Your business' future in your hands

If a key person in your business died or became totally and permanently disabled, how would your business be affected?

Would your business continue to operate? Would your business loans still be serviced? Would your clients take their business elsewhere?

In the event of death, permanent disablement or critical illness, a properly structured funding agreement will ensure that cash is available for the departing principal (or principal’s estate), while the surviving principal’s achieves control of the business. Without both the funding or transfer arrangement in a business continuation plan, disputes may arise which may not be easy to resolve. Hence there is a need for all parties to agree on the following:

1. the parties to the arrangement;
2. the events that trigger either a sale by the existing principal or purchase by the surviving principal’s;
3. the price – or if this is not possible, the valuation method; and
4. the funding solution.

Without such arrangements, problems may occur for both the departing principal (or their estate) who may find that they do receive the price the business was worth, or the survivors, who may find that they cannot work with the deceased or departing principal’s heirs.

Take a case point: Pizem v Malek (1985): 3ACLC62
This case highlights the problems that may occur where the principals fail to establish a properly funded business continuation arrangement. Pizem v Malek deals with Section 461(k) of the Corporation Law which provides for the windup of a company under the ‘just and equitable’ rule. This rule gives the discretionary power to the court to wind up the company in a variety of situations including incompatibility. Incompatibility suggests a lack of harmony in a relationship and an inability to work together.

A court wind up order is a drastic remedy which can cause financial loss to creditors and much bad publicity for the Directors of the company, making it difficult for them to re-establish themselves in the business community.

The case of Pizem v Malek (a brother and sister) involved a petition to wind up the company because of a personal dislike and personality clashes between the two parties.

The plaintiff, Mr Pizem, had enjoyed a long and cordial relationship in many commercial ventures with Mrs Malek’s husband. When Mr Malek died, Mr Pizem had agreed to the gradual integration of Mrs Malek into the business, but he believed that he should be the dominant partner. The court did not have any major disagreement with this position.

The difficulty lay with the interpretation of reasonable conduct by Mrs Malek, assuming that Mr Pizem’s statements were true. There was evidence to suggest a build up of dislike and lack of confidence. A trivial incident – the recovery of a briefcase by Mrs Malek from her late husband’s office – developed into a dispute as to who’s briefcase it actually was, and why a desk drawer had been forced. Mr Pizem strongly protested about what Mrs Malek had done, saying it was a “shocking thing” and that he would thereafter find it very difficult to trust her.

The judges summing up of the characteristics of the two parties was based on dishonesty. However, there was a build-up of distrust which arose from their private dealings rather than from their business dealings, and that eventually one party tried to gain control. The court ordered the wind up of the company. As a result, four of Sydney’s top restaurants closed, with the loss of 200 jobs and a major write down in the value of the assets, particularly the goodwill. As the business ceased to be a going concern, the substantial goodwill that existed prior to Mr Malek’s death, was virtually non-existent by the end of the winding up.

The solution: a properly constructed business continuation plan could have prevented the problem of incompatibility and the subsequent loss of the value of the business. Cash could have been provided to the remaining principal’s interest, at an agreed market value, while the remaining principal(s) could achieve control – without the trauma of dealing with the departing principal’s family. The results – peace of mind for all parties.

If you are not certain whether your business continuation plan is adequate, Baker Affleck Financial Solutions will be running free seminars through March on business risk click here to register your interest with Baker Affleck Financial Solutions or call Glenn or Deborah on (07) 5538 3088.

Incompatibility between Directors

The Life Writer, April/May 1993

By Andrew Pavuk. At the time of writing this article Andrew was National Technical Services Manager for MLC Life, specialising in Protection and Business Insurance.