Tuesday, April 05, 2005

Tough to Breakup

In Renbaum v. Custom Holdings, Inc., the Court of Appeals made it clear shareholders must jump a high bar if they seek to force a judicial dissolution of a corporation on the grounds that the directors are deadlocked. In the Court's view, not any deadlock will do. The deadlock must be over an issue or issues that prevent the corporation from "perform[ing] its corporate powers."

In Renbaum, the corporation was a holding company, the sole business of which was to invest in publicly traded securities. The corporate stock was owned by two brothers and their wives. A serious dispute arose over the company's relationship with an attorney who simultaneously acted as the general counsel to the corporation and as the personal attorney for one of the brothers. Part of the dispute centered on the legal bills submitted to the corporation by the attorney. In addition to their inability to agree on who should serve as general counsel, the brothers also argued over whether and in what amount dividends should be paid. However, this dispute was resolved prior to the entry of a final judgment. Thus, by the time that the case was presented to the appellate courts, the only dispute extant between the parties was the general counsel issue. Curiously, however, the parties were in harmony concerning the management of the company's investment portfolio, agreeing to delegate that task to a specific third party investment manager.

Holding that, in order to justify a judicially ordered dissolution, there must be a deadlock concerning a "transcendant corporate function" which, if not broken, made "the object of corporate existence unobtainable." In order to make this determination the Court found that
[u]seful factors [that should be considered] . . . include: (a) whether the corporate function(s) have ceased; (b) the power in dispute is expressed as a discretionary or mandatory power in the corporation’s Articles of Incorporation, by-laws, or other corporate governing documents; (c) the role of that power in achieving the corporation’s primary function(s); and, (d) whether the corporation has exercised, as a matter of practice, that power routinely in its operations.
This case is significant because typical "canned" corporate forms (i.e., articles of incorporation, bylaws, etc.) often default to provisions that allow bare majorities of the shareholders to elect the majority of the members of the board of directors and allow a majority of directors to control the board. Absent fraud or some other basis upon which to demand a judicial dissolution, the minority shareholders can be frozen out. Thus, the ability of minority shareholders to pull the nuclear option of judicial dissolution is a power that the minority shareholders must bargain for at the inception of their relationship with the corporation.

It should be noted that the corporation in Renbaum is a general corporation, not a Maryland statutory close corporation. In the case of a close corporation, §4-602(a) of the Md. Corps. & Ass'ns Art. provides that a judicially ordered dissolution is available on the basis that "there is such internal dissension among the stockholders of the corporation that the business and affairs of the corporation can no longer be conducted to the advantage of the stockholders generally." That standard does not come into play outside of the context of a statutory close corporation. In the case of an LLC, it appears that the stricter standard applicable to general corporations applies, since LLCs can only be judicially dissolved if "it is not reasonably practicable to carry on the business [of the LLC] in conformity with the articles of organization or the operating agreement." See Md. Corps. & Ass'ns Art. §4A-903.

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