generally is, is there an attorney’s fees provision somewhere in a contract or some basis to get your attorney fees covered should you try to proceed further?
Most people come in with the expectation that, “Oh, the other side will end up paying my fees in this dispute,” when in fact that’s just the opposite. Generally, that’s not the case. So a big element is how attorney’s fees are going to be paid.
The other issue … LegalZoom is making me a fortune because LegalZoom does not go into questions such as what law are we going to apply to your entity. For example, in the real estate businesses, often you have a technically proficient person that knows how to develop and he’s got a series of passive investors that want to come in but this is not the only project he has. So questions like, “Can he run his other projects? Can he raise money and develop other properties at the same time without taking on too much and decreasing the profits the investors expect?” are important questions.
Those types of limited liability companies generally have very limited fiduciary duties between the operator and the owners because they’re just in it financially and they expect a return on this project and they understand he’s in other projects. Operating businesses are entirely different. In your operating business, you want that manager to be thinking about that business 24 hours a day. You don’t want them to have the ability to form another company to do business with you or take a license to your major asset and go use in some other form or fashion. Yet those are the very questions and those are the very issues that are implicated by questions of fiduciary duty and when you’re operating agreement is formed by an organization that doesn’t discuss it with you, you’re going to be coming to see Jonathan and I later when these issues arise.
Ryan: And better you than me because I don’t understand anything you just said over there. All that is just way over my head but I’m glad we have some experts in here today.
Bonnie: I think you can sum it up by saying an ounce of prevention is better than a pound of cure. Up front, yes, a lot of people when they’re starting businesses don’t have a lot of money to put into this but creating these agreements, talking about the difficult things of how are we going to break up when we are done and putting all these things in place, to me, sounds like it could save you thousands and thousands if not, in crazy cases, millions of dollars down the road when you just don’t know what’s going to happen.
Jonathan: And to that point, you know, a lawyer can build these answers into those initial agreements.
Halsey: Businesses are very dynamic today and two and three years down the road we’re doing things drastically different than we ever envisioned the day we got in the business. And so your governance documents, which is what these operating agreements are primarily, have to have a flexibility about them.
Jonathan: Another issue for a growing dynamic business that we see a lot is ownership. The business is growing, the owner wants to incentivize employees. They think they’re being generous and say, “Hey we’re going to give you stock options or ownership in the company.”
Ryan: It’s very popular and trending these days.
Jonathan: It is and that’s good for them. I think you do want to incentivize employees. But there are ways to do it where they’re getting the upside but you’re not necessarily giving them ownership in the company because that’s where some heartache happens down the road when you’ve got all these minority owners that you’ve just given away parts of the company to, they start to get in your way a little bit and hamstring you in some of your decision making. So there are ways to design these things where you give the upside to the employees or your sales force or whoever without giving away the company.
We at Atlanta’s Most Trusted Advisors hope you’ve had a wonderful winter holiday and that you now have some good ideas for preventing and addressing business disputes and crises. If you’d like to hear the full interview, you can download the podcast at the Business Radio X website.