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On 04 June 2017 the Law of Ukraine “On Amendments to Certain Legislative Acts of Ukraine regarding Improvement of Corporate Governance in Joint Stock Companies” (the “Law”) came into force. This Law has introduced the squeeze-out and sell-out mechanisms for joint stock companies in Ukraine along with the concept of the escrow account, which is a significant progress in Ukrainian corporate law.
The Law does not apply in practice, as the legal enactments required for its implementation have not been approved yet. However, the National Commission of Securities and Stock Market (the “NCSSM”), the Central Depository of Securities (the “CDS”) and the National Bank of Ukraine (the “NBU”) have recently developed the draft of the respective legal enactments which are currently under review at different stages. According to the transition provisions of the law the government shall ensure development of bylaws for implementation of the new law within 6 months upon coming into force. As the state bodies involved have been mostly active, it is expected that the new law will be enforceable by the end of current year.
What the new law brings?
The Law provides for the mandatory transfer of shares of the minority shareholders upon request of the latter (sell-out) or majority shareholder (squeeze-out). The Law stipulates two types of squeeze-out: takeover squeeze-out and corporate squeeze-out. While take-over squeeze-out shall apply in case of acquisition of majority stake, the corporate squeeze is available for any current dominating shareholder (owners of 95% or more shares) who has acquired dominating stake before the Law came into force. The dominating shareholder may start the squeeze-out procedure and exercise his squeeze-out right within 2 years, i.e. on 4 June 2019 at latest. This article will address corporate squeeze-out, which is of interest to many investors in Ukraine.
Why is the corporate squeeze-out of interest to the business community?
Because of the requirements of the privatization law Ukraine got a huge number of the joint stock companies in last decades. As of 1 January 2016 there were around 15,5 thousand joint stock companies (including about 4 thousand public joint stock companies) according to the published state statistics. This number is higher than in many other European countries.
As joint stock companies are subject to extensive reporting, most of them have considered transformation into a private joint stock company and / or a limited liability company as a solution for decreasing administrative expenses and simplifying management procedures. However, before May 2016 many public joint stock companies were not able to transform into private ones, because total number of the shareholders in a private joint stock company could not exceed 100 persons. The reorganization into a limited liability company was also not available because of the similar restriction.
According to the Law the dominating shareholder will have a right to squeeze out minority shareholders and decrease the total number of minority shareholders. As soon as the total number of shareholders is less than 100, the joint stock company can be converted into a limited liability company. That will result in reduction of administrative expenses related to compliance with the publicity requirements, minimization of the risk of corporate blackmailing, etc.
In view of the above, the squeeze out will significantly simplify managing and operating business for many investors in Ukraine.
What are key challenges of the corporate squeeze-out?
The Law provides for a very detailed and step-by-step guideline of the squeeze-out procedure. The Law looks to be systematic, as it introduces changes to over twenty bylaws. The Law seems to address all major issues required for exercising the right to squeeze out. However, there is no certainty about how this will work in practice.
According to the Law the dominating shareholder shall lose its squeeze-out right, if the deadlines (for giving a notice, publication and issue of the irrevocable buy-out request) set by the law are not met.
According to the Law the dominating shareholder shall send to the company the irrevocable buy-out request along with the copy of the escrow bank agreement within 10 business days upon receipt of the information from the company on the market value of the company’s shares. The market value of the company’s shares shall be defined by the professional appraiser and approved by the supervisory board within 25 business days upon receipt of the notice of the dominating shareholder.
Considering complexity of the appraisal of the business and time required for approval of the appraisal as well as opening a bank account, the above timeframes look to be very short. Thus, the dominating shareholder and the company should reasonably start working on both aforesaid issues in advance.
Proper notification of shareholders
According to the Law the dominating shareholder shall have a right to apply squeeze-out in strict compliance with the procedures and terms stipulated by the law.
Within 5 business days upon receipt of the list of company’s shareholders from the CDS the company shall send the copy of the irrevocable buy-out request to each shareholder, approve the list of the shareholders specifying purchase price payable to each shareholder and submit such a list to the bank in which the escrow bank account is opened. The list of shareholders shall be approved on the basis of the list received from the CDS.
The law does not clearly stipulates legal consequences of failure to comply with proper notification requirement. Considering a huge number of minority shareholders in an ordinary joint stock company (1 – 5 thousands), the notice can be sent to a wrong person or address. This might happen, in particular, due to technical mistakes which may occur because of short time line and other reasons. According to the current court practice the notice shall deem to be improper in the above cases.
What should happen if the company fails to notify any of minority shareholder on withdrawal of his/her property (shares)? For a long time the squeeze-out concept has been strongly criticized by the Ukrainian society, as it suggested expropriation of the private ownership.
It would be inappropriate, if the court would disregard such mistakes. According to article 41 of the Constitution and article 321 of the Civil Code the person may be deprived of its property solely in cases and according to procedure stipulated by the law. However, it is also questionable if this is a sufficient legal ground for reversal of the squeeze-out right of the dominating shareholder, given that notification obligation is imposed on a different entity (a joint stock company itself).
Taking into account the above, it looks to be reasonable if the company will request from the CDS the list of shareholders and get ready for sending notices in advance.
Notably, for cost optimization reasons many joint stock companies provided in their charters that notices shall be given to the shareholders by a non-registered mail. This does not contradict with the laws currently in force and such notification is deemed to be sufficient according to recent practice of the High Commercial Court of Ukraine (if evidenced by the company’s outgoing correspondence register, copies of the envelopes, other documents, etc).
Considering that the squeeze-out interferes with the private ownership right of the minority shareholders it seems to be reasonable to opt for registered mail (ideally, with declared value and list of enclosures). This will significantly increase legal safety of the squeeze-out transaction.
Market price of shares
In case of corporate squeeze-out, the price of the shares (which are not listed on the stock exchange) shall be determined by the professional appraiser approved by the joint stock company. As most shares are not listed, the price determined by the professional appraisal will be mandatory for shares of most companies. The Law stipulates that the evaluation shall be completed according to the applicable legislation on valuation of property and property rights.
Other than in case of the takeover, the corporate squeeze out rules do not oblige to apply the recent share purchase prices (if any) as a mandatory purchase price. However, according to section 52 of the National Appraisal Standard the appraiser shall consider, inter alia, all information related to the object of the appraisal, information on recent transactions as to the similar property, other essential information. In practice, the dominating shareholder and the company can sometimes buy out small portions of shares at the prices above the market level. It is worth mentioning that even though the price in such transactions is not mandatory, it would increase the price determined by the professional appraiser.
The market level of the price is the core issue of the squeeze out procedure. It is clear that the fair price constitutes a balance between the rights of the dominating shareholder, on one side, and minority shareholders, on the other side. Thus, it is crucial that the professional appraisal is legitimate and reliable.
The law does not prescribes detailed procedures for the professional appraiser who is free to choose methods of evaluation. The national courts have so far not developed clear criteria for legitimacy and reliability of the professional appraisal. However, there are precedents in which the decisions or agreements made by the company or state officer on the basis of the professional appraisal were reversed, as the latter was approved in breach of the applicable rules.
For the reasons mentioned above, it is advisable that the professional appraisal will be selected among the highly competent appraisers. It is also recommended that the report of the professional appraiser is reviewed and confirmed by another professional appraiser or expert councils of the appraisers’ associations. This is stipulated in the article 13 of the Law of Ukraine On Appraisal of the Property and Property Rights and would increase trust to the results of the professional appraisal**.**
Although the Law governing a squeeze out procedure is very progressive, of a good quality and pretty detailed, exercising the squeeze out right will definitely raise many issues. At this stage, there are no clear answers to them.
In view of huge number of shareholder to be dealt with and paperwork to be done, it is strongly recommended that the businesses start preparing for implementation of the squeeze out procedure in advance. First of all, joint stock companies should care for all issues related determination of the market price by the professional appraisal.
Needless to say, strict compliance with the procedures stipulated by the law will help to ensure lawful implementation of the unexplored procedure.