On 16 December 2016, the EU's committee of permanent representatives (COREPER) approved an agreement between the Slovak presidency and the European Parliament representatives regarding the amendment of the Shareholder Rights Directive (2007/36/EC) (“the SRD”).
The adoption of this final agreement by the Council and the European Parliament is expected to follow soon. It will mark the end of a lengthy process which started in April 2014 with the Commission releasing its proposal for an amending directive.
Having addressed longstanding controversial issues like a say on pay for directors’ remuneration, it was rather surprising to see the proposal be mostly criticised for its new regulations regarding related party transactions for listed companies. Inspired by the British FCA Listing Rules, the Commission had proposed a regime on related party transactions which would have been inconsistent with the existing position in many continental European jurisdictions.
The final version of the directive is evidence of the protracted agreement process, as it leaves Member States far more discretion in the way they can transpose the directive. However, a few aspects of the upcoming Art. 9c SRD regulating related party transactions are also surprisingly strict.
The key elements are:
1. “Related party” has the same meaning in the directive as in IAS 24. Although not explicitly stated, one can also expect the term “transaction” to be used in accordance with this accounting standard, meaning that Art. 9c SRD will cover a broad range of transactions. As such, it was necessary to allow Member States to exclude transactions that do not pose a real risk of potential abuse (see point 5 below).
2. Art. 9c only affects “material” transactions, which can be defined by the Member States based on quantitative ratios. Non-material transactions with the same related party are aggregated in any 12-month period. Member States may set different materiality thresholds for different company sizes and procedural safeguards.
This approach has proven effective in jurisdictions like the UK, where FCA Listing Rule 11 only applies to transactions when one of the ratios resulting from the application of class tests is greater than 0.25 % (see LR 11.1.6 (1) and paragraph 1 of LR 11 Annex 1). However, by not setting the quantitative ratios for the materiality threshold, the European legislator leaves the decision to Member States as to whether they want to enact a strict regulatory regime or merely a protection against the most substantive related party transactions.
3. Material transactions must be publicly announced by the time of their conclusion, with the announcement containing all relevant information for outside shareholders to decide whether the transaction was made on fair and reasonable terms.
In contrast to the initial proposal by the Commission, Member States only may provide that a fairness report accompanies the announcement. This is remarkably lenient, as a thorough fairness report by a third party would be very useful for less sophisticated shareholders to decide whether the transaction is fair, especially if they must approve it (see 4).
4. In addition to the disclosure provisions, material transactions must be approved by the general meeting and/or the administrative or supervisory body of the company. In principle, related parties are excluded from the approval process. However, Member States may allow related shareholders to take part if they are not able to outvote the majority of outside shareholders or independent directors. In a case where related shareholders hold 60 % of the voting rights, for example, they may be entitled to vote in the general meeting if the majority threshold is at least 80 %.
The approval procedure has been the most controversial aspect in the legislative process, since the Commission initially wanted to provide for a mandatory vote by the general meeting as in the FCA’s Listing Rule 11. This would have been detrimental to the existing regulatory frameworks in many continental European countries, which are far more board-centred than in the United Kingdom (see Enriques (2014) and Troeger (2014)).
The alternative board approval mechanism currently provided is however a weak safeguard: By not excluding representatives of the related party from the voting process (as the European Parliament had previously proposed), the EU relies on the Member States to set procedures which “prevent a related party from taking advantage of its position” (Art. 9, para. 2 SRD). In this regard, the directive is unnecessarily vague, creating the potential its intended restriction of the voting power of related parties to be circumvented.
5. Transactions in the ordinary course of business which are concluded on normal market terms are excluded from the directive’s requirements. The administrative or supervisory body of the company is only obliged to establish a periodical assessment of their customariness and fairness. In addition to this important exemption, Member States are given the option to exclude or allow companies to exclude several types of transactions according to paragraph 4 of Art. 9c SRD.
The paragraph lists a variety of transactions that are unlikely to be used as a means of misappropriation, such as those which national law requires shareholder approval for anyway, which are already regulated by the say-on-pay provision in Art. 9a SRD, or which are offered to all shareholders on the same terms.
One of the surprising outcomes of the negotiations between the EU institutions is the lack of an exemption for corporate groups that many German scholars and practitioners insistently called for (see, for example, the the BDI/DAI position from 12 November 2015). Instead, only transactions with subsidiaries that are wholly-owned, in which no other related party has an interest or when national law provides for adequate alternative protection may be excluded. The new regime, therefore, fully applies to transactions between listed subsidiaries and their parent company, even if there is an alternative system of compensation like the German Enterprise Agreement (see sections 291-307 of the German Stock Corporation Act).
6. In order to avoid circumvention of the new regulations, the disclosure requirements (see 3) also apply to transactions between a company’s subsidiaries and a related party. The level of protection is however lower, since the approval requirements do not apply.
How will these new regulations affect national laws?
In the model jurisdiction for the new regime, the UK, there will be no need to change the existing strict regime on related party transactions set out in LR 11. Jurisdictions like Italy, which modernized their protection against abusive related party transactions over the past two decades, will also hardly be affected by the directive’s requirements.
When it comes to Germany, however, fitting the requirements into the laws of corporate groups will be a challenging task. In its new rules the EU retains a transaction-centred approach to protect the interests of shareholders within corporate groups. Alternative approaches that allow greater flexibility in balancing the interests within corporate groups like the French Rozenblum Doctrine are rejected by the directive.
Considering the substantial leeway national legislators are given in Art. 9c SRD, the directive will certainly not lead to a uniform regulatory regime for related party transactions throughout Europe. However, one can expect Member States to transpose the new rules more ambitiously than other European endeavours. The markets closely watch the regulatory level of investor protection and in its Doing Business Reports, the World Bank Group rigorously reviews and ranks the regulations of related party transactions around the world. When it comes to related party transactions, laissez-faire is not an option anymore.
Andreas Tarde is a Research Fellow at the Institute of German and European Corporate and Business Law, University of Heidelberg, Germany. In Michaelmas 2016, he was a Junior Academic Visitor at the Commercial Law Centre.