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Editorial

The challenges of inheriting shares in a limited liability company in Bulgaria

75 % of the small to mid-size companies in Bulgaria are owned by families and their development has a significant role in defining the economy of the country. In the EU, family owned businesses represent more than 60% of all registered companies and ensure over 40% of the overall employment.

Despite all this and although a key issue in this type of business structure, the process behind transfer of ownership and inheritance of a family business is frequently overlooked and underestimated. Taking into account that the limited liability company is in effect the most common business structure, the present article aims to discuss some of the more important practical issues related to the inheritance of shares in a limited liability company (Ltd), which should be considered as early as possible when planning to organize a business in this manner.

Although, that strictly speaking the limited liability company belongs to the so called "capital" business structures, it has many of the characteristics of a "personal" business or partnership due to the personal involvement and contribution of each of the shareholders.

According to the Bulgarian Commerce Act, the shares in a Ltd company can be inherited. However, this poses the question: Do the heirs actually become full right shareholders in the business and what are the main challenges when inheriting company shares?

This article will focus on and discuss the following issues:

-          When does the "membership relation" of the heirs arise and do they directly become shareholders in the company;

-          What counter measures may be expected from the other shareholders;

-          What are the challenges which should be considered when inheriting company shares, and

-          How to ensure maximum protection of your interests in case of the demise of a shareholder

The company share represents part of the assets of the limited liability company (art. 127 of the BCA) and the "membership rights" are defined as the right to participate in the management of the company and the profit distribution, the right to be informed about the company's activities, the right to review company documentation and the right to a liquidation quota. Basically, this means that the law establishes a distinction between ownership of a company share and the rights of the shareholder in a Ltd. - his membership relation.

The right of inheritance arises upon the occurrence of an actual fact - the demise of a shareholder. The right of inheritance is a right which always carries pecuniary characteristics, since the personal and non-pecuniary rights Đľf the deceased do not pass to his heirs.

In case of the demise of a shareholder in a Ltd. company, his pecuniary rights - ownership over the company shares are inherited, but his membership relation is not. The heir has in effect acquired the shares but has the position of a third party vis-Ă -vis the company itself and therefore has to be accepted in the company in order to acquire membership rights. In this case the heir does not substitute the deceased shareholder and does not step into his membership relation but can only acquire membership rights on his own account and subject to approval by the General Assembly (GA).

The acceptance of a new shareholder is within the competence of the General Assembly and therefore if such approval is not granted, the heir does not acquire the non-pecuniary rights under art. 123 of the Bulgarian Commerce Act. The inherited shares determine the heir's right to receive the equivalent of the shares' value in accordance with art. 125 (3) of the Commerce Act if he does not wish be accepted as a shareholder in the company or if such acceptance is refused by the GA.

Therefore, as a general position under Bulgarian law, the inheritance of shares in a Ltd. company is not equivalent with becoming a full right shareholder in the company.

According to the purely doctrinal legal view which is shared by most legal experts in Bulgaria, in case the company's Articles of Association expressly provide that the heirs of a deceased shareholder automatically become full right shareholders in the company, further approval by the GA is unnecessary. In this case it is presumed that the approval of the GA has been granted on the grounds of the Articles of Association. However, the court practice does not share this view.

In the past years Bulgarian courts, including the Supreme court of cassation have been consistent in their now unified position that in order to accept heirs as full right shareholders in the company, a GA needs to be convened and carried out under the rules of the Commercial Act.

In the sake of completeness, it should be noted that in order to be accepted as a shareholder in the company, the heir needs to meet the general requirements for a shareholder under law, namely to be sui juris local or foreign individual or legal entity.

If all above conditions are met, in order for the heir to become a full-right shareholder in the company, the following steps need to unfold:

  • The heir must have accepted the inheritance and must have filed an explicit request with the company which expresses his desire to become a full right shareholder and accept the Articles of Association;
  • The GA needs to be convened and must approve the heir's acceptance as a full right shareholder in the company;
  • The Articles of Association must be amended accordingly to reflect the changes in the shareholding structure and must be published in the company's file with the Commercial register.

It should be noted that the heirs cannot dispose of (i.e. sell) the inherited shares since they do not have the capacity of shareholders in the company before they have been accepted by the GA. However, in this case the existing shareholder(s) can acquire the shares from the heirs against payment of their equivalent.

Unfortunately, there is no unified court practice on the issue of calculation of the equivalent of the inherited company shares. Therefore, it is important tĐľ have the rules for evaluation set out in the Articles of Association in order to avoid complications.

A number of district courts in Bulgaria have adopted the position that the evaluation of the inherited company share should be based on the fair market value of the assets of the company and not on their balance value. To support this position the courts have run a parallel with the scenario of liquidation of the company where the assets are disposed of at their market value based on which the shareholders receive their liquidation quotas.

This court practice accepts that the logical interpretation of the law leads to the conclusion that the market value of the company's assets should be the basis for evaluation of the shares. According to art. 127 of the Commerce Act each shareholder owns a share of the company's assets, which is defined on the basis of his participation in the company capital, if not agreed otherwise. Art. 125 (3) regulates the right of the leaving shareholder to receive the monetary equivalent of his company share. The interconnective interpretation of the above provisions leads to the conclusion that the value of the company shares which the leaving shareholder is entitled to under art. 125 (3) of the Commercial Act can not be different than the value of the share he owns in the company's assets. To accept the contrary, namely to base the evaluation of the shares on the value of acquisition, would mean that the leaving shareholder would receive an amount which is different than the actual value of the share, be it higher or lower. In order to guarantee the right of the leaving shareholder to receive the market value of his share in the company, the law provides for the preparation of an explicit accounting balance which evaluates the assets of the company based on their current market value.

Other courts, including the Supreme court, adopt the position that the property of a functioning company is an aggregation of right obligations and factual relations and not purely ownership rights. This is why these courts support the view that the evaluation which should serve as the basis for calculation of the share of the deceased shareholder should be the balance value of the company's assets and liabilities and not the market value.

In order to avoid long court disputes and in order to minimize the risk of embezzlement of the shares of the deceased shareholder by the remaining shareholder(s) and in order to clearly define the rights and obligations in the case of inheritance of shares, we suggest that before starting a business or accepting new shareholders in an existing business, expert legal advice should be sought. Our legal team has strong experience on the issues related to the inheritance of shares and have always aimed to provide a preliminary in-depth analysis of the connected potential risks. As a leading corporate law firm we are in the position to provide a professional legal opinion on the specific scenario and will be able to identify and minimize the risks by tailoring the company's Articles of Association to meet the client's needs.

Taking into account the existing gap in the regulations and the issues raised above, we advise the client to adopt Articles of Association which put forward clear and comprehensive procedures to be followed in the case of a deceased shareholder, convening of a GA in such circumstances and evaluation of the inherited share in the company.

Many of our clients chose to organize their businesses under the form of a joint stock company (JSC) as an alternative to the Ltd. since this legal form provides for a more secure protection of inheritance rights. Nevertheless, the small to mid-sized business is predominantly organized under the legal form of a limited liability company and shareholders should take due care when dealing with the issues raised above.

Due to historical, social, political and other reasons a significant part of the family business in Bulgarian is at the stage of being transferred from first to second generation, which makes the topic of inheritance of company shares extremely important and the issues it raises - more and more interesting.

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