Navigating Business Deadlocks: Some Practical Tips for Founders/Business Partners in the Post-COVID World

Pooja Sinha [1]

The Post-COVID Business Landscape: Change is the Only Constant

In a business context, we have seen the deep impact that the COVID-19 pandemic has had on pretty much every business on the planet.

Just recently, we have seen news of some very established companies make very difficult business decisions, to significantly pivot their business strategy such as exiting some markets and/or even moving entirely online. A high-profile High Street example is fashion retailer, Zara’s decision to permanently close as many as 16 per cent of its physical outlets worldwide with the closures concentrated in Asia and Europe[2].

What has become increasingly clear is that the full domino effect of the economic “doom and gloom”/uncertainty brought about by the pandemic is as yet unquantifiable. In short, the economic landscape will remain an uncertain one for several years to come.

It is widely acknowledged that the practical impact of the new economic landscape is that almost every business on the planet will be forced into an internal rethink.

Specifically:

  • A business will have to make some sort of pivot to its business strategy and/or operations to thrive (or for some even survive) in this new economic landscape.
  • The scale of the pivot and the underlying fundamental re-assessment of a company’s strategic direction is unchartered territory for most (this is even when the pivot presents an opportunity).

The uncertain economic business landscape is likely to heighten the risk that there will be binary views between founders and between business partners on the nature and the extent of the pivot required to the existing business strategy.

Indeed, from a legal perspective, us lawyers have already seen this heightened risk play out in the form of an increase in disagreements between founders and business partners being processed through court and arbitral proceedings.

To summarize, we see one of the key features of the post-COVID risk landscape being the heightened “deadlock risk” — i.e. the enhanced risk of founders and business partners facing a deadlock- by which we mean an inability of the parties to agree on strategy or other important decisions affecting the venture, due to, among other things:

  • a genuine disagreement between parties; or
  • a fundamental breakdown in relationship.

Essentially, it is a scenario that prevents the company from moving forward in the business.

The traditional method of resolving differences is of course the legal process- However, involvement in any such legal process (be it for “offence” or “defence”) comes with its own “baggage” of expenses and diversion of valuable management time.

In addition, parties to a legal documentation often tend to have a “false comfort” around the extent to which legal provisions in their contracts can fully insulate them from business risk. This is because they fail to appreciate the nuances of actually enforcing contractual documentation in a real-world scenario and more so when cross-border elements are involved. In the box below, we use the “force majeure clause” (which, by the way, has been hotly dissected in the legal press of late) as an example of some of the nuances that are often missed out by deal parties.

For the reasons above, my proposition is that we need to take a fresh look at how to resolve deadlocks most efficiently from a cost and process perspective.

The central thesis of my proposition is that, in today’s economic landscape, it is imperative for deal parties to consider hardwiring a FRAMEWORK for resolution of deadlocks into their legal documentation at the start of the business relationship. The common focus of each of these frameworks is setting out a pre-agreed PROCESS for framework resolution which we believe can be far more cost-efficient than trying to anticipate and provide a solution for all the areas of disagreement in the legal documentation (even assuming that such identification was feasible).

This would help to avoid the “nuclear option” of a formal legal proceedings to the maximum extent possible. In addition, where the deadlock resolution is not successful, thought should be given to a fair framework to allow one party to exit the business venture.

The deadlock resolution frameworks outlined in this article are not new as such. What I have done is to select and showcase some of the specific frameworks that are particularly well-suited to mitigate the “deadlock risk” explained above.

I set out below information on the deadlock resolution frameworks that I propose.

These frameworks can be embedded into the deal in various different ways- through the very corporate structure of the investee company and/or the intra- shareholders’/founders’ agreement and/or the constitutional documents of their investee company.

FRAMEWORK 1: DEADLOCK PROVISIONS EMBEDDED IN THE CORPORATE STRUCTURE

Swing Director

A swing director is an additional independent director appointed to the board only to determine the deadlock. It may be difficult to find and agree on a candidate. It may be appropriate if a prompt and sudden decision is made.

Alternating Chair

Each founder/shareholder appoints chair for an alternating period (eg. 1 year). The chair has a casting vote on a deadlock. This is advantageous to one party despite an alternating chair.

FRAMEWORK 2: MEDIATION AS AN ALTERNATIVE DISPUTE RESOLUTION MECHANISM

I would also argue that in the current landscape, it is particularly important for deal parties to consider alternative dispute resolution, and in particular mediation.

Mediation is a particularly effective tool in current times given the advent of the Singapore Mediation Convention which came into force on 12 September 2020. This Convention provides a process for the direct enforcement of cross-border settlement agreement between parties resulting from mediation in that a settlement agreement may be enforced directly by the courts of a state that has ratified the Convention. This is a particularly useful tool for Singapore-based parties which contract with parties based in another country that has ratified the Convention (Singapore was one of the first few countries to ratify the Convention and has been followed by an ever-increasing list of countries).

In some recent cases in Singapore, some very effective mediations have been conducted with the deal parties effectively “locked into a room” (physical or virtual) for a pre-agreed period (1–2 days) to thrash out a commercial agreement with a lawyer acting as the mediator. Being outside the court process has also allowed for some more creative solutions such in-kind contributions or deferred payments as an alternative to settle cash payment obligations.

FRAMEWORK 3 :TERMINATION PROVISIONS EMBEDDED IN THE DOCUMENTATION

Examples of such termination provisions are the “Russian Roulette” and the “Texan Shootout”.

Russian Roulette

Each shareholder makes an offer to buy the other shareholders’ shares at a specified price. The recipient shareholder may buy or sell at the agreed price. Because the initiating party may either have to sell or buy, this should ensure a realistic price is offered. This may backfire if there is unequal position of the parties. (eg. if the receiving party is in financial difficulty and the offeror offers at a discount knowing that the recipient will be forced to sell at that price). It is only appropriate for two party ventures.

Texan shootout.

A common version of this mechanism is a party can serve a purchase notice on the receiving party stating that it is willing to buy the other out and setting out the price. The receiving party has a period to serve a counter notice either stating that it is prepared to sell at the price offered or that it wishes to buy the interest of the initiating party at a higher price. If the second option is chosen, then there may be an auction or a sealed bid (the highest bid wins).

While I recognize that each of these frameworks have certain limitations, I would strongly suggest that deal parties carefully consider incorporating these frameworks (or a version of these frameworks) into their deal architecture.

I also recognize that it is not typical for lawyers to advocate for “process-related” provisions over “legalease”.

However, if there is one key takeaway from the blitz of contractual interpretation that has followed the COVID-19 pandemic, it is that there are gray areas in enforcing contractual rights particularly in a cross-border context.

This article is an effort to approach legal issues in a more pragmatic and holistic way -in my view, precisely the commercially-oriented lawyering that is the need of the hour in these times of flux .

[1] Pooja Sinha is a Partner at GLS Law Firm, an international law firm. The views expressed herein are in her individual capacity and do not represent the views of her firms. The contents herein are purely informational and should not be construed as legal advice or opinion (the authour has consulted with Jean Foo, Managing Director of Forte Law LLC, a Singapore law practice in relation to Singapore law matters but nothing herein should be construed as Singapore law advice) . Please contact a lawyer for advice on the specific risks that may apply to your fact situation.

[2] https://www.straitstimes.com/business/companies-markets/zara-owner-to-close-up-to-1200-stores-globally-after-first-ever-loss.

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Pooja Sinha

A global deal lawyer running her practice from Singapore. Recently caught the lockdown writing bug. LinkedIn: https://sg.linkedin.com/in/pooja-sinha-singapore.