Can You Fire Your Business Partner for Losing Money?

My partner cost us a lot of money over the past 6 mos. Can I get rid of him?

Can a Business Partner Be Removed for Causing the Business to Lose Money?

No law says a partner has to be good at business. Since half of new businesses fail, it’s obvious that some people will make errors of judgment. If a partner causes a financial loss by intentionally harming the business, that violates a fiduciary responsibility which could justify legally removing a partner.

That means taking chances with the business, even to the point of being slightly reckless is not grounds to remove a partner. But the law does say that you can remove your partner if he violates his fiduciary responsibility. So what is that?

What Is Fiduciary Responsibility in a Business Partnership?

To have a fiduciary responsibility means that the partners but the best interest of their partnership ahead of their personal interests including business interests outside of their partnership. In plain language, that means that partners have a legal obligation to avoid conflicts of interest with their business partnership. If you and I open a small book store, it would be wrong (and legally enforceable) for me to open another book store down the street with lower prices than our store.

While I give an obvious example above, there are other circustances that come to me for mediation that are slightly less clear. Here’s another example that is a little less clearly wrong. You and I make great cookies. All the local restaurants want to buy our cookies so we form a partnership and start a business. We are very successful and find ourselves working a lot of hours to meet demand. I tell you that I need more time off because I feel like I’m burning out. You agree. Then you find out that I’m using my time to make pies that I’m selling to our restaurant customers. You are furious and threaten to cut me out of our cookie partnership. Do you have a case? Probably. You could argue that my pies compete with our cookie sales. You might even argue that I took time away from our business to work on my own business. And, I’m using our customer base to grow my side business. These are valid points if you can show that our cookie business was harmed. I merely illustrate that it may not always be clear whether fiduciary responsibility is violated.

Duty of Good Faith and Fair Dealing

Partners have a duty to be fair with each other. Let’s say that you keep the books and do all of our banking for our cookie business (be sure to read this post about banking in a business partnership). I am getting tired of making $50 a month and I ask you to increase our salaries. You tell me that we’re not making enough money to increase our pay. Later I discover that we have a large cash reserve and that you have been taking out twice the amount I’m getting. Even though it’s perfectly legal for one partner to take money from the business without permission, it’s not legal to deceive your business partner. Thus, there is a violation of the Fair Dealing clause. Telling me there is no money to pay me isn’t keeping with Good Faith. I would have a good case if I decided to sue.

When it comes to money matters, it’s not the action per se that makes a break of fiduciary responsibility, how that action came about might be more important. Taking money from a business is not illegal. Taking money and representing it to be for a pupose other than what it actually goes to is another thing. If I take a $2,000 for the rent and instead buy a nice TV for my home, that’s a problem.

Duty of Loyalty

This part of the fiduciary responsibility has to do with a partner’s need to place the partnership ahead of personal (private) gain. Again, using our cookie business as an example, if a big customer asked for a discount and promised to give me, your partner, a secret kickback, that would be wrong. If a customer asked me for a discount and I granted it to close a big deal, there is no violation of duty even if I did the math wrong and sold a bunch of our cookies at a loss! If I’m not doing that for personal gain, no foul is committed.

Duty of Care

Duty of care means that each partner has a responsibility to make all reasonable effort to avoid bringing harm to the business or the partnership. Of course, there is always risk in business so you can’t have your partner booted because an advertising campaign failed to generate business. But if your partner bet the entire cash reserves of the business on a horse race, that qualifies as failure to take reasonable care of company assets. Reckless behavior violates the duty of care clause.

Duty of Full Disclosure

Partners must let their partner know about all details that might impact the business for the positive and especially the negative. Let’s say that my cousin owns a commercial building that has been vacant for a long time. I tell you we should move into that building and expand the cookie business. I don’t tell you that my cousin is headed for foreclosure unless he can get a tenant in the building. Also, my cousin is going to pay me a $5,000 kickback because he will be able to sell the building if he can get a tenant. And, the new owner will raise the rent because my cousin is giving us cheap rent with only a 1-year lease. I know these things, but I don’t tell you. You would have grounds to remove me as a partner.

Do You Have Cause?

As you read this post about fiduciary responsibility, you can see several instances where your partner has violated these provisions. She broke the fiduciary responsibility so that means it’s easy for you to kick her out, right? Wrong.

Burden of Proof

You must prove that your partner has broken the fiduciary responsibility laws of your state. That’s nearly as complex as proving a criminal case. To remove a partner who refuses to step down voluntarily, you’ll have to either make a very clear presentation to your partner and hope that intimidation will open his eyes. He may decide to give you control while retaining his ownership. Maybe.

If he won’t step down, your other option is to start a legal case. If you adequately prove your case in court, a judge can order your partner to surrender his share of the business. However, a judge can order you to compensate your partner for his interest. That’s relatively common as our courts don’t like to take away property without pretty good reason. Worse yet, the court may order the dissolution of the business. The partnership has failed and therefore the business is ordered dissolved. The remaining assets are divided and the parties go their separate ways. This is a likely outcome for most small businesses.

One Bright Spot

There is a bright spot in this. Many calls I get are about some bad deal or arrangement their partner forced on them. In one case, a partner complained about having no say in the operation of the business because her partner demanded full control of he would ruin the business. In a similar case, a partner wanted to take the company in a different direction, and he told his partner that if he didn’t agree with the new direction, he would take the business “over a cliff.” Anytime a partner enters into some arrangement because of pressure applied by a partner; the “care” clause is broken. If you’re stuck with a bad arrangement in your business partnership, it may have been improperly set up.

In one case recently a man was “forced” to give up his rights in a 50-50 partnership. His partner took 2% of his interest making it 52%-48%. When I asked why he would agree to that, he told me that he had to. One partner handles the administration while the other handles sales. And an agreement was drafted saying that Partner A would always run the business professionally. Partner B would never let sales decline year over year. If either partner failed to perform, that partner would lose 2% stake in the business to the other partner. The economy dipped, sales dropped very slightly (but net profit actually rose) and the other partner seized control. Frankly, that deal was dead from the start. Yes, it’s okay to have performance standards but this was clearly a set up to seize control. When I explained this to both partners at a mediation meeting, they decided to work out their differences and stop with the games. It all worked out well. I proposed bonuses to compensate for great performance.

Fiduciary Responsibility is Serious

What’s the takeaway? If there is a breach of fiduciary responsibility by your business partner, you have recourse. However, with the burden of proof on you, it can be costly to enforce. These cases last from 3-5 years and cost about $50,000 on average. And, the outcome in the fun-house court system is never guaranteed. If you can avoid the fight and work out a deal, do it. Few businesses survive a 5-year court fight. Better to spend a few thousand dollars to work it out rather than fighting it out.

If you find yourself in a bad position because of a bad deal you made with your business partner, relax. The law protects you from harm if your partner hasn’t acted appropriately. Remember, the interests of the partnership and the business must come before personal gain.

Thank you for reading this lengthy post. If you have questions, please contact me directly.

Chris Reich  Email: Chris@TeachU.com

“If you feel like you are being cheated or pressured by your business partner, you might have legal protection. If your business partner is hurting the business, you might have a case to remove him.”