Share transfer restrictions in closely held corporations: shareholders' protection and exit strategies

is a phrase we often hear in practice when it comes to a deadlock, or incurable differences among the shareholders. When forming a company, prospective shareholders mostly concentrate on the economic side of business and, when determining the management and governance, focus on the allocation of property and voting rights, often neglecting to consider efficient mechanisms to resolve potential intracompany conflicts. Overconfidence, overoptimism and initial excitement for doing business prevents the parties from eliciting thoughts about the methods of resolving future conflicts of interests and exit strategies. ¹⁾ In addition, increased transaction costs associated with the setting-up of an additional corporate right might lead to a contracting passivity of the prospective shareholders, even in situations where the negotiation of the business parties would be more efficient and improve their position in the legal relationship. Therefore, shareholders often rely on the statutory ready-made standards that - although being intended to fill contracting gaps - are often insufficient and inadequate to resolve the case at hand. ²⁾ Yet a careful consideration of rules agreed beforehand (ex ante) has a significant influence not only on maintaining the company's primary ownership structure, but also on a smooth and efficient procedure of a shareholder's exit as one of the potential solutions to a conflict between the shareholders. ³⁾

While by definition, free transferability of shares is the one of the defining feature of corporations, ⁴⁾ various share transfer restrictions are typical for closely held corporations and family businesses, as stipulated in the articles of association or shareholders' agreement. ⁵⁾ Closely held corporations are characterised by a small number of shareholders who live in the same geographic region, are bound by a family bondage, or know each other well, and all or at least as much as the majority of them are represented in the company's bodies, or are key employees. ⁶⁾ Personal and family relationships, that underlie the cooperation between the shareholders in closely held corporations, are beneficial for a stable functioning of the company. It is also applied that how closely the corporation is held, may be modified within statutory limits. An appropriately chosen type of share transfer restriction may not only suitably protect the corporate ownership structure from the entry of unwanted third parties, but also provides for a shareholder not being locked in the company for good without a possibility of exit. ⁷⁾ In the process of company formation, it is therefore advisable to pay reasonable attention to a careful drafting of share transfer restrictions, their anchoring in the respective document, depending on whether it is intended to be of contractual or corporate nature, and, last but not least, the possibilities of their efficient application in specific situations, . in the event of share transfer to other persons or handover to the next generation or legal successors. Share transfer restrictions shall always be considered and appropriately arranged so as the interests of both the exiting and the continuing shareholders in a closely held corporation, and the interest of the business organisation itself, are protected.

The most common ground for a share transfer restriction in closely held corporations is kinship, loyalty and mutual trust between the shareholders. ⁸⁾ In practice, share transfer restrictions are utilized as a tool for p