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Infringements of minority stockholders’ rights by principal stockholders of Ukrainian enterprises
12.05.2009 16:18

Concentration of corporate capital in the hands of limited number of shareholders is universal trend in joint-stock relations development. First of all, it is connected with the fact that fundraising for joint-stock companies with the help of stock market is characteristic only of USA, whereas in European countries such enterprises are mostly developed at the expense of large investors.
The process of adjustment of interests between minority and majority shareholders is characterized by the search of balance. Why protect the rights of minority? The will of joint-stock company is formed at the meeting of shareholders. Decisions are generally made by the simple majority of votes. The owner of a large shareholding, thus, may exert serious influence on the decisions, whereas minority shareholders are unable to do that at all. For example, public corporation may pass resolutions concerning prohibition of pre-emption of the additional issue of shares, modification of the charter, reorganization of enterprise and so on. It restricts the rights of minority shareholders, because they are unable to put any question on the agenda, demand carrying out audit or revision.
Therefore, in the joint-stock legislation of most countries minority shareholders are vested in with special rights which protect them from the tyranny of large shareholders and provide with an opportunity of disaffiliation with an organization by means of compulsory sale of shares.
Since first joint-stock companies emerged law has been responsible for establishment of mechanisms to prevent transgressions, settle disputes between minority and majority shareholders. It has remained quite topical now and this trend is likely to remain henceforth. The reason of shareholders’ conflicts is tightly connected with the nature of joint-stock company, and cannot be resolved once for all. The reason lies in unequal nature of both shareholders’ rights and their opportunities to exercise these rights.
Really, in joint-stock company, as well as in any other organization operated by the majority of votes, occurrence of the conflict between the majority and minority which results from discrepancy of their wills and necessity of minority to submit to the will of majority is inevitable. However, the contradiction is not so glaring if the number of members is large enough and their rights are quite equal: in such cases it is not important whether shareholder belongs to majority of minority, and, by the way, the result of the voting is also not so predictable.
In joint-stock company volume and substance of rights of separate members are not identical, but proportional to the quantity of shares each of them owns. In such situation it is not difficult to form a stable majority group: either by purchase of control stock by one person or by conclusion of a treaty among few large shareholders who together own control stock. If this scheme is realized in full without any limitations, such principle of management inevitably causes situation in which a fixed number of persons make decisions whereas minority shareholders have no chance to influence the outcome of any voting at all.
It should be noted that on its own account such power redistribution within enterprise does not infringe the interests of minority shareholders. Because the person joining such company is first of all interested in profit earning, not in the management of enterprise itself. Participation in management of joint-stock company is only a means towards that end.
To add up, the surrender of power to majority is theoretically justified by the idea of majority interests coinciding with interests of the whole company(this is not absolutely right, because the majority may be just relative and represent less than 50% of authorized capital), and consequently majority group represents joint interests better than minority one.
The problem is that the majority has an opportunity to abuse its position and study its private interests under the guise of pursuing common good. There are many ways to commit such abuse. But all of them add up to creation and/or use on the part of majority of legal opportunities to earn indirect profit from the operation of company or even its inactivity. So, large shareholders may involve the company in economic cooperation with affiliated persons and (by overpricing or underrating) increase their profit to the detriment of the company, bring it’s activity up to a close to the benefit of affiliated persons, take executive positions within enterprise and set unreasonably high compensations for themselves. Whereas, minority shareholders are able to earn profits from company’s activity only in a form of dividends or sale of shares.
Thus, disproportionate redistribution of authority in joint-stock companies leads to disproportionate redistribution of incomes between majority and minority shareholders. In such situation the income received by the shareholder depends not only and not so much on a principal value, quantity and category of shares he owns, as on whether he belongs to majority or minority group. It is obvious that unanimity assuming full equality of shareholders may hypothetically be an alternative to existing principle of decision-making in joint-stock company.
It would reduce to zero the essence of conflict between them and will also eliminate disproportions concerning the redistribution of income. However, such control strategy is unacceptable owing to its utmost inconvenience, sluggishness and inefficiency, as well as considering threat of blackmail on the part of minority shareholders, whose votes would become too influential compared to amount of their investments.
Eventually, it would make existence of joint-stock companies with a large number of members impossible. Thereby, the legislation tends to either moderate the “law of majority” or eliminate the most negative effects of it.
Moderation of the “law of majority” is attained with the help of certain legal methods designed to make the will of minority more important in the process of decision-making:
1) limitation of the quantity of votes one shareholder may possess;
2) cumulative voting that secures proportional representation of the minority groups of shareholders at the committee of directors;
3) lodging the minority shareholders with the right of veto by rising the minimum number of votes necessary to pass resolutions at shareholders’ meetings (both directly and by establishment of basis for votes’ calculation);
4) separate calculation of votes of those shareholders whose rights are affected by certain decision, and their separate voting;
5) deprivation of the right to vote of certain majority shareholders if their interests collide with interests of the company concerning the question on agenda;
6) lodging the minority with the right of a casting vote.
Let's examine these methods in detail taking legislation of the European Union countries for example.
The principle of strict conformity of shareholder’s number of votes with the quantity of shares belonging to him (his contribution to the authorized fund) leads to inequality among shareholders and may be qualified as antidemocratic, even though shares of one type provide equal rights for their owners. This principle would multiply the actual inequality inevitably arising from a decision-making pattern by a majority vote even if each shareholder possessed one vote. The most universal way to moderate such inequality is to limit the quantity of votes possibly available for each shareholder to possess regardless of how many shares he owns.
The modern joint-stock legislation of many countries establishes by a permissive rule the principle “one share - one vote” (or one share of certain type – certain quantity of votes), however permitting this correlation to be modified within the charter.
Article L 225-125 of the Commercial code of France and § 134 of the Joint-stock law of Germany contain similar norms. For example, the latter permits to amend the charter - introduce positions restricting the shareholder’s right to vote by fixing of the limited number of votes or lowering coefficient of votes. In Germany public corporations with large number of shareholders often include in the charter position that limits the right to vote to 5-10% regardless of the size of shareholding.
However, low efficiency of such restrictions was already noted as far back as in the beginning of last century, because large shareholders could bypass it easily by temporarily transferring the shares to figureheads. Now the legislative methods of prevention of such frauds have been introduced. For example, according to § 134 of the Joint-stock law of Germany, one must sum up the quantity of shares belonging to certain person with shareholdings purchased by other persons at his expense, shares belonging to enterprises controlled by this person, managed by this person or connected with him/her in one concern. The main argument against such restriction is that joint-stock company is the union of capitals and the scope of management rights should be measured only by the size of contribution of each shareholder; proportional increase of large shareholders’ measure of rights is caused by the fact that they are more interested in bonanza of the joint-stock company and will certainly show greater care.
However this statement is also disputable, because one can’t deny that while running the company shareholders operate as persons and consequently it is necessary to treat them as equal.
Nevertheless, such restriction of large shareholders’ right to vote established as an imperative, would contradict their interests, that’s why it exists basically in a form of an opportunity, and is of no importance for the protection of minority shareholders due to its rare use.
One should pay attention to the methods of rights’ protection of minority shareholders which are used abroad and thus were until recently unknown for us. One of such methods is cumulative voting, which allows the use (concerning some questions) of more than one vote. Usually such additional votes are available due to refusal of shareholder to use his vote to influence decisions on other questions. For example, the Russian legislation enables cumulative voting at elections of members of the public supervisory board.
The distinctive feature of cumulative voting is that the number of votes belonging to each shareholder is multiplied by number of persons who are to be elected in the public supervisory board, and the shareholder has the right to give all his votes for one candidate or to distribute them between two and more candidates.
Those candidates who get the most votes are elected. As a rule, consolidation of efforts of minority shareholders at such type of voting enables them to elect their representatives into the public supervisory board. The law of Ukraine “About the joint-stock companies” enforced in the end of April 2009 has made the procedure of cumulative voting available in our country.
Next way to protect the rights of minority shareholders is to lodge them with powers to bring an action against officials who have causes damage to the company. Those persons who have voted for tortuous decisions are to repair the damage caused by these decisions. It means that those members of the collective body who voted against the decision or did not participate in the given voting at all are not responsible for the damage.
Among the methods of protection is also endorsement by the general meeting of large transactions, if one of the shareholders (or enterprises connected with him) has the special interest in carrying it out. In such cases the interested person is not to take part in the voting.
Other method presupposes establishment of the qualified majority principle. In most foreign countries qualified majority is necessarily required to pass the most important resolutions at general meetings. In Article №2 (paragraph 179) of the Joint-stock law of Germany the majority of votes is required to modify charter of the company, and these votes should necessarily represent three-quarters of authorized capital.
The same type of majority is required to decide increase/reduction of amount of the authorized capital (paragraph 193 and 222 accordingly). It is remarkable that one requires not three-quarters of present members to vote, but three-quarters of authorized capital to be represented, which is even stricter a requirement than the one in Ukrainian legislation.

Legislation of European countries is characterized by variety of approaches towards the problem of proportional representation of shareholders in the collective body of the company. In Germany it is allowed to prescribe in the charter of joint-stock company the right of some shareholders to delegate the fixed quantity of representatives to the supervisory board (§101 of the Joint-stock law of Germany).
Ukrainian legislation prescribes that decisions of general meeting of shareholders may only be passed by the majority of votes (50% + 1 vote) of those shareholders who own voting shares and are present at the meeting.
Legislations of European states contain similar norms. If all members are present at the meeting the control over the company belongs to shareholders (shareholder) who own 50 % +1 voting share. If there is no requirement about the minimum necessary quantity of members (owners the voting shares) present at the meeting (requirement of quorum); and if the shares are scattered among the great number of shareholders and their activity is low there is a possibility that decisions on behalf on the company will be made by the minority.
But at the same time the establishment of high requirements to quorum at absence of large shareholders can lead to an absolute impossibility to hold competent meeting of shareholders at all. That’s why legislation of most European countries does not establish requirements to quorum for general meetings of shareholders (Germany) or establishes low quorum for the first assembly and no quorum for the following ones (France).
At the same time serious requirements both to quorum and to the majority of votes are established by the state only for cases of great importance concerning fundamental questions of company’s activity: modification of the charter and authorized capital, reorganization and liquidation of the company, carrying out large transactions.
So, as prescribed in the §179 of the Joint-stock law of Germany, decisions concerning modification of the charter, increase of the authorized capital or liquidation of the company are to be passed by the simple majority of votes at presence of the shareholders owning three-quarters of the authorized capital.
The same majority of votes is required to endorse transactions about transfer of all property of the company (§361), contracts about merging of joint-stock companies (§340с), contracts about the enterprise (about management and allocation of profit) (§293), decisions about joining other company (§319), decisions on endorsement of certain types of transactions stipulated by the charter or the supervisory board (§111), decisions on exception of the pre-emptive right (to purchase additional shares).
By the way, decision on merging of joint-stock companies should be endorsed by the same majority of votes by holders of each sort of shares.
According to Article L 225-96 of the Commercial code of France, quorum for special general meeting of shareholders able to modify the charter is to consist of members (having the right to vote) who possess 1/3 of shares; at the second convocation – members who possess 1/4 of all shares, while the decision is passed by 2/3 of votes of shareholders present at the meeting.
According to “the Company Law” of Finland, the decision on modification of the charter is endorsed by the majority of 2/3 of the votes of shareholders present at the meeting, provided that there are also present those shareholders who own 2/3 of the shares. According to the Civil code of the Netherlands, the qualified majority of 2/3 of votes of present shareholders (who own not less than half of the issued capital) may pass resolutions concerning the non-use of the right of preferential subscription to stock, granting of options, warrants, making decisions about joining other companies.
Legislation of Sweden and Finland also requires qualified majority of votes to modify constituent instruments, alter the rights of shareholders, owners of the certain types of shares; legislation of Portugal, the Netherlands, Finland and Austria requires such majority to pass resolutions concerning merging of enterprises, allocation of profit, liquidation of a company; legislation of Belgium and Austria – concerning modification of the authorized capital.
Ukrainian legislation establishes stricter requirements to quorum in comparison with the European countries, however, it does not raise these requirements when deciding the most important questions of company’s activity. To add up, our domestic legislation prescribes the necessity of qualified majority (3/4) of votes of those shareholders who own voting shares and take part in meetings concerning the following questions:

Additions making and modification of the charter of the company; endorsement of the revised charter.
Reorganization of the company.
Liquidation of the company, appointment of the liquidation committee, endorsement of progress and final liquidation balances;
Endorsement of large property transactions, the cost of which makes more than 50% of book cost of the company’s assets.
Buy-back of previously emitted shares.


Besides, to amend the charter with provisions striking at the rights of preference shares’ owners one has to secure the majority of 3/4 of the votes of above-mentioned shareholders, and 3/4 of the votes belonging to owners of other voting shares present at the general meeting. Establishment of requirements about the qualified majority and the quorum means actually lodging minority with the right of "veto". Optimal tactics for minority shareholders is determined by such criterions: how scattered the shares are among shareholders, the attendance of assemblies, size of shareholdings belonging to majority shareholders, degree of consolidation among minority shareholders. Depending on the above-mentioned these tactics may consist in either voting against the unfavorable decision or non-appearance at the meeting in order to “wreck” the quorum. However the last variant is useless if the majority possesses the quantity of shares enough for quorum.
The most specific and flexible way to protect interests of minority shareholders (or, more precisely, all shareholders’ common good) from unfair actions of majority shareholders is to deprive them of the right of a casting vote concerning questions in which these certain shareholders are personally interested to the prejudice of common interests of the whole company. Such deprivation is applied practically in the following cases:
1) If it is a question of control over activity of these persons in the authorities of the company, their discharge, lodging them with the rights and in some other cases;
2) When concluding a contract concerning which certain shareholders, members of the committee of directors or top-managers of the company have personal interest.
It should be noted that according to §136 and §142 of the Joint-stock law of Germany, it is forbidden to vote for oneself or for somebody else if there is approval of one’s accounts, question of discharge or reclamation on the agenda; when appointing auditors member of the Board or the Supervisory Board has no right to vote either for himself or for somebody else if the audition concerns events connected with approval of his accounts or legal dispute between the company and this member of the Board or the Supervisory Board.
In conformity with Article L 225-138 of French Commercial code, when voting for cancellation of privilege for buying shares for the benefit of certain shareholders, these shareholders are not to take part in the voting.

We would like to emphasize these moments, because one of the subjects of our research is buy-back of previously emitted shares announced by Ferrexpo. This company is registered in England and domestic law of this country differs from the French legislation concerning this question.
The most important method of protection of minority shareholders is to deprive certain shareholders of the right to vote on questions in which they are personally interested. The procedure of conclusion of such contracts is settled in the same Commercial code of France and legislative acts of some other European countries. As the question of conclusion of contracts in which certain shareholders are personally interested deserves special consideration, we will describe it in detail later in the part concerning the buy-back of Ferrexpo shares.
It should be also noted that legislation of some countries lodges minority shareholders with the right to demand that company should make certain decisions.
So, according to the legislation of Sweden (§12 of the “Company law”) and Finland (§12 of the “Company law”), even 1/10 of shareholders, if the smaller percent is not stipulated by the charter, may demand allocation of half of profit (but no more than 5% of the company’s assets) among shareholders in form of dividends. In this case the decision about allocation is virtually made not by the majority, but by the minority. It is clear that legislations of Scandinavian countries act on the premise that generally ruling majority is not interested in allocation of profit in the form of dividends, and, hence, their voting will be certainly biased. There are no such mechanisms in our country’s legislation, but to our way of thinking establishment of such norms would be quite expedient.

So, we have listed the legal methods used in some European countries to moderate the rigid majority principle and to prevent majority shareholders from making decisions notoriously harmful to the company. Such methods as separate voting, stricter requirements to the quorum, establishment of the qualified majority principle, prohibition to vote for personally interested persons are applied in various combinations in order to settle issues potentially dangerous for the interests of minority shareholders. Among such issues are:
1) increase and reduction of the authorized capital;
2) reorganization of a joint-stock company;
3) carrying out transactions in which certain shareholders are personally interested;
4) carrying out large transactions;
5) protection of the rights of outside shareholders when the company is entering into the group of the enterprises as a dependent or affiliated company;
6) carrying out transactions connected with transition of control over the company;

Alongside with voting mechanisms examined in our research rights of minority shareholders are also protected by direct regulations or prohibitions about the conditions and special procedures of decision-making which provide a significant role for minority shareholders. In a sphere of corporate relations Ukrainian issuers are characterized first of all by a large number of minority stockholders having emerged in a course of privatization process; this peculiarity makes Ukrainian corporate relations very different from those in developed countries (where such relations have a long history of development).

Another prominent feature is absence of elaborated legislation to protect minority shareholders. This fact as well as weak judicial system makes minority shareholders virtually powerless when making decisions about company’s activity. One can’t actually claim that Ukraine exercises leadership in the frequency of shareholders’ rights being infringed. But the problem is all the same very serious and there are a lot of examples to prove it. But we will focus our attention on only a few of them.

In April 2004 shareholders of public corporation «Nikolaev aluminous factory» (NAF) (Николаевский глиноземный завод) were offered to decide the fate of their shareholdings in 10 days term. They had 2 options: either to sell their shares for price underestimated more than twice or to unite with other shareholders in order to collect around 9 million shares, which can be exchanged for one security of new nominal value.
Before this, in the middle of March 2004 general meeting of shareholders of NAF public corporation made a decision to denominate the shares of the company. It was planned to consolidate about 3 billion previously issued ordinary registered shares at the value of 25 copecks each by their proportional exchange for 80 ordinary registered shares at the value of UAH 9 456 584 each; the size of the authorized capital and the rights given by possession of shares were not to be changed. Those shareholders, who had not enough shares to buy at least one security of new nominal value (in other words, those who possessed less than 1.25 % of the authorized capital) were offered the following options:

to sell the shares to the company, but not at the nominal value of 25 copecks, but at the cost of 10 copecks. To carry out this variant these shareholders were to send corresponding application to the managers of company. But regardless of whether the shareholder had been inclined to do this, he was, in any case, to receive his proceeds at the notary public. And the Board of NAF was to inform the above-mentioned shareholder about it with first-class letter. So, virtually minority shareholders had no choice at all.
The second option was to unite the shares belonging to these shareholders into common property by conclusion of the corresponding contract followed by transfer of these documents to the company’s registrar. And if the shareholders failed to unite in 10 days, they were also to receive their money from the notary public. With no alternative.

It is obvious, that such rigid terms of securities’ exchange were unwelcomed by the minority shareholders. At least many of them regarded such tactics as tyranny. It is ironic that in fact NAF operated legislatively. From legal viewpoint there were no infringements at all – the shareholders were given fixed 10 days to make a decision as it is prescribed by legislation. The matter is that such issues are not directly settled by Ukrainian legislation as well as the pricing mechanism of the shares’ buy-back.

The next example is connected with the leader of Ukrainian metallurgy industry. At the shareholders’ meeting of integrated iron-and-steel works “Zaporozhstal” (Запорожсталь) held on the 7^th of June 2006 had passed a resolution to increase the authorized capital up to UAH 660.9 million (that is UAH 450 million more than before). This aim was to be attained by attachment of 5 public corporations to “Zaporozhstal” – “Zaporozhstal firm” (Торговый дом “Запорожсталь»), “Steel track” («Стил Трэк»), “Refractory materials firm” (Торговый дом огнеупоров»), “Zaporozhstal-Invest-Torgprom” («Запорожсталь- Инвест-Торгпром») and “Centersteel” («Центрсталь»). In this case minority shareholders fall between two stools, because they had no right to commit buy-back of additionally emitted shares not being shareholders of the above-mentioned attached enterprises. The minority shareholders were offered to redeem additionally emitted shares at the price of nominal value – UAH 0.25 per share. But at the moment of decision-making on additional issue of shares their market-price made UAH 6.05 and dropped to UAH 2.5 right after it.
According to minority shareholders, the last stockholders’ meeting was held with a whole number of infringements and the only aim of increase of the authorized capital was to dilute the share of minority stockholders from 8% to 3% and earn additional profit (75 million dollars) for benefit of majority stockholders as a result.
Initially minority had an off-chance to cancel the decision about additional issue. However, when the meeting was held there had already been a legal decision prohibiting to hold stockholders’ meeting; both emitter and Zaporozhye territorial department of the State Committee on securities and stock market were notified of it. Besides, according to minority stockholders they were disabled to participate in the last meeting. However, these arguments proved to be insufficient for the court to take the minority’s side – the minority stockholders owned only a few percents of shares whereas those who voted for the increase of authorized fund owned more than 60%.
Minority shareholders of “Zaporozhstal” have also failed to obtain compensation for unfairly established buy-back prices, because procedure of indemnification in case of additional issue of shares is not settled in the current legislation of Ukraine. As it is prescribed in the law «About economic companies» (О хозяйственных обществах) repurchase price must not be lower than the principal value of shares, so, formally majority shareholders of “Zaporozhstal” acted within the pale of laws.

We shall focus our attention on one more story closely connected not only with unethical acts, but also with a whole bunch of infringements difficult to run across even in Ukraine. On 22^nd of June 1994 Ukrainian-American Closed Joint-Stock Company “Borschagovskiy chemical and pharmaceutical factory” (CП АОЗТ БХФЗ) was registered. It was founded by 325 citizens of Ukraine possessing 50% of its shares and owning “R&J Trading International, Inc” company (USA) which in turn possessed another 50% percent of BCPF shares. Ukrainian side has invested property and circulating assets in the authorized fund. The American party invested technologies and equipment, owing to which BCPF became able to quickly resume manufacture of medical products.
Unfortunately, it has turned out to be a great fraud as a result of which the image of Ukraine suffers. This fact has to do a lot with Lyudmila Bezpalko, the head of BCPF. L.Bezpalko had initially planned and successfully executed a hackneyed bunko of the honest foreign investor. The plan was simple, but audacious and reliable. First of all (in 1995) three officials of joint venture BCPF (president L.Bezpalko, chief accountant T.Artemenko and the chief of a legal department T.Kalchenko) had illegally founded the enterprise with the similar name – public corporation “Scientific production center “Borschagovskiy chemical factory” (ООО НПЦ БХФЗ). It was illegal because when registering this enterprise its founders failed to invest 30% of their shares in the authorized fund.
In the same 1995 L.Bezpalko organized illegal additional issue of BCPF shares without the knowledge of foreign investor. After that the shareholding belonging to “R&J Trading International, Inc” abruptly decreased percentagewise. The majority of illegally issued shares were subsequently sold to “Scientific production center “Borschagovskiy chemical factory” owned by L.Bezpalko and her people.
One should pay special attention to the fact that “Scientific production center “Borschagovskiy chemical factory” purchased additionally emitted shares of BCPF for illegally accrued and paid dividends in the sum of about 1 million dollars. Accrual of such dividends has not been agreed with representatives of “R&J Trading International, Inc” and it was illegal to decide such issues without endorsement of company owning 50% of shares of BCPF. Moreover, on 15^th of September 1995 Leningradskiy (nowadays – Darnitskiy) district council (in Kyiv) amended the charter of company for a bribe and without the knowledge of American founders of the joint venture.
It was obviously the way to artificially bankrupt Ukrainian-American Closed Joint-Stock Company “Borschagovskiy chemical and pharmaceutical factory”. As a result, the foreign founder - “R&J Trading International, Inc” was deprived of a right and ability to run the joint venture, dispose of its property and earn profits from the activity of this enterprise.
The transaction of property from balance of joint venture enterprise to the balance of company belonging to the leaders of “Borschagovskiy chemical factory” began right after “Scientific production center “Borschagovskiy chemical factory” (L.Bezpalko and her partners, in fact) became co-owners of BCPF. Factory departments, basic means of production, machinery and equipment were illegally alienated (but actually stolen) from the foreign investor. All money resources on settlement accounts of BCPF were illegally transmitted to accounts of “Borschagovskiy chemical factory”.
To conceal these illegal actions from the foreign investor and law enforcement bodies, Bezpalko had forged contract about transition of property to BCPF in 1995. This contract was written post factum and the date on it was the 24^th of June 1994. According to this contract an artificial debt of joint venture to “Borschagovskiy chemical factory” was created. But how on Earth could BCPF have been already indebted in 1994 to the enterprise which hadn’t even existed then?
Drawing of such false contract broke interests not only of the foreign investor, but also of several hundreds of natural persons - shareholders of the joint venture BCPF; their property and money resources were alienated in favor of the founders of “Borschagovskiy chemical factory” (Lyudmila Bezpalko, first of all). Bezpalko has also post factum forged minutes of BCPF shareholders’ general meeting on the 24^th of May 1996. According to these minutes term of office of Ukrainian representatives in the Board was allegedly prolonged. And, of course, representatives of “R&J Trading International, Inc” were not invited to the meeting (because actually there was no such meeting at all) however, their signatures under the minutes were successfully forged.
After that L.Bezpalko organized bankruptcy of the joint venture BCPF. In order to carry it out in January 1997 certain figureheads referred a claim to Public Prosecutor’s Office of Leningradskiy district (Kyiv) against the joint venture, Leningradskiy district administration and “R&J Trading International, Inc” in order to nullify the charter of BCPF. As a result of it, on the 1^st of October 1998 the groundless adjudication nullifying the charter of joint venture was made.
Later, thanks to the diligent work of law enforcement bodies, legal proceedings against L.Bezpalko were instituted. One of the cases concerned the infringement of order of securities’ issue (namely illegal issue of BCPF shares). As a result, Chairman of the Leningradskiy district court of Kiev cancelled the decision about nullification of BCPF’s charter and Leningradskiy district administration also passed a corresponding resolution.
However, L.Bezpalko has addressed the Supreme Court of Arbitration with a request to reexamine the case, having backed this request with some powerful "arguments". And, unfortunately, the court has yielded to the temptation of money reward. Consequently, new imaginary circumstances were found by misinterpreting of one of the decisions of Leningradskiy district court. Allegedly, some defects of proceedings occurred – respondent was not changed (whereas it was necessary because “Borschagovskiy chemical factory” had purchased the shares of BCPF), copies of the court decisions were not passed to “R&J Trading International, Inc”.
Since then L.Bezpalko has been managing the property, half of which belongs to “R&J Trading International, Inc”, by her own. In order to strengthen her position, L.Bezpalko together with the chief accountant have founded the registrar’s company "Reesta" («Рееста»), to which the BCPF shareholders’ register was subsequently transferred. It was also a blatant violation of legislation on securities.

In the end of our research we’ll give a rather non-typical example, already mentioned above. It is non-typical due to the fact that it touches upon a public company, owned by a top Ukrainian businessman. However, this company – and we’re speaking of Ferrexpo – is registered in England. I.e., it operates under English legislature.
A digression is needed to describe the factors, which have negatively influenced this mining company’s activity recently.
Ferrexpo’s main asset is Ukraine’s largest producer and exporter of iron-ore pellet, public company “Poltavskiy gorno-obogatitelny kombinat” (PGOK) (Полтавский горно-обогатительный комбинат). A company’s main activity is production and export of iron-ore pellet. One should mention that PGOK specializes on open-pit iron ore mining. Until recently total annual production reached nearly 9 million tons. About 90% of stock was exported. Main consumers included companies from Austria, Poland, Romania, the Czech Republic, Slovakia, former Yugoslavia, Bulgaria, and Italy.
Ferrexpo’s controlling interest (51%) is owned by “Fevamotinico” company, to which businessman and a people’s deputy representing Block of Yuliya Timoshenko Konstantin Zhevago is the only beneficiary. “New World Resources” N.V. (NWR, the Netherlands) possessed 25% of the shares, being controlled by the Czech billionaire Zdenek Bakala through Cyprian company “RPG Industries SE”.
In 2007 Ferrexpo Plc became the first Ukrainian company to get listing at London Stock Exchange main site. Ferrexpo got ₤ 213 million for selling shares at LSE. Although in fact the result was negative: due to lots of mistakes during IPO preparation, shares’ price was 30-35% lower than it could be for potential investors. In 2008 the company was included into FTSE-100 index in Great Britain.
One should also notice, that due to additional emission in the end of 2008 Ferrexpo increased its share in PGOK from 87.84% to 90.9%.
Starting from the second half of 2008, a crisis hit world metallurgical industry. Situation in mining industry is no better. According to the prognosis of Australian bank Macquarie, transoceanic iron ore trade will drop 15% this year, while steal production will drop 18%. Macquarie’s experts foresee a considerable – about 33 million tons – overproduction of iron-ore and 35-50% drop in prices.
Under current circumstances Ukrainian mining industry is in the worst condition. The point is that when Ukrainian economy is collapsing (Ukraine has already demonstrated worst records in many regards), the state has no opportunity to support the branch. There is no inner demand for metallurgical products due to a complete halt of building and construction and sharp decrease in machine building and automotive industry. The situation is worsened by problems in financial sector – the banks are unable to give more loans and thus stimulate the demand. Political situation deteriorates almost every day, so there is no hope for foreign investments.
Facing lack of demand, market agents started to cut the production. World giants, such as Arcelor Mittal, are planning a 10-40% cut of production. An export-oriented Ukraine was one of the first to feel a crisis on steel market. The production of steel in our country fell 48% in December 2008 comparing to the same period in 2007, while metallurgic industries workload is only 40-50%. Several enterprises had to stop production for a month or two, and that’s only a beginning. It’s clear, that some metallurgical plants will not operate for much longer.
Certainly, producers of raw materials got worse. Ferrexpo got notification of a significantly decreased demand for iron-ore pellet for the whole year 2009 from all buyers-exporters, earlier contracted. It was due to a significant decrease of both demand and production of steel.
Ferrexpo’s clients asked not to make a considerable part of supplies, planned for year 2009, at all. The result of this will be a considerable increase in non-distributed production volumes this year, overload of storage facilities, drop in working capital, which will further stimulate Ferrexpo’s production slowdown. A serious decrease in demand will have a negative impact in 35-50% on expected Ferrexpo’s production sales on the whole in 2009.
The drop of demand mainly influenced Ferrexpo’s production, containing 62% of iron, which makes Ferrexpo decrease production of this type of pellet, constituting a lion’s share of production, made at PGOK, which belongs to Ferrexpo. I.e., Ferrexpo will become unprofitable in the nearest future.
A sharp decrease in demand for Ferrexpo’s production is strengthened by the fact that company’s clients lessen storage of iron ore at the main regional market of Ferrexpo – in the Central and Eastern Europe. Ukrainian potential consumers of Ferrexpo’s production are practically unnoticeable, which significantly increases Ferrexpo’s bankruptcy risks.
It’s evident, that shares of Ukrainian mining and metallurgical companies in general and Ferrexpo in particular face risks of further decrease. One shouldn’t expect high market activity in 2009. Most likely, investors will wait and the market activity would obtain ability to grow no earlier than in the second half of 2010. Most of Ukrainian companies are comparatively overpriced. Moreover, investors’ attitude to Ukrainian companies’ shares has changed with the view of looking for fundamentally strong assets with relatively low debt level, clear strategy and tactics, high level of corporate management.
Ferrexpo is out of this group of assets. The only move by K. Zhevago concerning personal management of the company (more is given below) is enough to demonstrate the absence of transparency in Ferrexpo’s activities. The company’s liabilities stand high chances of dramatic fall in 2009. Such dark expectations concerning Ferrexpo shares are already coming true. The British stock indexes provider FTSE Group has excluded Ferrexpo’s shares from its FTSE-100 index. This decision was taken during a quarterly review of the list of FTSE-100 participants and is based on quarterly dynamics of shares’ quote at the London Stock Exchange. In the last quarter of 2008 Ferrexpo shares’ price dropped 68%.
Ferrexpo’s industrial activities data prove complete usefulness of investing into the company. In 2008 Ferrexpo Plc lowered ore mining at 17.4% comparing with 2007, while the production of ore-mine concentrate dropped 15.8%. Last year Ferrexpo also produced 16.4% less pellets than in 2007.
Ferrexpo is already starting to cut its business. A project of development of Lavrikov field in the Poltava region is on hold. Moreover, due to a world financial and economic crisis, in 2009 PGOK itself plans to cut production of iron-ore pellet at 15% comparing to 2008. Clearly, such a decrease in production level is capable of bringing Ferrexpo capitalization to zero. It’s also clear, that in practice decrease in production will be even bigger due to recession in world economy, and the fact that Ukrainian economy will fall much lower than other countries at the average.
Let’s now dwell on the question directly connected with the subject of our research.
A shareholders’ meeting of Ferrexpo was planned to be held on May, 19, 2009. Company’s controlling interest belongs (via Fevamotinico company) to K. Zhevago, a businessman and a people’s deputy from BUT. The meeting’s main concern will be a buy-back of up to 10% of Ferrexpo shares, quoted at London Stock Exchange (LSE). According to plans of Ferrexpo management, purchased shares can be later resold, nullified, or used for company’s stuff reward.
Actually, under panic on stock markets, more companies, quoted at stock exchanges, can use a buy-back of their own shares. A buy-back is when a company buys it own shares at an open market. However, even speaking abstractly, buy-back is a short-term measure, which brings effect for only a short period of time.
When using a buy-back, a company faces a sharp rising of risks in a long-term perspective. Thus, when a decision to buy-back company’s shares is taken, there is a risk that speculators would artificially “warm up” market, rise shares’ price, which would make senseless for a conscientious issuer to buy-back. Moreover, companies, capable of buying-back, will not make their plans public, since that would lead to a rapid rise of shares value and increase of buy-back operations’ expenses.
In reality, Ferrexpo’s buy-back looks rather ambiguously. There are reasons to claim, that K.Zhevago has other goals in mind, namely to support his stagnating enterprises.
The buy-back of Ferrexpo shares may be conducted in the following manner: at the expense of Ferrexpo (49% of its property belongs not to Zhevago) Ferrexpo shares would be called away from “Fevamotinico” belonging to Zhevago. It is clear that holding a post of executive director general of Ferrexpo (previous directors were relieved of their posts on 25^th of October 2008) Zhevago has additional possibilities to carry out buy-back. In future money of Ferrexpo may be as well directed to “Finance and Credit” (owned by Zhevago) being in difficult financial state.
We shall remind you that on the 18th of March 2009 the above-mentioned bank officially requested public relief, confirmed by the stockholders’ meeting of this bank held on 24^th of March. However, the state made it very clear that it was free to grant financial help only to those banks where temporary administration had been established. It is clear, that Zhevago would not welcome temporary administration in this bank. According to experts “Finance and Credit” is solely in need of at least UAH 3.5 billion. Can Zhevago be planning to obtain this sum from the minority shareholders of Ferrexpo by specific operation of buy-back?
We should note, that on March, 23 international rating agency Moody’s lowered “Finance and Credit” ratings from level B1/B2/E+/Aa3.ua to Caa2/E/B3.ua, i.e. to de facto default level. Moody’s explained lowering “Finance and Credit’s” rating by the fact that the bank had not paid a $ 70 million credit in time (only 5% of the total sum of the credit were paid). That means that “Finance and Credit” is really in a state of default. One should mention, that the loan was initiated in March 2008 by Raiffeisen Zentralbank, Standard Bank, and VTB. Credit rate was LIBOR+1,95%.
When conditions of recapitalization for six out of seven banks, shareholders of which asked for state assistance, were revealed, independent experts got surprised. In exchange for financial support, the government is going to get 99% of shares in bank “Kiev”, Rodovid Bank, and Ukrprombank; 91.8% of shares in “Nadra” bank 75%+1 shares in Imexbank, and Ukrgasbank. “Finance and Credit” should transfer 50%+1shares to the government in exchange for financial support.
But one of the key conditions for getting financial help was no less than 75%+1 share being transferred to the government.
The authors of this article took interviewed Deputy Secretary of the National Security and Defense Council of Ukraine Dmitriy Vydrin concerning special conditions for “Finance and Credit” recapitalization. It will be presented in the end.
Returning to Ferrexpo one should mention that situation on market favors Zhevago. In the beginning of April 2009 Ferrexpo shares quoted at LSE at the level of 0.6-0.62 pounds, but already on the 14^th of April they cost 0.77 pounds. And on the 27^th of April 2009 their market value was 1.315 pounds. Thus it looks like the market has reacted accordingly on the announcement of buy-back of Ferrexpo shares and Zhevago’s plan was realistic. However in such case minority shareholders are “behind the eight ball”.
By the way, similar operation with the return repayment of actions of K.Zhevago has done in September, 2008. Then, in connection with falling of the price of actions Ferrexpo it had a situation with necessity довнесения money on margin call within the limits of the credit from bank JP Morgan for the sum of 2.2 billion dollars.
However, these 77 million dollars have not saved the day: Zhevago failed to both cancel the credit and to increase credit security. As a result, JP Morgan has sold pledged Ferrexpo shareholding (20.79%), which had belonged to Zhevago before.


We shall also notice that there is a great difference between the buy-back announcement and real purchase of shares. Of course the announcement may cause the growth of share price, but it usually has temporary effect. The announcement of buy-back does not necessarily lead to real purchase. A good deal of announced buy-back operations have not been carried out completely. Even the representative of Ferrexpo Gavin Mackay has recently made a statement that that the company is not going to carry out the buy-back. Allegedly, the question of vesting the right of buy-back of up to 10 % of shares in Ferrexpo has been put on the shareholders meeting agenda scheduled on the 19^th of May, however, according to mister Mackay, the company will not necessarily exercise this right. So is it possible that Zhevago has declared the buy-back only to provoke the short-term rise in prices of Ferrexpo shares in order to sell his own shareholding? Should we consider such possibility as real? Or Zhevago all the same hopes that buy-back will bring him really serious financial advantage?

One may reasonably assume that Zhevago’s motive is to redeem his shares at the expense of Ferrexpo shareholders and consequently misappropriate their money. And the buyback will be carried out at the unfairly overestimated price – it became possible as a result of successful market manipulation.

Dmitry Vydrin’s (assistant of Secretary of the National Security and Defense Council) commentary:

The new “state-knows-better” concept has been introduced lately in our country. The existence of any kind of private property irritates the highest executive authority of Ukraine. The state is annoyed with the truckers writing the waybills for themselves, private newspapers being censored by their owners, private gas traders trading for their own profit. And private commercial banks also annoy the state. That’s why the prime minister of Ukraine has made an unparalleled thing – she has called people (three times!) to bank only in the national banks.
Moreover, she has done more by naming the most “appropriate” national banks as well as those commercial ones which are the most “inappropriate”.
Taking this into consideration I suppose that the state, namely the prime minister, will continue to carry out both consistent policy of absorption of the clients of private banks into the governmental sphere, and transformation of joint-stock and private property into the public one.
Why there is no uniformly in approach to various banks? It is easy to explain: there is game of politics occurring in the meantime. And consequently owners of the banks find themselves in uneven conditions because of their uneven contributions to the “court” political struggle. Those of them who are ready to provide large contribution rate are offered more favorable conditions; those who are able to contribute less face more rigid approach. It is connected once again with the collision of political game and economic struggle.
If it were not for this collision, all the banks liable to legal recapitalization would have been already recapitalized.
But political game amends the process and one must be aware of the participation of the banks in this game.
That’s why it becomes possible for the state to gain control over shareholdings in a course of recapitalization of the banks. The size of these shareholdings helps to define how much the certain bank is “guilty” towards the state, namely its chief executive.
The state shareholding in the bank “Nadra” is 91.8% because those who tried to purchase it were simultaneously funding political projects undesirable to chief executive and criticizing the operating executive authority. Whereas state shareholding in the bank “Finance and Credit” is only 51%, which means that the state has forgiven them 49% of their “guilt”.


However one should mention that Zhevago’s acts concerning Ferrexpo have caused certain domestic and foreign policy “side effects” for country on the whole and namely for Timoshenko’s government. However national interests of Ukraine don’t actually bother our politicians, one can’t but mention that potential scandal concerning the company registered in Switzerland and belonging to Ukrainian citizen may seriously damage the image of our country. Moreover, disputes between Swiss bankers and the world community on reluctance of Switzerland to adjust its financial legislation to international requirements concerning fight against money laundering and tax evasion (in Ukraine it is ironically called “optimization” of income) would draw undivided attention of international supervisory financial organizations to any scandal concerning Switzerland even indirectly. Such unwelcomed attention would inevitably spread also on Ukraine and Ukrainian businessmen as persons concerned to the scandal.
Consequently, Ukrainian enterprises would at least face additional difficulties in obtaining credits available on world market; at most – they might become subjects of international inquiry. In the period of world financial crisis it would cause inevitable and quick collapse of business.
Though, the main difficulties would be faced by Timoshenko’s government loyal to Zhevago.
Having put a severe strain on Ukrainians, crisis lessened people’s sympathies towards the prime minister. Her rating as presidential candidate cannot give her confidence about victory in the first round anymore: the elections will be held in at least 6 month, crisis is unlikely to disappear, Ukrainian government’s money resources are wearing thin and attraction of international credits becomes more and more difficult. That’s why it is almost impossible to predict what will happen with her rating’s decrease in future.
Theoretically this process is still reversible and successful election campaign may help her to (at least partly) recover popularity. Taking into account both management reserves available for the head of government and the fact that in the second round Timoshenko will probably have to compete with Yanukovich, acting prime minister’s chances to win are still quite high.
But situation would change drastically if the banker under patronage of Timoshenko found himself in the thick of scandalous events (one should remember that bankers are not in favor with people at the moment).
Zhevago’s connection with Block of Yuliya Timoshenko (he hasn’t returned the mandate) and Timoshenko’s silence on this question one cannot either explain or hide. Against such a background any explanations about how “Finance and Credit” had obtained state support on preferential terms would not be taken in by electorate.
Maybe the prime minister will lose only 1.5-2% of votes due to this scandal, but in consideration of Yatsenyuk’s party being widely promoted she had better value each and every vote. Because, if more than 2-3 survey organizations report about her yielding to Yatsenyuk Timoshenko’s rating will start decreasing dramatically.

Moreover, one can’t but remember that due to the fraud with Ferrexpo similar scandal with the same acting persons may simultaneously burst out in Europe. First of all, two corruption scandals would “nourish and support” one another. Secondly, the Swiss Ferrexpo banking scandal (not related with Ukrainian one) would make its corrupt version more credible in the eyes of common voter not having any financial, economic or political education. Thirdly, European mass-media treats Ukrainian “Orange” politicians (those who had organized protest actions in 2004) quite scornfully as it is. Heretofore Timoshenko has managed to explain all her faults by confrontation with the President. However, one may reasonably suppose that greedy for sensations European journalists not having the same “orange” reasons to sympathize Timoshanko would happily savour such a well turned story about a corrupt prime minister of Ukraine.
Such stand-alone Ukrainian-Swiss corruption scandal may deprive Timoshenko of already 5% of voters – virtually 1/3 of all her present adherents. In such case her rating would become comparable to that of Simonenko and, as Yuschenko’s example indicates, after rating’s decrease below this mark outflow of voters becomes almost incontrollable. With such level of popular support one had better give up taking part in elections in order to save the face and the money.
In the end, such scandal in the midst of election campaign would seriously affect the international image of Timoshenko. However, while resolving domestic political problems she has always been counting on real (or even imaginary) public support on the part of the foreign politicians in recent years. One may endlessly wonder how naпvely people respond to the photos of Timoshenko with Vladimir Putin, Angela Merkel and Silvio Berlusconi but the fact remains that purely ceremonial pictures are taken for trust relationships between state leaders by public.
In case everything comes to light visits of the official involved in a Europe-wide corruption scandal would not only be cancelled. It is not difficult to endure absence of new photos – old ones are always there. But the reason of cancellation will inevitably become known in Ukraine in exaggerated form.
Thus, resolving small tactical problem of business financing at the expense of state and shareholders’ money Zhevago saws the branch he is sitting on. There are only 6 months left and obviously Timoshenko won’t manage to solve all Zhevago’s problems for this short term and if Block of Yuliya Timoshenko loses power Zhevago will lose his source of income, and maybe will be even forced to return what he received. There is also a chance that Zhevago will follow the footsteps of Khodorkovskiy, because whatsoever next president would feel necessity to find “scrapegoat” in order to show righteous fight against oligarchs.

Summing up our investigation it should be first of all emphasized that with the help of executive authority of Ukraine businessman and People’s Deputy (representative of the Block of Yuliya Timoshenko) Konstantin Zhevago has been taking non-transparent measures in order to rescue the commercial bank “Finance and Credit” belonging to him. Moreover one should apparently expect that in the nearest future an absolutely fraudulent operation of Ferrexpo shares buy-back will turn up: at the expense of minority shareholders of this company K. Zhevago is going to earn additional money resources to rescue his other enterprises.
Taking into account that Ferrexpo shareholding belonging to Zhevago plus shareholding belonging to New World Resources N.V. (Netherlands) makes more that 75%(enough to secure the number of votes necessary for buy-back) one may reasonably assume that business corporations belonging to Zhevago will be able to obtain additional financial resources from the minority shareholders of Ferrexpo.

In order to prevent such actions one should vest in the shareholders the right to bring an action against the officials of the company on behalf of the whole enterprise to repair a damage caused by the above-mentioned officials. And also one should acknowledge the existence of transactions in which some shareholders are excessively interested and expel them from the list of voters concerning this certain transactions.