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In the last edition of the Client
Briefing, we looked at an issue that is usually overlooked in the
excitement of adding a new business partner: The creation of a
fiduciary relationship between the new owner and the controlling
owner. In the earlier article, we described how this duty could be
breached inadvertently by financial arrangements (such as licenses
of intellectual property, leases and sales of real and personal
property, operation of other businesses that may compete with the
business, and o owner compensation) between the controlling owner
and the business. Here we will look at ways a controlling owner may
limit exposure to claims of breach of fiduciary duties. In addition
we will review other trouble spots to consider before bringing on a
new owner.
The essence of fiduciary duties is fairness and disclosure.
Controlling owners owe new owners a duty to operate the business
primarily for the benefit of all owners. Anytime the business and
the controlling owner enter into a financial arrangement, the
arrangement needs to be fair. Fairness can be shown by an expert,
such as an appraiser, or it can be established by the consent of the
new owner after full disclosure of the arrangement. The least
expensive route is approval by the new owner. These approvals should
be received prior to issuance of the ownership interest or before
the arrangement is entered into.
Other issues to consider before bringing on new owners involve
protecting against disclosure of confidential business information
to competitors and planning for termination of the relationship.
Promises of confidentiality and non-competition should be received
from the new owner. Typically, these promises are given in
connection with execution of employment agreements (if the new owner
is an employee), shareholders agreements, or limited liability
company operating agreements.
A shareholders agreement or limited liability company operating
agreement should also outline the events which give the controlling
owner the right to buy out the new owner which generally include,
transfer of ownership, breach of agreement, termination of
employment, death, disability, or bankruptcy. While the controlling
owner may be delighted to welcome a key employee as an owner, the
owner may not be interested in having the new owner's bankruptcy
trustee, spouse, children, personal representative or legal guardian
participate in the business. Before admission of a new owner, the
controlling owner should carefully consider how operation of the
business will be affected by his or her responsibilities owed to the
new owner.
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