What is Corporate Deadlock?
The New Jersey Business Corporations Act and current New Jersey Limited Liability Company Act have slight differences in the way they define and address “corporate deadlock.”
The New Jersey Business Corporations Act contains two “deadlock” provisions. N.J.S.A. 14A:12-7. Subjection (1)(a) provides that the court may take remedial action upon proof that: “the shareholders of the corporation are so divided in voting power that, for a period which includes the time when the two consecutive annual meetings were or should have been held, they failed to elect successors to directors whose terms have or would have expired upon the election and qualification of their successors.” N.J.S.A. 14A:12-7(1)(a). Thus, deadlock may be shown if the members fail to elect the requisite number of directors per the bylaws for two consecutive annual meetings.
The second statutory deadlock provision in the New Jersey Business Corporations Act is more general. It states that a Court may order appropriate relief if a corporation’s directors “are unable to effect action on one or more substantial matters respecting the management of the corporation’s affairs.” N.J.S.A. 14A:12-7(1)(b). That section applies when the corporation is unable to act because the directors cannot agree. An example of deadlock would be if the two directors could not agree on whether or not the corporation should borrow money when the corporation was unable to meet its obligations.
Once “deadlock” is established in the case of a corporation, the Judge is free to utilize various statutory and equitable remedies at their disposal. For example, the Judge could appoint a provisional director or receiver to run the affairs of the corporation. They could also order one side to buy the other out, dissolve the company or split the assets of the company. The use of provisional directors and receivers is often an effective tool within the Court’s arsenal to insure that deadlock does not paralyze or destroy the corporation during the pendency of the litigation.
The term, “deadlock” is not used in the current New Jersey Limited Liability Act. Rather, the concept of “deadlock” is sort of addressed in N.J.S.A. 42:2B-49 (“Dissolution by Decree”). That section of the current version of the New Jersey Limited Liability Company Act allows a member or manager to seek dissolution of the LLC “whenever it is not reasonably practicable to carry on the business in conformity of the operating agreement.” Moreover, the current version of the LLC Act does not explicitly permit the Court to appoint a receiver or provisional director to run the company when deadlock is present. Notwithstanding the same, the New Jersey Supreme Court in Brenner v. Berkowitz found that the Chancery Courts are a court of equity and the Judge’s are not limited to the enumerated statutory remedies. Hence, a Chancery Judge may through the use of their inherent equitable powers appoint a receiver or provisional director to run the LLC if they find that equity necessitates the same.
Recently, I’ve written a lot about the New Jersey Revised Limited Liability Company Act. That act which will go into partial effect on March 18, 2013 and full effect on March 1, 2014, recognizes the minority oppression cause of action and for the first time statutorily allows the Chancery Court to appoint a provisional director or receiver to be appointed when the Court determines that it is warranted. Although, Chancery Court’s always had these powers within their equitable powers, some Chancery Judges were more reluctant to be proactive and go outside the statutes to formulate a remedy. The New Jersey Revised Limited Liability Company Act will give members and their counsel greater ability to convince Judges who may have been hesitant to go outside the statute when formulating a remedy. That is, because for the first time these remedies are codified.
Scott Unger is a Shareholder in Stark & Stark's Lawrenceville, New Jersey office concentrating in Shareholder & Partner Dispute Litigation. For questions, or additional information, please contact Mr. Unger.
