An Overview of Founder Lock-In Clauses in Bulgaria: Exploring the Provisions and Avoiding Potential Disputes13 July 2023
The Essentials of Founder Lock-in Clauses
Founder lock-in clauses are provisions in shareholder or M&A agreements that restrict the ability of founders to sell or transfer their shares for a specified period after a transaction. While the specific language may vary depending on the circumstances and negotiations, it is useful to examine the terms conventionally used in founder lock-in clauses to mitigate legal risk. Below we provide some terms that typically appear in establishing founder lock-in clauses.
- Lock-in Period: This specifies the lock-in length, which prohibits founders from selling or otherwise transferring their shares. This duration can range from a few months to several years, depending on what is agreed upon.
- Exceptions and Permitted Transfers: Various exceptions and/or permitted transfers may be made to the lock-in clause, enabling founders to transfer their shares in certain circumstances. E.g., the clause may allow transfers to family members, trusts, or entities controlled by the founder.
- Change in Control (CoC) Trigger: This clause defines the events that trigger lock-in, typically tied to a change in control of the company, such as on an acquisition or merger. It outlines the conditions that must be met for the lock-in to take effect.
- Release Mechanisms: Some agreements include mechanisms that permit an early release of lock-in restrictions. If certain performance targets or milestones are achieved, for instance, the lock-in provisions may be lifted partially or entirely before the end of the agreed-upon lock-in period.
- Founders’ Employment and Engagement: This lock-in clause may require the founders to remain actively employed by or engaged with the company they had founded during lock-in. It may detail their roles, responsibilities, and compensation arrangements, to ensure their continued commitment to the business.
- Consequences of Breach: The agreement may detail the consequences of breaching the lock-in provisions. Some consequences may include financial penalties, forfeiture of certain rights or benefits, and other remedies available to the non-breaching parties.
Disputes Resulting from Founder Lock-In Clauses
While these provisions seek to protect the interests of financial investors, funds or an acquiring company, they may give rise to potential disputes. Here are some common areas of dispute associated with founder lock-in clauses:
Freedom to Exit
The restriction on founders’ freedom to exit the company may be seen as violating their shareholder rights. If the provisions are too restrictive or overly burdensome, they may be challenged legally as an infringement on the founders’ rights to sell their shares. Typically, liquidated damages under Bulgarian law are agreed upon. The use of this approach to ensure a natural person’s compliance ought to be considered because the amount of liquidated damages may be challenged in court in such cases.
Bulgarian law poses certain restrictions depending on the type of company. In a limited liability company, for example, the consent of the General Shareholders’ Meeting is mandated to carry out a valid transfer of shares to non-shareholders. The Resolution is one of the required documents for making a submission to change ownership in the Bulgarian Company Registry. Shares are generally freely transferable in joint stock companies, however limitations may be imposed when the shares are issued (a ROFR is often provided for).
Employment and Compensation Issues
In some cases, a Founder lock-in clause may also stipulate that the Founder(s) remain employed with the company during the lock-in period. This requirement can create problems if the Founders and the incoming investor disagree regarding employment terms, job roles, or compensation. In these instances, penalties may be imposed by one of the involved parties and challenged by the other before the court.
Depriving someone from the right to change employment could raise the question of its compliance with the Bulgarian Constitution, and post-termination non-compete clauses may be vulnerable to interpretation. Case law in Bulgaria tends to consider such non-compete clauses as invalid.
Change in Control Provisions
Founder lock-in is often triggered by a change in control of the company. Vague or ambiguous language in the lock-in agreement can give rise to differing interpretations and potential legal disputes.
Enforcement and Remedies
If a founder violates the lock-in provisions, the enforceability of the agreement and the available remedies may arise as an issue. The effectiveness of specific remedies, such as damages or injunctions, may depend on the jurisdiction and the terms of the agreement.
Enforcement of such Founder lock-in clauses may be challenging in Bulgaria and parties may resort to the use of other tools such as agreeing on liquidated damages. Such clauses are contractual provisions that specify the predetermined amount of compensation to be paid by a party in the event of a breach of contract.
Balance should be sought when the clauses are drafted as the agreed liquidated damages may in certain cases be either reduced or found by the courts as void. For instance, in cases where the liquidated damages are deemed excessive compared to the actual damages suffered, or if the obligated party performs the contract incorrectly or partially, the court may reduce the amount of liquidated damages.
Given the diverse nature of the obligations for which liquidated damages are applied, no universal standards are established in theory or case law to evaluate their excessiveness. A careful examination of the specific circumstances involved is thus required to determine whether the liquidated damages may be deemed excessive.
Founder lock-in provisions may exacerbate existing conflicts or disputes among the founders. If one or more founders disagree with the terms of the lock-in provisions, it can lead to internal disputes and potentially impact the overall success of the transaction.
It is crucial to practise careful drafting of founder lock-in provisions in shareholder or M&A-related agreements. In doing so, your business will mitigate the risk of potential legal problems and ensure the delivery of transparent and fair contracts.
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