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President, Gramatskiy & Partners Attorneys at Law
Liberalization of Corporate Legislation: the Main Aspects
It is a well-known fact that Ukraine has great economic potential as well as a strategic geopolitical location, and these advantages may constitute the basis for further economic growth at international level. There has been a constant economic growth and total reform of almost all spheres in Ukraine over the last few decades. As a result, investment in the economy has become more affordable, liberal and more secure for businessmen.
It should be noted, that despite Ukraine being a young state and the institution of corporate governance in joint-stock companies is at its development phase, the respective legislation has been constantly changing and improving in accordance with international standards, particularly the rate of corporate culture and protection of shareholders’ rights has been dramatically improved. On 23 March 2017 the Verkhovna Rada of Ukraine adopted the Law of Ukraine On Amendments to Certain Legislative Acts of Ukraine Regarding Improvement of Corporate Governance in Joint Stock Companies (hereinafter — Law No. 1983-VIII), which came into force on 4 June 2017; this is a remarkable achievement of the Ukrainian Parliament.
Law No.1983-VIII aims to simplify and improve corporate governance in joint-stock companies by introducing the procedures of squeeze-out and sell-out. In accordance with the squeeze-out procedure, the majority shareholder may exercise his right to force the minority shareholders to sell their shares. A similar procedure has been introduced in favor of minority shareholder (sell-out), which allows the majority shareholder to demand the buy out of their shares. However, both procedures are strictly regulated by the Law.
It should be noted that exercising squeeze-out and sell-out rights is widespread in European Union countries. Adoption of these procedures in Ukraine was due to the introduction of the Association Agreement between Ukraine and the EU (Annex XXXIV), and the Directive 2004/25/EU of the European Parliament and of the Council on takeover bids, of 21 April 2004. By adopting Law No.1983-VIII the Ukrainian Parliament confirmed its intention to facilitate and improve corporate governance in join-stock companies and harmonization of local legislation in accordance with the acquis communautaire.
Article 65-2 of the Law of Ukraine
On Joint Stock Companies specifies the procedure for the mandatory sale of ordinary shares upon the demand of a person (persons acting jointly), who is an owner of a dominant controlling stake.
The said article states that a person holding personally or through its affiliates a dominant controlling stake is obliged to file a notice to the National Securities and Stock Market Commission of Ukraine (hereinafter — the National Commission) on the acquisition of the ownership of shares within one day from the day of purchase of such a stake. A dominant controlling shareholding is 95% and more of ordinary shares in a joint-stock company.
For exercising the squeeze-out right, a dominant controller should submit to the company a public irrevocable request on the acquisition of shares from all other remaining shareholders; such request should be filed within 90 days from the day of submission of a notice regarding acquisition of ownership of a dominant controlling stake.
Once the public irrevocable request has been filed, the other shareholders, except for persons acting jointly with the dominant shareholder and its affiliates, as well as the company, are obliged to sell their shares to the requesting party. Thus, the adopted amendments enable the shareholder (persons acting jointly), owning a stake of 95% and more in the company’s shares, to
exercise unconditional and compulsory shares buybacks from minority shareholders and become a single controller over the company, even if the remaining shareholders do not agree. At the same time, it should be noted that despite the dominant controller having the possibility to enjoy his squeeze-out right, he/she is not obliged to exercise it.
Another essential advantage of the squeeze-out procedure is that it solves the old problem of so-called “deadheads”.
The term “deadheads” usually relates to minority shareholders (0.01 — 5%) who have not concluded securities account agreements with a depositary organization and do not participate in the company’s general meeting. As a result, the majority shareholder faced many different problems and was limited in exercising some of his rights with respect to the company because he was not able to buyout shares if information regarding a minority shareholder was not known (available) or he did not agree to sell his shares.
Currently, the owner of a dominant controlling stake may enjoy benefits from exercising his squeeze-out right (for example, to exercise his corporate rights by managing the company within his/her own discretion, to reduce expenses for convening general meetings of shareholders as well as to enjoy protection from corporate blackmail).
By contrast, Article 65-3 of the Law of Ukraine On Joint Stock Companies specifies the procedure of mandatory buyout by the dominating shareholders of minority shareholder’s shares upon their demand. According to the sell-out procedure, each shareholder in the company whose ordinary shares are free from any restrictions and encumbrances, has the right to demand the mandatory buyout of its shares by the dominating shareholder after publication by the National Securities and Stock Market Commission of a notice regarding acquisition of the dominant controlling stake by another shareholder. In such case the dominant shareholder is obliged to buy the minority shareholder’s shares in accordance with the Law of Ukraine On Joint Stock Companies.
Minority shareholders are usually vulnerable to stock market factors, they do not obtain profit from their shares and bear expenses related to the maintenance of such shares (for example, fees to a depositary organization, expenses related to participation in the company’s general meeting, etc.). Currently, they are entitled to demand the mandatory buyout of their shares and this right makes the process of the company’s corporate governance simpler.
Implementation of the sell-out procedure also solves another critical problem of joint-stock companies, that of dividend payments to minority shareholders. As practice indicates, joint-stock companies are often reluctant to decide to pay a dividend to its shareholders and minority shareholders are not able to change such decision. In this light, the sell-out procedure may become an effective mechanism for protection of their corporate interests, particularly by obtaining a fair value price for the sale of shares owned by minority shareholders.
If Dominant Shareholder Fails to Perform its Obligations
In addition to the unconditional right of a dominant shareholder to buyout the remaining shares, the Law of Ukraine On Joint Stock Company determines the preventive mechanism for protection of minority shareholders’ rights in case when the dominating shareholder does not execute his/her buyout right. The person (persons acting jointly) who directly or indirectly has acquired the dominant controlling stake (personally or through its affiliates) and fails to execute its obligations, as specified by the Law, shall have voting power only with its ordinary shares that should constitute 95% of the Company’s shares minus one share, until such dominating shareholder duly performs its obligations. Furthermore, the Company’s remaining ordinary shares that are directly or indirectly held by such persons, do not give voting power for determining a quorum, until the actions, as required by the Law, are duly executed. At the same time, the decisions of the Company’s General Meeting of Shareholders that were taken using such shares may be determined in certain cases as invalid.
Implementation of Escrow
Law No. 1983-VIII also introduces an escrow bank account. The squeeze-out and sell-out procedure should be carried out through an escrow account in the Company’s name.
In accordance with the escrow agreement, a bank is obliged to credit to the client’s account monetary means transferred by the account’s owner or third parties and, upon the occurrence of certain events, to transfer such amounts to a beneficiary (beneficiaries) indicated by the account’s owner. The key feature of an escrow account is that neither the account’s owner nor beneficiary (beneficiaries) have the right to operate the account and transfer the monetary means as payment for the acquisition of shares under the squeeze-out or sell-out procedure.
Therefore, both procedures shall be done through the escrow account and the money on such account cannot be used with any other purposes except for those prescribed by the agreement. The escrow provides better protection to majority shareholders (while exercising the sell-out right) as well as to minority shareholders (while exercising the squeeze-out right).
My Personal View
Introduction of the squeeze-out and sell-out procedures is a significant step toward the harmonization of national and European legislation; it will have a positive impact on both majority and minority shareholders.
At the same time, despite the positive outcomes, there are still other unregulated points related to these procedures. In particular, the National Bank of Ukraine should amend its regulations regarding the opening, disposal and closing of escrow account. The said alterations are currently being developed by the National Bank of Ukraine and hopefully in the near future certain legislative acts will be respectively amended.