The Warsaw Voice » Advice from Law Firm » Monthly - July 30, 2012
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Priority Right and the Right of First Refusal: How to Protect the Composition of Shareholding?
   
When founding a limited-liability company, the shareholders want to protect themselves against a situation where, as a result of the unregulated sale of shares by one or more other shareholders, they would have to cooperate with a new, potentially unwanted entity.

To avoid this situation, in the articles of association of limited-liability companies, the shareholders often include contractual provisions aimed at reducing the possibility of changing the company’s shareholding composition. It is common for the articles of association to set out that, if any shareholder intends to sell their shares in the company, then the other shareholders will have a priority right (prawo pierwszeństwa) to acquire them. However, in many cases, priority rights are confused with the right of first refusal (prawo pierwokupu), causing complications in the subsequent functioning of the company.

These two rights are very similar and easily confused, especially as they have slightly different meanings to their equivalents under the common law systems of the U.S. and the UK. However, though the difference in meaning may be subtle, the ramifications can be significant. The confusion often leads to disputes, which usually end up by the unanimous intention of the parties being established in court, during which the court interprets the statements of intent of the contracting parties to determine what the shareholders “had in mind” when concluding the articles of association. When this happens, the court “re-creates” the content of the articles, bearing in mind all the circumstances in which the statements were made by the shareholders, the rules of social interaction, and established customs.

Right of first refusal (prawo pierwokupu)
The right of first refusal (prawo pierwokupu) is set out in Article 596 et seq. of the Civil Code. It is the right of a specified person to be able to purchase property in case the owner intends to sell it to a third party. In the case of shares, a shareholder who intends to sell its shares to a third party is obliged to conclude a conditional share purchase agreement, then the shareholder must offer eligible shareholders the right of first refusal to purchase shares under the same conditions as set out in the conditional agreement entered into with a third party.

If the eligible shareholder does not take up the offer within the period stipulated in the articles of association, or within the statutory period (under the Civil Code, it is a week from making the offer), then the conditional agreement takes effect. If, however, the shareholder exercises the right of first refusal, then the final share purchase agreement is between that shareholder and the shareholder selling the shares, with the same content as the conditional agreement previously entered into with the third party.

The sanctions for an unconditional sale of shares to a third party, or of not informing eligible shareholders of the sale, or of giving false information on the relevant provisions of the conditional sales contract is liability for damages limited to “negative contractual effect” (negatywny interes umowny), which means damages limited to the scope of only those losses that have arisen due to the fact that the aggrieved party was counting on the conclusion of the agreement. It should be noted that current trends in rulings consider the possibility of qualifying share purchase agreements entered into unconditionally despite shareholders holding a right of first refusal as ineffective towards the eligible shareholder pursuant to Article 59 of the Civil Code. In essence, this institution repeals the effectiveness of legal action against certain people, while leaving the effectiveness of this activity to others. The court will consider such a demand when made by an entity properly holding the right of first refusal, and only in situations where the right of first refusal was established with the knowledge of both parties, and less than a year has passed since it was established.

Priority right (prawo pierwszeństwa)
Under Article 182 of the Commercial Companies Code, shareholders may make the transfer of shares dependent on the company’s consent, or restrict it in other ways. One way to limit the sale of shares is using the priority right (prawo pierwszeństwa), which is not defined in the Code of Commercial Companies or in the Civil Code. Therefore, it is assumed that the priority right means the possibility of existing shareholders acquiring shares if one of the shareholders intends to sell them. In this case, the selling shareholder is required (even before concluding a share purchase agreement) to invite the entitled shareholders to exercise their priority right to submit offers to purchase the shares. This opens the deadline to the existing shareholders to submit offers to purchase the shares, and may lead to the conclusion of a share purchase agreement if the seller accepts the terms offered.

Selling shares without first offering them to an eligible shareholder holding a priority right is generally regarded as ineffective against the company and the shareholder with the priority right.

Basic differences
The main difference between the priority right and the right of first refusal boils down to when the right is exercised. The holder of a priority right exercises it before any agreement is signed, whereas with the right of first refusal is exercised after concluding a conditional agreement. There are two main obligations under the right of first refusal: the conclusion of a conditional share purchase agreement, and the notification of the content of the contract to shareholders holding the right of first refusal. The priority right, on the other hand, is something subtly different. In this case, the shareholder should only notify the right-holder of his intention to sell the shares. It is worth remembering, however, that shareholders may establish priority rights in the articles of association in many other ways, for example, by indicating that the selling shareholder is required to make an offer to the holders of the right of priority itself, rather than an invitation to make an offer. In this case, a positive response to the offer will lead to a share purchase agreement being concluded.

In any case, in order to determine the validity and effectiveness of the proprietary restrictions, it is important not to end up with a situation where the provisions of the articles of association effectively prevent the disposal of shares. Under Polish law, such provisions would be void and have no legal effect.

Mateusz Dróżdż, lawyer at Gide Loyrette Nouel, lecturer at Lazarski University


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