The potential for management deadlocks is typically an issue with private companies having two shareholders each holding 50% of issued shares, having equal voting and management rights and each shareholder having one nominee director on the board - usually the shareholders themselves. A deadlock will arise if the directors are unable to agree on the conduct of the business.
It is essential at the outset of planning the constitution of a company where there is potential for future deadlock, to consider and make provision for resolution before the conflict has arisen.
One option is to make no provision for conflict resolution, relying on the members to compromise and agree a solution to avoid liquidation of the company. The risk of this “Mexican Standoff” approach is that a solution cannot in practice be reached and, in the absence of the courts being called on to offer a solution, the company would have to be wound up.
A usual provision in memoranda and articles of association is that the chairman at board meetings is given a casting vote, however, this may not be an appropriate mechanism if the chairman is to be one of the directors. The parties might in the alternative consider appointing someone who could be appointed as an independent Chairman, trusted by both parties, who has mediation skills to encourage consensus or who otherwise will exercise a casting vote if required to do so.
Provision could be made in the company’s articles of association for the powers to be reserved to shareholders to make decisions in the event of board deadlock, although this may be ineffective if the shareholders and directors were the same individuals.
An alternative mechanism may be for an independent, non-executive director, to be appointed to assist in decision-making for the company, from its inception, or during a period of director conflict. Such individual would need to have appropriate business expertise and be prepared to take on potentially significant risks and responsibilities, presumably for a fee. For technical, rather than commercial issues, the issue over which there is deadlock could be referred to an independent expert for resolution.
Put and call options
Including mutual “put and call options” in the shareholders’ agreement are a mechanism for allowing each shareholder the right on notice to require the other to purchase or sell his shares within a stated period in accordance with an agreed mechanism and formula in the event of deadlock. Such provisions usually favour the financially stronger shareholder who can afford to buy out the other shareholder.
Court intervention and mediation
The courts can be called on to intervene in a variety of circumstances related to company deadlock, for example where there is a breach of the company’s written constitution or in the event of gross misconduct in the form of fraud or breach of fiduciary duty. The court can also assist with disputes that arise from expectations relating to original arrangements for the joint participation in the management of the company or a share of the profits and liabilities.
Unfair prejudice petitions made to the court under Part 20, Articles 141-143 of the Companies (Jersey) Law 1991 give members the power to apply to the court for an order on the ground that the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or some part of them, or that an actual or proposed act or omission of the company is or would be prejudicial. Such applications require fault to be demonstrated on the part of the other shareholder and where both shareholders are equally at fault there is not necessarily unfair prejudice and the court will not assist.
In the recent Royal Court judgement of Representation of Galasys Plc JRC149A the Royal Court endorsed an historic and little used legal principle that allows shareholders to intervene when a company's board is deadlocked. The basic facts of the case were that the board of a Jersey company were unable to make a decision concerning litigation the company was engaged in because of personal interests that some of the directors had in the litigation which conflicted them from counting in a quorum.
The court relied on a 1914 English case, Baron v Potter which established the principle that where the board of a company is unable or unwilling to act, the shareholders of the company may in certain circumstances intervene in the management of the company by passing an ordinary resolution. A company’s articles of association usually make provision for the shareholders to give directions by ordinary or special resolution, but where a board is not functioning they may not be able to implement the shareholders’ direction.
The Baron v Potter principle may allow the shareholders to use the company’s powers directly, effectively to manage it in certain circumstances, although the scope for such potential intervention is currently unclear.
The use of mediation in seeking to achieve a mutually beneficial solution should always be seriously considered first when litigation looks like a real possibility. Parties need to approach mediation in good faith and intending to compromise as a mediator has no power to impose a solution on the parties. In the alternative an arbitrator could be appointed to determine a particular technical issue and impose a solution on the parties.
Relying on litigation as fallback solution in the event of a paralysed board is unlikely to be satisfactory, being costly, adversarial and usually not fast enough to meet the commercial needs of the business.
A further drawback of relying on a court solution is that a judge will be concerned with finding wrongdoing and laying blame rather than applying commercial judgement to the situation, and such course of action may produce an outcome very different to the one anticipated by the parties, for example that a company be wound up on just and equitable grounds.
Winding up of the company
If other mechanisms for resolving a company deadlock are not available or unsuccessful in resolving the issue, voluntarily putting the company into liquidation may be the only workable solution. Indeed, a shareholders’ agreement might specifically provide that the assets are to be sold and the company wound up if the deadlock continues for a stated period of time - usually with either shareholder being able to bid for the assets.
In the absence of cooperation between the companies in putting the company into voluntary liquidation a party may be able to achieve winding up by an order of the court.
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