Shareholders v. Managers. Conflict in Priorities in Supreme Court Jurisprudence

WeWork used to be one of the most successful Silicon Vallie unicorns, worth almost half the entire value of publicly traded US real estate investment trusts at its peak valuation. But on the release of its public prospectus in August 2019, the company became subject to fierce criticism. One of the reasons was its CEO’s behaviour. Adam Newman managed the company by bypassing the corporate governance, taking loans from the company at below the market rate, and leasing his real estate to the company. The scandal led to shareholders incurring multi-billion losses, numerous lawsuits, and a severe reputation hit to the start-up.

The story of WeWork is a cautionary tale for shareholders worldwide. Their welfare largely depends on the diligent performance of managers, who are expected to make smart decisions and take steps to maximise shareholder value. Occasionally, however, the priorities of shareholders and managers diverge. The asymmetry in information and control incentivises the latter to act opportunistically and inflict high “agency costs” on shareholders.

Laws establish decision-making procedures, standards of conduct, and remedies to reduce such costs and foster collaboration. In the case of Ukrainian laws, executives are legally obliged to act reasonably and in good faith, and not to exceed their authority. If a manager violates these rules, the shareholders can suspend or terminate his/her powers. They can also challenge the validity of transactions arranged by the executive outside his/her mandate and pursue him/her in courts for damage. The corporate statutes and policies further specify such rules and procedures.

In principle, shareholders can request courts to collect both actual losses and lost profit from poor managers. Historically, though, Ukraine’s courts have followed quite a formal reading of the law and facts and rarely found sufficient grounds to grant companies’ damages claims against managers. This has resulted in depriving shareholders of one of the central remedies to protect their interests in conflicts with executives.

But the same year WeWork lost USD 39 billion in the evaluation in part due to its CEO’s misbehaviour, the Grand Chamber of the Supreme Court issued its landmark case, siding for the first time with the company seeking monetary compensation for sustained damage from its former manager[1].

In this case, the company’s director refused the company’s subsoil permit in favour of a legal entity in which he was an ultimate beneficial owner. The Grand Chamber found the director’s permit refusal unlawful because it was arranged without the approval of the company’s general meeting and the director failed to explain the commercial logic of his decision. Given these circumstances, the court ordered the manager to compensate the company for damage equivalent to the permit’s value.

Interestingly, the Supreme Court later also stressed that the national law does not prohibit the company’s representatives from entering into transactions with affiliated entities, but the representatives should disclose the conflict of interest, and the counterparties bear the burden of proving that transactions do not violate the rights and interests of the represented party.[2]

The new approach adopted by the Supreme Court does not formally affect the legal criteria for holding executives liable for damage under the law. To pursue their claims successfully, shareholders must still demonstrate the following four elements of the manager’s civil liability: (i) an offence, (ii) loss, (iii) a causal link between the offence and loss, and (iv) fault. The principal difference with the previous judicial approach lies in the departure from the formal assessment of the managers’ conduct and enforcement of the fundamental principles of the corporate executives’ standards of conduct.

It is insufficient for the manager to merely comply with law, a statute, or shareholders’ decisions, the Supreme Court explains in its new jurisprudence, because “even when an official has formally fulfilled all the requirements of law and founding documents of the company, his/her conduct may not be in good faith, reasonable and committed in the company’s interests”.[3]

The fiduciary character of relations between shareholders and managers entails that managers bear the duty of care and the duty of loyalty, which require managers to exercise their powers and skills diligently and within the limits of normal business risk, to avoid conflicts of interests, and to act in the company’s best interests. The manager’s non-compliance with his/her duties can lead to losses for the shareholders and trigger the manager’s obligation to compensate for damage.[4]

Companies’ directors must be aware that they could be held liable for ill-judged decisions even if they act without self-interest or malicious intent. In another case considered by the Supreme Court, a company filed a lawsuit against its director for damage inflicted by the undue payment of taxes. Eventually, the court found that the director paid the taxes by mistake, which would not have happened if he had performed his duties with reasonable prudence. Given that and the material damage to the company it caused, the director was ordered to compensate for inflicted damage.[5]

This Supreme Court jurisprudence should be praised by both shareholders and managers. Shareholders now bear lower corporate risks because they have a more efficient legal remedy against their managers’ unscrupulous behaviour implemented by the Supreme Court. In turn, diligent managers can count on better compensation from the shareholders who can now be more certain of the former’s honesty and high-quality performance.

 

 

 

[1] Resolution of the Supreme Court dated 26 November 2019 in case No. 910/20261/16.

[2] Resolution of the Supreme Court dated 06 July 2022 in case No. 909/276/21.

[3] Resolution of the Supreme Court dated 22 October 2019 in case No. 911/2129/17, Resolution of the Supreme Court dated 25 May 2021 in case No. 910/11027/18, Resolution of the Supreme Court dated 21 July 2021 in case No. 910/12930/18.

[4] Resolution of the Supreme Court dated 25 July 2022 in case No. 922/2860/18.

[5] Resolution of the Supreme Court dated 24 February 2021 in case No. 904/982/19.

  • Olga Shenk

    Partner, CMS Cameron McKenna Nabarro Olswang

  • Roman Hryshyn-Hryshchuk

    Associate, CMS Cameron McKenna Nabarro Olswang

CMS Cameron McKenna Nabarro Olswang

Address:

38 Volodymyrska Street, 6th Floor,

Kyiv, 01054, Ukraine

Tel: 380 44 391 3377

E-mail: office.kyiv@cms-cmno.com

Web-site: CMS in Ukraine – International Law Firm

Founded in 1999, CMS is an integrated, multi-jurisdictional organisation of law firms that offers full-service legal and tax advice. With 78 offices in 43 countries across the world and over 5,000 lawyers, CMS has long-standing expertise both in advising in its local jurisdictions and across borders. From major multinationals and mid-caps to enterprising start-ups, CMS provides the technical rigour, strategic excellence and long-term partnership to keep each client ahead in its chosen markets.

The CMS member firms provide a wide range of expertise across 19 practice areas and sectors, including Corporate / M&A, Energy & Climate Change, Funds, Life Sciences & Healthcare, TMC, Tax, Banking & Finance, Commercial, Antitrust, Competition & Trade, Dispute Resolution, Employment & Pensions, Intellectual Property and Real Estate.

CMS in Kyiv has been in Ukraine for over 15 years. We provide access to more than 40 domestic and internationally qualified lawyers, who combine their understanding of the Ukrainian market with the requirements and expectations of global organisations and investors. Its banking, corporate M&A, energy, dispute resolution, competition and property lawyers specialize in key sectors of the Ukrainian economy, including, Infrastructure, Energy, Agribusiness, and Technology. With the expertise and experience to deal with transactions and matters of all sizes, CMS handles local, national and multi-jurisdictional projects. Our lawyers are highly ranked by leading international and local directories, including Chambers Europe, 2012-2022, Legal 500, 2016-2022, IFLR1000, 2017-2022, Ukrainian Law Firms in Corporate/M&A, Energy, IT & Communication, Infrastructure, Banking & Finance, Real Estate & Construction, Dispute Resolution, Competition/Antitrust sectors and practices.