Navigating Shareholder Deadlock: Legal Options for Breaking the Stalemate

Introduction

The rights and obligations of the shareholders of a company inter se are typically regulated in a shareholders’ agreement (“SHA”). The SHA (together with the company’s constitutional documents) sets out the governance structure of a company and it ensures business continuity by providing a mechanism for resolving a deadlock or impasse in the decision-making process. Where there is no such formal written agreement, the default position is to typically rely on applicable law and the company’s constitutional documents where there is sufficient detail. However, this is not ideal and underscores the importance of the SHA.

A deadlock in the decision-making process may adversely disrupt a company’s ability to operate effectively, create financial instability and in the absence of effective dispute resolution mechanisms, lead to a relationship breakdown, indecision and a governance crisis.

A deadlock may occur either at the board or the shareholder level. At the board level, a deadlock often results in the decision being escalated to the shareholders for resolution or the decision failing due to the lack of the required majority for approval.

At the shareholder level, a deadlock generally arises when a decision cannot be made due to the requisite majority for approval not being met. This may occur where no single shareholder has a clear majority such as instances where there is a 50:50 shareholding structure or where shareholders have disproportionate shareholding but due to minority protections, one or more shareholders are able to exercise veto rights in respect of certain decisions.

Resolving a Deadlock

Shareholders acquire and hold shares in a company for their own interests and objectives, which do not always align. Deadlocks are inevitable and not uncommon in shareholding relationships, especially in joint ventures and/or family businesses. However, if there are effective resolution mechanisms in place, deadlocks should not be feared.

Usually, when there is a shareholder deadlock, the shareholders will, in good faith, attempt to negotiate and reach agreement to resolve the deadlock. However, if these negotiations fail, there must be other ways to resolve the deadlock. Below are common examples of mechanisms to address deadlocks.

Status Quo

If there is a deadlock, the decision fails, and the status quo prevails. The only way to resolve the deadlock is for the shareholders to reach consensus on the decision. While this mechanism seems straightforward, the disadvantage is that, until there is consensus, the decision will continuously fail, which may result in operational paralysis with the company stuck in limbo, incapable of making important decisions.

To mitigate this danger, the following safeguards should be considered: (i) limit the number of consecutive failures for a decision; (ii) escalate to an alternative deadlock-breaking mechanism after a defined limit is reached; and/or (iii) depending on the nature of the decision, make provision for a pre-agreed default position if there is a deadlock (for example, if the annual budget cannot be approved due to a deadlock, the annual budget for the previous year will apply subject to agreed escalation or adjustments to the previous annual budget).

Third Party Tiebreaker

The deadlock is referred to a third party, such as (i) the chairperson of the board, who may hold a casting vote; or (ii) an independent expert or (iii) arbitration. In each case, consideration should be given as to whether these determinations are to be binding or simply advisory; for certainty, such provisions are typically made binding. Referral to a chairperson can be advantageous in family conglomerates or closely held companies where the chairperson is one of the founders or considered an experienced elder statesman in the company. While an independent expert or arbitrator may offer neutrality, their competency must align with the matter at hand; an expert or arbitrator without the necessary expertise may fail to deliver a satisfactory outcome. In addition, shareholders may find it difficult to outsource or delegate critical governance or investment decisions to a third party who may not have experience owning or running a company, knowledge of industry nuances or “skin in the game” and a financial investment to protect.

Russian Roulette

In a Russian roulette, a shareholder offers to sell its shares in the company to the other shareholder at a specified price. The other shareholder has the option to either accept the offer and buy the shares or sell its own shares to the shareholder that made the offer at the same price. This mechanism is more straightforward in instances where a company has two shareholders.

If the company has more than two shareholders, the SHA must be drafted to avoid a situation where some shareholders accept the offer to purchase while others sell their shares instead. The shareholders receiving the offer should be obliged to act jointly in either accepting the offer or selling their shares. Due to its coin-toss nature, the risk of an unfavorable outcome focuses the minds and motivates shareholders to resolve the deadlock quickly.

Russian roulette is susceptible to abuse if there is a financial imbalance between the shareholders. The shareholder in a stronger financial position may artificially trigger this deadlock mechanism and specify a price, in the offer, that is lower than the fair value for the shares knowing that the shareholder receiving the offer cannot afford to accept the offer and buy the shares. In this case, due to its inability to accept the offer, the offeree shareholder must sell its shares in the company at the lower price set out in the offer. To mitigate the risk of abuse, the shareholders may agree, upfront, on a floor price or a methodology for determining the price.

Texas Shootout

In a Texas shootout, each shareholder submits a sealed bid to an independent third party setting out the price that it is prepared to pay to purchase the other shareholder’s shares. The shareholder with the highest bid wins and is obliged to purchase the other shareholder’s shares at the price set out in the winning bid. This mechanism is commonly used when only two shareholders are involved but can be adapted for more than two by requiring the winning bidder to buy all other shareholders’ shares.

Like Russian roulette, this mechanism may be used by a shareholder with greater financial resources to force the other shareholder to sell its shares. The shareholder with stronger financial resources is likely to win the bid, potentially at less than fair value.

A variation to the Texas shootout is the Mexican shootout. While infrequently used, the Mexican shootout may protect against potential abuse. Under this mechanism, the shareholder with the highest bid wins and is obliged to purchase the other shareholders’ shares at the price set out in the losing bid. Each bidding party will offer a non-exploitative price, knowing that they might have to sell at that price if they lose.

Compulsory Sale

This mechanism has a few options. If there is a deadlock, a shareholder may request that: (i) the company undertakes a process to sell all or part of the company’s shares to a third party; (ii) the other shareholder either sells its shares to the requesting shareholder (call option) or purchases the requesting shareholder’s shares (put option); or (iii) subject to compliance with applicable law, the company buys back the shares of the requesting shareholder.

A sale to a third party will not immediately resolve the deadlock, especially if the sale is conducted through an auction process with multiple bidders. A partial sale may be quicker to implement if the third party has already been identified, the shares are sold at a price that is attractive to the third party and/or the third party has adequate liquidity or financing arrangements. The arrival of a new shareholder as a result of a compulsory partial sale can itself resolve deadlocks in subsequent decisions.

A sale amongst shareholders or a buyback by the company is often faster to implement when there is a pre-agreed price mechanism and sufficient liquidity to finance the transaction. Moreover, shareholders should consider potential tax consequences of opting for a company buyback versus a share transfer.

Liquidation

Due to the implications of this mechanism—especially on employees, creditors and other third-party stakeholders—it should be considered a measure of last resort. It should only be triggered if: (i) the deadlock relates to a material decision; (ii) there is an irreconcilable breakdown in the relationship of the shareholders; and (iii) all other available deadlock resolution mechanisms have been exhausted without success. Under this mechanism, any shareholder may request the dissolution or liquidation of the company which will result in the assets of the company being disposed of and the proceeds being distributed to creditors and shareholders in accordance with applicable law.

Given the severe consequences, shareholders should avoid this mechanism whenever possible, and it is in the best interests of the shareholders to exhaust all other available deadlock resolution mechanisms.

Conclusion

A layered approach is ideal for resolving deadlocks. Shareholders should begin with amicable negotiation and, if necessary, proceed to mediation or referral to a third party. Exit options should be contemplated only after other remedies have been explored, bearing in mind the potential for abuse by financially stronger shareholders. While liquidation should generally be avoided, it may be the only viable solution if there are irreconcilable differences or a breakdown in trust.

Any deadlock resolution strategy should be carefully aligned with the applicable governing law (particularly with respect to enforceability) and tailored to the company’s specific business context and shareholder rights. It should also incorporate clear timelines and well-defined dispute resolution procedures.

Ultimately, an effective deadlock mechanism not only preserves business continuity but also protects shareholder value by ensuring that disputes are resolved swiftly, fairly, and predictably. A well-drafted SHA can therefore serve as both a roadmap for cooperation and a safeguard against paralysis when disagreements arise.