Everyone involved in starting a business is optimistic at first. In fact, relentless optimism is often an essential personality trait for entrepreneurs. However, as the business grows, so do the number of risks that need to be taken and the investor involvement. Disputes between shareholders can inevitably develop and if left unresolved, such disputes can result in a deadlock, leaving the company paralysed and unable to move forward.
Deadlocks can be disastrous. Take the decade-long legal dispute that affected Turkcell, Turkey’s top mobile network operator. The company was subjected to a feud involving ownership and control of the company between Mehmet Emin Karamehmet, who has long been one of Turkey’s richest businessmen, and Mikhail Fridman, the Russian oligarch. The rift prevented dividends being paid to shareholders from 2010 to 2016, when a Turkish government agency intervened and put control temporarily in the hands of state-appointed board members[1].
Shareholder disputes and deadlocks do not have to be so dramatic that government intervention is required which could destroy investor confidence and prevent profitable projects from being completed. A company with two shareholders, each holding 50% ownership in the organisation, can become deadlocked if they are unable to agree on the future conduct of the company, so it is important to set out mechanisms to prevent such scenarios.
What are the options to break a deadlock between shareholders?
If a deadlock occurs, there are several options you can take to settle matters commercially. Shareholder deadlocks can be resolved by:
Chairperson’s casting vote
Up until October 2007, a chairperson was automatically given the right to a casting vote in the event of a tied members’ vote via the company’s articles of association. The right was provided by Companies Act 1985, which no longer applies by default under the Companies Act 2006.
However, the right can still be provided by amending a company’s articles of association or by introducing it in a shareholders’ agreement.
Shareholders’ agreement
Provisions of how to break deadlock can also be found in a shareholders’ agreement (if there is one in place). The most common deadlock clauses are below:
Russian roulette:
This type of clause entitles one or more disputing shareholders to offer either to buy the shares of the other party or to sell their own shares to the other party at a specified price. If nobody agrees to sell at the specified price, this clause can escalate to allow counteroffers, until a suitable price is reached. This clause may force the exit of a number of shareholders, and typically favours shareholders who are in a stronger financial position. It allows for a rapid exit at a good price.
Texas shoot out
This involves each shareholder giving a third-party a sealed bid for the other shareholder’s shares. The bids are opened simultaneously. The shareholder who made the highest bid must then purchase the other shareholder’s shares. Again, this allows for a rapid exit at a good price.
Golden share
Another alternative is to issue a ‘golden share’ to an impartial outsider or someone on the board to exercise a vote to break the deadlock. This is similar to a chairman’s casting vote, and in the long-term, having a third-party enter into the company as a shareholder may prevent a deadlock.
Buy-out the other shareholder
If both parties feel they can no longer work with each other, one can offer to buy-out the other party using a simpler purchase method than those cited above. Although, the ‘Russian roulette’ and ‘Texas shoot-out’ options allow for a quick resolution, there is an element of uncertainty regarding the purchase price for the shares. In regular buy-outs, the parties agree a share valuation method and payment timeline in advance, in case they ever need to consider a buy-out.
100% buy-out of the company
This clause gives to one shareholder the authority to locate a buyer willing to purchase the entire shareholding of the company for the same price per share. If the shareholder fails, the authority passes to another shareholder, and so on, until all shareholders have had a chance to find a buyer.
Voluntary liquidation
If the company cannot be sold and neither party can afford to buy out the other, then as a last resort, the company can be put into voluntary liquidation. This will involve the company being wound up and its assets distributed. Shareholders can agree in advance how the assets will be distributed if there is a surplus on liquidation, although it is often based on the proportion of share capital owned by each shareholder i.e. a majority shareholder would be entitled to a majority of the surplus assets
Concluding comments
Shareholder deadlocks can completely derail up and coming businesses. To avoid such a scenario occurring, make sure you:
pick your business partner carefully, and
have a well-drafted shareholders’ agreement or joint venture agreement which has clear deadlock and/or dispute resolution procedure to resolve any disagreement in the future. Whilst disagreements are a part of any business, it is important to have methods that ensure they do not get out of hand
Saracens Solicitors is a multi-service law firm based in London’s West End. We have dedicated and highly experienced commercial law solicitors who can advise you on all shareholder and joint venture matters. For more information, please call our office on 020 3588 3500.
[1] https://www.ft.com/content/66326e36-0673-11e3-9bd9-00144feab7de