Luis Prados Ramos
Notary

CO-OPTION, PROPORTIONAL REPRESENTATION AND ALTERNATE DIRECTORS ON THE BOARD OF DIRECTORS.

CO-OPTION, PROPORTIONAL REPRESENTATION AND ALTERNATE DIRECTORS ON THE BOARD OF DIRECTORS.

The regulations contained in Law 1/2010 on Capital Companies regarding the Board of Directors are scarce, but in return it provides a certain margin for self-regulation through the company bylaws and internal regulations of the Board (Article 245 LSC), which is mandatory in the case of listed public limited companies (Article 528 LSC).

In this post we will discuss three closely related issues: co-optation, proportional representation and substitute administrators.

But as a starting point, to delve into this matter, we must point out that when a Board of Directors is chosen as a form of government for a company, it will be made up of a minimum of three members, with the statutes being responsible for setting the exact number or the maximum and minimum, and in this case, the shareholders' meeting being responsible for determining the specific number of its members. As a limitation in a limited liability company, the maximum number of members on the board may not exceed twelve.

The determination of the appropriate number of directors depends on each company, depending on the number of shareholders and how they are to participate in management. To avoid the existence of equal groups, facing each other on the Board, it is highly advisable that the number of Directors be odd, or that a deciding vote in the event of a tie be assigned to the Chairman of the Board.

For example, in a company, no matter how large it is in terms of capitalization or employees, when there are two partners, it only makes real sense to establish a Board of Directors when independent directors are incorporated. For the listed company, although it should be applicable to any other, the composition of the Board must be sought, with people with diverse experiences and knowledge (article 529 bis), or paraphrasing Jean Giradoux, at this time of the Rugby World Cup, the composition of the Council should integrate the ideal proportion between men (1).

Through the Co-optation and substitute administrators It is intended to respond to the situation arising from a vacant position of a councillor, as could be the case of a death or resignation; while through the proportional representation The aim is to allow minorities in a company to have access to the Board of Directors, in order to avoid dominance by majority shareholders.

A.- COOPTATION.

It is the power that the Board of Directors has, exclusively in public limited companies, to fill vacancies that occur during the time in which its members were appointed. Its regulations are contained in article 244 LSC and its development, for registry purposes, in articles 138, 139, 141 and 145 of the Commercial Registry Regulations, noting that the acceptance of the appointed Director is necessary.

Co-optation is an exception to the general rule that Directors must be appointed by the Shareholders' Meeting, and precisely because of this exceptional nature, It has limitations, in which the Director appointed by co-optation can only be a shareholder and his appointment is temporary, as it only lasts until the first general meeting is held, which may be either ordinary or extraordinary, in which he will be ratified in his position or dismissed.

As I have mentioned on other occasions, it is very useful to use the example of a large corporation to understand corporate law. Let us think of one of the large Spanish companies listed on the Stock Exchange; in these companies, the convening of a Shareholders' Meeting is long and costly, both in terms of material and human resources. Taking into account that the maximum period that can exist between one meeting and another is one year, it can be considered economically efficient to give the Board the power to appoint, by co-optation and therefore temporarily, a director from among the shareholders.

The fact that the Director appointed by co-optation must be a shareholder. If one of the shareholders were already a member of the Board, it would not be possible to appoint him by co-optation, since in this way the rule that the agreements of the board of directors are adopted by an absolute majority of the directors present at the meeting (article 248 LSC) would be circumvented, since it would be equivalent to recognizing a plural vote to one of the Directors.

This situation that I describe may not be as exceptional as it might seem at first glance. Let us consider the case of a company, whose only two shareholders are two family holding companies, and a Board is established, in which the shareholders (legal persons) and other members of each family participate. In these cases, the death or dismissal of one of the members of the Board, members of each family, would not give rise to co-optation, since it would only be possible to appoint someone who is already a Director.

In order to avoid circumstances such as the one mentioned, it would be worth considering whether it is possible to carry out some adaptation, via the statutes, to the regulations that govern co-optation, such as extending it to limited companies, or allowing co-optation to allow the election of persons who are not shareholders as members of the Board. Although some authors defend the full autonomy of the will in the statutory regulation of the co-optation system, the truth is that any agreement contrary to the requirements seen is difficult to register. The Resolutions of May 4, 2005 and September 15, 2008, of the General Directorate of Registries and Notaries, have declared the impossibility of registering the establishment of a co-optation system in limited liability companies.. Therefore, in everything that goes against the precepts seen, it will be more convenient to regulate its operation through a shareholders' agreement..

The only limitation to co-optation that can be established by statute would be its prohibition. Therefore, in order to resort to it, it is necessary that the statutes have not prohibited it; but on the other hand, if co-optation is provided for or not prohibited in the statutes, it is not obligatory to resort to it, provided that the Board can continue to function without some of its members, since the board of directors will be validly constituted when the majority of the members attend the meeting, present or represented, and under these conditions it can adopt its agreements.

Since co-optation is a power of the Council, the question has been raised as to whether it can be used when vacancies occur, which means that the Council cannot be constituted, that is, when the vacancies exceed half plus one of the councillors. The simplest example would be the case of a Council of three members, and the death of one of them occurs; a Council of two is conceptually impossible, since only unanimous action is possible. This situation has been referred to in the Resolution of the General Directorate of Registries and Notaries of 31 July 2014, stating that “From this perspective, the provision made by article 247.2 of the consolidated text of the Capital Companies Act, which for the valid constitution of the board of directors of a public limited company requires that “the majority of the members attend the meeting, present or represented”, makes complete sense, and this majority can only be referred to, as it follows from the provision, to the number provided for in the bylaws or determined by the appointment agreement. This interpretation is confirmed by article 171 of the same consolidated text, which, in the case of the termination of the majority of members of the board of directors, enables any shareholder to request the judicial convening of a meeting, confirming that the board cannot be validly constituted (as demonstrated by the comparison made by the provision itself to the impossibility of the functioning of the other forms of organizing the administration). If it is understood, as the appellant proposes, that this majority refers to the members who are currently in office, the board could validly meet even in the extreme case that only one member remained in office, contrary to the provisions of article 242.1 of the Capital Companies Act and the company's own bylaws (the board of directors shall be made up of a minimum of three members). It is obvious that such a situation implies a complete distortion of the regulation of the board of directors that cannot be upheld.

B.- PROPORTIONAL REPRESENTATION

Proportional representation is the right that shareholders have, only in public limited companies, through the procedure that we will see, of appointing a certain number of Directors, proportional (with certain corrections) to their participation in the share capital.

Its regulation is contained in article 243 LSC and its development, for registration purposes, in articles 138, 140, 141 and 145 of the Commercial Registry Regulations, with the acceptance of the appointed Director also being necessary.

We must also take into consideration Royal Decree 821/1991, of May 17, which develops article 137 of the consolidated text of the Law on Public Limited Companies in relation to the appointment of members of the Board of Directors by the proportional system, and which we can consider to be in force, despite the fact that it is a matter subject to some discussion, because article 243 TRLSC essentially reproduces the text of the repealed article 137 LSA.

To understand how it works, I borrow the following example from Deloitte's publication “The Board of Directors. Practical Aspects”.

There have been four vacancies on the Board of Directors of a public limited company, which is made up of eight members (if there had been three vacancies, the possibility of co-optation would exist). In these circumstances, the Board of Directors calls the general meeting in order to fill the vacant seats. The share capital of the company amounts to €100,000, divided into 1,000 shares with a nominal value of €10 each, all of them with voting rights, and are distributed among three shareholders as follows:

  • A: 51% = 5,100 shares; • B: 33% = 3,300 shares; • C: 16% = 1,600 shares

Shareholders B and C have notified the company in due form and within the deadline of the exercise of their right to group shares to appoint directors by the proportional representation system.

The result of dividing the share capital (€100,000) by the number of board members (8) shows that it is necessary to group together shares representing €12,500, which means grouping together 1,250 shares to appoint each director. Therefore: • B has announced that it is grouping together 2,500 shares of its own to appoint 2 directors. The remaining 800 shares of its own retain their voting rights at the general meeting in the event that the remaining vacancies are not filled after the grouping.

  • C has announced that it is pooling 1,250 of its shares to appoint 1 director. As in the previous case, the remaining 350 shares held by it retain their voting rights at the general meeting in the event that the remaining vacancies are not filled after their pooling.

In this way, 3 of the 4 vacant seats on the board of directors will have been filled at the general meeting without the need for a vote and the remaining seats will be filled by voting at the meeting itself, in which A retains the voting rights corresponding to all of its 5,100 shares, while B and C will retain their voting rights corresponding to 800 and 350 shares, respectively, which they did not group together for the appointment of directors.

The appointment of directors by the proportional representation system constitutes an exception to the exclusive competence of the Board for the appointment of administrators. Its exceptional nature, for the protection of minorities, means that it is impossible to introduce exceptions to this reserved competence by statutory means or by excluding its application, and there are even authors who go so far as to suggest that the majority should be prevented from making any modification to the structure of the administrative body that would reduce the possibilities of the shareholders to use the proportional representation mechanism. In this way, the modification of the number of Directors could only be reduced with justification, that is, the majority would have to argue that the reduction of the number is essential for the sake of good governance (companies that have an excessive number of directors).

The possibilities of modifying the proportional representation system by statutory means have been limited, given the prohibition of its establishment in limited liability companies, despite some isolated rulings, such as that of the Supreme Court of March 3, 2009, the establishment of a weighted voting system, both in public and limited companies.

Through weighted voting, certain members of the governing body, or all of them, would be allowed to have, in terms of voting, the weight determined in their appointment in accordance with the company's bylaws. To put it with an example, this would be the case where in a board of five members one of them would have 50% of the weighted vote, two would have 20% each, and two others would have 5% each.

The purpose of weighted voting is to provide representation on the Board to the minorities among the shareholders, without the need to excessively increase the number of directors. In other words, if we want the shareholders or groups of them to be able to have representation on the Board, in order to achieve this purpose through the proportional representation system, it may be necessary, in many cases, to increase the number of directors excessively so that due to its very size the Board becomes inoperative or excessively onerous and is also subject to the will of the board, which by reducing the number of directors can eliminate from the Board the smallest minorities within the capital of the company.

The arguments against the weighted vote would be that its establishment is contrary to article 248.1 LSC, which provides that the agreements of the board of directors of public limited companies shall be adopted “by an absolute majority of the directors present at the meeting”; thus, interpreted literally, the article seems to make it essential for the legislator that each director has a single vote on an equal footing with the vote of the other directors.

In favour of establishing a weighted vote, provided it is duly regulated, and in combination with a proportional representation system, it does not seem that the article is infringed by giving one director more vote than others, since ultimately this responds to a lawful purpose and, regardless of the strength of the vote of each director, the agreements will continue to be adopted by an absolute majority, although not of directors, but of votes cast by the directors. In other words, the weighted vote is still a different and cheaper articulation of proportional representation, although its correct articulation is a different matter and should be the subject of very careful regulation in the company's bylaws.

In limited liability companies, the wording of article 245 of the LSC may be an argument for admitting weighted voting, which, by allowing the bylaws to regulate the manner in which the board deliberates and adopts agreements, seems to mean that there would not be any major difficulties in admitting a weighted vote for each of the board members. It should also be noted that for these companies, plural voting assigned to certain shares is admissible, so in principle it can be thought that there should not be any inconvenience in attributing a plural vote to certain directors.

A type of weighted vote that can be considered a fully consolidated doctrine in the corporate life of our capital companies is the casting vote of the Chairman of the Board, provided, of course, that it is duly established in the bylaws, and limited to cases of a tie.

In order to better fulfil the intended purposes, it has been suggested that the right of proportional representation should prevail over co-optation, so that, once the shares have been grouped by the minority shareholder and his desire to appoint a director has been announced, the company could not cover by co-optation any vacancy that may arise, a vacancy that would be immediately filled by appointing the director proposed by the minority shareholder. In other words, there is no reason why the appointment of the director proposed by the minority shareholder should be made within a Shareholders' Meeting (in fact, such appointment, even if made on the occasion of a Meeting, is not a meeting agreement). In any case, this is one of the, let's say, star issues of proportional representation. Requiring to go to it through the Shareholders' Meeting, instead of doing it through co-optation, only generates a fleeting gain in time, in the event of a conflict between partners.

Finally, to conclude the topic of proportional representation, we will point out that its validity can sometimes be very limited, due to the jurisprudential criterion of the free removal by the majority of the appointed administrator, through proportional representation, with no other limits than those of the abuse of rights by the majority when proceeding to the dismissal in accordance with the doctrine established by the Supreme Court in the judgment of July 2, 2008, qualified in that of November 24, 2011.

The majority doctrine maintained the criterion that the majority cannot remove the director appointed by the minority shareholder ad nutum, that is, there must be just cause. At this point, the normative argument would be given by the distinction between art. 223 and art. 224.2 LSC. If directors can be removed ad nutum by the majority – 223 – and can be removed for just cause at the request of a single shareholder (224.2 LSC), it should follow that, when the Law grants a shareholder the right to appoint a director, the majority can only remove him when there is just cause, that is, his removal would be applicable not to art. 223 LSC, but to 224.2 LSC. In the argumentation of when there is just cause for removal, the interpretation of art. 224.2 (“directors… who in any way have interests contrary to those of the company”) must be restrictive and limited to cases of direct competition between the director appointed by the minority – or the partner who appoints – and the company.

C.- THE SUBSTITUTE ADMINISTRATOR.

Unlike what happens with co-optation and proportional representation, the regulation of substitute directors is applicable to public limited companies and limited liability companies, and its scope of application, although not excluded, is normally outside the Board of Directors, since it takes on real meaning when representation is attributed to a sole director or to several joint directors, since in these cases, when the death, termination or incapacity of a director will determine the paralysis of the administrative body.

However, when there is a Board of Directors, the establishment of substitute directors is not useless, but quite the opposite, since the dismissal of a director could lead to the parity within the Board being broken. With the appointment of substitute directors, continuity is given to the interests represented, without the need to resort to co-optation or proportional representation systems, and since these systems are only admissible in public limited companies, within a limited company, it can be highly advisable.

Its regulation is contained in article 216 LSC and its development, for registry purposes, in article 147 of the Regulations of the Commercial Registry, noting that the appointment remains the responsibility of the Board, but is only registered when the replaced administrator has ceased. Very graphically we could consider it as an administrator under a suspensive condition, so that when an administrator is appointed, if his possible substitute or substitutes are designated, the effectiveness and registration of the appointment of this one is suspended until the principal administrator ceases to exist.

That is, with this system, the need to call a new shareholders' meeting to appoint an administrator when a vacancy occurs is avoided, but the substitute administrator will only be so for the period pending completion by the person whose vacancy is filled and the substitute takes the place of the dismissed administrator, but without the powers and delegations existing in favor of the previous one.

(1) “A team consists of 15 players: eight are strong and active; two are light and cunning; four are tall and fast; and one, finally, is a model of phlegm and cold blood. Precisely, the ideal proportion among men.”

Some bibliographical notes on the subject

Jesús Alfaro Águila-Real.- The right of proportional representation: an economic understanding of a peculiar institution. www.almacendederecho.org

José Ángel García-Valdecasas, Commercial Registrar of Granada. Question about whether the existence of weighted voting within the Board of Directors is possible. www.notariosy registradores.com

Aleix Plana Paluzie. Between laws and jurisprudence. aplanapaluzie.blogspot.com

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