Solve The Family (Corporate) Feud Through A Provisional Director

Wednesday, May 26, 2004

Prof. Susanna Kim, http://

Abstracted from: The Provisional Director Remedy For Corporate Deadlock: A Proposed Model Statute

By: Prof. Susanna Kim Chapman University School of Law
Washington & Lee Law Review - Vol. 60, No. 1, Pgs. 111-181

Overview:
Provides a detailed examination of the provisional director remedy. Analyzes the practical and public policy aspects, and suggests preferred structures for state corporate-law statutes.
Feuds, showdowns, and deadlocks. Bitter feuds between the shareholders or directors of a small company can lead to insurmountable corporate deadlock. Shareholders may be so divided that they cannot elect a board of directors, or the board may be unable to take effective management action. Supermajority voting requirements and veto rights given to minority shareholders to prevent oppression can exacerbate the impasse. Close corporations are particularly vulnerable; with a small number of shareholders and no easy market for shares, exit is all the more difficult. Since 95% of all American businesses are family enterprises, the potential for emotional conflict, sibling rivalry, and intergenerational battles is high. In the most severe cases, Prof. Susanna Kim writes, irreconcilable differences may require that the business be dissolved.

Less drastic remedies.
Dissolution is not the only remedy available to a court faced with a deadlocked corporation. Using its equitable powers, the court can order the corporation or even a shareholder to buy out another shareholder. It could partition the corporation’s assets, but less drastic measures are available, such as appointing a temporary guardian or receiver to manage the company while the owners cool down. This, points out the author, is not a problem-free alternative, since it may negatively impact the company’s relationships with its suppliers, creditors, and customers. The court can appoint an arbitrator to decide the matter on which the parties are deadlocked or name a third party to mediate the dispute. In a hybrid form, a mediating third party attempts to help the parties decide the controversy themselves, but if they cannot do so, the third party will take on the role of arbitrator and render a decision.

Add a provisional director to the mix.
Another remedy available to courts is the appointment of a provisional director: a neutral third party who sits on the board and acts as the tie breaker. The mere presence of a third party at board meetings sometimes causes directors to be on their best behavior, the author notes. The provisional director serves as an in-house mediator, facilitating discussion among the parties at board and shareholder meetings, and also as an arbitrator, having the power to render decisions by casting the tie-breaking vote. Over 20 states specifically empower courts to appoint provisional directors, including Delaware, California, and Ohio. The laws differ on when a provisional director may be appointed and who has standing to request one, as well as the duties and term. Several states broadly equip the provisional director with all the rights, powers, and duties as a duly elected director. Others limit the power to the term and conditions prescribed by the court.

Not a clear scope of responsibility.
Corporate laws on provisional directors leave many questions unanswered. One example cited by the author are statutes that explicitly limit the scope of a provisional director’s duties to those set by the court but do not state whether the director can engage in policymaking beyond the issues that are the subject of the deadlock. It is also not clear whether the provisional director owes a fiduciary duty to the corporation and its shareholders. Imposing such a duty would protect against the provisional director’s self-dealing or usurpation of a corporate opportunity; on the other hand, it might discourage individuals from serving, particularly since they might not enjoy judicial immunity. Some states allow plaintiffs to petition only in defined circumstances. California and Alaska, for example, provide that a deadlock exists when there is division among an even number of directors or the shareholders are so at odds that they cannot elect a board comprising an uneven number. In the author’s opinion, these statutes are too narrowly drawn, because other circumstances could lead to paralysis of corporate decisionmaking. Other states allow appointment when the directors are deadlocked and the corporation is suffering irreparable injury as a result. Some do not require irreparable injury, merely that the business affairs of the corporation can no longer be conducted advantageously.

Abstracted from Washington and Lee Law Review, published by Washington and Lee University School of Law, Lexington, VA 24450.

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