By: Antoine Del Sordo
Shareholder exclusion clauses are provisions incorporated into a company’s bylaws that sanction a breach by a shareholder when there is conclusive evidence that such shareholder is not acting with affectio societatis, pursuant to previously established grounds. These clauses intend to prevent disputes between shareholders and the company, as well as to avoid potential harm to the latter.
As noted above, exclusion clauses must be incorporated into the bylaws either at the time of the company’s incorporation or through a subsequent amendment. There is ongoing debate as to whether unanimous shareholder consent is required to approve an amendment providing for exclusion provisions. In the author’s view, it should suffice that the resolution is adopted in an Extraordinary Shareholders’ Meeting, in compliance with the requirements set forth by the law and the bylaws, including the applicable call notice requirements, and quorum for attendance and voting. This position is justified because, upon subscribing shares representing the corporation’s capital stock, each shareholder accepts that the bylaws may be amended in accordance with statutory and bylaws formalities. Therefore, only in those cases where the bylaws expressly establish a 100% of the capital stock quorum for attendance and voting would unanimous consent be required. In the absence of such provision, it is entirely permissible to amend the bylaws to include exclusion provisions without unanimity.
Exclusion grounds must be based on material and specific breaches by shareholders against the company, such as competing with the company, misappropriating intellectual property or confidential information of the company for personal business, failing to attend duly convened Shareholders’ Meetings for a persistent period previously established or engaging in fraudulent or willful misconduct against the company. The critical point is to ensure that the exclusion clause does not become a de facto instrument enabling a group of shareholders to arbitrarily exclude another.
It is likewise advisable to establish a specific procedure governing the application of exclusion clauses. Such procedure should clearly define applicable terms, the officers or percentage of capital stock entitled to trigger the exclusion process, the evidentiary threshold required to commence proceedings, the quorum for attendance and voting necessary to approve the exclusion, the opportunity afforded to the shareholder subject to exclusion to exercise the right to demonstrate that no breach has occurred, and the method for determining the amount of capital reimbursement to the excluded shareholder in the event the exclusion is upheld.
It should be noted that, as exclusion operates as a sanction, the bylaws may provide for reimbursement of the nominal value of the shares rather than their fair market value, or even stipulate as a liquidated damages provision an amount up to the current commercial value of the shareholder’s contribution, in which case no reimbursement would be made to the excluded shareholder and such amount would remain in favor of the company. In either scenario, the excluded shareholder’s shares must be cancelled, and the company’s capital stock must be correspondingly reduced.
As set forth above, shareholder exclusion clauses constitute a legitimate mechanism to safeguard the stability and continuity of the company. Nevertheless, it is essential that they be grounded in clear causes that materially affect the affectio societatis upon which the corporate contract is founded. Likewise, establishing a defined, transparent and proportionate procedure is indispensable to ensure that exclusion fulfills its purpose without arbitrariness and strengthens the enforceability and execution of this mechanism.
