It’s happened many a time. I get a call from a worried business owner recently served with a corporate dissolution petition, who relates his or her suing business partner’s brash prediction, “My lawyer promises me the company will be dissolved in two months.” My usual reply is, “Yeah, right, on what planet?”
In my own experience, and as illustrated by many of the cases I’ve written about on this blog, business divorce cases can last years before there’s a judicial resolution or, as more often happens, the case is settled by means of buy-out or division of the business assets.
Time is an important factor in these cases and — here’s my main point — it usually favors one side more than the other.
Why is time important? Every business is dynamic and operates in a dynamic environment. Sales and costs grow or shrink. Key personnel join or leave the firm. Competitive threats come and go. The industry outlook improves or worsens. General economic conditions brighten or deteriorate. All of these dynamic factors and others directly or indirectly affect the value of the business, and provide different and often conflicting financial and strategic incentives for the opposing sides in a business divorce case that can tilt the litigation playing field and shift settlement leverage.
Why does time usually favor one side more than another? There’s no one answer that can address every situation. Here’s a sampling of possible reasons:
- When a frozen-out minority owner seeks dissolution and the majority elects to purchase the minority interest followed by a time-consuming valuation contest, the minority owner typically sees no financial return for the duration of the buy-out proceedings while the majority owner exercises unfettered control of the business and its finances. The majority owner has a built-in incentive to delay, tempered only by the possibility of having to pay an above-market interest rate on the eventual fair value award (depending on the delta between the market rates and the rate selected by the court assuming it awards interest on the fair value award). This dynamic generally places more pressure on the minority owner to settle.
- Take the same situation above, but throw in the risk over time of insolvency of either the business or the majority owner. It’s one thing for a minority owner to get a fair value award, it’s another to collect it. I once had a case where the majority owner caused the company, which had elected to acquire the minority owner’s interest, to file for bankruptcy literally on the eve of the valuation hearing. The risk can be mitigated to some degree by asking the court to require bonding of the fair value award.
- The longer a case lasts, the higher the legal fees. The owner with the deeper pocket can exploit that advantage to great effect, particularly if the majority owner is tapping company coffers to pay legal and expert fees.
- Business owners often perform different roles in the business. One may concentrate on sales and have stronger customer relations than the other who may exercise greater control over finance and back-office functions. Over time each owner may attempt to utilize their respective areas of strength to their own advantage in anticipation of a break-up of the business, which can also affect the value of the business as the parties jockey toward a possible buy-out settlement.
- Changes in general economic conditions can dramatically impact the course of a business divorce case. For instance, the steep drop in real estate values that began in 2007 and accelerated post-Lehman in 2008, had a decidedly negative impact on the settlement prospects and values of then-pending dissolution cases involving realty companies.
What’s the takeaway? Number one, whichever side you’re on, never base your strategy on the assumption that the case will be judicially determined in just a few months. It is the exceedingly rare case that gets resolved that quickly, except by way of settlement. Number two, whichever side you’re on, and keeping in mind that opposing ownership factions will be battling both in court and at the office over the fate of the business and its assets, before you embark on your strategy look down the road at least two years and project as best you can all that can go right and all that can go wrong for the company, the industry, the economy generally, and your own financial ability to ride out a lengthy, expensive litigation. Only then can you possibly gain an understanding of whose side time is on, and shape your strategy accordingly.