How to expel disloyal shareholder from private company in Latvia

In both, Latvian and foreign, jurisdictions private or limited liability company (in Latvian – sabiedrība ar ierobežotu atbildību [SIA]) is defined as a company for which the basis is mutual loyalty between shareholders. However, over time, as a result of the dishonest action of one or more shareholders of the SIA, which is incompatible with the objectives set by the shareholders when establishing and investing in the company, loyalty between partners disappears and conflicts arise. Such problem situations are often solved by bringing legal action in court regarding expulsion of the shareholder from SIA in accordance with Article 195 of the Commercial Law. As the Supreme Court has pointed out in its recent judgment "neither the company nor its shareholders need to bear a shareholder who does not only fulfil his duty of loyalty, but has also caused significant harm to the company by his actions, and it is possible that he would harm hereafter" (see paragraph 7 of the judgment of the Department of Civil Cases of the Supreme Court of the Republic of Latvia, dated January 31, 2018, No. SKC-34/2018).

In practice, the expulsion of a shareholder from the company and the subsequent transfer of shares to the company has proven to be an effective way of solving conflicts between shareholders and, at the same time, a way to protect their investments. Article 195 of the Commercial Law, which in the terms of content has been taken over from the Commercial Law of Estonia, is quite laconic and for a non-lawyer it even seems to be rather unclear. However, in legal doctrine and jurisprudence there are few conclusions that must be taken into account when assessing the prospect of potential claims for expulsion of shareholders.

As provided in Section 195, paragraph one of the Commercial Law, the ground for expulsion of a shareholder from SIA is the non-fulfilment of its obligations without an excuse or other significant harm to the company’s interests. Filling of this indeterminate concept of law with content is left to the law doctrine and case law, therefore it is not possible to exhaustively list all cases that would qualify as a harm defined in Section 195, paragraph one of the Commercial Law. However, it is recognized that company’s shareholder causes harm to the company’s interests if, for example, he uses the intellectual property of the company in the interests of another company, carries on a commercial activity using a similar company name or trademark, provides information about the company to its counterparties that adversely affects the company’s reputation or that leads to the refusal by the counterparties of further cooperation or other activities contrary to company’s interests (J. Jurkāns. Requirements for expulsion of a shareholder – practice and issues (Prasības par dalībnieka izslēgšanu – prakse un problēmjautājumi). Jurista vārds, dated 13 July 2013, No. 27/28 (778/779). Available at: http://www.juristavards.lv/doc/258081-prasibas-par-dalibnieka-izslegsanu-prakse-un-problemjautajumi/). In this regard, it is important to emphasize that the basis for expulsion of a shareholder may also include the actions (action or omission) of a shareholder that he has performed while being a member of the Management Board of the company. Accordingly, his action as a member of the Management Board also falls within the scope of Article 195 of the Commercial Law. Consequently, a shareholder may be expelled from the company if, for example, he has misused the company's financial resources for his own purposes, made unreasonable costs, falsified the Shareholders’ Register, sold company's property at a lower price than the market price, provided guarantees on behalf of the company for his personal obligations etc. Such circumstances may be the basis for civil liability of the member of the Management Board for the loss suffered by the company, as well as basis for shareholder’s expulsion of the company. It is important to emphasize that both claims, for harm from a member of the Management Board and expulsion from the company, can be included in one claim and examined within one civil law case.

In addition to the fact of harm, claimant must also prove the materiality of the harm. Court practice does not offer a single mathematical approach or formula for the calculations. It should be understood that the loss of EUR 10,000 for a small company caused by a shareholder may be fatal and lead to insolvency, however for a company with a turnover of several tens or even hundreds of millions of euros it may not significantly affect its business activities. For example, when the counterparty waives cooperation with the company, significance of a loss can be demonstrated by reliable calculations, which show that the company is expected to experience a significant drop in turnover or the increase of turnover will not be possible.

Finally, we must look at who is the person claiming shareholder’s expulsion. As provided in Section 195, paragraph one of the Commercial Law, a shareholder may be expelled from SIA on the basis of an action by the company. On the one hand, such wording of the law indicates that unilateral conduct in bringing an action is inadmissible, even though the shareholder owns more than 50% of the share capital. At the same time, in practice, uncertainty has arisen from not very successful wording of the Section 195, paragraph two of the Commercial Law, according to which the claim may be brought by shareholders representing not less than half of the company's share capital, if the Articles of Association does not provide a requirement of a higher number of votes. In this regard, in the legal doctrine it has been clarified that the Section 195, paragraph two of the Commercial Law does not confer permanent rights of claim to a shareholder or shareholders, but it is fundamentally understood as the need to adopt a decision of a meeting of the shareholders on bringing an action against the shareholder in accordance with Section 210, paragraph one, clause 7 of the Commercial Law (J. Jurkāns: Requirements for the expulsion of a participant - practice and problem issues. (Prasības par dalībnieka izslēgšanu – prakse un problēmjautājumi.)) Therefore, in order to prevent the court from leaving the company's claim without consideration, it is recommended in practice to convene a meeting of the shareholders and to adopt a decision on the expulsion action against the respective shareholder. In addition, it should be emphasized that this shareholder is not entitled to participate in voting regarding this decision in accordance with Section 211, paragraph two, clause 2 of the Commercial Law.

by Aivars Lošmanis, Partner, Latvia

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