Business Divorce

By Louis Lehot | November 16, 2020

Breakups hurt — both financially and emotionally — in both business and in marriage. Just as sociologists have predicted spikes in marital divorce rates, there is now also a noticeable increase in partner disagreements in healthy, thriving businesses. And insurance companies are no exception.

Since the first case of the contagious coronavirus was found in the United States on Jan. 20, 2020, the COVID-19 pandemic has had clear and significant implications for businesses, large and small, across the country. Business owners and investors in the insurance industry must now come to terms with the reality of an increase in “business divorces” in 2020 and beyond.

A business divorce is one of the most painful events any business owner can experience. From the outsider’s perspective, it is “just business,” but the business divorce often creates just as much emotional drama as a divorce between spouses. Similar to a marital dissolution, a business divorce can be full of egos, emotions, accusations and expensive legal fees. Often, when it’s all said and done in a business divorce, the divided parts equal less than the pre-divorce whole. No matter how well documented the partners’ business relationship is, a business divorce can still be nasty and expensive as parties look for loopholes in contracts, claim financial irregularities, and more.

Today, insurance companies play a pivotal role during times of economic stress by helping companies and people manage risks and cushion against losses. As one of the largest groups of investors, they are especially vulnerable to volatility in financial markets. It would be smart for insurance company owners to take a look at positions with partners, investors and investments, and make some hard decisions to protect their future. The same is true of insurance agencies.

While publicly held companies such as airlines in the news these days tend to have diversified investor and owner bases with a corporate structure to address business challenges, many insurance firms do not. Instead, many insurance firms have two to three partners and one to two primary investors. While these businesses might face a similar economic environment and business challenges resulting from COVID-19, they operate through a partnership where decision-making is not streamlined.

During the current COVID-19 pandemic, insurance companies may need to respond drastically when business is not profitable. The current coronavirus crisis and required responses can be the subject of real disagreement among insurance company owners. It may also affect how owners resolve them. Some will seek to sell shares and member interests, while others may invoke dispute resolution procedures and pursue relief under a governing state statute. We are seeing an increasing number of situations where the owners find that business divorce is their only viable option.

According to a recent report by The University of Miami Herbert Business School, with corporate divorces thorough due diligence is recommended to reduce information asymmetries. While industry and location knowledge is essential, organizational culture is a crucial factor that needs to be assessed before entering into a merger.

“Not all corporate divorces are bad, some are necessary,” wrote Desiree-Jessica Pely, a visiting scholar. “That’s mainly when you realize the industry is going down; it’s not a good fit anymore. And there are divorces because maybe it was a bad decision to get married in the first place — you didn’t do enough due diligence to investigate.”

The report showed that unforeseen “shocks” within the industry and cultural dissimilarities were primarily to blame for many breakups. “Shocks” have to do with disruptions in the industry or the economic landscape that neither company could have foreseen and that cause even a well-conceived strategy to go south. For instance, the current COVID-19 scenario is an extreme example of a shock.

Insurance companies today are facing many of the same issues, according to a Law360 expert analysis, including: demand for products may have fallen; supply shortages and delays are affecting companies resulting in scarcity and higher costs; disagreements about employees that are currently not needed and salaries that are no longer affordable; businesses unable to fulfill contracts; fixed costs that will remain due; and cash needs that may have changed significantly.

At the onset of COVID-19, there was a great deal of information published about close to impossible exit strategies like force majeure, frustration of purpose, impossibility, outs due to “material adverse change,” management deadlock, and judicial dissolution. Although these are extraordinary times, there is no certainty that these remedies will be successful in an unprecedented pandemic.

Consequently, in most cases, business relationships and the contractual agreements cannot just be set aside with equal division of assets and future potential business prospects. Therefore, it is essential that all business partners deal head-on with the operative agreements in their business relationships, with extra scrutiny.

During these extraordinary times, planning is crucial. It is best to take out the partner agreements and get ahead of the problems now.

About Louis Lehot

Lehot is the founder of L2 Counsel, P.C., a boutique law firm based in Silicon Valley. Lehot is a corporate, securities and M&A lawyer, and is formerly co-managing partner of DLA Piper’s Silicon Valley office.

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Insurance Journal West November 16, 2020
November 16, 2020
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