Cassation Bench Decision made in relation to companies limited by shares

This briefing has been published by Mesfin Tafesse & Associates, Ethiopia, who have agreed to Simmons & Simmons making it available to elexica subscribers.

In 2005, Ethiopia introduced a feature into its legal system that would have a profound impact in setting new rules and providing binding interpretations that have the force of law. Article 2 (1) of the Federal Courts Proclamation Re-amendment Proclamation No. 454/2005 provided that the interpretation of a law by the Federal Supreme Court rendered by its Cassation Division (the Bench) with not less than five judges is binding on all courts at the federal as well as regional levels. The Bench has been entrusted with the power of cassation over final decisions of the Federal High Court rendered in its appellate jurisdiction, final decision of the regular division of the Federal Supreme Court and final decision of the Regional Supreme Court rendered as a regular division or in its appellate jurisdiction. Making use of this power, the Bench has made several decisions over the course of a decade that reverberate within the legal system giving rise to impassioned legal reviews and comments both from the judgment creditors’ and debtors' perspectives. These decisions have been compiled in volumes and made available online. In this article we would like to highlight some of the key decisions of the Bench impacting limited liability companies: Private Limited Companies (PLC) and Share Companies (SC).

By way of background, PLCs are by far the most prevalent forms of limited liability companies in Ethiopia. They are often established among persons having close relationships such as friends, family members, etc. They are also the vehicle preferred by foreign investors. They are governed under Articles 510 to 543 of the Commercial Code of Ethiopia. SCs are not that many but have increased in number over the years with the development of the banking and insurance sector. They are governed under Articles 304 to 428 of the Commercial Code. Many disputed matters relating to the rights and obligation of shareholders in both forms of companies and other aspects of their operations have been brought to the attention of the Bench and a number of decisions have been passed by it. The decisions can be categorized into two categories. The first ones relate to the interpretations of the relevant law filling in perceived gaps in the relevant provisions of the Commercial Code. The second ones relate to the correct application of relevant provisions of the Commercial Code that the Bench felt were misinterpreted by lower courts. In the following sections, we will highlight those decisions that fall under the first category followed by the second.

Gap filling interpretative rulings timing of shareholders' contribution

Although there is no provision in the Commercial Code which expressly provides that subscribed contribution of a shareholder has to be made prior to the establishment of a PLC, the Bench has decided that contribution should be made prior to establishment of the company and not after it has commenced operation. The Bench has cited the relevant provisions of the law dealing with formation of the company. Article 516 of the Commercial Code provides that the company is said to be formed when the memorandum of association is signed by all members. The subsequent provision dealing with the terms of a memorandum of association provides that the memorandum shall show a statement that the capital is fully paid. Reading the two provisions together, the Bench has argued that for a company to be formed it is a requirement that shareholders sign the memorandum of association which according to the law should show a statement that the capital is fully paid. Therefore the Bench has decided that contribution has to be made prior to the establishment of the company.

In addition to this provision, the Bench has cited another provision dealing with share register. However there is discrepancy between the Amharic and the English version of the provision used in the decision.

The Amharic version provides that the share register shall show the value of the contribution that is to be contributed by the member which indicates that it is not a requirement that the contribution be made and that it can be done at any time in the future even after the operation has commenced while the English version reads that the share register shall show the value of the contribution made by the member which implies that the contribution has already been made.

In cases where there is discrepancy between the two versions in the law, Federal Negarit Gazeta Establishment Proclamation No. 3/1995 Article 2(4) states that;

“The Federal Negarit Gazeta shall be published in both the Amharic and English language; in case of discrepancy between the two versions the Amharic shall prevail.”

However, the court has adopted the English version of the text of the law and decided that the provision should be interpreted in such a way that payment of the contribution has to be made prior to the establishment of the company and not after commencement of the operation.

Share transfer

It has been decided that share transfer in a PLC has to be made in writing and shall not have effect to the company or third parties unless it has been entered in the share register of the company. The provision of the Commercial Code, as far as transfer of shares between members is concerned, provides that there shall be no restriction unless otherwise agreed under the article of association.

In relation to transfer of shares outside the company, it provides that there needs to be approval from majority of the members representing at least three-quarter of the capital unless a larger majority or unanimity is fixed in the article of association. The provision also states that the approval shall enter into the commercial register. Therefore the Bench has concluded that transfer cannot be final and valid until the approval of the transfer has been entered into a commercial register. The document evidencing the transfer is the proof of the entrance into a commercial register and not the resolution approving the transfer. The resolution is valid only if it can be proved that it has been entered into the commercial register.

Attachment of share

Another issue decided by the Bench was attachment of share to settle a debt owed by a member who has been a judgment debtor. The provision of the Commercial Code is silent as to the effect of not obtaining an approval from the shareholders when a request to enter into the company has been sought by an outside person. It is provided under Article 523 (5) that where execution is levied on a member’s share, the purchaser shall obtain the consent of the other members.

The court has interpreted the provisions dealing with share transfer in PLC (Articles 522 to 524) and decided that the provisions does not prohibit the transfer of shares to outside members. Even though the decision recognized the unique nature of PLC being a company established among people who are related, it did not prohibit an outside person from buying the share of a judgment debtor shareholder. The Bench stated that the law protects the free transfer of shares to outside members however it did not prohibit the sale of the share to an outside person if it has been attached as an asset to settle a debt.

The Bench argued that these provisions in line with the unique nature of the relationship of the members of the company only reserve priority right for the remaining shareholders to buy the share of the member whose shares have been attached. The Bench stated that the provisions in no means allow them to retain the share by its actual value after making payment to the judgment creditor the value of the share. If the remaining shareholders are not willing to buy the share of the judgment debtor, then the Bench decided that they should be sold to an outside person.

As far as the selling price is concerned, the applicable law cited by the Bench was the Ethiopian Civil Procedure Code dealing with execution. The Bench stated that it should be the marketing price of the share and not the actual valuation of the asset. Similarly there is no provision which explicitly provides that sale has to be made by the market value of the asset both in the Commercial Code and the Civil Procedure Code. The provision dealing with order for sale of property attached provides that every sale in execution of a decree has to be made by public auction. The Bench interpreted this provision and stated that the reason why a property is sold by public auction is to guarantee the protection of both the decree holder and the judgment debtor to receive a fair value from the sale of the property. Therefore it has concluded that sale of a property attached has to be made by the market value and it can be made to a third party if the remaining shareholders are not buying the share at a market value and irrespective of their approval.

Dissolution of a company

Dissolution of the company has to be on grounds which have been provided under the law and any other ground shall not be accepted. In the case before the Bench, a party who has a ground for dissolution in accordance with the law did not prove to the satisfaction of the court that the ground existed. Therefore the Bench ruled that grounds which have not been established before the court are as good as groundless dissolutions and do not render the court to give a decision on dissolution.

Reinstatement of a manager

Article 527 provides the different forms of dismissing a manager based on the manner of his appointment: appointment by the memorandum of association or appointment by members. The provision states that a manager may not be removed from his position without good cause unless it has been explicitly provided in the article of association that he may be removed at the pleasure of the members irrespective of the form of appointment. If the court is of the opinion that dismissal was without good cause, Article 527 (3) of the Commercial Code states that it may grant damage to the manager.

Therefore, in accordance with the provision, the Bench stated that, if the article of association does not provide that the manager can be dismissed without good cause at the will of the shareholders, then dismissal can only be made for good cause acceptable to the court. The issue before the Bench was about reinstatement of a manager who has been dismissed without good cause. As provided above, the law does not provide for any other remedy that can be granted to a manager who has been dismissed unlawfully. The Bench however has decided that this provision allows a manager to be reinstated to his position if the court believes that the dismissal was without good cause. The Bench argued that sticking to the literal text of the provision which reads as:

“a manager who has been dismissed shall forthwith and forever cease to function. Where the court is of the opinion that a dismissal was without good cause, may grant damage to the manager”

This may restrict the power of the court to review the cause of the dismissal and awarding a remedy for such unlawful act.

The Bench decided that when the law states that the manager should cease to function, it is referring to those managers that have been dismissed with good cause. For a manager who has been dismissed in violation of the law, the Bench stated in its decision that the court can give multiple remedies other than awarding damage. Therefore the Bench concluded that the court can either grant damage or decide that the manager be instituted to his position.

Reversal of lower courts’ decisions

The following decisions of the Bench are decisions which have altered the provisions applied by lower courts and have been passed by using the relevant provision of the law. The decisions have been provided in two separate sections: those dealing with SCs and PLCs.

In relation to share company liability of managers

Courts in first instance and appellate level usually reject claims instituted by shareholders against directors by citing Article 365 (1). The provision states that no proceeding shall be instituted against directors without a resolution of a general meeting to this effect. Therefore lower level courts usually require shareholders to first secure a resolution of a general meeting to that effect. Additionally these courts argue that shareholders are only allowed to directly institute proceedings only under Article 365(4) which provides that it is when the company fails to institute proceedings adopted in the resolution within three months that the shareholders who voted for the resolution may jointly institute the proceeding.

However, the Bench ruled that the law deals with the liability of directors separately and the application of Article 365 is for cases where the company wants to institute a proceeding and not applicable to proceedings instituted by shareholders. If the shareholders want to institute a proceeding the applicable provision is Article 367 of the Code which enables them to directly institute an action without securing a resolution provided that they can prove the existence of injury that has been caused by the fault or fraud of the later. Therefore, it has been decided that claims in relation to management of the company can directly be brought by a shareholder.

Pledge of share

The decision discusses the conditions under which a share can be pledged. It states that shares can be either a bearer shares or registered in the name of the shareholder. According to Article 340 (1) and 341 (1) of the Commercial Code, assignment of bearer shares can be made by mere delivery without any other requirement while ownership of registered shares can be transferred by the relevant entry in the register kept at the head office of the company. The lower court which has tried the case cited Article 2828 of the Civil Code which provides that a contract in relation to pledge of movable goods is valid, where it is evidenced by writing.

The Bench however stated that the relevant provision to determine the pledge of shares is the one dealing with pledge of intangible goods as opposed to pledge of tangible movable goods. The Bench used Article 2864 and 2865 of the Civil Code which specifically deals with pledging of claims or other intangibles by arguing that shares are intangible assets and the relevant provision applicable in their attachment shall be different from those dealing with contract of pledge in general and applicable to tangible movables.

In this regard, the Bench ruled that in accordance with Article 2865 (1) of the Civil Code, the pledging of rights shall be executed in the form prescribed for the transfer of the rights. Therefore, since this provision cross refers to the relevant law dealing with the form prescribing the transfer of the right, the formalities provided under the provisions of the Commercial Code will be applied for the transfer to constitute valid. In this regard the Commercial Code provides that entering into the register of the head office suffice for the transfer of ownership. Therefore irrespective of the existence of a written contract of pledge, which was considered to be essential in the decision of the lower court, the Bench ruled that the act of delivering a share to another and entering it into the share register alone constitutes the transfer of share in the absence of a written agreement concerning the transfer.

In relation to private limited companies

Liability of managers

The Bench has affirmed that a manager who has committed a fault in the administration of the PLC by breaching its duty under the Commercial Code or the article of association is liable individually or jointly and severally as the case may be to the company and third parties in accordance with Article 530 of the Commercial Code. This means that the aggrieved party can hold both the company and the manager liable for faults the manager has committed towards him.

Dissolution

The Bench decided that dissolution of a PLC can only be made in accordance with the law and cannot be dissolved by the decision of other dispute settlement body. The particular case entertained by the court was a company which was established by a husband and wife as shareholders. In such case the Bench ruled that decision cannot be passed to divide the PLC as forming part of the common property of the spouses and be partitioned equally among the spouses or be sold and have the proceeds be equally divided between them by arbitrators.

Rather the Bench states that the rules governing dissolution of companies shall be applied. The decision stated that the thing to be partitioned is the remaining asset of the company after liquidation has been completed and the legal personality has been cancelled in accordance with the law. Therefore a PLC owned by spouses cannot be divided by an arbitrator among them equally but has to go through a formal process of liquidation.