Negotiating and Structuring the BUSINESS DIVORCE

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1 Negotiating and Structuring the BUSINESS DIVORCE Curtis L. Golkow Golkow Business Law LLC Pennsylvania Bar Institute 2012 Presentation for PBI Seminar, Owners Disputes in Closely Held Corporations, Partnerships and LLCs 2012 Golkow Business Law LLC

2 The Goal a Business Divorce buy out other owner at a low price and with extended payment terms sell to other owner or company at a high price for cash at closing sell the business to a third party divide the business (by geography, product/service lines, etc.) and retain the desired portion liquidate and dissolve

3 DEVELOPING THE STRATEGY STEP #1 - LEARN THE FACTS Type of Entity and State of Formation corporation (C or S corporation) limited liability company (LLC) general partnership (e.g., undefined joint venture) limited partnership trusts, other

4 DEVELOPING THE STRATEGY STEP #1 - LEARN THE FACTS (continued) Governing Law state of incorporation/formation state where litigation is brought choice of law provision in shareholders, LLC operating or partnership or other agreement

5 DEVELOPING THE STRATEGY STEP #1 - LEARN THE FACTS (continued) Document Review: formation/organizational documents buy-sell agreements, options, subscription documents employment agreements restrictive covenants loan documents leases, franchise documents and other material contracts

6 DEVELOPING THE STRATEGY STEP #1 - LEARN THE FACTS (continued) Relationship among Owners and the Business: relations with key employers relations with key customers/supplier special know-how, techniques or skills ownership of IP or other crown jewel asset other relationships unrelated to business

7 DEVELOPING THE STRATEGY STEP #1 - LEARN THE FACTS (continued) Facts Concerning the Business: value (worth fighting over?) growth opportunities (upside) competition risks (downside) borrowing capacity (source of funding the buy-out)

8 DEVELOPING THE STRATEGY STEP #1 - LEARN THE FACTS (continued) Particular Facts and Circumstances: ability to endure and fund litigation ability to finance buy-out skeletons in the closet and other sensitivities

9 KEY FACT: Who Has Control? majority of voting equity majority of votes as director/manager President/CEO check signing authority ownership of key IP, know-how or crown jewel asset relationship with key customers, suppliers, etc. (absent restrictive covenants)

10 Gathering Information Assessing Leverage and Building the Record for Litigation: inspection rights discovery attorney-client and work product privilege Information = Ammunition

11 LEVERAGE for the party with CONTROL the FREEZE OUT issue additional shares or other interests (dilution) terminate employment reduce compensation discontinue/reduce dividends/distributions (S corporation or partnership for tax purposes) discontinue/reduce owner s goodies increase controlling party s compensation hire family members and friends enter into favorable related-party transactions pursue growth opportunities through separate venture

12 LEVERAGE for the party with CONTROL the SQUEEZE OUT expulsion or redemption per formation or organizational documents or buy-sell agreement (e.g., buy-out upon termination of employment) squeeze-out merger, share exchange or other transaction dissenters rights reverse stock split

13 LEVERAGE for the party with CONTROL - LITIGATION build record for litigation assert claims - lawsuit funded by the business, choosing the timing, choosing the court

14 LEVERAGE for the party with CONTROL - VEXATION change business name demote (title, reporting relationship, role in the business) promote others over an owner take away indicia of importance (corner office, secretary, parking spot) disrespect, embarrass

15 LEVERAGE for the party without CONTROL - DISRUPTION extensive inspection of books and records meetings to build a record for litigation airing dirty laundry destabilizing important relationships offer shares to outsiders

16 LEVERAGE for the party without CONTROL - LITIGATION Substantive Claims: breach of fiduciary duty breach of duty of good faith breach of contract (e.g., employment agreement or restrictive covenant) usurpation of corporate opportunities oppression

17 LEVERAGE for the party without CONTROL LITIGATION (continued) Substantive Claims (continued): conversion, misappropriation, unauthorized use or waste of business assets theft of trade secrets tortious interference with contract or prospective business advantage defamation, libel, slander, commercial disparagement fraud, intentional misrepresentation negligent misrepresentation securities fraud Computer Fraud and Abuse Act (other computer crimes)

18 LEVERAGE for the party without CONTROL LITIGATION (continued) Substantive Claims (continued): RICO Wage Payments and Collection Law unfair trade practice unfair competition unjust enrichment quantum meruit civil conspiracy aiding and abetting malpractice or ethical changes (if licensed professional)

19 REMEDIES for the party without CONTROL damages constructive trusts equitable accounting custodian provisional director/manager or tie-breaker involuntary dissolution and liquidation injunction to prevent action order invalidating past action order compelling a buy-out

20 Helpful Professionals valuator mediator arbitrator broker/finder (for sale to third party) other?? (relationship between opposing counsel)

21 DEAL STRUCTURE Allocation of Consideration: repayment of loans distributions purchase of equity interests compensation for services to be rendered (e.g., consulting) deferred compensation (watch out for I.R.C. 409A) consideration for restrictive covenants payments under leases and licenses

22 THE BUY-OUT Termination of Ownership Status: cross purchase of equity interests direct (entity) purchase (i.e., redemption) recapitalization or similar reorganization merger, share exchange, division

23 BUY-OUT TERMS PURCHASE PRICE payment in full at closing vs. seller financing contingent purchase price payments/adjustments - performance based (earn-out) - specified contingency (e.g., change in law, retention vs. loss of customers) - payments conditioned upon compliance with restrictive covenants - subsequent sale of the company - subsequent sale or issuance of equity

24 BUY-OUT TERMS POST-CLOSING PAYMENTS protections for seller as lender - collateral security - personal guarantees - limits on compensation, distributions and other payments (subordination) - restrictive covenants - corporate/company opportunities subordination to acquisition financing

25 TERMINATING RELATIONSHIPS amendment/termination of buy-sell agreement (e.g., transfer of insurance policies) resignations (board, officer, manager, employee, trustee of benefit plan, other?) vs. termination (unemployment compensation) discontinue use of seller s name (transfer phone number)

26 CONTINUING RELATIONSHIPS IP assignment or license press release, public statements (including to employees, customers, other business relations) employment references COBRA other benefits use of company personnel forwarding mail (unopened) and other communications

27 COMPANY PROPERTY Return to Company vs. Transfer to Former Owner: automobile (keep lease in place, former owner responsible) personal computer/laptop - licensed software - company data - owner s personal data and embarrassing files furniture and furnishings other??

28 POST-SALE COVENANTS post-sale services (e.g., consulting, availability to answer questions) restrictive covenants - confidentiality, non-disclosure/use (existing fiduciary duties) - non-competition, non-solicitation (except for personal assistant) - non-interference (e.g., communication with employees, customers, lenders/investors, etc.) - non-disparagement (mutual)

29 REPRESENTATIONS AND WARRANTIES business, assets, liabilities, financial condition, prospects rely on own due diligence no unauthorized actions; no sabotage no known third-party claims (pending, threatened or potential unasserted) disclose known basis for claims by or against third parties (careful) 10b-5 disclosure vs. non-reliance

30 RELEASES, INDEMNITY & CONTRIBUTION mutual releases (specific requirements under OWBPA) indemnification (and defense with advancement of expenses) against third-party claims - bylaws, operating agreement, applicable law - specified known claims - selection of counsel (joint defense, conflict waivers) - whose fault was it? contribution for potential company/owner liabilities ( whistleblower problem) company s claims against third parties - selection of counsel - allocation of litigation costs - control of assertion or settlement of claims - responsibility for counterclaims and defense costs

31 BASIC TAX ISSUES deductible vs. non-deductible payments amortization of goodwill 355 spin-off direct purchase vs. cross purchase (increase tax basis) capital gains (long term vs. short term) vs. ordinary income ( hot asset rules for partnerships) installment sale tax information reporting S corp or partnership (LLC) final distribution all income or taxcoverage distribution amendments to tax returns and changes in method of tax reporting affecting pre-closing period future tax audits

32 Contact Information Curtis L. Golkow, Esq

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