M&A Vocabulary – Understanding Experts: Deadlock

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give or refresh a basic understanding of a term and provide some useful tips from our consultancy practice.

The term “deadlock” describes a stalemate between two or more parties. In corporate law, deadlock can occur at the level of the shareholders and at the level of the board of directors. While the shareholders can usually intervene and break a deadlock at the level of the board of directors, this is not so easy at the shareholder level.

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

Background of a deadlock

A deadlock at the shareholder level can occur in a joint venture, especially in the case of equal shareholdings and voting rights. Joint venture companies are set up for a variety of reasons. A joint venture allows parties with different strengths to exploit the synergy potential, e.g. in terms of know-how, capital or customer base. The allocation of shares and voting rights should be in accordance with 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, if the law of the host country requires the foreign investor to form a joint venture with a local party in order to be allowed to carry on business in the host country. The allocation of shares and voting rights are issues that are often prescribed by law.

Regardless of whether a joint venture is based on the interests of the parties 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 joint venture parties, i.e. the shareholders of the joint venture company, disagree on key issues.

Effects of a deadlock

A deadlock between the joint venture partners can threaten the existence of the joint venture company. If, for example, the shareholders cannot agree on financing issues, the company may be threatened with insolvency. Legal difficulties can also arise if, for example, the company is no longer able to meet its reporting and publication obligations due to the deadlock. Without corresponding provisions in joint venture contracts, deadlock can only be resolved based on legal regulations, which are sometimes quite vague, especially in developing and emerging countries. Depending on the applicable law, the liquidation of the company or, if possible, the redemption of shares of a joint venture partner are to be considered. However, in many cases the statutory provisions do not lead to a satisfactory result.

Strategies to avoid a deadlock

The risk of a deadlock should be considered already when setting up a joint venture company. In the joint venture contract and, as far as possible, in the articles of association of the joint venture company, a deadlock should be addressed to avoid its occurrence in the first place. Here, for example, the allocation of shares and the respective voting rights as well as dispute resolution mechanisms should be considered. Joint venture contracts usually also contain deadlock clauses, which provide a remedy by defining a deadlock situation and stipulating a share transfer mechanism as well as the termination of the joint venture relationship. Such clauses should be drafted carefully, as some jurisdictions may not acknowledge them. Even if the respective jurisdiction acknowledges a deadlock clause, the clause must be drafted as precisely and pragmatically as possible because the relationship of trust between joint venture partners in a deadlock situation is usually shaken. If this is not appropriately regulated, the parties are likely to take judicial or arbitration proceedings, which might not lead to any quick and, pragmatic solution of the deadlock that would ensure company’s further existence.

Deadlock situations become even more complex in international business situations where the joint venture was necessary due to local investment restrictions. In such a case a joint venture cannot be terminated without putting the foreign investment at risk. Here, too, a precautionary approach is recommended, for example by including several independent local partners into the joint venture.

Conclusion

A deadlock can threaten the existence of joint venture companies and must be taken into account right from the beginning when setting up a joint venture. With respect to business activities abroad which fall under a foreign jurisdiction, the investor should apply even more caution as otherwise the entire investment might be at risk.