What Is a Deadlock Provision?
A deadlock provision is a procedure for resolving disputes. It specifies the process that must be followed if a deadlock exists. 3 min read
2. Deadlock Provision Options
3. Operating Agreement Mechanisms Preventing Deadlock
A deadlock provision is a procedure for resolving disputes. It specifies the process that must be followed if a deadlock exists. A deadlock is a tied vote, occurring when an equal number of votes that were cast both for and against the decision in question. It can also refer to the failure to reach a unanimous decision if one was required to pass a resolution.
Deadlock provisions help a company to deal with decisions for which there is no majority vote because if shareholders cannot agree on a decision they will be stuck and unable to move on. Many issues may be subject to a vote by a company's shareholders — the election of directors, various management decisions, company strategy, and more. This is one of the most important reasons why every company needs a strong contract, or operating agreement, that contains a deadlock provision.
What Happens Without a Deadlock Provision?
An LLC that does not have a deadlock provision in its operating agreement often requires the intervention of a court case. This results in judicial dissolution, or some other alternative measure for resolving the deadlock. This is just one of the events that may lead to the dissolution of the company, which means that the company shuts down and its business affairs are completed. These are some situations that require shutting down the business and its activities:
- Any event that causes dissolution under the company's operating agreement.
- Consent of all of the members in the affirmative.
- Lack of company members for 90 consecutive days.
- A judicial ruling that the company's activities are unlawful or management have acted in a fraudulent manner.
- A judicial ruling that it is no longer possible to conduct company business as required by the certificate or organization and operating agreement.
- A statement of administrative dissolution is filed by the Secretary of State.
Deadlock Provision Options
There is more than one type of deadlock provision. Companies may choose between several options:
- Mediation Clause: The matter may be resolved with the assistance of a neutral party, or mediator. This clause can also require shareholders to hold an extended meeting to resolve the problem.
- Arbitration Clause: An outside expert must be called in to study the facts and circumstances of the dispute, and that person may make a decision about the issue.
- Auction Deadlock Clause: The shares held by dissenting shareholders may be bid on by other shareholders.
- Chairman Deadlock Clause: One shareholder is given the power to serve as Chairman, and therefore has the power to end the deadlock by making the final decision.
- Liquidation Deadlock Clause: The shareholders will be forced to liquidate the business in the event of an unresolved deadlock.
Operating Agreement Mechanisms Preventing Deadlock
An LLC's operating agreement may include various mechanisms for addressing deadlock and solving the problems it causes. One of these is the Buy-Sell Provision. The appraisal model brings in an expert to make an independent appraisal to determine the value of an ownership interest.
The “shotgun” model allows one member to make a purchase offer to the deadlocked member for a pre-set price with established terms. The person receiving the offer is required to accept the price and terms or else purchase the ownership interest of the offeror at the same price and terms. However, “shotgun” provisions are often unfair because parties have different opinions about the interests' value and differences in their financial ability to purchase other shareholders' interests. If everything goes smoothly, however, this strategy can be effective because it provides an incentive to shareholders to work things out first.
Another method of dealing with a deadlock is the use of tiebreakers, which can be either external or internal. In the case of a tied vote, the decision will be given to the tiebreaker. This can be a group, a professional advisor or mediator, or an industry expert. The problem with this is that the decision is placed in the hands of people who may be unfamiliar with the company and lack the insight to make the decision properly.
Put or Call mechanisms are commonly used as tiebreakers in LLC operating agreements, though they must be drafted and applied carefully. The most important issue is determining the triggering event, which is the situation that allows a party to exercise a “put” or “call.” When putting together an operating agreement with this type of provision, consider what types of deadlocks should use it.
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