In Pennsylvania, Manufactured Deadlocks are Unlikely to Trigger Judicial Dissolution
In disputes among the owners of a closely held company, involuntary judicial dissolution is the nuclear option.
When a group of shareholders successfully petitions a court to dissolve and then liquidate their company because the owners reached an impasse they could not overcome, there will be no more company to speak of. While that might have been the intended outcome for the petitioning shareholders, the fire-sale price the company’s assets will probably fetch on the open market is an unpleasant accompanying pill they’ll have to swallow.
Despite the risk of a fire sale, in many shareholder disputes at least one party will threaten to seek judicial dissolution of their company. They argue that dissolution is required because of some irreconcilable difference that makes it impossible to continue operating the company.
But what would a Pennsylvania court do when the impasse claimed by the parties seeking judicial dissolution of their company isn’t a true impasse? What if the claimed deadlock is just a series of typical disagreements over business operations packaged to appear as an impasse? If a recent Delaware case is any indication, a Pennsylvania court would (and should) dismiss the petitioning parties’ case because it would not consider a manufactured or contrived deadlock to be an actual deadlock.
Pennsylvania’s judicial dissolution statutes
Pennsylvania law allows shareholders of limited liability companies and shareholders or directors of corporations to petition a court to dissolve the entity.
The commonwealth’s LLC statute allows a court to enter an order dissolving an LLC, on application by a member, if “it is not reasonably practicable to carry on the company’s activities and affairs in conformity with the certificate of organization and the operating agreement.”
The commonwealth’s Business Corporation Law, “upon application filed by a shareholder or director of a business corporation,” allows a court to:
entertain proceedings for the involuntary winding up and dissolution of the corporation when any one of the following is made to appear: (3) The directors are deadlocked in the direction of the management of the business and affairs of the corporation and the shareholders are unable to break the deadlock and that irreparable injury to the corporation is being suffered or is threatened by reason thereof.
Although Pennsylvania courts have stated that involuntary dissolution is a harsh remedy to be avoided if possible, none appear to have ruled in a case where a party had allegedly manufactured a deadlock in order to secure a judicial dissolution. But because the Delaware statute that allows for judicial dissolution of a Delaware LLC requires the same “not reasonably practicable” standard to be met as Pennsylvania’s LLC statute, a recent decision out of the Delaware Chancery Court provides some clues.
A Delaware LLC member fakes it, but never makes it
In In re Dissolution of Doehler Dry Ingredient Solutions, No. 2022-0354-LWW (Del. Ch. Sept. 15, 2022), a 25% member of a company that manufactured and marketed dried food ingredients went to court seeking to dissolve the company based on alleged actions his fellow members took against him. These actions included removing him as a manager of the LLC, limiting his ability to invoice the LLC for services he performed, hacking his email, forming a competing company using the LLC’s resources, and incurring over $25,000 in debt without the required consent.
In deciding the motion to dismiss filed by the defendants in the case, Vice Chancellor Lori W. Will, noted that the petitioner’s claims fell well short of the “arduous standard” for judicial dissolution that he had to meet: that the LLC’s management had become “so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in . . . a voting deadlock or where the defined purpose of the entity has become impossible to fulfill.”
First, Vice Chancellor Will noted the petitioner did not allege facts that inferred the LLC was deadlocked at the member or manager level. For one, the petitioner framed the $25,000 loan issue as a breach of contract issue and not a deadlock issue. Also, the petitioner claimed that because of the alleged actions taken by other members, he would decline to approve nine actions critical to the LLC for which unanimous approval was required. But Vice Chancellor Will noted that this is merely a threat of prospective deadlock and not evidence of an existing deadlock. On this point, Vice Chancellor Will added that the LLC operating agreement provided contractual remedies to overcome deadlock and a process for dissolution that the petitioner did not make use of.
Second, Vice Chancellor Will noted that the petitioner’s allegations did not show that the “defined purpose of the entity has become impossible to fulfill.” That’s because nothing in his petition inferred that the LLC could not, because of the alleged wrongdoing, invest in the dry foods business, which was its purpose as set forth in the LLC operating agreement.
In Pennsylvania, manufactured deadlocks are unlikely to unlock judicial dissolution
It does not appear that Pennsylvania courts have decided a case where there were allegations that a deadlock was manufactured in order to secure judicial dissolution. Until a Pennsylvania court decides a case regarding manufactured deadlocks, based on the Doehler decision, we can sketch out how a court might rule.
First, a Pennsylvania court would likely take a 360-degree view of the alleged deadlock to determine if it was real or manufactured. It would probably look closely at the actions of the petitioner and their fellow members and the options available to them outside of court (such as provisions in their LLC’s operating agreement regarding deadlock) when deciding whether a company’s members or its shareholders and directors are truly deadlocked.
Second, a Pennsylvania court would likely require the actions allegedly causing the deadlock and making it not reasonably practicable to carry on the company’s activities (if it’s an LLC) or that are causing it to suffer irreparable injury (if it’s a corporation) to impact the fundamental operations of a company, perhaps even causing them to grind to a halt. The actions likely need to be more than causing the company to not distribute profits or causing the company to reimburse a few thousand dollars of personal expenses. They probably need to be along the lines of causing the company to not pay its employees or vendors, not fulfill its contractual obligations with its customers/clients, or not file tax returns or pay taxes.
Finally, it will be no easy feat to persuade a judge to order that a functioning company be dissolved. As Vice Chancellor Will noted in Doehler, the party seeking judicial dissolution must meet an “arduous standard.” Seeking dissolution of an insolvent company or one that has a single asset, such as a real estate holding company, might not be too difficult if a party can make the showing required of it under the applicable statute.
But seeking dissolution of a solvent and operating company could cause people to lose their jobs and could negatively affect the company’s customers/clients, vendors, local community, and other stakeholders. For that reason, when faced with a close call, a Pennsylvania judge might still find a way to avoid ordering dissolution even where the party seeking it appears to have made the required showing under the applicable statute.
Disagreements among co-owners or directors of closely held companies are not rare. That’s what happens when people with vested interests in the operations of a company have differing views on the best path forward. Sometimes, those disagreements could cause a co-owner or director to run to the courthouse seeking judicial dissolution of their company because those disagreements allegedly caused a potentially fatal deadlock.
If that courthouse was in Pennsylvania, the party seeking dissolution would likely have an uphill battle persuading the court to dissolve the company if it appeared the party manufactured a deadlock for the purpose of securing a dissolution.