Deadlock. Impasse. Stalemate. There are few words more dreaded to a corporate director (except maybe “SEC investigation”). What to do when the power brokers in a company just can’t agree is a problem that plagues business planning experts and litigators alike. Spoiler alert: there are ways to dodge the bullet of corporate deadlock by way of savvy business planning. But what happens when directors are already at the point of no return?
The Massachusetts Supreme Judicial Court (SJC) answered this question recently in Koshy v. Sachdev, which dealt with a contentious fight between the two shareholder-directors of a close corporation. 81 N.E.3d 722 (Mass. 2017). One director filed a lawsuit seeking corporate dissolution pursuant to Mass. Gen. Laws ch. 156D, § 14.30. The trial court rejected the director’s claim that the parties were deadlocked, but the SJC reached the opposite conclusion: that the two shareholder-directors were in a state of “true deadlock,” and that dissolution could be an appropriate remedy.
Koshy was the first time the SJC interpreted the state’s corporate dissolution law, and the decision is a useful guide to what constitutes “true deadlock” under the statute. Pursuant to Mass. Gen. Laws ch. 156D, § 14.30, “true deadlock” requires (1) deadlock in the management of corporate affairs; (2) inability of shareholders to break the deadlock, and (3) the threat or existence of irreparable injury to the company.
Expanding on these three criteria, the SJC first noted at least four factors relevant to determining whether deadlock exists. Specifically, it highlighted: (a) “corporate paralysis” affecting the primary functions of management, like hiring, firing, and payroll, as a result of the deadlock; (b) company size, with small companies more likely to experience deadlock; (c) whether a party “engineered” a deadlock by manufacturing disputes, which should weigh against finding a deadlock; and (d) the degree and extent of distrust and hostility between directors.
The company in Koshy hit all the right (or wrong) notes: an inability to agree on basic matters like staffing; a grand total of two shareholders; no evidence that either party “engineered” the dispute, but rather that it grew out of genuine disagreement; and a record “replete with personal insults, questioning of motives, and general acrimony,” enough to satisfy any inquiry into the hostility between them.
The SJC also saw that there was no way for the shareholders to work around the deadlocked directors. The company’s governing documents had no buy-sell agreement, and the alternative dispute resolution provision required the parties to agree to an arbitrator, which the SJC felt certain would never happen. Last, the SJC found that the stalemate between directors “cast a cloud” on the future of the company and threatened irreparable injury.
Ultimately, the SJC concluded that the directors had reached a state of “true deadlock” under Mass. Gen. Laws ch. 156D, § 14.30. It also determined that dissolution of the company was a potential-but not compulsory-remedy, returning the case to the trial court to fashion an appropriate solution.
Of note, a buy-sell agreement in the company’s governing documents could have avoided this bitter court battle. In fact, the shareholders did try to buy each other out, but didn’t agree on the value of their respective shares. Worse still, their alternate dispute resolution method required them to agree on an arbitrator at a time when they couldn’t agree on anything at all.
Your business doesn’t have to go the way of Koshy. Make sure you have a plan in place if your directors reach an impasse, and dodge the bullet of true deadlock. For information on business planning best practices, buy-sell agreements or other business matters, contact Attorney Samantha M. Vasques at 401-824-5100 or email [email protected]. We welcome your comments, questions and suggestions.