When can a put option be exercised at a predetermined price?
In a put option agreement, the holder of a put option is entitled to sell the equity shares held in a company to the other party, which is then obligated to purchase, at a specific price or at a price to be calculated in accordance with a pre-agreed formula within a specific timeframe.
According to the prevailing case law of the Italian Supreme Court, a put option agreement is null and void pursuant to Article 2265 of the Italian Civil Code when it provides for the permanent and total exclusion of a shareholder from sharing in the profits or losses of a company by exercising its put option right (see judgement no. 8927 dated October 29, 1994 and our previous contribution for a more detailed analysis of the case law). Specifically, such exclusion would be contrary to the general interest in the proper management of the company, leading the shareholder to disregard the proper exercise of its administrative rights, and the purpose of establishing a company and entering into the relevant agreement, which is identified by Article 2247 of the Italian Civil Code as exercising an economic activity for the purpose of sharing its profits (and its losses).
Through the decision dated July 4, 2018, the Supreme Court ruled out the invalidity of an agreement between two shareholders of a joint stock company whereby one shareholder undertook to hold the other one (i.e. the holder of the option) harmless from any company losses by allowing the latter to exercise a put option right at a predetermined price equal to the initial purchase price of the equity paid by the holder of the put option plus the accrued interests and all amounts contributed to the company by the holder of the option.
Specifically, the Supreme Court clarified that a put option agreement is legitimate and valid and consequently does not violate the principle set forth in Article 2265 of the Italian Civil Code (in Italian “divieto di patto leonino”) when:
(i) the put option agreement is entered into only by a limited number of shareholders and not by all shareholders and is not a clause included in the company’s articles of incorporation. Therefore, the put option agreement does not alter the role of the shareholders in the company or the statutory rules governing corporate relationships between the company and the shareholders and it does not have any effect vis-à-vis the company. The distribution of profits and losses among the shareholders would take place in accordance with the provisions of the law and the articles of incorporation, but through the put option agreement, the relevant risk will be transferred from one shareholder to another;
(ii) the agreement is entered into by the shareholders for a concrete purpose (in Italian “causa concreta”) worthy of protection by the law. In the case at hand, such purpose was the financing of the company’s business. According to the Supreme Court, this type of put option agreement represents an alternative instrument of corporate financing that is becoming widespread in the market.
Based on these principles, judges are called to check the validity of this type of put option agreement on a case-by-case basis, because an agreement by which one shareholder can exercise its put option right at a predetermined price equal to its entire contributions to the corporate capital is not in itself in breach of the law, but can be considered a legitimate instrument of corporate financing worthy of protection by the law, depending on the circumstances.