17 April 2019

Shares in the Digital Age

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Within the framework of so-called Security Token Offerings ("STO"), companies limited by shares can, for example, digitally issue shares or participation certificates in the form of tokens and hence facilitate the tradeability of their investments.

In times of digitization, there is a growing need to process more and more legal transactions in a digital framework - also in the area of raising and processing of funds or in general corporate transactions. Within the framework of so-called Security Token Offerings (""STO""), companies limited by shares can, for example, digitally issue shares or participation certificates in the form of tokens and hence facilitate the tradeability of their investments. It must be ensured that, in addition to the digital transfer of the tokens, the shareholders rights are synchronically transferred, fully compliant with local laws and regulations and legally valid.


Uncertificated Securities or Negotiable Securities?

According to art. 965 of the Swiss Code of Obligations (""CO""), a security is instrument to which a right attaches in such a manner that it may not be exercised or transferred without the underlying certificate. Certificated or “securitized” shares issued in the form of negotiable securities usually exist as physical deeds. In contrast, uncertificated securities within the meaning of art. 973c CO are fully dematerialized securities, i.e. they lack of any physicality. Companies limited by shares are free to choose the form in which they wishe to issue theirs shares (negotiable or uncertificated). However, the issue of uncertificated securities requires a corresponding statutory regulation.

Digital shares are generally issued as uncertificated securities. This is mainly due to the fact that the use of physical paper in digital ecosystems appears to be inefficient.

How is the legally valid transfer of Shares conducted?

Every company limited by shares with registered shares is legally obliged to keep a share register of their shareholders. At the latest when such a company is sold, the question arises whether the entries in the share register are (still) up-to-date and correct. As part of a legal due diligence, the buyer will insist on verifying ownership of the shares. The company must be able to prove for each share that there is a complete chain of ownership from the time of issuance. In practice, however, it happens very often that shares have not been transferred legally valid and, as a result, the share register is not correct or up-to-date and hence, no complete chain of ownership can be proven.

If shares need to be transferred, it must first be clarified (i) what type of share it is and (ii) in what form they were issued.

Shares may be bearer shares or registered shares. Both types of shares can be issued either in certificated or uncertificated form. The securitization takes place, for example, in a share title or in share certificates. In the uncertificated form, shares can be issued, for example, as uncertificated securities. Uncertificated securities are created upon entry in the book of uncertificated securities (art. 973c CO); in addition, a statutory basis in the articles of association is generally required for their creation (art. 973c paras. 1 and 2 CO).

Uncertificated securities are transferred by written assignment (art. 973c para. 4 CO). The transaction must be hand signed by the assignor to be legally valid (art. 165 para. 1 and art. 973c para. 4 CO). The written form requirement can alternatively be met by a qualified electronic signature (“QES”). If these requirements are not met in the transfer of shares, the buyer does not become the legal owner. An entry in the shareholders’ register of the buyer may not remedy this deficit, as entries in the shareholders’ register are only declaratory in nature and cannot create ownership of the share.

Transfer of Digital Rights via Blockchain-based ""daura"" Platform

Since February 2019, companies limited by shares are able to issue uncertificated securities not only in digital form but also in ""tokenized"" form thanks to the Blockchain-based platform solution provided by daura AG. Uncertificated securities are represented by cryptographic tokens and registered on a blockchain and functionally fulfill an uncertificated securities holder’s proof. By transferring these tokens on the blockchain, uncertificated securities can be easily transferred worldwide between registered platform users and formalities such as a hand-written assignment are not needed. Instead of by assignment, a claimcan be transferred by way of contractual agreement between all parties involved, i.e. between the old creditor, the new creditor and the debtor. This is referred to as a tripartite transfer agreement.

According to the lawyers behind the legal concept of the daura platform, it must not only be possible to dispose of claims in a form-free manner, but also, analogously, to dispose of uncertificated securities by agreement between all legal entities involved. By transferring the cryptographic tokens via the blockchain infrastructure, the rights represented by the tokens are transferred synchronously from one platform user to another. All platform users agree to the informal transfer of uncertificated securities within the terms of use in general, as well as at the moment of each transaction once again. The booking on the blockchain automatically leads to a new entry in the shareholders’ register, since the shareholders’ register is kept directly on the blockchain. This considerably simplifies the administrative life of companies limited by shares, as the individual entries no longer have to be entered or updated manually. 

A Glimpse into the future of Swiss Legislature

During its meeting on 22 March 2019, the Federal Council initiated the consultation on the adaptation of federal law to developments in distributed ledger technology (DLT). It thereby aims to increase legal certainty, remove hurdles for DLT-based applications and limit risks of misuse.

In the Swiss Code of Obligations, the possibility of an electronic registration of rights that can guarantee the functions of negotiable securities is to be created. This is intended to increase legal certainty in the transfer of DLT-based assets. The precondition is that the rights are displayed in a distributed electronic register based on the DLT, meeting certain requirements and that the parties entitled and obliged by the right have agreed to this registration. If this is the case, the register takes over those functions which have traditionally been performed by negotiable securities. ""DLT uncertified securities"" shall then be transferable without the requirement of written form.