Here’s a problem that cost the parties to a business entity plenty of money, but could have been avoided if the inner contract was drafted to provide for a way out in the case of hopeless business deadlock. It could happen in the context of a joint venture partnership between two entities, or it could happen in the context of four owner/operators of a business entity. The agreements might provide for argument resolution techniques, but the big elephant in the room, which no one thinks about, is that despite all the inner issues, there are State statutes pursuant to which there can be court-ordered dissolution of the business.
If you’re the general counsel of a company involved in a strategic partnership, take observe. But I will describe the problem in the context of four owners of what was essentially a joint venture limited liability company. After a few years, there were some disagreements, and the 4 owner/managers found themselves divided into two factions, one faction wanted to dissolve the business (the “Dissolvers”), the other faction wanted to continue the business (the “Continuers”). There was no non-compete agreement governing the parties to the business, which was a trading firm. The inner Agreement provided that all decisions were to be made unanimously.
In some situations, the Dissolvers will be using a ploy to dissolve so that they can continue the business under a new name, and get a business divorce from the others. In many situations, there is a non-competition clause contained in the original agreement, but sometimes that clause is not artfully drafted; the parties may not compete with the entity, but what about competing against each other?
So, despite issues such as breach of contract, breach of fiduciary duty, without of good faith that encompassed the inner argument, one factor remained: there was a deadlock, and the Dissolvers made it known that under the terms of the State statute, the entity could be dissolved, without a hearing regarding the inner issues. The other issues could be litigated in a separate action. The Dissolvers filed a lawsuit in State court, asking the Court to dissolve the company due to deadlock.
Although the inner issues could be litigated in a separate civil action, that was no balm for the Continuers. Civil litigation is expensive and time-consuming, and the Continuers wanted the Court to hear their arguments in the context of the dissolution lawsuit, and hoped that the Court would in this example make a ruling not to dissolve the entity until it heard the claims made by the Continuers.
Unfortunately for the Continuers, there was no leeway for them to bootstrap their arguments into a lawsuit brought to dissolve the company pursuant to the deadlock statute. The Court had read all the submissions, and applying the letter of the law, that the company was not able to pursue its business due to the argument among the four owner/operators, it dissolved the company and ordered the dispensing of its assets in accordance with liquidation procedures.
Now, what could have been done to cure the situation? Certainly, anytime there is an already number of parties, and equal voting strength, a stalemate or deadlock can occur, especially in instances in which unanimous vote is required for company action. In many situations, the deadlock won’t affect the operation of the business, and can be worked out among the parties. However, in instances in which one set of parties is most interested in terminating the relationship, the provision calling for unanimous vote as a predicate to corporate action can be used as a sword, instead of a protect; that’s the situation described in this article.
This is why it’s basic that voting agreements within these entities must be reviewed and drafted in a way to avoid deadlock. There can be clauses calling for majority of votes for certain issues, or super majority votes for other issues, and in some instances, such as dissolution of the company, or admission of another partner, the usual course is for unanimous vote. However, if there has to be a unanimous consent voting provision, the language of the Agreement can be tailored to review the provisions of the applicable State statute regarding deadlock, and language can be inserted into the Agreement so that if unanimous action is needed, there will be provisions which remove the argument from the situations described in the applicable State deadlock statute. In the example described herein, the Dissolvers were then able to start a new competing business, since their non-compete clause extremely them from competing against the now-dissolved limited liability company. already numbers of partners can bring rough results.