Validity and enforcement of minority protection rights in shareholders’ agreements

As a general rule under Swedish company law, all provisions of the Swedish Companies Act (the “Companies Act”) that protect shareholders (as opposed those protecting third parties/creditors) may be departed from provided that all shareholders give their consent. It is very common for shareholders’ agreements to include provisions that depart from the Companies Act on matters such as voting rights, share transfer restrictions and various minority protection rights. 

It has been established that only the parties, and not the company, are bound by the provisions of a shareholders’ agreement. The relationship between the parties is governed by civil law and the shareholders’ agreement, whereas the parties’ relationship with the company is governed by the Companies Act and the company’s articles of association. The effect of this is primarily that the company’s bodies (board of directors and managing director), as a rule, are not bound by provisions in shareholders’ agreements. For example, a transfer of shares that violates the provisions of a shareholders’ agreement does not prevent the board of directors from registering the new shareholder as owner of the shares in the company’s share register, although only to the extent that the transfer complies with Swedish company law and the company’s articles of association. The legal effects of such a breach are instead to be found in the shareholders’ agreement (i.e. specific sanctions agreed between the shareholders) or in general principles of civil law (normally damages or invalidity).

Minority protection rights in the Companies Act (and in shareholders’ agreements)

As stated above, the parties, and not the company, are bound by the provisions of a shareholders’ agreement. In principle, this means that a shareholder may still force the company to carry out an action in violation of the provisions of a shareholders’ agreement. It is very common in Swedish management (and other minority) shareholders’ agreements for the managers to waive all their minority protection rights pursuant to the Companies Act and thus agree not to invoke any minority protection rights pursuant to the Companies Act. For example, a minority shareholder (or a group of minority shareholders) holding more than 10 % of all shares in a company may request the annual general meeting to approve the distribution of 50 % of the remaining profit for the year pursuant to the adopted balance sheet. Another example is that a shareholder that owns more than 50 % of the voting rights in a company may dismiss and appoint board members despite the fact that the shareholders’ agreement may state that such action requires approval by other shareholders. Based on this, therefore, a majority shareholder cannot be entirely certain that a minority shareholder will not invoke its legal minority protection rights according to the Companies Act against a majority shareholder, even though the parties have agreed on this in a shareholders’ agreement. This also means that a minority shareholder cannot be certain that a majority shareholder will not invoke its legal rights according to the Companies Act against a minority shareholder. 

The Supreme Court case

The Swedish Supreme Court recently ruled on a case of fundamental interest in the area of company law in general and the relationship between the shareholders’ agreement and the Companies Act in particular. The case concerned the effect of a shareholders’ agreement in proceedings for the compulsory buyout of minority shares and comprised several important questions of principle.

Under Chapter 22 of the Companies Act, a shareholder who holds more than nine-tenths of the shares in a company (the majority shareholder) is entitled to buy out the remaining shares of the company’s other shareholders. Any shareholder whose shares may be bought out is entitled to compel the majority shareholder to purchase its shares. This is referred to as compulsory buyout. 

Two companies each owned 50 % of the shares in a Swedish company. According to a shareholders’ agreement each party had the right, under certain circumstances, to acquire all except one of the other party’s shares in the company. An arbitration award established that the conditions in question had been met and that one of the parties had the right to acquire all except one of the other party’s shares in the company at a certain price level.

Following the award, the new majority owner requested to buy out the remaining share in the company, referring to Chapter 22 of the Companies Act. The minority shareholder disputed the request and argued that the parties had waived their rights to request a compulsory buyout with reference to the Companies Act according to the provisions of said shareholders’ agreement. The main question discussed was whether the buyout provisions under Chapter 22 of the Companies Act may be departed from by a provision in a shareholders’ agreement.

The Supreme Court concluded that the provisions of the shareholders’ agreement did not prevent a party from invoking its right of compulsory buyout under the Companies Act. One of the main reasons for this conclusion is that, according to the preparatory works of the Companies Act, a company’s articles of association cannot provide for the right or obligation for a compulsory buyout to be limited or for the provisions of compulsory buyout to be subject to conditions other than those laid down in the Companies Act.  The provisions of compulsory buyout are thus not considered to be optional, i.e. the parties cannot deviate from the provisions by agreement.

The Supreme Court did not discuss the issue of whether the losing party could seek recourse by way of damages or other specific agreed recourse for the winning party’s breach of the provisions of the shareholders’ agreement. 

Comments

One conclusion that can be drawn from the case is that the principle that a shareholders’ agreement is valid between the parties is to some extent restricted and that the principle’s scope is now more uncertain than it was before the case. One can therefore not be sure which provisions of a shareholders’ agreement, that restrict a party’s minority rights (or other rights as provided by law), that are considered valid or invalid and therefore enforceable or unenforceable in court. The judgment does not discuss or affect the question of whether sanctions in a shareholders’ agreement linked to a breach of restrictions of compulsory buyout will be maintained (wholly or partially). However, the judgment could ultimately lead to a more restrictive interpretation and application of provisions of shareholder agreements that deviate from provisions of the Companies Act. In order to assess whether or not a provision is valid, one should be able to gain some guidance by studying the purpose of the rules in question in the preparatory work of the Companies Act.

The case creates problems in general when drafting and negotiating shareholders’ agreements, and in particular when drafting and negotiating shareholders’ agreements when a majority owner is to allow management of the company or other minority investor to own or acquire less than 10 % of the shares in a company. Depending on which side you represent, this case will lead to the majority owner always having an “option” to acquire the minority’s shares and the minority always having an “option” to sell its shares to the majority shareholder, with no possibility for the parties to agree otherwise. This uncertainty also applies to other minority protection rights as described above.

To handle the problems described above, the parties could include provisions in the shareholders’ agreements that are designed to prevent the other party from invoking its minority protection rights, or vice versa. Many shareholders’ agreements contain provisions entitling a party to purchase the breaching party’s shares at a discounted price in the event of a breach of contract. In many cases the shareholders’ agreement does not provide for different types of sanctions tailored to different types of breaches of the agreement, such as liquidated damages.