Squeeze-out and Sell-out as progressive mechanisms of the law without practical implementation

AssociateDespite its positive objective of harmonizing the relations between majority and minority shareholders, the first draft of amendments to the Law “On Joint-Stock Companies” was criticized by the public as being in violation of citizens' rights to property, and therefore was vetoed by the President of Ukraine in 2012.

Only 5 years later, in March 2017, in connection with the need for fulfilment of the obligations undertaken by Ukraine during the ratification of the Association Agreement with the European Union, the Verkhovna Rada of Ukraine and the new President signed the Law “On Increasing the Level of Corporate Governance in Joint-Stock Companies” (No. 1983-VIII of 23 March 2017).

Herein, we want to focus your attention not only on the analysis of the innovations, but also on certain peculiarities of the implementation of the implemented mechanisms and a number of issues for which the law does not give a clear answer.

What positive expectations can shareholders have?

The law on increasing the level of corporate governance in joint-stock companies is a complex regulatory act, which many people associate only with the introduction of such mechanisms as squeeze-out (the right of the owner of the dominant controlling stake to purchase shares of other members of the company) and sell-out (the right of minority shareholders to sell their own shares in case a certain person acquires a dominant controlling stake). At the same time, this law also provides for other innovations, such as: categories of shareholders with significant (75 %) and dominant controlling stakes (95 %), no need to involve securities traders in the implementation of squeeze-out and sell-out mechanisms, as well as the introduction of escrow accounts.

Besides, the law allows quasi-public joint-stock companies to effectively turn into private joint-stock companies or to abandon the specified organizational form completely. The transformation of “public” companies into non-public organization forms prevents significant expenses for maintaining the company's public status, greatly simplifies the organization of the work of the supervisory board, conduction of audits, etc.

Returning to the mechanisms of squeeze-out and sell-out, we would like to draw your attention to the fact that such mechanisms are aimed at protecting the interests of both minority and majority shareholders. Consequently, a positive result from the implementation of mandatory purchase and sale of shares is to be expected from both parties.

With regard to minority shareholders, the entry into force of the law on increasing corporate governance provides them with the opportunity to avoid the costs of servicing securities accounts at depository institutions, the costs of taking part in general meetings of the joint-stock company, as well as to obtain the fair price for their own shares. Given the fact that a significant number of joint-stock companies decide not to pay dividends, a mandatory purchase of shares may be the only way to obtain a fair remuneration for holding corporate rights for minority shareholders.

Majority shareholders, in turn, will be able to reduce the costs of holding general meetings of shareholders (for example, the costs of sending mandatory notices to all minority shareholders of the company on convening a general meeting, fines imposed by the Securities and Stock Market State Commission (“SSMSC”) in case of violations of the requirements for sending such notices), to simplify the processes of management of the company (in case of acquisition of a sole shareholder control by the dominant shareholder), to reduce the risk of corporate blackmail (greenmail, blackmail), and to reduce the risk of blocking important company decisions or significant transactions (by appealing against decisions of the general meeting of shareholders and imposing seizure on assets or shares of the company).

What amendments will make the law work?

At the same time, we would like to draw your attention to procedural peculiarities and problems that are related to the practical implementation of the squeeze-out and sell-out mechanisms. Despite the fact that the relevant amendments to the law came into force on 4 June 2017, at present the above mechanisms are practically
impossible to implement due to the lack of appropriate amendments to a number of subordinate regulations.

The authorized government authorities are currently just developing a number of relevant legislative amendments designed to make implementation of the squeeze-out and sell-out mechanisms possible in practical terms. In particular, the following amendments can be distinguished among the relevant amendments to the subordinate regulations.

• Amendments to the decision of the SSMSC “On the Procedure for Disclosure of Information by the Issuers ofSecurities.” The relevant amendments provide for the procedure for submittingspecific information on the change of owners of 5 and more percent ofordinary shares for public joint-stock companies; for acquiring a stake in theamount of 50, 75 and 95 percent of the company's ordinary shares by aperson; establish a procedure for the sale of mandatory issue of shares by theowner of the dominant controlling stake (the updated procedure is important, asthe SSMSC may impose a fine on a company in the amount from 17 to 85 thousandhryvnias in case of failure to provide special information about the company);
• Amendments to the decision of the SSMSC “On the Conduct of Depositary Activities.” The proposed draftamendments provide for the regulation of actions of the National Depository ofUkraine and depositary institutions during the forced purchase of shares by theapplicant for an irrevocable claim, as well as update the procedure forcompiling the register of holders of registered securities;
• Amendments to NBU Instruction No. 492 “On the Procedure for Opening, Using and Closing Accounts inNational and Foreign Currencies.” In accordance with the draft amendments tothe Instruction, a new type of account will be introduced, namely an escrowaccount. This type of account will be used to pay the price of shares of theapplicant for an irrevocable claim to purchase shares from minorityshareholders.

Despite the fact that the law on increasing the level of corporategovernance in joint-stock companies is progressive, certain gaps are currently not regulated. For instance, there remains an issue regarding the balance of funds on escrow accounts, in the event the beneficiary owner of such account, or his/her/its successors, did not apply to the bank to receive the funds for shares.

Also, we expect the approval of the decision of the SSMSC “On Information Contained in the Notification on the Acquisition of Title to a Dominant Controlling Stake and a Public Irrevocable Claim,” which provides for an irrevocable claim form, as well as the form of filing information on the ownership structure of the claimant and his/her/its affiliates. There are two main positions in regard of the above issue. According to the first one, it is proposed to recognize such funds as escheat property in case the account beneficiary has died and his/her/its legal successors have not accepted the inheritance within the period established by the legislation (in this case, after a year the funds on accounts will be transferred to the ownership of a territorial community). According to the second position, it is
proposed to return the funds from escrow accounts to the applicant for an irrevocable claim or to the issuer of securities.

Besides, an issue remains as to the need for the owner of a dominant controlling stake, which solely owns the required number of shares (95 % or more), to indicate information about all the affiliated persons that also own shares in such a company when filing an irrevocable claim. In the absence of such information in the irrevocable claim, such an applicant will formally be required to deposit the corresponding amount of funds to the escrow account, and the depositary institution will be required to transfer the rights to such shares to the applicant. It follows from the analysis of the norm that the lack of funds for the acquisition of such shares is a violation of the requirements of the law, and the claimant loses the right of mandatory purchase until such requirements are fulfilled.

Similarly, the issue of the procedure for confirming the transfer of funds to the escrow account by the applicant for an irrevocable claim remains unresolved, as well as the issue of the procedure for compiling the register of holders of registered securities, in the absence of information about the latter (their place of residence or other information about their location).

CONCLUSION

As we see, despite the progressive nature of the law on increasing the level of corporate governance in joint-stock companies, there remains a significant number of unsettled issues that prevent shareholders from using the mechanism of mandatory purchase of shares in practice. We hope that in the near future the relevant regulatory acts will be adopted, and shareholders of Ukrainian companies will receive a complete working instrument that will enable them to exercise their rights more effectively.

Taras Lytovchenko, Associate GOLAW