In the whirlwind of the fast-growing Venture Capital and M&A ecosystem, deadlines are often measured in days. However, financing dynamics frequently collide with an insurmountable barrier in corporate law: the prohibition on transferring shares or social participations before the company’s incorporation or the capital increase agreement is recorded in the Commercial Registry.
This limitation, set forth in Article 34 of the Corporate Enterprises Act (LSC) and extrapolated to capital increases by registry doctrine and the Commercial Registry Regulations, generates operational frictions that can paralyze investment rounds or complicate secondary transactions if not managed with the appropriate legal architecture.
The constitutive nature of registering shares and social participations in the commercial registry
To understand the significance of this rule, one must look at its legal nature. The legislator does not impose this prohibition as a mere bureaucratic whim, but as a mechanism to protect the principle of public reliance on the registry and the security of legal transactions.
From a substantive law perspective, social participations or shares do not legally exist until the act that creates them (incorporation or capital increase) enters the Commercial Registry. Before that moment, what exists is a financial disbursement or a contractual obligation, but not an intangible movable asset called a “share” or “social participation.”
Therefore, any attempt at an actual transfer prior to their registration is a legal transaction involving a non-existent object, which will be null and void pursuant to Article 1261 of the Civil Code (a legal transaction must be carried out on a valid and existing object at the time it is executed). That is to say, for legal purposes, the transfer has never taken place, and the shares/participations belong to their original owner, without prejudice to their commitment or promise to transfer (the contract is valid because it generates obligations between the parties, but the transfer is null and void).
Herein lies an essential technical differentiation, given that the private contract is fully valid as a binding transaction; that is, the parties can sign a commitment in which they oblige themselves to transfer the participations in the future and remain bound to do so. However, the transfer does not produce real effects, nor does it grant shareholder status vis-à-vis the company or third parties, until it is officially registered.
Nor would it be valid under the legal system to condition the effectiveness of the sale to the registration of the act (incorporation or capital increase) that creates the shares or social participations. The dogmatic problem is that a condition precedent suspends the effectiveness of a transaction over an existing object, but it cannot compensate for the non-existence of the object at the time of execution. If the object does not exist at the time the act of disposal is perfected, the transfer contract is born “dead” under Article 1261.2 of the Civil Code.
Practical problems in the Venture Capital ecosystem
This rigidity in the registry system translates into three recurring problems in the daily operations of startups (Note: the source text mentions three but lists two):
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The “bottleneck” in chained rounds (Bridge Rounds)It is very common for a company to need to close a subsequent round or a convertible bridge loan when the capital increase of the previous round has not yet been registered due to some curable defect in the Registry. This situation paralyzes the capitalization table (cap table), since the new round cannot be based on participations whose issuance has not yet been consolidated due to the lack of registration in the Commercial Registry.
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The risk of “blind” secondary transfersIn transactions where an outgoing investor seeks to sell their position to a third party before the capital increase in which they participated is registered, the secondary buyer assumes a high risk: they are paying for a title that legally does not exist and whose registration could be denied by the Commercial Registrar.
Alternatives and contractual mitigation mechanisms
Given that a condition precedent on the title does not avoid the underlying problem, nor is it possible to grant a call option subject to registration for the same reason, M&A and Venture Capital practice has developed alternative formulas to provide legal certainty to the parties while the registry process is completed:
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Unilateral or bilateral promise of sale (pactum de contrahendo): the parties do not execute the transfer, but rather bind themselves to execute the definitive sale and purchase agreement within a specified period after notification of the registry registration. This pre-establishes the main terms and conditions of the transaction, such as the price or the seller’s representations and warranties.
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Deferred closing with Escrow accounts: the buyer signs the commitment contract and deposits the funds in a custody account (escrow). The funds are not released to the seller, nor is the transfer deed executed, until the informative note (registry extract) from the Commercial Registry is presented accrediting the correct registration of the prior incorporation or increase. The funds are then released upon the formalization of the sale previously agreed upon by the parties.
Ultimately, the prohibition of Article 34 of the LSC requires that the closings of investment rounds be designed not solely from a financial perspective, but also by considering the timelines and requirements of the Commercial Registry to avoid null transfers and guarantee the valid entry of new partners.
Article written by:
Raúl Campos
Lawyer – Corporate and M&A
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