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Resolving Deadlocks in Joint Ventures: How Effective are “Shoot-out” Mechanisms in India?

posted 12 months ago

“What happens when an unstoppable force meets an immovable object?” The Joker – the iconic villain from The Dark Knight – used these words to describe the impasse that he and his nemesis Batman had reached. Believe it or not, similar impasses exist in the world of business as well; and when two parties in a joint venture (JV) fail to reach an agreement on critical matters, it is commonly referred to as a deadlock.

A deadlock in a JV can arise due to several factors. For instance, when there is a split view between board members with equal representation, at the shareholder level where members exercise equal voting rights, when minority shareholders exercise “veto” or “affirmative voting” rights to block a move by the majority shareholder, or when there is lack of quorum on crucial meetings, especially those for resolving “reserved matters” or “affirmative vote matters”.

What are “shoot-out” mechanisms?

Broadly, a “shoot-out” entails structuring a call/ put option in a manner where one party initiates the process by issuing a notice setting out timelines and the price for buying/ selling shares of/ to the other party. This eventually culminates into exit of one party from the JV. There can be several variants of shoot-outs – “Russian Roulette” and “Texas Shoot-out” being two of the more commonly known options.

Imagine a JV between party A and party B where a deadlock has arisen. One party – let us assume A – tells the other party, B, via a notice that it wishes to sell its shares to B or buy B’s shares at a specified price and within a timeline indicated in the notice sent by A. Consequently, there is a mandatory sale and purchase between the parties leading to one party exiting the JV. This is “Russian Roulette”. In a Texas Shoot-out, also colloquially referred to as the highest sealed bid, A tells B that it wishes to purchase B’s shares at a specified price and within a timeline indicated in the notice. B can either accept that offer or make an alternative offer to buy A’s shares at a higher price. If B chooses the alternative, A and B would consequently submit their bids in a sealed envelope to an independent third party and the highest bidder prevails, getting the right to buy out the other party.

Shoot-out mechanisms, including its variants discussed above, are considered quite frequently in western jurisdictions. Proponents of the shoot-out mechanism argue that there is an inherent fairness in the process which virtually compels one party to propose a reasonable and fair price for the shares.

“Shoot-out” mechanisms – Indian perspective

In JVs involving an Indian party and an offshore party, however, these “shoot-out” mechanisms are far from a viable option. The central reason for this is that the pricing regime in the case of transfer of shares by a resident shareholder to a non-resident shareholder is skewed in favour of the resident shareholder. When a resident shareholder seeks to transfer its shares to a non-resident shareholder, the fair market value of the shares determined as per the foreign exchange laws acts as the “floor” price, i.e. the lower limit. In contrast, when the non-resident shareholder seeks to transfer shares to a resident shareholder, the same fair market value of the shares acts as the “cap”, i.e. the maximum price. Any share purchase transaction between a resident and non-resident party in deviation of these pricing norms will necessitate prior approval from the Indian regulatory authorities, which may be denied, delayed and/ or conditioned.

Let us assume that in the above example, A is a non-resident entity while B is a resident party and the fair market value of the JV (a private limited company) is ₹ 100 per share. A deadlock has occurred in the JV. If A were to send a notice to B setting out the price at which the “shoot-out” would play out, it would need regulatory approval to complete a transaction of selling its shares to B at a price above ₹ 100 per share (fair value). However, B is at an unfair advantage here as it can set any price above ₹ 100 per share for sale of its shares to A, without prior approval.

Deadlock resolution – Alternative mechanisms

In light of the above, the fundamental question is then what is the ideal deadlock resolution mechanism in the Indian context? Here are a few options and suggestions to avoid and/or resolve an impasse.

  • Avoid structural deadlock: A 50: 50 JV model is a conceptually flawed model and invariably leads to a deadlock. Right from day one, the structure itself is inherently deadlocked.
  • Well defined affirmative vote rights/ reserved matter rights: Affirmative vote rights in favour of the minority shareholder should be defined with great attention and clearly specifying the relevant thresholds, which once breached would require the majority shareholder to approach the minority shareholder to seek consent. Further, these rights should be designed to safeguard the interest of the minority shareholder and should not be used as a tool to obtain operational control over the JV.
  • Well-balanced JV provisions: It is critically imperative to have a well-articulated JV agreement which provides clarity and guidance on several operational aspects to mitigate room for deadlocks eventually. For instance, a meticulously designed business plan outlining the broad contours of key operational matters is immensely helpful. Unfortunately, oftentimes in a bid to hastily sign off the JV agreement, parties do not spend sufficient time on these items at the outset and leave these items to be decided later. This must be avoided; a little bit of attention, effort and pain upfront can save a lot of blood, sweat and tears during the life of the JV. Similarly, the Managing Director/ Chief Executive Officer of the JV could be empowered to take certain decisions which need not be brought back to the board level.
  • Gin and tonic’ provisions: These are basically provisions requiring time bound principal to principal discussions at a very senior representative level to resolve the logjam. Where representatives of the parties are pragmatic, well advised, and deadlock is not artificially engineered, relationship between the JV parties is not damaged beyond repair, surprisingly, this benign looking option can many a times amicably resolve the stalemate and come to rescue of parties to the JV.
  • Swing vote: This option assumes relevance in a JV which has an independent director with impeccable repute. In this scenario, to strike a balance, instead of letting the independent director decide on all deadlocked items, parties can shortlist a set of items which can be resolved by the independent director. This can be particularly useful for business matters, especially, where the independent director is a person who has the requisite expertise to comprehend the nuances attached to the business and the attendant deadlocked items, thereby taking an informed call.
  • Chairman’s casting vote: One party’s board member or representative, who is nominated as the chairman is vested with the power of casting an additional vote to resolve a deadlock. While this is a quick fix, it leads to an imbalance in the power structure and may not be acceptable. Parties however could explore options of rotating the chairman or alternating the years in which one party’s board member is conferred with such power.
  • Liquidation / Winding up: This is considered more of a nuclear approach and seldom agreed to by JV parties as the consequences are quite draconian. 
  • Call and put options: Call and put options are akin to buy and sale of shares arrangement and not an ideal deadlock resolution mechanism in JVs involving a non-resident party. This is principally, on account of pricing norms, the very reason for which shoot-out mechanisms don’t work in the Indian set-up.

What if the JV Agreement is silent and there is a deadlock?

In such a scenario, especially if the deadlock is persistent, the relationship between the parties could suffer irreparable damage. Where a JV party acts unreasonably or oppressively, and/or the deadlock is pretty much an artificially engineered deadlock for ulterior motives, the party at the receiving end should consider approaching judicial authorities to seek appropriate recourse. The nature of relief will really depend on the facts and circumstances of each case. In some instances, Indian judicial authorities have permitted buying/ selling of shares by one party to the other, or even ordered winding up of the JV. However, as it is evident, there is a degree of uncertainty in this option.

With the global economy still grappling with the impact of the COVID-19 pandemic, the way we do business is also undergoing a paradigm shift. Unforeseen obstacles and newer hurdles may be around the corner. Therefore, it is better to spell out the deadlock resolution mechanism in the JV agreement or at the very least, factor in some of the suggestions enumerated above. Options like shoot-outs that work in other jurisdictions are not practical options in the Indian context. Parties must weigh in the options as per the facts, circumstances and dynamics of each JV, and carefully craft the provisions in discussions with experts.

Khaitan & Co – Prasenjit Chakravarti and Sonakshi Sharma

The content of this document does not necessarily reflect the views / position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at [email protected].

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