Partnership agreement clauses and their compliance: Contractual remedies

Partnership agreement clauses and their compliance: Contractual remedies

Partnership agreements 

Are defined as those whereby “the partners aim to regulate, with the force of a mandatory link, aspects of corporate legal relationship amongst them without using the channels specifically provided for this purpose in the law and the company statutes”.

Partnership agreements are therefore a contract and to the same will apply the remedies of the law of obligations in case of non-compliance by any of the signatory parties.  For example, article 1091 of the Spanish Civil Code establishes that  obligations arising from contracts have the force of law between the contracting parties, and must be complied with in accordance with them” or article 1256 of the Civil Code provides that “the validity and enforceability of contracts cannot be left to one party”. So, in case of a non-compliant partner of the signed agreement, the remedies provided by current legislation may be applied.

However, it is advisable that partnership agreements incorporate clauses establishing guarantees for the shareholders in the event of contractual default by any of the partners, such as: specific performance; compensation for damages caused; establishment of penalty clauses; being the last remedy and for the most serious situations the resolution and termination of the contract.

The most common clauses that usually contain the contracts or pacts between company partners, although they will vary depending on the object of the company, the interests of the partners or investors or the phase in which the project is found, could be the following (among many others):

  • Commitment of permanence (“vesting “)The partners agreement usually regulates the establishment of a period of permanence in the company, usually of the founding partners, so that the acquisition of all the shares is subject to compliance with certain conditions, metrics or milestones. (relative to the functions of the shareholder in the company, attainment of clients or volume of operations, …). The consolidation method is established over a period of time (annual, semi-annual …) after which, if the objectives have been met, the member gradually acquires a percentage of the shares until the total consolidation of the same.

Its application is ensured by granting the rest of the members a purchase option on the shares of the defaulting partners, and forcing the partner who disassociates from the company to sell the percentage of unconsolidated shares to the rest of the partners. 

 

Contractual limitations on the transfer of shares (tag and drag along rights)

In the case of the shareholders who proceed to the transfer of their shares in violation of the agreements signed or refuses to comply with the obligation to sell their shares, a compliance action must be exercised:

a)  Drag-along clauses

State that if a third party wants to  buy the entire share capital, the partner who has the right to drag may force the other partners to sell the shares to the said third party, if  determined conditions are met (for example number of votes in favour, minimum price subject to the valuation of the company, option of the rest of the partners to match the offer, term of transmission …) .

In order to guarantee compliance with this obligation, a purchase option is established in favour of the partner that holds the right to carry out the actions of the non-complying partner for a price lower than that offered by the third party (penalty).

b) Tag-along clauses
Oragreement in which it is agreed between the partners that in case a third party intends to acquire the shares of one of the partners, the rest will have the right to offer to this third party to sell their  shares in the same conditions offered and in proportion to their participation in the share capital.

In this case, in order to guarantee compliance with the agreement, it is agreed that the non-compliant partner can be obliged to buy the shares of the rest of the at a higher price (penalty) than they would have sold to the third party.

  • Voting agreementsIt is one of the most common partnership agreements: The signatories of the contact agree to vote in a certain sense in the partnership board meetings. Courts have admitted the validity of these covenants, but limited to the internal scope of the partners relationship, so not enforceable to the company.  So, the vote cast by the partner eluding the discipline of vote will be valid in the company field regardless of the effects it generates in the private partners relationship.

In the case of a non-compliant member who issues a vote in a meeting contrary to the agreement, it would be physically impossible to hold the meeting again for the issuance of a new vote, this vote will be effective against the company, so could be requested by the rest of injured partners the compensation for the damages suffered derived from the breach, according to the covenants established in the partnership.

  • Non-competition agreements: This agreement consists of requiring the exclusivity of the partners for the period established by committing themselves not to provide services for other persons or entities that compete in the scope of activity of the company, either directly or indirectly (by participating in said company), and usually also after the departure of the company. 

Regarding the duration of these covenants, Courts have declared excessive those that contemplate a duration of more than two years from the departure of the partner of the company, applying for that purpose the labour legislation, so in case that is not possible to justify the reasons of a longer term of duration of the agreement it could be cancelled.

In the event that a partner fails to comply with this obligation, they will be required to enforce it, but in addition, damage clauses can be established, imposing the payment of an economic amount to the non-complying partner, and causing their exclusion of the company.

Finally, in addition to establishing contractual provisions for specific compliance (so that the defaulting partner complies with the agreement) or the establishment of compensation for damages arising from the breach of the contract for the above cases, the partnership agreements must contemplate the causes that will lead to the termination of the contract in the case that one of the partners seriously breaches the obligations incumbent upon him as a last remedy to end the partners agreement in case of situations of blockade or ungovernability of the company, although, it can also be articulated a right of separation of the compliant partner and / or a right of exclusion of the non-compliant partner.

 

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