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Is Squeeze-Out Law Able To Release Companies From “Deadheads”

04.10.2017

Oleksandr Vygovskyy, attorneys at Ilyashev & Partners Law Firm
Source: Liga.finance

Whether the law on minority shares squeeze-out is able to make major shareholders of the Ukrainian companies less vulnerable.

In 2017 the procedure of compulsory sale of the shares of minority shareholders to the holders of dominating controlling stake (“squeeze-out”) was introduced for the first time in the Ukrainian legal field. This is a widely spread mechanism in the corporate law of the European countries. This mechanism was required in Ukraine, in particular, due to the implementation of the Directive 2004/25/EU of the European Parliament and of the Council within the fulfillment of the Association Agreement between Ukraine and the EU.

Law Against “Deadheads”

In the context of these developments the holder of the so called “dominating controlling stake” (95 and more percent of company’s common shares) is obliged to file the notification to the National Commission on Securities and Stock Market (NCSSM) on the acquisition of the ownership of residuary shares on the next day from the day of purchase of the abovementioned stake. Further the company within 25 business days from the date of receipt of such notification should approve the market price of shares, for which the shares should be purchased from minority holders (provided that the higher price is not established based on the law). The dominating controller should forward to the company the public irrevocable request on the acquisition of shares from all remaining shareholders. Therewith, all shareholders and the company itself will be obliged to sell their shares to the major shareholder. Minority shareholders will be able to find out about such requirement, in particular, on the company’s website and from the mailing of the copies of this requirement to all minority shareholders by the company.

There is no secret that in the number of joint stock companies there are the so called “deadheads” – minority shareholders that do not participate in general meetings and with whom the company frequently losses any liaison. There is a good chance that such “sleeping shareholders” with never respond to the requirement of the dominating controller to sell their shares. To avoid such a dead-end situation the legislator developed the buy-out mechanism that may be implemented practically without the participation of minority shareholders.

Major shareholder should open an “escrow account”, the beneficiaries of which shall be the shareholders from whom the shares shall be purchased. This is the exact account whereto the funds shall be transferred by major shareholder for the purchased shares. Thereafter, the bank where escrow account is opened shall transfer the funds to the shareholders (their heirs or successors) to the accounts provided by them or shall give the cash in case such shareholders apply to the bank. Central Depositary upon the receipt of information concerning the settled payment for the shares shall remove previously imposed restrictions on the operations with these shares in depositary system and shall ensure their transfer to depositary facilities from securities accounts of the shareholders to securities accounts of major shareholder.

Consequently, the compulsory purchase of the shares by major shareholder is carried out practically without the participation of minority shareholders (in particular, without the execution of shares purchase and sale agreements and orders of minority shareholders on shares writing-off from their securities accounts), and does not require the participation of securities dealer, obtainment of exchange permit or other licenses and approvals of state authorities. Moreover, even the seizures or other encumbrances or restrictions with regard to the shares of minority shareholders cannot prevent the compulsory sale of such shares to the dominating controller.

The new law not only provides the advantages to major shareholder mitigating the risks of corporate blackmail, but also protects minority shareholders, which in case of the concentration of more than 90% of shares in the hands of a single person shall loose the opportunity to impact effectively the company’s activities and shall not be able even to implement jointly those additional corporate rights that are envisaged by law for the holders of 10 and more percent of shares. It is clear that the cost of the remaining minority shareholdings on the stock market will be significantly reduced as a result of dominant control acquisition. From now on the holders of minority shareholdings shall have the opportunity to sell their owned shares for the market price, which means that they shall get a fair compensation for their investment. Taking into consideration the fact that the implementation of “squeeze-out” mechanism is the right, but not the obligation of majority shareholder, the legislator also provided minority shareholders with the right to demand from the dominant controller to purchase their shares for a fair price (“sell-out”).

Courts Against The Law

Law amendments providing for “squeeze-out” procedure have been recently implemented (on 4 June of this year). Therefore, so far there is no established practice of its application, which would attest the efficiency of this mechanism. Definitely, the opportunity for major holder of the company to squeeze-out the minority shareholders holds a potential of abuses on behalf of major shareholder. Procedural aspects envisaged in the new Article 65-2 of the Law of Ukraine “On Joint Stock Companies” are brand new for Ukraine and so far their details are not elaborated even at bylaws level, not to speak of the law enforcement practice.

The question whether the Ukrainian market is ready for such new game rules remains open. In particular, we may forecast the claims of minority shareholders who lost their shares as a result of “squeeze-out” mechanism, interpreting such actions as the violation of the constitutional guarantees of their ownership rights. In addition, the provision under which the public irrevocable requirement of the major shareholder to acquire shares has the highest priority over all existing restrictions (encumbrances) with respect to the shares may be ambiguous; the possibility of replacing the subject of encumbrance in this situation without the consent of the pledgee of the relevant shares can be considered by creditors of minority shareholders as the infringement of their rights, and entail the litigations. In other words, we may talk about the effectiveness and rationality of newly enforced “squeeze-out” and “sell-out” mechanisms only after a longer period of time.

 
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