What happens if two business partners don’t agree on the direction of a business? With no deciding vote in director’s meetings, it can be difficult to intervene – leaving one business partner vulnerable should the other go rogue.
A common scenario
Take the following example. Let’s say you have a very good business which has been operating since 2003. You and your business partner Bob have done very well out of it.
You don’t have a written agreement between you and Bob, as you’ve always trusted each other and gotten along very well. You don’t foresee that changing.
In 2015, Bob wanted to start a new business with you and to continue the current business as well. You had second thoughts about the new business. It was not as well-placed in the marketplace as the current one, but you go along with Bob because you have been working together for so long and you don’t want to rock the boat.
The new business turns out to be a disaster. It’s now 2020 and the business is still losing $5,000 per week. No matter how you approach Bob about the issue, Bob is adamant that with time things will turn around. But you know Bob is just dreaming. The issue has caused enormous friction between you both.
Bob is continuing to pay the new company’s accounts with the funds from the old company. That was the initial agreement five years ago and he wants the agreement to continue. You can’t stop it because you can’t get him to vote with you at a directors’ meeting to change this arrangement.
He is also beginning to take control of the suppliers and creditors – and freezing you out of the day-to-day management of both companies. He is preventing you from accessing key clients.
The company’s accounts are being merged and you find it difficult to determine what expenses are expenses of the new company and what expenses are expenses of the old company. You have asked for an audit. Bob has refused. You have asked for a forensic accountant to be appointed. Bob has refused.
You can see your nest egg evaporating before your eyes. So much for retiring at 55. You may never retire. What can you do?
There is legal recourse
This scenario is unfortunately common, but the good news is that there are legal remedies.
If the court decides you are an oppressed or unfairly prejudiced beneficiary, you can seek a host of orders, such as:
- an order for the sale of shares by one party to the other; or
- the winding up of the company that is insolvent; or
- that one party does nominated things. This could include agreeing to sell the business.
Where activity evidences:
- a lack of probity; or
- it is inequitable or unjust; or
- it exhibits commercial unfairness
then the remedies under section 232 of the Corporations Act can apply.
Of course, the earlier court intervention is sought, the better the likely outcome.
It has become easier to intervene
Up until recently, you could only ask the court to interfere with a trustee’s decision if the trustee:
- exercised its discretion and powers in bad faith, arbitrarily, capriciously, wantonly, irresponsibly, mischievously, or irrelevantly to any sensible expectation of the settlor, or without giving a real or genuine consideration to the exercise of the discretion.
- did not exercise their powers in accordance with the purpose for which the powers were conferred, or the trustee acted in conflict with their duty.
So no matter how unfair or unreasonable or unwise the trustee’s decision; an oppressed or prejudiced beneficiary had no remedy. In the example of Bob, he may have been able to argue that his behaviour did not meet the criteria.
However recent decisions indicate that this is beginning to change.
If the company is the trustee of a trust, then recent cases show that the benefits available to persons who are oppressed or prejudiced by the acts or omissions of others can trickle down to the beneficiaries.
Recent cases have applied these concepts to trading trusts. That is, any trust which is running a business. But only where the beneficiary is also a shareholder of the corporate trustee.
The lessons for business partners
The example of Bob reveals that even when business partners trust each other and have successfully operated a business for several years, things can still go awry without a written agreement. You can never know how someone’s circumstances may change – such as going through a divorce or facing financial pressures – which can affect decision making and lead to a lack of alignment.
While the law does provide protection to ensure that parties aren’t unfairly prejudiced or oppressed, business partners should endeavour to prevent these issues from emerging down the track by preparing a written agreement upfront. Preparing for the worst-case scenario is the smart thing to do.