Italy – capital increases: a new rule complicates the position of minority shareholders

24 October 2020

Italy

Corporate
Private equity

Summary: Article 44 of Decree Law No. 76 of July 16, 2020 (the so-called “Simplifications Decree“) provides that, until June 30, 2021, capital increases by joint stock companies (società per azioni), limited partnerships by shares (società in accomandita per azioni) and limited liability companies (società a responsabilità limitata) may be approved with the favorable vote of the majority of the share capital represented at the shareholders’ meeting, provided that at least half of the share capital is present, even if the bylaws establish higher majorities.

The rule has a significant impact on the position of minority shareholders (and investors) of unlisted Italian companies, the protection of which is frequently entrusted (also) to bylaws clauses establishing qualified majorities for the approval of capital increases.

After describing the new rule, some considerations will be made on the consequences and possible safeguards for minority shareholders, limited to unlisted companies.

Simplifications Decree: the reduction of majorities for the approval of capital increases in Italian joint stock companies, limited partnerships by shares and limited liability companies

Article 44 of Decree Law No. 76 of July 16, 2020 (the so-called ‘Simplifications Decree‘)[1] temporarily reduced, until 30.6.2021, the majorities for the approval by the extraordinary shareholders’ meeting of certain resolutions to increase the share capital.

The rule applies to all companies, including listed ones. It applies to resolutions of the extraordinary shareholders’ meeting on the following subjects:

capital increases through contributions in cash, in kind or in receivables, pursuant to Articles 2439, 2440 and 2441 (regarding joint stock companies and limited partnerships by shares), and to Articles 2480, 2481 and 2481-bis of the Italian Civil Code (regarding limited liability companies);
the attribution to the directors of the power to increase the share capital, pursuant to Article 2443 (regarding joint stock companies and limited partnerships by shares) and to Article 2480 of the Italian Civil Code (regarding limited liability companies).

The ordinary rules provide the following mayorities:

(a) for joint stock companies and limited partnerships by shares: (i) on first call a majority of more than half of the share capital (Art. 2368, second paragraph, Italian Civil Code); (ii) on second call a majority of two thirds of the share capital presented at the meeting (Art. 2369, third paragraph, Italian Civil Code);

(b) for limited liability companies, a majority of more than half of the share capital (Art. 2479-bis, third paragraph, Italian Civil Code);

(c) for listed companies, a majority of two thirds of the share capital represents-to in the shareholders’ meeting (Art. 2368, second paragraph and Art. 2369, third paragraph, Italian Civil Code).

Most importantly, the ordinary rules allow for qualified majorities (i.e., higher than those required by law) in the bylaws.

The temporary provisions of Article 44 of the Simplifications Decree provide that resolutions are approved with the favourable vote of the majority of the share capital represented at the shareholders’ meeting, provided that at least half of the share capital is present. This majority also applies if the bylaws provide for higher majorities.

Simplifications Decree: the impact of the decrease in majorities for the approval of capital increases on minority shareholders of unlisted Italian companies

The rule has a significant impact on the position of minority shareholders (and investors) in unlisted Italian companies. It can be strongly criticised, particularly because it allows derogations from the higher majorities established in the bylaws, thus affecting ongoing relationships and the governance agreed between shareholders and reflected in the bylaws.

Qualified majorities, higher than the legal ones, for the approval of capital increases are a fundamental protection for minority shareholders (and investors). They are frequently introduced in the bylaws: when the company is set up with several partners, in the context of aggregation transactions, in investment transactions, private equity and venture capital transactions.

Qualified majorities prevent majority shareholders from carrying out transactions without the consent of minority shareholders (or some of them), which have a significant impact on the company and the position of minority shareholders. In fact, capital increases through contributions of assets reduce the minority shareholder’s shareholding percentage and can significantly change the company’s business (e.g. through the contribution of a business). Capital increases in cash force the minority shareholder to choose between further investing in the company or reducing its shareholding.

The reduction in the percentage of participation may imply the loss of important protections, linked to the possession of a participation above a certain threshold. These are not only certain rights provided for by law in favour of minority shareholders[2], but – with even more serious effects – the protections deriving from the qualified majorities provided for in the bylaws to approve certain decisions. The most striking case is that of the qualified majority for resolutions amending the bylaws, so that the amendments cannot be approved without the consent of the minority shareholders (or some of them). This is a fundamental clause, in order to ensure stability for certain provisions of the bylaws, agreed between the shareholders, that protect the minority shareholders, such as: pre-emption and tag-along rights, list voting for the appointment of the board of directors, qualified majorities for the taking of decisions by the shareholders’ meeting or the board of directors, limits on the powers that can be delegated by the board of directors. Through the capital increase, the majority can obtain a percentage of the shareholding that allows it to amend the bylaws, unilaterally departing from the governance structure agreed with the other shareholders.

The legislator has disregarded all this and has introduced a rule that does not simplify. Rather, it fuels conflicts between the shareholders and undermines legal certainty, thus discouraging investments rather than encouraging them.

Simplifications Decree: checks and safeguards for minority shareholders with respect to the decrease in majorities for the approval of capital increases

In order to assess the situation and the protection of the minority shareholder it is necessary to examine any shareholders’ agreement in force between the shareholders. The existence of a shareholders’ agreement will be almost certain in private equity or venture capital transactions or by other professional investors. But outside of these cases there are many companies, especially among small and medium-sized enterprises, where the relationships between the shareholders are governed exclusively by the bylaws.

In the shareholders’ agreement it will have to be verified whether there are clauses binding the shareholders, as parties to the agreement, to approve capital increases by qualified majority, i.e. higher than those required by law. Or whether the agreement make reference to a text of the bylaws (attached or by specific reference) that provides for such a majority, so that compliance with the qualified majority can be considered as an obligation of the parties to the shareholders’ agreement.

In this case, the shareholders’ agreement will protect the minority shareholder(s), as Article 44 of the Simplifications Decree does not introduce an exception to the clauses of the shareholders’ agreement.

The protection offered by the shareholders’ agreement is strong, but lower than that of the bylaws. The clause in the bylaws requiring a qualified majority binds all shareholders and the company, so the capital increase cannot be validly approved in violation of the bylaws. The shareholders’ agreement, on the other hand, is only binding between the parties to the agreement, so it does not prevent the company from approving the capital increase, even if the shareholder’s vote violates the obligations of the shareholders’ agreement. In this case, the other shareholders will be entitled to compensation for the damage suffered as a result of the breach of the agreement.

In the absence of a shareholders’ agreement that binds the shareholders to respect a qualified majority for the approval of the capital increase, the minority shareholder has only the possibility of challenging the resolution to increase the capital, due to abuse of the majority, if the resolution is not justified in the interest of the company and the majority shareholder’s vote pursues a personal interest that is antithetical to the company’s interest, or if it is the instrument of fraudulent activity by the majority shareholders aimed at infringing the rights of minority shareholders[3]. A narrow escape, and a protection certainly insufficient.

[1] The Simplifications Decree was converted into law by Law no. 120 of September 11, 2020. The conversion law replaced art. 44 of the Simplifications Decree, extending the temporary discipline provided therein to capital increases in cash and to capital increases of limited liability companies.

[2] For example: the percentage of 10% (33% for limited liability companies) for the right of shareholders to obtain the call of the meeting (art. 2367; art. 2479 Italian Civil Code); the percentage of 20% (10% for limited liability companies) to prevent the waiver or settlement of the liability action against the directors (art. 2393, sixth paragraph; art. 2476, fifth paragraph, Italian Civil Code); the percentage of 20% for the exercise by the shareholder of the liability action against the directors (art. 2393-bis, Civil Code).

[3] Cass. Civ., 12 December 2005, no. 27387; Trib. Roma, 31 March 2017, no. 6452.

Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

**Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market**

In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

Taxation of share deal and asset deal in Italy

The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
If the seller is a natural person, the rate on the capital gain is 26%.

A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

movable assets, including patents and trademarks: 3%;
goodwill: 3%;
buildings: 9%;
land: between 9% and 12% (depending on the buyer).

If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

Share deal and asset deal: risks and responsibilities towards third parties

In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
the buyer benefits from the prior enforcement of the seller;
the buyer is liable up to the value of the business or business unit;
for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

Some ways to deal with the risks

To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

In an asset deal:

Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

Debts:

transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

Tax debts and tax liabilities:

obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
transfer the debts to the buyer, and reduce the price accordingly;
agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

Contracts: for those that will be transferred:

verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

In a share deal some tools are:

Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

Other factors influencing the choice between share deal and asset deal

Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

Cyprus is emerging as a new investment fund centre in Europe following the efforts for evolving and upgrading the regulatory and compliance framework which was initiated in the late 1990s. The enactment of the Alternative Investment Funds Law, No. 131(I)/2014 (AIF Law) is the latest development which aimed at the creation of an attractive and competitive environment for further enhancement and development of the alternative funds industry in Cyprus. The AIF Law replaced the previous regime under which Cyprus managed to develop into a regional domicile for investment funds and their managers.

The following possibilities for alternative investment funds (AIFs) were introduced by the AIF Law:

Umbrella funds with multiple investment compartments/sub-funds which may adopt different investment policies and manage different pools of assets
Transferability of shares
Public offerings of AIF’s shares or units
Listing of securities issued by AIFs

AIFs may be open-ended or closed-ended and may take one of the following legal forms:

Fixed Capital Company
Variable Capital Company
Limited Partnership
Common Fund (contractual)

The relevant rules applicable to the respective legal form are based on Anglo-Saxon common law principles which are incorporated in Cyprus law (company law, partnerships law and contract law etc.).

AIFs may have a limited or unlimited duration.

Investor Classification

AIFs may be established either to be marketed to retail investors or to professional and/or well informed investors (see below for the exception applicable to AIFs with limited number of persons). Investor classification is to be made on the following basis:

Professional Investor: For an investor to be considered as professional investor the requirements for professional clients under Markets in Financial Instruments Directive 2004/39/EC (MIFID) must be satisfied. A basic characteristic of professional investors is the fact that they possess the experience, knowledge and expertise to make their own investment decisions and to properly assess the risks they incur.

Well-Informed Investor: A well-informed investor is not a professional investor within the above meaning but one who:
- confirms in writing the well-informed investor status and awareness of the risks related with the proposed investment; and
- makes an investment of at least €125.000 or has been assessed as having the expertise, experience and knowledge in evaluating the suitability of the investment opportunity in the AIF by a credit institution, investment firm or a management company for Undertakings for the collective Investment in Transferable Securities (UCITS Management Company)
Retail Investor: A retail investor is an investor who does not fulfil the above requirements so as to be classified as a professional or well-informed investor.

Types of AIFs

The AIF Law allows for the establishment of AIFs to be addressed to an unlimited number of investors as well as for funds addressed to a limited number of persons (maximum 75) who may only be professional and/or well-informed investors.

AIFs to be addressed to an unlimited number of investors must to comply with minimum initial capital requirements i.e. €125.000 if externally managed and €300.000 if self-managed.

AIFs may be subject to investment restrictions depending on the investor type, the category of the assets to be held in their portfolio and the overall investment policy to be adopted. On the other hand, AIFs with limited number of investors are subject to a lighter legal and regulatory framework and are not subject to investment restrictions or investment limits.

Management of AIFs

AIFs may be managed externally by a manager appointed to perform the management of the portfolio of assets and related services. Different entities may undertake this role depending on the type of AIF:

For AIFs with unlimited number of investors the external manager may be:
- An Alternative Investment Fund Manager (AIFM) established under local law or under the Alternative Investment Fund Managers Directive
- A UCITS Management Company established under local law or under the Undertakings for the collective Investment in Transferable Securities Directive
- A MIFID Investment Firm established under local law
- An AIFM established in a third country but complying with the relevant provisions of the local legislation
For AIFs with limited number of investors the external manager may be:
- A MIFID Investment Firm established under local law or the MIFID
- A UCITs Management Company established under local law
- An entity established under local law solely for the purpose of managing a specific AIF with limited number of investors
- An entity established in a third country and licensed to provide asset management services and subject to prudential supervision

In the case of AIFs which are companies, the AIF Law provides the option of self-management whereby the management of the portfolio of assets is performed by the board of directors subject to certain restrictions (cap on value of the assets under management, restrictions on leverage, lock-up periods).

Depositary

The depositary of an AIF may be a credit institution or a MIFID Investment Firm or other entity which is subject to prudential regulation and ongoing supervision and which is eligible to act as depositary under its home state legislation.

The depositary must have its registered office in Cyprus or in another member state of the European Union or in a third country, provided that the Cyprus Securities Exchange Commission has signed with the competent authorities of the third country a Memorandum of Understanding for Cooperation and Exchange of Information.

Under certain circumstances it is possible for small AIFs with limited number of persons not to appoint a depositary.

Utilisation of the AIFs

AIFs may be utilised for investments in a wide range of asset classes. Such funds have been established for investments in debt and equity securities as well as real estate and private equity. In a structure with multiple investment compartments/sub-funds, different compartments/sub-funds may invest in diverse asset classes.

Key benefits

Cost-efficient and simple set-up process with fees being significantly lower than in the more mature fund centres e.g. Ireland and Luxembourg
A single and accessible regulator for the alternative funds and their managers
Flexibility as to the asset classes that may be included in the AIF portfolio
Transparency, reporting and risk management aiming at investor protection
Regulated environment in line with the European Union regulatory framework for Alternative Investment Fund Managers, MIFID Investment Firms and UCITSs
Passporting of the marketing of funds in the European Union where the manager is an AIFM
Redomiciliation in and out of Cyprus is possible

Taxation

Cyprus’ growth in this sector has been driven by the country’s tax treaty network, originally rendering it a jurisdiction for launching investments funds with investments primarily into Russia, the former Soviet republics and Eastern Europe but recently also in Asian countries.

Main aspects of tax treatment in Cyprus:

Subject to 12.5% flat corporation tax
Exemption from tax on dividends received by the AIF
Exemption from tax on profits from sale of securities or other instruments (except where the securities are in companies owning immovable property in Cyprus)
No subscription tax on assets of funds
Exemption on capital gains tax from the sale of immovable property located outside Cyprus
No capital gains tax on disposal of shares/units by the holders
Benefiting from an extensive network of more than 50 double tax treaties offering interesting tax planning opportunities

In a rapidly changing funds industry, the options and opportunities available for the setting up and operation of alternative investment funds under the Cyprus regulatory regime are worth exploring by fund managers, investors and their advisors.

Simone Rossi

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