Business Succession Agreements

//Business Succession Agreements

It is important for businesses to plan ahead.  It is especially true to plan for those events that are foreseeable.  Whether we want to admit it or not, there will come a time when we will no longer be able to continue working.  It is also true of business owners. But what happens to the business when the founder or key member of the company retires, has a serious illness or dies?  That is where the business succession agreement comes into play.

A business succession agreement can address a multitude of issues that may arise when there is a change in the business’s management.  Among other things, it can specify what the roles and responsibilities of the new controlling members will be and under what circumstances the succession plan will be implemented.

It can be especially difficult when these events involve family businesses.  If not properly addressed in a succession agreement, litigation between family members may arise or the family business may not survive.  For example, in Crabapple Corp v Elberg (153 AD3d 434 [1st Dept 2017]), siblings became embroiled in litigation over who would become the managing member of the family’s business after the death of their father. There was no succession agreement regarding the management of the LLC in the event of the death of their father, the majority member.

Ruben Elberg, the son of Jacob Elberg, asserted that he was the sole managing member of the LLC.  His sister, Tamara, as co-executor of their father’s estate, asserted that their father was the sole owner of the LLC and that she was the LLC’s co-manager by virtue of her status as the co-executor, along with Ruben.  The record demonstrated that Ruben was a minority member and not a managing member.   Pursuant to Limited Liability Company Law § 608, the executor of a deceased member may exercise all of the member’s rights for the purpose of settling his or her estate.  Therefore, the Court held that their father’s controlling interest in the LLC passed to his estate upon his death, and Ruben and Tamara, as co-executors of the estate, both had authority as co-managers of the LLC.

Even where a succession agreement exists, if not carefully drafted, litigation may still occur.  In Shyer v Shyer (2019 NY Misc LEXIS 4022 [Sup Ct, New York Co, July 18, 2019]), after the death of Robert, one of the four siblings who owned and managed Zyloware Corporation, the company filed a third-party complaint against his widow, the preliminary executrix of his estate,  in her individual capacity, for among other things, wrongful interference with a contract.

In Shyer, the Shareholders Agreement and Master Executive Employment Agreement the siblings entered into were to formalize the succession of leadership in the company.  Pursuant to the Shareholders Agreement, the company informed Robert’s estate that it intended to purchase his remaining shares along with the price it was willing to pay for those shares.  Robert’s widow, on behalf of the estate, rejected the company’s terms.  She claimed that the company’s offer breached the Shareholder Agreement.  The company claimed the estate’s actions breached the agreement as it “ran contrary to the Shareholders Agreement.”

The company alleged that the widow, in her individual capacity, improperly interfered with the Shareholders Agreement by inducing the estate to breach the shareholders agreement by failing and refusing to deliver the shares to the company no later than the Closing.  The company alleged that the widow procured the estate’s breach by forcing and directing the estate to act contrary to its contractual obligations.  The company alleged that she, as preliminary executrix, caused the estate to breach the agreements.

The company argued that the widow was implicated in her role as preliminary executrix of the estate since the estate could act only at her behest as she was the “sole executor” of the estate.  The company claimed that the estate’s actions in allegedly breaching the shareholders agreement could not be “decoupled” from the widow’s ordering the estate to do so.

The court however reasoned that the claim that the widow interfered with the Shareholders Agreement was tantamount to a claim that she should be held personally liable for the estate breaching the Shareholders Agreement.  It held that the widow’s actions did not describe the procurement of a breach, but the breach itself.

Under New York Estates Powers and Trusts Law § 11-4.7(b), a personal representative is individually liable for obligations arising from ownership or control of the estate or for torts committed in the course of administration of the estate only if she failed to exercise reasonable care, diligence and prudence.

The court held that the company’s claim threatened to circumvent the statutory standard for imposing personal liability on estate administrators.  The company’s allegations against the widow stemmed from her “control of the estate or for torts committed in the course of administration of the estate.”  The company did not allege that the widow “failed to exercise reasonable care, diligence, [or] prudence.”  Although the court dismissed the company’s claim against the widow in her individual capacity, it did go on to say that the company could still sue the estate for breach of contract.

Planning for succession in a business, including a closely held family business, can help ensure the continuity of the management and operation of the business long after the founder or majority manager is gone.

Contribution by Jacque K. Vincent, J.D.

By |2019-10-31T10:16:51-04:00October 17th, 2019|Categories: TRK Blog|0 Comments