The owners of small or closely-held business enterprises should be cautious when making personal guarantees of payment to their suppliers.  That was the lesson in an opinion issued by the Ohio Fifth District Court of Appeals on March 12, 2012 in Countywide Petroleum Co. v. El-Ghazal Gasoline Servs., Inc., 2012-Ohio-1009.  In its decision, the Court determined that the doctrine of “promissory estoppel” permitted a supplier of goods to recover damages from a business owner when that owner had personally promised to pay for those goods.

In Countywide, the plaintiff was a wholesale supplier of gasoline.  The Defendant was the sole owner of an LLC, “EGS”, which operated a gas station located in Massillon, Ohio.  The parties entered into a business relationship, during which EGS submitted credit applications to the Plaintiff in which the Defendant and his wife personally guaranteed EGS’s account.

During an audit of the parties’ accounts, it was determined that the Plaintiff was owed approximately $82,000 for the delivery of gasoline that EGS had not paid for.  The Plaintiff asserted that in addition to its contract with EGS, it could recover damages from Defendant personally because he had personally promised to pay the invoices.  To support its position, the Plaintiff relied upon an affidavit filed by the Defendant during the trial.  In his affidavit, the Defendant argued that a cognovit note entered into between the parties during the course of their business relationship was invalid because it had not been properly completed.  However, the Defendant also admitted in the same affidavit that he had originally agreed to “pay each invoice within 30 days” of receiving it.  The Plaintiff asserted that it expected the Defendant to be personally responsible for the payment of the invoices, which is why it continued to do business with him.

The Court decided that the principles of the doctrine of promissory estoppel applied to the Defendant’s promise and ruled that he could be held personally liable for the unpaid invoices.  Promissory estoppel is a doctrine that attempts to prevent harm to parties which reasonably rely upon another party’s false promises.  To establish a claim for promissory estoppel, a Plaintiff must show:

1. A promise that is clear and unambiguous in its terms;
2. The party to whom the promise is made (the Plaintiff) must rely on that promise;
3. The Plaintiff’s reliance must be reasonable and foreseeable by the Defendant; and
4. The Plaintiff must be injured by the reliance.

Countywide, 2012-Ohio-1009, ¶ 26.  The Court determined that, despite the fact that the Defendant’s business was a limited liability company, because the Defendant had personally promised to pay the invoices, he was personally liable for the Plaintiff’s damages under the promissory estoppel doctrine because his promise was “reasonably relied upon” by the Plaintiff to its detriment. Id, ¶31.

If you are a business owner, the lesson that you need to take away from the Fifth District’s decision in Countywide is that you must be extremely careful when negotiating business arrangements with your suppliers or other parties you enter into contracts with.  If, in an effort to get a deal done or to make sure that you continue to receive supplies on a timely basis, you promise that you will personally pay for any shortfalls that your business may run into, you may be forced to fulfill to that promise later even if you otherwise would be protected from liability because of the structure of your business.

The Defendant in Countywide was the owner of a limited liability company, meaning that he had substantial protections from the liabilities and debts of the company that he owned.  However, because he admitted that he had personally guaranteed to pay the Plaintiff for any invoices which his company could not pay, the Court required him to live up to that promise because it believed that the Plaintiff had relied upon that promise and was injured as a result.  This may lead to some hard decisions; because suppliers and lenders frequently require personal guarantees to work with small businesses, you may not have any other options, but you should at least be aware of the possible consequences to your personal bank account.

The temptation to enter into a deal with the Plaintiff caused the Defendant in Countywide to step beyond the protections offered by his company’s limited liability and led him to make a promise that he ended up regretting.  Learn a lesson from the Defendant’s mistake – think carefully before you make a personal guarantee just to get a particular deal done and, if you do make a guarantee, understand the potential consequences of doing so.

Powers of Attorney need to have language in them regarding disability or they will not be effective after the grantor of the power becomes disabled.

Section 1337.09(A) of the Ohio Revised Code states in part,

Whenever a principal designates another as attorney in fact by a power of attorney in writing and the writing contains the words “This power of attorney shall not be affected by disability of the principal,” “this power of attorney shall not be affected by disability of the principal or lapse of time,” or words of similar import, the authority of the attorney in fact is exercisable by the attorney in fact as provided in the written instrument notwithstanding the later disability, incapacity, or adjudged incompetency of the principal…

In a recent matter handled in our office, our review of a power of attorney, prepared (not by our office)  out of state, failed to contain the above language.  The result requires a guardianship to be established to take care of the principal.  Going through the formality of the guardianship is much more expensive and time consuming than having a properly drafted power of attorney.  If you have a question contact our office to review the document.

Early planning is key when addressing the issue of an owner(s) successfully exiting a business.  In 2003, it was estimated that within 20 years more than 90 million baby boomers will retire and more than $10 trillion will transfer to the next generation.  The largest generational transfer of personal wealth in history will occur during this time.  Seventy percent (70%) of the 12 million privately owned business will change hands.  (MassMutual & Raymond Institute’s American Family Business Survey 2003)

Most of these businesses are short on cash to fund a buyout.  Many of these business owners, because they do not have a family member(s) active in the business or a strong management team in place willing to take on the risk, will chose to sell their businesses because it is the only viable alternative available.  Many of those will have to sell at a price well below what they anticipated to be the fair market value of their business.  Some will find that they will have to operate the business well beyond the age at which they would have preferred to retire.  Others will find that simply closing the business and liquidating the assets is the most viable option.  These options frequently result in dissatisfaction on the part of the owner(s).  They are either unhappy with the net cash realized or the need to work well beyond their desired retirement date; consequently, these issues are often ignored by owners until it is too late for effective planning.

Sometimes, the highest dollar value can be achieved by selling the business to someone already involved in it.  This may also be the most risky.  For example, if the successor fails to operate successfully, the former owner may find he or she is right back in a business from which they thought they had retired.  A spouse of a deceased owner may find that he or she may have to step into a business they know little about when the new owner operator fails to meet payment obligations.  It is even more complicated if the new owner is a family member.  Achieving this higher dollar value means you are not really out of the risks associated with the business, such as the market generally, dependence on the business skills of the successor and the size of the burden assumed in relation to the businesses ability to meet the obligation.

Many of these issues can be effectively addressed if the parties have in place a buy sell agreement that covers the issues well before the event occurs that may trigger a buyout.  An agreement typically addresses value; provides a method of payment and addresses other issues such as divorce, personal bankruptcy, disability, future incompatibility of owners, retirement and death.  If the business owners are multiple generations of family members, the agreement can address the various issues among the members of the generations.  One of those issues often concerns the rights of the operating generation to reinvest in the business, versus the rights of non-operating family members who are looking for a stream of income from the business.  These issues are complex and the right answers change, based on the personal dynamics of the people involved and therefore one size does not fit all.  Because of these competing interests, multiple representatives of the various individuals involved may be required.  The process may be frustrating and expensive.  Discussions will often involve consideration of life insurance, disability insurance, deferred compensation and reasonable payment period and valuation.

However, if done properly, the issues that keep owners up at night can be successfully addressed resulting in a secure retirement from the business.

A well drafted buy sell agreement is a critical document for a closely held business.  It is useful in order to keep ownership within a family or limited group of owners, avoid termination of a Sub-S election or partnership, create a market for an owner’s interest and establish an orderly method for liquidation of an owner’s interest upon death, disability or retirement.

Any business where there is more than one owner should consider the advisability of such an agreement.  Unless registered as a publicly traded company there is generally no market for the ownership of an interest within a company whether it is a corporation, partnership or LLC unless the owners themselves create such a market.  This should be of particular concern if the owner is a minority owner.  A minority owner is one who generally owns less than voting control which in many states is 66 2/3% of the voting power of the company.

Many family businesses employ sons and daughters-in law in the business but are often concerned about other in-laws acquiring an interest who could later pass that interest on to even more distant relation or unknown owners.  The agreement should address these issues through restrictions on transfers, mandatory purchases upon divorce or death of the original owner and conversion of an ownership interest to a non-voting interest upon a triggering event.

The agreement can provide a mechanism for the patriarch to sell control to one or more business children, with payment made over a period of time, so as to treat fairly other non-business children.  More family business have been destroyed, from my observations of over 30 years in practice, by patriarchs dividing ownership evenly among all children whether involved in the business or not so that no one child has control of business decisions.

The agreement can also provide a mechanism for resolving business disputes.  This is especially important if ownership is divided so that no single owner has control.  While minority owners have certain protected rights by law (see my January 2, 2011 blog) enforcing those rights can be expensive and can ultimately harm the business of the company if the majority owners have to be constantly looking over their shoulders to gauge the reaction of a well-heeled minority owner prepared to fight.

A buy sell agreement is a document not easily discussed in one article and has permutations that need to be discussed in detail.  Therefore, over the coming months I will explore the various common provisions of business buy sell agreements on an individual basis through a series of articles.

As a business attorney representing closely held business I am often approached by clients who desire to make a key employee, a spouse, family member or an investor an owner. This usually prompts a discussion of their reasons. Typical responses include a belief that if the employee has a stake in the future of the company they will be less likely to quite; will maybe be more willing to stick it out when times are tough; the owner feels a sense loyalty to a key employee or spouse, a desire to reward past performance that has helped to make the company successful, this is a family business, to avoid paying interest on a loan or because it is a requirement of the investor.

The owner usually desires to maintain control which normally includes the ability to sell the business, control compensation and make all the important decisions concerning the business. This results in a discussion concerning what control means. Many owners believe that if they own 51% that they have control. Under Ohio law that is not necessarily true. Corporations normally require a 2/3 vote of the shareholders to approve many transactions unless the articles of incorporation provide a lesser amount but in no event may the vote be less than a majority. ORC 1701.76 (A)(1)(b) (asset sale) ORC 1701.83 (A) (stock sale) ORC 1701.78 (F) (merger) ORC 1701.71(A)(1) (amendment of articles of incorporation) In a limited liability company any action taken by a member that is not in the ordinary course of business requires the unanimous consent of all the members unless there is an operating agreement in place specifying a different ratio. ORC 1705.25 (A)(3).

Another common issue is whether there should be any restrictions on the transfer of ownership. While an owner is usually comfortable with an employee or investor owning stock the same does not follow for maybe their spouse, creditors, children or other heirs. It is for this reason and others that most often such ownership usually result in the implementation of a shareholders agreement, closed corporation agreement or operating agreement. Such agreements usually address a myriad of issues including restrictions on transfer, management control, covenants not to compete, purchase of ownership interest upon death, termination of employment, divorce, bankruptcy and disability.

Owners who are used to total control should also be mindful of the duties and restrictions Ohio courts have placed on majority owners of businesses. In 1989 the Ohio Supreme Court in Crosby v Beam 47 Ohio St. 3rd.105 created a fiduciary duty on the part of the majority owners of a closely held company to their minority owners. The minority has a right to have an equal opportunity to benefit from the business as the majority. On the face of it this only sounds fair. However, when you consider that as long as the owner owns all of the company he had no such duty. He or she is free to sell the business, hire or fire employees within the confines of employment law or simply close the business and open a similar business.

In larger businesses and in particular corporations if the majority or management take actions that advantage themselves or disadvantage the corporation the disadvantaged shareholders may only bring suit on behalf of the corporation to recover damages which if they are successful are paid to the corporation.. The individual shareholders have no independent right of recovery except possibly for attorney fees. This is commonly referred to as derivative shareholders suit. In a closely held corporation minority shareholders have a right to recover personally for any harm they may have suffered at the hands of the majority. Below are examples of issues courts have considered.

Two of three shareholders formed a new company to conduct a similar but unrelated business. Court held it was a question of fact for the jury to decide if they had breached their heightened fiduciary duty to the third shareholder who was not included. Medina v Perumbeti (1994 WL 716539)

An officer and shareholder of a company were not allowed to enter into new business that the minority believed would compete with the business of the company. Morad v Task (1994 WL 78157)

A shareholders employment could not be terminated unless there was a legitimate business reason. Morrison v Gugle (2001) 142 Ohio App. 3rd 244.

Minority shareholders may question the compensation paid to the majority shareholder. Soulas v Troy Donut University, Inc. (1983) 9 Ohio App 3rd 339.

Minority shareholders may force the payment of dividends. Ohio Jurisprudence 3rd Business Relations 721.