Estonia: Amendments to the Estonian Commercial Code

On 1 January 2006 extensive amendments to the Estonian Commercial Code (hereinafter: CC) entered into force, which inter alia deal with the foundation of a company; the principles regarding the general meeting of shareholders of a company and meetings of the management board and the supervisory board; the liability of members of management bodies; remuneration of members of management bodies; the pledging of shares of a private limited company; and the procedure for transformations, divisions and mergers of a company.

Below is a brief summary of several of the key amendments of the CC effective as of 1 January 2006.

An important change in the procedure for registering pledges of shares of private limited companies creates a risk that pledges that were attached to shares prior to January 1, 2006 may be terminated. The risk arises if the share subject to the pledge is transferred to a third party who in good faith assumes the shares are not subject to a pledge.This concerns all persons who have assigned a pledge to a share of a private limited company or whom a share of a private limited company has been pledged to before 1 January 2006, if these shares are not registered with the Estonian Central Registry of Securities.

Understanding the change in procedure for registration of pledges makes this more clear. According to the previous wording of Article 151 (5) of the CC the private limited company had to be notified of all pledges of shares. The management board was obliged to make a note of the encumbrance to the list of shareholders within three days as of the receipt of such notice, and after this the acquisition of the share in good faith – free of the pledge – was not possible. According to the new wording of the second sentence of Article 151 (2) of the CC, now pledging is done through a notary public. The notary public is obliged to notify the registrar of the commercial register of the pledging of a share. As of the 1 January 2006 the acquisition of a share in good faith is now possible according to Article 151 (5) of the CC if the purchaser of the share proves that notice of the right of pledge had not been submitted to the registrar of the commercial register and that the purchaser did not know of nor should have known of the pledge. According to Article 151 (5) of the CC the right of pledge is terminated with the acquisition of the share in good faith.

Since the amendment act to the CC does not include implementing provisions, which would stipulate that the acquisition in good faith is only possible regarding pledges assigned after 1 January 2006, it must be assumed that the regulation of Article 151 (5) of the CC applies to all rights of pledge, including such rights of pledge, which were assigned before 1 January 2006. Notaries were not obliged to notify the registrar of the commercial register in the form indicated in the second sentence of Article 151 (2) of the CC of rights of pledge assigned before 1 January 2006. Hence there is a risk regarding all pledges assigned to shares of a private limited company before 1 January 2006 which have not been registered in the Estonian Central Registry of Securities, that if the share encumbered with a pledge is transferred to a person after 1 January 2006 who in good faith assumes that the shares are not pledged, the right of pledge is terminated according to Article 151 (5) of the CC. The acquisition of a share in good faith can only be avoided by notifying the registrar of the commercial register ex post facto according to the second sentence of Article 151 (2) of the CC.

It is possible that in the event of a dispute,a court would rule that the new regulations with respect to pledging and transfer of shares in good faith does not apply to rights of pledge assigned before 1 January 2006. At the same time, it is not certain that the court would accept the argument that this would be an appropriate interpretation of the law.

The law does not directly regulate how the registrar of the commercial register should be notified ex post facto of the rights of pledge assigned before 1 January 2006. The notaries do not have an obligation stemming from the law to notify the registrar of the commercial register of pledges assigned before 1 January 2006. In order to avoid the termination of the right of pledge it is suggested to reach an agreement with the notary that certified the original pledge agreement in order for the latter to submit the notice of encumbering a share with a pledge to the registrar of the commercial register regarding the pledge assigned before 1 January 2006 in the form stipulated by the Minister of Justice on the basis of the second sentence of Article 151 (2) of the CC.

The amendments to the CC include significant changes in the legal regulations regarding members of the management and supervisory boards of a company. The most significant amendments with respect to this are described below:

• As of 1 January 2006 upon re-electing members of the management or supervisory board an application must be submitted to the commercial register to modify the entry regarding the members of the management and supervisory board of a private limited company or public limited company (Art. 33 (7) of the CC). This means that an entry application has to be submitted even if the person specified in the entry of the commercial register does not change. If the respective application is not submitted and the authority of the members of the management board has passed for over two years, there is the risk that the court may commence compulsory dissolution on its own initiative (Art. 203 (1)2) and Art. 366 (1)3) of the CC).

• As of 1 January 2006 members of the management board of a subsidiary public limited company or a subsidiary private limited company may not be also a member of the supervisory board of a parent public limited company or a parent private limited company (Art. 318 (4) of the CC). Since the CC does not stipulate transitional periods then in such case the member of the management or supervisory board should be removed from one of the aforementioned positions.

• The procedure for remuneration of members of the management and supervisory board of public limited companies and private limited companies has been amended. As of 1 January 2006 it is possible to reduce the agreed or assigned fees of members of the management or supervisory board without their consent if the continued payment of the fees would be unfair towards the company due to the deterioration of the economic situation of the company (Art. 180.1 (3) and (4), Art. 314 (3) and (4), Art. 326 (3) and (4) of the CC). At the same time the rights and obligations of the members of the supervisory board and management board are not affected by the reduction of the fee. They do, however, have the right to cancel the agreement entered into by them giving one month advanced notice.

• As of 1 January 2006 the right of a member of the management or supervisory board of a public limited company or a private limited company to resign from the management or supervisory board with good reason has been explicitly stated in the law (Art. 184 (7), Art. 309 (5), Art. 319 (7) of the CC).

• The liability of members of the management and supervisory board has been clarified in an innovative manner. As of 1 January 2006 members of a management or supervisory board may be liable to the company if they do not fulfil their obligations with the due care of a diligent entrepreneur (Art. 187 (1), Art. 315 (1), Art. 327 (1) of the CC). Based on prior Supreme Court practice wherein the Supreme Court has specified the obligation of diligence of members of the management board, it may be concluded that a member of the management or supervisory board acting with the due care of a diligent entrepreneur conforms to at least the following minimum criteria – careful, sufficiently informed to make decisions and does not take unnecessary risks to the company (Supreme Court judgment number 3-2-1-41-03).

• As an update, beginning with 1 January 2006 the management board of a public limited company has an obligation to carry out an internal audit to discover circumstances, as early as possible, which may jeopardize the activity of the public limited company (Art. 306 (7) of the CC).

In addition to the above mentioned amendments regarding management and supervisory boards we find it necessary to draw special attention to the following updates in the CC effective as of 1 January 2006:

• According to the new wording of the CC, a public limited company has the right to apply for an entry of a pre-emptive right in the Estonian Central Registry of Securities (hereinafter: ECRS), to ensure that the pre-emptive rights stated in the articles of association are realized in practice. If an entry has been made, the disposal of a share after the making of the entry will be null and void to the extent to which it infringes or limits the performance of the pre-emptive right (Art. 229 (2.2) of the CC). According to the previous wording, making an entry in the ECRS was possible, but the entry did not provide such legal effects. The ownership of a share could be transferred regardless of the pre-emptive right of other shareholders. If the ownership of the share was transferred, the shareholders with a pre-emptive right only had the right to claim for compensation (Supreme Court judgment 3-2-1-145-05).

• As of 1 January 2006 it is allowed for private limited companies and public limited companies to pay dividends to shareholders more than once a year (Art. 157 (1) and Art. 277 (1) of the CC). In addition, as of 1 January 2006, if stipulated in the articles of association, the management board of a public limited company may, with the consent of the supervisory board, after the ending of the financial year and before the approval of the annual report, carry out advance payments to shareholders on the account of forecast profits in the amount of up to a half of the sum that may be distributed between shareholders (Art. 277 (3) of the CC). Such an update has not been made regarding private limited companies.

• As of 1 January 2006 the CC imposes liability when a person abusing his influence over a public limited company has influenced a member of the management of supervisory board or procurator to act to the detriment of the public limited company (Art. 289.2 CC). In this case the person asserting the influence, the influenced member of the management or supervisory board or procurator, as well as persons who benefited from the detriment are all liable.

• According to the new wording of the CC, members of a supervisory board not present at a supervisory board meeting may participate in the vote by submitting their vote in a form that can be reproduced in writing, for instance by e-mail (Art. 322 (2.2) of the CC).

• The regulations regarding the procedures of the general meeting of shareholders of a public limited company have also been amended:

• when giving notice of the general meeting the invitation must be sent in a manner that it reaches the addressee by the date stipulated by law (Art. 294 (3.1) of the CC). Before the amendment, this requirement stemmed from Supreme Court practice (Supreme Court judgments number 3-2-1-13-99, 3-2-1-6-03);
• if a public limited company knows or should know that a shareholder’s address differs from that entered into the share register, the notice of a general meeting of shareholders must be sent additionally to that other address (Art. 294 (3.1.) of the CC);
• in the notice for summoning the general meeting of shareholders a proposal of the supervisory board must be submitted regarding each matter in the agenda (Art. 294 (5) of the CC);
• changes in the agenda must be notified of according to the same procedure and by the same term as when sending the notice for summoning the general meeting of shareholders (Art. 294 (6) of the CC);
• the names of shareholders entitled to participate in the general meeting of shareholders is designated according to the status present 10 days prior to the general meeting of shareholders (Art. 297 (5) of the CC).

• As of 1 January 2006 a resolution of the meeting of shareholders, general meeting of shareholders and supervisory board is null and void, if it infringes a provision stipulated for the protection of creditors or other public interest or it does not comply with good morals, or if the legal procedure for summoning the meeting that passed the resolution is violated (Art. 177.1, Art. 301.1 (1), Art. 322 (7) of the CC). In addition to the aforementioned a resolution of the general meeting of shareholders of a public limited company is also null and void if the protocol of the general meeting adopting the resolution has not been notarised when so required by the law. The law also provides for other grounds of nullity.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.