Tuesday, September 7th, 2021
Very few divorces end with a clear “winner”, as the late great Jerry Reed made famous in “She Got the Goldmine (I Got the Shaft)”. This applies to a personal divorce as well as to a “business divorce”.
Business divorce disputes take place between majority owners and minority investors who may be co-founders, family members, or long-time friends. As with a personal divorce, conflicts between individuals who hold significant stakes in private companies can be complex, personal, and highly contentious.
A business divorce can result from a longstanding disagreement between business partners, or it can be triggered by other factors, including a change in leadership, a significant change in the company’s financial performance, or an external problem that threatens the continued success of the company. In many cases there is the potential to escalate a conflict between business partners to such an extent that it becomes difficult for them to come to an agreement on a pragmatic solution.
Add to the complexity that there are different types of business units, and the laws governing their management and operation can vary widely. This complexity is compounded in the cannabis industry for a number of reasons.
First, many cannabis agreements are oral, reduced to rudimentary written form, or both. And often the paperwork, if any, is not done by a lawyer. In the event of a dispute, therefore, there are inevitably vague terms and disagreements about the intentions of the parties. This uncertainty makes it difficult for even the well-meaning parties to resolve disputes efficiently, and often leads to litigation – something few cannabis companies can endure well financially.
Second, the cannabis market is not yet fully mature, making it particularly vulnerable to ever-changing market conditions. There are more market participants than necessary, but not enough responsible and experienced participants. As a result, many businesses fail for a variety of reasons. In addition, and this is especially true for the hemp industry, changes in the supply of raw materials can lead to dramatic fluctuations in sales compared to forecasts.
Third, many cannabis investors do not fully realize the legal and regulatory risks associated with investing in the industry. For example, an investor might think that a smokable flower is a good investment, and that may be true for a time. But what if the state legislature suddenly bans smokable flowers in the state? That act could take an otherwise profitable investment and essentially render it worthless overnight.
All of these factors contribute to a kind of “wild west” mentality that has been a hallmark of the legal cannabis industry since it resurfaced in the United States more than two decades ago. And while that mentality has fueled a generation of inspiration and ingenuity, the legal side of business has not kept up with the creative side – hence the emergence of divorces in the cannabis business.
Prudent majority owners and minority investors will take the following steps when entering into a cannabis business relationship:
Document every aspect of the transaction in writing so that both parties can understand it. And while it may seem a shameless plug, both parties would do well to hire lawyers to help with this process. An ounce of prevention can be worth a pound of cure here.
If you are a majority owner, make sure that you disclose all possible risks in writing to all potential investors so investors can’t come back saying they didn’t understand the risks in case the company goes south. If you are an investor, take the time to read up on the cannabis industry and its potential investment so that you understand the questions and the likely risks before investing your money. Again, it helps to attract professionals who are familiar with the cannabis industry.
Get a “preliminary contract.”Include provisions in your legal agreements that make it clear what to do in the event of a business divorce. Force yourself to think what would be fair if one or more parties wanted to end the relationship. It’s much easier to do this on the front end when the parties are in line than after a relationship has frayed.
These tips don’t guarantee a permanently happy marriage, but they hopefully increase the chances that a breakup will be amicable.
© 2021 Bradley Arant Boult Cummings LLPNational Law Review, Volume XI, Number 250