Uncategorized

Deadlock Provisions in Buy-Sell Agreements

A standard Buy-Sell Agreement might provide for an appraisal prior to a buyout. These agreements don’t anticipate there being a conflict after the appraisal — what happens if the appraisal comes in lower than the departing member expects, or higher than the remaining member expects? What about situations where appraisal of the company’s value is very hard to ascertain? Over the years, business attorneys have developed deadlock provisions that address these types of situations specifically, in order to compel an involuntary buyout of one or more members. Here are a few colorfully named examples of deadlock provisions in buy-sell agreements:

1. Texas Shoot-Out (or “Russian Roulette”) Method

This is one of the most well-known deadlock provisions, although it can be a very dangerous one. It’s often used when there are only two members or partners in the organization. The mechanism is artfully simple: the partner demanding a buyout names his/her price, and the other partner may choose whether to buy or sell at that price. This mechanism is best used in situations where both partners are well-capitalized and valuation of the business is difficult–perhaps there is real value in being able to control 100% of the company, or minority shares (those that do not entitle the holder to control) are practically worthless since the company doesn’t pay dividends or distributions.

An alternative mechanism for the Texas Shoot-out is where the partner seeking buyout can name his/her price, but the receiving partner then gets the choice of accepting the buyout price or bidding a higher price to buy out the first partner. The rounds of bidding continue until one partner accepts the deal on the table.

This method is a bit like the old cake-cutting proposion, where “I cut, you choose.” There is real danger in using this clause when one or more partners might not be ready to buy or sell the business at a moment’s notice. One partner may be able to take advantage of the other partner’s poor financial condition by offering to sell his/her share of the business at a lowball price, and the member receiving the offer, unable to pay even the low price, is forced to sell his/her share to the first partner.

2. Mexican Shootout (or “Dutch Auction”) Method

This deadlock provision involves all parties submitting the lowest price at which they will sell their shares in the enterprise. The highest bidder in this “auction” then gains the right to buy the “loser’s” shares at the lowest price in the auction.

3. Deterrence Approach

This deadlock provision calls for a fair valuation to be set by a preappointed entity. The Buy-Sell Agreement then authorizes a no-questions asked buyout at a 20% discount, or a purchase of the other member’s interest at a 20% premium. The deterrence approach isn’t necessarily meant to provide a viable “out” for anyone, but instead prevents any partner from taking the process too lightly, and hopefully encourage everyone to come to the negotiating table.

Conclusion

All of these deadlock provisions serve to prod the partners or members into a quick resolution of who buys out who and at what price. These deadlock provisions are widely recognized in US courts, but caution should be used when employing any of these methods. A court might later find out that a “low-ball” offer pursuant to any of these deadlock provisions violates the fiduciary duty of one partner to another, especially when one partner is “forcing” the hand of a financially weaker partner.