Getting dividends from Ukrnafta will help fill the state coffers at the expense of shareholders
The newly adopted law introduces the right approach. However, without a fundamental reform of Ukrainian corporate legislation, it will not improve the investment climate
Quorum reduction – the right move, but without a full-fledged reform of corporate legislation it will upset the existing system of checks and balances in joint-stock companies, will provoke corporate conflicts and may encourage business to move offshore.
Recently Ukraine’s Parliament (Verkhovna Rada) adopted Law No.1310, which decreased the quorum requirement in joint-stock companies. Henceforward, a shareholder meeting will require attendance of a simple majority of shareholders that jointly represent 50% plus one share, rather than 60% of shares, as was previously required. Initially, the draft law provided that the new rules would apply to joint-stock companies where the state has a stake only. Fearing that the discriminatory approach to public and private property could be used to challenge the constitutionality of the law, the draft was amended so that starting 1 January 2016 the new quorum requirements apply to all joint-stock companies in Ukraine.
“UKRNAFTA” as a key problem of corporate legislation
For Ukrainian MPs, the key issue with the Law of Ukraine On Joint-Stock Companies seemed to be the state’s inability to manage companies where the state held a majority stake. Indeed, one of the existing problems is the conflict between the quorum requirement (requires 60% of the shares) and the decision-making requirements (only 50% + 1 share). The majority shareholder has the right to take decisions on all matters that do not require a qualified majority, but without participation of minority shareholders cannot hold a meeting where such decisions can be taken.
Therefore, by holding, alone or jointly with others, more than 40% of the voting shares, a minority shareholder can abstain from attending the shareholders’ meeting, thereby blocking any decision-making – on distribution of dividends, appointment of new executive management, etc. Nothing highlights the problem better than the situation around Ukrnafta. Even though Naftogaz owns 50% + 1 share, and the Privat Group only around 40%%, the management of the company is de facto controlled by the minority shareholder.
But there are more of us!
This novelty will affect not only state-owned companies though. There are more than 23,000 joint-stock companies in Ukraine, including 3,000 public companies and about 500 private companies, the rest have not been re-registered and function as open and closed joint-stock companies.
In countries with developed stock markets, the purpose of joint stock companies, in particular public, is to attract and consolidate capital, rather than create a vehicle for joint operation of the shareholders. Thus, the level of the owners’ involvement in the enterprises affairs is lower, and the companies are run primarily by professional managers. Joint-stock companies, particularly public, operate differently from limited liability companies (equivalent of Ukrainian LLCs) and partnerships for a number of reasons: higher number of shareholders in public companies as compared to private ones; related difficulties in reaching a compromise; the absence of a controlling stake; the need to protect minority shareholders and various risks inherent to a particular form of business entity.
In Ukraine, the conceptual difference between limited liability companies and joint-stock companies is removed. Only few would use joint-stock companies for the intended purpose, that is to attract funding from private investors. Historical reasons determine the form of business entity. Some companies, which have passed into private hands, were created in the process of privatization (i.e. through the creation of a joint-stock company). The current owner has consolidated a controlling stake but lost any contact with the company’s former employees who became shareholders (people moved, died, etc.). As a result, he cannot reorganize the company into a limited liability company, which would suit his interests, or even reduce the number of shareholders, so that a public company would turn into a private one. Many owners of companies do not change the organizational form of their business as they are not willing to re-apply for licenses and certifications required for the operation, re-register the land, real estate and other assets. Some activities may only be performed by joint-stock companies, banks in particular. State corporations operate as joint stock companies, so do companies in which some shares were privatized, such as “Ukrnafta”.
The law is good:
- The risk of blocking the work/decision-making of the general meeting due to the absence of minority shareholders is reduced. This issue is particularly important if there are many shareholders, and the holdings are not consolidated.
- The requirements for shareholders’ responsibility and involvement in the company’s affairs are raised. In Ukraine, participation in a general shareholders’ meeting is not a shareholder’s duty. In companies with no majority shareholder, the decrease of the quorum requirement will increase the number of active shareholders who attend the meetings.
- The State gains control over companies with the state shares of 50% + 1 vote, which is important in the current situation (according to the transcript of the Parliament’s meeting the adopted law will enter into force upon the date of its publication for joint-stock companies where the sate holds a share, and for all other joint-stock companies in 2016).
- There is now incentive using joint-stock companies according to their purpose – to attract financing from small and large investors who cannot or do not want to get involved in the management of the company.
- The national corporative legislation moves towards international standards. In Europe, for example, the quorum is 50% + 1 vote or lower. In many countries in order to prevent blocking of decision-making, a quorum is reduced for repeated meeting. For example, in France the quorum is 25% of the votes, in some cases 20%, in Spain – 25%, and only for certain issues (such as changing the share capital) – 50%, in the Czech Republic – 30%, in Russia – more than 50% (30% during the second meeting, a smaller quorum is possible if there are more than 500 thousand of shareholders), in Austria presence of even one shareholder is sufficient.
But it creates problems:
- The established system of checks and balances within corporate structures is destroyed, which will provoke corporate conflicts. As stated before, ownership in many joint-stock companies in Ukraine is consolidated. The main source of share capital is not small shareholders, but strategic investors with large stakes in the business. In exchange for the funding they give they expect to have some level of control over the company, such as a seat on the board of directors, the veto power over certain issues, tag-alone and drag-alone rights, right to use certain other mechanisms. I.e. the very things that do not work in Ukraine. As a result, two mechanisms of influence were developed. With a holding of 25%, a minority shareholder could veto decisions requiring a qualified majority. The Ukrainian laws, however, limited the number of such issues. A greater control has a shareholder with a 40% + 1 vote stake. Such shareholder, by blocking the work of the shareholders’ general meeting, could force others to listen to him. The newly adopted law means that this leverage is lost and the owner of a large minority stake will have to seek other mechanisms of influence. Thus, provoking provoke corporate conflicts.
- The rights of minority shareholders are negatively impacted. The rights of minority shareholders in Ukraine are not well protected. Now this will be a concern not only of owners of small stakes, but also holders of 40% of votes in the company.
- Another incentive to move offshore is created. The abolition of one of the few working methods of regulating the shareholders’ relationship is another reason for moving corporate structures offshore. Foreign legislation is often more flexible and allows partners to control the decision-making process in the company, including with regard to the quorum requirement.
What can and should be done:
- Shareholders’ agreements should be allowed. Owners of Ukrainian companies do not have the right override the rules of the company’s management, prescribed by the law, even if those rules do not match their goals. Shareholders’ agreements and charters, which could give a minority shareholder the right of veto, change the quorum, give each shareholder the right to have a have a seat on the board of directors, agree on the procedure of sale of business, are not observed in Ukraine. This should be changed. The interests of minority shareholders will not be violated as shareholders’ agreements are valid only between the parties thereto, but not all shareholders of the company.
- Quorum requirements, minimum number of votes required for decision-making should be allowed to change, provided that such decisions will be supported by certain number of votes, including those who own a minority holding (for example, such changes may require the approval of 75% of the votes). This must be done at least for private joint-stock companies (i.e. companies in which the number of shareholders is minimal).
- Conclusion of shareholders’ agreements on behalf of the state should be restricted, due to the risk that a corrupt official can abuse his official position and sign a disadvantageous agreement for the state.
- Ukraine’s corporate legislation should be liberalized.
To sum up, the newly adopted law introduces the right approach. However, without a fundamental reform of Ukrainian corporate legislation, it will not improve the investment climate, and instead, can create problems for those already present in the market.
The authors do not work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations