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The admissibility in our legal system, and the scope, of a “Russian Roulette” clause have been the focus of debate in the most recent legal literature and case law. This paper intends to analyse the most interesting aspects related to such clause, with particular reference to its legitimacy and validity, regardless of the provision for a mechanism of pre-determination of the price of the shareholding being transferred.
A Russian Roulette Clause represents the most popular remedy to solve any deadlock (empasse, stalemate) that may occur during the life of a company.
Such clause can be either contained in bylaws or in shareholders’ agreements and, in practice, anti-deadlock clauses are very common in case of an equal shareholding in a company (the typical case is that of an equally-owned joint venture) or where high quorums are envisaged for certain decisions.
The purpose is, in any event, to prevent the situation of paralysis that has occurred from resulting in the dissolution of the company, according to the provisions of Article 2484, first paragraph, of the Italian Civil Code.
“Deadlock” means that situation where a company’s Board of Directors and/or Shareholders’ Meeting are unable to adopt a resolution as a result of a disagreement occurring among the shareholders’ representatives or the members of the Board of Directors.
The risk of a deadlock is higher in equally-owned companies or in companies in respect of which the parties have in any event contractually identified a number of resolutions, deemed particularly important for the life of the company, stipulating that they can only be adopted by unanimity or, in any event, by a qualified majority[1].
Once the event causing the deadlock (“trigger event”) has occurred, the activation of a Russian Roulette Clause involves one of the two partners (“offeror”) being entitled to make an irrevocable offer to the other party (“offeree”) to purchase the offeree’s shares, at the same time fixing the value of the same even in the absence of pre-determined quantification criteria.
The offeree, on receiving the aforementioned “purchase offer,” obtains the right to end the deadlock, within a certain period of time, either by accepting the offer and selling his shares at the price thus determined by the other party who implemented the procedure (offeror), or by purchasing the offeror’s shares himself, assuming as a price the same exact value notified by the other party.
As a rule, the clause also includes provisions to prevent the procedure being in turn blocked due to obstructive behaviour on the part of the offeree not replying to the offer. Thus, a mechanism of consent by silence is usually provided, which allows the translative effect of the proposed purchase to take place on the expiry of the period agreed for the exercise of the option, thus in lieu of the offeree’s acceptance[2].
The price determination mechanism is one of the most controversial aspects of the clause under examination.
The issue of concern lies in the fact that, in most cases, the clause does not provide preestablished criteria for determining the price at which the partner’s stake may be sold or purchased. In essence, the offeree is subjected to the offeror’s sole discretion, as the valuation of the shares is done “in the dark.”
This might lead to arguing either that the mechanism described amounts to breach of Article 1349 of the Civil Code, resulting in an unilateral determination of the price on a purely discretionary basis, or that it represents a merely potestative and, therefore, void condition under Article 1355 of the Civil Code.
Case law[3] has however confirmed and reaffirmed[4] the validity, in principle, of Russian Roulette clauses.
More specifically, case law held that, in Russian Roulette clauses, the advantageous position of the offeror - involving, if anything, the possibility of determining the value of the offeree’s stake - does (or should) not result in an undue advantage for the offeror.
The determination of the price, though not being subject to limits or notification criteria, that is, “in the dark” would in the words of the court[5] give rise to an “inherently balanced” mechanism.
Indeed, even disregarding the fact that the activation of the procedure aimed at determining the value/price is not without costs for those who activate it, the balance would lie in the risk, taken by those who propose the same value/price, of “getting the valuation wrong”. Since the choice of whether or not to purchase the shares is left to the party who did not determine the price, any undervaluation of the share capital would advantage the potential buyer (who would pay a price lower than the market value of the stake), while - on the contrary - any overvaluation would result in the offeror disbursing an amount higher than the market value, with obvious unfavourable effect for the party that is active in both and opposite scenarios.
As concerns the other critical issue, i.e., the potential breach of the prohibition of providing for merely potestative conditions, this is overcome on the basis of the assumption that the mechanism of the clause, while giving one of the partners the advantage of determining the price, finds a limit in the alternative obligation arising on the part of the offeree.
Therefore, the clause cannot be deemed null and void based on Article 1355 of the Italian Civil Code, as the existence of that absolute freedom that marks the merely potestative condition is not recognisable.
According to case law, such freedom can only be found in cases where the party’s activity is based on mere discretion “unrelated to any rational assessment of opportunity and expediency”[6].
Such assessments, on the other hand, in the context of the clause under consideration, are necessarily made by the offeror, keeping well in mind the right of choice given to the offeree[7], which causes the valuation of the offeree’s stake to be true and thoughtful.
Another issue that has come to the attention of case law[8] and legal literature[9] is whether the pricing mechanism of the Russian Roulette Clause conflicts with the general principle of equitable valuation of shareholdings, taken from the drag along clauses and possibly applicable to Russian Roulette Clauses as well.
Again, however, it was held to rule out any breach of the general principle of fair valuation of shareholdings for two reasons:
(i) first, the two clauses serve a different function. Drag along clauses are covenants that provide a right in favour of the majority shareholder, who, where wishing to dispose of his shareholding, acquires the right to negotiate with third parties (under the same economic conditions) the sale of not only his shares, but of the entire share capital (including also minority shareholdings). Such clause therefore involves a right of the selling shareholder who “drags” the minority shareholder’s stake into the project of selling his stake. The minority shareholder is therefore forced to dispose of his stake at a price imposed at the initiative of the majority shareholder.
The Russian Roulette Clause has on the other hand the function of resolving deadlock situations by reorganizing the corporate structure.
In a nutshell, the protection of the minority shareholder is made necessary, in case of a drag along clause, because of the situation of subordination in which the minority shareholder finds himself with respect to the majority shareholder and results in providing criteria for determination that ensure compliance with the principle of fair valuation of shareholdings. In the presence of a Russian Roulette Clause, such a mechanism is missing, because there is no subjection of the offeree, who has the option, where deemed appropriate, to purchase the shareholding of the offeror rather than sell his own;
(ii) second, the distinction between bylaws and shareholders’ agreements must be borne in mind. Even assuming that the provision of pricing criteria is a condition for the validity of a Russian Roulette Clause contained in by-laws, this could not be argued with such clause being contained in a shareholders’ agreement, which, by definition, is based solely on the autonomy of the parties. In other words, while a Russian Roulette Clause contained in by-laws should provide for criteria that ensure fair valuation, the relevant case law holds that this cannot be said when the clause is included in a shareholders’ agreement, as it is not possible to “place regulatory limits on the parties’ freedom of negotiation to arrange the economic terms of a contract of exchange that binds the parties only”.[10]
Among the main criticisms raised against the lawfulness of a Russian Roulette Clause relates to the potential breach of the prohibition of leonina societas covenants.
In this case too, case law[11] and legal commentators[12] ruled out the aforementioned breach, noting how deadlock clauses such as Russian Roulette clauses are not suitable, either for their purpose or for their structure, to allow a shareholder to take advantage of the exit right, which can only take place in the face of a decision deadlock.
So, as long as the company remains operational, each partner will earn profits and incur losses according to the standard rules.
On the other hand, it could not happen that a shareholder takes advantage of the exit possibility by remaining neutral with respect to profits or losses, after he himself having caused the deadlock and activated the buy-sell procedure, since evidently, even if the other shareholder has not paralyzed the abusive conduct upstream by an exceptio doli generalis, in any case the determination of the price will be based on the current value of the shareholding, taking into account the higher value or the depreciation of the shareholding that has occurred in the meantime.
Article 2341 bis of the Italian Civil Code provides that shareholders’ agreements cannot have a term of more than five years and are considered to be entered into for such term even if the parties have agreed upon a longer term.
Thus, case law has been dealing with the possible indirect violation of this rule, if shareholders’ agreements provide that failure to renew them constitutes a deadlock that may trigger a Russian Roulette Clause procedure. In particular, the issue was raised as to whether the activation of the procedure under the clause under consideration may be considered as a real sanction for non-renewal of shareholders’ agreements, thus involving their potentially unlimited duration since either the agreement is renewed (thus assuming a term of more than five years) or the corporate relationship is dissolved limited to an individual shareholder.
However, case law held that “the clauses linking the non-renewal of the covenant to the start of the anti-deadlock procedure - giving one of the parties the power to determine the price and the other the alternative between the purchase and sale of the shareholding - are not a priori invalid, since they do not appear to be aimed at conditioning the will of the parties to the covenant for the purpose of “crystallising” the balances (ownership and governance) reflected in the covenant. On the contrary, they are aimed at “rearranging” such balances precisely for the case that the shareholders’ agreement is broken as a result of non-renewal and, thus, at preventing the dissolution of the company”[13].
In other words, the Russian Roulette clause represents a typical example of a “teleologically atypical” shareholders’ agreement, whereby the shareholders aim to resolve management and decision-making deadlocks by means of a new and different company structure, and not by consolidating or “stabilising” the existing ownership structure or governance of the company.
Case law emphasized that the mechanism whereby the parties regulate in advance the terms and conditions for setting up the ownership and governance features of a company, for the event that the shareholders’ agreement ceases to exist, is not intended to crystallise the agreement beyond the statutory time limits but is aimed at preventing a decision-making deadlock from occurring among shareholders following the dissolution of the shareholders’ agreement[14].
As a result of this examination, it can be concluded that Russian Roulette Clauses can be considered ex se lawful and worthy of protection under the Italian legal system.
At the same time, it cannot be kept silent about the fact that, even if it passes the test of lawfulness and legitimacy for the species, the clause might in practice be deployed in such a way as to obtain a result prohibited by the legal system.
Any abuse committed, however, would not be such as to undermine the aforementioned principles enshrined in case law, but would reasonably be a sign of invalidity of the individual clause in the specific case, which could - consequently - be declared invalid, without this affecting the matter in general terms.
This article is for information purposes only and neither is nor can be considered as a professional opinion on the topics covered. For more information, please contact Sara Dameri and Luca Dettori.
[1] Luigi A. Stabile, La Validità della russian roulette clause nei patti parasociali, Il Corriere giuridico 11/2021.
[2] M. Facci, La Clausola di Roulette Russa, in Le nuove Leggi Civili Commentate 3/2020.
[3] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[4] Court of Appeal of Rome No. 782 of 3 February 2020.
[5] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[6] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[7] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[8] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[9] Luigi A. Stabile, La Validità della russian roulette clause nei patti parasociali, il Corriere giuridico 11/2021.
[10] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[11] Court of Appeal of Rome No. 782 of 3 February 2020.
[12] Giuseppe de Falco, Commento sulle clausole statutarie russian roulette (orientamento Consiglio notarile di Firenze n. 73/2020), in La rivista delle operazioni straordinarie No. 1/2022.
[13] Court of Rome, Special Business Division No. 19708 of 19 October 2017.
[14] Giuseppe de Falco, Commento sulle clausole statutarie russian roulette (orientamento Consiglio notarile di Firenze n. 73/2020), in La rivista delle operazioni straordinarie No. 1/2022.
