Is an intractable deadlock among the shareholders good grounds to force the sale of a large, successful corporation? That was the issue before the Delaware Supreme Court in a case in which the trial court’s decision to sell the business as a going concern – over the objection of one shareholder –was affirmed by the Supreme Court.
In this case, a trial court’s ability to fashion and equitable remedy based on the circumstances of the case ran into direct conflict with the limited remedies that are available to minority shareholders under Delaware law.
Court Orders Sale of Corporation in Shareholder Deadlock
The decision in Shaw v. Elting is without controversy, with one of the justices writing a lengthy dissent arguing that the Court was overstepping its authority and the combatants hiring their own PR firms to spin their positions. Nor was it without its stars, including argument from celebrity Harvard Law Professor Alan Dershowitz and the appearance of various corporate litigation powerhouses to argue for the parties. The result, meanwhile, has resulted in an effort by some to preclude a court from forcing the sale of a solvent business.
The case pitted Philip Shawe and his mother Shirley Shawe against Shawe’s former fiancé and business partner, Liz Elting. Shaw and Elting started the global translation and communications business in a dorm room at a time when they were engaged. They built the business into a wildly successful enterprise, but later became the subject of a juicy, public corporate divorce, full of extraordinary intrigue. Experts testified at trial that the company could fetch $800 million or more at auction. Shaw had offered Elting $300 million for her interest, which she declined.
When mediation failed and the parties continued to be unable to reach any agreement, Chancery Judge Andre Bouchard appointed a custodian to take control of the business, sell it at auction and distribute the assets to the shareholders. Judge Bouchard also sanctioned Shawe for litigation behavior two months later imposing a multi-million fee award to Elting.
Remedy in Shareholder Deadlock Case
The fundamental issue was whether the court could, in a case in which there was no dispute about the nature of the deadlock, order the sale of a solvent company. (Delaware law does not give judges the authority to order one side of a dispute to sell to the other.) The Supreme Court affirmed the trial court’s decision, holding that the trial court did indeed have such a power as a last resort.
[I]n circumstances such as this, when intermediate measures were attempted but failed, the Court of Chancery properly exercised its discretion to sell the company and distribute the proceeds to deadlocked stockholders.
Transperfect is actually a holding company for dozens of subsidiaries. Its bylaws provided for three directors, but the third spot had never been filled. Shaw and his mother owned 50 percent of the shares; Elting owned the other 50 percent.
The Court affirmed the trial court’s finding that a deadlock existed and that the shareholders had been unable to fill the vacant board seat. It also affirmed the trial court’s finding that the deadlock presented the risk of irreparable harm to the company.
Appointment of Custodian in Oppressed Shareholder Cases
The issue, therefore, was whether the Court had exceeded its authority under Delaware G.C.L. § 226(a), which provides that “[t]he Court of Chancery, upon application of any stockholder, may appoint 1 or more persons to be custodians, and, if the corporation is insolvent, to be receivers, of and for any corporation .”
Custodians, the Supreme Court noted, appointed for solvent corporations and receivers for insolvent corporations. Receivers are intended to marshall the assets of the business and oversee its liquidation. Custodians, normally, are intended to protect the ongoing business from harm.
The appointment of the custodian was not a major source of dispute. While Shawe objected to the appointment of the custodian because the company was not in danger of “imminent corporate paralysis,” the appellate court noted that the inability to elect a director was sufficient and, in any event,
Far from trivializing the irreparable injury requirement, the Court of Chancery accepted the fact that the Company was profitable, but also recognized the extremely dysfunctional relationship between the founders and its effect on all of the Company’s operations. If allowed to persist, the Company was likely to continue on the path of plummeting employee morale, key employee departures, customer uncertainty, damage to the Company’s public reputation and goodwill, and a fundamental inability to grow the Company through acquisitions.
Shawe argued that even if the appointment of the custodian was appropriate, the court erred in ordering him to sell the business. The Supreme Court affirmed the trial court’s interpretation of the statute as permitting such a remedy. The custodian has all of the powers of a receiver, the court noted, but
the authority of the custodian is to continue the business of the corporation, and not to liquidate its affairs and distribute its assets, except when the Court shall otherwise order …
The Supreme Court seized on the language “except when the Court shall otherwise order” to find that the trial court may order the custodian to sell a solvent business. This language, the majority held, was clear and unambiguous.
Rather than read the key language “except when the Court shall otherwise order” as having no significance, we read it consistently with the overall design of the statute, and its intention to allow our Court of Chancery the discretion to deal sensibly with corporations that are unable to move forward with governance because their owners cannot take fundamental action to elect a new board.
Similarly, the Court declined to adopt the argument that the court may have the power to sell assets, but not to compel the auction of the owners’ stock to a third party.
It is also not convincing to characterize the method chosen by the Chancellor as somehow different for purposes of § 226 because it involves a sale of the corporation’s stock, rather than its underlying assets. Stockholders of Delaware corporations are only entitled to the rights that come with their stock, and those rights are subject to the Court of Chancery’s power under statutes like § 226. Many Delaware statutes, including those dealing with certain mergers, subject stockholders to giving up their shares over their objection.
When a stockholder buys stock in a Delaware corporation, it knows that our statute provides the Court of Chancery broad authority to address corporate deadlocks of various kinds, authority that may well affect fundamental ownership interests. Stockholders buy stock in Delaware corporations to gain from the underlying operations of the corporation. It is therefore inconsistent with the practical and efficient design of corporate law in the DGCL, to require asset sales and liquidations, simply to allow stockholders to hold their paper shares and receive a final, and likely lower, liquidating dividend. Nor is it the case that sales of corporate assets or of the entire corporation are somehow unusual when the corporation in managerial deadlock is profitable.
Sale of Stock is Last Resort in Shareholder Dispute
Finally, the majority noted that the sale of the stock was approved only after other remedies had been pursued or eliminated. The appointment of a custodian to mediate had failed. The appointment of the custodian to serve as a third director would required to serve as a constant tie-breaker and monitor without any end. The solution of a sale protected the interests of the business, its shareholders and its employees, the majority held.
The dissent of Justice Valihura, however, focused on the distinction between selling assets in liquidation as a result of judicial dissolution and the sale of stock without shareholder consent. When Delaware law authorizes the court to compel an owner to sell stock, the dissenting justice noted, it does so specifically.
The sale in this case was overly intrusive, the dissent argued, because it forced shareholders to sell personal property without advance notice in the statute. The dissent argued that in every circumstance in which the shareholders may be forced to sell, shareholders have advance warning because the statute provides the specific remedy of a forced sale.
The opinions of the Delaware Supreme Court are persuasive to other states, and it is not uncommon that the liquidation of a corporation will provide the shareholders with much less value than the sale of the entity as a going concern. I would not be surprised to see this opinion cited in other jurisdictions for the proposition that a court’s powers are not limited to the sale of assets.
Oppressed shareholder actions arise under the general remedy of a minority shareholder being able to force a dissolution of the corporation. The rationale behind such a remedy was that it provided the means for the shareholder to secure the value of their investment. Over time courts have developed other remedies that avoid dissolution. The question now is how much the sale of the corporation as a going concern will become an accepted remedy.
New York’s Business Corporations Law, for example, permits the majority in an oppressed shareholder action under BCL 1104-a to purchase the aggrieved minority’s shares at fair value. That election under BCL 1118 can be made within 30 days of the petition.
Similarly, New York courts that have found good cause for a judicially ordered dissolution may order the sale of a party’s shares as a remedy, and it isn’t much of a leap to order the sale of the enterprise when the circumstances exist as an equitable remedy.
New Jersey law permits the court to order the sale of a party’s shares either to the corporation or to any other party. We are aware of one decision in which the Court authorized the sale of the entity as a going concern after the parties did not agree to a sale between themselves. (article here.)
Surprisingly, there is not a lot of guidance on the issue of whether the sale of an entity in its entirety is an appropriate remedy.