Deadlock is the culmination of a gradual deterioration in relations between co-shareholders/co-directors. Legitimate business concerns soon evolve into acrimonious allegations of all natures being hurled metaphorically across the boardroom table. It can cause irreparable damage to the relationship between co-shareholders/ co-directors who often become entrenched in their positions.

When deadlock arises, it is the business that suffers. If decisions are not made, the business will not operate leading to a loss of profit, a lack of dividends and the breakdown of the business in the long run. This usually accelerates the underlying dispute towards costly litigation.

The risk of litigation from deadlock can be minimised by putting in place a Shareholder's Agreement.

What is deadlock?

Deadlock means that no decision can be made on a particular business issue because of an equality of votes for and against the decision.

It can arise in 50:50 shareholder/director companies which adopted the Companies Act 2006 Model Articles (for private companies limited by shares) without amendment (or the "Table A" articles for pre 1 October 2009 companies). 

The Model Articles provide that decisions taken by directors will be made on a majority basis (with the chairperson, if appointed, having a casting vote).  As for shareholder votes, again the Model Articles provide for majority voting to pass a resolution (with resolutions being defeated if there is an equality of votes). 

So in reality (where decisions are taken less formally and without a chairperson having been appointed), a company will not be able to make any decisions unless there is a majority.  In companies with only two directors/shareholders, there will be no majority without unanimity.

Why does it arise?

Each business situation is unique, however, there are general themes that can lead to deadlock:

• Economic crisis: the pandemic has significantly impacted many SMEs causing a loss of sales and profits.  Many SMEs have made use of the Government backed loan schemes (CBILS and BBLS) or alternatively director/shareholders have taken on additional personal lending/given personal guarantees.  This added financial pressure can cause a difference of opinion between directors/shareholders.
• Lack of communication: many SMEs will have director/shareholders with specific roles.  One may be customer-facing dealing with marketing and sales, and the other may manage all financial aspects. If decisions are made unilaterally without discussion, this can lead to distrust. 
• Lack of financial transparency:  The non-financial director/shareholder may become unhappy if sufficient information or access to financial documents is withheld.  In turn, this may lead to challenges about financial decisions which can aggravate the financial director/shareholder.

What options are there if deadlock arises?

As the company cannot instigate litigation without both directors agreeing, it is for an individual shareholder to decide whether to take formal action against their co-shareholder/director.

In brief, available shareholder actions are:

1. To petition to the court for relief where the affairs of the company are being, or have been conducted in a manner that it unfairly prejudicial to the interests of shareholders – "unfair prejudice petition".  The most common outcome is for the court to order one shareholder to buy the other shareholder's shares;
2. To seek permission of the court to bring a claim in the company's name – a "derivative claim" - against a director of the company for negligence or breach of duty.  If permitted by the court, this could result in the company recouping monies from the defendant director/shareholder, but the cost benefit of such a claim would need to outweigh any irrecoverable costs incurred in pursuing the litigation.  And, the defendant director/shareholder would retain their roles in the company; or
3. to petition the court to wind up the company on just and equitable grounds – "just and equitable winding up".  If ordered by the court, the business will be liquidated.

Before taking such action or on receipt of such a claim, a shareholder should carefully weigh up the cost benefit of pursuing or defending the action.  Litigation is always costly and inherently risky. 

How does a Shareholder's Agreement help?

While a Shareholder's Agreement may not prevent a difference of opinion or a breakdown in the relationship, it provides a pre-emptive resolution should deadlock arise

The Agreement can set out a procedure to be followed if deadlock arises.  This could be an agreement to take part in a specific form of dispute resolution, or an agreed procedure for the sale/purchase of one shareholder's shares by another.

Top tips

• Prevention is often better than cure – put in place a well considered Shareholder's Agreement which includes an agreed procedure should deadlock arise;
• Appoint a director to be chair person to have a casting vote;
• Keep lines of communication open;
• Ensure decisions are not taken unilaterally;
• Take an interest in all aspects of the business; and
• Ensure all directors/shareholders have access to financial information.