Publication date: October 18, 2023
It will be fair to state that the commercial and trade practice require certain flexibility and as the free market can constantly evolve and invent new methods, ways of performing business activity. Some of the examples of these inventions or rather methods allowing to conduct business activities in a better, more efficient manner are different contract provisions, clauses, among which “option” clauses will be of this article’s interest. The very term “option” can be used first and foremost as regards to a specific type of contract, however the terminology can differ between countries and, moreover, the term itself is present in different contexts, which does not always necessarily prejudge its meaning. Nevertheless, this article is focused on legal provisions (included in contracts or, for instance, articles of association) that give the entitled subject certain right regarding the transaction. This right consists on being able to choose consequences, actions or just one of the options as provided for in the contract. The most common aim of these provisions is to secure interests of one of the party or balance interests of both parties. The option clauses are mainly applicable to company contracts but they can be used in commercial transactions to various types of contracts and activities.
Acknowledging the important role that these clauses play in cross-border business, we will start with and concentrate on the status of aforementioned clauses under Polish regulations.
The (non-extensive) scope of Polish regulations
On the contrary to the legal and economic tradition present especially in common law countries, in Poland option clauses were in general rather unknown and unused for a long time. After the System Transformation in the late 80s and in the 90s, Polish economy opened for a free market and all its consequences, part of which were different ways of conducting transactions, concluding contracts and new types of contractual clauses. Despite large legal changes and amendments made at that time, certain areas were not really entirely regulated. Therefore, what plays a significant role for option clauses are both developed practice and existing jurisprudence but also some basic general rules of (probably not only) Polish civil law, such as the freedom of contracts (Art. 3531 of the Polish Civil Code). Whenever it is possible and not against the nature of legal relationship, the statute (act of law) or rules of social coexistence, parties can freely form, create contractual provisions as they prefer. The freedom of course has its limitations but for our topic it is of great importance that it acts as a basis for creating innominate contracts which can be very useful for option contracts.
Bearing in mind the importance of that rule, it cannot be omitted that still some regulations will be applied for option clauses, despite they are not necessarily explicitly about these clauses. The most relevant acts for the sake of this article will be: Polish Civil Code from 1964 and Polish Code of Commercial Companies from 2000, both amended many times.
The essential option clauses
Despite differences and its specifics, the most basic clauses that appear in Polish law are similar to those used commonly in global commercial transactions. These clauses are generally called “options”. Importantly, options are clauses (or contracts) which give rights, not obligations, to perform a specific action. They can be used for various reasons, the most popular being an investment, speculation or a security measure in case of changes in value of an underlying asset.
Put option – in Polish doctrine sometimes called “sell option”. It gives the entitled the right to sell certain amount or number of underlying asset (e.g. shares, participation units) within a certain period of time at a specified price. It most probably will depend on the occurrence of a specified event. The price may be specified as an amount when drafting a contract but it can also be determined or calculated on the basis of a mechanism at the time the option is exercised. For companies, put options are most typically offered for investors to give them some kind of a security: the right to leave the company in the case of a failure to meet the purpose of a company’s operation.
As opposed to the “put”, call option is the right to buy certain amount or number of e.g. shares within a certain period of time at a specified price (which can be calculated in the same way as in put option). The entitled person can benefit from price differences buying shares for a lower price than the market value. An investor exercising this option can try to take over the business entity. On the other hand, shareholders can try to buy investor’s shares in the similar way.
This is somehow the “option” in the very meaning of this word. If the specified event happens, option holder can demand the obliged party to buy his/her (i.e. the option holder’s) assets, shares. In this situation the obliged party has a choice from two options: to agree or not to agree. In the latter case, the option holder acquires the right not to sell but to buy the other party’s shares. Eventually, the entitled from buy-sell option can either take over even all the shares or completely leave the company.
How to make a use of options under Polish regulations
An incorporation of a put or call option to the agreement can be challenging because of lack of specific regulation in that matter. Nevertheless, it should be noted that in the eyes of the Polish law options are recognised as financial instruments which are not securities, according to the article 2 section 1 point 2 letter c) – e) of the Act on Trading in Financial Instruments as of 2005. Still, the legislation is not extensive. Anyone thinking about making an option contract should know that there is no such specific contract in Polish law. Thus, as it was mentioned at the beginning, the use of innominate contracts is inevitable. These contracts are bilateral legal actions which can have some parts or elements taken from other existing nominate contracts; no act provides for their essentialia negotii (essential aspects). In the Judgement dated 2013 (File No.: I ACa 915/12) the Polish Appellate Court in Katowice indicated basic features of an option contract: consensual nature, bilateral obligation and chargeable nature. It is commonly accepted that to construct option contracts one has to use elements from nominate contracts from Polish Civil Law. Moreover, it was even officially confirmed by a Polish Appellate Court in Warsaw in the judgement dated 10 October 2014 (File No.: I ACa 437/14). The Court stated that the very obligation to buy or sell e.g. shares, included in the contractual clause, is not enough to make a desired effect: it will only let to claim compensation if the obliged party fails to perform his/her obligations. As the Court said: „As option contracts are not separately regulated in Polish law, one of three mechanisms is used to secure the effective exercise of an option: the institution of a conclusion of a contract by offer, a conditional or terminal binding agreement and a preliminary agreement”. Consequently, we should take a closer look at these methods of securing the effectiveness of options.
It consists in the obliged party making an offer: to sell (call option) or to buy (put option) or both offers together (buy-sell option). Pursuant to Art. 66 para. 1 of the Polish Civil Code, the offer must indicate the material provisions: the subject of the contract and the price. The price does not have to be rigidly specified; it may be indicated by a specific formula for its calculation. In addition, the offer should indicate the term of its validity: at that time, the entitled party may accept it. The irrevocable nature is important in order to secure the right to exercise the option – if it were otherwise, the obligor could revoke the offer at any time.
In turn, in order to exercise the option right, the entitled party must make a declaration of acceptance of the offer. It is essential that both the offer itself and the declaration of acceptance are made in the appropriate form.
Conditional/terminal binding agreement
Typically it is a sale contract being subject to a condition or a time limit. The first, described as a future and uncertain event, the second, as a future and certain event. A transaction of this kind is based on bilateral contractual relationship and is regulated by the provisions of Polish Civil Code.
This is a specific type of agreement known in the Polish law. Pursuant to the art. 389 para. 1 of the Polish Civil Code, by a preliminary agreement one party or both parties agree to conclude a promised contract; a preliminary agreement should determine material provisions of the future, specified contract. In this case the subject of an agreement will be options; the price and the time limit should also be specified. The agreement should be made as unilaterally binding so that the right of option will be restricted only for the entitled party.
There are several ways to secure even stronger the entitled party’s capacity. The parties may agree to grant the entitled the irrevocable mandate to conclude a promised contract. Another way is to agree upon contractual penalties, for instance in case the agreed actions are not made in a specified time.
Other option clauses
Apart from “classical” options, which are used in different types of commercial transactions, there are other clauses of optional nature that appear in the legal practice, not only in Polish one.
Tag along clause
Together with drag along clause, it represents clauses most typically used by business entities (especially joint ventures, private equity types) in their practice. They may be incorporated into articles of association or other company’s deeds. Tag along clause is applied when the sale of shares occurs. Entitled shareholders have the right (not an obligation) to demand the acquisition of their shares; the seller will have to make the buyer acquire not only the actual seller’s shares but also certain number of shares of entitled shareholders. That is why tag along is sometimes called “co-sale right”. The aim of it is obviously to secure the position of minority shareholders. Terms and conditions as well as the price shall remain the same when tag along right is executed.
Again, when operating in Poland one has to use Polish civil law constructions. This time, it is a third party service agreement, regulated in Art. 391 of the Polish Civil Code. Pursuant to this provision, the shareholder who sells his/her shares (usually a majority shareholder) will be liable for the damage that other shareholders (usually minority) entitled from tag along clause suffered if the buyer is not willing to acquire their shares too.
Drag along clause
This clause enables the majority shareholder to demand from other shareholders to sell their shares, in a situation when the majority shareholder is selling his/her shares. Usually, it may refer to the context of selling the whole company or other type of an entity. Drag along right secures the majority shareholder’s position when, for instance, minority shareholders could not allow for a sale which can be seen as beneficial. At the same time, it protects minority shareholders’ interest too, allowing them to sell on the same terms and conditions as majority shareholders. In Polish law this clause can be incorporated using legal construct from Art. 393 of the Polish Civil Code. Translating it in a bit literal manner as the “contract for the benefit of a third party”, it is similar to the aforementioned Article 391. The difference is, in this example the shareholders – being the debtors, the obliged party – have to act “for the benefit” of a buyer, being the third party. They have to sell their shares if the entitled shareholder executes his/her right. Moreover, this quoted provision gives the right to demand the sale for the buyer also, which can change the nature of drag along right.
In more general terms, tag along and drag along clauses can be secured additionally, using different legal ways. Available methods are, among many: contractual penalties, conclusion of option contracts (put or call option to buy or sell shares; which makes somehow a “multi-level” option clause), specifying to what number or percentage of shares drag or tag along right refers to (to all shares, some part, etc.).
Right of first refusal and pre-emption right
Clauses with these rights can provide similar effects to e.g. buy-sell options, when put in the contractual clause. They are used very broadly in different areas of law and economic activity, thus the execution and specifics may differ. Nonetheless, the general meaning of the right of first refusal is that the entitled party can act before other parties if others express interest in some product, asset or transaction; in other words the entitled party can conclude a specific agreement as the first. It limits the owner’s capacity but secures the entitled holder’s interests – he/she can treat it as an insurance policy and benefit when the potential profit seems clear for other investors. This clause is quite common in real estate business, e.g. giving preference to property tenants, or in agricultural real estate but also in company transactions. Under Polish regulations, the key difference between first refusal and pre-emption right is that in the first case the obliged party has to offer the agreed item (the product, the specific real estate, the shares) to the entitled (from a clause) party when the obliged party wishes to sell but before the very conclusion of the sale contract with the third party; then, the entitled party has a real option: to accept or not to accept. Only in the latter case can the specified item be sold freely to other parties. Pre-emption right grants the entitled party very similar right: to be able to purchase something before some other person does. However, the execution is different: a sale contract with the third party has to be concluded but with a special clause, condition: that the entitled person will not execute his/her pre-emption right. If he/she does so (pursuant to the Art. 598 para. 2 of the Polish Civil Code there is, as a rule, one week or one month – if it concerns real estate – for doing so), the contract with the same terms and conditions will be concluded but between the seller and the entitled party. The caution should be taken on the possible differences in the legal regulations regarding these rights in different national legislations.
In Polish law, another difference is the scope of regulation. Pre-emption right is quite well-developed and regulated in the Polish Civil Code (we can speak of statutory and contractual rights of this type), whereas the right of first refusal is, on the whole, rather not regulated extensively: there are regulations concerning it in various statutes (e.g. Real Estate Management Act from 1997) but the final form of such clause will depend on the will of the contractual parties. As regards the real estate, the example of the right of first refusal is the Article 34 of the Real Estate Management Act which establishes the right of first refusal for, inter alia, a tenant of premises for an indefinite period of time, if the property is disposed of by the State Treasury or a local government unit. Pre-emption right is regulated in many places, including Articles 596 – 602 of the Polish Civil Code. The specific feature of it (especially statutory type) is that the entitled party is quite often public entity, such as the State Treasury. That creates certain limitations in conducting land transactions. For example, restrictions apply to the disposal of: lands designated as forests, lands located within the Special Economic Zones, agricultural properties which were subject to the tenancy agreement for a definite date, performed for at least 3 years, concluded in writing (then, the tenant can acquire the pre-emption right).
Apart from the real property, the rights mentioned herein can be applied to the companies’ business practice. Right of first refusal will be in that case based almost entirely on the provisions from the Polish Commercial Companies Code from 2000 (Art. 258 for limited liability companies – sp. z o.o. – and Art. 433 for joint-stock companies) and usually the clause is included in shareholders’ agreement or articles of association, whereas pre-emption rights will be based on the aforementioned provisions of the Polish Civil Code.
Another difference between these rights in the Polish law are the consequences of carrying out a transaction contrary to these clauses. Pursuant to the Art. 599 para. 1 and 2 of the Polish Civil Code, in the case of the right of pre-emption, liability for damages will then accrue, and if the right was vested by law in the State Treasury, a local government unit or a co-owner or lessee, the unconditional sale will be null and void.
In the case of a right of first refusal, the situation is not as precisely regulated, but the most common consequence will be liability for damages only, without the sanction of nullity of the contract.
The form of a document and the role of a notary public
A lot of differences and problems may arise when conducting cross-border commercial transactions using option clauses. One of the most fundamental aspect of drafting any legal document is its proper, lawful form. In general, it is highly advised to have contracts from multinational deals in writing, however in some jurisdictions it may not be enough. To some extent, a lot depends on the type of a contract, document and its subject. In Poland, any option clauses or pre-emption right clauses included in contract obliging to transfer property title and real estate shall be in the form of a notarial deed. Otherwise, the contract will be invalid (Art. 58 para. 1 in connection with Art. 158 sentence 1 of the Polish Civil Code). The same requirement binds preliminary agreements concerning the transfer of ownership of real estate. The same goes with companies’ agreements and their articles of association. Whereas, agreements on the sale of shares (containing e.g. put or call options) or granting power of attorney shall be concluded with notarial authentication of signatures: by that, a document is not a notarial deed but a part of it is authenticated by a notary public. Hence, the role of a notary public is inevitable in transactions under Polish law but not only, certain requirements are similar in other countries. Moreover, even if it is not necessary and obligatory, the use of professional advice from a notary could be really beneficial, specifically because of complex nature of option clauses, their different “types” and ways they are incorporated into business agreements. Not to mention it may act as an additional safety measure in case of court disputes: the notaries verify and validate the identity of persons involved in signing a contract.
Some differences between legal systems
It needs no extraordinary underlining that clauses described above are of various origins. As pre-emption rights can be dated back to the Roman law, options (call, put, buy-sell) are mainly associated with ancient Greek law (sometimes Mesopotamian) but are inextricably linked to the common law system and features of its contract law. One of these features is the meaning of an offer. It is a rule in common law that an offer can be revoked or changed up until the acceptance by the offeree. The offer becomes binding once it has consideration, which should be provided by the specified payment – to the offeror for not revoking the offer. It sounds similar to irrevocable offer described under Polish law. Indeed, it is, but in common law (at least in traditional sense) irrevocable offer can be made exclusively by providing consideration and thus creating a form of option contract. This contract, in turn, is regulated in detail in the US or UK legislations.
Another traditional difference concerns two basic types of options existing currently. American-style option can be exercised on any day before the expiration date (including the very expiration date), whereas European-style option can be exercised only at a specified expiration date. The first one is more popular, especially with stock and equity options but the second one can be more common for trading index options. The choice of option style will be of great importance in any transaction related to options. On the whole, American-style are more flexible and typically worth more, whereas European are seen as more stable and less risky. Sometimes the choice can be predetermined since it can depend on the place of e.g. making investment. Either way, the final payoff is calculated in a similar manner, which is the difference between yet another style: “exotic options”. There are also other option styles but certainly they are less common than the most popular American and European ones.
Various application for option clauses
Different types of option contracts
As it was already underlined, the most popular usage for options is the financial industry and share-trading. Yet it is not the only possible area of application for put or call option. Similar to pre-emption rights, real estate transactions prove to be valuable area. The real estate option assigned to the buyer (a bit like a call option) gives him/her the opportunity to think about the final purchase decision. The parties agree upon the fixed price and the seller gets only the deposit sum. That way, the buyer has a right to back out of it (if any problem arises, e.g. during property inspection) or to eventually buy the property for an agreed price.
Lease option agreement is a contract (rent-to-own type) allowing the renter to purchase the rented property at any time (or at the specified time) during the lease. Apart from paying rent, the renter has to pay an option fee also (for the very possibility to buy the property later). In fact, “lease option” clause can be simply included into a regular lease agreement but the key factor is to make it optional, non-obligatory. Otherwise, a “lease purchase agreement” will be created and due to its obligatory nature, it is not an option contract of any kind.
Another option agreement, possibly the most atypical from all mentioned, is a film option agreement. It is useful in the entertainment industry especially on an early production stage, when a studio or producer wants to “book” the rights to screen adaptation. By paying rather small amount of money, the purchaser (producer) gets the option to purchase the rights to the source material (a screenplay, a book, a music album etc.) during a specified period of time; the period may vary from months to years (although usually it is up to 18 months) and can be extended, for another fee. If the purchaser is ready to exercise the option, he/she has to pay the agreed price and conclude another contract: Rights Purchase Agreement. Only then will the purchaser get the rights to make a motion picture from the purchased source material. In general, one of the reasons for using this type of option contracts, apart from booking rights, is small costs compared to the whole film production. From a legal point of view, this is another type of option contract, based on the similar legal basis. Therefore, it is also possible to create a film option agreement under Polish regulations but, just as with other option contracts, using legal constructions from civil law.
What to bear in mind when concluding cross-border transactions
There are some general rules to follow in cross-border transactions, which can be applied also when dealing with option clauses. The most basic ones are important: specifying payment methods, currency, contractual terms. A choice of governing law and the jurisdiction for dispute resolution are crucial elements, especially if one of the parties is located in a country like Poland, where the legislation concerning options or tag along, drag along clauses is non extensive. At a first glance, it can be beneficial giving more freedom and flexibility in constructing the terms of an agreement. On the other hand, the proper contract formation requires knowledge from different areas of law and appropriate precision, particularly from the point of view of the effectiveness of a contract.
Managing the differences between local specifics and legal cultures is another problem that has to be answered. As it was shown, the use and the tradition of use of option clauses differ significantly between countries, not only between common law and civil law systems. Common practice of adopting clauses of optional nature makes the transactions easier but it may remove from sight many issues decisive in the matter of making a successful transaction. Nevertheless, in many cases much here depends on the choice of the parties: from the type of option clause to the option style. This choice should be made wisely, taking all the necessary information into consideration.
Covering all aspects of option clauses in commercial transactions deserves more than just few pages of an article but even from these, hopefully, some general overview of legal aspects arises. Option clauses, seen as provisions in legal documents, contracts, allowing the entitled party the right to choose certain activity, have different forms, names and structure. Still, their general aim is to give a right, thus making contractual obligations more free and flexible, and securing the interests of one of the party or both parties. Some of them, such as, for instance, pre-emption right are recognised in legal systems worldwide, whereas others, such as options, are not entirely regulated under certain jurisdictions, as it is in Poland. Recognising and understanding these differences is of utmost importance to making any cross-border transactions. The extensive use of option clauses in very different contracts and business areas suggests that in the near future these clauses will be even more present in commercial transactions of various types: from buying shares to buying real property.