Shareholders often disagree with each other on how their company should be managed and controlled, and the direction and strategy it is taking. Differing views may be beneficial to a business, but disagreement, potential deadlock and an inability to make important decisions can be severely damaging to the company (and, in the long run, to shareholders).
Deadlock provisions within shareholders’ agreements, investment agreements or articles of association provide a means of resolving issues which shareholders cannot agree or otherwise compromise on.
What is deadlock
Usually, shareholders’ agreements set out the conditions that must be met for deadlock to occur. However, these are generally situations which go beyond a mere single ineffective vote by shareholders.
Usually, a number of votes on the same issue must be made over a period of time, with the outcome being each time consistently indecisive. Such delay would generally give shareholders time to compromise on or find other ways of resolving the issue.
Deadlocks can also occur when other dispute resolution methods have been tried and failed, for example, when shareholders’ agreements provide for shareholders using mediation to find an amicable solution if an issue cannot be resolved after two general meetings.
Deadlock provisions are a way of forcing a decision in such situations, being often so severe for one side that the threat of their use is enough for the issue to be resolved by compromise. The circumstances in which they can be used are usually limited to matters significantly affecting business operations.
The most common types of deadlock clauses
Although deadlock clauses can be given all sorts of interesting names, they all boil down to a requirement of one party selling their shares to the others so that there is a change of control and the remaining shareholders can make a decision on the disputed matter. In effect, these are all types of conditional termination provisions. Common examples of deadlock clauses in shareholders’ agreements include:
Shotgun / Russian Roulette
Essentially, such clauses allow one shareholder to make an offer to buy out the other shareholder for a certain price and under certain terms and conditions, who is then allowed to either accept such offer or buy the shares of the offeror for the same price and under the same terms and conditions (assuming there are two equal shareholders).
Texas Shootout
In this type of deadlock clause, each shareholder sends a sealed bid for the others’ shares to an independent and neutral third party. The third party then opens all bids at the same time and the highest bid wins, with the winning shareholder required to buy the others out at that price.
Auction
An auction is similar to a shotgun mechanism as the offering shareholder may have the opportunity to pay a price of their choice, including a premium. However, an auction also differs from a shotgun approach, in that it lacks adverse consequences for shareholders making low bids, as the outcome simply depends on who makes the highest bid.
Summary
The absence of appropriate clauses to resolve deadlocks before they occur can come with a high cost. With such clauses, if there is severe disagreement, there are various ways of seeking exit from the company or resolving the problem such as using drag along clauses. Given the genuine possibility of a deadlock among shareholders and the existential threat this can pose to a company’s ongoing viability, shareholders should ensure the shareholders’ agreement contains robust and precise provisions on procedures designed to resolve these matters.
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See also
Controversial amendment to the Commercial Companies Code
