Legal Update - Sharing is not always caring

By Warrick de Wet

Director – Warrick de Wet Attorneys

All of us (especially those with siblings) have, from an early age, had to deal with the challenges of sharing something. Perhaps it was a toy or a bicycle or a seat on the couch. Whatever the case, it wasn’t always easy. Sure, it is easy to measure how something should be shared evenly and fairly, but making certain that things turn out that way is a different story. In reality, other forces are at work, such as which brother is older, bigger, faster or stronger. In the end, it’s human nature that you will come up against.

In essence, the same fundamental forces remain in play later in life, but the stakes are a lot higher. Owning an immoveable property in syndication with other owners is a typical scenario. Whether the joint owners are each the registered owners of the property as partners, or whether they are shareholders in a company or members in a close corporation which in turn owns the property, the principles are the same. One is dealing with multiple owners of a single asset that cannot be split into different pieces when things fall apart.

In the practise of law in this field, we come across the same sorts of problems repeating themselves quite predictably. Its seems that there is not much variety in the human experience when it comes to the difficulty of sharing – which makes us wonder why so few successful and business orientated people take adequate steps to cater for likely outcomes in advance. Below are some of the recent scenarios we have come across (for the sake of confidentiality, the identity of the persons concerned has been changed).

Scenario 1

A group of fishing buddies owned a rustic fishing cottage together on the KwaZulu-Natal North Coast through a Close Corporation. Each owner was a member of the CC. Between them there was no written agreement in place governing their ownership of the CC. They didn’t need one, they thought, because they were friends and had the same aspirations for the cottage – which were very low. The place wasn’t in good shape and that’s the way they liked it. In time a new owner, John, joined the syndicate and became a member of the CC. He was not part of the initial group of friends. Because no Association Agreement had ever been in place, no thought was given to getting one when John joined.

Unlike the other owners, John was not keen to see his investment deteriorate. He lobbied the owners to repaint, carpet and perform security upgrades at the cottage. Initially there was some support but it was limited to approval from a distance. The other owners had no intention of participating in the renovations or suffering the inconvenience of sourcing and overseeing contractors. After a few years of this, the cottage was looking great but by that time John’s goodwill towards his partners was exhausted. The others had never bought into John’s vision for the cottage and were happy to go along for the ride as long as John carried the responsibility.

Eventually John, in his long-suffered frustration, reached a point of breakdown. He no longer found any pleasure in the cottage and wanted out. There was no pressure on the other members to buy John out and none of them were coming forward with an offer. So, it was up to John to find a buyer if he wanted to recover his investment.

In the meantime, one of the owners had died and an Executor had not been appointed to his Deceased Estate. The deceased’s family continued using the cottage and they saw no practical need to appoint an Executor. The result was that John could not exit the CC and could not sell to an incoming buyer, as he needed to file with CIPC a CK2 form signed by all the members of the CC and the buyer. Without an Executor to sign the CK2 form for the deceased member, John was stuck and so was his investment.

We advised John to apply to Court for the liquidation of the CC. The property would have been sold and the members would have taken their pro rata share, or someone would have got an Executor appointed in order to save the syndicate. John didn’t have the appetite for that level of conflict. He ultimately walked away from the cottage with nothing to show for it and surrendered the value in his investment.

Scenario 2

A firm of accountants in KwaZulu-Natal owned their offices in the suburbs through a company – distinct from their professional partnership. They had themselves drafted their own Shareholders’ Agreement in the property-owning company, based on what they understood of such Agreements. The Agreement provided that if one of the accountants resigned from the accounting firm, then he would be deemed to have also resigned from the property-owning company, and his partners could buy him out.

In the passage of time the senior partner, Michael, decided to resign from the professional practise. The junior partners saw the value in the investment in the offices and exercised the option to buy Michael out of the property-owning company. The junior partners were facing continuing in practise without Michael. Turnover was expected to reduce as a result and so they were motivated to drive a hard bargain in the property deal.

On the other hand, Michael was not going to remain in practise. His income from the professional practise was going to dry up and the taking of a reasonable equity share in the property-owning company was critical to his financial planning.

Clearly there were conflicting interests in the property deal between the partners. This is the point at which things became complicated. The Shareholders’ Agreement made the following provisions:

  1. the partners who exercised the option to buy the resigning partner’s Shares would pay a price for the Shares pro rata to the value of the property owned by the company, less the amount of the outstanding bond over the property at the time;
  2. if the partners entered into a dispute, the dispute would be resolved by arbitration before an arbitrator who would be agreed upon between the parties.

Although at first glance, the above terms seem reasonable, they are in fact sorely lacking – as Michael was about to find out.

It is almost always the case that no relationship between people comes to an end without a measure of fall-out. Michael’s case was no exception. In addition to their differing positions in the negotiation over the sale price for Michaels’ shares in the property-owning company, the partners entered into conflict over the past management of certain funds in the professional practise. Accusations of fraud began to fly and as one would expect the relationship between the partners was destroyed and communication broke down.

Michael was under financial pressure to get his investment out of the property-owning company and the junior partners were not budging in the negotiations on price. Attorneys were engaged on both sides. The point taken by the junior partners was that the price for Michael’s shares was determined by the value of the property, but the shareholders’ agreement did not specify what type of valuation or what valuation methodology should be employed. Because the agreement did not expressly mention “fair market value”, the junior partners contended that the value to be ascribed to the property was a “forced sale value” which was far less than “fair market value”. The difference in valuations was in the region of R600, 000-00.

Michael could not accept it. He referred the dispute to arbitration in terms of the agreement. However, the agreement required the arbitrator to be someone agreed upon by the parties. That is all good and well until one finds oneself in a dispute. By that time there is no communication and no prospect of reaching agreement on anything. That’s what then proceeded to happen. Michael proposed 3 possible arbitrators to his junior partners. They rejected all 3 on various grounds and instead proposed someone they had a close relationship with. It was impossible to come to agreement on the arbitrator. Months were passing by and all the while Michael was without his equity investment, out of the practise and paying legal fees.

Eventually there was an application by Michael to the High Court to have an arbitrator appointed to the valuation dispute. That application was opposed on the basis that the parties had not yet agreed the terms on which the appointed arbitrator would value the property. Legal matters in court take many months to come before a Judge who will hear the case and make a decision. The putting up of a feeble defence which ultimately fails can therefore cause delay in finality and result in significant legal costs being incurred.

By this stage Michael was already 2 years after his resignation from the accounting firm. He had incurred legal fees of close to R250, 000-00 and was not prepared to take the matter all the way. On Michael’s instructions, a settlement was reached with the junior partners on the amount of the purchase price for Michael’s shares. Michael was eventually paid out, but because he was under pressure to settle he settled poorly and suffered a serious discounting of the value of his shares.

Solution

Part of the solution to these types of problems is having an association, shareholders’ or partnership agreement in place to cater for future events. However, that is only part of the solution. Many people have taken false comfort in such an agreement only to find that although it canvasses the general terms of the transaction it does not eliminate all possible disputes which could still arise. The key to the effectiveness of these types of agreements is to render them litigation-proof as far as imaginably possible.

The cost of drafting such an agreement is going to be about 10% of the litigation fees that one would spend on taking such a dispute to court, and as the drafting fees are divided equally between all the parties, it is even cheaper. Taking the time and going to the expense at the outset to draw up an adequate agreement should be viewed as part of the investment cost and not an avoidable grudge spend.

Finally, when choosing an attorney to draft such an agreement, look for someone who has experience both in drafting the agreements and litigating on failed agreements. Experience in both areas will result in a practically workable document which roadmaps fast-tracked solutions to potential disputes, keeping the parties out of court and saving them time, money and the associated heartache.

Courtesy: Warrick de Wet Attorneys

By Warrick de Wet

Director – Warrick de Wet Attorneys

Suite 14,

11 Sinembe Crescent,

Umhlanga

[email protected]

www.wdattorneys.co.za

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