Legislative changes seek to improve corporate governance and boost Ukraine’s investment climate.
The adoption and entry into force of new legislation improving takeover regulations and corporate governance in joint stock companies (JSCs) has been a pleasant surprise for Ukrainian legal and stock markets. Even those who initially brought up the issue, drafted the legislation, and wholeheartedly supported it through all the stages of the lawmaking procedure remained unconvinced that it would become law. They remembered the efforts of 2011-12, when a similar legislative initiative suffered rejection by the market and received a presidential veto.
However, it is now clear that the squeeze out and sell out amendments to Ukraine’s JSC law are the most cardinal changes to this legislation since its introduction in 2008. The newly introduced mechanisms should help improve the level of corporate governance in medium and large-scale businesses. They will go a long way to resolving historical problems plaguing the stock market, and generally improve the Ukrainian investment climate and the M&A market situation.
Prior to the recent changes, Ukraine’s tender offer rules consisted of literally one article within the country’s JSC legislation obliging the majority shareholder, upon his acquisition of a controlling stake, to send an irrevocable public offer to the remaining minority shareholders to purchase their shares. If accepted, the majority shareholder would then purchase their shares at the market price.
The new law has elaborated significantly on the consequences of share consolidation in the hands of a single shareholder. For example, once a majority shareholder acquires a dominant controlling stake of 95% or more shares in a private or public JSC, they are entitled to force out minority shareholders at a fair price via a so-called squeeze out. Meanwhile, minority shareholders holding 5% or less of a private or public JSC have the right to require purchase of shares at a fair price.
In a bid to address the traditional Ukrainian problem of majority shareholders seeking to manipulate share prices, the revised law has elaborated on the determination of a fair share price, while also introducing an escrow agreement. Under both the squeeze out and sell out procedures, the share purchase price paid by the majority shareholder is established as either the highest price paid in the previous 12 months, or the market price established by a licensed appraiser.
As expected, immediately after the law came into force, the changes relating to squeeze out mechanisms became the hottest topic of discussion among legal professionals. The debate centered on concerns that the squeeze out device, although facilitating the efficient operations of the company in question, would also infringe on the property rights of minority shareholders. While I wholeheartedly share these concerns regarding the rights of minority shareholders, I believe the Ukrainian corporate environment will benefit from the new-look squeeze out mechanism.
First of all, it is no secret that after the original JSC law was introduced, the Ukrainian securities market suffered from a situation where almost every public JSC had the formal features of a public company but was de facto not public at all. There are various reasons for this, including the high degree of capital concentration in JSCs and the reluctance of majority shareholders to pay dividends. You can count the number of genuine publicly traded companies in Ukraine on the fingers of two hands. The new squeeze out device should enable “quasi-public” companies to align their de jure status and activities with reality via transformation into private companies.
There is no doubt that the authors of the law understand the basic principles underlying property rights, including the protection of private property. However, in circumstances where minority shareholders often use their corporate rights in contravention of, or sometimes even against, the company’s long-term goals, it becomes apparent that the majority's right to squeeze them out does not actually infringe property rights as long as fair compensation is paid.
The new squeeze out mechanisms should allow a majority shareholder to resolve problems concerning “irresponsible” minority shareholders who, in addition to their non-participation in decision-making processes, create various obstacles to the efficient operation and development of the business. Ukrainian JSCs often have large numbers of “sleeping shareholders”, mainly individual shareholders who acquired a fraction of the firm's equity during the privatization process and, in view of their shareholding insignificance or some other reasons, do not participate in the company's life at all. Then there are dishonest shareholders who exploit their shares for greenmailing, raider activities, or corporate conflict purposes.
In addition, nobody can guarantee that the new dominant shareholder's actions will result in the company's further development or generate increased profits. Instead, the company might lose its business position, thus resulting in a share price drop or even bankruptcy. In such circumstances, the squeeze out procedure would guarantee receipt by minority shareholders of fair compensation for their shares. It is also worth mentioning that the squeeze out device is balanced by a corresponding sell out procedure that can be triggered upon the initiative of dissenting minority shareholders.
The new squeeze out and sell out mechanisms adopted in Ukraine have already proven extremely efficient in many developing and developed economics throughout the world. The Ukrainian legislation that now governs the squeezing out and selling out of minority shareholdings has adopted the best practices of these existing international mechanisms as they are used in various popular jurisdictions, while still taking into account the specifics of the Ukrainian business environment. This should substantially contribute to bringing the Ukrainian corporate environment into alignment with the global corporate world. In essence, it is a progressive move designed to foster growth and remove some of the legislative barriers to investing in Ukraine.