Ambiguous agreement prior to establishment of the enterprise: potential risks and disputes

After the 2014 Law on Enterprises came into effect, the regulations related to the establishment and operation of enterprises are increasingly more open, enabling enterprises to develop freely. Hundreds of thousands of enterprises have been established; however, the truly developed and successful enterprises are not many. Most enterprises were founded by two or more founders with good initial business ideas. However, in the process of putting such ideas into practice, internal conflicts have arisen partly because such founders have not obviously agreed on the rights and obligations of the founding members/shareholders prior to the establishment of the enterprises.

Such issue has arisen in many enterprises because the founders cannot predict the risks which may arise when it comes to the operation of the company. Recently, at DIMAC Law Firm, we have solved a typical internal corporate dispute arising from the fact that the members failed to explicitly agree prior to the establishment of the company and dealt with the arising matter when not grasping the prevailing law, which made the internal disputes to last and caused damage to the company.

Specifically, five (05) friends, who had the same business idea, planned to set up ABC limited liability company[1] with two or more members (the "Company") to carry out the agreed business. These members simply agreed that each person would contribute 20% of the charter capital. However, after the enterprise was established, only one (01) person fully contributed his committed capital while other four (04) people did not contribute capital and practically did not participate in running the business. Then, due to not grasping the provisions of the law, the member who fully contributed his committed capital determined to implement the business idea and himself contributed 100% of the charter capital. Instead of proceeding to change the number of members and convert the Company into a single-member limited liability company, the Company just informed the Business Registration Office that the Company had fully contributed the charter capital and still maintained the structure of five (05) members.

After 5 years of operation, the company had grown up with monthly profit equivalent to the initial charter capital. At this time, the old friends realized that they were still the members of the Company and returned to ask for contributing 80% of the charter capital as agreed in order that they may be distributed the current profits of the Company. Due to disagreement, the internal dispute had arisen in the company so that its development has been severely limited since the start of the dispute. Instead of focusing on business development, the members have plunged into a legal battle to win back their interests.

When we assisted the Company to resolve the dispute among the members, we found that the fully contributing member and the Company had made a mistake on several issues on the establishment of the Company, specifically as below:

  • The members did not clearly agree on the time limit for capital contribution and the legal consequences for the members who do not fully contribute their committed capital;
  • The members did not specifically agree on their position and role in the Company as well as their rights and responsibilities in running the Company;
  • When four members failed to contribute their committed capital, instead of notifying the Business Registration Office of the matter, the fully contributing member contributed the charter capital on their behalf; and
  • The Company did not conduct the procedurer for changing the number of its members, based on the actual situation of the charter capital contribution.

After studying the case, the solution to this dispute that we proposed would be (i) the parties have to meet each other and hold negotiation for settlement of the dispute; or (ii) the parties would take the dispute to a competent court.

Because the parties failed to reach agreement on a solution and wanted to get more than their present interests, they had to refer the dispute to the competent court. Although the person who contributed the capital and made effort to build the company regained the control of the whole company, he had to spend a lot of time, effort and money in solving this dispute, besides, their previous close friendship were also gone. Morever, due to the impact from the lawsuit, the Company had missed many good business opportunities to develop.

From this case, we find that from the beginning, the members should (i) obviously agree on the capital contribution and the legal consequences of not fully contributing the capital; (ii) obviously agree on the position, roles, powers and responsibilities of each member in the management of the Company; (iii) agree on the way to deal with the case where a member supports other members to contribute capital because the other members do not have available money to contribute; and (iv) be honest and compliant with the provisions of the law. If the above had been complied with, the Company would not have caused any disputes as well as obstructed the development of the Company.

Therefore, for those who wish to start a business, (a) in addition to the current regulations, it is necessary to reach a clear agreement among the founding members on all matters relating to the establishment of the company, including the amount of capital, method and time limit of capital contribution, management, structure of enterprises and the way to deal with the delay in capital contribution; and (b) they must adhere to the regulations in order to avoid potential legal risks in the future. If these two things are strictly observed, the internal disputes will be significantly limited. If the members are not acquainted with preparing a clear, reasonable and legitimate agreement, they can be assisted and consulted by a professional law firm.

We hope our experience as shared above will be useful to anyone who wishes to start a business and to newly established businesses that have not had a clear agreement in that they may avoid the "trap" of an internal dispute from arising between the members in the future.

 


[1] The company’s name mentioned here has been changed, only for illustrative purpose and without any intention to refer to, indicate or include in connection with any company that have the same name.