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What are the Warning Signs in a Business Relationship?

February 28, 2023 Breach of Contract

Operating your own business can be both exciting and challenging. The aspects of entrepreneurship can become more complicated when you have formed an LLC or a corporation and disagreements arise with the other shareholders. If you fail to take appropriate steps to protect your rights from the onset of these relationships and during their duration, then you may face liability for another shareholder’s conduct. You may also find yourself in a dispute with the other shareholders themselves. Fortunately, there are steps you can take to protect yourself against the poor business management, if not the outright fraud, of others. This article will discuss the potential consequences of entering into a bad business relationship, signs the relationship is problematic, and steps you can take to protect yourself. If you need assistance, contact us today to speak with a New Jersey business dispute attorney.

Common examples of problematic business relationships include:

  • A lack of accounting transparency and financial mismanagement
  • A shareholder or principal hiring their friends or relatives in the business
  • A shareholder not participating in the day-to-day operations of the business
  • A shareholder making one-sided business decisions

These types of situations can result in later learning that another shareholder has been committing embezzlement, that you have been paying large amounts of payroll for underperforming employees, a partner not following through with their obligations as an owner, and you being potentially liable for agreements entered into by the other shareholders. Fortunately, there are signs that such trouble may be brewing and steps you can take to protect your interests. Let’s look at each of these in turn.

Warning Signs in a Business Relationship

A lack of regular accounting reports

A common warning sign for business owners is when another shareholder or principal in the company insists on handling all of the accounting functions but provides no transparency. Such situations include a partner not providing regular (typically monthly) financial breakdowns of what the business took in, what the business spent, and other issues related to finances. This leaves the shareholders who are not “doing the books” in the dark as to the well-being of the company.

Partners regularly hiring friends or relatives without consulting with the other principals

A common occurrence in a business is for one of the shareholders to quickly begin hiring their friends and relatives for various positions. This can include a shareholder hiring their child to serve as a receptionist or in some other more menial role. It can also include the hiring of such individuals for more important and sensitive roles. The bottom line is that such hiring practices mean that people are being hired due to a relationship and not due to them being a good fit for the job. This can greatly reduce efficiency and profitability.

An absentee partner not participating in day-to-day business management

Unfortunately, there are many individuals who do not understand that they have to wear the hat of a business owner in addition to working on the business’ core service. Being involved in a company with such an individual can mean that you are performing one hundred percent of the business functions such as dealing with vendors, etc. This, in turn, often winds up with the other individual receiving a full share of the profits while they are not doing the work of an actual principal.

Shareholders making one-sided business decisions

It is a common occurrence for shareholders in an LLC or corporation to make major decisions that bind the company without consulting others. These types of agreements can include signing a lease on a new building, entering into long-term contracts with vendors, signing promissory notes for major business purposes, etc. Since such obligations will typically be in the name of the company, such an occurrence can mean that your ownership interest is intertwined with the decision another has made.

Steps a Shareholder Can Take to Avoid Falling Into a Bad Business Relationship

Fortunately, there are several steps that can be taken to avoid the types of situations described above. The following are just a few examples of protections you can put in place from the onset of the company to ensure that you are protected.

Have a detailed shareholder agreement that details the rights and responsibilities of the shareholders

It is more likely that you can avoid disputes if you have a detailed shareholder agreement (which is something many companies lack). This agreement should detail the rights of the shareholders. These rights should include the provision of regular profit and loss statements, the provision of monthly banking statements, etc. In an ideal world, they will also spell out which shareholder is responsible for which activity (i.e. which shareholder is in charge of accounting, etc.).

Ensure that all hiring and termination decisions are jointly made

Allowing an individual shareholder to hire and fire employees can be problematic. Your shareholder agreement can include a provision that states that an individual cannot be hired unless multiple shareholders (if not a majority) consent. These same requirements can be put in place regarding the termination of employees. At a minimum, no one shareholder should have sole hiring and firing authority.

Have a mechanism for removing shareholders

If a shareholder is not holding up their end of day-to-day operations, then the best course of action is to see if the situation can be resolved. A resolution can take the form of the individual stepping up their efforts or leaving the company voluntarily. To insure against a shareholder who will not do their part, however, it is best if your operating agreement includes a provision in which a shareholder can be bought out, if not outright removed, from the company. An experienced attorney can assist you in developing the type of criteria which would trigger such a provision.

Protect yourself against one-sided decisionmaking

Your shareholder agreement can include clauses that require a shareholder to gain the consent of other principals before binding the business. An additional clause can state that a shareholder will be personally liable to the business in the event that they bind the company without appropriate consent. It is best to discuss the scope of such provisions with an attorney.

Contact a New Jersey Commercial Litigation Attorney if You Are in a Bad Business Relationship

If you are in a problematic business relationship involving your LLC or corporation, contact us today to speak with a New Jersey commercial litigation attorney. Daniel P. Silberstein has more than two decades of experience in assisting business owners. Contact us online or by telephone. Our Cranford office is located in Union County and we serve companies throughout the state. This includes those in Elizabeth and Newark.