The Opening Shots in Corporate Warfare - The First Steps May Establish the Access to the Vaults...and Eventually Victory

The collapse of a business relationship is, in many ways, akin to the collapse of a marriage. What was a good working relationship, often founded on mutual respect and affection, can quickly escalate into truly bitter and hostile feelings and actions and, as with a marriage on the rocks, the party who is the most ruthless in the initial steps can often establish a position that is nearly unassailable.

Or, as one client put it, “If I had been as hard hearted as him, I would not have dithered around, trying to avoid escalation…and he would not have grabbed all the accounts.” The client was bemoaning his position because our opponent had achieved access to the sizable resources of the company to fund his litigation before our client had even considered the need to retain legal counsel.

One also sees similar situations in divorce, where a spouse will change the names on bank accounts and assets before the unsuspecting husband or wife even knows a divorce is imminent.

Forget “fairness” and forget “justice.” If one side achieves access to significant resources to afford the fight at the commencement of the fight, that advantage can have a tremendous effect on winner and loser. While the wronged party may seek to reclaim the assets in various expensive and prolonged proceedings, the simple fact is that one party is thrown on the defensive, often without funds, and the best that party can hope for is to be placed back where he or she was before the “Pearl Harbor” attack occurred.

Equally important, the party who obtains effective operational control of the company can often alienate employees, vendors and customers from the ousted owner, achieving such dominance in that regard that the ousted owner feels disoriented, alienated and incapable of reclaiming his or her former role. That, alone, can alter the dynamics of the struggle with the ousted party simply hoping to salvage some value and giving up control of the company.

Thus it is vital for any owner or officer facing potential litigation involving control of the company to move quickly and effectively to maintain the status quo…or achieve a power base…or the fight may be over before it is begun.

This article shall briefly describe the key areas of concern and action required, but close discussion with counsel is obviously critical before these steps and protections can be implemented.

The Basics:

It is assumed that the reader has already read our article Corporate Struggles: Who Has the Power When Push Comes to Shove. The lessons of that article will be assumed to be already known to the reader.

The party who gains access to corporate resources can usually obtain access to critical benefits that will allow predominance in later litigation. If the corporate counsel, documents, e mails, personnel, files, and equipment are in his or her control, that is a tremendous advantage. If access to corporate funds is also available to fund the struggle, the fight may be over before it begins.

While wrongfully achieving access to corporate assets may impose liability on the wrongdoer, and while the wronged party may seek injunctive relief in court, realistically it is still a tremendous advantage.

1. The ousted party will probably end up spending tens of thousands of dollars in seeking injunctive relief and can expect the party in control to claim that to keep the doors open it was vital to eliminate the ousted party who was alienating employees, vendors, etc. Many judges are not business people and can be persuaded that such steps were vital. Even if the ousted party gets the Court to take action, it will normally be to appoint a third party to act as a tie breaker director thus the ousted party may still not achieve the same power base he or she had before the move.

2. If the ousted party cannot convince the court (and the party in control will have declarations from vendors and employees, etc. that the ousted party was endangering the company) then quite often the ousted party will face fighting corporate resources with only private resources.

3. Most people achieve their “identity” in our society by what they do for a living. Taking an executive officer, throwing him out of his or her position, and leaving him or her often without salary or their prior role can be a tremendous psychological and economic blow. This writer well remembers one client who was so nonplussed by finding the door to his office locked that he seemed incapable of planning appropriate counter moves.

4. And the longer the party in power remains in power, the less likely it is that the ousted party will regain the prior role simply because the ousted party loses contact with those key parts of the business that are vital to understand the business and make it run. Defacto, the ousted party becomes the supplicant hoping to be bought out rather than the executive seeking to maintain his or her position.

5. And all this can occur before the lawyer for the ousted party is even brought into the mix. More often than not our office is consulted a week or two after the ousted party finds the accounts and office closed to him or her and is already desperate.

In reality, the party remaining in power faces equally daunting dangers:

1. The ousted party, if he or she has resources, will be outraged if not disheartened and will have little to lose by “going to war.” A court hearing is likely and if the ousted party has fifty percent of the stock, there is a good chance the Court will appoint a third party director to participate in the company. That director is unlikely to know much about the company, almost never takes decisions that are other than extremely conservative, thus putting the company at competitive risk, and will be an additional cost to the company of some magnitude.

2. Litigation will be inevitable unless the ousted party capitulates immediately and it will be bitter and prolonged. Few companies easily survive that type of infighting.

3. Employees, seeing the owners locked in litigation, will leave. Competitors will seek to take advantage of the confusion within the company, including hiring away key employees. If guaranties are in place with banks or third parties, the ousted party may revoke them causing economic turmoil.

4. And the Court may very well conclude that the ousted party is the wronged party and impose liability on the party remaining in power, including damages for breach of fiduciary duty.

But while those risks are run by the party retaining control, one particularly ruthless business owner known to this writer commented that all business is risk and if he has to risk being slapped by the Court or having his adversary have access to corporate resources…he would chose the former any day of the year.

Thus, obtaining control of corporate resources, particularly if done with a modicum of corporate propriety, is a tremendous advantage and all owners must keep that in mind as the relationship begins to deteriorate.

A variation on the above is that the party who wishes control simply abandons the corporate shell but seeks to obtain key employees, vendors and accounts and begin his or her own company. While that avoids the issue of the corporate structural struggles, the same result is achieved-the business goes to one of the owners to the detriment of the others. Again, the timing of the assault is critical since most such efforts are done in secret until suddenly an announcement is made with the former owners revealing that he or she is starting a new business and resigning simultaneously.

PROTECTIVE STEPS:

1. Get good legal advice as soon as you can and if that means meet at night or on weekends, do so. Speed matters. Without planning with your legal counsel, you are at the mercy of your opponent.
2. Your lawyer will need access to the documents that provide for power within a company. The question of who are the directors, the officers, the key employees are vital. Bring to the lawyer the minute book, bylaws and articles of incorporation of the company. If an LLC, the Operating Agreement and any minutes should be brought to the lawyer.
3. Any and all management contracts, employment contracts and letters and/or e mails concerning them should be obtained. Remember, access to computers and hard drives, files and personnel may soon be restricted. Get access to them and make copies immediately.
4. Banking information is equally vital. Get copies of all such recent account statements and names and locations of accounts as soon as you can.
5. If accounts are in joint control, you may want to consider contacting the bank to make sure they know that neither owner can close or transfer an account alone. If the account does allow that and the other owner has not done so already, it may be possible to alter the account so that two names are needed. If the bank will not agree to that, it may be possible to alter the account by opening a new one and placing it where both names are needed…or your own if you are willing to fight.
6. Contacting vendors and employees can be counter productive. However, if your other owner does so, you are at a disadvantage. Assuming no such steps have been taken, your lawyer will probably recommend a strongly worded letter to the other owner, warning of precipitous action and suggesting some ground rules as to future actions and advance notice of action to be agreed upon. If the other owner will not so agree, your lawyer may decide to go to court immediately…if the actions are agreed upon, then the situation may be stabilized…BUT ONLY IF THE GROUND RULES ARE IN WRITING WITH ENFORCEMENT PROVISIONS CONTAINED IN THEM. Words mean little…you need a binding agreement.
7. In short…either move first or make sure your other owner cannot move first to take unfair advantage. Once stabilized, you can negotiate a fair resolution…or begin the struggle on equal footing.
8. If it is found you are already too late and the accounts, vendors, etc. are already alienated, your attorney will advise you as to protective actions you can take albeit not as effective ones if you had moved faster.

THE DANGER OF INACTION...OR TOO MUCH ACTION

Two contradictory emotions must be carefully controlled.

As in a marriage, parties can sometimes find it implausible that a break up is truly imminent and are concerned that taking protective steps might further exacerbate an already tense relationship. As such, they sit by inactive or exchange conciliatory e mails while their opponents consolidate their position. We call this the Munich Doctrine of Corporate Warfare, after Chamberlain’s futile efforts to appease Hitler. It leads, of course, to disaster.

The other extreme is a preemptive strike in which the potential victim overreacts and brings on the warfare by doing precisely what he or she feared the other owner would do. The other owner, seeing such activity, overreacts as well and two sides go to war, each convinced the other had it planned all along. We call that the Iraq War Syndrome.

While both dangers exist, calm and professional analysis of both the power structure and the already known actions of the other party can usually indicate what is appropriate action and what is not. Merely hoping for the best will not work…the situation must be fully and calmly investigated and action taken. Even if the other side has not yet moved, an understanding for a “stand still” arrangement while differences are ironed out makes good sense for the parties and the company.

And if the investigation reveals the other party is already moving…act quickly for the initial week or two of struggle may determine the next decade or two of business life of the owners.