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What is deadlock?
“Deadlock” arises when those in control of a business are engaged in an irresolvable conflict between themselves. A typical situation involves a company with two shareholders at loggerheads over a particular issue.
In an ideal world, before setting out in business together, everyone concerned would turn their minds to and agree to what should happen in the event that they were to fall out. The agreement would then be recorded in writing in either a company’s articles of association or as part of a shareholders’/members’/partnership agreement. Quite understandably however, especially where the parties to a joint venture are close or in cases involving first-time entrepreneurs, the ‘worst case scenario’ is often overlooked.
There are various tried and tested methods for agreeing to resolve deadlock. These usually provide a mechanism by which one party can force the other to either buy or sell their share in the business.
If nothing is agreed and a deadlock situation does arise, the consequences can be catastrophic. If the business fails or is forced to stop trading because of the stalemate, the parties may have wasted a great deal of time and money. If what was previously a going concern becomes nothing more than a group of assets, a huge amount of worth can evaporate.
It is quite often, particularly where misconduct is being alleged as part of the deadlock, that some parties try and remove others from a business. The repercussions of doing so are outside the scope of this article but such a course of action can be dangerous. If in this position, always take advice.
What should/can be done if deadlock arises?
Resolving deadlock can be complicated, expensive and involve some very difficult decisions.
1. Check your records
First of all, check to see if anything was recorded in writing. It may have been a number of years since the business was established and documentation may have been long forgotten.
If the business was set up as a company then articles of association will be held at Companies House and there may be a Shareholders’ Agreement contained in the company’s statutory books (a file containing the company’s corporate documentation which should be kept at its registered office). If the business is a partnership or LLP then there may be a Partnership or Members’ Agreement recorded. Any of these documents may provide a mechanism for resolving deadlock.
Agreements do not necessarily have to be contained in a single document, signed or in fact recorded in writing at all. If you recall that something was discussed or agreed then check your emails/files to see if you can find anything which sheds some light.
2. Try to negotiate
If nothing was agreed, and one or more parties wish for the business to continue, then it may be possible to negotiate the purchase of the other parties’ shares. The parties will largely be free to negotiate a resolution, and successfully doing so will undoubtedly be quicker, less costly for the parties and less damaging to the business.
The window for negotiation may be small; particularly where the conflict is preventing the business from moving at all and losses are being suffered. The longer the dispute goes on, the more damage is caused to the business and the greater the cost to all. It is always advisable to record a negotiated agreement in writing and for all formalities to be dealt with (such as transferring title to shares/assets or terminating directorships/memberships) at the time to achieve a clean break whilst minds are still focused on the deal.
In such negotiations, the parties whom wish to continue running the business will feel the pressure. Those leaving the business will recognise that delay means damage to the business, and may try to hold the others to ransom.
If the conflict is so fundamental that the parties cannot continue to work together, but nobody is prepared to sell their share in the business, negotiations may be deemed to fail and more draconian steps may be the only option.
3. Winding up/dissolution
If the deadlock cannot be resolved then the only option may be to try to bring the business to an end. There are different ways that this can be done, depending upon the nature of the business. As a fall-back option, a threatened winding up or dissolution of the business may help focus the minds of the parties on doing a deal.
Where the business is a partnership, and no partnership agreement is recorded, a partner can simply serve notice on the other(s) to dissolve the partnership. The dissolution can be immediate.
After the notice is served, the business must be sold. The proceeds will then be used to pay off creditors and then distributed to the partners (following certain rules). If the business cannot be sold as a going concern then the assets of the business must be broken up will be sold separately. This may have significant financial implications. If there is a shortfall in the amount owed to creditors then the partners themselves will be liable to creditors.
Where a deadlock affects a company or LLP, it is open to the shareholders/members to petition the court seeking an order that the business be wound up.
If the business is solvent, the court may wind a company up if it considers that it is ‘just and equitable’ to do so. The courts recognise that deadlock situations, especially those involving parties of equal power, can render it just and equitable for the business to be wound up.
If the business is insolvent, the position is more straightforward. A company or LLP is treated as being insolvent when it is unable to pay its debts as they fall due. If this is the case, the court has the power to wind the company up without having to consider whether or not it is just and equitable to do so.
There is no easy solution when it comes to deadlock. In certain situations, a disposal of the business may be the only option. Prevention from the outset is the only way in which parties can seek to protect their interests. Agreeing over the worst case scenario will no doubt be easiest when spirits are high.
Progression Solicitors are happy to advise clients on all aspects of business and commercial law and can do so at our Ulverston office or our office at 5 Crescent Road, Windermere. Please telephone 0808 2021300 to arrange an appointment.
Whilst we have made every effort to ensure the accuracy of the information given in this information sheet, this information is provided for general information purposes only and no warranty or representation is made as that the information is completely free from errors or inaccuracies. Specific legal advice on this topic will vary according to individual circumstances and should be sought in every case. Any advice given in this sheet does not constitute legal advice and shall not without our express written consent in each individual case be relied upon by any person.