In the world of business, conflicts between shareholders are not uncommon. Shareholder deadlock is a situation where the shareholders of a corporation are unable to reach an agreement on a matter that requires their consent. This can occur when there is an even number of shareholders (such as a 50-50 split), or when a minority shareholder disagrees with the majority shareholders. In such situations, it is essential to have a well-drafted shareholders’ agreement in place to provide for the resolution of any deadlocks.
What is a Shareholder Deadlock?
A shareholder deadlock occurs when two or more shareholders in a corporation are unable to reach a decision on how to run the business. When shareholders are at an impasse, the business can grind to a halt, and the value of the company can be at risk.
One of the most common causes of a shareholder deadlock is an even number of shareholders. In this situation, it can be difficult to achieve a majority vote, and the shareholders may be unable to resolve their differences. Another common cause is a fundamental disagreement about the direction of the business, such as a disagreement about the adoption of new technology or the expansion into a new market.
Strategies for Resolving Deadlocks
A well-drafted shareholders' agreement can help prevent a deadlock by clearly outlining the decision-making and dispute resolution process between the shareholders, such as voting rights, information rights, the right to participate in dividends and distributions, appointment of directors and officers, and decision-making for fundamental matters (i.e. major business decisions). In addition, a shareholder agreement can provide a mechanism for resolving disputes and breaking a deadlock. This can include provisions for mediation, arbitration, or buyout options.
When putting together deadlock provisions in a shareholders' agreement, the parties must define the deadlock situations which will trigger the deadlock procedure and include these situations in the agreement.
Consider incorporating the following provisions in the shareholders' agreement to help resolve deadlock situations:
Chairperson Swing Vote
The shareholders can provide that the Chair of the Board or a third party can have a casting vote in the event a deadlock occurs. This clause effectively provides a veto to one person.
Russian Roulette
A Russian Roulette clause (also called a "Shotgun" or "Buy-sell" clause) allows one shareholder to offer to sell their shares at a price they determine to the other shareholder, who can either accept the offer or make a counteroffer to buy the shares at the same price. This mechanism encourages shareholders to compromise and find a mutually acceptable solution, as they know that they could end up owning the entire company if they do not. This type of clause is to be used with caution as it can be abused by shareholders with more financial means than another.
Texas Shootout
This is a variation of the Shotgun clause which provides for each shareholder to submit a sealed bid to a third-party indicating their willingness to either buy or sell their shares at a specified price. Once the bids are opened, the shareholder with the highest bid gets to purchase the other party's shares at the price submitted by the other shareholder. The winning shareholder is required to buy the shares at the price offered by the losing shareholder, or they can choose to sell their own shares to the losing shareholder at the same price.
Compulsory Buy-Out
Under such a clause, one shareholder is given the right to buy out the other shareholder’s shares at a predetermined price in the shareholder agreement. This mechanism can be helpful when there is a significant power imbalance between the shareholders, as it allows the majority shareholder to force the minority shareholder to sell their shares.
Drag-Along
Under this provision, the majority shareholder has the right to require the minority shareholder to sell their shares in the company if the majority shareholder is selling their shares to a third party. This provision can be effective in breaking a deadlock, as it provides the minority shareholder with an incentive to reach an agreement.
What options are available under the Business Corporations Act?
Corporations are creatures of statute, such that where the shareholders failed to turn their minds to the demise of their business relationship when they were ad item (whether at the beginning of their enterprise or at any point throughout), and are not able to reach an agreement as to how they will part ways, they must turn to the relevant legislation to resolve the issue. In Ontario, there are two applicable statues, the Canada Business Corporations Act and the Ontario Business Corporations Act.
One option is to ask the court for an order to resolve the deadlock. This can include an order for the appointment of a receiver, an order for the sale of the business, or an order for the purchase of shares by one or more shareholders. The court can make an order it sees fit.
Another option is to wind up or dissolve the corporation under s. 207 of the Business Corporations Act, a corporation may be dissolved if the shareholders are deadlocked and the corporation is unable to carry on its business. A similar section exists under the Canada Business Corporations Act. Both legislations require that in situations of shareholder deadlock, the courts must be satisfied that dissolving the corporation is “just and equitable". The courts have repeatedly characterized winding up remedies in deadlock situations as “draconian” and a solution of a “last resort”.
The court may also make an alternative order where dissolution is not "just and equitable". In fashioning an alternate remedy, a court will take into consideration the reasonable expectations of the parties while being minimally intrusive by not delivering a remedy that favours one side. The court’s must resolve the deadlock and not to punish one party or the other.
In conclusion, a shareholder deadlock can have significant consequences for a corporation. Shareholders’ agreements that include provisions for resolving deadlock situations can help to prevent disputes from escalating and provide certainty for all parties involved. However, it is crucial to seek legal advice and ensure that any deadlock provisions in a shareholders’ agreement comply with applicable laws and regulations.
To discuss your business law needs, you may get in touch in the following ways:
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email at reception@arralawfirm.com, or
phone at 905-629-2722.
