From stalemate to solution – how to avoid shareholder deadlock

Disputes between shareholders or joint venture partners can disrupt, or even derail a business. However, deadlock breaking mechanisms can set you up for success and ensure there is an effective resolution strategy should a deadlock occur.

Need to know:

• Alignment between business partners will lessen the chance of a future deadlock.
• A written Shareholders’ Agreement or Joint Venture Agreement can include mechanisms for resolving a deadlock if it arises.
• As a last resort, there are remedies available through the courts.

A new business venture usually starts with a lightbulb moment – and founders who are full of enthusiasm, hope and optimism for future growth and returns. In the honeymoon period, it’s unlikely shareholders or business partners are contemplating the possibility that down the track, a crippling dispute could derail the venture’s future.

The reality is that it’s likely that at some point, partners or investors in a business will have a difference of opinion over its direction which could result in a deadlock. But there are ways to ensure that a deadlock doesn’t sound the death knell for the business.

When a deadlock arises

Board or shareholder deadlock occurs when directors or shareholders cannot agree on a proposed resolution, and where the terms of the Shareholders’ Agreement mean those who are in favour of the resolution, cannot carry it on their own.

Deadlock typically occurs in a 50:50 joint venture (JV), or where there is an even number of shareholders with equal voting power. Deadlock can occur at board level or shareholder level, but more often than not, it arises in situations where voting power is equal at both board and shareholder level.

Deadlock can bring business operations to a complete standstill and distract directors and management from running the business – and generating returns for shareholders.

Avoiding or resolving a deadlock

The best way to deal with a deadlock is to put processes in place from the very start of the venture so that a deadlock doesn’t arise.

Ideally, there will be alignment of values and a shared vision between JV partners, co-founders or investors. Where this doesn’t exist at the outset, it’s likely to cause problems down the track. For example, an investor may be looking to re-invest profits to maximise capital growth over a five-year horizon before seeking a sale of the business. If the founders have a longer-term strategy and would prefer to return some of the profits to shareholders in the interim, the parties will lack alignment from the beginning.

Even where parties are aligned and on good terms at the outset, there’s still the possibility that views will differ when it comes to matters of strategy and execution. For this reason, it’s sensible to include mechanisms in constituent documents, such as a Shareholders’ Agreement – for resolving deadlocks should they arise.

These mechanisms (individually or used together) include:

• Chairperson casting vote – A chairperson can be given a casting vote at either a board or shareholder meeting to break the deadlock. The chairperson could either be appointed by the shareholders each year on a rotating basis or be an independent chairperson who votes in the event of a deadlock. The drawback of this mechanism is that in a 50:50 JV, the parties do not usually want to cede control over a fundamental decision affecting the JV, whether to the other JV participant, or to a third party.
• Dispute resolution – At a minimum, most Shareholders’ Agreements will provide for a deadlock to be referred to senior management of corporate shareholders for resolution, failing which it is referred to mediation. This is often a pre-step to the other mechanisms highlighted in this article, as it does not ultimately bring about a resolution if the mediation cannot break the deadlock.
• Russian roulette – This mechanism is typically used when there are only two shareholders. In the event of a deadlock, it permits a shareholder to issue a notice to the other shareholder, offering either to sell their shares to that other shareholder at a specified price (or at fair market value), or to purchase the other shareholder’s shares at a specified price. The shareholder receiving the notice has the option to either purchase the shares of the shareholder issuing the notice, or to sell their shares to that shareholder at the same price. It’s considered a drastic measure, as the shareholder issuing the notice takes the risk that they could be compelled to sell their shares, or forced to purchase the other shareholder’s shares at the specified price.
• Texas shoot out – Again, this mechanism is typically used where there are two shareholders. Each shareholder submits a sealed bid to buy out the other shareholder’s shares. The shareholder making the highest bid will have to buy out the other shareholder. This can be a quick way to resolve a dispute; however, it favours the shareholder that is in a better financial situation.
• Buyback of shares – A buyback provision permits the company to buy back the shares of a shareholder in the event of a deadlock. This depends on the company having sufficient funds to purchase the shares and a process for determining the value at which shares are to be bought back. A buyback must also strictly follow the provisions of the Corporations Act 2001 (Cth) (the Act).
• Shareholder / third party buy out – A Shareholders’ Agreement can provide for a shareholder who is wishing to exit to sell their shares to the other shareholder(s) (usually in the form of a pre-emptive rights clause) or, for the shares to be sold to a third party. This mechanism depends on there being a shareholder wanting to exit and, if applicable, being able to find a willing and suitable third party purchaser.
• Winding up – As a last resort, a Shareholders’ Agreement can require that shareholders do everything necessary to wind up the company if the deadlock cannot be resolved.

Resolution of last resort

If there is no Shareholders’ Agreement, or it does not contain a mechanism for resolving a deadlock, shareholders (holding more than 75% of shares on issue) can pass a special resolution to have the company voluntarily wound up. Alternatively, a shareholder can commence legal proceedings: a potentially costly course of action, which can negatively impact the reputation of the business.

Triggers for getting the courts involved – and remedies

Oppression Remedy

A shareholder can apply to the court under the Act to resolve a deadlock if it arises out of:

• the conduct of the company’s affairs;
• an actual or proposed act or omission by or on behalf of the company; or
• a resolution, or a proposed resolution, of members or a class of members of a company.¹

The deadlock must also be contrary to the interests of the members as a whole, or oppressive to, unfairly prejudicial to, or unfairly discriminatory against a member or members whether in their capacity as members, or in any other capacity.²

This resolution is commonly referred to as the ‘oppression remedy’. Pursuant to s 233 of the Act, a court can make a wide range of orders if a shareholder is successful, including:

• that the company be wound up;
• that the company’s existing constitution be modified or repealed;
• for the purchase of any shares by any member or person to whom a share in the company has been transmitted by will or by operation of law;
• restraining a person from engaging in specified conduct or from doing a specified act; and
• requiring a person to do a specified act.

Compulsory wind up

It is also possible for a shareholder to apply to court to have a company compulsorily wound up on ‘just and equitable’ grounds pursuant to s 461(k) of the Act. There is no exhaustive definition of what constitutes ‘just and equitable’ grounds, and the court has wide discretion in this regard – although courts can be reluctant to wind up a solvent company. Case law provides that there needs to be an irretrievable breakdown in relationships before the court will be satisfied that the requirements for compulsory wind up have been met.[3] It is also worth noting that winding up a company on a solvent basis almost always results in significant value destruction for shareholders.

Resolving a deadlock: put it in writing

Before embarking on a business venture, a founder, investor or shareholder should consider the most appropriate mechanisms to resolve potential deadlocks – and document these in a written Shareholders’ or JV Agreement to minimise business disruption and ideally, preserve future relationships.

For more information, please contact: Benny Sham, Peter Williams or Rachael McGurgan.

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¹Corporations Act 2001 (Cth), s 232.

²Ibid

³The Skippy Film Company Pty Limited [2017] NSWSC 646.