Wednesday, 25 April 2018 12:09 GMT

Kuwait- IMF report 'somewhat critical' of Kuwait's corporate governance regime

(MENAFN - Arab Times) The International Monetary Fund ("IMF") issued its "Kuwait Country Report in November 2004". The report was somewhat critical of Kuwait's overall corporate governance regime at the time, finding that "minority shareholder protections" in particular were lacking. In the ensuing decade, Kuwait has passed legislation to address a number of the IMF's concerns, and in the process has created a "framework" of minority shareholder protections and enhanced corporate governance. This framework is primarily embodied in two pieces of legislation, the first being a comprehensive Capital Markets Law enacted in 2010 (Law 7/2010). The second of which was a complete overhaul of the country's Commercial Companies Law (Law 25/2012, as amended). Before that, the old Commercial Companies Law (Law 15/1960) had gone nearly 50 years without substantial revision. Following is a survey of the legal framework of minority shareholder protections and corporate governance regime created by these two very important pieces of legislation

As alluded to above, minority shareholder protections and corporate governance in Kuwait have traditionally been considered weak by some international standards. To some degree this has an historical basis as the country's corporate tradition grew up around powerful "merchant families". In that regard, an outsider opting to buy-into a closely-held family enterprise was expected to appreciate the fact that decisions were going to ultimately be made by the family members in control (typically the family patriarch). Indeed, at the time of the 2004 IMF report, there was only one minority protection provision of any real significance under the old Companies Law. This protection came under Article 136 of the old law, which provided that a minority shareholder (if they held at least 15% of the company's shares), could bring a lawsuit to overturn "prejudicial" actions taken by the company's extraordinary general assembly. This was the extent of the minority protections under the old law.

Obviously, if one's only course of action is to file a lawsuit to protect one's rights, then the majority has considerable discretion to do anything it wants. But why should minority shareholders need any protection at all? Simply stated, in the area of corporate governance, control means power. The tension is therefore about who has control and the degree to which they can wield them power to determine the course and direction of the company, (e.g., who sits on the board, when/if it can pay dividends, issue more shares, etc.). This tension is not new and has probably been around as long as there have been corporations.

On the one hand, it seems justifiable that a person or persons holding a majority stake in a company should be the ones who run the show. But vesting absolute control in that manner while "arguably" justifiable from a purely economic perspective, fails to acknowledge the fact that such control/power can and often times is used to the detriment of the minority. This offends our notion of what is considered "fair" and is essentially the underlying point of the IMF report. Indeed, it is now a guiding principle of corporate governance (whether or not codified) that the majority shareholders, though they wield power, may not use such power to oppress the minority or act to their detriment. So what does it mean to have minority shareholder rights/protections

What we really mean when we talk about minority shareholder rights/protections is that "basket of rights" that gives minority (non-controlling) shareholders the right, among other things to

* access pertinent information about the company,

* maintain their ownership interest in the company

* compel fair compensation either from the members of the board or the company when the majority overreaches or the board fails to protect their interest, an

* generally hold the directors and officers of the company accountable for their misdeeds, etc.

While this list could go on for pages, as alluded to above, the underlying principle that one must bear in mind when considering these types of protections really revolves around the notion of "fairness"

So in that sense, any regulatory scheme/framework must look to balance the rights of the few (minority), against the interest of those who have the lion's share of the financial stake in a company (majority)

So what are the minority protections offered under the new Companies Law/Capital Markets Law framework

While the Capital Markets Law led the shift to what is unquestionably a more robust corporate governance paradigm, the full impact of that shift should first be considered against the backdrop of protections under the new Companies Law, which was passed in 2012, two years after the Capital Markets Law. The new Companies Law has broader applicability to all types of commercial companies formed in Kuwait, not only those entities under the auspices of the Capital Markets Authority

Access to Information

A hallmark of good corporate governance is a shareholder's ability to protect his interest through access to pertinent information, which obviously includes the corporate records and books of the company. Under the new Companies Law, shareholders are granted broader access to books and records, depending on the nature of the particular type of entity involved. These protections are generally set out in Articles 47, 69 and 110 of the new law. In addition to the right to inspect books and records, shareholders in the general assembly of limited liability companies and public joint stock companies now have enhanced rights to question management and the auditors regarding the company's financial position and profit distribution.

They also have greater rights when it comes to appointees and dismissing of managers, as well as the control council/board of directors and auditors. These rights are generally set out in Articles 114 and 242 of the new Companies Law, with additional guidance provided by the law's executive regulations

Pre-emptive Right

If one considers minority shareholder protections as being on a continuum, then pre-emptive rights are perhaps at or near the first level of defence. Pre-emptive rights essentially fall into two categories. The first category involves the right of existing shareholders to purchase their pro rata share of any proposed new share (or other types of securities) issuance by the company. This is the classic type of pre-emptive right, and the purpose of this protection is straightforward - i.e., to allow each shareholder if they are willing and have the financial wherewithal to do so, to maintain their percentage of ownership in the company. This is in effect a "balance of power" or "maintenance of the status quo" protection; because if everyone participates, then the company gets the additional capital it is seeking, but the existing shareholders' ownership percentages are not diluted (reduced)

The second type of pre-emptive right (more commonly referred to as a right of first refusal/first offer), generally gives existing shareholders the right to buy the shares of other existing shareholders on the same terms as they are proposed to be sold to third parties or even other existing shareholders. Again, the purpose is to maintain continuity, and if all parties participate then their ownership interest relative to each other is maintained. In the case of closely-held companies, this is a further protection for the minority in that it allows some degree of self-determination as to whom an existing shareholder chooses to do business with on a going forward basis. The new Companies Law provides one or both of these types of pre-emptive rights depending on the type of corporate entity involved

For example

* In limited liability companies, consent of the existing shareholders must first be obtained before existing shares can be transferred to a new shareholder. These restrictions are set out in Articles 40, 62 and 100 of the new Companies Law, as applicable;

* For public joint stock companies, Article 160 of the new Companies Law gives each existing shareholder pre-emptive rights to subscribe for their pro rata share of new issuances by the company; an

* In the case of closed joint stock companies, existing shareholders have the right to subscribe for/purchase existing shares that are proposed to be transferred by existing shareholders if so provided in the bylaws of the company or new shares proposed to be sold by the company. See Article 270 of the new Companies Law

As discussed above, the rights and protections afforded to the minority must be balanced and recognize the vested pecuniary interest of the majority as well. In that sense, the new Companies Law is flexible in allowing pre-emptive rights to be waived under certain circumstances, as well as establishing reasonable time periods by which such rights must either be exercised or otherwise forfeited

Fiduciary responsibilities of director

In addition to pre-emptive rights, fiduciary duties imposed on directors and management of a company help to ensure that such managers/directors act in the best interest of the company and all of its shareholders, not just those in the majority.

The new Companies Law, management and directors are now liable to the company and the shareholders for all acts of fraud, abuse of authority or any contravention of the law or the company's charter, as well as for any mismanagement.

Furthermore, shareholders in public joint stock companies in particular can file a claim for indemnity against a director whose error has caused damage to that shareholder

In addition, shareholders who have representatives on the board of directors of a public joint stock company are not permitted to have an interest in agreements entered into by the company, unless such arrangements are approved by the company's general assembly. This is obviously intended to prevent self-dealing transactions by those in control of the company

Remedies for unfair prejudice

Although the above discussion deals with rights now "afforded to minority shareholders", such rights are of dubious value without an effective scheme to enforce such protections. Under the new Companies Law, minority shareholders do not have to necessarily bring a lawsuit to contest unfair prejudice by the majority shareholders.

In brief, these new remedies afforded to minority shareholders come under Articles 251, 282, 292, 295 and 327 of the new Law, and address those circumstances where corporate action is taken which is deemed to violate the company's charter, contravene Kuwait law, or is otherwise intended to damage the company. Depending on the nature of the underlying action, a shareholder may claim indemnity or the right to nullify the action petition the Ministry of Commerce and Industry (MOCI) taken or look to exit the company altogether

* Claim to annul corporate action and seek indemnity. A shareholder may file a claim to annul a resolution issued by the board of directors, the ordinary or extraordinary general assembly in contravention of Kuwait law or memorandum of the company, or if it is intended to cause damage to the interests of the company and claim indemnity as applicable. Such a claim must be filed within two months of the date of the resolution

* Complaint to the Ministry of Commerce and Industry. A shareholder can file a complaint with the MOCI regarding the implementation of the new Companies Law or the company's charter. If the MOCI finds that the company has acted to the detriment of the interests of the shareholder or the company, it has the authority to invite (read: compel) the company's general assembly to remedy the adverse actions

* Application for withdrawal from the company. A shareholder who objects to a resolution to transform the company, to merge it or otherwise divide it, may withdraw from the company and recover the value of his shares. In some jurisdictions this is referred to as a "right of appraisal", which simply means the right to recover the fair value of a shareholding rather than being compelled to go along with extraordinary corporate action that the shareholder does not agree with

Other Consideration

The following table contains a number of other corporate governance related provisions under the new Companies Law, although such provisions do not necessarily speak solely to minority protections

(Read as Article (in italics) and Provisions)

Board Qualifications: A member of the board of directors, must: (i) have legal capacity to act, (ii) no criminal convictions punishable of imprisonment, negligent bankruptcy or fraud, crime against honor or honesty or any crime in violation of the provisions of this law, unless he has been rehabilitated and (iii) hold or represent someone who holds a requisite number of shares in the company, (except for independent directors) (Article 224, new Companies Law)

Prohibitions on Inter-Locking Interests: A person, even if in the capacity of a representative of an individual or corporate entity, cannot be a member of the board of directors of more than five public shareholding companies headquartered in Kuwait and can only be chairman of the board of directors of one shareholding company headquartered in Kuwait (Article 225, new Companies Law).

Directors Selling Shares: Neither the chairman nor board members in a public or listed company may dispose of shares of the company during their tenure (unless approved by the CMA) (Article 226, new Companies law).

Prohibitions against Leaks: Members of the board of directors may not disclose to shareholders, other than through the general meeting, or to any third parties, any secrets of the company they may come to know of during the course of their directorship (Article 227, new Companies Law).

Competition: Neither the chairman nor any member of the board of directors may be a member of the board of directors of two competing companies (Article 228, new Companies Law).

Conflicts of Interest: Shareholders who appoint a representative to the board of directors, the chairman or any member of the board of directors, any member of the executive management and their respective spouses or relatives of the second degree, cannot have any direct or indirect interest in agreements or acts entered into with the company or on its behalf without the prior authorization of the company's shareholders general assembly (Article 230, new Companies Law).

Company Secrets: Subjects Members of the board of directors, managers, member of the supervisory board or employee, who has disclosed, except in cases permitted by law, or has exploited the company's secrets known by virtue of his position for his own benefit or for the benefit of a third party or to the detriment of the company is liable to be imprisoned for a term not exceeding three years and/or a fine ranging from a minimum of KD 10,000 to a maximum of KD 100,000, without prejudice to more severe penalties provided for in any other law (Article 334 (6), new Companies Law).

Recusal: No shareholder (nor his representative) is permitted to vote in matters in which he has a personal interest (Article 239, new Companies Law).

Abuse of Position: Any member of the board of directors or manager who exploits in such capacity the company's assets or shares with mala fide intent for his own benefit or for the benefit of a third party is liable to be imprisoned for a term not exceeding one year and/or a fine ranging from a minimum of KD 5,000 to a maximum of KD 10,000 (Article 335 (4), new Companies Law)

What minority protections are provided under the Capital Markets Law

Whereas the new Companies Law provides further minority shareholder protections primarily focused on regulating corporate procedural matters, the Capital Markets Law by comparison focuses more on corporate governance and those matters that impact a shareholder's investment decision.

These protections are generally intended to drive "transparency" by, amongst other things, compelling disclosure of ownership, regulating takeovers and prohibiting insider trading

Disclosure of Interes

As a shareholder it is important to know who actually owns what - or more importantly whether a "hidden hand" guides the company's actions unbeknownst to everyone else. In that regard, the Capital Markets Law requires that voting blocks or parties holding a certain level of beneficial ownership interest in a company ownership disclose the extent of their interest, notwithstanding that some other entity or individual may have legal title to the shares at issue

Under Articles 100 and 101 of the Capital Markets Law, anyone who owns 5% or more of the capital in a listed company is considered a "beneficiary" and is required to disclose their level of ownership both to the company and the stock exchange. Beneficiaries are required to make this disclosure within 5 working days of such party becoming a beneficiary. The rule also captures divestiture transactions as well, such that any movement in a beneficiary's ownership of +/-0.5% must also be timely disclosed.

Amongst other things, these disclosure requirements are intended to shed light on "hidden hand" control, but they are also intended to prevent "stealth" or "creeping" takeovers of a company, or otherwise prevent beneficiaries from dumping their shares onto the market to the detriment of non-beneficiaries.

Article 103 of the Capital Markets Law also makes such disclosure obligations applicable to directors in listed companies who are required to disclose their interests in the share capital of such company, regardless of the percentage, to the Capital Markets Authority, the stock exchange and to the company. This disclosure requirement also applies to the director's first degree family members and spouse as well

Note that "ownership" is a broad concept under the Capital Markets Law and includes direct and indirect ownership of shares held in association with others (e.g., family members, voting agreements, etc.)

The penalties for violating the disclosure rules are severe. For example, under Article 121 of the Capital Markets Law, anyone who violates the disclosure provisions may be fined a minimum of KD 10,000 up to a maximum of KD 100,000. Moreover, these fines are cumulative - i.e., they may imposed over and above any other fines/penalties under other applicable laws

Mandatory Takeover Rule

Article 74 of the Capital Markets Law, provides that any person who directly or indirectly acquires more than 30% of the listed shares of a company is required to make an offer for all the remaining shares, within 30 days of exceeding the 30% threshold. The procedures for this type of offer are explained in the Capital Markets Law's executive regulations.

Under Article 271 of the Capital Markets Law executive regulations, any person or group of their subsidiaries or "allied parties", must lodge a takeover bid to all the remaining shareholders within 30 days of directly or indirectly coming into possession of more than 30% of the voting shares in a listed company.

The takeover bid must be a cash offer made at the higher of, the likely average of the daily trading price for the six months preceding the date of the offer and the highest price paid by the bidder or any of his affiliates, allied or associated parties within the 6-month period preceding the takeover offer (this, must also in be accordance with the CMA Instructions on Procedures for Mandatory Acquisition Transactions No. C.A.M./Q.T.A/ A.A / 7/2013).

Article 1 of the Capital Markets Law executive regulations defines an "allied party" as a person who is subordinate to another person or persons or is subject to their authority, while "subsidiary" is defined as an entity held as to 50% or more by another person. Article 381 of the Capital Markets Law further provides that when calculating the total number of shares in which a beneficiary has an interest, all shares owned or controlled by their spouse, minor children or any company in which they own 30% of more of the voting rights must also be taken into account. As with the disclosure rules discussed earlier, any person violating the provisions of Chapter 7 of the Capital Markets Law (which includes the mandatory takeover offer provisions noted above) is liable to be fined from KD 5,000 up to KD 100,000 or 20% of the value of the "violated shares" - i.e., the shares held by the violating person, whichever is the higher amount

Insider Trading

Information moves markets. Indeed in the area of traded shares this is a key element, as what one party knows about a company may make for a trading advantage. And it goes without saying that those "inside" a company (i.e., its directors, managers, key advisors, etc.), know more about the company's financial health, product pipeline, marketing strategy, M&A potential, etc., than does the general public. So allowing "insiders" to trade on information that is not generally available to the market at large (i.e., everyone else), is not just unfair, but potentially criminal. The rules concerning insider trading, commonly referred to as the "Insider Rules", are contained in the Capital Markets Authority's Instructions No. CMA/SS/CG/5/2013. These rules speak specifically to the conduct of members of the board of directors and management, as well as other "authorized persons" who may come into possession of "material data and information" that has not yet been digested ("priced in") by the market

Article 1 of the Insider Rules, defines "members of the executive management" as any of the issuer company's employees, who accessed, by virtue of his position material data and information about the issuer company or its clients. "Authorized persons" refers to any person, who has access, by virtue of his position, to material data and information about the issuer company or its clients which is not publicly available. This includes board members, members of executive management and the other persons who had been granted access to such data and information through their professional relationships with the issuer company.

Further, "material data and information" is an expansive term and includes any data and information held by the issuer company with respect to its activities, identity, financial position, management or clients, which are not available to the public and have effect on the assets, liabilities, financial position or the general direction of the business of the issuer company or its client and may lead to a change in trading price or volume or attract or disincline the dealers in shares of the issuer company or the other shares in which the issuer company or its clients have interests or which may affect the issuer company's or client's ability to fulfill its obligations

The Insider Trading Rules prohibit certain types of conduct. For example

* Article 5 (1) of the Insider Rules members of the board of directors cannot trade in the issuer company's shares while they are on the board. The rule provides limited exceptions for (i) transfer of shares as a result of inheritance or by will, (ii) transfer of shares under to a court ruling, (iii) transfer of shares amongst portfolios managed by licensed companies for the same original holder, and (iv) holding the minimum number of qualification share

* Article 5 (2) of the Insider Rules members of the board of directors cannot trade in shares of the parent company, a subsidiary or any affiliate of the issuer company during blackout periods: (i) 10 business days before the end of the financial year quarter until release of the quarterly financial results and (i) 10 business days before the end of the financial year until release of the yearend financial results

* Article 5 (4) of the Insider Rules members of the board of directors cannot trade in shares of the parent company, a subsidiary or any affiliate of the issuer company, as well as shares of the issuer company's clients of natural persons or securities in which the issuer's clients have effective positions, from the date they access the material data and information relating to those parties until announcement of such material data and information

Note that the restrictions under Articles 5(2) and 5(4) are equally applicable to members of executive management and other authorized persons vis-€¡-vis the issuer company itself, the parent company, a subsidiary or any affiliate of the issuer company

In addition, pursuant to Article 7 (1) of the Insider Rules, members of the board of directors and executive management, as well as their first degree relatives and spouses, must also disclose information about any contemplated transaction in the shares of the parent company or any subsidiary or associate company of the issuer company. Such disclosures must be made to the Capital Markets Authority, the stock exchange and the issuer company five business days before the contemplated disposal and five business days after the disposal.

The required disclosure must also include the name of the member of the board or executive management, the name of his/her first degree relatives and spouse intending to trade in the shares (where applicable), the position held in the issuer company, the volume and nature of the shares to be traded, the nature of the trade and the date and location of the trade

The penalty provisions for violating the Insider Rules in terms of severity are generally in-line with the penalties for violating the disclosure and mandatory takeover rules, as described above. In that regard, Article 118 of the Capital Markets Law, provides that anybody who exploits internal information through purchase or sale of securities, or whoever reveals or discusses internal information with outsiders is liable to be imprisoned up to a maximum of five years or a fine ranging from a minimum of whichever is higher between the value of the benefit or of the avoided loss and KD 10,000 and a maximum of whichever is higher between three times (3x) the value of benefit or of the avoided loss and KD 100,000.

Article 120 of the Capital Markets Law provides that anyone who ignores, hampers or hides major information that should serve as guidelines, must be disclosed to the Capital Markets Authority and the stock market concerning sale or purchase of shares, as well as recommendations for sale of purchase of shares, is subject to fines ranging from a minimum of KD 10,000 to a maximum of KD 100,000

Corporate Governance Rule

Capital Markets Authority Decision No. 25 of 2013 of the Capital Markets Authority Council of Commissioners is referred to as the "CMA Corporate Governance Rules"

Pursuant to Principle 6.2 of the CMA Corporate Governance Rules, members of the board of directors may not have any direct or indirect interest in the business and contracts undertaken and carried out for the account of the company without authorization from the general assembly. Such authorization must be renewed on a yearly basis.

Further, the board of directors is required to develop policies to minimize conflicts of interest, which must include, amongst other things, an obligation for to inform the board of their personal interest in contracts and business undertaken for the account of the company. This must also be confirmed and recorded in the minutes of the relevant meeting. A conflicted director may not vote on the relevant decision

Pursuant to Principle 7.2 of the CMA Corporate Governance Rules, information related to transactions and interests between the company and related parties must be disclosed to shareholders and investors through "proper" disclosure means (e.g., in the daily newspapers, company annual report or through the stock exchange or any other tool or means deemed appropriate and on the company website)

Under the CMA Corporate Governance Rules, "related parties" are defined as a party or person that

(i) has direct or indirect control of the company,

(ii) is a subsidiary or an affiliate company,

(iii) is a member of the same group to which the company belongs,

(iv) is a member of the board of director or a member of the company executive / senior management,

(v) is a second degree relative of a person mentioned in item (i) or (iv) and (vi) is a company under the control or joint control or under a significant influence of the persons mentioned in item (iv) or (v) above with their major direct or indirect voting influence.

Mandatory provisions of the CMA Corporate Governance Rules are already in effect while the ultimate deadline to comply with the remaining provisions is Dec 31, 2014.

Non-compliance with the CMA Corporate Governance Rules outlined above may entail disciplinary measures in accordance with the provisions of the Capital Markets Law and its executive regulations.

Although the framework of the new Kuwait minority shareholder protection and corporate governance regime is not perfect and some elements remain untested, it is clear that the Kuwait authorities took the 2004 IMF report to heart in constructing the framework

Kuwait- IMF report 'somewhat critical' of Kuwait's corporate governance regime

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