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Discovering Fraud By Your Business Partner: Act Now or Forever Hold Your Peace?

When you catch your partner in a breach of trust, can you ever trust him again?  And even if you can, are you better off just moving on separately, or can the relationship ever really be repaired?

It may sound like this article is discussing a marriage, but that is what a business partnership is like in some cases.  In fact, one judge in New Jersey often refers to business separation litigation as a “corporate divorce.”

A breach of trust with your business partner can occur in many ways, from finding out that he or she has opened a competing business to discovering that he has been reimbursing himself for wildly expensive and purely personal expenses for years, always hiding the evidence from you.  In some cases, it might have been extremely difficult to know (competing business), while in other cases, perhaps you were a little lax in reviewing corporate records (expense reimbursement abuse).  But now that you know, what do you do?

To a large degree, this is a purely personal choice and will be affected by a variety of different factors, including various measurements of both the costs and benefits of each competing option.  Staying together might seem impossible, but separating the company might seem too costly and cumbersome to undertake or even to contemplate.

Here is where one of the true differences between a marriage and a business partnership comes into play.  In a marriage, if you try to work it out, you can always file for divorce later if things don’t get any better.  Most states, New Jersey included, are “no fault” divorce states where you do not need much of a reason at all to divorce.

But in a corporate divorce, a much different result could take place.  The court could apply the doctrine of waiver, or other equitable principles, to determine that you waived a perfectly viable claim when you failed to act after you discovered what your business partner had been doing.  For example, a court could determine that if you really had a problem with the expenses your partner was paying himself, you would have taken affirmative steps once you learned of it.  In one case, a fifty percent shareholder had it held against him by the court that he failed to take any steps whatsoever to amend tax returns once he discovered that improper expenses, not really business-related, had been both reimbursed and deducted from the corporation’s taxes.

The court did not mean to imply that the complaining shareholder actually knew and did not dispute the fact that he objected – in writing – when he learned of it.  However, the court found that he would have been willing to live with it if other things in the business relationship had worked out, so he can not be heard to complain that his fellow shareholder’s actions were so outrageous as to amount to shareholder oppression.

Instead of self-diagnosing, speak to an attorney experienced in shareholder disputes when faced with a significant problem with your business partner.  A good, reputable attorney will point out not only what to expect if you do want to take action, but also what might happen if you fail to act.