Start-ups

JV series – deadlock resolution

Some joint venture parties may prefer not to specify in detail how any deadlock is to be resolved, relying instead on finding a solution as and when such a situation arises. One reason for this is the view that, if parties wish to settle a disagreement, they will do so, whereas, if they are not willing to compromise, the drafting of detailed deadlock resolution procedures will not force them to agree.

However, including detailed deadlock resolution procedures in the joint venture agreement may focus the parties’ minds in the event that a disagreement arises, particularly where failure to resolve the deadlock will have serious consequences (such as the termination of the joint venture). Successful deadlock resolution procedures will encourage the parties to reach an amicable and speedy settlement of the outstanding issues.

Common deadlock resolution procedures include:

• granting a casting vote to the chairman of the board
• use of an outsider’s swing vote
• escalation of the issue to the parties’ chairmen or chief executives, and
• reference to mediation, arbitration or expert determination

Chairman’s casting vote

Deadlocks at board level may be unlocked by giving the chairman of the board of directors a casting vote. However, this arrangement is unusual in a 50/50 joint venture because it gives an advantage to the party who has appointed the chairman. Even if the joint venture agreement provides for the parties to take turns to appoint a chairman for a specified period, a party may be unwilling to take the risk of a key decision being taken when a chairman appointed by the other party is in place.

The standard articles of association as prescribed in Schedule 2 of the Companies (Model Articles) Notice (Cap. 622H of the Laws of Hong Kong) give the chairman of the board a casting vote at both shareholder and board meetings[1]. If the joint venture parties do not want the chairman to have a casting vote, then the relevant provisions of Table A should be expressly excluded in the articles of association of the joint venture company.

Outsider’s swing vote

If the parties are not willing to provide for the chairman of the board (who may be appointed by another party) to resolve a deadlock, they may be willing to provide for an impartial outsider to resolve deadlock situations. At board level, this could be a non-executive director not connected with any of the shareholders. At shareholder level, the company may issue a golden share to the outsider.

Whether the outsider is a director or a shareholder, there are a number of considerations which must be taken into account if this method is used, including:

• identifying a suitable impartial person with appropriate business expertise
• the costs of referral to an outsider, i.e. what payment will the outsider require, and
• whether deadlock resolution may be delayed by the time taken for the outsider to understand the issues

Escalation

The joint venture agreement may provide for deadlocks which cannot be resolved at board level to be escalated to higher levels of management within the joint venture parties (potentially up to the level of the parties’ chairmen or chief executives). Such a procedure may be effective where the parties have several levels of management because:

• it will concentrate the minds of the management team (as they will be unwilling to have to refer the matter higher up in their own organisation), and
• managers at higher levels may be better able to appreciate the broader strategic picture and to appreciate the value of the joint venture from that party’s point of view

However, this procedure is not likely to be effective where the parties have few or no levels of management above those directly involved in the joint venture.

Mediation, arbitration or expert determination

Referring a dispute to an external expert or arbitrator could unlock deadlocks at either board or shareholder level. However, such referrals may involve considerable time and expense and may not be appropriate where the deadlock arises for a business rather than an operational reason.

Mediation may be used to assist the parties to achieve deadlock resolution themselves but will not provide a final resolution if the parties are unable to agree on a solution to the deadlock.

If the parties are unable to agree on the deadlock resolution and none of the above methods are effective, options will usually be limited to a transfer of shares or voluntary liquidation of the joint venture company.

A particular interesting way to deal with deadlock resolution is known as the Russian roulette, please refer to SMEs – SMEs expanding business needs.