50/50 Ownership Relationships can be Trouble, Plan Ahead

It is not uncommon for a family business, business among friends, or perhaps boyfriend and girlfriend or husband and wife, enter into a business where the two people want to be ‘fair’ with each other and state they will split everything equally – ’50/50.  This sounds great in theory, but in reality, as the Delaware Supreme Court has taught us in Philip Shawe v. Elizabeth Elting, the business doesn’t always run smoothly and relationship issues/ disagreements on the direction of the business can get in the way of development. Moreover, growth can stagnate because decisions aren’t being made due to deadlock situations and other persistent problems. Take for example, a business founded by two college friends, that own a business 50/50, although one owner gave one percent to his mother. Aside from being business partners, the two founders were initially engaged. The engagement was called off, and the relationship soured and remained hostile. Despite the breakdown of the personal relationship, the business grew to be one of the largest in its industry.

An unintended (but foreseeable) consequence from this type of arrangement is the dysfunctional personal relationship resulted in deadlock in the election of directors and the directors remained deadlock in decisions. The two owners clearly stopped getting along and can now take the contrary position from the other owner simply out of spite. This creates a negative impact on the business and a potential breach of the duty of good faith, duty of care, or the duty of loyalty to the Company. There is a possibility that one can argue irreparable injury to the business, its reputation, goodwill, customer relations and employee morale.

A court in a situation like this can do several things: (i) Do nothing, or perhaps (ii) Appoint a provisional third director or a custodian. In the case referenced above, the court clearly saw that injury was occurring to the business, and that a provisional third director was likely to result in continued involvement by the Court, so a custodian was appointed. Rather than have the custodian conduct the business, the order directed the custodian to sell the business in a modified auction process allowing for either of the current owners to individually bid, as well as others. The custodian was tasked with picking the winning bid. Despite arguments by the owners against a custodian intervention and forced sale, the Court evaluated the statutory interpretation arguments and found that the authority to order a custodian and the remedy of a sale was within the equitable authority of the Court.

Clearly, this is not something business owners want to leave to chance. If the ownership percentages of the business are not scaled toward getting to a majority answer with every decision, deadlock will only create challenges and potentially end up leaving the fate of a business into the hands of the court. Again, why leave this to chance? It is your business, you should be able to have the control you desire to avoid third party intervention.

The following are some issues on this matter to be aware of: First, 50/50 splits are challenging when personal or business interests diverge. If neither party is willing to sell their interest in the business to one side or to third parties, or the price is not acceptable, deadlock can result. Second, ownership disputes can have a negative impact on the operations of the business, profit, customer and supplier confidence, and employee morale. Where the immediate impact on the business is not serious or irreparable, the deadlock could result in years of stalemate before it rises to the level that a court would order a sale of the assets and dissolve the corporation. In the meantime, the performance of the business may be suboptimal with very high levels of stress on the owners. Where dissolution by a court is considered, it is not unusual for one side or the other to make the argument that the “death of the business” is extreme and would cause a loss of jobs, value, etc.

Remember, dissolution of the ownership structure through the appointment of a custodian may, in fact, preserve a profitable business; however, as an important unintended consequence, ownership is gone, and it is a matter, a custodian could conduct a sale that allows the parties or others to bid, and preserve the going concern value. It is no longer your business. The advice that “50/50 relationships can be troublesome” is true. Ultimately, the Court in this case ordered a sanction against one owner for millions of dollars. For anyone who thinks that attorney fees for establishing a business and developing dispute resolution mechanisms in advance are too expensive, consider the total fees in this case but also the amount of money and problems that can be spared when consulting with an attorney first.