Vol. XVI No.4
April 2011


Oppression of Private Minority Shareholders in State -Owned Companies


Romanian Government and the International Monetary Fund are engaged in on-going discussions concerning the total or partial privatization or restructuring of Romania’s remaining state-owned enterprises, almost all of which may be of significant interest to potential investors. Under the supervision of the IMF, these companies will be either subject to restructuring, to complete privatization or to the sale of part of their shares to interested parties. These state-owned companies are active in coal, heat, energy, railway, airplane transport, and chemicals – all industries in which potential investors may find their involvement extremely beneficial. But potential buyers of minority interests in Romanian state-owned companies need to beware of the foibles of greed perpetrated by the Romanian Government.

Potential purchasers of minority stakes in state-owned enterprises must carefully inquire as to the scope of the state’s ability to oppress them in a numerous of ways, such as in the outrageous case of the government-imposed Romgaz donation to the state budget (see The Romanian Digest™ December 2010 issue at: www.hr.ro/digest/201012). In many instances, these state-owned companies are run by political appointees who make political rather than business decisions that result in less profit or, worse, no profit at all. Minority shareholders endure such mismanagement because Romanian law permits at least some aspects of their oppression – although no one actually believes that the theft of Romgaz profits by the state has any chance of ultimately being upheld in the courts. The purpose of this article is to highlight the dangers that private minority shareholders face in state-owned companies with regard to the profitability of those firms. 

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State-Owned Commercial Companies having Private Minority Shareholders
Brief presentation
After the December ’89 revolution, Law 15/1990 transformed the state enterprises previously existing under the communist regime into commercial legal entities with the state as sole shareholder. Thereafter, the state began its privatization efforts with respect to many companies in which it sold off all or most of its interests. The Romanian state also sold minority interests in some state-owned enterprises to private shareholders, retaining its major shareholder position.

In 2005, the Property Fund was created based on the provisions of Law 247/2005. The Property Fund set up as a mechanism to provide compensation to the victims of Romanian communism who were entitled to restitution by equivalent, acquired stakes in significant state-owned companies, thus creating private minority interests in those companies. Romgaz is such an entity.

Another manner in which private companies became minority shareholders in state-owned companies was through the listing of such companies on the stock exchange, followed by the sale of minority stakes in the share capital of such listed companies.

Legal regime
The legal regime applicable to state-owned companies with private minority shareholders is the one applicable to all commercial legal entities pursuant to the provisions of Law 31/1990, i.e. the Romanian Company Law. Furthermore, where companies are listed on the stock exchange, the special provisions established by Law 297/2004, i.e. the Capital Market Law, and also the regulations adopted by the National Securities Commission, must also be observed.

Additionally, there are special legal provisions applicable to state-owned companies with private minority shareholders. For instance, the budget of such a company must be adopted through a Government decision and not based on a resolution of the general assembly of the company, as in the case of other legal entities. There are also special rules applicable to the voting mandate held by the state in the general assembly of shareholders of the company. Moreover, there are other significant legal provisions concerning the state’s ability to grant financing to the company in its capacity as majority shareholder of that company without the need to comply with state aid rules.

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Practical Aspects
It is not our purpose to exhaustively detail the procedure under which state-owned companies with private minority shareholders function. But set forth below are the main problems that arise in the course of the activity of such companies in which private minority shareholders are, in our view, mistakenly excluded from participation and systematically oppressed.

Approval of the Budget through Government Decision
As mentioned above, the annual budget of state-owned companies with private minority shareholders must be adopted through a Government decision. Since the state is the majority shareholder of such a company, it is the state that has the major role in the elaboration of the provisional budget. For the most part, private minority shareholders do not even participate in this elaboration process. Consequently, the provisional budget is too often established on a false and unrealistic basis, reflecting inflated envisaged profits expected by the company in the upcoming year.

Unfortunately, it has proven to be a common practice for the Government to adopt, just before the end of the fiscal year, a new decision correcting the provisional budget of the company for the year then underway in order to rectify the inflated provisional budget that no longer reflects any possibility of attaining the inflated profit forecast previously by the company. On the contrary, it now reflects losses – this being the actual situation of the company throughout the year. By doing so, the final financial situation of the company for that year would actually correspond to the redacted provisional budget and, consequently, no claim could be submitted by private shareholders against the directors of the company for their mismanagement and failure to fulfill the provisions of the previously approved budget.

Unfortunately, the double role of the state – as a major shareholder of the company and as the entity invested to issue the decision adopting the provisional budget through the Government – leaves plenty of room for this practice, which hides the real financial situation of the company behind falsely fabricated budgets and allows the company to continue its existence on the same ill-conceived path of debt.

Election of the Management of the Company
Another significant aspect in the business of these companies is the activity of the persons appointed to manage the company, as well as the possibility to trigger their liability for non-performance of their obligations.

(i) The Board of Directors of the Company
Most often, in its capacity as majority shareholder of the company, the state chooses the board of directors of the company. In the absence of any specific provisions included in the articles of incorporation of the company with regard to the manner of electing the members of the board of directors, the state would have the freedom to appoint the persons it chooses since it has the majority of voting rights in the general assembly of shareholders. Regardless of any contrary opinions expressed by the private minority shareholders with regard to the directors proposed by the state, the latter has the legal right to appoint the persons it chooses.

Sometimes, the state’s appointment of members of the management board proves to be disastrous for the company as well as for the private minority shareholders whose main interest is in the company’s profitability. Not infrequently, these appointments are political plums given to party loyalists who do not have the requisite professional competence to run a major enterprise. These appointees gain hefty directors fees and salaries with neither the requisite professional criteria nor a modicum of interest in the business or the success of the company. Too often, the mass media has directed the public’s attention to situations in which the members of the management board of state-owned companies were actually involved in political schemes and in electoral games, instead of being focused upon fulfilling their obligations in their capacity as members of the management board of the company. Such political appointments continue to be the rule in Romania – highlighting for all that the interest in the profitability of these companies takes second place to the interests of the political parties in rewarding their cronies. Indeed, there is no recorded instance where the state has sought to obtain a recovery of damages caused to the company by the mismanagement of one of the directors it named – although the tales of misconduct by directors and officers in these companies fills the media.

(ii) The General Manager of the Company
In the same manner, often the president of the management board of the company is also the appointed general manager who is given very broad powers. Duties which usually belong to the management board of a commercial entity are awarded to the general manager. This transfer of power from the management board to the general manager is detrimental to the company since it will be only one person -- the general manger -- who will adopt strategic decisions essential for the company, thus leaving no legal possibility for the other shareholders and directors of the company to express their views. In such cases, the role of the management board of the company becomes merely decorative.

Criticizing the Weak Management of the Company
When faced with weak management, the private minority shareholders should seek to exercise all legal means available to them in order to change the management and restore the financial viability of the company. It is the right of any shareholder to criticize the management of the company. However, since the majority of the voting rights still belong to the state, too often, such private minority shareholders have been presented in the media as “enemies” of such companies, and their actions – which only represent the exercise of indisputable rights of shareholders – are presented as detrimental to the company in question. A pathetic example of this is found in the reported statements of Adriean Videanu, Romania’s former Minister of Economy, Trade and the Business Environment, accusing Fondul Proprietatea as a minority shareholder, of acting against the "national interest" of the state by considering only its own profit, when expressing its opinion against the creation of the two giants in the energetic fields, Electra and Hidroenergetica – and this is from the former Minister charged with improving Romania’s business environment.

The “Donations” to the State – Means to Diminish the Profit of the Private Minority Shareholders
Incredibly, state-owned companies “donate” money to the state based on resolutions adopted by general meetings of shareholders in which the state, as majority shareholder, imposes its will. Through such donations, the potential profit of the company is diminished almost to zero so that the minority shareholders receive a diminished dividend or none at all. It is nothing less than outright theft although Romanian courts have actually validated such donations and rejected the claims submitted by minority shareholders seeking the cancellation of such donations. These actions appear to be outright expropriations that violate Romania’s constitution as well as its bilateral investment treaties, but thus far the nation’s lower courts have had a fuzzier interpretation leading one to wonder who in their right mind would consider buying a minority interest in a state-owned enterprise without first getting ironclad guarantees against any such avaricious future behavior by Romania?

The “Parasite Companies” and Political Involvement
State-owned companies more often than not have a network of “parasite companies” around them that benefit handsomely from the business of the larger state-owned firm. There can be rather obscure relationships existing between and among the directors and managers of the state-owned company and the owners and operators of the private parasite firms. Not surprisingly, the small parasite firms manage to be quite profitable, while the state-owned companies, despite their superior access to markets and their greater marketing ability, cannot seem to duplicate the success of their smaller counterparts. The parasite companies are not infrequently the sole distributors of the state-owned companies’ products for which they receive more than significant sums of money, or they act as suppliers providing goods or services to the state-owned enterprises at inexplicably high prices. Regardless of what the guise may be, the activity of the parasite firms in relation to the state-owned enterprises not only damages the competitive environment, but it substantially diminishes the financial resources of the state-owned companies. Needless-to-say, such practices are often criminal in nature and violate Romanian law, but how many prosecutions have there actually been for such violations law?

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Potential minority shareholders in state-owned companies are most likely already aware of the problematic aspects of their proposed investment. They are interested in these companies because there is a tremendous upside for them if they can get the firms to function properly and profitably. Why would any investor think that they can overturn twenty years of cronyism and bad management now? The answer lies in the evolution of the Romanian capital markets, the increased pressure of the IMF and the European Union to eliminate corrupt practices, and in an emerging Romanian civil society that is young and resolved to end bad government and poor business practices.

Additionally, major investors should try to consolidate their position in the company through negotiations that seek, for example, to amend the articles of incorporation of the company so that certain business practices may only be performed with the vote of the absolute majority in the general assembly of shareholders – and this would turn the vote of the minority shareholder into a significant voice in the general assembly of shareholders. But since many of the state-owned companies are listed on the stock exchange, the sale of shares is done instantaneously, and there is no possibility to make the sale itself conditional upon obtaining any such favorable amendments of the articles of incorporation of the company. If unable to negotiate the amendment of the articles of association of the company in their favor, in case of potential infringement of their rights, the only real remedy for minority private shareholders to effectively oppose measures imposed by the majority shareholder is to commence suit in court.

If properly assisted and counseled, and if adequately equipped with a sound understanding of the Romanian economic environment, the problematic aspects of minority ownership in state-owned enterprises might also be diminished and investors may just find themselves in the right place – where they can get a stake in companies whose activities have remained the basic pillars of the Romanian economy and whose prospects if run properly continue to be promising.

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Editors Note: It is our policy not to mention our clients by name in The Romanian Digest™ or discuss their business unless it is a matter of public record and our clients approve. The information herein is correct to the best of our knowledge and belief at press time. Specific advice should be sought from us, however, before investment or other decisions are made.

Copyright 2011 Rubin Meyer Doru & Trandafir, societate civila de avocati. All rights reserved. No part of The Romanian Digest™ may be reproduced, reused or redistributed in any form without prior written permission from the publisher.

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