Many SMEs start out as a joint venture between friends or family who take an equal shareholding and act as directors. Despite the best intentions, sometimes relationships sour and the shareholder-directors find themselves disagreeing about how to run the business.
These disagreements can lead to a deadlock situation, where both sides have equal votes but cannot agree on a way forward. This can cause serious damage to the business. So what options are available?
The shareholders may have entered into a shareholders’ agreement; a private contract between them which sets out how they will run the business. A shareholders’ agreement is in addition to, and not to be confused with, the Articles of Association, the public constitution of the company. A good shareholders’ agreement will contain provisions which provide a way to deal with deadlock.
Find a way through
Before looking at ways to end the relationship, it is always worth exploring whether anything can be done to preserve it. This will require an element of cooperation by the existing shareholder-directors.
- Independent professionals such as consultants or mediators may be able to help identify and work through road blocks and agree a way forward. This could even involve putting in place a shareholders’ agreement if there isn’t one already
- Appointing an independent director to the board can break voting deadlock and may bring fresh ideas and perspective to the business.
Agree an exit
If the shareholder-directors cannot agree to work together, then a negotiated exit may be the best option. This could come in several ways:
- One shareholder could exit, with their shares either purchased by the other shareholder or by the company itself if it has sufficient profits
- The whole company could be sold to a third party
- It may be possible to split out the business into separate parts, each being run as a separate business in future
- The business could also be wound up by consent, although this will rarely be appealing.
Each of these options will require ongoing cooperation between the shareholder-directors. An independent share valuation may be necessary as well as the involvement of lawyers to assist with transactional work.
Force an exit through a shareholders’ agreement
If there is a shareholders’ agreement in place, it may contain terms which allow one shareholder to trigger a compulsory purchase of the other’s shares, or even the winding up of the company.
There is no general right to force out another shareholder no matter how much you may disagree, which is why a shareholders’ agreement can be so helpful.
The court can intervene on behalf of a shareholder where there is what is known as “unfair prejudice”. This is where the business has been run in a way which is prejudicial to a shareholder’s rights as a shareholder in a way that is unfair. This could be where there has been a failure to award dividends or exclusion from management. The court can give directions about how the company should be run or, more commonly, order the purchase of shares subject to an independent valuation.
Typically, it is a minority shareholder who is suffers unfair prejudice because the majority shareholder has control of the company. Where there is a true deadlock situation with no majority or minority shareholder, it may be unlikely that either party has had the ability to cause unfair prejudice for the other. There is, therefore, no guarantee that an unfair prejudice claim would be a viable way out of deadlock. Unfair prejudice claims are also complicated and costly.
The court has a separate power to wind up a company where it is “just and equitable” to do so, which can be where there is true deadlock. However, the winding up of a company is rarely the best way to maximise the value of a shareholding so this option may really be a last resort.
The best way out of a deadlock situation will usually be a negotiated outcome, whether that involves the relationship continuing or not. If there is a shareholders’ agreement or if there is unfairly prejudicial conduct, there may be a mechanism to force out a shareholder, but these options may not be available.
Given the damage which can be caused by deadlock, the sooner the danger is recognised, and steps taken to avoid issues escalating, the better the outcome may be.