Deadlock arises where the split of the shareholdings creates a situation of conflict in which cannot be resolved because no one has control of the company. Unless this is addressed quickly, it can be financially damaging for everyone involved.
How does deadlock arise?
In the smaller company it will most often arise in circumstances involving two equal shareholders each owning 50 of the shares who are both also directors and employees of the business. However, it can arise in any situation in which the shareholding is split 50/50 so that no individual or group has a majority shareholding. For example, where half the shares are owned by husband and wife (or other members) of one family and the other half are owned by the husband and wife (or other members) of a different family. Similarly in the corporate world it can arise in joint venture agreements where two organisations may create a new company in which each owns 50% of the shares and through which a joint enterprise is pursued.
What problems arise?
The consequences of a failure to resolve the dispute can be catastrophic. From the point at which the parties disagree, any action taken by any director on behalf of the company, which has not been approved by the other(s) will not have been authorised by the company or by the Board and will therefore be taken at the personal financial risk of the director in question.
Other practical issues may arise. For example, in situations in which there are joint signatories on the bank account or in which the business is run from home or from premises from which one or other party can be excluded. Furthermore there may be a concern as to whether the company should continue to trade at all e.g. in a situation in which one party considers that it may be trading insolvently (which could lead to personal liability on the part of the directors, if it continues to trade).
Unless the parties can resolve their differences quickly, they may find that difficulties will arise with their bank and with their customers. In turn these can create cash flow problems. Unless some interim working solution can be found it may be difficult for the company to continue to trade without one or other party injecting working capital. Unless the position can be resolved quickly or an interim working arrangement established in the meantime, both parties may end up losing the business that they have jointly created.
How can deadlock be resolved?
Once the shareholders fall out or disagree about the strategic direction of the company, how can the situation be resolved? Commercial joint ventures will usually be structured with a set of articles and a joint-venture shareholders agreement which provides for a mechanism which might apply where conflict arises. In the absence of agreement between the parties as to how to resolve the dispute, the documentation may contain a mechanism for resolving the deadlock e.g. a “Mexican shoot-out” or “Texas shoot-out” provisions. Put simply, these are approaches which allow or require either party to make an offer to purchase the shares of the other for what he regards as a “fair price”. The mechanism will provide that the recipient of that offer will be given the option either to sell his shares at the price which has been offered or to buy the other’s shares at that price. The mechanism is designed to encourage the parties to make fair offers on the basis that they do not know whether they will end up with the shares or with the money!
In the absence of an appropriate clause within a shareholders agreement or the Articles of Association, shareholders will have to seek to resolve the dispute in other ways. The ultimate sanction is that either party may apply to the Court for an Order that the business be wound up on the basis that it would be just and equitable for the court to do this under section 122(1)(g) of the Insolvency Act 1986. The costs and time involved with such a process, as well as the risk and uncertainty of outcome, is an inducement to find another way to resolve matters if at all possible.
If both parties are intent on trying to preserve the value of the business it can be beneficial to look at other options such as negotiation or mediation. If the business has not yet fulfilled its purposes (for example it is still in the development phase of a new business model) it may be possible to get both parties to agree to sell. However this is not a quick and easy process and it may not be easy to value the business. In that case and in others it may be necessary to find a basis upon which both parties may be prepared to continue to participate in the business to a given point in the future.
In many situations it can be useful to consider appointing an independent neutral Chairman (trusted by both parties) who will exercise a casting vote if required to do so if, despite the use of his mediation skills he cannot get the warring factions to reach a consensus as to the way forward.
Summary
Whilst the mere existence of a shareholders agreement does not provide any guarantee that the parties will continue to want to do business together, it can provide an effective framework within which business differences can be resolved. It would be wise for the parties to discuss and find a potential solution to a deadlock before it arises. A well-drafted shareholders’ agreement will certainly contain appropriate provisions. Once a conflict has arisen, some of these resolution techniques may still be appropriate, even if they have not been agreed beforehand.