The central point of this article is to answer the question whether a preliminary share-purchase agreement can be declared final by means of article 19, para. 3 OCA?
The preliminary agreement is a widely used legal instrument in civil and commercial relations. It aims to prepare the conclusion of a final agreement by binding the parties with obligations to fulfill pre-agreed terms. However, the transfer of registered shares presents specific legal limitations.
The Supreme Court of Cassation (SCC) has reviewed a case involving a preliminary agreement for the transfer of shares in a Jsc company and has provided an interpretation regarding the application of a preliminary agreement to share transfers. The SCC’s decision is significant because it constitutes binding judicial practice and is particularly relevant in M&A transactions where the target company is a joint-stock company, thus introducing procedural specificities.
Can the sale of registered shares be the subject of a preliminary agreement and be declared final under Article 19, Paragraph 3 of the Obligations and Contracts Act (OCA)? Can a court decision under such a claim substitute the endorsement of the shares? These are the questions the SCC addressed in Decision No. 222 of January 16, 2014, under Commercial Case No. 708/2012.
Differences Between an Agreement and an Endorsement
An agreement is a bilateral transaction between two or more parties, through which rights and obligations are created, modified, or terminated. It reflects the mutual agreement between the parties on the essential elements of the transaction.
An endorsement, on the other hand, is a unilateral legal statement through which the holder (endorser) of a security (such as shares) transfers their rights to another person (endorsee). The endorsement aims to materialize the transfer of rights associated with the security, typically in written form, either on the security itself or on an attachment (allonge). According to SCC, the endorsement is a unilateral transaction that solely embodies the transfer effect of the agreement between the parties and serves only as a mechanism for transferring the shares.
Under Article 185, Paragraph 2 of the Commercial Act, the transfer of registered shares is executed through an endorsement. However, the endorsement is not a component of the factual composition of the share purchase agreement; it is an action related solely to its transfer effect.
As with any sale agreement, a share purchase agreement is concluded when the parties agree on the essential terms of the deal—subject matter and price. The law does not require a specific form for the validity of such agreements. From the moment an agreement is reached, the parties are definitively bound—to transfer the shares and to pay the price. The endorsement is a legally mandated, special method for transferring registered shares, necessitated by their nature as order securities. Consequently, when the essential terms of a share purchase agreement are agreed upon, the agreement is final, not preliminary.
For this reason, the procedure under Article 19, Paragraph 3 of the OCA, which allows the court to substitute the missing consent of the parties to conclude a contract, is inapplicable. Since the transfer of shares via an endorsement is a legal act subsequent to the share purchase agreement and relates solely to its transfer effect, it cannot be the subject of such a claim. Moreover, under the current legal framework, a constitutive claim under Article 19, Paragraph 3 of the OCA is applicable only to contracts, not to unilateral statements like an endorsement.
The sale of registered shares cannot be the subject of a preliminary agreement. Such an agreement cannot be declared final under Article 19, Paragraph 3 of the OCA through a decision that substitutes the endorsement for the shares.
Once the essential terms of the transaction—subject matter and price—are agreed upon, the parties are definitively bound. Consequently, the plaintiff does not have the right to file a claim under Article 19, Paragraph 3 of the OCA and, therefore, does not qualify as a creditor with a non-monetary claim, which also deprives them of the legal ability to secure such a claim under Article 135 of the OCA.
Risks for the Buyer in the Absence of a Guarantee for Signing the Endorsement
- Failure to Fulfill the Endorsement Obligation
- Endorsement of Shares to a Third Party
To mitigate these risks, the contracting parties should agree in the share purchase agreement on the process for signing the endorsement on the same day the purchase price is paid and the temporary certificate with the endorsement is handed over to the buyer. A widely used mechanism to ensure this process is the escrow account.
The agreed price can be deposited into an escrow account managed by a trusted party (a bank, notary, or lawyer), with the condition that the funds will only be released upon the completion of the endorsement. This creates a financial incentive for the seller to fulfill their obligation, as they will receive the payment only after endorsing the shares and delivering the temporary certificate along with the endorsement to the buyer.
The buyer may also agree to include penalties for non-performance of the obligation to sign the endorsement and a prohibition on transferring the shares to third parties during the period between signing the share purchase agreement and the endorsement (if these actions do not occur on the same day). In the event of a breach of these obligations, although the buyer may lack a legal remedy to acquire ownership of the shares, they will be compensated for the damages incurred without needing to prove them.
The preliminary agreement for the sale of shares in a JSC company is not recognized as applicable in such cases, as clarified by case law. This creates a legal gap that places the buyer in an uncertain position if the seller refuses to endorse the shares. The lack of a recognized preliminary agreement in this context poses significant risks for the buyer, potentially resulting in serious financial and strategic losses.
To address these challenges, buyers should focus on including protective mechanisms in the agreement. Such mechanisms should ensure the fulfilment of obligations and mitigate the risks associated with non-performance.
