!Корпоративное право 2023-2024 / 2013-study-analysis_en

No, the starting point would be that the claim belongs to the company. However, if the company decides not to pursue the claim, shareholders holding 10 per cent of the capital may raise a derivative claim on behalf of the company.

Hypothetical IV: Duty of loyalty

A mining company (‘Bidder’) considers expanding business operations. The board identifies assets held by another company (‘Target’) as a possible acquisition. The following scenarios ask you to consider the liability of a director (‘A’) on the board of Bidder.

Director A is also majority shareholder in Target, holding 60 percent of the outstanding share capital of the company. As majority shareholder of Target, he is interested in an acquisition that is beneficial to Target. He proposes that Bidder purchase the assets for 10 million

Euro/Pounds/…, knowing that the value ranges between 7 and 8 million. Director A does not disclose his interest in Target to the board of Bidder. A majority of the directors approves the acquisition. A’s vote was not decisive for the positive vote.

Issue: Does the law require directors to disclose direct or indirect interests in transactions with the company? Is this duty laid down in the companies act or does it derive from the fiduciary position of the director? If the director violates the disclosure obligation, is the transaction void or voidable or does the director have to pay damages?

Yes, a director must disclose a conflict of interest and excuse himself (for the time it takes the board to decide). However, it may be permissible first to explain his view of the matter before leaving the board. A failure can make the decision void, even if the director’s vote was not decisive, however, it would depend on whether the failure to make the proper disclosure may have affected the decision made by the other directors.

As in scenario 1, but Director A discloses his interest in Target to the board of Bidder, and a majority of the uninterested directors approves the acquisition.

Issue: Does the interested director have to abstain from voting when the board decides on the conflicted interest transaction? If he/she fully informs the board and abstains from voting and the board approves the transaction, is it valid?

Yes and yes, see above.

As in scenario 1, but when the shareholders of Bidder learn of A’s interest in Target, they ratify the transaction, believing that it is in the company’s interests.

Ratification is probably possible.

Director A is majority shareholder and managing director in a competitor of bidder (‘Rival’), which is also active in the mining business. The assets held by Target that Bidder seeks to acquire consist in claims near Rival’s own mining territories. Director A is of the opinion that

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the assets are more valuable for Rival than for Bidder. He therefore arranges for Rival to make a competing and higher offer than Bidder, and Target accordingly decides to sell the assets to the former company.

There is no specific ‘corporate opportunities doctrine’, but the same result is achieved by using the ordinary standards of duty of care and loyalty, and the rules on conflict of interest, which prohibits the director from influencing the decision.

As in scenario 4, but A resigns from his position as director of Bidder before Rival makes the competing offer.

A resignation would probably not remedy the breach of the duty of care and loyalty, unless the resignation was made before the transaction was contemplated.

As in scenario 4, but after an initial expression of interest by Bidder in acquiring the assets and before Rival has taken any steps to make a competing offer, the Bidder board determines that an investment of that size is not advisable at the present time in light of Bidder’s weak financial position.

It is not clear, but probably no liability of the director if the board and thereby the company do not believe to have any interest that could conflict with the private interest of the director.

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Finland

Hypothetical I: Liability of the parent and directors of the parent for breaches of duty at the level of the subsidiary

A pharmaceutical company is currently developing two new drugs. After assessing the potential liability risks associated with the future products, the directors of the pharmaceutical company decide to incorporate two separate private limited companies, each taking over the development, research and future marketing of one of the two drugs.

The directors of the pharmaceutical company appoint the two project managers as directors of the two subsidiary companies. The two subsidiary companies enter into an agreement allowing them access to the parent company's research facilities. According to the subsidiary's articles of association, all major strategic decisions regarding the research, development and marketing of the drugs are subject to approval by their sole shareholder, the pharmaceutical company. The employees working for the subsidiaries are formally still employed with the parent company, but are posted with the subsidiaries under an agreement entered into by the parent company and the two subsidiaries upon formation of the two companies.

When the directors of the parent company learn about competitors working on similar projects, they try to accelerate the development process of the two drugs. They award substantial bonuses to the subsidiary’s directors, contingent on the drugs receiving regulatory approval within the next 6 months.

The original schedule provided for further tests, which would take at least 12 months.

Primarily because of the contingent bonus payment, the directors of the subsidiaries skip some of the planned tests and studies, and cover up this decision in their filings for regulatory approval.

The two drugs gain regulatory approval within the 6 month time span, and are successfully marketed shortly after that.

Two years after the initial marketing, independent studies reveal that one of the drugs causes a rare form of lethal cancer, exposing the relevant subsidiary to enormous product liability claims that far exceed its net assets. The drug developed by the other subsidiary proves to be safe and leads to substantial profits.

Is it possible that the parent company would be liable in circumstances comparable to the stylised facts above?

The answer does not include any considerations on product liability law.

The Companies Act does not include provisions on lifting the corporate veil (disregarding the legal entity). The issue has been discussed in the Finnish legal literature for decades. Some Supreme Court cases may be interpreted to contain wording that does not deny the possibility of lifting the corporate veil. However, there are no published court cases applying Companies Act whre the corporate veil would have been lifted. Clearly such a decision would require exceptional circumstances. Considering

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the circumstances of the case, especially that the directors of the subsidiaries skip test and studies and cover up this decision, it is most unlikely that Finnish courts would decide the parent company to be liable.

Under which circumstances would the directors of the parent company face a liability risk in those circumstances?

The answer does not include any considerations on product liability law.

If the directors of the parent company knew or should have known that necessary test and studies were skipped, this might cause liability if the parent company suffers a loss because of the directors’ passivity or neglect. The parent company might have a claim against its directors based on the losses suffered by the parent company due to one subsidiary’s exposure to product liability claims.

According to Chapter 1, Section 8 of Companies Act, The management of the company shall act with due care and promote the interests of the company. (It should be noted that the law includes the board of directors under the definition of management).

According to Chapter 22, Section 1, Sub-section 1, A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.

Hypothetical II: Duties in the vicinity of insolvency

After making losses for three consecutive years, an oil trading company’s equity ratio (equity divided by total assets) has fallen below [1% - 5% - 10%]. On average, comparable companies in the same line of business have an equity ratio of about 25%.

The company still has substantial assets, but the thin equity cushion makes it hard for the company to pursue its core business, as trading partners demand higher prices to compensate them for the perceived higher risk of the company's operations.

The company's directors evaluate different possibilities to improve the business prospects of the company. They attribute past trading losses to the substantially higher volatility of oil prices following the financial crisis, and maintain the view that the company's business model is sustainable in the long run. After exploring the possibility to raise new equity to recapitalize the business, they conclude that current market conditions would force them to issue new shares at prohibitively low prices, which would lead to a substantial dilution of their current shareholders.

After analysing the market conditions, the directors come to the conclusion that the market price for crude oil is bound to rise significantly over the next year, particularly due to high anticipated demand from emerging market economies. In an attempt to recapitalize the company the directors decide to invest heavily in crude oil futures. They expect that the anticipated increase in oil prices will lead to substantial gains from this transaction, bringing the equity ratio back in line with the industry average, and thus allowing the company to resume their trading operations at more sustainable conditions.

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The directors are aware that a sudden substantial fall in oil prices could potentially wipe out the remaining equity of the firm, but they consider the likelihood of this happening to be very low.

Shortly after entering into the forward sale agreement, worries about a sovereign debt crisis lead to a revision of worldwide economic growth forecasts. The price of crude oil falls more than 10% on a single day, the worst one day performance in many years. As the company cannot fulfil the margin calls on its forward sales contracts, the positions are closed by the counterparty. The closed positions have a negative value exceeding the company’s equity, leading to the company’s over-indebtedness. Trading partners refuse to enter into transactions with the company due to its financial position, and banks close all existing credit lines of the company.

Do fiduciary duties prevent directors from entering into particularly risky transactions?

Risk-taking is a normal part of business. It is the directors’ duty to assess the situation with duty of care. Business Judgement Rule is recognized under Finnish Companies Act (the preparatory text of the Government Bill acknowledges the Business Judgement Rule). The risk and required care are correlated between each other: the duty of care is emphasized when the risk increases (Government Bill HE 109/2005 page 40). This means that particularly risky transactions require particular care.

At which point in time does the law provide for additional duties of directors or the change of existing duties in situations of financial distress? (i.e. how is ‘vicinity of insolvency’ defined?)

Chapter 20, Section 23, Sub-section 1 of Companies Act stipulates the following.

If the Board of Directors of the company notices that the equity of the company is negative, it shall without delay notify the loss of the share capital for registration.

Sub-section 3 stipulates the following.

If the Board of Directors of a public company notices that the equity of the company is less than one half of the share capital, the Board of Directors shall without delay draw up financial statements and annual report in order to ascertain the financial position of the company. If according to the balance sheet the equity of the company is less than one half of the share capital, the Board of Directors shall without delay convene a General Meeting to consider measures to remedy the financial position of the company. The General Meeting shall be held within three months of the date of the financial statements.

What is the legal response to above situation? For example, the law may provide that the directors have to take primarily the creditors’ interests into account, rather than those of the shareholders or the company must cease to trade and the directors file for the opening of insolvency proceedings.

The law does not include a duty to the directors or CEO to apply for bankruptcy. However, continuing the business operations may cause liability to the directors or CEO under Criminal Code. It is not very rare that criminal proceedings are initiated after bankruptcy.

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Chapter 39 of the Criminal Code includes the provisions on offences by a debtor. E.g. according to Section 1, a debtor who increases his or her liabilities without basis and thus causes his or her insolvency or essentially worsens his or her state of insolvency, shall be sentenced for dishonesty by a debtor to a fine or to imprisonment for at most two years. Section 1a includes the provisions of aggravated dishonesty by a debtor when e.g. considerable or particularly substantial damage is caused to the creditors and the dishonesty by a debtor is aggravated also when assessed as a whole, the offender shall be sentenced for aggravated dishonesty by a debtor to imprisonment for at least four months and at most four years.

Favouring a creditor (Section 6) is also a crime.

Hypothetical III: Duty of care

A large banking institution is engaged in retail as well as investment banking. In 2000, a new CEO was appointed, who also sits on the board of directors. The CEO made the decision to invest heavily in collateralized debt obligations (CDOs) backed by residential mortgage backed securities, including lower rated securities that pooled subprime mortgages to borrowers with weak credit history. The investments were initially successful, generating high profits for the company. However, beginning in 2005, house prices, particularly in the United States, began to decrease. Defaults and foreclosures increased and the income from residential mortgages fell rapidly.

As early as May 2005, economist Paul Krugman had warned of signs that the US housing market was approaching the final stages of a speculative bubble. Early in 2007, a large US subprime lender filed for bankruptcy protection and a number of investors announced write downs of several billion dollars on their structured finance commitments. In July, 2007, Standard and Poor’s and Moody’s downgraded bonds backed by subprime mortgages. At the end of 2007, two hedge funds that had invested heavily in subprime mortgages declared bankruptcy. In spite of these warning signs, the CEO had continued to invest in CDOs until shortly before the Lehman bankruptcy in September 2008, accumulating a total exposure of more than 20 billion Euro/Pounds/… . The subprime mortgage crisis necessitated massive write downs, leading to an annual loss of eight billion in 2008, which can be attributed in equal measure to the CDO transactions undertaken in 2005-2008.

The CEO resigned in October 2008. As part of the resignation, the CEO entered into an agreement with the company providing that he would receive 50 million Euro/Pounds/… upon his departure, including bonus and stock options, and in addition an office, administrative assistant, car and driver until he would commence full time employment with another employer. In exchange, the CEO signed a non-compete agreement and a release of claims against the company. The agreement with the CEO was approved by all directors (the CEO abstaining from voting), acting on behalf of the company.

After the CEO’s departure and with a new management team in place, it transpires that the old CEO had used a number of ostensibly arms-length transactions with investment firms that were, however, controlled by the CEO’s nominees, to transfer assets at an undervalue to a company owned by the

CEO on the Cayman Islands. When the true nature of these transactions becomes known, the assets are no longer recoverable.

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Questions:

Is the CEO liable for annual loss suffered by the company in 2008?

The CEO is liable under Companies Act at least for the damage caused by the transaction taken to transfer assets at an undervalue to a company owned by the CEO him/herself. According to Chapter 6, Section 19 of Companies Act, section 4 on disqualification applies also to the Managing Director. According to Chapter 6, Section 4 of the Companies Act A Member [of the Board of Directors] shall likewise be disqualified from the consideration of a matter pertaining to a contract between the company and a third party, if the Member is to derive an essential benefit in the matter and that benefit may be contrary to the interests of the company. The provisions in this section on a contract apply correspondingly to other transactions and court proceedings.

For damages unrelated to the damages caused by the above-mentioned self-interest transactions, the answer is unclear. For losses caused by transactions taken in 2005, 2006 and early 2007 the CEO is not liable as the business was common market practice and had generated high profits for the company. Towards the end of 2007 and in 2008 signs of losses became clearer and it is possible that he or she is liable for neglecting the fiduciary duty. According to Companies Act, Chapter 1, Section 8,

The management of the company shall act with due care and promote the interests of the company.

According to Chapter 22, Section 1, Sub-section 1, A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.

According to Supreme Court case KKO 1997:110 risk-taking is a part of credit functions of commercial banking. According to the Supreme Court, duty of care requires, however, that credit decisions are prepared carefully and that they can be justified by commercial grounds. When assessing the duty of care, the decisive point of time is the state of affairs at the time when the decisions were made. Already when the first credit decision was taken 22 November 1990, the appellants had to be aware even based on the information given in the media of the weakening economic trends and the decreasing housing prices prevailing at that time. Nothing referred to an essential and rapid amelioration of the situation.

Have the directors (other than the CEO) breached their fiduciary duties by approving the agreement in conjunction with the resignation of the outgoing CEO?

The answer is written under the presumption that there was no previous agreement on the severance benefits.

The directors are liable. The described resignation agreement would be highly unusual in Finland for any company. In fact I don’t think such a package has ever been given to any CEO even in a highly successful company. Under the circumstances, when the resignation takes places in a situation of a loss of eight billion EUR, following the CEO’s investment decisions, the board has not acted with due care considering the exceptionally expensive resignation agreement.

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According to Chapter 1, Section 8, The management of the company shall act with due care and promote the interests of the company. (It should be noted that the law includes the board of directors under the definition of management).

According to Chapter 22, Section 1, Sub-section 1, A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.

Have the members of the company’s internal audit committee (of which the CEO was not a member) breached their fiduciary duties by not identifying the true nature of the ostensibly armslength transactions and are they, accordingly, liable for the loss suffered by the company as a consequence of the transactions? Have the other directors (except the CEO) breached their duties?

Under Companies Act, the answer is unclear. The members of the audit committee are liable, if the real nature of the transactions taken by the CEO was evident in the material or other information received by the audit committee. Even if the issue was not evident but there was anyway reason to doubt the true nature of those transactions. the committee members may be liable for neglecting the duty of care of Companies Act Chapter 1, Section 8. The same applies to the other directors. They are liable if they had reason to doubt the true nature of the transactions from the materials and other information that they had. The other directors may have had less possibility to notice the suspicious transactions and it is possible that only the audit committee members are liable. The law is not different for members and non-members but the circumstances in question determine who is liable.

Assuming that the company has a claim against the CEO or another director pursuant to one or more of the above questions, can a minority shareholder enforce the claim?

Yes, at least if the plaintiff hold at least 10 % of all the shares. An owner of just one share has the same right if non-enforcement of the claim would be contrary to the principle of equal treatment but this is not evident in the case description.

The Companies Act includes the following Chapter 22, Section 7:

Right of the shareholders to bring an action on the behalf of the company

(1) One or several shareholders shall have the right to bring an action in their own name for the collection of damages to the company under sections 1—3 or under section 44 of the Auditing Act, if it is probable at the time of filing of the action that the company will not make a claim for damages and:

(1)the plaintiffs hold at least one tenth (1/10) of all shares at that moment; or

(2)it is proven that the non-enforcement of the claim for damages would be contrary to the principle of equal treatment, as referred to in chapter 1, section 7.

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Hypothetical IV: Duty of loyalty

A mining company (‘Bidder’) considers expanding business operations. The board identifies assets held by another company (‘Target’) as a possible acquisition. The following scenarios ask you to consider the liability of a director (‘A’) on the board of Bidder.

Director A is also majority shareholder in Target, holding 60 percent of the outstanding share capital of the company. As majority shareholder of Target, he is interested in an acquisition that is beneficial to Target. He proposes that Bidder purchase the assets for 10 million Euro/Pounds/…, knowing that the value ranges between 7 and 8 million. Director A does not disclose his interest in

Target to the board of Bidder. A majority of the directors approves the acquisition. A’s vote was not decisive for the positive vote.

Director A is liable under Companies Act.

According to legal literature, competing action is forbidden due to duty of loyalty. Although the Companies Act contains no explicit provision on the duty of loyalty, legal literature agrees that it is part of duty or care (Chapter 1, Section 8). This is also stated in the Government Bill for the Act (HE 109/2005 page 79).

Furthermore, according to Chapter 6, Section 4 of the Limited Liability Companies Act, A Member [of the Board of Directors] shall likewise be disqualified from the consideration of a matter pertaining to a contract between the company and a third party, if the Member is to derive an essential benefit in the matter and that benefit may be contrary to the interests of the company. The provisions in this section on a contract apply correspondingly to other transactions and court proceedings.

According to Chapter 1, Section 8, The management of the company shall act with due care and promote the interests of the company. (It should be noted that the law includes the board of directors under the definition of management).

According to Chapter 22, Section 1, Sub-section 1, A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.

According to Chapter 22, Section 1, Sub-section 2, A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall likewise be liable in damages for the loss that he or she, in violation of other provisions of this Act or the Articles of Association, has in office deliberately or negligently caused to the company, a shareholder or a third party.

According to the Supreme Court case KKO 1997:110, even a deputy director may be liable for damages even when the deputy director did not participate in the decision-making, if he or she neglected the fiduciary duty e.g. by not disclosing to the board the essential factors related to the decision that he or she was aware of.

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As in scenario 1, but Director A discloses his interest in Target to the board of Bidder, and a majority of the uninterested directors approves the acquisition.

Director A is liable under Companies Act (Chapter 1, Section 8 as described in point 1). Also the above-mentioned Supreme Court case KKO 1997:110 shows that non-disclosure of essential factors may cause liability even when the director does not participate in the decision-making.

As in scenario 1, but when the shareholders of Bidder learn of A’s interest in Target, they ratify the transaction, believing that it is in the company’s interests.

Director A is liable under Companies Act (Chapter 1, Section 8 as described in point 1). Also the above-mentioned Supreme Court case KKO 1997:110 shows that non-disclosure of essential factors may cause liability even when the director does not participate in the decision-making. The ratification of the shareholders does not remove Director A’s duty to disclose his or her knowledge of the discrepancy between the purchase price and the value of the assets.

Director A is majority shareholder and managing director in a competitor of bidder (‘Rival’), which is also active in the mining business. The assets held by Target that Bidder seeks to acquire consist in claims near Rival’s own mining territories. Director A is of the opinion that the assets are more valuable for Rival than for Bidder. He therefore arranges for Rival to make a competing and higher offer than Bidder, and Target accordingly decides to sell the assets to the former company.

Director A is liable under Companies Act.

According to legal literature, competing action is forbidden due to duty of loyalty. Although the Companies Act contains no explicit provision on the duty of loyalty, legal literature agrees that it is part of duty or care (Chapter 1, Section 8). This is also stated in the Government Bill for the Act (HE 109/2005 page 79).

According to Chapter 6, Section 4 of the Companies Act A Member [of the Board of Directors] shall likewise be disqualified from the consideration of a matter pertaining to a contract between the company and a third party, if the Member is to derive an essential benefit in the matter and that benefit may be contrary to the interests of the company. The provisions in this section on a contract apply correspondingly to other transactions and court proceedings.

According to Chapter 1, Section 8 The management of the company shall act with due care and promote the interests of the company. (It should be noted that the law includes the board of directors under the definition of management).

According to Chapter 22, Section 1, Sub-section 1, A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.

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