We are commonly asked to advise directors and shareholders on how to resolve a management deadlock within their company. Management deadlocks can lead to damage to the business and business relationships and a lose-lose outcome for the partners.
What is A Deadlock In A Company?
A deadlock occurs when neither party (or factions) within a business control a majority of votes at either the board or shareholder level. Often, a deadlock over a specific issue can raise tensions and permeate into the operation of the company, which is invariably bad for business. This can lead to irreparable polarisation. Companies with a 50/50 split in shareholding and decision making (e.g. two directors who are equal shareholders) are commonly prone to deadlock.
Contracting parties are generally brimming with positivity at the outset of entering into a new venture. This is especially so for smaller companies where the parties often share a personal history, be it a family member, friend, or long-term co-worker. The possibility of a dispute arising down the track is often overlooked or perceived as unrealistic however, in reality, disputes frequently arise.
Common disputes leading to deadlock include:
- a difference in opinion about how the business should operate;
- shareholders believing their opinion is unheard;
- a difference in opinion on how dividends should be divided or invested; and
- shareholders claiming they are contributing more than others or are unsatisfied with the contribution of another shareholder.
Preventing and Resolving Deadlock
A well drafted shareholder agreement will consider the possibility of a dispute arising and include several mechanisms to prevent deadlock occurring and resolve it when it does arise. Common types of provisions relate to:
- alternative dispute resolution;
- seeking an independent third party to step in and assist in resolving the deadlock;
- the sale of shares;
Alternative Dispute Resolution
Dispute resolution clauses are commonplace in shareholder agreements. A dispute resolution clause can be as simple or as complex as the contracting parties wish to make it. Generally, a dispute resolution clause will include a notice period, followed by a timeframe in which the parties must confer and reasonably attempt to resolve the dispute in good faith. If the dispute cannot be resolved at this juncture, then generally the next step is to refer the dispute to formal mediation or arbitration.
Except for arbitration (where an independent arbitrator may rule on the dispute), alternative dispute resolution requires disputing parties to use their best endeavours to resolve the dispute in good faith. Albeit less confrontational, alternative dispute resolution can become ineffective in instances where there is a serious relationship breakdown, or the parties feel strongly about the subject matter.
Contracting parties negotiating a shareholder agreement may consider including a provision allowing an independent third party to intervene when deadlock occurs. Third party intervention is not always desired because (generally) people don’t like to relinquish partial control of their business and let others to get involved in their affairs. That said, it can be the most effective and fair method of resolving a deadlock and getting the company back on track.
Relevant shareholder provisions may include the ability to appoint an independent director who is not involved in the management of the business to come in and resolve the deadlock at board level. Alternatively, an expert may be appointed to assess the dispute and make an independent decision that is binding on the parties. If the matter is to be kept in-house, shareholder agreements may also nominate a predetermined shareholder who will become a ‘chairman’ and cast a deciding vote in case of a dispute.
Shareholder Deadlock – Sale of Shares
Sometimes a dispute cannot be resolved. The relationship may have deteriorated to the point the parties can no longer work with each other under any circumstances. That being the case, the company will continue to be in deadlock until one (or more) party leaves the business or alternatively, court action is taken to liquidate the company. Buying out a shareholder or selling the company can still be problematic when relationships have broken down, especially in respect to determining share price and selecting a buyer.
Shareholder agreements can be drafted to provide a way out of deadlock by taking the decision making out of the disputing parties hands. Common provisions include:
- “auction” deadlock clauses allows one or more shareholders to bid for an exiting shareholders shares. Obviously, this will require a party to exit the company voluntarily, which does not always occur.
- “shoot-out”or sometimes “Russian roulette”deadlockclauses which allows parties place confidential bids to buy out the other, until the highest offer prevails. Generally, contractual mechanisms such as notice periods and mediation will apply before a final “shoot out” can occur. Whilst these provisions can provide a definitive way out of deadlock, the downside is the disputing party with the deepest pockets has an advantage.
Deadlock Provisions or Deadlock Resolution Clause
Deadlock is not a great position for a company to be in and the deadlock provisions above are not always desirable outcomes. That said, the alternative can be far worse where the parties are unable to agree. In the absence of appropriate deadlock resolution provisions contained in a shareholder agreement, a party can apply to have the company wound up by a court in accordance with the Corporations Act 2001. To do so is a sometimes costly and slow process, however where there is a true deadlock it can be a reliable way to finalise the venture.
Daniel Dash is part of the commercial law team at NB Lawyers – lawyers for employers working with individuals and business owners on a range of matters including business sales, property disputes, estate disputes, shareholder agreements, intellectual property, litigation and taxation matters.