Monthly Archives: June 2015

One major sticking point in the business divorce is what to do with a departing owner’s interest in the company. That departing owner has invested money, sweat, and maybe committed a large share of his or her life to the company to build its value. Unless the corporate governing documents allow for the payment of that value upon departure, and provide a formula for calculating the value of such buyout, Arizona statutes provide no independent procedure to solve the problem. As a result, the parties create leverage, attempt to negotiate, and if necessary, file litigation utilizing certain statutes if applicable all in an effort to force the buyout.

Buyout Value

Assuming no corporate governance documents exist, the departing owner certainly will start negotiating for a buyout in exchange for returning their interest to the company or the other owners. But how do you set the value? The company accountant can be called upon to state the book value as then existing in the corporate records. But that is a low end value. Perhaps there have been third parties who have offered to buy the company. Most privately held shares are restricted preventing sale. Professionals may be employed to value the stock or appraise assets.

Valuation presents its own issues unique to the closely held business. Valuation experts utilize discounts from fair market value because of the lack of marketability generally of ownership interests in private companies and for a minority owner interest which may total up to 70% of the enterprise value. However, a concept has been created known as “fair value” which eliminates the concept of a willing buyer and seller in a fair market without compulsion. The rationale is that the other owners of the business who own the other restricted ownership interests are really the only persons interested in controlling those shares giving them full value and as a result, the discount should not apply. Thus, the more accepted practice is for the entire enterprise to be valued, no discount should be taken, and a pro rata value attached to the shares. In fact case law in Arizona has held under the dissenter’s rights statutes that no discount should be taken in a fair value valuation.

Several Arizona statutes permit a buyout that may assist the departing shareholder. First, under the dissenter’s rights statutes, a shareholder who objects to a merger, plan of share exchange, or a sale or exchange of all or substantially all of the assets of the company may dissent and be paid their fair value for their shares. Under the judicial dissolution statutes discussed in the last column, the corporation may elect or if they fail to elect one or more shareholders may elect to buyout the shares owned by the departing owner. In both circumstances, procedures to conclude the fair value process including court proceedings if necessary, are set forth in Arizona statutes.

There have been cases in other jurisdictions which have held that the court has the equitable power to order a buyout. This equitable remedy is fashioned out of  necessity, probably because insufficient statutory procedures exist in corporate settings.

The ability to have a court assist or force a buyout, under particular circumstances, helps solve the complexities of a negotiated buyout that the departing owner views as essential. But I propose the Arizona Legislature adopt a new approach to help resolve business divorce issues.

Read Part 2: here.

The owners of a partnership, limited liability company or corporation are entitled to inspect the books and records of the company as long as they are not doing so for an improper purpose. Restrictions on inspection will and should arise where for example confidential and proprietary information is being publicly disclosed or the information disclosed is being used to damage the company. But what do you do when as an owner you are having a difficult time requiring management produce such records?

If there are persistent problems with the production of company records to its owners I suggest the company appoint a person independent of management to handle corporate records production. While this person must be independent of the management who is reluctant to produce records, the person should have full access to company electronic and hard copy financial information. If litigation has commenced, apply to the Court under Rule 53 and have a Corporate Records Master appointed.

The Court has a broad range of powers to appoint a Master to aid the Court or the parties in litigation. Not only should such a Corporate Records Master have full access to records, but also to management to insure proper records are being produced. The Manager should have the ability to recommend to the Court sanctions for failure to produce records and on the other hand, control owners who are abusing their inspection rights. The Corporate Records Master may be a buffer and liaison to insure reasonableness yet protection in the production.

Arizona lawyers are attempting to give further meaning to the recent case of TM2008 and the Court’s holding that if the Operating Agreement does not contain fiduciary duty language no fiduciary duty exists. In that case, the Court said that it would not mechanically apply corporate or partnership law to limited liability companies to find fiduciary duties owed by a manager. The parties had to examine the Operating Agreement to find any such duty.

In a recent case an Operating Agreement did not contain fiduciary duty language.  However, we attempted to establish duties from other parts of the Operating Agreement. We asked the Court to find that fiduciary duties arise from the position of administrator, tax matters partner and arising from the manager’s powers section of the Operating Agreement. We argued that the basic principles of fiduciary duty consisting of a confidential business relationship of trust in those with power and control applied.

State Court Judge Blomo ruled that he would not extend or find a fiduciary duty arising from such language and the fact the Operating Agreement contained no clear establishment of a fiduciary duty meant that no fiduciary duties existed.

If you would like more information and/or a copy of the ruling please contact me at

3. Termination of Derivative Proceedings

A derivative proceeding may not be dismissed or compromised without approval of the court after notice. On the termination of the derivative proceedings, the court may make orders with respect to expenses incurred including attorney fees. If the court finds that the plaintiff’s derivative action has resulted in a substantial benefit to the corporation it may order the corporation to pay the plaintiff’s expenses and fees. However, if the court finds that the derivative proceeding was commenced or maintained without reasonable cause or for an improper purpose, the court may order the plaintiff to pay all defendant’s reasonable expenses and fees.

The Arizona statutes have a procedure which effectively terminates the plaintiff’s derivative claim and the right to be heard before a jury or a judge if certain conditions are met. First, if the corporation investigates the matter and resolves internally the issues raised in the derivative demand the basis for the lawsuit is eliminated. The second method available to obtain early termination of the litigation is for the corporation to move the court to appoint a panel of one or more independent persons to determine whether the maintenance of the derivative proceeding is in the best interest of the corporation. The court appointed panel, like the company appointed panel, must conduct a reasonable inquiry in good faith and if it concludes that the maintenance of the derivative proceeding is not in the best interest of the corporation, the corporation may ask the court to dismiss the claim. In sum then, the plaintiff’s claim falls to the hands of either a court appointed or company appointed independent panel to determine whether or not the claim should effectively be maintained in litigation.If in fact it is determined by this panel that the maintenance of the derivative proceeding is not in the best interest of the corporation, the plaintiff then has the burden to prove by clear and convincing evidence that the panel has not acted in good faith, may not have conducted a reasonable inquiry and has drawn a conclusion that is not in the best interest of the company.

In a business divorce context, plaintiffs pushing for separation who file direct or derivative claims, effectively have two fronts to attack the wrongdoers or those from whom they would like to separate. Derivative proceedings present a procedure that may reduce the cost of litigation by use of the independent panel. The pressures of litigation may force the parties to separate hopefully by settlement rather than litigation because of the direct or derivative claims.

When conflict within a privately owned company cannot be resolved through negotiation and the parties stand at the brink of filing litigation to resolve their disputes, the parties must analyze whether their claims are direct or derivative in nature. The distinction between direct and derivative claims and claim procedures may trap the unwary.

1. Definitions

Direct claims are those claims brought by an owner for losses suffered directly to that owner and are unique to the owner. In the personal injury context, the plaintiff is entitled to bring claims based upon their bodily injuries caused by the wrongful conduct of the defendant(s). Similarly, claims by a business owner must only be for the economic harm or equitable relief necessary to correct the wrong by the defendant(s).

Derivative claims are claims brought by an owner on behalf of or in the right of a corporation or LLC. The shareholder steps into the shoes of the company to enforce the rights of the company against the defendant(s). The owners’ claims arise because of their ownership in the company.

Stemming from these basic definitions are issues related to whether damages being sought are truly direct or damages suffered by all shareholders. If the damages claimed are suffered by all shareholders then the claim is not direct.

2. Derivative Claim Procedures

In Arizona, A.R.S. S 10-740 et al. discusses the necessary steps for a derivative claim. An LLC derivative proceeding is governed similarly under A.R.S. S 29-831 et al. First, a shareholder may not commence or maintain a derivative proceeding until it is established that the shareholder was an owner in the corporation at the time of the act or omission or became a shareholder through transfer by operation of law from someone who was an owner at the time of the wrongdoing. In addition, the shareholder must fairly and adequately represent the interest of the company in enforcing the rights of the company.

A shareholder may not start a derivative lawsuit until a written demand has been made upon the corporation to take suitable action to correct the wrongdoings and recover losses for the company. In addition, once a written demand is received, ninety days must expire from the date of the demand before a lawsuit may be commenced. Exceptions to this rule exist when the demand has already been rejected, the statute of limitations will expire within the ninety days, or irreparable injury to the company would result by waiting for the expiration of the ninety days. The purpose of the written demand is to give the company an opportunity to investigate the claims and take action prior to being embroiled in litigation. If the corporation does commence an inquiry even after the demand and a Complaint has been filed the court may take action to stay the derivative proceedings for a period necessary to complete such investigation.

If the parties are now prepared to file their litigation, they must also comply with Rule 23.1 of the Arizona Rules of Civil Procedure. The Complaint must be verified and allege that the plaintiff was a shareholder or member of the company at the time of the transaction or obtained their ownership interest by operation of law from someone who was such an owner. The Complaint must further allege with particularity the efforts made to obtain the action desired from the directors or other management authority of the company and the reasons for the plaintiff’s failure to obtain the action sought or for not making such an effort. In addition, the plaintiff must demonstrate that they fairly and adequately represent the interest of all shareholders or members similarly situated in enforcing the rights of the company.