Put option: Supreme Court explains the relationship with the so-called “patto leonino”
| Insights
The Supreme Court states the validity of a put option clause which is negotiated in a private equity deal with which a shareholder (usually the entrepreneur) undertakes to purchase, in a given time period, the shares of the other shareholder (the investor) at a predetermined price. Such price aims to indemnify the investor against entrepreneurial risks and therefore against company’s value reduction (Supreme Court, Section I – 04/07/2018, no. 17498).
The case faced by the Court confirms that in private equity transactions one of the most awkward aspect is the definition of an exit mechanism for the investor which, within a given time frame, predetermines the value of the investor’s share capital (strike price).
The put opinion
The put option is the best way to structure the exit strategy of the investor. Such disposition is usually negotiated within the shareholder agreement.
While in companies operating on the stock exchange market it is possible to refer to the market value to determine the value of the investor’s shares, the identification of such value is certainly more difficult in companies which do not operate in such liquid markets. Since there is no objectively recognized benchmark, the value of the company’s share capital is generally left to the parties’ negotiation.
However, a put option clause to sell the investor’s shares at a predefined price could violate the mandatory rule set forth in article 2265 of the Italian Civil Code (so-called “patto leonino”), which states that a provision which totally excludes one party from profits and losses is invalid. Indeed, the predetermination of the investors’ shares value could not reflect the real value of such shares, thus neutralizing the losses which could negatively affect the company and so its shares value.
Theoretically, put options in private equity deals are fully legitimate. With ruling no. 17498/2018 the Supreme Court outlined the main aspects that the put option must have in order to achieve an interest which is legally worthy of protection under article 1322 of the Civil Code and, therefore, not to be attracted by the invalid “patto leonino” provision.
The Judges clarify that Article 2265 of the Italian Civil Code actually refers to an absolute and constant exclusion [from losses or profits]. Therefore the scope of the rule is mainly to preserve the correct management of the company which would be irreparably jeopardized if a shareholder is totally excluded from losses.
Following such criteria, the Court points out that the transfer of internal risk between shareholders that does not directly involve the company is not able to jeopardize the correct administration of it (the company) because the agreement which is in force between shareholders usually does not create a totally and permanent investor’s exclusion from losses.
Moreover, the Judges pointed out that the scope of a put option clause within a private equity deal helps the company to raise the needed funds. Such an aim makes the put option clause worth of legal protection (its value is also indirectly confirmed by the legislator, who in the last years has considerably expanded the range of instruments to finance companies).
It is also pointed out that the lack of linkage between power and risk, which in the analysed case entails the right of the investor, entitled to exercise the put option, to be immune to reductions to the company’s value, does not cancel the shareholder’s interest in increasing the overall value of the company. Indeed, the company will be part of the assets of the other shareholders who have to buy the investor’s shares.
Finally, analysing the ruling it can be deduced that in company’s equity fund rising operations, the put option given to the investor to sell at a predetermined price such shares does not violate Article 2265 of the Italian Civil Code. Indeed, generally, the investor shareholder has all the economic and administrative rights which arise from owning the shares and the put option does not affect the distribution of profits and losses, but only the circulation of the share capital.