Deadlocked companies: breaking up can be hard to do

Setting up a company is a venture that can be both exciting and nerve-wracking. The buzz and excitement that comes building a brand, hiring a team, investing finances and purchasing resources often means that the underlying structure of your company can be overlooked, leading to frustrating consequences. A company in ‘deadlock’ is an example.

As a company grows, its shareholders are often required to make a number of important decisions. Examples of such decisions include; whether the company should change its name, whether it should permit specific asset transactions or whether it should obtain financing to help it grow?

A deadlock can arise in companies whose shareholders each own 50% of the shares in the company (or equal proportions if there are more than two shareholders) and who each have equal voting rights. In such an even structure, deadlock arises when an equal number of shareholders vote in favour of a resolution, as do against; and no-one will budge.

So what can a company do to prevent a deadlock, what can it do if it is in deadlock; and what can it do to mitigate the frustration of a deadlock situation that may arise in the future?

Preventing a deadlock
The obvious and only way of preventing a company deadlock is to have an uneven number of shareholders who all have equal voting rights. A company with three, five, seven or any bigger odd-number of shareholders with equal voting rights could pass a resolution with more shareholders in favour of it than against; or defeat a resolution with more shareholders against than in favour of it.

Breaking a deadlock
There are a number of ways a company can break a deadlock. Here’s a list, in ascending order of cost and complexity but descending order of attractiveness:

• Reconciliation

The shareholders’ could mutually sort out their differences. This could involve engaging a mediator to assist with reaching a compromise while ensuring all the shareholders can work together in the future.

• Make an Exit

If possible, one or more shareholders could buy the other shareholder(s) out, or alternatively one or more shareholders could sell their shares to a third party, bringing in in a new shareholder with a fresh opinion. The latter option doesn’t guarantee that the company won’t still be in deadlock though.

• Restructure the company

Consider whether it is possible to split the business or restructure it to include new investors who may have a new opinion. New investors can be introduced if the company allots new shares.

• Arbitration or Expert Determination

Referring the deadlocked matter to an external arbitrator or expert determiner could unlock the deadlock. However, such a referral can be time-consuming and expensive.

• Wind-up the company

Perhaps the least desirable option, but in the absence of other workable options; the shareholders could opt to wind up the company, divide the assets between them and go their separate ways. If the shareholders cannot agree to place the company into liquidation, company deadlock is a ground under section 122(1)(g) of the Insolvency Act 1986 to apply to the court for the company to be wound up.

Mitigating the frustration of a deadlock
Whilst there are options available to a company in deadlock, deciding which is the most attractive and cost-efficient can take time and ultimately requires mutual agreement between the shareholders; which given there is a deadlock, is something which there is likely to be a lack-of! Shareholders could turn to the company’s articles for an answer, but unless there’s a special article dealing with deadlock, it’s unlikely they will be of any help. The Companies Act 2006 is also unhelpful too in that it omits provisions which deal with a company deadlock situation.

However, a shareholders’ agreement could contain the hammer that will break the deadlock. Before a deadlock situation arises the shareholders of a company can mutually agree the method of resolving the deadlock and through provisions in a shareholder agreement; provide that such a method be employed in the event the company becomes deadlocked. Common methods include those listed above.

Here at Parker Bullen solicitors, our expert business lawyers are able to advise-on and draft bespoke shareholders’ agreements to suit your business arrangements; or offer your business comprehensive advice on company structuring and resolving deadlocks. For more information, contact a member of the Parker Bullen commercial team today.

ENDS

This is for information purposes only and is no substitute for, and should not be interpreted as, legal advice.  All content was correct at the time of publishing and we cannot be held responsible for any changes that may invalidate this article.