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Fighting Partnership Lawsuits: Five Threshold Issues

Laine T. Wagenseller, Wagenseller Law Firm

As real estate development projects fall apart and over-leveraged partnership properties run into financial distress, relationships among once friendly partners can become frayed. A poorly performing asset or an underwater investment can often bring down longtime friendships and business relationships. The pressures of financial problems often destroy the trust and collaboration that held the partnership together. Even though times are tough, you are confident that you can overcome these obstacles and work these issues out. Then, out of the blue, a process server appears at your door early on a Saturday morning with a lawsuit by your partner accusing you of fraud, breach of fiduciary duty, misrepresentation, theft and more. After you catch your breath and stop cursing your erstwhile partner, stop to consider these important threshold questions about partnership disputes.

1. Are You Being Reasonable?
Partnership litigation is very emotional. Even the most experienced and dispassionate business person gets upset and offended by a partnership lawsuit. The issues that really vex the partners are usually perceived slights and acts of disloyalty. He is not listening to me or she did not ask for my advice. I am working harder than my partner or my partner promised me something and is not delivering. The lawsuit only compounds this by making explicit allegations of betrayal and wrongdoing.

It is important in partnership litigation to figure out what the true legal and financial issues are versus the personal and emotional issues. Don’t dismiss the emotional component of the dispute but realize that it can distort your analysis of the best strategy and the most reasonable resolution. Listen to the advice of your attorney who is looking at the dispute from a more detached viewpoint.

2. Is Partnership Litigation Worth It?
Know that partnership litigation is very expensive. Like divorce proceedings, partnership litigation is often hotly contested and overly litigated. The emotional aspect of the litigation often leads to long and expensive fights that a more reasoned litigant may avoid by making a neutral and objective cost/ benefit analysis of the dispute. If you sue the partnership or the other partners successfully vote to indemnify themselves from partnership funds, your lawsuit may just end up draining the partnership of even more money. Is your lawsuit costing you attorneys fees while at the same time dissipating the remaining partnership assets? Partnership litigation involving real property often involves a lis pendens that ties up the property and prevents the sale or refinancing of the building. Will this drive the partnership into insolvency and risk foreclosure? You could risk losing everything and then be paying an attorney on top of that. That may not make economic sense.

3. How Will The Court Rule On My Dispute?
Many partnership disputes could be resolved quickly and efficiently if the partners consulted their partnership agreement and followed the terms and procedures set forth in the agreement. For example, is there a general partner, or, in limited liability companies, a manager, who has the authority to make decisions? Is this a partnership issue that the partnership or operating agreement requires be resolved through a vote of a majority (or some percentage) of the partners? Look to your agreement to figure this out.

When you finally get to court a year or two after the filing of the lawsuit, the court will look at the agreement and fashion a judgment using the rules and processes set forth in the partnership agreement. The court does not make up solutions out of whole cloth. For example, in distributing partnership assets after a sale or accounting, the court will simply look to the ownership interests of the partners and divvy up the money according to those interests. If ownership shares are not at issue, you can shortcut the two year court process and just agree with your partners to conduct an accounting and divide the proceeds by partnership interests. If the agreement provides for a dispute resolution process, the court will simply enforce that process. Look at your partnership agreement early on to figure out what it says about the issues raised in the lawsuit.

4. How Can We Figure Out What Is At Issue?
Issues regarding money can often be figured out by an accounting. Moreover, any litigation regarding these money issues will require that each party conduct an accounting and explain why they think the accounting favors their case. As ment ioned above, try to reach an agreement to short circuit the process and do the accounting early on. Schedule a mediation (see below) after the accounting is completed to help resolve the remaining issues.

Forego the temptation to fight for “justice”, “principle” or “pride.” Courts do not award these things anyway. Courts award money (and occasionally injunctions). While a settlement can be structured to provide for an apology (if that is important to one of the partners), a court judgment cannot. Frame your dispute first (specifically what are we fighting about?) then proceed to step 5— how to resolve those issues.

5. How Can We Resolve The Dispute Early On?
Start with an early mediation. Mediation is a process in which the partners get together (often with their attorneys) and hire a neutral third-party mediator to help them resolve the outstanding issues voluntarily. A mediator does not make rulings or decide who is right and who is wrong. A mediator attempts to fashion a mutually agreeable solution between the parties.

In partnership litigation the parties can fashion a number of different solutions. One of the most common is where one partner buys out the other partner or partners. The parties may be able to agree on a value for the company on their own or they can hire a business appraiser to reach an agreeable value. If there are accounting issues, they can be credited to or debited from the value to reach an acceptable buy-out number. While a solution could involve continuing the partnership, the partners are typically beyond the point of no return by this time and such a solution could just be a set up for the next lawsuit. You want to avoid any continuing ties with a partner that you cannot bear to be around.

Another option is to sell the business. The partners can put the business up for sale to see what someone is willing to pay for it. Like the buy-out option, accounting adjustments can be agreed upon and made in escrow. After creditors are paid off and the accounting adjustments are made, each partner will be entitled to his or her share of what is left over.

Partnership litigation can drain you financially and emotionally, but do not make it worse than it has to be. Stop to think about these issues and formulate a strategy from the very beginning. In the end your time and money are often better spent on building your business or investing in new projects, not litigating old disagreements.

Laine T. Wagenseller is the founder of Wagenseller Law Firm and specializes in real estate litigation, including partnership disputes. The firm represents real estate developers, property owners and investors. You can reach Mr. Wagenseller at (213) 286-0371 or ltw@wagensellerlaw.com.

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