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Darin D. Honn

Disassociation Of A Business Owner

December 2001

Darin D. Honn

Clients quite often come to attorneys to assist them in creating an entity that will include two or more partners, limited liability members or shareholders ("Owners").  A corporation, partnership or limited liability company often remains as the entity by which the Owners transact business for many decades.  On some occasions, however, one or more of the Owners find the business arrangement to be unsatisfactory.  In some circumstances, a disassociation of an Owner from the entity is preferred over a dissolution of the entity.  The disassociation may occur under a variety of circumstances, including a voluntary disassociation or a mandatory disassociation.  The circumstances of such a disassociation may be either cordial or antagonistic.

Whether there is the right to terminate an Owner's interest in an entity is quite often determined in a corporate shareholder agreement, partnership agreement or limited liability company operating agreement between the Owners ("Owners Agreement").  This document can include provisions allowing or requiring buy-out of a shareholder upon death, disability, termination of employment, retirement or a myriad of other circumstances.  The agreement can also specify methods to alleviate an impasse between the Owners, especially where ownership is held by two Owners each owning a 50% ownership interest.

The agreement should, in addition to specifying the triggering event, specify the valuation of the interest being purchased, as well as the payment terms.  Some of the valuation methods include (a) a set valuation formula based upon income or revenue, (b) obtaining an appraised value prepared by a qualified appraiser, or (c) a value set by arbitration.  The payment terms and interest rates should also be specified in that agreement.  Additionally, that agreement can specify that the departing owner will not compete against the remaining company, and a portion of the payment can be allocated to that non-competition provision.

In the absence of an Owner's Agreement, there probably will be no right to purchase an Owner's interest, even if the Owner is terminated "for cause."  Even in the few instances where an Owner's interest can be compulsorily purchased by statute, the value of the Owner's interest that is being purchased may have to be litigated, and the remaining entity will probably not have the right to prevent the withdrawing Owner from competing against the entity and/or from soliciting the company's clients.  While the costs of disassociation of Owners where an Ownership Agreement is in effect can be substantial, the cost of disassociation where an Ownership Agreement has not been entered into can be even greater.

In addition, an Ownership Agreement can help provide liquidity for a disabled Owner or a deceased Owner's spouse or estate.  The cash to fund a departing Owner's buy-out can be funded by the entity's cash flow, life insurance or disability buy-out insurance.  These funding mechanisms can give the Owners substantial peace of mind in knowing that they and their loved ones will have cash flow after their relationship with their company is terminated.

Obviously, the best time to create an Ownership Agreement is when the entity is being created, but a substantial number of Ownership Agreements are entered into subsequent to the formation of the entity.  The Business Department at Sussman Shank LLP can assist you in determining if an Ownership Agreement is right for your company.

Mr. Honn is special counsel at Sussman Shank LLP, with his practice focusing in business transactions and business litigation.

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