Could a ‘pre-nup’ help smooth in-house disagreements?

Running a business is never easy and the economic downturn of the last few years has only added to the difficulties.

The pressures of making vital decisions in such trying times can often put a strain on the relationship of company directors and business owners.

The danger is that businesses can begin to struggle when directors disagree over policy.

This is particularly true for new or small businesses. For example, if two directors have equal shares in a joint venture, settling disputes over which direction to take can become very difficult.

At that point, both sides may wish they had a business ‘pre-nup’ in place.

Such agreements set out how disputes should be settled in a way that is fair to both sides and for the greater good of the business. It is obviously better to decide on such issues at the start of the relationship when there is still trust and goodwill, rather than wait until things turns sour.

One simple matter would be to decide a policy on the transfer of shares. If one director wants to sell some of his shares in the future, should the other be allowed first refusal to buy? Should partial disposal of shares be allowed, or should it be forbidden to avoid fragmentation?

Problems can arise when two directors have equal shares in a business and therefore equal control. It could lead to deadlock in the event of a disagreement. One way round this is to agree an arbitration system. This could be done by nominating an independent third party as an arbitrator. This should be someone who understands the business and is trusted by both sides.

The first task of the independent arbitrator would be to try to help the two sides reach agreement. If that proves impossible, the arbitrator could then make a decision on principles set down by the directors in the pre-nup.

However, if disputes are impossible to resolve, it may be necessary for the directors to end their business relationship.

This could be done in several ways. For example, the business could be sold to a third party, in which case the directors would need to decide in advance how the proceeds should be divided.

Alternatively, one director might buy the other’s shares.  In that case, it would sensible to set out in advance how the shares should be valued. The valuation could be based on the company’s assets, its profits or by some other method.

There could also be disputes as to which director buys out the other, assuming they both want to continue with the business. There are various ways to settle this, including one system which is sometimes rather dramatically referred to as a shoot-out.

This involves each side submitting sealed bids for the other’s shares, with the higher bid winning. The winner gets the business, while the ‘loser’ also wins because he gets a higher price for his shares than he was prepared to pay himself.

These are just some of the issues that could be covered in a business pre-nup. Other key factors would include what to do with future assets generated by the business, such as intellectual property, and covenants restricting a director’s right to leave and set up a rival business within a specified period.

Laying down some simple ground rules in advance can prevent long and complicated disputes further down the line.

Please contact Sing Li if you would like more information about the issues raised in this article.