What is a 50/50 shareholder deadlock?
In corporate law, a deadlock is a situation where the shareholders of a company are unable to reach an agreement on key decisions or pass resolutions. This impasse typically occurs due to conflicts or disputes among director shareholders, and it is most common in scenarios such as 50/50 joint ventures or when there are two shareholders each holding equal shares and an equal 50% of the voting rights.
The inability to make critical decisions due to this deadlock can lead to significant operational challenges for the company. If the shareholders remain at an impasse, it can result in serious consequences, including the potential for shareholder litigation. Such litigation arises when one or more shareholders seek legal intervention to resolve the deadlock and address the governance issues that are hindering the company’s ability to function effectively.
How to avoid a 50/50 shareholder deadlock
There are several strategies that companies can employ to avoid a 50/50 shareholder deadlock. These strategies should ideally be implemented at the time of forming the company or when drafting the shareholders’ agreement. Issues often arise in these situations when no shareholders’ agreement has been written up and standard articles of association have not been modified. Outlined below are some common methods of avoiding this type of shareholder dispute:
Casting vote provision:
Companies may wish to appoint a chairman who holds a casting vote in the event of a tie during shareholder meetings. This ensures that decisions can be made even when there is an equal split in votes.
Weighted voting rights:
Businesses can assign different classes of shares with varying voting rights. This can ensure that not all shareholders have equal voting power, preventing a 50/50 deadlock.
Deadlock resolution mechanism:
Shareholders should include specific provisions in the shareholders’ agreement to address deadlocks. Common mechanisms include alternative dispute resolution or buy-sell agreements.
Pre-emption rights:
Shareholders should establish pre-emption rights that give existing shareholders the first right to purchase shares being sold by another shareholder. This can help prevent unwanted parties from gaining control and ensure a more balanced decision-making process.
Put and call options:
Businesses may wish to include put and call options in the shareholders’ agreement. This mechanism allows one shareholder to compel the other to buy or sell shares under certain conditions. This can provide a way out of a deadlock situation.
Escalation clauses:
Parties may wish to implement escalation clauses that require disputes to be escalated to higher management or even external advisors before a deadlock arises.
Rotation of control:
Another option is to agree on a rotation system where the control of the company alternates between the shareholders on a periodic basis. This helps to ensure each party gets an opportunity to lead and make decisions.
Independent director:
Companies may wish to appoint an independent director to the board who can act as a tiebreaker in case of deadlocked decisions. This person should be neutral and not aligned with either shareholder.
Supermajority voting:
A clause may be added which requires a supermajority (e.g., 75%) for major decisions, ensuring that critical decisions need broader agreement beyond just a simple majority.
How to resolve shareholder deadlocks
If there are no mechanisms within the shareholders’ agreement to resolve a deadlock, alternative dispute resolution methods, such as negotiation, mediation, and arbitration may be considered. If court litigation is required, the following methods may be used to resolve the dispute:
Issuing a petition in court for the equitable winding up of the company
Filing a winding-up petition leads to the cessation of the company’s business operations. While this may prompt negotiations and potentially prevent the actual winding up, it can severely harm the company. This approach is risky but may be suitable if a shareholder wants to exit with their share of the company’s surplus funds before the conflict escalates. In cases of deadlock, the court must approve the winding-up petition, and strong evidence is required to justify the order. However, liquidation typically results in the loss of the company’s goodwill.
Issuing a petition to force one shareholder to buy out the other
Courts have extensive authority in resolving shareholder disputes, including the power to compel a shareholder to purchase the shares of another. The court can also set the price per share, often based on evaluations from independent experts. The court generally does not apply a minority interest discount. This option can be used to resolve deadlock by forcing one shareholder to buy the other’s shares at a fair market value determined by the court.
De-merger or spin-off between shareholders
De-merging, or splitting the company, can be an effective solution in cases of shareholder deadlock, especially if the business has distinct operational segments. Accurate valuation is crucial in this process, and there are potential tax reliefs available to mitigate immediate tax liabilities. However, navigating these tax issues requires careful planning to avoid pitfalls.
Unfair and prejudicial conduct claims
Claims of unfair and prejudicial conduct can arise if a shareholder engages in actions intended to devalue the company or if one shareholder consistently blocks dividend payments to force the other out under unfavourable terms. Such claims are stronger if the aggrieved shareholder can prove a “quasi-partnership” and show exclusion from management or other detrimental actions. If successful, the court may order the purchase of the petitioner’s shares by the remaining shareholders or the company itself. The success of these claims depends on the specifics of the situation.
Buy back and cancellation of shares
In cases where the company has sufficient funds, a share buyback can resolve a deadlock. This involves the company repurchasing the shares from one or more shareholders at an agreed price. This method can provide a straightforward resolution to shareholder disputes if the financial conditions are right.
How can South Bank Legal assist?
South Bank Legal are a team of commercial litigation solicitors in England. Our legal professionals are highly experienced and can provide advice and assistance with 50/50 shareholder deadlocks.
If you would like more legal advice on 50/50 shareholder deadlock disputes or wish to discuss any of our services, you can contact us using the form below or telephone 02035765179 for a confidential discussion with one of our solicitors.
Michael Czechyra is a senior commercial solicitor and the founder and Managing Director of South Bank Legal, a commercial law firm in Central London.
Michael primarily acts for business clients in corporate and commercial transactions and disputes, focussing on fintech startups, mergers and acquisitions, commercial contract drafting, as well as assisting with insolvency matters on behalf of technology companies and service providers, intellectual property issues, and complex business disputes.
Michael is known for his practical approach, his accessibility and his ability to meet his client’s timelines. His clients have included global corporations, private equity investors, financial institutions and trading firms, political parties and a national competition and consumer law regulator.
Michael has practised as a commercial solicitor since 1998. Prior to founding South Bank Legal, Michael held various senior and board positions at City of London law firms for several years.