20.1 Conversion of shares

A share entails rights which are transferrable and which provide the rights holder with tangible advantages. A share is therefore a property right and accordingly a ‘good’, although it is not an independent good. As holder of the entire right to a share, the shareholder is in a relationship with the company and its representatives; such relationship being in essence not contractual. This relationship between the shareholder and the company is only activated by acknowledgement of, or the service of, the transfer, unless the company is itself a party to this. A share is in first instance a property right, but one which entails a relationship with the company and its organisation. The relationship comprises control rights which take the form of meeting rights and voting rights connected to the share (provided the shares are not non-voting shares), as well as property rights in the form of rights to the profits of the company and other payments, as set out in the articles of the company or as determined by law. A share therefore represents value. The rights attached to the share, both property rights and control rights, are determined by the company’s articles.

Conversion is not a legally defined term, which means varying definitions of the concept are now in use. It is generally accepted that the conversion of shares does not entail the repurchase or withdrawal of shares and the issuance of new shares. The rights and/or obligations attached to the existing shares change. Changes to the articles of a company cannot create a shareholder relationship but can alter an existing shareholder relationship. I do not see any property rights restrictions here. A ‘good’ or ‘property’ is not gained by means of the conversion of shares; that which the good entails is subject to change and thereby the good itself also. Given the large variety of types or forms of conversion of shares, I tend towards a broad understanding of the term. I define conversion as the conversion of one or more shares in the capital of a company into one or more shares in the capital of the same company with an equal, lower or higher nominal value, to which the articles of the company attach different rights and/or other obligations. The type or designation of the share does not need to alter as a result of the conversion.

For there to be any differentiation of rights attached to shares a provision allowing this must be included in the articles of a company. This is also the case for a dif-ferentiation of the obligations attached to shares. And separate reserves for premium and for profits also need to be provided for in the articles. Conversion of shares requires an amendment to the articles. A conversion provision in the articles should be seen as a provision facilitating a conditional change to the articles. If the articles do not contain a provision for conversion an amendment to the articles is necessary for any conversion to take place whereby the conversion of shares is effected and recorded.

Conversion of shares by amendment to the articles triggers the various provisions protecting minority shareholders, which must be taken into consideration or complied with whenever a decision is taken to amend the articles, or as part of the amendment itself. The level of protection offered by law to minority shareholders in a public limited liability company (naamloze vennootschap or NV) is relatively little in comparison to that afforded to minority shareholders in private limited liability company (besloten vennootschap met beperkte aansprakelijkheid or BV). The protection for minority shareholders in a BV takes many forms which can be broadly divided into four categories: (a) a requirement for the consent of shareholders whose rights will be affected, (b) a requirement for unanimity, (c) a requirement of a resolution of approval, and (d) any shareholder who did not consent to the decision not being bound by it. For both NV’s and BV’s, in addition to the legal provisions for protecting minority shareholders, the limited protection offered by the requirement for fairness and reasonableness also applies (Article 2.8, paragraph 2 of the Dutch Civil Code). Any shareholder who, due to a change to the articles, finds his/her interests in terms of control or financial-economic interest affected can seek to annul or reverse, either entirely or in part, the decision by which the interests of the shareholder are affected on the grounds that such a decision was unreasonable or that his/her interests are thereby unreasonably damaged. However, everyone who takes shares in a company knows the company’s articles can be amended by a decision of the general meeting and therefore the protection offered by this concept is certainly limited.

Where a conversion of shares by means of an amendment to the articles takes place, a provision for protection of minority shareholders is appropriate if, as a result thereof, harm is done to the rights of the holders of certain shares. Not every reduction in rights amounts to harm to those rights, but harm assumes a reduction in the rights of holders of certain shares. In many cases it is not easy to establish whether or not this is the case, and if it is the case, then to what degree the conversion itself causes any increase or reduction in the rights attached to the shares.

Given that conversion of shares on the basis of a conversion provision in the articles must be seen as an amendment to the articles which is brought into effect by the conversion-triggering provision being fulfilled (which includes any request or decision for the conversion to take place or a time-period provision which is part of that conversion provision being arrived at), the conversion effectively originates from the amendment to the articles in which the conversion mechanism was first included in the articles. Provisions for the protection of minority shareholders are therefore applicable to this amendment to the articles. It will often prove difficult beforehand to determine whether, and if so to what extent and for which shareholders, there will be an increase or reduction in their rights resulting from conversion, or indeed whether or not there will be any harm/damage to their rights, and therefore how to deal with provisions for the protection of a minority in the case of a decision being taken to make an amendment to the articles which includes the possibility of the conversion of shares taking place.

Euro-redenomination, conversion of shares through the lowering of the nominal value of the shares and (for an NV) conversion through the increasing of the nominal value of the shares, are three forms of conversion set out in law. What is not clear is whether the ‘expulsion provision’ (uitstotingsregeling) set out in the second sentence of Article 2:67b/178b of the Dutch Civil Code only applies to euro-redenomination or in general to any situation where the amount of the shares is altered. A special form of conversion takes place when an NV is changed into a BV and vice versa. Where such a conversion takes place the shares are converted into shares in the same entity but of a diffe-rent type. Conversion into a different legal form brings with it – through the change to the nature and of the articles of the company – other rights and/or obligations of the shares. Conversion of a company into one with a different legal form is accordingly also a form of conversion of shares. Transborder conversion within the EER is possible on the basis of judgments of the European Court of Justice, although there is no Dutch legal provision to encompass this in Dutch law. With respect to the form a decision takes, the requirements for fairness and reasonableness can be determining. In deter-mining the requirements to be observed, the procedure provisions governing transborder fusion and regarding the relocation of the seat of the company can be considered guiding. I am of the opinion that for the time being little attention needs to be given to the official first draft bill with respect to transborder conversion of a company.

I distinguish as the three main forms of conversion automatic conversion, conversion on request and conversion via a decision of a corporate body (orgaan). Con-version can seriously impact the interests of shareholders. Any provision setting out a conversion mechanism in the articles should therefore always be clear and com-prehensible. It should be clear by whom, in what circumstances and in what way conversion can be initiated, and what conditions must be satisfied, including with regards to timing, what consequences conversion will have on the reserves connected to the converted shares, the manner in which the affected shareholders and other shareholders should be informed of the conversion, and the registration in the share-holders’ register. With respect to the conversion of preference shares, the articles should determine whether or not the preferential rights to profits for the current book year until the moment of conversion will be attributable to the respective shareholder after conversion takes place. Provisions should also be made for what should happen to any premium or profit reserves attributable to the shares which are to be converted. If the articles stipulate a certain authorised share capital this should not be a barrier to conversion. A provision which is often seen dealing with this problem is one where when the conversion takes place the authorised capital is reduced by the number of shares to be converted and increased by an equal number of shares of the sort that the converted shares are converted into. However, it would be better to include the authorized capital in the articles in tranches to meet the statutory requirement that the articles mention the authorised capital. If conversion is subject to a condition, such as failure to perform obligations under a shareholders agreement, then the provisions in the articles relating to such a conversion should clearly set out who, or which corporate body, should have the deciding say if there is disagreement as to whether or not such a condition applies.

If the nominal value of a share is lowered by a conversion, the conversion implies a capital reduction. For an NV this cannot take place without certain procedures being followed as set out in Article 2:99/100 of the Dutch Civil Code. Where an NV’s articles contain a conversion mechanism no additional resolution of the general meeting is required for any conversion which leads to a capital reduction. This resolution was already passed as part of the resolution to amend the articles whereby the conversion mechanism is incorporated into the articles of the company. The law does not set out a fixed period in which a capital reduction should take place after a creditor objection procedure has been followed and therefore it could be argued that any creditor objection procedure could be considered valid for an unlimited period of time. However this seems no realistic standpoint. The ultimate cut-off date for an objection by creditors is, in my opinion, the first following publication date of the annual accounts. If the capital of the company has clearly altered in a negative way before that date then the capital reduction should not take place.

When a company acquires its own shares this should not be seen as a form of conversion. No other rights are attached to the shares in such a case. It is the quality of the specific shareholder – in this case the company – that means the voting rights cannot be exercised and that shares held by the company do not count towards any calculation of (profit)distribution. Loyalty shares, shares which bring the shareholder more rights the longer they are held, can be created by the inclusion of a provision for conversion in the articles.

Contrary to a BV, an NV may have ‘sub-shares’ (onderaandelen) in addition to its ordinary shares. Article 2:79 paragraph 2 of the Dutch Civil Code defines sub-shares as the parts which shares can be divided into in accordance with the articles of the company. Sub-shares do not form part of the shares from which they come. They are independent property rights which can be held separately. Sub-shares should not be seen as ‘fractions of shares’. This is not a legally defined term. The concept of a ‘fraction’ here is the right to a share in the share. This could be an economic right or a right to part of a community of property (gemeenschap) to which the share belongs. Division of shares into sub-shares is different to the division of shares into other shares with a lower nominal value, which results – after the division – in the creation of new shares. Division into sub-shares does not result in the creation of new shares but of sub-shares which carry different (less) rights and the share that has been divided into sub-shares ceases to exist. In terms of property law, sub-shares are created out of the shares, which as a result of this division change the nature of the property rights they carry, namely from a ‘share’ to a ‘sub-share’. Sub-shares can be converted into shares. For this to happen, just as with other conversions, an amendment to the articles or a provision for conversion in the articles is needed. Whatever applies to the conversion of shares is in principle also applicable to the conversion of sub-shares. For the conversion of sub-shares into a share it is not necessary that all the sub-shares come from the same share.

Limited rights, such as pledge or usufruct, which rest in the shares prior to the division or merger remain attached to the shares which result from the division or merger of those shares. If only some of the shares which are to be merged are under pledge, but not all of them, then after the merger a pledge will rest on an equal share in the resulting merged share. If shares belonging to various shareholders are to be merged then a community of property is established within the meaning of Article 3:166 of the Dutch Civil Code. The shareholders are entitled to the community of property in proportion to their original holdings; on the basis of their proportional rights they are not entitled to receive an equal share in the community of property (Article 3:166 lid 2 Dutch Civil Code). This is in principle not a bound community of property and accordingly in principle each of the participants can dispose of his/her share in it (Article 3:175 paragraph 1 Dutch Civil Code).

Simple conversion, a conversion whereby a share is converted into another share, leaves any right of pledge or usufruct over the converted share intact. However, the conversion can result in rights resting in a share being eroded or have consequences for the holder of the pledge or right of usufruct who, after all, has a right which is a derivative of the principal right: that of full entitlement to the share. It may even be the case that the holder of the pledge or the right of usufruct loses his/her voting or meeting rights as a result of conversion of the share over which he/she has the right of pledge/usufruct if this is converted into a share which carries no voting or meeting rights for the holder of limited rights, provided that the holder of the pledge or the right of usufruct over shares in a BV is protected against a removal of meeting rights by Article 2:227 paragraph 4 of the Dutch Civil Code.

If shares or share certificates are registered on a stock exchange this generally has consequences for the company and only indirect consequences for the shareholders. Conversion of shares only has consequences for the giro system when it leads to a change to the ISIN code. Conversions of shares which do have consequences for the ISIN code are (a) conversion of ordinary shares into shares of a different sort, (b) conversion through the division of shares, and (c) conversion through the merger of shares. I do not consider registration on a stock exchange to be a form of con-version. The articles of a company are amended with the view to gaining a registration and complying with the registration requirements and trading possibilities thereafter. Such an amendment to the articles implies, for so far as it impacts the rights and obligations carried by the shares, a conversion of shares. The registration as such does not. Registration on a different exchange is also not, in my opinion, a conversion of shares. The resulting changes to the rights and obligations should not be seen as changes to the rights and obligations carried by the shares as such. For as far as there are consequences for the rights and obligations attached to the shares these will be found in any change to the articles which was made with a view to securing a registration abroad or to having the shares traded on a foreign trading platform. Again, I do not consider giro-isation as a form of conversion because here the shareholder exchanges/swaps his/her ‘shares’ in the sense of company law for ‘stocks’ in the sense of the law on trading of giro-securities (de wet giraal effectenverkeer).