Setting up a company is relatively simple, particularly if there are only a couple of shareholders. However, as your business evolves, differences between the partners can develop. Sometimes these differences can be easily resolved, but occasionally gridlock can occur – the founders just can’t agree on a crucial business issue. In legal terms, this impasse is known as ‘deadlock’.
A deadlock situation can become doubly complicated where there’s no shareholders’ agreement in place that provides a roadmap for how to push through it. This is a particular issue when there are only two shareholders or founders with a 50% share of the business and half the seats on the board.
In the current business climate, with costs increasing and recession on the horizon, more and more businesses are encountering difficulties that lead to differences in opinion on how to move forward.
So, what can be done to avoid harmful deadlock arising, and how can you resolve it?
Jump to:
- What’s shareholder deadlock?
- What kinds of shareholder disputes can lead to deadlock?
- What do the Articles of Association say about deadlock?
- How can you resolve shareholder deadlock?
- Do I need a shareholders’ agreement to deal with deadlock?
- How can you sort out shareholder deadlock if there’s no shareholders’ agreement?
- Ask a shareholder to leave and buy back their shares
- The dissenting shareholder can sell their shares
- Invite another shareholder or non-executive director to join the company
- Chairperson/external ‘swing’ vote
- Mediation/arbitration/appointment of an expert
- Put in place a shareholders’ agreement
- Refer to senior management
- Winding-up or liquidation
- Court action
- How to put together deadlock provisions in your shareholders’ agreement to deal with disputes
What’s shareholder deadlock?
Starting a business can be an incredibly exciting time. And when you’ve co-founders embarking on the adventure it can be doubly so. However, just as with romantic liaisons, partners rarely consider the downsides when committing. It can put a damper on things, and discussing divorce when you’ve only just got engaged can make for an awkward conversation.
However, just like in a marriage, differences can occur. And smart entrepreneurs prepare for every eventuality so that they can get on with making a success of their business knowing there’s a safety net in the case of problems.
One such problem is shareholder deadlock. Shareholder decisions are made by voting, and a decision usually needs a majority vote to pass. Sometimes, you even need a 75% majority or even unanimity. When shareholders can’t reach a decision, then there’s an impasse or ‘deadlock’.
Where a company is owned by two shareholders who each hold 50% of the shares, or where there are multiple shareholders with an equal share of decision-making, this can be particularly problematic, especially if there’s also a deadlock at board level.
What kinds of shareholder disputes can lead to deadlock?
Here are the most common types of situations that can lead to shareholder deadlock:
Differences in business strategy
This can include disagreements about how funds should be spent, how the company is being managed, or whether the company should be restructured or even sold. These types of disputes are most common in small companies with just a couple of founders.
Majority shareholders ignore the wishes of minority owners
Because minority shareholders don’t have much influence in business decision-making, their needs can often be ignored by the majority owners. While the law can provide some protection to minority shareholders, these disputes can be disruptive.
Differences in contributions to the business
Where shareholders are also employees or directors, problems can arise if someone isn’t pulling their weight in the view of the other shareholders. Again, this is a particular problem in small or family-owned companies.
Withholding of information from shareholders
Particularly if a company is in difficulty, it can sometimes be tempting not to share the full picture with shareholders. This can create problems, however, once the full picture emerges.
What do the Articles of Association say about deadlock?
If you’ve bought a company ‘off-the-shelf’, your company will be governed by the standard or ‘model’ Articles. These state that you can only pass a resolution by a majority of shareholders voting in favour, or if there’s a 50/50 split, by the chair’s casting vote.
How can you resolve shareholder deadlock?
One way business owners resolve deadlock is by changing the business’s ownership. One shareholder may agree to leave, or you can onboard additional investors. In a worst-case scenario, you may have to resort to court action to resolve the dispute. This isn’t ideal when you want to concentrate on business affairs.
The best way to tackle a potential deadlock is to insure against this eventuality by
putting a shareholders’ agreement in place when the company is set up.
A shareholders’ agreement is a contract between the owners of a company that describes their rights and duties to the company. A well-drafted shareholders’ agreement will give the owners and investors confidence that the business will be run efficiently. And a good shareholders’ agreement will contain a deadlock clause. These clauses aim to resolve disputes by putting a dispute resolution mechanism into play to deal with disagreements when they occur.
Do I need a shareholders’ agreement to deal with deadlock?
A shareholders’ agreement is a kind of roadmap for how a business should be run. And a good one will provide a mechanism for resolving disputes and dealing with exits from the company. It will describe how decisions are made, what kinds of decisions may require unanimity, and contain procedures for transferring shares. It will also contain a procedure to follow in the case of deadlock.
So, unless you’re 100% certain that no disputes will ever occur, a shareholders’ agreement is an excellent way to protect your business investment against damaging disagreements.
While you can obtain a template shareholders’ agreement on the internet, it won’t have been written with your circumstances in mind. As a result, a non-bespoke shareholders’ agreement is unlikely to give you the peace of mind you’re seeking.
How can you sort out shareholder deadlock if there’s no shareholders’ agreement?
If you don’t have a shareholders’ agreement, deadlock is a very real business risk. Key contracts may depend on shareholder agreement, or financial arrangements may require a signature that you can’t obtain. In such a case, there are several ways out of the impasse.
Ask a shareholder to leave and buy back their shares
In some circumstances, a company can buy back an owner’s shares. You can do this legally, provided your company has enough distributable profits and you pay for the shares in full at the time of sale. So, you can’t agree to delay payment, but you can agree to buy the shares in tranches if the seller agrees.
The dissenting shareholder can sell their shares
Another potential solution is to have the dissenting shareholder sell their shares to someone who is of like mind with the existing owners, so prepared to vote alongside them when making a decision.
Invite another shareholder or non-executive director to join the company
Another possibility is to ask another shareholder to join the company so that the voting percentages are altered, allowing you to make decisions by majority. If this is an option, you'll need to know more about share dilution and the impact on existing and future shareholders.
If the dispute is occurring at board as well as at shareholder level, you could appoint a non-executive director so that decisions can be taken by the majority. This won’t be possible if you’re not able to agree on who this person should be.
Chairperson/external ‘swing’ vote
In older companies (before October 2007), the standard Articles of Association provided that the chairperson had a casting vote if members fail to agree. This right was removed by the Companies Act 2006 and no longer applies. You can, however, reintroduce this right by amending your company’s articles and appointing one of you the chair, perhaps on a revolving basis.
An alternative is to pick someone external to the company who will be given a ‘swing’ vote if deadlock occurs. It can be difficult to agree on who this should be, as they would have to have appropriate business or professional experience. You could ask your lawyers or accountants to nominate a suitable person and agree to accept their recommendation.
The advantage of a chair’s casting vote is that it will give quick resolution to the deadlock, and you don’t need to find a third party to assist. The disadvantage is that the views of one of you will prevail when disagreements occur.
Mediation/arbitration/appointment of an expert
If your dispute is fairly clear-cut or technical, you could appoint an outsider like a mediator, arbitrator or expert to help you resolve it. This is usually a cheaper and faster route than going to court, but only suitable where the issues are factual and don’t involve disagreements about strategy. Plus, in arbitration, the decision will usually be binding on both sides, even if you each disagree with the conclusion of the arbitrator.
Put in place a shareholders’ agreement
If your situation has not become too entrenched, you might be able to put a shareholders’ agreement in place that sets out how disagreements should be dealt with in the future. While a shareholders’ agreement isn’t a legal obligation and the Articles do give shareholders some protection, a shareholders’ agreement provides additional clarity and a procedure to follow. This is excellent insurance and will give comfort to investors that disputes will be competently managed.
Refer to senior management
If your company is a 50/50 joint venture involving two companies, you can sometimes resolve disputes by asking senior management from both sides to step in. Like mediation, this method won’t work if there’s a fundamental disagreement on the way the JV is being run.
Winding-up or liquidation
If you feel the business is no longer viable because of your dispute, then you can wind the company up or opt for a voluntary liquidation of the company, sharing between you any surplus after the assets have been realised or sold.
Court action
You can ask a court to step in to resolve a deadlock in litigation. A court can resolve a dispute, order a winding-up of the company, agree a valuation of shares or order a share transfer from one party to another.
How to put together deadlock provisions in your shareholders’ agreement to deal with disputes
When putting together deadlock provisions in a shareholders’ agreement, you must define the deadlock situations that will trigger the deadlock procedure and include these in the agreement.
Here are some examples of procedures that can be included in a shareholders’ agreement to resolve a deadlock situation:
Russian Roulette
This is a clause that enables one shareholder to offer to buy out the other, or sell their own shares, at a price set by the offering shareholder. The other shareholder can accept the offer and sell their shares or offer to buy the other out at that price, and so on. The advantage of this approach is that the person wanting to leave the company will be bound to offer a fair price, and you don’t need a company valuation. In addition, this enables the shareholder that eventually purchases the other’s shares to continue the business. However, this procedure does put the financially stronger party in a better position and so is open to manipulation.
Texas Shootout
In this procedure, each shareholder submits a sealed bid to a third party for the other shareholder’s shares. The shareholder making the highest bid will have to buy the other out. This can be a quick way to resolve a dispute, although to operate fairly, both sides must be financially equal.
Compulsory buy-out
These provisions allow one shareholder to buy out the other using a pre-determined formula for agreeing the price of the shares if a deadlock occurs.
For more answers to commonly asked questions and advice on shareholders’ agreements, deadlock and company disputes, consult our corporate and dispute resolution solicitors. Get in touch on 0800 689 1700 email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
