Pandemic Update: Review the Terms of Business Agreements

The global coronavirus pandemic is of course a challenging time.  Many businesses have been hard hit and may not recover.  Unemployment has skyrocketed.  On the other hand, there are many businesses that have been only mildly affected to date.

The conventional wisdom is that the economic pain will continue for some time.  Accordingly, it is an important time to review the terms of your business agreements, such as operating agreements or stockholders’ agreements (and frequently employment agreements).

We expect to see an increase in “business divorces.”  If you or your business partners are separating, the first step in evaluating the consequences is to review the governing agreements between the owners.  Some questions you may ask include:

1. What happens if you or another owner “quit” or voluntarily terminate employment? This may trigger equity buyout rights by the company or other owners.  It also may trigger severance pay obligations.
2. Do you have obligations if there is a capital call? In other words, could you be required to contribute money to the business if needed?  Who makes this determination?
3. What potential liabilities might you be responsible for, including any personal guarantees on bank loans or lines of credit? How easy or difficult will it be to be removed from these types of obligations?
4. If there is an equity buyout, how will the business be valued? Is an appraisal required, or does the agreement use a formula such as a multiple of sales or profits?  What are the payment terms for any buyout?  Often, this involves the buyer giving the seller a promissory note and paying it over a term of years (eg, three or five years).  What is the interest rate on such a note?  What security is there for the seller if the business is struggling?
5. What do the agreements say if you or another owner are disabled? This may include salary continuation, or a forced equity buyout.  What happens if an owner dies (for example, is there a mandatory or optional buyout?  On what terms?  Are there “permitted transferees” such that the remaining owners could be partners with the deceased owner’s family?
6. Can you exit the business and be paid for the value of your equity? Most business agreements do not permit an owner to simply exit, or “put” his or her equity to the company and get paid fair value in return.  You may not have an easy exit, in which case you may be at a disadvantage if you attempt to negotiate a buyout.
7. What other types of incentive compensation – such as stock options, profits interests – may be affected in the event of a business divorce?
8. In addition, if you do not have a current business agreement for your business, this may be a time to put one in place, so that you and the other owners have a plan and an agreement. Without an agreement, many of the issues mentioned above can lead to disputes and potential litigation.  It is prudent to work out agreements on these issues when parties are competent and getting along.

Business divorces raise important questions that should be reviewed with your attorney.

As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice.  For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.