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Deadlock Provisions in Limited Liability Company Operating Agreements

Posted on August 17, 2020 in Firm News

If there is more than one member in a limited liability company, there is a potential for the members to reach a deadlock on deciding whether or not to take certain actions on behalf of the company. The dispute may lead to loss of time and productivity, expensive arbitration or litigation, and even result in judicial dissolution of the company when “it is not reasonably practicable to carry on the business of the company in conformity with the articles of organization or operating agreement.” See NRS 86.495(1). Therefore, members should always consider including effective deadlock-breaking mechanisms in their operating agreement.

One common approach is the use of a tie-breaker. If the members are deadlocked, the operating agreement will refer the issue at hand to a tie-breaker which may be an inside or external professional advisor, a mediator or arbitrator, or an industry expert. When using this approach, the members should carefully consider who will be the tie-breaker since the decision is removed from the parties most familiar with the company and its business and put in the hands of a third party. Ideally, the tie-breaker should be someone that has some history and familiarity with the business and industry.

Another approach is the use of a buy-sell provision in the operating agreement providing that the disagreeing member must sell their interest in the company. There are typically two types of buy-sell provisions. The “appraisal” model requires a qualified third party to value the interest being purchased. The so-called “shotgun” model allows one member to make an offer to purchase another member’s interest at a set price and on specified terms. The offeree must then either accept the purchase offer or turn around and purchase the offeror’s interest at the same price and on the same terms.

Whenever there is a future possibility of a deadlock due to the composition of the members, the parties should include a carefully considered deadlock-breaking mechanism in the operating agreement in order to avoid the need for costly and distracting litigation or judicial dissolution.