Mechanisms to unlock deadlocks in joint-ventures or joint enterprises


In general, a joint-venture is understood to be a company that is incorporated and 50% owned by two companies in order to develop a project of common interest to them both (launch of a new product, introduction to a new foreign market, etc.).

The incorporation of a joint-venture is normally accompanied by the signing of an agreement between the partners establishing the bases for the collaboration (joint venture agreement or agreement between partners). It is common practice for this agreement between partners to include, among other provisions, clauses that establish mechanisms to prevent or solve situations of corporate deadlock.

 

Corporate deadlock

When a conflict arises in a joint-venture in which the share capital is divided between two partners that each hold 50%, responsibility for this conflict normally ends up with the corporate bodies (Board of Directors and General Meeting). What results is known as a situation of corporate deadlock, which brings the company to a standstill due to the impossibility of adopting agreements in either of these corporate bodies.

Lawmakers regard the dissolution of the company as one way out of the deadlock situation. Indeed, article 363.1d) of the Capital Companies Act establishes “the paralysis of the corporate bodies so that their operation is impossible” as grounds for the company’s dissolution. The existence of such grounds for dissolution does not imply automatic dissolution, but instead presents the company with the dilemma of having to adopt the relevant corporate agreements to remove the grounds for dissolution or being doomed to dissolution, either by corporate agreement, or by judicial decision if one of the partners requests this from the Courts.

However, in practice it has been found that the solution of dissolving the company is not an ideal outcome, given that the separate value of the company assets awarded to each partner will generally be much lower that that of an operational business that generates profits.

 

Unlocking mechanisms

The following are some of the main mechanisms used to solve corporate deadlock situations that allow for the departure of one of the partners in a deadlocked situation, in order to avoid the dissolution of the company.

In proposing the different mechanisms for solving the deadlock, we will use the following factual example: a limited company (Sociedad Limitada or S.L.) with two partners, each holding 50% of the share capital.

 

Grant of a purchase or sale option in favour of one partner

This consists of granting one of the partners the right to exercise a purchase option or a sale option (the partner chosen by draw once the notification of deadlock has been made), either over the other partner’s shares (if the purchase option is exercised) or over its own shares (if the sale option is exercised).

Once the deadlock notification has been made by one of the partners, an independent expert is entrusted with valuing the shares. Based on the valuation made by this independent expert, the partner chosen by draw may decide whether to exercise the purchase option and acquire the shares or to exercise the sale option and sell the shares to the other partner.

 

Russian Roulette

One of the partners (the partner chosen by draw once the deadlock notification has been made) offers to purchase the other partner’s shares at the price indicated in the purchase offer itself. After receiving the purchase offer, the other partner may (i) accept the purchase offer made by the other partner and sell its shares to that partner, or (ii) require the partner that has notified it of the purchase offer to sell its shares at the same price indicated in the purchase offer.

 

Auction

One of the partners offers to purchase the other partner’s shares at the price indicated in the purchase offer itself. Upon receipt of the purchase offer, if it does not agree with the price or does not wish to sell its shares, the other partner may make a counter-offer to the first partner to buy its shares at a higher price than the one indicated in the initial purchase offer from the other partner. This procedure continues until one of the partners accepts the other partner’s purchase offer.

 

Offers in sealed envelope related to the purchase price (Texas shoot-out)

Each partner gives a third party, usually a Notary, a sealed envelope containing an offer indicating the price at which it is willing to buy the other partner’s shares. The Notary opens the two envelopes and the partner that has made the highest purchase offer is obliged to purchase the other partner’s shares at that price.

 

Offers in sealed envelope related to the sale price (Mexican shoot-out)

Each partner gives a third party, usually a Notary, a sealed envelope containing an offer indicating the price at which it is willing to sell its shares to the other partner. The Notary opens the two envelopes and the partner that has set a higher price for the sale of its shares is the one that is obliged to purchase the other partner’s shares at the sale price indicated by that other partner.

These unlocking mechanisms have their advantages and disadvantages that must be analysed on a case-by-case basis, though they avoid what is normally the worst option, namely the liquidation of the company.