CORPORATE GOVERNANCE IN EURASIA: WHERE DO WE STAND?

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1 Gian Piero Cigna* ** 1 Sound corporate governance practices are essential for attracting investment. Evidence suggests that well-governed companies are able to raise funds at significantly lower costs than poorly managed firms. This reflects the lower level of risk for non-controlling investors. A precondition to the development of efficient capital markets is in fact that outside investors can expect insiders (managers and more often controlling shareholders) not to divert corporate assets to themselves. The law and its enforcement institutions play an important role in preventing insiders opportunism and, hence, in strengthening investors expectations. In 2005 the European Bank for Reconstruction and Development ( EBRD ) conducted a survey to test the effectiveness of corporate governance in the bank s countries of operations. The survey confirms that related party transactions remain an issue for concern in all transition countries, below what could be expected when looking at the law. KEY POINTS Related party transactions are an issue for concern in all countries in Eurasia; Only a few countries in the region offer an institutional framework providing minority shareholders with effective mechanisms to obtain disclosure of abusive related-party transactions; In case abuse is detected, minority shareholders have several avenues for obtaining redress but their effectiveness varies greatly. Laws in some countries suffer from poor implementation. EXTENSIVENESS: THE ASSESSMENT In 2004 the EBRD conducted an assessment of corporate governance legislation in the EBRD region. 2 It enquired into whether and to what extent corporate governance legisla- tion laws on the books in each of the EBRD s countries of operation complies with the Organisation for Economic Co-operation and Development ( OECD ) Principles of Corporate Governance and reported an uneven situation. In Eurasia, 3 Kazakhstan 4 was found to have the best compliance rating, followed by Armenia and Moldova. Mongolia, Uzbekistan and the Kyrgyz Republic showed problems on disclosure. In the latter, amendments to the Law on Joint Stock Companies in 2003 and 2004 have improved the corporate governance framework. However, problems relating to the protection of minority shareholders remain. Georgia, Azerbaijan, Ukraine 5 and Tajikistan were found to have corporate governance legal frameworks in urgent need of reform. EFFECTIVENESS: THE LEGAL INDICATOR SURVEY Laws on the books are all-important, but especially in transition countries there can be a gap the so-called implementation gap between the rights the law grants on paper and the actual Quality of Corporate Governance on the books in Eurasia Kazakhstan Armenia Moldova Mongolia Krygyz Republic Uzbekistan Georgia Azerbaijan Source: EBRD 2004 Corporate Governance Assessment. Note: the chart shows the compliance of national legislations with the OECD Principles of Corporate Governance. Ukraine Takijistan 494 Butterworths Journal of International Banking and Financial Law December 2006

2 possibility of enforcing those rights or of otherwise having them respected. This is especially true with corporate governance, where usually small, unorganised or anyhow not well-connected investors deal with controlling shareholders (or managers) who are among the most powerful individuals in the country. In order to fully assess corporate governance it is therefore essential to look at whether and how the law (in this context, mainly corporate law) works in practice. This implies a focus both on the legal actions available to outside investors, ie minority shareholders, and on the institutional environment features that may affect their outcome. The Legal Indicator Survey ( LIS ) conducted in the second half of 2005 financed by the Italian government focused on the effectiveness of corporate governance in the EBRD countries of operations: instead of looking at the law on the books, it aimed to assess how the law works in practice by taking the perspective of a minority shareholder wishing to find out whether the controlling shareholder abused its control power and, having ascertained abuse, to obtain redress. A hypothetical case study see Box 1 was developed in order to find out how well minority shareholders of both an unlisted and a listed corporation fare in the context of a typical conflict-of-interest situation between controlling shareholders and outside investors: when the controlling shareholder enters into a sale contract with the corporation and therefore stands on both sides of the transaction. The LIS focus is therefore on self-dealing, which is widely held to be the central problem of corporate governance in most countries. 6 The survey s scope broadly coincides with the EBRD s area of operation. In total, the survey covers 28 EBRD countries of operations. 7 This article focuses on the findings in Eurasia. METHODOLOGY The methodology employed in the 2005 LIS followed on from the successful methodology used in previous years for EBRD Surveys. 8 These involved working with leading law firms in the EBRD region. 9 These law firms were presented with two broadly similar hypothetical case studies involving a related party transaction. In the first case study Alfa Ltd is an unlisted company, controlled by Beta Ltd with 76 per cent of the shares, while the minority shareholder Gamma Ltd. owns the remaining shares. In the second case Alfa Ltd is a listed company, with Beta Ltd owning a 56 per cent controlling stake, Gamma Ltd owning a 12 per cent minority stake and 32 per cent of the capital floating on the market. 10 In both cases, the damage suffered by Alfa Ltd from the transaction was quantified at 2m. In this scenario the minority shareholder is faced with two problems: first it has to find out whether indeed the transaction was entered into and under what terms. Second, once this has somehow been ascertained, it has to obtain some form of redress through a private action in court or otherwise. BOX 1 THE CASE STUDY 100 % 100 % SUBSIDIARY OF BETA HOLDING LTD BETA HOLDING LTD Mr Beta ALFA MANAGEMENT 100 % BETA LTD SALE AT 5 DISCOUNT Foreign Investor ALFA LTD 100 % GAMMA LTD The joint stock company Alfa Ltd is a leading firm in a given country. Its registered seat and headquarters are located in the main business centre within that country. Alfa is co-owned by two companies: Beta Ltd is the controlling shareholder with a 76 per cent stake. Beta Ltd is owned by an influential business leader also controlling Beta Holding Ltd, one of the main conglomerates in the region. Gamma Ltd is an investment vehicle set up by a foreign investor, and owns a 24 per cent stake. Alfa s board of directors is composed of three members, all appointed by Beta. Two of them also sit on Beta Holding s board. Following an anonymous tip-off from an employee, Gamma has reason to believe that Alfa s directors have sold Alfa s property to a Beta Holding subsidiary at a 50 per cent discount on its fair value. According to the company s charter, such transactions (ie transactions where a director has, directly or indirectly, a conflicting interest and whose value exceeds a given amount) are to be approved by the shareholders meeting. Gamma is asking his lawyer s advice on what can be done in order to: determine whether the transaction has indeed been entered into; possibly restore the status quo ante (eg challenge the validity of the transaction); obtain damages relief for Alfa; obtain damages relief for Gamma; punish Alfa s directors and the majority shareholders behaviour (eg criminal sanctions, disgorgement of profits etc). Butterworths Journal of International Banking and Financial Law December

3 An extensive questionnaire was designed to find out how effective each country s legal system is in protecting the minority shareholder s interests in the circumstances outlined above. The questionnaire was sent to the law firms together with the case studies and law firms were asked to respond to it as if they were advising the minority shareholder on how best to protect its rights and preserve the value of its financial investment in the local company. The questionnaire focused on three main areas: (i) the mechanisms by which the minority shareholder can find out whether the transaction had indeed been entered into ( disclosure ); (ii) the tools for redress ( redress ); and (iii) the institutional environment in which such disclosure and redress tools have to be used. With regard to the first two areas, respondents were asked to provide information on the legal tools available and to assess their effectiveness in terms of speed, enforceability and simplicity. With respect to institutional environment, they were asked to assess a number of institutional features influencing enforcement of corporate governance law provisions and standards (eg, competence of courts and financial market regulators, availability of previous case law, presence of arbitration bodies specialised in business law etc). 11 THE VARIABLES Measuring the effectiveness of a legal mechanism is a difficult exercise. Several variables are to be taken into account and most of them involve subjective judgments by the respondents. The following have been used as measures for the effectiveness of disclosure and redress mechanisms. Speed is the most straightforward factor. With regard to disclosure, it refers to the average time between the initial filing of proceedings with the court and the issuance of an executable court order as assessed by the respondents. In redress cases, it spans the period from the initial filing of the proceeding to the issue of a court s executable judgment, again taking into consideration an appeal by the defendant, and as assessed by the respondents. Simplicity relates to the smoothness of proceedings and also takes into consideration the guidance offered by judicial precedents in interpreting the law. More precisely, respondents were asked to assess how clear, simple and straightforward the proceedings relating to the available actions are. Enforceability relates to the carrying out of the executable judgment in cases where the other party fails to implement it, and extends far beyond corporate governance. Respondents were asked to assess how smooth the procedure to enforce a judgement favourable to the minority shareholder and to obtain the desired outcome would be. The institutional environment relates to the capability of a given legal framework to provide the basic guarantees that are needed for the legislation to be effectively implemented and enforced. It includes a number of factors: with regard to disclosure, consideration was given to the perceived reliability of company books, the requirement to have the corporate financial information audited, the presence of the Big Four auditing firms in the country, 12 and the perceived independence of statutory auditors. With regard to redress, consideration was given to the perceived degree of competence and experience of courts and prosecutors, the availability of up-to-date legislation, the ease with which the defendant can delay the proceedings and the perceived influence that might be exercised on courts and prosecutors by a powerful defendant. With regard to both disclosure and redress, the 2005 Corruption Perception Index elaborated by Transparency International 13 was also taken into account. RESULTS The findings of the survey are necessarily limited and must be treated with caution. First, they reflect the views of a limited number of practitioners for each country. 14 Secondly, they address a very specific set of circumstances and must be considered within the boundaries of the case studies. Thirdly, assessing effectiveness is by necessity far more difficult and subjective than finding out what the law on the books states in a given country, as one has to deal with hard-to-measure variables such as courts competence, simplicity of procedures, ease of enforcement and so on. DETECTING DOMINANT SHAREHOLDERS WRONGDOING The first part of the analysis focuses on how a minority shareholder might find out whether a related-party transaction has indeed been entered into by the company s management on the assumption that the majority shareholder controls the board and no disclosure of the transaction is spontaneously provided to the minority shareholder. Disclosure is one of the key pillars of an effective corporate governance framework. 15 In the context of related party transactions, disclosure is usually analysed in terms of an obligation to inform the board and/or shareholders and/or the public at large about such transactions. 16 Since the LIS is about effectiveness of the legal framework for corporate governance as opposed to its extensiveness, the case studies assumed that, whatever the disclosure obligations in place, no disclosure had been given on the transaction to the relevant bodies, as is often the case when assets are siphoned off from a company by its dominant shareholder. Therefore, the questionnaire focused on the tools available to minority shareholders who have reason to suspect that a self-dealing transaction has been entered into and on how effective they are in the perception of the respondents, according to the criteria highlighted above and to their overall judgment on how likely it is that by using those tools the minority shareholder in the case study can succeed in detecting wrongdoing. For this purpose, the questionnaire listed six legal tools that may help a minority shareholder find out about whether a self-dealing transaction has been entered to: inspecting Alfa s books and other corporate documents; requesting information from the company s auditor; requesting an independent audit; requesting the court to appoint an independent auditor; requesting the court or another public body to have an administrator appointed; calling a special shareholder meeting to question the company s management. Respondents were free to add other actions that they would advise the minority shareholder to take. As the LIS reveals, only a few countries offer an institutional framework providing minority shareholders with effective mechanisms to obtain disclosure. In many countries, minority shareholders face substantial problems and their actions can be easily blocked by majority shareholders. 496 Butterworths Journal of International Banking and Financial Law December 2006

4 Specific action: Accessing reliable company documents Minority shareholders can request access to company books and documentation in most of the countries in Eurasia. 17 In Azerbaijan, this shareholder s right is clearly granted by the law. In case of obstruction by the company, shareholders can petition the court and obtain an executable judgment in about one year, but enforcement can then be an issue. When access to documentation is granted, finding the sought information can still be problematic as company books and annual reports are considered reliable only for a significant minority of companies. In Uzbekistan minority shareholders can review contracts entered into by the company and have access to bank statements. In case of obstruction by the company, shareholders can refer to court also summoning the internal auditor, who can be required to produce all relevant corporate documentation. The action should not take more than a month and is relatively simple. However, the effectiveness of the whole proceedings can be undermined by the bias of courts and auditors, especially towards powerful defendants. In Moldova, only annual reports are available in practice and corporate information is in general deemed not to reflect the real financial status of companies. When requesting the company or the court to access accountancy books, the procedure can be complex, lengthy and difficult to enforce. In Tajikistan, art 70 of the Civil Code grants shareholders the right to examine books and other documentation in the manner stated in company s founding documents. This avenue is considered complex and difficult to enforce, especially in case the founding documentation is not detailed on the procedure to follow. Specific action: Questioning the company s auditor This action is available in Armenia, Azerbaijan, Kazakhstan, the Kyrgyz Republic and Mongolia. The venue is usually the general shareholders meeting, where the company s documentation is discussed and approved. In Azerbaijan, the action is only available in theory, as auditors must first obtain the consent of the company s management which is very unlikely in the case study under analysis in order to disclose any information to shareholders. In the Kyrgyz Republic the procedure is deemed rather simple and enforceability is not deemed a major problem. 18 The time needed to obtain disclosure is usually limited to a few months, but several factors can delay the procedure to over two years. 19 Unfortunately the weak institutional environment poses doubts as to the effectiveness of the action. In Mongolia, the Company Law requires the auditor to prepare a report including a list of conflict of interest transactions concluded by the company and to confirm their compliance with the requirements set by the law. Questioning the company s auditor would then be possible at the shareholders meeting, but is limited to the content of such report. In case of refusal, a shareholder can petition the court. Here proceedings are deemed fairly clear and simple in terms of law, but substantial problems can arise, especially if the company refuses to collaborate. Specific action: Requesting an independent audit An ad hoc independent audit is generally considered the best action to obtain disclosure. In Eurasia, this avenue is possible in Armenia, Azerbaijan, Kazakhstan, Kyrgyz Republic, Moldova, Mongolia, Ukraine and Uzbekistan. In Armenia it is considered the most effective among those available. The procedure is simple and enforceability poses no particular problems. The time needed for obtaining an executable order is generally limited to less than a year. Only the quality of auditing might be an issue as the presence of international auditing firms is very limited. In Mongolia and Ukraine shareholders having more than 10 per cent of the company s shares can request a special audit and, to the extent that the auditor is denied access to the company s books, can file a claim to the court to force the company to collaborate. Unfortunately in both countries the procedure is not clearly provided by law and enforceability might be difficult. In Uzbekistan, minority shareholders can appoint an auditor and request the court to force the company to collaborate. The procedure is considered simple and the executable court decision is obtainable in around 40 days and it is not subject to appeal. Enforcement is also reported as smooth, even in the absence of the defendant s collaboration. The company s statutory auditor can be forced to produce all the company s documentation and be prosecuted in case of obstruction. Specific action: Consider an extraordinary shareholders meeting In all countries in Eurasia except Moldova, 20 a minority shareholder has the right to request a general shareholders meeting to question the management s action. In Armenia it is not difficult to have a general meeting called, but all decisions are taken by majority vote, leaving little room for minority shareholders. In the Kyrgyz Republic, shareholders owning at least 20 per cent of the company s shares can request a shareholders meeting, but the request has to be accepted by the company s board of directors. Although the law clearly limits the grounds for rejection; it is likely that the board will strongly oppose the request. In such a case, the only option available to shareholders is to start a legal battle, which might be quite complex and last for years. In Ukraine and Uzbekistan, local practitioners considered this action particularly effective when minority shareholders already have some evidence of the unlawful transaction. In this case the enforcement will be easier, as the management will be faced with specific questions and the threat of criminal liability in the case of refusal to provide specific answers to the questions posed. In Tajikistan shareholders meetings can be called by shareholders owning more than 10 per cent of the company s shares. However, the action is considered ineffective due to the possibility of the majority shareholder blocking eventual actions and questioning at the meeting. Other possible actions Amongst other avenues available to obtain disclosure, it is worth mentioning the situation in Armenia, where a minority shareholder with a 24 per cent stake has, by virtue of law, the right to nominate a representative on the board of directors. It is, however, doubtful whether the minority shareholder would gain access to such information, due to the board s fiduciary duty to the company and not to the shareholder appointing them. Butterworths Journal of International Banking and Financial Law December

5 In practice, however, this mechanism allows greater control over a company s operations and might discourage unethical behaviour by controlling shareholders. PARTICULAR NEEDS FOR IMPROVEMENT The survey revealed that obtaining disclosure is an issue in all countries in the region. Even in case access to relevant documentation is granted, finding the sought information can be difficult: The major problems evidenced are the lack of independence of statutory auditors and the reliability of corporate documentation. Requesting intervention of the court in case of obstruction by the controlling shareholder is generally possible, but enforceability of the decision is reported difficult in several instances. REDRESS MECHANISMS Once an abusive related-party transaction has been detected, the legal framework must offer effective mechanisms to obtain redress. Local practitioners were asked to indicate what legal remedies were available to the minority shareholder in the case study scenario. A menu of possible remedies was listed in the questionnaire. The following civil remedies were the main focus of attention: challenge to the validity of the transaction (ie rescission); liability suit against the company s directors on behalf of the company (ie a derivative suit); direct liability suit against the company s directors for damages incurred by the minority shareholder; liability suit against the company holding the majority stake (and/or its subsidiary on the other side of the transaction and/or its directors) on behalf of the company; direct liability suit against the company holding the majority stake (and/or its subsidiary on the other side of the transaction and/or its directors) for damages incurred by the minority shareholder; action against the counterpart to the transaction to obtain the disgorgement to the company of the profits made out of the transaction. Respondents, again, were free to add further remedies. The questionnaire also enquired into whether enforcement mechanisms other than before civil courts were available (ie criminal prosecution, national or international arbitration, and for case two only action before the securities regulator and the stock exchange). Once again, practitioners were free to add further remedies. For each of the remedies the usual questions on availability, speed, simplicity and enforceability were made. Respondents were also asked to assess the costs of the legal remedy they deemed to be most effective. More specific questions were also asked with regard to civil and criminal actions. GENERAL SITUATION In general, it can be observed that in all Eurasian countries minority shareholders have several options for legal action. Unsurprisingly, however, the effectiveness greatly varies from action to action and from country to country. The institutional environment for redress is deemed weak especially in Armenia, Azerbaijan and Tajikistan. Proceedings are considered complex in Ukraine and enforceability is a problem, especially in Armenia, Moldova, Mongolia and Tajikistan. The average time needed to conclude the proceedings varies from a few months in Uzbekistan to more than two years in the Kyrgyz Republic. In this respect, it should be noted that in all countries the first instance judgment may be subject to appeal which could suspend enforcement, thereby further delaying the action. Specific action: Challenge the validity of the transaction Only in Georgia filing a request to render the transaction void is not provided by law. The procedure is deemed simple in Azerbaijan and Uzbekistan. Enforceability is reported as a problem in Armenia and Tajikistan, while the time needed for concluding the action varies from a few months in Uzbekistan to more than one year in the Kyrgyz Republic and Ukraine. In Armenia, the effectiveness of the action is limited by the complex burden of proof required of the plaintiff. Minority shareholders have a duty to provide evidence that the other party was in full knowledge of the conflict of interests. Moreover, even in case of a positive court decision, enforceability remains an issue and obtaining the restitution of the property can be difficult. In Kazakhstan and Ukraine this avenue is considered the best among those available, but enforcement of the decision can turn out to be very difficult and the procedure quite lengthy. In Tajikistan the Civil Code provides the ground to render the transaction void, but the action is complex and, in addition to the difficulties with collecting evidence, the limited competence and experience of judges in the economic courts should be considered. In Uzbekistan, the clarity of the law in stating that a relatedparty transaction should be invalidated leaves no discretion to the court if the plaintiff is able to provide evidence of the transaction itself. An executable judgment should be available in less than four months but it is reported to be relatively easy for the defendant to delay the proceedings. Specific action: Derivative suit against the company s management This procedure presupposes the presence of specific provisions allowing a shareholder to represent the company in a legal action against the company s management. In Eurasia, the action is not deemed possible in Armenia, Azerbaijan, Georgia, Kazakhstan and Ukraine. In Moldova, the Law on Joint Stock Companies provides for the right of shareholders holding more than 10 per cent of the company shares to file a derivative suit. However, the procedure can turn out to be complex due to the limited use of this suit and the difficulty of securing evidence. Effectiveness of enforcement is dependent on obtaining the conservation of assets by the court. An executable judgment should generally be available in less than one year, but it is reported to be easy for the defendant to delay the proceedings. Courts are not very experienced in corporate law cases and can be biased in favour of a powerful defendant. In Tajikistan the action is possible but difficult to enforce due to the lack of specific law enforcement proceedings and the limited resources available to court executors. 498 Butterworths Journal of International Banking and Financial Law December 2006

6 In Uzbekistan this avenue is not reported to be particularly effective as Uzbek courts might lack the sophistication to conduct a thorough investigation with respect to a party s liability and might not be sufficiently independent to issue a fair judgment. This could render the procedure complex and enforceability a problem. Specific action: Direct Liability suit against the company s management This avenue is available in all Eurasian countries. In Azerbaijan, consultants rated this action as relatively effective, although the procedure can be complex. Enforceability is usually not a substantial problem and the time needed to conclude the action limited to 18 months. Major obstacles can be the ease with which the defendant can delay the proceedings and the bias of courts, especially towards a powerful defendant. In Kazakhstan proving the causal link between damages and directors actions and the directors fault is deemed a very difficult task. Furthermore, even in case of a favourable court decision against the directors and/or the company, enforcement is quite problematic. In Moldova the action can be started based on the general provisions of the Civil Code and on the fiduciary duties of the members of the board. However, the effectiveness is limited by the complexity of proceedings and the weak institutional environment. In Ukraine the complex procedure and the difficult enforcement seriously weaken the effectiveness of this avenue. OTHER ENFORCEMENT MECHANISMS The effectiveness of corporate governance mechanisms depends not only on courts but also on other public enforcement institutions and on private enforcement institutions such as arbitration courts and stock exchanges. 21 It may further be positively affected by the functioning of other informal types of pressure on insiders behaviour, 22 such as that exerted by the media or shareholders associations, especially when listed companies are involved, or by embassies, in cases involving foreign investors. Arbitration As an alternative to actions before the court, local practitioners were also asked to assess the availability and effectiveness of national and international arbitration procedures according to the same variables considered above. In order to assess the extent of the availability of arbitration, respondents were also asked whether a provision in the company s charter would suffice to start arbitration proceedings or whether instead an agreement among the disputing parties would be necessary. The survey revealed an uneven situation throughout the region. In Uzbekistan all disputes between national entities are settled by the courts. International arbitration is only available where one party is foreign and a specific agreement between the parties is concluded. In Moldova arbitration is considered relatively effective, although proceedings can be quite complex and the enforceability of the award problematic. In Tajikistan arbitration is theoretically possible but practically unrealistic. In case international arbitration is held outside the CIS, the arbitration award is not enforceable in Tajikistan. Action before the market regulator In Armenia, Georgia and Uzbekistan the action is not considered very effective. Enforceability of the market regulator s decision is considered smooth in Georgia, the Kyrgyz Republic and Mongolia, while it can be difficult in Kazakhstan. The length of the procedure is an issue, especially in Armenia, the Kyrgyz Republic, Moldova, Mongolia and Uzbekistan. The procedure is held to be simple in Moldova and complex in Armenia, Georgia and Uzbekistan. In Tajikistan there is no market regulator. SUPPORT TO THE ACTIONS Finally, the questionnaire asked whether the plaintiff should consider other support mechanisms to their actions. In Georgia, Moldova, Mongolia and Ukraine, a media campaign was considered to be a good support for the action, with particularly high ratings in Ukraine. Requesting support from the national embassy remember that our minority shareholder was a foreign investor was considered helpful, especially in Azerbaijan, Mongolia, Ukraine and Uzbekistan. In none of the countries was support from a shareholder association judged to be helpful. HOW MUCH DOES IT COST TO OBTAIN REDRESS? With regard to the redress mechanisms, practitioners were also asked to assess the expected costs of the legal action they deemed to be most effective to obtain redress. A few questions were also designed in order to find out about the rules on attorney s fees in shareholder suits. Especially in publicly held companies, the prospect of having to pay one s attorney s fees and possibly even the winning defendant s fees provides a great disincentive to shareholder suits. Ideally, as it happens in the US and in Japan, a shareholder should be able to bring a bona fide suit before a court with no out-of-pocket expenses. Otherwise, bringing action against insiders wrongdoing will imply a risk of loss most shareholders will be unwilling to bear. Hence, shareholder suits in countries with rules other than the ones in place in the US and Japan (ie in most states in the survey and even in continental Europe) will rarely challenge insiders behaviour in court, and laws protecting minority shareholders will be under-enforced and hence less effective. Estimating legal costs is a difficult exercise, as it depends on a number of circumstances, several of which are unpredictable. Bearing this in mind, the survey compared the estimate of legal and administrative fees with the damage suffered by the plaintiff. As a result legal costs were estimated in a range from 2 per cent in Georgia to more than 15 per cent in Azerbaijan. The survey further evidenced that administrative fees are particularly high in Ukraine (11 per cent) and the Kyrgyz Republic (15 per cent). According to the LIS survey, only in Moldova would an agreement between a law firm and a plaintiff, according to which the latter will owe the firm no fees in case of rejection of the action, not be considered valid and consistent with the bar s ethics code. In Azerbaijan, Kazakhstan, Kyrgyz Republic, Moldova, Tajikistan and Ukraine the plaintiff must pay for the other party s lawyers fees if they lose the case and the defendant must pay for the plaintiff s lawyers fees if they lose the case. Butterworths Journal of International Banking and Financial Law December

7 In all countries in the region in case of an action for damages, lawyers are allowed to agree with the client a share in the damages awarded. Finally, class actions 23 are available only in Georgia and the Kyrgyz Republic. CONCLUSIONS The LIS confirms that related-party transactions remain an issue for concern in every country in the region. The degree to which minority shareholders can obtain effective disclosure or redress is limited, and well below what could be expected when looking at the laws. Disclosure and redress are inextricably linked. This is because an action for redress can only be initiated when evidence is secured. The assessment reveals that requesting a general shareholders meeting is the most common action provided by law to minority shareholders, but it is unlikely to produce any disclosure when the company is controlled by a powerful shareholder. In case of obvious misconduct, criminal proceedings are available by law in all countries in the region, but the vast majority of contributing practitioners expressed serious doubts as to the experience and competence of prosecutors in corporate cases. When comparing extensiveness and effectiveness, it is interesting to note that countries that scored relatively high in terms of extensiveness (like Armenia and Moldova) fare worse in terms of effectiveness. This confirms that even excellent laws can suffer from poor implementation, which undermines the usefulness of legal provisions and diminishes the confidence of foreign investors in the legal system as a whole in particular, in its ability to uphold contractual rights. Most transition countries need to upgrade their commercial laws to standards that are generally acceptable internationally. Even more importantly, they must make those laws fully effective, particularly through strengthening their court systems, tackling corruption and adopting appropriate measures to strengthen the rule of law. * Gian Piero is the corporate governance and capital markets specialist in the EBRD s Legal Transition Team. Prior to joining the EBRD he worked in Belgium, the Netherlands, Italy, Albania, Romania and the Czech Republic both as a lawyer in an international law firm and as consultant to international organisations and various state institutions. In the Czech Republic he worked as Pre Accession Advisor to the Ministry of Justice and the Czech Securities Commission for the approximation of the Czech legislation with EU standards. Gian Piero, an Italian national, is qualified at the Italian bar. He graduated in law in Italy and attended postgraduate studies in the Netherlands and US. He is currently working on different projects on corporate governance in Eurasia and the Balkans. Publications include several essays on corporate governance, capital markets and banking law, most recently with a focus on eastern Europe and central Asia. CignaG@EBRD.com *** Counsel, European Bank for Reconstruction and Development (EBRD). EFFECTIVENESS OF CORPORATE GOVERNANCE IN EURASIA Armenia 10 5 Azerbaijan 10 5 Georgia 10 5 Kazakhstan Butterworths Journal of International Banking and Financial Law December 2006

8 1 The paper expresses only personal opinions. Substantial contributions for this paper were provided by Prof Luca Enriques University of Bologna. 2 The assessment was financed by the government of the United Kingdom. The assessment results are available on assess/index.htm. The assessment refers to legislation in force on 30 September For the purpose of this article, the following EBRD countries of operations have been considered: Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Mongolia, Tajikistan, Ukraine and Uzbekistan. 4 The principal legislation dealing with corporate governance in Kazakhstan is the Law on Joint Stock Companies ( JSC s), which was enacted in May 2003, replacing its predecessor law of The 2003 law was last amended in July 2005 in order to improve the system of state regulation of JSC activity and the protection of shareholders and investors rights. Kyrgyz Republic Moldova Mongolia 10 Tajikistan Ukraine Uzbekistan Note: The graphs show disclosure (D) and redress (R) in Eurasia. The average results from the case study scenarios are shown. Disclosure refers to a minority shareholder s ability to obtain information about their company. Redress refers to the remedies available to a minority shareholder whose rights have been breached. Institutional environment refers to the capacity of a country s legal framework to effectively implement and enforce corporate governance legislation. refer to the expenses a minority shareholder must pay to take legal action. The extremity of each axis represents an ideal score: the fuller the web, the better the corporate governance framework. Butterworths Journal of International Banking and Financial Law December

9 5 With an aim to improve the Ukrainian corporate framework, the Civil Code and the Commercial Code came into force on 1 January 2004, substantially amending the existing legal framework. Among the various novelties introduced, it is worth mentioning the possibility of a physical person setting up a JSC, the introduction of new rules concerning compulsory reduction of capital and the exclusive power of the general shareholders meeting to change the company charter and authorised capital. The latter provision abrogates the previous authority of the management board and/or of the supervisory board to decide on the increase of capital and is a clear improvement in corporate governance rules. Furthermore, the introduction of the possibility for shareholders representing 10 per cent of company capital to request an external audit on the company is another important improvement in minority shareholders protection. Notwithstanding the positive impact that the reform may have, the beneficial effects might be hindered by problems related to its application. Sometimes the new provisions are in conflict with one another and a difficult interpretation exercise should be performed in order to understand which provision prevails. Taking into consideration the special nature of the new Commercial Code, it might be concluded that, in case of conflict, its provisions supersede the new provisions introduced by the Civil Code, but the uncertainty is not beneficial to the rule of law and might cause increased litigation. 6 See Simeon Djankov, Rafael La Porta, Florencio Lopezde-Silanes & Andrei Shleifer, The Law and Economics of Self-Dealing, mimeo, 2005, 34 (emphasis in the original). Djankov et al s paper similarly devises a case study involving a self-dealing transaction and uses responses from practitioners in a number of jurisdictions to analyse the treatment of self-dealing transactions across the globe. 7 The EBRD countries of operations are 29, geographically divided in three regions: Central Europe and the Baltics ( CEB ): Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic and Slovenia; Southeastern Europe ( SEE ): Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Montenegro, Romania and Serbia; Commonwealth of Independent States ( CIS ): Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Mongolia, Russia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan. For the LIS, data on Turkmenistan was not available. 8 The results of previous Legal Indicator Surveys are available on the EBRD website: LIS on insolvency ( lis/index.htm) and LIS on enforcement of charges ( 9 Among others, the following law firms contributed to and supported the 2005 LIS: Studio Legale Tonucci (Albania and Romania); Chadbourne & Parke LLP (Azerbaijan, Belarus, Kazakhstan, Kyrgyz Republic, Russia, Ukraine and Uzbekistan); Advokat (Bosnia and Herzegovina); Spasov and Bratonov Lawyers Partnership (Bulgaria); Wolf Theiss (Croatia, Montenegro, Serbia and Kosovo); Linklaters (Czech Republic, Poland and Slovak Republic); Luiga, Mugu & Borenius (Estonia); Mgaloblishvili, Kipiani, Dzidziguri Law Firm (Georgia); Ormai es Tarsai CMS Cameron McKenna (Hungary); Sorainen Law Offices (Latvia); Lideika, Petrauskas, Valiunas & Partners (Lithuania); Law Office Polenak (FYR Macedonia); Turcan & Turcan (Moldova); Lynch & Mahoney law offices (Mongolia); Colja, Rojs & partnerji o.p., d.n.o.i. (Slovenia) and Akhmedov, Aziziv & Abdulhamidov Attorneys (Tajikistan). 10 For those countries where there is no active stock exchange, Alfa Ltd was to be considered a large opentype company with numerous minority shareholders. 11 The questionnaires were sent out and answers received in the second half of Before treating the data, a number of additional questions and requests for clarifications were sent to the respondents in order to clarify their answers. In some cases conference calls were held with local practitioners. 12 The underlying intuition is that the presence of the Big Four is a proxy of the quality of the audit profession. Cf. OECD, Corporate Governance in Eurasia: A Comparative Overview, 29 (underlying the importance of having well-trained accountants for a country s corporate governance); Bernard S Black, The Legal and Institutional Preconditions for Strong Securities Markets, 48 UCLA L Rev 781, (2001) (including [a] sophisticated accounting profession with the skill and experience to catch at least some instances of false or misleading disclosure among the core institutions that control information asymmetry and hence among the preconditions for strong securities markets). 13 See 14 In some instances, one single practitioner within the leading law firms to which the questionnaire was sent answered the questionnaire, in others it was a team of practitioners. 15 See OECD Principles II and V. 16 See eg Djankov et al, supra note This action is not available in the Kyrgyz Republic and Ukraine. 18 In the Kyrgyz Republic an internal auditor is legally obligated to answer to shareholders, but an external auditor would be legally obligated only by an agreement between the shareholder and the external auditor. 19 The timetable may be affected by the schedule of the judge; absence of the plaintiff; a requirement for additional expertise; or the death of a witness or party to the proceedings. 20 In Moldova the minimum shareholding for calling a general meeting is 25 per cent of the company s shares. 21 See E Berglöf and S Claessens, Enforcement and Corporate Governance (September 2004), World Bank Policy Research Working Paper No. 3409, com/abstract= Ibidem. 23 Defined broadly as a lawsuit brought by one or more plaintiffs on behalf of a large group of others who have an identical claim (e.g. an action filed by one shareholder on behalf of other shareholders as well). 502 Butterworths Journal of International Banking and Financial Law December 2006