This article was published on The Saigon Times on March 9th, 2023
Written by: Managing Partner Nguyen Van Phuc and Associate Nguyen Nhat Duong
According to the definition from Thomson Reuters Practical Law , “deadlock” is a situation where shareholders/ parties of a company (or an agreement) are unable to make a decision. A deadlock provision can be a mean to reach an agreement among shareholders or parties, recognizing a solution for settling disputes, and helping the corporation get rid of a deadlock situation.
A new perspective to Bay Water case
Bay Water is a multi-member limited liability company with two members, including SATO Investment Company Limited (Sato), which owns 10% of the charter capital, and Sun Wah Vietnam Real Estate Company Limited (Sun Wah), which owns 90% of the charter capital. Bay Water is the investor in the Sunwah Pearl project (90 Nguyen Huu Canh, Binh Thanh District, Ho Chi Minh City), which has been active since 2016.
In 2019, faced with payment burdens, Bay Water held two meetings of the Member’s Council (MC) to seek opinions on obtaining loans from credit institutions. However, on both occasions, Sato voted against the proposals, which was in accordance with Bay Water's charter: “any amendment to the charter…”, “any increase or decrease in loan capital and/or charter capital…” must require the approval of 100% of the members of the MC.
To avoid bankruptcy, on September 3rd, 2019, Bay Water held a meeting of MC on passing Resolution 05/2019 which was to amend the charter to remove provisions that required a 100% voting rate. The meeting minutes showed that Sato disagreed, but Resolution 05/2019 was still issued with the affirmative votes representing 90% of the contributed capital.
After that, based on the current valid charter of Bay Water, which was passed by the MC on June 15th, 2016, Sato filed a lawsuit to ask the court to cancel Resolution 05/2019.
On August 17th, 2020, the People’s Court of Ho Chi Minh City issued a first-instance decision declaring to cancel the resolution of Bay Water. According to the court, the passing of that resolution is illegal under the Law on Enterprise and the charter of Bay Water. But after Sun Wah appealed, the panel at the appeal trial had another judgment: Sun Wah contributed 90% of Bay Water, exceeding the regulation that there must be at least 75% agreement on contributed capital (Clause 3 of Article 60 of the Law on Enterprise 2014), so Sun Wah would have the right to pass on amending or supplementing the charter of the corporation. In addition, Sato had the right to order Sun Wah to buy back Sato’s contributed capital in accordance with the Law on Enterprise 2014 and the charter of Bay Water . Having disagreed with the award of the appeals court, Sato required an appeal by procuracy on cassation. Following that, the Supreme People's Court declared to cancel the appeal award and keep the first-instance judgment.
Though the cassation decision defended legit rights and interests of Sato in accordance with the charter of Bay Water and the Law on Enterprise. Looking at the interests of all members in Bay Water, Sun Wah could have suffered a larger damage than Sato.
Sun Wah occupied 90% of the contributed capital; thus, if Bay Water had real problems, Sun Wah would take more pressure on financial losses. Negative voting of Sato did not seem to have any effect on the operation of Bay Water. Loan increments, decrements, or charter amendments are serious factors for the company, especially in a joint venture between foreign investors and domestic ones. For the conflict between Sun Wah and Sato to escalate to the point where Sun Wah had to convene a meeting of the MC to amend the charter, it appears that the charter of Bay Water has no provisions addressing the specific situations that Bay Water was facing.
At Bay Water, members did not have equal contributed capital. However, to pass important decisions, it was required to have 100% approval. This made the proportion of contributed capital (9:1) of Sun Wah meaningless in important situations. The act of domestic investors requiring a 100% voting rate for important decisions is not uncommon, and in such cases, a deadlock can occur, as happened in the case of Bay Water.
What is the solution for the majority shareholders/members?
The lesson learned from the Bay Water case is that it is not always accordant to give veto rights to shareholders or members (referred collectively as "shareholders") who have a minority stake in the company. Along with granting veto power to minority shareholders, majority shareholders should also anticipate potential deadlock situations that the company may face and deliver solutions to address it.
Current Vietnamese laws provide the right to compromise for the deadlock provision to shareholders, according to Article 24 Law on Enterprise 2020, which requires the charter to abide by the principle of "internal dispute settlement principle" provisions. However, there is still no clear indication or regulation in legal documents guiding the implementation of this provision.
When reviewing the published charters of some public companies, it is clear that the regulations regarding internal dispute resolution are very sketchy and stereotyped, There aren't many methods of settlement offered, and solutions are frequently generic, rather than definitive. Please keep in mind that, due to the nature of a deadlock, it can occur even if there is no dispute between shareholders. Therefore, the internal dispute resolution clause may not always be effective in resolving the deadlock. Hence, when approving the company's charter, shareholders must establish clear and specific regulations on how to handle deadlocks, ensuring a definitive settlement of the deadlock.
Prioritize negotiation, protect joint venture business
Obviously, shareholders don’t want to close the joint venture before it has achieved its purpose, especially foreign shareholders. Therefore, when there is a deadlock, the first thing to do is keep an open mind, be ready for compromise, and look for a solution to settle the deadlock. In general, shareholders will appoint a representative to participate in negotiations for a particular duration. To resolve the deadlock, sometimes shareholders have to share their interests and work toward the overall business goals of the company.
Buy options or sell options
In cases where shareholders fail to reach an agreement, a buy or sell option is considered an effective solution to resolve the deadlock. Accordingly, the majority shareholder has the right to request to buy back some or all of the shares that the opposing minority shareholder is holding. The repurchase of minority shareholder shares ensures that the majority shareholder has sufficient power to make decisions that help the company get out of a deadlock. Meanwhile, for the sell option, the majority shareholder has the right to sell, and the minority shareholder is forced to buy back all the shares that the majority shareholder is holding. This also helps to free the company from the deadlock.
During the course of the company's operation, minority shareholders have many different reasons to veto a company decision, affecting the business activities of the company. With the majority shareholder's buy or sell option, the minority shareholder must carefully consider their veto when facing the possibility of closing the joint venture.
Default the business
In some cases, buy options and sell options are not preferred negotiations. Because when the company is in a deadlock situation, it is often a period when the company faces many difficulties in its business activities, especially financial problems. The fact that a shareholder exercises their buy option or sell option for all their shares will leave the remaining shareholders in “between a rock and a hard place” situations. The method of definitive settlement agreed upon by shareholders in this situation is the bankruptcy of the company. Accordingly, when a deadlock occurs, any shareholder has the right to file a petition for commencing bankruptcy proceedings. This agreement is also consistent with Clause 5 Article 5 of the Law on Bankruptcy 2014: “A shareholder or a group of shareholders owning less than 20% of ordinary shares for at least six (6) consecutive months has the right to file a petition for commencement of bankruptcy procedure when their shareholding company becomes insolvent if it is so stipulated in the charter of the company.”
As well as the buy option and sell option, regulating in the company's charter regarding the right to request bankruptcy proceedings of all shareholders will make shareholders more careful in making decisions that may cause deadlock for the company.
In conclusion, shareholders should pay close attention to the deadlock clause when agreeing, drafting, and issuing the company's charter. The provisions of the charter are not only principled and patterned, but they also need to be regulated appropriately, completely, and accurately so that the company can get out of the deadlock situation. At the same time, they also prevent deadlocks and possible conflicts, ensuring the stable and long-term development of the company according to the wishes of shareholders.
