Last week, I met a startup’s CEO and was questioned about how to get rid of a troublesome shareholder (also an employee) in his company.
From an employment relationship …
His question reminds me of my earlier days at a local law firm. In a weekly training session, a senior associate shared the firm’s experience in handling a ‘tough’ employment case.
A manufacturing company hired the firm to kick out one of its unwanted employees (after several failed attempts). Firing staff in Vietnam is never an easy job because labor laws expressly support the employees and judges often choose to stand on their side. Employment termination is only permitted under very limited circumstances and must strictly follow a series of procedural steps. Failing this would ultimately result in the employer’s obligation to take the employee back and pay compensations for his/her damages caused by the ‘illegal’ termination.
Back to our case, having realized that a chance to terminate by the book was virtually nil, the in-charge lawyer finally came up with an idea (or maybe he took it from somewhere). He advised the company to loosely ‘lock’ that employee in a room without giving him any specific job assignments. Of course, that employee was not permitted to do any private works during working hours. Every time he left the room for personal reasons, he had to report to the direct supervisor. This ugly technique turned out to be brutally effective – the victim ‘voluntarily’ resigned after just a few days of experiment.
Despite warnings that this strategy, which is not perfectly legal, should be treated as the last resort, quite a few employers just grab it at the first sight.
… to the corporate world
The above technique is no stranger to the corporate limelight where it is widely known as a ‘squeeze-out’. Squeeze-out describes a method that ‘does not legally compel outsiders to give up their shares but in a practical sense coerces them into doing so’, just like you squeeze a lemon. How a minority shareholder is oppressed under a ‘squeeze-out’ scheme varies in practice. The below hypothetical situation illustrates some commonly-used techniques.
Wolf, a 70% shareholder and also CEO of X Corp., wants to kick Lamb, a 10% shareholder and also X Corp’s employee. To force Lamb to sell his shares below its true value, Wolf increasingly gives pressures on Lamb by cutting off the latter’s salary and bonus, refusing to pay dividends to Lamb and ultimately creating a toxic work environment for Lamb.
A freeze-out, unlike its close cousin squeeze-out, refers to a method whereby the a controlling shareholder seek to legally compel a minority one to give up its shares. Freeze-out is permitted in some jurisdictions. For example, under UK’s corporate laws, a holder of 90% shares or more may offer to buy shares of the remaining shareholders on a compulsory basis. In the United States, minority shareholders can be forced out via a staged cash-out merger; a short-form merger or reverse stock split (RSS).
Vietnamese law realizes neither ‘freeze-out’ in the above sense nor, of course, squeeze-out. Minority shareholders are even given a right which is greatly similar to appraisal right in other jurisdictions. Under the ‘appraisal right’ umbrella, a minority shareholder may request his company to buy back his shares at a fair stock price if he has voted against an approved corporate resolution on (i) the company’s re-organization (e.g. – a merger, de-merger, split, consolidation, change of corporate form, etc.) or (ii) changes of rights or obligations of shareholders as stated the company’s charter. As such, at a minimum, a non-controlling shareholder is still given a choice to decide whether to continue his investment or not.
Nevertheless, just because the laws are silent does not mean that minority shareholders are totally safe from being either ‘squeezed-out’ or ‘freezed-out’. Because a ‘squeeze-out’, which is not uncommon in practice, is illegal, I do not discuss it here. Rather, in this note, I only talk about freeze-out, or more precisely, tools that may be used for a de-facto freeze-out:
(i). Appraisal rights: Ironically, a majority shareholder may take advantages of appraisal right to kick out the minority. Specifically, a majority shareholder may cause the company to pass a resolution approving a corporate re-organization in its favors or simply changing shareholders’ rights and obligations in the company’s charter to the detrimental of the minority shareholders.
(ii). Reserve stock split: In Vietnamese context, RSS may fall inside a broader concept of “merger of shares” (literally ‘gộp cổ phiếu’ in Vietnamese language). Though few companies have merged its shares in practice, it is not clear if any of such mergers is intended to get rid of unwanted shareholders.
(iii) Private placement: This technique does not aim to remove dissident shareholders but may effectively shrunken their equity ownership to a minimum. Under this approach, a controlling shareholder will actively approve a subscription of shares to his ‘ally’ investors. If a private placement is approved in compliance with the company’s charter, the minority shareholder’s pre-emptive right will be neutralized and its ownership will be automatically diluted.
(iv). Voluntary share redemption. The company may force a holder of dividend preferred shares to sell his shares. Transfer price must not be less than [fair] market price unless otherwise agreed by the company and that shareholder.
Apparently, none of the above is a magic stick. They all have side-effects. For example, using appraisal rights may get stuck at determining the fair stock price; because an RSS would result in a compulsory registration for par value change, licensing authorities might be hesitant to accept an ‘unusually high’ par value. Similarly, a staged private placement could be exposed to ‘related party transaction’ risk and ultimately be declared invalid by a competent court. It is therefore advisable to consult your legal counsels on pros and cons of each technique first.
 Emanuel Law Outlines: Corporations 5th Edition (page #470).
 Simply put, reserve stock split is ‘a process where shares are effectively merged to form a smaller number of proportionally more valuable shares’. For example, in a 100:1 RSS, any holders of less than 100 shares may end up with a fractional share (e.g. – less than 1 share). Because an RSS is attached with a plan to buy back all fractional shares, the minority shareholders are left with no choice but to exchange their ownership for cash.
 An appraisal right is the statutory right of a corporation’s minority shareholders to have a judicial proceeding or independent valuator determine a fair stock price and oblige the acquiring corporation to repurchase shares at that price.
 Analogous to ‘articles of association’ in many other jurisdictions.
 Vietnamese law generally allows holders of shares of the same class to enjoy same rights and obligations on a pari passu basis. This is where the non-controlling holders of shares of other classes (e.g. – preferential shares) are vulnerable to a possible change of the charter with respect to their particular rights and obligations.
 Because RSS may result in a change in par value of a joint stock company’s shares, it may not work for public companies whose par value is fixed at VND10,000.