Delaware Chancery Court Appoints a Custodian to Sell Deadlocked Company

In the last edition of the GT M&A Report, we explored some of the potential exit solutions for joint venture partners trapped in a soured business relationship. As we discussed, 50/50 joint ventures are particularly prone to deadlocks. However, management disputes can thwart any business at any time in its development. The case of In re: Shawe & Elting LLC1 (Shawe) demonstrates that even an established and highly profitable company can be derailed by conflicts among management and owners. The case also helps to demonstrate that the best time to deal with deadlocks and conflicts is before they arise, by having agreed upon dispute resolution and exit strategies in place from the outset.

In Shawe, the Delaware Chancery Court appointed a custodian to sell Transperfect Global, Inc. (Transperfect), a profitable Delaware corporation. The Court relied on Section 226 of the Delaware General Corporation Law (DGCL), which authorizes the appointment of a custodian for a corporation when the stockholders are so divided that they are unable to elect new directors, or the directors are so divided that the business of the corporation is suffering or is threatened with irreparable injury, and the stockholders are unable to terminate the division.

Transperfect began in 1992, in a New York University dormitory room shared by business school students Elizabeth Elting and Philip Shawe.2  Elting and Shawe were briefly engaged, but ended their relationship in 1997.3  Despite their failed romance, Shawe and Elting managed to run the Transperfect business as equal directors and co-CEO’s for 23 years, and to grow it into a global provider of translation, website localization, and litigation support services, with 92 offices and 3,500 employees.4  In 2014, the company had annual revenues of approximately $471 million, net income of $79.8 million, and no debt.5  However, after years of personal, professional and legal conflicts between Shawe and Elting, the management of the company had, according to the Court, devolved into a state of complete dysfunction.6

In June 2015, at the end of oral arguments in the case, Chancellor Bouchard urged the parties to settle their dispute, warning them that the Court’s opinion was not “going to be pretty.”7  Unfortunately, there was no settlement and the Chancellor was true to his word. His opinion, delivered in August, includes a 60 page summary of the facts of the case, which delves, in painful detail, into the bitter relationship between Shawe and Elting. It describes a culture of “mutual hostaging,” with Shawe and Elting withholding approval on the other’s projects until a concession could be exacted on a different matter.8  Even the pair’s personal disputes are discussed in the opinion, with the Court highlighting a “bizarre” incident when Shawe crawled under Elting’s hotel room bed and refused to leave while they were on a business trip in Buenos Aires,9  and recounting a confrontation in Elting’s office that resulted in a “Domestic Incident Report” against Elting over a scuffle to physically remove Shawe’s foot from her office doorway.10

The facts, as conveyed by the Court, leave no doubt that Shawe and Elting were trapped in a bitter deadlock. The parties had several discussions at various points regarding a buy-out of Elting’s interests, but failed to agree upon terms. This case seemed to present an ideal situation for a petition for dissolution under Section 273 of the DGCL, which provides for judicial dissolution of a 50/50 joint venture if the joint venture partners are unable to agree upon the desirability of discontinuing the joint venture and disposing of its assets. The Court noted, however, that while in substance the case involved the type of 50/50 deadlock that Section 273 was meant to address, technically Section 273 did not apply because Shawe’s mother held a nominal 1 percent interest the company.11

The Court instead turned to Section 226(a) of the DGCL, finding that the requirements of Section 226(a)(1) had been satisfied because the parties stipulated that they were so divided they failed to fill a vacancy on the company’s board, and also failed to elect successors to directors whose terms had expired.12

In addition, the Court found that conditions for appointing a custodian were also satisfied under Section 226(a)(2). This section requires a showing that the directors are so divided regarding the management of the affairs of the corporation that the required vote for action by the board cannot be obtained, and the stockholders are unable to terminate this division. The Court cited deadlocks between Shawe and Elting on several matters of critical importance to the company.13  However, the existence of deadlocks alone is not sufficient under Section 226(a)(2); the business of the corporation must either be suffering or threatened with irreparable injury because of the deadlocks. The Court found this to be a closer question because the business had been highly profitable, but noted that its profitability was not dispositive.14  The Court found that the company’s irretrievably dysfunctional governance structure threatened the company with irreparable injury.15  The third and final condition established in Section 226(a)(2) is whether the stockholders are unable to terminate the division between the directors, which the Court found “plainly exists” in this case.16

Shawe and Elting did not have a stockholders’ agreement or any type of written voting or management agreement. In addition, their efforts to negotiate a buy-out agreement, after their business relationship had already deteriorated, drove them into further conflict. The dispute in Shawe shows the limitations of DGCL Section 273, which is not available to corporations with more than two stockholders, even if the board and stockholders are equally divided in deadlock. Although Section 226 of the DGCL provided an alternative avenue for a judicial resolution of the impasse in Shawe, the Court made clear it was a very unusual remedy that places the fate of the company in the hands of the Court, rather than the owners of the company. All of this could have been avoided if the parties had in place a stockholders’ agreement, or similar agreement, with dispute resolution mechanisms and sale provisions, or other exit strategies before conflicts arose.

 

 1 In re Shawe & Elting LLC, Del. Ch., C.A. Nos. 9661, 9686, 9700 and 10449, Bouchard, C. (Del. Ch. Aug. 13, 2015)(Mem. Op.). up
 2 Id., at 4. up
 3 Id., at 5. up
 4 Id., at 2. up
 5 Id., at 7. up
 6 Id., at 1. up
 7 Matt Chiappardi, TransPerfect Co-CEOs Warned To Make Peace Or Else, Law 360. up
 8 In re Shawe & Elting LLC, Del. Ch., C.A. Nos. 9661, 9686, 9700 and 10449, at 94. up
 9 Id., at n.2. up
 10 Id., at 54. up
 11 Id., at n. 312. up
 12 Id., at 67. up
 13 Id., at 68. up
 14 Id., at 73. up
 15 Id., at 77. up
 16 Id., at 78. up