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Developments in the squeeze-out procedure

02.05.2005

The regulation of the takeover of shares held by minority shareholders by a majority shareholder (known as squeeze-out) was introduced in Estonia by the Commercial Code on January 1 2002, when Chapter 29(1) of the Commercial Code came into force. At the end of 2004 the Supreme Court gave two important judgments on the regulation of squeeze-outs.

 Interpretation

In the Liviko Case(1) a dispute arose between the majority and minority shareholders of AS Liviko, a public limited company whose shares were not traded on the regulated market. The Supreme Court held that, notwithstanding the fact that EU member states have until May 20 2006 to implement the EU Takeover Directive (2004/25/EC), the interpretation of the Commercial Code provisions regulating squeeze-outs should be guided by the provisions of the directive. The Supreme Court also judged that analogous laws and practices of other states can be used as comparative material when ascertaining the meaning and purpose of the Estonian law, even when the case does not concern a relationship under private international law.

The above applies first of all in situations that lack the implementation practice of a provision, which has been developed elsewhere for a similar provision and concerns states with whom Estonia shares a similar legal system and implementation practice of law - mainly other EU member states and states belonging to the legal system of continental Europe.

Compensation

In the Liviko Case the Supreme Court also dealt with the fairness of the compensation for the shares to be taken over from the minority shareholders. Under the Commercial Code only monetary compensation can be paid to minority shareholders and this compensation must be fair.

There are no legislative guidelines as to which evaluation methods should be used to determine the amount of compensation. The Supreme Court dealt with various evaluation methods in the Liviko Case, and stressed that the compensation payable to minority shareholders must guarantee full economic compensation for the loss of shares and for intrusion of the minority shareholders' ownership. The Supreme Court also argued, referring to adequate practice in Germany, that the fair compensation for the shares cannot be determined merely on the basis of the book value - as AS NG Investeeringud did when determining the compensation for minority shareholders of AS Liviko - as this does not take into account the company's future reserves. The Supreme Court further argued that if the value of the company would be smaller if it continued its activities than upon liquidation, the value of the company should be taken as the liquidation value and the compensation should be determined accordingly. The market value of the shares should be considered as a minimum for determining the compensation in cases where:

• an actual market exists;
• there have not been market manipulations; and
• the shares are liquid.

Referring to the practice of other EU member states, the Supreme Court argued that one of the most widely recognized methods for determining the fair value of a company is the discounted cash-flow method, as this takes into account the company's future profits. The Supreme Court ruled that, as the discounted cash-flow method is generally accepted both in Estonia and internationally, the court should also recognize it given that there are no better methods or no good reasons to justify valuing the company in other ways. After discussing several methods, the Supreme Court concluded that the fair value of the shares to be taken over is not necessarily the highest of the market value, balance-sheet value, liquidation value or the value found on the basis of the discounted cash-flow method, but rather depends on concrete circumstances. However, the compensation may not be lower than the recent takeover price.

Contesting Squeeze-Outs

The Supreme Court gave another important ruling on the contestation of squeeze-out in the Sampo Case,(2) which involved a dispute between the majority and minority shareholders of AS Sampo, a public limited company whose shares were listed on the Tallinn Stock Exchange.

The Commercial Code provides that a general meeting resolution deciding a squeeze-out can be invalidated by a court if the resolution is in conflict with the law. It further provides that a takeover resolution cannot be invalidated because the compensation payable to minority shareholders is determined as too small. In the latter case a court may, on the petition of a minority shareholder, specify fair compensation. In the Sampo Case the minority shareholders sought to have the takeover resolution declared invalid on the basis that the auditor's report on controlling the fair price determined by the majority shareholder was not in conformity with the requirements of the code. The Supreme Court ruled that, as a takeover resolution cannot be invalidated because the compensation payable to minority shareholders is determined as too small, an insufficient auditor's report cannot be the basis for invalidation of the resolution.

The Supreme Court ruled in the Liviko Case that minority shareholders usually have neither the opportunity nor the means to verify the value of a public limited company and the value of shares calculated on this basis. In addition, under the code shareholders have the right to receive information on the activities of the public limited company only at the general meeting, and even this can be refused. Therefore, before filing a claim with the court a minority shareholder cannot demand access to either the public limited company's accounts for a more thorough inspection or the documents it has submitted, other than those set out in Section 363(5)(1) of the Commercial Code. For this reason a minority shareholder also cannot have a thorough evaluation of the share conducted by a professional.

The Supreme Court stated that these circumstances must also be considered in dividing the burden of proof between the parties. Therefore, if a minority shareholder makes a statement to the court which gives it reason to believe that the compensation has not been determined fairly (eg, the wrong methods were used to determine the price or essential factors determining the value were not considered), as the defendant the majority shareholder must prove that the price has been determined fairly. Since in order to determine the fair value of a share it is essential first to determine the value of the public limited company whose shares are being taken over, if there is any doubt regarding the fairness of the price determined by the majority shareholder the court may order that an expert assessment be conducted to verify the compensation determined by the majority shareholder.

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