Veto Rights

What are veto rights?

Veto rights (German: Vetorechte) denote the ability of a shareholder or group of shareholders to prevent a resolution or measure of the company against the will of the other participants. A veto right does not confer power to shape decisions, but the power to stop a decision from coming about. A German synonym is Blockaderecht (blocking right); the statutory basic form is the blocking minority (Sperrminorität).

Veto rights have three sources. The first is the law with its majority requirements. The second is the articles of association (Satzung), the constitution of the GmbH (German limited liability company), with increased majorities, reserved consent matters and special rights. The third are contractual arrangements under the law of obligations that bind only the parties to the contract, such as the shareholders' agreement or a voting agreement (an arrangement on how to vote). In funding rounds, the founders' blocking minority and the investors' consent catalogue, the protective provisions, are the most important applications. Veto rights is thus the wider term: it covers every possibility of blocking, whoever holds it and whatever it is based on. In a company sale, veto rights determine whose consent is required for the sale and for restructuring.

Statutory majority requirements and blocking minority

Shareholder resolutions of a GmbH in principle require a majority of the votes cast (Section 47(1) of the German Limited Liability Companies Act, GmbHG), with each euro of a share conferring one vote (Section 47(2) GmbHG). For amendments to the articles of association, including capital increases, Section 53(2) GmbHG requires a majority of three quarters of the votes cast and notarial recording. The same majority applies to dissolution (Section 60(1) no. 2 GmbHG) and to a merger and a change of legal form into a stock corporation under the German Transformation Act (Umwandlungsgesetz).

From this follows the blocking minority: anyone holding more than 25% of the votes cast can prevent these resolutions. What counts are the votes cast, not the share capital. If individual shareholders do not take part or abstain, a smaller share suffices. If all vote, exactly 25% is not enough, because the remaining 75% reach the three-quarters majority. If additional obligations to perform are to be imposed on shareholders, each shareholder concerned must consent (Section 53(3) GmbHG); to that extent each person concerned has a veto right. In a stock corporation (Aktiengesellschaft, AG), the general meeting decides on amendments to the articles of association with three quarters of the share capital represented.

Veto rights from articles of association and agreement

Increased majorities

The articles of association can prescribe higher majorities, up to unanimity, for certain resolutions. Every such qualified majority gives shareholders above the arithmetical blocking threshold a veto right. The higher the threshold, the more participants can prevent a decision.

Special rights of individual shareholders

The articles of association can grant individual shareholders special rights, such as a right to appoint a managing director, a right to nominate a member of the advisory board or a right of consent to certain resolutions. According to the general view, special rights cannot be withdrawn or impaired without the consent of their holder. In this way founders secure, for example, a right of consent to changes to their own rights, to the leaver rules for their departure and to their non-competition covenants.

Contractual veto rights

Veto rights in the shareholders' agreement or in a pooling agreement, by which several shareholders undertake to vote uniformly, bind the contracting parties in their voting rights. If a bound shareholder votes in breach of the agreement, that shareholder's vote in the resolution is in principle still effective. The consequences are damages, contractual penalties and claims to a particular voting behaviour. Veto rights in the articles of association therefore have a stronger effect than purely contractual ones.

Limits of the veto right: duty of loyalty and deadlocks

A veto right, too, must be exercised within the shareholder's duty of loyalty. A shareholder may not use it to enforce collateral special advantages. In narrow exceptional cases, the duty of loyalty can even give rise to a duty to consent, for example where a measure is urgently required to preserve the company and is reasonable for the shareholder. This concerns above all restructuring situations.

If two shareholders or groups each hold half of the votes, each side has a veto right against every resolution. For this deadlock, shareholders' agreements provide for staged solutions. At the start come talks at shareholder level, mediation or an expert determination, possibly a casting vote of the advisory board. As the last stage come separation mechanisms in which one shareholder buys out the other, such as the shotgun clause or the Texas shoot-out.

Veto rights in funding rounds and company sales

The founders' statutory blocking minority melts away with each funding round. After two to three rounds, an individual founder is often below the 25% threshold. Founders therefore negotiate contractual veto rights for their core issues, while investors are protected through their consent catalogue. With each round, the number of participants who can prevent something rises. New investors therefore examine whether the company can still take decisions after the round.

In due diligence, an acquirer establishes whose consent it needs: for the transfer of shares because of transfer restrictions (Vinkulierung), for measures before closing and for restructurings. Rights of third parties are added. Change-of-control clauses in customer and financing agreements act economically like veto rights of the counterparties, because they trigger rights of termination or consent on a change of control.

Worked example: founders' blocking minority over three rounds

Two founders each hold 45%, a business angel 10%. Three funding rounds follow. In the Series A, the new investor receives 25%, in the Series B and the Series C 20% each. The existing holdings are diluted proportionately each time.

• After the Series A (factor 0.75): founders 45% × 0.75 = 33.75% each, business angel 7.5%, investor A 25%. Total: 33.75 + 33.75 + 7.5 + 25 = 100%.
• Consequence: Each founder can prevent amendments to the articles of association alone. Investor A, with exactly 25%, has no statutory blocking minority if everyone votes and needs contractual consent rights.
• After the Series B (factor 0.8): founders 27% each, business angel 6%, investor A 20%, investor B 20%. Each founder is still just above the blocking threshold.
• After the Series C (factor 0.8): founders 21.6% each, business angel 4.8%, investor A 16%, investor B 16%, investor C 20%.
• Consequence: No founder alone has a blocking minority any more. Together, the two hold 43.2% and can prevent amendments to the articles of association.
• Votes cast: If the business angel and investor C do not take part in a meeting, 100 minus 4.8 minus 20 = 75.2% of the votes are cast. A founder then holds 21.6 / 75.2 = 28.7% of these and can block alone in that meeting.

The example shows why founders should recalculate their veto position for every round. Anyone who relies on the statutory blocking minority usually loses it unnoticed in a later capital increase.

Distinctions: veto rights, protective provisions and voting rights

• Protective provisions: the agreed catalogue of topics for which the investors, usually as a group, must consent, down to individual transactions of the management. Veto rights are the umbrella term: it also covers statutory blocking minorities, increased majorities and special rights, which any shareholder can hold, including the founders.
• Voting rights: the right to take part in resolutions. A veto right is the special effect of a voting right where no majority comes about without those votes, or an independent right of consent.
• Qualified majority: a majority requirement above the simple majority. It is a source of veto rights, not the veto right itself.
• Advisory board consent requirement: a veto right at body level. It operates only to the extent that the articles of association give the advisory board this competence.

Common mistakes

• Blocking minority overestimated. Exactly 25% is not enough if all shareholders vote, and after the next round the threshold may already have been fallen below.
• Reference figure confused. The calculation uses the votes cast, not the share capital. Attendance at the meeting changes the calculation.
• Too many veto holders. If every round and every founder receives their own veto rights, almost any group can in the end halt essential decisions.
• No mechanism for deadlocks. With a 50% holding each, any disagreement without an agreed solution leads to standstill.
• Only contractual protection. A veto right that appears only in the shareholders' agreement does not reliably prevent a deviating resolution.

Frequently asked questions

From what shareholding does a GmbH shareholder have a veto right?

Against amendments to the articles of association, capital increases and mergers, from more than 25% of the votes cast. For simple resolutions, at least half of the votes are needed, because a motion is rejected on a tie. Further veto rights arise only through the articles of association or agreement.

Can a single investor block resolutions?

Only with its own blocking minority or if it has been granted an individual right of consent. Usual instead is the consent of an investor majority, so that individual smaller investors do not decide alone.

Does an investor with an advisory board seat have a veto right?

Only if the articles of association or rules of procedure provide for it. A board seat initially gives a vote in the body. A veto right arises only if certain advisory board resolutions require the consent of the investor's representative or the advisory board must decide by a majority that cannot be reached without that vote.

Is a resolution that breaches a contractual veto right effective?

In principle yes, to the extent that the veto right appears only in the shareholders' agreement. Whether the resolution can be challenged depends, among other things, on whether all shareholders are bound by the agreement. In addition, there are claims against the shareholder who voted in breach of the agreement.

Can a veto right be withdrawn again?

A special right in the articles of association only with the consent of its holder. Increased majorities can be abolished by amending the articles of association, which in turn requires the increased majority if the articles provide so. Contractual veto rights end under the agreed rules, often when a minimum shareholding is no longer held.

Are there veto rights in a stock corporation too?

Yes. Amendments to the articles of association and other fundamental resolutions of the general meeting can be prevented by anyone holding more than a quarter of the share capital represented. Individual veto rights can be anchored in the articles of association of an AG only to a limited extent because of the strictness of the articles (Satzungsstrenge); they are therefore often regulated in shareholders' agreements.

The Roemer Capital view

Before every funding round, we prepare with the client an overview of who can prevent which resolutions after the round: by law, by the articles of association and by the shareholders' agreement. From it, founders see from which round their statutory blocking minority falls away and which contractual rights they need in its place. Investors see whether the company remains capable of taking decisions after the round.

In a sale process, the same overview becomes the consent plan for the transaction: which shareholders, bodies and counterparties must consent, and by when. The legal assessment of individual veto rights is handled by the client's law firm.