Do-It-Yourself Contracts No. 1

Being an entrepreneur often means doing things yourself. But it doesn’t mean doing them badly.

For the past 20 years, Fred had run his own software company. Like any good small-business owner, he wore many hats—HR department, payroll processor, accountant, and chief technical officer, to name a few. He also dabbled in the law as his company’s in-house attorney, writing and reviewing all the contracts that his business used.  For 20 years this had served Fred well. That, however, was about to change.

As he approached his retirement years, Fred decided to sell the company.  (He had not been putting away any retirement in the meantime, despite some record profit years along the way, but that’s another story.)  Convinced that he could do the transaction himself—after all, he had written all of the company’s contracts for past twenty years—he began looking for a buyer.

Fred then met Jeff, a friend of a friend and also a member of Fred’s church. Jeff was very confident about his abilities and seemed very convincing.  Although he had no background in programming or software administration, he seemed to know the in the industry to which Fred sold his product and had developed some very ambitious (and lacking in detail) plans for how to market the company and where to take it. Jeff also talked constantly about the funds he had available to put into the company and from which to pay Fred.

Fred, anxious to get into retirement, and not seeing any other prospects on the horizon, agreed to sell to Jeff. The two of them put together a stock purchase agreement in which Jeff bought all of Fred’s stock in the company, but that was 100% financed by Fred, with Jeff making monthly payments regardless of how well the company operated. They also wrote a consulting agreement under which Fred would continue to work for the company and receive a salary, thereby ensuring a smooth transition from Fred to Jeff.

Not long after Jeff took control of the company, it became clear that both Jeff and Fred had gone into the deal unprepared. Jeff’s plans and his claims about funds were more talk than substance. The payments to Fred—both for the company shares and the consultancy contracts—starting coming late, first a few days, then a few weeks, then not at all. Fred could see that the company was being badly mismanaged, his retirement was drying up, and he had ceded control and so couldn’t even rectify the situation. It was clear that, because of his social and religious connections with Joe, Fred had forgotten a cardinal rule of business—trust and verify. While you should never to business with people you don’t trust, you also always need to verify their claims.

Fred came to us asking what he could do. The problem was he had not anticipated any of these problems and had no remedies in his DIY contracts beyond suing for the money. The one thing Fred had going for him was that, above all, Joe wanted to avoid a fight and having to pay attorneys. So while we didn’t have many good remedies, we were able to negotiate a settlement that had some teeth in it—teeth that should have been there from the beginning.

Entrepreneur’s like to do things themselves.  But that doesn’t mean doing it wrong. There are many things that our clients can do on their own in the process of selling their business—both keeping them involved in the process and keeping costs down.  Contact us early in the process, and we can discuss with you the checklists you should follow so you can successfully plan and execute your business transitions.

An oral buy-sell agreement is worth the paper it’s written on.

Ann and Judy were architects who had a lucrative firm in Lisle. They had worked together for many years, and the business was paying for a life insurance policy on each of them–“key man insurance” (or in this case, key woman). The proceeds of the policy were to be used to buy out the other’s family (who would inherit each woman’s shares in the business) should either of the partners die unexpectedly. That agreement, however, was never written down or memorialized in any other way.

One day Ann was struck and killed by a car while riding her bike. The insurance company wrote a $300,000 check to the architecture firm. Ann’s husband (Albert) soon began pressing Judy to pay him for Ann’s 50% share of the business. But Judy, distraught with the loss of her friend and business partner, dropped into a deep depression and began drinking heavily. In the process, she lost most of the insurance money gambling at nearby casinos.

Judy became worse and worse. Although she began seeing a psychiatrist, she was not careful about the medicines she was taking while drinking. On one bad night, she mistakenly took a lethal combination of pills and alcohol, and died herself.

Albert, while further saddened by Judy’s loss, saw an opportunity to receive something for what Ann had built. As a new shareholder, he made a claim against the insurance policy that the architecture firm had on Judy, which was still in place when she died. The insurance company, however, claimed that Judy had committed suicide, and refused to pay on that policy.

Can Albert do anything to recover the life insurance proceeds for his wife or Judy?

Albert sued the insurance company and was eventually able to prove that Judy had not committed suicide but had unfortunately overdosed. It cost him a significant amount of money, however, and he had to front the cost of the trial even though the proceeds were eventually enough to recoup those expenses.

In the meantime, the architecture firm wound down because there were no funds to hire new architects to finish existing projects, let alone bring in more work. In the end, the business could not be sold to generate further income for Ann’s and Judy’s families.

Had Ann and Judy executed a formal shareholders’ agreement memorializing their decision to buy each other out, Albert may have been able to intercept the insurance proceeds the company received for Ann before Judy drank and gambled them away.

 

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Charles Wentworth
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Charles Wentworth
Charles Wentworth
Charles is an attorney in Glen Ellyn, Illinois. After graduating from the University of Utah, he clerked for Chief Justice John T. Broderick of the New Hampshire Supreme Court. He then became a litigation associate at Kirkland & Ellis LLP before opening his own office and partnering with Rick Lofgren. He lives just outside of Chicago, where he participates in community activities, including Boy Scouts and little-league baseball.