Shareholder Disputes – Deadlock Situations
Theodore M. McGinn • August 18, 2020
When setting up a closely held business, the prudent action is to allocate the ownership 50/50 when dealing with two owners. Such an allocation generally ensures that the parties will work together to resolve any differences that they may have over the operation of the business. However, even in 50/50 situations, the parties may nevertheless still be unable to resolve any questions over the best course of conduct for the business thereby creating a deadlock. What can happen in these situations?
The Business Corporation Act of Illinois provides that the shareholders appoint the members of the board of directors of the company in their annual meeting. The board of directors then determine the officers for the company. Finally, the officers are then left to make the day-to-day decisions relating to the management of the business. Typically, the officers include the president, vice president, secretary, and treasurer. A question that is commonly presented: Can the president remove the vice president, secretary, and/or treasurer? In a shareholder dispute, cutting off the compensation that is remitted to the individuals can be a very powerful tool in negotiating an acceptable break up between the parties and provide a significant amount of leverage.
The Business Corporation Act provides that any officer may be removed by the board of directors whenever in its judgment the best interest of the corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the persons removed. Further, the Business Corporation Act provides that election or appointment of an officer shall not of itself create contract rights.
What these provisions mean is that only the board of directors can remove the officers of the company. In a 50/50 share allocation scenario during a dispute, it is unlikely that the parties will agree to the removal of one another as officers of the company. However, the second prong of the above BCA language is critical. Merely because an individual has been elected as an officer, such individual does not have any contractual rights (such as the right to receive compensation) unless expressly agreed. Furthermore, the president has the authority to make all final decisions with respect to the management of the company, including the termination of individuals as employees. In other words, although the shareholder who sits in the position of the president may not be able to remove the other as an officer of the company, such president would have the authority to terminate such individual as employee thereby putting an end to compensation, unless there is a written agreement to the contrary.
Our firm recommends that closely held businesses be governed under an executed shareholder agreement or operating agreement that addresses these management issues. Simply put, without such an agreement, even in a 50/50 share allocation situation, you still may be vulnerable to a corporate squeeze out.
If you would like more information on this topic, please contact attorney Theodore M. McGinn at 847-705-7555 or tmcginn@lavellelaw.com.
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