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Legal News November 2011

Shares with privileged voting rights: a useful, albeit controversial instrument

Grégoire Tribolet, attorney-at-law, Legal Services, gregoire.tribolet@ch.ey.com

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1. Introduction

During the course of a general shareholders' meeting at a public company, shareholders exercise their voting rights in proportion to the nominal value of the entirety of the shares held by them (Art. 692[1] Swiss Code of Obligations [CO]). In other words, shareholders in principle possess powers which are commensurate with the magnitude of their holdings in the company's equity capital. Be that as it may, it can also be advantageous if certain shareholders are able to exercise a proportionally greater influence on the company than their financial contribution merits. In this context, Swiss law provides a useful, albeit controversial instrument: shares with privileged voting rights.
 

2. Definition

Shares with privileged voting rights are governed by Art. 693 CO. Contrary to what might be inferred from the choice of legal terminology, each share only confers a single voting right. In reality, the voting privilege stems from a mechanism itself composed of two elements. On the one hand, the articles of association of the company contain a clause pursuant to which each share confers one vote regardless of its nominal value. On the other hand, the company issues shares of differing nominal values. Thanks to this procedure, and by way of example, if a shareholder owns 100 shares with a nominal value of CHF 10.– and another shareholder owns 100 shares with a nominal value of CHF 1.–, they would each have the same number of votes (namely 100) at the general shareholders' meeting. They would also each have the same influence on the company, even if the second shareholder held a stake in the company's equity that was ten times smaller than the first shareholder.
 

3. Limits

Normal shares may not have a nominal value that is more than ten times greater than those of privileged shares (Art. 693 [2] CO in fine). In other words, for shares having on aggregate the same nominal value, a shareholder could potentially have up to ten times more votes than another. Voting privileges do not apply when appointing auditors and experts charged with verifying management, nor when it comes to deciding on whether to impose special controls or to initiate an action for damages (Art. 693 [3] CO). Moreover, shares with privileged voting rights may only be issued as registered shares and must be entirely paid in (Art. 693[2] CO in initio).
 

4. Use

Shares with privileged voting rights are frequently found in family companies. In effect, they offer the possibility of maintaining control of the company within family hands, while at the same time allowing for a large share of the equity capital to be opened to the public. They are also used in order to grant strengthened decision-making powers to the founder of a company or to shareholders actively engaged in the company. In this context, it should be pointed out that numerous investors have no interest in exercising their voting rights and prefer to leave decision making powers in the hands of those who founded or who manage the company. In addition, shares with privileged voting rights are frequently seen as an instrument to prevent hostile takeovers, because their owners usually have a close and loyal relationship to the company. For publicly listed companies the use of shares with privileged voting rights seems to be diminishing. Approximately ten percent of such companies still use this mechanism, including the Swatch Group, Richemont, Lindt & Sprüngli, Kuoni as well as Bank Sarasin.
 

5. Criticism

In Switzerland, shares with privileged voting rights have given rise to debates for several decades. Some find that these kinds of shares, which allow their owners to exercise voting rights in excess of their holdings in the equity capital and their dividend rights, to be the source of a dichotomy between decision-making powers and economic risk which runs contrary to good corporate governance. In particular, majority shareholders holding shares with privileged voting rights would be in an even better position to extract benefits from the company to the detriment of minority shareholders. It is for this reason that several European countries, namely Germany, Austria, Italy, Spain and Belgium have banned shares with multiple voting rights (which allow shares to embody more than one voting right and which have a similar effect to shares with privileged voting rights as provided under Swiss law). In France, shareholders in public companies only have the possibility to obtain double voting rights.

Nevertheless, several voices in our country point out that companies which have shares with privileged voting rights, do not generally perform any worse than those companies who have a system of strict proportionality between equity shareholdings and voting rights. Similarly, there is a widely-held belief that public companies' freedom to organize themselves should be upheld, thereby leaving it to capital markets to reject those privileges which are deemed abusive. In any event, just prohibiting privileged voting rights would not prevent the use of other mechanisms, the effect of which would be to achieve an imbalance between equity holdings and corporate influence.

Among such mechanism we find namely pyramid-like structures in which investors or groups of investors have control of a holding company, which itself holds a majority stake in the target company. By way of an example, whoever holds 51 percent of a holding company, which itself holds 51 percent of the target company, has indirect control over the latter, even if he may claim only 26 percent of the ownership rights (51 percent multiplied by 51 percent). The dichotomy between equity holdings and voting rights could, moreover, be even greater in the event that the pyramid was characterized by several levels of holding companies.
 

6. Conclusion

Based on an impact study addressing the issue of proportionality between capital and control in publicly listed companies, the European Commission decided to take no action at Community level. In Switzerland, the draft bill revising the law on companies limited by shares essentially adopts the same mechanism as Art. 693 CO. The only difference resides in the fact that the voting privilege does not apply where the general shareholders’ meeting must decide on whether to initiate an action for restitution of unjustified payments (Art. 693[3][5] draft CO). It would seem that shares with privileged voting rights still have good days to come.