An Argument for a Business Prenup (Business Planning)

In marriage, the parties agree to come together "till death do us part." In business, although these words are not recited as such, the parties usually intend the same commitment. Nevertheless, the statistics tell us that many marriages fail and end in divorce. Similarly, and as any lawyer who has been in business for even a few years will attest, many "business-marriages" (partnerships and limited liability companies) fail and "end in divorce."

When a marriage fails, the parties divorce which is usually attended by a great deal of acrimony. Much of the acrimony revolves around three things: (1) custody of minor children, (2) the division of assets, and (3) child and/or spousal support. Similarly, when a business-marriage fails, the parties often separate (divorce) which is also often attended by a great deal of acrimony. Similar to a divorce, much of the acrimony revolves around three things: (1) who gets the customers (i. e., "custody of the minor children"), (2) the division of assets (equipment, premises, inventory, intellectual property, etc.), and (3) repayment of capital, loans, and/or buy-out of an ownership interest (i. e., "child and/or spousal support").

Now, and I readily admit, a prenuptial agreement is not romantic or sexy. No way around it. And a prenuptial agreement by itself will not decrease the hurt, pain and disappointment of a failed marriage. And I also admit that invariably, even though the parties "agree" to the prenuptial agreement, inevitably one party is disappointed by the bargain. But notwithstanding all of the foregoing statements, the parties do get one thing in return for a valid and binding prenuptial agreement: at a very difficult time they know what to expect. And at a time when they are likely only speaking through their lawyers, and cannot seem to agree on anything, at least they are not forced to start negotiating the economic terms of their divorce. And ideally, while they are "falling in love," and getting along, might be the best if not the only time to contemplate, negotiate, cooperate, and document the economic terms of their divorce. It's not romantic or sexy, but it sure might come in handy.

Doesn't the same hold true for business partners? While they are "falling in love," and getting along, is it not the best time to contemplate, negotiate, cooperate, and document the economic terms of a potential "business divorce." Who gets the "minor children" (i. e., the customers)? If one party operates the business (the "business operator partner" or "BOP") and the other party is "the money partner" (or "MP") it might make sense to give the customers to the BOP where the MP really has no ability or interest in operating such a business. And to reciprocate, maybe the MP should get some of her money back on a preferred basis, likely paid out over time while the BOP continues to run the business which may the only hope for both the BOP and the MP to recover their respective investments. The provisions could be put right in the partnership agreement, or more like the operating agreement given the ubiquitous use of the limited liability company as the business vehicle of choice these days.

You see as unromantic and unsexy as the business prenup provisions will no doubt be going in to a business marriage, it may be the parties' best if not only chance to save the business, their INVESTMENTS, and as a result their relationship (professional or personal). After all, a business unlike a marriage is about making a profit, making a living, you know, it's about money. Generally the parties may love the business, but they do not usually go into the business seeking to fall in romantic love with their partner. Human feelings are just so darned complicated. It is no wonder why divorce is so difficult. And while the same humans-with-feelings are the ones going into their business-marriages, the absence of that "love thing," and the absence of that "sex thing" should be a big help in allowing the parties to focus in a constructive way on that "money thing."

Why this article you may wonder. Why now. Well, just last week, I was referred another client whose business marriage has pretty much failed. And as always seems to be the case, there was no business prenup contemplated much less negotiated and documented. And even though their entire respective investments of time, energy and money are now on the line, the parties seem to have difficulty sharing a rational thought right now, much less able to see the forest for the trees.

So next time you fall in love (business style) and get to the point where you decide to go into business "till death do you part," take some time to at least contemplate the economic terms of your separation should your business-marriage not survive. It might just be one of the best decisions that you and your business spouse make.

Boy, this case turned out to be a real mess ... for the other guys.

A little over two years ago, a client came to me with what appeared to be a simple collection matter. The client was a clinical laboratory. One of its clients (we will call them ABC Co) had failed to pay about $24,000 for services rendered by my client. In fact, ABC Co never paid even $1.00 to my client over a period of approximately a year-and-a-half. When I contacted ABC Co to discuss the matter I was essentially ignored. My client authorized the filing of a lawsuit against ABC Co. After the "complaint" (this is the document that initiates the action) was filed at the Courthouse, it was time to "serve" (i. e, deliver) the complaint to ABC Co. The process server (the guys and gals that deliver the complaint) went to ABC Co's place of business to serve the complaint. The process server's "Status Report and Declaration of Non-Service" described what happened next:

The receptionist informed the process server that the business now at the premises is XYZ Co and that "they [XYZ Co] use to be ABC Co." The process server thereafter prepared the Declaration of Non Service, including stating that he "was unable to effect service for the following reasons: XYZ CO HERE, PER RECEPTIONIST, THEY USE TO BE ABC CO." Now, to make a very long story much shorter, after investigating what happened here is what I found. Sometime after my client (and I imagine others as well) had started to chase its money from ABC Co, ABC Co's owner (we will call her Dr. Tricky) filed a "Certificate of Dissolution" bringing an end to ABC Co's corporate existence. Dr. Tricky then incorporated a new entity (XYZ Co). Without missing a beat, Dr. Tricky continued to run the same business, at the same address, using the same employees, same equipment, etc. The only difference between the two entities (ABC Co and XYZ Co) was the name. As just one of many examples of misrepresentations made by Dr. Tricky, the Certificate of Dissolution of ABC Co that she executed and filed included the statement that "The corporation's known debts and liabilities have been actually paid." Ahem, ah, Dr. Tricky, remember us?

Dr. Tricky continued to basically ignore my client, me and the lawsuit, apparently feeling that it was not XYZ Co's problem, and certainly not her problem (as in no personal liability). Well, as we were now aware of the "shell game" that had been perpetrated by Dr. Tricky, I "amended" the complaint TO ADD XYZ Co as a defendant under "fraudulent conveyance" theories, and TO ADD Dr. Tricky, INDIVIDUALLY, for "conspiracy to commit a fraudulent transfer." Even then, perhaps believing that we could never succeed in getting a judgment against XYZ Co and Dr. Tricky herself, XYZ Co and Dr. Tricky (along with ABC Co) continued to ignore the lawsuit. Well ABC Co, XYZ Co and Dr. Tricky all "defaulted" (i. e., they failed to file any response to the complaint served on them). As a result, I succeeded in obtaining "Default Judgments" against all three (jointly and severally) for the $24,000 in unpaid invoices.

Well, as you can imagine, Dr. Tricky FINALLY stopped ignoring the lawsuit when she was finally served with a copy of the Default Judgment entered against her INDIVIDUALLY. Funny how that works. Her efforts to "set aside" (i. e., undo) the Default and the Default Judgment entered against her ultimately failed. In my experience, usually such "shell games" are done with a little more care and planning. Dr. Tricky's attempt was so blatant and transparent that it resulted in her becoming PERSONALLY LIABLE for the debt of ABC Co.

Also, it is usually not a good idea for a business with an established business address to ignore legal papers. I mean what do you tell the judge ... "yah, that's our address, but we are not there ...!"

Yes ladies and gentlemen, this really happened to me ...

When I was a younger lawyer in the late 90's I had a client in the movie theatre business. I'll spare you the details, but my client came to me and explained that he was owed about $65,000 resulting from an unpaid personal loan. "I want to sue this guy" he said. Music to my ears ... or so I thought.

I contacted the debtor's lawyer, explained that his client owed my client $65,000, and explained that if his client did not pay up I was authorized to sue his client. The usual saber rattling. The lawyer's response caught me quite off guard. "He is not going to pay your client but go ahead and prepare a judgment for $65,000 and I will have my client sign it." What is this I thought? No cat and mouse? No pounding the table? No threat of counter-suit? No "see you in court?" No blanket denial of the debt? What is wrong with this picture I wondered? This can't be good ...

California has a procedure called a "Confession of Judgment Without Action." See California Code of Civil Procedure Section 1132 and the following. That's right; you don't even have to file an action! Just prepare the judgment, get it signed, take it down to the Courthouse, file it (yes you will get assigned a case number at that point just like any other action), and voila, you have a judgment! Certainly the debtor isn't REALLY going to just sign a judgment for $65,000, right? So, I prepared the judgment for $65,000, sent it off to the debtor's attorney, and waited for the excuses and foot dragging to begin. No such luck. Within a few days, the judgment for $65,000 was duly executed and returned to me for filing! This can't be good I thought. What is going on here? I proceeded to file the "Confessed Judgment" for $65,000. That was easy. So now it was time to go find the debtor's assets. In the ensuing days here is what I learned ...

The debtor lived in Colorado. No problem, we could get the Confessed Judgment for $65,000 entered in Colorado. I learned the debtor was broke. It just so happened he lived with his ex-wife and their child in a home in Colorado. The ex-wife owned the home. Long story short, the ex-wife owned everything. The debtor owned nothing. My understanding was that the debtor and the ex-wife were very much in love and living in bliss with their child in Colorado. I was told (I forget by who) that the debtor's divorce from his ex-wife was simply some very effective asset protection planning. Now, there are what are known as "fraudulent conveyance laws" on the books intended to undo such so-called "asset protection planning" whose primary purpose is creditor avoidance. But let me tell you, in many situations such a "friendly divorce" can be a very effective asset protection tool. If spouses are willing to go to such lengths to avoid one spouse's creditors, or future creditors (as happened in my case), there are many instances in which assets in the hands of the non-debtor ex-spouse will be out of reach to the creditors of the debtor ex-spouse. Particularly where the assets owned by the non-debtor ex-spouse were acquired years before the debt giving rise to the claim was contemplated, must less in existence, (i. e., the future creditor scenario), the "friendly divorce" can be a very, very effective asset protection plan.

Long story short, in this case, it appears that the wife (the non-debtor ex-spouse) acquired all of the couples' assets years before my client loaned the husband (the debtor ex-spouse) the $65,000. It appears that by giving all of the couples' assets to the wife (the non-debtor ex-spouse) the husband ran around getting into all kinds of mischief without concern for his liability and exposure to all variety of business partners and transactions. An asset protection plan does not need to be bullet-proof to be very effective. After contemplating the expense involved in a trip to Colorado to "test" the integrity of the "friendly divorce asset protection plan," my client quickly threw in the towel and wrote the episode off to experience.