exit rights of minority shareholders in closely held ...

GRADUATE SCHOOL OF LAW

Thesis’ Title

EXIT RIGHTS OF MINORITY SHAREHOLDERS IN CLOSELY HELD CORPORATIONS: A COMPARATIVE STUDY OF ENGLISH, GERMANY AND ETHIOPIAN LAWS

Academic year

2011-2012

Program

LLM in International Economic and Business Law (IEBL)

Submitted by Student ID Date of Submission

Dagnaw Getahun Walelgn 2LA11032Y August 10, 2012

Under the Supervisions of

Professor Caslav Pejovic Professor Fenwick Mark Dalton

Fukuoka, Japan

Table of Contents Table of Contents ................................................................................................................................i Abstract ............................................................................................................................................... ii Acknowledgment .............................................................................................................................. iii Abbreviations .................................................................................................................................... iv Introduction ........................................................................................................................................ 1 Chapter One ....................................................................................................................................... 5 General Overview of Closely Held Corporations And Minority Shareholders .................. 5

1.1 Closely Held Corporations: Compared to Publicly Held Corporations .................................. 5 1.1 Why Minority Shareholders’ Protection ......................................................................................... 8 1.1.1 Who is Minority Shareholder? .................................................................................................................. 8 1.1.2 Problems of Minority Shareholders ........................................................................................................ 8 1.1.3 Protection of Minority Shareholders .................................................................................................... 12

Chapter Two ..................................................................................................................................... 15 General Overview of Exit Rights of Minority Shareholders of Closely held Companies ............................................................................................................................................................. 15 2.1 Exit Rights in General ........................................................................................................................ 15 2.2 England .................................................................................................................................................. 16 2.2.1 Just and equitable Winding Up .............................................................................................................. 17 2.2.2 The Unfair Prejudice Remedy................................................................................................................ 22 2.2.3 Appraisal Remedy...................................................................................................................................... 35 2.3.4 No Fault Divorce (Exit right at will).................................................................................................... 35 2.3 Germany ................................................................................................................................................ 37 2.3.1 Winding-up Remedy ................................................................................................................................. 39 2.3.2 Oppression Remedy: - Withdrawal And Expulsion ........................................................................ 40 2.3.3 Appraisal Rights ......................................................................................................................................... 44 2.3.4 Exit Right at will ........................................................................................................................................ 45 2.4 English and German Laws Compared ........................................................................................... 46

Chapter Three .................................................................................................................................. 48 Overview of the Ethiopian corporate Law and Governance ................................................ 48 3.1 Private Limited Companies: Compared to Share Companies ................................................. 48 3.2 The Position of Minority Shareholders Under Ethiopian Company Law ............................. 52 3.3 Special Situation of Private Limited Companies and Law and Exit Rights ......................... 57 3.4 Exit Rights of Minority shareholders Under Ethiopian Private Limited Companies ........ 60 3.4.1 Dissolution and Winding Up .................................................................................................................. 61 3.4.2 Mandatory Bid Right: ‘Oppression Remedy’? ................................................................................. 62 3.4.3 The Right to Withdraw: Appraisal Remedy? ..................................................................................... 63 3.4.4 Exit Right At Will ...................................................................................................................................... 64 3.5 Lessons to be learned from English and Germany Laws .......................................................... 64

Chapter Four .................................................................................................................................... 67 Conclusion......................................................................................................................................... 67 BIBLIOGRAPHY ........................................................................................................................... 70

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Abstract Closely held company form is prone to the problem of minority oppression. This is due to the nature of the firm that adopts the features of partnerships and corporate forms. When the majority becomes opportunistic, due to majority rule, there is no mechanism to tackle their action or easy exit. The shares are illiquid non-tradable. Advance planning is, practically, either prohibitively too costly or is not easy to be foreseen due to trust, confidence and optimism members inert se who either have familial, friendship or other relationships.

This oppression is unfair and economically inefficient and it will affect financial markets negatively. So corporate strategy towards minority oppression and exit right for the minority is unquestionably necessary.

Some advanced jurisdiction like England and Germany have devised different rules to this effect. Winding-up, unfair prejudice (oppression remedy), appraisal rights etc. are the most important exit rights adopted in the two systems. They adopt similar, if not the same, strategies towards the problem of minority oppression.

Ethiopian private limited company is similar to the English and Germany private limited companies. The two are two have a laws that shaped company laws of many jurisdictions and their experience is worth to be sought. If minority oppression is a problem in those jurisdictions then it is must be a big problem in Ethiopia too. This is because firstly investors using the same types of firms are seen to face similar problems. Secondly in Ethiopia where business is least developed, court system is weak and contract enforcement is weakest, investors are less sophisticated and market continuously fails government intervention in such regulatory measure is a necessity. It is my thesis that the Ethiopian legal system should adopt those strategies and make amendment to the already existing exit rights so that the minorities will be better protected, investment promoted and economic efficiency build. Taking principles, rules and doctrines from the two systems based on the merit of, and not total alignment to one of them, is wise choice.

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Acknowledgment

First and foremost praise to ALMIGHTY GOD who let things happen this way and make every thing possible. Next to this I would like to give my sincere gratitude to my supervisor Prof. Caslav Pejovic, for his priceless comments and guidance through out the paper. I am also indebted to my second supervisor Prof. Fenwick Mark Dalton, for constructive and insightful comments and guidance. Fitsum G/Michael Tiche, I owe you a debt of gratitude for all your intellectual, moral and material supports. Fassil Wondoson, You are best friend and colleague. Thank you for all the assistance you gave me whenever I needed. Last but not least I would like to thank the generous Japanese Government and Kyushu University, Graduate School of law, for giving me this invaluable chance to study at one of the most diverse and academically stimulating study environment in Asia.

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Abbreviations AG Art/s. CA 2006 CA 1985 Comm. Code GmbH IA PLC

German Company Limited by Shares (Aktiengesellschaft) Article/s Companies Act 2006 Companies Act 1985 The Commercial Code of the Empire of Ethiopia German Private Limited Company (Gesellscaft mit bescrankter Haftung ) Insolvency Act 1986 Private Limited Company

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Introduction Closely held company is reserved to designate types of companies characterized by small number of shareholders with few hold more than half of the shares; privately not publicly held, they are out of the influence of market and shares are not transferable; and there is an overlap in management and ownership.1 This company form has been a subject of heated discussion for years due to the problem of minority oppression.2 Different metaphors have been used to explain the seriousness of the problem. Some contrast it with ethnic minority3 while others make analogy to marriage. 4 Some make gags 5 on minorities of closely held companies. The heart of the matter lies in the fact of majority opportunism and minority oppression. This is because the type of company is the hybrid of partnership and corporate forms making it quasi-partnership Company. While the same has benefited out of the best advantages of the two different forms, it did not come for free. Much has to be paid to reap the fruits of hybridization: oppression. Closely held companies are established among family, close friends or former colleagues.6 This demands trust, confidence and cooperation. Unlike in public companies, shareholders in closely held companies are active investors, in most cases, that participate in the day-to-day affairs of the company.7 So in closely held companies the latter case there is close connection between labor and capital.8

See Bryan A. Garner, Black’s Law dictionary, 9 th ed., West Publishing (2004); Daniel Oran, Oran’s Dictionary of The Law, West Legal Studies Thomson Learning (3rd edn.) (200) P-93; Susan Ellis Wild, Webster’s Law Dictionary, Wiley Publishing, (2006). NB The definition of closely held company differs across jurisdictions and the above definition is not single whole definition. See also http://biztaxlaw.about.com/od/glossaryc/g/closelyheldcorp.htm and http://en.wikipedia.org/wiki/Corporation#Closely_held_corporations_and_publicly_traded_corporations accessed on August 7,2012, at 9:38, 2 Harm Jan De Kluiver, Private Ordering and Buy-out Remedies Within Private Company Law: Towards a New Balance between Fairness and Welfare, 8 EBOR 103, (2007) pp. 112-113 3 See generally Anupam Chander, Corporate Law’s Distributive Design, 118 YALE L.J. POCKET PART 82 (2008), See also Anthony Briggs, MINORITY SHAREHOLDER, MINORITY CITIZEN: A PERSPECTIVE PIECE, 9 Wash. & Lee Race & Ethnic Anc. L. J. 39 (2003). Available at: http://scholarlycommons.law.wlu.edu/crsj/vol9/iss1/6 4 Farrar, John H. and Boulle, Laurence (2001) "Minority Shareholder Remedies - Shifting Dispute Resolution Paradigms," Bond Law Review: Vol. 13: Iss. 2, Article 3, P-18 
 Available at: http://epublications.bond.edu.au/blr/vol13/iss2/3 1

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See Ladd A. Hirsch and James D. Sheppard, Claims for Oppression by Minority Shareholders In Private Companies Under Texas and Delaware Laws: A Plaintiffs Perspective, a paper presented at 2012 Securities Regulation And Business Law Conference, February 10, 2012
 Dallas, TX. P-1, The authors gave a hypothetical answer from Willie Nelson (American country song singer and song-writer) had he been asked what his advice will be to mothers of Texas private companies investors: as - “ Mamas don’t let your babies grow up to be minority without redemption agreement.” Robert B. Thompson, Corporate Dissolution and Shareholders’ Reasonable Expectations, 66WASH. U.L.Q 193, 193(1988) As cited in Douglas K Moll, Minority Oppression & The Limited Liability Company: Learning or Not From Close Corporation History, 06 Wake Forest Law Rev. 883, P-889 7 Ibid, P-888 8 Ibid, and see also Ladd Hirsch and Jason Fulton, A Pound of Cure: Remedy For Minority Shareholders Without Exit Strategy, 17 Business Torts Journal 4, 2010 (reprinted) 6

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Such companies are also far from the reach of the market influence in the sense that the shares though transferable are not in fact tradable 9 for restrictions either from the law or agreement of the shareholders. So the minority shareholders are ‘locked in’ and exit from the company is almost absent owing to the nature of the company. In this regard rules of company law are far more favorable to public companies than closely held ones. 10 Free tradability, which is not available for shares of closely held companies, could have provided both exit door and means of valuation of the shares through the publicly quoted stock exchange. The type of company is characterized by easy entrance11 but almost impossible exit even when the minorities are treated unfairly. Such vulnerable status will culminate in the majority oppressors demand for buy-out for an unfairly low price making it very difficult to escape the unfairness by sale of shares.12

There is also problem of advance planning by the contracting parties as to dispute settlement, principally for two reasons. Generally, advance planning is too costly and shareholders cannot envisage any issue that may arise in the future. Also the investors in closely held companies are not that sophisticated investors. Added to this the trust and confidence and cooperation between shareholders at the establishment of the company effectively will kill the chance of anticipating the existence of dispute in the future. So the pre-divorce arrangement by the parties is almost absent.

The grand norm of corporate law, majority rule, is also blamed in contributing to all the troubles. 13 The opportunistic majority may turn this tool into their favor at any time and oppress the minority in different ways.14 Were it not for this norm, minorities could have been able to veto any oppressive conduct or decision.

Due to all these problems that encircled the closely held corporation set up there is an obvious need for corporate strategy towards exit right of minority shareholders. 15 The problem is how to devise such a rule balancing the conflicting interests that will be

9

Reinier Kraakman et al, THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (3rd ed), (2009) page 11, see also Douglass Moll, supra note 6 at 891-892 10 Robert C. Illig, Minority Investor Protection As Default Norms: Using Price To Illuminate The Deal In Close Corporations, 56 Am. U.L. Rev. 275, (2006) P 283-284 11 This is because the requirements to establish private companies are easy and rules to this effect are flexible. 12 See Douglas K. Moll, supra note 6 pp. 891-892 13 See Robert C Illig, supra note 10 at 286 14 See Douglas K. Moll, supra note 6 pp. 889-890 15 Mette Neville, A Statutory Buy-out Right in SMEs-An Important Corporate Governance Mechanism and Minority Protection? Nordic and European Company Law LNS Research Paper Series, No 10-03, p. 277

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involved. 16 Providing a legal strategy by which constituents of the corporation can work cooperatively for common good while reducing, if not avoiding, agency problems is one of its main functions. 17 Thus by its legal strategy, corporate law responds to three types of agency problems namely manager-shareholders, among shareholders and corporation with other constituents’ conflicts.18 Ideal corporate law should be designed in such a way that it can minimize these agency problems. The principal focus of this paper, in this regard, will be majority opportunism and minority shareholder oppression and exit rights of minority shareholders. So other types of agency problems and means of minority protections other than exit, if any, are not the focus of this paper, though incidentally might be touched.

Many jurisdictions have adopted an exit strategy towards the problem of minority oppression. To this effect exit right of minority shareholders under English and German laws are going to be discussed comparatively. The two systems are worthy to be discussed for reasons of their own. English law, being the most business friendly company law has shaped the laws of socalled common law countries, principally. The German private limited company law is also one of the best legal transplants in continental Europe and Asia. Ethiopian corporate law regime dealing with exit right minority shareholders, if any, will also be a subject of focus. The adequacy or otherwise of the same and the way it addresses the issue will be evaluated in light of the two most developed systems and recommendations to this effect will be forwarded by the writer.

Accordingly, this paper consists of four chapters. The first part will deal with General overview of closely held corporations and minority shareholders, the main focus being the definition and peculiar feature of closely held corporations in comparison with publicly held companies and justifications why the protection of minority shareholders and exit right in closely held companies is necessary. Under Chapter Two exit rights of minority shareholders of closely held corporations under English and Germany legal systems will be comparatively discussed.

Chapter Three is dedicated for discussion of the Ethiopian Corporate Law. Introductory discussion of Ethiopian Company Law and in particular the Ethiopian private limited

16 17 18

Ibid See Reinier Kraakman et al, supra note 9 at p. 2 Ibid

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company regime will be made. The way the Ethiopian law addressed the issue of minority oppression and exit right, if any will be studied. Shortcomings of the Ethiopian private limited company, if any, and lessons to be learned from English and Germany laws will be provided as recommendation to the Ethiopian legal system, if at all necessary. Finally, in Chapter Four, concluding remarks by the writer will be provided.

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Chapter One General Overview of Closely Held Corporations And Minority Shareholders 1.1 Closely Held Corporations: Compared to Publicly Held Corporations Corporation is defined as an entity with perpetual existence and eternity, at least in principle, established by the law.19 It is characterized by separate legal personality, limited liability, transferable shares, and delegated management with board structure. 20 It arises out of the need to organize Capital in which firm is used as an alternative to the price mechanism in the market,21 a means of mobilizing huge amount of capital 22 by several risk-averse investors towards doing business in an organized form, under professional management, by contributing money. 23 Thus the company as a standard contract will serve to reduce transaction costs and the professional management system is one way to deal with opportunistic behavior that would have been acute problem if shareholders themselves were managers and directors. Additionally, there are several other considerations in using the corporate form as a business strategy. These include but not limited to tax reasons, the need to clear and defined member rights, advantage of mobilizing capital from the public, easiness to secure credit under corporate form, separate legal personality and limited liability and others.24

But not all companies are the same and there are different reasons for incorporation resulting in different types of companies. Accordingly, companies may be grouped into several categories. More importantly, based on the criterion of transferability, more specifically tradability, of shares, identity of the members and possibility of mobilizing fund from the public, companies can generally be categorized as public companies and closely held /private companies.25 This development is due to the considerations discussed above that led to the transformation of many small firms to adopt the corporate form usually in the form of private companies. 26 This led those companies to be hybrids of partnerships and corporate forms making them quasi-partnership companies. Hence, closely held companies can be understood as those companies characterized by small number of actively involved J. H. FARRAR & B. M. HANNIGAN, FARRAR’S COMPANY LAW, BUTTERWORTHS, (3 rd ed.), pp. 6-7 Ibid pp. 519-520 See also Reinier Kraakman et al, supra note 9 at p. 5 21 Ibid 22 see R. Posner, Economic Analysis of Law (3rd edn, 1986) p, 368 as cited in J.H Farar & B.M Hannigan, supra note 19, p.7 23 Ibid 24 See J.H Farrar & B.M Hannigan, supra note 19 pp. 519-20 25 See Reinier Kraakman et al, supra note 9 p. 12 26 See J.H Farrar & B.M Hannigan, supra note 19, pp. 520-21 19 20

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shareholders, one or some of them holding more than half or substantial part of the shares, illiquid shares and are owner managed, in most cases.27

In public companies of today there is a separation of ownership and control, at least in principle, whereby the right of control is transferred to some one who manage the company.28 Shareholders are inactive investors and they are not going to participate in the administration of the company, 29 which is done by delegated professional managers. The shareholders neither going to serve as board members / managers30 nor do they have the expectation to be, at least in principle. There is publicly quoted security exchange in the market that will provide both a means of exit and valuation of the shares owned under the company. In case there is oppressive conduct by the board or majority shareholders an aggrieved shareholder in public company can simply escape the unfairness by selling his share in stock exchange market. 31 This will encourage investment because businessmen will have an incentive to invest in the expectation that either the value of their share will increase and they can dispose it at any time they want whatever.32 So in public companies the market is a guarantee of fairness and provides both exit and means of valuation.

But the case for closely held companies is different. These companies are more flexible to establish, such as the way the management of the company is organized and run, minimum capital and minimum number of parties required are some of the privileges in the particular company form. There is also flexibility for shareholders as regarding waiver of some of their rights and also devise mechanisms to protect their rights. For instance, contracting shareholders may bind themselves by agreement, usually under article of association, and lock themselves into the company restricting transfer shares.33 They can also devise ex ante dispute resolution mechanism.

A closely held company is characterized by small number of shareholders, in most cases families, close friends and business partners, who may have the substantial role over the day–

27

See Bryan A. Garner, Susan Ellis Wild, and Daniel Oran, Susan supra note 1 See J.H Farrar & B.M Hannigan, supra note 19 p. 9 29 See Douglas K Moll, supra note 6 p. 888 30 See Sandra K Miller, Minority Shareholder Oppression in the Private Company in the European Community: A Comparative Analysis of the German, United Kingdom, and French "Close Corporation Problem" 30 Cornell Int'l L.J. 381 (1997) pp. 381-385 31 Ibid 32 Ibid 33 See Adam Chernichaw, Oppressed Shareholders In Close Corporations: A Market-Oriented Statutory Remedy, 16 Cardozo L. Rev. 501 (1994) p. 509 28

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to- day operation of the company as managers, officers and employees. 34 The role to be played by these shareholders, in most cases, may either be double or triple.35 This calls for relatively high level of trust and an intimate family-like relationship between shareholders. This in turn will kill, if not always, the chance of advance planning because it is either difficult to foresee the possibility of disputes or at least not easy to deal with it due to trust and optimism. This role of shareholders coupled with the doctrine of majority rule is likely to create conflict of interest, known as shareholder opportunism in which biased dealings towards oneself36 will be the outcome of most business decisions.

Another feature of closely held companies is that such companies are out of the influence of market, particularly, as regards transfer of shares. 37 If there is any way out at all it is dependent up on the buy-out by the other shareholder38 in which is easy to predict what will be the result when some or one of the parties is controlling shareholder. The restrictions on transfer of shares either by agreement or from the law39 will make exit at the mercy of the controlling shareholders who may be opportunistic of the situation at the expense of the minority. It is quite obvious, therefore, that shareholders in closely held companies are locked-in40 in such a way that it is really difficult, if not impossible, to get out of the company in case of disputes among them and more likely between controlling and minority shareholders. 41 Hence, closely held company is vulnerable to different problems, which are peculiar to its nature. These problems are mainly related with management and control and this mostly include ‘oppression of the minority shareholders’ 42 , corporate deadlock, waste and mismanagement, and problem associated with transfer of shares”.43 See http://www.enotes.com/closely-held-corporations-reference/closely-held corporations accessed on March 21, O’Neal & Thompson, As cited by Hunter, 35 See Sandra K Miller, supra note 30 pp.381-385, see also Robert C. Illig, supra note 10 p. 287 36 See Sandra K. Miller supra note 30 pp. 381-385 (Ibid) 37 See F. Hodge O'Neal, Close Corporation: Law and Practice (1958) (also known as O’Neal, Close Corporations), as cited in Manuel A. Utset, A Theory Of Self-Control Problems And Incomplete Contracting: The Case Of Shareholder Contracts, 2003 Utah L. Rev. 1329 (2003), pp.1342 & 1338; Robert C Illig, supra note 10, p. 288 38 Cynthia S. Grandfield, The Reasonable Expectations Of Minority Shareholders In Closely Held Corporations: The Morality Of Small Businesses, 14 Depaul Bus. L.J. 381, (2002), pp. 382-83 39 See Comm. Code, infra note 351 Art. 523 40 Paul Pieter De Vries, EXIT RIGHTS OF MINORITY SHAREHOLDERS IN A PRIVATE LIMITED COMPANY, KLUWER, 2010, p. 1 41 Robert C. Illig did not accept the kind of equivalency between partnerships and closely held companies. He called it false equivalency. He went further that, because of the shares held by investors vary in their rights the law should seek to determine which rights the parties think they have purchased rather than creating the kind equivalency with partnerships. The right should be determined by the price paid. An investor who pays more will have more corporate decision power, however, prejudicial to the other shareholder it may be. According to him, the bargain each share holds is important than the apparent equality between shares of the same value. However, closely held company is generally recognized as quasi-partnership Company. 42 See Robert C Illig, supra note 10, p. 276 43 See Cynthia S. Grandfield, supra note 38, pp. 382-383 34

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In conclusion the nature of closely held corporations, though attractive option for enthusiastic investors who may cooperatively work towards common goal, has problems of its own where the shareholders who have the majority vote try to turn every thing in their favor at the expense of the minority. The friendship and family relationship cannot guard the interests of the minority shareholders. When the trust and fiduciary relationship is not there any more the minority shareholders of the company will be put in vain. This problem lead Courts, legislatures, scholars and commentators to dedicate their time and energy finding way-out on minority protections and exit rights.

1.1 Why Minority Shareholders’ Protection 1.1.1 Who is Minority Shareholder? The concept of majority-minority, common notion in corporate governance, is aimed at drawing distinction as to who actually controls the firm in decision-making. 44 Quite naturally, a shareholder that controls the majority of the votes is majority and the one that lacks this privilege is a minority shareholder. 45 But this does not mean that the majority shareholder should always own more than half of the shares in the company. The most important element here is control over decision-making.46 Two or three shareholders, though individually did not hold more than half of the shares, may make coalition and take control of the decision-making.47 In some cases, where larger majority is required, holding more than half of the shares may not entitle the position of majority for there will not be a control over the decision making.

1.1.2 Problems of Minority Shareholders As discussed so far, minority shareholders in closely held companies have vulnerable status. This status of vulnerability is the result of the special attributes of the type of company that adopted both the quasi-partnership structure. Actually being a minority shareholder is in most cases is deliberate choice,48 save exceptional cases. That is to say an investor who pays less price will have less stake and consequently will be minority. So every decision by majorities 44

See Paul Pieter De Vries, supra note 40, p. 2 Ibid 46 ibid 47 ibid 48 ibid p. 3, see also Robert C Illig, supra note 10, generally. He further argues that investors have different risk preferences. The minority should only be protected when he/she is unaware of that risk and when not compensated for that vulnerable position by payment of less amount of money for the minority shareholding. 45

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that may affect his/her interest is not, necessarily, actionable. It is a reality that there will be conflicts of interest and disagreements. There is some kind of consensus that the minority should live peacefully with that vulnerable status.49 The doctrine of minority oppression will only come into play when the majority abused their power and the consequence becomes that the minority is expropriated in different ways, 50 termination of employment, freeze-out or denied of the distribution of profits or dividends as the case may be. The oppression may also come from the management that may act, in most cases, in favor of the interest of the majority. 51 When the ownership structure is concentrated one the distinction between the management board and the majority shareholders will be futile as the latter can dictate what the former has to do.52 This is the point where public companies are favorable choices than closely held companies. Being open to the public and the market, in public companies, opportunistic behavior by the majority is less likely due to publicity. 53 This publicity is not available in case of closely held companies and it may be prejudicial, even it existed, where the majority’s conduct is oppressive.54

Private company and its structure are favorable for oppression of minority. This is because there is no real exit for minority shareholders once locked into the company who cannot sell their share, exercise buy-out right or require dissolution.55

Firstly, unlike public corporations where the shares can be sold on the publicly quoted stock exchange market the same option is not available for minority investors in closely held companies. And even if there is buyer, the right might have already been waived by shareholders’ agreement or valuation of shares may be real difficulty in the absence of ready market that will provide a means of valuation.56 And even when the minority who want to exit the company is able to find some one who will buy his share, minority position is not attractive57 in the same company and the new comer will likely devalue the share offered to him and that may not reflect its true worth. Further more, even with the amount the new 49

See Paul Pieter De Vries, supra note 40 P-3c See S. H. GOO, MINORITY SHAREHOLDERS’ PROTECTION: A STUDY OF THE COMPANIES ACT 1985, CAVENDISH PUBLISHING LIMITED, (1994), p.1 51 See Paul Pieter De Vries, supra note 40, pp. 3-4 52 ibid p. 4 53 See S.H Goo, supra note 50 at p.1 54 In closely held companies publicity of the majority conduct may jeopardize the interest of minority shareholders in some cases. That is to say, even if the minority can find some one to buy his share and to be put in his shoes the new comer that has information about the problem due to the publicity will offer a price that will not reflect the actual worth of the shares held by the minority. The new comer may put a discount on that share because of the oppressive conduct of the majority. 55 See generally Douglass Moll, supra note 6 at pp. 900-905 56 See Manuel A. Utset, supra note 75 at pp. 1342-1342 57 See Robert C. Illig, supra note 10, p. 288 50

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comer is willing to buy, the option may not be available because of the prohibition of, either by the law or article of association, introducing a stranger to the company. Cumulatively, minority shares may not be tradable at all are less attractive for the buyers who will put a discount on it. So any exit strategy, will be economically too prohibitive to escape any opportunistic behavior of controlling shareholders. Secondly, problem of minority oppression is aggravated by lack of buy-out right for the minority shareholder. Had there been such right for buy-out then the minority could have escaped any oppression by the majority. Finally, dissolution right as in partnerships is not an option in case of closely held corporations. Of course the kind of remedy for the minority shareholder will be too harsh for other shareholders, perhaps other minorities, and is not attractive and should be remedy of last resort. But it can be a good guarantee in shaping the conduct of the majority whose interest will be affected if ordered to dissolve the company. That is, the remedy will force the majority to forbear from any act that will jeopardize the interest of the minority.

Even where there is exit right the valuation of shares may at times be very difficult because of the contribution by shareholders may not necessarily be money contribution.58 The ultimate result of the absence of all the above remedies just locked the minorities into the company and make exit almost impossible unless at a high price. This in turn will enable the controlling shareholders to oppress the minority by different squeeze-out and freeze-out techniques such as removing from management, terminating employment, stop paying dividends and any other activity that is prejudicial to the interest of the minority.59

The minority oppression would not have been that a problem, were it not for the grand norm of corporate decision making-majority rule.60 The norm of majority rule contributes to the problem of oppression in closely held companies61 and coupled with high cost of exit right for the minority it is more likely that the majority will be opportunistic. 62 Due to this, mostly when abused by the board or the general meeting, there is a chance that minority shareholders interest will be prejudiced. 63 If the act is either breach of agreement or law minority

58

See Dan Prentice, The Theory of the Firm: Minority Shareholder Oppression: Sections 459-461 of the Companies Act 1985, 8 OJLS, 55 (1988), p. 58 59 See Douglas Moll, supra note 6, pp. 904-905 60 Ibid pp. 905-907, see also Paul Pieter De Vries, supra note 40, p. 1 61 This does not mean that the allocation of control in a company should be divided equally. To try to avoid one problem [minority oppression] disregarding the possibility of another [corporate deadlock] is not smart choice. As Robert C. Illig (P, 288-2889) has pointed out there must be a way by which corporate decision-making should be made. 62 See O Neal’s Close Corporations, as cited in Manuel A. Utset, supra note 75, p. 1339 63 See S. H. Goo, supra note 50 at p. 2

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shareholders can challenge the act by bringing personal action. 64 But personal action by minority may not be that easy to exercise and protect minority interests. The prejudice to the minority interest may come from the decision of the board or the general assembly with in the limits of their power or the same may be subject to approval through process of ratification and it is recognized principle that only the company has standing on cases that involve its interest.65 So the principle of majority rule will enable the controlling shareholders to extract wealth from minority that gave rise to opportunistic behavior.66 And were it not for majority rule 67 it would have been very easy for minorities to block the decision of the majority and ensure that their interest is protected.

The other source of problem, which contributed for minority shareholders oppression, is lack of advance planning for ex ante remedies by the shareholders.68 It would have been remedied if shareholders’ provide ex ante plans. Minorities would have been far more protected had they expressly agreed as to their role, allocation of decision power in the board, if any, and resolution of disputes.69 However the kind of contractual planning by the parties is not easy task. The practicality of this option is really questionable70 especially in long-term contracts of this type. There are several reasons and explanations for this absence complete contracting by the parties. The obvious reason is contractual foresight or the transaction cost analysis 71 and if there is any possibility at all the cost of doing so will overwhelm the benefits by far. 72 Ignorance is another bar to complete contracting 73 as, in most cases, investors in familyowned business are unsophisticated in legal and business matters such that the need for contractual protection.

Peculiar to closely held corporations for the lack of advance planning is the existence of trust, optimism and loyalty between shareholders in cooperative ventures such as closely held family companies where they are likely to be family members, business partners or close 64

ibid ibid pp. 1-2 66 See Manuel A Utset, supra note 75 at pp. 1342 67 This should not be understood to mean that majority rule is unnecessary and should not be the norm. It is very important for genuine business decisions as it is in other cases. The problem is when it is abused. 68 See Douglas K. Moll, supra note 6 at p. 952 69 See Manuel A. Utset, supra note 75 at p. 1343 70 ibid, p. 1345 71 ibid, p. 1347, He indicated that the transaction cost justification is not dispositive of the reasons for incomplete contracting. According to him, even when transaction cost is zero it is seen to be too tempting for the parties to provide extensive rights for minority shareholders for the reciprocal nature of the problem. He summarized the opinion of some scholars as, if the minority shareholders are given a right for exit at will this will change the dimension of the problem to minority opportunism. 72 See Robert B. Thompson, The Shareholder's Cause of Action for Oppression, 48 Bus. Law. 699, 700-03 (1993) as cited in Adam Chernichaw, supra note 33 at p. 509, see also Manuel A. Utset, supra note 75 at pp. 1382-1382 73 See Douglas K. Moll, supra note 6, p. 912 65

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friends remedies for dispute resolution or likelihood of problem is not easy to be seen at the time of contracting.74 It may be also the case that even if one or some of the shareholders can foresee the likelihood of dispute and risks associated with their investment it may not be appreciated by the other party, who may be influential, and any attempt to bring the issue under consideration will likely kill the probability of reaching agreement to incorporating under the company.75

1.1.3 Protection of Minority Shareholders Firms provide a means to organize economic activity in a least cost than market itself would provide. But in the closely held corporation setting the costs assumes a different form and masked by another cover known as shareholders’ opportunism importantly the controlling shareholders against minority.76 So the role of corporate law as a tool and strategy should come up with way outs for these problems. The corporate structure should take into consideration of the issues of shareholders’ opportunism and should provide remedies for the minority shareholders who may be affected by the majority decision. Had there been a possible exit or parties are able to draft the most complete contract then there would not have such problem of majority opportunism and minority oppression. Company form, as a standard contract77 and prepackaged public good78 should address issues parties would have dealt with, like exit rights, had they costlessly agreed with each and every issue.79 Even if there is a chance for contracting parties to provide a means by which their rights and interests are protected in the company, for the limitations discussed above the chance is used rarely. And the silence of the parties to unveil the issues should not be understood as if they waived the right to do so and accept the minority oppression that would likely happen in the closely held company set up.80 The protection of minority shareholders

74

See Adam Chernichaw, supra note 33, pp. 502 & 509, see also Manuel A. Utset, supra note 75, pp. 1376-1379 Robert B. Thompson, Corporate Dissolutions and Shareholders’ Reasonable Expectations, 66Wash. U.L.Q 193, 196 (1988) as cited in Adam Chernichaw, supra note 33, p. 501, see also Manuel A. Utset, supra note 75, pp. 1341-42 76 See Dan Prentice, supra note 58 at p. 59 77 ibid 78 ibid 79 ibid 80 ibid p. 61 75

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can better be dealt under this prepackaged form than private contracting if the prepackaged form is drawn from the experience of previous users.81

The argument that complete contracting can be a safeguard for minority shareholders in the absence of the kind of corporate form is, therefore, untenable for several reasons discussed above and courts inability or unwillingness to interpret and enforce those sophisticated contracts as intended by the parties, if there is complete contract at all. 82According to this view, complete contracting even if exist, is not a sufficient guarantee for minority oppression problem in closely held corporation because there is no guaranteed enforcement in courts for several reasons. Especially minority investors in civil law countries are prone to abuse by controlling shareholders, as courts are not strong enough to discern over economic decisions over which governments are interventionists.83 Hence, no matter how complete the contract is it may not be helpful if not interpreted according to the deal.

The protection of minority shareholders is justified both on ownership and efficiency grounds. Minority shareholders need to be protected from the controlling shareholders. 84 Once minority shareholders have invested in a firm they shall have the right to disclosure and accounting rules, receive dividends on pro-rata basis, right to vote, participate in shareholders meeting and sue managers or majority shareholders for any alleged violation of the deal or law. 85 There should be clear and predictable system that protects the right of minority shareholders so that they can reap the returns out of their investment.86

Strong investor protection is favorable condition for the development of financial markets. If there is strong investor protection, there will be more buyers ready to pay for securities and make it possible for entrepreneurs to issue more securities. 87 Especially for developing countries that are recipients of capital it is necessary that they have a legal regime where the investors are protected and risks are lowered. Strong investors’ protection, both shareholders and creditors, can be a source of capital, especially in markets where there is lack of capitals. This is true for developing countries by 81

ibid p.59 See R. La Porta et al, Investor Protection And Corporate Governance, 58 Journal of Financial Economics 3 (2000), p. 7 83 Ibid pp. 9-12 84 Ibid, p. 6 85 Ibid pp. 5-6 86 Ibid p. 19 87 Ibid p. 15 82

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providing strong investor protection they may attract foreign investors and overcome lack of capital in their markets. In countries where there is strong shareholder protection there is strong stock market, many listed securities and higher rate of initial public offering and likewise strong creditor protection guarantees larger credit markets. 88 The consequence of strong investor protection is better saving that will be changed to real investment and financiers control over investment decisions of entrepreneurs will lead to improved efficiency in allocating resources.89

In countries with poor investor protection controlling shareholders have access to capital, the means to cope with the political influence to get it and thereby are protected from competition of new entrants into the market. 90 This will deny small firms and outside investors’ access for capital and the market and expropriation of the new comers if they enter into the already existed firm by buying shares. Poor investor protection is a bar to the flow of foreign investment, especially for developing countries that may be badly in need of capital and technology. Dozens of commentators91 have pointed out that portfolio investors are not willing to invest in countries and companies with poor corporate governance and weak investor protection. This is because of, on the one hand there is a likelihood that returns out of the investment will not be realized and on the other hand due to the ‘private benefits of control’ wealthy investors are willing to pay for a share more than its value and

92

the

valuation of shares did not reflect the discount for the would be expropriation and oppression of the shareholders and make entrance into it very expensive.93 That is, when ownership is concentrated only in the hands of few shareholders or single individual there is a high risk that minority shareholders will be expropriated. Absence of discount for the risk of expropriation because of the competition to be the controlling shareholder will make the entrance fee very expensive.

88

Ibid p. 15 Ibid p. 16 90 Ibid p. 21 91 Mariassunta Giannetti & Yrjo Koskinen, Investor Protection, Equity Returns, and Financial Globalization, 45 Journal of Fin. & Quant. Analysis 135 (2010), pp. 135-136 92 See R. La Porta et al, supra note 82, p. 13 93 See Mariassunta Giannetti & Yrjo Koskinen, supra note 91 at p. 136 89

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Chapter Two General Overview of Exit Rights of Minority Shareholders of Closely held Companies 2.1 Exit Rights in General It is discussed so far that minority shareholders in closely held companies have vulnerable status. It is a universal problem as companies in different legal systems using the same form face the same problem.94 The company form, in most cases, is dependent up on the personal relationship of the shareholders and the latter, importantly the minority, have expectations and all the problem will come when the relationship failed and those expectations are faded away.95 At this juncture the minority may want to exit the company but practically will find him/herself handicapped because of the nature of this firm. Against this background different legal systems try to approach the problem from different perspective and developed different doctrines but all with the same objective.

In public company entry and exit is cheaply available. But in closely held firms due to the nature of the company and due to the illiquid shares there is no mechanism to transfer the shares to third party. Majority shareholders who monopolize the corporate decision-making will use different techniques such as squeeze-out and freeze-out techniques and oppress the minority.96 Moreover, different decisions as to the appointment of officers, salary for these officers, sharing of profits, and how much to give to the minorities will all be made by the majority or their appointed board.97 Hence, it is important for a minority shareholder wishing to buy a stock in a closely held company to think of the way out when exit is necessary.98 There must be an exit strategy otherwise the minority will be locked into the company.99 Circumstances and conditions on which the minority can exit the company should clearly be outlined either by agreement of the parties and, more importantly, by the law. Otherwise, in most cases, unless clearly specified there is no general obligation either on the company or its shareholders to redeem the shares of exiting minority.100

94

See Reinier Kraakman et al, supra note 9 at p. 1, see also Hugh T. Scogin, Jr, Withdrawal And Expulsion In Germany: A Comparative Perspective On The Close Corporation Problem, 15 Mich. J. Int'l L. 127 (1993), p. 128 95 See Hugh T. Scogin, Jr. p. 129 96 See Ladd A. Hirsch
 James D. Sheppard, supra note 5, p. 2 97 Ibid 98 Ibid, p. 1 99 Ibid 100

Ibid

15

To this effect some doctrines by which such exit right of the minority can be realized are developed. For example in United States, court ordered dissolution as an exit strategy was recognized. 101 Later courts developed other doctrines and remedies aimed providing exit because of dissolution remedies in most cases were considered very harsh

102

and the

applicability of this rule was also very narrow because it is really difficult to show economic unviability whenever the interest of the minority is prejudiced and expectations frustrated.103 These make investors, almost, prisoners of their own creation for there was no reliable means of exit. Then comes variety of remedies for minority shareholders that takes different elements such as fiduciary duty, reasonable expectation and oppression than the traditional criterion of economic viability.104

Exit right is not one-sided remedy absolutely intended to favor the over the majority. The issue of minority opportunism is also envisaged and the different grounds put in exercising exit rights are meant to serve this. They are rather equally concerned about the interests of the company, majority shareholders, creditors and employees.105 The mere fact that a certain exit remedy better protects the interests of minority shareholders does not mean that it should always be enforced. The interests of the other stakeholders should also be balanced.

In the next two sections the most advanced company law jurisdiction of England and Germany will be discussed. Germany Private Limited Company Law (here in after GmbH), one of the best legal transplants that have shaped many countries’ of continental Europe and Asia, laws with regard to the small privately held companies.106

2.2 England English Law is one of the most advanced company law jurisdiction that has been transplanted to several jurisdictions. It is also one of the jurisdictions that have developed comprehensive

101

See Hugh T. Scogin, Jr., supra note 94 at p.129 See Ladd A. Hirsch
 James D. Sheppard, supra note 5 at p.130 103 Hugh T. Scogin, Jr., supra note 94 at p.130 104 Ibid 105 See Paul Pieter De Vries, supra note 40 at pp. 5 – 7 106 See Marcus Lutter, Zur Entwicklung der GmbH in Europa und in der Welt, 96 GmbHR 1(2005), and the essays in Marcus Lutter, 100 JAHRE GMBH-GESETZ (1992); Schlesinger, in Marcus Lutter, 100 JAHRE GMBH-GESETZ 830 (1992); BURKHARDT W. MEISTER & MARTIN H. HEIDENHAIN, THE GERMAN LIMITED LIABILITY COMPANY 24 (5th ed. 1988); Jan Thiessen, Transfer von GmbHRecht im 20. Jahrhundert - Export, Import, Binnenhandel in VANESSA DUSS, ET. AL., LEGAL TRANSFER IN HISTORY 446 (Martin Meidenbauer Verlagsbuchhandlung, ed. 2006); see also HANDBUCH DES INTERNATIONALEN GMBH-RECHTS (Rembert Suess & Thomas Wachter eds, 2006) (providing comparative documentation) as cited in Michael Beurskens and Ulrich Noack, The Reform of German Private Limited Company: Is the GmbH Ready for the 21st Century? 9 G.L.J , 1070 (2008) at p. 1070 102

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minority shareholder protection in closely held companies. The Companies Act of 2006 is the law that is in force regarding company law issues today. There are two statutory exit remedies under English Law. These remedies are just and equitable winding up remedy that is provided under the Insolvency Act of 1986 and the unfair prejudice remedy of the 2006 Companies Act.

2.2.1 Just and equitable Winding Up Winding up is the process by which the life of the company ceases to exist. And this will give members/shareholders a means to exit the company.107 There are several ways by which a company may wound up. Of which agreement of the members is an option. But practically since the same requires larger majority it is unlikely that the members will agree to the effect of winding up. 108 Hence, not good protection for minority that needs to exit. To fill this lacuna compulsory dissolution of the company is provided as an exit strategy for the minority shareholders who may find him/herself locked into the company with no other possible alternative. The oldest exit remedy recognized under English law is just and equitable winding up.109 As provided under section 122 (1) (g) of the Insolvency Act of 1986 the winding up of the company may be ordered if the court is of the opinion that it is just and equitable to end the life of the company. 110 This remedy is not restricted to shareholders 111 only. As provided under section 124 (1) & (4) it is open to directors, creditors, and secretary of state.112 Another issue in connection with standing is that the petitioner should have clean hands113 because the problem will be ‘what goes around comes around’ if the petitioner behaved in a wrong way. This is to say that if the ground for winding up of the company is caused by the shareholder then he/she can’t avail him/herself with the remedy. And the court will not lend its arm to the conduct it disapproves for simply the change in the status of control in the company. The

107

See Paul Pieter De Vries, supra note 40 at p. 2 Ibid p. 62 Ibid p. 61 110 See ROBIN HOLLINGTON Q.C., MINORITY SHAREHOLDERS’ RIGHTS, 3rd ed., Sweet & Maxwell (1999), p. 38 111 Shareholders are subsumed under the notion of contributors for the purpose of section 124 of the Insolvency Act of 1986. As Paul Peter (P-63) pointed out, “the term contributor includes persons liable to contribute to the assets of the company in the event of wound up of the company. Literally, Shareholders who pay only part of the contribution are contributors. Contrary to this, it is established that even a shareholder who paid fully is considered as contributory.” 112 See Paul Pieter De Vries, supra note 40 at p.63 113 Ebrahimi Vs Westbourne Galleries, (1972), 3WLR 1289, as cited in Paul Pieter De Vries, supra note 40 at p. 67 108 109

17

neutrality, however, need not be absolute and minor wrong doing by the shareholder will not bar the shareholder from invoking this section.114

The next issue worth explanation is the grounds that justify just and equitable winding up of the company. There are several grounds by which the company’s winding up may be ordered. These include loss of confidence and trust among members of the company, deadlock in decision making, failure to achieve the purpose of the company for which it is established, the case of fraudulent companies, breach of fundamental agreement or understanding. Each ground will be discussed in the following subsections.

i) Breach of Fundamental Understanding or Agreement This is the most important ground on which winding up petition may be instituted. 115 In closely held companies there are agreements, understandings, promises, bargains and expectations among members. Most importantly members of those closed companies often actively participated in the affairs of the company, like as a directors or officers.116 And it will be contrary to these expectations or understandings if minority acting in the management is excluded. In principle directors may be appointed or removed as the case may be and not every removal can justify an application for winding up.117The exclusion from management may well be justified by the majority vote and the subsequent disguise i.e. that is it is in the interest of the company such as the removed director does not fit very well to the place for he lacks the professional capability. The problem is what will be the basis to challenge this majority decision? It is established that the power of the majority to remove the minority director should be bona fide in the interest of the company.118 The court will use a metaphor of reasonable person if the latter will think that the removal is justified.119 If these tests are not satisfied then the exclusion from management will be adjudged unlawful and will be a ground for winding up.120

What it takes for the plaintiff, minority shareholder, is to prove that the company is of the nature that there is trust, understanding, confidence and cooperation between the

114

Ibid p. 67 See Robin Hollington, supra note 110 at p. 43 116 Ibid p. 43 117 See Victor Joffe QC et al, MINORITY SHAREHOLDERS: LAW PRACTICE AND PROCEDURE, (4th ed.) Oxford University Press (September 2010), p.212 118 Re Westbourne Galleries, 1 Ch. 799, CA; [1971] A.C 360, HL. As cited in Robin Hollington, supra note 110 at p.43 119 Ibid p. 43-44 120 See Victor Joffe QC et al, supra note 117 at p. 212 115

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shareholders/members of the company and the breach in relation thereto.121 However, too much analogy to the law of partnership and closely held companies will be erroneous in the sense that some companies though held by few family or friends may be purely commercial in nature and the said promises, understandings and fiduciary may not exist. In such cases only provisions of the article and the law will be applicable and reference to those bargains, understanding or promises whatsoever that are not subsumed in to the company structure will not be considered.122

ii) Justifiable Breakdown of Confidence In closely held companies the relationship of the parties is based on trust, confidence and cooperation, at least in most cases.123 The shareholders active participation in the company in their role as managers, officers and employee, which may be double or triple as the case may be, strengthens the above assertion. When it is established that there is lack of confidence of the minority on the majority this can be a ground for winding up petition. But either mere lack of confidence on the management or pessimistic view that is not shared by the majority is far from being a just ground towards successful winding up application. 124 Lack of confidence as a result of lack of probity of the management or the majority is necessary for this ground to be used. 125 Also improprieties in the company that may lead the trust and confidence between shareholders and directors to broke up will be a ground for winding up.126

Here the trust and confidence is not only limited to the minority shareholders in his capacity as a shareholder but also in his relation to the company and other shareholders.127 This is to say is the interest of shareholders in privately held companies went beyond just a shareholder. It is a relationship that lies somewhere in between shareholder and partner. So scope of confidence in this regard is not restricted to in his capacity as a shareholder but the over all relations he has with the company and shareholders. But this relationship and loss of confidence must be understood to a conduct in relation to the affairs of the company only.128 So the minority shareholder can invoke this ground as a means for dissolution and exit the

121

See Paul Pieter De Vries, supra note 40 at p.74 122 A.J.BOYLE, MINORITY SHAREHOLDERS' REMEDIES, Cambridge University Press, (2002), p. 92 123 See Robin Hollington, supra note 110 at p. 49 124 Re Agriculturist Cattle Insurance Co, ex p Spackman (1849) 1 Mac & G 170, as cited in Victor Joffe QC et al, supra note 117 at p. 214 125 Ibid p. 214 126 See Robin Hollington, supra note 110 at p. 50 127 See Paul Pieter De Vries, supra note 40 at pp. 68-69 128 Ibid p. 68 Loch v John Balckwood Ltd (1924) AC 783,

19

company where the trust and confidence that is necessary for cooperative carrying out of the companies’ affairs is broke up and it is just to wound up the company. 129 This ground can only be used if the broke up and loss of confidence is not attributable to the plaintiff, the minority shareholder in the case at hand.130

iii) Deadlock Deadlock is another ground for winding up of a company. Deadlock occurs where two shareholders have equal voting and management rights but are no longer able to cooperate and work together. It is an example of loss of confidence. 131 But it is easier to invoke deadlock as a ground because all it takes is to show that decision making cannot be reached for the two shareholders opt different ways and one cannot out vote the other. Practically, however, deadlock happens rarely for there are other curing mechanisms for the problem.132 Chairman’s casting vote in the case of directors deadlock, or the general meetings decision in the case of deadlock at the board level are some of the mechanisms where company may escape winding up though there is deadlock in decision making. 133 If all these are not available, however, winding up will be the last viable remedy. However, this winding up ground may not be that much relevant for the issue exit right of minority shareholders. This is because the issue of deadlock will rarely exist when there is a difference in shareholding and the subsequent voting power attached thereto. Deadlock is not necessarily restricted to cases where actual decision making between the parties become impossible but also can be ground of winding up when future confidence and cooperation between parties is no longer possible.134

iv) Loss of Substratum A company may be wound up and a petition to that effect may be lodged where the company’s existence is no longer viable. This includes cases where the company’s purpose is already achieved or the objective has failed.135 The first possibility that is envisaged is that when the company was established for a certain purpose and has achieved such purpose then the minority can realize his investment back. But if the majority want to keep the company 129

See Paul Pieter De Vries, supra note 40 at p. 68 See Fessner vs Farrad Properties Ltd. (1993) BCLC 1032 (Court of Session); Vujnovic v Vujnovic (1990) BCLC 227 (PC) as cited in A. J. Boyle, supra note 122 at, p. 93 131 See Robin Hollington, supra note 110 at p. 51 132 Ibid 133 Ibid 134 See Paul Pieter De Vries, supra note 40 at p. 69 135 See Robin Hollington, supra note 110 at p. 52 See also, German Date Coffee Co. (1882) 20 Ch D 169 CHD; Re Perfectair Holdings Ltd. (1990), BCLC 423, Jofle Drake/ Richardson Lightman (2008), pp. 166-168 as Cited in Paul Pieter De Vries, supra note 40 at p. 70 130

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alive despite the accomplishment of the objective envisaged at the time of incorporation then the minority can seek winding up remedy to exit the company. 136 The second element of loss of substratum is when the object of the company cannot be achieved or impossible to achieve137 and if it cannot be achieved it is a ground for winding up.138

Further more, failure by directors to pay dividends for those shareholders that are not participating in the administration of the company while receiving excessive salary for themselves is also actionable under the just and equitable winding up remedy.139

Generally, winding up remedy will be ordered of the petitioner can prove to the satisfaction of the court that the conditions for just and equitable winding up are exist.140 But this does not warrant for the petitioner that winding up will automatically be ordered by the court right after all the conditions are met.141 All these grounds may not help and winding up may not be ordered if the court is of the opinion that there are other remedies less drastic than winding up.142 To this effect, section 125 (2) of the Insolvency Act provides the court may order winding up if it is of the opinion that the petitioners are entitled to relief either by winding up of the company or by any other means.143 From the wording of this provision the winding up remedy is discretionary for the court and the court may order this when there is no equitable option other than winding up. So when there is an alternative remedy than the just and equitable winding up then the less drastic remedy will be chosen by the Court.

Just and equitable winding up remedy is criticized for being too broad by allowing winding up in in cases of breach not related to the law and or articles of association.144 The breach may extend up to breaches of equitable rights and legitimate expectations of the minority, which does not arise from either legal or contractual relationship, when the company is of a nature that requires trust and confidence of its member for its continuation.145 Further more the winding up remedy is criticized for not remedying the minority shareholder because of

136

Minority Shareholders Law Practice and Procedure, P-216 See Paul Pieter De Vries, supra note 40 at p. 70, see also Robin Hollington, supra note 110 at p. 52 Re German Date Coffee Co (1882) 20 Ch D 169, as cited in Victor Joffe QC et al, supra note 117 at p.216 139 Re a Company (No 00370 of 1987), ex p Glossop, [1988] 1 WLR 1068, as cited in Victor Joffe QC et al, supra note 117 at p. 214, 137 138

140

Ibid p. 218 Ibid See Robin Hollington, supra note 110 at p. 38 143 Ibid 144 See S.H. Goo, supra note 50 at p. 14 145 Ibid, See also A. J. Boyle, supra note 122 at, p. 92 141 142

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the break-up value of the assets will be low and often the potential purchaser of these shares is the oppressing majority.146

Due to all these factors doctrine of minority oppression was introduced in the 1948 Companies Act.147 The importance of winding up remedy is diminished with of new doctrine of oppression, later renamed as unfair prejudice as stipulated under s 994 of the 2006 Companies Act (formerly section 459 of 1985 Act). 148 The two exit remedies some how overlap 149 because both in just and equitable winding up and unfair prejudice remedies, breaches of understandings, bargains or promises are sufficient to seek remedy under both remedies. In doing so the court in O’Neill v Philips borrowed the standards developed under the Ebrahimi v Westbourne Galleries.150 The latter remedy, however, is dominant much more flexible because it does not necessarily require the dissolution of the company. And winding up remedy, which is subsumed under the unfair prejudice remedy, will be ordered as an order of last resort. The unfair prejudice remedy is broader and is an objective standard, which gives a playground for courts to determine its scope and application.151

2.2.2 The Unfair Prejudice Remedy This is the other statutory minority exit right provided under English law. The doctrine of unfair prejudice is developed out of the need for a much more strong, flexible and effective exit right for the minority that does not require winding up of the company and lacuna in the winding up remedy is considered too drastic for it involves the dissolution of the company.152 Further more the break-up of the assets of the company put a huge discount on the shares of minority shareholder and dissolution benefit the oppressor out of their wrong for the latter are buyers of those assets, practically. 153 The unfair prejudice remedy originally was an oppression remedy that was introduced in section 210 of the 1948 Companies Act.154 This

146

See Paul Pieter De Vries, supra note 40 at p. 75 Ibid 148 Ibid, See Robin Hollington, supra note 110 at pp. 38-39, and see also S.H. Goo, supra note 50 at p. 14 149 “Though the existence of overlap is beyond doubt there is a debate as to what kind of overlap exists between the two remedies; partial or complete. Paul Pieter De Vries (79) conclude that the issue is far from resolved. This is because, as pointed by Stanely Burnton LJ in the case Hawkes v Cuddy (2009) EWCA Civ. 291 at 107, a conduct may not be unfair but still winding up on just and equitable ground is necessary. According to him, therefore, the overlap is partial one. But there is neither confirmation nor rejection of the issue and discussion and debate stand still. The author suggested that winding up remedy be included to the remedies set out under s 996 of the 2006 CA.” 150 See Paul Pieter De Vries, supra note 40 at p. 75 151 See A. J. Boyle, supra note 122 at, p. 94 152 See Sandra K Miller, supra note 30 p.382 as sited in Carol L. Kline, Protecting Minority Shareholders in Close Corporations: Modeling Czech Investor Protections on German and United States Law, 23 B.C. Int'l & Comp. L. Rev. 229 (200) p. 243 153 See Cohen Committee Report (1945), pp. 60 & 152, as cited in Paul Pieter De Vries, supra note 40 at p. 75 154 Ibid p. 82 147

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remedy was introduced as an alternative to winding up remedy. 155 The definition and scope of the remedy was restricted, despite a suggestion to the effect that it should include fair dealing and lack of probity, to mean burdensome, harsh and wrong giving it little ground play for the special problem of closely held companies.156 That is to say, the narrow interpretation by courts of the remedy of oppression triggered by several limitations attached to the provision makes the remedy unsuccessful.157Another problem was section 210 of the 1948 companies Act was applicable only when the plaintiff was oppressed in his capacity as a member and nothing else making it non viable to the issue of closely held companies.158 Later the oppression remedy was changed into a new statutory remedy that deals with unfairly prejudicial conduct as is incorporated under section 75 of the 1980 Companies Act. 159 The same section was subsequently amended by the 1985 Companies Act as stipulated under section 459-461 of the Act160, to the 1989 Act by the inclusion of a phrase ‘members generally’ with the aim of widening the remedy161 and later replaced by section 994 of the 2006 Companies Act, and case laws that followed with, provides a way by which minority shareholders may bring action when the affairs of the company are conducted in a manner, which is unfairly prejudicial to the interests of its members generally or some of them including at least the petitioner.162

The plaintiff, or minority, who invokes this section, should establish the following elements that are included in the provision. These are the act or omission that is complained of must be in relation to the management of the affairs of the company, the conduct results in the prejudice to the interests of a member or members, and the prejudicial conduct is unfair.163

The interest recognized under this provision are interest as a member as can be seen the wording of the provision. And a member of a company is either subscriber or a person for who has consented, even though without binding legal agreement, to become a member and whose name appears on register of members.164 Section 994 (2) also allows the right to a person for whom shares are transferred by operation of the law. Stated otherwise, if a person

155

See Victor Joffe QC et al, supra note 117 at p. 238 Ibid See Paul Pieter De Vries, supra note 40 at p. 82 158 Ibid 159 See supra note 155 160 Ibid 161 See Paul Pieter De Vries, supra note 40 at p. 83 162 See A. J. Boyle, supra note 122 at, p. 94 163 See Robin Hollington, supra note 110 at p.76, see also Victor Joffe QC et al, supra note 117 at p.239 164 Victor Joffe QC et al, supra note 117 at p. 239-240 156 157

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is neither member nor shares have been transferred to him by operation of the law, he is devoid of the privilege under the same section of the 2006 Companies Act. 165 This lax attitude towards membership requirement is inserted in the interest of not restricting the remedy to only few circumstances as in the oppression remedy.166 A majority member of a company can also avail him/herself with the remedy under s 994 of the Companies Act. Even though this right is rarely used because the majority can avoid the prejudice by him/herself without the intervention of the court there is no prohibition to this effect.167

Another element to invoke s 994 is that the act, whether actual or proposed, or omission must be in relation to the affairs of the company. Under this section it must be established that the affairs of the company are being or have been conducted in a manner that is unfairly prejudicial or the proposed act or omission is or would be prejudicial. Acts and conducts of shareholders and acts and conducts of the company are distinguished here. 168 The unfair prejudice remedy covers all current, past and future (proposed acts) conducts and omissions.169 When the unfairly prejudicial act is continuing it can be a ground for seeking remedy under this section.170 However this is restricted to existing members or new comers who were not aware of the conduct or act.171 The fact that a certain prejudicial conduct has been remedied or is stopped does not exclude the application under this provided that the conduct may recur.172As regards proposed acts, every proposed act cannot be a ground for petition under s 994 and following sections but the proposal must be beyond mere threat and discussion stage.173 That is to say a decision has to be passed in order to proceed with the proposal.174 However, it is not necessary that there should be actual prejudice caused by the proposal. In addition to company’s affairs and member interests, the other element in that needs to be established to invoke the remedy under the above provision is that of prejudice. The member of a company in order to avail himself of the benefit of s 994 of the 2006 Companies Act is that his interest as a member must be prejudiced. However, the fact that the interest of

165

Ibid, p. 240 See Paul Pieter De Vries, supra note 40 at p. 95 Re Legal Costs Negotiators Ltd., [1999] 2 BCLC 171, as cited in Victor Joffe QC et al, supra note 117 at pp.242 & 243 168 See Paul Pieter De Vries, supra note 40 at p. 89 169 Ibid 170 See Victor Joffe QC et al, supra note 117 at pp.255 & 256 171 Ibid 172 Ibid p.256 173 Ibid p. 257 174 Ibid 166 167

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members is prejudiced by the complained act, conduct or omission may not necessarily entitle relief under s 994 of the 2006 Companies Act. The act in order to entitle relief should be unfairly prejudicial. 175 Hence, the doctrine of unfairness is at the heart of the remedy under the section.176 But the phrase unfairly prejudicial does not have a precise meaning. It seems, however, a deliberate choice by the legislature just to give playground for courts that will give it the meaning on case-by-case basis.177

Under s 994 of the CA it is stated that the conduct of the affairs of the company complained of must be unfairly prejudicial to the interest of the company’s members generally or some of its members including the petitioner. From this a question worth to ask is what are these rights of members in general, or at least that of the petitioner? What are the justifications for the kind of personalized claim under section 994 of the Companies Act? The scope and extent of members’ rights and interests depends on the nature and type of the company. Under general company law members’ interest is restricted to those rights that arise from statutes and articles or memorandum of associations. 178 Issue of locus standi may went further in seeking justification why members are allowed to invoke personalized right that is not expressly provided either under the law or article or memorandum. That means members can only enforce their legalized rights and they can’t bring their personalized rights that are not dealt either under the law or articles of association before the Court in sought of remedies. 179 Under closely held companies, however, due to the personal nature of the relationship there are legitimate expectations and understandings of shareholders inter se as to observance of rights that are not necessarily legal.180 Consequently a shareholder whose expectations are frustrated or defeated by the majority has locus standi. Hence, the scope of ‘member’s interests’ in closely held companies is too broad that includes expectations, promises, bargains and understandings, which may not necessarily be legal rights and the application of s 994 is not restricted to this general principle. 181 For example In public company where ownership and control is separated and when one of the shareholders is director or manager at the same time his rights as a member and as a manger can be defined with sufficient precision.182 But in closely held company the role of the shareholders may be

175

See Robin Hollington, supra note 110 at p.83 See Paul Pieter De Vries, supra note 40 at p. 94 177 Ibid, see also Re Macro (Ipswich) Ltd [1994] 2 BCLC 354, 404i as cited in Victor Joffe QC et al, supra note 117 at p. 263, 178 See Victor Joffe QC et al, supra note 117 at p. 258 179 See A. J. Boyle, supra note 122 at, p.111 180 Ibid 181 See Paul Pieter De Vries, supra note 40 at p. 97 and see also Victor Joffe QC et al, supra note 117 at p. 258 182 See Robin Hollington, supra note 110 at p. 80 176

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either double or triple as the case may be. They may act as shareholders, managers and officers. Under this company form where the participation of the shareholders in the day-today affairs of the company is essential and where there are no dividends, but only salaries, exclusion from management, when the values of shares is diminished seriously, for example, will be prejudicial to the interest of the member concerned.183 Due to this it is important for the shareholders to insist and strive for participation in the company, protect and develop their investment using their skills and labor as the case may be, and watch over the conduct of the co-shareholders.184 Closely held companies have the characteristics of quasi-partnership.185 They are established based on personal relationship, trust and confidence, there is an understanding that shareholders will participate in the management of the company and there is a restriction as to the transfer of shares. The same principle was adopted in the leading case of O’Neill v Phillips for unfair prejudice.186The kind of broad equitable principle is intended to remedy problems in firms that adopt both the partnership and company forms. 187 This is on the basis that in those closed/private company structures where, apart from declared will that is expressly agreed, there is promises, understandings, words or conducts between members inter se. And if those understandings, promises and expectations are not observed or respected by the members, importantly by the majority, then it will be unfair and prejudicial for the minority to continue to be a member of that company.188

2.2.2.1 Categories of Unfairly Prejudicial Conduct to the Interests of Minority From the case law concerning the unfair prejudice remedy a category of conducts that amount to unfairly prejudicial to the interest of the minority are discussed bellow. As some authors suggest, these list is not an exhaustive list and the issue of unfair prejudice is a matter for the court to decide on a case-by-case basis paying reference to the facts of the case than to category of the conduct. 189 These conducts include dismissal from management, failure to consult the petitioner or provide information, commercial mismanagement, breach of articles or shareholders’ agreements, Illegality, excessive remuneration for directors, failure to pay

183

Ibid pp. 81-85 See Dan Prentice, supra note 58 at p. 61 185 Lord Wilberforce in Ebrahimi V Westbourne Galleries, as cited in Paul De Vries, supra note 40 at p. 103 186 Ibid, O’Neill vs Phillips, Lord Hoffman (1999) 2 BCLC I 187 Ibid, See also See A. J. Boyle, supra note 122 at, p. 95 188 See A. J. Boyle, supra note 122 at, p. 97 189 See Paul Pieter De Vries, supra note 40 at p. 106, see also Victor Joffe QC et al, supra note 117 at p. 284 184

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reasonable dividends, allotment of shares and rights issues, removal of auditors, breaches of directors’ fiduciary duties, breach of information rights, different freeze-out techniques such as termination of employment or failure to share profits and or dividends, tunneling and dilution, etc. 190 By nature any of the above grounds can be breaches of the law, formal agreement, informal agreement or other circumstances that demand for equitable considerations.191

i) Excluding Minority From Management Most of the s 994 of the 2006 CA petitions are based on a prejudice of interest because of exclusion from management and this by far makes it the most important members interest in closely held companies. 192 In closely held (quasi-partnership) companies a member can complain exclusion from management as a ground for winding up as in Ebrahimi v Westbourne Galleries and in O’Neill v Phillips it was held that exclusion of minority shareholder from management without being offered to buy his shares is unfairly prejudicial conduct. 193 This right of minority shareholder may not necessarily be in the agreement expressly agreed but can only be inferred from promises, bargains, understandings, expectations and obligations of shareholders inter se. 194 Here, even if the application for unfair prejudice it may be unfair on equitable grounds. In closely held companies there is an informal agreement or understanding that each member will participate in the management of the company. 195 Quite naturally, therefore, exclusion from this position will make the conduct unfairly prejudicial.

ii) Excessive Remuneration for Directors In principle remuneration for directors and or salary for employees is regulated by the articles or agreement of shareholders. And it is established that it is a commercial decision by company’s board and court will not interfere in the same matter. 196 It was suggested that remunerations be fair and competitive.197Today, however, it can be challenged under s 994 of the 2006 CA. When the remuneration is not in accordance with the articles that duly provides

190

See Paul Pieter De Vries supra note 40 at pp. 106-113; Robin Hollington, supra note 110 at pp. 94-114; and also see also Victor Joffe QC et al, supra note 117 at pp. 284-311) 191 See Paul Pieter De Vries, supra note 189 192 Ibid; see Victor Joffe QC et al, supra note 117 at p. 285; and see also S.H. Goo, supra note 50 at p. 35 193 See Paul Pieter De Vries, supra note 189; See also Robin Hollington, supra note 110 at p. 94 194 See S.H. Goo, supra note 50 at p. 36 195 See Paul Pieter De Vries, supra note 40 at p. 107 196 See S.H. Goo, supra note 50 at p. 37; see also Re Halt Garage (1964) Ltd [1982] 3 All ER 1016, as cited in Victor Joffe QC et al, supra note 117 at p. 294 197 Cadbury Committee, The Financial Aspects of Corporate Governance, 1 December, 1992, as cited in S.H. Goo, supra note 50 at p. 37

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how remuneration has to be fixed it will amount to unfairly prejudicial conduct. 198 It may also appear that a manager of the company will pay excessive salary for himself such can be challenged according to the same section of the CA. Courts attitude towards excessive salary for directors is usually exercised with care in fear of interfering with commercial judgment of the board.199 But when it appears that the service rendered by the director and the respective salary can be valued easily it may be easy to show that the salary was excessive making it unfairly prejudicial. 200 In such a case the court will lend its arm to correct the unfairly prejudicial conduct. Some times it may appear that the company is not commercially feasible any more nevertheless the directors or majority shareholders want to keep trading, the court may conclude that this decision is made in view of getting their salary at the expense of the company.201

iii) Failure To Pay Dividends Failure to share profits or pay dividends is one of the freeze-out tactics that majority shareholders use in order to kick the minority out of the company. In closely held company set up it is not necessarily true that there will be dividends. That is to say there may not be any dividend to be declared at all, especially the case when there are few shareholders in the company and all of them have managerial or employment positions. So in such cases it may be agreed or there will understand division of profits will be in the form of salary. So as long as the salary is being paid regularly then there is no issue to be brought under the section. But it is not always true because the number of shareholders may be large and some of them may not be employed at all so adequate dividends or profits must be paid. But still, this is the discretion of directors whether to pay dividends or not. Such decision of the directors, in principle, is in the interest of the company and the Court cannot substitute its view in place of management’s decision. 202 It is a business judgment of the company’s management. However, the court will intervene when asked by minority that the failure to pay dividends is unfair and has no imperative commercial reasons.203 In such cases failure to pay adequate dividend can be a ground to invoke s 994 of the 2006 CA. So the intervention by the court as to whether it is fair or unfair depends on the facts of the case and the latter may make

198

See Victor Joffe QC et al, supra note 196 See Robin Hollington, supra note 110 at pp. 103 & 104 Ibid p. 104 201 Ibid pp. 104 & 105; see also S.H. Goo, supra note 50 at p. 46 202 Ibid p. 106; see also Victor Joffe QC et al, supra note 117 at p. 297 203 Re Sunrise Radio Ltd [2010] 1 BCLC 367, [140]–[141] as cited in Victor Joffe QC et al, supra note 117 at 298 199 200

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reference to those understandings, arrangements and circumstances in reaching at conclusions.204

iv) Commercial Mismanagement & Fiduciary Duties Commercial mismanagement can be used as a ground for the petition under s 994 of the 2006 CA. The Court, however, refrain from interference in most cases205 by reason that business decisions are reserved for the management and it would be too arbitrary if the court has to make those decisions by putting it self in the place of directors or management board. Hence, Courts’ view is that it is not their business to decide as to the appropriateness or otherwise of a business decision. There are two reasons forwarded to this effect. Firstly, the judge is barely qualified to make the decision as to whether a particular business decision is appropriate or otherwise and secondly there is always risk as to the quality of the management and minority shareholder is presumed to buy shares taking those risks.206 But where it appears that the majorities, despite incompetency, rather want to keep the management because one way or another they will benefit from, then the Court will intervene.207 In principle directors owe fiduciary only to the company and not to shareholders.208 Only in exceptional case that minority shareholders can invoke fiduciary duty. That is to say, breach of fiduciary duties by directors is not by itself unfairly prejudicial conduct as in the sense of s 994 of the 2006 CA.209 But it can be a ground on which unfairly prejudicial conduct may be ascertained because eventually it will affect shareholders’ interests. 210 These breaches of fiduciary, even if warrant a derivative action, can be brought under s 994 of the 2006 CA.211 There are several conducts that can be brought and this category. Victor Joffe et al identified these conducts from the case law that developed under s 994. These conducts include but not limited to:  Diversion of the company business to majority shareholders or a company owned by them,

204

See Victor Joffe QC et al, supra note 202 See Paul Pieter De Vries, supra note 40 at p. 111 Ibid p. 112 and See Robin Hollington, supra note 110 at p. 107 Re Elgindata Ltd [1991] BCLC 959 207 Ibid 208 See S.H. Goo, supra note 50 at p. 41 209 Victor Joffe QC et al, supra note 117 at p. 306 210 Ibid; Scottish Co-Operative Wholesale Society Ltd v Meyer [1959] AC 234; Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, 18d, 31g–31h; O’Neill v Phillips [1999] 2 BCLC 1; Wilkinson v West Coast Capital [2005] EWHC 3009 (Ch), [234]; Re Woven Rugs [2010] EWHC 230 (Ch) 211 See S.H. Goo, supra note 50 at p. 43 205 206

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 Misappropriations of the company’s assets where the beneficiary or the family of the director is a majority,  Misuse of corporate assets,  Transactions that benefit another company using the company’s assets without the minority being benefited,  Divulging confidential information of the company to third parties etc.212  However, neither mere existence of all these conducts nor the fact that it benefited the majority cannot guarantee relief under the above section, unless the petitioner prove to the satisfaction of the court that due to any of the conducts he/she has suffered prejudice.213

v) Breach of Statutes (Illegality) Another possibility where unfair prejudice remedy can be invoked is that of illegality, i.e. where there is violation of the 2006 Companies Act.214 Provided that the violation is not of minor importance, it can be brought under the ambit of s 994.215 Hence, not all breaches can get relief under the same section but breaches that are unfairly prejudicial.216 Conducts such as failure to hold general meetings, repeated late filings of accounts and returns that undermines the minority confidence, managing the company in an irregular way generally, failure by directors to take record of director’s salaries, increase in share capital contrary to s 561 are all unfairly prejudicial conducts on which relief can be sought under s 994.217 More over, the directors or majority shareholders may use different ways to expropriate the assets of the minority thereby prohibiting the later realize his investment goals. So the above discussion is by no means an exhaustive list of categories on which the unfair prejudice remedy can be invoked under English law.

As discussed above we have seen several grounds on which the relief under s 994 of the 2006 CA may be sought by minority shareholders/ members of a closely held/private company. The next issue worth to be discussed are sorts of remedies available once unfairly prejudicial conduct is found by the court.

212

See generally Victor Joffe QC et al, supra note 117 at pp. 306-309 Ibid, p. 309 Ibid p. 303 215 Ibid; Re a Company (No 005685 of 1988), ex p Schwarcz (No 2) [1989] BCLC 427 216 Ibid p. 304 217 Ibid pp. 303-305 213 214

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2.2.2.2 Categories of the Remedies under s 996 of the 2006 Companies Act There are several reliefs for the petition under s 994 of CA. These remedies are provided under s 996 of the same Act. The court can make an order it thinks fit and these orders may be to regulate the conduct of the company’s affairs in the future, require the company to refrain from doing or continuing the conduct or do the omitted act, authorize civil proceedings to be brought in the name and on behalf of the company by such person on terms directed by the court, require the company not to make any, or any specified, alterations in its articles without the leave of the court. Most importantly, for the purpose of this paper, the order may provide for the purchase of the shares of any members of the company by other members or by the company itself and, in the case of a purchase by the company itself, the reduction of the company’s capital accordingly.

One should bear in mind, however, the door open to the minority shareholder invoking all those grounds under s 994 of the CA will not necessarily allow him/her to litigate the matter as he/she wish it to be. On the one hand, the conduct of the petitioner will be taken into account in deciding whether the alleged act is unfairly prejudicial. 218 This is the concept of clean hands on the part of the petitioner, though it is not dispositive.219 That is to say, unlike in the case of equitable winding up, clean hand requirement, under s 994, will not bar a finding of unfair prejudice in favor of the petitioner but may be used against him in different ways such as in the determination of the date of valuation or the kind of relief.220 On the other hand, the door open to the plaintiff (minority) can be closed, even after petition has been lodged, if the respondent (majority) has made a ‘reasonable buy-out offer’.221 This is done in the interest of the Court’s time and resources of small companies that may be consumed during the litigation.222

Under the following sub section, buy-out remedy as an exit right of the minority will be discussed. Despite the existence of different orders the court may choose under the above 218

See S.H. Goo, supra note 50 at p. 59 See Robin Hollington, supra note 110 at p. 123 See A. J. Boyle, supra note 122 at, p. 108; see also Re London School of Electronics Ltd [1985] BCLC 273, 279f; Re Baumler (UK) Ltd [2005] 1 BCLC 92, [180]–[181] & Re London School of Electronics Ltd [1985] BCLC 273, 279e–279f; Parkinson v Eurofinance Group Ltd [2001] 1 BCLC 720; Jones v Jones [2003] BCC 226, [44]; Richardson v Blackmore [2006] BCC 276, [53]; Nagi v Nagi LTL 25 October 2006, [32] as cited in Victor Joffe QC et al, supra note 117 at pp. 320 & 321 219 220

See AJ Boyle (2004), pp. 105-107 and O”Neill v Phillips, 1999 2 BCLC, as cited in Paul Pieter De Vries, supra note 40 at p.114; Reasonable buy-out offer, as in the opinion of Lord Hoffman, should include all that plaintiff will get had the case been dealt in the court. These includes; an offer that reflect fair value, determined by competent expert, in the absence of parties’ agreement, determined objectively based on economy and expedition, and in the determination process there should be equality of arms, the offer must also include cost of proceedings the minority has incurred already. Finally, the majority shareholder should be given reasonable time to make his offer 222 See A. J. Boyle, supra note 122 at, p. P-107 221

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section of the CA, the scope of this paper will be on buy-out remedy as an exit right for the minority shareholder in closely held company.

Buy-out Right of the Minority: Ideal Exit Remedy If it is found that there is an oppression of minority by the majority there are certain remedies to be ordered by the court of which buy-out order is most important one. As stipulated under s 996 of the CA, the court has discretion to order any of those reliefs as it thinks fit. Interestingly, most petitions under s 994 of the CA are for buy-out and as a response widely used of all the remedies is buy-out the minority shares by the majority shareholders.223 So an order for the purchase of the shares of the minority by the majority is a commonly used remedy. This is the best way to end the relationship of shareholders who has a conflict of interest and that are no more able to work together. 224 And this relief will enable the aggrieved minority to realize his assets that can be achieved with out dissolving the company.225 So it is less drastic remedy than winding up, which may affect the life of the company. Here the interest of both plaintiff and respondent will be taken into consideration giving an order of buy out remedy. Particularly the court will take into account factors such as any hardships to the respondent and the time frame with in which the purchase must be completed in giving an order for buy-out.226 Worth to be discussed along with the buy-out remedy is the issue of valuation of shares.227 In closely held companies valuation of shares in case of the existence of exit right is another problem. As has been said over and over, closely held/private companies are out of the reach of the market, which might have been an effective means of valuation of shares. Under English law, there is no hard and fast rule as to valuation of shares in private companies. But it is established that the valuation must be fair and equitable as between the parties.228 The valuation is one of the spheres the Court may exercise wider discretions under section 996 (1)

223

Ibid; see also Paul Pieter De Vries, supra note 40 at p.116 and Victor Joffe QC et al, supra note 117 at p. 329) As the authors pointed it out the, buy-out remedy may be either by the company, majority shareholder or minority shareholder. But practically the most widely used remedy is that of buy-out by the majority of the shares of the minority. Here one can also envisage possibility that the minority may be ordered to buy the shares of the majority. But As the case where a company buy out the shares of the petitioner has never been reported. One reason for this is protection of the interest of third parties (creditors) that will be affected. 224 Re Cumana Ltd Re Cumana Ltd [1986] BCLC 430, 442b–442d See also Irvine v Irvine (No 1) [2007] 1 BCLC 349, [356] as cited in Victor Joffe QC et al, p. 329 225

See Robin Hollington, supra note 110 at p. 64 Ibid p. 65 227 See A. J. Boyle, supra note 122 at, p. 108 228 Ibid 226

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of the Companies Act.229 The Court may order pro rata or discounted basis as it thinks it fit.230

2.2.2.3 Winding up and Unfair Prejudice: Choice of Remedies Worth to be discussed at this juncture is the choice between equitable winding up and unfair prejudice remedies. As provided under section 125 (2) of the Insolvency Act, a minority shareholder is entitled to relief by winding up of the company or any other means. But such may only be ordered if the court thinks it to fit and there are no other alternative remedies available. This wide playground is given to the court because of the harsh consequences of the winding up remedy. The mere fact that a particular act of the majority is inequitable can be a ground for action but may not be the basis on which winding up may be ordered. If the court is of the opinion that there are alternative remedies to winding up the latter will not be ordered. Of these remedies s 994 of the CA is much more important to the protection of minority shareholders and exit rights.231

The relationship between the two remedies, however, is not precisely clear. Though the existence of overlap is beyond doubt232 there is a debate as to what kind of overlap exists between the two remedies; partial or complete. AJ Boyle denies the existence of complete overlap between the two remedies. Paul De Vries is of the opinion that “the issue is far from resolved. 233 The basis for his position is the statements of judge Stanely Burnton LJ, ‘a conduct may not be unfair but still winding up on just and equitable ground is necessary.’ According to him, therefore, the overlap is partial one. But there is neither confirmation nor rejection of the issue and discussion and debate stand still. Paul De Vries suggested that winding up remedy be included to the remedies set out under s 996 of the 2006 CA.” 234 One difference exist between the two is that in case of winding up remedy the issue of clean hands is necessary but in case of unfair prejudice, though will affect the plaintiff’s claim, is not determinant for final relief.235

229

Ibid Ibid 231 Ibid p. 103 232 Ibid p. 102 233 See Paul Pieter De Vries, supra note 40 at p.79 234 Ibid; Hawkes v Cuddy (2009) EWCA Civ. 291 at 107 235 Supra note 231 230

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The use of the remedies is not absolutely the choice for the petitioner. 236 There is a tendency by the petitioner to use one remedy in alternative to the other and it is not a wise thing to do. 237 The application for winding up remedy should be as precise as possible. If the petitioner use winding up with a view of threatening the respondent and asked the court an alternative remedy of unfairly prejudice, then the petition for winding up will likely be struck out.238 The application for unfair prejudice remedy need not to be as precise as the equitable winding up remedy.239 All necessary is to prove the existence of unfairly prejudicial conduct of the controlling body/shareholders even though the act is within the scope of their right or in good faith. In the presence of alternative remedies available under section 994 through 996, an application based on and for winding up remedy should anticipate cases where the alternatives may not be a choice for the Court.

In conclusion, s 994 of the 2006 CA provides wide range of power for courts to remedy the problem of unfair prejudice. But to get remedy under this section the conduct or omission must be unfair and prejudicial to the interest of members generally or some of them. The effect of the conduct is necessary. And the application of the remedy is principally devoted the members legitimate expectations. But the remedy is a remedy of last resort and can only be ordered where there are no other corrective measures, such as making a certain proposal void when the effect is unfairly prejudicial. The end result of the application of this section is buy-out and courts are not allowed to dissolve the company under this section. The latter remedy is provided under a separate statute, the 1986 Insolvency Act. But this remedy is no wider than the unfair prejudice remedy.

English law generally does not cover the issue of mismanagement and ordinary shareholder conflicts concerning the running and development of the company. These are considered normal business risks.240 Unless the minority shows to the court that the conduct or omission would have enabled relief under general company law this section cannot be sought for conflicts concerning running and development of the company.241

236

Ibid See S.H. Goo, supra note 50 at pp. 116-118 Ibid p. 119; See also Robin Hollington, supra note 110 at pp. 52-54 239 Supra note 231 240 See Mette Neville, supra note 15 at pp. 264-265 241 Ibid 237 238

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A final conclusion that can be drawn from the discussion so far is that English law protects the minority shareholders by giving an exit right in several ways. In doing so it tried to strike a balance between the problem of shareholders prejudice in closely held companies and the danger of losing economic importance of these companies. So whenever an application for either winding up or unfair prejudice is brought before courts, they try to keep that balance. Courts, usually, do not interfere in commercial matters of the company. 2.2.3 Appraisal Remedy The other remedy for minority shareholder problem under English law is appraisal right. It is a statutory right of a shareholder who oppose extraordinary corporate action to have a fair stock price of his share determined by court or independent valuator.242 Principally appraisal right under English law is governed by s 111 of the Insolvency Act of 1986. 243 This scope of this right is limited to cases of reorganization of companies such as in merger and takeovers. 244 A shareholder that shows his dissent and did not consent to the merger or takeover is entitled to a fair value of his shares as compensation.245

2.3.4 No Fault Divorce (Exit right at will) Exit right at will gives an entitlement to a minority shareholder to leave the company whenever he pleases. Unlike in the case of partnerships, in closely held companies there is no default rule of exit-at-will for the aggrieved minority. 246 The same has been a subject of heated discussions and debate in many jurisdictions.247 Some suggusst that there should be exit-right-at-will for minority shareholders in closely held corporations. 248 The basis for this position is the close analogy between closely held corporations and partnerships. 249 They further argue that this company form is chosen, principally, for limited liablity purpose and therfore the rest of attributes of partnership should be used and especially exit-at-will should be provided as a norm.250 Empirical research, however, suggusted that this is not always true and there are other considerations which will negate this conclusion.251 On the other side of the spectrum there are personalities who argue that extensive exit right for minority 242

See Bryan A. Garner, supra note at 1 See Paul Pieter De Vries, supra note 40 at p.138 244 Ibid pp. 38-139 245 Supra note 243 246 See RANDALL K. MORCK CONCENTRATED CORPORATE OWNERSHIP, NATIONAL BEURAU OF ECONOMIC RESEARCH, UNIVERSITY OF CHICAGO PRESS (JANUARY 2000), p. 180 247 See Mette Neville, supra note 15 at p. 277 248 Hetherington and Dooley (1977) as cited in Randall K Morck, supra note 246 at p. 180 249 See Mette Neville, supra note 15 at p. 278 250 Ibid 251 Ibid 243

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shareholders is just to bring back the problem of opportunism from different source. 252 Proponents of this view argue that parties choose this corporate form and want to lock themselves in because there is less agency problem where they themselves particiapte in the day-to-day running of the business. 253 These scholars 254 are of the opnion that parties in deciding to dedicate their personal wealth to build up a company is a decision that envisaged the advantages of locked into the company and coperation among the parties. They further argue that extensive exit right for the minority will tempt the minority to be strategic and exercise their right against the majority and the company opportunistically. 255 So they conclude that, had the parties intended exit at will they either would have opted for partnership or could have provided exit provision in their agreement. 256 According to them, therfore, the choice is deliberate and does not need intervention by legislature or courts giving exit right-at-will.

Some scholars share the opinion that agency problem may not be a big deal in owner managed closely held corporations, especially when all or most of the shareholders participate in management.257 But that advantage did not come for free as there are relational conflicts and conflicts as regards the running of the company, in most cases of these corporations.258 The advance planning argument is also far from being a practical reality and is simply a theoretical possibility, for several reasons, and rather there is evidence that parties do give little or no effort in addressing the same before the dispute arises. 259 Further arguments based on companies financing will be hurt if exit is easy and redemption is requiered, are also unsustainable arguments for the problem can easily be alievated.260 Other scholars reject the idea of having lax exit right because, as they argue, minority shareholders are already protected by other remedies.261 Paul G. Mahony also rejects the view for extended exit right at will and share the idea that other buy-out and winding up remedies by courts are

252 253

254

Frank Easterbrook and Daniel Fischel (1986, 1991) as cited in Randall K Morck, supra note 246 at p. 181 See Ibid p. 279; Frank Easterbrook & Daniel Fischel: The Economic Structure of Corporate Law, 1991 p. 228 et seq. Ibid

255

Supra note 252 Supra note 253, p. 279 Easterbrook & Fischel, p. 239 257 See Mette Neville, supra note 15 at p. 280 258 Ibid; see generally pp. 249-260 259 Ibid see generally pp. 280-284 260 Ibid p. 284, the author quoted a section under Norwegian law that stated: “A claim for redemption shall not be accepted if it would cause significant harm to the business of the company or would otherwise be unreasonable in respect of the company.” 256

261

See Edward B. Rock & Michael L. Wachter in McCahery, Raaijnakers & Vermeulen (eds.): The Governance of Close Corporations and Partnerships, 2003 pp. 93-133 (at p. 107 et seq. as cited in Mette Neville, supra note 15 at p.285

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sufficient to guard the miority interests in closely held corporation.262 This argument is not also fully convincing in view of some scholars as the problems of minority-majority conflict may arise from tiny issues that are far from the reach of the law and argue of statutory exit right.263 Due to all these differing opinions there is no such remedy under English law. 264 And generally, until today, there is no legal system where this right is recognized for corporations. 265 Exit at will is considered incompatible with the principle of sanctity of contracts and also will undermine the economic importance they have.266 It is also argued, against such right, that it will result in break-up of the firm with minor skirmishes that can easily be cured.267

2.3 Germany The Gesellscaft mit bescrankter Haftung (here in after GmbH) is a form of company that is equivalent to the English limited liability company. It is governed by a statute, which dated back 1892 though amended in 2008 for the needs of the time. 268 It is has flexible management system and known for substantial shareholders’ involvement269 that regulate the internal affairs of the GmbH in the articles of association and additional shareholders agreements.270 So it leaves much option for the shareholders to design the company in the way that fits their particular interests provided some mandatory provisions are observed.271 This characteristic is the attribute of both company and partnerships. 272 So it took the best features the two types of business tools have. However, this does not come easy. As it is the case in many small private limited companies,273 minority shareholders of the GmbH face oppression by majority shareholders. The reasons are almost the same for all closely held companies.

262 263

See Randall K Morck, supra note 246 at p. 194 Supra note 261

264

See Paul Pieter De Vries, supra note 40 at p.18 Ibid p. 11& 18; “ He stated that, in Italy and Russia, the two legal systems where exit at will has found a way, was used seldom and already avoided, respectively.”See also Randall K Morck, supra note 246 at pp. 180-181 266 See A. J. Boyle, supra note 122 at, p. 134 267 Ibid 268 See Paul Pieter De Vries, supra note 40 at p. 147 269 See Sandra K. Miller, pp. 394-395 as cited in Carol L Kline, supra note 152 p, 238 270 See Paul Pieter De Vries, supra note 40 at p. 148 271 Ibid. See also Brinkman Tobias, Minority Protection under Section 459 of the Companies Act 1985, A Comparison with the Law of the German GmbH (Private Limited Company), 13 Eu. Bus. Law Rev. 1, 55(2002), p. 56 272 Supra note 268 273 See Brinkman Tobias, supra note 271 at p. 56, see also Sandra K. Miller, supra not 152 p. 382 265

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The first is that its capital is divided into illiquid shares, business interests, which are not freely tradable in the market.274 Thus the minority cannot avoid any oppression by exit from the company. And even if there may be a willing buyer, the articles of association of these companies usually put certain restrictions on the transferability of shares of the company to third parties. That is to say, even though, in principle, shares of the GmbH are transferable, the articles of association of most of the German Private Limited Companies put restriction on the transferability of the shares of the GmbH to third parties.275 Transferability of shares is often subject to the approval of the general meeting of shareholders. This has locked minority shareholders into the company in such a way that exit will only be at the mercy of the controlling shareholders. Though the rules will be meritorious in preventing the entrance of an outsider who do not understand the deal in that company, this is also an effective ban of exit for the minority shareholders who may be in need of exiting the company.276

The second is in relation to the decision making process in the type of company. As it is for companies in general, in GmbH many decisions are passed by majority votes and hence members with majority shareholding have effective control of the company. 277 Thirdly, personal nature of the relationship and the trust involved in the formation of these companies has also contributed it share in blinding the members to by-pass issue of advance planning.

All these contributed for the problem of minority oppression in closed companies. To this effect the German legal system has recognized certain exit remedies for the issue of minority oppression. These remedies are both statutory and judicial remedies.278 This exit rights are winding up remedy, oppression rights and appraisal rights. 279 These are legal strategies, which the Germany legal system has adopted in order to tackle the agency problem in closely held companies.280 Exit right at will, though can be included in the articles of association by the parties, is far from being accepted as part of German law.

274

see H JUNG & J GRES, STARTING BUSINESS OPERATIONS IN GERMANY 33 (1984) reprinted in RALPH H FOLSOM ET AL., INTERNATIONAL BUSINESS TRANSACTIONS (954) (3 RD Ed. 1995) as cited in Carol L Kline, supra note 152 at p.239, See also Brinkman T., supra note 271; and see Paul Pieter De Vries, supra note 40 at p. 1 275 Supra note 270 276 Ibid 277 See ibid. pp. 1-3 278 See Sandra K Miller, p. 392 & 396, as sited in Carol L. Kline, supra note 152 at p. 238 279 Supra note 270 280 See Sandra K Miller, p. 396, as sited in Carol L Kline, supra note 152 at p. 239

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2.3.1 Winding-up Remedy This is one of the two statutory exit remedies provided under the GmbH.281 Section 61 of the GmbH provides a winding up remedy for minority shareholders. The winding-up of the company may result either from a court order or shareholders’ resolution.282 In the case of court ordered winding up, one or more shareholders solely or jointly holding 10% of the share capital of the company may apply for the winding-up and dissolution of the company by showing an important reason. The company may also be wound-up if such is approved by the shareholders resolution. 283 The winding-up remedy is mandatory in the sense that the articles of association of the GmbH can neither exclude nor limit it. 284 The articles of association may, however, widen the scope of the remedy to afford more protection to the minority shareholders in so far as such amendment is approved by unanimity in the general meeting of shareholders. The winding up remedy can only be ordered where there is wichtige Grund important reason. 285 The definition of an important reason (weighty ground) is, therefore, crucial in the application of the winding-up remedy. There are two important reasons in this context. These are failure to achieve the object of the company286 and serious and incurable dispute among shareholders.

As to criterion of what amounts an important reason or substantial cause s 61 provides guideline. It is stated that a petition for the winding-up of the company can be made where it is no longer possible to achieve the purposes for which the company is established.287 The legislator provides such an open-ended criterion. This, however, gave courts an opportunity to develop the remedy later in their own way. However, the definition of substantial cause is restricted to the affairs of the company. Personal reasons of the shareholders may not, therefore, constitute important reasons within the meaning of the above section. 288 Exceptionally, however, personal reasons may constitute a substantial cause where personal cooperation of the shareholders is so crucial to the day-to-day running of the company. And the fact that such relationship is severed mean that the company can no longer function normally. However, winding-up and liquidation of the company is harsh remedy it shall only

281

Ibid see also See Paul Pieter De Vries, supra note 40 at p. 150, Ibid. 283 Ibid. Save lower or higher threshold that may be introduced by the articles of association, the winding-up should be approved by threequarters majority of the votes cast in the general meeting of shareholders. 284 Ibid p. 151 285 Ibid pp. 151-152; See also, Sandra K Miller, supra note 152 at p. 396 286 The object and purpose of the company can usually be inferred from the articles of association of the company. 287 See Paul Pieter De Vries, supra note 40 at p. 152 288 Ibid. 282

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be ordered where there is no any other choice, for instance, where amendment of the article of association and change of object of the company is impossible.289

As pointed out above, serious and incurable dispute among the shareholders of the company is the second ground for invoking the winding-up remedy.290 This ground should, also, be interpreted restrictively. This may, for example, be applied to resolve a deadlock situation happening between two shareholders having equal shareholding in the company.291

Once the court found that there is an important reason for the minority shareholder to invoke the winding-up remedy, however, it may order the winding-up and liquidation of the company. After the court order for winding–up has been filed; the company would be forced into liquidation. This remedy, however, is criticized for its two drawbacks. Firstly, the shareholder claiming winding-up gets the consideration for the shares pro rata parte according to the total liquidation value. The liquidation value is typically lower than fair market value. Secondly, it results in the loss of the business and job opportunity it has created. 292 To minimize these harsh results less drastic remedies have been developed by courts of which a buy-out right for the minority is most important one.

2.3.2 Oppression Remedy: - Withdrawal And Expulsion As discussed above, German law did not give any other exit remedy for minority shareholders and winding up is criticized as such, courts, through time, have developed oppression remedy which will result in either withdrawal and expulsion.293 This remedy does not exist in the statutory provisions. There were several attempts to include the same into statute form but it failed. 294 The remedy is recognized only in the case law and legal literatures.295 Similar to the winding-up remedy, there has to be an important reason296 to invoke the oppression remedy and the same remedy can neither be waived nor its application restricted.297 Unlike the winding-up remedy, the application of the oppression (withdrawal and expulsion) remedy is automatic.298 Unless existence of important reason is disputed, no 289

Ibid. 153 Ibid. pp. 153-154 Ibid p. 154, Lutter and Hommelhof (2009) s 61.8 292 See Hugh T. Scogin, Jr, supra note 94 at p.134 293 Ibid pp. 134-135; see also Carol Kline, supra note 152 pp. 239-242 294 See Paul Pieter De Vries, supra note 40 at p. 157 295 Ibid. 296 Lutter, M., Hommelhoff, P.,et al., GmbH- Gesetz, Kommentar, Koln, Verlag Dr. Otto Schmidt 2009, §34, 79, as cited in Ibid p. 158 297 Ibid p. 159 298 Ibid p. 158, see also Hugh T. Scogin, Jr, supra note 94 at p.176 290 291

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court order is required for the application of the oppression remedy. That is to say oppression remedy is not always litigated and this is in its own a remedy of last resort in which parties will resolve their dispute before coming to court.299 This remedy signals warning of court intervention if parties failed to reach an agreeable solution.300 So upon showing an important reason a shareholder may require compensation.

The important reason is an open-ended criterion, which is given shape through interpretations of courts. The imposition of additional obligations that cannot be satisfied is the first important reason defined by courts.301 There are two principal ways to establish important reason. These are personal factors and shareholders conduct.302There are several cases that fall under these two categories and the list is open-ended. Grounds based on the shareholders conduct includes additional obligation that cannot be satisfied, 303 repeated refusal by the company or the general meeting of shareholders for the transfer of shares of the minority shareholder 304 fundamental changes in the structure of the company 305 in the form of increasing the share capital of the company306, changing of the objects clause307 or integrating the GmbH in a corporate group as a subsidiary, 308 and freeze-out by the majority shareholder.309 In the second category, personal characteristics of shareholders, included are; personal urgent or extreme financial need, emigration (relocation abroad), lengthy and chronic illness of the minority shareholder or inability to perform required duties by shareholder.310

i) Repeated Refusal to Approve Transfer of Shares Under German private limited company there is a rule where shares may be locked-up and their transfer restricted, by the articles of association.311 But when the minority demands the transfer of shares but there is repeated refusal to that effect, it will amount to an important

299

ibid ibid See Paul Pieter De Vries, supra note 40 at pp. 164-165 302 See Sandra Miller, supra note 152 at p. 397 303 Supra note 301 304 Ibid p. 165 305 Ibid pp. 165-167 306 ibid p. 167 307 ibid p. 168 308 ibid, pp. 168 – 170 309 ibid pp. 170 – 171 310 ibid pp. 171-172 see also Sandra K Miller, supra note 152 at p. 397 311 Ibid p. 165 300 301

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reason and withdrawal can be sought on this basis.312 And where there is full lockup and for an indefinite period of time, for stronger reason, it will be an important reason.313

ii) Fundamental Changes in the Structure Company The other case that can be considered as an important reason is where there is a fundamental deviation from the original deal that brought the parties together and led for the establishment of the company.314 This is based on the theory of consent. And if the nature or structure of the company is changed without the consent of the minority been taken into account then it is an important reason for the later to exit the company.315 But how fundamental the change has to be is subjective and will be determined on case-by-case basis.316

iii) Increase of the share Capital Another case where important reason can be invoked is the case of increase of share capital of the company. 317 The increase of share capital requieres the amendement of articles of association as in the sense of s 24 of the GmbH statute.318 So a member of the company who did not consent for such amendement, increase of shares, can exit the company. The reason is that the member should not be liable for any deficincy with no consent on his part.319

iv) Change of the Objects Clause This is one of the important reasons that can be invoked by the member of the company outvoted by the majority as regards change in the object clause of the company. As in the case of fundamental changes discussed above, where there a change in the object of the company member who did not consent to it can exit the company.320

v) Personal Urgent Need of Money and Chronic Illness When there is personal reasons such as urgent need of money, emigration or where there is prolonged illness of member of the company, the same can be invoked as a means to exit the

312

ibid ibid 314 ibid, Baumbach/Huck (2006), Anh. s 34, 20: Rohricht (1991), P. 379 315 ibid p. 166 316 ibid 317 Supra note 306 318 ibid 319 ibid 320 Supra note 307 313

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company.321 In both cases the member may not be able to remain in the company because of his special circumstances and exit is possible in such circumstances.

vi) Freeze-out It is one of the technicalities by which the majority will oppress the minority abusing the position. Freeze-out techniques are methods by which the majority shareholders using their power deprive the minority of his/her role in the company. and this will end up in forcing the minority exit the company selling the share at unfair price. Not all decisions or acts against the minority are considered abuse and justify exit.322 Exit can only be justified in cases of abuse of the majority position, including but not limited to, freez-out, 323 excessive accumulation of profits.324

Therfore, if the minority shareholder establishes any of these important reasons to exit the company, his/her shares may be withdrawn, purchased by the company itself or offered for sale to existing co-shareholders or even third parties.325 The end result of this will either be withdrawal or expulsion of the minority or majority. The two remedies have in common the element of substantial cause, both cannot be waived or restricted by the parties otherwise agreement and both remedies does not exist in statutory form but in case law. 326 In these remedies one remedy completes the other. 327 That is to say when expulsion creates opportunistic behavior it can be overcome by the withdrawal, making them complementary remedies.

Withdrawal allows the aggrieved minority shareholder to exit the company despite the illiquidity of his/her share.328 The petitioner can satisfy important reason by showing personal reasons, behavior of other shareholders or just any special circumstances that justify withdrawal.329 The rational behind of the rule is clear. It does not want to see the minority shareholder locked into the company for life when the circumstance on which the business was established has changed, negatively, with time.330 The right of shareholder to withdraw 321

Ibid p. 171 ibid p. 170 323 ibid, Baumbach/Huck (2006), Anh s 34, 20: Hachenburg/Ulmer (1997), Anh. s 34, 52; Hulsman (2003), p- 198 324 Ibid p. 171, Lutter Hommelhoff (2009), s 34, 74 325 Ibid pp.172-173 326 See Sandra K Miller, P-396, as sited in Carol L Kline, supra note 152 at pp. 239-240, see also See Hugh T. Scogin, Jr., supra note 94 at p.135 327 See Hugh T. Scogin, Jr., supra note 94 at p.135 328 Ibid 329 See Sandra K. Miller, supra note 152 p. 397 and see also Carol Kline, p. 240, 330 Ibid (Carol K. Kline) 322

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from the company while getting the fair value of his stake is solution to the problem of nontransferability of shares in closely held corporations.331The problem with withdrawal remedy is that the oppressing majorities may benefit from their wrong to the exiting member. 332 The benefits of this remedy did not come easy. There is a potential for opportunistic behavior of the majority to oppress the minority and let him seek withdrawal. To this effect courts recognize a complementary expulsion remedy.

Expulsion remedy is the opposite of withdrawal. In this remedy the oppressor will be kicked out of the company leaving their stake to the minority who has to pay the fair value of their shares. Unlike the withdrawal remedy, important reason in case of the expulsion remedy is restricted to the behavior of shareholder to be expelled and personal characteristics. 333 In order to determine whether withdrawal or expulsion is appropriate under the circumstances in addition to the weighty ground criterion the share of responsibility for the loss of cooperation and conflict is important.334

Both withdrawal and expulsion are less drastic measures that bar the application of windingup remedy. As the consequence of existence of these less far-reaching measures, winding-up remedy is seldom applied. 335 But the problem with the two is that the criterion of substantial cause is too wide as to include personal characteristics of shareholder.336 That is to say if a shareholder act opportunistically more than any one else and result in the loss of cooperation and break down of trust, he/she will be kicked out of the company. 337 However, this remedy is being criticized as blurring the distinction between legal structure of company and personal relationships of shareholders inter se.338

2.3.3 Appraisal Rights The appraisal rights of minority shareholders are contained in a special statute called the Reorganization Act which has been introduced in 1994.339 The appraisal rights are applicable in cases or corporate restructuring resulting from legal merger, legal demerger, asset transfer

331

Ibid p. 241 Supra note 327 333 See Sandra K. Miller, supra note 152 p. 397 334 See Mette Neville, supra note 15 at p. 262 335 See Paul Pieter De Vries, supra note 40 at pp.154-156 336 See Sandra Miller, supra note 152 p. 397 337 Supra note 334 338 See Hugh T. Scogin, Jr., supra note 94 at p.136 339 See Paul Pieter De Vries, supra note 40 at p.185 332

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and conversion of the GmbH into another legal form.340 The rational behind of this right is to protect minority shareholders by ensuring that they are compensated adequately for being acquiered and swallowed by new company or legal entity. In the case of legal merger between a GmbH and another entity, the minority shareholder of the disappearing GmbH is entitled to the appraisal rights if the acquiring entity is of another legal form than the GmbHtype of a GmbH. Furthermore, the minority shareholder should have voted against the approval of the merger agreement in the general meeting of shareholders.341

In case where the GmbH takes part in cross-border merger, the minority shareholder is entitled to the appraisal rights if the acquiring entity is not governed by German law and the minority shareholder voted against the cross-border merger. 342 In cases of demerger, the appraisal right of minority shareholders can be exercised in two situations. The first is where the minority receives shares (as a result of the demerger) in an acquiring entity which is of a different legal type than the GmbH. The appraisal right may also be exercised where the acquiring GmbH has put more rigorous restrictions on the transfer of shares than those existed in the demerging GmbH. In this case, too, the minority shareholder may not exercise the appraisal rights unless he voted against the approval of the demerger agreement.343

In all these cases, the exiting minority shareholder is entitled to a fair compensation. In case of appraisal remedy, the fair compensation should be based on the amount of shares of full market value of transferring entity when the resolution for approval of reorganization is adopted.344 Neither the discount on the value due to the minority character nor the increase of the value generated by synergy effect will influence the valuation, in order to remain the balance between the exiting shareholders and the remaining shareholders.345

2.3.4 Exit Right at will In Germany legal system, as in English legal system, there has been discussion as to the need for exit right-at-will. The controversy with this right is that it allows a shareholder to leave the company any time regardless of the existence of oppression provided that prior

340

Ibid. pp. 185-186 Ibid. pp. 189 -190 Ibid. p.193 343 Ibid p. 196 344 Ibid p. 202. 345 Ibid pp. 202-203. 341 342

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notification is given to the remaining shareholders.346 And the natural consequnce is that, of course the fear, it will shift the source of problem-minority opportunisim. Further more it is, some how, business unfreindly as exit and dissolution347 will be very easy. Despite differing legal opinions as to the recognition of statutory exit right, the majority view rejects exit right at will.348The reasons for rejection are almost simliar to those arguments discussed under section 2.3.4. It is, therefore, safe to conclude that exit right at will does not have any place in German law. Nevertheless parties are at liberty to include exit right at will in the articles of association-contractual freedom.

2.4 English and German Laws Compared There is no significant difference in the two systems laws as regards minority oppression and the legal strategies. Despite the use of different terminologies and very few differences English and German laws respond to the problem of minority oppression in similar, if not exactly the same, way. These differences can be comparatively summarized as follows.

German winding up remedy is very narrow and is restricted to achievement or failure of the object of the company, serious and incurable disputes, very restrictively, and this remedy can only be invoked by a shareholder or shareholders having 10% of the shares in the company. Important reason criterion is also restricted to the affairs of the company and cannot be extended to personal reasons, unless it is very crucial, i.e. the company cannot any more function unless the members work cooperatively. English law; however, give several ways by which the company may be wound up. This includes also personal reasons. Unlike German law, in English law, circumstances such as break down of confidence and trust, deadlock, breach of fundamental understanding like exclusion from management can be invoked as a ground for dissolution. So the English winding up remedy seems more liberal than its German counterpart. But the application of winding up remedy is a measure of last resort and there is a very narrow avenue through which it can be practically applied. This is due to the harsh effect of the remedy. Unfair prejudice remedy is most often used remedy.

The oppression remedy under English law as a solution to harsh effect of winding up and as a solution to the special cases of closely held company set up, provides extensive grounds that includes breach of understanding, agreement and the law. The grounds have a wide coverage 346

Ibid p.10 Exit at will in principle did not require the dissolution of the company but there are circumstances where the remaining shareholders may not be able to redeem the shares of the exiting member and then winding up will be the available choice. 348 See Paul Pieter De Vries, supra note 40 at pp. 205-207 347

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but in their application there are some limitations. Importantly courts often try to forbear to interfere in the commercial or business matters even when the act of the majority is prejudicial to the interest of the minority shareholder. More personalized claims outside the affairs of the company cannot be invoked as well. This may be the philosophy of English business law; economic importance of contracts. In this regard the German law looks more flexible. Personalized claims outside the affairs of the company, such as urgent need of money can be used to invoke oppression remedy. The German oppression remedy is also better than the unfair prejudice remedy because it is automatic, unless there is dispute as to important reason, and this will save in the litigation cost. But the problem with German oppression remedy is that the remedy is not found in statutes and the effort to include the same has failed. It is only found in case law and legal literature. This will, some how, shade dark light on the efficacy of the remedy. In this regard English unfair prejudice remedy is by far better. Apart from the ample case laws that are available unfair prejudice remedy is statutory remedy.

The appraisal remedies sin both systems are almost the same and there is no basis to prefer one to the other. And in the same way both systems did not adopt exit right at will (no fault divorce). Despite debates in legal literatures for and against this right, the majority view is that the two systems reject the existence of no-fault divorce.

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Chapter Three Overview of the Ethiopian corporate Law and Governance The Commercial Code of The Empire of Ethiopia enacted in 1960 principally regulates Ethiopian corporate governance regime. There are also other specific laws and regulations such as the 1997 Commercial Registration and Business Licensing Proclamation. 349 The Commercial Code has recognized different tools under which economic activities can be conducted. 350 These are general partnership, limited partnership, joint ventures, Share Company and private limited company.351 Under this law companies are divided into two; share companies352 and private limited companies353.

In a Share Company, which corresponds to the German company limited by shares (Aktiengesellschaft) and the English public limited company, there is limited liability, shares are freely transferable, and funds can be raised from the public. Private Limited Companies are also recognized under the Commercial Code. These kinds of companies are much more resembles the English Private Limited Company and the Germany GmbH. There is a minimum and maximum limit on the number of shareholders and minimum required capital for the establishment of private limited companies under Ethiopian Law. Under Ethiopian law as discussed above there are two types of companies: share companies and private limited companies.

3.1 Private Limited Companies: Compared to Share Companies Share companies and private limited companies can basically be compared in the following way. The first parameter on which the two can be compared is minimum and maximum membership and minimum capital requirement. In private limited companies there is a minimum and maximum number of members and amount of capital required. The minimum requirement of membership of share companies is five persons contributing a minimum of 50, 000 Birr354 and the same requirement is two persons who have to contribute 15,000 birr

349

Booz, Allen and Hamilton, Ethiopia Commercial Law & Institutional Reform And Trade Diagnostic, January 2007, USAID, p. 4 Ibid 18-19 351 The Commercial Code of the Empire of Ethiopia, Negarit Gazzette, Birihanina Selam Printing Press, Article 212 352 Ibid Arts. 304-509 353 Ibid Arts. 510-543 354 See Getahun Seifu, Revisiting Company Law With The Advent Of Ethiopia Commodity Exchange (Ecx): An Overview, 4(1) Mizan Law Rev. 103 (2010) p. 117 350

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for private limited companies. In share companies there is no upper limit for the members in the company while the same figure in case of private limited companies is fifty.

As regards management, there are differences in the two types of companies. Private limited company have one or more managers while Share Company can only be managed by directors whose number must at least be three.

Another ground of distinction is the issue public subscription of shares. In share company public subscription of shares is possible and is of course the main feature of the kind of company. So capital can be raised from the public. But in case of private limited companies the kind of privilege is not available. So while in case of share companies’ shares can freely be transferred,355 this is not the case in private limited companies where it is clearly stated under the law that the shares are not transferable.356 Share companies should file prospectus while they are going to public subscription of shares but in private limited companies where there is no such public subscription it is quite natural that they are free from this requirement. Finally, there is a difference in the paid-up capital requirement at the establishment between the two types of companies. In case of share companies all capital must be subscribed and 25% of the capital must be paid-up before registration. Private Limited Company can only be registered by fully paid-up capital. Private limited company is the most popular form of company in Ethiopia.357 Unlike share companies, private limited companies are usually established by families or friends of close relationship and are commonly understood to be a family business. 358 One reason why it is popular is that it particularly fits to the problem of finding huge capital to establish Share Company. The other point is because it is some where in between Share Company and partnership; on the one hand the principle of limited liability is guard for members/shareholders whose liability will only be the extent of the contribution/share they hold in the company. If they already paid the paid-up capital there is no liability on each shareholder/member of the company and they are not liable for the company’s obligation, at least in principle. That is what makes this company form better than the partnership type of business organizations. The flexibility of management and independence enjoyed by owner 355

But Art. 333 (1) of the Comm. Code provide that the members may restrict the transfer of shares by the Articles of Association. The Com. Code, supra note 351 Art. 523 357 See Fekadu Petros G/meskel, Emerging Separation of Ownership And Control in Ethiopian Share Companies: Legal And Policy Implications, 4 Mizan L.Rev., 1 (2010) pp. 13-14, see also Booz, Allen and Hamilton, supra note 349 at p. 19 358 See Getahun Seifu, supra note 354 at p. 117 356

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managers is also another benefit. On the other hand shares are not freely transferred to the outsiders and there is no fear for a stranger will step in making it safe for an investor who devoted his wealth in trusting the other partner. So it adopts both share company and partnership structures taking the best advantages from the two forms.

Members of Ethiopian private limited company have voice and information rights. For this reason members are entitled to be kept permanently informed about the affairs of the company. In particular they are entitled to inspect and copy the principal records and documents inventory, the balance sheet and the auditors’ report.359 They are also entitled to be consulted in major matters and decisions that will affect their interest either by the general meeting 360 or by being solicited individually 361 . Hence, active participation of the shareholders, in most cases, directly like in management, employment and decision-making is usually important because the kind of company is mostly out of the influence of market. Decisions of ordinary meetings are taken on the first call by the votes of shareholders more than half of the company capital, and on the second call decisions are taken by simple majority disregarding the capital represented. Ordinary resolutions are used for matters, which involve no alteration of the company’s statutes. They include, for example, resolutions authorizing the managers to enter into a transaction, which the statues require the prior approval of the members, resolutions appointing or removing one or more non-statutory managers and resolutions ratifying contracts entered into between the company and one of its managers or members.

Resolutions that need to alter the nationality of the company must be decided by unanimous vote. Resolutions involving alternation of the company, transfer of share to outsiders 362 change of statutory manager363 must be passed by the votes of members who together hold at least 3/4th of the capital of the company unless a larger majority is required by articles of association. It is also clear that unanimity is required for an increase in the commitment of shareholders to subscribe or increase in his contributions. And as a rule, the number of votes, which each shareholder may cast at the general meeting, is equal to number of shares he holds.364 359

Comm. Code, supra note 351 Art. 537 ibid Art. 532 ibid Art. 533 362 ibid Art. 523(2), 363 ibid Art. 527(1) 364 ibid Art. 534 360 361

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Management of private limited company consists of one or more managers under the direction and control of shareholders.365 So as in the case of Share Company, management by professional managers, member or outsider, is one characteristic of private limited company366, which may be either statutory (appointed by statutes usually at the establishment of the company) or non-statutory managers (appointed by resolution passed by members).

The procedure of removal of managers depends on how the manager is appointed and we have two types of removal. The removal of statutory manager needs minimum of majority vote of the numbers representing three quarter of the capital unless a larger majority is provided in the articles of association.367 This is because dismissal of the statutory manager needs the amendment of the statute,368 and amendment of the statute requires minimum of three quarter’s majority. In the case of dismissal of non-statutory manager a majority of members representing more than one half of the capital and in the second call decision is passed by simple majority regardless of the capital represented.369 However, members may agree in the articles of association that manager may be dismissed at the pleasure of the members irrespective of the types of manager.370 The removal of the manager is only for good cause even though the law is silent as to what constitute good cause. Manager, therefore, may be dismissed for mismanagement, incompetence or physical disability, which may be considered as good cause.

Managers of private limited company have extensive powers, unless restricted by articles of association. They may act on behalf of the company in all circumstances, provided that they do not infringe the provisions of its statutes and that they do not act outside the scope of the objects of the company’s business purpose.371

As explained above in this chapter, private limited company is a business organization where by two or more persons, but not more than fifty, contribute a capital with the view to exploit

365

Ibid Art. 525 ibid Art. 526 367 ibid Art. 536 (2) 368 ibid Art. 536 369 ibid Art. 535 370 ibid Art. 527 (4) 371 ibid Art. 538 366

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business opportunity. These contributions can be in cash or in kind. The capital is divided into shares with the same nominal value, which may not be less than 10 birr.372

Unlike the shares of Share Company, the shares of private limited company are not transferable by the normal commercial forms of transfer, and cannot be represented by registered and bearer share certificates transferable in the same way as shares of Share Company rather shares in private limited company, must be made in writing. 373 Shares can be transferred to outsiders with the consent of majority of the members representing at least three-quarters of the capital unless a larger majority or unanimity is required in the articles of association.374 The rational behind for the kind of restriction as regards the transfer of shares outside the company is to protect members of the company form a stranger to their family or friendship relationship. So any member of the private limited company who wants to exit the company shall offer his share to the members and the latter have preemption right over the shares of the exiting member. Shares in private limited company are, however, freely transferable among the company members unless restricted by provisions in the article of association. 375 On the death of a member, his share shall pass to his survivor, save an otherwise agreement in the article of association, who has to prove his/her title as heir.376

3.2 The Position of Minority Shareholders Under Ethiopian Company Law Under Ethiopian Law, and corporate governance, the definition of minority shareholder is not precisely clear and consistent through out the code and it depends up on the purpose for which the definition is required.377 As Fekadu P. G/Meskel pointed it out: A single shareholder may always remain a minority. Shareholder that holds more than half of the shares of the company may be considered as a majority shareholder and one having less than half of the shares of the company may be a minority if outvoted by others in corporate decision-making. Generally, however, a shareholder having less than 10% of the shares of the company is considered as a minority shareholder and for the purpose of protecting the minority 20% is considered as minority shareholding.378

372

ibid Art. 512(2) ibid Art. 522 374 ibid Art. 523 (2) 375 ibid Art. 523(1) 376 ibid Art. 524 377 Fekadu Petros, 229 378 See Fekadu Petros G/Meskel, Ethiopian Company Law (in Amharic), Far East Trading PLC, Addis Ababa (Feb. 2004 E.C) p. 229 373

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Hence there is no single whole definition and minimum shareholding requirement for who is a minority under Ethiopian law. This figure depends on the purpose and circumstances why the classification of minority-majority is necessary. For example, for the enforcement of provisions dealing with minority shareholders protection at least 20% of shareholding is required.

The Ethiopian Commercial Code has adopted two types of mechanisms by which the rights of minority shareholders may be protected. These are preventive and restorative remedies. 379 The former are protection mechanisms aimed at preventing any decision that will likely cause minority oppression. This is going to be done by bringing the matter to the minority who has to agree or disagree to the measure that is taken. 380 Exit right of minority shareholders may also be taken as a good example of preventive mechanism. This is particularly important in case where there is no natural exit right, like in the case of closely held companies, where any maltreatment by the majority should be punished by the exit of the minority as of right. Restorative remedies of minority shareholder oppression are, however, remedies that will compensate and reinstate the victim minorities after the damage has already been materialized and this is done, conventionally, by damage.381

However, the protection of minority shareholders under Ethiopian law is not as clear as it should have been. For example, if one goes through the Code dealing with companies, whether Share Company or private limited company, there is no single provision where the rights of minority shareholder are explicitly articulated.382 And the kinds of preventive and restorative remedies can be found hidden under different provisions of the code and their role in protecting the minority is indirect.

As discussed so far in this paper, the company form is special business form because, among other characteristics, it is operates under the professional management system and such body makes most decisions in the day-to-day activities of the company. And in some circumstances, the general assembly will decide by majority vote over some issues with regard to the company. So it seems logically untenable to say that the right of the minority shareholders is prejudiced while the company is actually run by the decision of the majority. 379

ibid ibid 381 ibid 382 ibid at p. 230 380

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But in effect majority rule decision-making will affect the interest of minority. And the Ethiopian Commercial Code dealing with companies did not give clear rules to this effect.383 Neither the circumstances when the decisions of the majority are prejudicial to the interest of the minority clearly set out nor a playground given to courts as in the English unfair prejudice remedy.

It is a blunt fact that current company law literature is substantially overwhelmed by minority shareholders oppression and the need for exit right. The problem of minority oppression is recognized as an acute problem. There are several ways by which majority shareholders may expropriate the minorities using the instrumentality of norm of majority rule. 384 Removal from management, deny the minority investors of the return of their investment and others are kinds of minority shareholders oppression. In different legal systems there are different remedies and exit strategies for the problem of minority oppression.385

When the directors cause the oppression, the victim minority shareholder does not have a right to bring action to the controlling shareholders who are oppressive or the management. The oppression of minority shareholders by directors may be either indirectly by managing the company in a wrong way (commercial mismanagement) or directly against the minority. 386 The kinds of violation or wrongful acts to the company may be tunneling, excessive remuneration of directors, managing the company in a wrong way and violation of article of association.387 When directors violate the articles of association or do some thing wrong to the company the decision of the general assembly is necessary to bring action against them on the behalf of the company. 388 The only action minorities can take when directors pay themselves an excessive salary for themselves at the expense of the minority shareholders, the latter, provided that they have 10% shares of the total capital, may apply to the Ministry of trade for reduction of the salary.389 Shareholders, minority included, and third parties can also bring action for damages for the fault or fraud of directors.390

383

ibid ibid, Tom Haden, Company Law and capitalism, 2nd Edn, Weindenfled and Nicolson, London, 1977, P, 259, as cited in Fekadu Petros G/Meskel 385 England, Germany, Czech Republic, Netherlands, Untied States are just few examples. 386 Supra note 378 at p. 231 387 ibid 388 Comm. Code Art. 365 389 ibid Art. 353 (7) 390 ibid Art. 367 384

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The other problem of minority oppression, particularly in closely held companies, is by the controlling shareholders who hold the majority of the share. Where the ownership in a particular company is dispersed the issue of minority oppression, though it may happen some times, is not be a big problem because no one controls substantial part of the shares that will entitle monopoly of the decision-making. 391 But when the ownership structure in the company is concentrated there is a high potential for minority oppression by the majority because the latter may oust the minority in the corporate decision-making. Fekadu P. G/Meskel stated the instrumentalities through which minority will face oppression as: There are several ways by which the majority may oppress the minority shareholders. The majority through the instrumentality of corporate decision-making, majority vote, may use the assets of the company for themselves, selling or buying the assets of the company for low price, block any action against their relatives and fraudulent directors, block the division of profits under the guise of 392

expanding the company etc.

This problem of minority oppression by the controlling shareholders is exacerbated by the two dominant corporate law principles; majority rule and the rule that the company is the right plaintiff for any wrong done against it.393 The principle of majority rule will allow the controlling shareholders or majority to pass any decision they want as they can oust the minority with their vote. And the doctrine of corporate law that states the company is the right plaintiff for any wrong done against it will deprive the minority of bringing any action against wrong doing directors, managers and the majority when their action is prejudicial to the interest of the company, and of course the interest of the minority. So the remedies aimed at protecting minority shareholders are exceptions to these general principles394 and there are hurdles in exercising those remedies owing to their nature. So those instruments, both preventive and restorative,395 provided under Ethiopian law, with the aim of protecting the minority are scattered through several provisions of the code. Fekadu Petros states that: Preventive remedies for minority shareholder oppression under this law include remedies that require higher majority and some times unanimity. To this effect there are provisions that require decision of

391

Supra note 378 at p. 232 ibid at p. 233 393 ibid 394 ibid 395 ibid at p. 234 392

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the general assembly only and this indirectly shows the protection for minority shareholders from 396

oppression by the controlling shareholders.

Acts that require extraordinary general shareholders meeting and large majority decision include restricting the transfer of shares in the company,397 amendment of the memorandum of association,398 amortization of capital,399 extending the life of the company400. There are also acts that require unanimity in the general meeting of shareholders. These are change in the nationality of the company and require shareholders to increase their investment in the company.401

The other circumstance where minority protected under Ethiopian law is the assignment of auditors by minority shareholders who hold at least 20% of the shares in the company or an independent auditor.402 These provisions will have a benefit when minority shareholders did not trust the auditor appointed by the directors or majority shareholders.403

These restrictions and requirements are, however, indirect strategies of protecting the minority from prejudicial majority decisions. It is a preventive mechanism aimed to protect the minority before any harm or prejudice happen.

There are also restorative remedies that will put the prejudiced minority at the state they should have been had they did not suffer the oppression or prejudice. Even with the presence of the preventive remedies there is a greater chance that there will be minority shareholders oppression404 by the majority, like for instance in decisions that does not require unanimity. The Ethiopian law does not provide any remedy for any prejudice the decision of general meeting will cause on the minority shareholders and the only remedy mentioned in this regard is the case when such decision will be annulled on the ground of procedural errors.405 When the general meeting of shareholders is found to be problematic either in the call for the meeting or in the procedure of giving decision then the same can be avoided for being adjudged as unfair and unjust. 396

ibid Comm. Code Art. 333 (1) ibid Art. 423 399 ibid Art. 483 400 ibid Art. 495 (1) (a) 401 ibid Art. 425 (2) 402 ibid Arts. 368 & 381 403 Supra note 378 at p. 241 404 ibid at p. 234 405 Ibid 397 398

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There are also cases where the right of the minority is protected by mandatory provisions of the law. These rights are rights inherent in membership and neither directors nor the general assembly can decide on those rights.406 These rights inherent in membership (basic rights)407 include right to be a member, to vote, to challenge decision of the company, to receive dividends or a share in winding up.

But all these remedies are not really sufficient to protect the minority and the issue of minority oppression, in closely held companies, is far from the reach of this strategy of the law. There are several ways and technicalities by which majority may extract any benefit they want at the expense of the minority. Under Ethiopian law there is no single provision allowing the minority to challenge the action of majority or general assembly where the latter’s decision is prejudicial to the interest of the company and the minority shareholder interests. 408 This is the basis for some scholars’ 409 suggestion that the amendment of the Commercial Code should come up with the kind remedy for the minority shareholders.

3.3 Special Situation of Private Limited Companies and Law and Exit Rights Though all these remedies are available under Ethiopian law they are mainly designed to those minorities in share companies where there is a better chance, compared to private limited company, for the market to correct itself should there be any oppression. The legal regime on minority shareholders protection under closely held companies is ill-equipped and the available remedies are very far from being sufficient to guard minority shareholders problem.

It is a blunt fact that minority shareholders have a vulnerable status in closely held companies. This is because of, as discussed so far, the kind of company is out of the reach of market in the sense that the shares are not freely tradable. There is either legal or contractual restriction as to the transfer of shares in those closely held company settings. Also the corporate norm of majority rule has contributed for the problem of minority oppression. The assertion is true under Ethiopian private limited company as well. This company form 406

Ibid See generally pp. 234-235, As he pointed out, the reason behind of this provision is because rule of majority is the tool to make corporate decisions as regarding the company and it is not the rule how members/shareholders in the company are to be treated. 407 Comm. Code Art. 389 408 Supra note 378 at p. 237 409 ibid

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definitely fits into the notion of closely held corporation and the attributes of the later are observable.

This company form is established by small number of shareholders usually family members and or close friends and their number cannot exceed fifty. It is commonly regarded as a family business. This involves trust and fiduciary relationship between these parties that calls for ultimate cooperation and confidence. In order to maintain these features the law has put certain protections for these parties from the any entrance of stranger.

Under the Ethiopian private limited company set up, like in other jurisdictions, members to the company contribute money and or labor 410 making it very difficult to separate the shareholder from the company. They also expect participation in the management as directors, officers411 or seek any other employment position and there is a duty of loyalty, trust and mutual cooperation at the establishment of the company. On the issue of appointment of manager, though it is possible to have outside manager, 412 practically shareholders themselves act as managers and officers. The problem is when those expectations are not met, trust is lost, fiduciary is broken and cooperation among members is no more possible. All these relations cannot be a good mechanism to settle disputes should there be any conflict between the shareholders. This is because trust, fiduciary and confidential relationships are just standards that are not laws and though there may be room for the court to apply them in some circumstances it is not absolute guarantee for resolution of disputes among shareholders.

The basis to a kind of statement is on a hypothesis that advance planning is usually costly and the types of investors under consideration are not sophisticated investors. Added to this, where the relationship is between families, business partners and close friends it is not usually easy to deal each other for obvious reasons of trust, confidence, loyalty. Those special relationships can effectively thwart advance planning of any kind that has foresight of dispute and distrust. In most advanced jurisdictions where business culture is developed very well there is no advance planning to the extent that is required to tackle the problem of minority oppression in closely held companies. 413 For stronger reason, in Ethiopia, where 410

Comm. Code Art. 519 ibid Art. 526 412 ibid Art. 526 413 See supra note 257 411

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business is still underdeveloped the hypothesis/ assumption will more likely be a fact and it will be a more tenable position to take.

The Ethiopian private limited company is closed company form in the sense that the company cannot issue transferable securities in any form and the shares are in fact not freely tradable to an outsider. There is no also a mechanism to value the shares even when sell of a share to an outsider or insider is approved by majority shareholders or ordered by the court. Moreover, the contribution at the establishment of the company may in most cases include labor and skill of a member making it very difficult for valuation. There is a restriction, by law,414 that shares are not tradable to outsiders. Assignment/ transfer of shares outside the company requires the approval of shareholders who hold 3/4th the capital unless a larger majority or unanimity is required by the agreement of the shareholders, usually in the article of association.415 Those shares, however, can be freely transferred as between members save an otherwise agreement of the parties.416 The idea behind the law in making entrance of third party almost impossible is just to keep the close or familial relationship of members of the company which otherwise will be spoiled if there is an outsider who does not understand all the trust, fiduciary and confidence between those parties. But on the other side of the spectrum is that there is no possible means of exit other than decision of ‘divorce’ based on unanimity or consent of all shareholders. This will actually put the minority shareholders in a very difficult situation once they locked themselves into the company.

Like in share companies, in private limited companies, majority rule is the grand norm in decision-making. Decisions are generally passed by majority vote, with the exception of those that require unanimity417. In the decision-making, therefore, majority of members who own one half of the capital will prevail. 418 And members, obviously the majority, fix the salary of the managers.419

Furthermore, under the Ethiopian law, there is no any comprehensive exit right rule for an aggrieved minority. When the trust and confidential relationship that existed at the making of the contract is no more present after some time there should be a way by which the 414

Comm. Code Art. 510(3) ibid Art. 523 (2) 416 ibid Art. 523 (1) 417 ibid Art. 536 (1) and (2) second sentence provides that change in the nationality of the company and asking for increase of the contribution require unanimity. 418 ibid Art. 532 & 536 (2) first sentence 419 ibid Art. 529 415

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shareholders ‘divorce’ can be effected. Despite the huge importance such default provision would bring to the minority, there is neither a legal provision nor case law dealing with exit right of minority shareholders.

Due to the above elements that characterized the Ethiopian private limited company, the minority shareholders have vulnerable status. This problem is aggravated by the fact that there is no possible exit mechanism under Ethiopian law. For worse the law restricts the transferability of shares to an outsider, at least in principle. The protections for minority provided are neither adequate nor directed to the problem of closely held companies. The remedies, both restorative and preventive are provided to deal with share companies. Though it is possible to use those provisions to special case of private limited companies, they are not adequate to guard the minority interest and provide a way out of the company when necessary.

This is, therefore, my thesis that comprehensive exit right for minority under Ethiopian private limited companies is more than a necessity. There are recommendations to this effect. The members of the company should be allowed to draft their contract as regards the transfer of shares in a way they like. The restriction the law has put should be adjudged unnecessary, especially for the needs of today. The law420 must be a kind of default provision, and not mandatory as it is, and should restrict transfer only in case shareholders did not provide an otherwise agreement to that effect.421 Shareholders must be allowed to devise a provision that will either allow or restrict the transfer of their shares both as between members and outside the company.422

3.4 Exit Rights of Minority shareholders Under Ethiopian Private Limited Companies Apart from those preventive and restorative remedies discussed so far there are some exit remedies under Ethiopian law. But the scope is so narrow and comprehensiveness is far from being sufficient. The following are some of the exit rights for minority shareholders. There is no direct reference to such right but through construction, indirectly, minorities can be protected, at least to some extent. These are:

420 421 422

ibid Art. 523 (2) See also Booz, Allen and Hamilton, supra note 349 at p. 23 Ibid

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3.4.1 Dissolution and Winding Up Dissolution and winding up of a private limited company is one of the strategies towards the problem of shareholders oppression. Ethiopian law provides grounds by which dissolution and winding up of the company may be ordered.423 This provision makes a reference other provisions of the code dealing with grounds of dissolutions applicable to all forms of business organizations.424 It also states that dissolution can be ordered for good cause and up on the request of a party where the term of the company has not been fixed.425 Under the general part dealing with dissolutions applicable to all forms of business organizations, three types of dissolutions are recognized: legal, consensual and judicial dissolutions.

The first category includes cases where the company has lost its purpose, either by achievement or otherwise426 and when the time limit for which the company is established has expired, save for the otherwise agreement of the members. 427 The second type is consensual dissolution where the members of the company agree to end the life of the company at any time.428 Thirdly, the court can order dissolution for good cause up on the application of member/s of the company. 429 The provision provides specific cases where there will be good cause. These include serious failure by the partner in his duties, permanent illness or infirmity, or serious disagreement between the partners.430

From the above discussion we can see that, Ethiopian law provides winding up remedy in the same way to English and German laws. So this provision is adequate enough but its application will be restricted practically. As discussed so far 431 winding up remedy is a remedy of last resort and its consequence is so harsh and undesirable. And the specific cases where the remedy may be ordered are not developed judicially to make it more feasible. Practically to rely on winding up remedy the minority has to show the economic non-viability of the company, which is very difficult in most cases. And given the fact that most of the problems of oppression are relational conflicts winding up remedy is not a smart choice from the point of view of economic importance of the firm. Dissolution by agreement is also

423

Comm. Code Art. 542 (1) Ibid Arts. 217-218 425 Ibid Art. 542 (1) 426 Ibid Art. 217 (a) 427 Ibid Art. 217 (c) 428 Ibid Art. 217 (b) 429 Ibid Art. 218 (1) 430 Ibid Art. 218(2) 431 For discussions on winding up remedy see sections 2.2.1 and 2.3.1 424

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recognized under Ethiopian law but requires unanimity or larger majority and is not feasible to the protection of minority shareholders.

3.4.2 Mandatory Bid Right: ‘Oppression Remedy’?432 Under Ethiopian law minority shareholders have mandatory bid right 433 but its content is so narrow to remedy the issue of minority shareholders oppression. 434 Minority /dissenting shareholders can have their share redeemed by the company at an average price on the stock exchange435, in principle, when quoted or at a price proportionate to the company’s assets when it is not. But this right is limited only to those cases envisaged under the provision; change in the nature or object of the company and transfer of the head office of the company abroad. As regards profits and dividends, also, the law436 obliges the distribution of profits after the transfer for legal reserve is effected. This will be of help, therefore, in protecting, though not significantly, the minority oppression by the majority shareholders who otherwise would have got the money using their long arm, if not distributed on time.437

The mandatory bid right recognized under Ethiopian law is insufficient. As discussed so far438 there are several technicalities by which minority shareholders will be oppressed. The same may arise from breach of agreements, breach of the law and breach of understandings of members inter se. There are also several issues by which either majority will oppress the minority or the members of the company will not be in a position to work cooperatively any more. These includes, but not limited to, disagreements that does not justify winding up, personal conflicts, breach of fundamental understandings and expectations, improper determination of salaries or distribution of profits, appointment and termination of employees, break down of trust and confidence, improprieties of the majority, deadlock etc.

432

This right looks like the oppression remedy and buy-out right. But it is just one fraction of the circumstances that trigger for oppression remedy. 433 Comm. Code Article 463 (this is equivalent to the buy-out right under oppression remedy and buy-out right) 434 See Fekadu Petros G/Meskel, supra note 378 at p. 239 435 Despite an imperative need for security/stock market in Ethiopia there is no stock exchange where shares and securities can be sold. Usually companies will arrange for this sell or shareholders can sell their share by private arrangement. For more information See http://addisfortune.com/Vol_12_No_621_Archive/Ethiopian%20Stock%20Exchange%20Imperative.htm accessed on June 30,2012 11:07 am. 436 Comm. Code Art. 456 see also 539 437 See Fekadu Petros G/Meskel, supra note 378 at p. 237 438 See sections 2.2 and 2.3

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all these problems are far from the reach of the current law. There should comprehensive remedy to this effect.

For the protection of all these rights the oppression remedy and the consequent buy-out right, as in England and Germany, should be included in the upcoming legislation. The current law either did not regulate the issues or it is not adequate. 439 So comprehensive doctrine of minority oppression and buy-out right for minority shareholders should be made available under Ethiopian law.

3.4.3 The Right to Withdraw: Appraisal Remedy?440 Legal merger, demerger, conversion or amalgamation of the private limited company441 will change the nature of the company and the original deal. The decision to this change shall be made by majority vote of members who hold 3/4th of the capital.442In such cases there should be way out for minority shareholders who did not vote to the change. The provision provides the dissenting member (either to the acquiring or disappearing company) to withdraw from the company.443 His/her share shall be redeemed at a price proportional to the company’s assets as shown in the balance sheet for the last financial year. 444 Like in the English or German appraisal right, Ethiopian law requires the dissenter to vote against the change in the company form and the vote must be recorded in the minute.445 But the reading of 463(2)(b) of the Commercial Code shows the possibility of withdrawal from the company even when the dissenter did not vote and his vote recorded. So there is a contradiction between the two provisions. One way or another when the general meeting is not duly convened or the dissenter was unable to attend it for good reasons, s/he must be allowed to withdraw from the company and his shares redeemed. The other problem of appraisal right under Ethiopian law is the valuation may not reflect the market value of the shares. The above provision rather than saying market value of the shares at the time of resolution it makes reference the balance sheet of the last financial year of the company. This will affect the right of the minority shareholder negatively. And the proper date must be the date of adoption of the resolution and market value of the shares on that date as the appropriate compensation. 439

For example for unlawful dismissal Art. 527(3) provides for compensation to the dismissed manager. But this is inadequate for a member manager who relied on the salary as a means of profit/dividend unless, in addition, reinstated to the managerial position 440 This, somehow, looks similar to the English and German appraisal remedies. 441 Comm. Code Art 549, 547 442 ibid Arts. 545 & 547 cum 536 443 ibid Art. 547 (3) 444 ibid Art. 463 (1) second sentence 445 ibid 547(3)

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3.4.4 Exit Right At Will This right, like in other jurisdictions, is not recognized under Ethiopian law. There is no single provision or practice under Ethiopian company law dealing with exit right at will. One may also may, however, make a reference of the general contract law rule that provides for termination of contracts.446 The provision states that where the contract is for an indefinite period of time both contracting parties can terminate the contract on notice. Though company can fall under the long-term contract jurisdiction it is hardly practical that such provision can be invoked by minority shareholder and courts will accept such a plaint. Company has a peculiar nature and the justifications for the above provision are hardly observable when it is a company.447

Even other exit rights discussed above in sections 3.4.1, 3.4.2 and 3.4.3 did not in exist in a comprehensive form and they are not directly intended, but indirectly, to protect the minority. So to talk about the present right under Ethiopian law will be absurd and too ambitious. This right is not also well tested in other jurisdictions and to recommend the same to the Ethiopian legal system is to lead the regime into unknown leap.

3.5 Lessons to be learned from English and Germany Laws Currently the Ethiopian Commercial Code is under revision for amendment. It is perfect moment to recommend that the upcoming amendment should come up with provisions that will give minority shareholders an extended and comprehensive exit right out of the company.

I am of the opinion that comprehensive exit rights, as in England and Germany, should be adopted under Ethiopian law. Particularly, most important to the closely held corporations is oppression remedy. This remedy is one of the most important legal strategies of all towards the problem of majority opportunism. The flexible and wide playground the remedy will give will serve as a good protection for minorities. As in the English unfair prejudice or German oppression remedies, the Ethiopian law should adopt the doctrine. But the question is which system should Ethiopia have to take as a benchmark. Which one should be consulted principally will be very premature recommendation at his stage. There are several factors that 446

The Civil Code of The Empire of Ethiopia, Extra ordinary Issue, Addis Ababa [Birihanina Selam Print. Press, (1960) Art.1821 The reason behind of Art. 1821 is to allow the parties to end an obligation whose term is not fixed. The law does not want the parties to be under obligation for eternity. But incase of companies one of the feature is perpetual existence. 447

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should be considered, apart from the merit of the particular laws in relation to exit rights in the two systems. There are also philosophical reasons for the approach taken by the two systems. The fact that Ethiopia is Romano-Germanic civil law country may lead one to stick to Germany law. But the fact that the Ethiopian commercial practice has been dominated by the Anglo-American practice and that the Ethiopian Commercial Code is a mix of several systems is a reminder for the necessity of consultation for both English and German law and even further. From accessibility view point English law may be easy to consult and transplant because it is statutory law accompanied by stores of cases. Merit wise, however, as discussed under section 2.4 English and German laws are not that different in this regard and, if they are different, just only on some thing that has minor importance.

It is my recommendation Ethiopian law should take the experiences of both England and Germany to come up with comprehensive exit right for minority shareholders in private limited companies.

There are justifications for the above recommendation. The first is the fact that, despite some differences, investors using similar company form are seen to face the same problem in several jurisdictions 448 is one convincing justification for the need to adopt similar, if not the same, strategy towards the problem of minority oppression. The experience of using closely held company form shows that majority opportunism and minority oppression are an inevitable and is closely connected with those company forms that adopt both partnership and corporate structure.449 The form and characteristics of the Ethiopian private limited company is not different, if not exactly the same, in this regard. So the legal strategy adopted should also be considered under Ethiopian law.

The second justification in recommending comprehensive exit strategy, which I think will be more convincing is that, if the issue of minority oppression is real problem in most advanced jurisdictions like United States, England, Germany, Netherlands, etc. it must be a big problem under Ethiopian companies as well. That is to say minority shareholder oppression is a problem in those jurisdictions while the investors are too sophisticated, there is strong contract enforcement, strong judiciary and the market actually corrects itself, in most cases, it

448

See Reinier Kraakman et al, supra note 9 at p. 1 For example, the problem of minority shareholders oppression is a serious issue in United States’ limited liability company and close corporation, English limited liability company, and German and Netherlands’ private limited company forms, to mention few. 449

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will be a serious problem in Ethiopia where business culture is one of the least developed in the world, court system is the weakest and market is always distorted.

The fact that substantial numbers of the Ethiopian companies are private limited companies 450 will make the problem worse and well-crafted exit right, as a reaction, a necessity. This company form is an ideal business tool in Ethiopian where there is lack of capital to establish big companies. It gives a kind of practical flexibility for investors to establish the same with small capital under owner-managed company form. This company form as a most common way of doing business its contribution to the national economy is by far important compared to other forms of business organizations. The employment opportunity it will create also is non-negligible. Ethiopia is one of the least developed countries451 where there is a desperate need for huge capital towards economic development and eradication of poverty. Foreign direct investment may be of help, though its contribution to the GDP has been one of the lowest,452 if favorable investment condition is guaranteed. Foreign direct investments in most cases, among others, come in the form of equity joint ventures, as one form of closely held company. Protection of shareholders in these joint ventures and exit right for minority shareholders is one reliable tool.

450 451 452

See Fekadu Petros G/Meskel, supra note 357 at pp. 13-14, see also Booz, Allen and Hamilton, supra note 349 at p. 19 See http://www.unohrlls.org/UserFiles/File/UN_LLDCs_Factsheet.pdf accessed on 2 July 2012 at 6:13 PM. See http://www.indexmundi.com/facts/ethiopia/foreign-direct-investment, accessed on July 2, 2012 at 6:25 PM.

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Chapter Four Conclusion Closely held company set up has benefited from the flexibility privileges of partnerships. It has also got the advantages from corporate form such as tax benefits, separate legal personality, limited liability and other doctrines applicable to companies. This hybrid company form, however, has problems of its own that made is a ‘hot potato’ for minority shareholders.

Established among families, close friends and business partners, the company is commonly known as family business and is characterized as closed company form. This is a security for some one who invested the much of his wealth in the belief and understanding that all shareholders will benefit out of the cooperation. In this closed company, however, with majority rule, when ownership is concentrated in the hands of few and the remaining is minority, there is a high probability the majority will be opportunistic. It will be, therefore, too hard for the minority either to veto the wrong (unfavorable) or to escape the unfairness by selling the shares. This company form is far from the reach of the market in the sense that shares are not tradable to an outsider either by legal or contractual restrictions. So the market, which could provide both a means of exit and valuation of shares, is not available option. And, minority shareholders in closely held companies are locked into the company with no viable option to exit.

The parties are not also able to devise a contractual mechanism for exit the company when it is necessary. The issue of advance planning is not viable option as well. Complete contracting would have been a solution to the absence of exit right and minority oppression, should it exist. But for the overwhelming justifications discussed so far this option is seen as unviable. So drafting an ideal contract, efficiency consideration, for this company form will finally rest on the shoulder of legislature or courts.

Corporate law as a prepackaged standard contract should be drafted in a way that reflects the things shareholders would have done had they costlessly dealt over the matters such as strategies that will heal the virus of shareholder opportunism. These strategies include , but not limited to, voice rights, information rights, transparency and accountability procedures and importantly exit right. Exit rights are better prevention and cure for minority oppression. 67

There are several technicalities in which minority may be oppressed shareholders and their property expropriated by opportunistic majority or nominal board that works in the mind of the controlling shareholders. As a result several jurisdictions have came up with exit right of the minority as a viable tool. As discussed under chapter two, English and German laws are notable in this regard and have been transplanted to many other jurisdictions for being best strategies so far.

English law has provided several remedies for minority protection and in particular recognized dissolution and buy-out rights for the aggrieved minorities provided that the grounds for invoking those remedies are satisfied. Winding up remedy, the first statutory exit right, was considered harsh for it compromises the life of the business and employment opportunities the company has created. Then comes the unfair prejudice remedy, a much more flexible one that does not necessarily require dissolution of the company. Under this remedy several orders are provided for guideline for courts but the most common one is the buy-out right, be it by the company, the majority or even the minority. The application of winding up remedy is also suspended as long as there is a way out under the unfair prejudice remedy. The latter remedy is mainly applicable when the deal is not respected or legitimate expectation of the minority is frustrated.

There is even a further move under English law and legal literature that a much more extended minority exit right be provided in the form of so called ‘no fault divorce’. Exit right at will is being considered under English law but the majority view rejects this right.

Germany law also devised exit rights of the minority shareholders for private limited companies. Like English law, winding up remedy for weighty reason is the oldest exit remedy under German law. But due to the same reasons discussed, the winding up remedy was of less practical relevance though not avoided. To this effect courts develop the oppression remedy. This remedy may either be withdrawal or expulsion depending on whether the minority or the majority is responsible for the break up. This is an automatic remedy that does not need any litigation once the substantial cause (weighty reason) is established. The remedy can be invoked both for reasons of the behavior of the other shareholder or personal reasons. This is the aspect where the German law is much liberal than English law. Even personal reasons, such as illness or urgent need of money, can be grounds for exit. Like in English law, however, exit right-at-will is also rejected under German law. 68

In this paper the writer tried to show the problem of minority oppression and legal strategy English and German laws adopt to overcome it. This is the opinion of the present writer that experiences of these two systems should be consulted for Ethiopian law. As discussed under chapter three, in Ethiopia private limited company form similar to the English limited liability company and the German private limited company. These three similar company forms share several common characteristics that calls for similar, if not the same, strategy towards shareholder opportunism. Under Ethiopian law there is no comprehensive exit right for minority shareholders. There are voices and information rights are recognized but neither directly intended to remedy the problem of minority oppression nor adequate enough. And the role these rules play is indirect one. This will make joining the private limited company a bittersweet paradox. On the one hand investing in such closed company set up is advantageous for reasons discussed so far. But on the other side of the spectrum this company form is a source of several problems notably minority oppression.

So it is my thesis that the upcoming Ethiopian commercial law amendment should come with provisions that give exit right for the minority shareholders. The provision of the law dealing with winding up should include minority oppression as one ground of winding up. And moreover, buy-out rights for the minority should there be any oppression should also be recognized.

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