ROGUE ONE: A PARTNERSHIP STORY

What to Do When a Business Partner is Convicted of a Crime

Is business running smoothly within your partnership?  Has your partner been taking shortcuts, acting unethically, or getting involved in bad business practices?  What about your partner’s personal life? Any skeletons? Has your partner gone rogue? When your partner goes rogue, he may place you and your business in jeopardy. This article will discuss the ins and outs of preparing for and dealing with a partner who has been convicted of a crime.

The Muesli Company

In July of 2017, The Muesli Company’s co-founder, Jennifer Borchart, was found dead in her apartment by her boyfriend.  She had multiple stab wounds to her neck and chest. In July of 2018, Jennifer’s business partner of nearly thirty-five years, Peter Pavlis, was charged with her murder.  Together, Peter and Jennifer had turned their local muesli business into an international brand. Apart from being business partners, the two were lifelong friends: Jennifer drove Peter to work most mornings and Peter even had a key to Jennifer’s house.  Jennifer had no idea that he was a killer.

While your business partner is probably not a killer like Peter, his story highlights the reality that anyone is capable of committing a crime, whether it be tax fraud, unfair business practices, insider trading, employment discrimination, or crimes unrelated to your business, such as illegal drug possession, domestic violence, driving under the influence, etc.  Once a partner has committed a crime it can be challenging for a business to bounce back due to consumer distrust or even public perception, but there are certain precautions and preventative measures you can take to save your business and your reputation. If your business partner has been convicted of a crime or you anticipate a partner’s conviction in the future, then contact an Arizona business attorney today.

What Damages Can be Done from a Business Partner Being Sent to Prison?

If your business partner is convicted of a crime, there are a number of challenges that you and your business might face, including damages to your reputation, damages to the efficiency of your business model, as well as personal and business liability for the partner’s criminal actions.

Reputation

Depending on the severity and publicity of the committed crime, your business will almost surely face reputational damages on many fronts.  When the crime is serious and publicized, consumers will likely avoid using your services, vendors will find others to do business with, and investors may wish to pull out their financial support altogether.  Without customers, vendors, and investors, your business efforts may be thwarted due to inadequate funding and revenue. As a businessman your reputation is often your greatest asset. If your reputation has been damaged due to a partner’s criminal activities, talk to an experienced business attorney today to learn more about your options for getting your business back on its feet.

Efficiency and Work Distribution

How much can a jailed partner contribute to the running of your business?  Answer: Not much. If your business has only two partners to begin with, you will likely have to take on all of your imprisoned partner’s duties; however, if there are several remaining partners, then his duties can be divided up.  Evaluating how you will continue to run your business and get your daily work done without your partner will be a critical assessment and may ultimately determine whether you should leave and start your own business away from your partner’s baggage.

Personal and Business Liability

Is your business liable for your partners crime(s)?  Can you be held personally liable for your partner’s crime(s)?  Answer: Possibly, it just depends on the nature of your partnership and the nature of the crime.  When two or more individuals join together in a business partnership, each partner becomes bound by basic legal duties to the others.  This means that when one partner does something wrong in the scope of the partnership, the business itself and the other partners might be tied to such action’s consequences.  The damages can be severe and will surely injure your business, perhaps even your personal life.

What can you do to mitigate your damages?

There are a number of steps you can take and safeguards you can establish to mitigate the damages caused by your rogue partner. Due to the complicated nature of these precautions, the first step you should always take is speaking with a competent business attorney who will help you understand and appreciate both your risks and your options. While our analysis will vary based on your unique circumstances, it will usually entail evaluating both (1) the nature of your partnership and (2) the nature of your partner’s conduct and/or criminal conviction(s). Once the above factors are evaluated, we can then (3) determine what options will be most advantageous for you.

(1) The Nature of your Partnership

Understanding the nature of your partnership is the first step in perceiving how to best approach the challenge of separating from your partner.  What kind of partnership have you formed? Is it an informal partnership? Is it a limited liability partnership? Is there a partnership agreement in place?  Also, consider whether it is actually a corporation or an LLC? If it is a corporation or LLC, has the entity been legally formed according to Arizona state law?  Generally, the more formal your partnership is, the easier it is to make separation decisions. Here are simple explanations of some of the most common business models to help you remember the nature of your business:

What is a general partnership?

In general partnerships, all partners participate in the day-to-day operations of the business and they all bear personal liability for the debts and liabilities of the partnership. This is often referred to as unlimited liability. In general partnerships, any partner can be sued for the entirety of a partnership’s business debts. General partnerships can be informally created.  For example, if you and your friend decide to open up a lemonade stand together one day, you have just started a general partnership even though you have not agreed to anything in writing.

What is an LLP?

Limited liability partnerships (LLPs) typically allow certain partners to be shielded from liability for the acts of the others as well as employees. The LLP is a lot like the limited liability company only it operates under partnership rules.  LLPs can only be formed in Arizona by filing with the Arizona Secretary of State’s office.

What is a corporation?

A corporation is a legal entity that is separate and distinct from its owners.  To form a corporation, you must create a name, appoint a director, file with the Arizona Corporation Commission, draft articles of incorporation and bylaws, hold meetings, issue stock, etc. For more information on corporations, visit the Arizona Corporation Commission website, which has useful information and resources.

What is an LLC?

An LLC is not a corporation, but it does have the liability protection of a corporation and additional benefits as well.  LLCs are easily formed by naming the LLC, choosing an agent, filing articles of organization with the Arizona Corporation Commission, and preparing an Operating Agreement, etc.

(2) Formal Documents

Take a look at your partnership’s formal documents.  Such documents might be called partnership agreements, operating agreement, or Bylaws. By and large, formal documents are helpful in making separation decisions because they are usually drafted by a professional and they control a significant number of issues within the partnership, including: dissolution of the partnership, which partner performs which duties, how the partnership can borrow money, etc. Usually, these formal agreements will tell you what you can and can’t do in regards to removing a partner.

Dealing with a rogue partner becomes more difficult when your partnership has no formal documents, such as a partnership agreement. In such cases, you will have to either apply the default rules established by Arizona statutory law, or you will have to rely on past emails, texts, conversations, and other communications in order to determine the original intentions of the partners. Arizona default rules will vary greatly depending on your business model.

If no formal document exists, then it becomes challenging. Depending on the circumstances, you either need to reference a statute (i.e. especially for a Corporation, where most states will have “default rules” that control corporate powers, corporate formalities, and so on) or look to emails, texts and any other communications between the partners to fully assess the original intentions of the partners.

What is Arizona’s statutory rule regarding the dissociation of general partner?

Arizona partnerships, including limited partnerships, LLPs, general partnerships, etc. are governed by Arizona Revised Statutes (ARS) Title 29. If your business partnership is not a registered LP or LLP, then ARS 29-1051 will likely apply with regards to partnership dissociation. If you have a partnership agreement, then its rules will usually govern the partnership, not Arizona statutory law. 29-1051 states the following:

A partner may be dissociated or expelled from the partnership if any of the following circumstances apply:

1. 1. If either party in the partnership has expressed desire to withdraw as a partner currently or at a later date.
   2. A specified event in the partnership agreement causing partnership dissociation.
   3. The partner’s expulsion in accordance with the terms in the partnership agreement.
   4. If a unanimous vote by other partners results in the partner’s expulsion under various terms:
      1. Continuing partnership with the expelled partner is unlawful.
      2. A substantial amount of the partner’s transferable interests in the partnership have been transferred.
      3. Etc
   5. The partnership or another partner finds any applicable basis to expel the partner by judicial circumstances including:
      1. The partner has engaged in unlawful conduct that has had detrimental effects on the partnership and/or business.
      2. The partner has continually and deliberately committed a material breach of the partnership agreement or if duty that is owed to the accompanying partners or partnership has not been fulfilled.
      3. The partner participated in behavior in relation to the partnership and/or business that makes it detrimental to carry on the business with continued involvement with the partner.

Looking at the statute, there are two main subsections that make it possible for a general partnership to remove a rogue partner for his or her criminal activity. First, when it is unlawful to carry on business with the rogue partner and all other partners vote unanimously to dissociate such partner. Second, when a judge determines that the rogue partner’s wrongful conduct adversely affected the business or that the judge determines that it is no longer practicable, based on the partners unlawful conduct, for the other partners to carry on the business with the partner.

While Arizona statutory law provides a means for cutting off a partner who has been convicted of a crime, such provisions are not entirely clear.  In some cases, a rogue partner may even bring a legal action to prevent any co-partners from cutting him or her off from the partnership. Sometimes this leads to the requirement that the other partners pay damages. This may occur where a partner is expelled in bad faith, even if the expulsion is valid under the statutory law.

Your partnership will be much better off if you draft a clear partnership agreement that addresses this issue and only cut off a rogue partner in good faith. For help drafting a partnership agreement, call an experienced Arizona business attorney today.

What is an expulsion clause?

Many partnership agreements contain a provision commonly referred to as the expulsion clause. If your partnership agreement has one, you will have to read the language very carefully to determine whether or not it applies to your business partner’s criminal conviction(s). Generally, expulsion clauses give the partners an opportunity to remove another partner for bad behavior, such as criminal activity. Your partnership agreement should specify the kinds of situations that qualify.

Executing on your expulsion provision is a significant business decision, so it is critical that you discuss your expulsion provision with an attorney before kicking out a partner. Oftentimes, courts will find expulsion provisions are too broad to be enforceable. For example, if the expulsion clause is limited to partners who are criminally convicted, then it is likely enforceable. However, if the expulsion clause allows the partners to remove another partner for “wearing socks with sandals,” then a court will not likely find the expulsion provision valid.

If you are creating your partnership and are contemplating situations that would require you to remove a partner for bad behavior, then an expulsion clause might be a good provision to consider. Generally, the more formal you can make your partnership, the better. Our attorneys have drafted numerous partnership agreements and have a strong track record of success. If you need an attorney to draft, interpret, or evaluate your current partnership agreement or bylaws, contact us today.

(3) The Nature of your Partner’s Conduct and/or Criminal Convictions

In our experience, some of the most common issues surrounding a partner’s criminal activity involve the following type of conduct:

1. 1. Common crimes unrelated to the business (such as domestic violence, IRS fraud with personal tax filings, etc.)
   2. Stealing from the partnership, or in other words abusing expense reimbursements to cover up for using business funds and assets for personal use
   3. Committing criminal acts and taking significant legal risks as an agent of the company
   4. Committing IRS tax fraud on behalf the partnership by making up numbers, unlawfully distributing assets to foreign accounts, etc.

(4)What are your Most Advantageous Options?

You most advantageous option for dealing with a partner’s criminal conduct is to make sure your partnership has a game-plan ready before it happens. An experienced business attorney will help you draft a partnership agreement, bylaws, or operating agreement to make the expulsion of another partner for their criminal acts as easy as possible. With a solid partnership agreement in place, you will not need to worry about the future of your business as much because the agreement will spell out exactly what you and the other partners of your business will do.

If your business lacks any formal documents governing the expulsion of a partner who has been convicted of a crime, then your most advantageous option will depend on: (1) the model your business operates under, (2) whether you have evidence to back-up the original intent of the partners, and (3) the nature of the criminal activity that the partner has been convicted of.

The decision to expel a rogue partner might be one of the most significant decisions you have had to make so far as a business owner. In general, it is critical that you continue to follow your fiduciary duties to your partnership, LLC, or corporation (see below).

What are my duties as a partner?

A fiduciary duty is a legal duty requiring all partners, LLC members, and corporate officer and owners to act for the sole purpose and interest of the business.  Such duties include duties of loyalty and due care, to name a couple. These duties include avoiding conflicts of interest, not personally profiting from business transactions without the consent of the other partners, making all business decisions in a like manner to a reasonably prudent person, not being reckless with business funds and assets, etc.

With the above duties in mind, ask yourself whether the criminal conviction of the partner stems from a duty listed above or in violation of any bylaws, articles of incorporation, or partnership agreement. If the rogue partner’s actions do violate such duties, then you might consider taking one of the following actions:

1. 1. Demanding change from the partner and creating an improvement plan to help the partner refrain from repeating similar conduct;
   2. Limiting the partner’s duties in the partnership
   3. Abandoning the business altogether (avoid if possible)
   4. Filing a lawsuit against the partner for expulsion and reimbursement of any misappropriated business funds; or
   5. Expelling the partner by unanimous vote of the other business partners.

The list above only contains options based on some of the most common circumstances. By consulting with an experienced business attorney, you will be able to develop a well thought out and tailored plan in order to make the most advantageous decision for you and your business. It is important to remember that while lawsuits are usually treated as a last-resort option because they can be expensive and time consuming, filing one might be your best option moving forward. Here at Denton Peterson, we have both drafted countless partnership agreements to facilitate dealing with criminal convictions of partners as well as successfully won such disputes in trial when necessary.  When your partner has been convicted of a crime, don’t just walk away unless it is absolutely necessary. Instead, give Denton Peterson a call today.

Approved By:

Brad Denton – Denton Peterson, PC

1930 N Arboleda #200
Mesa, AZ 85213

Office: 480-325-9900
Email: brad@dentonpeterson.com
Website: dentonpeterson.com

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