Deadlock clauses

Differences in the views of shareholders of a company can occasionally become problematic especially with respect to critical business matters. This situation is known in legal terms as “deadlock”. The most common situations that can lead to deadlock are differences in business strategy, the majority shareholder ignoring the views of a minority shareholder and the different views on financial contribution to the business.

Therefore, having a deadlock clause can be vital to avoid deadlock paralysing the company and adversely affecting its business. A deadlock clause requires the shareholders to try to resolve the dispute and will often then provide an ultimate remedy if the dispute is not resolved, such as the company being wound up.

This article focuses on the situations when a deadlock may occur and the possible mechanisms to deal with a deadlock once it has arisen.

When may a deadlock occur?

A deadlock may occur in a shareholders’ meeting and/or a meeting of the board of directors (depending on the type of company involved), for example:

• where there is no quorum at a properly convened meeting of shareholders or directors and no quorum at the second meeting when it is reconvened;
• where there is a meeting of the board of directors and all the directors nominated by one shareholder vote against or abstain from voting on the resolution such that the required threshold for the vote set out in the law, the company’s constitutive documents or shareholders agreement is not reached; and
• where there is a shareholders’ meeting and a shareholder votes against or abstains from voting on the resolution such that the required threshold for the vote set out in the law, the company’s constitutive documents or shareholders agreement is not reached.

Shareholders can include disagreement on any other important matters as a trigger for the deadlock process. The shareholders should only include important matters in the deadlock clause to avoid the process being triggered for matters which do not have a significant impact on the company’s business.

A deadlock clause is usually included in a shareholders’ agreement as this is a private agreement between the shareholders. It could also be included in the constitutional documents of the company, such as the constitutive contract, but such a document has to be registered with the Ministry of Commerce, Industry and Investment Promotion and therefore is not a private document.

Possible mechanisms for resolving a deadlock

The deadlock clause should contain provisions dealing with when a deadlock occurs and specify the steps that need to be taken by the shareholders. A deadlock clause can be drafted in different ways and we have set out below one possible structure of a deadlock clause:

• Step 1: Usually, the process begins with the sending of a “Deadlock Notice” by a shareholder to the other shareholder stating that in its opinion a deadlock has occurred and identifying the matter over which the shareholders are deadlocked.
• Step 2: Then the shareholders, acting in good faith, use all reasonable endeavours to resolve the deadlock. This process is often performed by a senior representative of each shareholder. This step is usually limited to a finite period set out in the deadlock clause.
• Step 3: If the deadlock has not been resolved under step 2, then a “Buy or Sell Notice” may be sent by a shareholder offering to:
  • buy all (but not some only) of the other shareholder’s shares; or
  • sell to the other shareholder all (but not some only) of its shares,

for cash at a price and for a period set out in the Buy or Sell Notice. The notice needs to be sent within the time period specified in the deadlock clause.

If no shareholder choses to send a Buy or Sell Notice within the specified time period and no alternative procedure is set out in the deadlock clause, it may require the winding up of the company.

• Step 4: The recipient of the Buy or Sell Notice then can elect to choose one of the options in the Buy or Sell Notice within the specified period. If the recipient does not agree to buy or sell such shares or does not respond, it will be deemed to have accepted the offer to sell its shares (as per Step 3(b) above). This means the sender of the Buy or Sell Notice will be required to buy the recipient’s shares at the price mentioned in such notice.

An alternative type of deadlock clause gives a shareholder the right to send a notice asking for the other shareholder to buy all of its shares in the company at a price and in a time period specified in the notice. If the other shareholder does not respond or declines the offer, the first shareholder will be required to buy all of the other shareholder’s shares at the same price offered in the notice.

Although both types of deadlock clauses are common, from a practical point of view, they may be difficult to enforcement in Oman as the Omani courts tend to be reluctant to grant specific performance for the transfer of shares in Oman and it is not possible to transfer shares without the physical presence and signature of the transferor (or its attorney) before the Ministry of Commerce, Industry and Investment Promotion.

Alternative options: We have set out below a few alternative options for deadlock clauses. In each case, the option would need to be specifically stated in the deadlock clause.

• Chairman clause:  This option enables one of the shareholders to become the chairman of the board of directors in the event of a deadlock at a board meeting and have a casting vote on the dispute.
• Resolution Panel: A resolution panel is set up to deal with the deadlock. After receiving all relevant information and documentation on the deadlock, the resolution panel takes a decision on the deadlock matter within the specified time and informs the shareholders accordingly. Such an option needs to set out how the resolution panel is set up and the procedure for the resolution panel to follow.
• Appointing an Expert: An independent expert resolves the matter between the shareholders. Such an option needs to set out how the expert is chosen as well as the procedure that must be followed by the expert.
• Winding up the company: If the shareholders are unable to resolve the deadlock and the company is unable to operate its business, the company is wound up by the shareholders.

The most appropriate deadlock clause may also vary between different types of companies.

Conclusion

Having a deadlock clause can be an efficient mechanism to resolve a dispute and prevent unwanted winding up of a company. However, it is important that the clause is drafted with utmost clarity and tailored for the particular company and its shareholders. The shareholders need to ensure that the deadlock clause is only triggered for critical matters. The cost of not resolving a matter should be compared with the cost of triggering the deadlock clause that may result in a shareholder exiting from the company or even winding up the company.