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Business Owners: News Headline Illustrates the Potential Legal Consequences of Business Break-Ups

The American Bar Association Journal reported a bit of legal news today-  a Defunct Law Firm was Ordered to Pay Subleases for a Manhattan Office Building, see the article here

 

Business owners – you know why you create a business entity – a corporation, or a limited liability company – to limit your personal liability from the reach of creditors of the business.

 

However, this headline illustrates another issue that business owners should be mindful of when thinking about limiting liability: what happens when you break up a business partnership, or decide to dissolve and then create a new business?

 

 

I. When breaking up a business relationship:

 

What happens when you have a dispute with your business partner and you decide to go your separate ways?

 

Facts of the article above are helpful.  It involves a business with four shareholders.  Two of the shareholders decided to leave the business (the “Leaving Partners”) and the other two shareholders dissolved the business, stayed together as a partnership (the “Remaining Partners”) and resided in the former business office space.

The Remaining Partners, through their new business incurred lease expenses for the building.

Upon exit, the Leaving Partners received releases of liability from the Business.

 

Business Owners and Fiduciary Duties.

 

As a business owner, you have a fiduciary duty, to act in the best interest, of the company and the other shareholders.

When exiting a business relationship, naturally, removing yourself from this duty is important. In this case, the Leaving Partners were allowed to go their separate ways and they no longer had any responsibilities to the business for any future debts. They were not responsible for liabilities incurred by the remaining partners after their exit.  Their share of their former business’s  assets could not be used to pay their former business’s rent.

 

Points To Consider when exiting a business relationship.

 

When leaving a business relationships make sure to look at the partnership agreement, bylaws or operating agreement, that you entered into with the business partners.

That document will answer some of these questions:

  • do you have a right to leave voluntarily?
  • If so, how do you value your shares? Is there a different way to measure your shares depending on how you exit the company (good cause, voluntarily, disability, etc..)
  • Are you bound by a non-compete or non-solicit of company clients? If so, for how long?

 

The good news of ending a business relationship, as they two Leaving Partners found out in the article, is that you  no longer have any responsibilities to the departed business (assuming you didn’t personally guarantee any obligations of the business)

 

 

II. When Dissolving a Company and Creating a New One.

 

First, a good question to ask is, why do this?

 

When breaking up a business partnership that went bad, it could be simply to get a “fresh start”.  It could also be that you are getting into a completely different business, different market, different product line, different geography, etc…

 

The wrong reason would be that your prior business held a lot of debt and you want to distance yourself from that debt. That brings us to the topic of:

Successor Liability.

 

The 1999 Michigan Supreme Court case of Foster v Cone-Blanchard Mach Co, 460 Mich 696, 702; 597 NW2d 506, 509-10 (1999), gives a good definition of “Successor Liability”.

 

“The traditional rule of successor liability examines the nature of the transaction between predecessor and successor corporations.
If the acquisition is accomplished by merger, with shares of stock serving as consideration (e.g. “stock Purchase“), the successor generally assumes all its predecessor’s liabilities.
However, where the purchase is accomplished by an exchange of cash for assets (i.e. “Asset Purchase“), the successor is not liable for its predecessor’s liabilities unless one of five narrow exceptions applies. The most often invoked exception:
(5) where the transferee corporation was a mere continuation or reincarnation of the old corporation.”
Point to consider when dissolving a business to start-up a new venture: is this new venture merely a continuation of your old company?  If so, you won’t be able to avoid any outstanding debts from your old company.
Questions? Comments?
Email: Jeshua@dwlawpc.com

 

 

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