Closely-Held Company Litigation? Pay Attention to Schedule K-1
Despite their sophistication, entrepreneurs and businesspeople sometimes build and invest in companies without the legal scaffolding necessary to withstand disagreements among the owners. Individuals provide money without having a clear agreement on whether the payments are a loan or were made in exchange for an equity interest.
July 02, 2019 at 01:26 PM
7 minute read
In a perfect world, groups of potential business partners would sit down before they started their new ventures to hash out the details of their relationship. They would work in close consultation with one or more attorneys to produce detailed subscription, operating and loan agreements documenting their arrangements and clearly delineating responsibilities. In the real world, the birth of closely-held businesses is sometimes far messier.
Despite their sophistication, entrepreneurs and businesspeople sometimes build and invest in companies without the legal scaffolding necessary to withstand disagreements among the owners. Individuals provide money without having a clear agreement on whether the payments are a loan or were made in exchange for an equity interest. Particularly in the early stages of a business, individuals often provide valuable services for little or below market compensation based on the oral promise of equity, either immediately or vesting in the future. Such arrangements are frequently evidenced only by the vaguest of email exchanges or sometimes “friends” forego any kind of writing.
When disputes involving such businesses boil over into litigation, there is often fierce disagreement on the threshold question of whether someone is an owner at all. The determination of whether someone is an owner, a lender, an employee or simply a “volunteer” who provided services out of family ties or affection is dispositive for many claims common in closely-held company litigation. A putative owner that cannot establish their ownership lacks standing to assert claims for breach of fiduciary duty, waste, dissolution and access to books and records.
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