OVERVIEW
Preemptive clauses allow a person to acquire in priority shares of a company when they are about to be transferred. Although preemptive clauses can be embedded directly into the bylaws, drafters may also insert them in shareholders' agreements. In this QuickCounsel, we will mainly review the pertinence, validity and effectiveness of such preemptive clauses under French law.
THE PERTINENCE OF PREEMPTIVE CLAUSES IN SHAREHOLDERS' AGREEMENTS
From an objective standpoint: The clause is designed to fit with the shareholders' desire to increase their participation in the company, or at least to control the evolution of the company's capital.
From a comparative standpoint: Preemptive clauses can be distinguished from first offer clauses because the beneficiary of a preemptive clause is entitled to purchase first whereas the beneficiary of a first offer clause is only entitled to receive an offer first. Preemptive clauses are not approval clauses because approval clauses aim at requiring the prior approval of a person or an entity before the actual transfer of the shares instead of offering the shares to the beneficiary of the clause first.
Combination with an approval clause: Preemptive clauses can be used in conjunction with an approval clause. This aims at combining the effectiveness of approval clauses with the larger scope of preemptive clauses that may also apply to intern transfer between shareholders (Article L.228-23 §5 of the Commercial Code provides for the nullity of a transfer of shares in fraud of an approval clause). Even if preemptive clauses are often autonomous from the approval clause, it appears important to specify which clause applies first. On the one hand, if the preemptive clause applies first, a shareholder, wishing to leave the company, must first propose his shares to the other shareholders and, in case of refusal, must ask for the approval of the other shareholders before selling his shares to a third party. On the other hand, if the approval clause applies first, then the preemptive clause is mainly applicable if the entity that has to implement the approval clause did not approve the potential transferee. In the event of approval, the preemptive clause is still applicable if the share purchase agreement is not concluded.
Insertion in the bylaws: Bylaws are public, and therefore are effective against third parties under certain conditions. Inserting the preemptive clause in the bylaws creates a presumption that potential transferees have knowledge of the content of the company's bylaws. However, shareholders may prefer to benefit from the discretion of shareholders' agreements, which, in some cases, have no mandatory publicity rules. In addition to privacy, shareholders' agreements offer more flexibility regarding potential modifications than do bylaws as the modification of the bylaws requires a general meeting and publication.
THE VALIDITY OF PREEMPTIVE CLAUSES IN SHAREHOLDERS' AGREEMENTS
Regarding contract law
Issues: In addition to consent and capacity, the determination of the price as well as the duration of preemptive clauses have raised interesting issues.
Determination of the price: Is the determination necessary? According to Article 1591 of the Civil Code, parties must determine the price of a sale. Therefore, if parties do not determine the price of the shares, and unless they have defined objective constitutive elements to determine the said price, the share purchase agreement concluded under the preemptive clause may be voided. However, when the preemptive clause only provides for a mere negotiation, instead of a promise to sell or an offer, the absence of a determinable price does not lead to voidance of the share purchase.
Methods of determination: When the price is neither determined nor determinable through the preemptive clause, the price will sometimes be what the third party is offering to the shareholder to purchase the shares. Shareholders should not favour this solution because there is a risk of collusion between the shareholder wishing to leave the company and the third party purchaser. There are methods to determine the price while avoiding this risk. First, shareholders can provide for the intervention of a court appointed expert. When the mission of the expert is to determine the value of the shares, it would be wise to stipulate in the clause that the said value shall constitute the price of sale. Second, shareholders may choose to determine the price according to objective figures of the company, such as the net profit of the company. Third, shareholders can determine the price through private bids. Although this method allows the leaving shareholder to obtain the higher price, it does not guarantee the entry of the best shareholder, which seems incompatible with the purpose of preemptive clauses.
Duration of the clause: Preemptive clauses can have an undetermined duration. In such a case, they are consequently unilaterally revocable following a certain notice period. Agreements signed without explicit duration shall be treated as undetermined duration agreements. Submitting the duration of the agreement to the shareholder quality of the parties or their representative shall be considered as drafting undetermined duration agreements (Court of Cassation, Commercial Chamber on 6th November 2007. N° 07-10.620). According to contractual freedom, drafters are free to determine the duration of the clause and its conditions of termination. However, preemptive clauses constitute a limitation to the free disposal of one's own property. Therefore, the duration of the clause must not be excessive. One may consider that the maximum duration of ten years of non-transfer clauses should be applicable to preemptive clauses. Nevertheless, this solution may be too strict for preemptive clauses as the infringement is less important in the context of preemptive clauses.
Comparative view from Belgium: Under Article 510 of the Belgian Companies Code, non-transferability clauses must be limited in time and in accordance with the company's interest. Regarding preemptive rights, the limitation cannot last longer than six months from the date of the request of approval or invitation to exercise the preemptive right. Once a shareholder has made an offer, other shareholders have six months to agree to the transfer of shares. If not, the preemptive right is waived for that particular transfer.
Possible prolongation: Contracting parties may determine the renewal of the shareholders' agreement that contains the preemptive clause, in a tacit or explicit way. The renewal may be set up for the previous duration, or for pre-established periods.
Termination: When the implementation of the clause does not necessarily deprive its beneficiary of his rights, preemptive clauses end at the date agreed by the contracting parties. The beneficiary can exercise his rights more than once provided he is able to demonstrate that prior conditions were less advantageous to him (Court of Cassation, 3rd Civil Chamber on 29th January 2003, unpublished).
Regarding company law
Preemptive clauses and bylaws: The issue is that in some cases, the determination of the hierarchy between the shareholders' agreement and the bylaws is at issue and may affect the efficiency of the preemptive clause. In addition, companies are increasingly becoming parties to shareholders' agreements, making the enforcement of the shareholders' agreement against companies possible. This leads to a non-settled hierarchy. The superiority of the bylaws, which could be assumed given their legal importance, is not established. In particular cases, shareholders' agreements may prevail over bylaws, when the bylaws are less specific than shareholders'.
Publicity of preemptive clauses: For non-listed companies, publicizing preemptive clauses is not mandatory. This is not the case for listed companies. According to Article L.233-11 of the Commercial Code, inserted by the law n°2001-420 of the 15th May 2001, preemptive clauses inserted in shareholders' agreements shall be disclosed to the French Financial Market Authority (FMA) when aiming at least 0,5% of the share capital. All preemptive clauses entering the scope of application of the above mentioned Article must be published, even if concluded prior the 15th May 2001. Shareholders' agreements must be communicated to the FMA within five trading days after their conclusion. In the event of a takeover bid of a company's shares, the effects of the preemptive clause are suspended if publicity measures have not been accomplished. The suspension of the preemptive clause does not hinder its validity.
THE EFFECTIVENESS OF PREEMPTIVE CLAUSES IN SHAREHOLDERS' AGREEMENTS
Enforceability: According to the principle of the relativity of contracts, beneficiaries cannot invoke preemptive clauses against third parties. Therefore, the shareholder's agreement can only be opposed to the company if the company is party to the convention. As a consequence, the company could not be liable for not performing an obligation stemming from the agreement if it is not party to the agreement. Nevertheless, the shareholders' agreement can be opposed to third parties as a legal fact. Additionally, this agreement may establish liability as a tort of third parties when they participate in an operation likely to undermine the proper performance of preemptive clauses even though they were aware of the clause. Irrespective of these particular cases, the inability to invoke preemptive clauses is the major weakness of this clause. The effectiveness of preemptive clauses is even more limited when a minority of shareholders has only signed the agreement.
Allocation of damages: The relative effectiveness of preemptive clauses is also highlighted in the event of non-performance of these provisions. If the beneficiary is able to show damage, the main sanction for non-performance of preemptive clauses is the allocation of those damages to the beneficiary of the clause (For instance, Court of Cassation, Commercial chamber on 7th March 1989 (N° 87-17.212) and 3rd Civil Chamber on 30th April 1997 (N°95-17.598). The beneficiary can also make a claim for damages against the third party on the basis of Article 1382 of the Civil Code provided he is able to demonstrate that the third party was fully aware of the preemptive clause and chose to participate in the share purchase agreement in fraud of the preemptive clause. The issue of the demonstration of damage remains tricky because it is difficult to determine what is the actual damage suffered. It has been held that the loss of one's equal position in the company, due to the violation of a preemptive clause, constitutes a material damage (loss of negotiability) and a non-material damage (loss of influence in the day-to-day business life of the company: Paris' Court of Appeal, 3rd Chamber on 21st January 2005).
Voidance of the transfer: In addition to the allocation of damages, the beneficiary of a preemptive clause can also make a claim for voidance of the transfer if some conditions are met. The annulment of the contract is only possible within five years (Article 2224 Civil Code) and if the share purchase agreement was concluded in fraud of the beneficiary's rights. Consequently, the mere fact that the third party was aware of the agreement is not enough, it also must be shown that the third party knew that the beneficiary intended to exercise his preemptive right (Court of Cassation, Commercial Chamber on 27th May 1986 (unpublished, commented in the Trimestrial Review of Law 1987 p.88). In other words, it is about showing that the third party contracted with the assignor under fraudulent conditions. When those requirements are proven, the beneficiary can make a claim for the voidance of the contract, or if it is allowed by the agreement, can demand to replace the third party. However, such conditions may be difficult to establish. To improve the effectiveness of preemptive clauses, shareholders should provide for a clause in the shareholders' agreement that presumes the beneficiary's intention to exercise his preemptive right.
Penalty clause: In order to strengthen the effectiveness of preemptive clauses, shareholders can also stipulate a penalty clause in the shareholders' agreement that would be applicable in case of non-performance of a covenant. If this solution appears at first more efficient, as this clause applies by the effect of the sole non-performance, regardless of the existence of a damage (Court of Cassation 3rd Civil Chamber on 12th January 1994, N°91-19-540), its interest can be limited by judges who are allowed to reduce the amount of the indemnity if it is deemed excessive (Article 1152 Civil Code). Shareholders can also provide for a covenant to give back the shares if the shares are sold in fraud of a preemptive clause. Conditions for the implementation of this restitution must be specified in the shareholders' agreement.
Management of the stockbook by a third party: To avoid transfers in fraud of preemptive clauses, shareholders may decide to entrust an agent to manage the stockbook. The agent would be in charge of collecting offers of transferring shareholders, which would enable him to control every transfer of shares. Additionally, the agent would be liable for not performing the mission he was entrusted with by shareholders (Article 1191 Civil Code) The major weakness of this solution is that the share transfer period may then be much longer. In addition, law firms could be reluctant to face the risks associated with this case.
CONCLUSION
Preemptive clauses allow shareholders to control the flux of shareholders and maintain the existing proportion in the sharing of capital. When stipulated in shareholders' agreements, the preemptive clause only binds shareholders party to the agreement. The pertinence of preemptive clauses has to be considered on a case-by-case basis and depends on the objectives of the shareholders' agreement. Its pertinence is minimized in companies where the capital is widely shared.
- Sécuriser les pactes d'actionnaires : quels outils? (in Les Échos 11/18/2011) Vers une application plus restrictive de la clause de préemption (by Nathalie Malkes Koster) Les droits de préemption dans les pactes d'actionnaires (in Economag) Confirmation d'une tendance jurisprudentielle faisant primer le pacte d'actionnaire sur l'intention des parties (from Squire Sanders; in La Revue) L'exécution forcée d'un pacte d'actionnaire, entre vagues d'audace et rochers de réalisme (Droit des marchés et stratégies commerciales, by Nicolas Cré)