Time for a 'Business Divorce'

From outstanding tax liability to unearthed financial irregularities, biz breakups can be every bit as emotional and complicated as a marital split

By Karen E. Klein

When the economy is in recession, it's a given that many businesses will be sold or go under. And when that happens, it often triggers what attorney Michael A. Gold, of Jeffer Mangels Butler & Marmaro in Los Angeles, calls a "business divorce." From outstanding tax liability to business debt and unearthed financial irregularities, these breakups can be every bit as emotional and complicated as a marital split, Gold says. He spoke recently to Smart Answers columnist Karen E. Klein; edited excerpts of their conversation follow.

You represent developing and entrepreneurial companies across a range of industries. When did you start to see an increase in business dissolutions and partnership splits?

When the economy was really booming there were very few of these. But I noticed in early 2007—and by the end of 2007 it became apparent—that that part of my practice was really picking up. And then 2008 tuned out to be a very busy year, especially after Lehman Brothers tanked.

Business partnerships are often related to marriages; you liken partnership splits to divorces. Why?

Business divorce does have some of the same characteristics of a family divorce, just without the china and silverware. But there are usually substantial assets involved and people often bring a lot of emotion to the table. Many times they want a lot of things that can't be obtained in court.

Why do business partnerships break up?

Soured personal relationships, financial strains, and bad business models can contribute to a decision by the owners of a closely held business to part company. Sometimes the breakup is amicable, although it can often be hostile and litigious. And where there is no pre-existing agreement—like a shareholders' agreement, a limited liability company operating agreement, or a partnership agreement—with a road map that governs the separation, business divorces can quickly become very nasty.

Are you seeing business divorces triggered by situations specific to this recession?

Yes, especially post-Lehman Brothers I'm seeing partners realize that they have different risk profiles. One guy might believe this is the greatest real estate buying opportunity of all time, while the other wants to take his chips off the table because he thinks we haven't yet hit bottom in the commercial real estate market.

I've also seen some near-death financial experiences, where a bank has pulled financing, or there's inadequate capitalization and the bank comes back and wants guarantees from the partners. Suddenly, one partner realizes he doesn't want to guarantee a debt with the other partner, and those personal and credit issues cause them to re-evaluate whether they want to be in business together.

What kinds of unexpected issues arise in business divorces?

Very often we are dealing with banks and other third-party financing. One case I'm working on involves seven different lenders, all with different loan agreements, scattered across the Southwest. One shareholder may want to pay the debt in full, while the other says 'Why do we want to do that? These guys will let us get away with paying 75¢ on the dollar!'

Dealing with employees can also be a significant problem. In California, for instance, as a matter of policy and law the courts take fair treatment and payment to employees very seriously. When companies find themselves in trouble they sometimes short the employees— which can give rise to significant liabilities. We also face a lot of tax issues and competition issues.

Do you see partners who haven't really gotten along for years but have managed to work together while their business is doing well?

Oh yes, all the time.

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