A shareholders agreement is a contract. Breaching it gives rise to damages, but it does not, in principle, annul a transfer made in disregard of its clauses. A clause written into the articles of a société par actions simplifiée follows the opposite logic: article L. 227-15 of the Commercial Code makes void any transfer effected in breach of the statutory clauses. It is that trade off between articles and agreement, not the length of the document, that determines how much protection there really is.
Three founders set up a company in equal shares. Five years later one of them sells his holding to an outsider, ignoring the pre emption clause of the agreement signed on day one. The other two discover the new shareholder at the annual meeting. They have an agreement, they are right on the merits, and yet their position is poor: the outsider is in the share capital, and they will have to show that he knew of the agreement and of their intention to rely on it if they are to hope for anything beyond compensation. The same clause placed in the articles would have made the transfer void.
Articles or agreement: three differences that change everything
The first difference is publicity. The articles are filed at the registry and open to anyone, including competitors, clients and candidates for entry into the capital. The agreement stays confidential. Shareholders who do not want to expose their governance, their exit rules or their non competition undertakings prefer an agreement for that reason alone, and it is a legitimate choice.
The second is enforceability against third parties. The articles bind every shareholder, present and future, and the third party buyer. The agreement binds only its signatories: a shareholder who came in later is not bound unless he acceded to it, and an agreement that does not require new entrants to accede empties itself of substance at the first funding round.
The third, and the weightiest, is the sanction. In a société par actions simplifiée, article L. 227-15 of the Commercial Code provides that any transfer effected in breach of the statutory clauses is void. Breach of an agreement, by contrast, is dealt with by contractual liability. The practical consequence is simple: the clauses whose effectiveness depends on being able to undo the transaction, pre emption and approval first among them, belong in the articles, the agreement taking charge of what concerns the organisation between shareholders.
What a SAS may put in its articles
Article L. 227-13 of the Commercial Code allows a clause making shares inalienable for a period not exceeding ten years. Article L. 227-14 allows any transfer to be made subject to prior approval by the company. Article L. 227-16 allows it to be provided that a shareholder may be required to transfer his shares, and that his non pecuniary rights are suspended until he does so, which is the exclusion mechanism.
Article L. 227-19 sets the conditions for adopting these clauses, and the distinction is decisive. The inalienability clauses of article L. 227-13 and those of article L. 227-17 can be adopted or amended only by unanimity of the shareholders. The approval clauses of article L. 227-14 and the exclusion clauses of article L. 227-16, by contrast, may be adopted or amended by a collective decision taken on the conditions and in the form provided by the articles. An exclusion clause can therefore be introduced by the statutory majority, which changes the balance between majority and minority and has to be anticipated when the articles are first drafted.
The clauses that really matter
Pre emption, or a preference agreement within the meaning of article 1123 of the Civil Code, binds the party who gives it to offer the beneficiary first refusal if he decides to deal. Putting it into effect requires a precise mechanism: notification of the proposed transaction, the content of that notification, the time for reply, the price or valuation method, and what happens to the balance if several beneficiaries exercise. A pre emption clause that does not say how the price is determined is a clause that cannot be operated.
A tag along right allows the minority to require that a selling majority shareholder procure that the buyer also acquires the minority holding, on the same terms. A drag along right allows the majority to require the minority to sell so that 100 per cent of the capital can be transferred. Good leaver and bad leaver clauses adjust the buyback price of a managing shareholder shares according to the circumstances of his departure. Anti dilution clauses protect the minority on capital increases. Governance clauses organise the decisions requiring prior consent, the composition of the corporate bodies, periodic reporting and deadlock resolution.
Two clauses deserve particular care. A non competition covenant must be limited in subject matter, in time and in territory, and proportionate to the legitimate interests protected, failing which it is set aside. The valuation clause is the one that decides the entire financial stake on exit: referring to an expert appointed under article 1843-4 of the Civil Code, taking a multiple of an accounting aggregate, or fixing a formula, are not the same contract.
How to sanction a breach effectively
Article 1123 of the Civil Code provides that the beneficiary of a breached preference agreement may obtain compensation, and that he may in addition seek annulment or ask the court to substitute him for the third party where that third party knew of the agreement and of the beneficiary intention to rely on it. That twofold condition is heavy to establish. The same text gives the third party an interrogatory action: he may ask the beneficiary in writing to confirm, within a reasonable period that he fixes, the existence of the agreement and his intention to rely on it, failing which the beneficiary loses the right to seek substitution or annulment. A beneficiary who leaves such a letter unanswered therefore loses his protection.
Article 1221 of the Civil Code also allows specific performance to be pursued after formal demand, unless performance is impossible or there is a manifest disproportion between its cost to a good faith debtor and the creditor interest. It is on that basis that enforcement of a promise to sell contained in the agreement is argued. In practice the mechanisms that work best are not judicial: reciprocal unilateral promises granted at signature, a penalty clause set at a deterrent amount, escrow of the share transfer forms, a mention in the articles that an agreement exists without disclosing its content, and notification of the agreement to likely third parties. They create bad faith on the part of the third party or make the breach physically impossible.
Duration: the perpetual undertaking trap
Article 1210 of the Civil Code prohibits perpetual undertakings and allows each contracting party to bring them to an end on the conditions applicable to a contract of indefinite duration. An agreement with no stated term is therefore terminable unilaterally by any signatory, on reasonable notice. That is exactly what the shareholder discovers when he has relied on a governance clause signed twelve years earlier.
The answer is to stipulate a fixed term, renewable if wished, or to tie the term to an objective event: for as long as the signatories together hold a given percentage of the capital, until a change of control, until an initial public offering, for the life of a loan. The term must stay reasonable, because an excessive one falls back into the prohibition. It is one of the clauses most often botched in standard agreements.
What makes an agreement fail in practice
The recurring defects are few and always the same. New shareholders never acceded, for want of a mandatory accession clause backed by a binding mechanism. Exit clauses refer to a market price that cannot be determined. Pre emption and approval clauses sit in the agreement when they should have been in the articles. The agreement contradicts the articles with no indication of which prevails. No deadlock breaking mechanism is provided, so that the only way out is judicial dissolution for disagreement. And no term was stipulated.
When it is drafted matters as much as what it says. An agreement negotiated at incorporation, when relations are good and the stakes abstract, is almost always better than one negotiated on the arrival of an investor or at the start of a conflict. Conversely, an agreement never revisited after a fundraising, a change of corporate form or the departure of a founder has become a decorative document.
What the firm does
Upstream, the work consists in allocating the protections between articles and agreement according to what must be capable of being annulled and what must stay confidential, in drafting exit clauses with a valuation method that can actually be applied, in securing the accession of future shareholders, in fixing a workable term, and in backing the sensitive clauses with cross promises and mechanisms that physically block the shares.
In a dispute, the task is to establish the third party knowledge of the agreement, to choose between annulment, substitution, specific performance and compensation, to deploy protective measures over the shares, and to coordinate that litigation with the other fronts that almost always accompany it: removal of the manager, abuse of majority or minority, an application for a management audit, even dissolution for disagreement.
Are you drafting a shareholders agreement, or has a co-shareholder just breached yours? The firm checks what belongs in the articles, what belongs in the agreement, and what is actually enforceable.
Frequently asked questions
Does breach of a shareholders agreement annul the transfer?
In principle no: the agreement is a contract, and breach is sanctioned by damages. Article 1123 of the Civil Code does, however, allow annulment or substitution of the beneficiary for the third party where that third party knew of the agreement and of the beneficiary intention to rely on it. Conversely, article L. 227-15 of the Commercial Code makes void any transfer made in breach of the statutory clauses of a SAS.
Should clauses go in the articles or in the agreement?
Clauses whose effectiveness depends on being able to undo the transaction, such as pre emption, approval and exclusion, are better placed in the articles of a SAS, where article L. 227-15 of the Commercial Code sanctions their breach with nullity. The agreement remains preferable for what must stay confidential, in particular governance, the allocation of roles and financial undertakings between shareholders.
Is an agreement with no stated term valid?
It is valid, but fragile. Article 1210 of the Civil Code prohibits perpetual undertakings and allows each signatory to end it as he would a contract of indefinite duration, on reasonable notice. It is better to stipulate a fixed term or to tie it to an objective event, such as maintaining a holding threshold or a change of control.
Can a shareholder be excluded?
In a société par actions simplifiée, yes, if the articles so provide. Article L. 227-16 of the Commercial Code allows it to be stipulated that a shareholder may be required to transfer his shares and that his non pecuniary rights are suspended until he does. Article L. 227-19 states that this clause may be adopted or amended by a collective decision on the conditions provided by the articles, with no requirement of unanimity.
How long can an inalienability clause last?
Ten years at most in a société par actions simplifiée, under article L. 227-13 of the Commercial Code. That statutory clause can be adopted or amended only by unanimity of the shareholders, under article L. 227-19, which makes it difficult to introduce after the event.
Article written by Herve Guyader, member of the Paris Bar, doctor of law. This content is general information and does not replace legal advice.