Midterm Notes (Unit 1-5) PDF

Governance and Legal Environment 1 Unit 1: Business Organization – Basic Concepts 1.1 Purpose of this Unit 1.2 Companies and Company Law 1.2.1 Reasons for Incorporation  Matching different skills o ITler & Business Student  Matching skills and resources o Pers...

Governance and Legal Environment 1 Unit 1: Business Organization – Basic Concepts 1.1 Purpose of this Unit 1.2 Companies and Company Law 1.2.1 Reasons for Incorporation  Matching different skills o ITler & Business Student  Matching skills and resources o Person with wish to operate company and person with the money to do so o Original reason for companies: railway construction, no one person had enough money to finance everything -> so they attracted multiple shareholders, also less risk  Increasing equity finance Discussion: Equity and debt Debt: fixed interest, independent of profit or loss of company Equity: shareholders dividends depend on the profits of the company, no remuneration. downside for equity providers: only get dividends if profit upside for equity providers: no limits to the dividends they can get  more risk (no remuneration) but also more potential return (unlimited dividends) Insolvency: Amount owed to creditor gets payed back first, equity investors are seconds. This is why decisions are usually done by providers of equity and not debt (=general meeting of shareholders)  Business integration o Want to expand your business, owner of machines wont sell but will provide them to the company in exchange for a share of the company 1.2.2 Reasons for and Types of Company Law Company Law has 2 types of rules: (See more below)  Protecting: Mandatory Rules: rules you have to follow  Enabling: Default rules: rules that apply if not specified otherwise 1.2.3 Purpose of Company Law Issue 1: Whose welfare should companies maximize? General Agreement: Companies should maximize welfare in the long run Whose welfare? Traditional view: Purpose = long-term shareholder value  Does company law achieve that? Or is there short-termism? Competing view: Purpose = shareholder value and stakeholder value  If you want to maximize shareholder value in long term: have to satisfy stakeholders in the company (employees) Discussion: Shareholder value vs Stakeholder value Is shareholder value a goal in on its own? Or need to maximize stakeholder value to be able to maximize shareholder value? Issue 2: Should the company assume broader social objective? = more equal vs more efficient?  Today: increasing reports on sustainability in stock market firms  BUT reporting on sustainability is ≠ sustainability is a goal of the cooperation  Issue: is sustainability a goal of the company? Is a trend  Fact: Woman are underrepresented in corporate boards  Purpose of Law? Should Company Law aim at making things more equal? Or should Company Law aim at increasing efficiency? Issue 3: Should company law enable or protect? Company Law has 2 types of rules:  Protecting: Mandatory Rules: rules you have to follow  Enabling: Default rules: rules that apply if not specified otherwise 1.3 Partnerships and Company Law 1.3.1 Definitions and Topics of the Text 3 Preliminary Issues: Issue 1: (terminology)  Company law vs. “Gesellschaftsrecht”  Gesellschaftsrecht = covers partnerships and companies  Company/Corporate law = covers only companies Issue 2: Numerus clausus of types of partnerships/companies = You cannot invent your own partnership/company type! This differs from general contract law, there one can create new contracts. Why? Because this contract only ties 2 parties together. Companies also affect third parties which would not be able to have a say in the contract Issue 3: Business register provides information to third parties Third parties can rely on that information as long as they don’t know better -> (are in good faith) Discussion: power of representation (=example for Issue 3) Man A is entered in the business register to represent Company X, the company revoked this power of representation but forgot to enter it into the business register -> third parties can still assume Man A is representing company X 1.3.2 The Business Register 1.3.3 Partnerships  General Partnership (=Offene Gesellschaft, OG) o Joint and several liability = all partners are liable, each partner has to answer for the entire liability(debt), is not limited in any way o (Joint and several) management = all partners are also managing the company o No share transfer (default rule) (reason: if every partner can manage the company, one person’s liability depends on another ones actions -> you want to have control over who that person is because they can put your part of the company at risk)  Limited partnership o Limited liability = once they payed in the promised money no additional risk of liability, you can only use the money invested. o Limited partners are not active managers (but are entered into the business register – so not anonymous)  Silent Partnership o Silent partner is not disclosed (silent partner raises 10000 Euros, the 10000 Euros become property of the entrepreneur) o Silent partner does not participate in business activities (only entrepreneur enters contracts (e.g. bank loan) with third parties) o Downside for silent partner: may lose the personal contribution (10000 Euros) but is not personably liable for the debts of the entrepreneur  Partnership under Civil Law  o Joint and several liability for all partners IF they participate in the business o Not disclosed in business register o Doesn’t need a physical contract o Example: orally agree to share costs of vacation home 1.3.4 Companies Criteria for a company  Legal personality (of its own) o Meaning contractual partners ≠ shareholders BUT: the company -> company itself can sue/can be sued  Members are not personally liable for a company’s debts o Only thing you can loose is the money/time you payed into the company or a contribution of kind which isn’t actually your property anymore bc you gave it to the company o Default rule  Delegate management by third parties o Can be shareholders but don’t have to be shareholders  Transferable shares o Default rule! Could also say that its only possible with consent of shareholders, etc.  Investor control/ownership o Your vote counts more depending on your contribution (default rule) o Not the same for partnerships: all shareholders have equal vote (default rule) Types of company:  Public limited company (Aktiengesellschaft AG) o Idea: widely held company, listed on stock exchange o More regulations, more mandatory provisions  Private limited Company (Gesellschaft mit beschränkter Haftung GmbH) o Fewer members (often only 1), closer to partnership o More flexibility -> less regulations, more default provisions o Cannot ! be listed on stock exchange  Company vs group of companies o Group of companies: One person sets up a private limited company (parent company) and the company itself (subsidiary) sets up another company o Parent company not liable for debts of subsidiary, subsidiary liable  consequence: Discussion: asset partitioning  If company sets up a new, very risky business it doesn’t have to do it itself (company liable for new business)  BUT instead: parent company can set up a subsidiary and give certain assets to subsidiary  = only subsidiary will be liable for new risky business 1.3.5 Hybrids Discussion: company law and taxation For taxation, the company is a legal entity of its own as well:  2 levels of taxation  Level 1: Taxation of profits at the level of the company  Level 2: Taxation of dividends at the level of the shareholders Partnership is not a legal entity of its own -> a partners shares only get taxed once Hybrids: Limited liability (from company) and direct taxation (from partnerships)  Doesn’t work with limited liability partnerships bc there it still takes 1 partner that’s liable(=general partner)   Trick: general partner can be a natural person OR legal person -> set up limited liability partnership where the natural person is the limited partner and the general partner a limited liability company (private limited liability company)  Advantage: no natural person becomes liable for more than its contribution AND taxation only happens at level of partners 1.3.6 Other Legal Entities Others forms of a legal person: cooperatives, associations, foundations 1.4 Company Law between National and European Law Basically, company law is still national law 1.4.1 Sources of National Law Company law as national law:  Austria law as a starting point (explain problems and give solutions)  Codified law as a starting point for Austria  (Case law (in Anglo-American area)) o Court decisions play an important role BUT don’t forget: court decisions are results of private enforcements(judge) o Courts are always reactive, have to wait until cases are brought to them Companies are not only limited by company law but also by other laws:  Soft law o (esp. Corporate Governance Codes) o Are not binding but companies have to declare whether they follow them or not o Comply or explain mechanism: either comply or explain why not comply o Set up by association, not the state  Securities law (=capital markets law) o E.g. affects public limited company (AG on stock exchange) o Additional regulation for listed companies o Mostly mandatory law  Insolvency law o Deals with companies that cannot meet its debts -> regulated procedure where creditors get at least partial money back o Aims for equal treatment of all creditors o Ideally: also aims for restructure/survival of company 1.4.2 Company Law in the European Union Company law as a European law:  no European code of company law  BUT European law influences national company law in a number of ways: Way 1: Primary law  = treaty on the functioning of the European union  Freedoms of establishment o Huge issue before: o Can you set up a company form from one country = France, but have center of business activities in another country = Austria (not meaning selling goods in Austria) o Traditional answer: No o Now: Yes, you can use business forms form other EU countries  Freedom of movement of capital law  o Discussion: golden shares o Golden shares = gives shareholder veto power over changes to the company's charter. -> worth more than its price o Has been abolished by European court of justice because of freedom of movement of capital law Way 2: Harmonization via Secondary Law  Legal acts (directives) harmonize national laws  Directives are not directly applicable in the countries, but have to be transposed into the national legislature  Directives only cover selected issues  Esp. important securities legislation Way 3: Separate company forms set up by EU  Societas Europaea o Meant to be used for large cross border businesses o Set up via regulations (regulations are directly applicable, don’t have to be transposed) o Questionable success o E.g. STRABAG  No corporate form for small and medium enterprises (SMEs) on European level 1.5 Principal-Agent Conflicts 1.5.1 Introduction  Principal puts assets in agents hands for him to manage  Principals welfare depends on agents actions o Issue: In whose interest does the agent act? o Ideally: welfare of principal, Reality: agent acts in his interest Issue 1: Control: How can the principal control whether the agents actions are in his/her best interest  Discussion: Asymmetry of information  Agent has information which principal would need to figure out whether the agent acts in his best interest  Even if the principal has the info, does he have the time to conclude whether the agent acts in his best interest? Not guaranteed Issue 2: Measurements: If the principal thinks the agent does not act properly – what can he/she do about it? Principal-agent conflicts in company law: (followed chapters = 3 examples) 1.5.2 Shareholders and Management Shareholders=principal Management= agent  Managers (usually) = third party and NOT shareholders  Agency cost: shareholders would need to incur costs in order to control managers -> not doable for small shareholders bc costs exceed dividends  Freeriding: if other shareholder decides to bear costs all shareholders benefit  o If danger of freeriding big: change that no one monitors agents (management)  How important that issue is depends mostly on the structure of corporate ownership o Huge problem of freeriding if you have: widely held companies with no controlling shareholder but atomized shareholding (everybody only owns a tiny bit) o Small problem of freeriding if you have: concentrated ownership (50-70% of shares held by one person -> he gets entire/large part of benefit) o UK: usually no controlling shareholder, Austria: usually controlling shareholder -> principal agent issue not big 1.5.3 Majority and Minority Shareholders Minority shareholder = Principal Majority shareholder = Agent because he can influence decisions on general shareholder assembly not in the best wish of the minority shareholder  Huge issue in Austria  Issue in corporate groups (subsidiary has parent company as major shareholder but there are also other shareholders)  transfer pricing = parent company buys from subsidiary goods below market price  corporate opportunities  See Unit 4 1.5.4 Shareholders and Creditors Issue between equity and debt Creditors= Principal Shareholders = Agents  Creditors have claims but cannot influence business activities  Esp. important if company is in crisis because there is a huge incentive to act to the detriment of creditors  See Unit 2 1.5.5 Shareholders and Employees Employees = Principal Shareholders = Agents  Employees invest human capital into the company but cannot decide on business activities  Rather an Issue of labor law but influences company law bc employees have right of representation at the board of supervisors. 2 Unit 2: Limited Liability and Creditors 2.1 Purpose of this Unit 2.2 Limited Liability Reasons for incorporations:   Facilitate accumulation of capital o Child of rail work o Limit liability of shareholders to encourage more shareholders to buy stocks  Enable diversification o Minimize risk through limited liability makes shareholders able to invest in multiple businesses  Minimize burdens on cash-flow  Counter risk aversion o Question: limited liability makes sense if there are many shareholders, but why can a single shareholder set up a limited liability company too? -> counter risk aversion  Allocate assets to ventures o Minimize risk by only being liable for the assets you put into the business -> your family is not liable for your business debts Advantages of the creditors of the shareholder / parent company o limited liability is an advantage (because they don’t compete with the creditors of my business venture) o if I would be a general partner -> my creditors would have to compete with the creditors of my business venture Advantages of the creditors of company itself o limited liability can be an advantage (because the creditors of the company don’t compete with my personal creditors as a shareholder) o Rather creditors of company have priority as to the assets of the company o Easier assessment of risk involved (debts of members do not matter bc they are not liable) 2.2.1 Rationale and Dangers to Creditors Danger to Company’s Creditors:  Mismatch between control and liability o Natural person: I take 100% control of my actions and therefore 100% of risk involved o A single member Private Limited Company: This single person takes 100% control of the companies’ actions but NOT 100% of the risk o Results in: decisions of members result in (negative) effects on the creditors How can a company act against the interest of a creditor?  Ex ante opportunism o Company overstates assets when trying to get a loan from a bank o Rules prohibit ex ante opportunism (e.g. Accounting rules)  Ex post opportunism o Company provides correct statement but makes changes afterwards behind the back of the creditors o E.g. (hidden) distribution, increase debts, increase risk Discussion: risk and interest rate: Company takes out one loan in favorable conditions then takes more loans with higher interest rates. Why higher? Bc having  only one loan is easier to pay back -> less risk -> lower interest rate. But bank did not calculate additional risk for more loans -> relationship debts vs assets gets worse -> problem for creditor: 1st creditor has lower interest rate but way more debt 2.2.2 Information ex ante Combating ex-ante opportunism via accounting:  Balance sheet (assets and liabilities) o Assets rise, liabilities same = equity rises o Assets fall, liabilities same = equity falls  Profit and Loss account (income and expenditure) o Profit increases equity, loss decreases equity  Equity debt Every Company has to do this but also a group of companies as a whole has to prepare group accounts (=consolidated accounts) Discussion: 3 purposes of accounting rules  information of the entrepreneur (=informing entrepreneur)  information of the general public (= informing public)  Only profits which are calculated according to the harmonized rules of accounting can then be distributed to the shareholders. Accounting rules provide a framework on the presentation of accounts AND solve substantial issues (e.g. valuation of assets) “Gate keepers”:  Role of auditors: ensure that the companies accounts comply with the rules o Sometimes auditors fail in their job (e.g. Wirecard)  Role of credit rating agencies: give mark on the credit worthiness of companies (e.g. AA+, C-)  Large creditors will ask for additional documentation besides accounts and marks 2.2.3 Creditor Self-Help and Its Limits =Ex post opportunism Measures of self-help for creditors:  Opting out of limited liability by private ordering (=by introducing contractional clauses) o How? If bank advances loan for a single member private limited company, bank will ask that one member gives a personal guarantee for debt resulting from the loan.  Requesting collateral o How? Collateral provided by company (e.g. mortgage on company premises) OR collateral provided by the member running the company (e.g. mortgage on family house)  Contractual covenants o = Contractual provisions prohibiting certain actions by the company (e.g. taking up additional debt) o If this contractual covenant is broken by the company, the bank can accelerate the loan -> meaning it has to be repaid immediately Limits to Creditor Self-Help:   Small trade creditors cannot introduce contractual covenants or opt out of limited liability (not enough trade power?)  Employees are creditors providing their work beforehand (don’t have the position to ask)  Involuntary creditors (e.g. tort creditors when company damaged sth – damage = what you do/ damages = what you pay afterwards) (e.g. State when company has tax debt) 2.2.4 Limits to Limited Liability  In exceptional cases court may decide to “pierce the corporate veil” = make them liable for the damages because you have been shockingly illegal/unfair 2.3 Legal Capital 2.3.1 Rationale Capital = money raised by shareholders in exchange for their shares In Austria:  Public limited company (plc/AG): 70.000Euros  Private limited company (ltd/Gmbh): 35.000 Euros (min. 17.500 Euros in cash)  Higher figures for certain types of businesses (e.g. banking, investment)   Losses decrease equity, only once equity is gone debts loose value = overindebtedness -> ground for insolvency  In this case up to 100000€ loss (amount of legal capital), equity looses value -> legal capital = cushion for creditors  Losses are first born by shareholders, only once no equity left, losses are born by creditors Legal capital = historical figure  Once upon a time, these 100000 Euros have been paid in, it does not mean the company has the 100000 Euros at the moment the balance sheet is drawn up  Legal capital can be used in business (does not have to be held back only for creditors) Legal capital = trivial  Fixed for all types of business at the same level (level = either plc or ltd)(means, no matter if small software firm or hotel complex – same amount of legal capital has to be dedicated)  Purpose and results of legal capital: (issue of legal capital)  NOT the purpose of legal capital: conclude companies trustworthiness through legal capital (bc its historical)  Purpose of legal capital: Helps keep shady operators away from the advantages of limited liability  Critics on Legal Capital: 35000 Euros = basically nothing for the damage that can be done with it, since legal capital hasn’t changed in years  Result: different rules abroad  EU Rule for plc: 70000  No rule for ldt: huge differences between member states even Austria and Germany o Germany: Unternehmergesellschaft mit beschränkter Haftung (legal capital: 1 Euro) o Austria: First 10 years, ltd can be set up with only 10000 Euros (5000 Euros in cash) 2.3.2 Raising of Capital If you want to fix the legal capital issue, you need rules for:  Raising capital (making sure that the legal capital is actually paid in) o Rules applicable to initial raising of capital and later increases How is money raised? (2 options)  Cash consideration o Directors declaration and bank certificate that checks if company can freely dispose of funds(=legal capital) o If declarations turn out to be wrong:  Shareholder has to pay another 35000(17000) Euros  Director and bank may become liable if they were at fault for the wrong declaration  Consideration in kind o Value determination = difficult  Also difficult to check if the value has been determined right  If wrong, for plc, shareholder has to pay remaining amount in cash. No proportional liability of all members  If wrong for ldt, if the shareholder cannot pay the remaining amount, all shareholders are liable for a proportional amount -> they all have to pay a portion of the missing value in cash  To avoid such things for plc in Europe: independent, court appointed expert checks if valuation has been correct  To avoid such things for ltd in Austria: can only bring up 50% of legal capital as consideration in kind without requiring an independent court expert Discussion: worthwhile to avoid rules? Case: Agreement: I make a cash consideration to the firm of 100000 Euros, you will give me the shares and agree that therefore the company will afterwards use the 100000 Euros to buy real estate from me.  Shareholder (I) will have to pay again because company was not able to freely dispose of funds but was obliged to buy my real estate 2.3.3 Maintenance of Capital If you want to fix the legal capital issue, you also need rules for: Capital maintenance (= capital must remain in company and is not payed back to shareholders afterwards) Rules on capital maintenance:  Paying dividends o If assets – liabilities > capital + non distributable reserves o -> Legal capital = barrier for paying dividends if company is not ready for it because you have to replenish legal capital if there is not enough there before paying out dividends o See again importance of accounting rules (e.g. valuation of fixed asset -> always price at which you bought fixed assets, rise in market value ≠ rise in value -> which would lead to profits. BUT profits can only happen if I sell it for the higher market value = needs prove (not just because it might be more worth now)) Discussion: profits and liquidity -> 2 different concepts  E.g. company may make a profit but afterwards may not gave the money to pay out the dividend  Profit = balance sheet concept Companies try to avoid paying out dividends(profit):  Disguised (hidden) distributions = ILLEGAL o = parent company/shareholder gains from subsidiary without subsidiary making profits o E.g. transfer pricing  = parent company owns 100% of shares of the subsidiary.  Normally: parent company only receives money from subsidiary as dividends if subsidiary makes profit  But assume option 1: parent company receives goods from subsidiary for transfer price which may be lower than the market price  Option 2: parent company sells goods to subsidiary above market price o E.g. single member of ldt and manager at the same time -> receive remuneration above market value o BUT parent company/shareholder has duty to repay (does not depend on fault) o Claim can be brought by subsidiary and parent company o But nobody will bring the claim as long as the situation works because management of subsidiary is dominated by parent company, and parent company gains o Case where claim is brought by insolvency administrator: Insolvency 2.4 Creditor Protection through Insolvency Law 2.4.1 Purposes of Insolvency Law Insolvency = Shareholders stakes in the company have been wiped out, there have been losses -> there is no equity left, not enough assets left to satisfy the creditors in full What happens?  Company is wound up = company is terminated  Assets are sold  proceeds are used to satisfy creditors via insolvency dividend Insolvency dividend < debt due to creditor 3 Purposes of Insolvency Law  economic purpose: ironing out unsound businesses o if not: would distort market for products and is a danger to creditors  equal treatment of creditors o prohibits first come first serve principle – no creditor gets back everything  saving businesses where possible o give a chance to fundamentally sound businesses that were just badly run o e.g. agreement: if pay back 40% of debts, may continue operating Alternative to court procedure in case of insolvency:  “pre-packaged” insolvency = Legal o Creditors agree to forgo a certain amount of debt due to keep company running o But every creditor has to agree on a quota 2.4.2 Grounds for Insolvency When does a company become insolvent? -> 2 grounds for insolvency  Cash-flow test o = checks ability to pay due debts at the moment they become due (30 days) o Needs sufficient liquidity o If company cannot do this on its own and needs a bank loan for it -> insolvent  Balance sheet insolvency (=over indebtedness) o 1. Compare assets to debts (all debts even if they are not due) o If assets don’t cover debts -> balance sheet insolvency o 2. Subtest: is it likely that the business will be able to continue operating successfully? o Kicks in earlier than cash-flow test usually Discussion: Is this a successful system? No, insolvency dividends are still low even with on-time checks. Even worse: in many situations court proceedings aren’t opened, because court appointed expert discovers that assets are not sufficient to pay court costs. Court may refuse to open such cases because then the taxpayer would have to pay 2.4.3 Overview of Insolvency Proceedings  Duty to file insolvency within 60 days   Court appointed insolvency administrator o Runs company in interest of creditors, no longer in interest of shareholders o Management cannot represent company any longer o Exception: “debtor in possession”  If court thinks there is a way to keep company running, court may appoint former management instead of administrator  Once insolvency is declared: creditors cannot enforce claims individually (=cannot sue company)  Equal treatment of all creditors = guiding principle of insolvency law o Claims with priority  Secured creditors first  Then unsecured creditors Discussion: types of securities:  Mortgage: real estate gets sold off, and only after the creditor with the mortgage has been payed in full, the remaining money will go to the unsecured creditors  Liens: priority by sale of moveable goods (=chattels)  retained title: agreement between company and supplier: supplier retains title (=is owner of the goods) until he is payed for them Result of insolvency proceedings: court sanctioned settlement  by the creditors = company pays e.g. 40% of debts in 2 years and continues operating  OR liquidation 2.4.4 Liability Issues  Civil liability for directors if they do not open insolvency proceedings in the 60 days o Civil liability = pay money o Criminal liability = go to jail  Special rules for social security and tax debts  Shareholders are protected by limited liability even in case of insolvency EXEPT if insolvency administrator discovers: o hidden distributions = important issue o Fraudulent conveyance rules = if shareholder received money immediately before insolvency knowing that insolvency was imminent, has to pay back the received money 3 Unit 3: Management of Companies 3.1 Purpose of this Unit 3.2 Overview Board Structures in Comparison: 3.2.1 Recapping Principal-Agent Theory Principal: Shareholders Agents: Management To balance the conflict of interest/solve this problem and make sure management operates with the shareholders’ interests in mind:  Give more influence to the members on the management o give shareholders strong influence  Bad solution if many small shareholders and no controlling shareholders -> you can give them as much influence as you want, they probably wont use it properly bc of problem of freeriding  Better solution, if one controlling shareholder, but: o New issue: new principal-agent conflict -> majority vs minority shareholders o Assume: alignment of interest between shareholders but against management 3 basic topics:  How are decision-making powers distributed between shareholders/members vs managers?  How does company law try to ensure that there is proper oversight of management? What are the mechanisms company law actually knows to solve that problem  If there is no oversight, is it possible to incentivize managers otherwise? E.g. by remuneration, danger of liability 3.2.2 Board Structures in International Comparison Main distinction between management and members:  Supervisory function o Monitoring small businesses no real problem (bc e.g. single member company automatically monitors himself/is his own supervisor) o Monitoring in companies with many shareholders:  Issue: separation of supervision and management Two different types of structure internationally:  One-tier structure o Has only one board of directors which takes central business decisions (not day-day running of business) AND supervises managers o Some directors = not-exclusive directors (“outsiders”) who are not fully employed  Take business decisions AND monitor/supervise the other, fully employed exclusive directors (CEO, CFO)  In order to not compromise their monitoring:  Remuneration/income not depend on companies success o Some crucial decisions (e.g. auditing, compensation committee = wage for fulltime managers) are made by board committees consisting ONLY of non-exclusive directors o Informal separation: fulltime managers manage, outsiders supervise  Two-tier structure o Two different boards: board of directors and separate supervisory board (= Aufsichtsrat) o Supervisory board: ONLY performs monitoring, members cannot be managers  One advantage: formal separation leads to less influence on the managers against the supervisors o Management and supervision is formally separated Even within the two-tier structure, not all legal systems follow the same rules, especially for the function or composition   Function: In Austria E.g. managers have to collect agreement of board of supervisors first  Composition: In Austria, supervisory board is elected by shareholders AND employees o Austria, Germany: There are employee representatives  Both tier structure systems need independent directors BUT is independence good?  Less knowledge, less insight -> non-executives depend on managers informing them bc they are not part of the day-day business operation -> barrier of asymmetrical information bc managers only tell them what they want to  Independence from whom? From management! But shouldn’t they also be independent from major shareholders (CGC)? -> soft law, comply or explain why not comply  How to measure independence? Use proxies (=Stellvertreter) that could give an indication of independence (e.g. financially independent from managers), hard because independence depends on soft factors (e.g. friendship, knowledge) which are hard to prove/determine 3.2.3 Board Structure of an Austrian AG  Austrian plc AG: o Board of directors  Managing board (1+ member: CEO, CFO etc)  Independent from shareholders  Directors may decide to ask the shareholders but don’t have to o Board of supervisors  Tasks: Monitoring AND appoint directors AND approval of major business decisions  Range. 3-20 members (CGC recommends max 10)  Codetermination: 1/3 of members appointed by work council (have to be employees and not outsiders (e.g. trade unit officials) Discussion: why codetermination? Internationally prevalent?  Because employees invest human resources (work, specific skills) into the company which may be hard to use elsewhere therefore they have the right to be present on the board of supervisors.  Not internationally prevalent, only in Austria and Germany 3.2.4 Board Structure of an Austrian GmbH  Austrian ltd GmbH o Directors as managers o Members as decision-makers and monitors  Appoint directors AND can force directors to certain actions o Board of supervisors by statute, mandatory only if  > 50 members and > 70000 capital  Because then one member only 2% shares -> freeriding  Or: > 300 employees on average  Because codetermination: 1/3 representing employees o Board of supervisors in ldt doesn’t appoint directors but members do! 3.2.5 Board Structure of a Societas Europaea 3.3 Management and Third Parties For third parties it is very important to understand how can a company act (AG, GmbH): It cannot act by itself it always needs a natural person acting for the company. How to find out? Company Law solves this with two different techniques:  Standardization o Specifies who can enter a contract: power of representation -> directors  Determine who can enter contracts and take legal action on behalf of company?  Exception: directors cannot represent c for own employment/service contract o specifies limits of power of representation  Company Law states certain decisions (mergers, capital increases) have to be ratified by members  otherwise unlimited, cannot be restricted by shareholders -> no worries for third parties where the power of representation is -> always director, only for certain decisions like mergers, capital increase not  contract valid,  even if outside of business purpose of company  lack of approval of supervisory board  or contrary to directions by the members of a GmbH (e. g. real estate) o Advantage of standardization: third parties can trust in the directors power of representation -> lowers transaction costs; easier doing business o Additionally directors can give power of representation to certain employees -> agency law (contract law) Discussion: benefits of standardization? On every case? Advantage of standardization: third parties can trust in the directors power of representation -> lowers transaction costs; easier doing business Benefits usually outweigh disadvantages  Transparency o Refers to business register bc representors are entered there o Third parties can rely on that entry even if it’s wrong! o Usually more than one director -> plurality of directors -> do they have to agree on a contract? Depending on the company, but also entered into the business registers  No, each director on its own  Yes, joint representation (e.g. banking, insurance industry) 3.4 Appointment and Removal of Board Members 3.4.1 Aktiengesellschaft (Public Limited Company) 3.4.1.1 Members of the Board of Supervisors Board of supervisors Appointment  2/3 appointed by shareholders o Members of board of supervisors elected by shareholders for 5 years in the general meeting by an ordinary majority (50% of the shareholders with voting rights present) o Soft law in Austrian CGC: one/two representatives of minority shareholders o Company’s statues may foresee that up to half (unlisted companies)/ third(listed companies) can be appointed by certain shareholders without shareholder vote  1/3 appointed by works council  Qualifications to fulfill monitoring: balanced composition board o maximum number of board seats: 8 (listed)/10 (unlisted) o diversity: gender balance; quota=30 % for each gender if board ≥ 6/9 members representing the shareholders, > 1000 employees, ≥ 20% female employees Removal  removal by supermajority (75%) of shareholders and the shareholder has to give no reason for removal  directly appointed board member by one shareholder -> that one shareholder can just remove him Discussion: independence of supervisory board? Easier to be independent for members of the supervisory board since they are only doing this part time and their livelihood does not depend as much on it 3.4.1.2 Directors Board of directors Appointment  Appointed by supervisory board, not by shareholders o double majority -> overall vote and shareholder ś representatives o for 5 years  no legal qualification (exception: regulated industries e.g. banking)  needs appointment itself AND contractual arrangement o free service contracts regulate rights/duties/remuneration o directors are not protected by labor law -> don’t have to be protected against the boss because they are the boss o free service contract prepared by nomination committee and external advisors o Issue: removal ≠ dissolving free service contract  disable by a clause stating that board membership is needed for free service contract  Or bargaining on termination -> gets a compensation package if free service contract is prematurely ended Removal  removal only with o sufficient cause (e.g. mismanagement) -> hard to prove o or loss of trust by shareholders = reason for removal -> but doesn’t mean supervisory board has to remove him, it can -> but usually it removes him, if it doesn’t remove him -> at risk of removal themselves  removal ≠ dissolving free service contract 3.4.2 GmbH (Private Limited Company) 3.4.2.1 Members of the Board of Supervisors Appointment and Removal is like with the AG 3.4.2.2 Directors Appointment  directors are appointed by members/shareholders in the general meeting by simple majority(directors as members –> voting behavior) o members have a much stronger role bc they directly appoint and remove directors o even if there is a board of supervisors, they have no say in appointment or removal of director  flexibility = reason for choosing ltd instead of plc. Statutes can o provide certain members with an appointment/nomination right o protect directors against removal by e.g. requiring higher majority for removal or even make removal by shareholders impossible without agreement of another director o directors can be removed by court order (sometimes single members (director himself because he is shareholder or a shareholder) blocks the removal -> members can file lawsuit if they have good reason)  contractual relationship is (in contrast to plc) often is subject to labor law because director is subject to directions by members-> therefore this director is in a position of dependence -> triggers labor law to protect him. Removal  removal by members even without sufficient cause and by simple majority 3.4.3 Remuneration Issue of remuneration Remuneration of directors -> core issue in company law  Preliminary issue: members as directors (GmbH) o members fix executive compensation = remuneration for directors -> (private autonomy) o if remuneration (for director who is also a member) above market level = problematic because this is disguised/hidden distribution and therefore illegal o if company insolvent, director would have to pay back remuneration -> leads to personal insolvency o also problematic because under company law, hidden distributions should be taxed like profit because its not actually payment for the work of the director   Who sets remuneration? o board of supervisors (AG): focus of public discussion (big companies)  Now: shareholders have to pass advisory vote on general principles of remuneration(`say on pay )́ : still means they don’t fix remuneration, but they can advise o members (GmbH): executive compensation via resolution or dividends  if dividends – remuneration can only be payed if company makes profit  if resolution – it doesn’t matter  What do directors get for remuneration? o AG: they get fixed and variable components  Option 1: Variable components are tied to the companies performance -> reason: supervisors try to align interests of directors with the shareholders  How to figure out the variable components? E.g. align them with management rations (e.g. ROI, EBITDA)  Option 2: stock option plans: right to buy shares below market value instead of cash (helps company save liquidity)  Problem: might drive to short-termism -> drive up stock value and then sell  What do members of the board of supervisors get for remuneration? o Only fixed components  Why? Because they should not be interested in running risky strategy’s but should be neutral Discussion: Purpose of remuneration  Fair compensation  Incentivize the directors of the board to act in the shareholders interest 3.5 Running the Company Task of directors To what extent can shareholders influence actions by management? Differences by country:  Internationally(UK): shareholder centric systems, shareholders have more power to influence directors  Austria, Germany, (partially) US: management centric system, shareholders have less power to influence Differences inside Austria:  Plc: less influence of shareholders  Ldt: more influence of shareholders Similar for both AG and GmbH  certain material decisions (basis for the company ś existence) must be taken by shareholders, e.g. o changes in capital (equity financing) o changes to statutes o mergers/divisions/sale of entire assets  o transaction without shareholder consents(but needed) (supermajority) typically invalid -> limit to power of representation of the directors GmbH  managerial dependence (members have strong position through decision rights, e.g. appoint directors, ratification of annual accounts)  directors have to put extraordinary decisions to members (e.g. opening a new line of business) o if they didn’t get consent: transactions directors did are still valid -> third parties are not affected, but directors violated contract -> opens for removal or company can claim damages from director  members may take initiative and give instruction to management/directors via a resolution (minority must be heard, but they can still be overvoted by shareholder majority) o directors have to comply (if majority shareholders agree with resolution) -> if not contract still valid (see above)  Summary: strong position of members idea: closely involved in running of the business; less coordination issues; basically no directions necessary Discussion: principal agent conflict for GmbH? In theory, little conflict because either member = director or members have a strong position anyways AG Different legal situations Managerial independence (from the board of supervisors AND from the shareholders) -> law formulates this as managers “act on their own responsibility” o = No binding instruction to directors neither by shareholders nor by board of supervisors o Shareholders cannot take initiative neither for ordinary nor for extraordinary measures o Management may have to ask for approval by board of supervisors for certain material decisions but cannot by obliged by anyone -> management still has to take the initiative -> no active order  usually: for ldt: directors have to ask members, for plc: directors have to ask board of supervisors  directors supposed to be less dependent on shareholders in the plc than in ltd  Discussion: does the system of managerial independence work? Directors are under threat to lose shareholder trust if they don’t agree -> may result in removal of directors by board of supervisors 3.5.1 Shareholder Influence 3.5.2 Internal Decision-Making Process 3.6 Liability 2 purposes of liability in legal system:  1. compensation (if sb has intentionally caused damage, he/she should compensate victim)  2. Incentivization (threat of liability = incentive to act properly) Liability will only arise because of fault -> breach of legal duty; `bad luck` is not enough -> shareholders have to bear this risk  Management liability usually goes towards company, not directly towards shareholders: o Economic perspective: damage to company = damage to its shareholders -> = reflex o BUT compensation must be made to the company, not the shareholder  Risk of business activity remains with the shareholder (except directors liable when violate specific duties) Specific duties (that if violated by director he becomes liable):  Duty of loyalty o Directors are prohibited to compete with company, and obligated to be confidential  Duty of care o Act with due care of a proper manager = Objective standard (meaning I can’t say I don’t know any better, but I will be compared to what a proper director should have done) o danger of hindsight bias (second-guess of business decisions)  Doesn’t matter if good or bad outcome -> only matters if decision was bad ex ante  Rule to avoid that: business judgement rule BJR = supposed to stop second guessing in court  If the following facts are met by the decision, then the business decision is not looked at any further:  Business decision, no conflict of interest, appropriately informed himself, no utter inadequate decision  If these things are not met, (=director didn’t fulfill them before his decision) then the judges will examine them closer  There is D&O insurance (director and officer insurance) in case the business decisions of the director cause damage. This insurance will compensate (partially because there is maximal coverage limit) indirectly? The shareholders Who can bring a lawsuit against directors?  AG: board of supervisors; GmbH: members  Lawsuits against directors = rare because usually preferred to settle issues quietly 4 Unit 4: Membership in Companies 4.1 Purpose of this Unit 4.2 Rights and Duties 4.2.1 Financial Duties  main financial duty: payment of contributions o members shall pay up the promised sum either upon foundation of the company or capital increase  if not: forfeiture of shares (=loose their shares)   GmbH: liability of other members if there is no recovery via market sale(=company will try to sell shares)  AG: shareholders are not exposed to liability risk -> downside shall not depend on the wealth of other shareholders  duty to make additional contributions? o in plc-> only if agreed by the shareholders (agreement between shareholders (enforced by courts)), but not obligated by the statutes o in ltd -> obligation in the statutes o What’s the difference between sth written in the statues and a shareholder agreement? o -> only what is written in the statutes can be enforced against new members 4.2.2 Duty of Loyalty  shareholders: duty of loyalty against co-shareholders and company o duty of loyalty = you should not act to the detriment of the company o precise nature? No, it’s just a standard /ownership structure? /nature of right? o Example 1: competing in line of business -> admissible? (=allowed)  Man A owns 5% of real estate company, can he set up another real estate company operating in the same field? Depends on situation:  small enterprise vs big company listed on the stock market o Example 2: resolution on distribution of profits -> considering the company ś interest?  Might it not be in the companies interest to retain profits, invest and make future profits?  right to receive a dividend vs urgent liquidity needs =  Possible (depends on situation) example of violation of duty of loyalty=  meaning sometimes majority shareholder does not want dividends payed out -> hungers out minority shareholders -> until minority has need for liquidity -> who will sell shares to? -> to majority shareholder at lower price  duty of loyalty in form of standards (=not rules because there can never be thought of every single thing that might happen… -> application of these standards is very case-specific 4.2.3 Financial Rights financial rights -> core rights of the shareholder  Primary right: dividends o right to receive a dividend (only if there are any profits for distribution)  What if company decides to reinvest profit? =Illegal? No, because if the company states at the preparation and ratification of annual accounts that some part of the profit goes towards the creation of reserves -> these parts are not considered profit anymore -> no dividends need to be paid out  Plc: directors and supervisors do the ratification of annual accounts - > they decide whether profit is invested or payed out  Ltd: majority of shareholders do the ratification of annual accounts - > they decide whether profit is invested or payed out  o typically distributed in proportion to financial investment (% of nominal value); statutes may provide otherwise (e.g. asymmetrical distributions -> some shareholders get larger dividend, some less)  secondary rights: o right to receive proceeds of liquidation if company is dissolved o pre-emptive right: if company increases capital and issues new shares, old shareholders have right to receive new shares in proportion to holding -> that protects against the danger of dilution o dilution may happen through:  loss in voting power (before owns 25% -> can block votes that need supermajority (75%) )  loss in value (if new shares are issued below value of the old shares -> new shareholders would get part of share for free/cheaper)  exclusion of pre-emptive rights: only with good cause; can be reviewed 4.2.4 Voting Right most important: voting right  free decision on how to vote (as long as it doesn’t violate any principles like duty of loyalty)  alignment of economic risk exposure and control = „one share –one vote“ o default rule for GmbH o mandatory rule for AG  2 exceptions:  preferential shares (receive certain dividend and only if there is something left -> leftovers distributed evenly between voting and nonvoting preferential shares)  voting caps (each shareholder can buy as many shares as he wants but cannot vote for more than (e.g.) 15%)  prohibition of voting in particular cases o AG:  releasing a shareholder from a duty(=shareholder becomes liable for damages, company decides to not make him pay but takes voting rights),  pursuing a claim (bc shareholder has received hidden distributions he cannot vote) o GmbH: contract between company and member o -> but no general rule that shareholders/members may not vote if there is a conflict of interest (shareholders can vote on resolutions regarding own board position) 4.2.5 Right to Information right to Information  shareholders need information to exercise their voting rights  strong information asymmetry between directors shareholders  danger that directors distort shareholder vote by misleading information  AG: shareholders can request management in the general meeting to provide information for items on the meeting ś agenda o outside the general meeting: shareholders cannot force management -> means only can ask for info once a year   GmbH: stronger position of members (than for plc) o right to inspect company ś books o general right to information --> full access to company ́s affairs Discussion: Dangers for the company (concerning shareholder having full access to company’s affairs) Example: Member is competitor, he can know about the company -> dangerous 4.3 Shareholder Resolution 4.3.1 Public Limited Company Shareholders resolution (Beschluss) in the general meeting:  shareholders decide on core issues  two types: annual general meeting/extraordinary meeting (only if needed)c  resolutions taken in physical meeting o meeting is convened by directors o chairman of the supervisory board chairs the meeting o meeting can take resolutions irrespective of number of shareholders present  extensive procedural requirements o e.g. binding agenda o notarized resolutions  right to participate and proof of ownership o ‘custody receipt’ for bearer shares ten days before the meeting for listed companies o share register for unlisted companies  typically limited attendance for widely held companies o small investors do not use their voting rights (don’t show up = rational apathy) Discussion: issue of rational apathy and institutional investors Smaller shareholders don’t show up = rational apathy Reasoning: it doesn’t matter if I show up because I can’t make a difference anyways Also true for institutional investors (banks, credit unions, pensions) -> tend to not show up but when not satisfied with resolution -> sell their shares  countermeasures o distance participation (e.g. satellite meetings) --> reluctance, but COVID-19 o authorization of third parties (“proxy“) --> attend the meeting on their behalf and to cast the votes vested in their shares --> “proxy fights” o pressure on institutional investors to cast votes? “Stewardship Codes” = Soft law, they have to show up or explain why they do not want to vote -> embarrassing so they show up o advent of proxy advisors (job is to look at companies and advise institutional investors how to cast their votes on general meetings) 4.3.2 Private Limited Company  no need to incentivize members to vote (because members typically hold higher share rate)  members can influence corporate affairs to a larger extent  convening and holding the general meeting requires fewer formalities o role of directors --> convene the meeting (detailed statutes) o issues to be put on the agenda in advance o quorum (at least 10 percent of the members present)  o Who is chairing the meeting? --> power to declare the results of a vote by members (said in statutes) o written resolutions outside of a meeting possible, but all members must approve on both method and substantial issue 4.4 Minority Shareholder Protection 4.4.1 Introduction private benefits of control (majority shareholder gets more benefit than he should from his votes, benefit ≠ proportionate to votes) & control premium (one person owning 50% of the shares is more value than 50 people owning each 1% shares) reasons for certain ownership structures protecting minority shareholders ex ante (private ordering) or ex post (after abuse) 4.4.2 Shareholder Resolutions Majorities  simple majority of votes cast (cast = have to be present)  super-majority for core issues --> 75% of votes cast o e.g. increases in capital without pre-emptive rights, mergers  deviation from contract law (=consent of all parties) o individual consent only in exceptional cases o e.g. transferability of share, right to receive a preferential premium; additional contributions substantive requirements for resolutions o resolutions have to treat all shareholders equal unless there is a justification. Certain resolutions need objective justification o BUT nobody supervises if the requirements for resolutions are met unless a shareholder challenges the resolution in court for illegality -> court review o BUT to be able to do that, shareholder has to say immediately at the general meeting “I protest” 4.4.3 Minority Rights minority rights  special minority rights which can be exercised outside of the general meeting o e.g. right to call a meeting, to include topics on the agenda  practically important: special investigation (if shareholder has a suspicion sth is wrong but can’t access information to figure out) o court-appointed special investigator  only if substantial grounds to suspect that grave violations have occurred o company will have to bear the costs (even if suspicion was wrong) 4.4.4 Board Representation Protection for minority shareholders through board representation via…  …Via try to get board representation via private ordering in statutes or shareholder agreement  o supervisory board: members directly appointed by minority shareholders o board of directors: -> harder bc supervisory board appoints directors. Only possibility: majority shareholder makes shareholder agreements to try to get “their” members on the supervisory board to elect the minorities preferred candidate for directorship o GmbH: easier bc right to appoint directors directly; statutes can confer directorship as a personal privilege  …Via rule that there must be independent members appointed to the board of supervisors 4.4.5 Tunneling Protection against tunneling -> also protects minority shareholder Tunneling= from of hidden distribution And in hidden distributions, money gets taken away from the company and therefore indirectly from the minority shareholders Tunneling is an illegal business practice in which a majority shareholder or high-level company insider directs company assets or future business to themselves for personal gain. 4.5 Transfer of Membership  Divestment (getting invested money back) by o Before: dissolving company o but not easy to dissolve  shareholders cannot just return their shares due to creditor protection and principle of equal treatment  only in special circumstances the company can buy its own shares from you  solution o selling shares on the market in order to exit company o free transferability of shares --> core pillar of company law o transfer of ownership in the legal person --> position as residual claimant 4.5.1 Public Limited Company For unlisted and listed:  general rule: registered shares --> company keeps a shareholder register; (unlisted)  company treats person as shareholder if entered into register --> not publicly accessible, helps keeping track of shareholder structure For listed companies  bearer shares --> “securitization“: AG issues share certificates representing ownership  today only for listed companies  AG lodges “global certificate” with a depository bank --> changes of ownership effected via account transfer (i.e. change of book entry in the depository ś ledger)  no individual certificate --> proof of ownership via “custody receipt” Discussion: shareholding is not really anonymous today for plc (nor ltd): unlisted companies: shareholder register at company can be accessed with valid reason, listed companies: bearer shares but account listed is still yours 4.5.2 Private Limited Company  members entered into business register (accessible to public!) o company treats person as member if entered into business register  transfer necessitates notarial deed in order to be valid --> required for promise of transfer and actual transfer at a later stage! Discussion: purpose of deed Legislator want to prohibit ltd shares to be easy to trade -> no markets for these shares should be created 4.5.3 Control of Membership Can the company control the circle of its members? Discussion why would want company to control its members? If competitor buys shares of company, he has access to information  restrict transferability o in company‘s statutes  transfer without company approval invalid (AG: directors; GmbH: members: resolution with simple majority--> minority protection?)  option for other members to pick up shares if certain conditions are fulfilled  tag along (if majority shareholder sells his shares, minority can sell as well) and drag along (minority HAS to sell as well) o in shareholders‘ agreement 4.5.4 Involuntary Transfers  shareholders can be expelled if they violate their duty to make their financial contribution  squeeze-out right o if shareholder owns 90 percent -> he can force the other 10% to sell him the shares o statutory default rule --> can be modified in statutes o compensation issue: set on the basis of enterprise value --> valuation? o court proceedings typically part of a squeeze-out  provisions in GmbH statute: possible to expel shareholders 5 Unit 5: Mergers and Acquisitions 5.1 Purpose of this Unit 5.2 Overview of M&A Structures Motives for M&A, e.g.  Retirement (run a small business but you want to retire so you sell your company to another)  Growth (buying up other companies)  Cost savings  Economies of scale  Synergies Asset Deal A/B = shareholders asset deal = company A exchange all asset for all cash -> shareholders are not involved, share ownership doesn’t change Share deal Ownership of assets doesn’t change – ownership of shares changes 2 possibilities: Merger  turns into: Two legal entities merge into one legal entity Company A merges into company B A: transferring company B: receiving company On shareholder-level: same result as share deal On company level: huge difference! After a merge, company A ceases to exist. (doesn’t become a subsidiary like in share deal) Division One legal entity becomes 2 legal entities = opposite of merger Important decision on which assets go to which company What happens on shareholder level? Non-proportionate: e.g. if 2 people cannot work together anymore (family business) Proportionate: at shareholder level nothing changes, A and B become shareholders of both companies in the same proportion they held shares before division 5.3 Asset Deal 5.3.1 Introduction Important! Contract law differentiates between signing and closing of a deal. Signing = a promise. Only when a deal is closed it really belongs to you! Closing may happen at a later time (e.g. wait for approval) 3 things have to pass for an asset deal: assets themselves, contracts to work the assets (employees), and liabilities 5.3.2 Assets  tangible and intangible assets  „singular succession“ o = acquirer has to check if he has become owner of each and every assets o Problem because different transferring rules for different assets  2 conditions for transferring assets: o 1. contract o 2. “modus” = handing over the actual assets  Does the person you buy the goods from has to be the owner? o Yes, (e.g. if you buy from thief purchase = invalid) o Exception: bona fide (“good faith”) acquirer 5.3.3 Contracts  decision of parties to asset deal whether contracts shall be transferred  General contract law rule: consent of (all) counterparty necessary o e.g. existing contract with supplier  BUT modified for asset deal: counterparty’s right to object to transfer (doesn’t need consent, contracts pass until counterparty says no)  special rules e.g. for rental agreements for certain business premises  not applicable to licenses etc. 5.3.4 Liabilities  If contracts are transferred: existing liabilities pass to acquirer but vendor remains liable for 5 years only acquirer liable for new liabilities  if contracts are not transferred: liability by acquirer for existing liabilities (details omitted) 5.3.5 Summary 5.4 Share Deal 5.4.1 Deal Structure in Detail Share Deal easier than Asset Deal because there is no transferring every single asset, contracts, liabilities but rather they stay with one company and only exchange shares/money.  Acquisition of company vs. acquisition of enterprise o (example: you bought clothing firm but it operated on premises of parent company and you have no rental contracts) o due diligence necessary (=check if you received every asset)  group structure if acquirer is company o separate legal entities o no direct liability of the parent company for the debts of the new (acquired) subsidiary  o if parent company took out loan to buy shares -> can finance that loan only out of profits of target o = no direct access to subsidiary’s assets o debt-push down (= acquiring parent company tries to tie assets of subsidiary to debts) illegal bc hidden distribution  consideration: cash or shares 5.4.2 Assets, Contracts, and Liabilities  No change in owner, no change in party to contract, no change debtor -> not transferred to owner, but is still asset to subsidiary. However it gets transferred indirectly to acquirer in the business sense since acquirer holds share of subsidiary)  Usually acquirer doesn’t have to worry about if contracts pass because they stay with the subsidiary anyways and acquirer only get the shares  But contracts may include “change of control clause” (e.g. if control over company changes - > meaning more than 50% of shares are sold, the party that is in contract with the acquired subsidiary may have the right to terminate that contract) o need for due diligence review (=look at company contracts and see if there are such change of control clauses to make sure there is no problem with crucial contracts after acquisition) 5.4.3 Minority Protection in Control Transactions Who holds the shares is of interest to minority shareholders (bc majority shareholder = agent, minority=principal -> minority depends on majority)  General rule of free transferability of shares brings minority into a bind  What can they do? o contractual protection, e.g. tag-along clause -> issue of private ordering o mandatory bid rule(acquirer has to offer to buy all shares if he buys more than 30%) for companies listed on stock exchange (=if majority shareholder sells to future shareholder, others can either decide to sell their shares to the future shareholder for the same price as the majority shareholder or keep their shares) 5.5 Mergers and Divisions 5.5.1 Merger  separate legal entities merged into one  at least one ceases to exist  merger of independent businesses vs. merger within group o up-stream (subsidiary merged into parent), down-stream (parent into subsidiary), side-stream(siblings(=companies with the same parent) are merged)  domestic vs. cross-border merger How does a merge happen?  automatic transfer of assets, contracts and liabilities to recipient/acquiring company once the companies are entered in the business register o = universal succession instead of singular succession  Then one company ceases to exist Who is affected by the merge? Creditors!   Creditors o Separate pools of assets with separate creditors -> after merge, only one pool of assets and combined creditors o Good for creditors of one group, bad for the others. Why?  Assuming one company has more debt per owned asset than the other, then this percentage changes after the merge  Company A: higher debt/equity ratio  Company B: lower debt/equity ratio  After merge: debt/equity ratio somewhere in between -> advantage to company with prior higher debt/equity ratio, disadvantage to company B with prior lower debt/equity ratio  Shareholders o Issue: who gets how many shares in the merged business? = share exchange ratio o Depends on relative value of the 2 businesses o Wrong determination of relative value is detrimental for one of the two prior businesses shareholders o Merger affects also shareholders who voted against shares (probably because they think share exchange ratio was evaluated wrongly)  They can ask for reevaluation 5.5.2 Division  one legal entity divided into at least two separate ones  no cross-border division  allocation of assets, liabilities and contracts according to de-merger plan dangerous for shareholders: you owned 20% of shares before merge, then own a company B fully but this company doesn’t own 20% of the assets not dangerous for shareholders because they are still shareholders of all companies 5.6 Common Issues 5.6.1 Risk and Opportunities  Issue 1: consideration = how much money you get when you sell the business   Passing away risk of business activity o Usually risk passes once deal is closed.  Earn-out mechanism o Risk between signing and closing deal  Locked box agreement (fix purchase price when you sign – you look at value of business today instead of when closing the deal)  Leakage issue (owner of company tries to pull money out of the company between signing and closing)  To protect from that: completion account mechanism + correct factors of adjustment (set a price, and then consider what changed price)  Representations & warranties (seller promises sth -> protects from risk) 5.6.2 Autorisation Approval for acquisitions by public authorities, e.g.  Competition law  Regulated industries  Takeovers in strategic sectors (fear that Chinese take over European companies)  etc.