Author: Dagmara Łudzińska

The liquidation preference clause in an investment agreement can serve as an effective instrument to guarantee the investor the repayment of at least a portion of the amount invested by them in the event of a liquidity event. We invite you to familiarize yourself with an article discussing the practical aspects of utilizing the liquidation preference clause in investment agreements.

What is the liquidation preference clause?

Incorporating the liquidation preference clause in an investment agreement ensures the investor receives repayment of at least a portion of the invested amount in the event of a liquidity event. Such an event could include the sale of the company, merger, division, or liquidation. The liquidation preference clause constitutes one of the mechanisms for protecting the investor’s interests, particularly in situations where the value of the company upon its sale does not cover the invested capital.

What forms can it take?

The liquidation preference clause comes in two forms: participating and non-participating. If the goal is to prioritize the investor’s satisfaction before other shareholders of the company (usually the founders), the participating form of the liquidation preference clause is employed. It is also possible to use a hybrid model that incorporates elements of both prescribed forms or introduce the maximum participation amount for the investor (the so-called cap).

When and why is it used?

The liquidation preference clause allows for determining the order and degree of division of funds obtained as a result of the company’s liquidation among individual shareholders.

In practice, when implementing the liquidation preference clause in investment agreements, the privileged party in the liquidation process is the investor. Securing their interests as a priority is justified, especially given the high risk of investment and the often substantial financial contributions made. This is one of the key reasons why investors seek assurance that, in the event of a company sale or liquidation, they will be guaranteed a sum equivalent to at least the amount invested in the company – regardless of the ownership structure or the amount received for the entire company. After meeting this condition and satisfying the investor, the remaining funds are divided according to the terms agreed upon by the parties.

In summary, the liquidation preference clause is often encountered in agreements with venture capital investors, serving as protection for their investments. Its precise terms are the result of negotiations between the parties and should be carefully tailored to the specifics of each investment and compliant with applicable law. In the legal and business context, the liquidation preference clause can be a significant element of an investment agreement aimed at safeguarding the interests of investors. However, its application should be carefully considered and adjusted to the specific circumstances of the investment and the applicable legal regulations.

We understand that this is a complex and demanding subject matter, therefore, if legal support in this area is needed, we invite you to contact the Hoogells team.

This key question requires distinction between two perspectives – that of the Beneficiary and that of its Counterparty.

Beneficiary’s perspective – because it is the entity to which the money from the NRP funds goes directly. The money will then be allocated by the Beneficiary for the implementation of the intended projects. This is an important perspective for business, as it allows business to make investments to improve their operations in the market.

Counterparty’s perspective – because without its participation, the NRP funds cannot be absorbed. It is the Counterparty that de facto executes the project for which the Beneficiary has obtained funds. Indirectly, it is the final recipient of the NRP funds. Hence, it is crucial to facilitate Counterparty’s access to undertakings implemented with NRP funds. This is an important perspective for business representatives, because in this way the NRP funds will be effectively absorbed and will strengthen the local economy.

Beneficiary

To successfully obtain funding from the National Recovery Plan, it is essential to understand the basics about the program.

Referring to previous posts by Hoogels, entities interested in receiving EU funds should:

• define the intended project;
• analyze the NRP Document and the regulations for the Investment in terms of the intended project;
• verify that the Investment and the conditions (criteria) for its implementation correspond to the situation of the interested entity;
• submit an application to the Responsible Institution.

This procedure is being facilitated by Responsible Institutions, which publish announcements of calls for proposals for a specific Investment implemented under the NRP. Along with the announcement of calls for proposals, the Responsible Institution presents general information on the Investment and its detailed terms and conditions (e.g., subsidy regulations, application template, subsidy agreement template).

Announcements of calls for proposals are generally published on the websites dedicated to the NRP program and the websites of individual Responsible Institutions. Calls for proposals should be looked for primarily on the websites:

https://www.gov.pl/web/planodbudowy/nabory

https://www.funduszeeuropejskie.gov.pl/strony/o-funduszach/fundusze-na-lata-2021-2027/krajowy-plan-odbudowy/nabory-wnioskow/

https://www.cupt.gov.pl/konkursy/aktualnie-trwajace/

Counterparty

The activities of a Counterparty who wants to participate in projects subsidized by NRP funds should be focused on different goals. This is because Counterparty needs to determine which entities have obtained funding and successfully compete for a contract for the realization of the project.

Firstly – in terms of projects implemented by public finance sector units, information about projects will be revealed to the market through the channels known so far, i.e. through tendering platforms.

In addition, potential Counterparties can monitor reports from Responsible Institutions and media information about the conclusion of funding agreements. In this way, Counterparties will gain the time advantage of obtaining information about funding at an earlier stage of NRP process.

See, e.g.:

https://www.gov.pl/web/planodbudowy/najwieksi-beneficjenci-kpo

Secondly – in terms of projects implemented by private entities, the way to obtain information about the funds-flow from the NRP to specific entities is significantly hindered. Private entities (Beneficiaries) will conclude contracts with contractors/suppliers (Counterparties) for the realization of the project using the freedom of contracting.

It is worth considering, for example, submitting requests to Responsible Institutions for public information on Beneficiaries who have obtained funding.

It is also possible for Counterparties to take the initiative. Under this model, a Counterparty could encourage and support a potential Beneficiary to apply for funding. E.g., by concluding contracts executed under the condition of obtaining NPO funding. Such contracts, however, should provide for securing the interests of both parties.

From the perspective of a potential Counterparty – regardless of the category of Beneficiaries (public or private entities) – it will also be prudent to familiarize themselves with the Investments envisaged in the NRP, as well as the amount of funds allocated for their implementation. This is the way business representatives to develop a business plan that takes into account the impact of NRP on the market conditions in which they operate.

In contract practice, we observe the notification by General Contractors of contracts, the subject of which is a de facto future obligation to order and deliver materials, provide designated services, respectively.

Within the framework of such contracts, the parties agree on the quantity of services, materials to be ordered/delivered within a specified time frame (e.g., within a period of 12 months from the date of conclusion of the contract), the unit price, the method of placing orders for the performance of supplies/services.

As a rule, the parties agree that the execution of the contract will be carried out on the basis of relevant orders, which will specify the quantity/scope of the ordered supplies/services and the date of their execution.

Based on the content of such agreements, the Investor receives general information about the assumed/planned scopes of supplies/services and the maximum value of the concluded agreement, i.e. obtains knowledge of certain boundary frameworks of cooperation between the contractor and the subcontractor.

Given the above practice, the question arises:

• about the legal nature of such contracts and the orders placed under them,
• whether, in the above circumstances, we are dealing with so-called framework agreements, on the basis of which subsequent civil law contracts are concluded,
• whether these individual orders require notification under the provisions of FIDIC Sub-Clause 4.4.

In contract law, there is no legal definition of the above-mentioned contractual relationships, which in practice function as so-called framework agreements.

Although a legal definition can be found in the Public Procurement Law (Article 7 item 26) as well as the Payment Services Law (Article 2 item 31), the scope of this definition does not apply to legal relations on the line of general contractor – subcontractor.

The issue of framework agreements was considered by the Sąd Najwyższy of March 29, 2017, ref: I CSK 395/16. The court’s considerations lead to the following conclusions:

• the framework agreement does not specify the provisions of subsequent agreements concluded by the Parties in view of the assumed commitment to cooperation,
• the framework agreement does not specify the elements of the target contracts to be concluded, orders to be placed,
• the framework agreement does not contain specific, firm, final obligations to purchase/perform supplies/services,
• the framework agreement leaves to the parties the final decision on the actual implementation of the obligations of the order or performance of certain activities stipulated therein,

Thus, it is reasonable to conclude that a framework agreement is not a contract whose content concretizes the material and procedural conditions of cooperation, i.e., which contains:

• a specific obligation to perform designated activities (e.g., a commitment to purchase 1,000 tons of aggregate and an obligation to deliver the quantity of aggregate in question, during the term of the contract),
• describes the method of placing orders,
• indicates the amount of prices, discounts, includes references to the calculation of prices, discounts (e.g., to available price lists in effect on the date of service/delivery),
• indicates the method of payment regulation, persons authorized to carry out the established procedures.

Orders placed on the basis of the provisions of the legal relationship structured in this way, i.e. orders constituting the technical element of the implementation of contractual obligations, despite the fact that their content indicates the scope of the service/supply, the date of execution, the price, the place of execution (i.e. the essential elements of the contract in the context of the formal-legal evaluation) do not justify each time their notification in connection with the procedures in force in the construction processes for notification of contracts concluded with subcontractors.

Contracts concluded on the basis of the FIDIC Conditions introduce a time limit of 28 days for submitting a claim, counted from the date on which the party submitting the claim became aware of the event or circumstance giving rise to the claim. The FIDIC Conditions provide that failure to comply with the time limit shall have the effect of releasing the other party from any liability arising in connection with the event or circumstance giving rise to the claim. Although the FIDIC stipulates a time limit for submitting a claim for both the Contractor’s and the Contracting Authority’s claims, in practice the issue mainly concerns claims submitted by the Contractor.

The admissibility of reserving the consequences of failure to comply with the time limit for submitting claims and the legal consequences of such reservations have been considered by the courts on more than one occasion. The most widespread decision in this regard is the judgment of the Supreme Court of the Republic of Poland of 23 March 2017, ref. V CSK 449/16, which, taking into account the decision of the Supreme Court of 22 June 2016, ref. III CZP 19/16, established clear rules on the time limits within which the contractor must notify the contracting authority of the circumstances giving rise to the claim.

This case law remains valid despite the passage of time. According to the judgment of the Supreme Court of the Republic of Poland of 27 April 2023, ref. II CSKP 70/23 “the time limit provided for in Clause 20.1 of the FIDIC Conditions for the Contractor to notify the Contracting Authority of circumstances justifying an extension of the time limit for completion of the works or justifying payment for additional works is a contractual time limit for a contractual act of diligence, on pain of losing a specific claim”.

It should therefore be noted that the contractor’s failure to comply with the deadline for notifying the claim may result in the loss of its right to require the contracting authority to settle the claim on the basis of the contractual provisions, but does not limit its right to pursue the claim in court.

As a result of the case law developed, the failure to comply with the contractual time limit for submitting the claim no longer leads in practice to the rejection of claims. If the assessment of the timeliness shows that the notice was submitted after the expiry of the 28-day deadline and the assessment of the merits of the claim shows that there are grounds for recognizing the claim, the contracting authority will normally accept the contractor’s claims, taking into account the risk of possible litigation and the subsequent risk of incurring additional costs arising from litigation. The use by the parties of the out-of-court dispute resolution procedure provided for in the contracts is a good practice that benefits both parties.

It is standard practice to include drag along clauses in investment agreements, especially in the case of selling a portion of shares rather than the entirety. The drag along clause plays a crucial role in the functioning of a company or startup. It is natural that investors, by injecting their capital into a company in its growth phase, are interested in securing their interests by obtaining influence over when and which share package may be subject to disposal when they decide to exit the investment.

What is a drag along clause?

The drag along clause, empowers a preferred shareholder (investor) to compel other shareholders to sell their shares in the company to a designated entity chosen by the preferred shareholder. This provision is triggered when the designated entity expresses interest in acquiring a larger share than what the preferred shareholder possesses. The terms under which the preferred shareholder can demand the sale of shares by other shareholders mirror those proposed by the preferred shareholder to the buyer or those offered to them by the buyer.

What should be remembered in the process of negotiating the drag along clause?

When negotiating a drag along clause in an investment agreement, it’s important to consider several key elements, particularly:

Timeframe for exercising the drag along right.

Considering that the company (startup) is still building its value, it’s essential to specify from which point onwards the drag along right can be exercised by the privileged shareholder. This is particularly significant from the perspective of the interests of other shareholders, to limit the investor’s ability to exercise the drag along right at any time. It’s also important to note that the capital obtained from the investor should contribute to the company’s value and its valuation post-investment. Time is needed to assess the extent of the investment’s impact on the company’s value and, consequently, the level of return on investment for the investor.

Conditions for exercising the drag along right.

It is imperative to address the determination of the conditions under which an investor can exercise the drag along right. It is advisable to specify in the investment agreement at least the minimum price per share at which the drag along right can be utilized. Another method of safeguarding against being dragged into selling shares at too low a price is for the parties to agree on a procedure for verifying the price of the shares, such as selecting independent appraisers who will determine the value of the shares in the event the investor exercises the drag along right.

It is also possible to include in the investment agreement the requirement for the privileged party to obtain a suitable offer, primarily concerning the attractive valuation of the shares, or to make the exercise of the drag along right contingent upon the occurrence of a specified event.

What impact can liquidation preference have on the exercise of the drag along right?

The drag along clause should not be negotiated independently of the liquidation preference clause, which guarantees the investor a specified level of return on investment (the liquidation preference clause will be addressed in a separate article). It should be remembered that under the liquidation preference clause, the privileged party is the investor. Failure to analyze the liquidation preference clause in connection with the drag along clause can, in the worst-case scenario, lead to a situation where the entire asset subject to division upon exit from the company will accrue to the investor.

Can the drag along right be limited by other provisions of the investment agreement?

Introducing into the investment agreement in favor of the remaining partners the right of first refusal or right of first offer can serve as a sort of protection against being drawn into a share sale transaction by the investor under the drag along clause. In such a situation, from the perspective of protecting the interests of the investor, it will be important to specify strict deadlines within which the partners will be able to exercise such right and the deadline for payment of the price.

In summary, effectively constructing and negotiating the drag along clause requires an understanding of the entire mechanism of the investment agreement, as exercising the drag along right and its protection may be interconnected and often linked to other clauses of the investment agreement.

We understand the complexity and nuances involved in this matter. Should you require legal assistance in navigating these complexities, we encourage you to reach out to Hoogells for expert guidance and support.

The tag along clause, also known as the right of accession, plays a significant role in investment agreements, particularly in terms of protecting the interests of minority shareholders. It is a legal instrument that ensures equality in situations where one of the shareholders, often the dominant one, decides to sell their shares.

What exactly is the tag along clause?

The tag along clause is based on the provisions concerning contracts for the benefit of a third party, as specified in Article 391 of the Civil Code. In essence, it obliges a shareholder who is selling their shares to enable other shareholders (the entitled ones) to also sell their shares on the same terms offered to the original selling shareholder.

The party ensuring performance by the third party is the seller (the entitled shareholder), who has the right to demand the inclusion in the sale, while the third party is the purchaser of the share rights. Consequently, in the event of selling shares to a third party (the purchaser of the shares), the selling shareholder undertakes to the entitled shareholder that the third party will also acquire shares from them at a price per share not lower than that offered to the selling shareholder. The obligation to make such proposals lies with the selling shareholder.

How to properly structure the tag along clause?

It is advisable to include the tag along clause in the article of association already at the stage of drafting. This will ensure transparency and certainty to shareholders regarding the rules of any future sale of shares. In such a situation, the application of the clause in the investment agreement must be in line with the provisions of the article of association.

When drafting the tag along clause, it is essential to consider significant rights and obligations that facilitate the exercise of the right arising from it. This includes, among other things:

• The obligation of the selling shareholder to disclose the possibility of other shareholders joining the transaction in accordance with the tag along clause.
• Ensuring that the selling shareholder allows other interested shareholders to sell their shares to a third party who offered to purchase the shares to the original selling shareholder.
• Stipulating that the conditions for the purchase of shares by entitled shareholders will not be worse than those proposed to the original selling shareholder.

In the investment agreement, it is crucial not to forget to specify the terms that will bind the shareholders exercising the right of accession and the third party acquiring the shares.

How to secure the performance of the obligation arising from the tag along clause?

The tag along clause represents an obligation that the parties to the investment agreement can secure by introducing a contractual penalty. Additionally, including this clause in the article of association along with a contractual provision can strengthen its effectiveness by specifying sanctions for its violation, such as subjecting the shares sold in breach of the tag along clause to compulsory or automatic redemption.

In conclusion, the tag along clause can prove to be a crucial element in an investment agreement, ensuring the protection of minority shareholders’ interests in the event of a sale of shares by a dominant shareholder. Its effective application requires precise drafting and consideration of significant rights and obligations of the parties involved.

The Congress of Listed Company Lawyers SEG organised by the Polish Association of Listed Companies (Stowarzyszenie Emitentów Giełdowych) is one of the most important events addressed to the capital market community in Poland. During the two days of the Congress, participants will have the opportunity to discuss issues relevant to legal departments of listed companies. The event will be held on 6-7 April in Jachranka.

On the first day of the Congress – April 6 – Miroslaw A. Metych, Partner, Head of M&A at Hoogells will take part in the panel discussion “Sustainable Financing – Green Bonds as an Example”.

You are cordially invited! After a long break, this is a unique opportunity to meet live, talk and exchange experiences.

Details about the panel and the registration form are available on the SEG website: MORE INFORMATION

Hoogells is once again expanding its practice in recent times – this time with the real estate & finance practice. Jakub Mosoń, previously Head of Legal Department and Group Compliance Manager at a leading international real estate development company, has been appointed its head.

“The growth of the Real Estate and Finance practice has been an indispensable element in Hoogells’ strategy alongside the Infrastructure and Public Procurement practices. It is the answer to our clients’ needs. I have known Jakub since my university days and I know that his experience from the last years spent in an international development group, including, among others, supervising M&A processes in the capital group, a number of due diligence projects for sale and acquisition of project companies or coordination of investment processes fits perfectly with our expectations. I am convinced that Jakub’s previous business experience and his managerial skills will be of great benefit to the firm’s clients who have been wanting to entrust us with their cases in this area for some time now. Welcome to the team!” – says Anna Oleksiewicz, CEO of Hoogells Law Firm.

Jakub Mosoń, lawyer and manager, from March 1, 2022, is a partner and head of real estate & finance at Hoogells, where he manages a team that supports clients in all aspects of real estate law and real estate finance transactions. Jakub has extensive experience in real estate legal services, office and shopping mall property management and a solid banking background. He also has a practical knowledge of compliance and corporate law. The significant experience of the law firm’s new partner is also his longstanding practice in the internal departments of banks, which allowed him to acquire the skills to solve financing issues from the perspective of the financing bank’s risk.