Why many manager removal provisions are doomed to fail

partnership agreementMost business partners start their venture with the intent to own a property or operate a business until selling it for a large profit. Hopes are high and intentions are real. As in any relationship, there could be bumps in the road.

Just as couples getting married should ideally agree about kids, money, religion and other major topics before they marry, business partners need to do the same. Governing documents often address many of the important issues a business might face. But even well-drafted governing documents often relegate one key topic to boilerplate language: how to remove a manager of the business when the partners disagree on how it is being run.

The partnership or company's manager is often a principal or a principal's affiliate. The manager typically is the person running the day-to-day operations. For real estate, the manager might be in charge of property operations or brokering leases, or have the sole authority to hire other entities to do so. The manager tends to handle the venture's finances, overseeing and controlling the books and records. Having a functional manager is essential to the success of any business.

When the business underperforms or, worse, the manager is up to no good, it could become necessary to remove the manager. Most partnership and operating agreements have manager-removal provisions, typically allowing removal upon the occurrence of one or more specified events and after a notice and cure period. If after the disgruntled party gives the notice the manager complies and exits management, the dispute might very well end there.

Many governing documents do not, however, account for what to do when the manager simply refuses to relinquish authority. The result is a deadlock. Left with no other options, the removing party is forced to file a lawsuit for an injunction or declaration to remove the manager.

Once in litigation, the parties often assert a variety of claims and the case can get bogged down in court, which is time-consuming and expensive. And throughout this process, the company is often left unable to effectively function. For example, third parties could be reluctant to deal with the company because of the uncertainty of who is in control. Further, the ousted manager may still have exclusive control over essential books and records.

This can have devastating consequences for businesses engaged in real estate or other markets that may lose the ability to acquire or dispose of assets at an opportune time. The cost to a business can go well beyond the attorney fees incurred in litigation, though the impact of attorneys' fees themselves can be exacerbated if the manager uses company funds to defend the case.

A first step would be for new partners to thoroughly discuss the removal provisions at the outset and provide for them in their partnership or operating agreement. If one partner has the right to remove the manager, they should consider how that will play out in the event of an actual dispute. One possibility is to agree that claims relating to the removal of a manager be expedited to a mediator or arbitration panel. The parties also could agree that claims relating to removal be adjudicated separately from any other claims between the parties. Such provisions could help avoid delays associated with a typical lawsuit.

The partners or members also should embrace a procedure to ensure that both parties have access to the necessary books and records in the event of a dispute over removing the manager. Too often the manager denies the nonmanaging partner access to records once conflict arises. Addressing the issue before a dispute arises will help to avoid the potential problem.

For those already operating a business, the parties should consider analyzing the removal provisions and amending them to ensure the business can function in the event of a management dispute. Of course, deciding which provisions are the right fit for a business depends on the unique characteristics of the business and the parties.

Like any other relationship, people generally enter a business relationship hoping and expecting that it will be prosperous. That optimism often results in a failure by the parties to adequately plan for the possibility that the relationship may eventually fail.

Business partners need to adequately analyze the manager removal provisions to ensure they are tailored to the unique characteristics and needs of the business. Planning for this possibility in the beginning can result in significant cost savings later.

Jonathan Hart of Shutts & Bowen LLP co-authored this post.  It is reprinted with permission from the April 26, 2016 edition of the Daily Business Review© 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited; contact 877-257-3382 or reprints@alm.com.

  • Matthew R. Chait

    Matt Chait is the Managing Partner of the West Palm Beach office of Shutts & Bowen LLP, where he is a member of the Business Litigation Practice Group. His statewide practice focuses on commercial real estate and land use litigation ...

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