“Diplomats operate through deadlock, which is the way by which two sides can test each other’s determination.” (Henry Kissinger)
Running a business with a partner can work brilliantly – until it doesn’t. When co-directors or shareholders fall out and can no longer see eye to eye, the company can grind to a halt, meaning everyone loses.
If the “deadlock” is just the two sides playing diplomat by testing each other’s determination to fight to the finish, there’s a chance they’ll negotiate a settlement before the company actually fails.
But if you find yourself in a fatal stalemate, you should think of cutting your losses and putting your company out of its misery altogether. A recent High Court decision provides an excellent example of how you can do just that.
The director disputes that destroyed a profitable business
The players in this unhappy saga were the 50/50 shareholders, and co-directors, of a small business importing tents from China.
At first, their arrangement clearly worked well. But as time passed, they fell out badly over disputes relating to the terms on which their own businesses (one in Kenya, the other in South Africa) could buy tents from the importer.
Their own attempts to resolve things failed, and the seriousness of their quarrelling led to allegations of fraud and of unpaid debts, together with threats to have one director declared a delinquent director and attempts to bring a third director into play.
A buyout attempt having failed, one of the directors applied for liquidation of the company. The other director’s fierce opposition rested on him asking for everything to be put on hold while he launched alternative litigation against his opponent.
But can you liquidate a solvent company?
Normally, only insolvent companies face liquidation, but the Companies Act allows courts discretion to order the winding up of a solvent company (a company able to pay its debts) in a range of circumstances. Three of those grounds for liquidation are relevant here:
- There is deadlock between the directors in the management of the company and the shareholders are unable to break the deadlock, resulting in or threatening irreparable injury to the company, or
- The result of the deadlock is that the business of the company cannot be carried on to the advantage of the shareholders generally, or
- It is otherwise “just and equitable” for the company to be wound up.
Past the point of no return
In granting the liquidation order, the Court found that the relationship between the directors had broken down irretrievably, and the resulting deadlock had reached the point of no return. The shareholders would be unable to break the deadlock and that had resulted in irreparable injury to the company. Its business could not be conducted for the advantage of shareholders.
The Court went further, holding that in any event it was just and equitable to order winding up. The mutual trust and confidence between the shareholders had been destroyed, there had been a complete breakdown of relationship between the directors and shareholders, and the company’s “substratum” (fundamental reason for existence) had disappeared.
Prevention is better than cure
When you co-own a company, especially if it’s split 50/50, stalemate is an ever-present risk. If this happens and you can’t agree on how to buy each other out or on how to break the deadlock, you could lose the entire business.
Prevention being better than cure, good planning upfront is essential. So, if you run or plan to start a business with partners, make sure that your shareholders’ agreement and other documentation includes clear and workable mechanisms for avoiding dispute, and for breaking deadlock if it occurs.
Common solutions are:
- As a way of hopefully preventing disagreements from arising, set out in writing clear boundaries as to each party’s contributions to the business, their roles in management and funding, profit sharing, obligations of good faith towards each other and to the company, and so on – every situation will call for different wording.
- Clauses to allow one owner to buy the other’s shares are essential, with a clear process for determining value and resolving any disagreement over price or terms.
- Provide for independent arbitration or mediation to resolve any disputes that may arise generally.
These safeguards are unfortunately no magic bullet, as witnessed by the inability of the directors/shareholders in this case to reach any form of agreement. This despite having deadlock-breaking mechanisms in their shareholders agreement, and despite their attempts at negotiation and mediation.
But safeguards are a lot better than nothing, and they will most definitely reduce the risk of you both ending up in court, paying legal fees and being grilled in witness boxes while your business dies. If that happens, everyone loses.
Bottom line? Disputes happen, but they don’t have to kill your business. Speak to us if you’d like advice on your company’s structure, and for help in drafting a shareholders’ agreement that protects you both if things turn sour.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact us for specific and detailed advice.
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