Indirect Approaches to a Squeeze-Out

Indirect Approaches to a Squeeze-Out

Contributed by Gárdos, Füredi, Mosonyi, Tomori

July 20 2005

Company Forms and Minority Safeguards
Alternative Squeeze-Outs

There are certain situations where the existence of minority shareholders can be detrimental to a company's interests. To deal with such problems, the law may give the majority shareholders a call option right, or allow certain corporate practices which result in the reduction or elimination of the minority ownership.
Corporate squeeze-outs occur when the majority owners of a business association force minority owners to sell their stake. In theory, a squeeze-out may be achieved in two ways. First, the law may allow the majority to buy out the minority outright. Second, it may allow for the dilution or modification of the minority owners' rights by more indirect means, with the result that the minorities are compelled to sell their interest in the business association.

Company Forms and Minority Safeguards
Pursuant to the Company Act (144/1997), a member of a limited liability company (Kft) may be excluded only by a court decision, and then only if the continued membership of the member in question would seriously endanger the aims of the Kft. A member may not be excluded from a Kft if it has only two members. A shareholder of a company limited by shares (Rt) may be squeezed out only if the squeeze-out takes place as part of a public takeover procedure in a public company and meets the requirements of the Capital Markets Act (120/2001).
The Company Act also contains various safeguards against the dilution of the rights of minority members. It gives them pre-emptive rights in the event of a capital increase, and their approval is required for decisions that may adversely affect their existing rights. For example, a resolution must be passed unanimously by a Kft members' meeting in order for the Kft to:

• increase or extend the obligations of the members as set out in the articles of association;
• establish new obligations; or
• restrict special rights.

In the case of an Rt, if the shares are issued in different series, a general meeting resolution to increase or reduce the share capital is valid only if the shareholders of each series involved in the increase or reduction give their consent by at least a three-quarters majority vote.

Alternative Squeeze-Outs
Nevertheless, Rts may take certain measures to try to restructure ownership to the exclusion of minority shareholders.
One such measure is a change to the company's capital. In the case of an Rt with printed share certificates, the share capital reduction or increase from company assets may be implemented by exchanging the shares, or (in case of capital reduction) by reducing the number of shares. In either case, the board of directors must call on the shareholders to submit their shares before a given deadline. Shares not submitted are declared invalid. The company then issues and sells new shares. Once the shares have been declared invalid, the holders in question lose the rights attached to them, but receive the sum realized from the sale. The resolution on the reduction or increase of the company's capital must specify the reason for the alteration.

Another possibility is the conversion of printed shares into dematerialized shares. By the terms of the Company Act, an Rt's general meeting may decide to dematerialize shares. As part of this process, the holders of the shares which are to be converted are given notice to submit their shares. Should a shareholder fail to submit its shares by the deadline, such shares are declared invalid and the shareholding rights related to them are terminated.

A lack of resources and interest means that minority shareholders often fail to take notice of such deadlines or otherwise comply with the procedures set out by the company, and are thus divested of their shares.
The rights of minority shareholders may also be affected by a change in the nominal value of the shares. By increasing the nominal value, the number of small shareholders in the company may be reduced. Lack of cooperation between small shareholders may make a squeeze-out easier. However, as in the case of a resolution on the reduction or increase of the company's capital, there must be a valid reason for a change in the nominal value. Although the point is as yet untested in court, there is reason to believe that wishing to exclude a shareholder on business grounds (eg, in cases where the cost of shareholder notification is the same as the shareholder's contribution) would be considered a valid reason.
In the absence of court precedent, it remains to be seen whether an Rt may make legitimate and effective use of these methods to squeeze out its minority shareholders.

For further information on this topic please contact Dr Katalin Füredi or Dr István Gárdos at Gárdos, Füredi, Mosonyi, Tomori by telephone (+36 1 327 7560) or by fax (+36 1 327 7561) or by email (furedikatalin@gfmt.hu or gardos@gfmt.hu).

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