Hats off – avoiding deadlock in business ownership

Business owners, particularly in small businesses, can often wear too many hats. Whether it be as a shareholder, director and/or employee, each of these hats carries very different rights and responsibilities:-

Shareholders: investors in the business and their relationship to each other is governed by the Companies Act and any shareholder agreement (if one is in place).

Directors: responsible for the day-to-day running and decision making of the business. Their obligations to the company are set out under the Companies Act. They have a duty to shareholders to act in the best interest of the company.

Employees: employed by the company to provide services under a contract of employment. They have various legal rights and duties under their contract and statute such as the protection from unfair dismissal and unlawful discrimination.

The positions of shareholder, director or employee are not mutually exclusive and business owners are frequently all three.

For many businesses the founders are close friends, family or marital/civil partners all with two shareholders each having a 50% stake.  Those two people tend to be the sole directors and are usually employed in key management roles.

All goes well to start with but fast forward down the line, what if someone wants out or wants  someone else out? The relationship breaks down; the roles have grown; there are performance or conduct issues; the business is going in a different direction or there is an unexpected life event such as divorce or long-term illness? 

This can often result in a deadlock scenario with business operations in paralysis due to the conflicting rights. They cannot work together but no major decisions can be made because as the sole directors they have equal voting rights and won’t co-operate. They potentially cannot manage the other’s performance nor can they suspend or terminate employment as they do not have overall authority over the other.

It’s easy in hindsight but taking advice early on is crucial when you are first setting up your business or planning succession.  Putting mechanisms in place via a shareholder agreement and tailored articles of association to deal with exit events is vital.  Equally, implementing appropriate employment contracts gives greater certainty around duties and roles and can protect your business when the employment relationship is coming to an end. To be effective, the contract should cover the duties, responsibilities, reporting lines of senior employees and directors, it should detail the disciplinary process and, crucially, the authority to discipline.  It should also set out the arrangements surrounding termination arrangements such as the notice periods and an obligation to resign a directorship in the event the employment comes to an end.  Finally, it should set out the obligations of confidentiality and detail the post termination restrictions that are appropriate to protect the business.