[*PG229]PROTECTING MINORITY SHAREHOLDERS IN CLOSE CORPORATIONS: MODELING CZECH INVESTOR PROTECTIONS ON GERMAN AND UNITED STATES LAW
Abstract: Privatization in the Czech Republic has opened the door to foreign investment. Investors, however, have been slow to invest in the Czech Republic because of its relatively weak shareholder protections. This Note analyzes the shareholder protections in the Czech Republic and suggests changes to the Czech Commercial Code based on German and United States protections for minority shareholders. Implementation of broader shareholder protections will perhaps increase confidence in the Czech Republic and stimulate foreign investment.
Investors face different legal protections depending on the state1 in which they make an investment.2 As each decision to invest requires a careful assessment of the risks involved, the protections afforded to investors—one way in which risk may be minimized—may influence where an investor chooses to invest.3 With increases in global investing4 and increases in the demand for investment in emerging econo[*PG230]mies,5 the differences among state investor protections may play a greater role in the analysis of investment risks.6
The recent privatizations in many of the former communist states of East and Central Europe provide opportunities to examine the development of investor protections and the effect such protections have on investor decisions.7 Emerging economies often look to their Western counterparts for investment and guidance.8 At the same time, Western investors are increasingly looking to emerging economies for investment opportunities.9 By examining investor protections in both emerging economies and developed economies, comparing those protections, and assessing their relative strengths and weaknesses, one may determine how emerging economies can create investment incentives by adopting stronger investment protections.10
Minority shareholders in close corporations,11 a subset of the numerous categories of investors, have received protections based on duties owed by other shareholders.12 These investors—owning only a [*PG231]small, illiquid interest in a business entity13—generally do not have the ability to control business decisions.14 As this lack of control creates additional investment risks, minority shareholders are systematically more vulnerable than other investors.15 This systematic disadvantage has prompted several states to adopt specific protections for minority shareholders.16
The Czech Republic, one of the biggest success stories in Eastern Europe,17 currently seeks to reestablish itself as a highly developed state.18 To accomplish this goal, the Czech Republic has taken several steps to make its business atmosphere more inviting to the Western business community.19 Although the Czech Republic has a skilled, inexpensive workforce,20 a strong industrial base,21 an excellent infrastructure,22 a democratic tradition,23 and proximity to both Eastern and Western markets,24 the Czech Republic still lacks the high degree of foreign investment found in Poland and Hungary.25 In order to [*PG232]stabilize its stock market and continue developing its free market economy, the Czech Republic needs to rely on foreign participation.26
This Note examines the comparative protections for minority shareholders in close corporations as promulgated by the Czech Republic, Germany, and the United States in order to understand how the Czech Republic may better protect minority shareholders and attract foreign investors. Although a full discussion of the usefulness of a comparison of Czech law to German and U.S. law follows in Part IV, it is important to note initially that the Czech Republic has already looked to Germany and the United States as models for some of its own laws, and any changes in Czech investment laws will affect Germany and the United States to some extent because the bulk of foreign investment comes from Germany and the United States. Part I discusses the transition to a market economy in the Czech Republic, forms of legal business entities in the Czech Republic, and statutory protections for minority shareholders recently enacted by the Czech Republic. This Part also discusses the structure of close corporations and minority shareholder protections in both Germany and the United States. Part II presents the investment issues unique to minority shareholders in close corporations. Part III undertakes a comparative analysis of the minority shareholder protections in the three states examined. Part IV suggests that in order to improve minority shareholder protections in the Czech Republic, the Czech Republic should adopt an amendment to the Commercial Code that will provide greater access to buyout remedies. This Note concludes that by emulating German and U.S. minority shareholder protections, the Czech Republic can develop a system of protection that is more enticing to foreign investors, maintain economic stability, and foster market growth.
The Austrian Commercial Code of 1863 governed business practice in Czechoslovakia27 until World War II.28 Czechoslovakia flourished during the time before World War II, ranking as one of the world’s most developed economies.29 The communists, following their takeover of Czechoslovakia in 1948, replaced the Austrian Commercial Code of 1863 with a nationalization scheme that eviscerated private enterprise.30 Under the communist regime, the Civil Code, the Economic Code, and the Code of International Trade, were developed.31
On December 29, 1989, the collapse of communism in Czechoslovakia ushered in an era fraught with economic, social, and political change.32 Following this collapse, Czechoslovakia faced the difficult task of determining how it would approach its goal of economic and political liberalization.33 The mere shift in political power and the introduction of a market economy were insufficient.34 In order to complete this transformation, Czechoslovak law had to restore private property rights, privatize state-owned businesses, and both stabilize and reduce inflation.35 Communist law severely limited the accomplishment of these goals.36
[*PG234] On January 1, 1992, the Commercial Code replaced the three codes promulgated by the communist regime.37 The Commercial Code was passed in order to stabilize the economy, facilitate business, and encourage investment in the emerging economy.38 The Commercial Code governs all organized business activities except for activities of state enterprises.39 The Commercial Code, according to its text, was also designed to harmonize Czechoslovak law with the law of other European countries.40
The Czechs and Slovaks could not agree, inter alia, on the pace of liberalization, and the two entities peacefully split on January 1, 1993.41 Upon the split of Czechoslovakia into the Czech Republic and Slovakia, all federal laws continued to be in effect for each state.42 Therefore, the Commercial Code, although enacted while the Czech Republic was part of Czechoslovakia, remained law in the Czech Republic.43
Throughout Central and Eastern Europe, the trend for former communist states has been to develop privatization schemes.44 Privatization is the transferal of ownership of state-owned enterprises to private parties.45 The goal of privatization is to promote economic efficiency by removing state controls and allowing more competitive producers to respond to market demands.46
The Czech Republic, pursuing a faster pace of economic liberalization than its Slovak counterpart, has sought rapid privatization of its state-owned enterprises.47 The Czech Republic’s privatization plan has [*PG235]served as a model for other East and Central European countries seeking to establish market economies.48
The Czech Republic accomplished its privatization goals through two different privatization laws.49 First, the Small Privatization Law was designed to facilitate the transfer of small state-run business to private owners.50 These businesses were sold through public auctions.51 The privatization of over 10,000 small businesses52 was completed in 1993.53 Second, the Large Privatization Law facilitated the transfer of large enterprises to private owners.54 In order to qualify under the Large Privatization Law, businesses had to submit privatization plans to the Ministry of Finance for approval.55 Although large businesses could be privatized through a direct sale,56 privatization for most large businesses was effectuated by the coupon privatization process.57
In May 1992, the Czech Republic (at that time still a part of Czechoslovakia58), initiated the world’s first mass privatization plan59 when it transferred about US$10 billion of property to the public through a coupon privatization scheme.60 The second round of coupon privatization, beginning on October 1, 1993,61 resulted in an ag[*PG236]gregate transfer of 80% of the state’s assets to the public.62 According to Tomás Jezek, Chairman of the Czech Stock Exchange Chamber, the total privatization by 1997 amounted to 90% of formerly state-owned assets, with 60% of Czech citizens63 participating in the privatization.64
The four legal business entities established by the Commercial Code are the limited liability company (spolecnost s rucenim omezeným), joint stock company (akciová spolecnost), general partnership (verejná obchodní spolecnost), and limited partnership (komanditní spolecnost na akcie).65 The limited liability company and the joint stock company are the two most common business entities.66
In a limited liability company, a shareholder is only liable for any unpaid capital.67 Each shareholder must invest at least 20,000 Czech crowns (Kc),68 and the number of shareholders is limited to fifty.69 The minimum capitalization requirement for a limited liability company is 100,000 Kc.70 A shareholder in a limited liability company may not withdraw from the company, but the shareholder may be expelled by the other shareholders.71 Limited liability companies have a flexible management structure—management may be effectuated however the shareholders determine.72
For a joint stock company, the major requirement is a net capitalization of one million Kc.73 A shareholder is not personally liable for any of the company’s obligations.74 Joint stock companies must have a supervisory board.75 Shareholders may pass resolutions with a [*PG237]simple majority vote if a quorum of 30% of the shareholders are present.76
In 1996, the Czech government introduced amendments to the Commercial Code that were designed to provide minority shareholder protections.77 These amendments were also intended to afford protections similar to other European countries.78 Effective July 1, 1996, these amendments introduced strict buyout rules in takeovers.79 At any time a takeover occurs, the person effectuating the takeover must offer to purchase the shares of the remaining shareholders for the average market price of those shares.80 This buyout remedy now affords minority shareholders an opportunity to exit the corporation.81 Furthermore, the amendments create limitations on minority shareholder squeeze-outs.82 Prior to the amendments, minority [*PG238]shareholders were subject to squeeze-outs when corporations canceled the ability to publicly trade shares or imposed restrictions on the transfer of shares.83 Due to this imposed lack of liquidity, minority shareholders were pressured to sell their shares on majority shareholders’ terms.84 The amendments now require shareholder votes to either cancel the public tradeability of shares or to impose limitations on the transferability of shares.85 If the corporation obtains shareholder approval for either of these changes, it must offer to purchase the shares of all shareholders who did not vote for the change.86
The limited liability company (Gesellschaft mit beschränkter Haftung or GmbH87) is the German form of business that meets the characteristics of a close corporation.88 The GmbH is the most common business entity89 and is governed by the Gesetz betreffend die Gesellschaften mit beschränkter Haftung (GmbH Law).90 The minimum capitalization requirement for a GmbH is 50,000 German Marks (DM).91 Each shareholder in a GmbH must contribute at least 500 DM.92
The GmbH has a flexible management structure.93 The GmbH need not create a supervisory board, and shareholders maintain ultimate authority over business matters.94 The shares of a GmbH are [*PG239]relatively illiquid.95 Shares of a GmbH—referred to in German as “business interests” (Geschäftsanteile)—may not be traded on the stock exchange.96 Transfer of shares must be effectuated by a notarial act.97 As a result of this close-corporate structure, minority shareholders in a GmbH may be vulnerable to abuse by dominant shareholders.98
Although Germany is a civil law country, both statutory and judicial remedies protect minority shareholders in a GmbH.99 These remedies provide minority shareholders with a means to regulate the conduct of majority shareholders.100 Similar to traditional remedies in the United States, the German judiciary has been granted statutory authority to dissolve a GmbH.101 The grounds for dissolution in Germany, however, are when a court concludes that a company can no longer accomplish its purposes or when it concludes that there are substantial causes (wichtige Grund) for dissolution.102 Two major downsides of dissolution, however, are the loss of the business and the loss of jobs.103
Beyond this statutory authority, the judiciary has developed two other highly discretionary remedies: withdrawal (Austritt) and expulsion (Ausschließung).104 Both of these remedies require the showing of [*PG240]a wichtige Grund.105 Neither of these remedies may be waived or restricted by the articles of incorporation.106
Wichtige Grund in a withdrawal proceeding may be established through any of the following categories: personal characteristics of the departing shareholder, behavior of other shareholders, or the existence of special factors.107 Significantly, neither fault nor exclusion from decision making are necessary to establish wichtige Grund,108 thereby making wichtige Grund broader than U.S. notions of fiduciary duties.109 The underlying premise for granting a right of withdrawal is that an individual should not be forced to stay in a long term relationship when the circumstances have “permanently and negatively changed.”110 Therefore, the breadth of wichtige Grund indicates that the withdrawal remedy will be widely available to minority shareholders.111
In order to effectuate withdrawal, the shareholder who wishes to depart must first give notice to the company.112 Next, the shareholder must obtain consent from the remaining shareholders.113 If the shareholder who wishes to withdraw does not receive consent from the remaining shareholders, the aggrieved shareholder may bring a court action seeking a withdrawal order.114 If a shareholder obtains a withdrawal right, either through consent or judicial order, that shareholder may leave the company and obtain the fair market value of his or her shares.115
[*PG241] A shareholder’s ability to withdraw from a company and obtain value for his or her interest in the company overcomes the illiquidity problem that faces minority shareholders in close corporations.116 On the other hand, a shareholder who withdraws still faces the loss of involvement with the company and the loss of future earnings.117 In these respects, withdrawal rights closely resemble U.S. buyout remedies.118
The expulsion remedy permits an aggrieved shareholder to remove the problem (i.e., the shareholder sought to be expelled) without losing his or her stake in the company.119 The ability to remove the problem without removing one’s self from participation in the corporation presents a marked contrast to withdrawal.120 Expulsion, because it is unavailable in the United States, presents the largest contrast to U.S. remedies.121 If expulsion is granted, the expelled shareholder will be required to leave the company after being paid the fair market value of his or her interest in the GmbH.122 The underlying premise for granting expulsion is that a majority position should not be carte blanche for a majority shareholder to do whatever he or she wants.123
Wichtige Grund in an expulsion action is narrower than in a withdrawal action.124 The grounds for proving wichtige Grund in an expulsion action involve only the personal characteristics of the shareholder in question and the conduct of that shareholder.125 For [*PG242]example, in a 1953 decision, the German court considered the defendant’s commission of adultery to be a relevant factor in granting expulsion.126 In that case, the court also considered the defendant’s mismanagement of funds and unauthorized purchases as factors contributing to a finding of wichtige Grund.127
The procedure for expelling a shareholder first begins with a vote by the shareholders.128 The shareholder in question, however, may not vote on the matter.129 This voting procedure makes it possible for a minority shareholder to vote to expel a majority shareholder.130 If the requisite majority of the vote is achieved, the court must order the expulsion as long as it is satisfied that there is a wichtige Grund.131 The expelled shareholder then must be paid the value of his or her holding.132
Close corporations, the most common form of business entity in the United States,133 generally have a small number of shareholders and no ready market for their shares.134 In addition, shareholders in close corporations often participate in management.135 Close corporations—often viewed as intimate relationships136—are usually formed [*PG243]by family members and friends.137 Approximately 95% of close corporations are family-owned.138
In close corporations, the minority shareholders often become employees and rely on their salaries as their return on investment.139 As the majority may control compensation and employment decisions, not only is the minority shareholder vulnerable to losing his or her investment, but the minority shareholder is often at risk of losing his or her job.140
The traditional remedy for minority shareholders has been to seek dissolution of the corporation.141 Dissolution involves the winding up of corporate affairs, selling the corporation’s assets, paying off corporate debt, and distributing the remaining capital to shareholders on a pro rata basis.142 Although viewed as a rather drastic remedy, dissolution is the most common form of relief granted to minority shareholders by state legislatures.143 As is precisely the case in Germany, dissolution in the United States is also drastic because the corporation is extinguished, along with any hope of future profits.144
Although several grounds for dissolution have been advanced by legislatures, the most common basis for dissolution has been a minority shareholder’s claim of oppression.145 Despite adoption of the term [*PG244]“oppression” by a number of jurisdictions, courts have varied with regard to what conduct they will deem to be oppressive.146
Until the 1980s, Illinois led the United States in developing the contours of oppression.147 The 1933 Illinois Business Corporation Act first introduced oppression as a basis for liquidation.148 Beginning with Central Standard Life Ins. Co. v. Davis, the Supreme Court of Illinois held that oppression did not require a finding of fraud or illegal conduct.149 Illinois courts have held that heavy-handed and arbitrary conduct on the part of another shareholder will constitute oppression for the purpose of dissolution.150 Some examples of this conduct include exclusion from control and participation in corporate affairs,151 misuse of corporate funds or assets,152 and failure to pay dividends.153 Several jurisdictions have followed the lead of Illinois decisions in recognizing broad bases for oppression.154
After the 1980s, New York led the way in developing the reasonable expectations test in order to determine whether there has been oppressive conduct.155 This development in the New York courts fol[*PG245]lowed 1979 legislation providing a buyout remedy as an alternative to dissolution.156
In re Topper, the first New York case to articulate the reasonable expectations standard, involved a one-third shareholder of two pharmacies who sought either dissolution or a buyout.157 Topper, the minority shareholder seeking judicial relief, put his life savings into the pharmacies, gave up a job in the drug business that he had held for twenty-five years, and moved his family from Florida to New York in order to participate in the business.158 Although Topper’s salary was raised from $30,000 to $75,000 during the time that he was involved with the businesses, Topper was fired after one year and was removed as an officer.159 In finding oppressive conduct, the New York court held that “the respondents’ actions . . . severely damaged [Topper’s] reasonable expectations.”160 “These reasonable expectations,” the court continued, “constitute the bargain of the parties in light of which subsequent conduct must be appraised.”161
Under New York law, the “bargain of the parties” does not necessarily mean the agreement (explicit or implied) among the founders of a corporation.162 Therefore, reasonable expectations may encompass expectations generated by subsequent events,163 shareholders who join the corporation after its foundation,164 or shareholders who are generations removed from the founders.165
[*PG246] The Court of Appeals of New York in In re Kemp & Beatley, Inc. further clarified the standard for finding oppression by holding that the expectations of an aggrieved shareholder must be both objectively reasonable and central to the decision to enter into the business venture.166 After finding that the corporation awarded de facto dividends to all shareholders except the minority shareholders, thereby preventing the minority shareholders from receiving a return on their investments, the court found that there was oppressive conduct on the part of the majority shareholders.167
The reasonable expectations test for finding oppression has been widely used in a different remedial context—judicially supervised buyouts.168 As dissolution is viewed as a drastic remedy,169 courts and legislatures have created remedies for oppressed minority shareholders that fall short of requiring the extinction of the corporation.170 Examples of alternative remedies generally include judicial action by means of an injunction or order, appointment of provisional directors or custodians, and buyouts.171 Buyouts, however, have been the focus of alternative relief.172
A buyout occurs when a court orders a corporation to purchase a minority shareholder’s interest.173 Although this permits a minority shareholder to overcome the problem of illiquidity, receive some return on his or her investment, and exit the corporation, courts have struggled with how to determine the value of the minority shareholder’s interest.174 Several complications include determining the method for valuation,175 assessing whether to discount the value because it is a minority interest,176 considering whether to discount the [*PG247]value because of the lack of a market,177 and calculating to what extent, if any, an adjustment should be made for the oppressive conduct.178
An alternative to granting remedies for minority shareholder oppression has been to award remedies on a theory of fiduciary duties owed to shareholders.179 Following the leading Massachusetts case, Donahue v. Rodd Electrotype Co., several jurisdictions have fashioned similar standards.180 Some examples of conduct that have been found to violate fiduciary duties are: selective repurchases by the corporation of its shares, terminating a shareholder/employee’s employment, violating share redemption agreements, issuing shares to change the relative control of the shareholders, and causing the corporation to favor a shareholder’s company in discharging debt.181 Although imposing fiduciary duties is a clear trend in U.S. case law,182 imposing these duties may not necessarily allow a minority shareholder to recover his or her investment and exit the company.183
Fiduciary duties—the obligations of good faith and loyalty—derive from the context of partnerships.184 Close corporations resemble partnerships because the business relationships in both are character[*PG248]ized by trust, confidence, and loyalty.185 Often, close corporations, much like partnerships, are founded by a few people who contribute not only capital, but also experience and labor.186
Donahue v. Rodd Electrotype Co., a Massachusetts Supreme Judicial Court opinion, is the leading case for establishing shareholder fiduciary duties in the close corporation context.187 In Donahue, the court imposed a duty of utmost good faith and loyalty among shareholders in close corporations.188 Euphemia Donahue, a minority shareholder in Rodd Electrotype, brought an action seeking recission of the company’s purchase of the controlling shareholder’s shares.189 After holding that “stockholders in the close corporation owe one another substantially the same fiduciary duty . . . that partners owe to one another,” the court determined that majority shareholders cannot avail themselves of the benefit of a stock repurchase without providing the same opportunity to the minority shareholders.190
The Massachusetts Supreme Judicial Court elaborated on the fiduciary duties owed to shareholders in a close corporation (often called the Donahue doctrine191) in Wilkes v. Springside Nursing Home Inc.192 In Wilkes, the court created a test for the application of the Donahue doctrine.193 If a controlling shareholder proves that there is a legitimate business purpose, the conduct will not violate the Donahue fiduciary duties unless the minority shareholder can prove that there is a less harmful means of achieving that purpose.194 The Wilkes court justified this burden-shifting approach by discussing the potential for a strict interpretation of fiduciary duties to stifle business decisions.195 Stanley Wilkes, a director and minority shareholder of the corporation, brought an action after the corporation both terminated his salary and voted him out as an officer.196 After establishing the burden-shifting standard, the court concluded that there was no legitimate business purpose for ousting Wilkes.197
[*PG249] The application of the Donahue doctrine, however, may be limited in several ways.198 First, these duties only apply to shareholders in a close corporation.199 The Donahue court defined a close corporation as having “(1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation.”200
Next, the shareholders’ relationship to each other must be similar to that of partners.201 For example, in Harris v. Mardan Business Systems, Inc., the Court of Appeals of Minnesota held that because plaintiff was an employee and not a partner, plaintiff was not owed fiduciary duties.202 The court in Harris analogized its holding to the fact that partners in a partnership do not owe employees fiduciary duties.203
Finally, and in marked contrast to withdrawal and expulsion remedies in Germany,204 these fiduciary duties may be waived by the shareholders.205 For example, in King v. Driscoll and Evangelista v. Holland, Massachusetts courts interpreted how stock purchase agreements affect fiduciary duties.206 Although the court in Evangelista held that the stock purchase agreement would not implicate fiduciary duties,207 the court in King held that when the stock purchase agreement is triggered by conduct that violates fiduciary duties, the stock pur[*PG250]chase agreement will not insulate the controlling shareholders from liability under the Donahue doctrine.208 In King, the stock repurchase agreement was triggered at the end of an employee’s tenure.209 The King court concluded that the controlling shareholder’s termination of the plaintiff was a breach of fiduciary duties.210 However, some commentators have noted that courts may scrutinize a waiver, particularly if the drafting or execution of that waiver violates fiduciary duties.211
Although several states have followed Massachusetts’ lead in fashioning protections for minority shareholders on a fiduciary duty theory,212 Delaware, a leading state in corporate law, has refused to apply these duties.213 In Nixon v. Blackwell, the Supreme Court of Delaware implicitly rejected the imposition of fiduciary duties on controlling shareholders in a closely-held corporation.214 Although the controlling shareholders in Nixon provided themselves with liquidity for their shares (through an employee stock ownership plan), the court held that the controlling shareholders did not have to provide the same opportunities to the minority shareholders.215 The Nixon court maintained that the only scrutiny of the controlling shareholders’ actions would be entire fairness.216
In close corporations, the shareholders often participate in the control of the corporation.217 Although this may afford minority shareholders considerable control over their investments, minority shareholders cannot generate opposition to majority shareholder decisions.218 Therefore, majority shareholders may elect to award themselves excessive compensation, fire minority shareholder employees, refuse to pay dividends, or engage in other self-interested activities.219 Coupling the ability of majority shareholders to control the corporation in ways that may adversely impact minority shareholders with the illiquidity220 of the minority’s shares, adds risk to a minority shareholder’s investment.221
For example, in the Czech Republic, the need for minority shareholder protections has been due partly to the control investment funds have exercised over investment coupons.222 Investment funds purchased many of the coupons held by Czech citizens in order to create large holding blocs in companies.223 Investment funds amassed nearly 75% of these coupons.224 Most striking is that the twelve largest investment funds (controlled predominantly by banks) administer 40% of the coupons.225 The investment funds may then use their majority position to force minority shareholders to sell their shares well below market value.226
Shareholders in close corporations also face the problem of illiquidity.227 Illiquidity refers to the inability of a shareholder to sell or transfer his or her interest in the corporation.228 The absence of a market for these shares is the predominant cause of this problem.229 Furthermore, a potential purchaser of a minority shareholder’s interest may be deterred because of the minority position the potential investor will inherit.230
Squeeze-outs occur when majority shareholders seek to effectively eliminate minority shareholders from either benefiting from the corporation or participating in the business.231 Some specific examples include refusing to pay dividends, granting excessive compensation to majority shareholder employees, depriving minority shareholders of employment with the corporation, and purchasing the minority’s shares at well below their value.232 A minority shareholder’s inability to control corporate decisions prevents him or her from blocking these practices.233 Furthermore, as there is minimal demand for a minority interest in a close corporation, the minority shareholder has no other means of selling his or her investment than selling at whatever price the majority will offer.234 Therefore, the lack of control and illiquidity of a minority interest in a close corporation make minority shareholders vulnerable to squeeze-out techniques.235
Many states have generated remedies for minority shareholders, but the costs of obtaining those remedies may be prohibitive.236 For example, in order to bring an action in the United States, a minority shareholder must incur the expense of filing a lawsuit and paying for [*PG253]an attorney.237 Although that minority shareholder may eventually obtain a judicially-supervised buyout of his or her shares, the benefits gained may be substantially reduced by the costs incurred and the effort expended.238
The inadequacy of enforcement mechanisms may also contribute to the risks a minority shareholder faces.239 For example, the Czech Republic has statutory protections for minority shareholders, but enforcement of those protections remains a problem.240 As of February 1, 1997, the Czech Republic was still in the process of creating its Securities and Exchange Commission (SEC) to deal with enforcement of the amendment.241 The SEC will take over supervision of trading from the Ministry of Finance.242 The SEC will also be given legislative enforcement and regulatory powers.243
Furthermore, the discretionary nature of some remedies may create uncertainty.244 For example, the broad nature of wichtige Grund in German withdrawal and expulsion remedies creates shareholder uncertainty.245 As wichtige Grund implicates personal characteristics as well as business behavior (plus other special circumstances for withdrawal actions), the myriad possibilities for demonstrating wichtige Grund create uncertainty in shareholder relationships.246
In addition, the German judiciary’s use of its discretion to achieve political ends may contribute to uncertainty.247 For example, during the Third Reich, being a Jew was wichtige Grund for expulsion.248 In 1942, two shareholders sought to expel the third share[*PG254]holder—a Jew.249 The shareholders seeking expulsion claimed that anti-Jewish laws would restrict the company’s activities because a Jew was a shareholder.250 The Supreme Court, in overturning both the district and appellate courts, concluded that Jewishness was wichtige Grund for expulsion.251 Although the practice of expelling Jewish shareholders was condemned after World War II, German courts still grant expulsion remedies.252
Finally, if a minority shareholder succeeds in pursuing a remedy, the nature of the remedy may not adequately address the minority shareholder’s loss.253 With regard to dissolution remedies, the minority shareholder receives value for his or her shares, but the business entity no longer exists.254 The profit-earning potential of the investment, along with the goodwill of the dissolved business is lost.255 For many minority shareholders, dissolution of the business entity also means the loss of a job and its accompanying salary.256
Withdrawal of an aggrieved shareholder or a judicially-supervised buyout also negates the opportunity to share in future profits, the goodwill of the business, and employment opportunities and compensation.257 This remedy permits the minority shareholder to remove himself or herself from the business entity, but the majority shareholder remains free to pursue the course of conduct that led to the minority shareholder’s withdrawal.258 Valuation of the departing shareholder’s interest also creates difficulties.259
Expulsion remedies may not be adequate because the minority shareholder must pay for the shares of the departing shareholder.260 In the event that the minority shareholder is unable to purchase the majority shareholder’s interest, the business entity will be dissolved.261
Due to the globalization of corporations and the opportunities for investment abroad, investors must consider how investment protections in foreign jurisdictions will affect investment risks.262 From the three countries described in this Note, one can see how the protections for minority shareholders in close corporations vary.263 Although the perceived return on an investment may be quite high, exposure to the risks of majority shareholder dominance may diminish the attractiveness of the investment.264
In the Czech Republic, minority shareholders are protected through the recent amendments to the Commercial Code and the expulsion rights of a limited liability company.265 The amendments to the Commercial Code permit shareholders to obtain fair market value for their shares in the event of a takeover of the business entity.266 The amendments also provide for shareholder votes whenever a corporation wishes to cancel the public tradeability of shares or limit the transferability of shares.267 If the corporation receives the requisite vote, it must then offer to purchase the shares of those who did not vote for the change.268 In addition, shareholders in a limited liability company may be expelled from the company.269 These remedies permit the business entity to continue, but do not permit the aggrieved minority shareholder to continue in the business.270 Although these remedies guarantee that the minority shareholder receives fair market value, problems of valuation and the loss of future earnings and good [*PG256]will place the departing minority shareholder in a disadvantageous position.271
German minority shareholders in a GmbH are granted several remedies: dissolution, withdrawal, and expulsion.272 The dissolution remedy prevents the majority shareholder from continuing the business, so the minority shareholder faces a proportional loss.273 Minority shareholders may even be able to continue in the business without the complications of dealing with the majority shareholder if an expulsion remedy is granted.274
In the United States, minority shareholders have been able to obtain dissolution and buyout remedies, but the basis for granting such remedies is narrower than the German wichtige Grund.275 This is because U.S. courts, unlike the German courts, refrain from looking at the personal characteristics of shareholders when determining whether remedies should be granted.276 In addition to these remedies, some courts in the United States have recognized fiduciary duties owed to minority shareholders.277 Fiduciary duties, stemming from duties owed to partners in partnerships, are unique as compared to the Czech Republic, but they may be analogous to the German concept of wichtige Grund.278 On the other hand, fiduciary duties contrast with German remedies because while fiduciary duties may be contractually waived by the shareholders, the rights to withdrawal or expulsion on the basis of wichtige Grund may not be contractually waived.279
As compared to Germany and the United States, the Czech Republic has the weakest enforcement of minority shareholder protections.280 The Czech Republic was still developing its Securities and Ex[*PG257]change Commission by mid-1997, and the introduction of statutory minority shareholder protections did not occur until 1996.281 The relative novelty of the Czech Republic’s system for enforcing minority shareholder protections results in an undeveloped and untested set of protections.282
Germany has a well-established system for granting minority shareholder remedies.283 The courts have been extremely active in this area, but the treatment of Jews during the Third Reich remains a shadow on the judicial enforcement of minority shareholder protections.284 The breadth of wichtige Grund has contributed to uncertainty in the law.285 Although judicial discretion and the broad reach of wichtige Grund permit a more flexible analysis of shareholder relationships, the uncertainty of the legal doctrine may adversely affect these relationships.286
The United States does not have a uniform system for enforcing minority shareholder protections because each state within the United States enacts its own legislation.287 Some jurisdictions within the United States, however, have developed broad bases for granting minority shareholder remedies.288 In Illinois, oppressive conduct (a basis for granting dissolution) only requires a finding of heavy-handed or arbitrary conduct.289 New York’s reasonable expectations standard (a basis for granting a buyout) allows a court to consider the bargain of the parties.290 Finally, Massachusetts fiduciary duties allow a court to probe into the good faith and loyalty of the shareholders.291 Both the number of remedies that may be available,292 and the broad scrutiny used to determine whether remedies should be granted,293 provide U.S. courts with similar enforcement power and discretion as German courts.294
The Czech Republic’s remedies do not appear to adequately protect minority shareholders.295 Although shareholders in a limited liability company may be expelled, and shareholders may seek fair market value in the event of a takeover, shareholders have no other option but to take the money and leave the company.296 Furthermore, buyout remedies are only triggered upon takeovers, cancellation of the public tradeability of shares, or limitation of share transferability.297 As the Czech Republic is trying to attract investors, particularly foreign investors, allowing only the option of expulsion or buyout removes the incentive to make the effort to invest in the first place.298 This is most contrary to one of the goals of the Commercial Code: fostering public confidence in capitalism and private business ownership.299 Czech citizens have only recently been introduced to the investment arena.300 If their first glimpses of shareholding are dominant investment funds capable of controlling business decisions and illiquid shares, they may be unwilling to enter the investment arena again.301 Foreign investors, with their numerous opportunities for investment in other countries, will seek more protective states.302
German minority shareholders appear to be adequately protected—they are afforded several remedies and a broad means through which to obtain them.303 The problem, however, is that the remedies available to minority shareholders may also be used against them.304 As wichtige Grund may be established based on personal characteristics of a shareholder, majority shareholders might try to expel a minority shareholder for one of these characteristics—being uncooperative, for example.305
The adequacy of remedies in the United States varies depending on the state in which the business entity is formed.306 In general, the major failure of remedies in the United States is that courts have been [*PG259]unwilling to expel a heavy-handed majority shareholder.307 From a minority shareholder’s point of view, either the minority shareholder can seek dissolution or a buyout (thereby losing all hopes of future profits and participation), or the minority shareholder can remain with the corporation with the majority shareholder (possibly seeking damages based on violations of fiduciary duties).308 In neither of these scenarios may a minority shareholder continue in the business without the heavy-handed majority shareholder.309
In order to alleviate some of the deficiencies of minority shareholder protections and attract foreign investors, the Czech Republic should adopt several aspects of minority shareholder protections already established by Germany and the United States.310 If German and U.S. investors look to the Czech Republic and find similar protections to those in their home states, they may feel more comfortable making an investment there.311 Increasing minority shareholder protections, therefore, may attract foreign investors and enable the Czech Republic to compete with Poland and Hungary.312
Several factors point to Germany and the United States as candidates for emulation by the Czech Republic.313 First, Germany and the United States rank first and second respectively in foreign investment in the Czech Republic.314 German investment accounts for 30% of the total foreign investment, and the United States accounts for 14%.315 Germany has already been moving capital and technology into the Czech Republic because of the low wages there.316
[*PG260] Next, the Czech Republic has already looked to Germany and the United States as models for change.317 The Czech Republic’s corporation laws closely model U.S. and German corporation laws.318 The Czech Republic planned to create its Securities and Exchange Commission partly based on the U.S. Securities and Exchange Commission.319 Furthermore, as a condition for providing much needed capital, U.S. institutions have demanded that host countries assimilate to their styles of doing business.320 According to Mr. Richard Salzman, head of the Prague Stock Exchange, “[Czechs] speak English, we take advice from Americans, but look at the map. We are going towards the German system.”321
Finally, as Germany is a dominant member of the European Union, and the Czech Republic is currently seeking admission into the European Union, emulating German standards may make transition into the European Union easier.322 Already, the Czech Republic has signed an association agreement with the European Union.323 During the term of this agreement, the Czech Republic has begun to bring its laws into compliance with European Union guidelines.324
In order to improve shareholder protections, the Czech Republic may wish to broaden the availability of buyouts.325 Currently, buyouts are only available in the context of takeovers or corporate actions to cancel the public tradeability of shares or limit the transferability of [*PG261]shares.326 In both Germany and the United States, buyouts are available when conduct of a majority shareholder becomes intolerable.327
Broadening the availability of buyouts and imposing fiduciary duties on shareholders, however, implicates a need to develop judicial standards for those concepts.328 Furthermore, the Czech Republic will have to establish a procedure for review.329 Within the past five years, both the Ministry of Finance and the Securities and Exchange Commission have played a role in overseeing the trading of shares.330 In addition to granting oversight powers to the Ministry of Finance or the Securities and Exchange Commission, the Czech judiciary could be granted a role in review.331
Although dissolution may be considered as an alternative remedy, the Czech Republic’s need to support competitive enterprises, thereby enhancing its market economy and inspiring investor confidence, may preclude this remedy.332 Upon dissolution, the corporate entity ceases to exist.333 Even with expulsion, if the minority shareholder does not have sufficient capital to compensate the expelled majority shareholder, the corporation will be dissolved.334 As the Czech Republic wants to encourage business, it may not want to introduce remedies that destroy business.335
Perhaps the most effective way to institute change will be to adopt an amendment to the Commercial Code.336 This is the means by which the Czech Republic adopted its most recent minority shareholder protections.337 As the Commercial Code governs business activities, passing an amendment to the Commercial Code to provide broader bases for buyouts is an adequate means to both protect minority shareholders and inspire investor confidence.338
Protecting investors is generally a task left to state legislative and judicial actions. The globalization of investments, however, presents an added question to these law-making bodies—how will investor protections affect foreign investment decisions? Particularly with emerging economies—economies starved for investment from developed states—this issue may impact the success of their transformations from planned economies to viable market economies. This Note has focused on one set of investor protections—protections for minority shareholders in close corporations—to see what lessons emerging economies may import from developed economies. After discussing the dearth of remedies available to minority shareholders in the Czech Republic, Germany, and the United States, this Note concludes that the Czech Republic should adopt an amendment to its Commercial Code that will provide broader bases for obtaining buyout remedies. With the implementation of minority shareholder protections derived from developed countries, such as the one suggested above, emerging economies may ease the fears of foreign investors and attract the capital necessary for economic growth.