Q: My business partner and I each own 50% of our company. What happens if we cannot agree on an important business decision?
A: Equal ownership is a common arrangement when two individuals start or acquire a business together. Each owner has an equal economic interest and an equal voice in major decisions. However, this structure can create significant challenges when the owners disagree and neither has the ability to make the decision without the other.
If that disagreement prevents a required decision from being made, the owners may be facing what is commonly referred to as a “deadlock.” Not every disagreement amounts to a deadlock; business owners regularly disagree and ultimately reach a compromise, or the issue may be small enough for one owner to defer. Generally speaking, a deadlock arises when a decision requiring owner approval cannot be made because the owners are evenly divided and neither has the ability to break the tie. In a 50/50 ownership structure, such disagreements can become particularly impactful when they involve a material matter, such as whether to incur debt above a specified threshold, make a major capital expenditure, or sell a substantial asset.
Ideally, the parties address that possibility before a dispute arises by defining in their governing documents what constitutes a deadlock and how it will be resolved.
Review of the Governing Documents.
When a deadlock occurs, the first place to look for guidance is the company’s governing documents. Depending on the entity, those documents may consist of an operating agreement, bylaws, a shareholder agreement, or a partnership agreement.
A well-drafted agreement should cover not only how decisions are made in the ordinary course, but also what constitutes a deadlock and how one will be resolved. No single deadlock provision fits every business. The right framework can vary depending on the number of owners, their respective roles, the nature of the business, and the parties’ expectations regarding a future separation.
One of the more common approaches involves appointing an independent director, manager, or other third party to resolve specified disputes, or requiring mediation or arbitration before either party pursues further remedies.
Other arrangements may provide for a buyout if the owners remain unable to reach agreement for a defined period. For example, a so-called “shotgun” provision may permit one owner to propose a price for the other owner’s interest, after which the receiving owner must either sell at that price or purchase the initiating owner’s interest on the same terms.
The parties may also agree in advance that a prolonged deadlock over a specified period will trigger a sale of the company or, as a last resort, dissolution of the business.
Whatever mechanism the parties select, the governing documents should clearly define when a deadlock exists and which decisions trigger the process (e.g., major borrowings, acquisitions, or sales of material assets, rather than routine day-to-day decisions). They should also spell out what steps must occur before more consequential remedies, such as dissolution or sale of the company, become available.
When the Governing Documents Do Not Provide a Solution.
If the governing documents do not include a process for resolving the dispute, the owners must rely on applicable state law for potential remedies. Those remedies vary depending on the type of entity and the jurisdiction in which it is organized, and may require owners to place the matter – and potentially the future of their business – in the hands of a court.
For example, under New Hampshire law, an LLC member may seek judicial dissolution where the members have reached a voting deadlock they cannot break and, as a result, the company faces irreparable injury or can no longer be conducted to its advantage; the court may order a remedy other than dissolution in its discretion. See RSA 304-C:134. New Hampshire corporate law permits a similar remedy for shareholders when director deadlock threatens the same kind of harm. See RSA 293-A:14.30.
Massachusetts law provides analogous remedies, although under somewhat different standards. A member or manager of a Massachusetts LLC may seek judicial dissolution where it is no longer reasonably practicable to carry on the business under its operating agreement. See M.G.L. c. 156C, § 44-45. For a Massachusetts corporation, shareholders holding at least 40% of the voting power may seek judicial dissolution where director deadlock, not just ordinary disagreements, threatens irreparable injury to the corporation. See M.G.L. c. 156D, § 14.30(2).
These statutory remedies are useful as a last resort, but going to court is rarely the best way to resolve an ownership dispute. A judicial proceeding can be costly and disruptive, and it leaves key decisions about resolving the deadlock in a judge’s hands rather than the owners’.
Addressing Deadlock Before It Occurs.
The best time to address a potential deadlock is before a dispute arises. A well-drafted agreement should define when an ownership disagreement rises to the level of a deadlock and establish the process that follows, helping avoid the cost and disruption of litigation. Business owners with equal ownership structures should review their governing documents with corporate counsel now to ensure those issues are handled before a serious disagreement occurs.