New Commercial Code 'Freezes Out' Modern Safeguards for Minority Shareholders

June 26 , 2021
By Yehualashet Tamiru Tegegn ( Yehualashet Tamiru Tegegn (yehuala5779@gmail.com), lawyer, consultant and researcher, ) , Dagmawit Kifle ( an independent lawyer. )

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The amended Commercial Code characteristically contains some of the traditional protections to minority owners in share companies. Unfortunately, it is silent on modern safeguards, such as those protecting against 'freeze-outs,' write Yehualashet Tamiru Tegegn (yehuala5779@gmail.com), adjunct lecturer at Addis Abeba University and an associate at MTA, and Dagmawit Kifle, an independent lawyer.

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Majority rule is the cardinal principle of business law, whereby most shareholders take the decision-making power in a company. Why should business organisations operate with the principle of majority shareholders rule?

There are two theories. One is a hangover from political democracy, where any shareholder should only have one vote a share and everyone needs to have a say in the management of a company. In economics, majority rule is justified for the company's effective operation, where rules and regulations are put together to ensure that the view of the majority of owners of a firm is respected.

Minority shareholders are those that own less than half of the total share outstanding and thus cannot control the corporation’s management or singlehandedly elect directors. The critical element here is effective control, the meaning of which is country-specific. But there are some yardsticks we can use to identify it: if a shareholder owns more than a certain level of voting shares issued; at least half of the directors are appointed by the shareholder and if a shareholder, either through related parties or directly, has a dominating control over corporate strategy outcomes.

There are instances in which the interest of minority and majority shareholders can conflict. In such cases, the latter may attempt to manipulate the company structure for their benefit at the expense of the former. As a result, minority shareholders are vulnerable to exploitation in the absence of adequate legal protection. This exploitation may take various forms: asset misuse, transfer pricing, profit allocation and acquisition of other business organisation that majority shareholders own. The law needs to protect minority shareholders.

One of the primary protections for such shareholders is the right to call up a general meeting, which plays an important role in the company's direction. It is also one of the most substantive legal protections afforded to minority shareholders under Ethiopian law. Once requested, the auditor is obliged to call a general meeting with shareholders representing at least a fifth of the capital of the company.

Going together with this protection is the right to appoint an independent auditor. Under Ethiopia’s revised Commercial Code, every share company must have at least one independent and impartial external and assistant auditor. A shareholder representing no less than a fifth of the capital of the company can appoint such a person.

Another protection is the right to challenge a resolution. Like many other legal systems, resolutions adopted at general meetings by the vote of the majority shall be binding. Any shareholder whose interest is affected by the resolution can apply to the court to invalidate such resolutions within three months.

Minority shareholders also have the right to access information from the management, which is necessary to take a position on agendas tabled during general meetings. However, access to information by the board may be prohibited where it is deemed that disclosure would cause significant damage to the company. A shareholder denied this right might sue, at which point the court will decide whether there is sufficient justification to hold back the information.

A minority shareholder also has the right to seek the dissolution of the company. A company may be dissolved by order of the court based on the application of just a single shareholder. A good cause should be determined on a case-by-case basis, but it could constitute a scenario where the company has failed at its main establishment objective.

Despite these and other protections accorded to the minority shareholders, the Commercial Code has failed to incorporate some of the modern safeguards for minority shareholders.

One is lack of protection against ‘freeze-out,’ using the corporate control vested in a majority of shareholders or board of directors to eliminate minority shareholders from the enterprise. It could also be an action that reduces the relative significance of their voting power, claims on corporate assets, or deprives them of corporate income or advantages. A freeze-out may take place through a merger or consolidation and may be utilised by the majority to transform the original company into a new one in which the rights of minorities are diminished.

This extends to the election of board directors, which are elected by a general meeting. Even if minority shareholders manage to get one representative or two in there, the majority can still freeze them out at any given time as directors are subject to general meeting decisions. They may be removed even without good cause and in the presence of a contrary stipulation under the memorandum of association. This will have a determinate effect on the minority shareholders since majority shareholders will use it to circumvent their representation on the board.

On top of these gaps, the absence of email voting system, proportional voting system, lack of veto right on some selected issues and lack of constructive derivative actions are some of the missing legal protections for minority shareholders under the revised Commercial Code.

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PUBLISHED ON Jun 26,2021 [ VOL 22 , NO 1104]

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