The Business Divorce Law Report
- 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.
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The inability to maintain normal operations is a characteristic of a deadlocked business.
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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.
There are, however, many nuances to deadlock and the concept will rarely apply to the mere inability to operate by consensus or disagreement on the daily issues that affect a business. In most jurisdictions, deadlock means at a minimum the inability to operate by ordinary majority rule. Deadlock is more than disagreement. It is corporate paralysis that threatens the business.
Deadlock is the Inability to Maintain Normal Operations
Here is an example of what is usually not deadlock: two of three members of a limited liability company cannot abide the presence of the third. The members are able to meet or agree on anything. If the minority member refuses to approve an action that requires unanimous approval of the members, is the corporation deadlocked? If the members simply exercise majority control to operate without the participation of the minority member, is that deadlock? The answer is probably not.
In this series of articles, we will examine decisions in which deadlock was the principal issue. We will consider when a court will find a deadlock and what the remedies are that might be imposed. Most of these decisions are rendered in case in which one of the parties seeks to dissolve the business because of the deadlock. The third decision involves an attempt by the majority to expel a minority member whose approval was required for a corporate action. In each of these cases, we come back to the same principle: deadlock is not the same as disagreement. Moreover, the dictionary definition of deadlock — ceasing operations, settling accounts with creditors and paying the balance to the shareholders or members, is rarely the remedy afforded by the court.
Judicial Dissolution Lawsuits and Deadlock
Deadlock is often, but now always, litigated through a proceeding to dissolve the business enterprise. This is because statutory and common-law doctrines classify the remedies that an aggrieved party may secure — whether it is a sale of the business or the compelled sale of an individual interest — in the context of a dissolution proceeding. In one case under Delaware law, however, the remedy of a sale of the enterprise was given under the Court’s general equitable powers to appoint a custodian to break a deadlock. (Read Shareholder Deadlock Grounds to Sell Corporation.)
While the specific criteria articulated by courts in different jurisdictions vary somewhat in their form, we see the same elements repeated.
- There is some fundamental inability to act based on the inability to get consensus or a binding majority.
- There is serious threat to the business, usually rising to the level of irreparable harm.
- There is no workaround or other solution available.
Dissolution is considered the ultimate remedy, and Courts generally are able to provide lesser remedies such as the compelled purchase or sale of equity, or to impose structural changes. Even in cases in which there is deadlock, it is rare that the Court will order the remedy of a true dissolution of a profitable business, which involves ceasing operations as an ongoing business, payment of creditors and distribution of any remaining assets.
If there is value to preserve, the court is far, far more likely to order a sale, either to one of the existing owners or the entity, or to sell the business as a going concern and spilt the proceeds among the equity owners. (See Court Appoints Receiver to Protect Partnership Assets.) The likelihood that a Court will order an existing business that is operating at a reasonable profit to shut its doors and liquidate is in most circumstances unlikely.
While certain concepts pertain to cases of deadlock, the definitions and remedies may vary between corporations and unincorporated business. We will examine some leading cases on corporations and limited liability companies, but will note that there are several critical elements that one finds uniformly among court decisions: that the business cannot make essential decisions about the business; that this inability to reach a majority outcome cannot be remedies, and that the business is threatened by the deadlock.
Our next article considers some of the elements that courts consider when they are asked to declare that a deadlock exists among the owners of a closely held corporation.