The Leonine Clause and the Exercise of Put and Call options

The State of Affairs in the Year 2015


In certain circumstances, option agreements can be deemed to conflict with the ban on leonine clauses, namely the compulsory regulation that prohibits clauses in articles of association or agreements between partners, which exempt one of them from contributing to losses.

More generally, the subject of each partner’s contribution must be subject to the risk of the company activity.

If the price-setting provision contained in the option agreement results in the beneficiary of the option being able to leave the company in exchange for a price which guarantees that he will suffer no loss on his original contribution, that agreement could be covered by Section 32 of the Companies Code (hereinafter referred to as “Comp. Code”).

At this time, case law and legal doctrine are relatively silent about the leonine clause, although the leonine clause is still a topic of discussion at the negotiation table in the event of a purchase of shares.

1. Leonine Clause

Agreements which allocate the entire profits to one of the partners are null and void. The same applies for a clause which exempts monies or goods contributed to the company by one or more of the partners from any contribution to the loss (Section 32 Comp. Code). This is the so-called leonine clause.

At least for the time being, there is relative consensus in the legal doctrine concerning the ban on exclusion from profit. The underlying reason for this ban is linked to the essence of the company: the pursuit of profit. However, the necessity for the presence of a profit motive at the constitution of a company is coming under pressure, and there are calls for it to be scrapped. If the profit motive ceases to be required by law, the ban on exclusion from profit of Section 32 Comp. Code loses its basis. But this point has not yet been reached.

The ban on exclusion from profit does not mean that all partners must share equally in the profit. As long as the shareholders are treated equally, disproportionate treatment is permitted.

For example, within a public limited company (NV) it is possible to work with different categories of shares, and shareholders being granted different rights according to category. It is perfectly conceivable that a specific category of shares may be granted a larger share of the profit than a different category. However, if the division into categories results in the de facto exclusion of one or more shareholders from the profit, one is faced with a forbidden leonine clause.

In a private limited liability company (BVBA) this kind of sub-division is prohibited by law, at least as regards the distribution of profit and the balance remaining after liquidation. The prohibited exemption from loss is subject to more controversy in the legal doctrine, inter alia, due to the fact that obligatory participation in the loss is not mentioned as a constitutive element in the definition of a company in Section 1 Comp. Code.

The other main focus of this article is the prohibited exemption from loss, and more specifically, the question whether put (and call) options pass the test for the prohibited leonine clause.

2. Put (and Call) Options

The problem of the prohibited leonine clause manifests itself in put and call-options:

  • With a put option the partner undertakes to purchase shares from another partner at a time to be decided by the latter, in exchange for a pre-determined (or at least determinable) price).
  • With a call option the partner undertakes to sell his shares to another partner at a time to be decided by the latter, in exchange for a pre-determined (or at least determinable) price).
Will put (and call) options pass the test for the prohibited leonine clause?

In the event of bankruptcy, put and call options are diametrically opposed. The put-option holder will happily exercise this option at the predetermined price. The call-option holder, on the other hand, will not consider exercising this option, because the price will be too high for the “worthless” shares. A partner who is obliged to pay the price agreed for the shares, seeks a way out, and thus ends up with Section 32 Comp. Code. A single call-option might also be regarded as a prohibited leonine clause. Consider the situation in which a specific call-option holder acquires the right to take over the shares of another partner (co-founder) at their contribution value, if the project for which the company was constituted, is successful.

3. The Milestone Rulings of the Court of Cassation: Torraspapel and Amon-Ra

The question arises: to what degree are agreements whereby a share buyer acquires the right to sell back his shares to the initial seller in exchange for a pre-set price (i.e. the initial investment price), the so-called ‘put option’, able to pass the leonine clause test.

As is known, at first the lower courts’ administration of justice was strict, and the risk-free holding (exclusion of loss) was simply forbidden. However, two rulings of the Court of Cassation were ground-breaking, because for the first time, they permitted a partner to have a risk-free holding in a company.

The first ruling of the Court of Cassation is a ruling of 5 November 1998, known as the Torraspapel Ruling. This ruling is characterised by the “criterion of causal independence, whereby the Court of Cassation judged “that only a clause that disrupts the balance of the company agreement in the sense of Section 1855, second subsection Civ. Code, or that whilst appearing to have a different subject in reality has the same aim, is prohibited”.

In its ruling of 29 May 2008, also known as the Amon-Ra Ruling, the Court of Cassation put forward a new theory, centred around the interests of the company: an agreement in which a party acquires a holding in a company on condition that the other partners undertake to buy these shares back in exchange for a predetermined price at the elapse of a specific period or when a specific condition has been met, does not fall under the ban of Section 32 Comp. Code “if this agreement serves solely the company’s interests”.

In this sense, an agreement which allowed the Holding Fund to sell its holding, acquired at a capital increase, back to the shareholders in exchange for a pre-determined price, was regarded as ‘non-leonine’. After all, this was part of the company’s financing requirements, and the holding fund was never intended for the development of a shared company existence. However, outside such financing operations, agreements containing put options can be justified in the light of company requirements. For instance, a stabilisation of share ownership can serve the company’s interest.

The concept of “the company’s interest” is a broad and flexible concept in Belgian company law

In the year 2015, the theory of the pure interest of the company is gaining ground in the courts and tribunals, due to its practical approach. The concept of “the company’s interest” is a broad and flexible concept in Belgian company law. The necessity to link it back to the actual intention of the parties is much less than for the criterion of causal independence: what matters is whether the put-option provides an advantage for the company.

Naturally, the option holder will always have his own interest in obtaining this put-option, but this may not outweigh the company’s interest in this agreement.

For each separate situation it will be necessary to determine whether a partner is exempt from any contribution to the loss, taking into account the actual circumstances of the option, inter alia, the period of the option, option price, aim, but also the interpretation of the concept of ‘loss’.

4. Conclusion: The Leonine Clause is not yet a thing of the past

The theory of the sole interest of the company advanced in the Court of Cassation ruling of 29 May 2008 creates an opportunity to incorporate the leonine clause into contemporary company practice.

The company’s existence is governed by the company’s interests. It could be argued that the aforesaid ruling permits full exemption of a partner from loss, provided that this is justified solely in the company’s interest. Application of this theory does not necessarily lead to the abolition of the leonine clause: exemptions from risk which conflict with the (sole) interests of the company can still be declared null and void.

This does not permit partners to obtain complete (legal) certainty of their exemption from loss. Common sense should be used when assessing whether the arrangement is solely in the company’s interest. The Court of Cassation’s ruling of 28 November 2013 assisted partners in this, by providing a narrower interpretation of the company’s interest, through reference to the collective profit interest of present and future shareholders.

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Leo Peeters

Leo Peeters