Leaving a Partnership — How To Do It Right
So, you’ve decided (or are considering) to leave the company you’ve either helped to form, purchased an interest in, or otherwise joined for one reason or another. There are many reasons why you may want or need to leave the company:
- Change of life circumstances, because of a family member death, change of careers, or other significant event
- Due to a disability or incapacitation
- Differences of opinion or management styles
- Loss of faith, disputes, or open hostility in one or more of the partners or co-owners
The first three green bullets above are most often associated with “uncontested departures,” while the remaining red bullets to are most often associated with “contested departures.”
Aside from the emotional issues of departing your partnership, there are legal and financial considerations that if left to their own devices, could spell financial ruin for you personally years later, whether contested or uncontested.
You will ALWAYS be better served in an uncontested departure, so if you can bite-the-bullet and do everything in your power to maintain a good relationship with your soon-to-be-former-partner or partners, you will save big.
Uncontested Departures are Best
As in divorce, an uncontested departure is significantly easier and more cost-effective than a contested departure.
Leaving a partnership takes planning and foresight. In an uncontested departure, you and your Partner(s) will collaborate and negotiate the terms for your departure, ultimately signing a “Separation Agreement” without the undue legal expense or court costs. Your Partner(s) may be unhappy about certain issues, or in you leaving, but in the end, will “do the right thing” either because they have to or because they want to.
In a contested departure, you and your Partner(s) will not communicate except through attorneys, and you will fight about the terms of departure, outstanding assets, and liabilities, and whether the Operating Agreement or Bylaws permit the type of departure you’re trying to accomplish. It may be very difficult or impossible to reach a “Separation Agreement,” and if you cannot, you may need to go to court or take the risk of departing without one. If you withdraw without a “Separation Agreement,” you run the risk of being sued, ruining your credit or worse, sometimes years after you’ve departed and thought you were in the clear.
How to Perform an Uncontested Departure
In an uncontested departure, use the following checklist to perform a proper departure that will help minimize your risks and future liability:
- Review the current Operating Agreement, Bylaws and/or other controlling corporate documents, to ensure you follow any and all departure requirements carefully
- Identify all assets and liabilities, and come to an agreement with your Partner(s) on the status of those assets and liabilities
- Identify all contracts, liens, mortgages and other obligatory documents that name you personally or where you otherwise act as a personal guarantee or surety
- Based on the above information, negotiate departure terms
- Have yourself removed from all obligatory documents and/or where you are a personal guarantee or surety
- Draft a Separation Agreement that documents everything, and have it executed properly by the Company and your Partner(s)
- If there is a long-term commitment by the Company to you (i.e. to pay you money over time, or retire some form of debt), consider mechanisms to enforce those commitments, including the right to audit or security interests
- Finally, make sure your name is removed from all formation documents, including but not limited to the Operating Agreement (for an LLC) or Bylaws / Corporate Register (if a C-Corp or S-Corp), Articles if your name is listed on the Articles, and with the IRS, if your name was used as the “Responsible Party” when your FEIN was obtained.
Sending a letter or notice of your departure will not relieve you of financial obligations to lenders and other third-parties.
It’s not easy to remove yourself from obligatory documents
Whether you’re listed as “a borrower” on a line-of-credit, a tenant on a commercial lease, or you’ve signed as a personal guarantee for the Company’s merchant account, these structures will seldom, if ever, allow you to leave without cancelling the account or contract outright, and requiring the Company to renegotiate a new relationship, account or contract. Simply sending a letter or notice to these Companies will NOT relieve you of your obligations, however. You must have a new contract or other document that firmly, unequivocally, releases you from any and all obligations associated with the obligatory document.
There may be strong opposition to this by your Partner(s), and oftentimes may cost the Company considerably more money in doing so.
For those obligatory documents, you cannot remove your name from, you will have to evaluate the risk associated with each one, and consider other options to the Company. Options include making the company put up some form of escrow account from which the obligation will be paid off, giving yourself some form of security interest in one or more of the Company’s assets, forcing your Partner(s) to personally indemnify you, etc. Clearly, if you’re confronted with this situation, you really do need to hire a competent business lawyer or business attorney to help you.
Make sure you identify (and address) all forms of liability before you leave
Outstanding obligatory documents you cannot be removed from represent one form of liability. Other liabilities to include in a Separation Agreement with your Partner(s) include but are not limited to potential lawsuits from third-party causes of actions (i.e. former disgruntled employees, past contract breaches, past violation of statutes or governmental regulations, and harms to customers or members of the public), outstanding tax liabilities (i.e. Unpaid NM Gross Receipts Tax), and accounts payable.
A strong Separation Agreement should be your departure goal
Law 4 Small Business can help you with your Separation Agreement. “learn more”.
The point of a Separation Agreement is to write down everything you’ve agreed to with respect to your departure. While this may not sound all that important when you’re getting along with your Partner(s), remember that things can really change during your absence. If the Company doesn’t live up to its promises, you need some form of proof and leverage to enforce compliance. If a third-party creditor or judgment (think lawsuit) comes knocking on the door, a Separation Agreement will help validate whether you’re subject to potential liability or not. Same thing if the tax man comes knocking.
Terms to negotiate with your Partner(s), that should find their way into the Separation Agreement include:
- Final disposition of assets and liabilities
- The price the Company is paying for your ownership, and how it’s paid (if some form of payment terms apply)
- How the Company will remove your name over time from any obligatory documents
Furthermore, your Separation Agreement should have the following legal clauses, at a minimum:
- Indemnities for the departing partner, to ensure the Company will hold you harmless for future lawsuits and harms
- A security interest to cover any outstanding monies owed, debts or other obligations that cannot be removed
- A clause covering material breach, should the Company not be able to cover its obligations
- A right to audit the books, if you have some form of payout over time, and it’s dependent upon revenues
How to Perform a Contested Departure
If you’re unfortunate enough to find yourself in the “Contested Departure” category, the formation documents will be controlling. If you have a LLC, that will be your Articles of Organization and your Operating Agreement. If you have a C-Corp or S-Corp, that will be your Articles of Formation and your Bylaws. There may be other documents, on top of those, including but not limited to a Partnership Agreement, Restriction Agreement or Investor Rights Agreement.
If no such documents exist, then you need to look to the statute in the state where your company is formed. The statute indicate rights, duties, obligations and procedures for owners and the company itself.
You must follow these documents (and the statute), and if they are (1) not being followed, or (2) create some form of inequitable relationship, your only recourse may be litigation. Otherwise, you vary from these formation documents at your peril, and your best option would be to get your Partner(s) to sign off on your departure. This means you may need to negotiate accordingly, and that may mean negotiating with a very weak position.
Before you do, you would be best served by consulting with a strong business attorney or corporate lawyer before you go too far down this path.
Consider talking to our experienced business attorneys to learn more about your options, if you think you’re in a “Contested Departure” situation.