The Comedy Store is a fixture of Hollywood and one of the world’s best-known comedy clubs. Opened in 1972 and operated by the Shore family since the early 1970s, the Comedy Store launched the careers of Johnny Carson, Jay Leno and David Letterman. Lately, however, ownership and operation of the Comedy Store have not yielded many laughs for the Shore family.
As a result of serious illness, Mitzi Shore, the family matriarch and life force of the Comedy Store for the past 35-plus years, is no longer capable of running it. Recently, a litigation battle has ensued between Mitzi’s famous son, actor and comedian Pauly, and his older brother, Peter. The litigation involves allegations of undue influence and a fight over control of the Comedy Store’s operations.
Orange County Choppers is not only a very popular custom motorcycle workshop in New York, but also the subject of the popular reality TV show American Chopper. The show has enjoyed six successful seasons because of the amazing custom motorcycles fabricated at the shop as well as the comedic yet acrimonious relationship between the shop’s owners, Paul Teutul and his son, Paul M. Teutul. Viewers were glued to their screens when Paul Sr. fired Paul Jr. But TV cameras weren’t around to capture the reaction to Paul Sr.’s lawsuit seeking a court order to purchase Paul Jr.’s stake in the business. Paul Sr.’s suit cited an agreement, in the form of a letter, that contained a one-sentence provision providing the father an option to purchase the son’s equity at fair market value.
Rockrose Development Corporation is a large-scale real estate developer in New York City. Owned and operated by the three Elghanayan brothers, the company enjoyed years of success and accumulated more than 8,000 apartments, nine office buildings and nine development sites.
Disagreements over succession planning and the role of their children in the company led one of the brothers to exercise a provision in their partnership agreement to effectuate a split of the family business. Pursuant to some very unique provisions—which involved a flip of a coin, selection of one of two envelopes (with the hope that the selected envelope contained a plastic coffee stirrer) and a drawing of straws—the family enterprise was split without the need for litigation.
What do all of the above scenarios have in common? All of them are examples of the emotionally charged process that we call the “business divorce”—the process of either divesting a family member of his or her equity position or splitting the family business into parts, with each family member equity holder becoming the sole owner of a part of the company.
Advantages of an agreement
Unfortunately, most family businesses are ill equipped for strife among the family members who are equity holders. Although most business owners have been advised of the benefits of buy-sell agreements, shareholders’ agreements, partnership agreements and operating agreements, many family businesses we have come across have no such agreements in place. They often tell us, “We are family—why would we need a buy-sell agreement?”
From time to time we come across a family business that spends some time, energy and legal dollars on a governance document. The business owners typically present this document to us with a “smarter-than-the-average-bear” smile. However, the smile fades when, after a quick read ing of the document, we discover that although it addresses the buyout of a family member’s equity upon his or her death or disability, it does not provide a remedy for insubordination, deadlock, unprofessional behavior, theft or other foreseeable issues.
Addressing straightforward occurrences such as death or disability of an equity owner is just the tip of the iceberg. Family business owners need a document that provides significant assurance that should an issue arise between family member equity owners, the dispute—and, if necessary, a separation—will take place outside the courts.
In addition to the costs and distractions that result from litigation, the family business will almost undoubtedly be detrimentally affected if it is involved in a very public process that puts its dirty laundry on display for all to see, including customers, employees, suppliers and other family members. The Elghanayan brothers, who had the forethought to prepare a comprehensive partnership agreement, enjoyed the benefit of a non-litigious, organized and, presumably, cost-efficient business divorce.
A divorce without a document
Although this may be obvious, it is worth noting that the only time you are likely to be able to agree on the terms of a buy-sell agreement is when all of the owners are reasonably happy and at peace with one another. But what if you’re faced with the prospect of a business divorce and your family business does not have a comprehensive buy-sell agreement? Here are some suggestions on what to do, and what not to do.
• Don’t be the oppressor. Op-pres-sion by a family business owner can take many forms. It may be overt, such as terminating the employment of an equity holder without notice and without cause. Oppression can also manifest as a failure to act in a manner consistent with the parties’ prior understanding or acting in derogation of their reasonable expectation, such as refusing to make previously agreed-upon distributions to the equity owners. An oppressive family member will be in a difficult position should litigation ensue.
• Take the high road. A family business owner must treat a co-owner appropriately and must not let emotion interfere with his or her legal and fiduciary obligations. Remember that short of a family member taking egregious action against the family business, each family business co-owner owes a fiduciary duty to the other co-owners. Placing personal interests ahead of the interests of the family business or taking actions contrary to the best interests of the business will not be viewed favorably by a court.
• Clean house before picking a fight. Take inventory of the skeletons in your closet (and the company’s) before initiating a fight with a co-owner. Repair prior wrongs to the best of your ability by writing a check to the company, filing amended tax returns or taking other similar action. Don’t leave yourself or the family business open to attack.
• Try to settle out of court. Litigation can significantly diminish your family business in a number of ways over and above the direct costs. Litigation almost always causes a diversion of the owners’ energy and may adversely affect the reputation of the business, its relations with customers and suppliers, and its value. While at times litigation must be used as a negotiation tactic, be mindful that the vast majority of cases settle. The only questions are when, how much it will cost and how much the business will suffer while litigation is pending.
• Hire experienced professionals. Hiring an attorney who has experience in business divorce law and strategy is key. Counsel must be familiar with both the corporate and litigation aspects of the dispute, and the attorney must engage experienced professionals for valuation services and business recommendations.
The courts’ power
Rights and remedies differ based on type of entity, the state of organization and the specifics of the cases. Many courts have broad equitable powers in business divorce cases, including the right to ignore written agreements entered into by the family business owners, to appoint a third party to control business decisions and to order a sale of a party’s interests—or of the entire business.
Further, absent an agreement, oppression, breach of fiduciary duty or other cause of action, a family business owner has no statutory or common-law right to buy out, sell to or fire his or her co-owner.
A well-thought-out plan of attack and properly documented records are key components of success. Initiating litigation at the first sign of trouble is rarely the best course of action. FB
Nicholas San Filippo IV is a partner at the law firm of Lowenstein Sandler PC. He acknowledges the assistance of partners Steven B. Fuerst and Christopher S. Porrino in the preparation of this article. Fuerst, Porrino and San Filippo formed and co-chair the firm’s Business Divorce Practice Group (www.lowenstein.com/businessdivorce).