It is a fundamental rule in many legal orders that when a debtor fails to pay his debt(s), his personal creditors can seize his assets. Legal seizure of assets is, as such, a necessary tool for creditors in order to force an unwilling debtor to fulfill his obligations. Ultimately, legal seizure can lead to a forced sale of the debtor’s assets.
When a debtor owns shares in a share capital corporation, these shares are part of the debtor’s assets as well. Just like the debtor’s house, car, or bank account, shares in corporations are available for creditors to seek recourse on for their unpaid claims. Therefore, proper legal seizure proceedings of shares are in place in order to protect the interest of personal creditors of shareholders and to consolidate this fundamental principle.
The legal seizure of shares is necessary for another reason as well. Corporate forms allow for the creation of arrangements between insiders that are binding upon third parties without their prior consent (“erga omnes”). The study of corporate and other entities from the angle of these “proprietary” effects is in the modern literature often referred to as organizational law, a term coined by Hansmann and Kraakman. Two of the most important of such “proprietary” dimensions of the corporate form are entity shielding (or “affirmative asset protection”) and capital lock-in (or “liquidation protection”). Shareholders of a legal entity do not have a direct formal claim in rem on the assets of the company. As a consequence, personal creditors of shareholders are precluded from seizing the company’s assets.[1] This is entity shielding. Shareholders are also prevented from pulling out their initial contribution in order to protect the going-concern value of the company. This is capital lock-in. The corporate capital lock-in is in principle binding on third parties, including the personal creditors of the shareholders.
Entity shielding and capital lock-in are intimately connected with the transfer of shares. The theoretical justification goes as follows: (i) entity shielding and capital lock-in protect the going-concern value of the business of the company; (ii) as a result, the value of the business of the company and the value of the shares in the company increase; (iii) personal creditors are harmed because they have no way to go after the assets of the company as a result of entity shielding and capital lock-in, but (iv) in return, they get the possibility to seize the shares, the value of which depends to a large extent on entity shielding and capital lock-in. In sum: the seizure of shares offers liquidity for the creditor without a liquidation of the company.
So far the theory.
In practice, the legal seizure of shares is not a “walk in the park” for the shareholders’ creditors. Transfer restrictions (obliged by law or written in the articles of association) are binding upon the seizing creditors in case of forced sale. The proprietary effects of these restrictions can have far-fetching consequences on the liquidity of shares due the legal uncertainty of the outcome of the transfer restrictions. Approval clauses, for example, require that a majority of the other shareholders approve the buyer of the seized shares. Without any certainty about their approval, potential buyers might be frightened or won’t be willing to take any risks. Eventually, this will lead to a lower “execution price” or, in the worst-case scenario, to a de facto exemption of shares as an execution object.
It’s remarkable to conclude that personal creditors can suffer the downside of entity shielding and capital lock-in, without reaping the benefits thereof. After all, they can’t seize the shares of the corporation, can’t seize the assets of the company nor demand the liquidation of the company. Ironically, the protection of the company against liquidation comes at the cost of depriving shareholders’ creditors of liquidity.
While (or perhaps: because) in jurisdictions other than Belgium the seizure of shares is often more adequately regulated, the international literature has not yet recognized the seizure of shares as a cornerstone of organizational law. Hansmann, Kraakman and Squire have called the costs that entity shielding imposes on the shareholders’ personal creditors as the next chapter in the evolution of legal entities.[2] They do not identify seizure of shares as one of the unresolved issues, but it definitely is an important part of the next chapter in the scholarship on organizational law.
Bram Van Baelen
Master of Laws, expected 2017, KU Leuven
[1] H. HANSMANN, R. KRAAKMAN & R. SQUIRE, “Law and the Rise of the Firm”, Harv.L.Rev. 2005-06, 1335-1403.
[2] H. HANSMANN, R. KRAAKMAN & R. SQUIRE, “Law and the Rise of the Firm”, Harv.L.Rev. 2005-06, (1335) 1399-1403.
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