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A recent case has demonstrated the importance of agreeing a formal deadlock resolution mechanism at the outset of a business relationship, according to a corporate lawyer.
“It is essential for two parties with 50% shareholdings in a joint venture company to anticipate the possible breakdown of their relationship” says Philip Round, a Partner at the Wolverhampton office of George Green LLP. “If they do not agree in advance a procedure for resolving a fundamental disagreement, for example a mechanism for one party to buy out the other, the parties will be left to negotiate a commercial solution when the dispute arises. The disintegration of the relationship often precludes an amicable dialogue, leading to stagnation of the business and, in many cases, the winding up of the company.”
According to Mr Round, the recent High Court case of Patel v Ferdinand illustrates the complications which can arise from this. “Miss Patel and Miss Ferdinand were partners in a Legal Aid practice carried on through a limited company in which they held equal shares. As a result of disagreements regarding the conduct of the business, the parties commenced discussions about a possible division of the practice. These were, however, never concluded. After communications had broken down, Miss Ferdinand relocated some of the staff to new premises, and arranged a repayment of her director’s loan and a distribution of accumulated profits. She continued servicing clients on behalf of the company until she subsequently acquired another practice and resigned her directorship. Miss Patel claimed that Miss Ferdinand’s actions amounted to unfairly prejudicial conduct.”
Mr Round continues, “the court held that the payment of the dividend constituted unfairly prejudicial conduct, as Miss Ferdinand had not observed the requisite company law formalities, and it was unclear whether the company had sufficient distributable reserves to permit payment of the relevant amount. Miss Ferdinand had not, however, acted improperly in setting up business on her own account, as it was clear that the relationship between the parties had irretrievably broken down such that a winding up of the company was unavoidable. Miss Ferdinand had technically breached her duty as a director by setting up the new practice. It is, however, possible for a court to grant relief in such circumstances to a director whom it considers to have acted honestly and reasonably, and the court did so in this instance.”
Mr Round concludes, “whilst Miss Ferdinand was held not to have acted in an unfairly prejudicial manner in establishing a new practice, and was granted relief against the claim for breach of duty, such a claim could have been avoided altogether if the parties had agreed a deadlock resolution mechanism on setting up the business. Shareholders’ agreements are comparatively easy to negotiate at the outset of a relationship when the parties are on amicable terms, and can prevent unnecessary legal costs on a subsequent falling out.”