Often, construction companies have to dissolve because the owners cannot cooperate. But many of these companies could have been saved by the power to expel. The power to expel means the majority of a construction company’s owners have the right to forcibly purchase a co-owner’s interest in the business.
Having the power of expulsion can be an effective way to protect the company from a deadlock, litigation or dissolution that results from personality conflicts, leadership failures or fundamental differences of opinion.
The Power to Expel
Under many state laws, if a company’s owners want the power to expel, this has to be agreed upon in the company’s governing documents or other contracts. For corporations or limited liability companies (LLCs), the power to expel may be found in the articles of incorporation, bylaws, shareholders’ agreements, operating agreements, buy-sell agreements or even stock/unit subscription agreements.
If this has not been established in your company’s governing documents or other agreements, then your company most likely does not have the power to expel unless your state law grants that power under its default rules. Unfortunately, many states do not do this or only grant the power under very limited conditions.
Some owners try to overcome these limitations by pressuring a co-owner to withdraw, but this exposes them to personal liability for minority oppression—this gives a legal claim to minority owners who are forced out by the majority through unfair treatment. One form of minority oppression involves terminating an owner as an employee, and the majority refuses to approve dividends or distributions to non-employee owners. This can be especially harmful in construction companies that distribute profits to owners in the form of employee compensation rather than dividends. Minority oppression fails as an expulsion strategy, and it can lead to costly judgments against the majority owners.
An expulsion provision should address the following questions:
What percentage of the ownership must consent to the expulsion? If family-owned, should the power to expel be broken down among family lines?
Will the expulsion rights apply only under certain conditions, such as illegal behavior or failing to perform obligations? Or can an owner be expelled without cause?
How will the remaining owners’ voting rights (for decisions) be affected (i.e., will the votes be cancelled or allocated among the remaining owners)?
How will the purchase price for an expelled owner’s interest be determined? The provision could require a predetermined purchase price, a formula for determining the purchase price, a method for appraising the expelled owner’s interest or a combination of these factors. Consider this provision carefully. Too often, the governing documents dictate a buy-sell price based on book value, which does not accurately capture the value of the business.
Will the expelled owner receive the payment in cash at closing or over a certain time period? If the payment will be accepted over time, what rights will the expelled owner have as a creditor (e.g., security, guarantees, financial covenants, conversion rights)?
Will the expelled owner have to resign as an employee, officer and director/manager?
Will an expelled owner be restricted from competing with the company? If so, what will be the terms of those restrictions? The restrictions cannot be too onerous, or they will not be enforceable.
Will the expelled owner be prohibited from using the company’s confidential information for future profit? How will that confidential information be determined (e.g., client lists, specific bids, budgets or other financial information)?
Once the expelled owner receives payment, will he or she be required to release the company from all claims? (Releases may have to be mutual.) Does the expelled owner have any other property rights that should be waived, such as intellectual property rights?
Will the company compensate the expelled owner for liability arising out of his or her former interest in the company? For example, if the company is a flow-through entity, will the expelled owner be paid for flow-through income tax liability? If the expelled owner has personally guaranteed company debt or served as a surety for company bonding, will the company and other owners indemnify him or her against liability as a guarantor or surety? And will these be secure indemnifications?
If a dispute arises out of the expulsion, will the parties submit to binding arbitration or some other form of alternative dispute resolution? This can significantly reduce the cost of adversarial proceedings and keep disputes private among the parties.
Well thought-out expulsion provisions can protect the value of your company and the rights of all owners to fully enjoy their investment in the company.