Corporate “Divorce” Leads to Tears and Fireworks
For many, being employed in a family business is like being in a warm cocoon. While it lasts, it can be extremely comfortable. But when the other family members in the business determine to freeze out a minority shareholder, the family business can quickly become a miserable place to work. That’s what happened to our client, let’s call him Peter. (All of the names in this article have been changed to protect client confidentiality).
Peter, age 44, had spent all of his working life in the family business, a successful property and casualty insurance agency that was founded in the 1930s by Peter’s father, George. The father brought Peter and Peter’s brother, Sam (age 43), into the business and, through gifting of stock, made each of them shareholders. Each of Peter and Sam owned approximately 21% of the capital stock of the Company.
Through the years, Sam was given more and more responsibility, until he finally became the general manager of the Company. Peter, on the other hand, saw his responsibilities gradually reduced until Sam, as general manager, stripped Peter of almost all executive authority. Bitter infighting developed between the brothers.
Along the way, Peter had discovered that an entire class of insurance customers (let’s call it the “Special Class”) were not having their insurance needs met by insurance companies, and were not being serviced by “P&C” (property and casualty) agents.
In an attempt to carve out a small corner of the family business for himself, Peter conceived of the idea of creating a “Special Class Department” which would service the insurance needs of these companies. His family scoffed at the idea, but eventually allowed him to create a Special Class Department within the Company, on the condition that he pay the salaries of his support staff out of his own pocket.
Notwithstanding the lack of familial support, the Special Class Department grew because there was an acute need for the products and services the Special Class Department offered to this class of business, and as Peter’s expertise grew, he quickly became more adept at servicing the need. As his customer base grew from local to regional to national in scope, Peter developed more clout with insurance underwriters and began to have more input into the type of coverage the insurance companies would underwrite for Special Class customers and to a certain extent, the premiums charged by the insurance companies. Ultimately, the Special Class Department became the most profitable department in the Company. Instead of reducing the internecine conflict in the Company, Peter’s success led to out-and-out war between the brothers.
When Peter initially consulted us, he informed us that his brother was threatening to terminate him for “cause” and force him out of the Company. Peter had some leverage: He was party to a Buy-Sell Agreement which gave him the right to “put” his shares to the Company and receive approximately $600,000 for his 21% interest in the Company. However, the Company took the position that the agreement was “ambiguous” and that it would never pay Peter the $600,000 to which Peter claimed to be entitled if he exercised his “put”. Instead, the Company insisted that Peter submit the entire dispute to binding arbitration with George’s brother (“Uncle Jim”), an 80-year old real estate attorney in New York City. Peter was torn between not wishing to sue the Company and risk alienating himself forever from his family, and not wishing (or having the wherewithal) to turn his back on the $600,000 the Company owed him. What should he do?
The first few telephone conferences we had with the Company’s attorneys confirmed the seriousness of the Company’s position that it would tie Peter up in court for years before it would pay him $600,000. Balancing Peter’s wish not to destroy the fabric of the family, with his need to be paid for his interest in the business, we developed a proposal for a “corporate separation”. Peter would surrender his interest in a business for $240,000 in cash plus the Special Class Business (the value of which Peter pegged at more than $500,000). The transaction was structured as a divisive reorganization under Section 355 of the Internal Revenue Code, so that Peter could treat the receipt of the Special Class Business (if not the cash) as a tax-free transaction. The Company accepted the proposal in principle and we proceeded to the documentation phase. It should have gotten easier at that point, but it did not. Almost every issue in the deal was the subject of intense negotiation. On more than one occasion, Peter called us and said: “My family does not want to do this deal. Let’s sue them for the $600,000!” It took many telephone calls at all hours of the day and night to help decide that a negotiated solution was preferable to litigation with his family.
At the last all-hands meeting before the closing, Peter’s father George was so upset that he would not bring himself to join the meeting. He sat in an adjacent conference room by himself. In the next room, the two brothers shouted at each other at the top of their lungs, giving vent to over twenty years of pent-up hostility. Peter’s mother cried while her sons fought. Finally, after agreement had been reached on the last outstanding issues, one of the brothers rushed to leave the conference room. A lawyer blocked the door, insisting that the brothers shake hands on the deal. The brothers shook hands and the deal closed.
Richard J. Lambert