What's a Russian Roulette Deadlock Clause?

If your LLC or corporation has two or more owners, you can get stuck (deadlocked) on making a decision or taking action if no one has enough voting rights to control the decision. This problem is easy to anticipate if there are two owners, each with a 50% ownership interest, but it can also arise in situations where an owner with a minority ownership position has the ability to veto a decision. For example, if a 66 2/3% vote is required to approve the sale of the business, and one owner (or a group of owners) holds 35% of the ownership interests, then he/she can block the deal.

One way business owners create a procedure for resolving a deadlock is to include a Russian Roulette Deadlock Clause in the Operating Agreement (for an LLC) or the Shareholders' Agreement (for a corporation). That clause provides that if the owners are unable to resolve their deadlock within a short period, any one owner can offer to buy out another owner by making an offer with a stated purchase price. The owner receiving the offer then has a short period to decide whether to accept the offer or to buy out the owner making the offer at the same purchase price and on the same terms. The intent of the clause is to keep people honest in the buyout offer they make because the other owner could turn that offer around and force it on them.

I have mixed feelings about including a Russian Roulette Deadlock Clause. While it might appear fair on its face, it really favors an owner who has the means to pay for the buyout. For example, if I have $100,000 at my disposal, and I anticipate that the other owner has only $20,000 at his disposal, then I might offer $50,000 to buy him out knowing that he won't be able to flip the deal on me. In that instance, the buyout price has little to do with the actual value of the business and everything to do with economic positions. But in other instances, such as when the owners are on a relatively equal economic footing and have had a history of disagreement, the Russian Roulette Deadlock Clause can be an effective tool. Note, too, that the mere existence of a Russian Roulette Deadlock Clause might cause the owners to work harder to negotiate a resolution before someone triggers the buyout clause.

Whether you include a Russian Roulette Deadlock Clause or not, I recommend you include a clause in your Operating Agreement or Shareholders' Agreement about resolving disputes (including deadlocks) by using negotiation, mediation, and/or arbitration.