What is the importance of a deadlock provision in by laws or operating agreement?

January 9, 2020

 

 Where there are an even number of directors or managing members of an entity, there is the potential that an action requiring a majority vote will be met with an even split – half of the directors or managing members will vote “yes,” and the other half will vote “no.” The result is a deadlock, where the entity cannot take any action.

In order to avoid this risk, it is a good idea to include a deadlock provision in the bylaws or operating agreement setting forth the procedure for breaking the deadlock. This way, in the event of a deadlock, there is already a system in place which will resolve the deadlock promptly in order for the entity to continue to carry out its activities without interruption.

And often just the presence of a deadlock provision, itself, motivates voters to work through and find a compromise rather than having to invoke the deadlock provisions.

So, what are some possibilities for a procedure to break the deadlock?

The simplest deadlock provision is a coin-flip. Each set of voters picks a side of the coin and someone flips it, and the winning side prevails. This method is quick, easy and free. It will also strike some, however, as a rather cavalier way of resolving what is likely an important decision regarding the entity.

Another deadlock breaking method is to select a single voter who will have tie-breaking authority. While implementing this method is also quick and free, it may be tough to get the parties to agree on which individual should have this power and, even once selected, later cause resentment and discord.

Another method is to select a neutral tie-breaker to break the deadlock. This person will not be a voter, and may not even be affiliated with the entity in any way. He or she may simply be one that each voter trusts and has confidence in to make the best decision for the entity. It could be the entity’s attorney, CPA or other fiduciary. The idea is that this person is a neutral party who will be entrusted by everyone with making the decision. While this method may be reasonable, using a third-party tie breaker could involve some delay in decision making, require payment to that person, and such person will likely request some indemnification that he or she not be held liable in any way for the consequences of his or her decision.

There are, of course, other ways to break a deadlock such as mediation, arbitration, a buy-sell arrangement (which must be conspicuously noted on the back of each stock certificate), or to negotiate in good faith for a certain number of days, after which such failure to agree will result in dissolution.

The key is to select a procedure which works best for the entity and all of its constituents. Whichever method is chosen, in the end, matters less than the fact that some deadlock breaking provision is chosen.

For more information about this article or other issues, please contact us, The Bachman Law Firm PLLC at judith@thebachmanlawfirm.com or 845-639-3210.

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