M&A Vocabulary – Understanding Experts: “Deadlock”

The term “deadlock” describes a stalemate situation between two or more parties. In corporate law, such stalemate situations can occur at the shareholder level and at the management level. While at the management level the shareholders can usually intervene and break a deadlock, this is not as easily possible at the shareholder level.

In this article, we look at the background of a deadlock at the shareholder level, the effects of such a stalemate, and mechanisms for how such a stalemate situation can be avoided or resolved.

Background of a Deadlock

A deadlock at the shareholder level can arise in a joint venture, particularly with equal ownership and voting shares. Joint venture companies are established for a wide variety of reasons. A joint venture allows parties with different strengths to pool them within a company, such as know-how, capital, or a customer base. The distribution of shares and votes should correspond to the interests of the parties and the applicable legal provisions.

In international business, however, joint venture companies may also be necessary due to investment restrictions. For example, when the law of the host country requires that the foreign investor form a joint venture with a local party in order to conduct business in the host country. Often the ownership and voting distribution is legally prescribed.

Regardless of whether a joint venture is based on party interests or on the investment law requirements of a host country, they can all be confronted with the risk of a deadlock.

A deadlock in a joint venture means that the shareholders disagree on essential points.

Effects of a Deadlock

A deadlock between joint venture shareholders can be life-threatening for the company. If, for example, the shareholders cannot agree on financing issues, the company may be threatened with insolvency. Legal difficulties can also arise, such as when the company is no longer able to meet its reporting and disclosure obligations due to the stalemate situation. Without corresponding provisions in shareholder agreements, deadlocks can only be resolved with the help of statutory regulations, which are sometimes rather vaguely designed, particularly in developing and emerging countries. Depending on the underlying legal system, dissolution of the company or possibly the forfeiture of a shareholder’s shares may be considered. As a rule, however, the statutory provisions do not lead to a satisfactory result.

Strategies for Avoiding a Deadlock

The risk of a deadlock should be considered when planning a joint venture company. Care should be taken in the joint venture agreement and, where possible, in the company’s articles of association to ensure that stalemate situations do not arise in the first place. Provisions regarding voting shares and conflict resolution mechanisms are conceivable here. Joint venture agreements typically also contain so-called deadlock clauses, which provide relief by defining a deadlock situation and a share transfer mechanism as well as termination of the joint venture relationship. Such clauses should be drafted with great care, as some legal systems may not recognize them; even if recognized, the clause must be designed as precisely and practically as possible. In deadlock situations, the relationship of trust between the parties is usually shattered, so the resolution mechanism of a deadlock clause must be precise and pragmatic. If this is not the case, there is a high probability that the parties will pursue court or arbitration proceedings. A quick, pragmatic, and company-preserving solution can then become a distant prospect.

Deadlock situations become even more complex in international business when the joint venture was necessary due to local investment restrictions. Often, a joint venture cannot simply be dissolved without jeopardizing the foreign investment. Here too, a precautionary approach is recommended, such as involving several independent local partners in the joint venture.

Conclusion

Deadlocks can be life-threatening for joint venture companies and must be considered from the outset when setting up a joint venture. Particularly in international business in foreign legal systems, one should act with foresight and caution so as not to risk the investment abroad in the end.

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