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Pros & Cons of Alternative Dispute Resolution in Shareholder Dispute Litigation

As many of you have read here before, the New Jersey Limited Liability Company Act now includes recovery for minority member oppression. Those remedies cannot be waived, as a matter of law. However, the parties to an LLC’s operating agreement (or a corporation’s shareholder agreement) can agree to an alternate dispute resolution (“ADR”) mechanism in advance, impacting the forum in which these issues will be decided.

Many people are familiar with the most common form of ADR – arbitration. However, even this familiar procedure has different permutations. Many clauses say that disputes will be resolved in arbitration, but if you specify that the rules of a certain organization will apply (such as the Arbitration Association of America), you may get more than you bargained for. Many people do not realize that a clause that says nothing more than “arbitration under the AAA” may mean a panel of three arbitrators, not one. So, while a New Jersey court provides plenty of judges – for free (well, at least paid for by the taxpayers) – an arbitration election could require that you pay a proportionate share of three paid arbitrators.

People often use another remedy to resolve disputes and break deadlocks in closely-held businesses, namely agreeing to appoint a trusted third party who will make such decisions. However, I have yet to see such a provision actually work. If you do not agree in advance on who the person should be that makes such decisions, it usually means that you could not identify such a person when you drafted the agreement. What makes you think things will be different now? Can you really find someone qualified to make decisions in your industry that does not already work in it? (If he already works in it, it could mean that you just appointed a competitor to resolve all disputes over how your business should operate.) What happens when you and your business partner cannot agree on the identity of such a third party? Will a fourth party help you pick such a third party?

These issues may apply to any litigation, but business disputes in closely held businesses are particularly ripe for being decided by way of ADR. Shareholder dispute litigation is vastly different than a fight with a vendor over payment terms. If the business partners are fighting over the very manner in which the company should be run, delays and a lack of a clear company direction could be fatal, as more than one business has died before a shareholder dispute trial could be scheduled. At the outset of a business relationship, the business partners should sit down with an attorney well-versed in ways to avoid business dispute litigation, and discuss ways to streamline the process that make sense in the event a serious dispute becomes wholly unavoidable.