When a company is owned 50/50 by two shareholders, is run by two directors and there is no shareholders agreement, then there is unlimited possibility for disputes that lead to deadlock between the two parties. When the relationship is at the point that one party has to leave, what are the mechanisms for forcing a sale?
Step One: Look at the Documents
Modern shareholder agreements usually deal with how share sales proceed. For example, the AVCAL open source shareholders agreement has provisions dealing with “bad leavers” – shareholders who are also employees and who have resigned or been terminated with cause (breach of employment agreement, fraud etc) can be forced to sell their shares back to the company. When you don’t have a shareholders agreement, however, you are in a difficult situation. Regardless, you should look at whatever documents you do have.
The first stop is the company constitution. Deadlocks at the director level can be resolved if the chairman has a casting vote, so always look for that at a first stop.
Most of the time, if a shareholder wants to sell his or her shares, he or she has to offer them to the others in proportion, according to:
- the company constitution or,
- if there is no constitution, under the replaceable rules in the Corporations Act that govern the company if for some reason the company has no constitution.
Depending on what the documents say, the usual situation is that once shares have been offered to the other shareholders and the offer is not accepted, the shareholder can sell to a third party. The thing to note, however, is that rarely do constitutions force one party to sell their shares to the other – they simply set out what happens if one shareholder wants to sell of his or her own volition.
Sell the Shares to a Third Party
This is harder than it sounds. If you don’t have a shareholders’ agreement, which right-minded third party is going to buy into a 50/50 company only to inherit the problems that caused the sale in the first place?
Further, if there are two directors and both must vote for the transfer of shares, how can the selling shareholder force the remaining shareholder’s director to register the transfer of shares? The killer clause in the company constitution is usually something like, “The directors may refuse to register a transfer of shares in the company for any reason.” Where the relationship has broken down, the remaining director may simply refuse to register the shares being sold to the third party.
On the upside, a deal of some sort can sometimes be negotiated even if there was no original shareholders’ agreement or the constitution doesn’t presently permit the shares being sold. For example, the remaining shareholder may agree to the departing shareholder selling to an outside party who is:
- going to add value, and
- agrees that the remaining shareholder has some sort of special voting rights at the director and/or shareholder level.
Unless the relationship between the two 50/50 shareholders has deteriorated irretrievably, some sort of deal can often be negotiated.
Because of the difficulties that arise when there is no shareholders agreement, however, the sale is often to the remaining party.
Sell the Shares to the Other Shareholder Subject to a Valuation
Appoint an Independent Valuer
The parties can agree to appoint an independent valuer and either:
- be bound by the decision of the independent valuer, or
- not be bound by the decision, but take it as a guide to negotiate in good faith for a fair price for the shares.
Where the parties are still talking and the second option is usually taken. It can also be the basis for a mediation. Where the relationship has deteriorated, however, the first option is sometimes favoured.
In order to be bound by the decision of the valuer, its not enough to agree orally or with a few emails that this is what you are going to do. You have to have agree the parameters for the valuation and the documents to be submitted to the valuer, as well as draw up a sale and purchase agreement for the shares so that the agreement is not void for uncertainty when the valuation comes back.
You also need to have dealt with who continues to be liable for the borrowings of the company, personal guarantees, repayment of loans by the company to the shareholders etc. This often needs delicate negotiation with banks and other lenders, as well as suppliers who have extended credit on the basis of personal guarantees.
Submit Sealed Bids to a Valuer
Where the parties need a more “sudden death” option, another solution might be to agree that the parties submit sealed bids to a valuer or third party, and the one with the higher bid buys out the other at the higher price.
Sell the Shares to the Other Shareholder on an Instalment Plan
When you can’t agree on a price, or the other side object to the valuation, sometimes the other shareholder is prepared to buy the shares on an instalment payment plan. It is an option worth exploring.
Sell the Shares to the Other Shareholder with “Russian Roulette”
One quick solution is to offer to sell the shares without a valuation to the other shareholder using a “Russian Roulette” offer. This solution avoids the need for a time-consuming valuation. There are two types of Russian Roulette offers and they are both generally thought to encourage a fair offer because there is a catch in each of them:
- Russian Roulette: The first shareholder offers to buy all the shares of the other shareholder. If the other shareholder likes the price, then the offer is accepted. If, however, the offer is not accepted, the first shareholder has to sell his or her shares to the other shareholder at the same offered price.
- Sealed envelope Russian Roulette: Each shareholder puts his or her offer in a sealed envelope. The envelopes are opened at the same time. The shareholder who made the highest offer has to buy out the other shareholder at that price.
- At least one of the original shareholders gets to continue to run the company.
- The price of the shares is thought to be fair because it has been nominated by the parties.
- It does not depend on, and entail the cost of, third party valuers.
Russian roulette clauses are best suited to commercial disagreements such as whether to raise new capital, pivot the business or make major expenditures. They should not be invoked where legal issues are causing the problem. These are best solved through mediation, arbitration or litigation.
Sell the Shares to the Other Party by “Texas Shootout”
A “Texas Shootout” is a form of auction for the shares where both parties get to bid on each other’s shares. The first party tells the other party that he or she wants to buy their shares. The other party then gets to either:
- Sell their shares to the first party at the offered price, or
- If the other party wants to buy the first party’s shares, the other party can put in a higher offer. The first party can offer a higher price to buy the other party’s shares, and the parties can then bid in an auction process until one party sells.
The Texas Shoot-Out works well when both parties have the same financial capacity to buy each other out and both are willing to sell out.
Buyback in the Name of the Company
- Shareholders can’t be forced to sell their shares to the company.
- Shareholders can’t require the company to buy their shares.
As a matter of company law, the general proposition is that a company can’t buy its own shares. The Corporations Act, however, makes an exception and lets a company buy its own shares if:
- The buy back doesn’t materially affect the company’s ability to pay its creditors, and
- The company follows the procedure in chapter 2J.1 division 2 of the Corporations Act.
There are five different kinds of buy backs under the Act, two of which are relevant to private companies:
- Equal Access buy back: This is an offer on the same terms for the same percentage of shares made to each shareholder. That’s not much help if both shareholders accept the offer, because you are left with equal percentages again. It is helpful, however, if the remaining shareholder does not accept and the departing shareholder does accept. In this case, the remaining shareholder ends up with a majority of the shares or all the shares.
- Selective buy back: This is an offer that is approved by the shareholders before it is put into effect, or is conditional on special approval being granted. The buy back has to be approved by either a special resolution passed at a general meeting where no votes are cast in favour of it by the shareholder whose shares are going to bought back, or a unanimous resolution of the ordinary shareholders at a general meeting.
Spitting the Business
Sometimes simply splitting the business assets amongst the two shareholders might solve the problem. For example, if one shareholder was keen to pursue one business strategy and the other were not, then splitting out the assets, IP and staff relating to that strategy and giving undertakings not to compete might resolve the issue.
Selling the Business
Although the departing shareholder usually can’t force a sale of the business, the other shareholder may agree to it if there is no other solution.
A sale to a third party may be the answer if the remaining shareholder is willing to accept the incoming shareholder. If the parties are still talking to each other and there is some goodwill, then a valuation as a guide to negotiations in good faith may work if the remaining shareholder has the capacity and willingness to buy out the departing shareholder. When the situation is tense, sometimes the “sudden death” solutions like Russian Roulette work. When the remaining shareholder has no desire or no capacity to buy out the departing shareholder, then aside from selling the business or splitting it, the remaining solutions usually involve mediation, arbitration or litigation.