The Squeeze-Out Procedure Remains Unsqueezed
For the last 3 years shareholders of Ukrainian joint-stock companies and courts have been dealing with a new corporate instrument introduced in November 2017, namely the procedure for the mandatory sale of shares at the request of the owner of more than 95% of the shares of a company, referred to as a squeeze-out. Since then, over 300 joint-stock companies have gone through a squeeze-out procedure, buying out thousands of their minority shareholders.
Naturally, when new corporate regulations come into force it does not take long before a conflict arises, and the squeeze-out procedure was no exception. Minority shareholders started challenging, among other things, whether Article 65 1 of the Law of Ukraine on Joint Stock Companies (the Law) amounts to unlawful alienation of property and, if not, how the fair value of the squeezed shares shall be calculated.
Previously, in October 2019 the Constitutional Court of Ukraine refused to consider the constitutionality of Article 65 which governs the concerned procedure on the mandatory sale of shares. Still, the Constitutional Court of Ukraine did not consider the constitutionality of Article 65 of the Law on merits and simply dismissed the application due to procedural flaws made by the applicants – the MPs.
The Supreme Court Decision
One of the original source disputes of the squeeze-out procedure became pivotal for the industry, namely case No 908/137/18, where minority shareholders claimed that the squeeze-out option applied to them was unlawful and breached their rights as the price offered for compulsory repurchase had been unjust. This case reached the Great Chamber of the Supreme Court of Ukraine (the Supreme Court) and eventually was considered on its merits.
On 24 November 2020, the Supreme Court of Ukraine delivered a final judgement by approving the appeal in part and stating that the procedure set out by the Law, as applied in this case, was not properly and thoroughly deliberated by the courts of previous instances. The Supreme Court overturned the decisions of previous instances in general terms and sent the case of the squeeze-out in question for a new trial back to the court of first instance, while providing some important thoughts on the squeeze-out mechanism to be accounted for by lower courts.
Importantly, in its decision, the Supreme Court noted that the introduction of regulations, which, depending on the chosen method of determining the price of shares may create huge differences in share price, and cannot guarantee a fair compensation that is proportionate with the interference in property rights to a minority shareholder in every case.
The Supreme Court noted that ensuring the possibility of a forced buyout of shares may be in the public interest. However, this procedure, as well as any other method of compulsory alienation of property rights, should be used in exceptional cases in order to achieve a legitimate goal and balance the interests of all shareholders, including fair payments to minority shareholders for their shares.
The Supreme Court supported the statement that the owner of the dominant controlling stake must have a legitimate aim for a compulsory squeeze-out of minority shareholders and rightfully appropriate ownership of their shares. This is subject to a court review in the event of a dispute.
Nevertheless, in the case of a procedure of compulsory alienation of shares challenged by minority shareholders, the court must establish: i) whether this procedure was conducted in accordance with the law; ii) whether it was carried out for a legitimate purpose, namely whether the motives of the majority shareholders were in the public interest in the implementation of this procedure; iii) whether the value of the share repurchase offered to minority shareholders is fair, and accordingly, iv) whether the criterion of proportionality of interference with the plaintiffs’ rights has been met.
The Supreme Court inferred that the buyout of shares in accordance with Article 652 of the Law of Ukraine On Joint Stock Companies is a transaction where a minority shareholder loses ownership of the shares in the absence of his will, without any influence on the pricing, and in the absence of a sound legislative mechanism for special control by the court or the regulator.
The Supreme Court Conclusion
The Supreme Court stressed that before stripping minority shareholders of their shares, the courts of previous instances failed to assess whether the price set in the irrevocable buyout offer had been fair and, consequently, if the criterion of proportionality had been met. the Supreme Court concluded that the introduction by the State of a special procedure for the compulsory alienation of shares should, in any case, be accompanied by the establishment of guarantees for the protection of the rights of the person deprived of property. The ensuing implication is that the State has not established enough guarantees.
The Supreme Court delivered a clear message to stakeholders and the industry at large that Article 652 of the Law of Ukraine on Joint Stock Companies is far from balanced and requires serious tuning. There is a reasonable expectation that the Ukrainian parliament will address this issue in the future. Still, any legislative initiatives aimed at resolving this will take months, even if there is a consensus on the matter in the first place.
Having considered the Supreme Court decision on squeeze-outs the summary is that both the shareholders and courts, if a respective squeeze-out is challenged, would struggle to apply Article 652 of the Law of Ukraine on Joint Stock Companies until there is a certainty that the mechanisms envisaged for setting share prices under the squeeze-out procedure are definitely lawful and balanced.
As a result, shareholders wishing to exercise the squeeze-out option before good industry practice and revised legislation are both established should seek sound professional legal advice which has to be tailored to their case, and keep in mind all Supreme Court decision-related implications as well as to foresee likely corporate developments.
And last but not the least, those minority shareholders who have been already squeezed out by virtue of the Law since its enforcement in 2017, have now the opportunity to consider its chances for appeal but should first ensure that the limitation period has not expired in their case.