Partnership Theft and Fraud Disputes
Partners in a business – including managing members of a limited liability company – normally owe each other fiduciary duties. Such duties require a partner to care for the business’ property as if it was his own. But fiduciaries like partners must also behave with loyalty to the business – which means their fellow partners. So what happens if two business partners’ relationship breaks down, and they struggle for control of the company or partnership?
Lock-outs, Freeze-outs and Squeeze-outs
One common dispute occurs when the partner who holds the business’ books refuses to provide information to the others. Texas law requires managing partners of a partnership to produce key documents (like a list of all partners) upon request. A business’ governing documents usually require managers to provide financial records for several years on request. The failure to perform this duty often signals embezzlement, severe financial issues, or even fraud that the company exists.
Another partnership dispute is shareholder oppression, where majority owners abuses their power to push minority owners out. One common tactic – a “squeeze-out” – occurs when the majority owner makes a cash call, where all partners must pay proportionately to their ownership. Typically, a partner who misses a cash call loses his interest (“dilution”) proportionally to the payment he missed. While cash calls are legitimate fundraising tools, an unscrupulous owner can abuse them to force out partners who lack liquid cash. Another common tactic is to “freeze out” a minority owner: because most businesses use majority voting, a majority owner can deprive minority owners of any control to pressure them into a sale. This tactic is especially harmful when minority partners cannot resell their shares to third parties, or they work for the business. In these situations, the minority partner’s financial risk makes resisting an aggressive majority owner difficult without outside assistance.
The Enemy Within
Seizing control of the business is only one way an overbearing partner can gain an underhanded advantage. A disloyal partner may also usurp partnership opportunities or misappropriate confidential information. This tactic is hard to detect: when business slows, is it because the market is weak, or because a partner held back potential clients for himself? Managing partners also owe fiduciary duties to the business’ other owners, which prohibit them from benefiting at the partnership’s expense. Yet all too often, a managing partner will bind the partnership to contracts with the partner’s own companies, draining the business dry. Worse yet, the minority partners often unwittingly approve these deals, thinking they’re getting a bargain when they’re actually losing their rights! Only consistent monitoring of the partnership can detect and prevent such wrongful competition before it collapses the entire business.
Partnership disputes are almost always “bet the company” lawsuits: if a dishonest partner loots a partnership once, he will not stop until the business is all his. Without a credible threat that the partnership’s rules will be enforced, negotiation only promotes further abuse of the partnership structure. If you suspect that one of your partners is defrauding you, call Bonnie Spencer at (713)-961-7770 for a free consultation. We have handled numerous partnership and business disputes in several different fields, and can help resolve yours.