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PUBLICACIÓN
Invalidity of an indefinite family charter covenant restricting share transfers
11 de marzo, 2020
The matter in dispute in the case under review revolves around the validity or invalidity of a provision contained in a family charter that, seeking an orderly transfer of group undertakings, imposes on each family branch the obligation to keep certain shareholding percentages in the corporate group after the death of the founders of the same, and the consequent validity or invalidity of certain group undertaking share swaps, sales and purchases and gifts carried out by several shareholders who signed the charter, years after the death of the founders, which altered the shareholding percentages under the charter.
Both the Court of First Instance and the Madrid Provincial Court concluded that the above-mentioned share transfers were valid insofar as there was no breach of the charter despite altering the shareholding percentages in the corporate group and, furthermore, no illegal purpose was proven to exist in said transfers. The Provincial Court based its decision on the following reasons: (i) the family charter, which goes beyond a mere morally enforceable agreement, was respected not only upon the death of the founders, but also long after, so that the commitment of an orderly transfer of undertakings provided for in the charter was fulfilled; (ii) there is no obligation to perpetually keep the shareholding coefficients of the family branches in the corporate group, as this would be contrary to the law; and (iii) the charter does not include any prohibition or limitation on share transfers, so that those carried out are valid (they are not contrary to the law or the charter).
In its Judgment of 20 February 2020 [ECLI: EN:TS:2020:507], the Supreme Court’s Civil Division affirms the appellate ruling and endorses the arguments put forward by the Provincial Court, albeit adding a further argument, precisely the one we are going to refer to in this paper, which is the legal impossibility or invalidity of a perpetual (or indefinite) covenant restricting the transferability of company shares; in this specific case, the covenant, contained in the family charter, to keep (indefinitely) a distribution of fixed percentages of share capital ownership among the shareholders. In short, these are the considerations of the Supreme Court on this issue:
(i) Every obligation is a restriction on the obligor’s freedom, and therefore – even if there is no specific or general statutory rule prohibiting the perpetuity of obligations – an unlimited period would be contrary to public policy (art. 1583 Civil Code).
(ii) In the case of an obligation that does not have a specific duration (which in any case cannot be perpetual), there are different remedies available when one of the parties wishes to release himself from the same, from the integration of the contract with business practices to the fixing of the duration by the courts, in accordance with the nature and circumstances of the obligation, including the admission of the power of any party to withdraw from or cancel the obligation – which is legally recognised for various types of indefinite contracts, as is the case with company formation agreements, although the exercise of this power of unilateral cancellation must be in good faith (which prevents the cancellation of a contract before sufficient time has elapsed for the relationship to produce its effects).
(iii) This is the approach advocated in some precedents of judicial practice in relation to syndicate share agreements without a set term. Although it is possible for shareholders to privately arrange the syndication of shares, restricting their power to dispose of the same, the foregoing is not valid if such restriction is of unlimited or permanent duration, the conversion of “syndicated shareholders into perpetual shareholders of the company” not being permissible “since, according to the agreement, they would not be able to withdraw from the company”.
(iv) Our law does not allow for the permanent binding of a shareholder’s financial (equity-holding) and non-financial (governance) rights, not because they directly violate explicit corporate rules regarding legal restrictions on the transferability of shares, but more widely because they violate the essential principles that should shape the very nature of the corporate relationship and the civil legal system; in particular, the principle of freedom of contract and of personal and financial disposition (company legislation on the transfer of shares may be cited as the inspiration for these principles, including the maximum period an inter vivos transfer of shares or a right to exit may be prevented under the articles of association [Art.108.4 LSC ]).
(v) The above considerations can be extrapolated to the case at issue: the interpretation of the family charter «in the sense of maintaining indefinitely the restrictions on the free transferability of company shares, preventing the alteration of each shareholder’s percentage of the share capital, and generating a kind of perpetual binding of shareholder rights, would be contrary [inter alia], to the aforementioned limits […] [the time limits on those limitations restricting free transfers], without the possibility of unilateral cancelation of or deviation from charter provisions, once the main purpose for which they were intended of ensuring an orderly transfer of family undertakings after the death of the founders has been satisfied, […] being regarded as contrary to the prohibition of abuse of rights or to contractual good faith (Art.7(1) of the Spanish Civil Code)».
Both the Court of First Instance and the Madrid Provincial Court concluded that the above-mentioned share transfers were valid insofar as there was no breach of the charter despite altering the shareholding percentages in the corporate group and, furthermore, no illegal purpose was proven to exist in said transfers. The Provincial Court based its decision on the following reasons: (i) the family charter, which goes beyond a mere morally enforceable agreement, was respected not only upon the death of the founders, but also long after, so that the commitment of an orderly transfer of undertakings provided for in the charter was fulfilled; (ii) there is no obligation to perpetually keep the shareholding coefficients of the family branches in the corporate group, as this would be contrary to the law; and (iii) the charter does not include any prohibition or limitation on share transfers, so that those carried out are valid (they are not contrary to the law or the charter).
In its Judgment of 20 February 2020 [ECLI: EN:TS:2020:507], the Supreme Court’s Civil Division affirms the appellate ruling and endorses the arguments put forward by the Provincial Court, albeit adding a further argument, precisely the one we are going to refer to in this paper, which is the legal impossibility or invalidity of a perpetual (or indefinite) covenant restricting the transferability of company shares; in this specific case, the covenant, contained in the family charter, to keep (indefinitely) a distribution of fixed percentages of share capital ownership among the shareholders. In short, these are the considerations of the Supreme Court on this issue:
(i) Every obligation is a restriction on the obligor’s freedom, and therefore – even if there is no specific or general statutory rule prohibiting the perpetuity of obligations – an unlimited period would be contrary to public policy (art. 1583 Civil Code).
(ii) In the case of an obligation that does not have a specific duration (which in any case cannot be perpetual), there are different remedies available when one of the parties wishes to release himself from the same, from the integration of the contract with business practices to the fixing of the duration by the courts, in accordance with the nature and circumstances of the obligation, including the admission of the power of any party to withdraw from or cancel the obligation – which is legally recognised for various types of indefinite contracts, as is the case with company formation agreements, although the exercise of this power of unilateral cancellation must be in good faith (which prevents the cancellation of a contract before sufficient time has elapsed for the relationship to produce its effects).
(iii) This is the approach advocated in some precedents of judicial practice in relation to syndicate share agreements without a set term. Although it is possible for shareholders to privately arrange the syndication of shares, restricting their power to dispose of the same, the foregoing is not valid if such restriction is of unlimited or permanent duration, the conversion of “syndicated shareholders into perpetual shareholders of the company” not being permissible “since, according to the agreement, they would not be able to withdraw from the company”.
(iv) Our law does not allow for the permanent binding of a shareholder’s financial (equity-holding) and non-financial (governance) rights, not because they directly violate explicit corporate rules regarding legal restrictions on the transferability of shares, but more widely because they violate the essential principles that should shape the very nature of the corporate relationship and the civil legal system; in particular, the principle of freedom of contract and of personal and financial disposition (company legislation on the transfer of shares may be cited as the inspiration for these principles, including the maximum period an inter vivos transfer of shares or a right to exit may be prevented under the articles of association [Art.108.4 LSC ]).
(v) The above considerations can be extrapolated to the case at issue: the interpretation of the family charter «in the sense of maintaining indefinitely the restrictions on the free transferability of company shares, preventing the alteration of each shareholder’s percentage of the share capital, and generating a kind of perpetual binding of shareholder rights, would be contrary [inter alia], to the aforementioned limits […] [the time limits on those limitations restricting free transfers], without the possibility of unilateral cancelation of or deviation from charter provisions, once the main purpose for which they were intended of ensuring an orderly transfer of family undertakings after the death of the founders has been satisfied, […] being regarded as contrary to the prohibition of abuse of rights or to contractual good faith (Art.7(1) of the Spanish Civil Code)».
