When a Delaware corporation is deadlocked and unable to operate as a result of dissension among its shareholders or directors, or has abandoned its business, what remedies are available to the company’s shareholders under Delaware law? Section 226 of the Delaware General Corporation Law (“DGCL”) squarely addresses this issue.  Under that statute, any shareholder of the corporation may petition the court to appoint a receiver to a deadlocked corporation.  This article will address Section 226 of the DGCL, along with the required showing for the Court to appoint a custodian or a receiver to a Delaware corporation that is deadlocked or has abandoned its business and failed to windup its assets.

Section 226(a) of the DGCL provides that the Court of Chancery may appoint a custodian, or receiver if the corporation is insolvent, when:

(1) At any meeting held for the election of directors the stockholders are so divided that they have failed to elect successors to directors whose terms have expired or would have expired upon qualification of their successors; or

(2) The business of the corporation is suffering or is threatened with irreparable injury because the directors are so divided respecting the management of the affairs of the corporation that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division; or

(3) The corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets.

8 Del. C. § 226(a).

Section 226(b) of the DGCL contemplates the potential powers that may be granted to a receiver or custodian appointed under this statute.  Under Section 226(b), a receiver “shall have all the powers and title of a receiver appointed under § 291 of this title”.  By contrast, a custodian “is to continue the business of the corporation and not to liquidate its affairs and distribute its assets, except when the Court shall otherwise order and except in cases arising under paragraph (a)(3) of this section or § 352(a)(2) of this title.”  8 Del. C. § 226(b).

Notably, the appointment of receivers of an insolvent corporation is generally made under Section 291 of the DGCL, given its broader and more permissive provisions.

Below is a brief summary of the inner-workings of Section 226 of the DGCL:

The Circumstances Under Which the Court May Appoint a Custodian or Receiver of a Corporation Under Section 226

• The shareholders are divided such that they cannot elect successors.

• The business of the corporation is suffering or threatened with irreparable injury because the directors are divided such that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division.

• The corporation has abandoned its business and failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets.

The Necessary Showing to Obtain a Custodian When There is Deadlock Among Shareholders

It must be demonstrated that the shareholders of the company are unable to elect successor directors due to deadlock.

The Necessary Showing to Obtain a Custodian When There is Deadlock Among Directors

• The corporation must be suffering or threatened with irreparable injury.

• The injury must result from the inability of the board to obtain the votes necessary to take action as a result of the division of opinion.

• The deadlock of the board must not be one that can be resolved by action of the shareholders.

Who Can Be Appointed as a Custodian or Receiver of a Corporation?

A judicial custodian is often, but not necessarily, a Delaware attorney.  He or she must be impartial and qualified, and will owe fiduciary duties to the corporation upon appointment.

The Scope of Authority Provided to the Custodian or Receiver

The scope of authority granted to the custodian will be determined by the order appointing such custodian.  These orders may be the subject of negotiation among the parties after the Court has determined that a custodian will be appointed.  If the parties cannot reach an agreement on the proposed order, then they may submit competing orders to the Court.

The authority provided to the custodian or receiver may vary based upon the circumstances of the corporation and its business.  Among other things, in the case of corporate deadlock, a custodian may be ordered to continue managing the corporate affairs for a period of time until appropriate measures are taken to resolve the deadlock.

When a receiver is appointed (in the context of an insolvent corporation), or a custodian (in the event that the corporation has abandoned its business under Section 226(a)(3)) such individual may be ordered to marshal the assets of the corporation, collect debts and claims of the corporation, prosecute and defend claims or suits involving the corporation, and take any other actions necessary to wind-up the corporation, consistent with the terms of the order appointing such custodian or receiver.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.