Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/2.2.2.2:2.2.2.2 Protection of shares

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/2.2.2.2

2.2.2.2 Protection of shares

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In this paragraph, I will focus on the role of Art. 1 First Protocol with respect to the protection of shares of minority shareholders. Oppression of a minority shareholder may lead to the effective deprivation of the shares, for instance when the stake of the minority shareholder is diluted. I will not elaborate on the subject of expulsion of a shareholder, as this study relates to exit rights.

As appears from case law of the European Court of Human Rights, a share in a limited liability company can be considered a possession as referred to in Art. 1 First Protocol ECHR, for the reason that it undoubtedly represents a certain economic value.1 As can be derived from the case of Sovtransavto Holding, not only the shares are protected against unjustified deprivation, but also the economic value that the shares represent. As can be derived from case law, Art. 1 First Protocol seems to offer protection to the rights attached to the shares as well, in particular voting rights.2 The European Commission of Human Rights put forward the following view, which was later on repeated by the Court:

"A company share is a complex thing, certifying that the kolder possesses a share in the company, together with the corresponding rights (especially voting rights), it also constitutes, as it were, an indirect claim on company assets."3

The view that shares fall within the definition of possession is currently standing law.4 The rule that shares are protected as being possessions can be regarded as one of the principles of company law.5

The case of Sovtransavto Holding against Ukraine is about a Russian minority shareholder, named Sovtransavto Holding, which held 49% of the shares in the Ukrainian company Sovtransavto-Lougansk.6 The company operated in the field of international carriages. In three rounds of issues of shares, the stake of the minority shareholder was decreased from 49% to 20.7% without the consent of the minority shareholder. A Ukrainian public body ratified these issues of shares, even though not all the formalities were complied with. The formalities of each issue of shares had to be verified by the Ukrainian public body. Moreover, in a period of several years, many assets of the company were sold to undertakings set up by the director of the company at considerable undervalue. Ultimately, the shareholders' meeting resolved to put Sovtransavto-Lougansk into liquidation and to transfer its assets to a new company.

After complaints were dealt with before the Ukrainian courts in a highly irregular way, the minority shareholder complained of violations of Art. 1 First Protocol ECHR before the European Court of Human Rights. Sovtransavto Holding contended, amongst other things, that it had lost its stake in Sovtransavto-Lougansk and that it received insufficient payment for the loss of its stake, as the payment was not proportionate to its original 49% stake.

The European Court of Human Rights held that whereas the shares undoubtedly represented an economie value, Art. 1 First Protocol ECHR is applicable. The Court held that the issues of shares had a direct negative effect on the minority shareholder, because:

"there were changes in the powers the applicant company exercised as a shareholder, that is to say in its ability to run the company and control its assets."

Because of the complexity of the case, the court did not place the interference with the property right into any of the categories of deprivation of property or of control of the use of property. The court chose to assess the alleged violation in the light of the general (first) rule. Firstly, the court reiterated that by virtue of Art. 1 of the ECHR (the convention itself, not of the First Protocol) each State

"shall secure to everyone within [its] jurisdiction the rights and freedoms defined in ... [the] Convention".

The Court put forward that the obligation to secure the effective exercise of the rights defined in the ECHR may result in positive obligations for States. The court held:

"As regards the right guaranteed by Article 1 of Protocol No. 1, those positive obligations may entail certain measures necessary to protect the right of property (...), even in cases involving litigation between individuals or companies. This means, in particular, that the States are onder an obligation to afford judicial procedures that offer the necessary procedural guarantees and therefore enable the domestic courts and tribunals to adjudicate effectively and fürly any disputes between private persons."7

The Court considered that the unfür manner in which the Ukrainian courts conducted the proceedings had a direct impact on the minority shareholder's right to the peaceful enjoyment of its possessions and brought uncertainties for a considerable period. The Court held that there were indications that the Ukrainian authorities tried to influence the Ukrainian courts in favour of the Ukrainian party involved in the case. It was even established that the Ukrainian President drew the attention of the courts involved twice in order to defend Ukrainian interests.

The Court held that the manner in which the case was handled upset the für balance that must be struck between the public interest and the interest of the minority shareholder in the peaceful enjoyment of his possessions. The Court stated that the State failed to comply with its obligation to secure to the effective enjoyment of the property right and pointed out that Article 1 First Protocol ECHR had been violated.

In addition, the minority shareholder requested indemnification under Article 41 of the ECHR. This provision stipulates:

If the Court finds that there has been a violation of the Convention or the Protocols thereto, and if the internal law of the High Contracting Party concerned allows only partial reparation to be made, the Court shall, if necessary, afford fust satisfaction to the injured party.

In a sub sequent judgment, the Court granted compensation to the minority shareholder pursuant to Art. 41 ECHR. It was held that the minority shareholder was deprived of real opportunities, for which it ought to be compensated.8 As a yardstick for valuation, the court took the actual value of the shares into consideration.9 The Ukraine was ordered to pay the minority shareholder inter alia €500,000 in pecuniary damages and €75,000 in non-pecuniary damages.10

This judgment makes clear that not only direct deprivation (expropriation) of shares, but also indirect and factual deprivation is covered by Art. 1 First Protocol ECHR.

The situation outlined in the case is comparable to the classic situation of oppression of minority shareholders: dilution of the shares held by the minority shareholder and transfer of assets to companies connected with the controller of the company at undervalue (defined as `tunnelling' in this study). In contrast to Dutch law, the case can be distinguished by pointing to the fact that the resolutions of the company had to be ratified by a public body. Moreover, the fact that the Executive attempted to influence the courts involved was a relevant factor in reaching the conclusion that Art. 1 First Protocol ECHR was infringed.

The view that shares and the value represented by the shares is protected by Article 1 First Protocol ECHR is repeated in the case of Olczak.11

The case of Olczak against Poland also concerned a minority shareholder who was faced with dilution of his shares. Olczak, the minority shareholder, held approximately 45% of the shares in the capital of a Polish bank. The majority shareholder had been arrested and extradited to the USA, because he had been convicted for financial fraud. In addition, several companies owned by the majority shareholder defaulted on loans provided by the bank, deteriorating the financial standing of the bank. The minority shareholder also took out a substantial Joan from the bank. The bank's financial situation was very weak, and requests by the National Bank of Poland to prepare recovery and restructuring steps were denied.

Later on, it appeared that the bank was on the verge of bankruptcy and external financing was essential. Finding a commercial investor was practically impossible. Subsequently, the National Bank appointed a Board of Receivers to replace the governing and supervisory bodies of the bank in order to protect the interests of the bank's customers. This board resolved to cancel a portion of the outstanding shares and to issue shares to the National Bank of Poland with extra voting rights. The existing shareholders were not offered to participate in the issue of shares. As a result, the stake of the minority shareholder was reduced from approximately 45% to 0.4%.

Olczak complained that the value of his shares had been arbitrarily reduced, that he was deprived of his pre-emptive rights, and, consequently, that he sustained considerable financial loss. The Polish court held that the resolution was not deliberately detrimental to the minority shareholder. Subsequently, the case was brought before the European Court of Human Rights on the submission that the resolution was in breach of Art. 1 First Protocol ECHR. The Court acknowledged that Olczak undeniably lost his property due to the resolutions of the Board of Receivers.

The European Court of Human Rights applied its threefold test in order to examine whether a violation of Art. 1 First Protocol ECHR is present. The court held that the Board of Receivers exercised its power to adopt the resolution in accordance with Polish law. The mandate of the National Bank of Poland was clearly defined in the Banking Act and properly complied with. Secondly, the court considered that the measures taken were designed to protect the interests of the bank's customers, especially those who had entrusted their assets to the bank, while there was a serious risk of bankruptcy. The National Bank had already wareed the bank at an earlier stage about its mismanagement. The difficult financial situation and mismanagement were also shown by an auditors' report issued before the measures were taken. The court was of the opinion that the measures taken were compatible with the public interest and fell within the margin of appreciation. Thirdly, the court did not find any reason to assume that the measures were not proportionate to its legitimate purpose. Accordingly, no violation of Art. 1 First Protocol ECHR was found.

Again the court acknowledged that dilution of shares may lead to a violation of Art. 1 First Protocol ECHR. In the circumstances of this case, Art. 1 First Protocol ECHR was not violated, because the deprivation was legitimate, in the general interest and proportionate. In my opinion, it is remarkable that the court did not take into regard the fact that the minority shareholder was not offered any indemnification. Perhaps this can be explained by the fact that the shares were almost worthless, because of the bark's poor financial position. In addition, the minority shareholder was not blameless either, as he accepted a Joan from the bank while being aware of its fragile financial position.

In my opinion, the conclusion seems to be justified that Member States have the positive obligation to address oppression of minority shareholders in an appropriate way in order to protect their property rights. The introduction of exit rights, in connection with a right to compensation at market value, can be an appropriate way to protect minority shareholders. However, it is probably not the only appropriate measure a Member State can take. The interests of a minority shareholder can also be protected in other ways. Article 1 First Protocol ECHR requires an appropriate level of protection of the minority shareholder, but neither prescribes nor explains what measures must be taken by Member States in order to reach an appropriate level of protection. In this respect, Member States have a certain margin of appreciation.

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