What happens if your business partner is no longer pulling their weight?

In this piece Karen Holden, founder of A City Law Firm, explores the legal considerations to bear in mind when a business partnership isn't working.

What do you do if the partnership puzzle can't be solved?

What do you do if the partnership puzzle can't be solved?

Starting a business is an exciting endeavour and there are many things to consider and action. Some of these you will enjoy, others you will probably want to put off. One of the things you may not have considered is what happens if you fall out with your business partner. It is perhaps unthinkable during the formation of your business that you could possibly get to the point where you resent working with one another, or that this could threaten the business itself, but it happens and the threat can be very real if care has not been taken from the outset.

There are many ways in which a business can be started, the most common being incorporating a limited company. In this case you and your partner may be equal shareholders and directors. This means that you both own and run the company.

So, in the event you feel your partner is no longer assisting the business, or worse, has become a hindrance, what can you do about it? It might not be as simple as you would like to think because, as well as being a director, your partner, as founder, may also be a shareholder and an employee.

To get rid of him/her completely, these positions will have to be addressed as quickly as possible. The one you will want to address first, however, will most likely be his/her position as a director given this will of course directly affect the day-to-day management of the company including, for example, access to the business bank accounts. Below are some key points to consider in respect of each position.

Removal of a director

Ordinarily it is not difficult to remove a director, however, to do so you need to have over 50 per cent of the votes of the shareholders. This is not something you can do if you hold the shares 50/50 and your partner disagrees!

If you can command over 50 per cent of the vote then you are obliged to provide special notice before passing the resolution to remove the director. This is currently 28 days.

Just consideration should be given to any director’s loans made by your partner director to the company. Unless agreed otherwise, a loan made to the company by a director is repayable in full on demand. In commencing the removal of your partner, you may unwittingly find yourself having to repay substantial loans. This may be a bitter pill to swallow, not to mention a costly blow for the company.

Further consideration should be had to any assets or documents that the director may have in their possession. This includes confidential information, trade secrets, client lists, intellectual property as well as credit cards, keys, company cars or other physical company property. If you are in the process of removing the director you may want to notify the bank that they should be removed from the mandate.

Hopefully, you will have accounted for these possibilities already and have in place a detailed shareholders agreement. Often, when shareholding is linked to management / directorship in the company, there will be a clause forcing a transfer of shares from the outgoing director, which can simplify matters greatly. This is something we usually recommend.

Termination as an employee

Unless there is serious wrongdoing enough to justify gross mis-conduct you will not be able to justify immediate termination and should comply with the notice period. The relevant notice period should be contained in the director’s contract of employment, however, frequently directors fail to properly draw these up. If there is no contract you will have to determine whether he/she was in fact an employee and rely on statutory notice periods.

You may want to suspend the director pending the outcome of any investigation into any wrongdoing. Notification with clear reasons will need to be set out. This should only be used where there are serious allegations being made against the director.

It is important to consider that all employees with more than two years continuous employment have statutory rights, including the right not to be unfairly dismissed. It goes without saying that whether the two years has passed, if you try to terminate employment for certain reasons, for example on grounds of discrimination, it will automatically be unfair and you will expose the company to a claim.

Employment law can be a treacherous minefield to navigate and the greatest care should be taken to ensure that you do not fall foul. So before taking any action you should seek legal advice.

Shareholders

Without a shareholders’ agreement in place which addresses the return of an outgoing director’s shareholding, it can be tricky to remove a shareholder. This is particularly so where shares are held 50/50. Most decisions for shareholders require over 50% of the votes. If this is not reached and such a situation is not properly addressed in a shareholders’ agreement, stalemate (or deadlock) arises and the company cannot function. In the absence of the proper mechanisms in place, the recovery of shares / resolution of deadlock will be a matter for negotiation. If that fails, then court action may follow and/or the company may be dissolved.

The roles of shareholder and directors are often confused. As a shareholder (only), you hold equity in the company and, unless agreed otherwise, you will not have responsibilities for the management of the company. You will, however, have specific shareholder rights, including the right not to be unfairly prejudiced. This cuts both ways; so, there is a risk of an action being threatened/commenced by your business partner if you seek to affect his role within the business but equally you could say that you are prejudiced by him continuing (if for example he/she is hindering the company’s ability to make money).

The above considerations may rightly be considered the ‘unsexy’ part of establishing and growing a business, but they are no less important. Legal documents providing you and your business protection may represent an additional expense, however, the cost of legal advice at the outset pales into insignificance compared to the costs of trying to resolve a dispute further down the line.

A shareholders’ agreement and directors service level agreement are imperative to govern the relationship with your co-founders. It’s a platform to develop from, a means to agree the future and a means to resolve any disputes or disagreements that arise.

Furthermore, when it comes to the question of investment or sale, any prospective investor or purchaser will need to see that all these issues have been handled correctly.

Karen Holden is founder of A City Law Firm.

Further reading on business partner

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