It’s very common for two people, often friends or former colleagues, to go into business together, to be equal shareholders (with 50% each) and to be the only directors of their company.
Unfortunately, splitting the management and ownership of a company straight down the middle without taking suitable precautions can result in a classic deadlock situation if things start to unravel. I’ve seen it countless times before. Let’s look at an example.
Imagine that two people set up a company, with one employed as the managing director, the other its finance director. As happens all too often, they don’t have written contracts of employment (no time for that!), the company has standard ‘Table A’ articles (what’s ‘Table A’ anyway?) and there isn’t a Shareholders’ Agreement (sounds unnecessary).
And then, you guessed it, they fall out. For the sake of argument, let’s say the MD discovers the FD has been fiddling the expenses to the tune of thousands of pounds.
Now the usual mechanism for removing a director is for the company to pass an ordinary resolution. But the MD can’t act upon this basis, remember, as she doesn’t have the requisite 51% shareholding. She also can’t remove the FD in his capacity as an employee. Even the suspension of a director who is also a co-owner of the business (still less his dismissal) falls outside the MD’s authority: a board resolution would need to be passed for the FD to be dismissed as an employee.
This, of course, won’t be forthcoming as, given the terms of standard Table A articles (those again), there’s deadlock at board level.
Recourse to the law?
Now you’d think in such circumstances that the MD would have straightforward recourse to the law, be able to remove the FD from the management of the business and potentially require him to give up his interest in the business altogether. Not on your nelly. Where there is a deadlock at board and shareholder level, things are nowhere near that straightforward.
For starters, there are never any guarantees in a court of law: the case could not only prove very expensive but also be lost. In any event, even if the FD were successfully removed in a court of law, whether as a director or an employee or both, that would still leave him as a 50% shareholder.
Another legal route for the MD is to take an unfair prejudice/derivative action under the Companies Act in the High Court. This could force the company to remove the FD both as an officer of the company and as an employee and to require him to give up his shares (although he would have to be paid a fair value for them). It could well work, but again the MD would have to bear the costs of taking the action in the first instance — and even if successful there’s no guarantee she would be able to recoup all the costs incurred.
Negotiate the problem
In the circumstances, the best course of action for this kind of deadlock situation is almost always to seek a negotiated solution outside of the courts. For example, this may result in the FD resigning as both a director and employee and the purchase of his shares by the MD.
It will frustrate the MD to have to pay to see the back of the FD when he’s behaved so badly, but given that that’s the probable outcome of any court proceedings anyway, it makes sense to avoid litigation.
Prevention better than cure
The moral of the tale is that if you’re thinking of going into business with someone on equal terms, take preventative measures at outset. Look at it as a corporate pre-nup. Properly drafted Shareholders’ Agreements and Service Agreements that allow for the removal of a director, as employee, officer of the company and shareholder where the individual has clearly acted to the detriment of the company would do away with any potential deadlock.
In the excitement of launching a new business with someone, though, this is so often forgotten.
- Catherine Gannon is managing partner at Gannons Solicitors