July 8, 2024
by Frank Burke

Anticipating and Resolving Disputes in Small Business Partnerships and LLC’s

small business concept diagram hand drawing on tablet pc

According to the latest available data from the U.S. Bureau of Labor Statistics, around 20%-23% of new businesses fail within their first year. About 595,000 small businesses fail or close each year, and 1.25 million small businesses fail or close within the first five years.[1]

Businesses continue to struggle with high prices and interest rates,[2] increasing business failures and court filings for breach of contract and business tort claims.

Given this track record, this article will focus on proactive strategies to protect, define rights and responsibilities, and describe reactive measures for the owners of small partnerships and limited liability companies. Small businesses may operate in various sectors, including retail, restaurant, services, technology, manufacturing, office buildings, industrial, shopping centers, multi- or single-family residential, ranches or farms or vineyards.

Causes of Small Business Failures

Common causes of small business failures include cash flow issues from poor budgeting, inadequate sales or mismanagement of inventory; difficulties in securing funding or starting with insufficient resources; inadequate management in finance, marketing or human resources; and ineffective business plans or marketing strategies.[3] Small businesses also report concerns about finding skilled workers and employee retention issues.[4]

Current high interest rates are also affecting small businesses by limiting access to capital, reducing consumer spending, and making it difficult to refinance high variable-rate debt.[5]

Advance Planning Scenarios

Appropriate Business Roles for Friends and Family

Small business disputes can become emotional, especially when friends and family are involved. It’s crucial to determine which individuals have the qualifications to become general partners, managing members or employees. These relationships can deteriorate over issues of fairness, contribution, compensation, respect and communication, leading to frayed or broken relationships.

Putting all Understandings in Writing

Owners should clearly agree on the rights and responsibilities of the entity and its partners or members. While oral partnership agreements might be enforceable in some states, they are not advisable due to differing recollections when conflicts arise. Boilerplate partnership agreements or LLC operating agreements may only cover legal requirements, ignoring essential additional agreements that should be written.

These agreements should address ownership percentages, management roles, business operations, compensation, profit calculations and distributions, capital contributions or loans to the business, repayment terms, and whether and how they will alter ownership percentages. Clearly defining these issues can prevent downstream legal problems.

These agreements should state what actions require consent and in what percentage, how to deal with deadlocks by adding additional partners or members, or by including voluntary or involuntary dissolution triggers.

Deciding on the Legal Form of the Business

Careful attention must be given to the designation of general versus limited partners and members versus managers in an LLC.

In a general partnership, each partner has joint and several liability and unlimited responsibility for the partnership’s obligations. Each partner owes fiduciary duties to the other partners. A written agreement should address how to handle deadlocks, management rights, profit sharing, and responsibility for losses and debts.

Unless specified otherwise, all partners have an equal share in the partnership; the partners have an equal right to manage and control the partnership, they have an equal share of any profits and are equally responsible for any losses and debts.

In a limited partnership, the general partner has control and unlimited liability, while limited partners’ liabilities are limited to their contributions. A general partner, which may be a corporation or LLC, faces joint and several liability and owes fiduciary duties. The general partner may be a corporation or LLC.

An LLC can be member-managed or manager-managed. In a member-managed LLC, members handle management and owe specified duties of loyalty and care. In a manager- managed LLC, managers decide on the activities of the LLC, except for disposal of substantially all of the LLC’s property or other conduct outside the ordinary course of business, owe fiduciary duties to members, and members owe only a duty to follow the operating agreement and act in good faith.

Members of an LLC are generally not liable for the LLC’s debts except in cases of alter ego liability or tortious conduct. Members and managers may be individuals or a wide variety of organizational entities. Managers may be, but are not required to be, members.

Buy-Sell Agreements

Buy-sell agreements are vital in small businesses with a limited market for ownership interests. These should be included in the organizational documents or a separate agreement. Owners prefer to choose those with whom they will be in business. Such agreements facilitate the process for those wishing to sell, providing for a sale with the consent of other owners and a triggering mechanism like a right to offer, right of first refusal, or forced buyout along with price and payment terms and security.

A valuation method should be agreed upon, as well as a funding method. The agreement may provide for a mandatory purchase of an owner’s interest who is an employee and is terminated. Other provisions may include mandatory distributions for taxes, intellectual property rights, and noncompete clauses. There are significant tax considerations depending on the form of ownership.

Dispute Resolution Clauses

Organizational documents should mandate negotiation between principals, followed by mediation with a third-party neutral and then arbitration. Settlements from mediation should be documented in a written agreement, signed by all parties, and enforceable in court.

Arbitration clauses require careful drafting, covering types of disputes (“arising out of” or “related to” the contract) number and qualifications of arbitrators, location, applicable rules, governing law, discovery limits, hearing types (live or on documents), arbitration duration, enforcement of the arbitration agreement, and available remedies.

Common Dispute Scenarios

Several common issues can lead to expensive litigation.

Management Disagreements 

Partners or members may disagree on how to manage the business, whether to hold it for investment, improve it or sell it. They might also clash on securing additional capital or hiring skilled employees.

Control Issues

One partner or managing member might control the business and real property, take excessive compensation, withhold profit distributions, or fail to account for revenues, expenses and profits properly.

Mismanagement and Misconduct

Litigation often arises from neglecting or mismanaging the business, concealing or usurping business opportunities, engaging in conflicts of interest, breaching fiduciary duties, mismanagement, self-dealing, commingling or embezzling funds, and making improper distributions or gifts.

Breaches of fiduciary duties vary depending on whether the party is a general partner or managing member. Other claims might include breaches of the partnership agreement or LLC operating agreement, fraud, negligent misrepresentation, conversion, or embezzlement. Damages can include lost profits, benefit-of-the-bargain damages, or disgorgement remedies. Possible legal remedies may include seeking an accounting or dissolution.

Potential Business Resolutions 

Sale of the Business

To negotiate a business sale, parties need appraisals, broker opinions of value, or other valuations of the business and associated real property, as well as verifiable bookkeeping or accounting records.

These provide a realistic view of the business’s value and help decide whether to continue the business or sell it and divide the proceeds. Accurate bookkeeping records are essential for reviewing party contributions, payments, expenses, revenues and business sustainability.


 Even without a formal buy-sell agreement, disputes can be resolved by one owner or group buying out the others or agreeing to sell the property and share the net proceeds according to ownership percentages.

Valuations must consider unequal owner contributions, loans, liens, encumbrances, mortgages and tax issues.

Real Estate Partition 

Partition actions can involve partnerships undergoing accounting or dissolution proceedings or partitioning partnership property. These actions may lead to the division or sale of real or personal property, with the resulting land or cash divided according to ownership shares.

Dissolution Issues

Dissolution can be voluntary or involuntary which may affect how involved the court or a tribunal is in the process.

In a partnership at will, voluntary dissolution occurs by a vote of at least half the partners. In a partnership for a definite term or purpose, it requires a unanimous vote, an event agreed upon in the partnership agreement, or an event making it unlawful to continue the partnership business.

An involuntary dissolution may occur when a partner successfully applies for a tribunal determination that the partnership’s economic purpose is likely to be unreasonably frustrated, a partner’s conduct makes it impracticable to continue the business with them, or it is impracticable to continue the business in conformity with the partnership agreement.

A limited partnership dissolves voluntarily upon an event specified in the partnership agreement or by consent of all general partners and of limited partners owning a majority of distributions as limited partners at the time the consent is to be effective.

Involuntary dissolution occurs if upon application by a partner a tribunal orders it, deeming it impracticable to carry on the activities of the limited partnership in conformity with the partnership agreement.

In both limited partnership and LLC dissolutions, the remaining parties may purchase the moving parties’ interests at fair market value, possibly requiring a bond. Tribunals may appoint three appraisers to determine the fair market value.

For LLCs, voluntary dissolution can occur due to events specified in the operating agreement or articles of organization or by the vote of 50% or more of the voting interests of the members or by a greater percentage as may be specified in the operating agreement or articles of organization.

An LLC Involuntary dissolution may happen if a tribunal finds it not reasonably practicable to continue the business per the articles of organization or operating agreement; reasonably necessary to protect complaining members’ rights or interests; the business has been abandoned; management is deadlocked or subject to internal dissension; or those in control have engaged in or knowingly countenanced persistent and pervasive fraud, mismanagement, or abuse of authority.

The responsible persons must establish the date of dissolution and file a certificate of dissolution.

Winding Up 

The winding-up phase is similar for partnerships, limited partnerships and LLCs. Responsible persons may preserve the business or property as a going concern for a reasonable time temporarily, prosecute and defend actions and proceedings, settle disputes by mediation or arbitration, and perform other necessary acts to settle and close the business. At the conclusion, they must file a certificate of cancellation and a final franchise tax return.

In a partnership, those responsible may dispose of and transfer the partnership’s property, discharge the partnership’s liabilities, distribute the partnership assets and perform other necessary acts.

In a limited partnership responsible persons may transfer property, perform other necessary acts, give notice to claimants, pay and discharge liabilities, settle and close the partnership activities, and marshal and distribute the assets of the partnership.

In an LLC, the managers who have not wrongfully dissolved the LLC may wind up the affairs of the LLC or the winding up shall be conducted per a decree of dissolution.

The persons winding up the affairs of the LLC must give written notice to all known creditors and claimants.

After determining that all the known debts and liabilities of the LLC, including debts and liabilities to members who are creditors of the limited liability company, have been paid or adequately provided for, the remaining assets shall be distributed among the members according to their respective rights and preferences as follows: to members in satisfaction of liabilities for distributions; to members for the return of their contributions; and finally to members in the proportions in which those members share in distributions.


Small business failures can result in costly litigation. This article describes best practices to help clients include all their understandings about operational details in writing, help them decide on the best form for their business, and include buy-sell clauses and mediation and arbitration clauses in their agreements.

If disputes arise and the business begins to falter, business resolutions may include buyout, partition or dissolution and winding up in order to minimize or avoid expensive lawsuits.

Frank Burke is a neutral at Frank Burke Mediation and Arbitration PC.

[1] U.S. Bureau of Labor Statistics, Business Employment Dynamics, https://www.bls.gov/bdm/, Entrepreneurship and The Economy, https://www.bls.gov/bdm/entrepreneurship/entrepreneurship.htm ; ” Percentage of Businesses That Fail-and How to Boost Chances of Success”, Lending Tree Analysis of US Bureau of Labor Statistics April 8, 2024, https://www.lendingtree.com/business/small/failure-rate/ ; Small Business Statistics at https://www.chamberofcommerce.org/small-business-statistics/
[2] February 22, 2024 report from the Federal Reserve Bank of Minneapolis https://www.minneapolisfed.org/article/2024/businesses-continue-to-struggle- with-high-prices-and-interest-rates.
[3] The Top 12 Reasons Startups Fail, https://www.cbinsights.com/research/report/startup- failure-reasons-top/ ; Small Business Statistics
at https://www.chamberofcommerce.org/small-business-statistics/.
[4] Q1 CBIZ Main Street Index, February 22, 2024, https://www.cbiz.com/insights/main- street-index.
[5] 2024 Federal Reserve Bank Small Business Credit Survey, March 7, 2024, https://www.fedsmallbusiness.org/reports/survey/2024/2024-report-on-employer- firms.

This article previously published in the July 2, 2024 edition of Law360

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