When I served in the armed forces, a shotgun was not exactly “standard issue”. It is far too much of a blunt instrument. The same might be true when dealing with a “shotgun buy/sell” provision in your shareholder, partnership or LLC operating agreement.
A shotgun buy/sell option agreement is a common contractual provision in a partnership, shareholder or LLC agreement. It is often overlooked as a potential mechanism to break a deadlock. A common example is the following:
Step 1: the initiating shareholder is permitted to give written notice of an intention to sell his interest, or to buy the non-initiating shareholder’s interest, at a set price, within a specified period, and on the terms set forth in the agreement (i.e., cash, delivery of a promissory note, etc.);
Step 2: the non-initiating shareholder is then granted an option, within a set period, to decide whether to either buy out the other shareholder at that price, or to have the initiating shareholder buy him out at the price stated in the notice; and
Step 3: the closing will then occur on the terms set forth in the notice and at the time and place required in the option agreement, thereby breaking the deadlock between the shareholders over the running of the business.
A Fair Price
The shotgun buy/sell is universally lauded as an effective means of preventing or breaking deadlocks over major business decisions. Further, it often allows for a quick buyout of a closely held corporation or limited liability company with few shareholders or members, at a fair price. It’s the “fair price” that can be quite risky.
I once saw a rookie mistake. In this instance, a shareholder sent a buy/sell notice at a very low price. He assumed that the other side was in a precarious financial position. As such, her only option was the acceptance of the buyout price and she would leave the company. It became clear that the non-initiating shareholder intended to buy out the initiating party at the notice’s bargain basement price. As a result, he tried to revoke the notice. Guess what happened next? The commencement of litigation.
That case, and others, have taught me that shotgun provisions are unique provisions intended to achieve a fair sale. However, the party who triggers such a provision cannot be certain whether he will be buying or selling his interest. Therefore, he has the incentive of ensuring that the offer price is fair. Case law has developed which one can point to for the proposition that this is an enforceable option which, by definition, is an “irrevocable offer” which must be kept open during the stated term, unless the agreement provides for revocation. In short, if you are going to trigger the shotgun option, be sure to pick a price you can live with. This is true as the seller or the buyer. And be sure to plan for any and all contingencies that may devalue the company while the option remains open.
Please call me if you have any questions about shotgun options or with other business owner rights concerns.