Articles Posted in Deadlock

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  • Well-drafted business governance documents include buy-sell agreements to address deadlock among the owners.

  • A shotgun buy-sell is an offer that sets only the price.  It can be accepted as either an offer to buy out the other side or to sell to the other side at the price in the offer.

  • Shotgun buy-sells are an efficient means to set the price of a transaction, but may be flawed when the owners have unequal knowledge of the business or inadequate financial resources.

    What happens when the owners of a business can’t come to an agreement on an issue that is critical to the business? This happens when neither side has a majority. For example, when there are two 50-50 owners or when unanimous agreement is required and there are holdouts. Our discussion today concerns how the owners of a small business may use contractual arrangements to address this problem.

    These contracts are known generally as buy-sell agreements, and that is that they require one party to sell and the other to buy. Now, buy-sell agreements can also include shotgun sales, which is a buy-sell agreement that’s triggered by a deadlock. And we’re going to focus today on the shotgun sale. That refers to the type of agreement that allows one party to set the price and then allows the other the party to decide whether, based on that price, they’re going to buy or sell.

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  • Limited liability company statutes often require the unanimous approval of the members before actions may be taken outside the ordinary course of business or for any amendment of the Operating Agreement.

  • The requirement for unanimous action creates a minority veto – any member can veto the actions of the majority – often leading to deadlock.

  • States that have adopted the Uniform Limited Liability Company Act, including New Jersey, Pennsylvania and Connecticiut, require unanimous actions.  Other states, including Delaware and New York, permit major actions to be taken by simple majority vote.

These days we’re seeing a  political world in which we have a national politics that is very, very closely divided, and one or two people have tremendous control over the rest of the country.  It’s not just the Congress, but over everyone. And they’re basically, even though they only have one vote, they’re able to stop things, able to derail a process. They have a minority veto. Continue reading

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  • Buy-sell agreements, like a shotgun sale triggered by a deadlock, are the principal means by which the owners of closely held businesses protect against the worst consequences of deadlock.

  • Commonly used shotgun provisions allow one party to set the price and allow the other party to decided whether to buy or sell at the offered price.  Closely related to the shotgun is an auction that allows offerors a chance to sweeten their offers to buy.

  • The compelled sale of an equity interest triggered by a buy-sell agreement will be subject to the fiduciary duty of loyalty and the implied covenant of good faith and fair dealing.

  • Courts may apply shotgun or auction techniques when compelling the sale of a business as a going concern.

A well-drafted agreement between the owners of a business will address the issue of what to do in the event they become deadlocked.  This is true of effective shareholder agreements or corporate by-laws, limited liability company operating agreements or partnership agreements.

Agreements that are intended to prevent or resolve a deadlock in most circumstances will contain language that in some circumstances will require the exit of one person from the business.  This exit, in turn, requires payment of the value of the equity interest of the departing owner.

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In this post, the last in a series on deadlock in the closely held business, we look at buy-sell agreements as a means of breaking deadlocks without litigation and, in particular, a form of buy-sell often referred to as a shotgun.  A buy-sell often avoids or greatly simplifies litigation between the deadlock owners of a business, sure.  It also has the effect of avoiding deadlock in the first instance.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Shotgun provisions are a form of weapons control, like the mutually assured destruction that has – thankfully so far, at least – kept the world powers from global conflagration.  Owners of a closely held business have an emotional as well as a financial investment in a business and triggering a process in which they may be forced to sell will be seen as a very unwelcome choice.  In many cases, shotgun language in governing documents triggers compromise among the owners of a closely held business.

Buy-Sell Agreements Triggered by Deadlock

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  • Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.

  • Anti-deadlock provisions may provide for the appointment of an independent director,  for alternative dispute resolution, or for the compelled sale of an equity interest.

  • The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

After a closely held business becomes deadlocked, it is extremely difficult to push the parties toward some mechanism that might either break the deadlock or preserve the current management system, or event let the parties separate themselves on mutually agreeable terms.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Human nature stands in the way.  The parties likely have financial and emotional positions that they are unwilling to compromise.  These may range from the ability to control some aspect of the operations of the business to the payment of dividends or bonuses.

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Lawyers and their clients try to address the potential for future deadlock with these contractual provisions that are known by a number of descriptions, such as buy-sell agreements, shotgun

provisions, put-call terms.  In the world of closely held limited liability companies, corporations and partnerships, a buy-sell agreement that is triggered by a deadlock is the pre-nuptial agreement of business divorce.

In this and the following post, we examine these contractual provisions that are used to break deadlocks.  We consider first the scope of anti-deadlock provisions, when they may be invoked and whether they are subject to judicial controls.  In a following post, we will look at buy-sell agreements in more detail and, in particular, shotgun language that is intended to keep a forced sale on terms acceptable to both parties. Continue reading

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  • Most limited liability company and partnership statutes make no mention of ‘deadlock’ as grounds to order the involuntary dissolution of a business.

  • Deadlock arises when the members or partners are no longer able to pursue the basic agreements on which the business was organized, typically an operating agreement or partnership agreement.

  • The key determination in an action to force the dissolution of a limited liability company or partnership is whether it is ‘reasonably practicable’ for the business to continue.

Courts examine deadlock involving a limited liability company or partnership through the lens of the operating agreement or partnership agreement.  The fundamental question in these cases is whether the LLC or partnership can pursue its essential purpose.  In this article, we primarily examine the elements of deadlock applied to limited liability companies.  Deadlocked partnerships are a rarity, but the analysis should be similar if not identical.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

A limited liability company or partnership is more prone to deadlock because unanimous agreement is required in most states to act on a number of issues.  The unanimity requirement is a core aspect of some of the central principles underlying unincorporated business associations (primarily partnerships and LLCs) – that the owners have unfettered discretion to pick their partners, that they cannot compelled to fundamentally change the business against their will and that they normally will participate in the day-to-day affairs of the business.Deadlock limited liability company | deadlock corporation | deadlock partnership

The Minority Veto Contributes to Deadlock

We see the “pick your partner” principle reflected in disputes over the admission of new members or partners, the unanimity requirement for amendments to an operating agreement, and in the rights of members to be free from interference in the management of the business by creditors.  It is also demonstrated in many states by the requirement that mergers and other transactions outside the ordinary course of business have the approval of all of the members. Continue reading

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  • Deadlock in a limited liability company or partnership occurs when the members can no longer pursue the purpose of the business as agreed in an operating agreement or partnership agreement.

  • A ‘minority veto’ occurs when a minority member or partner uses the unanimity requirement to block the will of majority.

  • Actions outside the ordinary course of business are likely to require unanimous consent, including the admission of a new member or partner, amendment to the operating or partnership agreement, a merger or sale of substantially all of the business’ assets.

Deadlock among the members of a limited liability company, or among the partners in a general partnership, involves the inability of the company to make decisions that are material to the continued operation of the business.  It is not an infrequent occurrence.  The direct participation of the owners in the day-to-day affairs of the LLC or partnership and the requirement that — in most circumstances — the most important decisions require a unanimous vote make it important that an LLC or partnership is able to reach consensus on the most important decisions.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Because LLCs and partnerships are unincorporated business associations, they are typically quite different in structure than a traditional corporation.  And while deadlock among the members of a limited liability company or partnership involves many of the same principles that one finds in the closely held corporation, there are significant differences as well.

New Jersey | New York | Deadlock limited liability company | deadlock corporation | deadlock partnership

In this article, we look at some of the differences between deadlock in corporations, which are generally governed by statute, and deadlock in unincorporated business associations (primarily partnerships and limited liability companies), which are governed primarily by principles of contract.  In many cases, the results are not very different, but there are some key distinctions.

In later posts, I will examine some of the circumstances in which the courts have been asked to resolve deadlock disputes through lawsuits seeking involuntary dissolution actions or the expulsion of a member or partner.

Deadlock Occurs When Contracts Fail

Unlike a corporation, which conceptually is a creature of statute, deadlock in a partnership or limited liability company usually does not involve any specific statutory provision that is intended to address the problem of deadlock.  In fact, neither the Revised Uniform Limited Liability Company Act (RULLCA) nor the Revised Uniform Partnership Act (RUPA) specifically mention deadlock.  Rather, because the limited liability company and partnership are fundamentally creatures of contract, the focus is not on the statutory criteria but the nature and scope of the express and implied agreements that exist between the owners.

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  • New York’s BCL requires at least 50 percent of shares to petition for dissolution based on deadlock, unless there has been a failure to elect directors.

  •  The fact that a shareholders agreement required the election of two deadlocked directors was not a basis to waive the statutory requirement.

  • Parties avoid claims of wrongdoing and oppressed shareholder action that could trigger mandatory sale of minority interest.

Oppressed Shareholder lawsuit attorney

Judicial Dissolution Petition Requires 50 Percent Shareholder

A minority shareholder in New York will have a difficult time pursuing a claim for dissolution because of a deadlocked board of directors or a deadlock among the shareholders.  New York law permits a cause of action for judicial dissolution based on deadlock, but only by shareholders with holdings of 50 percent or greater, unless the shareholders are unable to elect directors.

The statute can be harsh in its application, as demonstrated by a trial judge’s decision to dismiss a petition for dissolution under BCL § 1104, the provision of the New York Business Corporations Law that creates a statutory cause of action for judicial dissolution. (We discuss the issue of deadlock in more detail in our series on the topic, here and here.) Continue reading

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  • Courts use their authority to appoint a custodian to take control of a closely held corporation as a remedy to deadlocked directors or shareholders.
  • A showing of serious or irreparable harm is required before a court will intervene in a deadlock among shareholders or directors; more than dissension is required.
  • A court may direct a custodian to dissolve and liquidate a corporation, or sell the entire business as a going concern, in the best interest of the shareholders and other constituencies like employees.

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Appointing a custodian or receiver of a closely held corporation is a recognized remedy when the owners are deadlocked.  Once appointed, the custodian or receiver may be given wide authority to break the deadlock, to manage, to sell or dissolve the corporation — including cases in which the remedy seems to go beyond what is provided in the statute.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

A bitter business divorce between two former college sweethearts provided the background for the Delaware Supreme Court’s analysis of the circumstances in which it could provide a dissolution-like remedy and order the sale of a large successful business.

INTERVIEW

The decision of the Delaware Chancery Court, Shawe v. Elting, involved Transperfect Global, Inc., a corporation formed by Elizabeth Elting and Philip Shawe in 1992 while the pair lived together in a New York University dorm room.  The two became the co-CEOs, sole directors and equal owners of a company that provided a variety of translation services from locations around the globe, generating $80 million in profits in 2014. (Shaw later transferred 1 percent to his mother, but she remained firmly in his camp, which caused the deadlock to continue.) Continue reading

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  • Deadlock is more than an inability to make a decision.  It is an inability to act under circumstances that present the real threat of harm to the business.
  • Deadlock is triggered by the shareholders’ inability to elect directors.
  • When there are no alternatives to prevent harm to the business, like a buy-sell agreement, a Court is likely to find that the shareholders or directors are deadlocked.

For the closely held corporation, deadlock may be the result of a dispute among the shareholders, or among the directors in circumstances that the shareholders cannot fix by electing new directors.  Whether a court is asked to find deadlock under an applicable corporations statute or as part of a common-law remedy, deadlock is rarely found in circumstances in which there is no threat of significant or irreparable harm.

In this article, we will consider some of the circumstance in which courts have been asked to declare that a deadlock exists among the directors and/or shareholders of a corporation – often in a closely held corporation they are one and the same – and to fashion a remedy.  Most often the principal remedy in theINTERVIEW case of a “true deadlock” is the dissolution of the corporation, which entails the liquidation of the entity.  Courts rarely impose such an extreme remedy on a viable business entity, so such remedies as the sale of a minority interest, sale of the entity as a going concern or other types of injunctive relief are far more common.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Corporations statues vary in the statutory remedy for deadlock or oppression.  The Model Business Corporations Act (MBCA), on which many state corporations codes are modeled, provides for the judicial dissolution of a corporation when the shareholders are unable to elect directors or when the directors are deadlocked in the management of corporate affairs; the shareholders cannot break the deadlock; and there is either the potential for irreparable harm to the corporation, or the “business and affairs of the corporation” cannot be conducted to the advantage of the shareholders.  MCBA § 14.30. The model act also provides a court with broad powers to appoint a custodian to manage and/or wind up the affairs of the corporation.  MCBA §§ 7.48; 14.32. Continue reading

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  • Deadlock is the inability of the owners of a business to make critical decisions, a paralysis of the management of closely held corporation, limited liability company or partnership.

  • The inability to maintain normal operations is a characteristic of a deadlocked business.

  • Courts will intervene to prevent harm to a deadlocked corporation, LLC or partnership, typically when one of the owners petitions to dissolve the business.

Deadlock occurs when the owners of a closely held business, be it a close corporation, partnership or limited liability company, are unable to reach a decision on some matter involving the business. Because deadlock is typically associated with businesses in which most or all of the owners participate directly in management, they are characterized by emotions, self-interest and not always rational.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

In the simplest case, two 50/50 owners are unable to come to some decision that is critical to the business, for example whether to provide additional capital or give personal guarantees to a lender. Because the ownership is equally shared, the principals have to govern by consensus, or not at all.  This is true whether it is a corporation, limited liability company or partnership. Continue reading

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Jay R. McDaniel, Esq.
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Weiner Law Group LLP
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