Russian Roulette and Texas Shoot-Out Clauses

Introduction

The basis for the incorporation of a company or the establishment of a joint venture is a shared interest and a relationship of trust between the entity's shareholders. Should conflicts emanate between the shareholders at a later stage, this can severely compromise the decision-making process, which is vital to the successful conduct by any entity of its business. In 50/50 shareholding situations, deadlocks can bring decision-making to a complete standstill. Such deadlocks may be resolved by more or less draconian measures, including those known as 'Russian roulette' and 'Texas shoot-out'. The Nuremberg Higher Regional Court has recently confirmed the validity of such measures.

It should be mentioned here that the German statutory regulations governing deadlock situations between shareholders are unsatisfactory: The German Law on Limited Liability Companies (GmbHG) only envisages the winding-up of a company in addition to the exclusion of a shareholder on material grounds - which is not always helpful. The articles of association of limited liability companies consequently often contain provisions regarding the giving of notice of termination by a shareholder (even in the absence of material grounds) and the compulsory calling-in of shares (Einziehung von Geschäftsanteilen). In addition, there are Russian roulette and Texas shoot-out clauses.

Exit Clauses: Russian Roulette and Texas Shoot-Out

In order to effectively resolve deadlock situations, joint venture agreements and articles of association increasingly contain clauses derived from Anglo-American practice, which enable shareholders to exit quickly. A well-known example is the Russian roulette clause, the basic idea of which is as follows: The initiating shareholder offers its shares to the other shareholder at a specific price. The latter shareholder may then elect to (a) accept the offer (within a specified timeframe) and, by acquiring the shares, becomes the sole shareholder, or (b) sell its shares to the initiating shareholder at the price stated in the initiating shareholder's offer, whereby the initiating shareholder becomes the sole shareholder.

The Texas shoot-out is even more draconian: Each shareholder provides a sealed bid for the other shareholder's shares to an independent third party (e.g. a notary). Both bids are then opened simultaneously, with the shareholder having made the higher bid being obliged to purchase the shares of the other shareholder.

The key advantages of such clauses are the rapidity of the exit process and the guarantee of a reasonable price. The possibility of having to exit from the company at short notice may, furthermore, increase the willingness of the shareholders to reach agreement in the event of a conflict / deadlock. A disadvantage of the clauses is the lack of foreseeability they bring; neither shareholder knows in advance whether the process will end in its exiting the company or becoming the sole shareholder. Until now, it has also been unclear whether such clauses are valid.

Nuremberg Higher Regional Court Decision: Russian Roulette Clauses are Valid

A German court has now, for the first time ever, addressed the validity of such clauses. In its decision of 20 December 2013 (Az. 12 U 49/13), the Nuremburg Higher Regional Court has held that a Russian roulette clause is valid in principle in relation to a two-shareholder company. Although the German Federal Court of Justice has held that clauses, which grant a shareholder a right to terminate and exit from a company in the absence of special circumstances (so-called Hinauskündigungsklauseln) are contrary to public policy and hence invalid, the purpose of a Russian roulette clause - i.e. bringing about the resolution of a deadlock situation - is justifiable at least in the case of a company having two 50/50 shareholders. This also applies to the supplementary provision that upon a shareholder's exit from a company, the agreement appointing it as managing director terminates, with the latter being obliged to resign from office.

In the view of the Nuremburg Higher Regional Court, a Russian roulette clause may, however, be invalid, if one of the two involved shareholders has not been in a position from the outset, financially, to make to the other shareholder a bid to acquire its shares. It accordingly also cannot be excluded that a clause may become retrospectively invalid, if the economic performance of the two involved shareholders diverges over time.

The Need for Appropriate Articles of Association

The exit of a shareholder from a company ultimately leads to an accelerated share purchase and sale. In order to properly cater for such an eventuality, good articles of associations should therefore not only contain exit clauses, but should also deal with related matters, including the following:

• Acceleration / due payment, submission to compulsory execution;
• rights to profits;
• forfeiture of positions on company organs of the exiting shareholder;
• restraint of competition, customer protection clause;
• shareholder loans and shareholder guarantees;
• competition-law / antitrust approvals (merger control);
• guarantees;
• IP rights and know-how; and
• assumption of costs of transfer of shares (notary's fees).