PART 1 of 3
Don’t let that snazzy, eyeball catching, headline fool you. Nothing short of detailed legal analysis awaits you in this three-part series on why not to go into business with your friends, or at least, not without guidance.
Over the next few weeks, this three-part series will address an all too common theme in civil law; good friends with good intentions, getting into bad business situations. We’ll review how some of the most common issues are completely preventable, and many others foreseeable and thus, planned for. We’ll address what legal avenues and remedies are available to a party suffering damages, and some defenses to those claims as well.
My name is John Willbur. I’m an attorney; specifically, I am a commercial litigator and founder of Willbur Law, PLLC. This series is founded on an age-old legal principle, one which I learned from my grandmother. An ounce of prevention is worth a pound of cure. Let’s get into it.
Part I: It’s Derivative Dear Watson!
For our purposes we’ll operate under a hypothetical. Our players? Four friends, Fred Watson, Olivia Sherlock, Oriel Jones and Luis Lucky. Collectively, we’ll refer to them as, “Friends.”
The Friends are together one evening, and after a few beverages which encourage bold action, they decide they have a business idea. A business idea which each of the Friends could meaningfully contribute to, whether it be financially or otherwise, toward a mutually beneficial goal.
Being the savvy entrepreneurs that they are, the Friends form a Limited Liability Company (“LLC”). Now, the Friends have read a few articles like this one online. Thus, they decide to create their LLC without the aid of an attorney. They draft the by-laws governing the LLC which, among many other things, makes each Friend a member of the LLC, and affords each of the Friends ownership through an equal twenty-five percent (25%) “Membership Interest.” As with many LLCs, voting rights of the Friends is directly tied to their ownership or "Membership Interest."
Soon after, the novelty and “fun” of running a new company has worn off, and only one Friend, Luis Lucky, keeps up any efforts to make the LLC successful. Not much is heard from the other Friends for several years.
I know this is a compelling story, but let’s pause here. Already, there are serious, yet preventable, problems. What happens if the Friends disagree on the direction of the LLC, or a business opportunity the LLC might take? Let’s further say that two of them want 'X' and two of them want 'Y.' Because any combination of two of the Friends makes up half of the voting rights, how do you break the tie of a 2-2 vote? We’ll touch on that more in Part 3. For now, back to the action.
Sometime later, thanks to the miracle of social media, Fred Watson, Oliver Sherlock, and Oriel Smith learn that the LLC is doing rather well, and decide they’d like to speak with Luis Lucky about their share of the pie.
Luis Lucky doesn’t like this one bit. After all, he’s put in the blood sweat and tears to make the LLC a success not the other Friends! What right do they have to “his” profits? In addition to that, Luis Lucky loaned the LLC his personal money during the recent recession! Who is supposed to pay him back?
Luis Lucky tells the other Friends to pound sand! “How dare they?", he thinks. In fact, he tells the Friends are no longer welcome, and has law enforcement trespass the Friends from the LLC’s property. The other Friends have no proof with them of their ownership interest in the LLC, and are escorted off the property by police.
Very soon Luis Lucky is served with a lawsuit filed against him personally for various causes of action relating to his operation of the LLC.
But! Luis Lucky isn’t worried. He completed half a semester of law school and he knows that the other Friends can’t sue him individually, they have to sue the LLC in a type of lawsuit called a derivative action. Right?....Right?!
We’ll get into it. Next week, in Part II.
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