|Svyatoslav Igorevich Abramov,
Deputy Chief of the corporate legislation department
Department of corporate governance MED&T of the Russian Federation
Prospects of changes in the corporate and allied legislation on mergers and mergers (Regarding mechanisms of corporate control redistribution on the basis of the rules provided by chapter XI.1 of the Law On Joint-Stock Companies)
If we set aside subtleties of legal constructions about exclusive independence of an economic company as a subject of civil legal relationship, it becomes obvious, that behind the legal shell of a joint-stock company or a limited liability company there is always its real proprietor (group of proprietors), determining the will of this "shell", a “persona ficta”, according to the apt expression of Pope Innocent IV. (In 1245 Pope Innocent IV was asked a question, if it is possible to excommunicate a corporation from the church. He answered, that it was impossible, since corporation has no soul and is a persona ficta (corpus mysticum), that is it exists only in people’s imagination. Therefore a question on how to call this peculiar "person" is generally a question of semantics in spite of the fact that it is not "in" to speak about it from the pages of legal literature. The overwhelming majority of scientists do not challenge еру fact that from the economic point of view a legal entity first of all is a means to charge the risks of potential losses from participation in the turnover to a certain circle of property in advance.)
If we imagine a company as a kind of "scales", it is possible to notice, that on one scale there is a majority shareholder (economic proprietor), interested in the development of his own business. Unlike controlling (majority) shareholders, the preferences of minority shareholders can be reduced, essentially, to obtaining stable income from the capital investments they made.
The paramount problem of the "weigher" or the legislator is not to admit excessive overbalance of any scale, thus providing for the development of corporate management institutes on the basis of balance of interests between majority and minority shareholders.
Proceeding from the need to develop corporate relations and taking into account the all-European tendency for corporate property concentration, large-scale amendments were made in 2006 to the Russian Law on Joint-Stock Companies, they establish the mechanism for corporate control redistribution on the basis of detailed rules on acquisition of large share holdings of joint-stock companies by joint-stock companies and their participants (chapter XI.1 of the Law on Joint-Stock Companies).
This law, according to experts, on the whole corresponds both to the worldwide level of corporate management institutes development and to the "logic" of the Russian joint-stock legislation.
At the same time, considering the following:
"Debatable" character and ambiguity of the scheme for "exclusion" of small shareholders (the EU directive about merger was preceded by 14 (!) years of fierce debate, including numerous proceedings, including ones about compliance of national legislation norms on merger to the norms of constitutions and to the generally acknowledged principles of international law);
Speed of development and approval of the Russian law on merger;
Some "specific" peculiarities of the Russian model of corporate relations (peculiar, however, to the majority of developing economies),
there is an obvious need for certain updating of the legislation on mergers and merger.
Small experience in applying the norms of chapter XI.1. of the law on joint-stock companies (practical complexities in realization of the procedures provided by chapter XI.1 of the Law, will be described in detail by following lecturers) has already revealed a number of gaps in the legislative regulation, leading to unreasonable restriction, on the one hand, of the rights of owners of securities purchased on request from the company, and on the other hand – the ability of controlling shareholders to carry out measures aimed at corporate control concentration.
Experts note, that excessive barriers for M&A reduce companies capitalization and in fact do more harm than good to shareholders, managers, employees of these companies and their consumers. In their opinion, the benefits brought by free mergers and merger give rise to the necessity to increase the efficiency (including decrease of costs) of corporate merger.
On the other hand, one can understand the concern of small and very small shareholders who in the conditions of imperfection of compensatory mechanisms are inclined to regard the procedure of compulsory buy-out as a legalized mechanism of unfair (without the court decision) deprivation of property.
Taking into account the objective tendency for growth of the mergers and merger market as well as proceeding from the necessity to maintain the balance of rights and legitimate interests of controlling and minority shareholders during economic consolidation, it seems to be expedient to make amendments to the legislation on joint-stock companies and on the securities market in the nearest future, they must be aimed at the elimination of gaps and improvement of the existing model of corporate merger, including regulation of the procedure of acquiring large share holdings of open joint-stock companies.
Existing now proposals on amendments to the legislation on mergers and merger can be divided into 3 groups for convenience:
Radical aversion for the mechanisms provided by chapter XI.1 and, as a consequence, the demand for their prompt cancellation referring to their conflict with the norms of Constitution and international principles of law on impossibility of extrajudicial deprivation of property;
Proposals on improvement of compensatory mechanisms provided by the Law on Joint-Stock Companies to take proper account of the rights and legitimate interests of the owners of the bought-out shares;
Proposals on updating the legislation in order to eliminate practical problems concerning merger and exclusion mechanisms and to form positive practice in this sphere.
A) One may agree with the first group’ proposals only if one has no idea of basic categories of joint-stock business and mechanisms of economic institutes’ functioning. Such proposals, as a rule, come from small and very small shareholders (for the sake of justice, they are quite often "deprived" of dividend payments etc. by controlling shareholders – usually from workers of the enterprises). Typical claims of minority shareholders to squeeze-outs as a rule are based on distorted understanding of the mechanism of property withdrawal for social needs. For the sake of justice, it is necessary to note, that one may also meet not so typical arguments – for example, a shareholder of one of absorbed enterprises appealed to the forthcoming Russia's entry to the World Trade Organization and the related increase in the competitiveness of the plant’s production, which, according to the shareholder, could affect the size of dividend payments.
In this case the inexpediency of such amendments is substantiated by the position of the Constitutional Court of the Russian Federation on compliance of the provisions of items 84.7, 84.8 of the Law on Joint-Stock Companies with the Constitution and on possibility to protect the rights of owners of the bought-out securities solely by the compensatory mechanisms established in the corporate legislation (Definitions of the Constitution Court of the Russian Federation from July 03, 2007 No. 681-O-P, No. 713-O-P, 714-O-P).
It is in addition it is possible to note, that legislation norms in some European countries (for example, in Germany and Sweden), corresponding to these provisions of the Directive, also were more than once disputed in national constitutional courts as violating property rights of the owners of the bought-out shares, however, those courts in their turn pointed to constitutionality of the procedure of compulsory buy-out of minority shareholders’ shares with effective compensatory mechanisms existing in the legislation for protection of the owners of the bought-out shares and the judicial control over realization of this procedure.
Moreover, it is necessary to emphasize that the institute of compulsory shares buy-out was checked also for its compliance with the provisions of article 1 (“Protection of property rights”) of the Appendix to the Convention for the Protection of Human Rights and fundamental freedoms from November 4, 1950 and was recognized as to not conflicting with these provisions of the Convention (case of Bramelid and Malmstrom v Sweden (Appl. Nos. 8588/79 and 8589/79). At the same time in its decision on that case the European Commission, confirming the right of the legislative authority to secure such type of institute in the national legislation, specifically noted, that the institute of the compulsory buy-out cannot be considered as a case of property deprivation in its traditional meaning (as an “expropriation”).
Therefore it is rather strange, that sometimes similar opinions come not only from simple shareholders for whom it is not important what the phenomenon of corporate relations consists in, but from people having considerable knowledge both in institutional economy and in joint-stock business. One cannot but explain these slogans by some populist reasons.
B) At the same time it is easy to notice, that the legal position of the European commission and European constitutional courts (including, the Constitutional court of the Russian Federation) obliges the legislator to give minority to shareholders such guarantees and compensations that would allow to effectively counteract to unfounded infringement of their rights. Practice of applying the norms of chapter XI.1 of the Law on Joint-Stock Companies shows, that the mechanism of guarantees and compensations to minority shareholders established by the current corporate legislation has considerable reserves for perfection and quality improvement of the institute specifying the rights of corporate proprietors.
I think that legal regulation of corporate merger and of shareholders’ exclusion procedures should be developed proceeding from this premise.
1. Major "headache" for the issuer, controlling and minority shareholders, legislator and regulator are the rules of chapter XI.1 about buy-out of shares from minority shareholders. These norms are the apotheosis of the long-time confrontation between majority and minority shareholders, they are traditionally have to bear the avalanche of criticism, up to accusations in usurpation of rights and in legalizing expropriation of private property. The issue is both very complex and very interesting.
(a) Most prominent aspect of the procedure of compulsory buy-out of shares from minority shareholders in all jurisdictions without exception is the rules for establishing the price. Even if securing the right for compulsory buy-out of shares from minorities is the peculiarity of the effective corporate law, taking into account the problems described above, it will be fair and effective only to the degree in which the rules for establishing the price and the control over their observance are effective and fair.
The main problem consists in the order of defining fair buy-out price of the shares which are not circulating on the organized market (remember that the majority of companies in Russia are nonpublic).
It is not a secret that judging by actual (implicit) ratio of the number of shares and the material welfare they grant practically everywhere an appraiser, determining the buy-out price, uses discounts for the absence of control and low liquidity. Such practice at times leads to essential understatement of the price of the bought-out shares and causes losses of the shareholders.
This is why it is quite often proposed to prohibit using discounts in appraisal of the redeemed shares, and even to establishment an additional type of cost in the Federal Security Service and not to use discounts for the absence of liquidity estimating the cost of a business.
The basic arguments against the use of discounts:
- Financial theory proceeds from the necessity to "share" the control premium increasing the share belonging to one person in the company;
- Manipulation with discounts results in the general tendency to understate the cost of shares;
- All shares of the same type grant their owners identical amount of rights, including identical rights to receive dividends;
- Rights, granted by control package, by and large may are used only with the purpose to infringe the rights of minority shareholders (so-called “rights for assets withdrawal”, the right to use the company solely in one’s own interests”), and this must not happen;
- Understating of the sum of transactions means that the state does not receive sum in full.
The basic arguments for applying the discounts:
- Increasing the corporate control concentration threshold inevitably results in depreciation of shares in small holdings;
- Unreasonable benefits for 5 %-minorities;
- establishment of the duty to buy-out shares from 5 %-minorities at the control price will lead to actual impossibility of corporate control concentration because shareholders willing to get better prices will refuse to sell their shares until their compulsory buy-out. With such approach the company will never reach 95 % control and the essence of voluntary and obligatory offer will be lost => we will have extremely negative consequences: decrease in investment appeal and capitalization of the companies and rapid decline of the M&A market.
Thus, the question of using or not using the discounts determining the fair buy-out price is not as simple, as it may seem. It requires additional substantiation, and until then we are not ready to discuss such possibility seriously.
(b) Similar reasons can be given in relation of the term for realizing the right for a minority shareholder to present his demand for buy-out to the company (now it is 6 months).
Experts note, that the EU Directive not provide for similar restriction in time, moreover, "the presence of the unlimited right being an element of system of controls and counterbalances in corporate management, is capable to resist to abuses of its corporate power by the prevailing shareholder in relation to minority shareholders since the former will be permanently faced with the choice: either to follow the policy of reasonable compromise or to bear the costs of the buy-out of shares on demand from minority shareholders dissatisfied with his attitude to them".
On the other hand, in the conditions of the Russian law and order there is a risk of "using" a minority shareholder for corporate blackmail - and this case nullifies one of the goals of chapter ХI.1 – avoiding the escalation of corporate conflicts since the exclusion procedure can actually be indefinitely stretched out.
2. Preference shares: the problem of distributing the requests about preference shares buy-out requires its urgent solution. Here we can definitely speak about possibilities to improve regulation.
The law says, that a duty to send compulsory offer arises when a shareholder with its affiliated persons becomes the owner of 30, 50, 75% of shares. But what kind of shares? As a rule we speak about voting shares. The article 84.1 has a poor wording letting to assume, that the legislator speaks also about preference shares, which did not grant votes to their owners, but still might. The provisions of item 4 of article 32 FZ on joint-stock companies imply that a preference share can turn into a "situational" (D.I.Stepanov’s term) voting share when settling a number of questions on the agenda of the general meeting of shareholders, which, in turn, in some cases mean acquisition of the rights to control with such shares. Hence, the "absorber" in the presence of preference shares which do not belong to him cannot achieve full control over an AO (for more information see D.I.Stepanov “On drawbacks of the Russian law on merger// Corporate lawyer. 2006. No. 6). It seems that obligatory offer must also cover the acquisition of non-voting (according to the general rule) preference shares as well as issued securities convertible in non-voting preference shares.
The question of using discounts to the cost of preference shares must to be solved also. According to experts, with absolutely identical volume of rights granted by preference shares according to the company’s articles of association, in one case the cost of shares of the issuer was taken as 100% of the cost of ordinary shares and in another case as 30%. It’s unlikely that such difference in prices can be explained only by objective factors.
In order to prevent abuses it is proposed to specify the provisions of the law on buy-out of preference shares.
3. Problem of definition of a group of affiliated persons and disclosing the information on the absorber’s plans. The duty to give an obligatory offer, notice on the right to demand buy-out, the right to exclude minority shareholders emerges not only for the owner of a large share holding, but also for a participant of a group of affiliated persons, if the aggregate amount of their share holding has reached a certain limit. The current legislation does not provide for the presence of affiliated persons in a physical person. Thereby from the formal point of view if, for example, three brothers acquire share holdings of 25% each, it does not lead to the emergence of their duty to submit obligatory offer on the buy-out of all remaining shares. It is contrary to the idea of the law. On the other hand, nowadays affiliated persons include persons making a group of persons, which excessively expands the structure of affiliated persons and makes it extremely difficult to set the borders of such group of affiliated persons.
For the purposes of chapter 11 of the Law it might be expedient to use term “interrelated persons” instead of "affiliated persons", having defined, that the interrelated persons include: a person owning 50 and more percent in the authorized capital of another company and such company itself; a company, members of its control bodies and their relatives; closely related physical persons.
There are also certain problems in the field of disclosing the information. The law as a matter of fact provides for "formal" observation of the requirements on disclosing the information – it is sufficient to disclose the information about beneficiary owners of the first level standing most closely to the respective offshore company, which does not mean getting adequate information on the persons who are actually masterminding the merger. More specifically, the law establishes much more effective procedure to disclose the information on all beneficiaries (up to the final physical person) in whose interests the shares are held in order to place the shares at foreign stock exchanges. In this connection it is possible to examine respective issues in the law in greater detail.
It is necessary to note, that respective problems can be solved both in the framework of the package of bills developed by the MED&T improving regulation of the relationship between affiliated persons and disclosing the information about beneficiary owners, and by making "spot" amendments to the Law on joint-stock companies – it depends on the urgency of this or that solution.
4. Is the existence of norms on voluntary offer in the law justified? It is not a secret, that the distinction between voluntary and obligatory offer in the Law is essentially very small – in the framework of a voluntary offer a purchaser may realize his initial desire to get a certain holding of shares. It can be taken of course as a certain alternative to simple buying up of shares; but in this case when certain threshold value is exceeded the norms of the law on voluntary offer "are replaced" by the rules of presenting obligatory offers. At the same time the impossibility to use flexible pricing and long period of time necessary to realize the whole procedure make it unprofitable for investors to use this procedure. This is why voluntary offer on share holding acquisition at the set price is not very popular in practice.
Probably, we should abandon the norms regulating presenting voluntary offer in principle, having defined that any interested person may at any time submit an offer answering to the description of an obligatory offer. Or, at least, to establish that a shareholder owning more of 30 % of shares of a company has a right to send his offer to other shareholders at any time at his own discretion, and not only in cases when his holding exceeds the threshold limits of 50 and 75 %.
5. Obviously, it is necessary to enter legal and technical and more precise amendments into the text of the law and subordinate regulatory laws in order to avoid practical problems in realization and to streamline the judiciary practice. We do not intend to give a more detailed description of these practical problems in our report, but chapter ХI.1 – is a rare enough example showing operative reaction of the legislator to the needs of participants of the business, and we are ready to consider and take into account further proposals from the enterprising community in the frameworks of legislative activity of the Ministry.