Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/6.5.9.5:6.5.9.5 Freeze-out

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/6.5.9.5

6.5.9.5 Freeze-out

Deze functie is alleen te gebruiken als je bent ingelogd.Deze functie is alleen te gebruiken als je bent ingelogd.Deze functie is alleen te gebruiken als je bent ingelogd.

A classic example of oppression is the freeze-out of a minority shareholder. In § 1.1.4, a brief description of a freeze-out is given. Afreeze-out can be achieved by not distributing profits of the company. Maintaining profits within the company can be a result of the voting policy of the general meeting. As usually resolutions can be adopted by the general meeting by an ordinary majority of the votes cast, a majority shareholder may resolve to add profits to the company's reserves year after year. Although Johnson et alia1 define the freeze-out of minority shareholders as an example of tunnelling,2I doubt whether this is correct at least for the stage that the majority shareholder does not profit from the freeze-out but merely tries to bully the minority shareholder.

Before exposing some examples of freeze-out, I will first explain the rules on distribution of profits in a nutshell. Pursuant to Article 2:216 paragraph 1 DCC, the profits evidenced by the most recent annual accounts adopted by the general meeting shall be at the disposal of the general meeting, to the extent the net assets of the company exceed the reserves which must be maintained under statute or the articles of association. The articles of association may limit the powers to dispose of the profits or designate this power to another body of the company.

With respect to the resolution for distribution of profits the management board of the company has a right of approval.3 As follows from Article 2:216 paragraph 2 DCC, a resolution for distribution of profits that is not approved by the management board of the company has no effect. According to the same provision, the management board is only entitled to withhold its approval if it knows or reasonably should know that the company will not be able to meet its due and payable obligations (opeisbare schulden) after payment of the distribution.4 If nonetheless the management board approves of the distribution, all managing directors are jointly liable for the deficit that arises as a result of the distribution increased with statutory interest as of the date of distribution. A managing director who proves that he cannot be blamed for the distribution is not liable for the deficit, provided that he has not been negligent in providing measures to prevent the consequences of the distribution.

In addition, the persons entitled to the profits (usually the shareholders) that know or reasonably should know that the liquidity test was not met, are obliged to refluxd the profits for as far as the company has a deficit. In principle, these persons do not have to pay more than they received at the distribution, with the exception of an increase of the amount with statutory interest as of the date of distribution. If managing directors have already made payments to the company, the persons entitled to the profits have to pay an equal amount to the managing directors concerned instead of the company.

Although there is no case law available with respect to fi-eeze-out under the exit proceedings, it is widely accepted in legal literature that a freeze-out would fall within the ambit of the exit proceedings.5 Nonetheless, examples of a freezeout can be found in case law with respect to nullification of resolution on the basis that these are contrary to the principles of reasonableness and fürness and with respect to the inquiry proceedings.

1.

The Van Rees case is about a company active in the field of ship building.6 Pursuant to the articles of association of the company, profits were split between the shareholders, the reserves of the company, the management board and the supervisory board. The remainder of the profits was at the disposal of the shareholders. For several years, a high percentage of the profits was distributed to the shareholders. However, after some years a minor percentage was distributed to the shareholders, although the percentage distributed to the management board by way of bonuses increased. In the last year all profits were reserved. The Court of Dordrecht ordered the nullification of the resolution to reserve profits as under the circumstances this resolution was contrary to the principles of reasonableness and fürness. While the majority shareholder held that reservation was necessary because of the deterioration of the chipbuilding business in the Netherlands, the Court of Appeal of The Hague denied this as no concrete negative effects could be demonstrated. Consequently, the Court of Appeal upheld the decision of the District Court.

2.

In the Sluis case, the HR held that under the circumstances of the case, the reservation of profits during several years, taken into regard that such reservations were not justified by the interests of the company, lead to the conclusion that there were well-founded reasons to doubt the correctness of the policy of the company.7 Moreover, the HR held that the same can be supposed if the articles of association block distribution of the profits for several years, when this provision is no longer justified by the interests of the company. In his comments at NJ 1991, 51, Maeijer considers that under these circumstances the exit proceedings could be invoked as well.8

3.

The Uniwest case is also about a company in which profits were reserved without any justification as the company appeared to be profitable.9 The resolutions had been passed as the majority shareholder voted in favour of these resolutions. The District Court ordered for the nullification of the resolutions with respect to reservation of the profits of 1986 and 1987. In addition, the District Court held that a court cannot subsequently provide an order for the distribution of the profits, although such order was requested by claimant. The order for nullification was upheld by the Court of Appeal of Arnhem. Contrary to the District Court, the Court of Appeal of Arnhem surprisingly instructed for distribution of the profits of 1986 and 1987 as well.10 As far as I know, there has been no other case in the Netherlands in which a court ordered the distribution of profits.

4.

The Kerstens case concerns a BV with two 50% shareholders.11 The management board was entitled to resolve for reservation of the profits. One of the shareholders complained that the other shareholder, the laffer being the sole managing director as well, repeatedly reserved all profits. The managing director held that a provision contained in the articles of association prescribed reservation of profits. The OK held that this argument does not form a sound justification of the reservation policy. Taking into regard that the company possessed considerable reserves, the OK held that neglecting the wish of the other shareholder to distribute profits was unreasonable. Therefore, the OK held that there were well-founded reasons to doubt the correctness of the policy of the company.

5.

In the SirvanalEmba case, an inquiry was ordered by the OK at the request of the 49% minority shareholder.12 The company involved did not distribute profits for a period of several years. As established by the expert appointed by the OK, the reservation of profits appeared not to be unreasonable onder the circumstances of the case. Profits were used to cover losses, though it should be noted that not all circumstances could be verified by the expert. The OK held that in principle reservation of profits for an indefinite period is not justified. However, further to the facts of the case the OK held that the reservation of profits complained of could not lead to the conclusion that mismanagement (wanbeleid) was present.

The abovementioned cases raise the fundamental question how broad the discretion of the general meeting is in disposing of the profits of the company, either by reservation or by distribution. In my opinion, the scope of this discretion is quite broad. The principles of reasonableness and fürness contained in Art. 2:8 DCC form the boundaries of its discretion. Various circumstances may justify reservation or even repeated reservation. The following examples can be given: reservations in view of changing market conditions (for instance a credit crunch), reservations in view of considerable losses or foreseeable losses or reservations in view of necessary investments in the future in order to keep up with competing companies.

In assessing the resolution for reservation, the court may take into consideration how the ratio is between, on the one hand, the profits and, on the other hand, the distributed profits. Moreover, a relevant factor may be whether a similar restraint (compared with the restraint to distribute profits) has been taken towards remuneration of managing directors, including bonuses, bonuses of employees and remuneration of supervisory directors. Although the increase of remuneration or bonuses can be justified, a court may weigh whether a decent balance has been struck between the interests of all parties involved in the company.13

The discretion of the general meeting to resolve for reservation is not unlimited, as a court may interfere further to the proceedings for nullification of resolutions or the inquiry proceedings. A judgment with respect to the nullification of a resolution or an order in the inquiry proceedings does, however, not prevent that unjustifiable reservations will continue for many years. Therefore, in this unsatisfactory situation the exit proceedings could be a more favourable way of solving this dispute.

Comparable to the situation that profits are not distributed, is the situation in which the business activities of the company are sold, but the majority shareholder deliberately does not take further action to start liquidation and dissolution of the company or to find new ventures.

These circumstances were available in the case Het Swake Beheer.14 The District Court considered that the relationship between the majority shareholder and the minority shareholder had broken down as they had opposing views on the future of the company. Therefore, the court held that in principle such conduct of the majority shareholder leads to oppression of the minority shareholder and consequently ordered the minority shareholder's exit.

A severe form of freeze-out can be present when the repeated reservation of profits is combined with tunnelling, for example by way of granting excessive remuneration to managing directors of the company. By way of granting excessive remuneration, some of the shareholders may benefit, when appointed as managing director, as other shareholders may be prejudiced.

In the case of Het Bouwburo Beheer, a minority shareholder applied for inquiry proceedings at the OK.15 The shareholders holding the majority of the shares adopted resolutions for the reservation of all profits of the company, resolved to increase management remuneration significantly and with retrospective effect, and resolved to reward impressive bonuses to the majority shareholders. The OK held that the majority shareholders did not meet their duty of care with respect to the minority shareholder. On the basis of these facts, the OK put that there were well-founded reasons to doubt the correctness of the policy of the company and ordered an inquiry with respect to the policy and affürs of the company.

Deze functie is alleen te gebruiken als je bent ingelogd.