Finland: Exit Finland

By Tarja Wist & Mårten Knuts of Waselius & Wist

The current market situation has made a successful exit challenging. With initial public offerings down to zero, public take-overs, trade sales or even forced exits due to financial distress have become reality. Especially forced exits from joint ventures put the legal structure of the joint venture to the test.

General trends

Finland was long considered something of an investors’ backwater. In the latter part of the 1990’s, the foreign investment and the venture capital market, however, experienced substantial growth, partly riding on the wave of information technology. The booming growth of investments slowed down during the autumn of 2000. The economic downturn raised the previously unknown issue of exiting in times of bad weather, and due to the bearish stock markets, investors found themselves left with rather few opportunities of successful exits.

The reluctance of investors and the backlash of their interest for the stock market have narrowed out the opportunity of exiting through the previously preferred initial public offerings. On the Helsinki Exchanges the year of 2003 is yet to experience its first initial public offering, which obviously is very unsatisfying for investors who were aiming at walking away with a substantial winning from their investment. However, a glance onto the current trends of the stock market might reveal some light at the end of the tunnel as the market has shown some weak signs of recovery throughout Europe. The "Baghdad bounce" in the stock markets points to signs of recovery and although the market is still "far from rosy" experts see moderate growth after multiple years of austerity. Adding to that the fact that quite a few target companies have had a significant time to prepare for initiating a successful initial public offering, it is, hopefully, with some recovered confidence investors seeking to exit can look ahead on initial public offering opportunities.

In times of low tide on the initial public offerings market, a public take-over or a trade sale is often considered the second best alternative to exit. With decreasing values of the target companies, naturally, doors open for both public take-overs and trade sales. On the Helsinki Exchanges, many listed companies still have large single shareholders, assessing the market for a successful possibility to exit by being the target in a public take-over. Shareholders in the form of private equity investors, banks, insurance companies, but also original founders of the companies, who have listed their ventures, as well as the government, are keen to attract outside investors to initiate public take-overs.

An especially challenging exit appears when the investor is forced to exit due to financial distress. Financial hardships leading to an administration order, bankruptcy or other forms of insolvency of the investor put the legal structure created by the investor to the test as the barking creditors of the investor forcing it to exit attracts vultures to the carcass to profit on the remainder of the investor’s share in the target company.

An even more challenging exit is at hand if the investor aiming to exit merely is the minority shareholder in the company. In such a case it is not unusual that the former joint venture party, often the most likely purchaser of the stake at hand, is the one seeking to benefit the most from the forced exit. In its capacity as shareholder of the target company, the joint venture party usually holds current and accurate information on the target company. Based on this information the former joint venture party always has a head start on other prospective purchasers when assessing the price of the target company and placing a bid on the shares of the target company subject to sale.

Moreover, as the contractual arrangements between the shareholders in their joint venture often contain a redemption clause in the Articles of Association or the shareholders’ agreement of the target company, the other shareholder of the target company is many times properly equipped to effectively avert a smooth sales process. This can be done by refusing to waive the pre-emption right regarding the shares subject to sale and simultaneously blocking the exiting shareholder’s right to information on the target company, and moreover, by blocking the decision to let prospective purchasers perform a customary due diligence review of the target company. Thus, by effectively reducing the flow of information, even to the extent that only information which can be found in public domain is available for prospective purchasers, the former joint venture party, with the intention to benefit from the forced disposal, will be looking at cutting off a significant part of the bid from the outside prospective purchasers, thereby, setting the scene for pre-empting the shares subject to sale for an off market price.

However, the exiting investor needs not necessarily play along, as there are some remedies which can be pursued pursuant to the Finnish Companies Act (the "Companies Act") regulating (i) the transparency between the shareholders and the target company, (ii) the basis on which the Board of Directors must make their assessment on allowing prospective purchasers to perform a due diligence review of the target company, and (iii) the liability of the members of the Board of Directors of the target company, which liability can be upheld by a court, should the members of the Board of Directors act against the Companies Act.

As a rule, Finnish law treats a company and its shareholders as separate legal entities with separate assets, rights and obligations. Also intangible rights, know-how, and other confidential information are held to belong only to the party possessing them, therefore, the shareholders not having direct access to them, save as expressly provided by law.

Pursuant to the Companies Act, shareholders of a company with more than ten (10) shareholders, do not have a general right to receive confidential information or to review the company’s documents or receive copies thereof, except for the right to have answers to questions raised in the General Meeting of Shareholders on circumstances that may affect the assessment of the annual accounts or the financial position of the company.

In companies with ten (10) shareholders or less, however, each shareholder has the right to review the company’s documents and book-keeping to the extent the information contained therein may affect the assessment of the company’s Annual Accounts and economic position or other matters to be considered in the General Meeting of Shareholders. The above right may be exercised in connection with the General Meeting of Shareholders or otherwise, although it is limited to matters to be considered in the General Meeting of Shareholders. This right is further limited in case the disclosure of the information in question, in the opinion of the Board of Directors, would be likely to cause essential impediments to the company. Information, which, therefore, potentially would not be disclosed, may be expected to include, e.g., information that the company has undertaken to keep confidential, as well as sensitive market information.

The above right would apparently render some comfort to a shareholders forced to exit from a joint venture, as, to the above extent, a limited seller’s due diligence review could be performed in order to assess the current value of the shares of the target company subject to sale.

Under the Companies Act it is for the Board of Directors of the target company to approve that a due diligence review of the target company may be performed by a prospective purchaser. As with any resolution by the Board of Directors under the Companies Act, the Board of Directors of the company in performing its activities is bound by general provisions on liability set out in the Companies Act. Thereunder, the Board of Directors shall act with so-called "objective diligence", meaning a degree of care and diligence that objectively and reasonably could be expected of a person in the same position and situation (bonus pater familias). When assessing the level of objective diligence observed by the Board of Directors, at least the following should be analysed: (i) whether the Board of Directors has acted in compliance with the relevant provisions of laws, (ii) whether the Board of Directors has acted in accordance with generally accepted practice and (iii) whether the Board of Directors have acted in the interest of the company. It should be noted in this connection that the interest of the company is not limited, for example, to the interests of any particular major shareholder.

The Companies Act provides for a general principle of equality between the shareholders of a company. It cannot be outruled that the disclosure of information for the purpose of a due diligence review may in certain cases provide certain shareholders a benefit on the expense of other shareholders. However, the benefit of a due diligence review is generally neither only directed to a certain shareholder, nor is the due diligence review performed on the expense of the other shareholders or the company itself. In particular, in case of private companies not subject to public trade, the disclosure of information for the purposes of a due diligence review could rarely be considered a breach against the provisions of equality. On the contrary, if the majority shareholder is ultimately aiming at purchasing or pre-empting the shares of the target company subject to disposal, and by doing so benefiting from the Board of Directors’ resolution not to approve prospective purchasers to perform a due diligence review on the target company, arguably, it can be held that such resolution by the Board of Directors inevitably treats the exiting shareholder unequally compared to the shareholder aiming at purchasing or pre-empting the shares. By blocking the resolution to let a prospective purchaser perform a due diligence review of the target company, the Board of Directors favour the purchasing or pre-empting shareholder on the expense of the exiting shareholder, as such resolution generally must be held to reduce the price offered for the shares of the exiting shareholder. This could be considered as treating the exiting shareholder unequally compared with the other shareholder earning the possibility to purchase or pre-empt the shares for an off-market value.

Also in relation to the interest of the target company, a general aim of which the Board of Directors is bound by, it can be argued that the performing of a due diligence review by a prospective purchasers is a generally applied part of a transaction of acquiring the target company or shares therein. As a solid owner structure is a prerequisite for an effective development of the target company, and therefore in the interest of the target company, it is in the interest of the target company to allow a solid prospective purchaser to perform a due diligence review. The importance of a solid owner structure, and therefore a due diligence review, is naturally enhanced in case the exiting shareholder of the target company is in financial distress. Consequently, in light of the standard of objective diligence required from the members of the Board of Directors a resolution to grant access to a due diligence is standard procedure likely to be in the interest of the target company.

Under the Companies Act, as referred to above, the members of the Board of Directors act under personal liability for the damage caused by negligence or wilful misconduct both (i) to the company itself and (ii) to the shareholders of the company and third parties. In respect of the liability to the shareholders and third parties, this is only applicable upon a breach of the Companies Act or the Articles of Association of the company. Therefore, a resolution to block (i) the above shareholder’s right to information concerning the company or (ii) to hinder the prospective purchaser to perform a due diligence review, which would be against the principle of equality under the Companies Act, could cause the members of the Board of Directors of the company to be held liable both towards the company itself and towards the shareholder aiming at exiting the company. As always, such a liability is to be determined by a court of law, and it is therefore premature to elaborate on the probability of the success of such a liability claim in Finland.