Two families owned equal shares of a Minnesota business engaged in the production and sale of sand, gravel, and concrete blocks. Continuous dissension between the families became so pronounced that the two primary shareholders refused to speak except at board meetings. The rift became so severe that one of the shareholders, Fred Hedberg, built a partition by his desk to remove himself from all personal contact with the other shareholder, Charles Freidham.
Hedberg openly expressed his bitterness toward Freidham to company employees. Freidham's suggestions concerning operations were vetoed by Hedberg without consideration of the merits. Differences existed on basic questions of corporate policy and management.
Despite the deadlock, the business had prospered financially. However, due to the competitive nature of the industry, a less favorable market now prevailed. Accordingly, the Freidham family brought a lawsuit claiming that, due to the deadlock, the corporation could not be operated successfully and efficiently, and that any further attempts to carry on the business would result in depletion of its assets and irreparable damage to its shareholders.
Relying on the Minnesota corporate judicial intervention statute, the court in 1951 granted the Freidhams' request to dissolve the corporation. This statute permitted involuntary dissolution on the basis of deadlock where the differences between two equally divided factions were irreconcilable, and the dissension so incurable, that the continuance of the corporation would be unprofitable to its shareholders.
It's no secret that participants in family businesses sometimes have differences that just cannot be resolved and that paralyze the company. In many cases, such as the dispute between the Hedbergs and Freidhams, the disagreement escalates to the point where neither party is willing to accept a compromise, such as a buyout, and walk away leaving the business in the other's hands.
When the parties become deadlocked, one of them may go to court and evoke the ultimate weapon: a court-ordered dissolution of the company, requiring the liquidation of its assets and a division of the proceeds according to a formula of the court's choosing. In the end, the deadlocked shareholders, the family, and the company and its employees all lose.
The Minnesota case is illustrative of the older laws in many states which limited a court's options in providing relief to deadlocked shareholders. Today, however, more and more states are permitting courts to try less radical interventions, such as ordering a buyout, a partial liquidation, or some other remedy. Deadlocked shareholders would be wise to consider some of these options, rather than blindly seeking to destroy the other party. Better still, the aggrieved parties can try to reach their own resolution before resorting to the courts at all.
Court remedies
The typical state statute provides that a shareholder may obtain corporate dissolution if one of two conditions can be established: 1) the directors are deadlocked in the management of corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened or being suffered or the business can no longer be conducted to the advantage of the shareholders; 2) the shareholders have failed, for a period that includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired or would have expired, and the shareholders are deadlocked in voting power.
Some states are more liberal in allowing courts to grant relief to shareholders. For example, Michigan, Massachusetts, and Ohio permit judicial relief after one unsuccessful attempt to elect a successor to any director whose term has expired. Other states do not require a showing that irreparable injury will occur to the corporation. Maryland and Massachusetts permit judicial dissolution upon simply showing that the directors are deadlocked in the management of the company.
Most states also allow the appointment of a receiver to wind up and liquidate the corporation, or a custodian to manage the corporation's business and affairs. States such as Florida and Ohio allow the court to appoint a provisional director to sit on the board of directors for a specified time with full board rights and responsibilities, in hopes that the person could lead the board in breaking the impasse. Montana, New Hampshire, New Jersey, and North Carolina are among the states that permit the court to order a buyout as an alternative to dissolution, while other states do not allow this measure.
A few states allow the courts to consider lesser relief. North Dakota, South Carolina, and New Jersey permit courts to award an equitable remedy to one or more parties as a way of resolving their differences. Remedies might include a court order to change the governing documents or actions of a company in a way that provides relief to one party, such as canceling or altering a provision in the company's articles of incorporation or bylaws; prohibiting an act of the corporation or its shareholders, directors, or officers; or requiring the declaration of a dividend.
Some appeals courts have even shot down verdicts requiring dissolution. In a 1981 family business case, Henry George & Sons Inc. v. Cooper-George Inc., the state of Washington Supreme Court found that the trial court had erroneously ruled that the Cooper-George company should be dissolved. In this case, two families had created the Cooper-George company for the primary purpose of building an apartment house. The shares were evenly divided between the two families. The Cooper stock was placed in trust for Cooper's grandsons, James and Robert Marr. The George family sold out to the Pacific Securities company, which was owned by the Guthrie family. The Guthrie family then unsuccessfully tried to buy the stock owned by the Marr brothers.
The Guthrie family thereafter initiated suit to dissolve the corporation on the basis that the shareholders were deadlocked in electing new directors for two consecutive annual meetings. The company, however, was solvent, was not being mismanaged, and was not deadlocked at the director level over the transaction of business. The supreme court remanded the case back to the trial court to determine whether dissolution was in the best interest of all the shareholders. It directed the trial court to consider whether the corporation would be able to operate profitably despite the deadlock. Other factors the court could consider included the length of time the company had been in business, the stated purpose of the business, and whether one shareholder had a clear design to take over and was in a financial position to do so—to the detriment of other shareholders who might suffer adverse tax consequences. The court was also to take into consideration whether it would be best to let the shareholders find their own solution, by one party voluntarily buying out the others at fair market value.
Buyouts favored
If permitted by law, courts seem to prefer ordering a stock buyout as an alternative to the harsher remedy of dissolution. Typically, this occurs in a minority shareholder situation.
In a 1983 case, Maddox v. Norman, the Montana Supreme Court ordered the purchase of a minority shareholder's stock, rather than a liquidation of the corporation. A sister had sued her brother, who she claimed was mismanaging the family ranch and wasting corporate assets. While the court found that this could be a basis for a dissolution, it decided liquidation was too harsh a remedy. The ranch was a solvent and going business. The brother and his wife would be unjustly harmed by liquidating the assets that they had worked long and hard to build. The sister had no desire to remain in Montana and work on the ranch. The court found that ordering a stock purchase allowed the sister to obtain her rightful share of the corporation, while permitting the ranch to continue operating so the brother and his wife could enjoy the fruits of their labors.
In rare cases, a 50 percent shareholder might even be treated as a minority owner. For example, in a 1998 New Jersey Appellate Division case, Balsamides v. Perle, the appeals court approved a trial court's order for a chemical company to purchase the stock of a 50 percent owner. Interestingly, the court found that a 50 percent shareholder could qualify as a minority shareholder under certain circumstances, and in this case was entitled to relief because he had been mistreated. The appeals court noted that a buyout could be ordered when the only alternative was dissolution. The appellate ruling itself is now on appeal to the New Jersey Supreme Court.
Oppressive conduct
Many states will also allow judicial intervention in cases involving directors who have acted in a manner that is illegal, oppressive, or fraudulent.
Oppressive conduct is often hard to prove, as demonstrated by a 1992 Missouri Court of Appeals case, Struckhoff v. Echo Ridge Farm Inc. In this case, one brother who owned 50 percent of the shares of the family farming corporation sued for a dissolution on the basis of oppressive management by his brother and his brother's wife. The plaintiff's employment as a herdsman on the farm had been terminated and he brought the lawsuit several years later. He claimed that he had been excluded from corporate affairs; the company had made unauthorized loans to the brother's children; his life insurance had been terminated; and the farm had been slaughtering two cattle per year for consumption by its employees.
Ruling against the plaintiff, the Missouri appeals court stated that, in general, “oppression suggests harsh, dishonest, or wrongful conduct and a visible departure from the standards of fair dealing.” The court found that “unless extremely serious, no single act would constitute sufficient oppression to allow dissolution.” With the exception of the loans to the children, the claimed oppressive acts had been accepted business practice prior to the brother's departure. And while the loans may have been inappropriate, they did not constitute oppression.
Despite such rulings, majority shareholders must be careful about behavior that could be seen as oppressive when considering the termination of a minority shareholder. Some states provide extra protection. If oppressive conduct is found, some courts will order remedies such as a reinstatement of the minority shareholder, an award of back pay, a buyout of the shareholder's stock, or, in egregious cases, a dissolution.
Rely on yourselves
Although court action enables deadlocked shareholders to vent their anger and try to “win,” more often all the parties involved in a case lose. Resorting to litigation will obviously cause a rift in the family. Lawsuits can last for years, during which family members are barred from communicating.
Just as marital partners and their children benefit when the couple can amicably resolve their differences, deadlocked shareholders, their families, and employees benefit if the parties in dispute can work out a fair resolution instead of having to live with a judicial resolution that is forced upon them.
Proper planning is the only way to avoid resorting to judicial intervention in most cases. A deadlock situation can be prevented by carefully distributing stock so it is not divided 50-50 between two individuals or their families. Also, families with multiple owners should have a detailed shareholder agreement defining their roles in the business, with a buy/sell provision setting the stock purchase price at a fair value. Another tactic, for shareholders who have equal voting power, is to draft a separate voting agreement that gives an extra vote to one party in the event of a deadlock.
If the family relationship has broken down to the point that the family members can no longer work together, the parties should attempt to agree to a buyout. Deadlocked shareholders can pursue other equitable remedies as well. If oppressive management is the problem, a custodian can be put in place to operate the business while shareholders attempt to work out their differences. The appointment of a neutral individual to run the business provides an opportunity for both sides to focus on a resolving problems without either side “controlling” the business.
Sometimes, deadlocked shareholders are able to operate the business on a day-to-day basis but are unable to agree on the major decisions which would be determined by the board of directors. A professional director hired to sit on the board on an interim basis can be useful as a tie-breaker on necessary board votes.
Court action is sometimes the only way to resolve a shareholder deadlock. But knowing that there are more legal options than dissolution may inspire the shareholders to find a less emotional and less costly settlement. A compromise creates a chance that the family and the business can still survive.
Betsy G. Liebman is an attorney with Capehart & Scatchard in Mt. Laurel, NJ, which specializes in business, employment, and tort litigation.