Establishing a new company or investing in an existing business, no matter the size, requires an agreement between two or more shareholders of a corporation. The Shareholder Agreement is made not only to set out the capital and management structure, but also to mitigate any risk of default related to the implementation of the Shareholder Agreement. The Shareholder Agreement can later be implemented in the Company Article of Association.
The most common type of default event is a shareholder defaulting on injecting their capital into the company. In many cases, the defaulting party was delayed or refused to inject the capital even after the company’s Article of Association has been issued by a notary.
According to Article 48 of Law No. 40 of 2007 concerning Limited Liability Company (“Company Law”), in the event that the terms and conditions of share ownership as provided under the Article of Association were not fulfilled, then the defaulting party cannot exercise its right as a shareholder, and the shares shall not be counted in any quorum.
Therefore, it is important to make the event of default clause clear in the Shareholder Agreement to provide the condition that if there is any default in capital injection, the defaulting party cannot exercise its right as a shareholder. The rights as a shareholder are regulated under Article 52 of Company Law, where it is stipulated that the shares provide their owners the right to attend and cast a vote at the General Meeting of Shareholders (“GMS”), to receive dividend payments of the remainder or assets from liquidation.
The Company Law has made clear the consequences of failure to fulfill the term and conditions of share ownership as provided under Article of Association. Yet, we have received many common questions from our clients for the following condition:
If the Article of Association does not regulate the conditions of share ownership, is the defaulting shareholder able to exercise their rights as a shareholder?
Unfortunately, if the Article of Association does not regulate the conditions of share ownership, specifically the event of default clause, and if the shares have been recorded in the shareholder register, then, by the law, the defaulting party would be granted their rights as a shareholder.
If the defaulting party can exercise its right as a shareholder, is it possible for the non-defaulting party to withdraw its paid-up capital to minimize further financial risk?
According to Article 31 par. 1 of Company Law, any capital that has been fully paid to the company shall be considered the Company’s authorized capital. Therefore, any capital paid to the company will no longer be individually owned by the shareholder, but will belong to the company. This means the shareholder cannot withdraw their paid-up capital.
If the shareholder cannot withdraw their paid-up capital, is there any way for the non-defaulting party to exit the company?
Typically, the shareholder exit mechanism is provided in the Shareholder Agreement. The Shareholder Agreement can set that upon the occurrence of default, the non-defaulting party can either require the defaulting party to sell their shares to the non-defaulting party, or another party as desired by the non-defaulting party, or to require the defaulting party to purchase the shares of the non-defaulting party. The selling price in the event of default is also typically governed under the Shareholder Agreement.
If there is no such agreement for an exit mechanism, the non-defaulting party can either sell its shares to another party or seek legal recourse against the defaulting party.
How Schinder can help
Our team of lawyers has extensive experience assisting dozens of companies with drafting all kinds of joint venture agreements and/or shareholder agreements that have resulted in the most preferable outcomes for our clients. Should you need any services related to shareholder agreements and shareholder dispute matters, please feel free to write to us at email@example.com.