How can friends and business associates end up in such a bad place?
The idea was simple. The model was not a new one. These friends and associates each brought a particular know-how to the table for this business venture to succeed.
Neither probably realized the handling
of their business violated the Indiana Securities Act.
The friendly investment
The company owner offered a 49-percent stock share in a new business venture to a key employee. After discussion of some details, the project moved forward, leases were signed, equipment purchased, and cash investments were advanced for their new business venture.
A question that had not been resolved was whether the employee-investor would be compensated for management time. After startup, an additional question arose about whether a non-compete agreement would be required of the employee-investor-an issue not previously agreed upon.
Having a disagreement or a misunderstanding may not necessarily be a big deal. But the boss was the promoter, and handled the contracts and corporate arrangements. The boss invited his employee to invest. The employee-investor relied upon “no surprises” and everything being resolved. When the boss took his money and said “trust me, let’s get it started,” the investor thought it looked fine.
Because the management compensation and non-compete issues were deferred on the “trust me” principal, they ultimately degenerated into disagreements, bad feelings, business closure and expensive litigation. The lesson here is that even friends and trusted acquaintances must recognize the need for at least a complete and concise term sheet, if not a formal agreement, before moving forward.
At minimum, a term sheet listing the essential agreed terms, without all the legal jargon and the formalities of a full written contract, may have avoided this unfortunate result. The simple term sheet would have listed all agreed points and clarified whether all conditions were agreed or not.
We will agree here that the boss intended no harm. The boss even thought he was doing the right thing. Unfortunately, the boss was sloppy in not taking care that the terms discussed were followed precisely in the actions taken.
Sloppy, in this instance, equates to negligence. The boss took his friend’s money and flipped the switch before making sure the essential terms were clearly agreed, and that the corporate arrangements were clearly resolved.
These partners trusted that they would work things out. The boss trusted and assumed the employee-investor would knuckle under, and the employee trusted and assumed the boss would see things
fairly through the employee’s eyes. Yet another example of the failure to recognize and respect the conflict in perspective and the need to be businesslike about a business deal-even one among friends and trusted business associates.
Needless to say the friendship is over. The cost is not just friendship and money, but also extensive time, distraction and emotional turmoil.
The unintended fraud
Sadder still, this former friendship and business deal ran afoul of one of the most
neglected sections of the Indiana Securities Act.
The antifraud provisions of the state securities laws are liberally construed, and include a negligence standard for liability. Although the boss may not have intended to mislead the employeeinvestor, this negligence standard could result in the ultimate headache-liability for all money invested, and for 100 percent of the investor’s legal fees in recouping his investment.
In summary, the prudent business investor will take precautions to be certain
that important terms are made clear and that conditions qualifying the performance of others are firmly resolved-with no wiggle room. Had the boss done so, the deal would not have advanced without complete agreement.
The boss’ informality and lack of follow-through, if negligent, could well result in a violation of the antifraud section of the Indiana Securities Act.
Wright is a partner with the Indianapolis law firm of Kroger Gardis & Regas LLP. Views expressed here are the writer’s.