In closely-held businesses, it is common for owners to also work as employees. Often, their primary source of income is not from distributions of the business’ profit, but rather their regular salary. This is particularly true for service professions such as accountants, consultants, and medical professionals. The dual role of employee and owner can cause unexpected problems for a business when an owner-employee is terminated.
In a typical at-will employment relationship, an employer can fire an employee for any legal reason, or no reason at all. However, where employees are also owners of a closely held business, Minnesota law may give them a reasonable expectation of continued employment solely by virtue of their status as an owner. Minnesota law can impose liability on companies and majority owners for actions which violate the reasonable expectations of the owner (shareholder, member, or partner) of a closely-held business. In these cases, an employer who terminates an employee-owner for poor performance or misconduct may face an unexpected lawsuit for breach of fiduciary duty and wrongful termination. These claims carry the risk of significant damages, are expensive to defend and are often (but not always) outside the scope of insurance coverage.
The termination of an employee-owner also raises questions about their continued ownership interest. Many businesses assume that an employee-owner who is terminated from employment will automatically have his or her ownership interest terminated, and can be excluded from management of the business. In fact, absent an agreement to the contrary, an employee-owner who is terminated will usually still have the right to remain an owner of the company, along with an ongoing right to request information about the company and vote on matters that come before the owners. This can be particularly problematic if the terminated employee finds a new job and begins to compete with the business.
The Importance of Clear Documentation
There are solutions to this issue. Under Minnesota law, written agreements between owners are presumed to reflect the reasonable expectations of the owners concerning the matter they cover. Thus, the employee-owner and business can enter into contracts that clearly describe the circumstances in which an employee-owner can be terminated, what impact that termination will have on ownership or management rights and (if termination of employment results in termination of ownership as well) how the ownership interest will be redeemed.
Most small businesses know that they should have these documents. They may have even exchanged drafts and participated in meetings to try to agree on terms. However, because they want to save money for growing the business, or simply don’t have time to focus on legal documentation, they leave the drafts incomplete and unsigned or fail to have the documents reviewed by an experienced attorney. Unfortunately, when the dispute ultimately comes up, an unsigned draft or an incomplete agreement may not be worth the paper it’s printed on. Experience tells us that employee-owners are rarely willing to sign legal documents that limit or waive rights once disputes are already brewing. The best time to reach an agreement about the terms of an employee-owner’s relationship with the business is at the outset of the business, or at least while all of the owners are getting along and working in the same direction.