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Conversations with business leaders and changemakers on how they built their business and what keeps them going.
Pankaj (00:03)
Ladies and gentlemen, welcome back to another episode of Letters of Intent. I'm your co host Pankaj Raval and I'm joined today by my co host, Sahil Chaudry. Sahil, how are you today?
Sahil (00:11)
I'm doing great. And today we are picking back up where we left off with this potential partner dispute.
Pankaj (00:18)
Absolutely. If you miss part one, here's everything you need to know. Two best friends, twenty years, a 50-50 company. there were ten profitable years and not one page of governing documents.
Sahil (00:29)
And the thing that surprises people in a lot of the country, co-owning an LLC with somebody creates no fiduciary duty between the two of you at all.
Pankaj (00:39)
Exactly. Yeah, which is wild because you think that, if you're partners with someone, you owe some kind of duty, when you think about relationships, you wanna have some kind of understanding, respect at least respect for the other, right? there's really no legally required duty, which is all the more importance of having good contracts, right?
Sahil (00:56)
And knowing what state you're in. you know, in if
Pankaj (00:58)
Yes, yes.
Sahil (00:59)
you're in Texas or if you're in Delaware, the duties that you owe to each other and the company are different, which I think most people miss.
Pankaj (01:06)
Absolutely. And why choice of where you form is really important, your company, governing law and contracts is really important. These things cannot be glossed over because they have real consequences. So Sahil, let's get into the Texas Supreme Court. So let's see what they said. So what they said is in March of 2025, being co members on its own buys you nothing.
Sahil (01:23)
Exactly. And so in our situation, one of them finally sits down, one of the co-members, and has the honest conversation. Says it's not working, says he wants to find a way to split it up. No demands, no threats, no lawyer in the room.
Pankaj (01:36)
And by his own account, he thinks it went well.
Sahil (01:38)
And seven days later, his partner files suit and he could not log into the company bank account.
Pankaj (01:44)
So today we're gonna get into what that lockout actually was, what the law hands you when it happens, and the three ways out of a 50-50 partnership that has stopped working.
This is Letters of Intent, the podcast for deal makers and risk takers. Let's go.
Sahil (01:58)
Pankaj, first question everybody asks, was the lockout legal?
Pankaj (02:02)
And that's the wrong first question, Sahil, funny enough. And I say that as somebody whose instinct is to ask a two.
Because legal and effective are not the same. He was locked out either way. Whether it was legal determines what he can do eventually about it, but it does not determine who has the money this week. And this is an important distinction. So a bank signature card is a contract between the company and the bank about who's allowed to move the money. That's all it is.
Sahil (02:27)
It's not an ownership record.
Pankaj (02:28)
It's not an ownership record. Ownership lives in the company's governing documents and the books. Signature authority lives in whatever the bank happens to have on file. And in this story, these two things have been drifting apart for a decade. The account was opened by one of them, the formation paperwork named one of them. Nobody ever went back and fixed it.
Sahil (02:45)
Nobody fixes it because for nine years there's nothing to fix.
Pankaj (02:48)
Right. It costs nothing and it solves nothing until one day it decides everything. And look at what it does to the negotiation. Yesterday they were two equal partners talking about how to divide a company. Today one of them can make payroll and one of them cannot.
Sahil (03:01)
That's not a legal argument, but it is a clock.
Pankaj (03:04)
That is a clock and it's running against a person without access.
Sahil (03:07)
I wanna give the
structural version of this because the bank account is the vivid example, but it is nowhere near the only one. Any single point of exclusive control is a leverage asset. The banking login, the domain registrar, the payroll platform, admin rights on the accounting system.
Pankaj (03:21)
The premises lease. The insurance policy.
Sahil (03:23)
The lease, if one owner is the only signatory on the lease, that is leverage. If one owner is the only administrator on the books, that is leverage. If the biggest customer only has one owner's cell number, that is leverage.
Pankaj (03:36)
And none of it is necessarily wrongdoing, right? None of it's like nefarious on its own, but it becomes a big problem later on.
Sahil (03:43)
Yeah, it's not wrongdoing. And in fact, naturally it happens most of the time. We see a lot of people split things up as CEO, COO, as creative director, as president. We see people at gravitate to their natural strengths and then they end up casually organizing this authority, in a way that feels natural and fair in the moment, but when there's a conflict,
it no longer works. It's the way two people naturally organize. Somebody has to be the admin when you're opening let's say an email suite with Gmail. Somebody has to open a bank account, but it can come back to bite you when there's a conflict.
Pankaj (04:21)
Absolutely. And I mean this whole question about, wrongdoing and who's wrong, who's in the right, is only ever ever about or comes to fruition on what you do with it on a bad day when things are not working out.
Sahil (04:31)
Which is precisely why you want that answer written down on a good day when you're getting along. Leverage and rights are different things. Rights get vindicated eventually and expensively. Leverage works immediately and for free.
Pankaj (04:45)
So Sahil, let's put yourself in his chair on day one. He's locked out. What is the actual first move then?
Sahil (04:51)
Information, not money. And there's a statute for it that most owners have never heard of. Every state gives an LLC member some right to inspect the books and company records. In Texas, it is Business Organizations Code Section 101.502.
Pankaj (05:06)
And what does it actually get you?
Sahil (05:08)
On a written demand stating a proper purpose, you are entitled to examine and copy records that are reasonably related and appropriate to that purpose.
Pankaj (05:15)
So he cannot get to the money, but he can get to the ledger.
Sahil (05:18)
He can get to the ledger, which in a fight like this is worth more than the money, because the ledger is what tells you what the money did. Now, here's the part almost nobody has updated. That statute was amended in 2023, Senate Bill 1514 effective September 1st of that year.
Pankaj (05:34)
Mended how?
Sahil (05:35)
In two ways, both of them cut against the member doing the asking. First, the section now opens with the words unless otherwise provided by the governing documents.
Pankaj (05:45)
Hm, interesting. Say that again.
Sahil (05:46)
So in Texas, your company agreement can narrow your own access to the company's records.
Pankaj (05:52)
Interesting. So the document you signed at formation, the one you skimmed, can restrict your ability to see the books later.
Sahil (05:58)
Yes, it can. And the second change, the amended text carves out emails, text messages, similar electronic communications and social media information unless that specific item effectuates an action by the company.
Pankaj (06:10)
Which is where most of the evidence lives in a modern small business.
Sahil (06:13)
That's exactly right. I mean, that is where most of the evidence lives. Most of the time we see people communicating via text, email in very casual ways, and that's where the movement of the business actually happens.
Pankaj (06:25)
Now let's flip to California because the contrast is stark and it matters to most of the people listening today.
Corporations Code section 17704.10. Every member has the right to inspect and copy the records the company is required to maintain on a reasonable request for a purpose reasonably related to the interest of that member.
Sahil (06:41)
Regardless of percentage?
Pankaj (06:42)
Regardless of percentage. And this is important. A 5% member has the same access as a 51% percent member. And there's fee shifting. If the court finds the refusal was without justification, it could award a member reasonable expenses of getting that order, including attorney's fees.
Sahil (06:55)
Which changes the economics of stonewall.
Pankaj (06:57)
It changes them completely. In Texas, delay is close to free. In California, delay has a price tag.
And the piece practitioners point to, which I think is important here, is the operating generally cannot take those inspection rights away in California.
Sahil (07:09)
So it is the mirror image of the Texas Amendment.
Pankaj (07:11)
It is the mirror image. Texas makes records access waveable. California treats it as close to untouchable.
If you're gonna take one action item out of this episode, make it this. Find out today whether your operating agreement narrows your right to see the company's books. And most owners have never looked. And in two states, the answer is completely different.
Sahil (07:26)
That's right. And I actually do find that California in general makes a lot of rights non waivable that in other states are waivable. So that's especially if you're in California, it's important to understand your operating agreement and what the statutory floor is.
Pankaj (07:40)
Absolutely.
Sahil (07:41)
So back to our situation here, Pankaj, three exit ramps. Walk away, work it out, or force it. In our example, our partner here tried the middle one and got sued for his trouble. So what is actually behind door three?
Pankaj (07:55)
Court ordered wind up. And it is worse than people imagined.
Texas first, Business Organizations Codes section 11.304. A district court
Can order the winding up of a termination of an LLC on an owner's application. Three tests. Any one of them does it. One, the economic purpose of the entity is likely to be unreasonably frustrated. Two, another owner has behaved in a way that makes it not reasonably practical to carry on the business with that owner. And three, it is not reasonably practicable to carry on the business in conformity with the governing documents.
Sahil (08:25)
And test
three is where a deadlock lives.
Pankaj (08:28)
And with regard to test three, you have to read those words again because it says in conformity with the governing documents.
Sahil (08:34)
And they do not have any governing documents.
Pankaj (08:36)
And they don't have any. So one honest flag on this. The section is thinly applied to LLCs. Most of the Texas Authority construing that language comes out of the partnership side. So it is a real remedy with a thin body of case law behind it. And anybody who tells you otherwise is overselling.
Sahil (08:50)
Okay, and what does he actually get if he wins?
Pankaj (08:53)
Winding up termination, the business stops, the assets are liquidated, the creditors get paid, and the two of them divide whatever's left.
Sahil (09:00)
So he wins by destroying the thing he spent ten years built.
Pankaj (09:03)
And that is what door three is. Nobody should be surprised by that, and almost everybody is.
Sahil (09:08)
California gives you more grounds and one very sharp catch. Corporations code section 17707.03,
grounds include not reasonably practicable to carry on in conformity with the articles or the operating agreement, dissolution reasonably necessary to protect the complaining members, the business has been abandoned, management is deadlocked or subject to internal dissension, or those in control have engaged in or knowingly allowed persistent and pervasive fraud, mismanagement, or abuse of authority.
Pankaj (09:38)
That is a much wider door than Texas.
Sahil (09:40)
Much wider. Deadlock is named explicitly. In Texas, you're arguing it in test three and hoping. Now, the catch. Subsection C: In any suit for judicial dissolution, the other members may avoid the dissolution by purchasing for cash the membership interest of whoever brought the suit at fair market value.
Pankaj (09:58)
So say that again.
Sahil (09:59)
So if you file to dissolve a California LLC, the other side can respond by buying you out.
Pankaj (10:05)
Interesting. So filing a lawsuit hands your partner the option to purchase your half?
Sahil (10:08)
At fair market value, determined by appraisers, if the two of you cannot agree. You brought the petition so they get the choice. Pankaj, this kind of reminds me in tennis. We used to spin a racket and you could pick heads or tails, and whoever got it got to pick server side.
So it's kinda like a game. You get to pick. You
Pankaj (10:24)
Right. Right.
Sahil (10:26)
bring the petition so they get the choice.
Pankaj (10:28)
Yeah, exactly. Yeah. Like football or like soccer, I feel like, you can pick the direction or the something,
Sahil (10:33)
Yeah, right.
Pankaj (10:34)
yeah, yeah, or get the ball first, right? So, and I want to be clear here, it's not a loophole. That is a statute working exactly as designed. The legislature preferred a going business to a liquidated one.
Sahil (10:44)
Right. But it means you had better know before you file whether you're trying to end the company or trying to get bought out, because in California, filing may answer that question for you.
Pankaj (10:52)
Right. Exactly. Exactly.
Sahil (10:54)
And one
more thing about the number. For LLCs under that section, the standard is fair market value. For corporations under section 2000 it is fair value.
Pankaj (11:03)
Interesting. Different words. A fair value typically does not apply the same discounts.
Sahil (11:08)
Typically not, which means the entity form you picked years ago can move the price of your exit today. So today we talked about three doors. Walk away, work it out, or burn it down in court. Everything we've described across two episodes is just the work of keeping door two open.
Pankaj (11:23)
So here's the verdict, Sahil. You cannot litigate your way back to partnership. The documents exist to keep you out of the room where you would try.
Sahil (11:30)
Contracts and Controls Pankaj. That is the Carbon Law Group motto. Those are the two most important pillars of an agreement between partners. And one thing that's surfaced in this episode is you need to know the forum you're in. You need to know what state you're in, because that sets the floor and the ceiling of the rights that you actually have. and your dispute will rely upon that.
Write things down while you still like each other so that you can avoid burning the whole thing down.
Pankaj (11:55)
Absolutely.
So think about this as kind of the prenup, right? These agreements that you're investing in are the prenup to a very potentially lucrative marriage of sorts, you know, of partners and building something together. And you want to make sure it's clear at the beginning how you guys are gonna work together. While, sometimes prenups are uncomfortable, not always, you know, fun to think about. They're critical, especially in the context of company
where money is a much bigger element of this than necessarily in a marriage. So think about that when you're drafting these contracts and thinking through some of the provisions that will determine your rights later on. This is part two of us discussing a 50-50 deal and the problems with that. Also failures to document things and have proper paperwork in order.
Please like, share, follow for more. We always love to hear from our listeners. And if there's ever any comments or specific topics you like us to address, please let us know. We're here to provide educational material for you. Again, this is not legal advice. This is just educational information that we're providing based on our experience and we hope it's valuable to you.
So thank you again for joining us on this episode of Letters of Intent, the podcast for deal makers and risk takers, brought to you by Carbon Law Group.