Do good agreements make good friends? About the validity of price determination clauses and good/bad leaver clauses, in particular in the context of the dispute settlement procedure

1. Many shareholders’ agreements (and some articles of association) include exit mechanisms in the form of call and put options. In the case of unlisted companies, these agreements are conceived as a regulation of corporate relationships, and mainly focused on terminating the shareholdership without requiring the intervention of the court or a third party-transferee.

Financial investors, for instance, often negotiate for themselves a put option so that they will be able after a given period of time to valorize their investment, potentially at a guaranteed minimum price. Agreements between or with operationally active shareholders also often include options which, according to the agreements made, can be exercised on discretionary basis (i.e., without reason) or, most frequently, in given situations only, for instance in the event of serious shortcomings, a deadlock or the fact that a shareholder is no longer operationally active.

In many cases, the option’s exercise price is made subject to the concrete circumstances giving rise to exercising the option, and a lower price is negotiated in the event that a shareholder leaves/has to leave the company for actions that are considered as ‘wrongful’. But ‘wrongful’ is a broad notion. It can also include the termination of the operational cooperation on the shareholder’s initiative. These clauses are referred to as “good leaver/bad leaver” clauses.

2. The unfair situations that might result from it are not always considered, more in specific when a shareholder is forced to sell his shares below market value. Just think of the following situations:

  • the beneficiary of a call option exercises it shortly before its intended sale to a third party, in order to fully take the surplus value itself;
  • the operational function of a shareholder is terminated with the sole purpose to acquire the shares at a low price by exercising a (bad or even good leaver) option linked to the termination;
  • in case of an (imminent) conflict situation, a call or put option is exercised ‘last minute’ to avoid the invocation of a legal dispute settlement procedure.

If the application of a “bad leaver” clause is based on the shareholder’s wrongful behavior with respect to the company, there is also the risk that this shareholder will be penalized twice for the same shortcoming. A first time because he has been forced to sell his shares below market value, and potentially a second time through a claim for damages made by the company.

When concluding a shareholders’ agreement, shareholders often take it for granted that these clauses are valid and enforceable, but they find it much less obvious when exercising them. The question then arises as to which extent these option agreements can be assessed by the court, whether under common law or under company law.

3. A possible common law solution could be found in the obligation to perform agreements in good faith (art. 1134, third paragraph of the former C.C.) or – in other words – the prohibition of abuse of rights. In that case, the issue is not the validity of the option in itself, but the conditions in which it is exercised. Above, we have provided some examples of situations in which the option is exercised for purposes other than the (assumed legitimate) reasons that the parties had originally in mind, or in which the exercising of the options affects the legitimate expectations of the shareholder having granted the option right.

If it is considered that this is indeed the case, there may be an abuse of rights, in which case the related sanction is normally the limitation of the exercised right to reasonable limits. According to the circumstances, this may imply whether that the exercising of the option is declared null and void whether that the exercising as such is valid but that the conditions under which it is done must be modified, i.e., that the option’s exercise price must be adjusted to bring it in line with the actual (estimated) market value.

4. In the specific case of a call option that is exercised as a sanction for a given behavior (such as the termination of the operational cooperation), the question arises whether the provisions regarding the possible moderation of a penalty clause (art. 1231 former C.C.) may provide the court with additional grounds to intervene on the option’s conditions. If the consequences of the sanctioned behavior can be counterbalanced by a flat-rate compensation linked to it, there is no doubt that it could be moderated if it would be excessive and compensate more than the potential damage resulting from the shareholder’s exit. So, why not consider the application of this rule when the compensation mechanism actually consists of a purchase option whereby the shares can be acquired at a price (far) below their actual value, which, under certain circumstances, may be economically equivalent to a disguised penalty clause?

5. If the option is exercised in the context of a dispute, the mandatory rules of the dispute settlement may also provide a solution. Within the context of the dispute settlement, the court may require a shareholder to acquire, respectively transfer, the shares at the price that the court determines. There must however be serious grounds (“gegronde redenen”) to do so.

A shareholder could decide to file a claim for forced acquisition or transfer within circumstances that also meet the conditions of a call or put option. But in order to successfully file such a claim, he must be and remain a shareholder, which is no longer the case when the option is exercised prior to or during the procedure. But given the mandatory nature, the court could nevertheless decide to annul the exercising of the option with the applicable (negative) valuation. The (albeit scarce) case law seems to follow this line.

Since the introduction of the Code of Companies and Associations, the court is explicitly empowered to moderate the price determination clause within the context of a dispute settlement when this clause leads to a manifestly unreasonable price (art. 2:67 CCA). Strictly speaking, this provision does not concern the contractual or statutory options as they are set up to make the dispute settlement procedure unnecessary. But if the court is allowed to intervene on a price determination clause within the sole context of a dispute settlement, it can hardly be argued, given the compelling nature of the latter and the finality of the abovementioned provision, that the court’s assessment ability should be entirely set aside by ‘encapsulating’ a manifestly unreasonable price into an option.

Given the specific circumstances that lead to the application of the dispute settlement, we believe that the court is still free to decide that it is recommended whether to set aside the statutory or contractual option arrangement entirely, whether to assess the exercise price marginally, and, if need be, adjust it.

6. This doesn’t imply that every option that might be exercised at a price that is significantly different from its market value, may be censored as an abuse of rights, penalty clause or a violation of the mandatory rules of the dispute settlement procedure. Especially when the option was granted at the time that the shares were initially acquired, the global economy of the contract must be taken into account. If the shares were acquired below the then-current market value, or if the acquisition was only possible because of the relevant purchase option, these elements could support the option’s validity. So, the court will not only have to assess whether the option’s exercise price was unreasonable in relation to its market value, but also whether this fact cannot be justified considering the circumstances in which the option was granted. In our opinion, the court can only intervene if this is not the case.

7. So yes, good agreements make good friends, but they do not entirely exclude, nor the need, nor the possibility of judicial intervention. In order to part on good terms, attention should not only be given to the circumstances in which the put or call options can be exercised. It is also essential to strive as much as possible to do it at a reasonable transfer price.

Robbie Tas en Caroline Hotterbeekx, intui advocaten en