Shareholder deadlock can threaten closely held corporations

On Behalf of | Jan 31, 2020 | shareholder disputes |

The shareholders of a business share an interest in the direction of the company and its success. But sometimes shareholders struggle to make unified decisions, leading to a deadlock.

Deadlock situations happen most frequently in closely held companies whenever there is a split decision where the shareholders involved have equal amounts of shares on either side. A deadlock can render an organization powerless, unable to make decisions or take decisive action, and leave the corporation vulnerable to internal and external threats. A deadlock can also have a devastating effect on the working relationship between the shareholders. Action is needed to break the deadlock and allow the corporation to start working again. If out of court negotiations to resolve the deadlock fail, shareholders can bring forth a suit to seek relief.

Disputes, deadlocks and grounds for legal action

Given the somewhat changeable nature of business operations and decision making, shareholder disputes are not uncommon. A dispute and a resulting deadlock can stem from a gap in expectations between the business direction and what was conveyed to the shareholders, and disagreements related to board member appointments, salaries and dividends.

To have grounds for legal action when there is a shareholder dispute, you must be able to prove that one of the following is happening:

  • The directors are deadlocked, causing actual or threatened irreparable injury to the corporation such as preventing it from functioning
  • Shareholders of equal yet opposing positions are deadlocked and have failed to appoint a new board of directors after their terms have expired for two annual meetings, threatening the ongoing success of the business
  • Those in control of the corporation have acted, will act or are acting fraudulently, oppressively or illegally against the shareholder bringing forth the suit
  • The current leadership is misapplying or wasting the corporation’s assets and threatening the future of the organization
  • In certain instances, shareholders may have dissenters’ rights they can exercise to oppose a sale, merger or reorganization

If you have grounds for a shareholder deadlock suit, the court can take measures to end the deadlock. Court-ordered relief options could include:

  • Canceling or altering a provision in the corporation’s bylaws or articles of incorporation
  • Removing or appointing a board member or company officer
  • Ordering an accounting to examine further whatever issue caused the dispute
  • Appointing a custodian or a provisional director to manage the organization under the court’s direction until the matter related to the deadlock is resolved
  • Awarding financial damages for the aggrieved parties
  • Requiring the corporation to purchase the petitioning shareholder’s shares for their fair value
  • In extreme cases, the court can even order that the company be dissolved

Advance planning can avoid a deadlock

Deadlock situations happen frequently and can be detrimental to the day-to-day management and ongoing success of a business. Often the parties involved fail to seek legal advice until well after things have already soured. Ensure a timely resolution should a dispute arise by incorporating deadlock provisions into your shareholder agreement or bylaws during the formation process.