In this blog post, Akansha Mehta, an Associate at J Sagar Associates, Mumbai and a student of the Diploma in Entrepreneurship Administration and Business Laws by NUJS, describes the different types of resolution deadlock clauses in an investment agreement.
Commercial agreements, in which investment agreements form a crucial part, are designed in such a way that ensures smooth implementation of the agreed terms so that maximum benefit can be reaped for every stakeholder involved in it. Providing an amicable dispute settlement procedure forms an indispensable part of meeting this objective. Usually, while executing various commercial agreements, conflicts are bound to happen. If such conflicts are not dealt with at the right time and in the right manner, it has the potential to turn into a dispute which further creates a situation of a deadlock. This ultimately stalls the progress of the execution of the agreement undermining the very purpose of the entire activity. This situation is undesirable for every stakeholder. It involves an investment of time, money and energy which are more precious assets of every entity involved in such activities. Therefore, there comes a need of resolving the conflict as soon as it erupts in the most efficient and reasonable manner. For this, every investment agreement must have resolution deadlock clauses. Such clauses entail two essential features, one which provides for a solution to resolve the deadlock and the other which allows the dissenting stakeholders to exit the agreement.
How to draft a deadlock provision
No agreement, irrespective of how meticulously it has been written can ensure that all possible disputes that may arise between the stakeholders are incorporated. However, one may foretell by the nature of transaction about what are the most probable disputes which may arise. This will give the reassurance and confidence to every party involved regarding the negotiation and the commercial agreement as a whole. The first objective that it to be kept in mind while drafting one is to provide a method through which the dispute can resolve amicably. This is extremely crucial because often disputes can leave either of the parties unsatisfied which may further result in hostile exit prejudicial to the benefit of other parties. Therefore, the deadlock provision must also provide for an amicable and smooth route for the exit to any party which is not willing to continue with the agreement.
Since the deadlock situations can arise because of issues that require a majority or unanimous vote, the clause should restrict such issues to minimum (they are often called Restricted Matters). There can be various conflicts at many stages of execution of an agreement. In case every such conflict will be resolved through the formal process, this would further be prejudicial to the benefit of all. Therefore, the deadlock provisions should be drafted in such a manner that only those decisions which shall have a substantial effect on the execution and implementation of the agreement are actually resolved through it. Discussed below are the different types of resolution deadlock clauses that can be incorporated into an investment agreement.
Right of First Refusal
The Right of First Refusal is a system which allows the exit of the shareholders which are willing to leave on account of any dissent while allowing the non-dissenting stakeholders to buy the stakes which were initially held by the dissenting stakeholders. The price of the same would be determined either according to what was mentioned in the shareholder’s agreement or by the shareholders. Under this system, the dissenting stakeholders send a notice to other stakeholders offering the shares held. The board of directors notifies the number of shares and their value. In case these share not opt non-dissenting shareholders then the same shares are sold to any third party in the open market.
Valuation of Shares
The procedure followed under the ROFR is usually controversial as the calculation of the values of the shares remains ambiguous. Under this process, the exiting stakeholder can receive an amount that is equal to a specific proportion of the value of the net assets of the joint venture company. Otherwise, the value is decided mutually between the parties. This remains a huge bone of contention. In such circumstances, the value is calculated by an in-house or outside auditor. In either case, all the stakeholders must mutually agree upon the mode of valuation before the ROFR method is triggered.
Russian Roulette (Works in a Joint Venture)
In this system, one stakeholder (S1) will initiate the process of deadlock resolution by sending a notice in written to the other stakeholder (S2) explaining what it considers being a reasonable price for S2 in the investment agreement. This notice will also mention the period within which S2 must reply to if it will sell its shares to S1 or buy S1 shares at the price offered. In case there is no reply received from S2 then the silence will be assumed to be acceptance of the offer made. Under this circumstance, S2 will have to sell its entire shareholding in the agreement to S1. 
S1 can also quote an unreasonably low price for S2’s shares, but the risk in this is that S2 may offer to buy out the stakes held by S1. Thus , unless S1 is certain that S2 will not have the adequate resources to make such a similar offer S1 would normally refrain from making such an unreasonably low price. However, it must be noted that such an arrangement comes handy when there are not more than two shareholders in a joint venture. In case there are more than two shareholders then this process might become highly unpredictable. A slight modification in this system can happen where a notice by one stakeholder sets off a sealed bid for the share that is held by some other stakeholder. This kind of process is usually called Mexican Shoot-out. In either of these processes, one stakeholder will be forced to exit while the remaining stakeholder will eventually obtain the absolute control over the joint venture.
Multi-choice procedure
When there is a deadlock and the parties do not wish to exit or take any drastic measure, then the deadlock provision may provide for a series or list of options to the parties. The parties have to agree upon one of the solutions mentioned in this list. The advantage of having such a flexible clause is that it gives an opportunity to all the stakeholders to compromise.
Cooling-off/Mediation
This provision is another open-ended deadlock resolution clause wherein the parties are given the liberty to resolve the deadlock by going into mediation where each part may propose their solution, and the mediator will weigh each option according to its reasonableness.
Deterrence approach
This system is not the most desirable deadlock resolution clause as it rarely resolves the deadlock. Under this process, the deadlock is triggered as soon as one stakeholder serves notice to others stating that a situation of deadlock has arisen. Therefore, under this method it is not necessary that some key matter has been left unresolved, the deadlock situation will arise as soon as a notice is served. The second step involves two options – either the party which has served the notice will buy the shares of all other parties at the rate of 125% of the fair market value, or it will sell all its shares at the rate of 75% of the fair market value to another party.
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