Sweden: The Return of the Participating Debenture

Last Updated: 20 September 1999
Article by Magnus Brorsson

by Magnus Brorsson

Ivar Kreuger and the Kreuger Group became during the 1920s the symbol for the Swedish dream of success and an international role. Kreuger played a global role in the finance world and did in fact finance several countries against monopoly rights for his match industries. What nobody knew was the dark secrets of the group; the fact that the group was blown up with the help of internal transactions and that the participating debentures were in practice nothing else than junk bonds. The proceeds from the business was not enough to pay dividends but required that new debentures were issued to acquire capital. The crisis became acute in February 1932 when the International Telephone and Telegraph Corporation demanded that the acquisition of the Swedish telephone company LM Ericsson (now Ericsson) should be canceled because of misleading representations. Ivar Kreuger was found dead, presumably by suicide, only a few weeks later. After that there was no rescue; most of the companies in the group were liquidated. Lenders to the parent company, Kreuger & Toll, received a 43 % distribution but shareholders and holders of debentures did not receive any distribution at all.

The Kreuger crash left deep wounds in the Swedish financial body. Also Swedish corporate law was heavily influenced by the horrors that was revealed after the crash as Swedish corporate law was aimed at the protection of investors. "Never again Kreuger" is the motto under which Swedish corporate law has lived for over 60 years.

One of the financial instruments used by Kreuger was the participating debentures. The Swedish analysis was that the participating debenture did not deserve to exist; it was an evil thing used by Kreuger to deceive people. Thus, it was forbidden. Now, more than 65 years after the death of Ivar Kreuger the participating debenture is making its return into Swedish corporate law.

The Swedish Corporate Act contains a restriction against raising certain types of cash loans. Unless otherwise stipulated in the provisions on convertible loans, a company may not raise a cash loan on terms that require that it be repaid with other than a nominal cash amount or a cash amount determined with reference to monetary fluctuations. On the other hand, corporations are permitted to raise loans against bonds or other debt instruments that carry the right to interest, the amount of which is dependent wholly or in part on the dividend paid to shareholders or the profit of the corporation. In a new governmental report (SOU 1997:22) it is proposed that the prohibition of loans that are to be paid back with an amount based on e.g. the assets in a winding up situation etc. (participating debentures) is abolished.

The return of the participating debenture also opens the backdoor for shares without voting rights, something which has been like a red rag to a bull to Swedish corporate law makers.

Repurchase and Sale of a Corporation’s Own Shares

The participating debenture was not the only victim of the Kreuger crash. On many capital markets an important role is often played by the corporations themselves. A Swedish company may, however, not repurchase or in any other way acquire its own shares. The Swedish rules in this respect are more restrictive than those of most other countries. The committee behind the above mentioned report states that a major reason for allowing the repurchase of own shares is that it can improve the opportunities to refund surplus capital to their shareholders and thereby contribute to a more efficient use of capital.

With respect to public companies, a relaxation of the restriction against share repurchases must be implemented within the framework of the second Company Law Directive of the European Union. Therefore, it is suggested that a public company may only repurchase it’s own shares within the framework of the company’s non-restricted equity and that the company’s total holding of its own shares may not exceed ten percent of all the shares in the company. It is also suggested that the decision to repurchase shares shall be made by the general meeting or, with the authorization of the meeting, by the board of directors. However, the committee does not think that the limitations according to the directive are sufficient. It is therefore suggested that the repurchase and the sale of repurchased shares shall follow largely the same routines as decisions to reduce or increase the share capital. This means inter alias that a two-third majority of the votes of the general meeting will be required for such a resolution to pass and that the meeting shall have access to the same information for its decision as it does in the case of reductions in the share capital. It also means that the shareholders shall have a preferential right to acquire repurchased shares when they are sold. If the shares are to be sold on the market, the same decision-making rules must be followed as for a direct placement.

The committee is of the opinion that the proposed rules are balanced between the financial considerations and the protection of shareholders and others that the committee thinks corporate law shall provide. It is to be seen whether such a restricted possibility is enough for the capital market and, indeed, whether the political decision makers are ready to go even this far, even though the committee has also proposed special rules intended to prevent a corporation from influencing its own stock price on the market.

When it comes to private companies it is proposed that a decision to buy its own shares may only be made by the general meeting. The committee thinks a major reason for a private company to repurchase its own shares is to facilitate changes in ownership. Since this might require the repurchase of a significant portion of the shares no limit for how many shares can be repurchased is suggested for private corporations.

Redemption of Minority Shares

The committee is also proposing a completely new chapter on the redemption of minority shares. The chapter completely changes how the procedure is regulated. It is, inter alias, proposed that parties who are displeased with an arbitration judgment may bring action before the Svea Court of Appeal. This would shorten the judicial process compared with today. Cases involving compulsory redemptions would thereby be concentrated within a single court, which would have more experience with these types of cases.

If a parent company alone or together with one or more subsidiaries owns more than nine-tenths of the shares representing more than nine-tenths of the votes of all the shares in a subsidiary, the parent company currently has the right to redeem the remaining shares from the other shareholders of the subsidiary. Those who own shares that may be redeemed have the right to have those shares redeemed by the parent company. It is important to note that "parent company" in this context (as in most cases in Swedish corporate law) means a Swedish corporation. However, it is now proposed that every shareholder — together with their subsidiaries if applicable — who owns more than nine-tenths of the shares in a corporation shall have the right and the obligation to redemption. This will make the redemption rules applicable also in an international context, since the new rules do not require that the majority owner is a Swedish corporation or that there be a group relationship at all.

No Rules About Mandatory Bids in the Swedish Stock Market

The committee has evaluated whether mandatory bid rules should be implemented in the Swedish stock market. By mandatory bid is in this context meant the obligation on the part of those who have acquired a certain percentage of the shares in a company to offer to buy the remaining shares as well.

The main argument to supports such mandatory bid rules is usually that a corporation’s minority shareholders should have a possibility to get out of a corporation in connection with a change in controlling ownership. Such a change carries with it the risk that the value of the corporation’s share will fall, because of which those owners who are displeased should be able to get out of the corporation on the same conditions as those who have sold their shares to the majority owner.

According to the committee this reasoning has been criticized for being based on the unfounded assumption that a change in controlling ownership is typically damaging to the corporation’s other shareholders. Because of this and other criticisms against mandatory bids, the committee has decided not to propose any such rules.

Other Proposals

Around 20,000 corporations are formed each year in Sweden. Almost all of these are formed according to the so called simultaneous procedure ( a simpler procedure originally intended as an axception from the normal procedure). The committee proposes that the successive, normal procedure is abolished because it has served its purpose

Swedish law currently permits only one exception to the principle of a share’s free transferability. In its articles of association, a corporation may provide that shareholders or others shall be entitled to redeem shares that have passed to a new owner, the so-called right of preemption. This possibility is proposed to be retained for both private and public companies. However, certain changes are proposed. Further, an opportunity to utilize a right of first refusal (internationally the most common way of dealing with these issues) is proposed.

It is also proposed that private corporations shall be entitled to implement consent clauses, which would create an opportunity for closed corporations to limit the transferability of their shares with a binding effect on the corporation.

Timetable

The committee behind the report has been working on changes of the Swedish Corporation Act since 1990. Several of its proposals has already been adopted and there is no reason to believe other than that at least most of the new proposals will be adopted. The committee has suggested that the proposals made in the report shall be effective as of 1 January 1999.

It is the express end-goal of the committee to achieve an entire new Corporation Act. The amendments made this far has mainly concerned details, but details of great principle nature, such as the introduction a few years ago of the private and the public company (only the public company may raise capital from the general public, compare the British PLC and LTD). The work so far by the committee has also been aimed at adapting the Swedish law to the directives of the European Union. Even if those amendments carried some principle changes hard to swallow for some theorists, it remains to be seen if the justice department is willing to accept major principle changes such as the participating debenture and the repurchase of own shares when it is not forced by the EU to do it.

This article is based on the official report SOU 1997:22 "The Corporation’s Capital" (Sw: Aktiebolagets kapital) by the Corporate Law Committee appointed by the Government.

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