For tax reasons, international joint ventures are often structured by using a Dutch private limited liability company. As such, the joint venture company is governed by its mandatory articles of association. Besides the articles of association, the joint venture partners (shareholders) usually also enter into a separate joint venture or shareholders’ agreement to regulate the affairs of the joint venture and the obligations of each shareholder. Such agreements do not necessarily need to be governed by Dutch law, but can be governed by the laws of any jurisdiction. Regardless of what law governs the joint venture agreement, recent Dutch case law shows that shareholders can be forced to dilute.
Over the years, the provisions related to additional financing of joint venture companies have received more attention. The main reason for this development is that additional financing other than third-party financing can result in a shift in control over the joint venture company. Each joint venture party requires protection against the dilution of its position in cases where the joint venture company requests an increase in the equity capital. To achieve this, a qualified majority for decisions on the issue of new shares is often required according to the joint venture agreement (and the articles of association). This means each shareholder can control whether or not the capital of the joint venture company will be increased. It could be the case that additional financing is required and a shareholder blocks the required decision-making process because it is unable or unwilling to participate. This is a dilemma for the management of the joint venture company and the company could become deadlocked. On the one hand there is an existing shareholder that wants to avoid dilution of its interest in the joint venture company (based on the joint venture agreement) and on the other hand there is a shareholder that is willing to provide additional capital, but only if the non-participating party dilutes.
As with most legal disputes, disputes between joint venture parties are often about money and are ones that could easily lead to litigation. So when joint venture parties have a dispute on the additional financing of the joint venture company, the joint venture agreement provides no (clear) solution for the situation and the parties fail to otherwise reach an agreement on this matter, the possibility exists that legal proceedings will be initiated.
Enquiry proceedings may set aside foreign law joint venture agreements
Dutch corporate law allows, in short, that, inter alia, a shareholder holding at least 10% of the issued share capital, or shares with an aggregate nominal value of €225,000, to request an investigation into the affairs of the BV (besloten vennootschap – a Dutch private limited liability company) with the Enterprise Chamber of the Amsterdam Court of Appeal (the Enterprise Chamber). In addition, certain injunctions can be requested on the presumption that the outcome of the investigation will be that mismanagement of the BV occurred. If the Enterprise Chamber shares the view that the BV was mismanaged, it may order the implementation of injunctions.
The request for an investigation and injunctions is open for any 10% shareholder from any jurisdiction. As a result, specific dispute resolution provisions set out in a joint venture agreement, governed by the laws of a non-Dutch jurisdiction, do not prevent a Dutch court from ordering injunctions affecting the Dutch joint venture BV. Recent case law shows that the measures of the Enterprise Chamber can have an immense impact on the joint venture partners: forced dilution.
Recent case law: forced dilution
A Dutch joint venture company – a Dutch private limited liability company – has several shareholders. The company has one majority shareholder (59.5% of the shares) (shareholder I) and several minority shareholders, including a shareholder with 30.2% of the shares (shareholder II). Shareholder II also provided a loan to the company.
The company is in financial difficulties, partly as a result of the insolvency of an affiliated company to which the company has provided several loans. As a result of the financial difficulties, the company is unable to repay the loan of shareholder II.
The board of managing directors and the board of supervisory directors of the company investigated solutions for the financial situation. Shareholder II turned out to be willing to provide additional funding by converting part of its outstanding loan into shares in the company. The suggested issue of shares would, however, result in the dilution of the shareholding of shareholder I to 11.89% of the shares. The shareholding of shareholder II would increase to 86.04% of the shares. This scenario was supported by all stakeholders of the company, except for shareholder I.
As the issue of shares requires a resolution of the general meeting of shareholders of the company, a general meeting of shareholders was convened. At the meeting, shareholder I voted against the conversion and the consequent issue of shares to shareholder II. Shareholder I based itself on the joint venture agreement that contained a provision that shareholder I would at all times remain the majority shareholder. As a result, the proposal was dismissed, the financial difficulties continued and the company remained deadlocked.
As the situation of the company became more urgent and no sound alternative solutions to save it were available, an inquiry procedure was initiated before the Enterprise Chamber, and provisional arrangements were requested. The view of the Enterprise Chamber was that the company would go bankrupt in the event that no action was undertaken and that the conversion of the loan of shareholder II into new shares appeared to be an adequate measure to solve its financial difficulties.
The Enterprise Chamber ordered an investigation into the management and affairs of the company and ruled that, by way of immediate provision, the management board of the company was authorised to issue the new shares to shareholder II for the conversion, without the need for a resolution of the general meeting of shareholders to that effect and disregarding the pre-emption rights of the other existing shareholders of the company.
Shareholder I appealed against the decision of the Enterprise Chamber. The Supreme Court, however, confirmed the decision of the Enterprise Chamber.
Consequences
Although the Enterprise Chamber allowed ‘emergency funding’ in earlier rulings by authorising the management of a company to issue new shares, the recent case law goes one step further as, in this case, the pre-emption right of the existing shareholder is being excluded, while in earlier cases the existing (majority) shareholders had the opportunity to participate and as such avoid dilution of their shareholding. The exclusion of the majority shareholder from the funding leads de facto to ‘expropriation’: you could end up with a smaller shareholding in a Dutch joint venture company.
Remedies
Understandably shareholders want to be protected against dilution of their shareholding. The question is how to create sufficient protection against dilution.
Protection can be created in various ways – at least on paper. A shareholder could get a position provided for in the articles of association of the joint venture company that provides decisive influence on the adoption of the required resolutions. There are also several contractual options that explicitly provide protection against dilution. One such option is the obligation of (certain) shareholders to transfer their shares to another shareholder so that its shareholding remains at a certain level. As extra protection, voting agreements resulting in the blocking of resolutions for dilution can be included in the joint venture agreement. Some additional alternatives include working with various classes of shares, the issue of preference shares and providing shareholder loans.
With the recent case law in mind, however, it cannot be ruled out that specific circumstances arise that whatever protection has been created, the protection could be circumvented by the Enterprise Court. The one thing that could really help – also based on the recent case law – is very simple: proper drafting of the relevant clauses in the joint venture agreement, taking Dutch law consequences into account, also in the event that such agreement is not governed by Dutch law.