New progress toward minority protection

The development of regulated capital markets in the Baltics has been rapid but has sometimes progressed faster than legislation for investor protection. Now, increasing attention is being focused on the important area of minority protection, writes Ben Wilson.

A general rule in business is that, to be a minority shareholder to a dominant majority shareholder can be a miserable life. Just how miserable, however, depends on the laws and regulations of the country as well as the articles of the company and the attitude of its management and other shareholders.

Following early successes in introducing effective company law and regulated stock markets in the three Baltic countries, minority protection in law remained minimal. Now, new regulations and laws are coming through to afford greater minority protection, but the framework is still patchy and somewhat untested.

Minority protection refers to the way in which the laws and regulations in a country protect the rights of smaller shareholders, who have bought a shareholding that does not offer them outright control of a company (usually, a stake of less than 50 percent). The extent of minority protection says a lot about a country's attitude towards the fair treatment of those who invest in its businesses. It is essential for the smooth growth of capital markets, where many financial investors - from private individuals to large institutional funds such as pension funds - do not have any intention of investing a stake large enough to give them outright control in a given company.

The recent activity among regulators and legislators in the Baltics has concentrated on the introduction of takeover codes and amendments to corporate law. More work is required however on the amendment of corporate law to afford fair rights to minority shareholders.

Take care in a takeover

Effective takeover rules are coming just in time - even in some cases too late - to regulate the terms upon which international investors are increasingly buying in to majority shareholdings of the leading Baltics companies. Without them, small investors may have little chance to sell out before a majority investor steers the company to its own principal interests.

Lithuania was the first of the three Baltic countries to introduce a takeover code, in February 1998. The Lithuanian Securities Commission rules require an investor, acting either independently or in concert with others, who acquires more than 50 percent of voting securities of a publicly traded company, to submit a mandatory tender offer to buy the remaining voting securities. There are pricing rules for the offer, based on the weighted average prices of securities acquired by the investor in the year prior to exceeding the 50 percent limit. And there are exceptions to the requirement, such as in privatization.

Estonia made the necessary amendments to its law in January 2000, laying down similar rules for the takeover of companies.

Latvia's Securities Market Commission approved rules for mandatory tender offers in October 1999. The rules were controversial in that they apparently applied retrospectively, from the date upon which the original Law on Securities came into effect. Some strategic investors who had bought a majority interest in publicly quoted Latvian companies in the relevant period prior to the new regulations were caught by surprise. They must now make a mandatory tender offer before July 1, 2001.

Always read the small print

Protection of minority shareholders in corporate law of the Baltic countries has been limited. A "super-majority" is required in shareholders' meetings to pass certain types of corporate decision, and there are other provisions that provide minority rights. However in day-to-day decision making, the old rule applies - the majority investor is king, and life for minorities can still be miserable, unless the articles of association or a shareholders' agreement give greater protection.

However, a new law in Latvia - the Law on Business Concerns (Koncerna likums) promises to change the usual presumptions about a minority's lot in life. The law is radical and far-reaching in its provisions and applies to both private limited (SIA) and joint-stock (A/S) companies. The new law has stringent provisions for compensation by a controlling company of a controlled company, for losses that the controlled company may suffer as a result of directions passed down by the controlling company. A dependency statement must be prepared by the controlled company alongside its annual report, that states the extent of business transacted with the controlling company and discloses unprofitable deals and risks, and this dependency statement must be audited. If there is a shareholders' agreement, then this may be seen as a controlling agreement under the law, whereupon stringent (and vague) requirements for equalization or compensation to the minority shareholders may be required.

A number of commentators have suggested that the Law on Business Concerns presents significant practical difficulties in application. Certainly it is untested in Latvia, and western countries offer few precedents on application that may be followed. The law is now in force, and majority investors in Latvian companies where there are minorities should stand and take note. The law means that great care needs to be exercised in the way that a majority investor exercises its presumed control, while shareholders' agreements will need to be examined for their implications under the law.

Investors should seek professional advice prior to investing in Baltics companies.

Ben Wilson is a Senior Manager of PricewaterhouseCoopers, based in Riga, Latvia. He is responsible for Transaction Services in the Baltics providing a broad range of services to investors. He is contactable on +371 709 4400.