"Breaking (or Not Breaking) Boundaries: Rethinking Contract Termination in Shareholders' Agreements – A Legal Tightrope?"
The following text comprises the subjects to which I addressed in my presentation at the conference held at Lisbon School of Law on 15 January 2025 (20 minutes).
The following text comprises the subjects to which I addressed in my presentation at the conference held at Lisbon School of Law on 15 January 2025 (20 minutes).
1. Shareholders' agreements of Portuguese companies frequently use the term “termination” in a broad sense, encompassing various forms of the termination of the shareholders' agreements, such as the elapse of time, motivated termination, ad nutum termination, and so forth. I will concentrate my attention on termination for breach of shareholders agreements.
2. The primary question to be addressed is whether the legal rules applicable to breach of contract, and therefore to termination of contract, are sufficient to solve all the problems that arise in relation to shareholders' agreements. This question is not exclusive to shareholders' agreements. In private law, it can be posed in relation to breach of by-laws or to breach of commercial contracts.
3. In the absence of termination clauses, the circumstances that may give rise to termination for breach (lato sensu) of valid contracts are (i) partial impossibility of performance attributable or not attributable to the debtor affecting the creditor’s interest (Articles 793/2 and 802/2) (ii) failure to perform within a cure period set by the creditor (Article 808/1 and 2) (iii) late performance with loss of the creditor's interest in the performance (Article 808/1 and 2 and 792/1 and 2) (iv) non-conforming performance with loss of creditor’s interest in performance (Article 808/1 and 2) (v) anticipatory breach of contract. The law also foresees termination for change of circumstances (article 437.º of the Civil Code).
4. It is an established fact that the majority of shareholder’s litigation is initiated as a result of disagreements pertaining to the interpretation of contractual clauses. The breach of an obligation depends on the existence of such obligation. Interpretation is of crucial to determine the meaning of the agreement and the limits of the parties’ rights and obligations.
5. The prevailing the legal doctrine does not propose an autonomous model for interpretation of the shareholders’ agreements. Paulo Câmara has a different opinion and considers that “the general rules of legal business, with emphasis on the will of the parties, should only be fully applied in relation to agreements with no organizational significance, which in this respect will be governed in the same way as non-social clauses, regardless of where they are formally regulated” ([1]).
5.1. Let us imagine a clause stating the following: “shareholders shall not sell, assign transfer, pledge, encumber, hypothecate or in any other manner dispose of its rights in the Shares”. Would one consider that indirect transfers of control over the shares is included in this clause?
On the one hand, Shareholders agreements are usually formal agreements. Pursuant to the general rule of article 238/ 1, “in formal legal transactions, the declaration must have a minimum correspondence in the wording of the document, even if imperfectly expressed”. Furthermore, the rule of article 328 of the Companies Code is of free transferability of shares. In light of such rule, restrictions or limitations on that transferability must be express and interpreted strictly and broad interpretation or analogy are not allowed ([2]).
On the other hand, some shareholders agreements are intended to preserve personal or familiar relationships. This purpose may be considered as an element to be taken into account in the ShA’ s interpretation and may lead to a different conclusion. In intuitus personae agreements, the identity of the counterparty is a key consideration for executing the contract and serve as a basis of the Parties’ legitimate expectations as to performance and also as basis of the Parties’ agreement on the counterperformance.
Irrespective of the conclusion arrived at, the reasoning is grounded in a synthesis of general rules of interpretation, principles of corporate law, and the inherent nature of the ShA.
6. We shall now return to the matter of our scope. A first aspect to highlight is that the legal literature is unanimous in considering the ShAs may be terminated ([3]).
The wide range of breaches of ShA that permit termination can be attributed to the diverse nature of clauses and objectives inherent within ShAs. In fact, ShAs are negotiated aiming at establishing a differential treatment of shareholders, keeping private certain information regarding the company, regulating strategic goals, regulating restrictions on certain actions of the company, regulating rights to receive information, the dividend policy, the veto rights, etc.
7. Commercial contracts are subject to the rules of the Commercial Code, and when problems cannot be resolved either by the text of the commercial law, or by its spirit, or by the analogous cases foreseen therein, courts and tribunals shall resort to civil law (cf. article 3 of the Commercial Code). The Portuguese Companies Code does not include a provision on the breach of ShA.
The prevailing legal doctrine does not propose an autonomous model for breach of contract in relation to commercial agreements, and even less so for shareholders agreements. In this sense, Engrácia Antunes expressly recognizes that the exception of breach of contract (article 428 of the Civil Code) and the termination of contract (Art. 432/1, 802/2 and 808/1 of the Civil Code) are fully applicable to ShAs[4].
8. In my view, resorting to general remedies in relation to breach of ShA may give raise to complexities. I will share with you a couple of questions.
8.1. First question: is the type of ShA relevant? Are purely organizational/associative Shareholders Agreements similar to purely comutative Shareholders Agreements for the purposes of defining the legal remedies applicable to breach of contract?
Let us imagine a clause establishing the following “to the extent permitted by law, the parties shall ensure that the resolutions of the Board of Directors are approved with the favourable vote of X directors in relation to the following matters, which necessarily include the directors appointed by Y: a) Approval of the Company’s Strategic and Business Plans; b) Litigation which amount exceeds 5% (five per cent)of the Company's share capital”.
Disregarding the issue of the clause's limitations to prevent undue interference in the company's management, it is evident that the shareholder duty may be breached, resulting in termination. Legal doctrine does not draw a distinction between organizational and relational types of ShAs for the purposes of assessing the breach of contract. However, is it possible to individualize performance and counterperformance in the said clause? If not, would termination still be applicable?
8.2. Second question: the creditor’s interest plays a decisive role, when it comes to assess the impact of the debtor’s non-performance. Article 808/2 of the Civil Code enshrines a principle of objective assessment of such performance interest. In the event of a dispute, the non-breaching party faces the burden of alleging and of producing evidence on the termination requirements, notably of breach of contract (Articles 801(2) and 802(1) of the Civil Code. The following question must be posed: What is the meaning of creditor’s interest in the context of a shareholders’ agreement? It is my position that the interest of the shareholder takes precedence over that of the company and other stakeholders, unless otherwise stipulated in the shareholders' agreement.
6.3. Third question: Shareholders' agreements are in principle plurilateral contracts: such agreements regulate legally autonomous interests of shareholders or of blocks of shareholders. In case multilateral shareholders agreement, if one shareholder terminates the agreement for breach of contract of another shareholder, would the shareholder agreement remain in relation to the rest of the shareholders? Would the remaining shareholders be subject to the same terms of the agreement, or would the termination of one shareholder result in a revision of the agreement in relation to the other shareholders? Furthermore, would the basis of the transaction be affected?
6.4. Finally, shareholders agreements may establish individual or plural obligations. Determining the nature of such obligations is not always straightforward, but such qualification is relevant for the purposes of the rule of joint and severable liability of commercial obligations. It is also important to note that litigation regarding the nature of the obligation may also occur.
7. The Parties are at liberty to narrow or to broaden the termination requirements.
The exclusion of the right to terminate remains a contentious issue. Some traditional approaches advocate for limitations on the autonomy and freedom of the parties to determine the measures to safeguard their own interests. Nevertheless, such perspectives are open to criticism, and it is my opinion that such clauses may be valid in commercial contracts that provide an alternative option to the aggrieved party which reasonably allows such party to receive materially adequate protection of its right.
The Parties often resort to call options as a remedy for breach of ShA. In the case of a call option (i.e. an agreement that gives the holder the right to buy or sell an asset under predetermined conditions), the holder has the option to buy the defaulting party's share in the company's capital or, alternatively, to sell its share to the defaulting party. Sometime the price is deducted from the value of a penalty clause also agreed in the Shareholders' Agreement.
In my opinion, the Parties are allowed to include such call option as sole and exclusive remedy for breach of the ShA.
8. From a functional perspective, termination corresponds to a remedy which produces a necessary release effect and a possible recovery effect. It is not a discretionary remedy, rather a right or measure that depends on certain material requirements.
The release effect consists of extinction of the parties' future obligations. The release effect applies to shareholders agreements. However, it may not be total, and some legal positions may survive. From a legal standpoint, the principle of good faith (which requires particular care when applied to commercial law) may require the continuation of lateral duties aimed at protecting the counterparty legitimate interests (Articles 762(2) of the Portuguese Civil Code). Loyalty in the context of the ShA implies that the shareholder should conduct himself without engaging in acts that may cause harm to the shareholding and business interest of the other shareholder.
Some clauses may also survive, such as those dealing with the confidentiality agreements, arbitration agreements, etc.
9. The recovery effect is merely possible (not all cases of destruction of the contractual relationship imply recovery, either because the performance and counter-performance were not even performed or because the latter is not recoverable). As most part of shareholders’ agreements are enduring agreements, termination will not have retroactive effect (article 424/2 of the Civil Code).
10. Finally, it is important to note that other effects may occur in association with termination. The parties involved are at liberty to enter into an agreement regarding termination fees, which, in a number of cases (though not all) may be qualified as cláusulas penais. The question of whether termination fees will be subject to reduction if considered too burdensome by the court and the applicability of article 812.º of the Civil Code in relation to commercial agreements such as shareholders agreements may be subject of debate.
[1] Acordos parassociais: problemas de interpretação e de conversão, Direito e Justiça, Estudos em Memória do Prof. Doutor Paulo M. Sendim, 2012, p. 462.
[2] In this sense, Paulo Câmara upholds that “interpretative consequences must be drawn from the principle of free transferability of shares, manifesting itself in such a way as to prevent extensive interpretations of contractual restrictions on transferability; these must, as a rule, be interpreted restrictively. The principle, which applies to statutory clauses limiting transferability, must be applied in the same way to non-statutory clauses” Idem, p. 461.
[3] Raúl Ventura, Acordos de Voto – Algumas Questões Depois do Código das Sociedades Comerciais, “Estudos Vários sobre Sociedades Anónimas”, Almedina, Coimbra, 1992, M. Graça Trigo, Os Acordos Parassociais sobre o Exercício do Direito de Voto, 176, UCP, Lisboa, 1998.
[4] Os Acordos Parassociais: algumas reflexões sobre o seu regime jurídico, DSR vol. 25, 2021, p. 34.