November 2022
Pei-Ching Ji and Julian Lai
To secure its right of control and achieve sustainable succession, a family business may, in addition to establishing a foundation or setting up a property trust, establish a close company limited by shares after a dedicated section on close companies limited by shares was added to the Company Act in 2015. It is because a close company limited by shares can impose share transfer restrictions on its own through its Articles of Incorporation, which is different from an ordinary company limited by shares, whose shares are basically freely transferrable (Article 356-5 of the Company Act). For example, it is possible to impose the restriction that the transfer of shares is subject to the consent of all or a certain percentage of the shareholders, to grant preemptive rights to certain shareholders, or even to set up another more complex share transfer framework. As a result, close companies limited by shares have become an important tool for family businesses to plan their shareholding arrangements in recent years. One of the most famous examples is the establishment of Mao Yu Co., Ltd. (a close company limited by shares) by the family of Yao-ying Lin and En-ping Lin of Largan Precision Co., Ltd. (hereinafter, the “Largan Precision”), with the shares of Largan Precision held by the family members transferred to Mao Yu Co., Ltd. to achieve the objective of securing the right of control over Largan Precision.[1]
A close company limited by shares may impose share transfer restrictions via its Articles of Incorporation to avoid the outbound transfer of family shareholdings. However, in the event of succession by family members, a creditor’s compulsory enforcement of the shares owned, or a debt arising from the distribution of the marital property due to the divorce, it is noteworthy if this contradicts the share transfer restrictions under the Articles of Incorporation.
1. Transfer restrictions and inheritance
In the event of inheritance, if the heir does not meet the conditions of the transfer restrictions set forth in the Articles of Incorporation, e.g., if the heir is an illegitimate child of an original shareholder did not obtain the consent of a certain percentage of shareholders of the company to allow the heir to become a shareholder of the company, or if a preemptive right is granted under the Articles of Incorporation and the other shareholders have exercised the preemptive right, this will give rise to the issue of whether the share transfer restrictions specified in the Articles of Incorporation of a close company limited by shares may be raised as a defense against inheritance. In this regard, the Ministry of Economic Affairs (hereinafter, the “MOEA”) concluded in its meeting conducted on November 30, 2020 to clarify issues concerning the Company Act: “The provisions of the Civil Code on succession are part of the legal system, and everyone should comply with and respect its effects. Under Article 1148 of the Civil Code, since the heir shall assume all the rights and obligations associated with the property of the decedent from the beginning of the inheritance, the heir shall acquire the ownership of the shares from the beginning of the inheritance. Although the heir acquires the shares of a closed company limited by shares that are subject to transfer restrictions, the company still may not refuse to transfer the title of the shares on the grounds that they do not comply with the restrictions on transfer set forth in the Articles of Incorporation of the close company limited by shares since the heir acquire the shares pursuant to legal requirements.”[2] According to the meeting minutes, the MOEA believes that the transfer restrictions stipulated in the Articles of Incorporation of a close company limited by shares should not apply to the acquisition by way of inheritance as the statutory cause of transfer, and that a heir should be allowed to obtain the decedent’s shareholding in a close company limited by shares at the beginning of the inheritance.
In addition, the MOEA indicated in its circular dated December 25, 2020: “Article 1147 of the Civil Code provides that ‘inheritance shall begin with the death of the decedent’ and Paragraph 1 of Article 1148 provides that ‘except as otherwise stipulated by this Act, the heir shall inherit all rights and obligations associated with the decedent’s property, except the rights and obligations are exclusive to the decedent per se.’ If the provisions on the handling of the shares of a deceased shareholder in the Articles of Incorporation of a close company limited by shares violates public policy or morals or potentially involves any abuse of right, since this pertains to private rights, which fall within the scope of fact determination and application of laws by a judicial authorities, this matter should be resolved through judicial proceedings.”[3] According to this circular, the MOEA opined that if the Articles of Incorporation of a close company stipulates the handling of the shares left behind by a deceased shareholder, it should be determined by a judicial authority based on the specific facts of the cases.
Scholars believe that although an heir certainly inherits the property and the rights and obligations left behind by the decedent, still this does not mean that the property should be inherited in its original form. In a close company, the share transfer restrictions should be stipulated in the Articles of Incorporation, and the decedent becomes a shareholder of the company voluntarily whether by participating in the incorporation of the company or obtaining the company’s shares pursuant to the Articles of Incorporation after the incorporation registration and accepts the restrictions under the Article of Incorporation out of his/her free will. In other words, the heir inherits the shares of the decedent on the one hand and the obligation of the decedent to dispose of the shares in accordance with the company’s Articles of Incorporation on the other hand, with the arrangements mostly involving the exercise of preemptive rights by other shareholders (or a designated shareholder) or buyback by the company.[4]
In the opinion of the authors, since the shares held by the decedent are subject to the transfer restrictions set forth in the Articles of Incorporation, the subject of the heir’s inheritance should certainly be the shares subject to the transfer restrictions under the Articles of Incorporation, not shares free from any restrictions. Therefore, the company may still assert the transfer restrictions under the Articles of Incorporation as a defense against the heir. However, there is no clear decision in judicial practice on whether the transfer restrictions under the Articles of Incorporation of a close company limited by shares may be raised as a defense against inheritance. The future opinions of the courts needs further observation.
2. Transfer restrictions and compulsory enforcement
When the shares held by a company’s shareholders are subject to a compulsory auction by the court, the issue of whether the transfer restrictions under the Articles of Incorporation of a close company limited by shares may bind the winner of the auction will also arise. In this regard, the MOEA stated in its circular dated August 23, 2019: “With respect to civil enforcement matters, the Compulsory Enforcement Act applies. Except for Article 111, Paragraph 4 of this Act (authors’ note: the Company Act), which provides that the court shall follow certain procedures when transferring the capital contribution of a shareholder of a limited company in accordance with the compulsory enforcement procedure, the Company Limited by Shares Chapter does not have any provisions that exclude the Compulsory Enforcement Act.”[5] According to the interpretation in this circular, the MOEA seems to hold that the share transfer restrictions under the Articles of Incorporation of a close company limited by shares shall not be asserted as a defense against the winner of an auction conducted in the course of compulsory enforcement.
However, during the seminar conducted by the Taiwan High Court and its affiliated courts on November 25, 2020, it was pointed out, with respect to the legal issue of whether the provisions on share transfer restrictions in the company’s Articles of Incorporation should be specified in the auction notice for a civil enforcement matter concerning the auction of the shares of a close company limited by shares, that: “For an auction of the shares of a close company, regardless of whether share certificates are issued (the provisions on the enforcement of personal assets shall apply or be mutatis mutandis applicable), the winner of the auction should be bound by the share transfer restrictions under the Articles of Incorporation after the purchase, and circumstances sufficient to affect the willingness to participate in the auction such as the auction price, risk assessment, or other special circumstances shall be specified in the auction notice to caution potential buyers in accordance with Article 64, Paragraph 2, Subparagraph 1 of the Compulsory Enforcement Act and Point 37, Subparagraph 1 of the Notice for the Handling of Compulsory Enforcement Matters.”[6] This legal seminar was not conducted to address the issue of whether the share transfer restrictions under the Articles of Incorporation may be asserted as a defense against the winner of the auction in the course of compulsory enforcement. However, the explanation clearly indicates that the winner of an auction of the shares of a close company limited by shares is still believed to be subject to the transfer restrictions set out in the Articles of Incorporation.
The authors believe that since an auction conducted under the Compulsory Enforcement Act is a private law sale, i.e., the debtor being the seller and the winner of the auction being the buyer, and the auctioneer standing in the position of the debtor as the seller,[7] it is reasonable that the winner of the auction should certainly be bound by the share transfer restrictions set out in the Articles of Incorporation as well after the shares are auctioned to the winner. It is precisely for this reason that it was specifically stated in the above seminar of the Taiwan High Court and its affiliated courts that the share transfer restrictions specified in the Articles of Incorporation of a close company limited by shares should be specified in the auction notice to caution the potential buyers that they may be bound by the transfer restrictions under the Articles of Incorporation in the future.
3. Transfer restrictions and the distribution of marital property
In the event that the relationship under statutory matrimonial property regime is extinguished for reasons such as a divorce, it is possible that the shares of a close company limited by shares is transferred when a spouse exercises the right to claim the distribution of the marital property (Article 1030-1 of the Civil Code), which will also give rise to the issue of whether the transfer restrictions set out in the Articles of Incorporation of a close company limited by shares may be raised as a defense against the right to claim the distribution of the marital property.
The Supreme Court opined that the right to claim the distribution of the marital property is, by nature, only a claim for a monetary amount, not a right that exists on a specific subject property, and cannot be claimed and exercised with respect to a specific subject matter.[8] Accordingly, a spouse is basically unable to directly assert any right over the shares of a close company limited by shares in the possession of the other spouse. Therefore, if a spouse intends to establish accord and satisfaction concerning his/her shareholding in a close company limited by shares with the other spouse and transfer the shares of the close company limited by shares, since this is legally no different from a typical consensual transfer, the transferee is indubitably bound by the transfer restrictions set out in the Articles of Incorporation of the close company limited by shares. If the couple are unable to settle the debt arising from the distribution of the marital property by agreeing on the transfer of the shares of a close company limited by shares, one of the spouses can only apply to the court at best for a compulsory auction of the other spouse’s shareholding in the close company limited by shares and be repaid by the proceeds from the auction. In this scenario, this is the same as the above-mentioned issue of whether the transfer restrictions under the Articles of Incorporation can be raised as a defense against compulsory enforcement. Since compulsory enforcement is by nature a private law sale, it should be concluded that the winner of an auction should also be bound by the share transfer restrictions specified in the Articles of Incorporation after the shares are auctioned to the winner.
4. Summary
A close company limited by shares is characterized by a high degree of interpersonal bond due to its share transfer restrictions, making it possible for a family business to achieve arrangements for family succession and the right of control. Therefore, such restrictions have become a major tool for arranging the shareholding structure of a family business in recent years. This article analyzes and reviews the main issues that may arise in the course of succession, compulsory enforcement, and the distribution of the marital property from the transfer restrictions set out in the Articles of Incorporation of a close company limited by shares to invite future in-depth discussions and exploration of this matter.
[1] Major Changes to the Succession of Family Businesses to Prevent Internal Succession Struggles through Close Companies – Behind the Scene of the Worries of Yao-ying Lin Aged 87 about the Consolidation of the Right of Control over Largan, Wealth Magazine, Issue 577 https://www.wealth.com.tw/articles/e839df17-2bea-4fbb-a5e5-6232fee5e2e9 (Last Viewed on Oct.ober 25, 2022).
[2] The meeting minutes of a meeting conducted by the MOEA on November 30, 2020 to clarify issues about the Company Act
[3] The Jing-Shang-10902433700 Circular of December 25, 2020 from the MOEA
[4] Wuan-ju Tseng, The Defense for the Succession and Mergers and Acquisitions of Family Businesses – Current Status and Inadequacies of the Company Act, The Taiwan Law Review, Issue 325, June 2022, page 23
[5] The Jing-Shang-10802420910 Circular of August 23, 2019 from the MOEA.
[6] The 2020 Civil Enforcement Category Proposal No. 17 Legal Seminar of the Taiwan High Court and its affiliated courts.
[7] The 47-Tai-Shang-152, Civil Decision and the 49-Tai-Kang-83 Civil Decision of the Supreme Court
[8] The 105-Tai-Shang-1750 Civil Decision of the Supreme Court
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