The maxim that an ounce of prevention is worth a pound of cure holds up just as well in the business world as it does in the practice of medicine. Consider the following situation: partners Allen, Bob, and Charlie have a successful small business together. Through years of grit, industry, and team-work, they have taken a business idea from the theoretical into the practical and found a niche for themselves in a new market. In the course of success, they formed an LLC, developed relationships with marketers, suppliers, accountants and lawyers, and did their due diligence to ensure their growth and viability for the future.
But then disaster strikes. Maybe Allen is getting a divorce. Maybe Bob is faced with personal bankruptcy and criminal charges of fraud or tax evasion. Maybe Charlie has been in an accident and is looking at long-term care and permanent intellectual disability. The question of whether the business can survive (and at what cost) may rest on the partners having planned in advance for these contingencies.
In any of the situations described above, the lack of a formal recognized agreement between the partners could very well end the business. A divorcing spouse may be entitled to a share of the business assets, forcing a sell-off or dissolution. In the case of personal bankruptcy, accounts and assets of the business could be subject to judgments and liens. If a member of the business is afflicted with some type of disorder that prevents them from actively participating, the business could find itself hamstrung until a guardianship can be put in place if unanimous consent is required for some decision-making.
The most practical way for a business with multiple partners to guard against unanticipated disaster is to adopt a well-crafted buy-sell agreement. A buy-sell agreement is, in the simplest terms, a contract between all of the owners of a business and the business itself that governs how the interests in the business can be transferred. New York has adopted certain rules that restrict what an enforceable buy-sell agreement can include. For example, prohibiting a member of an LLC from ever selling his or her interest in the business to somebody else would likely be deemed an “unreasonable restraint on alienation” and unenforceable. On the other hand, New York courts will generally uphold a provision that gives the business or the other members a first right to “buy back” the selling member’s interest on the stated terms, or pursuant to a stated figure in the agreement within a certain time period.
The buy-sell agreement or operating agreement can be expanded to include rules that require certain outcomes based on triggering events such as death, divorce, incapacity, personal bankruptcy, imprisonment, etc.
There are other practical steps a business should consider taking with respect to its members. A business can take out life insurance policies on the members naming the business as the payee. Upon the member’s death, the business can then use the life insurance policy proceeds to pay a sum to the surviving family members, rather than trying to scrap together enough money through new loans and liquidating assets, to satisfy the amount owed for the decedent member’s share of the business. Another option is for the members to grant each other limited durable powers of attorney. A power of attorney is an agreement granting another person the authority to make certain decisions on his or her behalf. This is a useful tool for situations where consent must be unanimous (such as making large capital purchases or entering settlements and confessions of judgment). Powers of attorney can also be “springing” which generally means that they come into effect only if the principal becomes incapacitated. Again, the idea here is about saving time and money down the road by taking simple preventative measures.
Many of these steps also apply to business owners who operate as sole proprietors or who are in charge of single-member entities but wish to see their businesses continue on after their own involvement. To that end, lawyers can help to reconcile business goals with broader estate planning objectives.
All of these strategies and more should be considered by business owners, and can often be implemented expeditiously and without great cost, through an attorney or team of advisors familiar with the business’s operations and the owners’ goals. Failing to take proper precautions may cause, as Churchill said, “history to cast its verdict with those terrible, chilling words, ‘too late’”.