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The Course of Shareholder Dispute Litigation Can Be Affected By The Way Your Shareholder Agreement is Drafted

Many business owners involved in shareholder dispute litigation wish they could go back in time and rewrite their shareholder agreement.  Unfortunately, it is often during expensive, protracted litigation with your business partner that you learn how your shareholder agreement could have been drafted to save you a costly lawsuit, or at least alter the course of that lawsuit.

For example, in one recent case, the Court wound up appointing what is called a “Provisional Director” to break ties between two fifty/fifty owners of a subchapter S corporation.  Unfortunately, the Provisional Director began making all sorts of decisions that went against my client’s interests.  The decisions may have made some business sense, but they were clearly not what my client wanted to occur.

With better planning up front, this situation could have been avoided.  A Provisional Director is a court-appointed member of the board of directors of a corporation, and has all the powers to act as a director, essentially breaking any tie.  However, in New Jersey, he or she is not a shareholder and cannot act as a shareholder.  Of course, in a small, closely-held business, the shareholders are almost always the directors.  But on this point, the distinction is critical.  If the shareholder agreement provides that certain decisions can be made only by the shareholders, and takes certain issues out of the hands of the directors, a tie between shareholders in a shareholder vote cannot be broken by a court-appointed Provisional Director, at least in New Jersey.

In my case, the client desperately did not want raises to be given out, fearing that the increased pay would only be used by his co-owner to pay his attorneys’ fees, further fueling the litigation the client thought should not have been started in the first place.  Had the attorney who drafted the shareholder agreement thought about possible future shareholder dispute litigation, he could have drafted the document to require unanimous shareholder approval for salary increases and the award of bonuses.  But no such foresight was present at drafting, and the fifty percent owner’s fate was decided by a court-appointed stranger who knew very little about this – or any – company.

Many of the articles I write on this blog have a common theme: attempting to help the reader avoid problems before they occur.  Once again, steps taken at the outset can make a huge difference should shareholder dispute litigation become necessary.   And if your shareholder agreement – assuming you can find it – does not contain such a provision, it’s never too late to amend it; provided, of course, that all shareholders agree to the changes.