Shareholder deadlock is common: a company with two directors and shareholders, each owning 50%, cannot agree at board or shareholder level. No decisions can be made. In the legal sense, the company is “deadlocked”. Shareholder agreements and articles of association rarely cover deadlock.
The scenario is common. Two talented individuals pool skills and resources to create a joint venture. Often their skills and resources are complimentary. Disagreements materialise. The company becomes deadlocked. Although the company continues trading, the deadlock hinders performance. Growth is stifled whilst profitable opportunities are lost.
Here are some solutions:
Shareholder deadlock: no paperwork in place
Shareholder agreements and articles of association rarely cover deadlock. Creative solutions include bringing in an impartial, neutral third party, by:
- Appointing a non-executive director to resolve the deadlock at board level, and restore day to day decision making;
- Issuing of a new class of shares to a professional, e.g. an accountant or financial adviser. The class only carries voting rights, but no dividend or ownership rights. This resolves the dispute at shareholder level;
- Appointing an appropriate expert to decide. The expert’s decision is binding on the parties, whether made at board or shareholder level.
A shareholders’ agreement can cover for such scenarios. Unfortunately, by the time solicitors get involved, often the dispute has escalated, so a new shareholders’ agreement is not always practical.
Deadlocked companies: exit
Perhaps the parties have lost trust and confidence in each other, the relationship is broken, and neither party wants to continue in business with the other. Before resorting to court action, we suggest a share sale or purchase, so one party gains full control of the deadlocked company.
Do explore the possibility that one party might exit. A deal saves costs and preserves a relationship. You can even regulate the seller’s conduct post-sale, e.g. with non-compete restrictions. Your options are:
Buyback in the name of the company
If the company has sufficient profits/cash, the company can buyback its shares. The company purchases the shares of the shareholder who wishes to exit the deadlocked company. The remaining shareholder is not required to raise additional funds. The company uses its own profits and cash.
To claim the preferential 10% entrepreneurs’ relief rate of tax on sale, the departing shareholder must have held the shares for five years. We advise first negotiating a heads of terms agreement. It should have a defined “trigger date”, the date the company will buyback the shares. This is usually the date when the company has sufficient working capital for the remaining shareholder to continue with the company’s business.
Sell/buy shares subject to a valuation
The bar to a shareholder’s smooth departure is an agreed share valuation. There are two solutions, the shareholders could:
- Appoint an independent valuer, who works to both parties’ agreed instructions; or
- Submit sealed bids to a valuer. The valuer picks the highest price, or perhaps a median price.
Third party buyer
A shareholder may seek a third party buyer. Note the shareholders’ agreement or the company’s articles might prevent this sale. If not, the only hurdle is for the seller to find a buyer, and register the buyer as the shareholder.
The other director can refuse to register a share transfer, but the director must show a proper reason. Thus, the remaining director cannot usually refuse to register the transfer in retaliation to a shareholder’s exit. The remaining director is subject to the usual directors’ duties, e.g.to act:
- In good faith; and
- For the benefit of the company’s members as a whole.
Court action: the nuclear option
If negotiations fail, then we advise a court application. Perhaps a court application forces the other shareholder to negotiate sensibly. The clock starts ticking as the parties are subject to the court’s timetable. There are two common court routes.
Other shareholder’s conduct
The first option is against the other shareholder for conduct which is unfair and prejudicial to the members of the company. Usually the other parties’ behaviour deteriorates as the deadlock escalates.
For example, as a director, a party may refuse to vote a dividend in a profitable company. The party might be hoping to secure a favourable deal for the other shareholder’s exit. The petitioner applies to the court for the sale of their shares, or the purchase of the other party’s.
If successful, the court will order an independent valuation. Hence, always offer an independent valuation prior to court action to protect your position on costs.
Company winding up
The second option is to wind up the company. This is on the basis that it is just and equitable to do so. Deadlock is the ground pleaded.
The petitioner asks the court to wind the company up. You must show you have explored alternatives, then argue the company cannot continue in deadlock. The petitioner must show the shareholders’ expectation has been defeated, with trust and confidence lost. Courts take an objective viewpoint. Winding up is a drastic remedy, which courts do not advocate.
In any deadlock, it is imperative to stay reasonable. Emails are a pitfall. Any email could appear before the judge on any court petition.
Shareholder deadlock: how we separate the emotions
A company may have traded successfully for a long time. Yet, a slight disagreement on a simple board vote can escalate. Then it’s impossible to decide anything at any level. Often deadlock results after a string of disagreements and allegations between the parties. This culminates in damage to the company.
As solicitors, we maintain an objective viewpoint, see the full picture, and guide you to the correct resolution. For instance, often a company’s shareholding reflects close or personal relationships, e.g. a couple, or family relationship. Family run businesses often become deadlocked when other disagreements enter the workplace.
Deadlock arises if the shareholding split prevents a majority. Ideally provisions in a shareholders’ agreement resolve the deadlock. However, often there are no such provisions.
Fail to address the deadlock and everyone ends up financially damaged. Business interests are lost. In professional service companies, customers go elsewhere. Address the deadlock and avoid these issues. Oherwise your business evaporates.