A very well-structured decision from the Court of Rome[1] confirmed that Russian-Roulette clauses can be included in shareholders’ agreements as a valid method to solve deadlocks.
Generally speaking, Russian roulette clauses have been imported in Italy from the Anglo-American practice. Such clauses are usually included in shareholders’ agreements or joint venture agreements entered into with respect to companies equally owned by 2 shareholders to unblock decisional and/or operational deadlocks.
Russian roulette clauses are usually structured as follows:
- upon occurrence of a deadlock 1 of the 2 shareholders (shareholder 1) may activate the clause by sending a notice to the other shareholder (shareholder 2);
- the notice includes shareholder 1’s determination of the price of the company’s shares;
- shareholder 2 may choose to either (a) purchase the shares owned by shareholder 1 or (b) sell its shares to shareholder 1, in both cases at the value determined by shareholder 1 in the notice.
Below is an example of Russian roulette clause:
“If the parties are unable to resolve a Deadlock within [●] days from the occurrence of the Deadlock, then either party may within the following [●] days serve a Deadlock Resolution Notice on the other.
The recipient of a Deadlock Resolution Notice may choose to do either of the following, at the price for each share specified in the Deadlock Resolution Notice, by serving a counter-notice within [●] days of receiving the Deadlock Resolution Notice:
- buy all the shares in the Company of the server of the Deadlock Resolution Notice; or
- sell all its shares in the Company to the server of the Deadlock Resolution Notice.”
1. The case at stake
In the case at hand, the shareholders’ agreement entered into by two shareholders (hereinafter “Alfa” and “Beta”), owning a 50% stake each in an Italian joint-stock company provided a Russian roulette clause structured as follows:
- “Deadlocks” are defined as failure to meet for 3 consecutive board of directors/shareholders’ meetings the quorums and majorities required to resolve on certain key matters (e.g. approval of financial statements, sale of assets, etc.) and as failure of the parties to renew the shareholders’ agreement;
- In case of Deadlocks, Alfa has the right (i) to freely determine the price of its stake (the “Purchase Price”) untied from any predetermined evaluation criteria, and (ii) to invite Beta alternatively – at Beta’ sole discretion – to purchase Alfa’s stake or to sell its stake to Alfa at the Purchase Price.
The Court examined in detail each of the following arguments used by Beta to prove that Russian roulette clauses are invalid according to Italian corporate law principles.
2. The arguments
2.1 The fair determination of the Purchase Price
The 2 main arguments used by Beta are:
- the determination of the Purchase Price at Alfa’s sole discretion violates the Italian law principle whereby the scope of contractual obligations cannot be determined upon sole discretion (“mero arbitrio”) of 1 of the parties;
- Russian roulette clauses do not contemplate mechanics aimed at ensuring a fair determination of the Purchase Price.
On the first argument, the Court stated that the balanced determination of the Purchase Price is somehow guaranteed by the nature of the price determination mechanics under Russian roulette clauses.
Indeed, it would not be in the interest of the offeror to determine a disproportioned Purchase Price:
- taking into account that the offeror may be required to purchase the offeree’s stake, it would not be in its interest to determine an unreasonably high Purchase Price; and
- the potential acceptance of the offer by the offeree prevents the offeror from submitting an unreasonably low offer.
The Court disagreed also with Beta’s second argument: i.e.: as drag along clauses[2], also Russian roulette clauses should contemplate a floor (minimum purchase price) and such floor should be equal to, at least, the value of the equity determined according to the criteria set forth by law in case of withdrawal of a shareholder from a company[3].
The Court focused on the different nature of drag along clauses and Russian roulette clauses and concluded that it is not necessary to indicate a floor in Russian roulette clauses; indeed:
- drag along clauses are aimed at facilitating majority shareholders to sell their controlling interest to a third party by granting them with the right to force minority shareholders to sell their equity (along with the equity held by the majority sellers) at the same price (pro-rata) of the price agreed between the majority sellers and the potential purchaser;
- differently, as pointed out above (i) the purpose of Russian roulette clauses is to bypass deadlocks and (ii) in Russian roulette clauses the right of 1 shareholder to force the other shareholder to sell its stake is somehow counterbalanced by such other shareholder’s right to purchase its partner’s stake.
2.2 The leonine pact
Another argument used by Beta is that Russian roulette clauses violate the Italian law principle[4] whereby agreements aimed at excluding shareholders from participation in profits/losses (“patto leonino”) are considered null and void. In particular, assuming that the company is generating profits:
- Alfa could determine the Purchase Price in an amount that Beta cannot afford to pay;
- as a consequence of the buy-out at such purchase price, Beta would be de facto excluded from participation in profits.
The Court stated that the Russian roulette clause at stake does not violate the abovementioned principle since Alfa has the power to active the clause only upon occurrence of a Deadlock, not at any time and at its sole discretion (in other words: the company may not generate profits when a Deadlock occurs and Alfa is not entitled to activate the Russian roulette mechanics only because the company is generating profits).
2.3 The duration of shareholders’ agreements
According to Beta, the power granted to Alfa to activate the Russian roulette clause in case of non-renewal of the shareholders’ agreement violates (indirectly) the Italian law principle whereby shareholders’ agreements cannot be entered into for an initial term exceeding 5 years[5].
Beta argues that such principle is violated due to the circumstance that Russian roulette clauses may have a “punitive” effect: the party that is not willing to renew the shareholders’ agreement may be “sanctioned” through the activation of the Russian roulette clause by the other party. This would have the effect to disincentive the exercise of the parties’ right not to renew the agreement, hence, to lead to an indefinite duration of shareholders’ agreements.
The Court disagrees with Beta’s interpretation and states that the purpose of Russian roulette clauses (which contemplate non-renewal of shareholders’ agreements as triggering event) is (a) not to trap shareholders in indefinite shareholders’ agreements, but (b) to preserve the functioning of the decisional bodies of a company and, hence, to prevent the company’s dissolution.
For the above reasons, the Court concluded that the Russian roulette clause at issue does not violate the maximum 5-year term provided under Italian law for shareholders’ agreements.
3. Conclusions and drafting tips
To conclude, Russian roulette clauses can surely be used in shareholders/joint venture agreements as valid and efficient method to solve operational/decisional deadlocks.
The decision of the Court of Rome gives us some tips on how to draft an enforceable Russian roulette clause taking into account Italian law principles:
- it is fundamental to identify with a high degree of accuracy the circumstances that trigger the activation of the roulette mechanics;
- in no case the activation of the clause should be left at the parties’ discretion;
- it is important to avoid that Russian roulette clauses have a somehow “punitive” effect with respect to shareholders that do not intend to renew shareholders’ agreements (i.e.: this could be the case of Russian roulette clauses providing price determination mechanics whereby the price to buy-out the shareholders that do not intend to renew shareholders’ agreements is lower than the market value of the shares, etc.).
The decision from the Court of Rome is available at the following link: https://www.giurisprudenzadelleimprese.it/wordpress/wp-content/uploads/2017/11/20171019_RG42409-2014-2.pdf.
[1] Decision no. 19708 of October 19, 2017.
[2] The requirement to indicate a floor equal to, at least, the value of the shares that shareholders would receive in case of withdrawal has been established in the precautionary decision issued by the Court of Milan on April 1, 2008.
[3] Sections 2437-ter and 2473 of the Italian Civil Code.
[4] Section 2265 of the Italian Civil Code.
[5] Section 2341-bis of the Italian Civil Code.
