Quick! . . . Mediate That Business Divorce!

Corporate Law Practice Group

By Corporate Law Practice Group

One of the officers of a corporate client calls. You note the distress in his voice immediately. He tells you that a dispute has arisen between the major shareholder factions of the company, and he wants you to advise on what he and those in his faction can do to win this. And you can tell he expects you to talk “reason” to the other faction.

But you quickly realize that although for the moment knowledge of the dispute is restricted to people in the company, it will only be a short time before it gets out to the customers, suppliers, banks and others with whom the company does business, threatening the existence of the company.

You should consider recommending the factions mediate the dispute, if possible before litigation is filed.

Advantages of Mediation

Some advantages of mediation are:

No Publicity. No lawsuit is filed. The situation can be kept as confidential as the parties want.

Speed. Trial, or even a hearing for significant injunctive relief, will take months, if not years. And as soon as customers hear there is an internal dispute — and they will — they will take their business elsewhere, to a “stable” competitor. And this risk increases significantly if a lawsuit is filed. A mediation can begin immediately.

Possible Quick Reduction in Ill-Will. The early part of most mediations give the parties the opportunity to vent, and then to be brought by the mediation format to look for rational resolutions. The mediator could, for example, hold an immediate mediation session, not necessarily to reach resolution immediately but as a way to begin gathering information. But another objective would be to reduce the ill-will between the factions, pending one or more future sessions to be held a short time later. During the following interim, they would likely work better together, and the company’s employees will understand that they have begun to work out their problems.

Better Resolutions than are Available in Litigation. In most business divorce situations, the court at best has very limited options for resolution, usually being able only to dissolve the company and distribute the assets. The parties in mediation, on the other hand, have unlimited possibilities to resolve the dispute. The easy ones come readily to mind: one faction buys out the other, perhaps on a “push-pull” basis. Frequently a company has two or more lines of business, and different factions can take different lines into separate companies.

And courts, with crowded dockets and lack of expertise in complicated corporate structure, with tax and very complicated technical issues arising from the nature of each unique business line (hence the Business Judgment Rule), frequently make mistakes in their attempts at resolution, mistakes which the parties with their lawyers, advisors and a mediator are unlikely to make.

Complicated Issues Must be Resolved

The company’s lawyer, and the lawyers for the disputing factions, must be versed in those issues in deciding whether to go to mediation, and indeed, in choosing a mediator. And they and the mediator must be familiar with them in the mediation process.

Some of those issues are, to name a few:

Valuation (virtually all such cases require valuation of the business as a whole, and valuation of its lines, its hard assets, value claimed by each faction for work and assets previously contributed without compensation, etc.);

Possible legal restrictions on settlement by the statutes, the articles of incorporation and bylaws (or the articles of organization and operating agreements of LLCs) (e.g., companies may not purchase their own stock if it will “impair capital”; there may be shareholders who are not in the disputing factions whose rights must be preserved; labor laws may set requirements on treatment of employees in any settlement);

Rights of third parties (e.g., creditors and third parties to the company’s contracts may have guarantees and other rights from the disputing principals that must be accommodated);

Regulatory issues (e.g., brokerage firms, bars/restaurants and other businesses are frequently required to have licenses the continuation of which requires persons with certain qualification stay in management);

Tax issues (e.g., some flow-through entities incur serious consequences if the ownership of more than 50% of their equity changes).

But underlying the parties’ negotiation positions will always be their (and their attorneys’) beliefs about how favorable a resolution they would get if they filed and completed litigation. So the mediator must also be familiar with the complexities and vagaries of litigation: the remedies available, (partition? injunctive relief vs. mandamus?), motion practice, what evidence would be admissible in trial, the level of understanding of most judges with complicated business law issues, and others.

Mediation, Even Prior to Filing, is Usually the Best Decision

My experience as a transactional attorneyand a business litigator and arbitrator is that seeking to settle as quickly as possible, even before filing litigation or arbitration, has historically improved the outcomes for both (or all) disputing factions. Admittedly, business people as a class are strong-willed and aggressive, and often want to “win.” But they are also business people who regularly evaluate risk and prospective benefit, and negotiate to “deals.” With that mindset on the part of the disputing factions, the probability of a mediated settlement is greater among business persons than among most other groups. And even if the mediation does not resolve the dispute, it usually improves the tone and quality of outcomes in litigation that follows.

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