Conflict resolution mechanisms for 50/50 Joint Ventures

Alain Friedrich
Alain Friedrich
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When two people found a company and each of them owns 50% of it and both are the only members of the board of directors, differences of opinion can quickly lead to a so-called deadlock. The company can no longer pass resolutions and becomes incapable of acting. A real problem.

The following article explains which instruments can be used to prevent or resolve such deadlock situations.

I. What is the problem in the first place?

In stock corporations, decisions are made at the general meeting by an absolute majority of the share votes represented, unless the law or the articles of association provide otherwise. In the board of directors, decisions are made by a majority of the votes cast, i.e., each member of the board has a vote.

In the case of a 50/50 joint venture, there is a risk that no positive resolution can be passed because the two shareholders and board members have a different opinion on the matter. If no resolution can be passed, the status quo remains and the company might become incapable to act.

II. What instruments are there to prevent deadlocks?  

In 50/50 joint ventures, the possibility of a deadlock is structurally inherent, which is why precautions must already be taken when the company is being established. These can be implemented at the level of Swiss company law or by concluding contractual agreements.

A) Possible solutions at the level of Swiss Company Law

a) Decision by a casting vote of the chairperson of the board of directors

Deadlocks in the board of directors can be prevented by appointing an uneven number of board members.

If an even number of board members is appointed, the law provides a possible solution: According to art. 713 para. 1 CO, the chairperson of the board of directors has the casting vote, unless the articles of association provide otherwise. If the chairperson should not have a casting vote, it must be explicitly excluded in the articles of association.

In 50/50 companies, the casting vote of the chairperson is often excluded in order to prevent one shareholder from outvoting the other on the board of directors.  

b) Granting a casting vote to a third party

An alternative to granting a casting vote to the chairperson of the board of directors is to grant a casting vote to a third party at the general meeting. For example, each 50 %-shareholder can transfer one share vote to a neutral third party, who then makes the casting vote as an additional shareholder.

Furthermore, it is of course also possible to elect an independent and neutral member of the board of directors, who then – due to the uneven number of board members - has the casting vote. 

B) Possible solutions at the contractual level

a) Alternating the chairperson

In connection with the casting vote, it can be agreed upon in a shareholders' agreement that the shareholders will share the position of the chairperson, i.e. the chairperson (and thus the casting vote) will be changed periodically. The alternation of the final decision-making power also has a preventive effect: the knowledge of the change of the chairperson tends to protect against its abuse.

b) Modification of the casting vote

The parties can also contractually modify the statutory casting vote. For example, it can be limited to certain contractually defined fundamental issues. The casting vote can also be assigned to an external expert. Such an arrangement can be useful if the final decision is to be made purely from a technical perspective, detached from the persons involved.

c) Use of Joker Cards

Sometimes it is also agreed that each party has an annual "joker".  The "joker" allows a shareholder to veto a resolution. If the veto is used, the other party has the choice of accepting the veto or using its own "joker card". In the latter case, a deadlock occurs, which must be resolved by another mechanism.

An important element in the use of joker cards is that the party causing the dispute, i.e. the party using its joker card, loses its right to use its joker card in the following year. This "blocking" usually has a deterrent effect and is intended to increase the pressure on the parties to find a compromise.

d) Drawing lots (principle of chance)

Another way of resolving deadlocks is agreeing on the principle of chance.

Reaching a decision by a random drawing lot is particularly useful for elections or contingent motions where there are several possible options. In this case, the decision is not made by the majority or by a casting vote, but by chance. The Swiss Federal Supreme Court has confirmed that using the principle of chance is a valid instrument for resolving conflicts in the event of a tied vote, even in the general meeting.  The mechanism of drawing lots, however, must be stipulated in the articles of association (subject to agreements under the law of obligations in the shareholders’ agreement).

A decision reached by a random drawing lot is also permissible in the board of directors.

e) Involvement of a third party

A very good, and in practice often used, method of resolving conflicts is the agreement that the parties, in the event of a dispute, will involve an external third party to resolve the conflict (e.g. in the context of mediation or arbitration proceedings, by appointing an arbitrator). Various possible arrangements are being used in practice.

C) What happens if no solution is foreseeable?

If the parties fail to find a long-term solution, each party must have the option to "escalate" the matter. Here, each party is typically granted the right - after a failed conflict resolution process - to initiate a contractually defined buy-out mechanism. The aim of this procedure is to clarify which party will continue to operate the joint business and which party will leave. 

a) What does the buy-out mechanism look like?

In a buy-out, the discussions are no longer about reaching a consensus, but about clarifying whether the business has to be liquidated or whether it will be continued by one party on its own. If the company is to be continued, the withdrawing party is required to buy out the other at a fair price.

The focus is thus on finding a mechanism that ensures a fair price for the exiting party. Possible options are

  • External valuation of the company: A first approach is to have an external valuation of the company by an independent arbitrator accepted by all parties (or determined by an independent institution).
  • Internal auction process: A widely used alternative to the external valuation is to conduct an internal auction procedure. In this process, the company shares will be transferred to the shareholder who purchases the shares at the highest price.

There are different options in the contractual design of the internal auction procedure. The most popular are the so-called "Russian Roulette" and the "Texas Shoot-Out".

Russian Roulette

In the so-called Russian roulette, the buy-out process is initiated by the terminating party A with the submission of a purchase price offer for the acquisition of half of the company. Because it is unclear after this step whether A will ultimately sell or acquire the company, the terminating party A is forced to offer the fairest possible price. The other party B can then decide whether to acquire A's shares in the company at the offered price or to sell its own shares at the offered purchase price.

Texas Shoot-Out

If a so-called "Texas Shoot-Out" is agreed upon, the terminating party A also makes an initial offer for the acquisition of the company.

Party B then has the option to either (i) sell its own shares at the offered purchase price or (ii) offer a higher purchase price for the acquisition of the other party's share.

If a higher purchase price is offered, an internal auction procedure follows. The parties are free to design this procedure as they wish. The aim is always to award the company to the party that attaches the highest value to and offers the highest price for it. In practice, the financially stronger party will typically prevail.

Concluding remarks

The agreement of dispute resolution mechanisms is of great practical importance not only, but especially, in 50/50 joint ventures. Experience shows that once disputes have arisen, it is difficult to find a constructive solution. Accordingly, appropriate mechanisms should be discussed and agreed at the time of the company formation.

 

 
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