Reprinted with permission from the September 2, 2015 edition of the Delaware Business Court Insider. © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382).
Section 226 of the Delaware General Corporation Law permits the Court of Chancery to appoint a receiver or custodian for a corporation when its stockholders or directors are divided and the deadlock is injurious to the corporation. In a recent case, In re Shawe & Elting LLC, C.A. Nos. 9661, 9686, 9700 and 10449, Chancellor Andre G. Bouchard reinforced the court's authority under Section 226, even when the corporation in question is not only solvent, but quite profitable.
In a dormitory room at New York University in 1992, Philip Shawe and Elizabeth Elting founded a company to provide translation and language services to leading businesses. Although their friendship (and subsequent romantic relationship) was short-lived, the company they started, which ultimately became TransPerfect Global Inc., developed into one of the world's leading providers of translation, litigation support, and website localization services, with annual revenues approaching $500 million. Since its founding, Shawe and Elting, who each control 50 percent of the company's stock (Shawe only owns 49 percent, but his mother owns the other 1 percent) have served as co-chief executive officers of TransPerfect, and the sole members of its board of directors (a third board position was never filled). Shawe and Elting never entered into any written agreements governing the operation of the company or their relationship as stockholders, such as an operating agreement or stockholders agreement.
Despite the company's tremendous growth over the years, Shawe and Elting frequently disagreed about TransPerfect's operations. Their longtime solution was that each would assume responsibility for certain of the company's divisions, and they would share responsibility for certain divisions that impacted the company as a whole (e.g., human resources, accounting and finance), with those shared divisions' employees reporting to both of them. Although this structure seemingly worked for a number of years, the system broke down around 2011, when Shawe and Elting's personal animosity reduced the company's management structure to "complete and utter dysfunction."
The court exhaustively catalogued the disputes between Shawe and Elting, which resulted in years of "mutual hostaging," whereby Shawe or Elting would withhold approval of something that the other wanted until a mutually beneficial exchange could be worked out. This management decision-making approach became unworkable when each of them began to withhold approval on matters of import to the continued success of the company, including personnel decisions on key employees, proposed acquisitions, and stockholder distributions. The dysfunction led both Shawe and Elting to threaten at various times either to leave the company or otherwise shut it down.
Eventually, their disputes devolved into litigation, and they sued each other for breach of fiduciary duty, among other claims. Based on the board deadlock occasioned by Shawe and Elting being the company's only directors and being unable to agree on anything, Elting also petitioned the court to appoint a custodian to sell the company under 8 Del. C. Section 226.
Board Deadlock Warrants Appointing a Custodian
Bouchard determined that although TransPerfect is solvent and appears to be thriving, appointing a custodian to sell the company to resolve the stockholder and director deadlocks was in the company's best interest. He found that the requirements of Section 226(a)(1) were satisfied because Shawe and Elting had stipulated they were so divided that they could neither agree on a third director, nor elect directors to replace those whose terms had expired (namely themselves).
He further found that the requirements of Section 226(a)(2) were also satisfied, as the company was threatened with irreparable injury because the directors were so divided on matters of corporate management that actions necessary for the continued operation of the business were impossible. The chancellor examined each of the three conditions required before the court may exercise its authority under Section 226(a)(2), described in Hoban v. Dardanella Electric, C.A. No. 7615 (June 12, 1984).
First, he reiterated the existence of genuine deadlocks between Shawe and Elting on matters of critical importance to the company, including the pursuit of acquisitions, stockholder distributions, and the hiring and retention of various employees and company advisers. Second, he determined that the rift between Shawe and Elting was causing the company to suffer and be threatened with irreparable harm. Rejecting Shawe's argument that irreparable harm could not be found because the company has been highly profitable, the chancellor found profitability not dispositive, as Section 226 contemplates the appointment of a custodian for solvent corporations, and that irreparable harm includes harm to a corporation's "reputation, goodwill, customer relationships, and employee morale," which were present in this case. Third, he determined that the stockholders were unable to break the board deadlock, as Shawe and Elting occupy dual roles as the company's sole stockholders (imputing Shawe's mother's 1 percent to him) and directors. The chancellor considered and rejected less extreme alternatives as inadequate to achieve a lasting and effective solution to resolve the rift between Shawe and Elting.
Bouchard rejected Elting's prayer for equitable dissolution, finding it unwarranted because equitable dissolution is a remedy, rather than an independent cause of action, and that Elting had not pressed an underlying claim against Shawe as a basis for seeking such a remedy. Finally, the chancellor determined that Shawe's claims against Elting for breach of fiduciary duty were barred by the doctrine of unclean hands as a result of his participation in the dysfunctional "mutual hostaging," and by acquiescence to the extent that he was aware of the conduct about which he later complained and acquiesced at the time.
Court Will Protect Company's Interest
Although decided against a rather extreme factual backdrop, Shawe & Elting LLC is consistent with the Court of Chancery's historical powers and rulings. Even solvent (and indeed, quite profitable) corporations are not beyond the court's reach, and where stockholders and directors fail to establish a functioning governance structure, the court will not hesitate to intercede as necessary to protect the interests of the company and its stockholders.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.