A SECONDARY, AUXILIARY FUNCTION OF THE ENDORSEMENT OF SHARE CERTIFICATES?
Arno Mamassiyan[1]
The Supreme Court of Cassation’s recent Judgment № 133 from 14 January 2016 rendered under commercial case № 1834/2014 II commercial division, raises interesting issues. The judgment is one of principle and deals with an issue of considerable significance for commercial transactions in relation to the legal nature of the endorsement by way of which shares are transferred. In the abovementioned judgment, the court assumes that: "the endorsement on shares, unlike the endorsement on bills of exchange, has a secondary, auxiliary function –it is always in relation to a specific causal transaction for the transfer of the shares, in which case the endorsee derives their rights by means of the transfer. Therefore, the abstract nature of the endorsement is manifested when evidenced on the document, i.e. it is not necessary to mention the grounds for the transfer of the share rights, the interim certificate rights respectively, as well as in the dealings of the endorsee with third parties. However, as far as the contractual relationship that is formed by way of the endorsement is a causal legal transaction, the lack of cause, or defects in the cause, is of considerable significance in the endorser-endorsee relations.”
In the same judgment, the court goes even further, as it accepts in the case in question that in relation to the endorsement: "Lack of proven causal legal relationship leads to its voidness in accordance with the general rule of art. 44 of the Contracts and Obligations Act (COA) in connection with art. 26, para. 2 of the COA, as a consequence of which the transfer of ownership in the endorsed shares is extinguished retroactively". In other words, the court accepted that if the endorsee of the share cannot prove the existence of a causal relationship, which forms the ground for the acquisition of the share, then the endorsement is void. Another issue is the relation between the alleged voidness of the causal relationship and the retroactive extinguishment of the legal effect of the endorsement.[2] What is more significant is that such construal of the link between the causal relation and the endorsement denies the transfer of ownership effect the endorsement has on its own. In the legal doctrine and case law this effect is known as the transport function of the endorsement.[3] The issue of the link between the abstract transaction (there is no disagreement in legal theory and case law that endorsement bears the characteristics of an abstract transaction) and the causal relation is neither new to the theory, nor to case law. In a number of judgments the Supreme Court of Cassation has ruled on this link and in case law it is usually derived from art. 465 of the Commercial Act.[4]
From a theoretical point of view the abstract nature of the legal transaction is defined by the lack of necessity of the existence of a cause as a condition of validity of the abstract transaction.[5] It is considered that the transaction is detached from the cause for entering into it, also because the cause does not form part of the declaration.[6] More importantly, the abstract transaction is valid even when the parties have not pointed out the cause for entering into it. In other words, once the declaration is duly made (in unilateral abstract transactions), it creates the intended legal effect, e.g. assuming the obligations under the bills of exchange[7] or transferring the rights under the share on its endorsement. Lack of a link with the causal relation, which could be a condition for the validity of the unilateral abstract transaction, is especially prominent with guarantees on bills of exchange, as the guarantor cannot raise their own objections against the holder of the bill of exchange.[8] The contrary applies on causal transactions where lack of cause leads to voidness of the transaction (art. 26, para. 2, item 4 Obligations and Contracts Act). Certainly, there are authors who reject the notion of the abstract transaction as a whole and in general the classification of transactions as causal and abstract.[9] It is clear that the abstract nature of the transaction does not exclude the existence of a non-legal cause, which can be the reason for entering into it. The issue is that the cause does not form part of the legal fact or facts that give rise to the formation of the relationship and its intended legal effect. Regarding the endorsement of a share or interim certificates on ownership of shares, this means that the reason for the transfer of ownership (reason for the endorsement) is irrelevant for the creation of the legal effect intended with it, which concerns the transport function of the endorsement. In case law[10] the abstract nature of the transaction is defined not by the lack of the necessity to point out the cause in the declaration but by the lack of the necessity as a whole for the creditor to prove cause for the formation of the relation. As a result, not proving the cause cannot be treated as a ground for voidness of the unilateral transaction. The contrary, however, is what the Supreme Court of Cassation ruled in Judgment № 133 cited above. In this judgment (in an attempt to argue that the endorsement alone is not sufficient for the due transfer of ownership on the shares) a clarification is made that is significant and one of principle. It is stated that the endorsement of shares, unlike the endorsement of negotiable instruments, has a secondary, auxiliary function. The latter, as it becomes clear, is always in relation to a specific causal transaction that forms the grounds for the transfer of the shares. In said judgment the abstract nature of the endorsement is considered to be the lack of a legal necessity for the endorsement to point out the cause for the transfer, but then the lack of cause leads to lack of transfer. This understanding raises interesting issues, especially considering the case law of the Supreme Court of Cassation on the issue of the nature of the share purchase agreement, which is common cause for transfer of shares, acquisition of shares in the capital of a JSC respectively.[11]
Case law treats the share purchase agreement as always a final contract and the rule under art. 19, para. 3 of the Obligations and Contracts Act is not applicable to the agreement, whereas the endorsement on shares which are subject-matter of the share purchase agreement is not an element of the contract. That being said, it becomes readily apparent that the endorsement on shares is a separate and unilateral transaction, and the derivative nature of the acquisition of the endorsed shares[12] does not explain and does not provide for an auxiliary function of the endorsement.
The requirement for cause of the acquisition of shares as a condition for it validity “complements” the elements envisaged in art. 185, para. 2 of the Commercial Act in a way that does not correspond with the law and its spirit. Such understanding creates an unjustified auxiliary characteristic of the endorsement. If the notion of this auxiliary characteristic of the endorsement is accepted, it would create instability in the relationship that arises between the shareholders and the company, which on its part would lead to instability in the operation of the company, as the issue on whether there is lack of true cause for the transfer of shares could by brought up in any given moment. It should be noted that said instability in the relationship between a company and its shareholders could not be “rectified” by the recordings in the shareholders’ register. Case law consistently suggests that recording in the shareholders’ register is not an element of the transfer of shares but rather has a merely declarative function as far as the company is concerned.[13] Therefore, whether an individual is a shareholder can only be determined by means of the identification function of the endorsement and not by the recordings in the shareholders’ register, especially when the latter does not exist, the recordings are not up-to-date or disputed in court.
Rejecting the autonomous nature of the endorsement in light of its inherent effect of transferring ownership cannot be justified and explained in terms of justice. As noted in case law, the principle of justice in civil and commercial transactions dictates that all interests enshrined in law should be protected and defended.[14] In the light of the issue under discussion this means that the endorser who transfers shares when cause is lacking, would be able to claim remedies under art. 55 of the COA but lack of cause would not be a reason to reject the effect of the endorsement of transferring rights.
[1] Partner at Georgiev, Todorov & Co.
[2] If this theory is accepted, it would be more logical for the voidness of the causal relation to give rise to voidness of the endorsement, rather than its retroactive extinguishment
[3] In Judgment № 21 from 04.05.2012 under commercial case № 1091/2010 Commercial Chamber, II Commercial Division, Supreme Court of Cassation, it is noted that: “The endorsement is a unilateral, abstract, formal deal and its effect has three functions: 1/ transport function – the rights under the endorsed shares are transferred by the endorser to the endorsee; 2/ guarantee function – the endorser is liable to all subsequent endorsees under the same conditions as the debtor on the security; 3/ identification function – the endorsement identifies the endorsee as the creditor of the receivable incorporated in the security.
[4] Judgment № 52 from 25.04.2013 under commercial case № 472/2012 Commercial Chamber, I commercial division
[5] Kozhuharov, Al. G. Law on obligations, General part – obligation relations, Book two, Sofi – R, S., 1992, p. 69; Kalajdjiev, A., Law on obligations, General part, Sibi, S, 2007, p. 127, Pavlova, M. Civil Law, General part, Sofi – R, S., 2002 – p. 467
[6]Judgment № 206 from 06.04.2015under commercial case № 3701/2013 Commercial Chamber, II Commercial Division, Supreme Court of Cassation
[7] “The assumption of obligations under bills of exchange stems from an abstract transaction. The obligation arises for the person making the declaration solely by way of and on grounds of the bill of exchange. The existence of the obligation is not dependent on the reasons for which it has been assumed.” – Gerdjikov, O., Commercial Transactions, Trud i parvo, S., 2008, p. 296
[8] Judgment № 104 from 25.07.2016 under civil case № 5345/2015 Civil Chamber, III Civil Division of Supreme Court of Cassation
[9] Takov, Kr., Abstract transactions in the light of the notions of abstractness and causality, Commemorative compendium on the occasion of the 100th anniversary of Prod. Ivan Apostolov, 2001, p. 419 - 451
[10] E.g. Judgment № 85 from 05.07.2012 under commercial case № 438/2011 Commercial Chamber, I
Commercial Division of the Supreme Court of Cassation it is stated that: „Transactions concerning negotiable instruments are by definition of abstract nature and even though this abstract nature is not absolute in all cases, the cause for assuming the obligation to pay is not part of the declaration. Since Art. 535, para. 2 of the Commercial Act contains a requirement that for the validity of the negotiable instrument the promise to may must be unconditional, then the existence of a ground for issuing of a security should be considered as implied by the legislator in the case of abstract transactions. In this sense, a presumption under Art. 26, para. 2, ex. 2 of the COA exists that the ground is presumed until proved to the contrary. The creditor is exempt from the obligation to prove the ground which gave rise to the legal relationship from which the claim stems. By an argument of the provisions of art. 26, para. 2, ex. 2 of the COA and Art. 535, item 2 of the Commercial Act the creditor may request execution on the basis of an abstract transaction without proving the grounds for the occurrence of his claim under this or any other causal transaction related to the negotiable instrument transaction. Therefore, the mere fact that a causal relationship between the issuer and the underwriter of the promissory note is not proven does not constitute ground for voidness of the negotiable instrument transaction. For these reasons, the Supreme Court of Cassation, Commercial Chamber, I division responds the legal question posed as follows: The formal validity of promissory note that establishes a receivable which is due is not void if the creditor has not proved the existence of a causal relationship from which the receivable on the promissory note results. "
[11] Judgment № 222 from 16.01.2014 under commercial case № 708/2012
[12 ]In Judgment № 133 of the Supreme Court of Cassation it is said that on the facts the acquisition of the rights by the endorsee is on a derivative ground.
[13] Judgment № 52 from 25.04.2013 under commercial case № 472/2012 Commercial Chamber, I Commercial Division of Supreme Court of Cassation.
[14] Interpretative Judgment № 1 from 15.06.2010 under interpretative case № 1/2009 Joint Assembly of Commercial Chamber of Supreme Court of Cassation.