How do I Resolve a Shareholder Deadlock?

The most common form of shareholder deadlock usually occurs when a company is owned 50/50 between two equal partners (as discussed in THIS article). In such a case, all decisions have to be agreed to by both parties. However, deadlock situations can also arise with non-50/50 ownership arrangements too. It’s just that the 50/50 type is a lot more common.

When two partners own equal shares in a company, there needs to be a mechanism in place which can resolve any disputes or disagreements which could arise in the future. It’s often the case that at the outset, the two partners go into business as the best of friends, with no disagreements between them and a shared vision for how they want the company to grow and develop.

But sadly, things can always change in the future and if the parties don’t put a method in place from the outset for resolving arguments, the business can end up paralyzed, and unable to operate, should the two partners fall out.

The only way to resolve this situation (if there aren’t any deadlock resolution provisions in the shareholder's agreement) is to go to court and fight things out there – which is never an ideal solution.

So, a shareholders agreement between two 50/50 partners must contain a suitable deadlock resolution clause. Whilst it is possible that a disagreement between two parties may be solved by imposing the decision of an independent third party to decide between them, this is often not a good way of resolving matters, as a third party may not be totally independent, and may be biased towards one of the parties involved.

Another reason that appealing to a third party may be a less than optimal solution for breaking the deadlock is that they may not have all the information and/or knowledge required, or a proper understanding of the business, or at least, not as complete an understanding as the business’s actual owners have.

So, what’s the alternative?

There are two commonly-used mechanisms in a shareholders agreement for resolving a deadlock, which goes by the somewhat exotic names of ‘Mexican Shootout’ and ‘Russian Roulette’.

The ‘Mexican Shootout’ is easier to describe: If a deadlock occurs and cannot be resolved than either party can initiate the process to buy the other one out. As the business is owned 50-50, neither party should be given preferential treatment and the person who is prepared to pay the most for the other person’s share of the business wins.

This type of resolution doesn’t require the business to be valued, or for a minimum amount to be paid. Simply, the two owners bid against each other until there is no higher offer on the table.

The other option is called ‘Russian Roulette’. As the name suggests is that this is a one-shot deal. In the event of a deadlock, either party triggers the process by sending a notice to the other side stating a price. The recipient can then decide whether they want to either buy out or sell out their shares of the business at this price.

This idea works in practice because the person initiating the process doesn’t know if he’s going to be bought out, or if he’ll be the one buying out the other, so he should choose a reasonable, fair price.

Both of these methods provide an alternative to the company to become paralyzed or ‘frozen’ due to a disagreement. Of course, the business owners are always free to negotiate any other solution to the deadlock, but having these clauses in place means there is always a binding fallback solution which can be relied upon, if no other resolution can be found.