POSITION OF MAJORITY AND MINORITY SHAREHOLDERS

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POSITION OF MAJORITY AND MINORITY SHAREHOLDERS

1 Shareholders’ rights and duties

1.1 The right of shareholder in general

1.2 Contribution and liability

1.3 Shareholders influence

2 Establishing control over the votes of members

2.1 Shareholders’ decision review

2.2 Cumulative voting

2.3можна допи�?ати далі з комулейтів воутінг

3 Protection of minority shareholders

3.1 The rule in Foss v Harbottle

3.2 The majority minority shareholder conflict

3.3 Strategies protecting shareholders

3.3.1 The appointment right strategy

3.3.2 The decision right strategy

3.3.3 The appointment right strate1gy

3.3.4 The trusteeship strategy

3.3.5 The reward, constraints, and affiliation rights strategies

4 Corporate law in Ukraine

4.1 majority and minority shareholders under the Ukrainian legislation

4.2 Legal foundation of the adaptation process

4.3 Methodology of adaptation Ukrainian corporate legislation to acquis communautaire

some parts are subject to change

Dear Steven Hijink,

As I promised this is my thesis explanation.

In the first chapter I will write about shareholders, their rights and duties. That shareholders have definite rights in its property and management, definite obligations towards their rights and duties are not identical with those of the corporation itself. Then I want to compare liabilities of shareholders in different countries, like US, Germany, Great Britain, and France.

In the second chapter I’ll write about the techniques in every company that are available to control the exercise by the majority of the shareholders of their voting power over the company in an unfair way. I’ll mention about decision making and Listing Rules . In the 3d chapter I will examine about relationship between majority and minority shareholders. I’ll scrutinize different strategies for the protection of minority shareholders. In the last chapter I want to write about the Ukrainian legislation in the sphere of corporate law. Strategies of Ukraine in integration process to the EU (acquis communautaire)and also about majority and minority shareholders under the Ukrainian legislation. This is a short overview of my topic. I would be really appreciated for Your propositions.

Introduction

MICHAEL J WHINCOP

[The attention of policy makers has recently been focused on the entitlement of shareholders to participate in corporate governance. This issue is analysed from a perspective which combines social choice theory with other economic considerations. The appropriate degree of collective action that should be imposed by constitutional constraints or by the law is analysed over a range of different types of issues. The article argues that the law on the requisitioning of meetings should be contractible or should include a ‘counter requisition’ procedure; that the law on the proposal of resolutions should be differentiated across issue type and should embrace various forms of rationing; and that the case for mandating particular rules for the election of directors is not soundly based.]

This section first discusses the key components of corporate governance mechanisms and practices: their significance and generally agreed standards. This discussion serves as a background for explaining the selection of survey questions and the scoring of survey responses. Some of the practices, particularly those pertaining to shareholders’ rights, show little variations across firms in a country because they are subject to tight rules and regulations. Thus the survey results are discussed together with discussion of the relevant regulatory frameworks.

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1 Shareholders’ rights and duties

1.1 The right of shareholder in general

The typical corporate governance framework views shareholders as the principal, and the objective of the management of a corporation is to maximize the interests of the shareholders. Even though shareholders entrust the board of directors to guide and monitor the management, they are given rights and opportunities to participate directly in monitoring their firms. Their basic rights include obtaining relevant corporate information on a timely and regular basis, participating in and voting at general shareholders’ meetings, and electing board members (OECD 1999).

From the fact that a corporation exists as a legal entity independent of the shareholders it follows that the legal position of the shareholders is to be clearly distinguished from that of the corporation. The shareholders are not the corporation ; they have definite rights in its property and management, specific obligations towards it and to some extent definite liabilities with regard to it. But their rights and duties are not identical with those of the corporation itself.

This holds good even if one shareholder owns the majority of the shares. In principle it may be said that even if a single shareholder owns all the shares, his rights and duties are to be distinguished from those of the corporation, although in such a case the corporate status may be disregarded and the shareholder’s acts may be treated as those of the corporation or the corporation is to be dissolved.

The rights of the shareholders are usually exercised in general meeting. This applies to the election of directors, to amendment of the articles and, where by laws as distinguished from articles exist, of by laws, to assessment on the shares in excess of the unpaid part of their par value in so far as this is admitted, and to reorganisation, consolidation, merger and voluntary dissolution of the corporation.

There are some rights which may as a rule be exercised outside of meetings and belong to shareholders individually, such as examination of books and reports, preemptive rights, the right to dividend, the right to sue an officer of the corporation and to sue on behalf of the corporation or in proper cases to defend actions against it.

The management of the corporation is generally vested in the board of directors. This means that the board is empowered to perform all necessary acts in the course of management of the corporate affairs, and may disregard directions given by shareholders, unless a given act requires their assent.

A different view was adopted by Continental legislations until the later phase of German Company law. Under such legislations the shareholders in general meeting had the supreme right of direction of the management of the corporation, and directors and managers had to follow their instructions. This was generally held and in most legislations expressly provided by statute, although on the Continent the authority of directors as against third parties was and is much wider than in Britain, and even practically unlimited. Under the Anglo American system, if the directors disregard their wishes, the shareholders may refrain from reelecting them or may even remove them before the end of their term of office, but cannot otherwise undo their acts or fix on them responsibility for any disregard of instructions, per se. They may be responsible if their act was not reasonable. In the latest phase of German Company law the so called ” leader principle” (Fuhrerprinzip] was introduced, to the extent that managers (Vorstand) could not be removed without just cause, in case of gross mismanagement.

It is obvious that under these circumstances the control of corporations by their shareholders is remote and ineffective. This applies especially to the question of damages ; shareholders are not entitled to give instructions with the effect that disregard of them would involve the liability of the directors per se, and it may be impossible to decide whether an act or an omission of the directors was at the time reasonable or not.

It is true that the removal of directors is generally possible even before the end of their term of office, but usually it is a very hard task to organise the shareholders in order to obtain a resolution in general meeting for this purpose. If the practice as to general meetings (use of proxies and so on) is taken into account, the control of directors is in most cases ineffective, and an election may incidentally be fatal to the corporation and is without doubt a very risky undertaking.

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It is generally agreed that in his dealings with the corporation the shareholder is in the same position as any third party. He may look after his own interests in making or implementing a contract ; it is for the directors and officers to protect the corporation. This of course does not apply to frauds.

It has, however, sometimes been held that the shareholder is to some extent in a fiduciary position in regard to the corporation.

It has been said, that a shareholder contracting with his corporation is properly held to a larger measure of candour and good faith than third parties.

As a rule, however, a shareholder may purchase property from and sell it to the corporation by contract or authorised sale, make any other contract with it, engage in a competing business, acquire an adverse title or interest, purchase claims against the corporation, or, if he is its creditor, exercise a creditor’s rights in the same way and to the same extent as if he were not a shareholder. If he is at the same time a director or officer of the corporation, his duties as such may operate as limitations or restrictions on the exercise of his rights as a shareholder.

A special situation arises in cases of majority shareholdings. If one person holds the majority of the shares, or several shareholders assume control of the corporation in order to pass a resolution against the minority that they are under the duty to observe greater care for the interests of the corporation as a whole, i.e. for the equal interests of all shareholders. This greater measure of care has in some cases been described as a trusteeship or quasi trusteeship. This is of course not true in the sense of its amounting to a technical trust, but it is true that such resolutions or a contract made by virtue of them will be more closely scrutinised than if made with third persons, and equity will interpose to prevent such a contract being used oppressively and in violation of the rights of the minority.

Transactions between the corporation and the majority, whether it consist of one or several persons, are of course not void, but they “will be viewed by the Courts with jealousy and set aside on slight grounds”. This scrutiny is dependent on the discretion of the Court ; the protection of the corporation and the minority shareholders is therefore neither certain nor very effective.

Even this rule is not everywhere accepted. Thus under the British Companies Act it is generally held that the shareholders, even if they constitute a majority, are in no way restricted in the exercise of their rights, especially their voting rights. If we bear in mind that under English law the directors are under no restriction in making contracts with the corporation, and that their only duty is to declare their interest, the protection is indeed very weak.

1.2 Contribution and liability

In considering the obligations of a company’s shareholders to contribute to its capital, it will be concerned with the normal type of business corporation, namely, that which has a capital divided into shares with a par value. In many countries this is the only type that exists. The shareholders of such a corporation are as a rule bound only to pay up the par value of their shares, and their liability as against creditors of the corporation is limited to that amount. This, however, is not the only possibility, and the limitation of a shareholder’s duty to contribute to the corporation in case of need (his internal obligation towards the corporation) and of his liability to its creditors is the result of a long evolution.

Originally, as we have seen earlier, the formation of a joint stock company did not exclude the common law liability of the shareholders as partners, but was a privilege conferred by the Sovereign or the authority empowered to issue charters. Its basis was the charter.

1.3 Shareholders influence

Controlling shareholders in European countries typically have a strong influence on management. For instance, French law, allows shareholders to revoke the appointment of members of the board of directors (conseil d’administration) at any time, without giving a reason. Similarly, the conseil, which appoints the CEO of a company (directeur général), can remove the CEO at any time. Assistant general managers (directeurs délégués), who are appointed upon proposal by the CEO, can likewise be removed. While some scholars emphasize the strong position of the “PDG” (président directeur général), who is both president of the conseil and CEO, his power is constrained by large shareholders and the potential threat of replacement. Before the 2001 reform, shareholders were even able to directly remove the PDG by revoking his appointment to the conseil, as he was required to be one of its members. Similar situation is in Italy, under the traditional system of board organization the appointment of a director can be revoked at any time by shareholders. Nevertheless, the firm may have to pay damages to the director if the revocation was without cause. In both examples, these provisions are mandatory. In these countries such, where management is kept on a short leash by large shareholders, the potential for holdup of stakeholders is high. Large shareholders either control the board through direct representation or can directly threaten the firm’s senior managers with removal from their positions.

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By contrast, German law provides insulation of the board from shareholder influence as a matter of theory. German Aktiengesellschaften have a mandatory two tier board structure; a management board (Vorstand) takes care of the operations of the company, while a supervisory board (Aufsichtsrat) is expected to monitor it. Section 76 of the German Stock Corporation Act (Aktiengesetz) explicitly charges the management board with the exclusive responsibility of managing the company and implies that instructions from the supervisory board or shareholders are invalid. The provision is mandatory. The management board’s independence is reinforced by appointment and dismissal procedures. The supervisory board elects and dismisses management board members, but premature dismissal requires a showing of cause, which includes a vote of no confidence by shareholders. Thus, dismissal requires agreement between major shareholders and the supervisory board. Supervisory board members are elected by shareholders, have a period in office of up to five years, and normally can only be dismissed prematurely by a supermajority of three quarters. Interestingly, the motivational report accompanying the 1937 Aktiengesetz that first introduced this structure states:

“Under current law, the shareholder meeting is the supreme decision making body of the corporation; the authority of the management board and the supervisory board is derived from it. Fundamental decisions regarding the fate of the corporation are made by the majority of the providers of funds, who are personally not responsible, who usually lack precise and competent insight into business and the firm’s operations, and who typically put the concerns of capital into the foreground. The development of corporations has shown that conflicts of interest and power struggles between the administration and the shareholder meeting tend to develop, which are by no means to the advantage of the company and business life.”

The report explains that the law is intended to limit the role of the shareholder meeting. The quoted passage addresses concerns raised by shareholder empowerment, one of which appears to be close to the motivation of team production theory, where a irregular focus on capital is seen as harmful. The act concurrently directors “to manage the corporation as the good of the enterprise and its retinue and the common weal of folk and realm demand.” The provision set out the doctrine of the “Unternehmensinteresse,” under which the institutional interest of the firm transcends the interests of specific constituencies. Although the provision was introduced in 1937 and has linguistically been influenced by Nazism, it was not exclusive to that ideology. The origins of the doctrine can be traced to earlier writers such as Walther Rathenau, and it reflects a broader trend in German political and economic theory of the 1920s and 1930s. When the requirement to promote the “good of the enterprise” was dropped in the 1965 reform, the stated reason was that it was self evident that the interests of employees and of the public had to be taken into consideration. The doctrine continues to play a role in German corporate law.

Nevertheless, actual German corporate governance practice departs from the law on the books attempting to insulate management from shareholders. Large German firms are often controlled by single large shareholders, and sometimes by medium sized ones, who exercise control by forming coalitions and electing confidants to the supervisory board. Members of the management board must face re election after a period of at most five year at which time they face the scrutiny of these directors and, by extension, of core shareholders.

Furthermore, the requirement of cause to remove board members prematurely can be met by a vote of no confidence. Due to the close connection between large shareholders and supervisory board members and the fact that supervisory board members themselves can be removed by a supermajority of seventy five percent in the shareholder meeting, managers no longer enjoying the confidence of the controlling shareholder or coalition will typically be unable to maintain their position. Controlling shareholders and coalitions are therefore typically able to impose their will on the firm by threatening to replace the managers. Employee representatives on the board are typically not in a position to object, as the vote of the president of the supervisory board a shareholder representative is decisive in the case of a tie. There are possible exceptions in the cases where groups of shareholders fall out among each other and employee representatives are decisive. Nevertheless, as a general matter, shareholder influence as such would be strong enough to extract rents and quasi rents from stakeholders, even under German corporate law.

2 Establishing control over the votes of members

There is a growing interest in comparative studies on corporate governance and on shareholders’ representation and voting system in particular. There are several reasons for this. First, the investors’ internationalization of capital investments and the raising of funds globally by companies lead institutional and associations of private investors to ask how their interests are protected abroad. Second, the EU Commission aims at simplifying the operating regulations for public limited companies in the EU and therefore commissioned a comparative study dealing, inter alia, with shareholders’ representation at general meetings in the EU member states. Third, from a microeconomic point of view, the question is whether and what specific features of a given corporate governance system might contribute to better performance of the firms. Fourth, discontent with domestic regulations or the search for improvements of the local voting system leads quite naturally to the question of how this is organized in other legislations.

Of course, not all of these perspectives focus on the same points and follow the same lines. The global institutional investor will, for instance, be interested in learning about all different kinds of corporate governance features such as voting rights of shareholders and voting by a proxy, disclosure of financial information, takeover and insider regulations, transferability of shares, protection of minority rights, and so on. Shareholder voting is an integral part of the governance structure of publicly held corporations. Requiring shareholder consent for any fundamental change in corporate policy is a safeguard for the residual risk bearers of a corporation against ex post expropriation by the management. The right to vote assures the shareholders that the basic terms of their investment cannot be altered without their approval. In essence, then, voting rights are to stockholders what covenants are to bondholders: by limiting managerial discretion, they serve as a protection against moral hazard.

Unlike bondholders, however, shareholders receive most of the marginal costs and benefits of fundamental corporate decisions. Thus, shareholders as residual risk bearers have the appropriate incentives to decide on those matters. Also, vesting voting rights in shareholders is the only feasible method to implement major improvements of corporate policy that affect the terms of their investment. Because of the dispersion of equity holdings, renegotiations are difficult to organize. Moreover, renegotiations would require unanimity, thus giving veto power to all shareholders, including those who hold only a small fraction of shares. By allowing a majority to implement fundamental changes of corporate policy, however, veto power can only be exerted if a shareholder holds a substantial proportion of the shares; thus, a vetoing shareholder is forced to internalize at least part of the impact of his decision on firm value.

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Unfortunately, voting as a decision mechanism suffers from collective action problems. Widely dispersed shareholders are likely to be “rational apathetic” when it comes to acquiring information on changes of corporate policy proposed by management. The cost of informing oneself in order to cast an intelligent vote on a management proposal will exceed the expected benefits, even if one assumes that that vote will be decisive. Therefore, voters who hold only a small fraction of shares will remain rationally ignorant. If the management controls the agenda, as it does in most legal systems, shareholders will give their approval, assuming that the management acts on superior knowledge. Moreover, even if some shareholders have determined that a particular proposal will result in a loss in share value, “free rider” problems will discourage formation of an opposition. Each shareholder may gain from opposition, but each will gain more if other shareholders bear the costs. Shareholders are not rewarded for contributing to decision making. Thus, while it is better for all if everyone contributes, it is better for everyone not to contribute, with the result that the activities (information gathering, casting votes) will not be undertaken. There is no cost sharing mechanism that forces all the shareholders who gained from the efforts of forming an opposition to pay for these activities.

As a result, changes of corporate policy might be adopted even though they are value decreasing. Selling shares is not a viable alternative; informed traders would anticipate the approval of a value decreasing change of corporate policy, and they would lower their willingness to pay accordingly. Thus, investors cannot escape the detrimental effects of their collective action problems by selling shares. True, if a buyer acquires large blocks of shares, he can change the course of action of a particular firm and dismiss the incumbent management. Voting rights, then, help to provide incentives to the management to work hard on behalf of the shareholders because a poorly performing firm may become a target for a takeover. But large equity holdings come at a cost they reduce liquidity in the market and thereby limit the informational content of share trading. This cost is ultimately borne by the shareholders themselves, because reductions in market liquidity make performance evaluation of the management more difficult.

2.2 Cumulative voting

When investors purchase shares of common stock, they typically acquire the right to vote in the election of the firm’s board of directors and on other major issues facing the corporation. In straight voting each shareholder is entitled to cast votes equal to the number of shares held for each director position. if a group controls 51percent of vote, it can elect the entire board of directors by casting all of its votes for the candidate that it favors door each position. Some firms do not use straight voting but elect their board members through “cumulative voting” listed. According to cumulative voting each share entitles the shareholder to as many votes as there are directors to be elected. A shareholder may cast all votes for a single candidate or distribute them among more than one nominee. For minority shareholders with cumulative voting it may possible to elect some board members even if the majority of shareholders oppose their election. To elect these directors, the minority shareholders would cumulate their and cast them for a select number of directors.

Some people argue that cumulative voting is very important and should be used by all corporations. Proponents of cumulative voting argue that minority representation on corporate boards is important and results in batter managed firms, thus increasing the expected cash flows to common stockholders. Proponents also argue that cumulative voting makes it possible for corporate raiders or dissident shareholders to get a “foot in the door” and hence increases the likehood of a change in control. If the threat of change in control is high, management may have a greater incentive to work in the interests of shareholders and managers.

Other think that corporations should not use cumulative voting. Opponents of cumulative voting argue that the costs of dissent on a board outweigh any benefits (for instance, lower manager shareholder agency costs).

Still others argue that even when cumulative voting is available, almost all votes are cast in favor of the slate of management sponsored nominees. Therefore the whole issue of cumulative voting is unimportant. In addition, to the extent that all shareholders of a firm want the firm to take certain actions (unanimity holds), it may not matter how the voting power is split among the shareholders. Evidence that some management groups think that cumulative voting is important is seen in the actions of at least fifty two nationally listed firms that between 1962 and 1982 passed management sponsored charter changes to eliminate cumulative voting. Some eighteen other firms passed management sponsored changes authorizing cumulative voting. Also during this period, a substantial number of firms passed other types of charter amendments (discussed below) that affected the significance of cumulative voting by making it more or less difficult for a group of minority shareholders to elect board members. This study examines the common stock returns around these management sponsored charter amendments affecting cumulative voting. The study provides several important insights on the value of voting rights in the publicly held firm.

First, the study presents further evidence that the structure of voting rights in a corporation can affect the price of the firm’s common stock. This finding is consistent with the arguments of Manne and Easterbrook and Fischel that shareholder voting rights are important. The evidence does not support the argument of Berle and Means that because of the diffusion of ownership shareholder voting is unimportant. Our results also are consistent with those of and also are consistent with those of Lease, McConnell, and Mikkelson, which suggest that the distribution of voting rights within a firm can affect the expected cash flows to the firm’s various security holders.

Second, the study supports the view that cumulative voting in a corporation can have a positive effect on firm value. Finally, the study provides evidence that management at times acts to revise the voting structure of a corporation, resulting in a drop in firm value. This finding is consistent with those of several recent studies.

3 Protection of minority shareholders

Protection of minorities is one of the most controversial questions of company law. At one time it was generally assumed that shareholders are in the position of partners and should therefore enjoy similar protection. But with the growth of corporate enterprise the right of the majority to decide the business policy of the enterprise was increasingly recognised as the overriding consideration. A shareholder may acquire personal rights under an agreement to which he is party in his personal capacity, under the company’s articles of association, or under statue. Such rights, which are not vested in the company, may be protected by means of a personal action. For instance when shareholder seeks to enforce an individual right conferred to him as a member, such as his right to vote at a general meeting of the company. Conversely, where the shareholder seeks to enforce a right vested not in himself but in the company of which he is a member, for example a claim to the company’s property fraudulently misappropriated by the directors, he can only do so (if at all) by means of a derivative claim. The derivative claim is a claim brought by an individual shareholder in his own name, but on behalf of the company.” The reason the claim takes this form is that minority shareholder is not in a position to see that the claim is brought in the name of the company itself to enforce the company’s rights.

3.1 The rule in Foss v Harbottle

“The court will not ordinary intervene in a matter which it is competent for the company to settle itself or, in the case of an irregularity, to ratify or condone by its own internal procedure. Where it is alleged that a wrong has been done to a company, prima facie the only proper plaintiff is the company itself.”

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Foss v Harbottle (1843) is a famous decision English precedent on corporate law. In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself. This is known as “the rule in Foss v Harbottle”, and the several important exceptions that have been developed are often described as “exceptions to the rule in Foss v Harbottle”. Amongst these is the ‘derivative action’, which allows a minority shareholder to bring a claim on behalf of the company. This applies in situations of ‘wrongdoer control’ and is, in reality, the only true exception to the rule. The rule in Foss v Harbottle could be seen as the starting point for minority shareholder remedies.

Subject to any contrary provisions in the company’s articles of association, it is the directors of a company who have the right to define whether or not the company should start litigation to enforce its rights. If a shareholder (even a majority shareholder) commence litigation in the name of the company without the prior consent of the board, the action will be struck out, unless the board gives its consent after the proceeding started, the majority shareholder’s only recourse is to remove the board members. If an action brought by a shareholder in the name of the company is struck out, the shareholder will usually be ordered to pay the costs of the proceeding. Moreover, on application by the defendant to which lawyer must be made party, the claimant’s la

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