Main contractual clauses restricting the free transferability of shares in S.A. and S.A R.L. companies
Under the influence of common law, we have been assisting for many years in the exponential development of extra-statutory agreements under Luxembourg law (commonly known as shareholders agreements or partnership agreements or any combination of these terms). Designed to govern the relationships between the shareholders of a company in addition to its articles of association, the main advantages of a shareholders’ agreement derives from its high degree of flexibility and discretion in comparison to the articles of association. The main disadvantage is related to the « relative effect » of such agreements, which paradoxically explains (i) the frequent replication of some of its clauses in the articles of association of a company in order to make them enforceable against third parties, and (ii) the reference to its existence in the articles of association in order to draw the attention of third parties thereto (so that the latter could reasonably be compelled to examine the content of the shareholders’ agreement in certain relevant circumstances). Amongst the most frequently used clauses in such agreements are those aiming to restrict the free transferability of shares and ensure control of the shareholding of the company.
As an overview, there are three clauses that (directly) prevent the free transferability of shares, namely: clauses of inalienability, approval clauses and pre-emption clauses.
The inalienability clause is frequently used to ensure the strategic shareholders retain an interest and are maintained in the share capital of the company (e.g. the operating managers). Its purpose is to prohibit a shareholder from selling its interest in the company for a specified period of time.
The approval clause allows its beneficiary/ies to deny the entry of a third-party into the share capital of a company without obtaining the prior approval of some or all of the other shareholders, of an appointed management body or a third-party. Its purpose is to control the composition of the shareholding of the company by preventing the entry of “unwanted” persons (e.g. a competitor). It should be noted however, that there is nothing to prevent transfers between shareholders being subject to prior approval (notably to preserve an established balance between groups of shareholders). The approval clause is often coupled with a pre-emption clause.
The pre-emption clause enables shareholders, or some of them, to have a priority right to acquire any securities or debt securities issued by the company if one of the shareholders wishes to sell, thereby corresponding to a potential commitment to sell. This specific clause can permit its beneficiaries to increase their participating interest, or it can simply serve to maintain the existing proportions between shareholders in the share capital. Several variations of these clauses exist (often unnoticed because of the generic use of the term « pre-emption »): a clause stating that the shareholder who has received an offer has to submit it to the beneficiaries of such clause so that they may acquire the shares at price proposed by the third-party purchaser or as determined by an expert or even by the general meeting i.e. a clause of first refusal; a clause stipulating that a shareholder who is willing to sell all of his/her securities has to first offer them to the beneficiaries of such clause before receiving an offer for the purchase of these securities i.e. a clause of first offer; or also an English clause under which the potential seller temporarily sells his/her shares to the beneficiary of the clause subject to finding, within a determined period of time, a third-party candidate offering a better price. If the seller is able to find such third-party, the beneficiary of the clause then has a period to match the price offered by the third-party.
Other clauses indirectly restricting the free transferability of securities also exist, such as clauses organising a right to resale, a resale obligation and different options (exit obligation, exit right…). These clauses will not be dealt with in this first newsletter on the topic.
Before the law of 10 August 2016 which amended the law on commercial companies of 1915 (the « Law»), there was no legal provision governing the abovementioned clauses (apart from the right of approval provided for in a S.à. r.l.). Nonetheless, the doctrine and case law used to recognise the validity of such clauses in articles of association or in shareholders’ agreements, provided that in substance they were cumulatively (i) limited in time, (ii) not contrary to the corporate interest of the company, and (iii) not contrary to public order.
The reform introduced in 2016 has now provided for specific rules to govern inalienability, approval and pre-emption clauses in the S.A. and has amended the pre-existing approval rules in the S.à. r.l.
Therefore, in public limited liability companies, article 430-1 of the Law, which only targets inalienability, approval and pre-emption clauses, provides that the validity of inalienability clauses is subject to a time limitation period and that the validity of approval and pre-emption clauses is subject to a lock-up period which may not exceed twelve months.
Article 710-12 of the Law now provides for a mandatory approval mechanism in the S.à r.l., which is applicable in case of transfers of shares between living persons (inter vivos) and in case of a death of a shareholder. In case the transfer is denied in either case, the non-transferability of the shares concerned only is applicable for three months as from the denial.
To date, the question remains as to whether the above mentioned rules shall apply to clauses contained in shareholders’ agreements. It seems that the current trend of the majority doctrine is to consider that the contractual clauses of inalienability, approval and pre-emption are valid and are not subject to the aforementioned legal provisions, thus remaining governed by contract law (despite the principle of freedom of choice) .
In accordance to such principle, contractual inalienability, approval and pre-emption clauses are governed by the following rules:
With regards to public limited liability companies, inalienability clauses remain subject to the three conditions that were previously presented by the doctrine (namely (i) limited in time, (ii) not contrary to the corporate interest of a company or, according to some authors, must be based on a legitimate and serious reasons and (iii) not contrary public order principles). Such clauses are therefore subject to more restrictions than their statutory versions. In addition, in the absence of case law in this area, there is uncertainty as to the extent of the maximum duration allowed for this type of clause even if, in practice, it is generally admitted that a period of 5 to 7 years is reasonable.
Approval and pre-emption clauses remain subject to the conditions that were previously established by doctrine. However, they appear to benefit from greater flexibility (than their statutory version) in the absence of a common law obligation not to restrict the transferability of shares beyond 12 months. That being said, previous doctrine argues that there should be an exit possibility for a shareholder as a shareholder cannot indefinitely remain a “prisoner” of a company. It is thus recommended to provide for a mechanism for the repurchase of shares by the company, or at least an obligation for the company to find a purchaser under specific conditions to be set out in the shareholders’ agreement.
Finally, we note the lack of rules under common law regarding the price to be paid in case of pre-emption. It is thus necessary to provide for a contractual mechanism with a fixed or determinable price (with the intervention of a third-party expert in case of disagreement as the case may be).
With regards to private limited companies, the approval in accordance with article 710-12 of the Law is a matter of public order and as such cannot be circumvented. A shareholder must be able to leave within three months of refusal, which raises questions about the validity of inalienability clauses in the S.à r.l..
What about the sanctions for non-compliance with the inalienability, approval and pre-emption clauses contained in shareholders’ agreements? While for statutory clauses the sanction is clear (nullity), it is different for contractual clauses.
According to the majority doctrine, a breach of such clauses can only result in an award of damages (except if it can be demonstrated that the third-party purchaser acted in bad faith or as an accomplice). Therefore, there is a real interest confirmed by practice to double contractual clauses with statutory clauses or at least to refer to their existence in the articles of association.
In summary, as long as the statutory clauses of inalienability, approval and pre-emption are included within the articles of a company there is no doubt as to their legal regime. However, when only included contractually in an agreement, there may be some minor ambiguity.
The requirements applicable to inalienability, approval and pre-emption clauses now vary according to whether they are statutory or contractual. This entails a risk of inconsistency as to the rules in force (sometimes more flexible or more rigid depending on whether such clauses are statutory clause or not) and de facto creates legal uncertainty in this area.
Pending the position of the doctrine and jurisprudence in this respect being clarified, it is recommended to maintain a prudent approach and validate the drafting of such clauses by a professional on a case-by-case basis.
For further details, please contact :
|Jean-Philippe Smeets||Anna Gassner|
|Head of M&A||Manager|
|+352 26 48 42 35 63||+352 26 48 42 35 50|
 Article 189 of the law on commercial companies dated 10 August 1915 as in effect before 2016.
 Versus statutory clauses.
 « La réforme du droit luxembourgeois des sociétés », under the direction of André Prüm, édition Larcier 2017, in De nouveaux espaces de liberté dans le droit des sociétés luxembourgeois by Isabelle Corbier and André Prüm, page 35 n° 9 and 57 n°54 / Final report of the legal commission of 11 July 2016 (5730-15), observations of the Council of State, pages 35 à 37.
 One of the characteristics of a public limited liability company being the principle of free negotiability of shares.