HOW AND WHEN TO MEDIATE SHAREHOLDER DISPUTES
The story will sound familiar: family members, who had been getting along, suddenly find that they do not agree on how a company should be run, or feel betrayed and/or taken advantage of by one of the owners. There may be a disagreement over who should take control, or whether the company should be sold. Before you know it, the family is torn apart, with multiple lawsuits filed, allegations of bad behavior flying, all to be found in the public files.
By: Erica B. Garay, Esq.
Ask any of the New York Commercial Division justices and you’ll hear that their files are filled with disputes between business owners. The disputes are about “corporate waste” or “shareholder oppression.” The litigation involves claims of breaches of fiduciary duties, faithless servants and diversion of corporate opportunities. The complaints are filled with allegations of misuse or theft of trade secrets, and corporate resources and breaches of restrictive covenants or shareholder or operating agreements, and fights about “corporate freeze-outs” or who can control the company.
Counsel use their best efforts to fit the round peg into the square hole, that is, to turn the story a client tells of being pushed out of a company, frozen out of decision-making, or otherwise not treated fairly into a shareholder derivative claim or a dissolution case, with orders to show cause, claims for inspections and motions for injunctive relief. Often, the facts may not fit so neatly into cognizable claims, whether statutory or common law, resulting in motions to dismiss and delay. Litigation can be bogged down and become expensive when motions to dismiss are filed. Importantly, judicial remedies and legal theories may not provide the relief that the parties truly need: a severing of their interests so that the owners are no longer in business together.
As commercial litigators know, absent an applicable buy-sell agreement, a business owner cannot force his co-owner to buy him out. Even in the BCL § 1104-a case (that is a case seeking dissolution due to oppression or corporate waste), the petitioning shareholder can only hope that the respondent shareholder(s) or corporation will elect to purchase the petitioner’s shares under section 1118. And, unfortunately, absent an applicable buy-sell agreement or a clause concerning “disassociation” of members of a Limited Liability Company (LLC), the owners of an LLC do not have a statutory remedy similar to BCL § 1118 to separate interests.
This is where mediation comes in and can be an invaluable tool. In the settlement and mediation arena, of course, the parties can chart their own course, find their own remedies and achieve that separation of the owners without the need to make the case fit into a recognized statutory scheme, assuming such a scheme is available.
Mediation has a great advantage: it provides the owners with a forum to raise their “complaints” about each other and to forge (usually with the help of an experienced mediator) either a separation of interests, or a new agreement. The most important advantage of mediation is that, by employing a mediator, you are choosing the person who can assist counsel and the parties, including finding a person with the appropriate experience and skills that will best assist the particular case.
a) Choosing the Mediator.
In mediation, the parties are able to choose their neutral. They can find someone who has experience in shareholder disputes (and settling them!) and who understand appraisals and forensic accounting issues. By choosing a mediator with such experience, the parties and their counsel have a buy-in to the process, knowing that the mediator has the time to devote to the case and the experience necessary to get the job done. (Too often, congested court calendars prevent judges from devoting substantial blocks of time to settlement or the judge may even refuse to meet with the parties or their experts if they do not agree on the value of the company.)
A mediator with practical experience in this field will also be able to assist counsel in the event that there are disputes concerning drafting the essential parts of the buy-out. An experienced mediator can also help the parties by ensuring that there is a sufficient exchange of information to support the analysis required to prepare the business appraisal at the outset. This means that the parties can avoid expensive discovery and the delays of court and the litigation process, but can get to the settlement table early.
b) Bringing your expert to the mediation.
Usually as part of the mediation process the parties will have exchanged appraisals and, perhaps, even the terms being proposed to effectuate the buy-out. Defense of the enterprise value, discounts and purchase price, terms and allocation issues (for tax purposes) may be best addressed by the appraiser, tax advisor or forensic accountant who was involved in preparing the appraisal or other expert report. The expert analysis and support for counsel and the shareholder in real time at the mediation cannot be undervalued. This assistance can also be useful in explaining matters to the mediator and answering questions.
It may even be useful for the two appraisers to meet with counsel and the parties, along with the mediator, to have a discussion about the differences in the analyses, conclusions, and opinions that are the basis for the opined value. This, of course, can help counsel and the parties bridge the gap and find a way to compromise on price, payment terms and other key elements of the purchase.
In the pre-mediation conference call with the mediator, counsel should consider proposing a process for the mediation and the negotiations that best fits the particular case, as well as making sure that the required information is provided in advance. This potential creativity and flexibility can help resolve the case and differences to ensure buy-in to the process by the parties.
c) Preparing your client for the mediation.
One of the important roles of counsel is to prepare the client for the mediation. This includes not just explaining what mediation is and how the process works (such as educating your client about the use of joint and caucus sessions), but also what will transpire during the day. Counsel should discuss the role of the mediator (that s/he is not “deciding” the case or predicting who will win, but rather is helping the parties to find an acceptable solution that each can live with) and that the client has an important part to play. In addition, the client should understand that the mediator will help the parties by addressing the cost of discovery and continued litigation, likely outcomes, and possible problems with proving a case or a defense.
Many attorneys often fail to advise their client that the client may speak (or, worse, advise the client not to speak, thus losing an opportunity to give his version of events or tell how he was harmed financially or emotionally). Giving clients an opportunity to speak their minds is an important part of mediation and why it is usually successful. However, the value of client involvement and actual participation at the mediation should not be underestimated. Not only does the personal participation of the party help the mediator and the adversary (and opposing party) understand what transpired (and how the presentation may look to a judge or jury) but it also help the party feel that he has had “his day in court” by having the opportunity to vent, and, therefore, that party may be able to move forward and let go of the claims or defenses.
Such venting can be a very good substitute for participating in the litigation itself (especially because few cases ever get to trial). It also primes a party (and counsel) to address the emotional aspect of shareholder disputes, which often involve perceived slights and lack of fairness, feelings that h/she is underappreciated or that the other side is a bully or greedy and has taken advantage economically. Counsel should not avoid the opportunity to see how the opposing party would appear to a jury or judge.
Mediation creates a unique opportunity to create a forum in which a discussion can take place and real-life solutions can be negotiated, including the roles that the children will play. Mediation can be an opportunity to explain prior decisions and explore options.
d) Finding solutions
The role of mediation is to help the parties find common ground, common interests and acceptable solutions. A mediator is trained to look for such and to help the parties and their counsel analyze proposed potential resolutions and ways to achieve the common goals of the parties.
A mediator can help broach the subject of buy-outs, swapped interests, and assist the parties in finding ways to sever interests and be fairly compensated for a purchase, including severance agreements.
Another possible solution to be explored at mediation, if the parties do not sever their interests, may be to re-write governance documents so that they protect a minority owner against possible freeze-outs or oppression, including terms that give all parties a voice or role in certain business affairs (such as selling, borrowing, or adding other co-owners), including by requiring unanimity or super-majorities for taking certain actions.
One alternative is to include an arbitration clause or mediation clause in the new operating agreement or shareholder agreement, so that there is another way for the business owners to try to resolve disputes and avoid expensive litigation.
e) When to mediate
There is no one perfect time to mediate a shareholder dispute. Mediation can be considered at any time, that is, before the suit is filed, before discovery commences in the court case, or even later in the litigation including before and after trials and even when the case is on appeal.
In deciding when to mediate, it may be important for the parties (and counsel) to have an understanding of what claims are being addressed, or what defenses may be asserted and to have an exchange of financial information (even outside of “formal” discovery), so that the parties can appraise the business and address allegations of damages. Consider using the mediation to facilitate obtaining the information you need or what is necessary for an appraisal, so that the settlement discussions can be fruitful and based upon “real” information.
Practitioners should consider using mediation to help parties resolve disputes, sever interests and/or manage relationships in closely held businesses.
Erica B. Garay, Esq., is a member of NAM’s (National Arbitration and Mediation) Hearing Officer Panel and is available to arbitrate and mediate cases throughout the New York Metro area. Ms. Garay is Chair of the Alternative Dispute Resolution section of the Nassau County Bar Association and an experienced commercial litigator.
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For any questions or comments, please contact Jacqueline I. Silvey Esq. / NAM General Counsel, via email at firstname.lastname@example.org or direct dial telephone at 516-941-3228.