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Untangling the corporate knot: How to prepare for and resolve corporate deadlocks

By Ryan Olson

When it comes to dispute resolution, few circumstances are as complicated as a corporate deadlock. The professional consequences are potentially profound, with financial implications that could affect the lives and livelihoods of large numbers of employees. More often than not, corporate deadlocks involve a degree of emotion and personal conflict that can make a successful and mutually satisfactory outcome seem even more elusive. We put so much time and energy into building and growing a business that when challenges arise – whether it is differing opinions on what direction to take the company or differences in management philosophy – having conflict resolution mechanisms in place for ownership is necessary, otherwise any material issue affecting the company could lead to a standstill.

The beginning of a business venture can feel like a honeymoon period. Almost by definition, a thriving business has been through a period of growth and prosperity. But regardless of how sunny things look at the outset – or during periods when the business is flourishing and all members of the leadership team are on the same page – situations do change. New circumstances arise. Personal and professional priorities evolve. Market realities shift. And a well-established company is a very different animal than one just starting out. Even the strongest business relationships will ultimately be tested, and, in some cases, lead to friction – or, perhaps more commonly, simple-but-significant disagreements over the future direction of the organization.

Whatever the source of the dispute, an inability to come to an agreement about one or more material issues affecting the business can sometimes lead to a deadlock. Typically, a company’s governing instrument, whether it is an operating agreement or shareholder’s agreement, will set forth what issues are material to the business and which require a vote of the shareholders or members. Voting requirements in these scenarios typically call for majority-in-interest or super-majority. If the vote necessary to move the company in one direction or the other cannot be achieved, and ownership disagrees about how to proceed with the business of the company, a deadlock situation may arise. A deadlock situation without a mechanism to resolve the problem can lead to a costly company standstill and expensive litigation.

Courting trouble

Not only are deadlocks a potential financial liability, they can be emotionally challenging, and the uncertainty and leadership tension can be deleterious to the future of a business. The key is to minimize that uncertainty by agreeing upon a dispute resolution process well ahead of time – before conflicts arise. Any governing instrument, whether it’s an operating agreement or shareholder’s agreement, should clearly specify the agreed-upon deadlock remedy, with detailed steps clearly delineated. If a deadlock remedy does not exist, the deadlock may be subject to resolution by the courts. This is an outcome which should be avoided at all costs, as it could lead to a forced sale (which would almost certainly fail to return maximum financial value) or even the dissolution of the company.

To avoid an unfavorable resolution by the courts, decision-makers should address deadlock issues when starting a new business, inheriting a family business, or at the outset of any new professional relationship. Shareholder’s agreements and operating agreements should also be reviewed and updated periodically whenever there is a significant change in the business or ownership structure.

The important takeaway here is that you should never leave the future of your company and its employees up in the air: codifying a mutually agreed-upon deadlock remedy before conflicts arise is simply good business.

Breaking a deadlock

Common mechanisms for resolving a deadlock include:

  • Russian roulette: In this scenario, one deadlocked party serves a notice on the other. That notice specifies an all-cash price based on the serving party’s valuation of a half interest in the company. The party receiving the notice can subsequently decide to either buy the other party out at that price, or to sell their share of the business to the serving party at that price.
  • Texas shootout: In a Texas shootout, each party submits a sealed all-cash buyout bid to a neutral third-party. Both parties agree beforehand that the party who submits the highest bid must then buy out the low bidder’s share in the business at that price.
  • Mexican shootout: This process (also commonly referred to as a Dutch auction), begins with both deadlocked parties submitting sealed bids containing the minimum price for which they would be willing to sell their share of the business. The highest bid wins, and the winning bidder is obligated to then buy the loser’s share – but at the price the loser submitted.
  • Arbitration: A straightforward (binding) arbitration process overseen by an agreed-upon neutral third party.
  • Additional directors/third-party advisors: Third-party advisors who are trusted and respected by both parties will settle the dispute in a manner that they consider to be in the best interests of the company (without regard to who wants what).

These are just a few of the proven processes and strategies for resolving a corporate deadlock. By no means is this list comprehensive. Each business should identify a solution that works for them.

One thing to keep in mind is that the best way to resolve a deadlock is, if at all possible, to avoiddramatic remedies in the first place. It is best to advise clients preparing or updating their governing instruments to plan for the worst and hope for the best by including deadlock resolution provisions that foster collaborative solutions where possible. Also, encourage clients to give themselves some time (typically at least 2-4 weeks) to come to a mutual agreement, and then another 2-4 weeks to participate in guided mediation. If the deadlock is not resolved during that time, only then should you proceed with one of the processes outlined above.

Decision-makers with questions about corporate governance or resolving shareholder disputes would be wise to reach out to experienced legal counsel, preferably a trusted legal resource with a robust corporate law practice group and a reputation of exceeding client’s expectations.

Read the original article on Corporate Counsel Connect, part of the Thomson Reuters.