Shareholders’ agreements & deadlock clauses

One of the most important issues to be addressed by a Shareholders’ Agreement is what happens where the directors or shareholders cannot agree and a deadlock arises.  In cases where voting of Directors of a board is proportional to the shareholding represented by the appointed director, or there can be a deadlock caused by “one vote, one director” care needs to be taken to ensure that control can be exercised by addressing the deadlock issue.  Of course the deadlock can also be between shareholders.

There are a number of clauses (Deadlock Clauses) which can be included in a Shareholders’ Agreement to address a deadlock which are commonly referred to as:

  • Auction;
  • Arbitration;
  • Best Endeavours;
  • Chairman with have casting vote;
  • Compulsory Mediation;
  • Liquidation;
  • Russian Roulette; and
  • Sealed Bid.

In drafting a deadlock clause care needs to be taken at the outset to ensure that any such clause is not oppressive according to section 232 of the Corporations Act 2001(Cth) (Act).   Whilst the parties are free to contract it can be tempting for the drafter to cross the line into oppression with the stroke of a pen.  Minority shareholders must consider the financial resources of the majority in particular when considering dispute resolution clauses.

Read more about shareholder oppression here.  Generally disputants are required to comply with the dispute resolution provisions in a Shareholders’ Agreement before initiating proceedings in a Court of competent jurisdiction, subject of course to the right to seek injunctive relief..

Auction

An auction clause enables the disputants to bid on the other party(s) securities with the party that bids the most having the right to buy out the others.  Clearly this will be a battle of the cheque books and favour the one with the largest one.

Arbitration

An independent arbitration clause entitles the parties to appoint an arbitrator who will make a binding decision based on the submissions advanced by each disputant.   The Arbitrator has to take an objective look at the facts and make a binding decision.   An arbitration clause can apply in a variety of circumstances where a decision is deadlocked.  The best interests of the shareholders as a whole will need to be used as the basis of the decision.

Best Endeavours

This clause is perhaps the least confrontational as it broadly requires that the parties to the dispute (be they directors or shareholders) to meet informally to attempt to resolve the dispute between themselves.    That said, whilst not confrontational it is perhaps the least effective.

Chairman with casting vote

This clause entitles one of the directors to become the Chairman of the board and have a casting vote in the cases of a deadlock on certain matters.  The effect of this is to acknowledge that certain decisions can be made by the Chairman if the directors don’t agree.  There needs to be some exclusions where there is a conflict transaction or for some reason there is no chairman appointed at the time.

This clause can reduce the amount of issues which can give rise to a deadlock whilst effectively vesting power in the Chairman.  One of the benefits of this can be to provide the Chairman with a casing vote on some issues but not others, this reducing the number of decisions which can be disputed.  That said, this still means that a deadlock can arise and a further deadlock clause will be required.

Compulsory Mediation

A Compulsory Mediation clause can be described as a more onerous Best endeavours clause that forces the parties to the dispute to attend a mediation session with a third party mediator.  Mediators are generally skilled at facilitating the development of a solution they cannot pass judgement like an arbitrator.  They generally do not take sides and the mediator’s costs are generally shared.  That said care needs to taken in drafting this clause as there are timeframes to consider and also the cost of a third party mediators needs to be considered.

Liquidation

Whilst not palatable in a lot of circumstances, this clause enables the affairs of the company to be wound up by liquidation in the event of a deadlock.  It is usual for the security holders to share in the cost of the liquidator.  It is usually applicable where the dispute has been going on for some time and the company is not performing well.

Third Party Buyout

This clause appoints one security holder to be authorised for a set period of time to attempt to identify and negotiate with a third party buyer for the other parties securities.  The sale can be by buying assets or shares in the company.  The applicability of this clause will really depend on the stage of development of the business of the company and how profitable it is to third parties. It is usually not appropriate for early stage companies.  Most importantly is that when selling a business enterprise, much like selling residential real estate, it is preferable if the property is ‘styled’ or presented in its best light.  Where a dispute has arisen between shareholders this can be made practically more difficult.

Russian Roulette

This clause entitles one or more security holders, to buy the others securities at an agreed upon price, but also entitles the other to buy the bidder out at the same price.  If nobody agrees to sell at this price, this provision escalates to allow for counteroffers, until a price is agreed to buy a security holder.  This clause is similar to Sealed Bid clause that allows for counter offers.  It is usually applicable where there are a number of equally resourced parties.

Sealed Bid

This clause forces the disputing security holders to make a sealed bid to buy the securities of the others in addition to the other contracts with Director(s).  For example consideration may to be had to the benefits paid to contracts associated with directors.  The parties have one opportunity to advance a bid to a third party Arbitrator who must then decide which offer is to be accepted considering the submissions and the value of the bids.  The obvious bias in this option Iike a lot of others is that it favours the security holder with the greatest resources.

Links and further references

Legislation

Corporations Act 2001(Cth)

Related articles

Shareholder oppression – valuation issues

Shareholders’ right to information

What is a section 293 direction?

What do Shareholders’ agreements protect against?

Shareholder oppression

Shareholders’ agreements and inconsistency clauses

Tag along rights in shareholders’ agreements

Further information

If you need assistance or advice on shareholders’ agreements or shareholder oppression, telephone me for an obligation free and confidential discussion.

 

Franchising lawyersMalcolm Burrows B.Bus.,MBA.,LL.B.,GDLP.,MQLS.
Legal Practice Director
Telephone: (07) 3221 0013
e: mburrows@dundaslawyers.com.au

 

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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