From Interstate - Journal of International Affairs VOL. 2013/2014 NO. 1
The Interests of Minority and Majority Shareholders in the EU
IN THIS ARTICLE
The recent economic crisis roved to be immensely threatening to the economic equilibrium within the European Union (EU). Beginning in the United States, it then proved its "domino effect" by covering the EU, resulting in so-called 'financial stress' in all the Member States.1 In this context, some possible explanations for the crisis are worth mentioning: unsustainable macroeconomic inequalities , a lack of adequate policies preventing adventurous risk-t aking on the global scale,2 a complete failure in the system of global financial governance and its regulatory framework.3 Many of these explanations point toward wrong decision-making on the part of majority shareholders. Had there been a proper system of internal checks and balances within the companies, the financial backlash would not have been as devastating to the economy.
The following piece explores a variety of mechanisms and principles that the EU uses to guard the interests of minority and majority shareholders-. The analysis shall be undertaken on several plains: the balance of power in the company; minority and majority shareholders-; and empowerment and protection. The underlying idea of this piece is to provide an overview of how the EU regulates the often clashing and overlapping interests of shareholders.
1.1. Defining Minority Shareholders
Minority shareholders are those board members that possess less than 50 per cent of the shareholdings in a company.4 There are two approaches to identifying this group. Firstly, the quantitative approach depends on the percentage of capital owned, though this is often regarded as outdated. Secondly, the qualitative approach considers that control is of utmost importance, an approach often regarded as more realistic.5 For the purposes of this piece, let us accept that the objective numerical disadvantage of minority shareholders naturally results in decsion making impotency within the business organisation.
1.2. Defining Majority Shareholders
A majority shareholder is-a person or a company that owns more than 50 per cent of the stock within companies, which usually allows them to control the company's transactions, and more importantly, elect the board of directors.6 Thus, they are in de facto control of the company, which entails deciding directly or indirectly on the salaries of the management, on dividends , causing a break-up of the corporation, deciding on the merger, cash-out public shareholders, amending the rules on incorporation and selling the assets.7
It must be noted that a shareholder who 'owns a majority interest' or 'exercises control' over the business or corporation is subject to fiduciary duty towards minority shareholders, which may be both directors and controlling stockholders.8 Thus, th e fiduciary duty, based on the trust between the trustee and the beneficiary , gives a sort of "security" to minority shareholders and also disengages controlling shareholders from 'self-dealing transactions'.9 In order to balance this striking inequality of roles, this fiduciary duty extends to all responsibilities given to controlling shareholders in case of breakup of the corporation, merger with another company, in case of cash-outs, selling of corporate assets and others. Furthermore, majority shareholders are subjects to the duty of care, which stands for acting in a good faith, with ordinary care and 'in a manner the director reasonably believes in the best interest of the corporation' .10
1.3. Minority Shareholders: A Position of Disadvantage
The crux of minority protection can be found in the antagonistic relationship between the controlling bodies of a company, including its directors and majority shareholders, and the reluctant minority shareholders, in case of a change in corporate control This balancing act could be viewed as a matter of survival in the "corporate jungle". Those who manage to usurp control are in the company's "driver's seat", creating the rules and possessing more comprehensive and solid influence. These problems are countered by minority protection and minority empowerment, which are two sides of the same coin. The former is about the intervention of the state, in its judicary or legislative capacity that is entrusted with modeling and enforcing the external legislative framework of controls . Nevertheless , this is not about the state "picking sides", since it is at no point directly accountable to the minority shareholders. Minority empowerment is about the internal checks and balances in the struggle for power and granting clear-cut rights to the minority within the business entity itself.11 This piece sees both interpretations as relevant for the purposes of outlining the interests of minority shareholders.
Traditionally , the minority shareholders' position is disadvantageous, being at a greater distance from the information flows and the decision-making process. In the case of cross-border mergers within the EU, for example, the situation is relatively more inclusive in terms of consultation, although the final choice is made by the majority shareholders. Nevertheless , in cross-border mergers, approval requires a positive vote cast at the general meetings of the totality of the concerned companies.
The conditions for equal treatment of minority and majority shareholders are better, since the process occurs at the same moment in time and under identical terms. However, the possibility of indirect benefits for the majority shareholders is not to be dismissed and, therefore, the question of what remedies are available for the minority is still relevant. Apparently, there are only two options left - filing for damages or selling the shares. Both options can result in monetary compensation.12
2. Majority Shareholders: Abuse of Power
Although having been given an "assurance" in the duty of loyalty and duty of care, the minority shareholders at large still seems to have an antagonistic approach towards majority shareholders. The literature mainly focuses on the ways in which the majority shareholders may abuse their powers and "consume corporate wealth", for example by paying themselves excessive salaries, withdrawing funds, or blocking a value increasing tender. It may be rebutted, however, by the fact that in concentrated ownership model, the majority is directly involved in the management of the company. Thus, the majority shareholders play an active role in scrutinising the management. Furthermore, mechanisms such as corporate control trans actions, accounting rates of return of the company, a so-called transparency policy are available for the minority shareholders to prevent mismanagement13 More precisely, after a scandal related to Enron, the European Commission launched the Communication on the statutory audit followed by an Action Plan on Modernizing Company Law, focusing mainly on corporate governance enhancement and transparency.14 Furthermore, after the Parmalat insolvency issue - the collapse of a food and dairy corporation, which the BBC described as 'Europe 's biggest bankruptcy '15 - the reform s in the field of accounting and audit controls were necessary.
The scandal confirmed regulatory problems on both Member State and EU level. It unveiled that the European system attracted private benefits extraction; controlling shareholders have developed a variety of techniques to tunnel assets and profits. The collapse of Parmalat has made the EU realise that the accounting frauds and abuses coming from the board of directors were not solely an American problem.16 A need to introduce high quality company disclosure systems and regulations designed to protect investors were clearly missing in EU legislation. Therefore, the EU had been encouraging an adoption of the Financial Sector Assessment Program (FSAP), a United States-style corporate governance and securities law system. It has, however, struggled to create any measures on the national level, as various interest groups, national governments, have opposed it.17
Nevertheless, realistically, takeovers remains the trickiest of control transfers for vulnerable and powerless minority shareholders, since they are in the danger of becoming victims in a clash between titans, the target company and the one initiating the merger. First, they have no standing to bring action against the controller s for breach of fiduciary duty. Secondly, the Takeover Directive18 (or any European harmonisation instrument, for that matter) has failed to enlist specific rights belonging to or any express duties owed to this category of shareholders, nor does it speak of any legal bases for thos e. Thirdly, enforcement rules for regulatory offences are underdeveloped, because they do not cover private actions. Last, but not least, the legal system is not particularly favourable to law enforcement in relation to private investors.19
3. Protection of Minority Shareholders
Joseph Lee20 explores the rationale behind the need to protect minority shareholders. The proprietary argument notes that shareholders entertain a proprietary interest in a company's investments. Their rights could be appraised as those of passive owners and residual claimants, or could be construed as active ones, retaining entitlement over dividends, votes, equal treatment, law suit and others. In the meantime, the contractarian point suggests that the minority shareholders enter a unanimous and voluntary agreement with the company. The terms of the contract, based on fiduciary principles of trust between a trustee and a beneficiary, have the power to raL'>e the price per share, if found favourable by investors. Furthermore, another theory is that the controlling actors owe a duty of care to their fellow minority board members. A fourth important hypothesis is that of corporate democracy. It concerns the legitimacy of the rule of the majority, and the paper-thin boundary between that and a regime where the will of the minority is ignored. Corporate democracy is envisioned as a process of deliberation, where all points of view are taken into account and equitable principles are respected. Last, but not least, the distributive justice argument rejects state intervention in a free competitive market Following the social meritocratic principle within the closed community of a company, even the minority shareholders should be entitled to reap the benefits of their contributions.
4. Models of Empowerment of Minority Shareholders21
Lee proposes four general models of granting extra rights to minority shareholders, inspired by the English practice: internal control, market control, regulatory control and private action. The internal control pattern entails mechanisms inside the corporate structure, like board and general meetings. The underlying principle is that a company is master of its assets and the directors are bound to the company by means of a fiduciary duty. The privilege to bring action against the directors is conferred on the company. The minorit y shareholders may also start proceedings against directors by means of the doctrine of derivative actions originally coined in English law (Foss v Harbottle22).23 Almost all Continental European states, except for example the Netherlands, have accepted law suits by derivative shareholders. If damage sustained by negligence is inflicted on the company's assets, the shareholders can only sue in the company's name.
The shareholder can only liquidate the entire damage, not only the part equated to their stake. This mechanism has been designed to resolve the majority versus minority conflict: the wrongdoer enjoys the support of the majority in the general meeting, exercises "wrongdoer control", or is under the wing of the majority, should the breach of duty have benefited the controlling shareholder. Thus, a minority law suit reaffirms the principle of equal treatment of shareholders. However, problems arise where the interests of the company and those of the minority do not match.24
Lee's second model is the market control model In this case, the forces of supply and demand determine the price per share, which in turn is symptomatic of the management and performance of the company.25 Critics have established that there is indeed a correlation between those factors:
'Minority shareholders in countries whose laws promote and protect shareholder rights are probably more likely to be able to have the kinds of boards that they desire. In addition, corporate boards in countries where the law supports board oversight and actions are probably more likely to be effective. We hypothesise, therefore, that "good" shareholder laws and "good" boards go hand-in-hand, in the sense that they must be complements'.26
In order for this theory to work, shares sold in the market must comprise a substantial part of the total shareholdings. This trading must be done without any restraints and the company must be facing a takeover.27
With regards to markets which are subject to regulatory control, the state L'> the main actor, occasionally delegating to self-regulatory bodies of public authorities. It is a case of external supervision and inspection of mergers under a pre-established comprehensive framework. The state pursues the public interest, sometimes even at the expense of that of the shareholders or with a great deal of arbitrariness.28
The last model is the private actions model, which is most favoured by the authors. It is basically the right to a self-defence reaction in case harm is inflicted or unjust and inequitable treatment is demonstrated by the majority shareholders on the minority shareholders. It should be their prerogative to seek redress and compensation in court as well as cease the relevant authorities for malpractices. The judicial system should be more accommodating both financially and procedurally for minority shareholders.29Continued on Next Page »