Recently, Justice Andrew Borrok of the Commercial Division denied a summary judgment motion in a dispute involving what is colloquially referred to as a “shotgun” or a “buy-sell” clause in agreements governing joint ventures and partnerships.  See Seokoh, Inc. v. Lard-PT, LLC, Index No. 650983/2020, 69 Misc. 3d 1207(A) (Sup. Ct., NY Cty. Oct. 20, 2020). 

A “shotgun” or “buy-sell” provision typically requires one business partner to sell its interest in the business to the other business partner or to buy the other business partner’s interest in the business.  The provision is typically invoked if the business partners are unable to resolve a dispute among them.

In Seokoh, Justice Borrok denied Lard’s summary judgment motion—seeking a forced purchase of its interest in a firm and repayment of a loan to the same—based on an analysis of the “shotgun” provision and the parties attempts to pull the trigger on the provision at issue.[1]  The tangled history of this case provides a good example of how the use of a “shotgun” provision changes as the parties’ circumstances change.

The dispute involved Process Technologies and Packaging, LLC (“Process Tech”), a cosmetics manufacturer that was owned by Kolmar (51%) and Lard (49%).[2]  The Operating Agreement, dated October 13, 2016, provided for a board with 3 Kolmar and 3 Lard directors.[3] In the event that there was a deadlock between the split board or a material breach of the Operating Agreement, Party A could issue a Deadlock Notice and force Party B to either sell their interest to Party A or buy Party A’s interest under the procedures listed in the following “shotgun” provision:

10.2 Member Deadlock.

(a) In the event (i) a Reserved Matter is not agreed upon (that, if not resolved would result in a material adverse effect to the Company) at three consecutive meetings of the Members of the Company, or (ii) either Member materially breaches the terms of this Agreement (each, a “Deadlock”), the chief executive officers of Kolmar and [Lard], within 20 days from such Deadlock having arisen, shall meet (either in person or via telecommunication conference) to endeavor to resolve the matters giving rise to the Deadlock in good faith.

(b) If the Deadlock is not resolved within 20 days after the first meeting of the chief executive officers of Kolmar and [Lard], then either party in the case of Section 10.2(a)(i) above, or the non-defaulting Member in the case of Section 10.2(a)(ii) above (in either case, an “Initiating Member”) may give a notice (the “Deadlock Notice”) to the other party (the “Other Member”) that it intends to implement the Deadlock Procedures set forth below.

(c) The Initiating Member may serve a notice on the Other Member which requires the Other Member to either, at the price specified in the notice, (i) purchase the Initiating Member's entire Interests or (ii) sell the Other Member's entire Interests to the Initiating Member.

(d) Within thirty days from receiving such notice, the Other Member shall notify the Initiating Member in writing its decision to either purchase the Initiating Member's Interest or sell its Interest for the proportion value of the designated price in same day funds paid at closing; provided, however, if the Other Member fails to provide such notice in a timely manner, the Other Member shall be deemed to have accepted the Initiating Member's offer to sell; [. . .] .

(e) If a Member breaches any of the provisions of Section 10.2(d) above, the non-defaulting Member shall have the option to (i) buy (if such Member was required to sell its Interests pursuant to Section 10.2(c)) the defaulting Member's Interests at a proportionate price determined in accordance with Section 10.2(c), discounted by 30% or (ii) sell (if such Member was required to buy the defaulting Member's Interests) its Interests to the defaulting Member at a proportionate price determined in accordance with Section 10.2(c), increased by 30%.

Seokoh, Index No. 650983/2020, Doc. No. 3 at 37–38.

As explained in Justice Borrok’s opinion, Kolmar and Lard disagreed on a number of strategic plans for Process Tech from 2017 onwards.  Things ultimately came to a head in early 2019 when there was a disagreement between the parties as to the appointment of a new CEO.  While the Operating Agreement provided that the CEO “shall be designated by the [Lard] directors” it was still “[s]ubject to the provisions of this Agreement”—which included a provision that stated “[t]he officers approved by the Board from time to time shall be responsible for the implementation of actions taken and matters adopted by the Board and for conducting day-to-day activities.”  Id. at 28–29. 

In January 2019, Lard designated a CEO that Kolmar objected to and did not seek board approval.  Kolmar notified Lard that the appointment was a material breach of Operating Agreement in February 2019.  Kolmar then issued a Deadlock Notice under Section 10.2(b) in March 2019.  “The March Deadlock Notice also indicated that, pursuant to Section 10.2(c) of the Operating Agreement, Lard could either (i) purchase Kolmar's 51% interest for $10,408,163.27 or (ii) sell its 49% interest for $10,000,000 . . . .”  Also, Kolmar’s March Deadlock Notice stated that the purchasing party would assume all of the obligations and payment guarantees of the selling party in Process Tech. 

In April 2019, Lard responded to the March Deadlock Notice by stating that it would buy out Kolmar’s interest.  “However, in the April Response, Lard took the position that Kolmar’s offer price included ‘additional terms’ not contemplated by the Operating Agreement which Lard would accept provided that Kolmar would accept certain additional terms, including the extension of the current lease for Process Tech for up to 12 months at the current level of rent subject to a 60-day prior written notice termination right and either the immediate resignation of the Kolmar Directors or immediately causing the Kolmar Directors to vote consistently with the Lard Directors prior to closing . . .”

As discussed in the Court’s opinion, the parties negotiated through the summer of 2019, but could not come to an agreement—due in some part to Lard’s additional terms concerning the lease and directors.  In June 2019, Kolmar sent a letter to Lard claiming that Lard improperly delayed and failed to negotiate in good faith and that Kolmar would exercise its option under Section 10.2(c) to purchase Lard’s stake for $10 million to take control of a company that was deteriorating in the interim.[4]  Kolmar also stated that it was reserving its right to enforce the 30% discount under Section 10.2(e) for breaching the buyout procedures under Section 10.2(d)—if Lard failed to respond by the end of July, 2019 and Kolmar was forced to take further actions.

Kolmar’s June 2019 letter failed to resolve the dispute and Kolmar brought suit—Seokoh, Inc. v. Lard-PT, LLC, Index No. 650983/2020—in New York State Court, Commercial Division.  “In its complaint . . . , Kolmar alleges that ‘under the express terms of the Member Deadlock provisions, Kolmar is now entitled to purchase Lard-PT’s interest at the noticed $10,000,000 price discounted by 30%, i.e., $7,000,000’ . . . .”  Lard then brought its own suit—Lard-PT, LLC v. Seokoh, Inc., Index No. 651726/2020—in New York State Court on March 16, 2020 “seeking to compel Kolmar to purchase Lard's 49% interest in Process Tech for $13.75 million.”  Lard’s $13.75 million figure was based a 30% penalty under Section 10.2(e) for Kolmar’s alleged breach of Section 10.2(d) and—under the terms of the March Deadlock Notice—the repayment of a $750,000 loan that Lard extended to Process Tech.  At this point, both parties sought specific performance in their respective suit to compel the sale of Lard’s stake in Process Tech—the question was how much.

Kolmar and Lard filed these lawsuits right before the New York court system shut down due to the COVID-19 outbreak.  By the time that the court system opened up again and parties filed their answers and counterclaims in their respective matters in July and August, things had changed significantly.  As the Court summarized in the opinion:

Meanwhile, during the pendency of these actions, Process Tech’s losses have continued to mount. Although it had operated at a loss since 2018 . . . , its value plummeted as a result of the COVID-19 pandemic. Process Tech received a subsidy from the federal government of approximately $2.3 million in May 2020 to support its payroll obligations, but it recorded a $1.2 million net loss for Q1 2020 and approximately a $2.5 million net loss in Q2 2020.

In its answer and counterclaim in the Kolmar lawsuit, dated July 14, 2020, Lard argued that the Operating Agreement compelled the sale of Lard’s interest at either $7.75 million or $13.75 million—depending which party breached Section 10.2(d).  In its answer and counterclaim in the Lard lawsuit, dated August 10, 2020, Kolmar retracted its election to purchase Lard’s interest under Section 10.2(e)—citing COVID and alleged damage caused by Lard’s delays and failure to perform its obligations.  Subsequently, Lard moved for summary judgment on August 31, 2020 on its counterclaims in the Kolmar lawsuit—requesting the sale of Lard’s interest to Kolmar for either $7.75 or $13.75 million.

On October 20, 2020, Justice Borrok denied Lard’s motion for summary judgment, as part of an opinion that addressed seven motions filed by the parties across the cases.  Justice Borrok noted that “Lard argues it is undisputed that Kolmar must purchase Lard’s interest pursuant to the Deadlock Provision and repay the shareholder loan. Put simply, they are wrong.”

Justice Borrok stated that “the contract is straightforward” and that Lard had breached the Operating Agreement “on no less than three occasions” with: (1) the attempt to install a CEO without board approval; (2) the commercially unreasonably terms that Lard interposed in its April response to Kolmar’s March Deadlock Notice; and, (3) on the record before Court, Lard’s continued stymieing of the Operating Agreement “by failing to move forward even when Kolmar offered to buy Lard out without application of the 30% discount which they had an absolute right to do.”  Justice Borrok concluded that “[t]his continued breach discharged Kolmar's obligations.” 

Furthermore, the Court noted that “Kolmar’s subsequent unilateral offers to resolve this matter including bringing the Kolmar Lawsuit were not accepted prior to Kolmar rescinding its prior offers to resolve this matter;” additionally, Kolmar had a right to rescind the March Deadlock notice because the terms were commercially reasonable and Kolmar continued to act in a commercially reasonable manner during the course of the parties’ interactions.

Finally, the Court held that “no reading of the Operating Agreement supports the notion that the Deadlock Provision is designed to have the acquiring member satisfy Process Tech’s obligation to repay the member loans.”

This case provides a good example of the use of the “shotgun” provision by each side of a business transaction.  First, Kolmar triggered the provision to resolve a set of circumstances that came to a head with the appointment of CEO that it viewed to be unacceptable—either it would get full control of Process Tech or wash its hands.  Lard agreed to buy out Kolmar, but its proposal contained terms the parties couldn’t work through.  As a result, Kolmar activated the other option under the provision and exercised its right to buy out Lard; ultimately, going to court to force Lard to sell its interests under the provision.  Lard followed Kolmar into the court with its own lawsuit, arguing that it was owed close to twice the amount that Kolmar cited.  Finally, with the value of Process Tech eroded in the midst of COVID, Lard attempted to use the provision—and the parties’ previously agreed upon price—to extract more than the probable value of its interest in Process Tech through litigation.  However, the Court determined that, inter alia, Lard’s breaches of the Operating Agreement discharged Kolmar’s obligations under the “shotgun” provision.