Partner Dispute Resolution Mechanisms in Partnership Agreements

Hi everyone, this is Brett Cenkus. I am the right-brained business lawyer and a business consultant and this is another video in our series about mastering your business partnerships.

So, last time we talked about being the right partner, finding the right partner. Those are kind of two sides of the same coin and at the end I said we’d talk this time about exiting bad partnerships or hitting the eject button, getting out of a bad partnership. Before we do that though, I want to spend a little bit of time on dispute resolution, generally. So, exit clauses will be a future video.

Today we’re going to talk about dispute resolution. If you’ve read any commercial business contract there’s a section towards the back—what we call “boilerplate” that talks about how you resolve a dispute and the things you’ll see in there typically are what court, what home state or counties courts govern. In other words, if the parties get into a dispute where will they go file a lawsuit, where do they have to file a lawsuit? We’ll also cover the governing law under which the contract will be interpreted those are part of dispute resolution, we’ll get to those in a minute, but I want to talk about things that should be in partnership agreements around dispute resolution, because you need a lot more information than the appropriate court that is going to hear your case and what law will they apply. You want to head things off well before they get to that point. Litigation is a famous lose-lose-lose. People think only the lawyers make money – even lawyers end up frustrated sometimes at just how difficult a process it can be and how expensive and time-consuming and not equitable.

So, well before you ever end up in a court of law, you want to have dispute resolution mechanisms in your partnership agreement to fend off having to go litigate or go to court. So, aside from governing law and in what forum will you litigate, if it comes to that, there’s other things that you might see like mediation and arbitration and we’ll get to those in a moment as well. But we’re going to start even earlier than that, because mediation has its place, arbitration can be quite expensive—not that much cheaper than litigation in a lot of cases. So, we’re trying to come up with mechanisms for your partnership agreement, for your partnership to fend off ever having to get to some of that traditional dispute resolution stuff. It’s funny they call mediation/arbitration “alternative dispute resolution”, because 20 years ago or so when they came on the scene they were the alternative to litigation, but I think of them as traditional, all those things – mediation, arbitration, litigation. We’re talking here about much more ad hoc, fluid, less expensive, less time-consuming mechanisms to resolve and fend off disputes.

Okay so, number one: there’s the saying that the best defense is a good offense. You want to build in mechanisms to communicate with your partner. You want to “force” meetings. You want to force monthly, at the very least, quarterly meetings, where you and your partners sit down outside of the office preferably, but no matter where it is there’s intentional time set aside to talk about how things are going to talk about the results in the company, to talk about how the partnership is going, is it meeting everyone’s needs. This isn’t time to get together, it’s not your staff meeting, not time to get together to talk about you know so-and-so over in accounting isn’t performing, should we hire someone new. That’s not what this is about. That’s time set aside, could be just an hour, could be over a beer, could be on a hike, wherever it takes place it doesn’t matter, but it’s got to be time again preferably in my opinion outside of the office, but where you talk about: is this working for you? How’s it going? Is it meeting your needs? So, that time building that into your agreement to have set meetings like that is really, really important to keep up communication. If one partner is in charge of the finances, that partner should be delivering to the other partners reports, monthly reports, here’s what’s going on. Each partner, if you’re not in charge of finance, you’re in charge of something probably, usually founders and partners kind of have an area of responsibility to report back about how things are going in their department. So, feeding information to the other partners is, important part of communication, is spreading information, being on the same page about what’s going on.

So, beyond that let’s say that you’re doing all the things to proactively provide information and meet and talk about issues, let’s say a dispute pops-up anyway. Well before we get to mediation, arbitration and litigation, a couple things that you could consider building into your partnership agreement: one is a formal resolution meeting. This is really simple, you build in a little paragraph in the partnership agreement that says if a dispute arises under this agreement something related to our relationship together as number of shareholders partners, whatever your term, one party will issue the others a formal notice of dispute. So, actually send a letter, pursuant to the notice provision in the contract, to say “we’ve got an issue”. Now, the reason for that is to be very intentional and formal and set things in motion. Sometimes, no matter how much you think you’re communicating to someone, if you don’t kind of jump through that sort of a hoop, they may not understand they have a serious issue on their hands. They may think “oh yeah, yeah, yeah we’ll get to that no big deal,” not sort of hearing the message. When you send a formal notice of dispute, if that’s what the contract calls for, you step things up.

The formal resolution meeting is a meeting where just the parties in the dispute meet and talk about the issue and try and come up with a resolution. There’s no forced resolution, there’s no mediator, there’s no judge or arbitrator, it’s just, “now we’re getting serious, now we need to figure something out. Can we do that together?” If that doesn’t work, you go to the next step in the dispute resolution mechanisms.

So one that doesn’t work real well for very large companies, but works great for smaller businesses is neutral arbiter. So what that is is a provision that says, if we have a dispute between us, instead of going to litigation, we’ll engage so-and-so. And it’s usually a trusted neutral third party – it can be a friend, a business person, a mentor – it’s usually not lawyers and other professionals, because we feel like not one to be in the middle of that. Particularly if I’m representing the company, I don’t want to be in something where I could be perceived as having to decide for one person or the other, but you get the point. There are different ways to draft the provision, but it basically says “look we will contact the neutral arbiter and tell him or her that we have a problem. We’ll each write our version of what’s going on, they’ll interview to the extent they need to, each of us, they’ll spend a little bit of time (you can even build in that they can hire their own counsel for, you know, up to a couple thousand dollars).” You want it to be simple, you want it to be inexpensive, but you want it to be effective. Whatever mechanisms you think you need to build in, do so and then the neutral arbiter comes back and says “here’s my decision abide by it.”

Now, usually that that decision isn’t from a formal arbitrator or a judge, it isn’t entered into a court of law. One of the founders or partners could decide not to honor it, but you would hope that they would agree to the premeditated agreement to honor the decision of the arbiter. And, it could be a decision the company should undertake, it should be someway of divvying up responsibility or equity or money or something, but neutral arbiter are a great, inexpensive, simple mechanism to hopefully get a resolution.

So now, let’s say you’ve tried formal resolution meeting, neutral arbiter if it works for your particular business, or if it doesn’t, what’s next? Well then we go to those more traditional mediation, arbitration, litigation options. Mediation is formal, outside of the office in front of a trained, certified, third-party mediator – an opportunity to air the dispute and have the mediator try and come up with a resolution among the parties involved in the dispute. Sometimes the parties will be represented by their own legal counsel, most often I would say that they are, other times they won’t be. They usually share the costs of the mediator and the mediation facilities, which could run maybe a thousand dollars, up to a couple thousand dollars, could be a little less, little more for a day in front of a mediator. The mediator will not issue a decision. It’s not a forced resolution. The mediator will often split up the parties and kind of work each side a little bit and try to come up with a shared resolution. So, that’s relatively inexpensive, it happens pretty quickly, there’s no forced decision.

If none of these things work, then you’re in the realm of arbitration or litigation and those are usually an either/or. You either call for arbitration formally, it’s required under the contract or it’s not in which case you end up in litigation. These are lengthier processes. The arbitration will take place in front of certain arbitrating bodies. There’s all these arbitrating bodies, they’ve got rules and the rules apply to how that the case is heard. A decision is entered in the end in the arbitration and that decision can be entered into a court of law and has the binding power like a judge’s decision would.

Arbitration started as an alternative to litigation. It was supposed to be cheaper and quicker. It’s not in a lot of cases. Under simple rules it can be, under complex rules like a AAA it can be very expensive. A company I was general counsel for went through one where we spent six million dollars in arbitration fees. You’re paying the the arbitrators on day one, each side is paying the arbitrators. If you’ve got a three arbitrator tribunal it can get very, very expensive, very quickly.

So, you understand why I’m saying these other options formal resolution, neutral arbiter, mediation are much stronger. They’re quicker, they’re less expensive, but in the end, if you’re not able to come up with a resolution through one of those others -a resolution that the parties honor – then you’ve got to go to these other options.

Also in dispute resolution, you will deal with governing law. So, the governing law of a contract for a Texas Limited Liability Company is probably going to be Texas, but they can discuss that if the members are in different states. Again, it’s almost always in a partnership or founder agreement, it’s almost always going to be the law where the company was formed and is domiciled, but it could be different than that.

That’s dispute resolution. It’s really important to figure out, try and fend off the problems before they occur. If they do occur, you try and get rid of them judiciously.

That lays the basis for the conversation we’ll have about hitting the eject button. So if none of this stuff works or you decide there’s no way you’re ever going to get the point where your partnership is going to be effective for you, how do you get out of that situation? We’ll talk about that next time.

If you have any questions or comments about any of this, if you’ve been through an arbitration or a mediation, if you’ve used neutral arbiter – I’d love to hear from you. Remember the way I’m crafting this series is to hear from you. What do you want to hear more about? What do you need more of? What haven’t I covered properly?

So, please reach out, drop a comment. I appreciate you stopping by.