In the course of our representation of shareholders, partners, corporations, partnerships, Limited Liability Companies (LLC) on both sides of a freeze out or squeeze out, we have observed a repeating frequency of surprises facing the individual being frozen out or squeezed out. If you are the individual being frozen out or squeeze out then from your viewpoint they would be surprises. If you are the Corporation, Partnership, Limited Liability Company (LLC) or Shareholder or Stockholder doing the squeezing or freezing you would call it a strategy, possibly minority oppression (for which you could be liable for damages) although a strategy nonetheless. The scenario leading up to these surprises goes something like this:
At the inception of a small business or partnership more than likely the shareholders or partners are either close social friends or more likely close business acquaintances who have known each other for several years. Having litigated numerous corporation squeeze outs of shareholders and stockholders and partnership freeze outs as well as member freeze outs and squeeze outs of limited liability company (LLC), we understand there is a certain amount of trust and looseness with the details as part of the formation process. Much of this looseness and inattention to details is driven by the excitement of starting a business, signing a lease, opening a bank account and obtaining initial operating funds through a line of credit or commercial loan. Everything is upbeat and the last thing one would consider is “what if things go bad”? Not too many people in this situation ask themselves: “What am I doing now that will bite me if the gung ho team effort dissolves?” In fact you would be labeled dowdy, pessimistic, a cup is half empty personality, and feel like a duck out of water bringing up some of the issues that could surprise you if the luster wanes and dark clouds form above you or the business. The inception of the business, however, is exactly the time for a minority shareholder or partner to plan for the unexpected and unimaginable down the road; that is, planning to be squeezed or frozen out.
The reasons for the squeeze out or freeze out are numerous ranging from a business downturn and the need to downsize to “you are not pulling your weight” to “I’m going through a divorce or my children are starting college and I have to squeeze and freeze you out to pay for those events”. In the course of our representations, we have witnessed a wide variety of other reasons as well. Regardless of the reason, there are surprises lurking if insufficient consideration is given at the start of the business.
A typical freeze out and squeeze out begins with the minority shareholder or partner or LLC member being terminated from their employment with the business. As an example, they may come to work one day and find their desk or office is cleaned out and email password changed and not accessible. Alternatively, the person being frozen out and squeezed out would receive a letter or phone call at home saying they are no longer employed. If a buy-sell agreement or employment agreement with buyout provisions is in place then the termination of employment would trigger whatever buy out contingencies exist. And this is the point where the surprises (or the strategy if you or the business is doing the squeezing) take center stage.
You quickly discover not only are you no longer employed with a steady income, you also own an illiquid minority interest in a corporation, partnership or limited liability company and there is not much you can do to turn it into cash in the bank other than whatever buyout provisions are contained in the buy sell agreement if you had the foresight to convince the other shareholders, stockholders, partners, LLC members to enter into a buy sell agreement way back at the inception of the business.
The First Surprise: Hopefully care was given years earlier and you are not the victim of discovering the value of your business interest is based upon book value EXCLUDING GOODWILL. Not all buy sell agreements are drafted this way and if yours is, then the book value of many small businesses without a goodwill component will render a valuation much lower than what you believe the company is worth. With care at the time the buy sell was drafted, the person being frozen out and squeezed will be bought out for true market value.
The Second Surprise: The surprise regarding your buy out price will pale once you are made aware of the second surprise. Very often although not universally, a business line of credit or commercial loan will require the personal guarantee of each shareholder. When everything was happy, exuberant and upbeat at the commencement of the business, you had no trouble signing a personal guarantee for a line of credit or commercial loan. When the buy sell agreement or employment agreement was negotiated no one considered what happens to a continuing guarantee if you are squeezed or frozen out. When the squeeze actually takes place you are out of a job, receive a buy out of your stock, and remain liable on hundreds of thousands or even millions of dollars. Once again, the key to avoiding this issue is not when it happens but rather at the time you sign the loan guarantee.
The Third Surprise: As though surprises one and two were not enough, there is a third surprise awaiting many squeezed stockholders or partners. The business lease. Although we have not seen this surprise as often as the first two, personal guarantees by shareholders on commercial leases are fairly common. When an individual is squeezed out they are in the same position as surprise number two; that is, they could be out of a job, receive a minimal buyout of their stock, be liable on millions of dollars for a line of credit, and, be personally liable on a business lease extending three, five or more years. Once again, the time to avoid this is not when it happens, but rather at the time you are asked to sign personally.
The Fourth Surprise: Much further down the list of frequency we observe in our representations is where the minority shareholder or partner was a signatory on one or more bank accounts and in particular bank accounts from which paychecks were issued. If the business encounters hard times then one of the first liabilities to be ignored are payroll taxes to the IRS and the State Department of Revenue. Depending on the situation, the squeezed out shareholder or partner may face personal liability for these taxes well after they have separated from the business. Even worse, these debts more often than not are not dischargeable in bankruptcy.
The Fifth Surprise: Even further down the list of frequency we observe is the minority shareholder or partner signed personally for long term contracts such as copiers, postal machines, etc.
These surprises can be avoided by a implementing a simple rule: “If you are a minority shareholder or partner, plan for the possibility of being squeezed out not when it happens, but rather at the inception of the business and before signing any documents related to the business that expire in more than thirty (30) days.”
At this point you may ask yourself: “ok, I found myself in one or more of these situations; I know I should have been more careful; but here I am; what do I do now?” This is where we come in. There is no universal answer and the solutions are found by dissecting the facts of each particular case and designing a strategy to resolve it favorably. Having represented individuals and businesses on both sides of these controversies we are versed in some of the strategies available.
Contact us at: Info@hwChicagoLaw.com or 312 787 5533.