The Business Divorce: Maximizing Value For Clients in Property Settlements Houston Bar Association - Family Law Section, October 7, 2015

Transcription

1 The Business Divorce: Maximizing Value For Clients in Property Settlements Houston Bar Association - Family Law Section, October 7, 2015

2 Today s Presenters from Diamond McCarthy LLP Ladd Hirsch Partner lhirsch@diamondmccarthy.com (214) Charles Rubio Partner crubio@diamondmccarthy.com (713)

3 Settlement Counsel Adding Value to the Team Scenario #1: Divorcing couple have substantial ownership interest in private company illiquid value

4 Situations Where Settlement Counsel Add Value Scenario #2: Valuing the business (or interest in the business) is too difficult, expensive or unsuitable

5 Situations Where Settlement Counsel Add Value Scenario #3: Divorcing parties each desire to continue holding ownership interest in business after divorce

6 Changing Texas Legal Landscape: Claim for Shareholder Oppression Limited Ritchie v. Rupe, 443 S.W.3d 856 (Tex. June 20, 2014) New standard for shareholder oppression No buyout for proving shareholder oppression, only appointment of a receiver

7 Contract Buyouts Will Be Enforced Cardiac Perfusion Servs., Inc. v. Hughes, 436 S.W.3d 790 (Tex. June 27, 2014) Don t accept a buyout at book value

8 Dividend Plan is Essential Argo Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249 (Tex. App. Dallas 2012, pet. denied) Get a distribution plan

9 Benefits From Agreed Division of Business Interests Parties decide terms of property division, not court Court s solution may make both parties unhappy Judge can: (i) require sale of business, (ii) grant full ownership of business to one spouse, or (iii) make couple co-owners of business Court s order may create significant practical problems Couple can decide the best way to divide their ownership interest Settlements are potentially quicker and less expensive

10 Property Division Options Promissory Note (Debt) Requires valuation to establish principal amount Consider term, interest, amortization, and default events Hybrid Interests Preferred Equity Profits Interest Combination of Debt and Equity Equity Interest Generally requires most information and involvement to vote on owner matters Information and involvement needs vary with different type of interests

11 Secured Promissory Notes Perfection of security interests in collateral Real property records (County Clerks Office) UCC-1 Financing Statement (Texas Secretary of State) Account control agreement Only way to perfect a security interest in a bank account Possession/constructive possession

12 Business Bundle of Rights (and Responsibilities) Decision Making Power Distributions Goodwill Management Liability Capital Calls Business Opportunities Transfers Intellectual Property Compensation Dispute Resolution

13 Management Control Decision Making Power Management Liability

14 Co-Ownership Deadlock Scenario W H 50% 50% GP 49.5% 1% 49.5% Partnership

15 Decision Making Power Governance documents generally specify who has authority to make business decisions and the process for making decisions Under Texas law, the potential legal avenues the deadlocked owner include: (i) seeking appointment of provisional director to break the deadlock, or (ii) seeking appointment of a custodian or receiver Concerns to Balance Controlling spouse has Authority to enter into ordinary course transactions versus Both spouses have input on Major Decisions affecting the business

16 Continued Co-Ownership Requires Protective Terms Contract terms required to protect interests of non-controlling spouse These protections include, but are not limited to, the following: 1) Issue new equity and admission of new owners 2) Major business transactions (sale of substantially all assets, merger) 3) Major financings 4) Employ officers and directors and set compensation

17 Management Liability Concern to Address Available Options Duties to Owners Fiduciary Duties Duties to Third Parties Direct claims Derivative claims Veil Piercing Restructure scope of fiduciary duties and indemnifications (gross negligence, willful misconduct) Indemnifications Insurance

18 Economic Rights and Responsibilities Distributions Capital Calls Transfers Compensation

19 Distribution v. Allocation Entities taxes as a partnership (including limited liability companies) are known as a pass-through or flow-through entities for tax purposes The entity itself doesn t pay any income taxes; instead, the profits pass through the company to the owners, who report them as income on their personal tax returns The share of the profits and losses that each owner reports is the Allocation of profits and losses Distributions are when cash is transferred to owners

20 Phantom Income Concern to Address Available Options Phantom income occurs when pass-through tax entity has taxable income but no distribution to owners Restructure governance documents for mandatory cash distributions to cover taxes Rely on other assets to satisfy tax obligation Requires financial analysis to estimate future tax obligations

21 Distributions Generally, governance documents give discretion to make distributions to the company s management No guarantee distributions will be made Concern to Address Available Options Timing and Control Over Distributions Analyze underlying assets: Are In-kind distributions possible? Periodic distributions of cash Consider timing and permitted reserves (working capital, future investments, etc.)

22 Capital Calls and Dilution Capital Calls occur when company requests or demands that the owners contribute more money to the company Dilution is reduction in the ownership percentage of a company caused by the issuance of new ownership interest Concern to Address Available Options Capital call obligations (usually dilution results if owner fails to make capital call) Restructure governance documents to require owner loans rather than capital calls Restructure governance documents; make dilution provisions more equitable

23 Transfer Restrictions and Exit Strategy Generally, private companies restrict transfers of ownership interest Need to consider and plan for exit strategy: Sale of Business Interest (to outside investors) Consider rights of first refusal, tag-along and drag-along rights Consider retaining business brokers Buy-Sell Agreements Spouses should include the right for either one of them to be able to trigger a buyout at some point in the future pursuant to a specified valuation process

24 Buy-Sell Agreements Structuring a Buy-Sell Agreement Consider trigger events Pricing methodology Market test (right of first refusal) Formula calculated from financial information Opinion of valuation expert» Consider assumptions/discounts» Minority shareholder discount» Illiquidity discount

25 Compensation Concerns to Address Available Options Employee spouse taking out profits as compensation Structure compensation Caps on compensation and reimbursable expenses Structure bonuses to achieve a win-win for the parties

26 Intangible Considerations Goodwill Business Opportunities Intellectual Property Dispute Resolution

27 Goodwill Personal goodwill (also known as professional goodwill ) attaches to a particular individual rather than to the business that the individual owns Enterprise goodwill (or business goodwill ) is derived from characteristics specific to a particular business, regardless of who owns or operates it

28 Business Opportunities Concerns to Address Available Options Controlling spouse taking related business opportunities for himself/herself Non-compete agreements Enhance or limit fiduciary duties (the corporate opportunity doctrine )

29 Intellectual Property

30 Dispute Resolution Structure dispute resolution procedures: Mediation (optional or mandatory) Arbitration Specify duration Include limits on discovery Litigation Select choice of venue Jury trial waiver Injunctive relief; preserve right to obtain temporary restraining order as needed Structure penalties including litigation cost provisions

31 Questions? QUESTIONS?

32 Ladd Hirsch is a business oriented, highly successful trial attorney with 30 years experience representing clients in complex business litigation matters and arbitration proceedings. Ladd joined Diamond McCarthy as a partner in Previously, Ladd was a founding partner of a Dallas based litigation boutique. Before starting his own firm, Ladd practiced for almost 20 years with Haynes and Boone, LLP, a full service law firm, where Ladd headed up its Business Litigation Practice Group in Dallas. Ladd Hirsch Partner lhirsch@diamondmccarthy.com Laddʹs practice is characterized by his tenacity and creativity in handling the prosecution and defense of significant multi party business litigation matters. Ladd has had extensive experience handling complex business disputes presenting claims for breach of contract, fraud, minority shareholder oppression, violations of fiduciary duties, breach of non compete covenants, theft of trade secrets and business defamation. He has litigated claims arising in all of the following industries: manufacturing, commercial lending and financing, construction, computer software, insurance, real estate, beer distribution, retail sales, health care, food service, and video games. Ladd represents both plaintiffs and defendants in business cases under hourly, contingent and hybrid fee arrangements. Ladd has also been retained in a number of matters by other attorneys to serve as an expert witness on the subject of recoverable legal fees. Ladd has tried cases to judgment in both state and federal courts, including federal courts located in New York and Chicago, and he has argued cases on appeal at both the state and federal levels in Texas.

33 Charles Rubio is a partner based in Diamond McCarthy s Houston office. He is an experienced business attorney who represents clients in a broad range of corporate and financial transactions as well as commercial disputes. Charles s practice has a special emphasis on financial restructurings and multi party litigation. In addition, he has substantial experience in preparing sophisticated corporate and transactional documents. Prior to joining Diamond McCarthy, Charles was an associate in the Financial Restructuring Group in the New York office of Milbank, Tweed, Hadley and McCloy LLP. Charles M. Rubio Partner crubio@diamondmccarthy.com Charles advises clients in all stages of a business life cycle. He counsels clients on business formation issues and has worked with entrepreneurs focused on start up companies. Charles also works with business borrowers in negotiating and consummating financing facilities and other capital raises. In addition, he handles a wide range of commercial disputes including litigation involving contract disputes, breach of fiduciary duties, preference actions and fraudulent transfer claims. Charles represents vendors, landlords, and other parties who have sued or are being sued by bankrupt entities and advises clients during the wind down phase of a business lifecycle. These representations include counseling businesses and management on their rights and responsibilities during insolvency situations and representing clients in distressed asset sales and business restructurings. Charles is licensed to practice in Texas and New York

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