Shareholder disputes can be a challenging aspect of corporate governance, especially when they lead to corporate deadlocks. These disputes can prove very costly, stressful and time consuming, and can see a company prematurely being brought to an end. If a deadlock has arisen in your company, it is important to seek legal advice as soon as possible. Stanley & Co Lawyers in Adelaide are experts in resolving shareholder disputes, ensuring that businesses can continue to operate smoothly and efficiently. Book a free, no obligation 30 minute consultation with expert commercial lawyers today.
Shareholders & Directors: The Backbone of a Company
A company is a popular vehicle or business structure from which business can be conducted. The Corporations Act 2001 (Cth) provides that a company is a separate legal entity and recognised as an individual entity in its own right. The company’s operations and management decisions are overseen by its directors, who are the company’s “mind and body”. Shareholders, on the other hand, are the “owners” of the company and typically have a more passive role in its daily operations. These shareholders can be individuals or other corporate entities.
What are Your Rights as a Shareholder?
It is often intended by parties setting up a company that the company will be “owned” equally by each shareholder, and so each party becomes an equal shareholder in the company. Unless the company’s internal rules (i.e. constitution) or a well drafted shareholder agreement provides otherwise, most day-to-day decisions in relation to the company’s management will require agreement by both of its directors (where there are 2 directors) or otherwise by a majority of its directors.
Shareholder Disputes: The Perils of Deadlock
Shareholder disputes often arise when there is an equal shareholding in a company. These “deadlocks” can become problematic when a dispute arises between the directors (who are often also shareholders). Such situations can halt company operations, as decisions usually need majority shareholder approval. Without a predetermined mechanism to handle such disputes, a company can become paralyzed, unable to make decisions due to a 50:50 voting split. This is particularly concerning as directors are legally obligated to prioritize the company’s best interests over their own.
Helpful Questions & Answers
Case study: Worst Case Scenario
We recently represented one of the shareholders of a company which operated a café business. The other shareholder had been a friend of our client. Sadly, the other shareholder had developed an addiction to illicit substances and was not responding to our client in relation to important decisions concerning the company’s affairs.
Winding Up Application
Because the other shareholder was not responsive, no agreement could be reached in order to resolve the deadlock. We were instructed to make an application to the Federal Court of Australia for the company to be wound up.
That application was successful and a liquidator was appointed. A close family member of our client then offered to purchase the café business from the liquidator, an offer which the liquidator accepted. The court made an order that our client’s costs incurred in making the court application be paid out of the company’s assets by the liquidator.
After the winding up was complete, the business was able to continue operating, albeit that it was sold to our client’s family member. This example is the “worst case scenario”, but is illustrative of how deadlocks may need to be resolved if agreement cannot be reached.
How Can Corporate Deadlock be Prevented?
When incorporating a company business structure, this situation can be avoided by having a comprehensive company constitution and/or shareholders agreement prepared, which can set out dispute resolution procedures that all parties agree to at the time the company is first established. Some examples of how these agreements can prevent or resolve deadlocks are:
- “Russian roulette” clauses: in the event of a deadlock, a Russian roulette clause allows a shareholder to offer to sell its shares in the company to the other shareholder at a nominated price. The other shareholder can either purchase the shares, or can instead offer to sell its own shares at the same price to the shareholder making the first offer.
- Appointment of a “chairperson”: a shareholders agreement can appoint a “Chairperson” of the board who will have a “casting vote” at directors meetings. The chairman will have the final say if agreement cannot be reached between the directors.
It is not too late to have such an agreement prepared if one does not currently exist. These documents can be prepared at any time after the company has been incorporated provided that all relevant parties are prepared to agree to their terms.
Resolving Deadlocks: The Path Forward
If a deadlock arises and there is no agreement in place as to how it is to be dealt with, the following options are available in order to resolve the deadlock with a view to saving the company’s business:
- Discussions: it is best practice in all cases to enter into discussions in good faith with the other parties in an effort to reach agreement to resolve the dispute. Parties are expected to act in good faith in order to resolve the dispute without recourse to more formal proceedings.
- Mediation: if the parties are unable to resolve their dispute directly, an independent third party can be engaged to mediate the dispute and to facilitate further discussions between the parties. The parties can be represented by lawyers during the mediation process.
- Arbitration: the parties may agree to an independent third party “arbitrating” the dispute. The arbitrator will hear from the parties and make a decision (similar to a judge in court proceedings) which the parties agree to be bound by before participating in the arbitration.
- Buyout: the parties may wish to negotiate that one of them purchase the other’s shares, or that the shares be sold to a third party. In some cases, it might be agreed that all of the shares in the company be sold to a third party, thus bringing an end to the deadlock.
The Last Resort: Winding Up & Liquidation
If the deadlock cannot be resolved after exhausting all alternative dispute resolution methods available to the parties, “winding up” is a remedy of last resort. This ordinarily involves an application being made to the Federal Court to order that the company be wound up on the basis that it is “just and equitable” to do so.
In some cases, the directors will be at risk of being unable to meet their legal duties to their company as a result of the deadlock and so it is important that steps be taken to wind up the company if the deadlock cannot be resolved.
Once the court orders that a company be wound up, a liquidator will be appointed. The liquidator may continue to operate the company’s business in order to ensure that its creditors are paid (if it is profitable), or otherwise may elect to sell off the company’s assets, pay out all of its debts and distribute any remaining balance to the shareholders (after payment of the liquidator’s professional fees). It is sometimes the case that the shareholders receive nothing after the liquidation is complete because there are no funds left over for that purpose.