CASE STUDY: When Family and Business Don’t Mix

Family members often become “involuntary” co-owners of real estate and/or a business by inheriting a fractional interest in an asset co-owned by other family members.

Proper planning and related documentation should be completed by the first generation of (voluntary) co-owners, ideally at the time an asset is purchased. Otherwise, this co-ownership can become very problematic – even if such problems don’t arise until the death of a first generation co-owner.

This article features an interesting case on point that I’m handling now. I’ll summarize the background, illustrate the core legal issues and outline a lesser known legal remedy.

Basic facts (names changed): My clients are siblings, John, Jane and Judy, whose mother, Carol, died 17 years ago. For decades, Carol owned fifty percent (50%) of a commercial building with her brother, Sam. The family operated a retail business at the property, of which Sam long ago became 90% owner and Carol 10% owner.

It’s unknown what amounts Carol received from Sam for her 10% of the business and for rent that should have been paid by the business to Carol and Sam, as equal owners of the property.

When Carol died, my clients inherited her 50% of the property and her 10% of the business. My clients’ Uncle Sam continued to run the business and it seemed to be pretty successful. But Sam never provided any significant information to his nephew and nieces. He simply sent them each a small monthly check, without identifying whether these distributions were for rent and/or for business profits.

My clients are of modest means and could certainly have used more funds from their inheritance. But they loved their Uncle Sam and trusted he was being fair. As the years went by, the value of the property increased substantially and presumably so did the business profits. Yet, while purchasing a large home for himself and buying a nice home for his daughter, Sam did not increase distributions to my clients. My clients began to suspect they were not being treated equitably.

In recent years, my clients made numerous requests for a business accounting and other relevant information, but Sam gave excuses and failed to honor these requests. My clients became frustrated and finally asked Sam if he would buy their 50% of the property. Sam said he was unwilling to do so, and my clients felt as though they had no options.

John was referred to me, and after doing some due diligence for John and his sisters, I informed them that: a) they were not at the mercy of Sam to continue to be co-owners of the property; b) Sam could be compelled to produce an accounting for the business and the property; and c) Sam had breached the fiduciary duty he owed to my clients as co-owners of both the property and the business, unjustly enriching himself as to his 90% interest in the business at the expense of my clients who were receiving far less than market value rent for their 50% interest in the property.

I informed my clients that they could file a lawsuit, in which they could seek a Partition of the property. In a Partition action, if one (or more) co-owner of a property is not getting along with another co-owner or one wants to sell and the other does not, the judge will, except in rare circumstances, order the sale of the property. In addition, my clients had a right to demand an accounting and had various claims for damages.

I wrote a demand letter to Sam, giving him an opportunity to buy out my clients and settle as to damages sustained by my clients. Sam’s lawyer responded, acknowledging that my client would ultimately be able to force the sale of the property in the Partition action, but rejected my clients’ valuation of the property and denied liability for damages. So, I filed suit for my clients.

The parties have engaged in early settlement discussions and reaching a pre-trial settlement is likely. Unfortunately, however, the lack of any written agreements between the parties – either between Sam and Carol of the first generation or between Sam and my clients of the second generation – helped enable a conflict to spin out of control and ruin a previously close family relationship.

This article is intended to provide information of a general nature, and should not be relied upon as legal, tax, financial and/or business advice. Readers should obtain and rely upon specific advice only from their own qualified professional advisors. This communication is not intended or written to be used, for the purpose of: i) avoiding penalties under the Internal Revenue Code; or ii) promoting, marketing, or recommending to another party any matters addressed herein.

Mr. Silverman is an attorney with R. Silverman Law Group, 1855 Olympic Blvd., Suite 125, Walnut Creek, CA 94596; (925) 705-4474; rsilverman@rsilvermanlaw.com.

BUSINESS LEGAL SERVICES: Looking for a business formation and transaction attorney in Walnut Creek CA? Contact Robert Silverman at 925-705-4474 for legal advice on prospective business purchase, business entity formation and general business counsel, including vendor contracts, customer contracts, independent contractor agreements, employee matters, acquiring another business, offering to sell and selling or gifting fractional interests in the business (e.g. fractional LLC membership interests or corporate shares), insurance matters, establishing business retirement plans, disputes or potential disputes with customers, vendors, employees, or selling the entire business.