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Avoiding Deadlock: advance planning minimizes the impact of business breakups

By Ryan Olson

Business breakups often involve bruised egos, emotional sparring, and financial consequences. The complexities of resolving professional disputes or dissolving a professional connection can make business relationships even more fraught than personal breakups. The significant financial and professional consequences for all parties involved can be even worse, if they are not planned in advance.

When disputes between business partners occur, having the appropriate dispute resolution procedures in place minimizes the financial risk and uncertainty. Clearly defining the contours of the business relationship at the start can help manage expectations, set collective goals, and ensure that those involved have the same understanding.

No matter how positive the outlook may be for a business relationship at the beginning, circumstances change, resulting in different perspectives, priorities, and preferences. From financial challenges, shifts in the marketplace, or genuine personal or professional differences between business partners, disputes can arise in many ways.

Countering Deadlock

A deadlock is a specific type of dispute that occurs when business partners cannot agree on one or more material issues affecting the business, leading to company paralysis. To minimize the negative impact of a potential deadlock, business owners are advised to agree on a deadlock resolution mechanism when starting new businesses or when a change in ownership structure occurs.

If a company’s governing instrument does not outline agreed-upon deadlock resolution mechanisms, the deadlock and fate of the company will be subject to resolution by the courts. In the worst-case scenario, the result could be a costly forced sale or dissolution of the company.

Corporate management structures evolve over time. Don’t leave the fate of your company and its financial future up to someone else. Agree on a deadlock remedy before those situations arise. Some commonly used mechanisms for resolving a deadlock include the following.

Russian Roulette: A Russian roulette provision requires one of the two deadlocked parties to serve a notice on the other party. The serving party names an all-cash price at which it values a half interest in the business. The party receiving the notice can opt to buy the other party out or sell out to the other party at that price.

Texas Shootout: Another dramatic solution is a Texas shootout, where each party submits a sealed all-cash buyout bid to an umpire. The highest sealed bid wins, and that bidder must then buy and the loser must sell the other its share in the business.

Mexican Shootout: This variation on the Texas shootout requires both parties to submit sealed bids indicating the minimum price for which they would be prepared to sell their share of the business. The highest sealed bid wins, and that bidder buys the loser’s share at the price the loser submitted.

This list is not comprehensive, and the appropriate solution for any given company depends on the individual company circumstances.

Also whenever possible, deadlock resolution mechanisms should be used only as a last resort. It typically is advised that deadlocked parties should be given a period of time, such as 15 to 30 days, to try and work things out between themselves without any third party intervention. If that stalls, the parties should have another 15 to 30 days to mediate with a neutral third party.

If a deadlock still exists after mediation, then one of the three deadlock  mechanisms can be used to avoid court intervention. With the deadlock mechanism clearly defined in the company’s governing document, the expectations of the parties will be appropriately managed. As a result, the court will be prevented from dissolving or forcing a sale of the company if a corporate stalemate occurs.

Read the original article in Commercial Investment Real Estate magazine