Protection of minority shareholders

The protection of minority shareholders in capital companies is always a matter of balance. Often, the basic protection granted by law to minority shareholders is not enough to safeguard their rights. To remedy this, a series of mechanisms must be established to strengthen those rights, while maintaining a balance with majority shareholders in order to prevent the company from becoming ungovernable.

Basic protection

Minority shareholders seek protection against the majority.

The law already provides basic protection based on the right to information and through the legal liability of directors for actions that harm the interests of minority shareholders or the company. In the case of limited liability companies, minority shareholders are granted the right of withdrawal if at least one-third of the profits are not allocated to dividends, although the application of this measure was suspended until 2016.

Beyond the basic level, other degrees of protection can be established:

Enhanced protection

This would consist of requiring the favorable vote of no less than 81% of the capital for certain decisions of the General Meeting and ensuring that at least 50% of the profit is distributed among the shareholders.

The decisions of the General Meeting that would require 81% of the capital are capital increases or reductions. The guarantee of dividend distribution is achieved by stating in the bylaws that, from the annual net profit after taxes and after allocating to the legal reserve, at least 50% will be allocated to dividend payments, unless the General Meeting decides otherwise with the favorable vote of 81% of the capital.

An additional safeguard, which should be included in a shareholders’ agreement, is a joint exit right if the majority shareholders decide to sell (tag-along).

These mechanisms prevent the dilution of the minority shareholder through capital increases, ensure a minimum return on investment, and avoid the minority shareholder facing an unwanted partner if the other sells their stake.

Strong protection

Apart from the level 1 and 2 protections, a favorable vote of 81% would be required for Board decisions on:

Merger.
Spin-off.
Transformation.
Sale of a business unit.
To guarantee.
Dissolution.
Filing for bankruptcy.
Change of registered office.
Extension or modification of the corporate purpose.
Carrying out any act that exceeds the corporate purpose.
Acquisition of own shares (treasury stock).

Maximum protection

Apart from the measures of levels 1, 2, and 3, maximum protection may include additional measures, such as those allowing the minority shareholder to block the company, like requiring an 81% vote to appoint directors, by appointing two joint directors, one for each partner.

Other safeguards include requiring 81% approval for agreements on:

Exclusion of partners.
Issuance of financial instruments convertible into shares.
Participation in companies with the same corporate purpose.
Approval of accounts.
Distribution of dividends.

Such a company would be what is known as a deadlock company, which entails the possibility of judicial dissolution if no agreement is reached between the partners. To avoid dissolution due to deadlock, it is common to establish a mechanism whereby the majority is required to buy out the minority. If this mechanism is not established, any deadlock will mean that the minority may request judicial dissolution.

Models of agreements

A. Enhanced protection

FISCAL YEARS: The financial year corresponds to the calendar year and ends on December 31 of each year, except for the first fiscal year, which begins on the date the deed of incorporation is signed.

The result of each fiscal year, once taxes have been deducted and the legal reserve allocated, shall be applied, if positive, as follows: A) 50% to dividends; B) the remainder shall be allocated as decided by the shareholders’ meeting by a simple majority of the share capital.

B. Strong protection

Maintaining the article on FISCAL YEARS but increasing the dividend distribution percentage to 50% and modifying the one on BOARD RESOLUTIONS:

C. Maximum protection

The minimum dividend distribution is eliminated and transferred to the reinforced quorum of Board resolutions. It is added that the management system is composed of two joint directors.

DIRECTORS: The management of the company shall be entrusted to two directors who shall act jointly and represent the company.

BOARD RESOLUTIONS: The shareholders’ meeting shall decide by majority on all matters that by law do not require a higher percentage of capital. In any case, a favorable vote of 81% of the share capital shall be required to: A) decide on capital increases or reductions; B) merger, spin-off, transformation, or dissolution; C) filing for bankruptcy; D) granting guarantees; E) amending the bylaws; F) carrying out any act that exceeds the corporate purpose; G) acquisition of own shares; H) appointment of directors; I) exclusion of partners; J) issuance of financial instruments convertible into shares; K) subscription to or acquisition of a stake in companies with the same corporate purpose or that are competitors; L) approval of accounts; M) distribution of dividends.

By combining joint directors with a reinforced quorum for the appointment of directors, the appointed directors are safeguarded, since the majority shareholder may dismiss one or both of them, but cannot appoint a replacement without the minority shareholder’s votes.

Care must be taken with attorneys-in-fact, since a deadlock between joint directors can be bypassed by acting through an attorney-in-fact, whose power cannot be revoked if the directors do not agree. It would then be necessary to wait for the shareholders’ meeting, which also cannot be convened if the directors are in conflict, so the matter would ultimately end up in court with a judicially convened shareholders’ meeting.

What is a tag along?

Tag along is an agreement related to legal or financial transactions involving a commercial company. The translation would be right of accompaniment or co-sale right.

The tag along clause is usually included in purchase or investment agreements when there are several partners. This type of agreement is intended to protect the investment, usually made by a financial partner, allowing them to exit the company and recover their investment.

These agreements are common in venture capital investments. The tag along is also used to protect minority shareholders, who may sell their shares when the majority shareholder sells. That is, if a company has two shareholders, one holding 80% and the other 20%, the tag along would allow the minority shareholder to sell to the same buyer as the majority shareholder. The majority must disclose the buyer’s identity and the terms of the sale, and ask the minority whether they wish to sell alongside them. If the buyer does not wish to purchase all the shares, the sale is prorated in proportion to the shareholding.

What is a shareholders’ agreement?

A shareholders’ agreement is a document in which the members of a company regulate, outside of the corporate bylaws, their relationships with each other or with the company. These agreements are private and are not registered in the Commercial Registry, so they remain confidential or secret. Courts have upheld the validity of these agreements between the shareholders and with the company, although not against third parties, given their confidential nature.

These so-called shareholders’ side agreements are used to establish mechanisms for the protection of minority shareholders, minimum dividends, partner contributions, joint exit rights, call or put options, remuneration, and a wide range of agreements that, for whatever reason, we do not wish to include in the bylaws, in order to keep them from becoming public.

By Anna Calbet, Partner of the Tax & Corporate Department.