What to do when business relationships break down

Even in the first euphoric days of a new business, establish a process for resolving any future fall-outs, says John Bett

Notwithstanding the interesting times we live in politically, and the impact of uncertainty on business confidence, there has never been a better time to start a business. For all the debate about backstops over the last few months, having a business backstop in the form of a plan for what to do when relationships break down makes a lot of sense - it’s a case of prevention rather than cure.

New business formation is one of the key drivers of economic growth. A high business start-up rate drives up levels of innovation, competitiveness and productivity. Between 2004 and 2017, the Scottish registration rate per 10,000 adults has varied between 34 and 50 per 10,000 resident adults. Whilst we lag behind the UK average a little, we’ve made steady progress over the last few years.

Withvastimprovementsintechnology, innovation in financing and new strategic partnerships between business and academia, the journey from an idea to a business is becoming easier. The internet and the rise of online retail supports industries of online sellers, apps have revolutionised Fintech, and self-scanning machines have made our weekly shop significantly less cumbersome.

However, the film The Social Network, which depicts the rise of the global internet giant, Facebook, and the renowned fallout between co-founders Mark Zuckerberg and Eduardo Saverin, brings to life the very real problems that arise when relationships between entrepreneurs break down.

Riding on the wave of success and innovation, in most instances everything is rosy in a new business with a great idea. Until it isn’t.

Disputes among shareholders arise in a number of ways, with typical reasons being a fall out over the management and direction of the business, a sense that some are not doing their share of the work, personal issues that affect the business relationship, the death of a key shareholder and the requirements of their executors, new conflicts of interest, or concern over possible illegal or fraudulent activities by any or all of the board of directors.

Disputes of this nature often become further inflamed because the parties don’t get advice early about their legal rights and don’t understand the various options for moving forward. As well as significant business challenges, such as inertia or costly legal action, there is a human cost. Often these disputes are bitter and hostile and rock previously solid friendships.

The classic, worst case scenario shareholder dispute in smaller businesses is where two shareholders (or two groups of shareholders), with equal shareholdings, have a bitter fallout or can’t agree without any mechanism to break the deadlock.

Like many things in life, thinking ahead to what could happen is the best way of mitigating the worst impacts of an incident, should one arise.

The ‘trick’ here is to have recognised that prevention is better than cure and to have put a shareholders’ agreement in at the start or some other measure designed to avoid deadlock. That is often overlooked when setting up a company as the directors or shareholders will have been on good terms initially and understandably more focused on making their new business a success. There are a number of things new business owners could consider in this regard.

In the first instance, it’s important to check any shareholder agreements or articles you already have in place, as they may contain a process for resolving any issues.

In the absence of any sort of dispute resolution mechanism, sometimes good old-fashioned negotiation is a better route than adhering strictly to the letter of the law, or having someone help you mediate an outcome. The appointment of Non-executive Directors or external counsel, people who do not have a role in the day-today running of the business, can be very helpful in these situations.

That said, where all of these potential mitigation solutions have not worked for your business, for whatever reason, it isn’t too late to act. With the right advice, there are a number of other paths that can be explored to get a resolution in the situation where agreement can’t be reached.

There are a range of ways to have a backstop for your business, but the important thing to remember in the euphoria of growth and success is that it’s worth seeking advice early on about how to establish a process for resolving any bumps along the road.

John Bett is a Partner in Lindsays’ Dispute Resolution and Litigation team