Court Rules on Share Option Provisions in Articles of Association

Author: István Gárdos

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Court Rules on Share Option Provisions in Articles of Association

Contributed by Gárdos, Füredi, Mosonyi, Tomori

October 10 2005

Introduction
Facts
Decision
Comment

Introduction
The Court of Arbitration of the Chamber of Commerce and Industry recently ruled that an option agreement on shares issued by a company regulated by its articles of association replaces the specific agreement between the company and its shareholders, and is binding on the parties provided that the shareholders do not challenge its validity.
Under Hungarian company law, a general meeting can usually decide, for instance, to modify the articles of association without the presence and approval of all shareholders.

According to the Civil Code (4/1959), where an owner grants an option, the beneficiary is entitled to buy with unilateral notice. The option agreement shall be concluded in writing.
In addition, pursuant to the Company Act (144/1997), a company may issue a special type of share - up to a maximum of 10% of the registered capital - giving a call option on these shares for the company, according to the terms provided by the articles of association.

Facts
The articles of association of the defendant company granted an option on the shares for the benefit of the company. The claimant was a shareholder, which claimed shares from the defendant company. The defendant rejected the delivery of the shares by arguing that it had called its option under the articles of association.

The claimant argued that the articles of association cannot replace a specific option agreement between the relevant shareholder and the company, because an option shall be granted only upon the mutual agreement of the parties. In addition, the articles of association were modified against the claimant's will.

The defendant argued that an option agreement may be regulated by the articles of association, and the claimant could and should have challenged the validity of the relevant provision of the articles of association granting an option for the benefit of the company if it believed the provision unlawful.

According to the Company Act, an option agreement cannot be provided by the articles of association; the shareholders and the other contracting party - including the company - must enter into a specific agreement establishing the option. In addition, according to an earlier Supreme Court decision, while the members of a company can make civil law agreements at the general meeting and conclude them in the minutes of the meeting, these agreements bind only those members present at the meeting.

Decision
The arbitration tribunal held that unless the shareholder challenged the validity of the given provision of the articles of association according to the rules of the Company Act, the option right regulated in the articles was a valid right and obligation. In other words, if an option is granted in the articles of association (which in most cases can be granted without the presence and approval of all members), the shareholders must challenge the provision within 30 days of its approval. If they do not do so, it becomes a valid obligation, even for shareholders not present at the meeting or that voted against the decision.

Comment
This ruling may follow from a provision of the Company Registration Act (145/1997), which states that the invalidity of registered articles of association can be referred to only in certain circumstances, which do not include unlawful provision of an option right.
Therefore, shareholders that have a controlling interest in a company can try to eliminate the minority shareholders' ownership by including an option right in the articles of association. If the minority shareholders do not challenge the validity of this option right in time, the company can deprive them of their interest.

However, it is unclear whether a court would uphold an option provision if a shareholder challenged the provision under the Company Act. In this case the court would be likely to rule that granting an option right in the articles of association against the will of any of the shareholders affected by the option obligation is unlawful and so would terminate the provision. Empowering the majority shareholder to force out the minority shareholder by granting an option to the company would be against basic civil law principles.

For further information on this topic please contact Dr Katalin Füredi or Dr István Gárdos at Gárdos, Füredi, Mosonyi, Tomori by telephone (+36 1 327 7560) or by fax (+36 1 327 7561) or by email (furedikatalin@gfmt.hu or gardos@gfmt.hu).
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