Breaking the Deadlock, “Shotgun Clauses” and Free Exits
Sometimes directors and/or shareholders reach a stalemate or deadlock, where they are unable to agree about a particular issue: By way of simple example, if a resolution is put to the Board and 50% of the directors vote in favour of the resolution and 50% against. Or if a resolution is put to a General Meeting of Members and 50% of the members vote in favour of the resolution and 50% against.
Traditional Ways of Breaking the Deadlock
An obvious method of avoiding deadlocks is to give someone (e.g. the Chairperson of the Board) an extra vote (known as a “casting” or “deliberative” vote) which they can exercise if there
is a deadlock. (However, an issue with this is that the parties often cannot agree on who should have the casting vote).
Sometimes the parties agree that if there is a deadlock at Board level, then the matter is to be decided by members at a General Meeting.
Another approach is to adjust shareholdings, directors’ voting rights and the quorum (at director and shareholder levels) to remove or minimise the risk of a deadlock. For example, having an odd number of directors can assist. Or each director could be given voting rights in proportion to his/her nominating shareholder’s shareholding (vis-à-vis the total shareholding). (However, parties are usually reluctant to adopt an inferior position, which can prevent agreement being reached about these matters).
A little known or used approach to dealing with deadlocks is to use a “shotgun” clause. Typically, a shotgun clause is only used where there are two shareholders. It can, however, be used where there are more than two shareholders but it becomes more complicated.
In short, the shotgun clause operates as follows (taking the basic scenario where there are only two shareholders): If a deadlock occurs and the parties are not able to resolve the deadlock within agreed timeframes, either of the shareholders (offeror) can serve the other (offeree) with a shotgun notice which nominates a price and gives the offeree the option to either:
buy all of the offeror’s shares at that price; or
sell all of the offeree’s shares at that price.
There needs to be a default position in case the offeree does nothing. A common position is to provide that if the offeree does nothing, then the offeree must either (a) buy all of the offeror’s shares at the nominated price or (b) sell all of the offeree’s shares at that price.
The process has a built in price reality check and generally forces the parties to be reasonable. The offeree would not want to nominate a ridiculously high or low price because they might be forced to buy or sell at that price.
Where a deadlock arises, there can be a race to see who “triggers” the shotgun provisions first (by “firing off” a notice). (Strategic issues need to be considered, especially when deciding on the price to nominate in the notice. It can become quite interesting). The process can bring about a very quick outcome (depending on the minutiae of the wording). Often the serving of a notice precipitates negotiations but there is no guarantee that negotiations will ensue.
Depending on the wording in any particular case, there is a possibility that a party might be able or attempt to “manufacture” a deadlock in order to facilitate an exit or buy-out.
Some take the view that a party should be able to serve a shotgun notice at any time, even if there is no deadlock. If this is the position, there should be adequate time frames to allow for a smooth transition.
See our article on Shareholder Disagreements and Business “Prenups” here.
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If you would like to discuss any aspect of this article with us, or share your own experiences, please contact Rod Stumbles at +613 8692 7255 or here.
This article provides general information only and is not intended to constitute legal advice. No lawyer-client, solicitor-client or attorney-client relationship has been created between us. You must not rely on the contents of this article, whether as an alternative to legal advice from a lawyer or other professional legal services provider or otherwise. You should not take, discontinue or refrain from taking any action because your understanding of the contents of this article, including without limitation delay seeking legal advice or disregard legal advice. If you have any specific questions about any matter, you should engage us or other lawyers or other professional legal services providers to provide you with the necessary advice. Keep in mind that you may be facing important deadlines so you should not delay in engaging someone to provide you with the advice.