Where an investor (a minority shareholder) invests into a company over which it does not enjoy control, it is essential for him to ensure that the value of the assets and earning capacity of the company are not impaired and to ensure the development of the company's business in line with the business plan he has reviewed. A veto is one of the common tools available to achieve that end. The veto enables the minority to block a resolution at the shareholder level or the director level in relation to a matter being subject to the veto.
AIFC company law offers a great flexibility in structuring a veto by contrast with Kazakhstan law. The minority can fit the veto to his own circumstances to protect his own interest. For example, a veto can be couched in terms such that it is capable of exercise (a) by each shareholder, or (b) by named shareholders, or (c) by a specific majority of a body of those shareholders whose percentage shareholding attain a specific percentage threshold, or (c) by directors appointed by a specified class of shareholders (such as class A shareholders or class B shareholders).
A veto can be crafted into a shareholders' agreement and/or articles of association. That said, it is worth noting that where the AIFC Companies Regulations 2017 reserve a particular matter for shareholders' approval and specifies what kind of resolution (whether an ordinary resolution or a special resolution) is required, the provision, whether in the shareholders' agreement or the articles of association, that purports to set out a higher majority (or a veto) can be found ineffective and unenforceable against the company. For example, s. 43(a) of the AIFC Companies Regulations 2017 states that the company may not alter its share capital other than by a resolution (this is either an ordinary resolution or a special resolution) or decision of the directors. Therefore, the provision in the articles of association or the shareholders' agreement that requires unanimous consent of the shareholders for the alteration of the share capital may be at odds with the statutory provision of the AIFC Companies Regulations 2017 and, thus, unenforceable against the company. This principle is derived from the English case of Russell v Northern Bank Development Corp [1991] B.C.C. 517, to which the AIFC Court can have regard.[1] Under the rule in Russell,[2] neither shareholders' agreement nor articles of association may fetter the statutory powers of a company, and, accordingly, any provision (this includes a veto) that purports to do so is ineffective and unenforceable against the company. Practitioners have found ways to get round the restrictions of the rule in the Russell case which are outlined below. It is conceivable that in the context of AIFC law the rule in Russell might have more limited application due to a rather more flexible statutory framework in relation to some corporate matters.
Articles of association
Articles of association can split shares into different classes of shares (for example, class A and class B). Each class of shares can confer on the holder of such a class of shares specific rights attaching to that class of shares (i.e., class rights) which will be dissimilar to those rights attaching to the other class of shares, and each shareholder will subscribe for a specific class of shares (let's say, the class A shareholder would only acquire class A shares). The articles of association can then further provide that a specific matter (such as a reduction of the share capital) will be deemed to constitute a variation of a specific class of shares (take class A shares as an example) (Re Northern Engineering Industries plc [1993] BCLC 1151). Consequently, the variation of the class rights will require consent in writing of the holders in the aggregate of at least 75% of the nominal value of the shares of that class (s. 33(3) of the AIFC Companies Regulations 2017), unless the articles of association require a larger or smaller majority. The proportion borne by the number of class A shares to the number of class B shares may vary (say, one to four); however, as class A shares are solely held by the shareholder of class A, the shareholder of class B – as he does not hold any class A share – would not be in a position to carry out a resolution for the reduction of the share capital, notwithstanding that he is entitled to exercise 75% of the total number of the votes that can be cast in a general meeting of shareholders, which would be otherwise sufficient to pass a special resolution.
Having said that, a caution was expressed that a deemed variation of class rights provision can engage the rule in Russell[3] or might not be viewed as proper class rights.[4] Accordingly, the articles of association can provide for an alternative type of veto. Thus, the articles of association may create weighted voting rights attaching to a class of shares on all or specified resolutions. The weighted voting rights may, for example, enable the holder of the relevant class of shares to exercise such number of votes as is necessary to defeat any resolution in relation to the matters being vetoed (Bushell v Faith [1970] AC 1099). Further, a provision can be made that, in relation to all or specified matters, the shareholder of class A is entitled to exercise, say, 10,000 votes in respect of one class A share held by it.
It is conceivable that not all the shareholders may be parties to the shareholders' agreement. The class rights and weighted voting rights in the articles of association can be directly enforced against the company (s. 18(1) of the AIFC Companies Regulations 2017).[5] Also, the directors must act in accordance with the articles of association (s. 77(a) of the AIFC Companies Regulations 2017), and, consequently, they are personally liable to the company if they fail to comply with the class rights and the weighted voting rights.
Shareholders' agreement
A veto which is caught by the rule in Russell[6] is not enforceable against the company; however, such a veto should be directly enforceable against a shareholder (Russell v Northern Bank Development [1992] 1W.L.R. 588). A veto is normally enforceable by way of injunction.[7] The question of the enforceability of injunctions in the jurisdiction of the relevant shareholder has to be considered.
In a shareholders’ agreement, a veto is structured as an undertaking of a majority shareholder to cast its votes in a way that ensures compliance with the veto. For example, the majority shareholder would normally undertake to the other shareholder to procure that the company does not carry out specified matters without the consent of such shareholder. The majority shareholder – as he holds the sufficient number of votes which enables him to block any resolution or remove any directors who defies the veto – may feel comfortable to give such an undertaking.
However, where a company does not have a majority shareholder, then the minority shareholders are unlikely to be in a position to commit themselves in absolute terms to ensure that the business of the company is conducted in accordance with the veto.[8] The voting undertakings of the minority shareholders are likely to be qualified, for example, by an expression like "in so far as they are able to do so". The voting undertakings of the minority shareholders will usually be supported by another undertaking of each minority shareholder to join in with the other minority shareholders to procure that the veto is given effect.
It is submitted that a class right in the articles of association cannot be extended to subsidiaries.[9] Where the company is only a holding company of a group of companies, and the group carries on its business and holds its assets through its subsidiaries, it is worthwhile to make the company a party to the shareholders' agreement, under which the company will procure that no subsidiary will carry out any specified matter without the consent of each shareholder or a specific majority of shareholders. Provided that the company's undertakings in the shareholders' agreement do not fall foul of the rule in Russell[10] and other principles (such as the doctrine of maintenance of capital or the prohibition against financial assistance) the contractual obligations are capable of being enforced against the company.
Conclusion
AIFC law affords greater flexibility (compared to Kazakhstan law) in a manner in which vetoes can be folded into corporate transaction documents. Although it is yet to be seen whether the AIFC Court will apply the principles derived from the judgments of the courts in England, the case law and vast experience in drafting corporate transactions in common law jurisdictions (England in particular) provide instructive guidance as to how a veto can be structured.
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Disclaimer
The information in this article does not constitute legal or professional advice. No part of this articles should be relied on or used as a substitute for legal advice. The information in this articles is for general information purposes only. It should also be appreciated that the law may have changed since the date of this article.
[1] Article 13(6) of the Constitutional Statute of the Republic of Kazakhstan "On the Astana International Financial Centre" no. 438-V ZRK dated 7 December 2015 (the "Constitutional Statute") gives the power to the AIFC Court to take into account final judgments of the courts of other common law jurisdictions. The AIFC Companies Regulations 2017 contain provisions which are for the most part similar to those in the UK Companies Act 2006 and is understood to be based on the common law principles. The relationship between English law and the laws of financial centres (similar to the AIFC) was considered in the case of the court of the Dubai International Financial Centre ("DIFC") in Ithmar Capital and 8 Investment INC v 8 Investment Group FZE [2007] DIFC CFI 008, DIFC Case no. 008/2007 (24 November 2008) at paragraph 112 at which Justice Sir Anthony Colman stated that in construing the applicable DIFC law which is so closely modelled on common law principles "it is appropriate to add flesh to the concise bones of these legislative provisions by looking to the manner in which the common law court in England and elsewhere have given effect to similar principles. Whereas the ruling principles are those laid down in the DIFC codes, the manner of application can properly be informed by reference to English law not as a default system but as an aid to construction and application". This statement can be persuasive for the AIFC Court in the context of AIFC law in that English law can be used as an aid to construction and application of AIFC law notwithstanding that English law is not a default system in the AIFC. Indeed, the AIFC Court did apply the principle derived from an English case in the case of Kozhabay A. A. v "Qosil Limited" Private Company Case no. AIFC-C/SCC/2022/0021, at paragraph 14.
[2] [1991] B.C.C. 517.
[3] [1991] B.C.C. 517.
[4] For example, Tolley's Company Law Service, Lexis Nexis, para [S5014.1].
[5] For example, a class right can be enforced by way of an injunction restraining the company from acting on a resolution moved in defiance of the class right (Quin & Axtens Ltd v Salmon [1909] 1 Ch 311, although the case itself concerned the decision of the board comprising two directors who were also shareholders, and the articles of the company provided that no such decision should be valid on the relevant issue if either of two directors dissented, it is submitted that this case may be seen as a broad interpretation of the rights of shareholders qua shareholders, see Hollington on Shareholders' Rights 9th Ed. Sweet & Maxwell, para 4-28).
[6] [1991] B.C.C. 517.
[7] See Palmer's Company Law (Sweet and Maxwell), para 7.631, and the cases cited in it.
[8] Under article 19 of the standard articles for private companies limited by shares, the shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action.
[9] For example, Hewitt on Joint Ventures 6th Ed (Sweet and Maxwell), para 9-18.
[10] [1991] B.C.C. 517.
