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A relatively new practice is consolidation of shares in a company. In the autumn of 2000, FCS declared the current consolidation practices aimed to squeeze out outside shareholders unacceptable. Moreover, under discussion are amendments to law On Joint Stock Companies concerning the exclusion of the norm of consolidation of shares. However, in September of 2000 the FCS St. Petersburg department registered the issue of 20 ordinary shares in JSC Severnaya Neft (Republic of Komi), which should be exchanged for all other shares (after an additional issue, which diluted shares of a number of shareholders). The shareholders having blocks of shares insufficient to be converted into one share (i.e. holders of so called fractional blocks of shares) will receive pecuniary compensation.

Sibneft company justified the necessity to consolidate shares of its subsidiaries by the fact that remaining small shareholders (less than 5 per cent of shares) did not react to the proposal to transit to single share and there is no possibility to communicate with them. In this situation consolidation is a way to transform minority shareholders into creditors (via the proposal to redeem fractional blocks of shares). In December of 2000, the meeting of shareholders in Sibneft – Omski Neftepererabatyvayushchi Zavod approved consolidation (72 shares). A similar decision was taken at JSC Sibneft – Omsknefteprodukt. However, the small shareholders were offered a choice between a pecuniary compensation for fractional blocks of shares, exchange of their shares for shares in the holding (i.e. Sibneft) before the completion of consolidation, or creation of a consortium of fractional shareholders jointly owning several shares. After the share in subsidiaries makes 100 per cent, it is envisaged to reorganize them as closed joint stock or limited companies to simplify management procedures and increase the potential of the parent company to manipulate assets.

In general, it shall be noted that in year 2000 conflicts between companies and minority shareholders over transition to single share (mostly related to coefficients of exchange) were more often than not settled in a constructive way via negotiations. The first among Russian oil companies to initiate the transition to single share was LUKoil, followed by Surgutneftegaz, UKOS, and Sibneft. By the beginning of 2001 Sibneft was close to the completion of consolidation, while at LUKoil and Surgutneftegaz this process was underway with regard to some of their subsidiaries. It is interesting to note that in the process of consolidation companies became more transparent and open for minority shareholders. For instance, UKOS and Sibneft adopted corporate governance codes, invited independent directors. UKOS announced the transition to internationally accepted financial book-keeping and excluded the provision about announced shares from its charter.

The settlement of corporate conflicts with the help of enforcement structures became a fact of everyday life. In 2000, the most publicized examples were Moscow-based JSC Kristall and Moskhimfarmpreparaty, Babayevski confectionery concern, Kachkanar Iron Ore Dressing Works (Russ. abbr. GOK), JSC Uralkhimmash, Kamyshlovski Constraction Materials Plant (Sverdlovsk Region), etc. A common practice is to initiate protests on the part of employees (demonstrations, pickets, armed resistance) as a way to mount pressure on enterprises. An exotic, although effective method was applied at JSC Varyeganneft – the representatives of the owner of a 17 per cent block of shares were not allowed to enter the building, where the meeting of shareholders took place, under the pretext that some blasting works were carried out near the building.

An important precedent was set by the Supreme Arbitration Court (SAC) decision (December of 2000) that enterprises have the right to repay their debts with their shares. This practice was first employed by creditors of the Leningrad Metal Works, who in 1999 transferred the controlling interest in the enterprise to the Interos group via a closed additional floatation of stocks in order to repay the debt. It is important for future economic activities that SAC confirmed this right of creditors in spite of the protest of a large shareholder supported by the Federal Agency for Financial Rehabilitation. The SAC justified its decision by the fact that normal managing bodies of JSCs do not function at the time bankruptcy procedures are underway.

It is also necessary to mention the fact that some amendments to law On Insolvency (Bankruptcy) were submitted to the State Duma in year 2000. The amendments shall grant external managers the right to approve additional issuance of shares. While in the course of the bankruptcy procedure meetings of shareholders may be viewed as the successor of functions performed by normal managing bodies, the granting of this right to arbitration managers may worsen the situation even further.

On the whole, over the 1990s the institution of bankruptcy was used as a way to redistribute (size, keep, privatize) property, or a highly selective method of political and economic pressure on enterprises on the part of the state. There is observed a paradoxical situation: bankruptcy procedures are applied to enterprises of relatively good standing (since competitors have a favorable opportunity to size control over such enterprises), while hopeless enterprises avoid this procedure (since nobody wants to size these enterprises, while there is no chance to recover debts in the framework of bankruptcy procedure). It is necessary, on the one hand, to ensure the protection of creditors’ rights in the course of bankruptcy of enterprises, and, on the other hand, to protect debtor enterprises against simplified methods of unscrupulous seizure of control over enterprises or some of their assets via bankruptcy procedures.

In fact, initiation of bankruptcy procedures became a low-cost (in case of potential collusion between arbitration managers and creditors, arbitrators, and FCFR officials) alternative to hostile takeovers via buying shares up on the secondary market. In this connection, the hypothesis about a direct link between the effecting of the law On Insolvency (Bankruptcy) in 1998 and the low level of resistance demonstrated by the Russia’s stock market in 1998 through 20008. It is also of importance that law On Joint Stock Companies contains numerous legal ways to effectively repulse corporate aggressors in the framework of corporate law, while the bankruptcy procedures currently in force (if well applied) are a safe way for aggressor to succeed.

In this connection, courts shall less widely resort to the practice of applying bankruptcy procedures as a routine method to recover debts in order to protect enterprises from unscrupulous seizure of control over them (or some of their assets). According to Article 10 of the RF Civil Code such practice shall be viewed as abuse of the law. Initiators of the bankruptcy procedures shall be obliged to submit sufficient proof of impossibility to recover debts by other means.

It is also of importance that in January of 2001 stipulations of law On Insolvency (Bankruptcy) and the Code of Arbitration Procedure concerning the right of debtors to participate in court proceedings were reviewed by the RF Constitutional Court. The Constitutional principles of the right of defense, contentiousness, and equality of parties are not realized in the framework of the legislation currently in force. It would be appropriate to include in the new law on bankruptcy provisions stipulating the right to appeal against court decisions on bankruptcy and actions of arbitration managers (who remain uncontrolled at present) and to ensure equal priority of all creditors’ claims notwithstanding the time they were submitted (the introduction of collegial principle for claims concerning bankruptcy, participation of all interested parties).

There were registered attempts to intimidate government agencies into privatization of enterprises (Kamski TsBK (Pulp and Paper Integrated Works), Bor, Orgsteklo, Korund) at suitable prices via suitable privatization methods under the threat to introduce external management. External management may be introduced also in case the state intends to relieve the general director of a JSC with state-owned block of shares (so this person might be appointed as the external manager).

However, there were also registered instances of destabilizing activities on the part of the state. Among these instances is the attempt to dispossess cellular telephone companies Vympelkom and MTS of some their frequencies in the autumn of 2000. According to some evidence, the conflict concerning airline East-Line and privatization of Domodedovo airport, which broke out in 2000, was also related to the attempt of some governmental structures to size control over financial flows. The government failed to take a clear stand with regard to corporate conflicts in year 2000 (even after the Presidential elections held in the same year). On the contrary, it may be noted that the government demonstrated passivity even with regard to cases where the control over enterprises was seized via clearly illegal methods (by force). General declarations with regard to protection of ownership rights, banning of criminal redistribution of property, and the dictatorship of the law shall be propped up by serious practical deeds.

Realization of the measures aimed to protect ownership rights, which are stipulated by the draft Key Guidelines of Social and Economic Policy for Long Term Outlook (June of 2000) elaborated by the RF government, may become an important step forward. At the same time, the further passing of draft amendments to law On Joint Stock Companies aimed to protect the rights of minority shareholders (the State Duma passed them in the third reading on June 2, 2000) was blocked by the initiative of several largest companies. The new draft amendments approved by the State Duma in the late 2000 envisage the following:

  • general meetings of shareholders have exceptional right to take decisions on increases in authorized capital;
  • general meetings of shareholders shall approve the floatation of all shares by closed subscription and public floatation of more than 25 per cent of shares;
  • Boards of Directors shall unanimously approve additional issue of shares;
  • additional shares issued on JSCs property shall be floated among existing shareholders in proportion with their respective shares;
  • in case a JSC is reorganized (split-up of a JSC or separation of a part thereof) existing shareholders shall receive shares in proportion to their shares in the main JSC;
  • in case there are more than 50 shareholders in a JSC, its register shall be kept by a specialized registrar.

From our point of view, the approval of such amendments does not mean that the law and the state shall only support small shareholders in their struggle with large ones. From the angle of the dominance of the general principle of ownership rights protection, it is no less important to keep a balance between interests of different groups of participants of corporate relations, to defend issuers from unscrupulous practices (blackmail) on the part of minority shareholders9.

There were registered numerous instances of unjustified destabilization of JSC’s management within the corporate legislation framework. A novation of year 2000 is the application of Article 49 of law On Joint Stock Companies, which permits a shareholder (including a one-share holder) to sue the company for potential loss inflicted by a decision taken by the general meeting of shareholders. Most often shareholders resort to this practice aiming to ban pending meetings of shareholders (called to take important decisions concerning the JSC or appointment of a new manager) claiming that the board of directors convening the meeting is not legitimate. Obviously, such a conflict is initiated not by the formal claimant owning one share, but competitors or a real party behind the intra-corporate conflict. Besides, the owner of one or a few shares having the formal right to lodge the claim has little chance to suffer real losses. JSC Kristall was sued by its shareholder Technogres company contesting the appointment of a new general manager. As concerns Norilsk Nickel, the plaintiff contested the voting method used by the meeting of shareholders to settle some issues pertaining to the restructuring of the company. The case of JSC Polimerstroimaterialy was only aggravated as the company attempted to ignore the court ruling.

In terms of the law, it is important to find a reasonable compromise between, on the one hand, the necessity to ensure legal protection of small and foreign shareholders in case their ownership rights are infringed upon and, on the other hand, to avoid unsubstantiated claims clogging the judicial system10. However, new legislation shall aim to create an effective control mechanism suitable for conditions existing in Russia in order to prevent insiders from manipulating assets to the detriment to the enterprise itself, its outside shareholders, and the state.

Concentration of Property and Vertical Integration

It is necessary to mention a new and on the whole positive trend noticeable in 1999 and 2000, i.e. the transition from relatively amorphous entities (conglomerates) to vertically integrated structures of more homogeneous type with clear organizational and legal boundaries. This process was most pronounced in oil and metallurgy industries, however, it was also registered in chemical and food processing industries, civil aircraft manufacturing, a number of MIC (Military and Industrial Complex) sectors (although the attempts to establish or, more precise, to restore vertically integrated structures from the top have been failing over years).

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