When two equal partners pool their resources to run an enterprise together, they rarely anticipate any unsolvable disagreements between them. An intractable disagreement over a business issue is usually referred to as a “deadlock.” The topic of deadlock resolution is often underestimated and overlooked by business owners until they encounter it during their business operations. Fortunately, a partnership deadlock is preventable if discussed before the partnership is formed.
Methods to Address the Deadlock in the Partnership Agreement.
1. Upfront Responsibility Allocation.
If two partners discuss their responsibilities before forming a partnership, the likelihood of deadlock significantly decreases. Solidifying the responsibility allocation in the company documents can reinforce this result. Whether partners choose a limited liability company, a corporation, or a partnership, a management division clause in the formation document can be decisive.
2. Escalation Clause.
Another way to address deadlock is to include an escalation clause in the company documents (a partnership agreement, an operating agreement of the limited liability company, or the shareholder agreement of a corporation). Escalation can be binding or non-binding as a precondition to other methods of deadlock resolution. A business matter can be escalated to the company’s executives or people with special knowledge, including:
(a) an executive who does not participate in handling day-to-day matters but can bring a fresh perspective on the disputed matter, such as the chief executive officer.
(b) an expert who has special knowledge if the disputed matters require such knowledge, for example, technical, software, commercial, market analytics, accounting, etc. A specialist can be an employee or an outside expert invited to shed light on the business issue.
Some matters may be escalated to senior executives, and others to officers with special knowledge. Members of a limited liability company, or shareholders of a corporation, may decide to name the officer/executive or specify the title to whom the matter should be escalated in the operating agreement or shareholder agreement.
3. Buy-Sell Agreement.
Furthermore, a company agreement can include a buy-sell provision. This would allow one partner to buy the other’s share in the company if the partners cannot reach a decision, even with the assistance of the executive or experts. Having such a clause in the partnership agreement allows for uninterrupted business operations in the event of a deadlock.
4. Mediation, Arbitration, and Litigation.
An alternative to the escalation clause or a step “two” in a deadlock resolution can be mediation, arbitration, or litigation. It is best if this step is also addressed in the company documents, including the number of mediators or arbitrators, the procedure of their selection, their special knowledge, and the applicable rules. The dispute resolution through mediation, arbitration, or litigation can follow a non-binding escalation or be applied if escalation has not brought any desired outcome. The partner can also choose the dispute resolution method most suitable to their situation. However, discussing it before signing a partnership agreement makes it less challenging to handle a conflict.
Deadlock and Business Operation.
Another essential factor to tackle is the definition of “deadlock” in the formation documents. The “deadlock” can be defined as a “fundamental issue” that the partners cannot reach a decision about. It can be drafted by presenting (a) the list of fundamental matters that partners cannot agree on or (b) stating that this can be any matter requiring vote, and the vote the parties provide does not lead to a resolution of the matter, or © referring to matters arising under specific sections of the company agreement.
Examples of the “fundamental issue” may include the following: (a) entering into a new line of business; (b) adopting the company’s business plan or budget; © making capital expenditures; (d) raising capital or requesting additional capital contributions to the company; (d) entering into a material transaction, such as consolidation, stock or asset acquisition, merger, or sale of all or substantially all of the assets of the company; (e) initiating or settling any litigation or arbitration involving the company; (f) making expenses in excess to a specific limit.
The final question for discussion is the business operation during a deadlock. One of the options is to maintain business as usual during the turmoil of disagreement on a specific topic. A deadlock resolution clause may include a statement that the company shall continue its operations in the ordinary course of business. Additionally, it can further provide that “in the ordinary course of business”, among other things, means under a previously approved budget.
Regardless of the chosen partnership structure, preliminary discussions on responsibility allocation and clear deadlock resolution language within a partnership agreement significantly mitigate the risk of impasses and streamline their reconciliation when they inevitably arise.