To what extent can shareholders of a limited liability company protect themselves against the risk of a co-shareholder becoming insolvent?
For a long time it was unclear whether it was lawful to include rights of first refusal relating to the insolvency of a shareholder in the articles of association of a limited liability company: If the rights of first refusal become exercisable – i.e. in the case of the insolvency of a shareholder – such a clause gives the remaining shareholders the option of acquiring those shares held by the insolvent co-shareholder. The motivation for introducing such a mechanism is obvious: before an unknown person – firstly the insolvency administrator and subsequently a third party who buys the insolvent shareholder's share from the insolvency administrator – takes over the insolvent shareholder's share in the company, it should instead be possible for the share to be bought by one of the other existing shareholders. The shareholders can thus remain "among themselves".
In practice, such a first refusal clause is often accompanied by a provision giving the persons entitled to exercise the right of first refusal the option to acquire the insolvent shareholder's share at book value or at least at a significant discount to the market value.
A recent decision of the Higher Regional Court of Linz (from 2019) caused some uncertainty in practice because the court ruled that applicable insolvency law generally prohibits, for reasons of creditor protection, the articles of association of a limited liability company from containing a right of first refusal that can be exercised in the event of the insolvency of one of its shareholders.
This excessive decision has now fortunately been corrected by a decision of the Supreme Court of 6 September 2020 (6 Ob 64/20k). The case concerned the revision of a company's articles of association. The new version included a clause entitling the other shareholders to exercise a right of first refusal in the event that one of them becomes insolvent. The purchase price for the share in the company for the other shareholders was to be the appraised value (market value) with a discount of 20%. By its very nature, the intended clause would consequently have reduced the insolvency estate by 20% as a result of the discount applied to the purchase price and thus the creditors would have received less.
The Supreme Court has now provided the clarification that was desperately needed:
- Rights of first refusal are valid in the case of insolvency so long as – for creditor protection purposes – the voluntary departure or the death of a shareholder on the one hand and enforcement proceedings or the insolvency on the other are treated equally as cases in which rights of first refusal may be exercised.
- A settlement limit below the fair market value of the share in the company is only permissible if it relates to both a voluntary departure and an involuntary departure of the shareholder from the company.
- The legal limitations to this include any situation where there is intent to cause damage to creditors from the outset, which is deemed contra bonos mores.
This decision thus provides future founders of limited liability companies with sufficient leeway to prevent "uninvited guests" from becoming shareholders of the company.
However: The fact that a settlement limit below the market value of the share in cases of enforcement proceedings and insolvency is only deemed permissible if a corresponding reduction in the settlement claim is agreed for each possible voluntary and involuntary departure of the shareholder goes too far in our opinion. It should be sufficient if, in addition to enforcement proceedings and insolvency, the acquisition price is reduced by at least the same amount under the articles of association for at least one other comparable case of departure of the shareholder (e.g. voluntary resignation, exclusion or death).