Romania: Squeeze-outs of minority shareholders: methods and pitfalls

This issue is made more complex by the large number of Romanian companies with minority shareholders. Historically, state-owned companies were privatised through the management-employee buy-out (MEBO) method, which allowed employees to receive shares in former state-owned companies. From 1991 to 1996, this method was universally used for the privatisation of state-owned companies, and statistics show that more than 5 million Romanians may still own shares from that period. Such stakes are often granular (below 1% of a company's share capital) and in many instances such minority shareholders are dormant or even unaware of their participation in former MEBO-privatised companies.

Existing legal framework

The concept of a squeeze or sell-out is recognised in Romanian legislation only with respect to publicly listed companies. In this regard, the shareholder protection offered under Law 24/2017 mirrors that recognised under the EU Takeover Directive (2004/25/EC).

Conversely, under the general regime applicable to closely held companies, the legal protection conferred on minority shareholders is weaker and provides ineffective means of leaving (or being forced out of) a company. While this may be understandable from a corporate governance perspective, the general opinion in Romania is that the current legal framework insufficiently addresses the specific concerns with which many Romanian companies still struggle.

In general, the rights of minority shareholders which are currently recognised are:

• various information rights;
• the right to ask for a general meeting of shareholders to be convened (where the shareholding is above 5%); and
• the right to request an expert review of the management activity (where the shareholding is above 10%).

In terms of a sell-out, shareholders have the right to leave a company in exchange for adequate compensation in a limited number of cases – namely, when the company's interests with respect to its scope of business, corporate seat or legal form or during a merger or demerger no longer coincide with those of the withdrawing shareholder.

Despite their limited legal protection, minority shareholders can benefit from powerful mechanisms of which majority shareholders should be mindful. The Romanian courts have often ruled in favour of minority shareholders who have managed to prove that a majority shareholder abused its position and promoted shareholder resolutions to its primary benefit.

Hence, if a court believes that a majority shareholder has exercised its voting rights oppressively or in disregard of a minority shareholder's interests, it may pass a decision ending the discretionary practice. Such a decision may range from a damages award to the cancellation of the shareholders' resolution adopted in disregard of the minority shareholder's interest.

The courts are generally recognised as having wide discretion over the nature of relief granted to minority shareholders. However, minority shareholders have often asked the courts to cancel the resolution adopted by or under the control of the majority shareholder, with the view that this is the most successful method of repositioning themselves in their dialogue with a majority shareholder.

Available alternatives to squeeze-outs of minority shareholders

Absent contractual mechanisms leading to the squeeze-out of minority shareholders – such as buy-back programmes or drag-along rights triggered by the sale of a majority package – majority shareholders must seek alternative methods to restructure their companies and eliminate dormant or troublesome shareholders.

Options which lead to a whole or partial reduction in the number of shareholders and often affect minority shareholders that have shown no or a limited interest in their shareholding rights include:

• an increase of the share capital (leading to a further dilution of the minority shareholders not taking part in the share capital increase);
• a decrease of the share capital by an annulment of shares;
• a squeeze-out merger; or
• a reverse stock split, in which the number of shares are consolidated without affecting the aggregate value of the share capital.

In recent years, both majority shareholders and the courts have paid specific attention to reverse stock splits. In a reverse stock split, a company initiates the consolidation of its total number of shares by replacing a certain number with one whole share of stock. For instance, in a one-for-100 reverse stock split, 100 shares are consolidated into one share of stock.

There may be various reasons for a closed company to undergo a reverse stock split. In many cases, such a split is driven by the company's intention to streamline its corporate governance, following the inheritance of a large number of shareholders from the privatisation period and the increased formalities that must be met under the Companies Law in order to validly organise a shareholder meeting.

As regards minority shareholders, some may find themselves evicted from a company as a result of a reverse stock split.

Under the rule set out in the Companies Law, whereby no shareholder may hold fractions of shares, the only option available to minority shareholders that hold less than one whole share of stock and want to maintain their presence in the company is to increase their contribution to the share capital up to the value of such whole share. Conversely, minority shareholders that decide not to increase their contribution up to the value of a whole share become divested from the company and are generally offered fair compensation for their shares.

While many reverse stock splits are driven by well-justified and legitimate interests of the majority shareholder, minority shareholders have often seen the situation as an act of oppression and claimed that the only reason for such a split was the consolidation of the majority shareholder's position to the detriment of the other shareholders.

The Romanian courts have taken different approaches with respect to the validity of a reverse stock split, and case law on this topic, or at least clear guidelines with respect to the courts' perception of such, is still in its early stages. Many of the courts called to consider the validity of a reverse stock split have sought to determine the compelling business purpose of such a process and the inner reasons driving the majority shareholder's decision to resort to such corporate actions.

Comment

Reverse stock splits may be an efficient tool for majority shareholders to restructure their company and remove dormant shareholders from their shareholding structure. However, a reverse stock split must:

• be implemented correctly;
• be based on a sound business interest; and
• offer the proper protection to minority shareholders, including the option to preserve their stake in the company and receive fair compensation in case of their divestment.

This article was first published on www.internationallawoffice.com 

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