The division of ownership and control within companies usually reflects the power dynamics between directors and shareholders. With the exception of rights specified under the company’s Memorandum and Articles of Association (M&A) or those granted to shareholders at a general meeting by the Companies Act, directors, as the company’s representatives, have wide administrative authority. The Companies Act and common law require directors to uphold their fiduciary duties in order to lessen the likelihood of misuse. Directors have a duty to carry out their responsibilities with integrity and the firm’s best interests in mind. They must also behave morally, take adequate precautions, and stay out of conflicts of interest.
However, the shareholders of the firm are also its owners, and they are endowed with certain basic rights. Nevertheless, the business can close if these owners are unable to agree during their meetings. This is particularly valid for joint venture contracts that allow shareholders to choose directors and/or approve business decisions. For shareholders, decision-making is a major challenge. If serious issues are not resolved, the company might have to shut down completely or cease operations. How to break an impasse among shareholders is a problem akin to shareholder agreements.
As a type of minority protection, companies whose owners have a disproportionate number of shares or board seats occasionally include in their shareholders agreements a requirement for super-majority or unanimous assent at the shareholder and/or board levels. A deadlock arises when these reserved subjects cannot be resolved. While not all companies have this kind of protection, those that do might have a strong stalemate clause in their shareholders agreement that could help resolve the standoff. Typically, a corporation’s M&A is insufficient to break deadlocks. Shareholders may be compelled to take extreme action in these situations, such as shutting down the business.
Approaches to Deal with Shareholder Deadlock
Deadlock mechanisms, sometimes referred to as escalation mechanisms or deadlock resolution clauses, are included in thoughtfully drafted shareholder agreements to enable prompt resolution in the case of a competing interest-related shareholder stalemate. A solid deadlock clause basically consists of two components:
- An “escalation mechanism” that escalates the deadlock to the designated senior management of each shareholder for consultative resolution within a specified timeframe, with the goal of being sufficient to achieve deadlock resolution.
- A mechanism to be used when a deadlock cannot be resolved amicably by the consultative resolution.
Given their core duty to act in the organization’s best interests, the directors’ biggest dilemma is determining whose interests serve the corporation. If a show of hands vote ends in a tie, the meeting’s chairman—who is also typically the chairman of the Board—may call for a poll in accordance with the company’s M&A policies. If the M&A so indicates, the chairman may additionally be qualified for a second or casting vote in the case of a tie. Above all, the chairman needs to give the matter serious thought before deciding. Should he fail to act in the best interests of the company, he will be held accountable for breaching his fiduciary obligation.
If directors behave impartially and honestly in the best interests of the company, courts often won’t get involved in business decisions they make, even if they turn out to be financially unsound in hindsight. In this case, it is not always required for directors to behave in a way that is financially advantageous to the company; instead, they may consider immaterial benefits like maintaining goodwill or making prudent long-term investments. Furthermore, when making decisions, directors are allowed by the Companies Act to consider the interests of the firm’s shareholders, employees, and members.
What is fair to various shareholder groups may be a fundamental principle in business decision-making, since each may be affected differently by a given choice. For instance, it is unfair and the directors ought to oppose any action taken by a shareholder group that seeks to subjugate another or get a semblance of power over them. Another common scenario is when two groups of shareholders have different time horizons, like when an investment fund group is nearing the end of its fund and is at odds with staff or founder shareholders.
While the first group may be under pressure to create an immediate improvement in the share price and may be pushing for the realisation of short-term gains, the second group may be willing to take a longer perspective and may reject any disposals for short-term gain. Apart from compelling directors to maintain equilibrium, these difficult decisions serve as a warning that an unhappy shareholder has the option to sue under the Companies Act on the grounds of minority tyranny. These debates underscore how crucial it is to render decisions that favour one side over another with honesty and sincerity.
Directors should document the procedures they use to make decisions and the reasons behind the decisions they make. In the end, directors should keep in mind that acting honourably is their first responsibility and that, in the event of a deadlock involving two or more shareholders, their fiduciary duties to the company take precedence above any duties to specific owners. In very limited situations, the court may be able to dismiss the company’s case against a director for breach of duty if the director can demonstrate that he acted honestly and fairly in light of the circumstances.
Common Deadlock Provisions in a Shareholders Agreement
- Casting Vote: The chairman of the board is given the designated casting vote in the case of a tie.
- Designation of an Independent Party: The shareholders mutually agree to nominate an unbiased third party, maybe an arbitrator, in order to speed up the decision-making process and obtain a settlement.
- Russian roulette: Any shareholder may place a bid against another, either by proposing to buy it out at a fixed price or by demanding that the other shareholder buy it out. Through this method, the receiving shareholder can choose to accept the other shareholder’s offer or sell its own share to the other shareholder for the agreed-upon amount.
- Put and Call Options: The holder of the put option may demand that the other shareholder purchase its shares at a fixed price or at a market value ascertained by a third party. The holder of a call option may demand that the other shareholder sell their shares at a fixed price or at market value as decided by an impartial arbiter.
- Winding-Up: Any shareholder may ask for a voluntary winding-up of the company. In this case, all of the shareholders have agreed to divide the assets and close the business.
Conclusion
A shareholders’ agreement must contain proper impasse measures to address any deadlock circumstances. At the outset of a joint venture, shareholders should think about integrating deadlock procedures that suit their sharing structure and dynamics.
Please note that this article does not constitute express or implied legal advice, whether in whole or in part. For more information, email us at info@silvesterlegal.com
