Joint venture partners often begin their relationship full of optimism for a successful future. The pressures of growing and managing a business can drive a wedge between the closest of partners, however. This becomes particularly acute in 50/50 joint ventures where deadlocks over material decisions can cripple a company and destroy business relationships and friendships, as demonstrated by two recent cases involving Delaware and New York corporations, Charron v. Sallyport Global Holdings, Inc.1 (Charron) and In the Matter of Bermor, Inc.2 (Bermor).
The shareholders in Charron and Bermor pursued different solutions to their management deadlocks. The parties in Charron negotiated a buyout of one partner’s interest, but the terms of the buyout itself lead to further disputes. The shareholders in Bermor turned to the courts to resolve their impasse resulting in judicial dissolution of their companies. In both cases, some of the stress and expense the parties endured may have been avoided with careful planning on how to address deadlocks and thoughtful implementation of exit strategies.
Charron - Buyout with Windfall Protection
A “windfall protection” mechanism can facilitate a buyout transaction by helping to ensure that the exiting owner receives a fair price for his interest, alleviating concerns about seller’s remorse. If the remaining owner sells the business for a higher valuation within a short period, the former partner shares in the proceeds. The duration of the “windfall protection” period and the percentage of the proceeds payable to the former owner are usually highly negotiated. The remaining owner will want a short period and a lower percentage to ensure that the former owner is not rewarded with proceeds related to the growth of the business under the remaining owner’s sole stewardship. The exiting owner will want to ensure he is not cheated out of a deal with a buyer that the remaining owner may have waiting in the wings.
When the 50/50 shareholders of Sallyport Global Holdings, Inc. (SGH) found it impossible to continue as business partners, they resolved their impasse through a buyout agreement that provided “windfall protection” for the departing shareholder. The interpretation and application of the “windfall protection” provision unfortunately lead to further disputes and litigation for the parties.
SGH provided logistical support to government operations in Iraq, Afghanistan, and South Sudan.3 Its 50/50 shareholders, Thomas Charron and John DeBlasio, were West Point graduates who met in Iraq in 2004.4 Through Charron and DeBlasio’s leadership and military connections, within a few years SGH grew from a small start-up enterprise financed by a home equity loan on Charron’s house, to a prosperous company valued at tens of millions of dollars.5 But as the conflicts in Iraq and Afghanistan escalated, so did tensions between Charron and DeBlasio.
By 2009, Charron and DeBlasio started looking for an exit from their joint venture. After failed efforts to sell the company to a third party, in December 2010 Charron agreed to have his shares redeemed by the company for approximately $40.7 million, leaving DeBlasio as the sole shareholder.6 The purchase agreement for the transaction contained a “windfall protection” clause that provided for additional payments to Charron if DeBlasio sold the business to a third party within one year for a purchase price exceeding an enterprise value of $65 million.7
Two weeks after the buyout of DeBlasio’s interest, Charron began discussions with DC Capital Partners to sell the company.8 On June 29, 2011, DeBlasio sold SGH to DC Capital Partners for $60.7 million in cash and a 38 percent equity interest in Sallyport Holdings LLC, a new company set up by DC Capital to acquire SGH and an unaffiliated entity.9
Charron claimed that the sale to DC Capital triggered the windfall protection provision in the buyout agreement. Disputes arose between DeBlasio and Charron with respect to whether the sale price, taking into account the equity interest in Sallyport Holdings LLC, reached the $65 million threshold amount established in the windfall protection provision. The court eventually calculated the sale price at $81.7 million, finding that the windfall protection provision applied.10
Charron and DeBlasio also disagreed on whether the provision entitled Charron to 20 percent of the total proceeds of the sale or 20 percent of the amount that exceeded the $65 million threshold. Based on earlier drafts of the “windfall protection” provision and e-mail communications, it seemed likely that the parties intended for the 20 percent payment only to apply to the portion of the purchase price that exceeded the threshold amount, but the final agreement did not include any concept of the payment of incremental proceeds above the threshold amount.11 Noting the “clear language” of the windfall protection provision, the court found that Charron was entitled to 20 percent of the total proceeds of the sale, resulting in a larger payment in the aggregate than if he had remained a shareholder and sold his 50 percent stake directly in the DC Capital transaction.12
In the end, Charron’s “windfall protection” provided him with a windfall. The rush to conclude the buyout of Charron’s interest may have contributed to a costly error in the contract, as the court pointed out. “The sense of urgency was palpable on all sides, but in retrospect, no one can explain why the parties and their highly-paid professionals rushed to conclude the transaction on an arbitrary and ‘self-imposed’ deadline. Perhaps this litigation could have been averted by several days’ reflection.”13
Bermor - Judicial Dissolution
Although Charron and DeBlasio’s business relationship had broken down, they were able to negotiate a buyout that at least allowed them to terminate their contentious partnership. What happens when the parties cannot even agree on their separation? Section 273 of the Delaware General Corporation Law (the DGCL) allows a shareholder in a 50/50 joint venture to petition for judicial dissolution, if the joint venture partners are unable to agree upon the desirability of discontinuing the joint venture and disposing of its assets. In Bermor, the Delaware Chancery Court granted a petition to dissolve two Delaware corporations after the shareholders reached an impasse over liquidity issues.
Although the corporations subject to the dissolution petition in Bermor were owned by two 50 percent shareholders, Louis Grossman and Claire Cohen, the disputes at issue embroiled several members of two extended families. Morton Grossman, Louis’ father, and Bernie Cohen, Claire’s deceased husband, had a long standing partnership and the families had known each other for nearly 50 years.14 The two Delaware corporations subject to the petition for dissolution were formed to serve as general partners of two limited partnerships that owned commercial properties originally acquired by Morton and Bernie. At the time of the filing of the petition for dissolution, 25 members of the Grossman family and six members of the Cohen family were limited partners in the companies.15 The two Delaware general partners were each managed by a board of four directors, two from the Cohen family and two from the Grossman family.16
In 2011, members of the Grossman family asked their board representatives at the Delaware corporations to seek ways to generate liquidity from the limited partnerships. The Grossman directors proposed a refinancing, but this was rejected by the directors representing the Cohen family. When the issue could not be resolved, the Grossman directors proposed a buyout by one family or the other, but negotiations over a purchase eventually stalled. Proposals to add a buy-sell mechanism to the corporate documents, to hold an internal auction among the partners, and to sell the properties also failed.17
Louis eventually filed a petition pursuant to DGCL Section 273 to dissolve the two Delaware corporations serving as the general partners. In its decision on Louis’ petition, the Chancery Court reviewed the applicability of Section 273 and the court’s powers to grant dissolution, noting that under Section 273 the court may deny a petition that satisfies the minimum standards required by the section, but that such power should be used sparingly.18 The court found that there was a genuine inability between the shareholders to agree upon the desirability of continuing the joint venture and ordered dissolution of the corporations.19
Exit Stage Right
Judicial dissolution, as granted in Bermor, is often an imperfect solution of last resort. Negotiated solutions, such as the buyout in Charron, hammered out while disputes and personal animosities may be clouding the parties’ judgment, also may fail to provide satisfactory relief.
The best time to step back and reflect on potential issues and solutions may be at the very beginning of a partnership. No one wants to plan the divorce on the way to the wedding, but in joint ventures the parties need to be prepared if the time comes to part ways.
The shareholder agreement, partnership agreement, or limited liability company agreement for any 50/50 joint venture should anticipate deadlocks and provide some mechanism for dealing with them. This may include a process and a timeline for escalating deadlocks so disputes do not linger, mediation provisions to guide the parties’ efforts to resolve deadlocks, and arbitration to finally settle disputes. Bringing in an independent board member or manager with the power to vote on deadlocks can also provide a solution.
In many situations, parties will not want to leave important business decisions in the hands of a third party arbitrator or board member. A buy-sell mechanism agreed at the outset can provide a fall back when attempts to resolve deadlocks fail. There are several variations on buy-sell agreements with colorful monikers like “Russian roulette” and “Texas shoot-out.” In one version, the first partner to trigger the buy-sell agreement names a price and the other partner must decide to sell his interest at that price or buy-out the first partner at the same price. In another rendition, the parties submit sealed bids and the one with the higher bid buys out the other at the higher price. In a slight variation on the theme, the parties submit sealed bids with their lowest sale price and the party with the highest bid buys out the other party at the lower price. Less dramatic provisions allow for a sale or redemption at a predetermined price or at fair market value as determined by an independent appraiser.
Ultimately, the relative liquidity of the partners, their future plans, and their willingness to bring in neutral parties to help break deadlocks will play a role in determining which, if any, of these mechanisms is right for their joint venture. The most important thing is to address the possibility of impasse and deadlocks at the beginning of the venture so that disputes can be minimized and dealt with efficiently.
Jennifer Brady is a freelance writer and attorney admitted in the State of New York.