Article Post on 12 February 2021

Shareholder Conflicts (in Luxembourg): the Importance of Having Clear Articles of Association and a Shareholder Agreement

_The prevention of conflicts between shareholders should start long before a potential conflict arises, namely at the moment the parties become shareholders in a company. This is the start of the relationship between the shareholders and will be governed by the articles of association of the company (hereinafter AoAs), and possibly in addition, a shareholder agreement between the parties (hereinafter SHA), both being the principal documents determining the rights and obligations of each shareholder in the company.

It is therefore of the utmost importance to draft the AoAs or the SHA in such a way that reduces and mitigates the respective shareholders’ risk in relation to future conflicts, and provides efficient ways to solve such conflicts.

The following points are important in this respect and represent a non-exhaustive list, which should only to be considered for unlisted companies and is focused on Luxembourg practice:1

Information rights

Under many domestic laws, and certainly under Luxembourg law, if specific provisions on information rights are not provided in the AoAs or SHA, shareholders have only a limited right to receive information about the company. This includes mainly the annual accounts and, for example, does not include bi-annual or quarterly accounts, or other business documentation, such as forecasts. Shareholders further have the right to ask the managers questions at general meetings and to receive information and documentation in relation to the agenda points to be decided at a shareholder meeting. Outside of a specific court procedure that usually involves court proceedings to appoint an expert, shareholders do not have the right to force managers to respond to questions posed to them outside of shareholder meetings. Shareholders also do not have a general right to send an external accountant to the company to verify the books. However, such principles can be included in a shareholder agreement and may provide a major advantage to either prevent a conflict, or to strengthen the position of a shareholder in a conflict. Often, it is vital to be able to prove certain facts, and such information rights can be extremely helpful to obtain evidence on such points.

Solutions to deadlock situations

A conflict situation that arises frequently is when business parties become shareholders with equal parts in a company. The most common example is two parties with each holding 50% of the shares. The parties often do not regulate the scenario of a deadlock situation, because they believe they can trust each other or do not believe it likely that they would oppose each other in a conflict. However, reality frequently turns out to be different and parties, which were once close and trusted each other, end up having a major conflict. In this case, a relatively simple strategy to exert pressure is for one of the two parties to start blocking all company decisions that need to be taken at a shareholder level. Under the default provisions of Luxembourg law, to appoint new directors, a simple majority, i.e., 50% of the total votes of the company, plus one additional vote is necessary. The same goes for the approval of accounts. The increase of the share capital, or in general, the modification of the AoAs, requires at least a two-thirds majority (depending on the national company law form used). For example, if a shareholder blocks the appointment of new directors or the approval of the company accounts, this shareholder may paralyse the company, and even to force it into liquidation. While such a shareholder may be liable for damages afterwards2, legal proceedings will have to be started, and parties may take into account paying damages if they can nevertheless hurt the other party and place the company in liquidation. It is therefore of the utmost importance to foresee mechanisms that can resolve such a situation. Such mechanisms may include a buy-back mechanism of the shares of one of the shareholders, either by the company, by the other shareholders, or by a third party.

Reserved matters

Usually, decisions by a company have to be taken either at the shareholder, or managerial level. Domestic law regulates which decisions have to be taken by which competent body within a company. Usually, shareholders only take the fundamental decisions, such as the approval of accounts, distribution of dividends, amendments of AoAs, mergers (but not acquisitions), and so on. However, shareholders may want to further limit the competencies of the managers, by imposing that on other matters than those specified by domestic law, the managers are required to get shareholder approval, including for decisions by the shareholders requiring a specific quorum and majority. Such reserved matters could include that the acquisition of assets above a certain monetary limit needs to be approved by two thirds of the shareholders, with a quorum of at least fifty percent of the total votes of all shareholders. Whilst such a point may particularly pertain to manager-shareholder conflicts, it is also very important in pure shareholder conflicts, because frequently, one or several shareholders have the right to appoint managers.

Other measures in relation to corporate governance

In order to prevent conflicts, or to obtain a stronger position in a potential shareholder conflict, it may be an advantage to provide further mechanisms in relation to corporate governance, such as the right to nominate or appoint a manager or a board observer. The latter is a person that is allowed to be present at board meetings and to observe what the board members decide and discuss. However, an observer does not have decision rights. Depending on the situation, the shareholder might not make use of such a right from the start, but could make use of it once a conflict arises.

(Forced) share transfer clauses

Luxembourg law (and the same applies to many other domestic laws), does not provide for sophisticated regulation on certain mechanisms of the transfer of shares, such as tag-along rights, drag-along rights, or other ways that may force a shareholder to sell and transfer their shares. A tag-along right provides a shareholder with the possibility to sell their shares, if a (majority) shareholder sells theirs. A drag-long right provides a (majority) shareholder the right to force minority shareholders to sell their shares, if the majority shareholder wishes to sell. It may, however, be of the utmost importance to include clauses on such matters in the AoAs or SHA, amongst others to allow regulated and foreseeable share transfers, or to ensure that shareholders that manifestly violate their obligations can be forced to exit the company and sell their shares. On the basis of such a clause, a party that fraudulently attempts to liquidate a company, for example, by blocking all major shareholder decisions, could be forced to sell their shares.

Valuations

In case of a (forced) transfer of shares, a key matter is the valuation of such shares. A shareholder should always ensure that the clause on valuations in the AoAs or SHA is not to its disadvantage. This includes matters such as, on which basis the valuation is made, whether such valuation is made by an independent accountant, and if so, which parties have the right to appoint the independent accountant. Further, will the valuation be done based on one valuation, or can a second valuation be requested if a shareholder disagrees with such valuation? The question of who will pay for the valuation should also be addressed.

Clauses governing (material) breaches by shareholders

It may be effective to include clauses in an SHA or in the AoAs that provide for certain consequences, should shareholders violate their obligations. This may be, as mentioned earlier, a clause forcing shareholders to sell their shares. Such a mechanism may, however, also be a punitive damage clause, meaning that in case of a breach, the shareholder has to pay at least a predetermined, monetary sum with the advantage that specific damages do not have to be proven3. If such a clause is included, it needs to ensure that the wording is clear under which circumstances it may be activated. Such a clause should not simply provide that a forced transfer of shares can take place in case of a material breach of their obligations by a shareholder. It should define precisely which scenarios such material breach includes.

Applicable law

If an SHA is not applicable and therefore only an AoAs exists, the matter of applicable law is not relevant, as the law can only be the applicable to the company. In other words, if the company is governed by Luxembourg law, the AoAs must also be governed by Luxembourg law. If rights and obligations, however, are included in an SHA, a foreign law can be made applicable too. This happens frequently in investment structures in Luxembourg. In this case, it has to be ensured that the rights in such an SHA, governed by foreign law, are compliant with Luxembourg law. Also, if parties are shareholders in a company governed by a, for them, foreign law, such parties often presume that the foreign law is very similar to the domestic law. On many points this may not be the case, and the parties should obtain a general overview of the most important rights and obligations as shareholders under the foreign law, in order to be able to mitigate their risks.

Jurisdiction

If the relations between the shareholders are only governed by AoAs, Luxembourg courts will be competent in case of a conflict. However, in case an SHA is entered into by shareholders, the jurisdiction of a foreign court or arbitration tribunal can be made applicable too. The most effective option should be determined with legal advisors on a case-by-case basis. Arbitration may be faster than national procedures, but it may also be very expensive, possibly leading to parties not to start legal proceedings, as it would be too costly. Parties may also opt for a foreign court if they are located in a different country than Luxembourg. The consequence, however, could be that the foreign court may have to apply Luxembourg law, which may be a large disadvantage for the legal proceedings.

Enforceability of rights

It is vital to determine the consequences if certain rights and obligations are violated by one or several of the shareholders. For example, can a shareholder that violates their obligation to transfer their shares be forced to do so, or do the other shareholders only have a claim for damages? Whilst one might intuitively think that the other shareholders should be able to force such a shareholder to sell the shares, in practice the matter is often more complex and in certain situations only a damage claim is available. Also, in relation to the enforceability of the rights, it is key to verify with a legal advisor which rights need to be incorporated in the AoAs (a publicly available document), and which rights can be incorporated in an SHA (a private document between the shareholders).

Contact legal advisor

If a shareholder is not a legal expert on matters relating to AoAs and SHAs, it may be prudent to discuss such matters with a legal advisor that is specialised in such areas, as effective approaches always depend on tailor-made solutions and the drafting of such documents should be left to experts. Not obtaining advice could prove to be extremely costly in the future, as legal problems and disputes can be very expensive.

Get in touch with us

At Wildgen, we can assist you with an international team of experienced corporate litigation lawyers, with in-depth experience in both litigation and corporate transactions.

If you would like to talk to one of our expert team members about any queries you might have, contact the author, Dr Thomas Biermeyer, and we would be pleased to assist.

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1. The objective of this short article is to provide practical tips. For this reason, some points of Luxembourg law may be simplified as the objective is not to provide an exhaustive analysis of Luxembourg legal matters. It is, therefore, always advisable to discuss matters with a legal advisor, before taking any action in relation to a potential shareholder conflict.

2. Please note that it is completely within the rights of shareholders not to approve company accounts if they believe that there might be irregularities, or if important and legitimate questions as to the accounts are still open. Therefore, parties who do not approve accounts or force a company into liquidation, can do so for legitimate reasons.

3. It should be verified on a case-by-case basis whether such a clause would be enforceable in practice. Under Luxembourg law, punitive damage clauses are only valid within certain limits. For example, if the punitive damage clause stipulates that, in case of a material breach, a shareholder has to pay 50,000 EUR, but the actual damage is only 1,000 EUR, the judge would manifestly lower the amount of damages allocated and would not allocate 50,000 EUR.

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