Achieving An Effective “Corporate Divorce”

It’s that time of year (!)

Family lawyers habitually experience their busiest times of the year (regarding new divorce and separation instructions) immediately after Christmas and/or at the conclusion of Summer holidays (apparently - when the stress of being with spouse(s) / life-partner(s) has proved ‘too much’ for many).

Business lawyers likewise notice an upturn in the habitual friction within quasi-partnerships manifesting itself in a desire for a 'corporate divorce' at around the same times of the year (and this year has been no different for the writer!), the apparent motivation being that quasi-partners at around these times find themselves having to return to business with their quasi- partners (whom they no longer wish to be in business with).

Quasi-Partnerships (?)

The phrase 'quasi-partnership' is used in this discussion to describe a small number of individuals who (as owner / managers) co-operate in a venture / business in a manner similar to a partnership (but that is carried on through the legal structure of a limited liability company).

For various reasons, quasi-partnerships often reach a natural ‘fork in the road’ (say - simply, as the business has developed), and the quasi-partners then wish to separate their affairs.  

While a generally stressful and difficult time for those involved, matters are not helped by the fact that (while there are considerable practical and taxation reasons for using a limited liability company as a legal structure for a venture / business), limited liability companies were not designed for, nor are necessarily natural structures for operating quasi-partnerships conveniently, and there are a range of aspects & issues with their structure which complicate matters (particularly with regard the exit of a quasi-partner).

First-Steps

Every circumstance is different, so the writer suggests that the first stage in resolving matters is to ask an appropriately qualified and experienced business adviser (such as the writer) to fully analyse the current legal position of the relevant quasi-partnership and report upon what can be achieved in the particular circumstances, and the suggested approach to take.

It should be recognised in early course that any minority shareholder, in a quasi-partnership is in a particularly difficult situation in terms of resolving matters with a majority shareholder (e.g. ask any institutional shareholder in Sports Direct!).  

Shareholding structures with a 50-50 deadlocked shareholding are also particularly problematic to resolve. 

However, where a clear majority in shareholding is resolved to achieve a ‘corporate divorce’ with a minority shareholder, much can be often be achieved (even if potentially stressful & complex).

Ideally the business adviser should be able to advise across all relevant aspects relating to the exiting quasi-partner’s interests in the company.  Those interests tend to be in relation to the exiting quasi-partner’s service arrangements, the offices (e.g. directorship) which the quasi -partnership holds and their shareholding in the company. While closely related (in practice), the particular legal specialisms to deal with these different ‘hats’ that the exiting quasi-partner ‘wears’ - can be difficult to find in a single adviser.

Approach

The preferred approach in relation to seeking to achieve a corporate-divorce is (if at all possible) to resolve matters by mutual agreement.  

From a purely personal perspective, if a corporate-divorce can be resolved relatively amicably (so that the interested-parties can potentially continue a businesslike relationship in the future) that has to (arguably) be in all parties interests. 

However in reality, it is likely that an approach of ‘carrot and stick’ will be needed to focus minds and bring matters to an appropriate conclusion, applied in such relative proportions as circumstances demand.

If the analysis has revealed that a corporate divorce would appear to be unilaterally achievable, then the writer has found that the following is generally the order in which matters need to be resolved.

Service Arrangements

A careful understanding needs to be obtained as to the basis upon which an exiting quasi-partner has been involved with (i.e. provided their services and / or been remunerated by) the company.

It is becoming more and more common (particularly in relatively early stage ventures) to find that the relevant exiting quasi-partner is not an employee of the business.  In such circumstances, a relatively straightforward review of the contractual relationship by which they provide services to the venture (e.g. consultancy agreement etc) is required, and a contractual termination of the relevant arrangements (e.g. by serving notice etc) is generally all that is required.

Even if the relevant exiting quasi-partner is held to be an employee of the company, they may not have served as an employee for a sufficient length of time to have obtained statutory employment protections (so much the same position applies).  At present – and very broadly - an employee has to have been employed for two years to be able to claim statutory employment protections.

Great care must be taken in analysing the factual circumstances, both as to whether an employment relationship exists and whether statutory employment protections have arisen and are therefore an issue for the relevant company. If they are, then matters will potentially become considerably more complex (and costly) to resolve.

Hopefully, a sensible discussion on a without prejudice and subject to contract basis with the exiting quasi-partner may lead to a mutually agreed termination of the relevant service arrangements, but this may need to be (at least initially) accompanied by steps to force the issue (e.g. suspension, exclusion from premises and service of notice).

Offices (Directorships)

Those with majority control of a company subject to a corporate divorce will need to resolve any offices with the company (e.g. Directorship etc.) which the relevant exiting quasi-partner holds.

From a practical perspective, any ability for the exiting quasi-partner to represent himself as a continuing active director with apparent authority to bind the company etc needs to be dealt with (at least initially) by whatever practical steps can be taken (e.g. removing the relevant exiting quasi-partner from bank mandates etc).

However, those with control of a majority of the shares, quite often find themselves in a position where they do not have a expressly agreed contractual provision (in Articles of Association or elsewhere) which allows the relatively informal and timely removal of an existing director.

While the relevant companies legislation provides a procedure for a majority of shareholders to remove a director, for various reasons this is quite a time-consuming and administratively cumbersome process to undertake.

Broadly, if a director can be encouraged to resign voluntarily in relatively short order this is likely to be a preferred approach, although it may be practically necessary to start the relevant companies legislation process to achieve this (as ‘a stick to accompany a carrot’).

Alternatively, if the relevant majority have an ability to pass a special resolution (requiring a 75% majority of shares), then it can be quicker and easier to amend the company's Articles of Association to include a provision allowing for a less formal removal of directors - either by a majority of shareholders and / or a majority of the existing board.

Shareholdings

Often the quasi-partner’s shareholding is the most difficult aspect of matters to be resolved, and it may (in practice) not be possible to do so.

This is because the Companies' Act Model Articles (often adopted as, or forming the basis of the constitution of many limited companies) don't contain rights to purchase shares from an unwilling to sell shareholder, even if the relevant shareholder was also previously actively involved in the company but has now left.  The relevant shares are broadly protected as a property right.

Some articles, particularly (where well advised external investment has been taken) contain ‘leaver provisions’, allowing a company (or other interested shareholders) to call for a transfer of the relevant exiting quasi-partner’s shares upon them ceasing to be actively involved with the company – although these are unlikely to exist in most 'plain vanilla' quasi-partnership arrangements.

The ongoing owner / managers may well wish to resolve the position of the exiting quasi-partner's shareholding, because it is difficult for them to justify the "carrying of a sleeping partner" into the future.  Further, the existence of ‘legacy shareholdings’ can complicate the ability to run a company (on an on-going basis) and (in particular) to raise external investment by way of share capital.

Resolving a legacy shareholding position by negotiation can be hugely difficult because there is often a huge disparity between the valuations placed upon the shares as between the exiting quasi-partner (as potentially selling shareholder) and the continuing shareholders / company (as potential buyers).

Even in circumstances where an exiting shareholder might be persuaded to sell their shares at a mutually acceptable valuation figure, there is often a considerable difficulty in financing such a transaction.

Matters are considerably simplified if external finance can be obtained for the purpose, but external equity investors who are prepared to finance a ‘cash-out’ deal are extremely rare. Often the continuing quasi-partners do not have the necessary external financial resources themselves to buy the relevant exiting quasi-partner’s shares.

It is theoretically possible to undertake a ‘company own-share purchase transaction’, but in practice the often necessary external bank debt which is required is difficult to obtain. The practicalities of undertaking such an exercise are hugely complicated by various aspects of companies legislation which are designed to protect creditors of the company by ensuring a maintenance of share capital in a company.  Broadly, a company own share purchase transaction generally needs to be financed from a company’s profit and loss reserves (which are often insufficient for the purposes) and which (even if possible) is administratively cumbersome and time-consuming to achieve.

Thankfully, there are a number of recognised (if ‘secret sauce’!) alternative means of resolving the exiting quasi-partners shareholding ownership interests by agreement - without offending companies legislation’s principles of maintenance of share capital. 

Carefully used, they allow a company to finance the practical exit of a shareholder from a share register (and give the effect of the relevant shares having been ‘cancelled’) in a much more flexible manner than a company own-share purchase.

Negotiations re: share sale & purchase are considerably assisted if the continuing quasi-partners have an ability to pass a special resolution of shareholders (≥75%), since this will potentially allow the adoption of new articles with provisions introduced (say) as to allow the re-purchase of a leaver’s shares. Great care has to be taken with such an approach, but such an approach should focus the exiting quasi-partners mind as to the potential ‘stick to which they may become subject’.

Ultimately, the aim has to be for short, simple and straightforward 'exit' paperwork to be available for signature to encourage a negotiated, and agreed corporate divorce. However, often, more unilateral paperwork to 'force the issue' may also have to be prepared (even if not ultimately utilised).

Thought & care should be taken as to how any relevant exit payments are structured (from a tax perspective - both now and in the future).        

Should you wish to discuss the relevant methodologies for achieving an acceptable “corporate divorce”, please do not hesitate to discuss the same with the writer.

Dan.Johnson@EquitableLaw.com

+44 (0) 7788 537 187 (U.K. Cell. Tel.)

www.EquitableLaw.com