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Adoption of stricter corporate governance standards for Estonian companies

02.08.2006

Since the beginning of 2006, many important amendments regarding corporate governance in Estonian public limited companies (in Estonian: aktsiaselts or AS) became operative.

 Firstly, extensive amendments to the commercial code entered into force as of 1 January 2006. The purpose of many of the amendments was to systematise the corporate governance applied by Estonian public limited liability companies and to make the management of such companies more transparent. Changes are most consequential to a company's internal control measures, cooperation between managerial bodies, liability of members of such bodies and shareholders' right to information.

Secondly, following the recent years' trend in Europe and beyond, the Estonian FSA and the Tallinn Stock Exchange laid down the corporate governance recommendations effective since 1 January 2006. The recommendations are applicable through listing rules requirements to companies whose shares are admitted to trading on a regulated market in Estonia. Other companies are invited to implement the recommendations as well. The recommendations are guidance in nature, mandating listed companies, however, to report the extent they follow the recommendations or the reasons of any non-compliance (the "comply or explain" principle).

1. Internal control measures

Commercial code amendments oblige the management board to lay down sufficient measures, above all internal control systems, for tracking down any events and circumstances that may be harmful for the company's activities. Although such obligation could have been derived from the corporate governance principles also before the amendment, the law was lacking express obligation of the management board to lay down internal control systems. However, the law does not provide specific requirements regarding this obligation. For listed companies, support is furnished by the corporate governance recommendations and for subjects of financial supervision the advisory guidelines of the Financial Supervision Authority regarding the arrangement of operational risk management (effective from 1 September 2005). Those recommendations specify to some extent the obligations of the management board in carrying out internal control of a company.

2. Enhanced cooperation between management board and supervisory council

In Estonia, listed companies have a two-tier management structure - managerial function is executed by the management board and supervisory function by the supervisory council. The two-tier management system is sometimes said to result in insufficient information flow between the management board and the supervisory council. The amendments to the commercial code strive to avoid such situation. Firstly, an amendment vests every member of the supervisory council with the right to receive information and activity reports from the management board. Such right was vested to the supervisory council as a body before. This amendment should also ensure efficient information flow to individual supervisory council members who are representatives of minority shareholders. Secondly, the reporting obligations of the management board to the supervisory council were extended. The management board is now required by law to notify the supervisory council of all circumstances regarding the related companies (e.g. subsidiaries), rather than only the company itself, that may affect the activities of the company.

The cooperation between the management board and the supervisory council is further specified in the corporate governance recommendations. The recommendations provide, first, that both bodies should together ensure the reciprocal flow of information, second, that the division of tasks between the bodies should be disclosed and, finally, that the management board should participate in laying down the activity plans and strategy of the company and notify the supervisory council of all events and circumstances deviating from such plans and strategy.

3. Specified duty of care standard for members of the management bodies

Members of the management bodies of a public limited liability company are bound by two general fiduciary duties - duty of care and duty of loyalty. An amendment to the commercial code specifies the first, duty of care standard. The law now provides that members of the management bodies must fulfil their duties with "care of a diligent entrepreneur" and that a member of a management body is released from liability if he establishes that he has fulfilled its obligations with care of a diligent entrepreneur. Once again, the law expressly lays down the principle that could have been derived from the logic of the law also before.

It follows from the "diligent entrepreneur" standard that ultimately the activities of a management body's member will be compared with activities of other similar companies' managers. Preparatory materials to the legislative amendments also maintain that the larger the company and the number of persons affected by its operations, the higher expectations are entrusted to the member of a company's management body. The duty of care test must thus be applied on case-by-case basis, taking into account the particularities of respective company and the member of the management body.

4. Enhanced informational rights of shareholders

The amendments to the commercial code provide that the shareholders must be given more information about the general meeting of shareholders in advance. The notice calling shareholders' meeting must now contain proposals of the supervisory council regarding all items included in the agenda of the meeting.

The corporate governance recommendations specify the practices that must be applied in carrying out the shareholders' meeting. Most importantly, the exercise of shareholders' rights should not be hindered by unreasonable formalities and the controlling shareholder should avoid abusing its position at the shareholders meeting (and also upon organising the company's management generally). The recommendations also stress the importance of the company's website. Important corporate documents such as articles of association, financial reports, shareholders' agreements concerning concerted exercise of shareholders rights (if known to the company), data about members of the management and auditor should be made available on-line.

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