SHAREHOLDERS’ AGREEMENTS AND DEADLOCKS
A shareholders’ agreement is a private contract between the members of the company containing, inter alia, the rules for running and owning the company. The shareholders’ agreement regulates that relationship as well as setting the grounds in the event of a deadlock. In advance, it will usually deal with indicating respective ownership of shares and with the levels of shareholders’/directors’ authority for making decisions as regards the company, such as the acquisition or disposal of the company’s assets. It is essential thus for the shareholders to enter into the agreement before or upon the incorporation of the company in order to be aware of their rights and obligations towards each other.
Shareholders’ agreements are closely related to the company’s Articles of Association. As under common law principles, the Articles of Association must always prevail over a Shareholders’ agreement in the event of a conflict between the two documents, it is prudent that all the provisions included in the Shareholders’ agreement be thoroughly transposed into the Articles of Association of the company.
It should also be stressed out that any term of the shareholders’ agreement which contravenes any statutory provision of the Cyprus companies Law, CAP.113, is considered invalid under Cyprus Law.
Essential provisions contained in a Shareholders’ agreement
A fully-fledged Shareholders’ agreement should contain provisions which:
· Set out the shareholders’ rights and responsibilities;
· Regulate the appointment, resignation and removal of directors;
· Regulate the issuance, transfer and sale of shares of the company;
· Specify the matters reserved for the shareholders to decide;
· Regulate the way of declaring and distributing dividends;
· Clarify dispute resolution practices;
· Set out provisions to resolve potential deadlock scenarios.
Where a company is owned and is managed jointly by any even number of entities, there is a risk that the company may be deadlocked.
A deadlock usually arises in a 50:50 joint venture, where each shareholder owns 50% of a company and the parties involved are unable to reach a decision on a crucial matter in relation to the company. This situation may lead to the adverse effect of paralyzing a company's operations.
Issues commonly leading to deadlock
1. Any matter relating to the reorganization of a Company (for example, by way of a merger);
2. Any matter concerning the disposal of the company’s assets;
3. A proposal by one of the shareholders to initiate a winding-up procedure;
4. A decision regarding the reduction or increase of a company’s share capital;
5. A decision regarding the division of classes of shares;
6. The approval of the financial statements of the Company;
7. The appointment of a new Director and/or Secretary in the Company.
Resolving the Deadlock:
1. Deadlock provisions in a Shareholders’ agreement
A well-drafted shareholders’ agreement must contain a deadlock clause with a dispute resolution mechanism to deal with disagreements.
Examples of clauses that can be included in a shareholders’ agreement to resolve a deadlock situation:
Russian Roulette This clause enables one shareholder to offer to buy out the other, or sell their own shares, at a price set by the offering shareholder. The other shareholder can accept the offer and sell their shares, or offer to buy the other out at that price, and so on. The advantage of this approach is that the person wanting to leave the company will be bound to offer a fair price, and no valuation is required. In addition, this enables the shareholder that eventually purchases the other’s shares to continue the business.
Texas Shootout In this procedure, each shareholder submits a sealed bid to a third party for the other shareholder’s shares. The shareholder making the highest bid will have to buy the other out. It is noted that this is a quick and popular method to resolve a dispute, although for this clause to operate fairly, both sides must be in an equal position financially.
Compulsory buy-out This provision will allow one shareholder to buy out the other using a pre-determined formula for agreeing the price of the shares.
Resolving the deadlock:
2. When there is no Shareholders’ agreement in place
The following are some suggested solutions which can be utilized in cases where there is no Shareholders’ agreement in existence:
Inviting another shareholder or non-executive director to join the company Another shareholder can be invited to join the company so that in the future, any decision-making can be taken by the majority. Alternatively, a non-executive director could be appointed so that decisions can be taken by the majority at board level. However, for the above solution to work, the shareholders must agree as to who this person should be!
Chairperson’s or external person’s ‘swing’ vote The Company’s articles of association can be amended to provide that the chairperson has a casting vote in the event that the shareholders fail to agree. The chairperson appointed can be either one of the shareholders on a revolving basis. Alternatively, a person external to the company can be chosen, who will be given a ‘swing’ vote if a deadlock occurs. Since it can be difficult for the shareholders to agree who this person should be, it is advisable that the shareholders ask their lawyers or accountants to nominate a suitable candidate and mutually agree beforehand to accept their recommendation. Mediation/arbitration If the dispute arisen is clear-cut or technical, an outsider like a mediator or arbitrator may be appointed to aid in resolving the deadlock.
Shareholders agreement If the situation has not become too entrenched, a shareholders’ agreement can be put in place to specify how disagreements should be dealt with in the future. It is noted that the Articles of Association of the Company may need to be amended to include all the provisions that will be contained in the newly drafted shareholder’s agreement.
Referral to senior management
If the company is a 50/50 joint venture involving two companies, a senior management from both sides can be asked to step in and adjudicate the disagreement.
If, due to the nature of the dispute, the shareholders believe that the business is no longer viable, they can opt for a voluntary liquidation of the company, with any surplus after the sale of assets being shared between them.
One of the shareholders can petition the court which can resolve a dispute by ordering a winding-up of the company Pursuant to Article 211 (f) Cap.113.
The court may also, upon an application lodged by one of the shareholders, agree a valuation of shares or order a share transfer from one shareholder to another.