The exclusion of the partner in the company.

Introduction

The exclusion of a partner from a company is not a straightforward issue, as it involves only partially resolving the contract of several partners to form a company. Given that companies are normally incorporated for life, with indefinite duration; and given that the investment is illiquid, i.e. there is (even today) no SME market in which to sell the shares, regulating the possibility of exclusion of a partner is complex and requires a strong degree of protection for minority partners.

This is why the Capital Companies Act (as well as the preceding rules) contemplated the exclusion of partners only in the limited company (which is a closed company, initially conceived to represent the will of a few partners) and did not provide for it in the public limited company.

However, the exclusion of partners is already provided for in the 1885 Commercial Code.

In fact, Article 218 CCom provides for “partial termination” and not “exclusion” as such. However, this partial termination is only provided for in the case of partnerships (limited partnerships and general partnerships) and not in the case of closed companies (limited liability companies and public limited companies).

The contract of a general partnership or limited partnership may be terminated in part for any of the following reasons:

1. For the use by a partner of the joint capital and the company’s registered office for his own business.
2. For interference in the administrative functions of the company by a shareholder who is not responsible for carrying them out according to the terms of the company contract.
3. For any managing partner committing fraud in the administration or accounting of the company.
4. For failing to put into the common fund the capital that each party stipulated in the partnership contract after having been required to verify it.
5. For a member carrying out trading operations on his or her own account which are not lawful under the provisions of Articles 136, 137 and 138.
6. For the absence of a shareholder who is obliged to provide personal services to the company if, having been requested to return and fulfil his duties, he fails to do so or does not provide evidence of just cause temporarily preventing him from doing so.

7.º For failure in any other way by one or more partners to comply with the obligations imposed in the company contract.

The current Capital Companies Act (hereinafter LSC) does include the exclusion of shareholders with respect to capitalist companies. It does so in article 350 et seq.

In a 2011 reform of the LSC, the possibility of exclusion of shareholders was extended to the public limited company, provided that such a possibility is provided for in the company’s Articles of Association.

Thus, the legal grounds for exclusion of a shareholder are not applicable to a public limited company, but it is possible for a shareholder to be excluded from a public limited company, provided that this is established in the Articles of Association. And if this is not provided for in the Articles of Association at the time of incorporation, unanimity is required when amending the Articles of Association.

Is the exclusion of a partner a sanction?

No, exclusion of a partner is not a sanction.

The legal grounds that will be discussed below are the result of reprehensible behaviour by the member to be excluded. However, from a legal point of view, there is no “sanction”. This is because the member whose exclusion is sought is paid the reasonable value of his share, without any “discount”. From a strictly legal point of view, the exclusion of a member cannot be interpreted as a punishment.

Moreover, exclusion does not seek or imply compensation. It requires a resolution of the general meeting, in which it is assessed whether the cause for exclusion has been met. As a consequence of the exclusion, the shareholding or shares of the shareholder may be acquired by the company or redeemed.

The exclusion of a partner should be assessed as if it were a sanction.

Despite what we have indicated in the previous section, there is recent case law that considers that the assessment should be treated as if it were a sanction.

Ruling 26/2021, of 19 January, of the Provincial Court of Alava

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“This is why, once the company has applied, by means of a resolution, the sanction for a specific conduct of a shareholder, it falls within the scope of judicial control to examine whether the process provided for in the articles of association has been followed to apply that sanction, whether the sanction imposed is indeed one of those provided for that offence in the articles of association and also the verification of the reality of the fact on which the sanctioning resolution is based.

However, despite this statutory freedom, as a complement to the limits of private autonomy, the basic principles that inspire all sanctioning procedures, such as legality, non-retroactivity, proportionality, concurrence of sanctions, right of defence, etc., must be applied. And in any case, as the case law holds, the interpretation of the rules on social discipline must be restrictive, because any extensive interpretation of the law on sanctions and of the rules limiting rights must be rejected, and any doubts must be resolved in favour of the member affected (Supreme Court ruling of 28 December 2000).

In other words, as stated in the SSTS 23 June and 30 November 2006, the doctrine of the Supreme Court has gradually evolved towards a restriction of the scope of judicial control over decisions to expel members, until it fully agrees with the Constitutional Court that such control should be limited to determining whether all the rules of competence and form have been respected in the sanctioning proceedings and whether or not there is a reasonable basis for the expulsion agreement, assessing whether, in the exercise of the sanctioning power, the entity has respected the principles of typicality, legality and proportionality of the sanction”.

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First conclusions

Exclusion occurs with the adoption of the expulsion resolution, except in the event that the excluded shareholder holds a shareholding equal to or greater than twenty-five per cent, in which case it would become effective with the final judgement ratifying the exclusion.

The Law establishes three specific grounds for exclusion of the shareholder, and only for limited liability companies. Similar grounds could be introduced in a public limited company, but as we have said above, this would require a determination in the articles of association (and if by way of amendment of the articles of association, by unanimity).

Legal grounds for exclusion of a partner

These legal cases do not automatically determine exclusion: they are a cause for exclusion, which the General Meeting must agree if the causes concur, and provided that the concurrence of the cause is relevant.

What are the only three possible grounds for exclusion of a partner?

1. Voluntary non-compliance with the obligation to provide ancillary services

Ancillary services are additional obligations that the shareholders have to fulfil over and above their contribution to the share capital.

Examples of Ancillary Benefits:

1. Performance of specific tasks: A partner may undertake to perform specific tasks for the benefit of the partnership, such as the management of certain operational or administrative aspects.
2. Contribution of business contacts or networks: The partner can commit to contribute business contacts, potential customers or business networks that will benefit the development and growth of the partnership.
3. Active participation in decision-making: The commitment to actively participate in the company’s meetings and strategic decisions, contributing ideas and contributing to the company’s development.

What are the conditions for the creation of ancillary benefits?

1. Determination in the articles of association: Ancillary services must be clearly defined in the articles of association, specifying the additional obligations that the partners must assume over and above their capital contribution.
2. Voluntariness: It is essential that ancillary services are assumed voluntarily by the partners, as voluntary non-compliance with these obligations may be grounds for exclusion of the partner, as established in the law and the articles of association.
3. Established procedures: There should be a clear and established procedure for the implementation and monitoring of ancillary benefits, which may include mechanisms to verify compliance with these obligations.
4. Possibility of exclusion: In the event of a serious or wilful breach of ancillary obligations, the company should have the legal possibility to exclude the offending shareholder, provided that this measure is supported by law and the articles of association.

Membership shall not be lost for non-performance of ancillary services due to involuntary causes, but shall be lost if the Board finds that the non-performance is voluntary.

What is not possible is to exclude a shareholder for “non-compliance” with an obligation that was not constituted as an ancillary obligation. Ancillary performance is not something that can be inferred, intuited, deduced … Ancillary performance is binary: either it is expressly included in the Articles of Association or it is not. In practice, very few Articles of Association include ancillary benefits. Moreover, the Commercial Register is rigorous in judging whether the ancillary service is generic (and will therefore refuse to register it) or whether it is perfectly defined.

The importance of ancillary services in a capital company lies in their complementary role to the obligations of the shareholders in relation to the share capital.

2. Infringement by the administrator of the competition prohibition

The prohibition of competition is based on the ethical substratum that should govern economic relations, which is why a rigorous interpretation of the precept is required ( Judgment of the Supreme Court of 9 September 1998).

The legal regulation is inspired by the damage that may be suffered by the company, which must be a serious and consistent risk that may be actual or potential and does not require the demonstration of an actual benefit to other companies or persons (Supreme Court Judgement of 12 June 2008).

The Supreme Court ruling of 5 December 2008 establishes as case law that the prohibition of unfair competition that Article 230 of the LSC imposes on directors is infringed by the creation by the latter, without the express authorisation of the company, of a company with an identical object, unless it is demonstrated, taking into account the circumstances, that there is no conflict of interests.

The director of a limited liability company is prohibited from competing with the company, as an embodiment of the duty of loyalty. If he competes with the company, this can lead to his removal as a director, but also, in the case of a limited liability company, to his exclusion as a shareholder.

The LSC aims to safeguard the interests of the company and to make it easier for any shareholder to ask the court to remove a director who puts his or her interests before those of the company he or she is supposed to serve.

The company director owes loyalty in the exercise of his office and, for this reason, the prohibition of competition is imposed on him as a negative obligation, which will only cease when the General Meeting, being aware of the director’s competitive activities, expressly authorises him to exercise them.

In order to give rise to exclusion, it would be better to specify in the articles of association what is considered to be “competing” with the company, since in principle it would not be sufficient, e.g., to have a minor shareholding in a company with a similar object, but the logical thing would be to require effective exercise as an entrepreneur. It is not necessary for the director’s competition to have caused actual damage, the possible potential damage is sufficient, and setting up a company with the same object as the one being administered is an act of competition, even if in the end it does not cause any damage.

Can the fact that a director sets up a company with identical objects be considered to be competition, and if the newly formed company with identical objects is not operational, is it considered to be competition?

There is minor, nuanced case law on the question of whether or not there should be real and effective competition between companies.

However, the case law of the Supreme Court is practically unanimous in interpreting the existence of unfair competition through the creation by the administrator, without the express authorisation of the company, of a company with an identical object, unless it is demonstrated, taking into account the circumstances, that there is no conflict of interests (SSTS 5 December 2008 , 12 June 2008 , 11 April 2007 , among others).

Can the director of a public limited company be authorised by the general meeting to incorporate a company with a similar or identical object? Relative prohibition vs. absolute prohibition.

Limited Partnerships: Relative prohibition

Under the regime of limited liability companies, the prohibition becomes relative, as the board is exceptionally allowed to authorise the director to engage in “the same, similar or complementary type of activity as the corporate purpose”.

It is essential that the matter has been formally submitted for decision by the general meeting of shareholders so that, after deliberation, it may grant or refuse authorisation, bearing in mind, moreover, that the shareholder who is also the director interested in the authorisation must abstain from voting on the corresponding resolution.

Knowledge of the activities carried out by the administrators is essential for the shareholders to freely and consciously authorise the exercise of such activity, or in this case to renounce its exercise.

It is reiterated case law that establishes that the waiver of rights, as a manifestation of will carried out by the holder of a right by virtue of which he relinquishes it, must be, in addition to being personal, clear, conclusive and unequivocal, without any condition whatsoever, with an indisputable expression of the criterion of will determining the same and express or tacit revelation, but by means of equally clear and unequivocal conclusive acts (SSTS 24-10-1991 (RJ 1991, 7863) , 13-12-1992 (RJ 1992, 10399) , 22-02-1994 , 30-10-2001 (RJ 2001, 8140) among many others).

Corporations: Absolute prohibition.

In the case of public limited companies, the prohibition of competition is no longer relative but absolute, as it means that any shareholder can request the dismissal of the director, which cannot be prevented by an authorisation of the general meeting.

Does a director who, in turn, becomes a director of a concurrent company engage in prohibited conduct?

There is unanimity in considering that the assumption of the position of director in a concurrent company as a clear case of concurrent activity on behalf of others.

In short, the existence of an effective result of concurrence of activities is not required, and the risk of this occurring is sufficient. Judgment of the Barcelona Provincial Court, 15th section, 17 June 2013.

1. Orders the administrator to pay damages

It is also a cause for exclusion if the managing shareholder is sentenced by final judgement to compensate the company for damages caused by acts contrary to the LSC or the articles of association or carried out without due diligence. Articles 236 to 240 of the LSC regulate the possible liability of the director for damages to the company caused by negligent or wrongful conduct. Well, if there is a firm sentence to pay compensation, apart from that sentence, and the removal of the director, there will be cause for exclusion as a shareholder.

Statutory grounds for exclusion of the partner

In addition to the legal grounds, specific grounds for exclusion may be incorporated in the statutes, or those previously included therein may be amended or deleted.

If they are incorporated at the founding moment, there is already unanimity among the founders, and if they are incorporated or modified during the life of the company, unanimity is required, given the enormous importance of this type of clause in the articles of association.

Initially this power was established only for limited liability companies, but Law 25/2011 has extended the power to other limited liability companies as well. This power does not infringe the right of association.

Causes for exclusion in the articles of association can relate not only to the breach of obligations as a shareholder, but also to other extra-corporate actions (e.g., in certain closed companies, an unlawful action of a shareholder in other areas can affect the company’s reputation). What is essential is that the clause is laid down in the articles of association and is “determined”. It is therefore considered that a very generic clause (e.g. “the board may exclude a shareholder for any breach of his obligations” or “the board may exclude a shareholder for just cause”) would not be appropriate.

Exclusion of partners procedure

In capital companies, when the right of separation is exercised, a process is triggered which consists of several actions:

1. information to the shareholder on the value of his holdings or shares; agreement or, failing this, an expert’s report valuing them;
2. payment or reimbursement (or, where applicable, consignment) of the established value;
3. and, finally, the execution of the deed reducing the share capital or acquiring the holdings or shares. As recalled in Supreme Court Ruling 32/2006 of 23 January, “the acts to be carried out by the company are due acts, and not optional conditions”.

The receipt of the partner’s communication by the company triggers the above procedure.

But for the effects of the right of separation, i.e. the termination of the relationship between the shareholder and the company, to take place, this first link is not sufficient; the company relationship must have been liquidated, and this only takes place when the shareholder is paid the value of his shareholding.

Until this process is completed, the shareholder remains a shareholder and retains the rights and obligations inherent to this status (art. 93 LSC).

In conclusion, the right to receive the value of the shareholding after the separation of the shareholder is only satisfied when it is paid, because the status of shareholder is not lost when the company is notified of the exercise of the right of separation.

For the exclusion of shareholders, the Law adopts an extrajudicial procedure, the resolution of the general meeting, but with possible subsequent judicial control (by means of challenging the resolution).

As a general rule, exclusion is effective as from the resolution of the general meeting; but if the shareholder has a shareholding equal to or greater than twenty-five per cent, it is only effective as from the date of a final court decision. The excluded shareholder no longer has the right to attend and vote as from the exclusion resolution, although the exclusion may not be enforceable against third parties until registration.

The minutes of the meeting or an annex to the minutes shall state the identity of the members who voted in favour of the resolution.

Exclusion cannot be agreed by the administrators.

In the case of limited companies, the shareholder whose exclusion is proposed may not vote at the meeting adopting this resolution, and his shares shall be deducted from the calculation of the capital.

While the shareholder may attend the meeting and vote on the other resolutions prior to expulsion, this may be the case in public limited companies if it is provided for in their articles of association.

Each expulsion is voted on separately, and each vote must involve those members whose exclusion is not agreed.

If all members were prevented from voting, a minority could exclude a majority of members.

When the excluded shareholder has a share in the capital of less than twenty-five per cent, the resolution of the general meeting entails his exclusion, even if the resolution is contested.

To this effect, the Law establishes that “Any shareholder who has voted in favour of the resolution shall be entitled to bring the exclusion action on behalf of the company when the latter has not done so within a period of one month from the date of adoption of the exclusion resolution.

In this way, the company has a period of one month to file the lawsuit. It is precisely in order to know who may exercise this power that it is required that the minutes of the meeting that resolves the expulsion must include the identity of the shareholders who voted in favour of the resolution. Regardless of whether or not they are directors of the company, they are subject to the same time limit as the company, one month, but counted from the time the plaintiffs became aware that the company had not exercised the expulsion action, by application of the common law.

Exclusion of the shareholder has the same effects as separation. The company must pay him the fair value of his holdings or shares, and he may either acquire these holdings or shares or redeem them.

Valuation of the shareholder’s units or shares

The law grants the separating or excluded shareholder the right to obtain from the company the “fair value” of his holdings or shares. This valuation may not include a negative value adjustment because the shareholder is a minority shareholder, so that the “fair value” requirement is not rhetorical, but a requirement that must be strictly complied with. While the valuation must have considered the company to be “in operation”, if the separation of the shareholder results in the dissolution of the company, then the valuation must take into account this dissolution.

In the absence of agreement, the Law determines that the fair value will be determined by an independent expert, appointed by the commercial registrar, who could not be the same auditor of the company’s accounts.

As the expert has no knowledge of the company’s accounts, he may obtain from the company all the information and documents he deems useful and carry out all the verifications he deems necessary. He has two months from the date of his appointment to issue his report. The expert shall notify the company and the shareholders concerned of the report immediately after it has been issued by notarial means, enclosing a copy, and shall file a copy with the commercial register. The expert’s remuneration shall be paid by the company, which, in cases of exclusion, may deduct the amount to be reimbursed to the excluded shareholder from the amount to be reimbursed.

Fair value reimbursement

The segregated or excluded shareholder is entitled to receive the fair value of its units or shares within two months after receipt of the valuation report, so that the company has time to make any divestments that may be necessary to obtain the necessary liquidity. The articles of association could not vary this deadline, nor provide for payment in instalments, although it would be permissible for one of these options to be proposed to the shareholder. The deadline will be extended if there is a right of opposition from creditors.

Can the company pay with assets?

In principle, it would be admissible if the shareholder accepts it, but it would not be possible to oblige him to do so. However, this admission raises the important problem of how to check that the goods delivered are of the value assigned to them for this purpose, and the simple value fixed in the accounts is not a sufficient guarantee that it is really their current value. Therefore, in order to make a payment in natura it would be preferable to have some additional guarantee of the value of the good.

Creditor protection

When we talk about the exclusion of a shareholder from the company, we think of two parties, the shareholder and the company. But when we say that it is the company itself that can use part of its net assets to buy the shares or holdings, we are actually involving a third party: the company’s creditors.

That is to say, insofar as the separation or exclusion gives rise either to a reduction of capital or to the acquisition by the company of the holdings or shares. In each of these cases, logically, the creditor protection systems specific to the institution apply.

In the limited partnership, the separated or excluded partner is liable for the company’s debts prior to the separation or exclusion up to the amount corresponding to the company’s contribution, but this liability could be excluded by setting up a reserve that is unavailable for five years, or by establishing in the articles of association a right of objection by creditors.

When there is a right of opposition from creditors, the only thing that the Law adds as specific to the separation or exclusion is that a personal communication must be made to such creditors.

If the company does not reduce capital, but acquires the holdings or shares itself, then the system for treasury shares applies, which requires the company to set aside a restricted reserve for the amount of the amount amortised. In this way the company retains an amount equivalent to the amount of capital acquired, so that the actual “impoverishment” of the company is offset by the need to retain an equal amount, which can no longer be used for distribution to the shareholders.

Reduction of capital or acquisition of units or shares

In the event of separation or exclusion, the company must opt either to reduce its capital or to acquire the units or shares itself. The latter requires a resolution of the general meeting called for this purpose.

In the case of a reduction, once the redemption has been effected or the amount thereof has been appropriated, the directors shall, without the need for a specific resolution of the general meeting, immediately execute a public deed of reduction of the share capital.

It is necessary to require the declaration of the administrators or liquidators of the company that the value of the shares of the separated or excluded shareholder has been reimbursed or that the amount has been deposited, in the name of the interested party, in a credit institution in the municipality in which the registered office is located, accompanied by a document accrediting the deposit.