What are shares bound by other contracts? Main legal risks to note

In corporate practice, shares bound by other contracts are a situation that arises frequently but is often underestimated. Where shares are subject to arrangements outside the company charter or share transfer agreements, shareholders’ rights and the ability to dispose of shares may be directly affected, significantly increasing the risk of legal disputes if such binding is not properly identified and managed in a timely manner.

I. Common legal risks relating to shares bound by other contracts

Shares bound by other contracts carry substantial legal risks if shareholders and companies fail to identify them from the outset. In practice, common risks include:

• Risk to the validity of transactions: Share transfers may be declared invalid, suspended, or required to be rescinded if they breach binding provisions under previously executed contracts.
• Risk of restriction on shareholder rights: Shareholders may be restricted in voting rights, transfer rights, dividend entitlements, or be required to prioritize performance of obligations to third parties under relevant contracts.
• Risk of disputes: Disputes among shareholders, between shareholders and the company, or with third parties are likely to arise where contractual bindings are not properly disclosed or conflict with the company charter.
• Risk of legal liability: Failure to disclose or concealment of the binding status of shares may result in liability for damages, contractual sanctions, or other legal sanctions.
• Risk to corporate governance and investment: Bound shares undermine transparency, complicate corporate governance, capital raising, and future investment transactions.

These risks highlight the critical importance of comprehensive contract review, full disclosure, and strict compliance with applicable law when addressing matters relating to shares bound by other contracts.

II. Understanding shares bound by other contracts

In corporate legal practice, shares bound by other contracts must be properly identified and understood before assessing the relevant rights, obligations, and risks.

A clear grasp of the nature of such encumbrances, their causes, the types of contracts creating them, and their impact on shareholders’ interests forms a main basis for dispute prevention and protection of the lawful interests of the parties concerned.

1. What are shares bound by other contracts and why does such a matter?

Pursuant to Point (a), Clause 1, Article 111 of the Law on Enterprise 2020, the charter capital is divided into equal portions called shares, demonstrating that shares constitute the units of charter capital and are associated with shareholders’ rights and obligations.

Shares bound by other contracts are shares in respect of which the establishment, exercise, or disposition of shareholders’ rights (such as transfer, voting, dividend entitlement, etc.) is governed not only by the company charter and the Law on Enterprise 2020, but also by one or more other civil contracts that have been duly executed.

Under Articles 8 and 385 of the Civil Code 2015, parties are free to enter into agreements on a voluntary basis, and lawfully executed contracts are binding upon the parties. Accordingly, where shareholders enter into contracts such as share transfer restriction agreements, capital contribution agreements, or loan agreements secured by shares, the relevant shares become subject to contractual obligations arising therefrom.

Such an issue is particularly important because, under Article 115 of the Law on Enterprise 2020, shareholders enjoy fundamental rights in respect of their shares; however, such rights may be lawfully restricted where shareholders have undertaken other contractual commitments. Failure to properly identify shares encumbered by other contracts may render share transactions invalid, lead to disputes, and directly affect the lawful rights and interests of shareholders and related parties.

2. What situations commonly give rise to shares being bound by other contracts?

In practice, shares are commonly encumbered by other contracts in the following situations, based on the principles of freedom and voluntariness in contracting under Articles 3 and 385 of the Civil Code 2015:

• Execution of share transfer restriction agreements: Shareholders undertake not to transfer, or to transfer shares only upon satisfaction of certain conditions, in accordance with the freedom of contract under the Civil Code and the rules on share transfer under Article 127 of the Law on Enterprise 2020.
• Capital contribution and investment cooperation contracts: Shares are created or used to secure performance obligations under capital contribution or business cooperation contracts, resulting in contractual constraints on the disposition of shares.
• Loan agreements secured by shares: Under Article 292 of the Civil Code 2015, shares may be used as security, leading to restrictions on their transfer or disposition.
• Agreements among shareholders or with third parties: Shareholders’ agreements, rights of first refusal, share option arrangements, and similar agreements lawfully executed create binding obligations affecting shares according to Article 385 of the Civil Code.
• Commitments in mergers and acquisitions transactions: In M&A transactions, shareholders may undertake lock-up commitments or restrictions on share transfers for a defined period, resulting in shares being encumbered by other contracts.

These situations demonstrate the necessity of reviewing all relevant contracts to accurately determine the legal status of shares encumbered by other contracts.

3. What types of contracts can lead to shares being bound by other contracts?

In practice, shares bound by other contracts commonly arise from the following types of agreements, based on the binding force of contracts under Article 385 of the Civil Code 2015:

• Shareholders’ agreements: Agreements between shareholders or between shareholders and investors governing transfer restrictions, pre-emptive rights, voting rights, and similar matters that directly affect the disposition of shares.
• Capital contribution and investment cooperation contracts: Shares formed or used to perform capital contribution and profit-sharing obligations are subject to agreed contractual constraints.
• Loan agreements secured by shares: Pursuant to Article 292 of the Civil Code, shares may be pledged or mortgaged as security, restricting shareholders’ rights of transfer or disposition during the security period.
• Conditional share sale and transfer agreements: Agreements providing for deferred transfers, buy-back rights, call options, or put options may create contractual binding over shares.
• Share entrustment, management, or trust arrangements: Where shareholders authorize other parties to exercise rights attached to shares, the direct exercise of shareholder rights is altered or restricted in accordance with law.
• Commitments in mergers and acquisitions transactions: Lock-up clauses and transfer restrictions in M&A transactions lead to contractual encumbrances over shares.

Where lawfully executed, the above contracts may give rise to shares being bound by other contracts, directly affecting shareholders’ rights and interests.

4. How do shares bound by other contracts affect shareholders’ rights and interests?

Shares encumbered by other contracts may directly affect shareholders’ lawful rights and interests in several ways:

• Restrictions on disposition of shares: Shareholders may not be free to transfer, pledge, mortgage, or sell shares if doing so would breach contractual commitments, notwithstanding the general principle of free transferability of ordinary shares under Article 127 of the Law on Enterprise 2020.
• Impact on voting rights and corporate governance: Contracts may bind voting arrangements or proxy voting, reducing shareholders’ participation in corporate management as provided under Point (a), Clause 1, Article 115 of the Law on Enterprise 2020.
• Increased risk of legal disputes: Where contractual bindings are not fully disclosed or conflict with the company charter, shareholders may face disputes with the company, other shareholders, or third parties.
• Exposure to legal liability and damages: Where shareholders breach contractual obligations that encumber shares, they may be subject to contractual sanctions or damages under Articles 351 and 360 of the Civil Code 2015.

These impacts underscore the importance of fully identifying and assessing shares bound by other contracts to safeguard shareholders’ lawful interests.

III. Applicable legal framework governing shares bound by other contracts

Shares encumbered by other contracts may lead to disputes over ownership and transferability. The current legal framework regulates encumbrances, decision-making authority, and dispute-resolution mechanisms.

1. How does current law regulate shares bound by other contracts?

Although current law does not expressly define the concept of “shares bound by other contracts,” the legal framework governing this issue is established through the Law on Enterprise 2020 and the Civil Code 2015, in particular:

• Rights attached to shares: Under Article 115 of the Law on Enterprise, shareholders have ownership and disposition rights over their shares, subject to compliance with law and lawful contractual commitments.
• Transfer of shares: Article 127 of the Law on Enterprise provides that ordinary shares are, in principle, freely transferable unless otherwise provided by law or the company charter. In practice, lawful contractual restrictions may create binding over shares.
• Binding effect of contracts: Under Article 385 of the Civil Code, contracts lead to rights and obligations and are binding if lawfully concluded; accordingly, contracts relating to shares may create legal encumbrances over the relevant shares.
• Performance of obligations: Article 351 of the Civil Code requires obligors to duly perform contractual obligations; breach may entail civil liability, including in relation to share disposition.

These provisions demonstrate that shares bound by other contracts are indirectly recognized through the legal regime protecting the binding effect of contracts and freedom of contract, provided such arrangements do not contravene mandatory law or the company charter.

2. Who has authority to decide disputes relating to shares bound by other contracts?

Where disputes arise in relation to shares bound by other contracts, decision-making authority depends on the parties and the legal relationship involved:

• Competent courts: Under Article 30 of the Civil Procedure Code 2015, civil and commercial contract disputes relating to shares fall within the jurisdiction of the courts, which may review contract validity, the scope of binding over shares, and the rights and obligations of the parties.
• Commercial arbitration: Where an arbitration clause exists, disputes may be resolved by arbitration pursuant to Articles 5 and 7 of the Law on Commercial Arbitration 2010, with arbitral awards being final and binding.
• Internal corporate bodies: For internal disputes among shareholders or between shareholders and the company, matters may first be addressed in accordance with the company charter under the Law on Enterprise; however, internal bodies do not have final adjudicatory authority if no agreement is reached.
• Party autonomy: Pursuant to the principle of freedom of contract under Article 3 of the Civil Code, parties may negotiate or mediate disputes prior to initiating formal proceedings.

Accordingly, final adjudicatory authority in disputes over shares bound by other contracts lies with the courts or commercial arbitration, depending on the agreed or elected dispute-resolution mechanism.

3. What measures are available to resolve disputes arising from shares bound by other contracts?

Where disputes arise in relation to shares bound by other contracts, current law permits the following dispute-resolution measures pursuant to Article 317 of the Law on Enterprise 2020:

• Direct negotiation between the parties, consistent with the principles of freedom and voluntariness in contracting under Article 3 of the Civil Code.
• Mediation through a neutral intermediary to reduce costs and preserve cooperative relationships.
• Resolution by arbitration or courts:
• If the contract contains an arbitration clause, disputes may be referred to commercial arbitration under the Law on Commercial Arbitration 2010.
• In the absence of an arbitration clause, disputes fall under the jurisdiction of the courts according to the Civil Procedure Code 2015.

In addition, parties may seek interim relief measures under the Civil Procedure Code 2015 to prevent unlawful transfer or disposition of shares during the pendency of the dispute.

IV. Questions regarding shares bound by other contracts

This section addresses common questions concerning identification of bound shares, relevant contractual clauses, shareholders’ rights, litigation options, and liability for failure to disclose binding.

1. How can one determine whether shares are bound by other contracts?

To determine whether shares are bound by other contracts, both internal corporate documents and civil contractual relationships should be reviewed:

• Reviewing the company charter and internal resolutions: Pursuant to Article 24 of the Law on Enterprise 2020, the company charter and resolutions of the General Meeting of Shareholders/Board of Directors may provide for restrictions relating to shares.
• Reviewing executed contracts and agreements: Under Article 385 of the Civil Code 2015, lawfully executed contracts are binding; accordingly, all shareholders’ agreements, capital contribution contracts, share-secured loan agreements, and conditional transfer agreements should be examined for bound clauses.
• Reviewing the register of shareholders: Under Article 122 of the Civil Code 2020, the shareholder register evidences share ownership, and certain binding (such as pledges or mortgages) may be noted therein.
• Verify secured transactions: Where shares are used as security under Article 292 of the Civil Code, relevant security agreements and registration status (if any) should be reviewed to determine the scope of binding.

These steps help accurately identify shares bound by other contracts and mitigate legal risks in transactions and corporate governance.

2. Which contractual clauses may cause shares to be bound by other contracts?

Contractual clauses that create restrictions or regulate the exercise of rights over shares commonly lead to binding. Based on the binding effect of contracts under Article 385 of the Civil Code, typical clauses include:

• Share transfer restriction clauses imposing lock-ups or conditional transfers, notwithstanding the general free transferability of ordinary shares under Article 127 of the Law on Enterprise.
• Pledge or mortgage clauses over shares under Article 292 of the Civil Code, restricting disposition during the security period.
• Pre-emptive rights, and options requiring priority sale to specified parties or granting purchase rights under agreed conditions.
• Voting and governance arrangements affecting the exercise of shareholder rights under Clause 1, Article 115 of the Law on Enterprise.
• Profit and dividend allocation clauses deviating from standard mechanisms, affecting dividend entitlements under Article 135 of the Law on Enterprise.
• Sanctions and damages clauses under Articles 418 and 360 of the Civil Code, which, while not directly restricting shares, exert legal pressure limiting free disposition.

Where lawfully agreed, such clauses may bind shares and directly affect shareholders’ lawful rights and interests.

3. What rights can shareholders claim where their shares are bound by other contracts?

Where shares are bound by other contracts, shareholders may still seek protection of their lawful rights and interests within the limits permitted by law:

• Right to require due performance of contracts: Under Article 351 of the Civil Code, shareholders may require counterparties to properly perform contractual commitments concerning shares.
• Right to statutory shareholder rights: Under Article 115 of the Law on Enterprise, shareholders retain core rights such as meeting participation, voting, and access to information, except where they have lawfully agreed to restrictions.
• Right to dividends and economic benefits: For cases lacking contractual arrangements, shareholders may require dividend payment under Article 135 of the Law on Enterprise, and seek remedies where such rights are unlawfully infringed.
• Right to claim damages: Where contractual breaches infringe shareholders’ interests, damages may be claimed under Article 360 of the Civil Code.

Accordingly, even where shares are bound by other contracts, shareholders retain a legal basis to seek protection of their interests within the scope of law and contractual commitments.

4. In what circumstances may shareholders initiate legal action where their shares are bound by other contracts?

Shareholders or groups of shareholders holding at least 1% of ordinary shares may initiate proceedings in their own name or on behalf of the company where their rights or the company’s interests are infringed, according to Article 166 of the Law on Enterprise 2020. Relevant circumstances include:

• Breach of duties by company managers under Article 165 of the Law on Enterprise resulting in unlawful binding over shares.
• Acts in breach of law or the company charter affecting rights and obligations attached to bound shares.
• Abuse of position, information, or business opportunities for personal gain or third-party benefit, causing unlawful binding or restriction of shareholders’ lawful rights.
• Other circumstances prescribed by law or the company charter where lawful rights and interests are infringed.

Thus, even in the context of shares bound by other contracts, shareholders have a legal basis to initiate proceedings against company managers where bindings arise from unlawful acts or breaches of the company charter that prejudice shareholders’ lawful interests.

5. Who takes liability for failure to timely disclose that shares are bound by other contracts?

Legal liability for failure to timely disclose binding over shares depends on the party bearing the disclosure obligation and the consequences arising therefrom:

• Liability of shareholders: Where a shareholder is aware that its shares are bound but fails to disclose this to the company or transferees, causing loss, the shareholder may be liable for damages under Article 360 of the Civil Code.
• Liability of the company: Where the company fails to duly update and record binding information in the shareholder register under Article 122 of the Law on Enterprise, causing loss to purchasers or new shareholders, the company may be liable for damages under Article 597 of the Civil Code.
• Liability of relevant third parties: Where bindings arise from security agreements, pre-emptive rights, or options and third parties fail to fulfill disclosure or confirmation obligations under the relevant contracts, they may be liable for damages under Article 361 of the Civil Code.

Accordingly, failure to timely disclose encumbrances over shares may lead to civil liability for shareholders, the company, or third parties, depending on the breaching party and the losses caused, in order to protect the lawful interests of the affected parties.

V. Looking for a reputable law firm to assist with issues relating to shares bound by other contracts?

In corporate governance, particularly in matters affecting shareholder rights and shares bound by other contracts, timely advice from NPLAW can assist companies and shareholders to:

• Clarify rights and obligations relating to shares, including the scope of binding, disposition rights, dividend entitlements, and contractual obligations, thereby mitigating legal risks and disputes arising from unlawful management decisions.
• Determine legal liability and compensation obligations under the Law on Enterprise and related regulations, ensuring transparent and lawful handling of infringements of shareholders’ rights.
• Draft, review, and refine internal documents, including the company charter, resolutions of the Board of Directors/General Meeting of Shareholders, and shareholders’ agreements, to establish robust protection mechanisms, clarify liability for damages, and prevent disputes relating to encumbered shares.

The above information is for reference only. For tailored advice on specific cases, please contact Ngoc Phu Law Company Limited for timely and professional support.