Put and call options are deal devices widely adopted in M&A transactions to prevent or resolve shareholders’ conflicts without the need to start arbitration or litigation. In Brazil, such provisions can be embedded in shareholders’ agreements or formalized as standalone agreements. While usually effective, put/call options sometimes do not work as advertised and give the party against which they are being exercised the leeway to oppose enforcement.
The option holder can rely on a series of mechanisms to enforce the option and usually succeeds in doing so. As demonstrated by precedents from São Paulo and Rio de Janeiro courts, the holder can usually resort to fast-track enforcement proceedings which allow the court to execute the transfer of the shares prior to any merits discussion. For instance, the Rio de Janeiro State Court in 2014 affirmed the validity of a put option clause on the grounds that it is possible to set the option price using foreign currency as a parameter as this did not depend on the discretion of the option holder.
On the other hand, recent arbitral awards entered under the rules of the arbitration center of the São Paulo Stock Exchange (the so-called “CAM-B3”) show that contractual provisions on the setting or adjustment of the option price could ultimately become hurdles to enforcement. These awards reveal that parties may face a bigger challenge when attempting to enforce options that involve pricing methods which may affect the value of the underlying shares depending on the outcome of certain events. Consequently, any criterion that results in the shares becoming disproportionately cheap or expensive vis-à-vis fair market value may be disregarded.
These were precisely the grounds on which an arbitral tribunal voided the adjusted price of a put option agreement in 2020. According to the tribunal, the price would allow seller to recover its investment, but the proposed calculation subtracted from the invested amount any dividends of the company distributed to seller whilst he remained a shareholder of the company. This was deemed to breach the statutory rule by which no shareholder may be prevented from earning profits and bearing losses of the company.
Another award from 2018 highlights that the adjusted price should reflect the current value of the shares at the time of the exercise of the option. The arbitral tribunal found that any share devaluation over time should be factored in when calculating the put option price where such devaluation stemmed from normal business risks. In the end, the tribunal dismissed seller’s claim for payment because the net equity of the company was negative – despite the way the parties had structured the put option.
Ultimately, the parties are free to agree that one of them (or both) will have the discretionary right to sell shares to or buy shares from the other party at a certain price if certain conditions are met; however, at the same time, the option holder must act in good faith and its discretion may not go as far as to unilaterally control if and when the agreed-upon condition will be met, or to avoid all risks while pocketing all gains entailed in share price variations.
Notwithstanding the complexity of M&A deals and their parties’ sophistication, a basic principle applies: you can’t have your cake and it eat too. But this is obviously much easier said than done, which is why it is so important that parties pay extra attention when negotiating put/call options, to make sure that they can get as much upside as possible without jeopardizing the validity or enforceability of their rights in the future.