Shareholder deadlock is no holiday – two salutary tales

Background

If you are in business with anyone but haven’t thought about or put in place any mechanism to resolve any potential deadlock which might arise, the situation can be disastrous. Unfortunately, I see the after effects of this all too often, and can usually offer only limited help in trying to sort things out after the event (I am not a litigation lawyer, and if the parties can’t resolve the issues between themselves then the only way out is for someone to go to court).

The more usual kind of deadlock structure is where you have two people owning a company on a 50:50 basis. However, it can arise in other situations as well, such as the one I describe below

Case study: What is a shareholders agreement worth?

Once upon a time about 11 years ago an accountant referred three people to me who were in business together, saying they wanted a quote to review a draft shareholders agreement they had cobbled together (with the help of some solicitors) and the accountant had recommended me.

To help me estimate the work that might be needed I looked at the draft agreement. It seemed to be more of an initial questionnaire which they had given answers to. I also looked at the company structure (they actually had two companies for some historic reason, one owned by two of the clients, and the other by that company and the other client).

I told them that I had a number of concerns due to the unusual company structure and to the fact that the shareholders agreement didn’t clearly address how they might resolve various issues which might come up (such as if any of them couldn’t agree on things, or fell out with each other or wanted to go their separate ways).

I gave them a very reasonable and competitive estimate for the work I could do in:

• advising them on issues they needed to be concerned about and suggesting ways to address these
• helping them improve their company structure, and
• drafting an appropriate shareholders agreement (and possible tailored Articles of Association to go with it).

At this stage they said that they were not really budgeting for me to spend more than two hours of my time on the whole thing.

Having failed to persuade them of the possible value in investing a bit more than this in getting specialist professional advice and help to regulate their relationships in the business they were planning to invest a lot of their money, time and effort on over at least the next ten years, I set out the summary of my review, charged for two hours of work and left them to it.

Following my review I heard that they had simply signed the original cobbled together document they had shown me. Although they had agreed at the time that they were at some stage going to change the company structure in the way I had suggested and produce a better shareholders agreement (basically on the basis that they would have one company in which they each owned a third share, and would put together a new thought out shareholders agreement based on that structure) they never quite got round to it.

11 years later they came back to me. They were not all getting along quite so well. One of them had been wanting to retire for some time but they couldn’t work out how to manage this at shareholder level. And there were business issues they couldn’t all agree on.

Unfortunately there is no mechanism in the shareholders agreement or in the two companies’ Articles of Association for them to resolve the deadlock that has arisen (due to the unusual company structure), or to regulate how to deal with the shareholder who wants to retire. If they cannot get round to agreeing a way forward they might end up having to go to court to ask for an appropriate order to be made (for example to regulate how the companies should be run, or to order some shareholders to buy the other out, or simply to order that one or both of the companies should be wound up). This could all get rather messy, and the costs (let alone the economic damage causes to the businesses and the individuals arising out of the deadlock) would far exceed what it would have cost to put together something sensible 11 years earlier.

Suffice it to say that they now regret not investing in getting proper help at the start.

Second recent case: history repeating itself?

A couple of weeks ago a firm of solicitors referred their client to me who wanted a quote to amend their shareholders agreement because they were bringing in a new business partner. Once again I spent time looking at their current agreement. It was useless in a number of ways. Most importantly, it was a standard deadlock company (two 50:50 shareholders), but the agreement didn’t address how any deadlock might be dealt with! I gently pointed this out to the potential clients, and also suggested a number of other things they might want to think about if bringing in a new partner. I then gave an estimate based on the time it might take me to advise them further and ultimately produce a new agreement to address the new situation (the existing agreement not being one I would want to work with being a/ based on completely different dynamics and b/ horribly drafted).

Once again the process of just reviewing the existing agreement and providing an estimate took me a couple of hours. Having not heard back for a while I chased up and was told that the estimate was considerably more than budgeted, and that the client was approaching the original solicitor who had drafted the existing agreement (ie the agreement which I had advised was next to useless) to see what they would recommend. I was subsequently told that my estimate was £4k but they had ‘had a price back from the original solicitor to make the arrangements and it’s only a grand. I can’t justify it.’ So it looks like they’re going back to the original solicitor!

I wish them luck…

Conclusion and tips

There are a number of ways in which you can try to legislate for a deadlock situation, some of which I touch on in my ‘Food for thought Guide to shareholders agreements’.

I find it frustrating that people will not recognise the need to get good professional advice and help when they go into business together. They may think they want a shareholders agreement, but only as something to tick off their list. No corporate lawyer worth their salt is going to be able to do a proper consultation, give proper advice and then put together appropriate shareholders agreements or Articles of Association for the kind of budget which is all that some people want to pay.

So, please, don’t come to me to ask for a shareholders agreement if you just see it as something to be ticked off a to-do list, but don’t really understand the need for it. But if you want an experienced specialist corporate lawyer to review your situation and provide considered advice, and if necessary to help draft appropriate agreements (and yes, all at good value for money compared to what you might get anywhere else) – I would be happy to hear from you.

If you think you might be affected by anything discussed in any of my articles, feel free to contact me for a free no-obligation 15 minute consultation when I will help you to identify and understand issues which you might need to address and will suggest ways in which you might address them.