A Shareholder's Exit from a Limited Liability Company: Case Study

A Shareholder's Exit from a Limited Liability Company Through Voluntary Redemption of Shares Out of Net Profit

Redemption of shares in a limited liability company (sp. z o.o.) is one of the most commonly used tools of company law that allow a shareholder to leave a company without having to find an external buyer. Voluntary redemption of shares out of net profit, combined with a conditional agreement for the acquisition of the shares by the company for the purpose of redemption, allows the exit transaction to be structured flexibly, taking into account the interests of the exiting shareholder, the company and the remaining shareholder. The situation becomes particularly complex where the exiting shareholder is also a management board member and the company is party to obligations towards third parties whose performance has been secured with the involvement of that shareholder. In such cases the standard pattern (resolution, agreement, filing with the National Court Register (KRS)) is not sufficient, and the exit transaction requires an individually designed mechanism that takes into account the interests of all participants.

In this article, based on the facts of a matter handled by the Law Firm, we discuss the following issues:

1. The structure of a voluntary redemption of shares in a two-shareholder limited liability company (50/50),
2. Redemption of shares out of net profit without reducing the share capital (Article 199 § 6 of the Commercial Companies Code (CCC)),
3. The appointment of a proxy under Article 210 § 1 CCC where the exiting shareholder is a management board member,
4. A conditional agreement for the acquisition of shares by the company for the purpose of redemption, and the legal nature of a condition precedent consisting in obtaining the consent of a third party,
5. A notarial deposit as a mechanism securing the financial settlement between the parties,
6. The moment at which the agreement takes legal effect and the significance of the entry in the KRS,
7. Accompanying transactions: a conditional agreement for the transfer of copyright and a conditional agreement for the sale of shares in a subsidiary.

Facts of the Case

The client approached the Law Firm about a limited liability company whose share capital was held by two shareholders with 50% of the shares each. The shareholders were also members of the company's management board.

The shareholders decided to end their joint business: one of them was to leave the company, while the other was to stay and continue the business. As the mechanism for the shareholder's exit, we used voluntary redemption of the exiting shareholder's shares, made out of the company's net profit from previous years, without reducing the share capital. The consideration for the shares being redeemed was set at nearly PLN 3,000,000.

An important feature of the case was that the company was party to an agreement with a third party, performance of which was secured by a surety given by the exiting shareholder. A change in the company's ownership structure, including the definitive exit of the shareholder, required that third party's prior acceptance of the modification of the terms on which the agreement was secured. The need to obtain the third party's consent to the change of security determined the legal structure of the chosen solution.

Voluntary Redemption of Shares in a Limited Liability Company Out of Net Profit: Legal Basis (Article 199 CCC)

The redemption of shares in a limited liability company, governed by Article 199 CCC, consists in extinguishing the shares: upon redemption, all rights and obligations arising from them expire. The voluntary redemption mechanism chosen in this case requires a sequence of two consecutive acts: the adoption of a resolution of the shareholders' meeting on the redemption of the company's own shares acquired in this way, and the conclusion of an agreement for the acquisition of the shares by the company from the shareholder for the purpose of redemption.

In this case, Article 199 § 6 CCC was applied, under which the redemption of a share out of net profit does not require a reduction of the share capital. This structure made it possible to avoid:

1. the need to carry out the convocation procedure, that is, announcing the capital reduction, calling on creditors to lodge objections within three months and having to satisfy or secure creditors who lodge an objection,
2. the need to amend the articles of association as regards the amount of the share capital,
3. the requirement to file the capital reduction with the registry court.

After the redemption, the number of remaining shares and their nominal value do not correspond to the amount of the company's share capital shown in the register. This is permissible and may be a permanent state of affairs.

We discussed other ways of shaping a company's capital structure, including recapitalisation and changing the proportions of shareholdings, in the articles Ways of Recapitalising a Limited Liability Company and Disposal of 50% of the Shares in a Limited Liability Company by Shareholders Holding an Odd Number of Shares: Discussion of the Issue and Practical Solutions.

Appointing a Proxy for an Agreement to Acquire the Shares of a Management Board Member (Article 210 § 1 CCC)

Because the exiting shareholder was also a management board member, concluding the agreement for the acquisition of the shares by the company for the purpose of redemption required the special representation provided for in Article 210 § 1 CCC. Under this provision, in an agreement between the company and a management board member, the company is represented by the supervisory board or by a proxy appointed by a resolution of the shareholders' meeting. If the management board signs the agreement for both parties in such circumstances, the agreement is absolutely invalid under Article 58 of the Civil Code.

Among the resolutions adopted by the company's Extraordinary Shareholders' Meeting was therefore the appointment of a proxy to conclude on the company's behalf, with the management board member, both the agreement for the acquisition of the shares for the purpose of redemption and the accompanying agreements (including an agreement for the transfer of economic copyright in works created by this shareholder during their participation in the company, which is discussed later in this article). The resolution defined the scope of the proxy's authority precisely, including by identifying the draft agreements attached to the minutes, and provided that the terms of these agreements could not be changed without the prior consent of the shareholders' meeting.

We wrote in more detail about the formal requirements for agreements concluded by a company whose counterparty is a management board member in the article Loan to a Limited Liability Company from a Shareholder Who Is a Management Board Member: Legal and Tax Requirements.

Conditional Agreement for the Acquisition of Shares by the Company for the Purpose of Redemption

The most important element of the legal structure was making the dispositive effect of the agreement for the acquisition of the shares by the company dependent on the fulfilment of several conditions precedent. The structure of a conditional agreement for the disposal of shares, based on Article 89 of the Civil Code, allows the effects of a legal act to be made dependent on a future and uncertain event. The parties are bound by the agreement from the moment it is concluded, but the dispositive effect (the transfer of title to the shares) occurs only when the last of the stipulated conditions is fulfilled.

The agreement between the company and the exiting shareholder stipulated, among others, the following conditions precedent, whose joint fulfilment caused title to the shares to pass to the company automatically (with no need for further declarations of intent):

• payment of the consideration into a notarial deposit,
• obtaining the third party's consent to a change in the terms of the security agreement leading to the complete release of the exiting shareholder from liability under the existing security, including by establishing new security with the involvement of the remaining shareholder.

The conditions precedent were stipulated for the benefit of the exiting shareholder, which means that the exiting shareholder has the right to waive them unilaterally. This structure further strengthens the exiting shareholder's position, giving them full control over the completion of the transaction where fulfilment of a given condition becomes objectively impossible or pointless.

Until all the conditions precedent are fulfilled, the exiting shareholder retains the status of a shareholder of the company, and the company is not entitled to exercise any rights attached to the shares covered by the agreement. We discussed the conditional sale of shares in more detail in the article Protecting the Company and Existing Shareholders When Admitting New Shareholders: Compulsory Redemption of Shares or Conditional Sale?.

Notarial Deposit: Securing Payment of the Consideration for the Redeemed Shares

Using a notarial deposit to settle the consideration for the shares being redeemed protected the interests of both parties to the transaction. The company had certainty that the funds would not be paid to the shareholder until the shares had been effectively transferred and the change had been disclosed in the register. The shareholder, in turn, had certainty that the funds were already deposited and would be paid promptly once all required formalities had been completed, with no risk of payment problems on the company's side at the moment when all other conditions of the transaction had already been met.

Payment of the funds from the notarial deposit was made dependent on three requirements being met jointly: fulfilment of all conditions precedent (or their effective waiver by the shareholder), effective transfer of title to the shares to the company, and a final and binding entry of the changes in the KRS. If any of these conditions is not fulfilled, the funds are returned to the company, which further eliminates the risk of a dispute over the status of the deposited funds.

When the Redemption of Shares Takes Effect and the Entry of Changes in the KRS

In the structure used in this case, several separate moments must be distinguished, each with different legal effects:

1. Redemption of the shares on the basis of a resolution of the shareholders' meeting.
2. Conclusion of the agreement for the acquisition of the shares by the company for the purpose of redemption: from this moment the parties are bound by the agreement, but title to the shares does not pass. The exiting shareholder retains all rights and obligations attached to the shares.
3. Fulfilment of the last of the conditions precedent: at this moment title to the shares passes to the company automatically, with no need for further declarations of intent. The company becomes the holder of rights in its own shares.
4. Filing the change with the KRS: after the redemption of the shares, the management board must file with the registry court an updated list of shareholders reflecting the new ownership. In this structure the entry is declaratory: the shareholder loses that status by operation of law upon redemption of the shares, regardless of the date on which the register is updated.

In practice, in the conditional agreement and in the record of acceptance of the funds into the notarial deposit, the parties gave the KRS registration operational significance by making payment of the funds from the deposit dependent on it. This eliminates the risk of the funds being paid before the change is disclosed in the register, which could create difficulties for the remaining shareholder.

Summary

Voluntary redemption of shares in a limited liability company out of net profit, based on a conditional agreement for the acquisition of the shares by the company for the purpose of redemption, is an effective tool for a shareholder's exit, in particular where a standard disposal of shares to a third party or to the remaining shareholder is not possible or not advantageous. The structure used in this case made it possible to:

1. carry out the transaction without reducing the share capital and without the convocation procedure (Article 199 § 6 CCC),
2. protect the interests of all parties through conditions precedent and a notarial deposit,
3. take into account the company's particular business circumstances, including its obligations towards third parties and the personal obligations of the exiting shareholder,
4. structure the company's representation correctly where the exiting shareholder is also a management board member (Article 210 § 1 CCC).

In practice, precise design of the contractual structure is of key importance, in particular as regards the conditions precedent, the schedule of payments from the notarial deposit and the documentation of the fulfilment of the individual conditions. Imprecise drafting of these matters may lead to disputes over the moment at which the redemption of shares takes effect and over the status of the exiting shareholder during the transitional period. Every transaction involving a shareholder's exit from a limited liability company requires an individual analysis of the company's corporate and contractual circumstances.