In an ideal world, we get along with our friends and family 100% of the time. There is no such thing as divorce. Our children grow up exactly the way we want. Our business partners are absolutely amazing, never making mistakes, working as hard as you do, and acting 110% in the best interests of the company.
The Harsh Realities of Business Relationships
Unfortunately, we do not live in an ideal world. As it relates to business partners, much like a spouse, people change over time, different personalities clash, loyalties shift and trust can erode.
Hopefully, if you’re in a situation where this is occurring to one or more of your partners in your business, you have the option to gracefully exit the partnership or otherwise gracefully show your partner to the door without conflict. Read our article entitled, “Leaving a Partnership – How to do it right,” for more insight on how to perform a graceful exit (the secret: leave uncontested, while the going is good).
Unfortunately for some of us, simply leaving isn’t an option. This might be because the company is too valuable, you have too much at stake, or the company cannot afford to pay you properly on your departure. You might also not want to leave because you fear the problems of the company will follow you, even after your departure. So despite your desire to cut ties with your partner(s), you stay in a bad situation, doing your very best to minimize whatever damage or harm is being done by your partner or partners.
What do you do in such a situation? How do you handle a rogue business partner, who you feel is putting the company or even you in some sort of financial or legal jeopardy?
The answer is, you have options, depending on the circumstances. Your best option, of course, is to talk to a competent business attorney, who will have the training and experience to discuss your particular situation and the factual situation to help you understand your options and appreciate your risks. When potential clients contact me about a possible rogue business partner, I will usually use the following process to assess the situation and render advice:
(1) What is the Nature of the Partnership?
The nature of the partnership will help determine the steps you will need to take in your separation.
The first question I ask is, what sort of partnership do we have? Is it an informal partnership consisting of two or more people simply working together towards a common cause, or is it more formal with a formal “Partnership Agreement” in place? Is it an actual company? If so, is it a Corporation (i.e. S-Corp or C-Corp) or a LLC, and are there formal formation documents (i.e. Operating Agreement for a LLC, or Bylaws for a Corporation)?
Formal documents for the partnership are always helpful, whether a Partnership Agreement, Operating Agreement or Bylaws, because these documents are usually very sophisticated and control a great many things about the partnership. Some of the things these partnerships include are who has what powers and how to handle different circumstances, such as dissolution, cash issues, borrowing, and so on. Therefore, no matter what the particular problem or issue is with the rogue partner, referring to these formation documents is always going to be a component of the analysis and almost always helpful.
If no formal document exists, then it becomes challenging. Depending on the circumstances, you either need to reference a statute (i.e. especially for a Corporation, where most states will have “default rules” that control corporate powers, corporate formalities, and so on) or look to emails, texts and any other communications between the partners to fully assess the original intentions of the partners.
(2) What is the Nature of the Problem or Issue with the Rogue Partner?
It is important to fully understand the issue with a partner and to determine whether or not those issues extend to the business.
With over 20+ years as a business attorney, as you might imagine, I’ve seen and heard it all. The most common issues I encounter concerning rogue partners are as follows:
- Acting in their own best interest, versus the business or in concert with the other partners
- Making too many decisions (or important decisions) on their own, without consulting the other partners
- Making decisions or acting in ways to embarrass or tarnish the brand, or otherwise place the business in some form of financial or legal risk
- Stealing from the business, or otherwise taking too many expense reimbursements or using business funds / assets for personal use
- Committing some sort of criminal act or otherwise taking significant legal risks under the name or guise of the company
- Simply leaving the business, not reporting for work, or otherwise simply being an absent partner
- The list goes on and on …
One big question to ask, is whether the problem or issue extends to the partnership or company? Is the rogue partner acting on behalf of the business, and therefore are his or her actions being imputed to the business?
(3) Is There Some Form of Criminal Activity with Respect to the Rogue Partner?
If your business partner is involved in some type of criminal activity, the personal legal risk to you and your company is very high.
Obviously, if you are actively involved in some way in a criminal matter or otherwise facilitating or furthering that criminal matter, no amount of corporate umbrella will shield you from personal liability.
However, if your partner is involved in some form of criminal activity, can his illegal activity create personal criminal liability for you, just because you happen to be a partner of his in business?
The answer to that question depends on many factors, the primary one being is the business being used in any way, in furtherance of the rogue partner’s criminal activity? If the answer is “yes,” or even “maybe,” then the answer is, you run a very high risk of criminal personal liability, although it can depend somewhat on the nature of the criminal activity, and especially if you’re simply turning a blind-eye or you are indirectly profiting from that criminal activity (i.e. the company is benefiting with more profits, more revenue, more assets, etc).
The rule is, if your rogue partner is involved in any sort of criminal activity, run far and run fast. And of course, seek legal counsel immediately.
If your partner’s criminal activity is purely personal (for example, you know your partner pirates movies or software, and your business is a dog-grooming business that has nothing to do with pirated movies or software), you should still beware because your partner could one day be arrested and unavailable to the business, or at the very least, bring negative light to the business that could have long-term negative consequences.
(4) What Options Exist to Deal with a Rogue Partner?
The answer to this is going to depend on the answers to the previous questions above. Do formation documents (i.e. Partnership Agreement, Operating Agreement, Bylaws) or anything else exist? Do we have evidence to backup the original intentions of the partners? What is the nature of the problem or issue with the rogue partner?
In general, partners have the following duties or requirements to the partnership, corporation or LLC:
- A Fiduciary Duty. A fiduciary duty is an actual legal duty that requires each partner, corporate officer and/or owner (hereinafter “Principals”) to act solely in the interest of the partnership or company, and must avoid conflicts of interest and may not profit from the relationship without the consent of the other Principals.
- A Duty of Loyalty. A duty of loyalty means each Principal must act without personal economic conflict. The duty of loyalty can be breached either by making a self-interested transaction or taking a corporate opportunity for him or herself, instead of making it available to the partnership or company.
- A Duty of Care. Each Principal must act (and make decisions) in the same manner as a reasonably prudent person in their position would.
- Powers and Limits as Specified in the Formation Docs. Each Principal, depending on their status, role or title, has powers granted and limitations that will be specified in the relevant formation documents, if such exist. For example, if a Principal is the “Managing Member” of a LLC, the Operating Agreement will have specific powers granted to the Managing Member, and such Principal may not exercise powers outside those granted to him or her.
So, depending on the nature of the problem or issue with the rogue partner, you must ask yourself whether the rogue partner is violating one of the duties listed above, or otherwise in violation of the formation documents? If so, the list of available options include:
- Talking with the rogue partner, and demanding change or compliance
- Sanctioning the rogue partner in some way, in a form permitted in the formation documents or law, such as requiring reimbursement for company funds used for personal affairs
- A reduction in role or pay, as permitted in the formation documents
- Finally, a lawsuit, especially if the rogue partner is unfairly leveraging greater ownership or title within the company
A lawsuit is expensive, but may be your last resort. You will need to seek a judge to sanction, remove or otherwise rewrite formation documents as necessary to remove a rogue partner who is violating the law, one or more duties, or the formation documents. Remedies available are numerous, including injunction, actual damages, removal from the company or partnership, and more.
(5) Avoid, at All Costs, Simply Walking Away
The most important things to take away from this is that you need to fully understand the situation, seek legal advice if you are unsure about anything, and face the problem head on.
While it may be hard, emotionally taxing or even (hopefully not) dangerous to confront a rogue partner, simply walking away from your partnership can expose you to all sorts of liabilities down the road. Don’t think for a second, that simply walking away will remove liability to you personally, relating to the business or the actions of a rogue partner. Read the other blog article mentioned earlier, How to Leave a Partnership Properly, to learn about the issues and liabilities that could come to harm you down the road.
Law 4 Small Business. A little law now can save a lot later.