Twitter Logo Youtube Circle Icon LinkedIn Icon

Bulgaria > Legal Developments > Law firm and leading lawyer rankings

Editorial

Violation of Inheritance Rights over Shares in Limited Liability Companies

It is a well-known fact that the limited liability company (LLC) was ‘invented' by German legislators more than 110 years ago as a harmonious combination of an intuitu perosnae and a shared capital company. As a legal form of incorporation, the LLC best serves the interests of small and medium-sized enterprises (SMEs) and, owing to the flexibility of its model, has grown into the most common form preferred by natural persons who have come together to pursue a common economic activity.

 

 

 

The Bulgarian Commerce Act (CA) was drafted under the strong influence of the relevant Spanish law, as well as the German LLC Law, which is important for properly interpreting its content and the way in which it settles various legal issues.

 

One such issue is the inheritance of shares.

 

CA Art. 129 (1) clearly states that a company share ‘may be transferred or inherited'. The same paragraph clearly and exhaustively defines the various scenarios whereby a share is transferred from one partner to another, respectively to a third party, while par. 2 provides that such transfer is effected by a contract with notarized signatures. Transfers between partners are free from any restrictions, whereas a transfer to a third party is subject to the other partners' approval. This is a clear-cut fact with no room for dispute.

 

Nowhere in the law has the legislator provided any special procedure for acquisition of shares through inheritance, which may be an indication for a lapse in the law that deserves to be filled. There is no doubt, however, that at the same time the legislator has clearly determined that a share can be inherited; therefore, no omissions of the law may serve as an excuse for interpreting a legal provision against the grain of the law, towards denying the right to inheritance, as unfortunately the Supreme Court of Cassation (SCC) has been doing in this country for the past couple of years. Let us not even for a moment forget that the LLC is the preferred choice of legal form for SMEs, used mostly by natural persons for whom the issue of inheriting a deceased partner is a crucial one.

 

Each heir is given a free choice, in accordance with the specific rules of inheritance that also apply to the inheritance of a company share, whether or not he or she accepts to inherit the share in question. Such a right of an heir may be exercised either by joining the company directly as a partner, which must follow a due process; or by addressing an explicit statement to that effect to the company, including at a general meeting especially convened for that purpose. It is, however, unacceptable for the other partners to simply embezzle the shares of the deceased partner, without first convening a general meeting or otherwise ascertaining what the heirs' intentions are. It is the company's duty to pay out to the heirs, should they so wish, the equivalent of the value of the relevant share towards the end of the month in which the death occurred, which amount must then be deducted from the assets of the LLC and a new balance sheet must be drawn up to reflect such deduction. In this case, the heirs do not join the company as partners.

 

Any acts on the part of the surviving partners in violation of the law, such as failure to convene a general meeting, to invite the heirs, to honour their will, or failure to abide by imperative provisions of the law with respect to the rights of partners in relation to the share being inherited, are null and void.

 

SCC Decision No. Ф-129/15.07.1997 follows that same logic, stating that ‘the acquisition of a company share, respectively membership in an LLC may be effected in two ways: primary or through direct legal succession; while membership through legal succession on the other hand could be acquired in one of two forms: ‘by transfer or inheritance of a company share - CA Art. 129(1)'. What is more, in its decision referred to above, SCC states correctly in no uncertain legal terms that an LLC cannot deny the heir the right to succeed the grantor in his/her membership rights and obligations in relation to the company through any of its bodies, unless there is a legal obstacle preventing the heir from becoming a partner or the articles of association provide otherwise.  

 

For greater accuracy it should also be noted that the articles of association cannot, by definition, rule out inheritance of property rights arising out of the ownership of a company share; all it can do is prevent the heirs from taking over the position of the grantor, i.e. to acquire membership rights and obligations in relation to the company. The absence of an explicit provision to that effect in the articles of association means that the general principle of inheritance as provided under CA Art. 129 (1) applies, whereby membership in the LLC is acquired with the death of the grantor. Heir's incapacity would be the only possible obstacle to it.

 

The general meeting has no legal powers to deprive the heirs of their right to inheritance. The heir is fully entitled to decide whether he/she wishes to be a partner, i.e. this is an option granted exclusively to him/her: ‘it solely depends on his/her own will whether an heir will make partner or will receive the cash equivalent of the inherited company share.' (Prof. Ognyan Gerdjikov, Comments on the Commerce Act)

 

As seen from the above, it is entirely up to the heirs to decide whether or not to join the LLC as partners, a circumstance that must, of course, be reflected in the book of shares (if the company has one) and entered in the Commercial Register; to that end, the heirs must submit a copy of the death certificate of the deceased and a certificate of inheritance. The German authors U. Eisenhardt and R. Fischer, as well as Prof. Ognyan Gerdjikov in his Comments on the Commerce Act, also support this view.

 

The legal provisions in Spanish law are quite explicit in recognizing the right of heirs, whether by law or by bequest, to acquire the legal status of partners in a company. The assumption is that the level of trust which the partners once enjoyed among themselves also applies to their heirs.

 

Even if we proceed from the restrictive interpretation of Art. 129 (1) by the SCC, when an heir is denied the right to join the LLC as partner, then said heir shall be automatically entitled to receive the cash equivalent of the inherited company share.

 

The SCC's interpretation and its practice of recent years resulting in an artificial distinction between the share owned by a partner in an LLC and his/her membership in it, are baffling     to say the least from both a legal and a purely human perspective, as it is the share itself that substantiates and serves as the basis for said membership rights and obligations, which constitute an intrinsic and integral element of the ownership of a company share.

 

Moreover, no changes have been introduced to the CA, which explicitly provides that shares in an LLC may be inherited! Abovementioned court practice debates that according to CA Art. 125 (1) membership rights of a partner are terminated automatically in the event of his/her death, citing this as an argument in support of the claim that membership rights and obligations are severed for good.

 

Indeed, this could not be any other way - it is from the moment of termination of the membership rights of the deceased that the rights of the heirs take automatically effect. This provides the basis for new membership relationships, namely between the heirs and the company.

 

The irrational, legally absurd and artificial distinction between ownership of a company share in terms of property and the membership rights arising exactly on the basis of such ownership, has led to various distortions of case and registration practices. Thus, SCC Decision No. 166/30.03.2009, SCC Rulings No. No. 464/20.09.1996 and 232/29.03.2002, and SCC Decision No. 161/11.01.2011 all determine that the right of inheritance is always a right of a pecuniary nature, since personal and non-pecuniary rights, including the status of partner in an LLC, are not passed automatically from a grantor to his/her heirs. As if the law itself does not define the actual share as a form of participation in the company assets. Pursuant to CA Art. 127, each partner owns a share in the company assets; it is that share that determines and gives substance to all other rights and prerogatives of the partner. The personal membership rights and obligations referred to by the SCC, as a result of the acquisition of partnership status by the heir, take effect after the heir has joined the company. It is only the company share that is inherited; all other rights arise as a natural consequence of the fact of the new partnership composition.

 

The application of legal norms contrary to their content and meaning allows, in practical terms, the embezzlement of the share of the deceased partner by the surviving partner, without duly informing the heirs, let alone properly compensating them.

 

Under current practice of the courts, it is quite sufficient for a surviving partner who barely owns 10% of the equity and has scant contribution to the growth of the company, to somehow obtain a second original or even a copy of the death certificate and without convening a general meeting and inviting the heirs, without proper minutes stating explicitly that the heirs are not acceptable as partners (whether on legal grounds or otherwise) and without paying them the cash equivalent of their company shares, then to simply indicate within minutes with clearly false contents drafted by him/her,  that he/she is the sole owner and is taking over the share of the deceased partner through paying in the nominal value of the registered capital - something that clearly contains the element of document fraud, in order to embezzle the entire LLC.

 

From that moment on, it is as if the Commercial Register and the entire judicial system collude to cement the situation created by the dishonest partner who while ‘rubbing his/her hands' is watching the powerlessness of the heirs to break through the jurisprudential siege. Surely at long last justice will prevail, but the judicial system's belated protection renders such justice too little, too late in a case as referred to above. The possible conviction by a criminal court of justice for the crime of documentary fraud committed by the surviving partner would be small consolation to the heirs.

 

Thus, the dishonest partner robs the deceased of his/her rights, the fruits of his/her labour, even part of his/her life, by refusing to pay the heirs the cash equivalent of their share.

 

Therefore the SCC should not be allowed to interpret an imperative legal norm contrary to its contents without consideration of common fairness and the will expressed by the partners in their lifetime, as codified in the articles of association of the company. Otherwise the enormous human loss caused by the death of a partner is compounded by practically irrecoverable damages to his/her heirs.

 

Through its most recent practices, the SCC has further weakened the legal status of the heirs; individual judges, including Sofia City Court justices, absurdly allege that the heirs have no legal interest in claiming collateral, or demand exorbitant guarantees, justifying that with the fact that the heirs, having never been partners in the LLC, might harm the interests of the company, while blatantly disregarding the counterargument, namely that at the same time the company is unlawfully exploiting assets belonging to the heirs for a profit, without in any way having compensated them for that privilege.

 

Given the case law invoked by SCC, by its Decision No. Ф-29/08.04.2010, the Sofia Appellate Court at least confirms that prior to ‘taking over' the share of the deceased partner, the other partner should have convened a general meeting, and if the surviving partner refuses to accept the heirs as partners, he/she must present evidence that the company has settled any and all property relations with said heirs. In other instances not even that is required by the varying case law.

 

Even if we assume, for the sake of argument, that the share does not coincide with a partner's membership rights and obligations in an LLC, as a result of which a share is practically not inheritable, whereas only the pecuniary entitlements arising therefrom are inheritable, then it becomes quite clear that the LLC may deny partnership to the heirs provided that it has immediately compensated them with the cash equivalent of their inherited share.

 

Registry clerks must check and verify all this ex officio, especially if notified by the heirs to that effect.

 

The current legal framework, notably the CA and the Commercial Register Act (CRA), despite all gaps therein, is clear enough in explicitly providing for proper control by the courts and the Commercial Register preventing, respectively reversing the unlawful embezzlement by a dishonest partner of the share of a deceased partner without due and proper compensation for their heirs. When functions of registry clerks are reduced to the mechanical entry of data, without verifying their completeness and without checking the documents required by law for compliance with Art. 21 (4) & (5) of the Commercial Register Act, this may produce the kind of entries that create a sense of insecurity and instability for SMEs.

 

This prompts the conclusion that additional training of registry clerks, as well as stricter professional oversight on whether all conditions and requirements as prescribed by law have been satisfied are desperately needed. Of course, ultimate discretion lies with the relevant public servants, who should, however, be aware of the huge burden of responsibility placed upon them and the harm they can cause by acting negligently.   

 

Given the practices described above, in addition to disciplinary responsibility, public servants must also assume albeit limited liability for the quality of their work. Besides speed and efficiency, the Commercial Register must also guarantee accuracy, if businesses are to be able to rely on it.

 

Often in the supporting arguments of a court ruling we encounter the justification that the heir seeks to acquire the shares in question as a third party, therefore all provisions concerning the admission of a new partner acting in his/her own capacity must be adhered to, subject to a resolution of the general meeting. The court points out that it is not the share but the membership right that authorizes a person to participate in the management of a company.

 

Then, from Varna Appellate Court Decision No. 90/23.06.2010 we learn that the heirs to a partner ‘are the acquirers of his/her shares', while at the same time being ‘third parties' vis-à-vis the company, therefore they can acquire membership rights only if admitted as new members.

 

All of the court decisions referred to above recognize, on the one hand, that ‘the company share alone' is subject to inheritance. However, on the basis of the existing legal provisions regarding the transfer of shares they draw the completely irrational from a legal perspective and absurd conclusion that there is no other way to acquire company shares apart from their transfer between existing partners or the admission of third parties as new ones.

 

One would think that there is no explicit provision in CA Art. 129 to the effect that in addition to being transferred, shares can also be ‘inherited'.

 

It is not that hard to draw the logical legal conclusion that the option of inheritance solely depends on the will of the heirs, and can never be subjugated to the will or decision of the general meeting, and even less, to that of the other partner (if the LLC had two partners in the first place), who under the law is given no additional rights and competences related to the death of the deceased partner. All rights emerge directly to the benefit of the heirs should they opt to join the company, provided that there are no legal obstacles nor do the articles of association prescribe any conditions for admission that one or more of the heirs fail to meet. The rest of the partners are solely obligated to undertake relevant technical steps to ensure admission of the heirs as full partners in the company.

 

Even today none of the courts has disputed the right of heirs to transfer the rights over a company share to another partner, which in itself prompts the legally reasoned conclusion that such a right of the heirs can under no circumstances be violated by the other partners through abusing, of their own accord, the legal form of the general meeting to dispose of the share of the deceased partner, thus depriving the heirs of this right and practically embezzling the share.  

 

Frequently occurring and tolerated by both the Commercial Register and the courts, but nonetheless even more absurd, is another scenario in which all the surviving partner needs to do to acquire title of the deceased partner's share is to draw up minutes presenting him/herself as the sole owner, in support of which he/she submits a miraculously obtained second original of the death certificate of the deceased,  having no right to possess one in the first place, which in the end allows him/her to take over the entire LLC.

 

Regrettably, such artificial distinction between a share in an LLC and the rights of membership in it leads to flaws in the supervision of entering changes in the Commercial Register, where registry clerks fail to demand a shred of evidence that a general meeting has been duly convened or that the company has settled relations with the heirs in one way or the other.

 

Unacceptable, even legally inadmissible is the current practice of the Commercial Register and the courts to ‘guard' the illicitly misappropriated rights of the surviving partners, while completely neglecting the rights of the heirs, as illustrated by the cases referred to hereinabove.

 

When filing a suit or a claim for compensation against the company, the wronged heirs, who have in the meantime been reduced to the weak party, often have to learn that as a third party vis-à-vis the LLC, they have no legal interest in it and that their claim for significant collateral is being considered ungrounded as this may allegedly harm the company.

 

Therefore, it is necessary to supplement the CA as soon as possible, to the effect that shares of a deceased partner are inherited at the sole discretion of the heirs, without any interference on the part of the general meeting, provided that there are no legal hurdles or other restrictions in the articles of association for instance.

 

The CA should also prescribe the exact steps for heirs to join an LLC as partners.

 

For all cases where the heirs do not, for one reason or another, become partners, the CA should explicitly state that the LLC is obliged to immediately pay out to them the cash equivalent of the share, or to enter into an agreement with the heirs regarding the terms of settlement of the pecuniary implications resulting from the death of the deceased. If none of the above is the case, then the heirs should have every right to join the LLC as partners.

 

Relevant changes must also be made in the CRA, which should make it incumbent upon registry clerks to check that all requisite documents are present and, if any of those are missing, or if the heirs have made a contestation, supported with evidence of a claim filed with a court of law, they should suspend registration until such omissions are cured or until the court has passed a ruling. Clerks should be made liable to disciplinary sanctions or fines for omissions on their part.

 

Otherwise, we would be facing a practical impossibility for the heirs, once ripped off by dishonest partners, to have their rights duly and properly protected, which is often also in the best interest of the LLC itself.

 

Pursuant to the explicit provision of CA Art. 129 (1), it is legally inadmissible for the heirs of the deceased partner to be equated to random third parties, totally unrelated to the LLC, while surviving partners benefit from non-existent rights, allegedly derived from the death of the deceased partner, which take precedence over the rights of the heirs themselves.

 

Otherwise, SMEs would switch to the public shareholding company as a form of incorporation, which is typical for big business and entities listed on the stock exchange and not particularly suitable for them in the first place, where the above described problems with inheritance simply do not exist.

 

Let us not forget also that the Bulgarian CA is directly influenced by Spanish and German law, therefore any restrictive interpretation of omissions in the texts, bordering on contra legem to the intended meaning and significance of the possibility for company shares to be inherited, i.e. disregarding the legislator's intentions and considerations should be considered erroneous and lacking conformity with the will of the legislator.

 

It is therefore advisable to supplement existing legislation in order to preclude any possibility for abuse of existing gaps by dishonest partners who take advantage of the death of a partner to practically embezzle the entire LLC, without having compensated the heirs with the cash value of the deceased's share.

 

Thus, it turns out that the legal status of the heirs is even inferior to that of third parties applying to acquire a share, since heirs are equated to an expelled partner - a practice that needs to stop as soon as possible, as the LLC is the typical and preferred form of incorporation for SMEs where the scenario of a partner's death raising the issue of inheritance of his/her share by the heirs - a possibility explicitly provided for by the Bulgarian CA, is all too possible and even natural.

 

According to current court practice, while the heirs are, on the one hand, entitled to dispose of the share they have inherited by transferring it to one of the surviving partners, at the same time, without such a scenario playing out in practical terms, the courts in some cases allow unilateral acts amounting to a ‘takeover' (i.e. plain embezzlement) of the deceased partner's share by the surviving partner, who ‘assumes' the rights and entitlements of the heirs to inherit the property rights over the company share as recognized even in the most restrictive interpretation of the above mentioned CA Art. 129 (1). The heirs do not even suspect that such acts have been undertaken and are faced with a fait accompli, finding themselves in a legal cul-de-sac. They are then forced to engage in legal disputes and wage court battles for years on end, and even if they eventually win, they may end up in possession of an LLC that is plundered, decapitalized and dysfunctional.

 

The logical continuation of such judicial malpractice is that neither the surviving partners nor the company as a whole can be ‘forced' to pay the cash equivalent of the inherited share to the heirs - another legal obligation explicitly prescribed in the CA, because the courts are less concerned with the rights of the weaker party.

 

Pursuant to the explicit provisions of CA Art. 129 (1), unless legal or other obstacles arise, the heirs are fully entitled to inherit the company share and that right of inheritance is in no way dependent on the will of the general meeting or of any other partner; therefore, if the heirs have been prevented by any surviving partners from joining the LLC as full partners, they must have the legal option of filing a claim under CA Art. 71. The membership rights themselves arise automatically with the death of the grantor who was a partner in the company, irrespective of the moment they were registered.

 

The court's assertion that the heirs have no right to file a claim under CA Art. 71 as they were never, not even for a moment, partners in the company just goes to show how dangerous the restrictive interpretation of CA Art. 129 (1) really is, as it deprives the heirs of the possibility to defend their rights and entitlements, even if they are in a position to prove that no legal obstacles exist for their inheritance of the share and despite having legally opted to join the LLC as partners.

 

The adoption of the relevant amendments to the CA and CRA, which would contribute significantly to the establishment of the LLC as the preferred form of incorporation of SMEs, will give the necessary confidence and a sense of security to natural persons who have pooled their efforts for pursuing joint economic activity, while their heirs will be in a position to inherit the company share in accordance with the original intention of the founders of the company, if the articles of association do not provide otherwise.

 

 

 

Vladimir Penkov

Interview with...

Law firm partners and practice heads explain how their firms are adapting to clients' changing needs

International comparative guides

Giving the in-house community greater insight to the law and regulations in different jurisdictions.

Select Practice Area

GC Powerlist -
Europe