Non-compete obligation for board members and shareholders of a closely held company limited by shares

Legal Insight

October 2024

Konstantina Daskalopoulou, LLM

Summary: The rule in a public limited company is that shareholders are not burdened with obligations. By simply paying their contribution, shareholders enjoy the privileges of corporate participation, the main one being the right to receive dividends. In this paper, we will examine an exception to this rule, which, under certain conditions, imposes a duty of loyalty, specifically in the form of an obligation for shareholders to refrain from engaging in competitive acts that could potentially harm a closely held, family-run SA.

1. Introduction:

The public limited company (SA) is a corporate form oriented toward raising capital from the market to achieve its corporate purpose. Individuals who acquire shareholder status (through the subscription of shares offered at the time of company formation or during a capital increase) have no further obligation other than to pay their contribution, that is, the value of the shares they have undertaken. The lack of obligations for shareholders is associated with the classic form of the SA, which is multi-shareholder, consisting of individuals who are continuously changing, so it is considered that the imposition of additional obligations would hinder the transfer of shares and negatively affect their marketability. However, under certain conditions, the imposition of a duty of loyalty on shareholders in companies with personal characteristics (also known as "family-run," "closely held," or "small" public limited companies) is recognized.

2. Rule: The Duty of Loyalty & the Obligation to Refrain from Competitive Acts Concern Partners in Partnerships

This obligation is a fundamental characteristic of partnerships (e.g., General Partnerships, Limited Partnerships) and consists of the partners' duty to act in a manner that promotes the realization of the company’s purpose (positive aspect) and their obligation to refrain from actions that prioritize the service of their personal interests or the interests of third parties and conflict with the company’s interests (negative aspect). Essentially, the duty of loyalty requires partners to pursue the best possible balance between individual and corporate interests, to consider the personal interests of their partners and the company, and to choose the necessary, appropriate, and, where applicable, the least onerous means to satisfy their individual interests (Court of Appeals of Patras, 77/2023).

A specific form of the duty of loyalty is the obligation to refrain from competitive acts. Acts are considered competitive when they are similar to those falling within the scope of the company’s purpose, as defined by the articles of association, in combination with the company’s actual economic activity. In this context, it is not permissible for a shareholder to even participate in another company that operates in the same or a similar field as the company in which they hold shares. According to case law, the prohibition of competition covers not only acts that constitute unfair competition but also the performance of legitimate competitive acts, with the key element being the risk posed by the competitive act (Court of Appeals of Patras, 77/2023).

Thus, while the duty of loyalty is an obvious consequence of participation in a partnership, the same does not apply to capital companies, and specifically, in the case of the SA, where shareholders are not, in principle, burdened with such obligations.

3. Exception: The Duty of Loyalty & the Obligation to Refrain from Competitive Acts Imposed on Shareholders in an SA

The obligation to refrain from competitive acts, as an aspect of the duty of loyalty, is not unknown within the provisions that regulate the SA. Both the duty of loyalty and the prohibition on engaging in competitive acts are explicitly recognized in Law 4548/2018 (Articles 97 and 98) as obligations that bind the members of the Board of Directors (BoD) of the SA and, in general, individuals involved in the management of the company, but not the shareholders.

Specifically, Law 4548/2018 explicitly imposes on the members of the BoD the obligation to refrain from competitive acts (Article 98). This provision prohibits BoD members who participate in any way in the company’s management, as well as its directors, from acting for their own account or for the account of third parties in ways that fall within the company’s purposes, as well as from participating as general partners or sole shareholders or partners in companies pursuing such purposes. This prohibition is justified by the fact that, due to their position, members of the management have access to confidential company information, the exploitation of which facilitates the pursuit of personal goals through the development of competitive activities.

However, this prohibition can be lifted or limited with the approval of the General Assembly or a relevant provision in the company’s articles of association. Additionally, the law establishes the company’s right to claim compensation against the member in case of a willful violation of the prohibition. Alternatively, the company is entitled to demand that the competitive act be considered as performed on its behalf (when the BoD member sought to satisfy personal interests), or to receive the remuneration that the BoD member would have earned from acting competitively in favor of a third party.

However, as mentioned earlier, the law does not include a corresponding provision imposing a duty of loyalty on the shareholders of the SA, nor a provision requiring them to refrain from engaging in competitive acts that would be detrimental to the company’s interests.

The absence of such a provision in the framework of the SA is consistent with the fundamental characteristics of this corporate type in its classic form. What matters in a public limited company is the raising of capital, while the identity of the shareholders, who change frequently and can liquidate their investment at any time, is of no importance. Under this lens, no personal relationships develop among the shareholders of a classic SA, and for this reason, as noted in case law (Court of Appeals of Patras, 77/2023), there can be no question of a duty of loyalty.

However, it is accepted that the obligation to refrain from competitive acts may be recognized, depending on the circumstances, for the majority shareholder or shareholders in a closely held, family-run public limited company. Thus, based on key criteria, such as the shareholder’s ability to influence corporate affairs and the structure of the SA, the duty of loyalty and the associated obligations are accepted on a case-by-case basis, to a degree and intensity that are adapted to the particular characteristics of each company.

4. Specifically, the Duty to Refrain from Competitive Acts in Small, Family-Run Public Limited Companies:

The vast majority of public limited companies operating in Greece exhibit the characteristics of small, family-run SAs. These are companies that do not possess the classic features of an SA (primarily the dispersion of shares and the frequent turnover of shareholders) but exhibit traits that resemble the relationship formed among partners in partnerships. Such traits include stable shareholding composition, the development of personal relationships among shareholders (who are often connected by family ties, leading to the term “family-run SA”), and their involvement in the company’s management. These characteristics imply strong shareholder involvement in corporate affairs and the potential risk of harm to the company’s financial interests through the performance of competitive acts.

In reality, the choice of another corporate form (e.g., partnership, private company) would be more suitable for these characteristics. Nevertheless, the SA is preferred by market participants, even though its structure is suited to open-type companies with a large number of shareholders who change frequently and are primarily interested in capital participation. As the Court of Appeals of Patras noted in a relevant decision (77/2023), “The fact that most public limited companies in Greece consist of related persons, i.e., they are not purely capital-based and impersonal but have personal and family-like characteristics, indeed amounts to the indirect undermining of the capital-based nature of the SA, as such a form does not economically fulfill the mission of the public limited company, to which the legislator was aiming, thus creating a major legislative problem.”

Consequently, in the case of public limited companies with the above characteristics, it is accepted that shareholders are bound by the duty of loyalty, including the obligation to refrain from competitive acts, toward the company and the other shareholders due to the personal relationships developed among them.

The breach of this obligation establishes the shareholder’s liability for the damages suffered by the company or other shareholders (based on Article 914 of the Civil Code), and in the case of competitive acts, the obligation to cease and refrain from the disputed conduct. In this latter case, the granting of interim measures, in the form of an injunction against competitive acts, is also possible. In this context, with its decision No. 14255/1996, the Patras Single-Member Court of First Instance prohibited a doctor, who was a shareholder of an SA, from engaging in competitive acts, specifically from providing services outside the medical center operated by the company, given its personal nature (the company’s shareholding consisted exclusively of two doctors, who supported both its scientific and administrative, as well as its financial, progress).

5. The Duty to Refrain from Competitive Acts by the Majority Shareholder (?);

The shareholder’s ability to influence corporate management allows them to gain, even indirectly, access to information related to the company’s activities and to use it for their own benefit and to the detriment of the company. For this reason, the duty to refrain from competitive acts primarily burdens the majority shareholder, who can, by selecting the individuals managing the company, gain access to confidential information and business secrets, which can be exploited in a manner contrary to the company’s interests.

On the other hand, it is argued that the minority shareholder, lacking the corresponding influence, is not burdened with this obligation. However, the Court of Appeals of Patras in the aforementioned decision (77/2023) recognized that a shareholder holding a 35% stake was also burdened with this duty, given that, in this particular case, “although it was proven that the first defendant did not have the status of a dominant shareholder of the company, in the sense that he did not exert significant influence on the decisions of the BoD, his active role over the years in the management of the company, namely his conduct of all transactions and negotiations leading to contracts that resulted in the company’s profitability and the realization of its corporate purpose, as well as the extensive experience he gained in commercial transactions due to his position, reinforced the duty of loyalty that he had as a shareholder.” In this case, of course, the specific public limited company was a purely family-run business, and the shareholder holding 35% had been the president, CEO, and company representative for 13 consecutive years, resulting in “his person being inextricably linked to the company.”

Similarly, the Supreme Court, in its decision No. 432/2016, deemed it entirely justified to establish a duty of loyalty for a minority shareholder of a public limited company due to its structure and, specifically, the fact that it was a public limited company with a limited number of shareholders, and the BoD members, including the litigants, had developed personal relationships with each other.

It is therefore clear that the specific characteristics of each SA, and especially its structure (number of members, development of personal relationships among them), justify the imposition of the duty to refrain from competitive acts on every shareholder, regardless of their percentage of participation in the company.

It should be noted that if the shareholder (whether majority or not) personally participates in the company’s management, they are in any case bound by the obligation to refrain from competitive acts imposed by Article 98 of Law 4548/2018. Consequently, the recognition of a duty of loyalty for shareholders is particularly important in cases where the roles of shareholders and managers of the SA do not coincide. Furthermore, since the duty of loyalty and the related obligation to refrain from competitive acts ceases with the loss of BoD membership, linking this obligation to the shareholder status under the above conditions renders unnecessary any tactical resignation of a shareholder from the company’s management, aimed solely at avoiding the obligation to refrain from competitive acts.

Thus, the Court of Appeals of Patras, in its decision No. 77/2023, ruled that the establishment and participation of a shareholder in a limited partnership with a similar purpose to that of the public limited company in which they held a 35% stake, as well as the provision of their personal labor to this partnership, constitutes a direct competitive act against the interests of the SA on the grounds that “in this way, he deprived the company of profitable transactions and business opportunities, which he secured for the benefit of another entity.” It is noteworthy that, in this case, the shareholder resigned from the BoD of the SA and, a few days later, founded with his wife (a former employee of the SA) a limited partnership with a similar corporate purpose, harming the interests and reputation of the SA.

6. By Way of Conclusion:

The closed structure of a public limited company makes it necessary to deviate from basic concepts of SA law to adapt it to the corresponding transactional reality. In this context, it has been ruled that the invocation by a shareholder of the publicity formalities of a personal SA, which the company traditionally did not observe since its formation, is abusive (Piraeus Single-Member Court of First Instance, 746/1996). Following the same reasoning, the recognition of the obligation of SA members to refrain from engaging in competitive acts represents another example of a fair adjustment of the public limited company to meet the needs of transactions, to avoid behaviors by shareholders that could harm the company’s progress.