Shareholder Deadlock (Deadlock Clauses)

Deadlock happens when no side has the votes to decide and no rule says what happens next. It most often arises between two equal owners who each appoint the same number of directors. It can also arise where a minority holds a veto: a shareholder agreement that requires unanimous or supermajority approval for major decisions lets any holder of a blocking stake stop the corporation from acting.

Not every disagreement is a deadlock. A well-drafted clause defines it, for example as a failure to approve the same matter at two properly called board or shareholder meetings held within a set period, followed by a written deadlock notice. A precise definition matters because the remedies that follow, especially a shotgun clause, are drastic and should not be available over a minor dispute.

Day-to-day operations can continue during a deadlock. Decisions on financing, budgets, senior hiring, dividends or a sale of the business stay frozen until it is resolved.

Under section 97 of the Business Corporations Act (OBCA), shareholder questions are decided by a majority of the votes cast, and the chair of a shareholders' meeting has no second or casting vote on a tie unless the articles, by-laws or a unanimous shareholder agreement provide otherwise. The Act supplies no casting vote at board meetings either, so a tie-breaking vote for the board chair has to come from the articles, the by-laws or a unanimous shareholder agreement. With equal shareholdings and equal board seats, the default result of a disagreement is that nothing happens.

The Act offers court remedies, not a tie-breaker. That is why the deadlock clause belongs in the shareholder agreement or, where the owners want it to bind future shareholders automatically, a unanimous shareholder agreement. Section 108(6) of the OBCA expressly allows a unanimous shareholder agreement to provide that, if the shareholders who are parties cannot agree on or resolve a matter pertaining to the agreement, the matter may be referred to arbitration. Our article on what happens without a shareholder agreement in Ontario explains the default position in more detail.

The court as a last resort. Without a workable clause, an owner can apply to the Superior Court of Justice. Under section 207 of the OBCA, the court may order a corporation wound up where it is just and equitable to do so, a ground often invoked where owners are genuinely deadlocked, or where a unanimous shareholder agreement entitled a shareholder to demand dissolution after a specified event and that event has occurred. On a winding-up application, section 207(2) also lets the court make any order available under the oppression remedy in section 248, which includes ordering one party to buy the other's shares. These proceedings are slow, public and expensive, and the judge rather than the owners decides the outcome. Our guide to removing or buying out a shareholder in Ontario explains the court routes and what a negotiated exit looks like instead.

Deadlock clauses draw on a familiar set of tools, roughly from the softest to the most drastic:

• Casting vote. The chair, or a director named by one side, breaks ties. It is simple but hands control to one owner, so equal owners rarely accept it unless the chair rotates.
• Independent director. A neutral director chosen jointly holds the deciding seat on the board.
• Escalation. The matter goes to the principals or senior representatives for a fixed period of direct negotiation.
• Mediation. A neutral mediator helps the owners reach agreement; nothing is imposed on them.
• Arbitration or med-arb. An arbitrator decides the issue under the Arbitration Act, 1991. In med-arb, the same neutral first mediates and then arbitrates. Section 35 of that Act bars an arbitrator from conducting any part of the arbitration as a mediation or similar process that might compromise, or appear to compromise, the arbitrator's impartiality. Section 3 lets the parties vary that rule, though not the section 19 requirement to treat the parties equally and fairly, so a med-arb clause should vary it expressly. See arbitration clause.
• Shotgun buy-sell. Either owner names a price and the other must buy or sell at it.
• Put and call options. One owner can require the other to buy its shares (a put) or to sell its shares (a call) at a price set by formula or valuation.
• Sale of the business. Either owner can require the company to be marketed and sold to a third party, with the proceeds shared.

The first five aim to resolve the issue and keep the owners together. The last three end the co-ownership, so they normally apply only after the softer steps fail. A buy-sell agreement supplies the price and payment terms the exit options rely on.

Most modern clauses combine several mechanisms into a ladder with fixed deadlines, so neither owner can stall:

Other drafting points:

• Limit which matters can be declared a deadlock, for example the annual budget, new debt, major contracts and changes to the business.
• Keep the business running under the last approved budget while the process runs.
• Decide whether the exit step is available for every deadlock or only fundamental ones.
• Bar the exit step while one owner is in breach of the agreement.

Lamba Law's free shareholder agreement builder includes a mediation-then-arbitration ladder and a shotgun option, and produces a discussion term sheet to take to a lawyer.

Ravi Sharma and Joanna Kowalski each own half the shares of a Mississauga commercial cleaning company and each appoint two of its four directors. Their shareholder agreement defines a deadlock as a failure to approve the same matter at two board meetings held at least 10 days apart. It then requires 15 days of direct negotiation and 30 days of mediation. For a deadlock over the annual budget or any contract worth more than $500,000, either owner may trigger a shotgun once mediation fails. Until the deadlock is resolved, the company runs on its last approved budget.

Ravi wants to bid on a five-year, $2.4 million hospital cleaning contract that would need $350,000 of new equipment. Joanna thinks the margin is too thin. The board splits twice, and Ravi serves a deadlock notice. Direct negotiation goes nowhere, but in mediation they agree to bid at a higher price, lease rather than buy the equipment, and require Joanna's approval for any further capital spending over $100,000 that year.

Neither owner had to risk the shotgun, and the company ran on the previous year's budget throughout the process.