How to resolve your shareholder dispute in a deadlocked company
Steve Dillon, 4th December, 2013
Two friends or relatives who trust each other implicitly go into business together, setting up a company for that purpose. Both are appointed as the only directors and they are each allocated 50% of the shares in the company. There is great optimism at the start. However, a few years later things do not look so good.
They have a disagreement over the direction that the business should go in. Because they are pulling in different directions but have equal control of the company, the company is effectively frozen (or ‘deadlocked’.) The business operated by the company quickly starts to suffer and the early optimism turns to bitterness.
This is, believe it or not, a common scenario. Quite often the first time that I am asked to advise is after the relationship between the parties has broken down.
To try to resolve the impasse, the following need to be considered:
1. Is the company deadlocked at all?
Sometimes, a company that appears on paper to be deadlocked is not. One of the parties, for example, may have additional voting rights due to being a different class of shareholder; or one may have a casting vote at Board level.
Just because one party has ultimate control does not mean, of course, that the dispute itself has gone away. If anything, for the party not in control, the situation is even more critical and he or she may need urgent advice to protect their position. Although outside the scope of this article, that may include considering unfair prejudice proceedings or bringing other commercial pressure to bear. Even the party who is in control will still need careful advice on how to validly protect and assert his or her rights if he or she is to avoid difficulties, such as an unfair prejudice proceedings.
2. Consider mediation
Where the company is genuinely deadlocked, then I regularly advise my clients to consider mediation.
Mediation is an alternative way of resolving disputes without the need to go to Court. The Courts themselves actively encourage the parties to consider mediation, and can (and do) penalise a party to a Court action who has refused to even contemplate trying to resolve matters via mediation.
Mediation is designed to try to move the parties in dispute towards reaching their own agreement to settle the issues between them with the assistance of an independent party, the mediator. A skilled mediator usually attempts to achieve a consensus over the course of a day (or longer depending on the complexity of the issues) through frank discussions in a combination of meetings with all parties present and private meetings with one party or the other.
Mediation is more flexible in what it can achieve as an outcome than the Court process because the parties can settle the claim on any basis permitted by the normal law of contract. The remedies that the Court can force upon parties are much more limited. I have been involved in several mediations that actually end with the parties successfully agreeing to work together going forward, but even if this is not achievable there is a good chance that the parties will be able to resolve their issues by way of one party exiting the business or the company being closed down in a sensible and cost effective manner (see ‘Winding Up’ below).
Mediation is invariably quicker and cheaper than the Court process and has a surprising rate of success even where the parties believe that their relationship has broken down irretrievably.
3. Winding up
Where, ultimately, all else fails the parties can place the company into liquidation.
Dialogue between the parties (whether via mediation or otherwise) can result in an agreement that the company ought to cease trading and be wound up. Even if the parties cannot resolve their differences, sometimes this is an attractive option as it places a third party in control of the company which, in itself, can break a deadlock – albeit at the price of the death of the company.
If the parties can agree at least this much then a voluntary winding up can be considered, and I often advise on the benefits of this route for particular companies and help their directors liaise with experienced and professional insolvency practitioners.
If the parties cannot reach any agreement at all, it remains open for one of the parties in a deadlocked company to ask the Court to order that the company be wound up on the grounds that, because the company can no longer carry out the functions it was incorporated to, it is just and equitable for it to do so.
4. Shareholders’ agreement
The most effective way of dealing with a dispute is, of course, to avoid it altogether.
The best way to avoid a company becoming deadlocked, or, alternatively, to set out a procedure for what is to happen if a deadlock does arise, is for the parties to plan ahead at the earliest possible stage by agreeing a shareholders’ agreement between them.
While nobody wants to consider the possibility of problems when times are good, a well-drafted shareholders’ agreement will enable the parties to agree in advance. The parties can hold a sensible and practical debate on what will happen if difficulties do arise, reducing the need for acrimony later.