This article, written by attorney Charles Waters, was as originally published by New England Biz Law Update and can be found here.
For years, courts in all jurisdictions across the United States wrestled with what constitutes a “deadlock” for a privately-held company, but without attempting to fashion an overall framework for evaluating claims of deadlock. That changed with the Massachusetts Supreme Judicial Court’s decision in Koshy v. Sachdev, 477 Mass. 759 (2017). However, since then, courts have resisted expanding the concepts set forth in Koshy, and have applied the SJC’s framework strictly.
By way of brief background, in Koshy, the SJC ruled in favor of an equal owner and director of a Massachusetts software company by interpreting for the first time the Massachusetts Corporate Dissolution Statute (a/k/a the “Deadlock Statute”)(G.L. c. 156D § 14.30). It found that a “true deadlock” existed in the company’s operation and management that required court intervention. The Court then ruled that “dissolution” is not the only remedy available, and decided that “lesser remedies” are implied by the statute, such as a court-ordered sale of the company to one of the owners or a third party.
The Court established a four-factor test for determining whether a deadlock exists (as required by the first prong of the statutory criteria for a “true deadlock”).
- Have irreconcilable differences between directors resulted in corporate paralysis – that is, a stalemate in a primary management function of the business?
- Is this a privately-owned business with evenly-divided ownership and without a ready market for ownership interests – thus, susceptible to deadlock and oppressive tactics associated with deadlock?
- Is there evidence that one party has manufactured a dispute in order to engineer a deadlock and, thus, force dissolution or ownership change?
- What is the degree and extent of antipathy and distrust between the deadlocked parties – do they preclude compromise to break the deadlock?
In Koshy, it was clear that a deadlock existed in the corporation – owned in equal percentages by its two founders. They were unable to agree on any major decision, from strategy to hiring, exhibited intense mutual antipathy and distrust over a period of years, and had a history of accusatory lawsuits against each other.
To determine whether the deadlock was irreconcilable, as required by the second prong of the statutory criteria for a “true deadlock,” the Court looked for the existence of a mechanism for breaking the deadlock, such as a Shareholder Agreement or Operating Agreement with a buy-sell or other dispute resolution provision. The Court determined there was none, and that the valuation provision contained in the company’s Articles of Incorporation was not applicable for resolving deadlocks.
The Court then considered whether the irreconcilable deadlock caused or threatened irreparable harm to the corporation (the third and final statutory criteria). In doing so, the SJC ruled that “irreparable harm” is not limited to financial harm, and that a deadlock can present a threat of irreparable harm to a company that is presently profitable and performing well. It found that the inability to manage the corporation effectively (and resort by the shareholders/directors to “management by litigation”) demonstrated a clear threat of irreparable harm to the corporation in the long term, and the existence of a “true deadlock.”
Having found the existence of a “true deadlock” as a matter of law, the Court considered the remedy. It reviewed the statutory remedy contained in G.L. c. 156D § 14.30, which provides that if a court finds the existence of a true deadlock it may dissolve the corporation. Here, faced with a profitable business, the lower court had found this remedy “draconian” and was expressly loathe to apply such a remedy to an ongoing concern. Again establishing new law, the SJC held that the statutory remedy of involuntary dissolution necessarily includes “lesser remedies” that permit the continuation of an ongoing concern, such as sale to a third party or buy-out of one party’s interests. Therefore, it remanded the case to the lower court to consider the appropriate remedy.
Since Koshy, courts have been hesitant to expand the application of the Koshy framework. For example, in 2022, the Massachusetts Appeals Court declined to use Koshy to decide whether a true deadlock existed regarding an internal dispute within an incorporated public charity under G. L. c. 180. Chapter 180. Spilhaus v. Austin Found., Inc., 100 Mass. App. Ct. 1125 (2022)(“[w]e reject the plaintiffs’ attempt to apply this statute by analogy to a public charity incorporated under G. L. c. 180. Chapter 180.”).
Other courts have strictly applied the Koshy framework. In Scudder v. Scudder et al.; Hyannis Harbor Tours, Inc. v. Scudder (Lawyers Weekly No. 12-005-22)(Barnstable Superior Court)(Feb. 10, 2022), the court found a deadlock, but not a “true deadlock.” Specifically, it determined the first two prongs of Koshy were met, but not the third. The trial court found that the deadlock was not a “true deadlock” because it had not “caused irreparable injury” and had no adverse impact on the company’s “reputation, goodwill, customer relations, and employee morale.”
In looking forward, while the SJC successfully created a mechanism in Koshy for the resolution of deadlock disputes in many private companies, the practical application of these factors by courts since show that findings of a “true deadlock” will be rare, and require exceptional circumstances.