A shareholder deadlock occurs when the owners of a company can no longer agree on the decisions the company needs to make, and no one holds the voting power to break the impasse. For a shareholder or director in that position, the immediate question is what can be done, and how quickly. There is no single mechanism that resolves every deadlock. What is available depends on the company’s constitution, any shareholders agreement, the conduct that produced the impasse, and whether a commercial resolution remains realistic. The interests of the company must also be considered separately from the personal interests of the shareholders. Directors continue to owe their statutory and general law duties despite the dispute.
What is a shareholder deadlock?
A deadlock arises where the shareholders are unable to reach the level of agreement required for a company decision to be made. It is most readily associated with companies owned by two shareholders on a 50/50 basis, because neither party can carry a resolution without the cooperation of the other. Deadlock can also arise in other ownership structures where the voting arrangements prevent the necessary majority from being achieved. This may occur where the constitution or shareholders’ agreement requires a special majority or unanimous approval for specified “reserved matters”, even though one shareholder holds more than 50% of the shares.
The percentage of shares held does not always determine voting power. Different classes of shares may carry different voting rights, and a person’s voting rights may also be affected by the constitution or another binding arrangement.
Not every disagreement amounts to a genuine deadlock. Shareholders may disagree strongly about a particular decision while the company continues to operate. The position becomes more serious where the disagreement prevents decisions necessary for the management of the company, or where repeated disputes mean the company’s affairs can no longer be conducted effectively.
Why 50/50 companies are exposed to deadlock
Equal ownership can work well while the shareholders have a functioning relationship and a shared view about the direction of the business. When that relationship breaks down, a 50/50 company may have no straightforward way for one shareholder’s position to prevail. That distinguishes it from a company in which one shareholder holds a clear voting majority and can resolve the question by exercising it.
If both shareholders are also directors, the same disagreement can affect decisions at board level as well. A dispute that begins with a single issue, such as expenditure or distributions, can therefore develop into a broader impasse about the operation of the company. For that reason, the company’s governing arrangements become the first place to look.
Does the shareholders agreement provide a way forward?
When a deadlock arises, the company’s constitution and any shareholders agreement should be reviewed before anything else. A properly drafted shareholders agreement may contain a procedure designed specifically to deal with deadlock. The mechanism varies between agreements: the dispute may have to be escalated between the parties, referred to mediation, or dealt with through an agreed process that can ultimately lead to a shareholder exit.
The wording of the clause decides how it operates. Before attempting to activate a deadlock provision, a shareholder needs to understand when the provision applies, what steps must be followed and what consequences may result. A mechanism intended to resolve a disagreement can have significant commercial effects, particularly where it may require one party to sell their interest at a value determined by a process they did not choose.
What happens if there is no shareholders agreement?
The absence of a shareholders agreement makes a deadlock harder to resolve, but it does not leave the parties without options. The company’s constitution and the Corporations Act 2001 (Cth) still provide the framework within which the company operates, and other contractual or equitable rights may also be relevant depending on the circumstances.
In most cases the first question is whether the parties can negotiate a practical resolution. Where that is not possible, attention turns to the conduct that gave rise to the deadlock, its effect on the company, and whether there is a legal basis for seeking the Court’s intervention. A 50/50 disagreement does not, by itself, give one shareholder a right to require the other to sell.
Can one shareholder buy out the other?
A negotiated buy-out is often considered once the relationship has deteriorated to the point that continuing in business together is no longer realistic. If the parties agree in principle that one shareholder will leave, attention then turns to the terms of that exit.
Valuation frequently becomes the central issue. The parties may disagree about the value of the company, the value of the particular shareholding, the appropriate valuation date, or the treatment of shareholder loans and other financial interests. There may also be questions about personal guarantees, employment arrangements, access to intellectual property, restraints and liabilities that remain after the transfer. A shareholder exit therefore requires consideration of more than the price attached to the shares.
Where the parties cannot agree on a voluntary buy-out, whether a court can order the purchase of shares depends on the legal basis on which the Court’s intervention is sought.
Can mediation resolve the dispute?
Mediation can be effective where the shareholders have been unable to resolve matters between themselves but a negotiated outcome remains possible. It allows the parties to consider solutions that extend beyond the immediate legal issues, which matters in a shareholder dispute because the resolution may need to deal with ownership, management, valuation, loans, guarantees and the parties’ future involvement with the business. A negotiated resolution also gives the parties greater control over the outcome than a contested proceeding.
Mediation will not be appropriate or successful in every case. If company assets are at risk, if urgent action is required, or if one party is unwilling to engage meaningfully, other steps will need to be considered first.
Does shareholder deadlock amount to oppression?
Deadlock and oppression are different questions, and the fact that two shareholders cannot agree does not of itself establish shareholder oppression.
Section 232 of the Corporations Act allows the Court to intervene in defined circumstances. These include conduct of a company’s affairs, an actual or proposed act or omission, or a resolution, that is contrary to the interests of the members as a whole. They also include conduct that is oppressive to, unfairly prejudicial to, or unfairly discriminatory against a member or members.
In some deadlock disputes, the conduct surrounding the breakdown raises issues under those provisions. Allegations may arise, for example, about exclusion from management, the use of company funds or opportunities, or the withholding of information from a shareholder. The statutory test still has to be established on the particular facts, and a serious disagreement is not enough simply because the relationship has become difficult. Where oppression is established, section 233 gives the Court broad powers, including the power to regulate the company’s affairs or to order the purchase of a member’s shares.
Are directors’ duties relevant to a deadlock?
Yes. A shareholder who is also a director must distinguish between those two capacities. Directors must exercise their powers and discharge their duties with care and diligence, in good faith in the company’s best interests and for a proper purpose. They must not improperly use their position or information to gain an advantage or cause detriment.
A breakdown in the shareholders’ relationship does not suspend those duties. Potential issues may arise if a director:
- diverts customers, contracts or opportunities from the company
- uses company money to fund a personal dispute without proper authority
- removes or conceals company records
- authorises related-party payments
- prevents the company from meeting tax, employment or regulatory obligations
- takes steps designed primarily to disadvantage the other shareholder
A wrong suffered by the company is ordinarily a claim belonging to the company. In some circumstances, a shareholder or director may seek leave to bring a statutory derivative proceeding on the company’s behalf. That is distinct from a personal oppression claim.
Can a deadlocked company be wound up?
Section 461 of the Corporations Act sets out grounds on which the Court may order that a company be wound up, including where the Court is of the opinion that it is just and equitable to do so. A breakdown in the relationship between the participants in a closely held company can be relevant to such an application, depending on the circumstances.
Winding up remains a significant step. It can result in the company’s business and assets being dealt with through a liquidation process rather than the company continuing as a going concern. The Corporations Act also gives the Court a discretion to decline to order winding up on the just and equitable ground where another remedy is available and the applicant is acting unreasonably in seeking winding up instead. The availability of other practical or legal remedies therefore needs to be assessed carefully before that course is taken.
When the business needs an urgent decision
Urgency may arise where the company needs funding, where a significant transaction requires approval, where assets are at risk, where important contracts are affected, or where one shareholder is taking steps that may materially alter the company’s position. In those circumstances, waiting for the broader dispute to resolve is rarely commercially realistic.
The appropriate response depends on the nature of the risk and the legal rights of the parties. Urgent orders may be available in some disputes, but the basis for the Court’s intervention has to be established, and the consequences of taking that step should be weighed before it is taken. Obtaining advice before the company’s position deteriorates usually widens the range of options still open.
Weighing the options against the commercial outcome
The legal position is only one part of the assessment. A shareholder may hold a firm view about what has occurred and still need to decide what outcome is commercially realistic: whether they wish to remain in the company, whether the working relationship can be repaired, whether either party could fund a buy-out, and whether preserving the underlying business is the priority.
Those answers change the strategy. A negotiated exit may be the sensible course in one deadlock, while in another the shareholder’s continued involvement in the business is the point of the dispute. In a more serious matter, action to protect the company’s position may be required before any broader resolution can sensibly be discussed.
Frequently asked questions about shareholder deadlock
No. The disagreement must prevent the required decision from being made under the company’s applicable voting arrangements. A company may continue to operate despite disagreement on a particular issue.
Not merely because each party owns 50% of the company. A compulsory sale may arise under a valid deadlock or transfer provision, through an agreed settlement, or under a court order made on an established legal basis such as oppression.
No. A majority shareholder’s voting power remains subject to the Corporations Act, the constitution, any shareholders’ agreement and equitable constraints. Conduct may be challenged if it is oppressive, unfairly prejudicial or unfairly discriminatory, or if directors’ powers are exercised for an improper purpose.
Yes. If the requirements for relief under sections 232 and 233 of the Corporations Act are established, the Court may order a person to purchase a member’s shares. The terms depend on the facts and the remedy the Court considers appropriate.
No. Winding up is a significant remedy that may destroy or reduce the going-concern value of the business. The Court may consider whether another remedy is available and whether the applicant is acting unreasonably by seeking winding up instead.
Costs depend on the forum, outcome and orders made. In court proceedings, costs commonly follow the event, but the Court retains discretion. Company funds should not be used to pay a shareholder’s personal legal costs without proper authority and a lawful basis.
Obtaining advice when shareholders are deadlocked
A deadlock affects more than the relationship between the shareholders. Where it prevents the company from making decisions, or begins to damage the business, employees, customers, creditors and the value of each shareholder’s investment are affected with it.
Mazzeo Lawyers is a Melbourne litigation practice acting for clients throughout Victoria, with more than three decades of practice behind it under its Principal, Nick Mazzeo. Both the firm and its Principal are members of the Law Institute of Victoria, and the firm acts in matters before courts including the Supreme Court of Victoria and the Federal Court of Australia. We advise shareholders, directors and business owners in property and business disputes, including disputes involving equally owned companies. Every matter the firm acts in receives the time and personal attention of an experienced lawyer.
We consider the company’s governing documents, the legal position of each party and the commercial outcome the client is seeking. Legal costs depend on the nature, complexity and scope of the matter, and we explain the applicable fee arrangements and provide costs information in accordance with our legal obligations before commencing substantive work.
If a disagreement between shareholders is preventing the business from moving forward, the first step is usually a review of the constitution and any shareholders agreement against the decisions the company currently cannot make. All enquiries are handled in strict confidence, and an initial conversation does not commit you to anything. Arrange a confidential discussion about your matter.
