George Koshy and Anupam Sachdev were friends who formed Indus Systems, Inc., in 1987. Indus provided CAD services, taking client-supplied information, such as manuals and diagrams, and turning them into digital renderings. Koshy and Sachdev each owned 50 percent of Indus’s shares and were its sole directors.
In 1999, Indus was awarded a US government contract, enabling it to bid on projects for federal agencies. Indus continued to grow and, in 2004, earned a STARS contract, which allowed government agencies to purchase services directly from Indus without going through the bidding process. By 2007, Indus was making at least \($2\) million in revenue per annum, 60 percent of which was derived from government contracts. However, the two shareholder-directors developed different visions of Indus’s future. Koshy wanted to continue focusing on government agencies while Sachdev wanted to pursue new markets. The business disagreement raised tensions between Koshy and Sachdev. Problems were further exacerbated in the fall of 2011 when Koshy wanted \($1.4\) million in retained earnings to be paid out while Sachdev did not. That November, Koshy cut himself a check for approximately half of the \($1.4\) million and suggested Sachdev do the same. Sachdev responded by initiating a lawsuit against Koshy on Indus’s behalf and stopping payment of Koshy’s salary. Sachdev went so far as to change the locks to Indus’s offices. Although the dispute was resolved and the complaint dismissed, Koshy and Sachdev’s relationship was doomed. The next salvo of litigation began in June 2012, when Koshy filed a complaint asserting Sachdev had committed a breach of his fiduciary duty to Koshy, among other things. A trial was held in October 2013, but the decision remained pending until August 2015. The judge rejected all of Koshy’s claims and Sachdev’s counterclaims, including Sachdev’s claim that the parties were deadlocked. Koshy appealed the judgment, asserting among other things, that the trial court had erred in concluding the parties were not deadlocked and therefore dissolution was not applicable.
JUSTICE LENK The first part of the test for “true deadlock” concerns whether the “directors are deadlocked in the management of the corporate affairs.” Since neither the statute nor the drafters’ comment defines the term “deadlock,” we look to its ordinary meaning. The plain meaning of “deadlock” is “a state in which progress is impossible, as in a dispute, produced by the counteraction of opposing forces.” Other courts to have considered the matter have reached a comparable understanding of the term.
Based on this common definition, we conclude that at least four factors are relevant in determining whether a deadlock exists. The first factor is whether irreconcilable differences between the directors of a corporation have resulted in “corporate paralysis.” By “corporate paralysis,” we refer to a stalemate between the directors concerning “one of the primary functions of management.” Examples of such primary functions include payroll, client services, hiring and retention of employees, and corporate strategy.
A second factor in discerning whether a deadlock exists is the size of the corporation at issue. A deadlock is more likely to occur in a small or closely held corporation, particularly one where ownership is divided on an even basis between two shareholder-directors. Moreover, in closely held corporations, the lack of a ready market for a shareholder’s stock, and the greater likelihood that a shareholder is reliant on the corporation for a salary, tends to increase the potential for deadlock and accompanying oppressive tactics.
A third relevant factor in determining whether deadlock has occurred is an indication that a party has manufactured a dispute in order to engineer a deadlock.
In such circumstances, a court should view the party’s claim with skepticism.
A fourth factor in determining whether a deadlock exists is the degree and extent of distrust and antipathy between the directors. Mutual antipathy can transform what may begin as a run of the mill disagreement into irreconcilable conflict and stalemate where hostility precludes compromise.
Given the undisputed evidence, the conclusion that the conflict between the parties constitutes a deadlock is inescapable. Applying the first factor, the acknowledged facts underscore corporate paralysis with respect to a number of key matters. The parties have profoundly different opinions regarding both Indus’s daily operations and its future. They disagree on such basic matters as staffing needs, as well as dividend and tax distributions and, even more fundamentally, hold diametrically opposed views as to long-term corporate strategies and goals. The areas of disagreement between the parties appear to far outweigh the few areas of agreement. Over the past few years, the parties appear to have agreed only on the matter of employee raises and the need to hire a new salesperson. As the Xifaras incident demonstrates, their agreement on the latter issue was superficial at best. The parties are diametrically opposed on nearly every issue of importance concerning Indus’s current operations and its future.
The second factor also argues in favor of deadlock. Since the parties each own fifty per cent of Indus, each has the ability to prevent the other from enacting any policy with which he disagrees, on any subject; their stalemate thereby effectively paralyzes Indus on all of the issues on which the two disagree. As to the third factor, we discern no indication in the judge’s findings that either party engineered the dispute in bad faith. Rather, the facts reflect a genuine disagreement between the parties concerning the most basic aspects of company policy.
Looking to the final factor, the parties do not contest the trial judge’s finding that they operate based on a relationship of mutual distrust and antipathy. The judge was well warranted in concluding that Koshy “views all of Sachdev’s actions as an attempt to freeze him out of the management of the company” and that “Sachdev questions all of Koshy’s actions.” The record is replete with personal insults, questioning of motives, and general acrimony between the parties. This mutual antipathy in a two-director corporation has prevented the parties from compromising and has inspired increasing levels of brinksmanship. Accordingly, we conclude that Koshy has met his burden to show that the parties are deadlocked within the meaning of § 14.30 (2) (i).
The second part of the test for “true deadlock” under § 14.30 (2) (i) requires that the “shareholders are unable to break the deadlock.” … In making this determination, a reviewing court must decide whether there is a mechanism by which the deadlock can be broken. In closely held corporations, two of the more common such mechanisms are buy-sell agreements and agreements providing for methods of alternative dispute resolution such as third-party mediation of disputes. A buy-sell agreement is a contract or other legal mechanism that provides for “the mandatory or optional repurchase of a stockholder’s shares by the corporation or by the other stockholders upon the occurrence of a certain event,” such as a deadlock. An agreement requiring alternative dispute resolution in instances of deadlock also may provide shareholders with a mechanism to break it. The record contains no indication that such a mechanism exists in this case.
Sachdev points to section five of the articles as a potential means by which the deadlock could be broken. That provision, however, requires the parties to agree upon an arbitrator who then will value the selling shareholder’s stock. We discern no indication in the record that the parties would agree upon such an arbitrator, particularly given their previously demonstrated inability to agree on the price for a buyout of each other’s shares. In light of this, Koshy has met his burden of establishing that the shareholders are unable to break the deadlock.
The final part of the “true deadlock” test requires that “irreparable injury to the corporation is threatened or being suffered.” Since the term “irreparable injury” is not defined in the statute, but has a long-standing meaning at common law, we assume that the Legislature intended to incorporate the common-law meaning. [A]n irreparable injury is a harm which cannot be vindicated by litigation on the merits. An irreparable injury need not be financial in nature. A corporation may suffer irreparable injury due to severe corporate dysfunction or a frustration of the company’s purpose, or by placing the company’s business in jeopardy. A court may also consider “harm to a corporation’s reputation, goodwill, customer relationships, and employee morale.” The plain meaning of the term “threatened” implicates an assessment of the substantial likelihood that irreparable harm will occur. In this respect, the term is analogous to the concept of “substantial risk” in our jurisprudence on preliminary injunctions.
In determining whether a corporation is “threatened” with irreparable injury, a court must look beyond its current, short-term status. While a presently declining revenue stream, the departure of employees, or the depletion of clients may signal a threat of irreparable injury, the present well-being of a corporation does not preclude such a threat. A deadlock that prevents corporate management from effectively addressing the vital functions of the corporation creates a threat of irreparable injury even if the company appears financially profitable. Accordingly, a court must examine the nature and impact of a deadlock to determine if the company can remain viable in the long term. If not, then the corporation is threatened with irreparable injury.
In the circumstances here, we conclude that the fundamental nature of the deadlock between the parties threatens irreparable injury to Indus, because the parties’ mutual antipathy renders them unable effectively to manage the company. Their impasse regarding nearly every major corporate decision has cast a cloud on Indus’s future. The parties cannot agree on anything of substance, and as the Xifaras situation demonstrates, the palpably corrosive acrimony between them prevents them from functioning even in areas of theoretical agreement. Meanwhile, as their dysfunctional relationship continues to deteriorate, the parties repeatedly have resorted to costly litigation, in efforts to outmaneuver each other and gain the upper hand in steering the corporation. Resort to management by litigation is neither a viable means of corporate governance nor an adequate substitute for functional management and planning. On the record before us, the trajectory of Indus plainly points south and a threat of irreparable injury has been shown. We therefore conclude that the parties’
dispute constitutes a “true deadlock” within the meaning of § 14.30 (2) (i).
The corporate dissolution statute provides that a Superior Court judge “may dissolve a corporation” if the three-part test for “true deadlock” set forth in §
14.30 (2) (i) is met. Given that the statute authorizes the “extreme” remedy of dissolution, we conclude that it also authorizes lesser remedies, such as a buyout or the sale of the company as an ongoing entity. The appropriate remedy should be decided in the first instance by the trial judge, and we remand the matter for such a determination.
CRITICAL THINKING:
If the third factor for determining if “true” deadlock was present instead said “there must be no indication that a party manufactured a dispute to engineer a deadlock,” would the evidence the court used to justify its reasoning concerning the third factor be sufficient? Explain why. What kind of evidence would a court need to determine that the third factor was indeed fulfilled?
ETHICAL DECISION MAKING:
Do you think lawmakers intended for Section 14.30 of the RMCBA concerning corporate dissolution to be usable by individuals and entities that are both shareholders and directors? Do you think there is or should be a distinction between a shareholder of a corporation and a director, who presumably holds more power?