Shotgun Buy-Sell Agreements – What Are They? Do I Need One?
The premise of the shotgun buy-sell agreement is an age-old technique that dates back far beyond its legal history. Explore this analogy with me: one piece of grandpa’s famous chocolate cake remains from a family birthday party and both you and your sibling want that cake but cannot agree on who gets what size portion. Negotiations stall. Along comes your mother and she proposes that your sibling divides the slice, and you get to choose your portion. Given the arrangement, your sibling aims to slice as evenly as possible. In doing so, both you and your sibling receive a relatively equal portion of the cake. This is the shotgun buy-sell agreement in a nutshell and, also, why it is otherwise known as the ‘cut and choose’ method of deadlocked dispute resolution.
Commonly, LLC members agree in their LLC agreement to break deadlock with a shotgun buy-sell agreement. As previously analogized, in the event of a deadlock, the initiating member names a price, giving the other member the option to either buy the initiating member’s interest or sell his own interest at that price. In other words, “I cut, you choose.”
The recent case of Seokoh Inc. v Lard-PT highlights the necessity of properly drafting a shotgun buy-sell agreement.
Seokoh Inc. v Lard-PT
Seokoh, Inc. (“Seokoh” is also referenced as “Kolmar”, a member of Seokoh) and Lard-PT, LLC (“Lard”) are joint venturers in Process Technologies and Packaging, LLC (“PTP”). Amidst managerial deadlock between Kolmar (51% equity) and Lard (49% equity), they employed their deadlock procedure, the shotgun buy-sell provision, detailed in their LLC Agreement. The LLC agreement provided that once the “Initiating Member” gave certain notice, the “Other Member” had to either—at the price specified in the notice—purchase the Initiating Member’s entire interest or sell the Other Member’s entire interest to the Initiating Member. Additionally, the LLC Agreement established a remedy for a member’s breach of the buy-sell provision. If either Member breached the obligation to buy or sell, the non-defaulting Member had “the option” to either buy or sell its interests to the defaulting Member at a 30% price adjustment in their favor.
Kolmar pulled the trigger on the buy-sell provision, giving Lard-PT the option to either buy Kolmar’s 51% interest for 10.4 million or sell to Kolmar for $10 million. Lard timely elected to purchase Kolmar’s interest but conditioned its purchase upon Kolmar’s acceptance of several additional terms not specified in the LLC Agreement.
Negotiation around the additional terms surrounding the buyout stalled. Kolmar argued that because Lard had refused to close on the sale of Kolmar’s interest without adding commercially unreasonable terms, Lard was in breach of the LLC Agreement. Kolmar claimed Lard’s breach gave Kolmar the “option” to purchase Lard’s interest at a 30% discount.
The New York court held that Lard had in fact breached the LLC agreement during the deadlock process by conditioning the sale on commercially unreasonable terms not required or anticipated by the Operating Agreement. As a result, Kolmar had the option to purchase Lard’s interest at a 30% discount.
In this case, issues arose due to the complexity of the LLC’s shotgun buy-sell agreement. It is debatable which contingencies a shotgun buy-sell agreement should include because, as evidenced in Seokoh, should drafters go too far down the rabbit hole, they may trip themselves up down the road. On the other hand, if drafters are too simple in their terms, their agreement may not be enforceable at all. Be careful to arrive at the “Goldilocks” solution for your agreement: plan for the foreseeable but still provide flexibility. Easy to say, hard to do.