Manufactured Deadlocks? The Problematic “Bad Faith Defense” to Forced-Sales of Delaware Corporations Under Section 226 of the Delaware General Corporation Law

Boston College Law Review, Feb 2018

Title 8, Section 226 of the Delaware General Corporation Law authorizes courts to force the sale of Delaware corporations when the stockholders or directors are in a state of complete deadlock. Some courts have tentatively acknowledged that a party may successfully oppose the sale by arguing that the stockholder bringing a Section 226 action has done so in bad faith by manufacturing a deadlock in the hopes of obtaining a court-ordered sale (i.e., the “bad faith defense”). This Note explores the idea of the manufactured deadlock in Section 226 actions, through the lens of Shawe v. Elting, a recent, highly publicized case where the Delaware Chancery Court ordered the sale of a profitable company against the wishes of a 50% owner. There exist inherent problems in attempting to determine whether an ostensible deadlock between business owners is authentic or manufactured. An examination of cases grappling with deadlock in business dissolution actions, which are analogous to those brought under Section 226, highlights these issues. In light of the fundamental difficulties in determining whether a deadlock is legitimate or fabricated, courts should move towards rejecting the legitimacy of the “bad faith defense” to court-ordered sales entirely.

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Manufactured Deadlocks? The Problematic “Bad Faith Defense” to Forced-Sales of Delaware Corporations Under Section 226 of the Delaware General Corporation Law

Manufactured Deadlocks? The P roblematic “Bad Faith Defense” to Forced-Sales of Delaware Corporations Under Section 226 of the Delaware General Corporation Law Brian C. Durkin 0 0 Boston College Law School Follow this and additional works at: http://lawdigitalcommons.bc.edu/bclr Part of the Business Organizations Law Commons, Commercial Law Commons, and the State - Article 6 1 See Shawe v. Elting, 157 A.3d 152, 156 (Del. 2017);In re Shawe & Elting LLC, C.A. No. 9661-CB, C.A. No. 9686-CB, C.A. No. 9700-CB, C.A. No. 10449-CB, 2015 WL 4874733, at *3 (Del. Ch. Aug. 13, 2015),aff’d, Shawe v. Elting, 157 A.3d 152 (Del. 2017). This dispute in its entirety (including both the lower court and appellate actions) is referred to throughout the text of this Note as the “TransPerfect case.” See infra notes 2–174 and accompanying text. The Chancery Court Order of August 13,2015, will be cited as “In re Shaw” in the footnotes and the Delaware Supreme Court opinion will be cited as“Shawe v. Elting.” See infra notes 2–174 and accompanying text. vices.”2 In 2007 they incorporated TransPerfect in Delaware as part of a company-wide reorganization.3 In recent years, TransPerfect has achieved staggering profitable growth, recognizing in 2014, for example, revenues exceeding $470 million and a net income of $78.9 mill4ioDn.espite the corporation’s considerable success, Shawe and Elting’s relationship began to deteriorate in 2011, and eventually became so hostile that in May 2014, Shawe and Elting filed a total of four individual lawsuits against one anohter.5 Of the four separate actions filed, one has since gained national attention: Elting’s petition in the DelawareChancery Court seeking an appointment of a custodian under Title 8, Section 226(a)(2) of the Delaware General Corporation Law to sell the corporation as a whole.6 2 See In re Shawe, 2015 WL 4874733, at *3. Shawe and Elting were engaged in 1996 but ended their personal relationship in 1997S.ee id. According to Elting, Shawe was thoroughly upset by the breakup and would“say horrendous things” about the man that Elting subsequently married in 1999. See id. 3 See id. Along with translation services, TransPerfect offerswebsite localization and litigation support services and employs over 3500 people. See Shawe v. Elting, 157 A.3d at 156. Shawe and Elting incorporated TransPerfect as a Subchapter S corporation, which allowed for certain income tax benefits—specifically, the ability for income not to be taxed at the corporate level.See 26 U.S.C. § 1361 (2012) (defining Subchapter S corporations);In re Shawe, 2015 WL 4874733, at *3. There are 100 shares of common stock of the corporation issued and outstandingIn. re Shawe, 2015 WL 4874733, at *3. Elting owns (and has owned since the corporation’s founding) fifty shares, and Shawe has owned fort-ynine shares, with Shawes’ mother, Shirley Shawe, owning the laste-r maining share. See Shawe v. Elting, 157 A.3d at 156. For all intents and purposes, Shawe and Elting are each viewed (and treated by the Chancery Court) as 50% owners despite the fact that technically speaking, Shawe is only a 49% ownerS.ee In re Shawe, 2015 WL 4874733. at *1T.his is so because Shawe’s mother has essentially pledged to vote in tandem with Shawe on all issueIsd.. This point will become relevant in the pages that follow discussing Elti’nsgpetition filed under Title 8, Section 226 of the Delaware General Corporation LawS.ee DEL. CODE ANN. tit. 8, § 226 (2011) (authorizing the appointment of a custodian or receiver for deadlocked corporations with more than one stockholder). See generally In re Shawe, 2015 WL 4874733(assessing Elting’s petition for the appointment of a custodian.) Elting originaly filed a petition for dissolution under Title 6, Section 273, a joint venture dissolution statue that governs cou-ortrdered dissolutions of corporations with only two stockholders. See DEL. CODE ANN. tit. 8, § 273 (authorizing the dissolution of corporations with only two 50% stockholder)s; In re Shawe, 2015 WL 4874733 n.7. As noted by the Chancery Court in the TransPerfect case, Elting eventually dropped that action, recognizing that because there are technically three stockholders, Section 273 did not apply, and instead pursued the appointment of a custodian under Section 226. In re Shawe, 2015 WL 4874733 n.7. 4 See In re Shawe, 2015 WL 4874733, at *4. 5 Id. at *18. At trial, the Chancery Court inIn re Shawe examined the breakdown of Shawe and Elting’s interpersonal relationship in “painstaking detail” and the Delaware Supreme Court’s opinion reiterated a few examples of the toxic nature of their relationship: Shawe engaged in a “secret campaign to spy on Elting,”seeking to have Elting criminally prosecuted, and disparaged Elting by disseminating a memorandum to company employees and issuing a press release containing “false and misleading information.” See Shawe v. Elting, 157 A.3d at 156–57; In re Shawe, 2015 WL 4874733, at *2, *27. 6 See DEL. CODE A (...truncated)


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Brian C. Durkin. Manufactured Deadlocks? The Problematic “Bad Faith Defense” to Forced-Sales of Delaware Corporations Under Section 226 of the Delaware General Corporation Law, Boston College Law Review, 2018, Volume 59, Issue 2,