A company can become deadlocked if shareholders fall out so that neither party or side can produce a majority. This is often an issue for small companies where the shares have been split 50/50 and there is no shareholder agreement in place. In this type of situation judges have a range of powers to bring such paralysis to an end and enable all concerned to move on with their lives.
One High Court case concerned a pipe fitting company in which two men each held 50 per cent of the shares. They were also co-directors but, after their business relationship ended acrimoniously, one of them (shareholder A) claimed that he had been excluded from the company. The other (shareholder B) had stopped his salary and purported to terminate his employment.
After shareholder A launched proceedings, the Court found that the company was deadlocked and that within the meaning of Section 994 of the Companies Act 2006 (CA06) its affairs were being conducted in such a manner as to constitute unfair prejudice to both shareholders. Section 994 of the CA06 gives a shareholder the right to apply to the court if the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of the shareholders generally or some of the shareholders or that an actual or proposed act or omission of the company is or would be so prejudicial.
In this case, the Court made an order under Section 996 of the CA06, requiring shareholder B to buy out shareholder A. They could not, however, agree an appropriate price for the shares. In the circumstances, the Court put a value on the company on the basis of expert evidence and made rulings as to any deductions that should be made to the sum payable to shareholder A. The men were encouraged to resolve any remaining issues by agreement so that their lawyers could precisely calculate the sum due.
This case is an all too familiar scenario to most solicitors advising SME (Small to Medium sized Enterprise) clients and we always dread asking the question, “Do you have a shareholders’ agreement?” Whilst the CA06 does provide shareholders with remedies, these are often difficult and expensive to enforce.
A good shareholders’ agreement will set out remedies to break the deadlock (and much more besides) and because this is a contract, the parties can be creative in how they wish to resolve the situation. The judge on the other hand only has access to a few remedies. As in this case, the usual one is for one side to buy out the other at an agreed price.
Another excellent reason for having a shareholders’ agreement is that if the relationship breaks down and deadlock occurs, a breach of contract claim under the agreement is usually easier and cheaper to enforce as it is often much clearer where the breach has occurred.
The best time to get a shareholders’ agreement is just as the company finds its footing and when the relationships between the shareholders at their best.