How the put option may pass the test for the leonine pact?
3 Maggio 2017
Milan Court Decision of August 3, 2015 confirmed that, under certain circumstances, a put option does not fall within the qualification of the leonine pact. Namely the put option is valid and effective where it is convened for a determinate period of time and for interests deserving protection in relation to the efficient management and the business of the company.

The put option

The put option gives the right to the holder (the “put option holder”) to sell a company’s equity at a pre-set price (the “strike price”), within a certain period of time (until its “expiration”), to the other party (the “seller of the put”).

The seller of the put undertakes to purchase shares against a premium paid by the put option holder for taking on the risk associated with such an obligation.

Put options are most commonly used in the stock market to protect against the decline of the price of a stock below a specified price. If the price of the stock declines below the specified price of the put option, the put option holder has the right, but not the obligation, to sell the asset at the predetermined (or at least determinable) price, while the seller of the put has the obligation to purchase the asset at the strike price if the put option holder exercises their right to do so. In this way, the latter will receive at least the agreed strike price, even if the asset is currently worthless.

The leonine pact

It is clear that the put option purpose is to shield the holder against the company’s losses which may occur between the acquisition of the put option and the exercise of the same, provided that the strike price is fixed. The above protection triggers the risk that the put option is considered a leonine pact, which is forbidden under Italian law.

According to section 2265 of Italian Civil Code any clause whereby the contribution of a shareholder is shielded against all losses – or when all benefits are allocated to one shareholder – shall be considered as leonine and, therefore, null and void.

An agreement, or single clause, which unconditionally shields the contribution of a shareholder against losses – or provides the allocation of all profits to one shareholder – is not compliant with the purpose of the company agreement, identified by section 2247 of the Code as “the joint exercise of economic activity for sharing profits”.

Three judgments on this issue

1)     When the put option should be considered a leonine pact

The Italian Supreme Court ruled on the question whether the put option should be considered a leonine pact and, therefore, null and void under Italian law.

According to the Decision of the Italian Supreme Court (the “Court”) of October 29, 1994, no. 8927 the leonine pact provided by section 2265 of Italian Civil Code must be related to the “permanent and total exclusion” of some shareholders from participation in the business risk and/or in the profits.

At the same time the Court stated that the leonine pact does not concern clauses where the participation in business risk and/or in the profits is not proportional to the shareholders’ shares in the capital or which subordinate the participation in the profit or in the losses to particular events legally relevant.

The Court clarified that the prohibition of exclusion of the shareholder from participation in the profits or losses shall be regarded in substantive sense. This means that the put option will be considered a leonine pact and, as a consequence, null and void, exclusively if (i) the terms of the participation in the profits or in the losses are impossible to achieve, and (ii) determine an effective total exclusion from said participation for an unlimited period of time.

In order to rule out the invalidity of a put option it is necessary to assess the worthiness of the shareholder’s provisions, which determine that the put is not solely intended to circumvent the legislative prohibition, being instead the bearer of function worthy of protection in the legal system.

2)     An example of put option as null and void

Milan Court Decision of December 30, 2011, clarified that section 2265 of the Code will be breached – and, therefore, the put option will be considered null and void – in the contest of a corporate acquisition, where the strike price comprises the price paid for the purchase of the shares of the target company and the future investments (e.g. increases of the share capital, non-repayable financing or other non-repayable contributions) to be carried out in that company by the put option holder .

In this case, the put option does not pursue the economic interests of the target company, but only the personal interest of the put option holder, who has predetermined the termination of his investment in the company and, in view of that, the total exclusion from participation in the losses for the entire duration of his time as shareholder of the company.

In light of the above, the put option will be considered a leonine pact since the buyer of it will be completely and unconditionally shielded against the company’s losses for all of the period of his participation in the share capital.

3)     Conditions making the put option valid and enforceable

The Decision of the Court of Milan of August 3, 2015 has confirmed the consolidated case law, stating in positive that, a put option would not be considered a leonine pact (even if inserted in the company’s by-laws) where it is convened (i) for a determinate period of timeand (ii) for interests deserving protection in relation to the efficient management and the business of the company.

If the holder does not exercise the put option within the agreed period of time, then he will no longer be shielded against the losses of the company exactly as the other shareholders and, therefore, the limited duration is an element that plays in the favour of the validity of the put option.

Furthermore, the Court of Milan highlighted that in the case at hand the put option was part of a bigger business transaction with which the companies involved aimed to strengthen the know-how and the financial and economic resources to compete within domestic and foreign markets. Therefore, the put option, in that case, met a sort of general interest deserving protection and not only a personal interest of one or more shareholders.

The Decision of the Court of Milan of August 3, 2015 is available at the following link:

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