1. Introduction
In 2023, the Italian Court of Cassation stated the validity of the “Russian roulette” clause. In order to fully understand the relevance of this decision, it’s important to underline how, throughout the years, many common law institutes have been gradually incorporated into the Italian legal context. Among the most significant institutes already established in civil law systems leasing and factoring are two important archetypes.
As a way to introduce the topic, a definition must be given as to how these clauses work both in the American and European legal systems and how they are invoked to overcome a decisional and/or operational stand-off.
1. What’s a Russian roulette clause?
First of all, the Russian roulette clause is a specific kind of buy-sell provision aimed at getting around impasse situations that can sometimes arise in a company’s life. In particular, whenever there is a decisional paralysis, one of the contracting parties can offer to buy the other one’s shares at a unilaterally established price. On the other hand, the party receiving the offer is entitled to an alternative: they can either accept the offer and sell their shares at the price that the counterparty decided, or they can reverse the situation. In that case, the party that originally proposed the offer would have to sell their shares for that abovementioned price.
Starting from this basic principle, many other variants were elaborated by common law experience. For starters, the clause can be symmetrical or asymmetrical based on whether one or both parties have the right to make the initial offer. In some cases, the parties can even establish a priority mechanism that allows one offer to prevail over the other. Moreover, the clause can state a peremptory time limit starting from the stall (trigger event), after which one partner loses (while the other one gains) the chance to initiate the offer. Finally, the so-called “Texas shoot out” clause allows the parties to eventually raise the price of the offer, whereas the “Sale shoot out” clause changes the initial proposal from an offer to buy to an offer to sell.
Generally speaking, such clauses are usually included in shareholders’ agreements or joint venture agreements of companies equally owned by two shareholders, the so-called “fifty-fifty companies". As a matter of fact, this particular composition of shareholders can be very risky: a potential disagreement could lead to serious economic consequences, even to the company’s liquidation. In particular, the stand-off in the company's management can be caused either by internal provisions (stalemate), for example by giving extensive veto powers to the parties, or by the actual state of affairs (deadlock), such as in the abovementioned equally owned companies.
2. The Russian roulette clause: a comparative overview
As previously mentioned, Russian roulette clauses have been imported to Italy from the Anglo-American practice. Their legitimacy has been established since 2002, when a United States’ Court of Appeal observed that “the possibility that the person naming the price can be forced either to buy or sell keeps the first mover honest”. Therefore, the parties’ different roles and powers in the agreement were considered to be “presumptively fair” and compliant with the fundamental principle of checks and balances of common law systems.
Needless to say, in order to obtain an outcome that is actually fair, both parties must act in good faith. As a consequence, clauses that allow for evident prospects of abuse must be regarded as illegitimate. In the US, this risk is sometimes prevented by using disclosure mechanisms: the parties are required to provide all relevant information regarding the company and its value to their counterparty so that they can make an informed decision.
As it often happens, this clause became very widespread not only in the US but also in many European countries, and the legal debate was picked up by their courts. Gradually, many civil law countries have recognised the legitimacy of the clause, deeming the peculiar mechanism of checks and balances sufficiently compliant with all basic principles of their respective legal systems. In particular, in 2006 a French Court of Appeal rejected the argument that described the Russian roulette clause as a sanctionary measure, stressing the fact that the stipulation of the provision always comes from the parties’ free will. In the following years, both Austrian and German courts came to the same conclusion: there is no violation of public policy because both parties have the right to initiate and to overturn the shoot-out procedure.
In other ways, the Nuremberg court also followed the general trend of declarations of validity, but it further emphasized the need to always take into account the concrete circumstances of the case at hand. Namely, any possible abuse deriving from financial disequilibrium that could have influenced the parties’ choice or any spurious use of the clause to force the counterparty out of the company.
3. Arguments from the Italian Court of Cassation's ruling
The Italian Court of Cassation, in its ruling on July 25th, 2023, stated the validity of the "Russian Roulette clause" in business contracts. This landmark judgment reflects a progressive approach to contractual freedom. With this decision, the court expressed some key arguments in support of the clause's legitimacy.
First of all, central to the court's reasoning was the principle of legal autonomy. When parties enter a contract, they are generally free to establish the conditions of their agreement, as long as those do not violate public policy or the law. The Court considered the Russian roulette clause a reflection of the parties' intention in a contract. The clause serves a practical function in resolving standstill situations in joint ventures or partnerships.
Moreover, the rationale of the court underlines the increasing interest in the Italian legal system regarding clauses aimed at resolving situations of operational paralysis. The Milan Notary Council in 2019, in support of the Court’s reasoning, stated that clauses known as "Russian roulette" do not violate the prohibition of an unfair agreement and are admissible statutory clauses. It’s important to make a distinction between clauses of a parasocial nature and statutory clauses, since only the latter must comply to the principle of fair valuation.
Another notarial statement from the Florence Notary Council in 2020 is quoted, affirming the legitimacy of statutory "Russian roulette" clauses, even without the need to specify a pre-established price. However, the valuation criterion for participations must consider the situation of the company in case of a deadlock and the possibility of liquidation.
The Italian supreme Court takes into consideration two examples of other clauses used to regulate shareholder dynamics: "drag along" and "tag along" clauses, which impact the sale of social shares. Drag-along clauses are provisions in shareholder agreements that allow majority shareholders to force the minority ones to join in the sale of a company or its assets. This ensures that all shareholders are compelled to sell their shares, typically on the same terms and conditions as the majority shareholder. Tag-along clauses give minority shareholders the right to join in the sale of their shares when a majority shareholder decides to sell. This enables minority shareholders to "tag along" with the majority shareholder's transaction and to protect their interests by achieving better terms and conditions.
The inclusion of a "roulette clause" in a contract may hypothetically conflict with the provisions of Article 1355 of the Italian Civil Code (merely potestative conditions) and Article 1349 (the determination/determinability of the contractual object). Regarding the first provision, the Court interprets the concept of a "merely potestative" clause, which is invalid, in a very restrictive way compared to "potestative" clauses. On this matter, in its judgments (Section 5, Judgment No. 30143 of 2019 -- Section 3, Judgment No. 18239 of 2014--Section 2, Order No. 9879 of 2018) the Court of Cassation makes a clear distinction between "merely potestative" and "potestative" conditions. The former is based on the party's arbitrary decision and implies the absence of a serious intention to be bound by the contract. The latter represents an alternative capable of satisfying the party's own interests. It is also important to consider that the Court stated as valid a merely potestative condition, as long as it is resolutive, since Article 1355 of the Civil Code limits nullity to the cases regarding those that are suspensive.
Another potential point of debate is represented by the prohibition of a "one-sided agreement", also known in the Italian legal system as “patto leonino”, established by Article 2265 of the Civil Code, which states that "an agreement by which one or more partners are excluded from any participation in profits or losses is null and void." The nullity of the agreement is linked to the nature of the economic activity carried out by the company and the aim pursued: the division of profits (Article 2247). If there is no distribution of profits among all partners, there is no company, just as a partner who is entirely exempted from the risks associated with losses cannot be considered a part of the company. However, the jurisprudence of the Court believes that this provision does not cover clauses that establish a participation in profits or losses that is not proportional to the value of one's share. In this regard, the Russian roulette operation is not immediate but it is subject to the circumstance of a deadlock in the company, predetermined by the contract but entirely possible.
From a different perspective, another doubt arises regarding whether a minimum floor should be established to ensure a fair valuation of the outgoing partner's stake. The provisions to take into consideration are article 2347 regarding a withdrawing partner and forced redemption stated by Article 2437-sexies. This argument is largely rejected by most scholars who have addressed the issue since it results from an undue overlap of the drag-along clause over the Russian roulette clause, between which there isn't a real analogy. It is claimed that the only common element is the departure of the partner from the company, while the functions of the two clauses are quite different. A question of applicability of Article 2437-sexies of the Civil Code to the Russian roulette clause only arises when it is included in the bylaws. This issue cannot be raised when it concerns a clause in a shareholders' agreement.
The potential activation of the clause can act as a deterrent against “bad faith” negotiations. Both parties are equally exposed to the risks and rewards of the mechanism, neither of them is unfairly disadvantaged. The unpredictability of who will initiate the clause and the subsequent decision to buy or sell ensures that both parties are on the same level. Furthermore, the clause can prevent several years of legal battles and the associated costs.
Bibliography
Corte di Cassazione, sentenza n. 22375/2023, 10 marzo 2023
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