Companies with two or more shareholders entitled to vote on decisions may sometimes be in disagreement with one another on crucial business issues.
What is a Deadlock Situation?
Shareholder decisions are usually made by voting, often requiring a majority vote to pass. This means that when shareholders cannot reach a decision, they can end up in a stalemate situation, known as a ‘deadlock’. This can be particularly problematic when a company is owned by two shareholders holding 50% of the shares or multiple shareholders with an equal share of decision-making.
Deadlocks can have a damaging effect on a company’s business as it means shareholders are unable to make important business decisions relating to the company. Some will even end in liquidation.
How a Shareholders’ Agreement Can Deal with Deadlocks
A carefully drafted shareholder agreement will provide mechanisms for resolving disputes. For example, there may be a dispute-resolution mechanism in place that requires the intervention of an independent mediator, arbitrator or decision-maker to help resolve the issue.
However, if those methods have failed, additional mechanisms can be triggered in a shareholders’ agreement to force a decision.
Russian Roulette
This is a provision that allows one shareholder to name a price at which they would be willing to sell their share of the company. The other shareholders then have the option to either accept the offer and purchase the shares at that price or reverse the offer and offer to sell all their shares at the same price.
The advantage of a Russian Roulette clause is that the shareholder invoking this clause will, in theory, offer a fair price as they do not know whether they will be the seller or the purchaser. This works well if both parties have similar financial resources. However, if there is a disparity, the party with the greater financial resources will be in a better position and therefore may be able to manipulate the process and offer a lower price, discerning that the other shareholder may not have the financial resources to be able to fund the offer to buy.
Texas Shootout
A Texas Shootout clause is another way to resolve a deadlock. This involves shareholders each submitting a sealed bid to buy out the other shareholders’ shares in the company. The auction will be overseen by an independent party and the bids are opened at the same time. The highest bidder will then buy the other parties’ shares. This method is a quick way of resolving a deadlock; however, as with the Russian roulette procedure, both parties should be on an equal financial footing for it to operate fairly. Furthermore, given the nature of a bidding process, it may ultimately result in a higher premium being achieved for the shares.
There are advantages and disadvantages for each of the deadlock mechanisms mentioned above, so you must carefully consider whether they are appropriate for your business. Even if you do conclude that they are not, a shareholders’ agreement that sets out a process for resolving disputes is still essential and will give the parties a framework to follow in the event of a dispute, which will, in most cases, avoid expensive and lengthy court proceedings. To discuss shareholder agreements, including deadlock mechanisms, contact our expert Dispute Resolution team today via email.
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