50/50 Ownership Relationships can be Trouble, Plan Ahead
Case Study: Trans Perfect Global, Inc.
Philip Shawe v. Elizabeth Elting, Delaware Supreme Court, February 13, 2017
TransPerfect is a successful global translation business founded by two college friends, Philip Shawe and Elizabeth Elting, and owned 50/50, although Shawe gave one percent to his mother. Aside from being business partners, the two founders were initially engaged. The engagement was called off, and the relationship soured and remained hostile. Despite the breakdown of the personal relationship, the business grew to be one of the largest in its industry.
According to The Court of Chancery opinion, the dysfunctional personal relationship resulted in deadlock in the election of directors and the directors remained deadlock in decisions. The opinion recites, in detail, actions business and personal actions taken by Shawe and Elting and the negative impact on the business.
Elting filed for dissolution of the corporation under 8 Del. C. Section 226. The parties stipulated that deadlock existed. After a trial and public dispute, Chancery found irreparable injury to the business, its reputation, goodwill, customer relations and employee morale. In fact, a publicity campaign was conducted by the employees regarding the dispute and the Chancery decision.
The Chancery’s Options
Chancery was faced with several options: Do nothing. Appoint a provisional third director. Appoint a custodian.
Finding that injury was occurring to the business, and that a provisional third director was likely to result in continued involvement by the court, a custodian was appointed. Rather than have the custodian conduct the business, the order directed the custodian to sell the business in a modified auction process allowing for either Shawe or Elting to bid, as well as others. The custodian was tasked with picking the winning bid.
Shawe objected and appealed. On appeal, a four arguments were advanced (either timely raised or not): the appointment was not authorized by the statutory language; the forced sale of a profitable company was not supported by the statutory language; the sale was an extreme and lesser remedies should have been considered, and, eventually, that the forced sale of the one percent held by Shawe’s mother was an unconstitutional taking.
The Delaware Supreme Court (4-1) evaluated the statutory interpretation arguments and found that the authority to order a custodian and the remedy of a sale was within the equitable authority of the Chancery. The Court found that the sale remedy was within the Chancery’s discretion to deal sensibly with the dissolution based on deadlock and the detailed findings of impact of the dispute on the business.
The constitutional argument was first raised on appeal and, as a consequence, not considered. Counsel for Shawe has said that further appeal to the federal courts was being considered.
- 50/50 splits are challenging when personal or business interests diverge. If neither party is willing to sell their interest in the business to one side or to third parties, or the price is not acceptable, deadlock can result.
- Ownership disputes can have a negative impact on the operations of the business, profit, customer and supplier confidence, and employee morale.
- Where the immediate impact on the business is not serious or irreparable, the deadlock could result in years of stalemate before it rises to the level that a court would order a sale of the assets and dissolve the corporation. In the meantime, the performance of the business may be suboptimal with very high levels of stress on the owners.
- Where dissolution by a court is considered, it is not unusual for one side or the other to make the argument that the “death of the business” is extreme and would cause a loss of jobs, value, etc.
- Dissolution of the ownership structure through the appointment of a custodian may, in fact, preserve a profitable business, although it would not be owned by the original parties going forward. As with the TransPerfect matter, a custodian could conduct a sale that allows the parties or others to bid, and preserve the going concern value.
- An alternative solution is to have the parties enter an order containing the terms of a purchase agreement, the appointment of a neutral, the provision of proof of financing, and a process to determine the price. The price being a function of one side making an offer and the other side either selling at that offer price or countering at a pre-determined higher amount, with the requirement to close. Game theory aside, this approach has been successful in resolving disputes, especially where neither party wanted to sell but understood that an agreement was better than on ongoing dispute and the court deciding for them.
- The advice that “50/50 relationships can be troublesome” should lead counsel and advisors to consider methods of resolving disputes in advance.
Ultimately, the Chancery court ordered a sanction against Shawe in the amount of $7.1 million. Aside from the conduct that the court found, the amount is interesting. It was based largely on attorney fees of Elting in the motion for sanctions, and there was a reference to the fact that this was a fraction of the fees incurred by her. For anyone who thinks that attorney fees for establishing a business and developing dispute resolution mechanisms in advance are too expensive, consider the total fees in this case.