LLC Members Should Carefully Consider a Forced Buy-Sell Provision

Posted by Jeffrey N. Berman on

In many operating agreements, a Forced Buy-Sell provision, also known as a “Russian Roulette” provision, is a standard provision. Essentially, this provision is a dispute resolution mechanism. It allows one or more members in a limited liability company to exit the company if they are not getting along or are not able to agree upon important decisions related to the limited liability company.

Offers to Buy
With a Forced Buy-Sell provision, a member can offer (the “Offeror”) to buy another members’ interests at a stated price and terms. The Offeree, or the member who received the offer, can sell their membership interests to the Offeror at a specific price or buy the Offeror’s membership interests at the same price and terms. The Offerees’ decision is binding on both members. 

If the Offeree does not respond, then it is deemed that the Offeree elected to accept the offer to sell the membership interest to the Offeror.  As a result, one of the members will sell the membership interest to the other member, making it so one of the members will no longer have ownership interests in the limited liability company. 

The Unforeseen of a Forced Buy-Sell Provision
On its face, a Forced Buy-Sell may seem simple. However, it can be used in ways that members may not foresee. If one member, for example, has quick access to capital, then he/she could make a Forced Buy-Sell offer that includes an all cash closing in two days. If the Offeror knows that the Offeree cannot match the offer, then the Offeror could lowball the purchase price knowing that he/she/or the associated entity will be the purchaser. 

As illustrated in the above scenario, it is important to have a well-thought-out Forced Buy-Sell provision. In the above scenario, the Forced Buy-Sell provision could have provided that a closing does not occur before a stated number of days (e.g., 30 days). This would give the Offeree time to raise the capital, if the Offeree desires to be the buyer. It could have also resulted in a more reasonable purchase price. 

Beware. The above illustration is just one example of how one member can manipulate the Force Buy-Sell provision. There are numerous other scenarios. Therefore, it is critical to have a well-thought-out Forced Buy-Sell provision. This will avoid one member being able to take advantage of another member.

Furthermore, keep in mind that a Forced Buy-Sell may not be appropriate in all situations, particularly if one member has greater resources or owns significantly more of the limited liability company.

Lastly, a Forced Buy-Sell provision can also be used in a shareholder agreement.

As always, please let me know if I can help.