Introduction
People who control a company, be they directors, managers or controlling shareholders, may use their power to divert the company's wealth to unfairly enrich themselves or others. They can do this in a variety of ways. Transfer pricing, excessive compensation for management, personal loans and appropriation of corporate opportunities are good examples. Such abuses have serious adverse implications for minority investor interest.
Legal measures against such abuse come in two major forms. The first is the public enforcement method relying on prison terms and fines, which are covered under the relevant criminal/tax law provisions. The second approach, which the Ethiopian Commercial Code Proclamation No. 1243/2021 ("New Commercial Code") has adopted, facilitates private enforcement of good behavior. Laying clear standards of conduct expected from the management is an indispensable first step in this regard. Extensive disclosure of information that helps to prevent breaches of the rules is another. Enabling minority shareholders to effectively participate in decision making and take legal action in the event of breach of the rules is yet another strand of the private enforcement approach. This brief update provides a bird's-eye-view of the most significant changes introduced by the new Commercial Code to protect minority investor rights through private enforcement mechanism.
The Mission of Management and Standards of Conduct
The New Commercial Code articulates the grand mission of management, and the standards of conduct expected from it in a much clearer and detailed manner compared to the 1960 Commercial Code of Ethiopia. The newly introduced provisions under Art.315(1-5), 316-320 and 322 are good examples in this regard. Particularly, the New Commercial Code imposes on management an overarching duty of loyalty (Art. 316). It requires directors to 'act in the way they consider, in good faith, would be most likely to promote the success of the company.' More pertinently, they are under obligation to act for the benefit of shareholders of the company as a whole. The Code obliges directors to discharge their responsibilities not only with care, skill, and diligence but also to exercise independent judgment.
Besides, the New Commercial Code requires every director to 'avoid a situation in which he has a direct or indirect interest that conflicts or possibly may conflict with the interest of the company.' It then attempts to regulate conflict of interest situations that are likely to arise. For instance, it prohibits directors from competing with the company by engaging in private trade on their own behalf or for the benefit of third parties (Art. 319). This prohibition remains in force even after a person has ceased to be a director, as far as the exploitation of information and business opportunities of which he became aware of because of his position as a director are concerned.
Enhanced Transparency to Identify Fraudulent Transactions
The New Commercial Code has introduced provisions designed to identify beforehand transactions that may pose a risk of conflict of interest. It requires, for this purpose, every share company to maintain a register which shows, among other things, information about people that are affiliated with the company. This includes not only the directors, members of the supervisory board, managers, auditors, and company secretaries but also people who are related to them by blood or marriage. Besides, the register must indicate business organizations or concerns in which any of the foregoing people are shareholders, directors, managers, employees, beneficiaries or hold any other responsibility or interest (Art. 311(1) cum 306(6)). This register is open for inspection by shareholders and public officials free of charge. (Art. 311/3/). Such enhanced transparency helps flag transactions under consideration that potentially involve conflict of interest and trigger special approval procedure discussed below to protect the company, and ultimately minority investors.
The law goes further regarding a company formed by public subscription. Such a company is required to disclose to the Ministry of Trade and Regional Integration all persons or entities who, individually or together with others that have shared interest, directly or indirectly hold 5% or more of the capital of the company. It also regards family members and members of the same group of companies as having shared interest with the shareholder for this purpose (Art 312 cum 258 to 260).
Prior Approval of Major Transactions by Disinterested Shareholders
The New Commercial Code requires prior approval by shareholders as regards transactions involving ten or more percent of the assets of a company. It also sets in place measures that enable them to take informed decisions. It requires, to this end, every director, manager, or shareholder with a potential conflict of interest in a proposed transaction, to give complete and accurate information to the external auditor of the company about conceivable grounds for conflict of interest. The auditor examines all the available information regarding the matter and submits to the shareholders a report with his own recommendation as regards the transaction under consideration.
Any shareholder who stands to benefit from the transaction may not vote at the meeting of shareholders considering the approval of the transaction. This affords minority investors the opportunity to block transactions aimed at directly or indirectly enriching the controlling shareholders, directors, concerns in which they may have interest or their own relatives by affinity or consanguinity. If the proposed agreement is approved, it must be reported to the Ministry of Trade and Regional Integration and published on the company's website within 72 hours of approval. This enhances the chances of further scrutiny. An agreement that has not been approved or publicized in the foregoing manner may be invalidated at the request of the company, shareholders, or creditors of the company.
The elaborate approval process above represents a major departure from the rules under the 1960 Commercial Code. The 1960 Commercial Code required prior approval only by the board of directors irrespective of the amount a transaction involved (Compare 1960 Com. Code Art. 356 and the New Com. Code Art. 306 & 395).
Derivative Action Made Easier for Minority Investors
The New Commercial Code relaxes the preconditions for the institution of a derivative suit as regards a transaction involving conflict of interest. A prior resolution of shareholder meeting to sue directors is no longer a prerequisite. Shareholders representing not less than 10% of the capital may directly institute legal action against directors who have failed to discharge their responsibility in relation to a transaction involving conflict of interest. The law allows such direct action by investors, where a company has made an agreement 'directly or indirectly with directors, a member of the supervisory board, general manager of the company, secretaries of the company, auditors or persons affiliated with such people'. The law considers as affiliated persons those that have relationship with the foregoing by blood or marriage and organizations or concerns in which they have interest. (Art. 328/3 and 306)
The New Commercial Code has introduced provisions that enable minority investors to identify documents and gather information that they may need as evidence for the derivative action. Shareholders that intend to bring derivative action are entitled to inspect agreements they assume to have involved conflict of interest and associated documents. The company is obliged to provide copies of such documents and other evidence necessary to institute such an action (Art. 328(4)).
The law has also introduced changes as regards the cost of litigation. Shareholder plaintiffs have the right to recover their legal expenses from the company regardless of the outcome of the legal action as long as the derivative action was instituted in good faith. (Art. 328(5) of the New Com. Code). As such, minority shareholders who want to bring derivative suit will not be dissuaded from instituting legal action for fear of having to shoulder the cost of litigation.
Conclusions
The New Commercial Code has introduced significant changes to protect minority investor rights through private enforcement mechanism. These include a clear articulation of the mission of management and the standard of conduct expected in the discharge of its duties. The Code also includes provisions that aim at enhancing transparency and preventing or at least identifying transactions involving conflict of interest.
Besides, it subjects transactions that involve more than 10% of the assets of a company to prior approval by disinterested shareholders, hence enhancing the ability of minority investors to block transactions that may unfairly benefit controlling shareholders and the management directly or indirectly. The Code also relaxes the preconditions to instituting derivative suit affording minority investors the opportunity to protect their rights.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
