It Takes Two to Remove a Tiebreaker
December 21, 2020
“I don’t get no respect” was a famous Rodney Dangerfield comedy routine. It also could be ascribed albeit less comedically to tiebreakers assigned the often thankless task of resolving deadlock between 50/50 owners or managers of closely held business entities. If the deadlock concerns a heated, major issue, the tiebreaker’s vote favoring one of the two factions is likely to alienate and sow mistrust or worse in the other. Or, if prior to putting a decision in the tiebreaker’s hands, faction #1 perceives that the tiebreaker has developed a bias favoring faction #2, faction #1 may seek to remove or otherwise disenfranchise the tiebreaker.
The latter scenario generally describes what happened in Franco v Avalon Freight Services LLC, C.A. No. 2020-0608-MTZ [Del Ch Dec. 8, 2020], in which the plaintiff, representing a 50% ownership faction of a Delaware LLC, sought a declaration that he had the right unilaterally to remove the mutually agreed tiebreaker director designated in the LLC agreement.
The novel issue presented to the court was whether the terms of the governing provision, which did not address removal of any directors,
- as the plaintiff agued, required the continually renewed, mutual agreement of the two factions to his appointment such that either faction could at any time withdraw its agreement and unilaterally demand removal, or
- as the defendants argued, referred only to the one-time, past event of designating and appointing the tiebreaker director without any reference to future or ongoing agreement regarding the continued service of the tiebreaker and therefore did not authorize unilateral removal.
The Tiebreaker Provision
Avalon Freight Services LLC (“Avalon”) is a maritime freight transportation services provider that primarily operates in California. It has a single member, GH Channel Holding LLC, which is owned and controlled 50/50 by one faction led by Harley Franco and the other by Greg Bombard. Franco and Bombard equally control the parent company as the two sole members of its board of directors.
Section 3.1 of Avalon’s operating agreement vests its management in a five-member board of directors: two aligned with Franco, two aligned with Bombard, and one tiebreaker director:
Subject to the provisions of the Act and any limitations in the Certificate of Formation and this Agreement as to the action required to be authorized or approved by the Member, the business and affairs of the Company shall be managed and all of its powers shall be exercised by or under the direction of the board of directors of the Company (the “Board”). The Board shall have five (5) directors. Two of the directors shall be Greg Bombard (“Bombard”) and Harley V. Franco (“Franco”). Bombard shall be entitled to designate and elect one additional Board member, who shall initially be Timothy A. Bombard. Franco shall be entitled to designate and elect one additional Board member, who shall initially be Richard J. Padden. The fifth (5th) director shall be mutually agreed upon and appointed by Bombard and Franco, who shall initially be Doug Houghton. Any vacancy in a Board seat may be filled only by the vote or action of the director entitled to designate and elect such seat. [Emphasis added.]
Franco brought suit in Delaware Chancery Court against Avalon and the tiebreaker, Houghton. Neither in his complaint nor in the motion papers that followed did he identify the underlying dispute with Bombard, or refer to any specific matter to be voted upon by the directors, or allege any specific reason or disqualifying conduct by Houghton warranting his removal. The most Franco cryptically offered is that he no longer consents to Houghton’s continued service as tiebreaker “for reasons unrelated to this action.” His complaint essentially alleged:
- Franco no longer agrees to Houghton serving as the tiebreaker.
- Bombard continues to consent to Houghton serving as the tiebreaker director.
- Houghton made several unsuccessful attempts to remove Houghton voluntarily.
- Franco and Bombard are deadlocked.
- Franco is entitled to a declaration under Section 3.1 of the LLC agreement that he has the right to remove Houghton from the board and that a new tiebreaker director must be mutually agreed upon and appointed by Bombard and Franco.
The parties’ arguments are ably set forth in their summary judgment briefs which you can read here (Franco’s) and here (Houghton’s). For the sake of simplicity, and on the assumption that Bombard was the real party in interest behind Houghton’s position, I’ve relabeled Houghton’s argument as Bombard’s argument.
Franco’s Argument: Franco contended that under the “plain meaning” of Section 3.1, “once Franco and Bombard no longer ‘mutually agree’ on the 5th Director (in this case, Houghton), he must be removed and replaced with a new 5th Director ‘mutually agreed upon and appointed’ by Franco and Bombard.” As a matter of textual interpretation, Franco argued that the use of the conjunctive “and” in the phrase “mutually agreed upon and appointed” revealed the parties’ intent to require ongoing agreement to the tiebreaker director, otherwise the words “agreed upon and” would be rendered meaningless. He further explained that the tiebreaker provision, designed “to prevent one side or the other . . . unilaterally controlling the company to the detriment of the other,” inherently requires “that the 5th Director be mutually agreed upon, not just at the time of appointment but throughout the duration of his or her service” and that both parties thereby “are protected knowing that, in the event the 5th Director does become unduly aligned with the other side, the 5th Director can be removed by withdrawing consent for his or her continued service.”
Bombard’s Argument: Bombard argued that Section 3.1 does not permit unilateral removal of the tiebreaker and that no vacancy in that position occurred that would trigger the need for Bombard and Franco to mutually agree upon a replacement. Bombard contended that Franco’s construction of Section 3.1 “ignores important temporal signals” establishing that “the mutual agreement as to the fifth director is an event that occurs just one time, and is not an ongoing or forward-looking event.” Had the parties “intended the opportunity to re-evaluate their mutual agreement,” he added, they “could have easily drafted a provision requiring periodic assessment’s of the fifth director’s mutual acceptability.” Bombard also argued that “as a practical matter, Franco’s position means the fifth director could only break a tie once before being deposed, because one cannot remain simultaneously beholden to two split factions and fulfill a tie-breaker role.”
The Court’s Ruling
The matter was decided by Vice Chancellor Morgan T. Zurn who, in her order handed down earlier this month, denied Franco’s summary judgment motion and dismissed the case based on her conclusion that “Section 3.1 does not empower Franco or Bombard to unilaterally remove Houghton from the Avalon Board.”
VC Zurn agreed with Bombard’s construction of Section 3.1 and the phrase “mutually agreed upon and appointed,” writing:
Section 3.1 addresses appointing members of the Avalon Board, not removing them. Its plain language provides for appointment at two junctures: (1) the appointment of the initial board, and (2) appointment if a vacancy arises. Section 3.1’s plain language compels Franco and Bombard to agree only upon Houghton’s initial appointment or upon his replacement if his seat is vacated. Both “agreed” and “appointed” are in the past tense, indicating that Houghton’s appointment, and the factions’ agreement to that appointment, are one-time events. This interpretation does not render “agreed” or “appointed” redundant, as Franco argues. Section 3.1’s “agreed upon and appointed” language is consistent with and parallel to its language permitting each faction “to designate and elect one additional Board member”: the first verb identifies the director, and the second verb places him on the board. And any redundancy in “agreed upon and appointed” is preferable to reading in meaning the drafters did not intend.
VC Zurn also addressed the practical difficulty implied by Franco’s interpretation of Section 3.1 as to maintaining the “balance of power between Franco and Bombard,” explaining that Franco’s position
creates the reciprocal problem, as it would force Houghton to bend to the will of the side threatening to remove him. Reading in an unlimited and unilateral removal power would cause the exact problem Franco fears: a fifth director who is beholden to one side. Preventing one side from unilaterally removing Houghton does not undermine his independence, but rather, protects it. . . . Unilateral removal of the tiebreaker would undermine that director’s neutrality and disincentivize cooperation. If one party could remove the tiebreaker at any time and without restriction, any particular tiebreaker would not stay in office for long, and substantive disagreements would swell into the removal of the tiebreaker and selection of a new one, without resolution of the underlying dispute. Rather than subjecting themselves to endless control battles, potentially leading to dissolution, Franco and Bombard instead mutually decided to select Houghton to settle their disputes. Section 3.1 compels adherence to that choice unless and until Houghton’s seat is vacant.
The Takeaway: In my experience the sparsely-worded tiebreaker provision in the Avalon LLC agreement is unusual in its plenary appointment of Houghton as a fifth director, seemingly requiring him to participate in all board decisions and not just on the occasion of deadlock between the two Franco-appointed directors and the two Bombard-appointed directors. I saw nothing in the briefs or in the court’s decision that sheds any light on whether Houghton routinely participated in board meetings and, if so, whether there were any 3-2 decisions in which Houghton cast a deciding vote that caused Franco’s disaffection. The briefs and decision also don’t reveal if Houghton worked for Avalon or had a business and/or social relationship with the Bombard faction that might have contributed to Franco’s effort to oust him from the board in anticipation of a contentious board decision.
The use of a tiebreaker to resolve deadlock over an important business decision inherently can give rise to hard feelings and disgruntlement on the part of the defeated faction. There’s no one, perfect tiebreaker provision but, in my view, it should include the following elements:
- Name an independent tiebreaker whose judgment is respected by both sides and who only participates in board decisions when deadlock occurs.
- Name a successor tiebreaker and detail a process for designating an unnamed successor in the event the original or named successor dies, resigns, or is otherwise incapable of continuing to serve.
- Require a formal declaration of deadlock on major decisions to trigger the tiebreaker mechanism.
- Following such declaration, mandate that the co-equal factions hold one or more meetings over a specified time period in an effort to resolve the deadlock before bringing in the tiebreaker.
- Bring in the tiebreaker only should the preceding step fail.