62893 v1 TOOLKIT 4 Resolving Corporate Governance Disputes VOLUME 1 : RATIONALE VOLUME 1 : RATIONALE MODULE 1 : What Are Corporate Governance Disputes? 1.1 Corporate governance disputes involve corporate authority and its exercise. Such disputes frequently involve the corporation’s shareholders, board directors, and senior executives. These disputes constitute a category of their own, one that differs from labor, commercial, consumer, or other disputes involving the corporation. Although they are less common for well-governed companies, most companies will experience a corporate governance dispute. To ensure that corporate governance disputes are properly prevented or efficiently resolved, this module helps users identify the different kinds of corporate governance disputes and the context in which they may arise. THIS MODULE REVIEWS Corporate governance disputes Other disputes involving companies Different kinds of corporate governance disputes How corporate governance disputes affect different types of companies Contexts in which a corporate governance dispute may emerge MODULE 1 WHAT ARE CORPORATE GOVERNANCE DISPUTES? DISPUTES AFFECTING The elected board is the company’s principal CORPORATE AUTHORITY governing body. The board appoints management, led by the CEO, but it retains ultimate responsibility for Corporate governance is “the system by which companies protecting the company’s integrity and its shareholders’ are directed and controlled.”1 It involves the balance of investment. powers among three key corporate constituencies: the board of directors, which is charged with monitoring, In addition to the board, shareholders, and management, overseeing, and guiding the company; the shareholders, a corporation has many other constituencies, or who invest their funds in the company’s shares and, “stakeholders,” who are important to the company’s therefore, have the right to elect and possibly dismiss operation. These stakeholders may include employees, directors; and, the company’s management, whom the suppliers, creditors, financial institutions, communities, board hires to run the company on a day-to-day basis. and even publicly regulated agencies. By law, boards have the ultimate responsibility for the company’s affairs, hiring and giving direction to Defining Corporate Governance Disputes management and representing shareholders’ interests. Corporate governance disputes involve corporate Thus, the board sits at the center of the company’s authority and its exercise. Governance disputes involve governance structure. the board’s powers and actions, or its failure or refusal to act. These conflicts may arise between the board and its shareholders, or between directors and executive management. They may also involve issues among the INTERACTION AMONG THE MAIN directors themselves and between the board and other GOVERNING BODIES OF A COMPANY stakeholders. A governance dispute implicates the board in one way or another as a party, or as an active RE participant, and requires the directors’ concurrence to PR FO R ES resolve the conflict. EN TS T EN & AG RE Corporate governance disputes emerge in many different PO AS RT ways. Common disputes include: ACT TO Disagreements between the company’s shareholders and the company or its board. A shareholder or a group of shareholders claims that their rights as shareholders have been violated or that their shares’ value has declined. Disputes between the board and the CEO and/ or senior management. The board hires the CEO and empowers him or her to manage the company. SOURCE: Adapted from IFC Pakistan Corporate Governance Project 2007. The board may question the CEO’s performance or otherwise be dissatisfied with her or him. The CEO MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 1 may be concerned about the board’s decision-making EXAMPLE process. Both situations can create a poisoned atmosphere in which the company’s productivity and value could be impaired. Common Corporate Governance Disputes Brazil Disputes among board directors. These may include the chairman, the CEO, and all other executive and On June 18, 2008, the Brazilian Institute of Corporate Governance (IBGC) organized a non-executive directors. discussion forum on corporate governance and alternative dispute resolution. Disputes between the board and employees’ representatives. In such countries as Germany Forty-six participants — consisting of lawyers, or Slovenia, where employees have a voice on the company directors, shareholders, consultants, academics, and two journalists — were given company’s supervisory board, the differing concerns a questionnaire about the nature of corporate and views of labor and management can play out in governance disputes. The questionnaire listed the boardroom and, sometimes, spill into the media. 10 types of disputes and provided space for comments. Participants were asked to mark the Disputes between the board and communities and/or four most frequently occurring disputes based social activists. Other constituencies’ disagreements on their individual experiences. with the company may become matters in which the Here are the results: board itself becomes involved. Questions regarding social policies, the environment, and sustainability TYPES OF DISPUTES OCCURRED become governance issues when these issues are RELATED-PARTY TRANSACTIONS 61% directed at the company through either the proxy voting process or a demand for board action. INVESTMENT DECISIONS 55% RIGHTS OF MINORITY SHAREHOLDERS 52% Differentiating Corporate Governance Disputes MANAGEMENT PERFORMANCE 52% To better understand what corporate governance MERGER AND ACQUISITIONS DECISIONS 45% disputes are, it is helpful to distinguish them from NOMINATION/APPOINTMENT other types of disputes that may involve a company. For 42% OF DIRECTORS AND OFFICERS example, a dispute over a contract, a labor claim, or a DIVIDEND DECISIONS 36% commercial matter involves the company as an entity but does not pertain to its governance. These disputes are FINANCIAL RESTRUCTURING 24% AND TURNAROUNDS typically part of doing business, and it is generally up to management to resolve them. As part of its oversight and REMUNERATION OF DIRECTORS 21% AND OFFICERS monitoring functions, the board is typically informed OTHER (BUSINESS STRATEGY, about significant litigation that may affect the company’s CONFLICTS OF AGENCY) 12% reputation, operations, and finances. In addition, it is APPROVAL OF ANNUAL ACCOUNTS appropriate for the board to assure itself that the company AND FINANCIAL STATEMENTS 0% has dispute resolution policies and mechanisms available to mitigate disruptions and limit expenses resulting COMMENT from these disputes. But routine business or commercial Since 2008, IBGC has used this questionnaire in matters are handled by management; the board does not some of its training programs, and every time, take direct action in resolving them. participants selected “related-party transactions” as the main cause for governance disputes. TO LEARN MORE ABOUT THE BOARD’S ROLE IN ADOPTING CORPORATE DISPUTE RESOLUTION SOURCE: IBCG. POLICIES, SEE VOLUME 2 MODULE 1. 2 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 GLOSSARY Corporate Governance Disputes Corporate governance disputes involve corporate authority and its exercise. Parties to a corporate governance dispute may include the company’s shareholders, its board members, and senior executives. Other stakeholders who challenge the company’s governance, ethics, or strategy may also be involved. Corporate governance disputes typically require the board’s attention, regardless of whether the board or individual directors are a direct party to the dispute. Other Corporate Disputes Corporate governance disputes differ from other disputes that a company may face. Here are some comparisons: Commercial disputes arise from the conduct of business. They involve such external stakeholders as clients, consumers, and suppliers. Thus, they represent a wide spectrum of issues. In all of these, something has gone wrong, at least in one party’s view, during the normal course of business. The dispute may be over any number of issues — price, quality, contract terms, and payment, for example. Essentially, commercial disputes involve problems in which one or more parties claim that business transactions have gone awry. The board’s role may involve ensuring that appropriate dispute resolution procedures are in place, but these types of disputes will typically be handled by management. Financial disputes can sometimes be viewed as a subset of commercial disputes. However, these disputes involve funds required for capital investment or business operations. They may involve such matters as rights and obligations under debt financings, collection of funds that are claimed, or other matters dealing with the debt portion of the company’s financial structure. Securities disputes. Many disputes arise from the public trading of securities, such as stocks or bonds. In these disputes, one party claims, for example, that a rule has been violated, in the sale, purchase, or exchange of securities. Securities disputes may involve the parties who facilitate these transactions, such as stock exchanges or brokerages. Some securities disputes — where shareholder rights may have been violated — may also be governance disputes. Labor disputes. This category involves controversies between a corporation and its employees, or among a company’s employees. Employment or labor disputes can typically involve disagreements over wages, benefits, or scope of work issues. Disputes between an employee and supervisor are another example. Employment disputes also can revolve around working conditions, such as safety matters, hours of service, and unethical or inappropriate practices (e.g., employment of children, discrimination, and harassment). Here, again, the board’s role may involve ensuring that appropriate policies and procedures are in place, leaving management to handle the dispute. Regulatory disputes. Governments impose regulations and restrictions on companies and their operations. Companies or their executives often disagree with the regulatory agency’s interpretation of its own regulations or with the application of those regulations to the company. These disputes involve the company and relevant regulatory agencies. MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 3 As a general rule, close scrutiny should be given to the parties’ identity and the nature of the dispute to distinguish corporate governance disputes from other corporate disputes. For example, a dispute may arise between the board and management over a contract for services or goods that was awarded in violation of the company’s policy on related-party transactions. This would be regarded as a corporate governance dispute. In contrast, if a dispute erupts between management and a supplier over the terms of the aforementioned contract, it would typically be a commercial dispute. 4 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 DISPUTES AFFECTING ALL TYPES change, too, including its shareholders, management, OF COMPANIES and directors. What began as a small family business, or as a “dot com” start-up, may eventually become a large One can better understand the nature of corporate company whose shares trade on a stock exchange. governance disputes and how these disputes can affect all types of companies by reviewing some basics about The enormous variety of corporations, coupled with a corporation’s organization. Corporate structures vary different legal or cultural norms, can result in many widely, but every corporate enterprise involves at least situations in which governance disputes may erupt. three core requirements: capital, labor, and leadership. Those involved in governance issues — directors, senior Leadership is further divided between those who management, investors, and other stakeholders — participate in the company’s governance (directors) and should be cognizant of the kinds of disputes that can those who are directly involved in supervising employees arise as the company’s business, ownership base, and and producing goods and services (managers). The capital structure evolve. relationships and interactions involving these three business elements can be a fertile ground for disputes. Small Companies In a small company owned by a single person, that Theoretically, a corporation has perpetual life. This person can fill all three core functions required to run means that the corporation continues operating even a business — providing capital, leading/managing when those who founded it, or work in it, are no the business, and working to produce goods and/or longer involved. During its existence, the corporation services. That scenario becomes more complicated if will evolve, and many aspects of its governance will the company’s founders include several people who, along with running the business, must manage their relationships with one another. In other words, even in QUOTE a small, closely held company, disputes can arise within the small group that owns and controls the business. Conflict in Family Firms As the company grows, different people or institutions assume these roles. Capital may come from people or “Conflicts within family firms have a special character. In most cases, what is involved is not institutions that invest funds in exchange for equity merely a difference of opinion about business ownership. It may also come from lenders — banks and policy but issues within the family and its history. other financial institutions. The way in which conflicts are addressed in the family also has an impact on family firm conflicts. Regardless of funding sources, shareholders elect If there is little dialogue and consultation within the board’s directors. The directors, in turn, hire the the family, that will generally also be the case within the family firm.” company’s executive management, which is responsible for hiring labor and running the business. As the JOZEF LIEVENS business expands, the composition of shareholders can PARTNER, EUBELIUS LAW FIRM easily become more diverse, often changing regularly — MEMBER OF THE FORUM’S PRIVATE SECTOR ADVISORY GROUP sometimes daily — through trading on an exchange, sales between individuals, and inheritance. Management can change rapidly, too, as the business evolves. The founders who held executive positions may SOURCE: Jozef Lievens. “Collaborative Conflict Resolution — no longer work directly in the business. Their shares the ‘Harvard Approach’ Applied to Family Business.” 2002 may become diluted when the company issues more working paper provided by the author to the GCGF. shares to raise capital. As a result, they may no longer MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 5 EXAMPLE Family Firm Dispute India: Reliance Industries Dhirubhai Hirachand Ambani founded Reliance percent decline — in Reliance shares in three Industries in 1966 to import polyester yarn and months on November 19, the day the comments export spices. In 1977, he took the company public, were widely circulated in newspapers. and its turnover soared to $10 billion yearly by 2002 On November 25, six of 14 directors of Reliance as the business expanded into petrochemicals, Energy quit without giving a reason. Reliance textiles, crude oil and gas production, and polyester Energy’s shares fell 6 percent, their biggest drop in and polymer products. Reliance Industries became six months. one of India’s most powerful non-state holding companies. In December, Anil questioned the company’s decision to consider a share-buyback program, stating he When Dhirubhai died in July 2002, the Ambani was neither informed nor consulted on the issue, family was in control of 46.76 percent of the according to the Times of India. That public dispute company. Yet the founder left no succession plan added to the volatility of share prices for Reliance to determine the company’s leadership. He left no Industries, which lagged in performance behind will, either, meaning the business had to be shared those of the company’s competitors. with his two sons, two married sisters, and his wife. Neither the mother nor the two sisters expressed In June 2005, the Ambani brothers agreed to any interest in managing the business. split the $20-billion business and, thereby, end their ownership feud. Mukesh retained control of Dhirubhai’s two sons — Mukesh Ambani, who refining, oil, gas exploration, and chemicals, while earned an M.B.A. from Stanford University, and Anil took cellphones, power, and financial services. Anil Ambani, a graduate of the Wharton School — The news caused shares in Reliance to hit record formally took the group’s reins after their father’s levels. “The trench war is finally over,” one investor death. Rivalry for control between the two quickly said. “I’m sure the stock will run up. It’s positive for emerged, resulting in an intense family feud that the shareholders and the stock market that the deal attracted media attention and worried investors. has been inked.” On July 27, 2004, the feud was brought to a head The calm was broken in February 2006, when Anil when Reliance’s directors approved a proposal disputed the terms of a gas supply agreement with to give Mukesh Ambani power to overrule Anil Mukesh, accusing Mukesh and his group of acting in Ambani’s decisions. an “arbitrary, non-transparent and unfair manner.” “The core of the differences, however, is said to be The dispute headed to the courts in India. that Mukesh Ambani wants to take a larger control Additional tensions surfaced in May 2008 when of Reliance Industries and its subsidiaries,” the New Anil’s company, Reliance Communications Ltd., was York Times reported. “The fissures between the in buyout talks with the MTN Group, South Africa’s brothers, apparently, extend beyond the control of largest mobile phone network operator. Mukesh the Reliance group. Mukesh Ambani is said to be claimed he had first rights of refusal to purchase a unhappy over Anil’s recent plunge into politics and controlling stake in Reliance Communications Ltd. his nomination as a Member of Parliament.” In January 2009, the Bombay High Court temporarily On November 16, the rift spilled into the public lifted a ban on the sale of natural gas, allowing arena. Mukesh Ambani told a journalist in Mumbai Mukesh to tap the gas reserves. that there were “ownership issues” inside Reliance. The news prompted the biggest drop — a 3.4- 6 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 own a controlling share of the stock, losing their ability to determine which directors are elected. With expansion comes the need, typically, to hire more people and to differentiate job responsibilities, including a separation of management from employees. While the COMMENT employees may own stock, they typically do not own This situation illustrates the problems that arise where enough shares to control a board election. there is no clear succession plan, and how family disputes, grounded in emotion and differences in In summary, as the business grows, the separation business outlook, can undermine a publicly traded widens between ownership and governance, on the one company. As reported (April 27, 2005) by the hand, and between ownership and the management of International Herald Tribune, “The brothers’ feud at Reliance underscores how shareholder interests the business, on the other. The increasing complexity can suffer when family members cannot resolve and differentiation of functions can easily trigger fundamental problems.” The long-running dispute disagreements and disputes. between the brothers demonstrates how protracted conflicts can continue to emerge over new issues that draw from the tensions of earlier hostilities. Joint Venture Companies The unresolved disputes affected share prices. A joint venture represents a strategic alliance between investors with complementary strengths. Invariably, the parties’ ownership and control rights to a joint venture company are subject matter for corporate governance disputes. Disputes can erupt at the board over the strategic direction for the joint venture company. For example, a local joint venture’s expansion into another market can threaten or bring more competition to one of its co-venturers that has a presence in that market, thereby leading to a split board. In situations where no single co-venturer has a simple majority on the board, such disputes, unless resolved properly, can sometimes lead to deadlocks. SOURCE: Saritha Rai, “A Family Rift Roils the Market in India,” New York Times, November 23, 2004. Available at: http://query. Family Firms nytimes.com/gst/fullpage.html?res=9B0CE7D7163EF930A157 Family-owned and -operated businesses are very common. 52C1A9629C8B63. Abhay Singh and Ravil Shirodkar, “Indians Await Peace at Reliance.” International Herald Tribune, April 27, The family itself provides a defined social structure, which 2005. Available at: http://www.iht.com/articles/2005/04/26/ bloomberg/sxreliance.php. Ravil Shirodkar, “Reliance Shares Hit can translate into a successful organization for a business. Record on Accord,” International Herald Tribune. June 21, 2005. However, families are not simply groups of people who Available at: http://www.iht.com/articles/2005/06/20/bloomberg/ sxreliance.php.“Face-off: Ambani Brothers Trade Fresh Barbs,” band together to conduct a business. They are bound Times of India. February 5, 2006. Available at: http://timesofindia. to one another through emotional, social, economic, indiatimes.com/articleshow/msid-1401519,prtpage-1.cms. Associated Press, “India’s Ambani Brothers’ Feud over Reliance and legal relationships, which have the added overlay of Communications’ Talks with South Africa’s MTN.” International cultural imperatives. Hence, governance disputes may Herald Tribune, June 17, 2008. Available at: http://www.iht.com/ articles/ap/2008/06/17/business/AS-FIN-India-Reliance-MTN.php. result from familial clashes and vice versa. The factors that Archana Chaudhary, “Indian Court Lifts Ban on Reliance’s Gas make family relationships strong and lasting can translate Field Sales,” Bloomberg, January 30, 2009. Available at: http:// www.bloomberg.com/apps/news?pid=20601091&sid=a13q. into a healthy governance structure. By the same token, Oi0MQ9Y&refer=india. factors that result in rancor or mistrust in the family can produce dysfunctional governance. MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 7 For example, as one generation retires or dies, the next However, as one generation succeeds the next, ties generation must assume their predecessors’ roles. This among family members tend to weaken. For example, often triggers many issues. Do all family members wish the founder’s authority over his children may be stronger to work in the business? Are all family members equally than the relationships among the siblings who inherit qualified, and do all family members work equally hard? the business. The next generation of the family may How will succession be determined — by line of descent, involve cousins, whose own ties may be substantially age, gender, or non-familial criteria? Will rivalries weaker than those of parent-child or sibling-sibling. and jealousies among family members play out in the Share ownership can become more fragmented over governance of the business? These and other related generations as each family member divides his or her issues can form the basis for bitter disputes if there is no shares among his or her children. Cousins do not process for resolution. respond to the authority of a patriarch or matriarch as their children would do. The jealousies that stem from In a family-owned business, disputes initially would sibling rivalries can translate into deeply emotional have been settled by the authority of the founder. disputes over the course of the business. EXAMPLE Family Firm Dispute Brazil When the company’s founder died, it was like opening a Pandora’s Box. He had developed a market- leading, world-class company, and left it with a professional management structure and a shareholders’ agreement, which included an arbitration clause. That failed, however, to prevent conflicts among the heirs. The founder’s two sons soon engaged in a fierce judicial battle, which has lasted for more than three years. One brother is a big spender, whose top priority is to control the company and finance his lavish lifestyle. The other has large cash reserves, refuses to negotiate, and favors adjudication. They only speak to each other through their lawyers. The board consists of six non-executive directors, who were relatively successful in shielding the company from the conflict’s effects but didn’t stay neutral. The board’s meetings became a fighting arena where lawyers set most of the strategy. The judiciary has been ineffective because judges often prefer a “Solomonic Justice” to balance the involved parties’ interests instead of making decisions to help the company. The almost-ruined brother eventually escalated the conflict by seeking help from a “white knight,” who proved instead to be a “knight of darkness” because of his shady methods. Prospects worsened for the shareholders and the company. The stakes got higher and the company began suffering as the dispute expanded to involve other stakeholders and attracted media attention. COMMENT The lack of succession planning is a common source of major disputes in family firms worldwide. Family business members often delay the process of succession planning for several reasons that are often influenced by the cultural context. In some cases, leaders find it difficult to let go. In others, succession discussions are postponed because of the fear that decisions could create conflicts and provoke criticism. In some cultures, it is furthermore difficult or uncomfortable to discuss a leader’s retirement or death. Yet without proper succession planning, firms are left vulnerable after their leaders’ retirement or death. This can lead to bitter and embarrassing disputes that can harm the company’s reputation and performance. SOURCE: Leonardo Viegas, Director, IBGC; Member, Forum’s Private Sector Advisory Group 8 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 Independent or non-executive directors are often EXAMPLE appointed to the board of family firms with the expectation that they will help resolve disputes among family board members. Yet, the appointed directors State-Owned Company Dispute are not always prepared for that role and can find it Bulgaria: E.ON Bulgaria disconcerting and challenging to handle those disputes and remain “neutral” as the dispute(s) unfold(s). When the state of Bulgaria owned one-third of the regional utility company E.ON Bulgaria between 2003 and 2005, the government’s TO REVIEW THE SKILLS REQUIRED FOR relationship with the foreign owner grew CORPORATE GOVERNANCE DISPUTE RESOLUTION, increasingly strained. In 2005, Bulgaria’s SEE VOLUME 3 MODULE 1. Economy Minister Petar Dimitrov raised questions about the owners’ management State-Owned Companies in handling a sale of two power distributors in Gorna Oriahovitsa and Varna to Germany’s For some companies, the government of the country E.ON. He also questioned the lack of dividend in which the business is located may be a significant distributions that should have occurred when shareholder. In such situations, disputes can go beyond the sale was completed. The sale was initially business issues and involve politics or public policy. In drafted in late 2004 with an April 30, 2005 countries where public policy shifts from government deadline. If concluded by that deadline, the 2004 ownership and industry control to privatization, the dividend would be distributed proportionally to shareholders based on their equity holdings. change in governance structure, the composition of E.ON Bulgaria did complete the sale in early the controlling group, and the company’s perceived 2004 but did not pay the dividend promised objectives can all become fertile ground for disputes. under the sales agreement. High restructuring costs in the two years prior to the utility’s sale Listed Companies and booming construction caused demand for But what happens when the small, closely held business — electricity to soar. The company maintained that the dividends were to be plowed into necessary family-owned or otherwise — prospers and grows? As investments to modernize the transmission grid, the number of shareholders expands, only a few of them countering charges that the dividends were will sit on the board and participate in the company’s being expatriated. governance. It is likely that no single individual or family COMMENT member will own a controlling share of the company’s In partially state-owned enterprises or partially stock. Capital requirements, or the lure of greater wealth privatized companies, disputes can easily erupt for shareholders, may result in the company “going between private and public shareholders over public.” The company and/or its shareholders may sell the company’s short-term strategic goals. The shares to the public to raise capital. Since the company’s state as shareholder may have public policy shares will trade on public exchanges, the composition expectations that are neither a priority nor a concern for the company. Whether state-owned of the shareholders may change daily. or not, a board should act in the best interests of the company and all its shareholders. Yet, state Shareholders often are institutions such as pension representatives can find it difficult to ignore funds, insurance companies, foundations, venture capital political and societal pressures that may conflict funds, private equity funds, mutual funds, and hedge with the company’s best interests. funds. A corporation may begin life with capital from an institutional source, and that institution may be one of the shareholders — or, perhaps, a controlling shareholder. SOURCE: “Bulgaria: Raps Power Distributors for Dividend Non- Once a company goes public, the people who become payment,” Dnevnik, August 9, 2007. shareholders do so for their own financial investment MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 9 objectives. Emotional ties do not enter the picture for families may have directors, executives, or significant shareholders, who may not have any direct relationship shareholders who are the founder’s descendants. Or with the company’s board or management. Thus, the some directors may have developed emotional ties to company’s ownership may gradually become divorced the company. This emotional overlay can easily clash from control of its board and management. However, with the perspective of investors or directors who may should these shareholders become dissatisfied with the be motivated by their own financial objectives. company’s direction or performance, they may seek to influence its governance. Shareholders and directors with a long-term view of the company may accept lower financial returns in the The company may grow through mergers, acquisitions, short run to strengthen the company’s future. Other or global expansion. Its culture may change. These shareholders or directors may favor short-term gains. developments, in turn, may bring in new directors and senior Disputes around these and other strategic issues may managers who have no experience working together. emerge among shareholders or with the company’s board. Unresolved, such disputes can reach a point As the company grows and changes, the possibilities where the disgruntled shareholders seek to replace some for disputes increase exponentially. Tensions may or a majority of the directors, exercising their power arise among the directors. Companies founded by through voting rights that come with their stock. EXAMPLE Corporate Strategy Disputes United States - UAE: Sonus Networks vs. Legatum Capital Sonus and its largest shareholder, Legatum Capital of Dubai, are in talks to address several disputes. In a June 18, 2008 statement, Legatum Capital of Dubai, which is said to hold 25 percent of Sonus Networks Inc., raised several issues and said it would withhold its votes for those directors standing for election to the board at the June 20 annual meeting. It said the company’s stock price was sitting near a five-year low and complained that the three directors in question “have presided over years of poor operational performance,” the “company lacks transparency” and “its board...is unresponsive to shareholder concerns.” Two days later, Sonus responded that it was disappointed with Legatum’s statement and needed to know more about Legatum’s structure. Sonus said its business touches on national-security telecommunications infrastructure in the United States. It was unclear who, via Legatum, hold Sonus stock. At the annual meeting, shareholders elected the three directors including Chairman and CEO Hassan M. Ahmed. Legatum withheld its vote. Afterwards, Sonus said it was willing to discuss naming a Legatum representative to the board, after a review of that person by the board’s nominating committee and subject to the two sides signing a standstill accord. In mid-May 2009, the company named Richard N. Nottenburg as president and chief executive. He succeeded Ahmed, who continued as chairman. COMMENT This cross-border corporate governance dispute illustrates conflicting views over the company’s strategy. While the dominant minority shareholder’s priority is to seek greater involvement and better returns, one board’s priority has been the preservation of national security interests. SOURCE: Robert Daniel “Sonus in Talks to Address Legatum’s Concerns.” MarketWatch, June 23, 2008. Available at: http://www.marketwatch. com/story/sonus-networks-uae-investor-in-talks-to-resolve-dispute. 10 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 DISPUTES AFFECTING INTERNAL AND Boardroom disputes often reveal serious issues facing EXTERNAL CONSTITUENCIES the firm. The revelation of these problems, in turn, can lead to large declines in share value, trigger changes in Most companies are likely to experience corporate top management, and disrupt the board’s work. governance disputes at some point. These disputes can fall into two broad categories: internal and external Boardroom disputes can be classified into three broad corporate governance disputes. categories: Board processes Internal governance disputes occur within the company, especially among directors or between directors and Agency problems senior management. Such disputes often have their Corporate strategy source in the relationship between the CEO and the chairman and/or other executive and non-executive directors. EXAMPLE External governance disputes involve constituencies that are outside the company — mainly shareholders. For example, dissident or dominant shareholders may Board Composition Dispute see a change in the company’s policies or in the board’s United States: Phoenix Timber composition. In some cases, other stakeholders, such as Corporation employees or communities, may have grievances that they In 1985, a group of minority shareholders, led want the board, rather than management, to resolve. by board member Michael Hermann, sought to appoint three independent directors. The board’s chairman then, Dennis Cook, wanted to Internal disputes are obviously the most disruptive to keep executive members on the board. Hermann board decision-making, but shareholder disputes are argued that the existing structure was counter- increasingly troubling directors. Unresolved, internal productive and lacked both innovation and team and external corporate governance disputes can spirit due to intense competition internally. In impair the board’s ability to function and improve the a very stormy meeting, both sides claimed to company’s performance. represent the former CEO’s legacy. Hermann’s request was neither heard nor followed; the board structure remained the same. The board’s TO REVIEW THE IMPACT OF CORPORATE instability nevertheless continued and led to GOVERNANCE DISPUTES, SEE VOLUME 1 MODULE 2. poor corporate performance. Phoenix had to announce a substantial loss for that year. This, in turn, led to the resignation of several directors, including its chairman, in the year following the Internal Disputes dispute. As boards generally operate out of the public’s view, there COMMENT is little empirical data related to internal disputes. Yet Conflict within a board can erupt to the point anecdotal evidence of board disputes that became public where the board becomes paralyzed and indicates that boards do not always function smoothly, ineffective. Unresolved boardroom disputes can that they sometimes experience discord and strife. lead to poor corporate performance. In the United States, listed companies must disclose the details of internal disputes involving directors when a SOURCE: R. Reuben, Corporate Governance: A Practical Guide director resigns or refuses to stand for re-election due for Dispute Resolution Professionals. Washington, D.C.: American Bar Association, 2005. to disagreements involving the company’s operations, policies or practices.2 MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 11 Disputes Leading to Director Resignations United States This table provides a classification of 168 disputes into four categories based on the main issue cited by resigning EXAMPLE directors: agency problems, board processes, corporate strategy, and miscellaneous disputes. Dispute episodes are identified from SEC 8-K filings made between 1995 and 2006 that contain an Exhibit 17 (director’s resignation letter) citing disagreement. CATEGORY OF DISPUTE EXAMPLES OF ISSUES CITED FREQUENCY Board Processes Special board meetings were called on short notice regarding 65 important matters Directors were given insufficient information on financials and operations Resigner was forced to vote upon unfamiliar matters without adequate board discussion No review of corporate disclosures and executive employment contracts Company made inappropriate use of resigner’s name as signatory in 10-K filing Dispute over money (cash or stock) owed to resigner Directors and officers insurance coverage not renewed Agency Problems Management seems to pursue its own interests, unconstrained by the board 42 of directors Excessive option grant to the CEO Board decisions regarding management personnel that failed to protect shareholders’ interests Disagreement with adoption of shareholder rights plan Calls for resignation of CEO/Chairman were ignored Board’s governance practices, especially CEO compensation and succession CEO used pseudonym to post misleading messages on Internet stock message boards Corporate Strategy Disagreement over the company’s direction 43 and Financial Policy Company has moved away from its R&D focus, to the shareholders’ detriment Lack of clarity in business, marketing, and financial plans Disagreement with management over how to restore the company to profitability Board rejected takeover offer that would have added to shareholder value Inadequate terms of private offer Company is undercapitalized and, therefore, unable to deliver on long-term plans Resigner disagrees with company’s decision to enter into $15-million credit facility Miscellaneous Issues Workplace environment was counterproductive 18 Management did not foster diversity in the workplace CEO withheld wages from line employees Payroll taxes were delinquent Unspecified disagreement with the company’s operations, policies, and practices SOURCE: Anup Agrawal and Mark. A Chen. July 2008. “Boardroom Brawls: An Empirical Analysis of Disputes involving Directors.” University of Alabama and Georgia State University. Working paper. Available at: http://papers.ssrn.com. 12 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 EXAMPLE EXAMPLE Corporate Strategy Dispute Corporate Merger Dispute Russia: TNK-BP United States: Hewlett-Packard James Owen, the chief financial officer of TNK-BP, In 2002, the board became embroiled in a announced his decision to resign in August 2008. fight over the company’s strategy, specifically Owen explained why he was leaving his job in a whether HP should merge with Compaq. Every letter to the TNK-BP CEO Robert Dudley and the director supported the merger except for Walter board. In his opinion, the board’s conflict with Hewlett, the son of HP co-founder Bill Hewlett. the shareholders did not allow him to fulfill his Soon after Hewlett voiced his opposition, the duties as a financial director in a transparent, family of David Packard, the other co-founder of independent way. HP, announced its support of the Hewlett family’s position. Together, the two families owned 18 After assuming the CFO position in January 2006, percent of the outstanding voting shares. The Owen became a member of senior management rest of the board was very vocal in supporting the at TNK-BP. He participated regularly in board merger; they authorized letters to shareholders meetings and was chairman of key corporate that discredited Hewlett’s opinion, saying that governance committees. Prior to this position, he was a “musician and academic” and “never he worked for Chevron. worked for the company.” Walter Hewlett The corporate conflict between the Russian and responded by revealing that the CEOs of the two British shareholders of TNK-BP involved disputes companies would receive a total compensation about the company’s strategic development and package of $115 million if the merger were to corporate governance. The Russian shareholders be completed. HP management then accused insisted on TNK-BP expansion in international Hewlett of disseminating misinformation about markets, even if this competed with BP. They employment terms for senior executives. They suggested that BP have independent directors also clarified that the then CEO of HP, Carly on its board to secure parity with the TNK-BP Fiorina, would only get a sizable compensation board and its “daughter” companies. The package if she remained in her position for three Russians proposed that Dudley be exchanged for years and delivered a significant increase in the an “independent” director. share price. The dispute between Hewlett and the board led to a costly lawsuit. Hewlett was The Russian shareholders also requested that not reappointed as a director on the merged HP- their British counterparts maintain a balance Compaq company, and the company’s image between the number of foreign and Russian was hurt by the media campaign. experts working in TNK-BP. British shareholders had already refused these suggestions. As of COMMENT October 2008, the conflict was pending in the This famous dispute shows how sensitive mergers court. Dudley had to leave Russia and continued and acquisitions can be, and how easily they can managing the company from abroad. lead to costly disputes. Moreover, this dispute provides insight into how business and personal COMMENT issues become intertwined as disputes escalate. This example shows how strategy and governance Such disputes often cannot be contained disagreements can evolve into destructive disputes within the boardroom. The media becomes a that may disrupt the board’s work, harm the battleground for the parties involved. company’s reputation, and lead to the resignation of key executives. SOURCE: R. Reuben, Corporate Governance: A Practical Guide for Dispute Resolution Professionals. Washington, D.C.: SOURCE: RBC News, “English CFO Resigns.”August 4, 2008. American Bar Association, 2005. MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 13 While some dissension in a group may be inevitable, in financial results, major quality issues with its products a corporate environment, certain situations significantly or services, a natural disaster, directors’ views on increase the risk that a disagreement will devolve into a how to weather the crisis often diverge. Some board dispute. Often, these situations occur during transitions directors tend to want to minimize the problem’s and before or after certain momentous events: impact while others prefer to widely disclose (beyond mandatory disclosure requirements) the problems — Adopting new strategies. When the company needs to even if this may result in a short-term drop in share change course, directors’ opinions may differ or their value. understandings may vary as to what the new strategy should be. Post-crisis environments. When the company has emerged from a significant crisis — financial, Mergers and acquisitions. A company can undergo operational, government inquiry, litigation, etc. — tremendous structural and strategic changes during the crisis itself may have been the board’s unifying its existence. Mergers and significant acquisitions can element. The immediate objective of surviving the alter a company’s culture and dynamism, particularly crisis supersedes other goals. Once the crisis is over, the if the company finds itself embarked on a different board may find itself without shared goals or strong course from the one before the merger. Not all bonds to unite the directors. As a result, differences directors may be comfortable with the changes. may arise regarding corporate strategy and goals. Fundamental change in the corporation. Determining Board composition changes over time. Some members the company’s ultimate course can exacerbate board leave, and new people take their places. These changes tensions. For example, overtures from private equity don’t always go smoothly, especially when they involve concerns to buy a company and take it private involve either a large number of directors or the appointment of questions about whether the company is to continue a new CEO or chairman. in its present form. The possibility of a merger or sale of a substantial part of the company raises profound business issues, but it often has an emotional FOCUS component. Transformation from not-for-profit to for-profit Not Every Disagreement Is a Dispute company. Non-governmental organizations are often Discourse and debate are at the heart of inclined to swap the not-for-profit company model the board’s work. A significant objective of with a for-profit one to attract more capital to meet having a diverse, independent board is to their growth challenges. For example, microfinance include a broad spectrum of views and ideas institutions are increasingly experiencing such a in the directors’ deliberations. Differing views, transformation by establishing themselves as banks to perspectives, and ideas foster constructive debate. This brings more information into mobilize deposits and diversify their product range. the decision-making process, challenges Board disputes at such companies may arise where assumptions, and sharpens focus. Debate, some board members fear a “mission drift” and want however, should not be a free-for-all shouting to continue to align the company’s social objectives match. Rules and procedures should be with those of its shareholders to make profits. established to ensure that the debate is orderly and productive. Crisis situations. Not all directors have the same approach to crisis management. Such situations can easily lead to counter-productive disputes in the boardroom. Whether the crisis is due to alarming 14 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 Change in board composition. Changes in the board’s GLOSSARY composition that involve a significant number of new directors in a short time can lead to misunderstandings and increase disputes markedly. For example, a merger Dissident Shareholders and Directors may involve directors from the acquired company joining the acquirer’s board. Or, an entirely new board Dissident shareholders oppose a firm’s management or management policy. For may be formed, and the directors may not be familiar example, dissident shareholders of Hewlett- with one another since they haven’t worked together Packard opposed that firm’s offer to purchase before. Until the group’s members have experienced Compaq Computer. working together, the risk of underlying discord and Dissident directors wish to change a firm’s overt disputes is substantially heightened. policies and generally act in opposition to the other directors’ currently held views. Succession on the board and in management. Choosing successors involves agreeing on the company’s current SOURCE: http://financial-dictionary.thefreedictionary.com. and future needs. In turn, these perceptions are related to understandings of long-term strategies. When directors do not agree on these fundamental matters, disagreements and disputes emerge. EXAMPLE New CEO; new chairman. When either the CEO or the chairman is new, he or she must simultaneously master his or her new job while developing relationships Capital Increase Dispute with the directors. These daunting tasks are rife Kenya: Tsavo Securities Group with possibilities for misunderstanding and poor In October 2008, Kenya’s Business Daily reported communication. Trust is imperative for good CEO- that disagreements among the directors of the Chairman-Board relationships, and anything that financial advisory and stock brokerage agency, Tsavo Securities Group, have heightened concerns impairs building and sustaining that trust presents over corporate governance of capital market opportunities for dispute. intermediaries. Directors nominated by dissident shareholders. Once Tsavo is the second case in a short span of time where boardroom intrigues have threatened someone is elected to a board, he or she must use his sound management of a securities industry or her best judgment and act only in the interests of firm. The battles at Tsavo are believed to have the corporation and its shareholders. Thus, directors been sparked by the company’s attempt to raise nominated and elected by dissident shareholders more capital to finance its expansion through a should not simply serve as representatives or Sh250-million private placement. mouthpieces for the specific interests and investment COMMENT strategies of those who nominated and voted for Although most board disputes remain in the them. However, as a practical matter, when directors boardroom, the media are increasingly reporting nominated by dissident shareholders are elected, they on internal corporate governance disputes, which join the board with opinions about the company’s likely tarnish the company’s reputation. focus and direction that likely differ from those of the incumbents. This clash of ideas and vision becomes immediately ripe for disputes. SOURCE: Emmanuel Were and Eunice Machuhi, “Boardroom Intrigues Threaten Tsavo Securities.” Business Daily, October Other issues with a high risk of dispute involve ongoing 17, 2008. Available at: http://www.bdafrica.com. irritants to the board’s functioning. These include: MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 15 Failure to respect the board’s role versus management’s member. Relationships with the CEO can be fraught role. Boards have an oversight and policy role. If with opportunities for dissent. directors begin to cross the line and start managing, or if management does not respect the board’s CEO-Chairman difficulties. In companies where the role, the company is headed for trouble. Similarly, positions of chairman and CEO are separated or in management may overstep its role, intruding on areas a two-tier board structure, major conflicts can arise which the board feels are its own. In a two-tier board between dominant personalities who espouse different structure, this would translate as the failure to respect visions for the company or who fail to understand the the supervisory board’s role versus the management parameters of their different roles. board’s role. Dissatisfaction with content and conduct of board Board-CEO difficulties. The board depends on the meetings. Whether the meeting chair is the problem, CEO to run the company and develop strategies or whether the board has been using procedures that that the board can scrutinize and adopt. The CEO prevent discussion, dissatisfaction with the meeting typically has a dual role — manager and board itself can become an ongoing irritant. EXAMPLE Board versus CEO Dispute United States The newly recruited CEO quickly realized that the mid-cap, technology-related company’s principal product faced obsolescence. With the help of outside consultants, he developed alternate strategies, one of which the board, after some convincing, adopted. As a first step in executing the new strategy, he acquired another mid-cap company. The strategy paid off: the stock price jumped, Wall Street was happy, and the board’s kudos came. Several months later, the board summoned the CEO, to his chagrin, to a special meeting. At that meeting, the lead director handed him a three-page letter charging him with violating company policy, including breaches of the ethics code. A highly ethical person, the CEO did not believe that he had ever violated the ethics code. The board’s action left him without an opportunity to refute charges. Furious, hurt, and embarrassed by what the CEO perceived to be grossly unfair actions by the board and its sudden change in support, he resolved to bide his time, wait until his time-restricted stock vested, and then resign. The dispute with the board was never resolved even though, from the point of view of the overall business, the CEO had driven an effective strategic turnaround. Ultimately, the CEO left the company citing “health reasons.” COMMENT In this case, tensions had obviously been building between the board and the CEO. The CEO failed to bond with the directors and understand their individual views about the company and its business. The board made no effort to work with the CEO, explain its concerns, and attempt to resolve the problems before they escalated into a confrontation. No director acted as the CEO’s mentor. This case illustrates the potential consequences when virtually no dispute prevention and management techniques are employed. Since communications were ineffective, issues simmered below the surface, and there was no effort at collaborative problem-solving between the board and CEO. 16 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 One or more poorly performing directors. Being a director involves a great deal of work and responsibility. QUOTE Directors who do not share the load, or whose performance is lacking, hamper the entire board in accomplishing its objectives. Board Disputes “Board disputes usually involve a firm’s top Potential conflicts of interest. When conflicts of management and rarely occur just among interest appear, directors may be pulled in different outside directors. Moreover, in most cases, directions. For example, in a private equity situation these disputes are related to substantial where the CEO will be given the opportunity to rifts between the views of directors and management regarding board functioning, continue in his or her role after the company is taken agency problems, firm strategy, or specific over, the CEO’s personal interests may be different corporate control or financing transactions. than those of other shareholders. A CEO, who is also a This suggests that board disputes are likely director and pushes an agenda that benefits himself or the result of power struggles between top herself, can create disagreements and disputes within management and certain board factions.” the boardroom. ANUP AGRAWAL PROFESSOR, UNIVERSITY OF ALABAMA Personality clashes. Sometimes disputes occur because MARK A. CHEN personalities clash. Two directors may simply dislike PROFESSOR, GEORGIA STATE UNIVERSITY one another, and their antipathy can poison the board’s SOURCE: Anup Agrawal and Mark A. Chen, “Boardroom atmosphere. Whether directors like one another is not Brawls: An Empirical Analysis of Disputes Involving a criterion for board membership. People must put Directors.” July 1, 2008. Third Annual Conference on Empirical Legal Studies Papers. Available at: http://ssrn.com/ their personal and emotional differences aside when abstract=1101035. serving together on a board. Disputes between the chairman and the CEO — with one or the other trying to dominate the board — can be especially disruptive EXAMPLE to the board’s work. Confrontational directors. Periodically, some people Board versus CEO Dispute serve on boards who are contrarians or who, because United States: Merrill Lynch of personality or other issues, cannot arrive at a Merrill Lynch Chairman and CEO Stan O’Neal consensus with others when acting as directors. came under fire in 2007 when the world’s largest This type of personality creates a constant series of brokerage firm announced third-quarter losses disputes. Sometimes, a director is by temperament of $2.3 billion. Yet it was O’Neal’s exploration a contrarian who makes a point of contesting the of merger possibilities with Wachovia — without prevailing view. In other situations, particularly the board’s knowledge and approval — that led those involving less experienced directors, the to the loss of support of the firm’s 11 directors in what was called a corporate mutiny. O’Neal was director may not understand that one can argue a dismissed in October 2007. case and participate in a debate without adopting a confrontational attitude. Similarly, less experienced COMMENT directors may initially feel that their status as an To avoid disputes over the board’s role versus that of management, all directors and senior executives independent director requires them to overtly must have a clear, common understanding of the confront management. Being a contrarian and board’s duties and responsibilities. challenging prevailing norms can be healthy and SOURCE: NPR, October 30, 2007. Available at: http://www. invigorating for a board. However, the challenge npr.org/templates/story/story.php?storyId=15768986 . for the board is to encourage independent thinking MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 17 and debate and to arrive at consensus without the TO REVIEW PROCESSES AND TECHNIQUES TO deliberations devolving into internecine disputes. PREVENT AND RESOLVE BOARDROOM DISPUTES, SEE VOLUME 2 MODULE 1. Adverse regulatory finding. Management is charged with running the company in accordance with all External Disputes applicable legal requirements. If regulatory agencies Not many years ago, directors rarely had any direct accuse or determine that the company has violated contact with the company’s constituencies other than a regulation, recriminations can start and become a management. The rationale for the board’s isolation was source of dispute. simple: To ensure that the company spoke with a single voice, boards left it to management to communicate Executive misconduct. When the CEO is accused directly with outside stakeholders, including of misconduct, or if the board believes the CEO shareholders. Times have changed. Shareholders are no has engaged in misconduct, whether true or not, longer passive. As a result of high-profile scandals and misunderstanding and dispute could arise. growing mistrust, shareholders are now more actively scrutinizing companies’ strategy and performance while When the circumstances described above occur — or are increasingly seeking involvement in board matters. even suspected — boards should recognize the increased risk of a dispute following shortly thereafter. In such cases, Dominant shareholders (large institutional investors, risk-management responsibilities involve recognizing the for example) often loudly express their disagreements heightened risk and developing or activating processes with board policies and actions. Increasingly, unhappy and procedures to resolve disagreements before they shareholders more frequently nominate their own slates become disputes, or, if the disputes occur, to bring of dissident directors when they have failed to resolve parties together to develop a consensus. their issues with the board. Disputes that go unresolved EXAMPLE Corporate Merger Dispute Germany: Deutsche Telekom and T-Online The majority of T-Online shareholders had given the go-ahead in April 2005 for the reintegration of the company into Deutsche Telekom, the German telecommunications giant. Yet, Deutsche Telekom could not move forward with its plans to reintegrate its separately listed Internet arm T-Online because several shareholders opposed the offer’s terms. T-Online asked the court to allow its merger with Deutsche Telekom to be completed despite objections from dissident shareholders. Yet the court ruled against the merger, and T-Online had to appeal the ruling by the regional court in Darmstadt. A year later in June 2006, the Federal Court of Justice cleared the way for the merger. COMMENT This case shows how legal battles related to corporate governance disputes can delay important strategic decisions. Yet, Deutsche Telekom’s problems with shareholders did not end there. Some minority shareholders continued to contest the share exchange ratio of the merger, saying it did not reflect the value of T-Online shares. In March 2009, a court ruled the German telecommunications giant must reimburse former T-Online shareholders. The cost could total $252 million. Plaintiffs still consider the figure too low and could file a new complaint with the courts. SOURCE: Agence France Presse. November 29, 2005. 18 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 Corporate Strategy Dispute Canada: Environmental Management Solutions Inc. In a press release issued on March 3, 2005, the Dissident Shareholders of Environmental Management Solutions EXAMPLE Inc. (EMS) announced that they had filed court affidavits designed to ensure that the Special Meeting of EMS shareholders be held as scheduled on March 17, 2005. “The meeting was called because they have completely lost confidence in the current board of directors. The drastic change in the vision, direction and strategy of the company has been disastrous for all shareholders. They believe the current board is attempting to delay the Special Meeting in order to allow time to continue with the strategy of selling off core assets and divisions of EMS. “The Dissident Shareholders believe that this is the wrong strategy for the company and will only continue the process of eroding shareholder value. On January 20, 2004, the day the current board was announced, EMS’s shares traded at $3.60 per share. The share price at close of trading on the Toronto Stock Exchange on March 2, 2005 was $0.78 per share, a reduction of 78 percent. “The shareholders of EMS must be given the right to elect a slate of directors that will immediately fix the critical financial state of EMS and put appropriate bonding in place so that EMS can bid on significant contracts. Unless the March 17, 2005 meeting proceeds, a new board is elected and appropriate financing is put in place, EMS will lose the opportunity of submitting bids for millions of dollars in contracts and EMS and its shareholders’ interests will be further irreparably damaged… “The Dissident Shareholders believe that EMS’s present business model has changed so drastically that it no longer supports the total solutions approach but rather has become an organization with a loss of identity, direction and vision. The Dissident Shareholders believe in the original vision and strategy upon which EMS was founded, to become a national integrated service provider to the environmental remediation industry.” COMMENT Shareholders including dissident and minority shareholders, are increasingly challenging major board decisions. If shareholders’ opinions and questions are not dealt with in a timely, proper manner, disputes are likely to erupt, and, in turn, be disclosed to the media and/or brought to court. As in this case, the cost of these disputes can be extremely high. The EMS 2005 Annual Report stated: “The former President and CEO, upon his termination, feted a number of suits against the Company and Board of Directors. These costs, along with the associated costs of defending against a dissident shareholder requisition led by the former CEO resulted in restructuring charges and other items of $5.3 million during the twelve months ended December 31,2005 composed of: $1.0 million in severance expenses for employees terminated throughout the Company; $2.0 million of corporate legal, forensic accounting and consulting charges related to reorganizing the office of the CEO; $1.7 million for the settlement of litigation brought about by the former CEO and related parties; $0.3 million of premises closure costs and costs to exit leased facilities; and $0.3 million in additional costs associated the special shareholders meeting; Other costs related to the reorganization of the Western Canadian operations were classified as part of discontinued operations.” Furthermore, the report notes that, “While the possibility of litigation is a risk faced by most companies, EMS spent most of 2005 involved in litigation with various parties associated with former CEO Frank D’Addario that posed a threat to its viability as a business. The uncertainty caused by these legal actions was a barrier to restructuring its long-term loans, arranging for future financing and securing bonding required for it to win significant new contracts. The settlement negotiated in 2005, and completed in the first quarter of 2006, reduces continuing costs and, more importantly, removes significant uncertainty about the future of the Company.” SOURCE: Business Wire, “EMS Dissident Shareholders Seek to Protect Shareholders.” Available at: http://www.allbusiness..com/company-activities- management/company-structures-ownership/5029597-1.html. Environmental Management Solutions Inc. Annual Report 2005 Business Wire, March 3, 2005. Available at: http://www.englobecorp.com/pdf/annual-report/2005_ Annual_Report.pdf. MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 19 EXAMPLE Financial Disclosure Dispute Bulgaria: Petrol In June 2008, bondholders for the Bulgarian fuel retailer Petrol were concerned about the company’s failure to disclose its audited, consolidated financial figures for 2007. Petrol had placed a Euro100-million bond offering with an 8.375 percent coupon in October 2006, these bonds traded on the London Stock Exchange. At that time, the bondholders said the consolidated report was two weeks late and that their requests for information from Petrol went unanswered. Off the record, company sources blamed the delay in its financial reporting on the sale of 75 Petrol filling stations and a fuel base to local rival Lukoil. The deal apparently triggered the need for corrections in the 2006 and 2007 consolidated reports. Petrol had already revised upwards 2.3 times its net unconsolidated profit for first quarter 2008 to BGN103.7 million as a result of the Lukoil transaction. The bondholders also complained that they had not been able to obtain information about plans for spending the proceeds from the Lukoil deal. A Petrol bondholder revealed that they were very happy with the business model of the fuel retailer and with the amicable resolution of its spat with Lukoil. But the fact that the bond is trading below nominal value is a source of concern, and they would like management to shed light on the company’s activities. Petrol announced that it would invest most of the proceeds in an expansion of its business to quickly offset the loss of market share after the sale of 75 outlets to Lukoil. However, the sale of a sizeable chunk of assets is a trigger event that could prompt bondholders to seek accelerated repayment of their principal, according to some bondholders. Under the notes’ conditions, Petrol is obliged to invest the proceeds from the sale of Petrol stations in a similar business activity or otherwise seek investors’ consent to channel the funds into another business. Clouds thickened above the Bulgarian fuel distributor after the global rating agency Fitch Ratings on September 30, 2008 placed its solvency and bond ratings on Rating Watch Negative. The move was triggered by bad corporate management in spending BGN463.5-million of asset sale proceeds on share buybacks in the second quarter 2008 and, other purposes veering off from the business expansion plan laid out to the agency. The fuel distributor repurchased stocks worth more than BGN90-million to distribute dividends to majority owners at the bondholders’ expense, threatening the company’s liquidity, Fitch said. The agency warned that, unless Petrol delivered extra information on the wrongdoings, its rating outlook may be downgraded to negative. Petrol told Fitch that the share buyback is a temporary investment. COMMENT This case illustrates a public dispute between corporate bondholders and shareholders that badly reflects on the company and its board. The board is expected to be more transparent about the company’s plans and to resolve the dispute to reassure bondholders, reverse the bad rating, and improve its image in the media. SOURCE: Dnevnik Daily, June 4, 2008. 20 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 can threaten the company’s governance structure and shareholders can become extremely complex given the performance. with various viewpoints involved. Several situations in particular can lead to disputes Matters and areas that are increasingly leading to battles between the board and shareholders. In Finland, for between the board and the company’s shareholders example, the most common dispute is related to the include: valuation of share prices during a merger or acquisition. It is typically a battle between the majority shareholders, Mergers and acquisitions. Disputes between who initiate the transaction, and minority shareholders, shareholders and boards regarding a proposed who fear they might be sold short. Unresolved, these acquisition or disposal of a substantial part of the disputes can lead to high-profile court cases, heighten company’s assets are common. reputational risk, impair governance, and threaten to change the company’s course. Not all shareholders Takeover procedures. Shareholders increasingly act and think alike. Shareholder disputes involving scrutinize terms and conditions of a proposed EXAMPLE Share Value Dispute Russia: UTK In December 2004, despite the independent directors’ objections, UTK’s board decided to sell 52.5 percent of its shares in Telesot-Alania for $6,196,575. UTK’s independent directors believed that this transaction price was below market value based on estimates from rating agencies. In December 2005, their assessment was confirmed when MTS bought the remaining 47.5 percent of Telesot- Alania from a third party for $32,600,000. The share value of Telesot-Alania was five times higher in December 2005 then in the previous year when the company’s controlling stake had been sold. Under Russian law, although the board assesses the monetary value of assets, that valuation has to be based on fair market value. On June 21, 2007, the Investor Protection Association, on behalf of UTK minority shareholders, filed a court action against UTK’s board for damages suffered by the company. The minority shareholders argued that the loss of profit due to the sale of undervalued shares in 2004 caused UTK to suffer substantial damages. UTK minority shareholders requested that UTK directors indemnify the company for damages estimated at $8 million. On August 30, 2007, the Moscow Arbitration Court (Commercial Court) dismissed the case after a first hearing. Dissatisfied with the decision, the Investor Protection Association is continuing to seek redress on behalf of minority shareholders. COMMENT Worldwide, minority shareholders are increasingly scrutinizing important decisions made by boards and are demanding action if they feel their rights have not been respected or — as in this case — they believe that the board made a decision that was not in the company’s best interest. This example also shows that major disputes may rise among shareholders — especially between controlling shareholders and minority shareholders. SOURCE: Investor Protection Association, Russia — June 8, 2008. MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 21 takeover, including compliance with internal (e.g., of shareholders from a joint stock company by means articles of association) and/or external (e.g., listing of cash compensation (“squeeze out”). In Germany, rules, securities legislation) rules. for example, a pool of shareholders owning at least 95 percent of a company’s shares has the right to squeeze Share and bond valuation. Disputes between share- out the remaining minority shareholders by paying holders and the board on the share/bond valuation them an adequate compensation. The decision to method are increasingly common when there is a enforce a “squeeze out” must be made by voting at compulsory acquisition of the stakes of a small group the general meeting. Since the major party already EXAMPLE Sustainability Dispute United States: Exxon Mobil A group of pension funds and institutional investors accused Exxon Mobil Corp. of failing to act on global warming concerns and demanded a meeting with the company’s board over the issue. Exxon Mobil had long been a target of environmentalists and activists for questioning the science behind global warming. Demands for the company to do more to address climate change concerns and invest in renewable energy sources gathered momentum in the days ahead of the company’s annual meeting, scheduled for May 31, 2006 in Dallas. The group, comprised of pension fund trustees from eight states and New York City, as well as eight other institutional investors, said they were concerned that Exxon’s handling of the climate change issue left it lagging behind its peers, such as BP and Royal Dutch Shell. “Exxon Mobil is making a massive bet with shareholders’ money that the world’s addiction to oil will not abate for decades,” Connecticut State Treasurer Denise Nappier said in a statement. “As investors, we are concerned that Exxon Mobil is not sufficiently preparing for ‘tomorrow’s energy’ and runs the risk of lagging significantly behind its rivals.” In response, Exxon said it had an ongoing dialogue with the group’s members and was setting up a meeting in July 2006 to discuss these issues. However, the July meeting was only expected to be with Exxon staff, a spokeswoman for the investor group said, noting they were seeking an audience with the company’s board. Exxon released its annual corporate citizenship report, saying it is responding to the climate change issue by improving energy efficiency and cutting greenhouse gas emissions, among other things. “In part, our position includes the fact that we recognize that the accumulation of greenhouse gases in the Earth’s atmosphere poses risks that may prove significant for society and ecosystems,” Exxon Mobil said in a statement. “We believe that these risks justify actions now, but the selection of actions must consider the uncertainties that remain.” COMMENT Shareholders are holding companies accountable to their obligations for sustainable business practices. Engaging in a dialogue, sharing ownership for the issues, and demonstrating commitment in addressing shareholders’ concerns are some of the ways in which boards can resolve conflicts. SOURCE: Reuters, “Investors Attack Exxon on Global Warming.” May 19, 2006 Available at: http://www.enn.com/top_stories/article/4288 . 22 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 commands the vast majority of votes, this usually is a Non-respect of corporate governance best practices. mere formality. The compensation value is determined With the adoption worldwide of corporate by the company’s financial situation when the general governance best practice codes and stock exchange meeting occurs, the minimum compensation being listing requirements, shareholders can review the the share’s average price during the past three months. governance of the companies they invest in by accessing the companies’ websites and comparing Lack of disclosure. Disputes between shareholders company practices against governance norms. and boards often concern the poor quality of financial Disputes may arise over the interpretation and disclosure and the lack of nonfinancial disclosure implementation of codes and the effective application based on best practice and regulations. of the “comply or explain” principle as provided in many corporate governance codes. Shareholder agreements. When acquiring a company’s stock, major shareholders increasingly sign Discharge of individual board members/executives. a shareholder agreement that describes the company’s Shareholders more actively express their satisfaction governance, including bylaws on the sale and purchase or dissatisfaction with board members. Disputes of shares, investment policies, etc. Although they can may erupt over the performance of individual board help protect investors, these agreements can also be a members and/or the alleged mismanagement of a fertile ground for disputes. senior executive. EXAMPLE Cross-Border Dispute Malaysia: Nike - Hytex Nike, Inc. said it has taken steps to correct worker-abuse problems at a factory it uses in Malaysia. The athletic apparel giant said its actions reflect its concern about the country’s chronic labor shortage and how it affects factory workers. Nike alleged abuses at Hytex Integrated Bhd., a Kuala Lumpur-based garment manufacturer that owns a factory producing Nike T-shirts. Nike, which is based in Beaverton, Oregon, said it had completed its initial investigation into “claims of unacceptable living conditions, withholding of worker passports, and garnishing of wages” that began after an Australian television report alleged worker mistreatment at Hytex. Michael Saw, executive director of Hytex, said the company met with Nike compliance officials to discuss violations of Nike’s code of conduct for foreign contract manufacturers, and that Hytex has “rectified” the issues. “We have been working for Nike for the past 15 years,” Saw said, maintaining that the allegations of abuses by the Australian reporter were “out of proportion” to the facts. Nike itself has battled criticism of its labor practices since the 1990s. COMMENT Investors and stakeholders are increasingly pressuring companies to adhere to practices that ensure employees worldwide have humane working conditions. As a result, CSR and governance policies adopted by international companies can result in disputes with their subsidiaries or suppliers. These cross-border disputes can be further complicated by differences in laws, social mores, judicial processes, and corporate governance practices. SOURCE: The Wall Street Journal Asia. August 4, 2008. MODULE 1 What Are Corporate Governance Disputes? VOLUME 1 23 Nomination/appointment of board members. about the company’s long-range future and the Disputes can easily emerge among majority and strategies that will increase the company’s value while minority (or dissident) shareholders and between working to protect the environment and operate in a shareholders and the board over the nomination or sustainable manner. appointment of board members and senior executives, as well as over the nomination criteria. Cross-border operations. Globalization and cross- border trade increase a company’s risks that social, Remuneration/bonuses of board members and senior political, and cultural differences can create deep rifts executives. Disagreement over the remuneration between the company and its external constituencies. and/or bonuses of board members and senior Reputational and operational risks can increase executives, as well as with the board’s compensation dramatically. policies is, effectively, a disagreement with the board’s performance as overseer of the company’s When a company’s business crosses national borders, or management. If the board’s compensation decisions when shareholders and directors come from different are rejected, directors suffer public embarrassment, countries or cultures, the potential for a dispute increases. and it becomes clear that the board and the Different perspectives may exist as to a company’s shareholders, whose interests the board represents, purpose and whether that purpose involves creating are not in alignment. “Say on pay,” in which wealth for the company and its shareholders, or whether shareholders express their approval or disapproval of the company exists principally to perform a certain senior executive compensation, is a sensitive, highly public function. For example, in some countries, the publicized issue that can trigger disputes. primary purpose of utility companies, such as electric or water companies, is serving the public good. Directors In jurisdictions where “say on pay” is not required, the and shareholders from different national or cultural question as to whether the board should adopt this perspectives may view the same company’s principal practice can itself be contentious. purpose as creating shareholder value as measured in financial terms. Thus, different national, political, or Corporate social responsibility. Social and ethical cultural perspectives can result in decision-makers using issues involving the company’s broader range of various criteria to shape their view and decide their stakeholders are increasingly becoming an issue vote. These different perspectives can become the basis for shareholders, especially institutions that invest for severe disputes deeply rooted in cultural values and across borders. Disputes may arise over shareholders’ perceived national or political interests. concerns about employment policies and/or the company’s interaction with the communities or even Other issues involving culture and national law or policy the countries in which it does business. can easily exist in the ethics arena, or in situations in which the policy of one country differs from that of Sustainability. As the world increasingly focuses another. Global companies may have conflicting laws on matters involving sustainability, questions arise and different ethical mandates to address. Endnotes 1 This definition of corporate governance was provided by Sir Adrian Cadbury in 1992 in the Report on Financial Aspects of Corporate Governance in the United Kingdom. London: Gee and Company. Available at: http://www.ecgi.org/codes/documents/cadbury.pdf. 2 Anup Agrawal and Mark. A Chen. July 2008. “Boardroom Brawls: An Empirical Analysis of Disputes involving Directors.” University of Alabama and Georgia State University. Working paper. Available at: http://ssrn.com/abstract=1101035. . 24 VOLUME 1 What Are Corporate Governance Disputes? MODULE 1 VOLUME 1 : RATIONALE MODULE 2 : Why Care about Corporate Governance Disputes? 1.2 Companies, their boards, investors, and other key stakeholders need to care about corporate governance disputes because once they arise, they can harm the company. Left unchecked, corporate governance disputes can have a highly negative impact on the company’s reputation, operations, and performance and thereby lead to a loss in shareholder value and market standing. Although the court is the traditional way of resolving disputes in many jurisdictions, the impact of litigation for corporate governance disputes can be highly counter-productive. The proceedings can inflame the dispute, increase its cost, damage the company’s reputation, and delay the resolution of strategic issues. Moreover, corporate governance disputes often lack the legal basis to be tried in court, or are premised more on personal issues and/or business judgment than on legal principles. THIS MODULE REVIEWS Impact of corporate governance disputes on the company’s reputation, operations, performance, and shareholder value Impediments and limits of litigating corporate governance disputes Need to effectively deal with corporate governance disputes MODULE 2 WHY CARE ABOUT CORPORATE GOVERNANCE DISPUTES? DISPUTES PUTTING THE COMPANY Shareholder activism, or the ability of shareholders AT RISK to assert their power as the company’s owners to influence its behavior, is a positive trend. Shareholders In the boardroom, disagreements are often who scrutinize a company’s performance and question unavoidable — especially when the board is composed of its strategic decisions are part of a healthy corporate independent-minded, skilled, and outspoken directors. governance system that helps protect shareholder rights This is not a bad thing. There should be debate in the and keeps board members and senior executives alert. boardroom, and decisions should result from a process in which directors consider all reasonably available Yet, if boardroom disagreements and/or shareholder information. A board that never argues or disagrees conflicts are not dealt with properly, they can devolve is most likely to be an inactive, passive, or inattentive into acrimonious disputes that undermine a company’s board — in other words, an ineffective board that is operation and performance. Left unchecked and neither fulfilling its oversight function nor carrying out unattended, these disputes escalate quickly into public its duty of care. matters that can have severe, long-term consequences for the company and its key stakeholders. EXAMPLE When disputes become public and are discussed in the press or trigger litigation, they indicate an The Need for Disagreement in Boardrooms important failure of governance. They demonstrate United States: General Motors a mismanagement of conflicts within the board or between the company and its stakeholders — mainly Twentieth Century business guru Alfred Sloan (1875-1966), who was General Motors chairman its shareholders, but sometimes also its suppliers, clients, from 1937 to 1956, stressed the importance of creditors, and the communities in which the company boardroom debate by summing up the end of a operates. Corporate governance disputes reflect the GM executive meeting as follows: inability of executive managers or directors to address “Gentlemen, I take it we are all in complete major strategy issues and conflicts. agreement on the decision here,” he said. Everyone nodded their heads in agreement. TO FIND OUT MORE ABOUT INTERNAL AND “Then,” he added, “I propose we postpone further EXTERNAL CORPORATE GOVERNANCE DISPUTES, discussion of this matter until the next meeting to SEE VOLUME 1 MODULE 1. give ourselves time to develop disagreement, and perhaps gain some understanding of what the Corporate governance disputes undermine confidence decision is all about.” in the company and harm its competitive position. COMMENT External and internal corporate governance disputes Boards should discuss and debate strategic can impair a firm’s ability to prosper and grow. Unless decisions. Disagreements are not disputes, but left unspoken, they may become disputes. resolved quickly, and especially if they become the subject of a lawsuit and media headlines, governance SOURCE: The Economist, “Guru: Alfred Sloan.” January 30, 2009. Available at: http://www.economist.com/business/ disputes can weaken the capital markets’ confidence in management/displaystory.cfm?story_id=13047099. a company, threatening its ability to attract capital and retain investors. MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 25 The full implications of disputes generally do not become The media can be a critical element in a dispute’s clear until the dispute becomes public. In most cases, the unfolding. While shareholders and stakeholders have dispute becomes “toxic” as soon as news organizations a right to be informed about ongoing disputes, senior and/or bloggers report information about it. The management or the board must ensure that the supply company’s reputation is immediately affected, creating of information is properly managed if they don’t want doubts for shareholders and other stakeholders (e.g., the situation to spin out of control. The media are potential investors, clients, and vendors). Investors may often used as a tool by parties to a dispute, dissident want to sell their shares. Credit agencies may revise their board members, and shareholders to raise awareness ratings downwards. Creditors and suppliers may turn and pressure the other party(ies) or the company into less flexible in the business terms that they are willing to addressing the dispute and finding a solution. This is accept. Employees may start questioning their employer’s especially true when large corporations are involved, or future; the most capable ones may leave to work for better- there are social and ethical issues. Boards must be able run companies. In short, the company may come under to communicate effectively and in a timely manner with tremendous pressure to resolve the conflict and restore its the media at all times, but especially when the company share value, as the ongoing dispute plays out in public. faces a crisis or is entangled in a dispute. FROM HEALTHY DEBATE TO PATHOLOGICAL DISPUTE BOARDROOM DEBATE SHAREHOLDER ACTIVISM DISAGREEMENT DISAGREEMENT GOOD GOVERNANCE DISCUSS | RESOLVE DISCUSS | RESOLVE IGNORE INTERNAL IGNORE EXTERNAL DISPUTE DISPUTE REACT CONSTRUCTIVELY — REACT CONSTRUCTIVELY — RESOLVE WITH MINIMAL HARM DISPUTE INFLATES RESOLVE WITH MINIMAL HARM BOARD SPLITS SHAREHOLDER FIGHT DISCLOSE DECISION DISCLOSE DECISION DISPUTE GOES PUBLIC NEGATIVE MEDIA DIRECTOR LAWSUITS HEADLINES RESIGNATIONS COMPANY IN TROUBLE 26 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 FOCUS PRACTICE Impact of Corporate Governance Disputes Cost of Corporate Governance Disputes Although a company may be doing well, All companies suffer negative consequences corporate governance disputes that are left from corporate governance disputes. The actual unchecked and unresolved can have the impact can be difficult to measure. In most following negative impacts on the company: cases, the impact is underestimated and only takes into account the direct cost of the dispute, LEVEL 1 if quantifiable, and the associated legal fees — especially if the dispute goes to trial. When Divert boardroom resources assessing a dispute’s impact, the following Disrupt board’s work factors should be considered: Obstruct company’s operations Cost of the dispute in relation to the value of Delay major strategic decisions the matter in dispute Number of staff members involved in dealing LEVEL 2 with the dispute Undermine company’s reputation Amount of staff time involved in dealing with Reduce market share the dispute Deter investors Degree of satisfaction with the dispute’s outcome Cause share value to fall Level of recovery from the dispute Divert corporate financial resources Incidence of destruction in business Divert corporate human resources relationships Weaken internal and external stakeholder Incidence of director and / or senior executive trust resignations Prompt resignation of board members and Incidence of loss of shareholders senior executives Incidence of loss of business opportunities LEVEL 3 Number of corporate strategic decisions delayed Impair growth Amount of goodwill or reputation lost Increase governance costs Amount of negative media coverage Entail high litigation costs Other? Cause a breakdown in stakeholder relations Affect corporate results MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 27 FOCUS EXAMPLE Corporate Governance Disputes Publicized Boardroom Dispute and the Media Australia: National Australia Bank If unresolved and left to fester without being In late 2003, to prepare for his succession, Charles addressed quickly and effectively, the dispute will Allen, chairman of the National Australia Bank, attract media coverage. Given the proliferation of sought to promote one of his directors, Graham communications technologies, major corporate Kraehe, to the position of deputy chairman. Eight governance disputes do not remain hidden for out of nine directors agreed with this choice. Some long. analysts believe that the longest serving director, Catherine Walter, voiced her opposition because Information can be leaked anonymously or she coveted the chairmanship herself. The board voluntarily disclosed to the media by: decided to postpone its decision rather then to Party(ies) to the dispute (e.g., shareholder, appear split. director, senior executive) In February 2004, Allen and the Bank’s managing Whistleblower (e.g., employee, creditor, director, Frank Cicutto, resigned in the face of a client) major foreign-exchange trading scandal. This time, Graham Kraehe was unanimously voted in as the The company (e.g., official declaration to bank’s new chairman. the press) Stakeholders, including dissident shareholders Yet although Catherine Walter, who chaired the board’s audit committee, volunteered to oversee Lawsuit (e.g., public filings) the PricewaterhouseCoopers-led investigation into the AUD360-million trading loss, the board gave Reasons for media disclosure include: the task to Kraehe, who was also the head of the Strengthen a party’s position risk committee. Outsider’s believe that this decision triggered the collision between two high-profile Attract attention to the dispute directors, disrupting the board’s collegiality. Act for the common good Insiders surmised that Walter believed the PwC File a lawsuit report would be used by Chairman Kraehe to remove her from the board. She questioned PwC’s Silence rumors independence, accused the chairman of not sharing information with other directors, and claimed to be Benefits of media disclosure include: the victim of a vendetta. To head off any criticism, Informing shareholders and stakeholders the chairman decided to hire PwC’s rival, Deloitte, to investigate areas where PwC could be considered Generating pressure to resolve the dispute to be conflicted. He also hired a law firm to oversee Containing and squashing rumors PwC’s work Walter, furthermore, criticized the risk committee, Risks of media disclosure include: which was set up the previous year but had only Creating partial, imbalanced information on met once even though it knew about the financial the dispute regulator’s concern over the bank’s foreign- exchange trading activities. Increasing rumors Escalating the dispute (e.g., the media With tensions running high within the board, becomes a battleground for the dispute) Kraehe accused Walter in March of leaking information to the media. Walter retorted that Creating public embarrassment she was sharing information in the best interest 28 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 of shareholders, but that she had never divulged As soon as the appointment of the well-respected confidential information. Michael Chaney was announced, NAB shares increased by 1.43 percent. In March, when the PwC report was released, Walter had to give up her position as chair of the COMMENT audit committee. Although the report didn’t single Although the trading scandal triggered this out Walter, it did point to all directors by referring highly publicized dispute, the board became to board oversight issues. Fellow audit committee divided because of unresolved issues between the members Kraehe and Ken Moss were promoted. chairman and a dissident director. As a result, the board lost its focus and failed to pull the company Walter accepted the board’s decision to remove her out of a major crisis. Entrenched in the dispute, the from the audit committee but expressed concerns board in part failed to act in the company’s best over a media campaign waged in an effort to oust interests. This example also shows how the media her. can become an important battleground for internal disputes when issues are not properly handled The chairman wrote to her on March 18, saying that within the boardroom at an early stage. This can be she had neither his confidence nor that of the other extremely damaging for the company’s reputation directors. Seven non-executive directors publicly and lead to a loss in shareholder confidence. announced their intention of calling an extraordinary general meeting to vote her off the board. Walter countered that the board had failed to fully investigate the trading scandal and that all the directors should resign when their three-year rolling terms expire, without retirement benefits. In April, the board announced that it would hold a general meeting of shareholders on May 21 to consider five different resolutions: Remove Catherine Walter from the board Remove all non-executive directors over time Censure the board Request a search for a new chair Express views as to the re-election of non- executive directors and retirement benefits Under pressure, Walter and two other directors (including Moss) resigned in early May, and the SOURCE: Sydney Morning Herald Online, “Heads Roll at NAB general meeting was canceled. Chairman Kraeher over Foreign Exchange Scandal.” March 12, 2004. Available at: agreed to step down once Michael Chaney, who http://www.smh.com.au/articles/2004/03/12/1078594547046. html. NAB Press Release, “Chairman Outlines Board Renewal was appointed to the board in June, took over as Program.” April 6, 2004. Available at: http://www.nabgroup. the new chairman in September. com/0,,46793,00.html. MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 29 Impact of Internal Corporate Governance board’s attention and resources are diverted, which can Disputes lead the board both to neglect its oversight functions Internal governance disputes are those that arise within and to freeze decision-making. Chaos and lack of clarity the company itself — for example, among directors, can then spread quickly throughout management ranks. or between the board and the CEO. Whether these While on the surface, the company’s operations may internal disputes become public, they can impair a appear to be on track, management’s focus and efficiency board’s operation. come into question. A board mired in dispute cannot provide management To appreciate the harm that unchecked internal with the direction it needs for a strategy of long-term, disputes can cause, one must understand how boards sustainable growth. When governance disputes occur, can take actions to unite a corporation. Unlike the rest board and management can lose focus on their roles in of the corporation, the board’s structure does not have creating value for the company and its shareholders. The a built-in arbiter of disputes. EXAMPLE Impact of Corporate Governance Disputes United Kingdom and the United States: Cadbury Schweppes and Hershey In 2007, Todd Stitzer, chief executive of Cadbury Schweppes plc in the United Kingdom, met with his counterpart at the U.S.-based Hershey Co., Richard Lenny, to propose the creation of a “global confectionery powerhouse.” Cadbury’s strong European market presence would complement Hershey’s North American strength, Stilzer suggested. The combined Cadbury-Hershey could use its joint strength to expand into emerging markets, including China and India. Both companies already had existing, successful business partnerships in place. A merger would build on those partnerships’ success. In an initial response to the potential merger, LeRoy Zimmerman, who then served as board chairman of the Milton Hershey School Trust that holds the majority voting rights for Hershey, told The Wall Street Journal that the Hershey Trust has “a responsibility to listen to all potential possibilities that might come forward.” Yet, he said he had “absolute confidence” in the management team at the time and was unwilling to give up a controlling interest in the company. The trust had previously decided against another sale proposal in 2002 in response to staff protests. The trust’s opposition to a sale eventually led to Lenny’s “retirement” and the subsequent departure of eight Hershey directors in October 2007 in what a local newspaper dubbed “the Sunday night massacre.” “Hershey’s downward spiral offers an illustration of how a breakdown in communication and trust among a company’s main actors — management, the board of directors, and key shareholders — can paralyze an organization and leave it vulnerable,” The Wall Street Journal observed. COMMENT The CEO’s dismissal and the departure of all but one director provide a classic example of mistrust and misunderstandings that brewed over a long period of time. Lack of open communication — in this case, management’s pursuit of a merger without advising the controlling shareholder — proved disastrous to management, the board, and the merger. SOURCE: J. Largon, M. Karnitschnig, and J. Lublin, “How Hershey Went Sour,” The Wall Street Journal, February 23, 2008. 30 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 Contrast the board’s situation with that of management. populating boards that are increasingly independent of Management tends to be organized hierarchically, with management; they take their oversight roles seriously, the CEO at the top of the company’s pyramid. The rather than being subservient to the CEO. With the CEO is the ultimate decision-maker on the management CEO’s ability to resolve disputes gone, a vacuum exists, team, and, by his or her authority, he or she can end and boards must develop their own mechanisms for disputes among subordinates. In contrast, the board is recognizing and resolving internal disputes. more democratic in its operation. The board acts by taking a formal vote; the results of that vote constitute the board’s official action. Each director has the same EXAMPLE vote and power. The highest ranking board members — such as the chairman, lead director, or a committee chair — may be in positions to exert greater influence, Impact of Boardroom Disputes on but none has the authority to single-handedly resolve a Corporate Value and Performance dispute among other directors. United States In a study of the consequences of boardroom Many views may exist among directors. Binding action disputes using a data set of internal disputes in only results from a vote, which, along with a thorough publicly traded U.S. companies over 1995-2006, description of the action, is recorded by the company’s researchers Anup Agrawal and Mark A. Chen secretary and preserved in the company’s official minutes. reached the following conclusions: Stock prices decline significantly (both Director votes are not required to be unanimous, but, as a statistically and economically) upon news of practical matter, a consensus among directors is desirable. director departure amid dispute. When the Persistent dissenting votes, or repeatedly delayed voting resigning director is an insider, the decline is even sharper in magnitude. by the board, signal a lack of consensus. Because directors typically vote on matters that are very important, if not The decline in stock prices is typically greater surrounding disputes related to agency crucial, to the company, continued dissension among problems, corporate strategy or financial the board directors signals to management and the decisions; it is generally more muted for other investing public an irreconcilable disagreement about types of disputes such as those dealing with key issues facing the company. In turn, this dissension board processes. infects the company and its business. Management Companies with boardroom disputes becomes uncertain about the direction the board wants experience poor operating performance in to pursue for the company and the performance goals the years surrounding the dispute episode, that will be established. When management lacks clear weak stock price performance during the direction, the risks of lackluster performance increase. 12 months both before and after a board director’s resignation over the dispute, and a This sets up a scenario in which the board, or at least a significantly greater incidence of stock market part of it, will always be disappointed with management delisting in the post-dispute year. performance, and management will, in turn, be frustrated in understanding the board’s expectations. COMMENT Director resignations are often a sign of ongoing conflict or disputes within the boardroom. Not so long ago, the CEO dominated boards, typically Resignations impact corporate share value, either selecting or approving all its members. The operations, stakeholder relations, and employee CEO or founder was therefore in a position analogous morale. to his or her role within management. By default, he or she had the authority to cut through disputes and reach conclusions. Today’s situation is starkly different SOURCE: Agrawal and Chen, op. cit. in a growing number of countries. More directors are MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 31 Ironically, the very characteristics that empower of the company’s products and services in the face of boards and make them effective overseers of the governance conflicts. company — independence and diversity — create an environment that is more fertile for misunderstanding, Impact of External Corporate Governance disagreement, and disputes. This new environment Disputes raises the risk that board disputes, and their consequent External disputes involve the board and stakeholders threat to board effectiveness, will increase unless outside the company. Shareholder dissatisfaction, social boards develop and adopt processes and procedures activist unrest, questions about human relations, and for handling disputes. cross-cultural matters can rise to the board level if these issues cannot be resolved by management. External Similarly, with family firms, the company’s founder, in disputes can become public very quickly, leaving the a patriarchal or matriarchal fashion, may have typically board to carry out resolution in the fishbowl of the selected and approved all the board directors. Given his public domain. or her position in the family and his or her role in setting up and growing the company, the founder has the FOR A MORE DETAILED DESCRIPTION OF EXTERNAL CORPORATE GOVERNANCE DISPUTES, authority to cut through disputes and impose a decision. SEE VOLUME 1 MODULE 1. Yet, once the founder has resigned or passed away, the successor (if they are not the cause of the dispute) no longer has the natural authority and ability to resolve External disputes can be debilitating for the company. disputes within the board or with family shareholders. Shareholder dissatisfaction can worry the markets and drive share prices down. The involvement of private Further, internal governance disputes are between equity and sovereign wealth funds can lead to efforts people who will have to continue working closely together. The goal in these situations is for those involved to iron out the subject of their disagreements QUOTE without impeding their work. It may be desirable for all directors to remain on the board. The CEO may want to continue in office. Therefore, the resolution The Inevitability of process must not only be quick and efficient, but Corporate Governance Disputes it must also leave few, if any, scars. If, as part of the “In 1998, private sector players in Uganda came dispute’s resolution, an environment is not created in together to set up the Institute of Corporate which the parties can work smoothly and amicably Governance of Uganda to promote good together, other problems will soon emerge. corporate governance through the propagation of the highest standards of ethical conduct, efficiency, accountability and probity for the Disputes that result in resignations of board members benefit of shareholders, workers, consumers, and and senior executives are equally disruptive for the all stakeholders. It is against this background, and company. They constitute a loss for the company if the the desire to attain the goals of good corporate resignations had nothing to do with performance, but governance that one can inevitably expect rather were the result of unresolved internal disputes. corporate governance disputes to arise.” JUSTICE GEOFFREY W. M. KIRYABWIRE Persistent dissension within the board eventually becomes COMMERCIAL COURT JUDGE, MINISTRY OF JUSTICE, public knowledge. Lack of a board consensus can poison UGANDA investors’ taste for the company’s stock. Lenders may feel SOURCE: Geoffrey W. M. Kiryabwire, “Mediation of Corporate their risk of repayment is heightened by the board’s lack Governance Disputes through Court Annexed Mediation.” Paper provided by the author to the Forum. of consensus. Dissension can also heighten reputational risk. Customers may have concerns about the integrity 32 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 to acquire the company or remove its board. The Today, however, the situation is vastly different. uncertainty and chaos that these situations bring to the Everywhere, institutional investors dominate ownership company skews planning, consumes company resources, of public companies. Whether these investors are mutual and disturbs the focus of management and the board. funds, pension funds, foundations, hedge funds, private equity, or sovereign funds, they represent enormous In earlier eras and in some jurisdictions, shareholder pools of capital managed by intelligent, sophisticated power in publicly traded corporations was dispersed professionals. Information travels instantaneously over among an enormous base of individual shareholders. the Internet. In the past, small shareholders could not These shareholders lacked the cohesiveness and effectively challenge a company’s board. Since they and sophistication to challenge the board and management. institutional investors no longer have the same constraints or impediments, their dissents are increasingly targeted at boards. EXAMPLE External governance disputes face a tremendous risk of increasing dramatically. The rise of institutional investors Shareholders Challenge the Board raises the prospect of more confrontations with boards. Finland: Elisa This risk is further increased through globalization of In 2007, an Icelandic activist investor, Thor business, which is broadening companies’ contacts with Bjorgolfsson, severely criticized the board and other societies and heightening the risk of cultural and, management of Elisa, Finland’s oldest telephone potentially, political miscues and disputes. Companies company. The dispute involved charges by are exposed to a wider range of stakeholders than ever Bjorgolfsson related to Elisa’s structure and before. Previously, a company’s relationships with the direction. Management responded by accusing the dissident investor of having a hidden communities in which it operates were likely to be in agenda. A coalition of institutional shareholders, the country in which it had headquarters. Nowadays, including Bjorgolfsson’s Novator Finland that however, as businesses circle the globe, corporations held 20.5 percent of Elisa’s stock, succeeded in must interact with people and governments worldwide. gaining board approval of a measure that limits Elisa’s board to six members and allows the While the precise mechanisms for dispute resolution election of four new, shareholder-nominated directors. of external disputes may vary from those that are most effective for internal disputes, governance disputes of all COMMENT kinds will increase in number and, left unaddressed, will Moves by dissident shareholders to change escalate in impact. company policies through election campaigns to seat new directors have increased dramatically. The concentrations of large blocs of shares worldwide in institutional funds raise the specter that these disputes and challenges will increase. A contrasting situation is the decision by the New York Times Company’s board to meet with dissident shareholders rather than to engage in a fight at the shareholders’ meeting. Ultimately, the company and the dissidents resolved their dispute, with the company agreeing to nominate two of the four shareholders proposed by the dissidents. SOURCE: David Ibson, “Icelanders Turn Up the Heat on Elisa,” Financial Times, December 12, 2007. MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 33 DISPUTES CALLING FOR causes, either. Moreover, the dispute’s cost on the OUT-OF-COURT RESOLUTION company accelerates exponentially, and strategic decisions affecting the company are often delayed. Litigation is Whether in developed or developing countries, the neither a fast nor inexpensive process. It can drag on conventional way to settle a dispute is by litigation. for years. The longer it goes on, the greater the costs Shareholder disputes and, in some cases, disputes in out-of-pocket expenses, management’s distraction, that arise in the boardroom can indeed be addressed consumption of board time, and impairment to strategic through litigation. For example, shareholders’ actions and operational decision-making. for monetary claims in mergers and acquisitions may be filed with a court to settle. Using the judicial process Cost of Court Litigation can be appropriate in corporate governance disputes Regardless of the chances of winning or losing a case, in which there is a question regarding the proper where speed and flexibility are at a premium, judicial application of law and the parties’ rights. However, resolution can be counter-productive for many reasons. in most cases, courts are not effective arbiters of governance disputes. They expose and accelerate an Litigation is slow and cumbersome. Corporate often irrevocable breakdown in business and sometimes governance disputes are time sensitive. They involve personal relationships. matters that require quick resolution because they are integral to how the company conducts its business. Litigation typically increases the negative impact of the dispute on the company’s performance, reputation, and Unless resolved, the board’s decision-making stalls. value. The outcome doesn’t necessarily fix the dispute’s When the board fails to make decisions, management’s performance (e.g., performance without clear objectives) will be judged sub-standard. In other words, the QUOTE enterprise’s basic needs to function efficiently can be impaired without a quick resolution. The key to Litigation Destroys Relationships managing corporate governance disputes effectively is to act quickly and assertively — only by doing so can “Business people spend their lives building boards address the problem before it becomes insoluble. relationships, but as soon as a dispute arises, if the parties resort to litigation, the adversarial nature of it destroys the relationship. It must be part Time sensitivity also applies to disputes with outside of a director’s duty of acting in the best interest constituencies. The longer the dispute remains of a company to try and preserve the business unresolved, the more uncertainty investors face, relationships. potentially increasing investment risk and impeding “Analysts and consultants have found that what realization of strategic goals. Shareholders must decide stakeholders want from a company after the whether to keep their investment in the company or to quality of its products or its services, is to have trust move their capital elsewhere. Shareholders who demand and confidence in the company. As soon as there board changes will not wait years until a dispute is is a dispute that becomes adversarial, public trust resolved. Yet, lawsuits take time, often years, as they and confidence wanes.” wind their way through trials and appeals. PROFESSOR MERVYN KING, SC FIRST VICE PRESIDENT, SOUTHERN AFRICAN INSTITUTE Even the best of rules can prove useless if courts are too OF DIRECTORS slow. Papua New Guinea, the Maldives, and Slovenia, MEMBER, FORUM’S PRIVATE SECTOR ADVISORY GROUP for example, have strong investor protection laws for bringing suits and gathering evidence. But even the simple SOURCE: Directorship Magazine. 2008. commercial disputes take too long to resolve — 591, 665, and 1,350 days, respectively, in those three countries. 34 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 Moreover, in some countries, the sheer volume of preparation, result in a drain on management, whose cases makes it impossible for judges to deal with each job it is to operate the business efficiently. case thoroughly. In India, for example, case arrears and decade-long legal battles are common. In spite of Litigation often lacks a tailored resolution. Judges having about 10,000 courts (not counting tribunals decide facts and apply the law as they understand and special courts), India has a serious shortfall of matters. But a judge may have little or no experience judicial servants. A termination dispute contested in dealing with a company’s particular issues and its until all appeals are exhausted can take up to 20 years governance disputes. for disposal, while writ petitions in High Courts can take between eight and 20 years. About 63 percent of Courts do not always have sufficient staff and expertise pending civil cases are more than a year old, and 31 to properly understand and litigate the increased percent exceed three years. number of complicated disputes involving shareholders of listed companies. Litigation distracts the board. Governance disputes distract boards from their work and delay important, Litigation is costly. Litigation costs have been time-sensitive decisions. When these disputes become increasing exponentially almost everywhere. Unless a or threaten to become the subject of litigation, the cost company seeks to set an incredibly strong precedent, and impact on board operations increases considerably. or a society-wide answer is sought to avert thousands Not only the progress of the litigation, but also the of similar cases, court battles should be avoided and enormous amounts of time and energy required for remain an exception. AVERAGE NUMBER OF DAYS TO ENFORCE A CONTRACT IN 2008 1200 1000 800 EASTERN EUROPE AND CENTRAL ASIA 600 OECD AND HIGH INCOME EAST ASIA AND PACIFIC 400 SUB-SAHARAN AFRICA MIDDLE EAST AND NORTH AFRICA 200 LATIN AMERICAN AND CARRIBEAN SOUTH ASIA 0 SOURCE: World Bank, Doing Business Database. 2008. MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 35 FOCUS Board Resources Focused on Litigation A study conducted by Lloyd’s, in conjunction with the Economist Intelligence Unit, revealed that “board members are increasingly concerned about the increasing number of corporate litigation cases facing the boards and the escalating cost in mitigating such risks.” The report found that, “one in five companies faced lawsuits targeted at individual directors or officers, including non-executive directors with employees and customers being the most likely source.” Boards are increasingly allocating resources to litigation issues, which is pushing up the price of products and services and leading many companies to adopt more cautious business strategies. On average, boards spend 13 percent of their time discussing litigation issues, and directors expect this to increase further over the next three years. There is strong agreement among the 168 board-level executives interviewed for this study that valuable resources are being spent on legal issues that could be deployed elsewhere. PERCENTAGE OF COMPANIES EXPECTING THE FOLLOWING CHANGES AS A RESULT OF CORPORATE LITIGATION IN THE NEXT THREE YEARS BY REGION (2008-2011) MORE CAUTIOUS ABOUT INVESTING IN NEW PRODUCTS MORE CAUTIOUS ABOUT INVESTING IN CERTAIN MARKETS/REGIONS MORE STRINGENT DUE DILIGENCE OF SUPPLIERS/PARTNERS GREATER ATTENTION TO RISK MANAGEMENT INCREASED BOARD INVOLVEMENT ON LITIGATION INCREASED TIME SPENT ON LITIGATION RELATED ISSUES 0 20 40 60 80 100 NORTH AMERICA ASIA-PACIFIC EUROPE SOURCE: Lloyd’s and Economist Intelligence Unit. 2008. “Directors in the Docks. Is Business Facing a Liability Crisis?” Available at: http://www. lloyds.com. 36 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 EXAMPLE QUOTE Munda Hydro-Power Dam Project Court Delays in India Dispute Between Shareholders of Amzo “The Indian judicial system is often criticized for Corporation LLC slow pace of justice delivery.... Delays in court have always been main concerns for stakeholders. AMZO Corporation LLC (AMZO), which is It is also perceived as one of the impediments incorporated under Maryland laws, sponsored in attracting foreign direct investment in the a multimillion-dollar hydro-power generation country. Lack of suitable infrastructure and project in Pakistan. AMZO first qualified for the inadequate number of judges is cited by the project in 2004. After completing a two-year- judiciary as one of the main reasons for delays long feasibility study, AMZO submitted its final in court.” report to the federal government in 2006. Amid crucial negotiations with the federal government, SUMANT BATRA a dispute arose between AMZO’s two main SENIOR PARTNER, KESAR DASS B & ASSOCIATES shareholders. This dispute led to the removal of one major shareholder from the board for his alleged unethical, fraudulent behavior, and SOURCE: The Economic Times (New Delhi), “Judiciary Ought to his mismanagement of the project company. In Do Introspection.” October 31, 2007. retaliation, the ousted director filed a civil suit before a local court, alleging oppression and mismanagement by the majority shareholder. The court prevented the majority shareholder from unlawfully interfering with the sponsor company. Subsequently, the feuding shareholders wrote several letters to the federal government QUOTE in which they defended their respective actions and posed as AMZO’s lawful representatives. As a result of the dispute, the project stopped. Cost of Class Action Lawsuits in Since AMZO failed to resolve the dispute quickly the United States on amicable terms, the federal government “The possibility of being sued for huge sums, reluctantly awarded the project to a public while also bearing high costs of legal defense, sector utility. As of August 2009, the litigation has brought many companies to a moment of among the shareholders remains pending in the reckoning that mitigates against registering their local courts. securities in the United States. The total value of COMMENT settlements in securities litigation class action The example demonstrates the negative lawsuits has continued to increase from $150 implications of a fully blown corporate governance million in 1997 to $9.6 billion in 2005. Given the dispute. risk and threats to their bottom line, regrettably, foreign companies are simply concluding that it’s not worth it to come to our market.” MARSHALL N. CARTER CHAIRMAN, NYSE GROUP SOURCE: “America’s Capital Markets: Maintaining Our Lead in the 21st Century.” Testimony before the Financial Services Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises, United States House of SOURCE: Pakistan Corporate Governance Project II, IFC Representatives, Washington, D.C., April 26, 2006. Available Advisory Services for the Middle East and North Africa. at: http://www.nyse.com. MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 37 EXAMPLE Impact and Perceptions of Corporate Court Proceedings Ukraine IFC conducted a comprehensive survey of commercial disputes of business in Ukraine in 2006. A total of 1,210 randomly selected companies were included in the survey. The findings show that litigation is friendlier to large companies than small ones and that, where trust in the legal system is weak, the competence, fairness, and independence of judges matter more than enforcement and costs: Large companies litigate disputes in commercial courts far more often than do medium or small companies: 86 percent of large companies have resolved disputes in court compared to 72 percent of medium-sized companies and 46 percent of small companies. The rate of success in court proceedings also varied greatly, correlated to the company’s size. Large companies frequently prevailed in court while small companies usually lost. Approximately 79 percent of the companies that prevailed in court reported that the court has completely restored their rights. Yet, in relation to their last dispute, companies reported that the court decision was completely enforced in only about 45 percent of the cases. About 37 percent of the cases were not being enforced, and the remaining cases were only partially being enforced. Thus, while respondents may have reported that their rights have been restored, it did not mean that their actual losses were fully compensated. When asked to rank the most important attributes of an effective court system, companies stated that the most important factors were the judges’ competence, the decision’s fairness, and the judges’ independence, while efficiency and enforcement were rated lower, and cost was the least important factor. PERCENTAGE OF COMPANIES SELECTING THE FOLLOWING FACTORS AS THE MOST IMPORTANT FOR COURT EFFECTIVENESS COMPETENCE OF JUDGES FAIRNESS OF DECISION INDEPENDENCE OF JUDGES TIME FROM FILING A CLAIM TO COURT DECISION DECISION ENFORCEMENT COST OF PROCEEDINGS 0 05 10 15 20 25 30 SOURCE: IFC, Ukraine Commercial Dispute Resolution Study. Researching Commercial Disputes among Ukrainian Companies. 2007. Available at: www.ifc.org/ifcext/eca.nsf/AttachmentsByTitle/UkraineADR_2006_Eng.pdf/$FILE/UkraineADR_2006_Eng.pdf. 38 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 While the outcome of litigation is by definition system is often a choice of last resort because it is uncertain, going to court involves lawyers, discovery perceived as unreliable and inefficient. proceedings, and often experts. All are expensive. Legal uncertainties. When corporate governance Shareholders ultimately bear the litigation costs involving disputes arise as a result of cross-border investments, the company in which they have a stake. Yet, these costs the uncertainty of judicial processes makes court not only have an impact on the company’s shareholders action impractical and more complex. The main legal but also on its customers. One logical outcome of risks stem from the uncertainty relating to the way in litigation costs is an increase in prices charged for which the court will view and understand the facts, products and services. the court’s competence with respect to the issue in question, the way in which the court will apply the law In the United States, the use (or threat) of class action to the facts, and the eventual outcome at the appellate lawsuits, is increasingly used by shareholders as a level. International treaties have neither solved these mechanism to influence companies’ governance.1 In issues nor the problem of enforcing judgments across these cases, a shareholder brings a lawsuit against a borders. company and seeks financial compensation on behalf of other shareholders in the same class. Approximately 200 Even if a shareholder, for example, obtains a class action lawsuits are filed in federal courts alone each judgment in their country of jurisdiction, he/ year.2 However, the costs can be a deterrent for large she may be unable to do anything to enforce the investors and companies. judgment within the country where the company has assets. And even if the shareholder is able to obtain Limits of Court Litigation a valid court judgment and to get it enforced, the Judicial resolution of corporate governance disputes may cost of the necessary procedures, including cross- be highly impractical for several reasons: border legal advice, may exceed the amount that can ultimately be recovered. One important element Weak judicial enforcement. Enforcement of good of the overall cost and decision-making of cross- corporate governance practices has always been a key border investments is therefore generated by the issue of concern in most developing countries. While legal uncertainties associated with disputes. Legal much has been achieved in raising awareness and uncertainties create a pervasive inhibitor for foreign improving corporate governance rules and procedures, investments because they are felt by the investor and progress remains constrained by poor regulatory the company. and judicial enforcement. These constraints result from inadequate funding, the lack of trained staff, Legal vacuum. The quality and spirit behind and systemic corruption. Ownership concentration corporate governance standards and principles often remains the most efficient response to weak cannot always be achieved through court activism. enforcement of corporate governance rules. Where Many governance principles and requirements the court systems are not well-developed, where are covered by soft laws and company bylaws. the judiciary may not understand business and In an area where there is a growing number of corporate issues, or where they are slow, inefficient, national corporate governance codes, monitoring or even corrupt, judicial resolution becomes highly interpretation and compliance cannot be done with impractical. According to the World Bank’s Doing traditional court systems. Disputes, therefore, arise Business 2008 indicators, Ukraine ranks 46th in terms over issues that have not been foreseen by laws and of contract enforcement. It takes 354 days to resolve a regulations or spelled out in contracts, or premised dispute in court, and 30 procedures are needed (from on business issues or individual relationships rather filing a court claim to receiving payment). What these than legal obligations. This is especially true when numbers do not reflect is the fact that Ukraine’s court articulating the concept of fiduciary relationships MODULE 2 Why Care about Corporate Governance Disputes? VOLUME 1 39 between managers and directors as well as those Boards need dispute resolution processes that provide between directors and investors. solutions quickly, so that they can fulfill their duties to the company and its shareholders. For these reasons, In addition, many countries still restrict private understanding and using techniques and processes that lawsuits by investors, relying instead on regulators provide a relatively quick resolution and allow directors to police corporate activities. Fines may be imposed to focus on the company’s operations and its future as punishments by regulators. Investors are rarely become very important. compensated for their investment losses.3 TO REVIEW BOARD DISPUTE RESOLUTION PROCESSES AND TECHNIQUES, SEE VOLUME 2 Good corporate governance practices are, essential to MODULE 1. reducing the likelihood of disputes. Yet disputes remain unavoidable and a fact of corporate life. Everything must be done to minimize the negative impact that Without alternative mechanisms to deal with corporate disputes have on a company’s balance sheet, share value, governance disputes, more and more companies, boards, reputation, operations, and stakeholder relations. Boards and individual directors will be facing high-profile trials must act quickly and efficiently. Investors do not wish to that may damage the reputation, performance, and risk their money on a company whose governance will growth opportunities of companies that are otherwise be impaired or simply stalled because the board is mired doing well. The key to controlling legal risks is often a in internecine squabbling. question of minimizing the prospects of court litigation. Seeking redress in court should be the parties’ recourse, In the last few years, much attention has been given to or last resort, only when alternatives fail. policies, practices, procedures, regulations, and listing rules designed to make boards operate more effectively in the company’s and shareholders’ best interests. Solid organization is imperative for a board to operate effectively. What can easily be overlooked, however, is that the capstone to good organization is a recognized, effective means of resolving the disagreements and disputes that inevitably emerge when any group of people have differing views. For example, directors who cannot agree on strategy and goals will find their company’s stock undervalued when a merger partner emerges, or when another institution wants to buy the company. Endnotes 1 “Caution — D&Os Working: Reducing Liability Exposure in 2005,” National Association of Corporate Directors. (January 3, 2005). In Eric Runesson and Marie-Laurence Guy, Mediating Corporate Governance Conflicts and Disputes. Focus Series. Washington, D.C.: Global Corporate Governance Forum, 2007. Available at: http://www.ifc.org/ifcext/cgf.nsf/AttachmentsByTitle/ Focus+Mediation/$FILE/Focus4_Mediation_12.pdf. 2 Cornerstone Research, Securities Class Action Filings: 2008 Mid-Year Assessment. Available at: http://securities.stanford.edu/ clearinghouse_research/2008_YIR/20080728.pdf. 3 World Bank Group, Doing Business. Comparing Regulations in 178 Economies. Washington, D.C.: World Bank Group, 2008. Available at: http://www.doingbusiness.org/documents/subnational/DB08_Subnational_Report_Philippines.pdf. 40 VOLUME 1 Why Care about Corporate Governance Disputes? MODULE 2 VOLUME 1 : RATIONALE MODULE 3 : How Can Alternative Dispute Resolution Help? 1.3 There are many approaches that a board can select outside of court litigation to resolve corporate governance disputes. Each varies in the process used to reach and then abide by decisions. All, however, share features that encourage constructive problem-solving without incurring the costs — in time, money, and adversarial relations — of court litigation. This module describes how alternative dispute resolution (ADR) processes and techniques provide avenues for effectively dealing with both internal and external corporate governance disputes. Adroitly implemented, ADR can help find relatively quick and appropriate solutions to all types of corporate governance disputes. The use of formal ADR processes is especially useful for disputes involving external stakeholders that have matured and in which the parties have squared off on different sides of the dispute. Disputes within the boardroom, however, often do not lend themselves to formal ADR processes. Boards and their directors in that case should consider using ADR techniques as a dispute resolution management tool. THIS MODULE REVIEWS Appeal of out-of-court dispute resolution Basic ADR processes Benefits and limits of ADR processes MODULE 3 HOW CAN ALTERNATIVE DISPUTE RESOLUTION HELP? MORE EFFECTIVE DISPUTE slow. In many countries, the quality of law and its RESOLUTION enforcement are weak. ADR approaches offer flexible and more efficient options to resolve disputes without Well-governed companies are less likely to have disputes. recourse to the courts. However, when a dispute arises, the board, investors, and other parties need to have a suitable process and ADR mechanisms are typically voluntary and venue to seek redress and resolution to the conflict confidential, and each has features that encourage in a timely, cost-effective manner. Therefore, a good constructive problem-solving without incurring the corporate governance framework should have a reliable costs — in time, money, and adversarial relations — of way of resolving emerging and existing disputes. court litigation. The board is responsible for ensuring that any problem Given these benefits, policy-makers are increasingly is solved as efficiently and expeditiously as possible, and encouraging the use of ADR processes. The European certainly before it can damage the company’s brand or Union, for example, adopted in 2008 a directive to foster reputation. the use of mediation as a more cost-effective and faster alternative to civil litigation. Benefits of ADR Traditional dispute resolution mechanisms (which TO REVIEW CORPORATE GOVERNANCE DISPUTE RESOLUTION POLICIES, SEE VOLUME 2 usually include the main court system, specialized MODULE 2. courts, and regulatory bodies) are typically costly and In countries in which the judicial system is not well- developed, ADR is especially attractive, because it QUOTE permits the parties to create, in large part, their own justice system. In doing so, together they can pick their Effective Dispute Resolution own arbitrator, who sits in the position of a judge, or they can choose their own mediator, whose role is not to “There is no advantage in having good governance judge but to help the parties fashion their own solutions. if, when a dispute arises, you haven’t got a good method to resolve it. If it would take several years ADR works on the basis of consensual agreement and to bring a dispute to trial, it is vital that mediation allows the parties to determine which standards to apply mechanisms exist to achieve resolution in a kind to resolve the disputes. of timeframe that big business can live with.” Companies are increasingly using ADR, particularly MERVYN KING, SC, PROFESSOR FIRST VICE PRESIDENT, SOUTHERN AFRICAN negotiation and mediation, to settle disputes outside INSTITUTE OF DIRECTORS the courts. In the United States, approximately 800 of MEMBER, FORUM’S PRIVATE SECTOR the largest companies have pledged to explore ADR ADVISORY GROUP before litigation when a dispute arises. In Colombia, out of the 97 companies that have developed their own SOURCE: Institute of Directors, Southern Africa, Bulletin: First Quarter 2007. corporate governance guidelines, 52 have included a dispute resolution clause promoting the use of ADR. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 41 GLOSSARY EXAMPLE Alternative Dispute Resolution Corporate Governance Dispute without “ADR is an amicable dispute resolution Legal Basis procedure based on the goodwill of the parties Bulgaria and the assistance of a neutral third party. It According to Bulgarian law, if a shareholder covers various techniques including mediation.” acquires more then 50 percent of a company’s SOURCE: International Chamber of Commerce (ICC). Available voting shares, he/she is obliged to offer to buy at: www.iccwbo.org. the shares of minority shareholders at market value. Until the majority shareholder has made Appropriate Dispute Resolution such an offer and it is either accepted or refused, The common denominator of all ADR methods he/she cannot vote during the general meetings. is that they are faster, less formal, cheaper, and often less adversarial than a court trial. In recent To avoid becoming a controlling shareholder and years, the term “alternative dispute resolution” complying with this legal provision, the main has begun to lose favor in some circles and shareholder of a company issuing and servicing ADR has come to mean “appropriate dispute credit cards transferred part of his/her shares to resolution.” The point of this semantic change is related parties. Owning together more than 50 to emphasize that ADR methods stand on their percent of the shares, the related shareholders own as effective ways to resolve disputes and changed the board’s structure and appointed should not be seen simply as alternatives to the new directors. courts. The new board arranged for the transfer of the company’s long-term assets of an estimated value of BGN 10 million to another company fully owned by the main shareholder for the symbolic value of BGN 1. EXAMPLE The credit card company was drained of its assets, and its share value plummeted. Corporate Governance Disputes Considering that their rights had been violated, Settled Through ADR Processes minority shareholders filed a claim with the ICC Financial Supervision Commission (FSC). The FSC found that no rules had been formally violated. From 2001 to 2006, 20 percent of company- Minority shareholders sought legal advice to law related disputes settled by the Paris-based seek redress in court, but were told that this was International Chamber of Commerce (ICC) were a case of bad governance and, hence, there was corporate governance disputes. Examples include no legal basis for a case. disputes over: share valuation, shareholders’ priorities, board remuneration, bankruptcy, COMMENT shareholder participation in decision-making, Some corporate governance disputes cannot be and takeovers. decided in court because they do not involve the violation of any rights according to the existing COMMENT legislation. Yet, if they become public, these Most mediation and arbitration centers do not cases can impact a company’s reputation and have a special category for corporate governance deter investors. related disputes but they are increasingly receiving requests to handle such disputes. SOURCE: L. Bouchez and A. Karpf, “Exploratory Meeting on Resolution of Corporate Governance Related Disputes.” OECD, SOURCE: Vassya Prokopieva, Managing Partner, EU&BG Legal Stockholm, March 2006. Available at: http://www.OECD.org. Consultants. 42 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 Appeal of ADR More flexibility and caution, nevertheless, needs to Although they have mainly been used for labor, be applied when dealing with disputes that take place family, and commercial disputes, ADR processes have within the boardroom. Introducing too formal of characteristics that make them particularly attractive in a resolution process in the boardroom can inflame corporate governance disputes. internal disputes and harden positions, rather than settle them. Activating formal procedures can destroy the Corporate governance disputes often deal with dynamic, collegiality and civility that are essential to the discussion ongoing situations; the speed and flexibility that ADR and deliberation processes and to the ongoing working provides is particularly helpful in the resolution process. relationship that the directors have. With internal ADR allows the parties to fashion their solutions to their disputes, ADR can play a crucial role by borrowing specific business needs. Unlike judicial proceedings, techniques from both constructive negotiation and which pass judgment on circumstances that have mediation. These include: identifying parties’ interests; occurred in the past, ADR solutions can be tailored by surfacing emotional and factual issues; focusing on the parties to deal with ongoing situations in a manner long-term objectives; promoting discussion; uncovering that allows the parties to continue working together. information; facilitating collaborative decision-making; ADR allows for interim reassessment that otherwise and, using a third party when appropriate. These may be hard to achieve once a case comes to trial and techniques can be adapted for the boardroom. battle positions have been drawn. TO REVIEW THE USE OF DISPUTE RESOLUTION TECHNIQUES IN THE BOARDROOM, SEE Moreover, corporate governance disputes do not always VOLUME 2, MODULE 1. involve determination of legal rights and, therefore, do not easily lend themselves to a court’s judgment, which applies the law based on a determination of the facts. The most common ADR processes are negotiation, mediation, and arbitration, but there are many approaches The use of formal ADR processes, which provide that fit within each of these broad categories. These can a structure and a third party to bridge differences, be more or less formal and include panel ruling, mini- can be especially effective in dealing with external trial, facilitation, early neutral evaluation, and collective corporate governance disputes, or disputes that involve bargaining. shareholders and, sometimes, other stakeholders whose contact with the board is situational and not ongoing. While negotiation is possibly the most common approach to resolving corporate governance disputes out of the courts, mediation is a more novel approach to QUOTE dealing with a corporate governance dispute. Arbitration is generally favored as a default alternative to a court trial by many large companies, especially when dealing with Out-Of-Court Dispute Settlement cross-border disputes. “Even if shareholder redress can be sought in court, it may often be in the best interest of Disputants do not have to choose between ADR and both the shareholder and the company to try to litigation. For example, if mediation fails, the parties still mediate and settle the dispute out of court.” have the option to go to court. In several jurisdictions, mediation can occur while a case is pending in court. In LEONARDO VIEGAS such countries as Uganda and Bosnia and Herzegovina, DIRECTOR, BRAZILIAN INSTITUTE OF CORPORATE GOVERNANCE (IBGC) the legal system even provides for court-referred MEMBER, FORUM’S PRIVATE SECTOR mediation where the judge requests the parties to try ADVISORY GROUP to mediate the dispute; only if the mediation process is unsuccessful will the case be tried in court. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 43 Use of ADR Informal approaches are typically most effective in The most effective approach to solving a corporate the early stages before a dispute has been blown out of governance dispute would have been to have foreseen proportion. the possibility of such a dispute and, then, to have established a dispute resolution framework to draw TO REVIEW A SAMPLE LIST OF ALTERNATIVE upon should a dispute arise. When such a framework DISPUTE RESOLUTION PROCEDURES, SEE VOLUME 1 ANNEX 6. is not in place, parties should try the most appropriate and effective approaches available before resorting to litigation. To help companies deal with their governance disputes, mediation and ADR specialists, law firms, consultants, The full range of dispute resolution options and institutes of directors, and corporate governance centers techniques should be considered and selected based are all increasingly advising clients on dispute resolution on the type of dispute and its stage of development. and offering mediation or other ADR services. GRADUATED STEPS TO DISPUTE RESOLUTION INTERNAL CG DISPUTE EXTERNAL CG DISPUTE PREVENTION AND NEGOTIATION FACILITATION (WITHOUT 3RD PARTY) Potential Dispute Dispute Resolved is Avoided Dispute Emerges Negotiations Break Down APPLY MEDIATION ACTIVATE DISPUTE TECHNIQUES WITHIN BOARD RESOLUTION POLICIES Dispute Resolved Dispute Crystallizes Constructive Approach to Dispute FORMAL MEDIATION FORMAL MEDIATION (WITH THIRD PARTY) (WITH THIRD PARTY) Agreement Agreement Parties Fail to Settle Parties Fail to Settle ARBITRATION COURT ARBITRATION COURT 44 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 EXAMPLE Factors for Selecting Dispute Resolution Methods Ukraine A study conducted by IFC in 2007 shows that without any awareness-raising campaign, Ukrainian companies are receptive to using ADR mechanisms. This chart presents the results of surveyed Ukrainian companies on the most important factors that are considered when selecting dispute resolution processes. PERCENTAGE OF COMPANIES TAKING THE FOLLOWING FACTORS INTO ACCOUNT WHEN SELECTING DISPUTE RESOLUTION METHODS GUARANTEED DECISION ENFORCEMENT EXECUTION OF THE LETTER OF THE LAW SATISFACTION OF INTERESTS PRESERVATION OF BUSINESS RELATIONSHIPS POSSIBILITY TO AFFECT THE RESULT POSSIBILITY TO CONTROL THE PROCESS PRESERVATION OF CONFIDENTIALITY POSSIBILITY TO APPEAL THE DECISION SAVING MONEY SAVING TIME NEUTRALITY & INDEPENDENCE OF THE 3RD PARTY INFORMALITY OF THE PROCESS 0 20 40 60 80 100 SOURCE: IFC, Ukraine Commercial Dispute Resolution Study. Washington, D.C.: IFC, 2007. Available at: www.ifc.org/ifcext/eca.nsf/ AttachmentsByTitle/UkraineADR_2006_Eng.pdf/$FILE/UkraineADR_2006_Eng.pdf. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 45 Several conditions determine the success or failure of PRACTICE such ADR processes as mediation and negotiation; The parties must be identifiable and willing to Advising on ADR Uses participate. For example, in a dispute over the benefits ADR service providers and lawyers should counsel of listing the family business on an exchange, all the clients on ADR uses. This advice should include: stakeholders and family members directly involved in the business must be willing to participate in person Full range of ADR techniques available or via proxy to discuss opposing positions. If such Legal and financial implications of each critical parties as the company’s founder are either Case’s suitability for ADR absent or are unwilling to participate in the dispute resolution process, the solution will most likely not be Approaching the other party to agree on ADR enforceable. Best time to attempt an ADR (process) The parties must have a degree of interdependence. For a productive resolution process, the parties need either each other’s assistance or restraint from negative SOURCE: Karl Mackie, David Miles, William Marsh, and Tony Allen. The ADR Practice Guide, Commercial Dispute Resolution. action for their interests to be satisfied. For example, Second Edition. West Sussex, England: Tottel, 2006. if none of the family members has a controlling stake in the family business, the decision of going public cannot be taken by one individual. Even if the founder has a controlling stake, his/her actions may require the moral approval of other family members involved PRACTICE in the company to avoid a family conflict that could adversely affect the company’s operations. Criteria to Consider for Dispute The parties must have a means of influence or Resolution leverage. For the parties to reach an accord over issues When selecting the right approach to resolving in disagreement, they must have other means to their dispute, parties should consider the influence the attitudes and/or behavior of other party/ following: ies. Often, influence is seen as the power to inflict pain Solution’s finality or undesirable costs. For example, the family business founder’s son or daughter may threaten to leave his/ Effect on current and future relations her position and never speak to his/her father again Speed if the later doesn’t agree to hear his/her vision on the Transparency company’s future. Yet exerting influence can also be Stakeholder impact the ability to convince the other party or to have the other party change its perspective on a dispute. Asking Satisfaction with the outcome thought-provoking questions, providing needed Transaction costs information, seeking experts’ advice, appealing to influential associates, exercising legitimate authority, or providing rewards — these are all means of exerting SOURCE: Eric M. Runesson and Marie-Laurence Guy, Focus influence. 4: Mediating Corporate Governance Conflicts and Disputes. Washington, D.C.: IFC, 2007. Available at: http://www.gcgf. org/ifcext/cgf.nsf/AttachmentsByTitle/Focus+Mediation/$FILE/ The parties must agree on some common issues and Focus4_Mediation_12.pdf. interests. To reach a settlement, parties must have 46 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 common issues and interests. Generally, parties will settlement options are possible as a result of participa- have some issues and interests in common with one tion in the dispute resolution process. If it appears that another while others concern only one party. At the the outcome can only be a win/lose settlement and a onset of the dispute resolution process, parties may party’s needs will not be met as a result, parties will be only be able to agree that they disagree on the family reluctant to enter into a dialogue. business’s future. Yet, as discussions progress, they may agree that they have the interests of both the The parties need to have the will to settle. For the family and the business as priorities. dispute resolution process to succeed, parties must want to settle. If continuing a conflict is more The parties have a sense of urgency. ADR is typically important than settlement, then the dispute resolution sought when there is pressure or a decision must be process is doomed to fail. The negative consequences reached urgently. For the dispute resolution process of not settling must be more significant than those for to be successful, the participants must jointly feel a reaching an agreement. sense of urgency and be aware that they are vulnerable to adverse action or lost benefits if a timely decision The parties must have the authority to decide. For is not reached. Urgency may be imposed by either a successful outcome, participants must have the external or internal constraints or by potential negative authority to make a decision. If they do not have a consequences of an unresolved dispute. External legitimate and recognized right to decide, or if a clear constraints include: court dates, imminent executive ratification process has not been established, the ADR or administrative decisions, or predictable changes in process will be limited to an exchange of information the environment. Internal constraints, for example, among the parties. may be artificial deadlines set by one party to enhance the motivation of another to settle. The parties must be willing to compromise. Not all the solutions to every dispute require Parties should have no major psychological barriers compromise. Agreements can be reached that meet to settlement. Strongly expressed or unexpressed every party’s needs and do not require any one to feelings about another party can sharply affect a party’s sacrifice something. However, in other disputes, the psychological readiness to find a workable solution willingness to have less than 100 percent of one’s to a dispute. For example, the chairman and the needs or interests satisfied may be necessary for the CEO systematically oppose each other’s views on the parties to reach an agreeable conclusion. company’s future because they cannot tolerate each other. As a result, the board has become a hostage to an The agreement must be reasonable and implementable. undefined dispute. Psychological barriers can also be Some settlements may be substantively acceptable but based on over-optimism or an unrealistic perception may be impossible to implement. Parties to a dispute of oneself. For example, the very successful founder must be able to establish through the ADR process of a company refuses to acknowledge that times such as mediation or negotiation a realistic, workable are changing and the market for his/her services is plan to carry out their agreement if the final settle- disappearing. He/she has thus far always made the best ment is to be acceptable and hold over time. For business decisions and refuses to discuss with his/her example, even if all the concerned family members partners the possibility of diversification. Psychological agree to listing the family business on a stock market, barriers to settlement must be lowered or eliminated listing requirements need to be fulfilled before the for innovative solutions to emerge; this often requires business can go public. a third party’s intervention. Good mediators and negotiators can often help the Issues must be negotiable. For a successful settlement parties find ways to overcome the obstacles described to occur, each party must believe that acceptable above. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 47 MORE FLEXIBLE DISPUTE RESOLUTION making process. Negotiation is also a distinct, out-of- court dispute resolution process. The process is informal, For this toolkit’s purpose, it is sufficient to consider voluntary, and in most cases confidential although, of three broad approaches to out-of-court dispute course, the outcome may be disclosed. resolution: negotiation, mediation, and arbitration. Negotiation and mediation are relatively informal and While it is the most commonly used out-of-court dispute self-directed approaches to problem-solving. The parties resolution process, negotiation is also the major building agree to procedures, ensure that issues are “surfaced,” block for many other ADR processes and a key phase of and generate their own solutions. Arbitration, which any formal mediation process. is on the formal side of the continuum, is a regulated, quasi-judicial procedure. Negotiations typically occur because the parties wish to achieve something jointly that neither could do on Negotiation and mediation emphasize self- his or her own. The parties acknowledge the conflict determination and joint problem-solving. The parties between them and think they can use some form of contribute to the design of the process, and they take influence to find a better outcome, rather than simply ownership of negotiated agreements. In contrast, taking what the other side will voluntarily give them. In when the parties choose arbitration, they empower an the boardroom, for example, directors typically prefer to independent arbitrator to assess the facts. The arbitrator search for agreement rather than fight openly, give in, or then decides upon a legally binding settlement. resign from the board. FOR A COMPARISON OF NEGOTIATION, When parties negotiate, they usually expect some “give LITIGATION, AND MEDIATION PROCESSES, SEE and take.” While they have interlocking goals that VOLUME 1 ANNEX 7. they cannot accomplish independently, they usually do not want or need exactly the same thing. This Negotiation interdependence can either lead to a win-lose situation, Negotiation is a problem-solving process in which two as in the court room, or to a win-win situation in which or more people voluntarily discuss their differences a novel outcome is found that satisfies both parties. and attempt to reach a joint decision on their common Hence, negotiation is very much dependent on both concerns. It is a standard feature of everyday business the type of issue involved and the way in which the and a component of any corporate governance decision- negotiation is conducted. The disputants will either COMPARING DISPUTE RESOLUTION MECHANISMS INFORMAL SELF-DIRECTED FORMAL REGULATED ADR INFORMAL FORMAL NON-BINDING BINDING NEGOTIATION MEDIATION/ MEDIATION/ COURT ARBITRATION ARBITRATION FACILITATION FACILITATION FAST PROCESS COST-EFFECTIVE LENGTHY PROCESS EXPENSIVE Business Dimension of the Dispute Legal Dimension of the Dispute SOURCE: Adapted from Lukasz Rozdeiczer and Alejandro Alvarez. Alternative Dispute Resolution Manual: Implementing Commercial Mediation, Washington, D.C.: IFC, 2006. Available at: http://advisoryservices.ifc.org/docspubs/docpub.aspx?id=621. 48 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 attempt to force the other parties to comply with their bargaining, the conflict is most likely to escalate rather demands, influence their position, and move toward a than be efficiently solved. Risks associated with hard forced compromise (hard bargaining), or manage to bargaining include the feelings of resentment, distrust, invent a solution that meets the objectives of all sides and anger that interfere with the loser’s decision-making. (constructive negotiation). In the context of corporate governance, the challenge in direct negotiation is to More than just a simple bargaining exercise, constructive focus on corporate interests. A major risk is confusing negotiation requires parties to identify issues about substantive corporate issues with personality conflicts. which they differ, educate each other about their needs When disagreements become interpersonal, the and interests, generate possible settlement options, and confrontations undermine the board’s work and can stall then bargain over the final agreement’s terms. important strategic decisions to advance the company’s best interests. When board members, shareholders, or When board members, shareholders, and other other stakeholders apply techniques associated with hard stakeholders can listen to one another’s concerns and engage in constructive problem-solving, they are more likely to address their own, the corporation’s, and GLOSSARY shareholders’ interests. Among board directors, features of constructive Negotiation negotiation include civility, discovery, open debate, and Negotiation is a process of joint decision-making, constructive dissent. Factors that encourage constructive in which two or more parties with differing outcomes in negotiation include: interests must jointly reach a decision — the resolution they ultimately agree to. Shared goals SOURCE: Morton Deutsch and Peter T. Coleman, eds., The Handbook of Conflict Resolution: Theory and Practice. San Concern for reputations Francisco: Jossey-Bass Publishers, 2000. Flexibility in approach Effective communication Long-term relationships FOCUS A basic three-step approach helps to foster constructive negotiations. This approach can be effectively used to structure debates in the boardroom and guide difficult Negotiation Benefits discussions with shareholders or other stakeholders. The Constructive approaches to negotiation create first step is for each party to prepare by defining their opportunities for directors, shareholders, and own interests and concerns and then those of the other other stakeholders to: parties. The second is to engage in a respectful exchange Identify common concerns of ideas. The third is to review progress. Bring issues to the surface Although directors may think they are naturally Analyze issues and define the problem talented negotiators, they are not always well-trained in dispute resolution processes and aware of the benefits Encourage a free flow of solution ideas of, or techniques for, achieving win-win solutions to Prioritize interests their disputes. Agree to solutions based upon interests TO REVIEW TYPICAL STEPS INVOLVED IN Implement and monitor agreements CONSTRUCTIVE NEGOTIATION, SEE VOLUME 1 ANNEX 8. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 49 QUOTE Limited Gains of Imposed Solutions “The least successful conflict strategy is the application of authority, whereby a ‘solution’ for the conflict is essentially imposed by using power. Generally, this strategy amounts to taking account of the interests of only a single shareholder, such as the founder-owner of a family firm. The other family members are left standing in the cold. The exercise of authority means that the other family members cannot achieve their own objectives, which generates anger, stress, and distrust. In many cases, the application of authority will seriously perturb the family relations, thus weakening the cohesion within the family firm.” JOZEF LIEVENS PARTNER, EUBELIUS LAW FIRM | MEMBER, FORUM’S PRIVATE SECTOR ADVISORY GROUP SOURCE: Jozef Lievens. “Collaborative Conflict Resolution — the ‘Harvard Approach’ Applied to Family Business.” 2002 Working paper provided by the author to the Forum. EXAMPLE Company Use of Dispute Resolution Methods Ukraine An IFC study conducted in the Ukraine in 2007 found that 77 percent of businesses solved their disputes through negotiation without third-party involvement. “When third parties are engaged to assist in negotiations, parties often feel they’ve been brought in to exert influence rather than to help the parties conciliate or find ways to compromise.” Despite this impression of the role of third parties in dispute resolution, 56 percent of the CEOs and other senior executives interviewed indicated that they would likely try mediation to resolve disputes if it were available. PERCENTAGE OF SENIOR EXECUTIVES INDICATING THE FOLLOWING DISPUTE RESOLUTION MECHANISM AS THEIR PREFERRED WAY TO SETTLE DISPUTES NEGOTIATION WITHOUT THIRD PARTY FORMAL SETTLEMENT COMMERCIAL COURT NEGOTIATION WITH THIRD PARTY ACTED VIA MASS MEDIA DOMESTIC ARBITRATION INTERNATIONAL ARBITRATION 0 20 40 60 80 100 SOURCE: IFC,Ukraine Commercial Dispute Resolution Study. Washington, D.C.: IFC, 2007. Available at: www.ifc.org/ifcext/eca.nsf/ AttachmentsByTitle/UkraineADR_2006_Eng.pdf/$FILE/UkraineADR_2006_Eng.pdf. 50 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 Hard Bargaining versus Constructive Negotiation CEO’s Compensation Package Review EXAMPLE HARD BARGAINING CONSTRUCTIVE NEGOTIATION CEO ACTS IN HIS/HER BEST PERSONAL INTEREST CEO ACTS IN THE COMPANY’S BEST INTERESTS PARTIES HAVE SET POSITIONS PARTIES ARE LOOKING FOR COMMON INTERESTS CEO REQUESTS A SPECIFIC INCREASE OF HIS/HER CEO REQUESTS A REVIEW OF HIS/HER COMPENSATION PACKAGE COMPENSATION PACKAGE PARTIES HAVE A COMPETITIVE AND PARTIES HAVE A COOPERATIVE AND OPEN POSITION AGGRESSIVE POSITION CEO PRESENTS AN ASSESSMENT OF HIS/HER CEO REQUESTS A MINIMUM INCREASE OF HIS/HER PERFORMANCE AND ASKS THE COMPENSATION COMPENSATION OR HE/SHE WILL RESIGN COMMITTEE TO OFFER HIM/HER AN IMPROVED PACKAGE BASED ON PERFORMANCE AND CORPORATE RESULTS PARTIES WITHHOLD INFORMATION PARTIES SHARE INFORMATION ABOUT THEIR INTERESTS CEO WITHHOLDS MATERIAL INFORMATION THAT MAY IMPACT NEXT YEAR’S PERFORMANCE CEO EXPLAINS HIS STRATEGY ON HOW TO MAKE THE OF THE COMPANY COMPANY GROW IN A NEW MARKET NICHE THAT WILL HELP IMPROVE THE COMPANY’S PERFORMANCE PARTIES ARE SUSPICIOUS AND PARTIES WORK ON BUILDING DISTRUST EACH OTHER UNDERSTANDING AND TRUST CEO THINKS SOME MEMBERS OF THE CEO ASKS THE COMPENSATION COMMITTEE TO COMPENSATION COMMITTEE DISLIKE HIM/HER AND TRUST HIM/HER IN IMPLEMENTING A NEW GROWTH WANT TO REPLACE HIM/HER WITH SOMEONE ELSE STRATEGY AND IS WILLING TO LINK HIS/HER PACKAGE TO THE RESULTS ACHIEVED PARTIES VALUE THEIR OWN GAINS PARTIES EXPLORE AND EXPAND OPTIONS FOR JOINT GAINS CEO SEEKS THE HIGHEST POSSIBLE COMPENSATION PACKAGE REGARDLESS OF THE CEO DISCUSSES PERFORMANCE OBJECTIVES COMPANY’S PERFORMANCE ON WHICH HIS REVISED COMPENSATION PACKAGE COULD BE BASED ONE WINS, THE OTHER LOSES MUTUAL GAINS (WIN/WIN) CEO GETS THE HIGHEST POSSIBLE COMPENSATION CEO GETS THE HIGHEST POSSIBLE COMPENSATION PACKAGE OR RESIGNS PACKAGE LINKED TO SPECIFIC GOALS AND INDIVIDUAL PERFORMANCE TARGETS THE OUTCOME IS DISTRIBUTIVE (EITHER/OR) THE OUTCOME IS INTEGRATIVE (BOTH/AND) THE CEO GETS MORE; SHAREHOLDERS BENEFIT LESS THE CEO AND SHAREHOLDERS BENEFIT MORE IF THE COMPANY PERFORMS BETTER SOURCE: Adapted from Richard G. Shell, Bargaining for Advantage: Negotiation Strategies for Reasonable People. New York: Penguin, 1999. Copyright 1999. All rights reserved. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 51 Traditionally, negotiation occurs directly between the Mediation parties. The assistance of a neutral third party is not In mediation, participants are assisted in resolving required, but in formal negotiation settings, parties may their disputes by an impartial, independent third party. be represented by a professional negotiator who typically Mediation is an alternative for addressing corporate would be — yet not necessarily the same professional in governance disputes when direct negotiation fails to all cultures — their lawyer. produce satisfactory results or is not a viable option when, for example, the parties refuse to talk to each other. When both parties are willing to engage in constructive negotiation, both tend to gain. However, if one of the Mediation is flexible, allowing the parties to control the parties adopts a constructive approach while the other dispute’s process and outcome. The parties own their maintains a hard bargaining position, the outcome is dispute and the solution. They fashion the solution to more doubtful. their issues themselves and formally agree to be bound by it. They are assisted in this process by a mediator. If negotiations break down and/or reach an impasse, This expert surfaces facts and issues, focuses the parties a third party may be introduced, creating a process on common interests, and helps them reach a formal of facilitated negotiation — also referred to as agreement to resolve matters. Features of an effective “facilitation” or “informal mediation.” For example, if mediation include: the board cannot easily come to a joint agreement over a strategy decision, the chairman can usefully convene Respected neutral third party a strategy retreat facilitated by a third party to help Confidentiality surface individual interests and needs, and, then explore Fair, impartial process alternative solutions. This third party can be a trained Consensual agreements mediator or a corporate strategy consultant. Accountability GLOSSARY GLOSSARY ‘BATNA’ Mediation BATNA stands for “best alternative to negotiated Mediation is an informal process employed by agreement.” This concept was popularized in disputing parties in order to arrive at an agreed 1981 by Roger Fisher, William L. Ury and Bruce solution. Patton in their well-known book Getting to Yes: Negotiating Agreement Without Giving SOURCE: Southern Africa Institute of Directors (IoDSA). In. The authors explain that the reason why Available at: www.iodsa.co.za. one negotiates is to produce something better than the results that can be obtained without negotiating. The alternative to negotiation Mediation is a flexible process conducted is the standard against which any proposed confidentially, without prejudice, in which a agreement should be measured. In other words, neutral person actively assists parties in working the negotiation’s outcome should always be towards a negotiated agreement of a dispute or better than what it would have been without difference, with the parties in ultimate control negotiating. of the decision to settle and the terms of resolution. SOURCE: Roger Fisher, William L. Ury, and Bruce Patton. Getting to Yes: Negotiating Agreements Without Giving In. (Second Edition). New York: Penguin, 1999. Copyright 1999. SOURCE: Center for Effective Dispute Resolution (CEDR). All rights reserved. Available at: www.cedr.co.uk. 52 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 The terminology used to describe mediation can vary QUOTE widely. Mediation, conciliation, and facilitation, for example, are often used interchangeably. The term “mediation” is mainly used in Europe while the same Customary Mediation process is referred to as “conciliation” in Latin America. “The general tendency in Uganda over the years was to litigate disputes with the view TO REVIEW SAMPLE DEFINITIONS OF MEDIATION to get a legally binding decision. However, FROM AROUND THE WORLD, SEE VOLUME 1 mediation as a dispute resolution mechanism is ANNEX 9. not all together new in traditional Uganda, and African society. There has for centuries been a Regardless of terminology, the important aspect to keep customary mediation mechanism, using elders in mind when looking into ADR processes is the role as conciliators/mediators in disputes using procedures acceptable to the local community, that the (neutral) third party plays in dispute resolution but which were not as formal as those found in and his/her level of engagement. In some cases, the courts.” mediators facilitate communication, strategic planning, and problem-solving. In other cases, the mediator will JUSTICE GEOFFREY W. M. KIRYABWIRE be expected to formally help settle disputes. COMMERCIAL COURT JUDGE MINISTRY OF JUSTICE, UGANDA SOURCE: Geoffrey W. M. Kiryabwire, “Mediation of Corporate Mediation provides a quicker, less costly, and more Governance Disputes through Court Annexed Mediation.” confidential way to resolve disputes than court litigation Paper provided by the author to the Forum. and, unlike arbitration or judicial forums, it helps preserve or restore valuable working relations between parties because it is founded on a negotiation approach. EXAMPLE Through creative win-win solutions, mediation can save executives time and attention that may be lost in pursuing legal resolutions that may not be in the parties’ Court Litigation versus Mediation best interests. Bosnia and Herzegovina According to data collected by IFC’s Commercial Mediation is typically a private and voluntary dispute Mediation pilot in Bosnia and Herzegovina, only resolution process, but the ways in which mediation six percent of the cases filed in court between has been introduced vary from country to country. In 2005 and September 2006 were related to corporate governance disputes and inadequate several countries — especially developing countries — protection of minority shareholder rights. During mediation has been introduced with the support of the the same period, 220 out of 300 mediated judiciary to help reduce the backlog of court cases. In agreements involved individual shareholders Uganda, Bosnia and Herzegovina, and Pakistan, for or corporate investors and led to the release of example, court-annexed mediation centers have been EUR4.2 million. used for early resolution of conflicts. For some cases, COMMENT a mediated settlement must be explored by the parties As in Bosnia and Herzegovina, out-of-court before the case can go to trial. In India, the Supreme settlement processes such as mediation can Court issued a landmark decision (Salem Advocate Bar prove very successful. Raising awareness for Association, Tamil Nadu v. Union of India) in which it held companies to better understand ADR benefits is an important factor determining the success and that reference to mediation, conciliation, and arbitration sustainability of out-of-court settlements. is mandatory for court matters. SOURCE: Lada Busevac, “The Promise of Mediation Practice in Corporate Governance.” Paris, February 2007. Available at: TO ACCESS LINKS TO SAMPLE MEDIATION RULES http://www.gcgf.org. AND PROCEDURES FROM AROUND THE WORLD, SEE VOLUME 1 ANNEX 10. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 53 Formal mediation generally consists of three phases: There are typically three dimensions to a dispute, the initial preparations, mediated negotiations in which particularly those involving corporate governance issues. each party makes free and informed choices, and the Although it might not always appear that way, every concluding phase in which parties formalize their dispute has a personal, business, and legal component. decisions. During mediation, each side may caucus or meet separately with the mediator. The mediator may The importance of each of these components may vary raise questions and offer insights to encourage parties to from one dispute to another. In the context of corporate resolve their issues. governance, the personal component of disputes is often hidden or ignored but may actually be the real cause, or TO REVIEW TYPICAL STEPS INVOLVED at least an important factor, of the dispute. For example, IN FORMAL MEDIATION, SEE VOLUME 1 a company’s CEO may be at odds with the board’s ANNEX 11. chairman or have a history of dissent with an independent FOCUS Benefits of Mediation Cost: Transaction costs are considerably lower than those of adjudication. Speed: The process can start as soon as the parties agree to mediation. The mediation process itself rarely takes more than a few days. Quality: Mediators can be selected according to their skills and expertise. Predictability: The decision cannot be imposed on the parties. Control: The parties own the dispute and craft its solution. Flexibility: The parties can decide on the type of mediation and the procedure they will use, including, the timing and the location. Confidentiality: Parties can disclose only what they wish to. The content of the mediation and information exchanged usually remains confidential, but the parties may agree on disclosing the agreement. Limited risk: Parties do not have to settle and have the choice to seek another form of dispute resolution — including a court decision. Liability: It doesn’t have to be admitted to reach a settlement. Non-binding: While the process is non-binding, the agreed outcome may be enforced as a contract or registered as a consent judgment. Voluntary: Unless required by court, the parties do not have to go to mediation. In all cases, parties do not have to settle. Perspective: Parties can gain a more objective, detached view of their positions before their views solidify and the battle lines are drawn, which makes a resolution more difficult to achieve. Further, the parties’ circumstances may have changed from those prevailing when the conflict first occurred, thus allowing for an interim assessment. SOURCE: Eric M. Runesson and Marie-Laurence Guy, Focus 4: Mediating Corporate Governance Conflicts and Disputes. Washington, D.C., Global Corporate Governance Forum, 2007. Available at: http://www.ifc.org/ifcext/cgf.nsf/AttachmentsByTitle/Focus+Mediation/$FILE/ Focus4_Mediation_12.pdf. 54 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 director that is affecting the board’s decision-making process. Yet the animosity between the two may not have THE THREE DIMENSIONS TO A DISPUTE anything to do with the actual decisions that must be made on the company’s behalf. Another example could be that of board members who have personal loyalties to the CEO, who is blocking shareholders’ efforts to separate the positions of chairperson and CEO. They LEGAL may hold a genuine principle against such a practice. In family firms, personal and business issues are often intertwined and the company’s long-term perspective may be handicapped by sibling rivalries or succession PERSONAL BUSINESS issues. An essential feature of mediation is that it can address the full dimensions of a dispute and help surface important issues that are hindering a corporate decision in the company’s best interests. While litigation only deals with a dispute’s legal dimension, mediation allows FOCUS for parties to vent and surface conflicts before refocusing the parties on the dispute’s business component and their common interest in finding a good solution. Third Party’s Role in Dealing with Corporate Governance Disputes Mediation is, therefore, a good risk-management Informal Mediation or Facilitation: The technique because it provides a more objective or detached third party provides a controlled forum for mirror of their position to executives who get caught up discussion to help surface issues prior to any in the throes of a personalized corporate governance material corporate decision (e.g., facilitation of conflict. Mediation is not just about win-win outcomes; a board retreat or strategy meeting). it can also help all parties confront the greater losses or Formal Mediation or Conciliation: The third risks that directors may face if they fail to settle. party tries to get the parties to reach an agree- ment but is focused solely on process and not The appointed third party will help the parties understand on who is legally right (e.g., mediation of a the dispute’s issues and focus on identifying each dispute between the board and dissident shareholders). party’s specific needs and interests in working towards a consensual resolution. Mediation may be performed Formal Mediation or Early Neutral Evalu- by a variety of professionals, who use different tactics in ation: The third party encourages the parties to reach an agreement but, also uses legal mediating corporate governance issues. The mediator’s knowledge to convince the parties that they skills as well as his/her cultural and personal styles will do not have a better alternative to a negoti- vary. Hence, the choice of a mediator will influence the ated agreement (e.g., dispute over the value mediation and the core issues that will be addressed. It is of shares in a squeeze-out procedure). essential that the parties in conflict respect the mediator and have confidence in the fairness and impartiality of SOURCE: Adapted from David Thaler and Aniella Berstein, the process. Strengthening Governmental Conciliation Institutions: A Practitioners Handbook. July 2003. U.S. Federal Mediation and Conciliation Services. Available at: www.fmcs.gov/apecImg/ APEC%20Handbook%2007.04.03/Handbook%5B1%5D. TO REVIEW THE SKILLS REQUIRED FOR Final.06.30.03.doc. CORPORATE GOVERNANCE DISPUTE RESOLUTION, SEE VOLUME 3 MODULE 1. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 55 EXAMPLE Three Dimensions of a Corporate Governance Dispute Family Firm Dispute Case Study Albert Tonga, a well-known agro-biologist in his country, set up a family firm 20 years ago to commercialize healthy baby food for busy working mothers. This was a new market niche at a time when only home-grown natural products were used to feed babies. Tonga’s business turned out to be a success, and the company started exporting its goods to the region five years ago. For tax purposes, Tonga transferred 30 percent of the company’s shares to each of his two children, who had turned 19 and 21. His wife already owned eight percent of the company’s shares, and Tonga kept a controlling stake of 32 percent. Although the company has been very successful, its performance could be threatened by multinational food companies, which have started commercializing similar products at lower prices. To better plan for the future, Tonga’s daughter thinks the family should list the company on the local exchange and raise funds to finance a diversification strategy, but no one ever listens to her. Tonga’s son, who sees himself as the company’s future CEO, thinks that the company should remain private, but the capital should be opened to a strategic investor, who could fund a new plant to produce processed food for babies. He already has one person in mind: the wealthy father of his best friend. Tonga thinks “small is beautiful,” and the company is doing well as it is. He is increasingly annoyed with all these discussions over his company’s future and upset that his children want to dilute the family business. He nearly regrets having transferred shares to them. They are too young and inexperienced to make good business decisions. Tonga’s wife doesn’t have a strong opinion on what the best option for the company should be, but she is increasingly worried about the tensions in her family. Her husband is sulking, and her children are hardly talking to each other. COMMENT This case study identifies the three dimensions of a family firm governance dispute — personal, legal, and business. A good mediator should address all three dimensions to help parties find a satisfying and sustainable approach to a growth strategy for their company. 56 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 DIMENSIONS RISKS OF DEALING ELEMENTS OF MEDIATION OF THE EXCLUSIVELY WITH ONE THE DISPUTE TECHNIQUES DISPUTE DIMENSION OF THE DISPUTE Tonga doesn’t want to be Allow each party to vent and For the sake of peace in the challenged by his children. The express their frustrations and family, strategic decisions in company is his. He invested his ambitions. the best interest of the whole life in it and he “owns” it. business are postponed. The PERSONAL DIMENSION Restore constructive channels business may or may not His son wants increasingly to of communications. survive it. play a role in the company and expects his father to hand over Help each party to listen to the business to him. the others’ viewpoints, explore options, and remind them of His daughter wants to be their common family interests. respected and her educated opinions to be seriously Consider laying the grounds of considered. She is as a succession plan as part of the savvy in business management final agreement. as her brother. His wife wants the family to be happy and feels torn between her loyalties to her husband and her children. No changes are made to the Help re-focus primary attention If an agreement is reached company’s current structure. on the company’s interests. in the best interest of the BUSINESS DIMENSION business without taking The company goes public. Review the pros and cons of into account the interests each business alternative. of individual family The company’s capital is opened members and the family to a strategic investor. Explore alternative innovative as a whole, it will likely options. fail later. Even the best strategy cannot be carried Review short- and long-term out properly if underlying benefits of each alternative. emotions, frustrations, and Help reach an agreement on resentments haven’t been a satisfactory way to help the addressed. company grow and make the necessary investments without losing family control. None of the family members Review the statutes of the The decision to open up LEGAL DIMENSION has a large enough stake in the company, the company law, and the capital of the company company to make a decision of listing requirements. or to go public can be put the company’s future by him/ to a vote. This will result herself. Clarify voting procedures and in a win-lose situation legal steps required for taking that will leave some family Family members can build material decisions affecting shareholders unhappy and alliances and put a suggested the company now and for the have a negative effect on option to vote. future. the harmony within the family. Most likely, this will set the grounds for future disputes. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 57 EXAMPLE FOCUS Shareholder Dispute Settled through Limitations of Formal Mediation Mediation Some disputes can be settled without third Uganda: K.M. Patel and another vs. party intervention (e.g., the chairman offers to United Assurance Company Ltd. “mediate” a dispute between two opposing (Company Cause No. 5 of 2005) views in the boardroom on the company’s In this case, two Asian brothers, whose family sustainability strategy) name is Patel, filed a minority petition as The need for court assistance/protection (e.g., shareholders to terminate one of Uganda’s a court injunction to put a major corporate largest private insurance companies. They transaction on hold because legal procedures alleged that their shares in the company — have not been complied with; ADR can then be owning 40 percent — had been wrongfully and sought to settle the substance of the dispute illegally diluted during a restructuring and sale of itself) the company without any notice to them. Justice Geoffrey K. M. Kiryabwire of the Commercial The need to set a precedent (e.g., a wronged Division of the Uganda High Court decided to institutional investor is seeking redress as a mediate the case with the parties’ consent. The matter of principle to influence governance mediation successfully settled the dispute and standards) led to a consent judgment where the insurance company bought out the two shareholders. The Seeking publicity (e.g., stakeholders want company’s CEO was later quoted by the media to shame and blame a company for ethical saying: “[We] are happy this has been amicably misconduct) concluded. I believe the Patels as the founders The wish to demonstrate power and/or to will leave us with their blessings....” threaten the other party (e.g., one of the main COMMENT shareholders is seeking to exert more control This case illustrates how mediation can contribute and sues the family shareholders to push them to finding a timely, cost-effective resolution to to settle) corporate governance disputes without tarnishing The lack of interest in settling to gain time the company’s reputation while preserving and avoid any outcome of a settlement (e.g., business relations. Typically, a judge would not a family business in which one family member directly mediate a dispute that comes before him is determined to take control and has no in court but, instead, refer it to mediation in a interest in dialogue or a company faced with jurisdiction where court-annexed mediation has an environmental dispute, which anticipates been established. a near-term political and legal change in its favor) SOURCE Geoffrey K. M. Kiryabwire, “Mediation of Corporate SOURCE: Adapted from Karl Mackie, David Miles, William Governance Disputes through Court Annexed Mediation.” Marsh, and Tony Allen. The ADR Practice Guide, Commercial February 2007. Paper provided by the author to the Global Dispute Resolution, Second Edition. West Sussex, England: Corporate Governance Forum. Tottel. Copyright 2006. Used by permission. 58 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 Despite a respected facilitator’s best efforts, a In arbitration, the parties contract to be bound by the constructive result may not be achieved. The parties decision of a single arbitrator or a panel of arbitrators. A in dispute may not be willing to resolve the problem, procedure resembling a trial ensues, and the arbitrator(s) unforeseen factors may arise, or it may not be possible render(s) a decision. to overcome or compensate for the perceived damages. If the parties cannot reach an agreement through TO REVIEW TYPICAL STEPS INVOLVED IN mediation, they may still consider other alternatives, STANDARD ARBITRATION, SEE VOLUME 1 ANNEX 12. such as arbitration. Arbitration is designed to bypass the courts for quicker, Arbitration less expensive, and more efficient adjudication. The Arbitration is a regulated alternative for settling process is confidential and generally less adversarial than corporate disputes. The process is usually confidential litigation, though more so than mediation. but awards may be made public. An independent, impartial arbitrator reviews documents and testimony and makes a judgment on the parties’ rights and obligations. Opposing claims must be specific enough FOCUS and formulated with sufficient clarity to allow for judgment. Arbitrators decide the case’s merits and how to correct or compensate for any wrongdoing. Their Use of Formal Arbitration awards are usually final and legally binding. ADVANTAGES Avoid the expenses and delays of court litigation GLOSSARY Parties can decide on the arbitration court and location Parties can jointly choose the arbitrator(s) Arbitration Availability of arbitrators with appropriate Arbitration is a proceeding voluntarily chosen by legal and other specialized competencies parties who want a dispute determined by an Confidentiality of the proceedings can be impartial arbitrator of their own mutual selection. legally protected The parties agree in advance that the arbitrator’s decision — based on the case’s merits — will be Legal protection of any information revealed final and binding. Awards are final, binding, and can be appealed only on the basis of a serious failing SOURCE: Federal Mediation and Conciliation Service, USA. of procedure International recognition of arbitrator decisions (awards) Non-Binding Arbitration LIMITATIONS The purpose of non-binding arbitration is to encourage settlement by having a neutral expert Needs agreement to refer to this procedure evaluate the facts and apply the relevant law. Can be time consuming and expensive, An independent, impartial arbitrator decides particularly for cross-border matters the case’s merits and the parties’ rights and May address only the legal dimension of obligations. The arbitrator’s award is not binding; disputes the parties in dispute retain the right to bring claims before the court. Has the risk of an unpredictable award MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 59 EXAMPLE Arbitration of Shareholder Dispute South Africa - Tanzania - Kenya: Rift Valley Railways Rift Valley Railways (RVR) was formed in Mauritius in 2006 as the holding company for the consortium led by Sheltam Corporation. This consortium had successfully bid for the 25-year concession of East Africa’s oldest railway line. Sheltam has a 35-percent stake in the company while Primefuels Kenya, a liquid fuels logistics provider, holds a 15-percent stake in RVR, and Mirambo Holdings, an investment company, has a 10-percent stake. The remaining shares are held by the local equity fund TransCentury Limited (20 percent), Babcok and Brown Investment Holdings of Australia (10 percent), and Centum Investment Company (10 percent). A dispute between the RVR partners arose from Sheltam’s last-minute decision to abandon Mirambo and Primefuels as it moved to takeover Kenya-Uganda railways in 2006 on the grounds that Mirambo and Primefuels had failed to sign a shareholders’ agreement when asked to do so. The dispute between Sheltam and its initial partners, Mirambo and Primefuels, went for arbitration in London under Article 14 of the consortium agreement. This agreement provided that any dispute would be settled by three arbitrators in London under the rules of the London Court of International Arbitration. Mirambo and Primefuels successfully argued that the document they had been asked to sign did not comply with the consortium agreement. The arbitrators decided that Sheltam had breached its obligation to serve a contractually compliant shareholders’ agreement for execution by its partners and declared that Mirambo and Primefuels were entitled to participate as RVR shareholders. The arbitrators further declared that Sheltam could not issue, allocate, sell, charge or transfer RVR shares in the manner it did and ordered that the two partners be brought back into the consortium. Sheltam contested the decision through an appeal it filed in London’s Royal Court of Justice in December 2007, arguing that the arbitrators had exceeded their powers in the awards. But a few months later, the South African firm threw in the towel and admitted that it had run out of money to pay the fees of its counsel for the case. A decision was made to discontinue the claim where Sheltam contested the arbitrator’s decision. The court further ordered Sheltam to cover the case’s costs. In July 2008, Mirambo and Primefuels returned as RVR shareholders. COMMENT This case demonstrates the importance of having dispute resolution clauses and processes in place before a dispute arises. Without an arbitration clause, this dispute may have dragged on much longer with parties arguing over which jurisdiction is most competent to decide the case. Yet, arbitration is typically more time- and cost-consuming than mediation. SOURCE: Jim Onyango, “Shareholder Wars Expose RVR’s Financial Weakness.” Business Daily Africa, August 11, 2008. Available at: http:// www.bdafrica.com. 60 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 QUOTE Increase in Arbitration Cases Bulgaria “The Court of Arbitration of the Bulgarian Chamber of Commerce and Industry has seen a steady increase in the number of cases of voluntary arbitration. The court rendered around 160 cases in 2001, 200 cases in 2005 and almost 300 in 2006. One of the main reasons for this is that the speedy arbitration process brings about final decisions on important legal issues years before the same issues can reach the higher instances of the state court system. “Because of the good work of the court and the notoriously disappointing functioning of the state courts, arbitration is becoming widely popular and used in Bulgaria. Reasons that would refrain from the use of arbitration include the wish to avoid liability in case of breach of duties and to delay a ruling by using the clumsy and ineffective state courts.” DR. SILVY CHERNEV PRESIDENT, COURT OF ARBITRATION OF THE BULGARIAN CHAMBER OF COMMERCE AND INDUSTRY SOURCE: Silvy Chernev.” Current Status of Arbitration and Other Dispute Resolution Means in Bulgaria.” 2008. Working paper provided by the author to the Forum. EXAMPLE Arbitration Trends Mexico Although commercial arbitration is a relatively new method of dispute resolution in Mexico, it continues to gain acceptance as a means of resolving disputes regardless of whether the parties involved previously signed an arbitration agreement. It has particularly been favored in disputes involving companies from different jurisdictions that run their businesses from different locations and operate under different laws. Two forms of arbitration can be used in the resolution of cross-border disputes. With traditional arbitration, the award is granted in strict adherence to a particular body of law agreed upon by both parties. The alternative form is “amiable composition” which is based on principles of equity and considerations of what is reasonable and just for the parties. COMMENT ADR approaches are gaining acceptance worldwide. Arbitration is especially favored for cross-border disputes, according to a study by the Australian Centre for International Commercial Arbitration. “The two main reasons corporations preferred international arbitration over litigation were flexibility of arbitral procedure and the enforceability of the arbitral awards. Two other advances that corporations considered important were the privacy of proceedings and the ability of parties to select arbitrators suitable for resolving their particular dispute.” SOURCE: Viviana Castro Hurtado at Basham Ringe y Correa SC, “Arbitration Mexico: Two Approaches to Amiable Composition,” International Law Office Newsletter, October 04, 2007. Available at: http://www.internationallawoffice.com/Newsletters/detail. aspx?g=0e3c3f48-4201-4ef2-8621-ff0ba097aaf0. Australian Centre for International Commercial Arbitration, Managing Cross-Border Disputes. Sydney: ACICA, 2006. Available at: http://www.virgilcameron.com/acica/ACICA-IABooklet.pdf. MODULE 3 How Can Alternative Dispute Resolution Help? VOLUME 1 61 One main advantage of arbitration as compared to arbitrator withdraw or be replaced because of prejudice, litigation is that the parties may jointly choose the biased behavior, or incompetency. arbitrator and the location of the arbitration forum on mutually agreeable terms. They may also select the type Each party must “cooperate in good faith” with the of arbitration hearing that they prefer: arbitrator, whose conduct is governed by codes of procedure, the parties’ agreements, and applicable law. Document Hearing — Arbitrator reviews documents The arbitrator has an ethical and legal obligation to or property to render a judgment, called an “award” or disclose any conflicts of interests. “order.” If negotiation and mediation have failed to help parties Participatory Hearing — Arbitrator reviews reach a satisfactory agreement and/or if parties wish documents or property and also receives testimony in to have the legal dimension of their dispute formally person, by telephone, or online to render a judgment. settled, arbitration may well be the appropriate process. Arbitration can be especially effective when dealing with Joint selection of the arbitrator ensures that he/she cross-border disputes. will have the required skills and expertise to render an informed award. In many jurisdictions, parties may To some extent, court litigation of corporate governance actually terminate the proceedings and ask that the disputes and, especially, cross-border disputes have been replaced by litigation before international or national arbitration tribunals. Yet, arbitration remains structurally related to litigation and, hence, burdened with the QUOTE many drawbacks of court proceedings, including time and costs that are notably higher than with mediation. Yet, parties may be able to avert such high charges by The Cost of Arbitration jointly demanding an efficient arbitration process when “Modern arbitral litigation is much closer to drafting the contract. litigation except that it is more confidential and more independent from government influence. It tends to encompass massive costs for litigants. Both sides will employ several lawyers to make its case. There will be as a rule a three-person tribunal. Assuming preparation time of 15 days for 10 lawyers and 25 days for the exchange of briefs and hearings and say 15 days for arbitral deliberation and decision making, the total bill for direct costs can easily run up to US$1 million or more. This doesn’t take into account staff time — corporate lawyers for managing the contract with the outside team, corporate management for giving evidence nor the time for enforcing an award once made.” THOMAS WÄLDE PROFESSOR, UNIVERSITY OF DUNDEE SOURCE: Thomas Wälde, “Mediation/Alternative Dispute Resolution in Oil, Gas and Energy Transactions: Superior to Arbitration/Litigation from a Commercial and Management Perspective.” Ogel Journal. 2003. Available at: http://www. ogel.org/journal-author-articles.asp. 62 VOLUME 1 How Can Alternative Dispute Resolution Help? MODULE 3 VOLUME 1 : RATIONALE ANNEXES 1.4 1. Further Reading 2. Sample Board Structures and Potential for Disputes 3. Excerpts from Directors’ Resignation Letters 4. Categories of Corporate Governance Related Disputes 5. Example of Dissident Shareholder Letter to the Board 6. Review of Selected ADR Processes 7. Table Comparing Negotiation, Litigation, Mediation 8. Typical Steps in Constructive Negotiation 9. Sample Definitions of Mediation from Around the World 10. Links to Sample Mediation Rules and Procedures 11. Typical Steps in Mediation 12. Typical Steps in Arbitration ANNEX 1 A N N EX 1 : F U RTH ER R EA DING FURTHER READING IFC. 2007. Ukraine Commercial Dispute Resolution Study. Researching Commercial Disputes among American Arbitration Association. 2007. Drafting Ukrainian Companies. Washington, D.C.: Dispute Resolution Clauses. A Practical Guide. New IFC. Available at: www.ifc.org/ifcext/eca.nsf/ York: AAA. Available at: www.adr.org. AttachmentsByTitle/UkraineADR_2006_Eng. American Bar Association. 2003. Mediation Practice pdf/$FILE/UkraineADR_2006_Eng.pdf. Guide: A Handbook for Resolving Business Disputes. 2nd Lloyd’s and Economist Intelligence Unit. 2008. ed. Washington, D.C.: ABA. Directors in the Docks. Is Business Facing a Liability Agrawal, Anup and Mark A. Chen. July 2008. Crisis? Available at: http://www.chiefexecutive.net. Boardroom Brawls: An Empirical Analysis of Disputes MacAvoy, Paul, and Ira Millstein. 2004. The Recurrent Involving Directors. University of Alabama and Crisis in Corporate Governance. Palo Alto, California: Georgia State University. Working Paper. Available at: Stanford Business Books. http://papers.ssrn.com. Masters, Jon and Alan Rudnick. 2005. Improving Baker, Mark and Arif Hyder Ali. 2002. “A Cross Board Effectiveness: Bringing the Best of ADR into Comparison of Institutional Mediation Rules.” Dispute the Boardroom. Washington, D.C.: American Bar Resolution Journal. (May/July 2002.) Association. Carroll, Eileen and Karl Mackie. 2006. International Messick, Richard. 2005. Alternative Dispute Resolution: Mediation — The Art of Business Diplomacy. 2nd ed. When it Works, When it Doesn’t. Washington, D.C.: West Sussex, England: Tottel Publishing. World Bank. Available at: http://www1.worldbank. Centre for Effective Dispute Resolution (CEDR). org/prem/PREMNotes/premnote99.pdf. 2004. The CEDR Mediator Handbook 2004: Effective Metzger, Barry. 2004. “Introduction: Global Resolution of Commercial Disputes. 4th ed. London: Corporate Governance Reform Quickens Pace” in CEDR. Global Corporate Governance Guide 2004, ed. B. Metzger. London: Globe White Page Ltd. Classens, Stijn. 2003. Corporate Governance and Development. Focus Series. Washington, D.C.: Global Millstein, Ira M., Shri G. N. Bajpai, Erik Berglof, Corporate Governance Forum. Available at: http:// and Stijn Classens. 2005. Enforcement and Corporate www.gcgf.org/ifcext/cgf.nsf/AttachmentsByTitle/ Governance: Three Views. Focus Series. Washington, Focus_1_CG_and_Development/$FILE/Focus_1_ D.C.: World Bank. Available at: http://www.gcgf. Corp_Governance_and_Development.pdf. org/ifcext/cgf.nsf/AttachmentsByTitle/Focus_3_ Enforcement_and_Corporate_Goverance_Three_ Ertel, Danny. 1991. “How to Design a Conflict Views/$FILE/Focus_ENFCorpGov3.pdf. Management Procedure that Fits Your Dispute” Sloan Management Review: 29-42. Moore, Christopher. 2003. The Mediation Process: Practical Strategies for Resolving Conflict. 3rd Ed. San Fisher, Roger. 1985. “He Who Pays the Piper.” Francisco: Jossey-Bass. Harvard Business Review (March/April): 150-159. Mnookin, Robert. 1995. Barriers to the Negotiated Fisher, Roger, Bruce Patton, and William Ury. 1991. Resolution of Conflict. New York: Norton. Getting to Yes. 2nd ed. New York: Penguin Books. Organisation for Economic Co-operation and Honeyman, Christopher, Julie Macfarlane, Bernard Development (OECD). 2004. OECD Principles of Mayer, Andrea Schneider, and Jeffrey R. Seul. June Corporate Governance. Paris: OECD. Available at: 2007. Thinking Ahead. Alternatives 99. Vol 25. #6. http://www.oecd.org/dataoecd/32/18/31557724.pdf. Annex 1 : Further Reading VOLUME 1 63 ANNEX 1 FURTH ER R EA D IN G : A N N EX 1 Reuben, Richard. 2005. Corporate Governance: A Practical Guide for Dispute Resolution Professionals. Washington, D.C.: ABA. Rodzeiczer, Lucas, and Alejandro Alvarez de la Campa. 2006. ADR Manual: Implementing Commercial Mediation. Washington, D.C.: IFC. Runesson, Eric and Marie-Laurence Guy. 2007. Mediating Corporate Governance Conflicts and Disputes. Focus Series. Washington, D.C.: International Finance Corporation. Available at: http://www.gcgf.org/ifcext/ cgf.nsf/AttachmentsByTitle/Focus+Mediation/$FILE/ Focus4_Mediation_12.pdf. Shell, G. Richard. 1999. Bargaining for Advantage: Negotiation Strategies for Reasonable People. New York: Penguin. Sullivan, John, Catherine Kuchta-Hebling, Jean Rogers, and Aleksandr Shkolnokov. 2003. In Search of Good Directors: A Guide to Building Corporate Governance in the 21st Century. Washington, D.C.: CIPE. Schneider, Andrea and Christopher Honeyman. 2006. The Negotiator’s Fieldbook. Washington, D.C: ABA. Thomson, Dianne and Ameeta Jain. 2006. Accountability and Board Functionality: National Australia Bank’s Experience. Paper presented at the 11th Finsia-Melbourne Center for Financial Studies Banking and Finance Conference September 25-26, 2006 Available at: http://www.melbournecentre. com.au/Finsia_MCFS/Monday/Stream%202/ DianneThomson_paper.pdf. United Nations. 2006. UNCITRAL Model Law on International Commercial Conciliation with Guide to Enactment and Use. New York: UN. Available at: http://www.uncitral.org/uncitral/en/uncitral_texts/ arbitration/1985Model_arbitration.html. 64 VOLUME 1 Annex 1 : Further Reading ANNEX 2 A N N EX 2 : SA M PL E B OA R D STRUCTURES AND POTENTIAL FOR DIS P UTE SAMPLE BOARD STRUCTURES AND POTENTIAL FOR DISPUTE Regardless of the type of board structure adopted, disputes may arise as a result of conflicting interests and diverging views on the company’s strategic and business priorities. Multiple variations of the board models described below have been implemented around the world. UNITARY BOARD STRUCTURE TWO-TIER BOARD STRUCTURE BOARD OF DIRECTORS SUPERVISORY BOARD CEO/CHAIR CHAIR LEAD DIRECTOR COMMITTEE CHAIRS NON-EXECUTIVES EMPLOYEE REP. EXECUTIVES NON-EXECUTIVES DIRECTOR A DIRECTOR C DIRECTOR A DIRECTOR C DIRECTOR B DIRECTOR D DIRECTOR B DIRECTOR D MANAGEMENT BOARD UNITARY BOARD STRUCTURE CEO BOARD OF DIRECTORS EXECUTIVES EXECUTIVES CHAIR DIRECTOR A DIRECTOR C CEO COMMITTEE CHAIRS DIRECTOR B DIRECTOR D EXECUTIVES NON-EXECUTIVES DIRECTOR A DIRECTOR C TWO-TIER BOARD STRUCTURE DIRECTOR B DIRECTOR D SUPERVISORY BOARD CHAIR HYBRID BOARD STRUCTURE SUPERVISORY BOARD NON-EXECUTIVES NON-EXECUTIVES CHAIR DIRECTOR A DIRECTOR C NON-EXECUTIVES NON-EXECUTIVES DIRECTOR B DIRECTOR D DIRECTOR A DIRECTOR C DIRECTOR B DIRECTOR D MANAGEMENT BOARD CEO BOARD OF DIRECTORS EXECUTIVES EXECUTIVES CEO/CHAIR DIRECTOR A DIRECTOR C DIRECTOR B DIRECTOR D EXECUTIVES NON-EXECUTIVES DIRECTOR A DIRECTOR C DIRECTOR B DIRECTOR D = POTENTIAL DISPUTE Annex 2 : Sample Board Structures and Potential for Dispute VOLUME 1 65 ANNEX 3 EX CERPTS FROM DIRECTORS’ RESIGNATION L ETTER S : A N N EX 3 EXCERPTS FROM DIRECTORS’ RESIGNATION LETTERS IN THE UNITED STATES ROBERT D. SANDERSON Fair Isaac Corp., 6/1/2001 I am resigning because I disagree with the rest of the Board’s willingness to grant 100,000 stock options to Tom Grudnowski in fiscal 2001. This was an incorrect decision for two principal reasons. First, the Company’s 1992 Long-Term Incentive Plan limits the number of options which may be granted to any one employee to 50,000 a year. While it may be legal to grant Mr. Grudnowski 100,000 options, doing so would violate the spirit of the agreement among the Company, the Board and the shareholders embodied in the plan. Second, Mr. Grudnowski doesn’t deserve the grant. He was hired to get the Company growing again and to develop Internet-based new business. During his tenure as CEO revenue growth has been below the Company’s long-term record, and revenues from new business have been miniscule. He has not earned the reward of an extraordinary option grant. It is my hope that the Board will conclude, as I have, that the Company will not achieve long-term success with Mr. Grudnowski in charge and that the best way to increase shareholder value is to sell the Company. JAMES A. MILLER Surge Components, Inc., 8/1/2001 Since joining the board of directors of Surge, I have on numerous occasions expressed my belief that I have not been given appropriate and relevant information necessary for me to perform my duties. It has been difficult for me to receive requested information either in a timely manner or at all. Furthermore, it has come to my attention that there were significant events and actions taken which were not properly disclosed to me. Case in point: the company recently filed two 10-Qs without my advice, review or approval. This is particularly disturbing given the fact that I am chairman of the audit committee. As a result of these and other unacceptable circumstances, I do not believe I can discharge my responsibilities in the manner in which the shareholders deserve. This letter shall serve as my resignation from the Board of Directors of Surge Components Inc., effective as of today, July 25, 2001. JEROME T. OSBORNE GLB Bancorp, Inc., 9/8/2003 This resignation is prompted by my profound disagreement with the decision of the Board of Directors to approve the proposed merger with Sky Financial Group, Inc. Accordingly to the preliminary proxy statement/prospectus (“Preliminary Proxy Statement”) relating to the special meeting of shareholders of GLB, filed with the Securities and Exchange Commission by Sky Financial Group, Inc. in its Registration Statement on Form S-4, filed August 22, 2003, the Board of Directors of GLB has also voted to recommend approval of the transaction, a recommendation I disagree with. The Board has abandoned the 66 VOLUME 1 Annex 3 : Excerpts from Directors’ Resignation Letters A N N EX 3 : EXC ER PTS F R OM DIRECTORS’ RESIGNATION LETTER original vision of GLB as a financial institution with a community focus and a substantial community ownership base. In addition, once the decision was made to sell the Company, I do not believe that the GLB Board of Directors received adequate information regarding, or adequately considered, the community impact or value of alternative proposals described in the Preliminary Proxy Statement, which is why I voted against the proposed merger with Sky Financial Group, Inc. For example, I believe that the transaction proposed by the institution described in the Preliminary Proxy Statement as “Bank X” would have provided a substantially greater value to the shareholders of GLB. J. PETER PIERCE Iron Mountain, Inc., 12/26/2002 My resignation from the Board will enable me to pursue shareholders’ rights with other interested shareholders in seeing to it that Iron Mountain is governed and managed properly. Board meetings that are held in violation of the bylaws should not be countenanced. Actions taken by “rump” sessions of the Board without notice to all Board members should not be authorized. If there are issues that exist with any Board members, special committees should be formed and authorized to investigate. This did not happen at Iron Mountain at any time. No minutes were taken of the so-called surreptitious “Board meetings”. The unauthorized nature of certain “Board actions” has been confirmed under oath by your general counsel Gary Watzke. It is also now clear that on March 27, 2002, the Executive Committee met and purported to authorize the lawsuit that was filed against me the next day in New Jersey state court, even though the Board had never given the Executive Committee this authority at a duly authorized meeting of which I received notice. Interestingly, even though the “Board,” as of March 5th, had purported to authorize the lawsuit against me, no disclosure of that “fact” was made by you in your note to the shareholders in the 2001 Annual Report, dated March 20, 2002, nor was there any mention of my alleged secret investment in Sequedex in the description of me as a Board member, that was set forth therein. In addition, there was no disclosure in the legal proceeding section of the first quarter Form 10-Q concerning the litigation filed against me as a material proceeding adverse to Iron Mountain. I simply will not be a part of a Board that attempts to conduct business in such a surreptitious and improper manner. JAMES SCHROEDER Streamedia Communications, Inc., 10/12/2000 Given the recent events at Streamedia and the vast disagreement and disarray of the principal shareholders I feel that I no longer represent the views and interests of those shareholders. I serve at their discretion and I in good conscience do not agree with the proposed direction of this company as set forth by the Chairman. It is the right of the shareholders to have the company run the way they want whether I, as a board member, agree or not. I do not agree to the recent direction and management suggestions of the Chairman and feel there will be severe consequences to the corporation. Therefore, I feel that I must resign as a director and allow the shareholders to choose a board of their liking. Annex 3 : Excerpts from Directors’ Resignation Letters VOLUME 1 67 ANNEX 3 EX CERPTS FROM DIRECTORS’ RESIGNATION L ETTER S : A N N EX 3 CLIFFORD WYATT Electropure, Inc., 4/20/1999 I have become increasingly concerned by the fact that the Company is seemingly unable to finalize its audit with respect to its financial statements for Fiscal October 1998, and accordingly is unable to issue a 10-K in compliance with Federal securities laws. Since the end of the fiscal year, several months have passed, including the end of the first quarter of fiscal 1999, and I have yet to receive any financial statements for any period of the current year....It was only after repeated requests and having a call made to the Company’s counsel for corporate matters that I finally received a draft 10-K....The draft 10-K contained numerous material misstatements and omissions which I found quite shocking. For example, it did not mention the cross-complaint filed by Wyatt Technology against the Company, although it did mention the action filed by the Company against Wyatt Technology. Further it appears that the Company had not informed its auditors that Wyatt’s position was that it was entitled to obtain rescission or termination of the technology license described at length in the draft 10-K. VAUGHAN SHALSON Discovery Laboratories, Inc., 3/27/1998 In summary, I have serious reservations about the judgment of Dr. Capetola and feel deeply that the compensation proposed for the management team, and in particular for Dr. Capetola, involves an excessive use of cash. As I have stated repeatedly in our conference calls, I do not believe this to be in our shareholders’ best interests....On the subject of Dr. Capetola’s judgment, at our Board Meeting on December 5 we discussed a merger proposal from Dr. Capetola dated August 28, 1997. The compensation package included in this proposal was characterized by one of the other board members present at that meeting as egregious. I and others agreed with this sentiment....My own evaluation was that Capetola’s proposal went so far beyond the pale of what could be considered negotiation posturing, as to lead any reasonable person to conclude that he exhibited either lack of experience or extremely poor judgment — neither of which should be acceptable qualities in the proposed CEO of the combined company....I regard this proposal as further evidence of Capetola’s lack of judgment, by even proposing to expose the company to cash payments of such magnitude that they could severely strain the company’s resources, and that are excessive by any reasonable standard for a development-stage company in such fragile financial condition. KENNETH P. WEISS RSA Security, Inc., 6/4/1996 In my opinion, you have surrounded yourself with a Board of Directors that does not, and perhaps is incapable, of providing you with independent objective guidance. To the contrary, from all of the actions that I have seen, these directors appear to be working for you, rather than you working for them. I have seen this time and time again under many circumstances. 68 VOLUME 1 Annex 3 : Excerpts from Directors’ Resignation Letters A N N EX 3 : EXC ER PTS F R OM DIRECTORS’ RESIGNATION LETTER Illustrative is the way in which you are able to influence the Compensation Committee to pay you what you demand and to make decisions based upon on what you want, rather than on any objective policy. Recent events in this area have been consistent with a pattern of conduct that I have observed over the years. For example, contrary to the compensation consultant’s recommendation for a consistent policy, you recently recommended that the vast majority of your bonus be calculated at “threshold” plan while the other executives had the majority of their bonus awarded at “stretch” plan. The Compensation Committee approved this unfair inconsistent treatment....On an individual basis, certain of these directors have performed particularly poorly for the company. In my opinion, one of them frequently disrupts meetings and appears to be motivated principally by self-aggrandizement and another appears to be inept and makes little or no positive contribution to the Board. Their continued participation on the Board is particularly glaring, especially in the light of your engineered forced departure of the most experienced director. NIRMAL MULYE, PH.D. Synovics Pharmaceuticals, Inc., 9/21/2006 During the past several months, however, you, the other members of the Board and employees of the Company under your direction have acted in a manner designed to curtail meaningful participation by me in my role as a director of the Company....Specifically, I have been asked to vote on matters as a director of the Company while being denied access to the information needed by me to make informed decisions with respect to such matters....I have also been denied the opportunity, on a number of occasions, to engage in full substantive deliberations with the other members of the Board with respect to matters on which I was then being asked to vote. For example, you as Chairman of the Board have severely restricted the ability of directors to discuss matters on which the Board was requested to act by either refusing to allow discussion of certain items at all or by abruptly and prematurely terminating discussions with respect to certain items and calling for an immediate vote on those items prior to all views of Board members being properly aired. STEPHEN D. MOSES AcuNetx, Inc., 5/5/2006 As each of you knows, I have endeavored to coordinate and mediate consensus on the issues confronting us from time to time. That is my style. I believe it to be not only appropriate, but optimal. But that technique does not work at AcuNetx. It does not work with a C.E.O. who responds to suggestions with petulance....It does not work with a C.E.O. who declines to be open and forthcoming with his Board...It does not work when the Board decides that it will not and cannot yet be fully Sarbanes-Oxley compliant, but allows the C.E.O. to announce to its shareholders that it will be Sarbanes-Oxley compliant and then reacts angrily when the Chairman notes that paying consulting fees to the Compensation Committee Chairman would be a violation of Sarbanes-Oxley....It does not work when the C.E.O. responds to suggestions, or worse, criticism, with McCarthy-like investigations and mischaracterizations of his critic. It is unfortunate that the C.E.O. can stifle dissent and/or creative advice with tyrannical conduct. Annex 3 : Excerpts from Directors’ Resignation Letters VOLUME 1 69 ANNEX 3 EX CERPTS FROM DIRECTORS’ RESIGNATION L ETTER S : A N N EX 3 RICHARD A. AJAYI Surgilight, Inc. 6/5/2001 Dr. Lin controls 70% of the voting shares of the company and I am convinced that he has repeatedly refused to accept, or simply ignored, some decisions and guidance of the Board regarding compliance with regulations of the Food and Drug Administration and the Securities and Exchange Commission. Therefore, after working diligently, but unsuccessfully, for several months to resolve these issues, I have come to the conclusion that there are no other alternatives for me but to resign from the board. PETER G. LEIGHTON Intelect Communications Systems Limited, 5/5/1997 This letter also conveys my resignation as a Director of ICSL. Because of my complete objection to the Facility, and the course on which ICSL has been set by a majority of its Board members, it is impossible for me to continue as a Director of this Company....In my view and belief, the Facility is not in the interest of ICSL in its present form. As a Director I disassociate myself from it as a funding option. The Facility is being forced upon ICSL by Mr. Frietsch (and certain other ICSL Directors, namely Anton Liechtenstein and Phillip Sudan) over my repeated objections. I have repeatedly made clear to Mr. Frietsch that I regard the Facility as a unilateral and improper initiative. I consider that ICSL’s entry into the Facility has been engineered by Mr. Frietsch, acting completely in excess of his executive authority as regards the Company’s affairs. SOURCE: Anup Agrawal and Mark A. Chen. July 2008. Boardroom Brawls: An Empirical Analysis of Disputes involving Directors. University of Alabama and Georgia State University. Working paper. Available at: http://papers.ssrn.com. 70 VOLUME 1 Annex 3 : Excerpts from Directors’ Resignation Letters ANNEX 4 A N N EX 4 : C ATEG OR IES OF CORPORATE GOVERNANCE RELATE D D I SPU T ES CATEGORIES OF CORPORATE GOVERNANCE Corporate Control (in M&A Transactions) RELATED DISPUTES Disputes between shareholders and boards regarding a proposed acquisition or disposal of a substantial part of Self-Interested Transactions the company’s assets Related-party transactions, insider trading, conflicts of interest by board members, executives, and senior Minority Shareholders’ Rights management Disputes between majority and minority shareholders in squeeze-out scenarios or on nomination/appointment of Annual Accounts board members Disputes between shareholders and the board and/or auditor over the withholding of shareholder approval Bankruptcy/Suspension of Payments Disputes between shareholders and/or bondholders and Nomination/Appointment of Board Members boards and/or receivers in corporate restructuring Disputes between shareholders and the nomination committee and/or the board over nomination and/or Share/Bond Issues appointment of board members/executives, as well as the Disputes between shareholders/bondholders and boards criteria for nomination/appointment on dilution issues Remuneration/Bonuses of Board Members Discharge of Individual Board Members/ Disputes between shareholders and the remuneration Executives committee and/or the board over remuneration and/ or bonuses of board members/executives, as well as the Disputes between shareholders and board members/ criteria for remuneration/bonuses executives on individual discharge regarding their performance in the past fiscal year Share Valuation Mismanagement Disputes between shareholders and the board and/or auditors on the valuation method in case of (a) squeeze Disputes between shareholders and boards on alleged out, and (b) share/bond issues mismanagement of the company Takeover Procedures Non-Compliance with Corporate Governance Codes Disputes between shareholders and boards regarding terms and conditions of a proposed takeover, Disputes between shareholders and boards on the and/or compliance with internal (articles of association) application of “comply or explain” principles as provided in and/or external (listing rules, securities legislation, corporate governance codes etc.) rules Works’ Council Disclosure Requirements Disputes between shareholders/boards and works’ Disputes between shareholders and boards regarding councils on the interpretation and applicability of works’ compliance with nonfinancial disclosure requirements council legal corporate governance related rights SOURCE: L. Bouchez and A. Karpf, Exploratory Meeting on Resolution of Corporate Governance-Related Disputes. Stockholm: OECD, March 2006. Available at: http://www.oecd.org. Annex 4 : Categories of Corporate Governance Related Disputes VOLUME 1 71 ANNEX 5 E XA M PLE OF DISSIDENT SHAREHOLDER LETTER TO TH E B OA R D : A N N EX 5 EXAMPLE OF DISSIDENT SHAREHOLDER LETTER TO THE BOARD Germany:Volkswagen AG vs. VIP (Vereinigung Institutionelle Privatanleger e.V.) By fax: + 49 5361 9 2369Vereinigung Institutionelle Privatanleger e.V. To: Volkswagen AG — The Executive Board Association of Institutional Shareholders HV-Stelle | Brieffach 1848 | D 38436 Wolfsburg Association des Actionnaires Institutionnels Hvstelle@volkswagen.de Kuthstr. 37a | D-51107 Köln www.vip-cg.com From: Hans-Martin Buhlmann, Vorsitzender Tel: +49 (0)221 · 297586 1 | Fax: +49 (0)221 · 297586 4 hmbuhlmann@vip-cg.com 10/04/08 Annual General Meeting of VOLKSWAGEN AG on 24 April 2008 Dear Prof. Dr. Martin Winterkorn, Dear Board Members, Regarding the convocation, announced in the eBAnz for 13./20. 03. 2008, of the AGM of VOLKSWAGEN AG on 24. 04. 2008, we — VIP Vereinigung Institutioneller Pivatanleger e.V. (Köln, fax + 49 1212 508233040) (www. VIP-cg.com) — hereby announce pursuant to § 126 AktG, as a shareholder in the company, the following (counter-) motion on the agenda and call on all shareholders to vote with VIP or give VIP e.V. their proxy to exercise their vote accordingly or in conformity with their instructions: 1. Counter-motion on agenda item 4: The Executive and Supervisory Boards propose to give discharge to the Executive Board — VIP Vereinigung Institutioneller Privatanleger e.V. (Köln, fax + 49 1212 508233040) (www.VIPcg. com) recommends: No, individual discharge, and assent only if company interests have been safeguarded. The Supervisory Board of VOLKSWAGEN AG has already for some considerable time been attracting special attention — not least since the chair of the German Corporate Governance Code Commission, Dr. Gerhard Cromme, resigned from that very Supervisory Board because of governance criticisms of it. Finally on 23 October 2007 the European Court of Justice clarified that the practice of the special law, the so- called “VW Act,” is unlawful. This decision must now be implemented, even if its beneficiaries lose their advantages (unlawful for years now). The Supervisory Board has, with or without discussion of the issue, failed in its duty to take account of the interests of all shareholders and establish homogeneous fairness among all those concerned — instead, individual Supervisory Board members have evidently pursued particular interests. There have been conflicts of interest that the Supervisory Board chair ought definitely to have taken up in his report! 72 VOLUME 1 Annex 5 : Example of Dissident Shareholder Letter to the Board A N N EX 5 : EXA M PL E OF DISSIDENT SHAREHOLDER LETTER TO TH E B OA R D The interests concerned are those of the State of Lower Saxony, and its secondment rights and those of the Federal Republic of Germany. These and the existing voting-rights restriction must be abolished in their entirety — yet management (through the Executive and Supervisory Boards) has made no recommendation for that. The point is to reduce the needlessly raised charter limit for structural and fundamental decisions to the normal legal level — on which not only are there no recommendations from the Supervisory Board, but not even any attempt to ward off the moves by some of its members to publicly ignore their obligations and bring in improper motions to conserve the unlawful special advantages of the State of Lower Saxony. Such proceedings run counter not just to the EU judgment but also, thinking personally, to the interests of shareholders. It is then only logical for shareholder Porsche SE to throw out the errors in the agenda in its motion in item 9.1, and it is pure self-interest for the State of Lower Saxony instead to create confusion and seek to conserve its special privileges in item 9.2. Had the Supervisory Board met its fundamental obligations to take account of the interests of all and not of individuals, it would have acted on this elementary point. Additionally, the Supervisory Board, represented by its chairman, has unpardonably neglected to inform shareholders of the existing conflict of interest. For such weakness in decision the Supervisory Board cannot expect any discharge from shareholders. We shall put the motion, instead of wholesale discharge, to consider each Supervisory Board member for discharge separately — enabling each shareholder to issue individual discharge instructions (to us or their proxy voter) up to their declarations at the AGM. The resolution put by Porsche SE as item 9.1 fits into a framework of good corporate governance in the interests of all investors, whereas the motion by the State of Lower Saxony as item 9.2 is, from the same viewpoint, clearly to be rejected with a No. It remains to be hoped that Porsche will actually cultivate this improved corporate governance at VOLKSWAGEN and also introduce it at Porsche — where several rules of best practice are still ignored (opt-out on executive remuneration, 1 share — 1 vote). Each shareholder should carefully consider whether he wants to re-elect the Supervisory Board members not to be given discharge immediately in item 5. In no case is it acceptable for the old representatives of the State of Lower Saxony to be re-elected, given the above-mentioned conflict of interest, unmentioned for so long. Neither VW, its employees nor the shareholders need a “Volkswagen Act” as a special law — all shareholders are called upon, even without a board recommendation, to form an opinion and vote or instruct a representative (www. vip-cg.com) to do so. We — VIP (www.VIP-cg.com) — point out that VOLKSWAGEN AG is obliged pursuant to § 126 AktG to make the foregoing (counter-) motions accessible to all shareholders. We are ready and willing to represent the voting rights of third parties or to execute instructions for casting the vote. Yours faithfully, VIP Vereinigung Institutionelle Privatanleger e.V. Hans-Martin Buhlmann Chairman SOURCE: www.vip-cg.com (English version provided by VIP). Annex 5 : Example of Dissident Shareholder Letter to the Board VOLUME 1 73 ANNEX 6 REVIEW OF SELECTED AD R PR OC ESSES : A N N EX 6 REVIEW OF SELECTED ADR PROCESSES providing for final and binding arbitration as the method for resolving disputes. Arbitration Arbitration is a private process where disputing parties Early Neutral Evaluation agree that one or several individuals can make a decision Early neutral evaluation is a process that may take place about the dispute after receiving evidence and hearing soon after a case has been filed in court. The case is arguments. Arbitration is different from mediation referred to an expert, usually an attorney, who is asked because the neutral arbitrator has the authority to make to provide a balanced and unbiased evaluation of the a decision about the dispute. The arbitration process dispute. The parties either submit written comments is similar to a trial in that the parties make opening or meet in person with the expert. The expert identifies statements and present evidence to the arbitrator. each side’s strengths and weaknesses and provides Compared to traditional trials, arbitration can usually an evaluation of the likely outcome of a trial. This be completed more quickly and is less formal. For evaluation can assist the parties in assessing their case example, often the parties do not have to follow state and may propel them towards a settlement. or federal rules of evidence and, in some cases, the arbitrator is not required to apply the governing law. Mediation After the hearing, the arbitrator issues an award. Some Mediation is a private process where a neutral third awards simply announce the decision (a “bare bones” person called a mediator helps the parties discuss award), and others give reasons (a “reasoned” award). and try to resolve the dispute. The parties have the The arbitration process may be either binding or non- opportunity to describe the issues, discuss their interests, binding. When arbitration is binding, the decision understandings, and feelings, provide each other with is final, can be enforced by a court, and can only be information, and explore ideas for the resolution of the appealed on very narrow grounds. When arbitration is dispute. While courts can mandate that certain cases non-binding, the arbitrator’s award is advisory and can go to mediation, the process remains “voluntary” in be final only if accepted by the parties. that parties are not required to come to agreement. The In Court-Annexed Arbitration, one or more arbitrators, mediator does not have the power to make a decision for usually lawyers, issue a non-binding judgment on the the parties, but can help the parties find a resolution that merits after an expedited, adversarial hearing. The is mutually acceptable. The only people who can resolve arbitrator’s decision addresses only the disputed legal the dispute in mediation are the parties themselves. issues and applies legal standards. Either party may reject There are a number of different ways that mediation can the non-binding ruling and proceed to trial; sometimes, proceed. Most mediations start with the parties together cost sanctions may be imposed in the event the appellant in a joint session. The mediator will describe how the does not improve his/her position in court. This process process works, will explain the mediator’s role, and will may be mandatory or voluntary. help establish ground rules and an agenda for the session. Generally, parties then make opening statements. Some Private (v. Court-Annexed) Arbitration may be “admin- mediators conduct the entire process in a joint session. istered,” meaning managed by private organizations, or However, other mediators will move to separate sessions, “non-administered,” meaning managed by the parties. shuttling back and forth between the parties. If the The decisions of arbitrators in private arbitration may be parties reach an agreement, the parties and the mediator non-binding or binding. can help the parties reduce the agreement to a written contract, which may be enforceable in court. Binding Arbitration decisions typically are enforceable by courts and not subject to appellate review, except Conciliation is sometimes defined as a type of mediation in the case of fraud or other defect in the process. whereby the parties to a dispute use a neutral third party Often, binding arbitration arises from contract clauses (a conciliator), who meets with the parties separately 74 VOLUME 1 Annex 6 : Review of Selected ADR Processes A N N EX 6 : R EVIEW OF SELECTED ADR PROCESSES in an attempt to resolve their differences. Conciliation or constituents. The ombudsman works within the differs from arbitration in that the conciliation institution to investigate the complaints independently process, in and of itself, has no legal standing, and the and impartially. The process is voluntary, private, and conciliator usually has no authority to seek evidence or nonbinding. In a second approach, the ombudsman call witnesses, usually writes no decision, and makes no is appointed by public bodies or industry sectors to award. Conciliation is sometimes used interchangeably adjudicate on citizen or consumer complaints by with mediation. recommendation and/or compensation awards. Mini-Trial Settlement Conference A mini-trial is a private, consensual process where the A settlement conference is a meeting in which a judge attorneys for each party make a brief presentation of the or magistrate assigned to the case presides over the case as if at a trial. The presentations are observed by a process. The purpose of the settlement conference is to neutral advisor and by representatives (usually high-level try to settle a case before the hearing or trial. Settlement business executives) from each side who have authority conferencing is similar to mediation in that a third party to settle the dispute. At the end of the presentations, neutral assists the parties in exploring settlement options. the representatives attempt to settle the dispute. If the Settlement conferences are different from mediation representatives fail to settle the dispute, the neutral in that settlement conferences are usually shorter and advisor, at the request of the parties, may serve as a typically have fewer roles for participation of the parties mediator or may issue a non-binding opinion as to the or for consideration of non-legal interests. likely outcome in court. Summary Jury Trial Negotiation In summary jury trials, attorneys for each party make Negotiation is a voluntary and usually informal process abbreviated case presentations to a mock six-member in which parties identify issues of concern, explore jury (drawn from a pool of real jurors), the party options for the resolution of the issues, and search for representatives, and a presiding judge or magistrate. The a mutually acceptable agreement to resolve the issues mock jury renders an advisory verdict. The verdict is raised. The disputing parties may be represented by frequently helpful in getting a settlement, particularly attorneys in negotiation. Negotiation is different from where one of the parties has an unrealistic assessment mediation in that there is no neutral individual to assist of their case. the parties to negotiate. Settlement Week Neutral Fact-Finding In a typical settlement week, a court suspends normal Neutral fact-finding is a process where a neutral third trial activity and, aided by volunteer mediators, sends party, selected either by the disputing parties or by the numerous trial-ready cases to mediation sessions held at court, investigates an issue and reports or testifies in the courthouse. The mediation sessions may last several court. The neutral fact-finding process is particularly hours, with additional sessions held as needed. Cases useful for resolving complex scientific and factual unresolved during settlement week return to the court’s disputes. regular docket for further pretrial or trial proceedings as needed. If settlement weeks are held infrequently and Ombudsman are a court’s only form of ADR, parties who want to use An ombudsman takes two forms. In one approach, the ADR may have to look outside the court or may incur ombudsman is a third party selected by an institution — additional litigation expenses while cases await referral for example, a university, hospital, or governmental to settlement week. This can be overcome by regularly agency — to investigate complaints by employees, clients offering at least one other form of ADR. Annex 6 : Review of Selected ADR Processes VOLUME 1 75 ANNEX 6 REVIEW OF SELECTED AD R PR OC ESSES : A N N EX 6 Case Evaluation (“Michigan Mediation”) conferences, articulating opinions about the merits of Case evaluation provides litigants in trial ready cases with the case, facilitating the trading of settlement offers, and a written, non-binding assessment of the case’s value. sometimes acting as a mediator. In some jurisdictions, a The assessment is made by a panel of three attorneys new judge will be required to try the case if a first judge after a short hearing. If the panel’s assessment is accepted has endeavored to settle it. by all parties, the case is settled for that amount. If any party rejects the panel’s assessment, the case proceeds Private Judging: A private or court-connected process in to trial. This arbitration-like process has been referred which parties empower a private individual to hear and to as “Michigan Mediation” because it was created by issue a binding, principled decision in their case. the Michigan state courts and subsequently used by the The process may be agreed upon by contract between federal district courts in Michigan as well. the parties, or authorized by statute (in which case it is Med-Arb., or Mediation-Arbitration: An example of sometimes called Rent-a-Judge). multi-step ADR, parties agree to mediate their dispute with the understanding that any issues not settled by mediation will be resolved by arbitration, using the same individual to act as both mediator and arbitrator. The parties may, however, be unwilling to speak candidly during the mediation when they know the neutral may ultimately become a decision maker. They might believe that the arbitrator will not be able to set aside unfavorable information learned during the previous mediation. Additional related methods have evolved to address this problem. In Co-Med-Arb, different individuals serve as neutrals in the arbitration and mediation sessions, although they both may participate in the parties’ initial exchange of information. In Arb-Med, the neutral first acts as arbitrator, writing up an award and placing it in a sealed envelope. The neutral then proceeds to a mediation stage, and if the case is settled in mediation, the envelope is never opened. Fact-finding: A process by which a third party renders binding or advisory opinions regarding facts relevant to a dispute. The third party neutral may be a technical or legal expert designated by the parties, or appointed by the court. Judge-Hosted Settlement Conference/Judicial Mediation: In this court-based ADR process, the settlement judge (or magistrate) presides over a meeting of the parties in an effort to help them reach a settlement. Judges have played a variety of roles in such SOURCE: Lukasz Rozdeiczer and Alejandro Alvarez de la Campa, Alternative Dispute Resolution Manual: Implementing Commercial Mediation. Washington, D.C.: IFC, 2006. 76 VOLUME 1 Annex 6 : Review of Selected ADR Processes ANNEX 7 A N N EX 7 : TA B L E C OM PA RING NEGOTIATION, LITIGATION, M ED I ATIO N TABLE COMPARING NEGOTIATION, LITIGATION, MEDIATION NEGOTIATION LITIGATION MEDIATION VOLUNTARY NOT VOLUNTARY USUALLY VOLUNTARY If agreement, can be Binding, subject to appeal If agreement, can be enforceable enforceable as contract as contract or court award No third party Imposed decision; Mediator selected by parties neutral involved decision-maker may have as third party neutral; may subject expertise have subject expertise INFORMAL FORMAL, RIGID RULES INFORMAL Freedom to choose how and Opportunity for each party to Freedom to choose how and when to present evidence, present proofs and arguments; when to present evidence, arguments, and interests; often focused on past events arguments and interests; often focused on the past focused on the future Outcome: Outcome: Outcome: mutually acceptable imposed decision, supported mutually acceptable agreement sought by reasoned opinion agreement sought PRIVATE PUBLIC PRIVATE Parties often not present Parties may attend, but Parties usually present and if there is a dispute participate in process only free to be fully engaged in the as witnesses process and outcome SOURCE: Centre for Effective Dispute Resolution. The CEDR Mediator Handbook. Effective Resolution of Commercial Disputes. Fourth Edition. London: CEDR, 2004. Annex 7 : Table Comparing Negotiation, Litigation, Mediation VOLUME 1 77 ANNEX 8 TYPICAL STEPS IN CONSTRUCTIVE N EG OTIATION : A N N EX 8 TYPICAL STEPS IN CONSTRUCTIVE NEGOTIATION 1. Prepare (Set the Stage) Gather information Identify common concerns Analyze own and other’s priorities a. My best alternative to negotiated agreement vs. Their interests b. My interests vs. Their options/choices c. My options/choices vs. Their best alternative to negotiated agreement 2. Engage (Negotiate) Express genuine interest in finding resolution Surface issues Listen attentively to each other’s perspectives Identify common concerns and interests Prioritize issues Brainstorm and prioritize alternative solutions Agree to solutions with joint benefits 3. Review (Formalize) How to improve future decision-making? How to monitor progress and make necessary adjustments? SOURCE: Adapted from: Richard G. Shell, Bargaining for Advantage: Negotiation Strategies for Reasonable People. New York: Penguin, 1999. Copyright 1999. All rights reserved. 78 VOLUME 1 Annex 8 : Typical Steps in Constructive Negotiation ANNEX 9 A N N EX 9 : SA M PL E D EF IN ITIONS OF M EDIATION FROM AROUND TH E WOR L D SAMPLE DEFINITIONS OF MEDIATION Mediation differs from other forms of conflicts FROM AROUND THE WORLD resolution in the following aspects: on one hand, the Mediator is the person who facilitates communication Albania — Albanian Mediation Law without intervening actively in the decisions; on the other, the parties involved keep in charge of the ART. 1 Mediation is an activity without going to the resolution of their conflicts, therefore transforming court, where the parties ask for the mediation of a third their relations in a positive way. person or a group of persons, to achieve an acceptable SOURCE: MEDIARE. Available at: http://www.mediare.com reconciliation of the dispute and which not non- br/01ingles/05mediac_instrum.htm. compliant with the law. SOURCE: Albanian Mediation Law No 9090 of June 26, 2003. Croatia — Croatian Law on Conciliation (2003) Conciliation is set as a general term comprising Bosnia and Herzegovina — Law on mediation and/or conciliation, meaning any procedure, Mediation Procedures regardless of its name, in which the parties try to resolve ART. 2 ART. 2. For the purposes of this law, the their dispute with the assistance of one or more neutral mediation shall be a procedure in which a third party conciliators helping the parties to reach an agreement (mediator) assists parties in an effort to reach a mutually without any authorities to impose any binding resolution acceptable solution to the dispute. The mediator may on the parties in dispute. not impose the solution to the dispute on the parties. SOURCE: Croatian Law on Conciliation (2003). SOURCE: Law on Mediation Procedures — Bosnia and Herzegovina (2004). Egypt — The Cairo Regional Centre for Brazil — MEDIARE Commercial Arbitration Mediation is becoming an important resource for the ART. 1 Where parties to a contract have agreed in resolution of conflicts in situations that involve different writing to seek an amicable settlement of disputes interests associated with the necessity of negotiating arising out of or relating to their contract by mediation them. It is a confidential and non-mandatory process in accordance with the Rules of Mediation of the where the parties are responsible for the decision-making. Mediation and ADR Centre (A branch of the Cairo Unlike Arbitration and Judicial Resolution — situations Regional Centre for International Commercial that transfer the decision to a third person — Mediation Arbitration), then such mediation shall take place in keeps the power of decision with the parties. accordance with such rules. SOURCE: The Rules of Mediation — The Cairo Regional Centre for The technical resources of Mediation have been widely Commercial Arbitration. used for the prevention, negotiation, and resolution of WEB LINK: http://www.crcica.org.eg/adr_rules.html. conflicts. As a preventive strategy it creates favorable conditions for cooperation in order to make it possible for continuing relations to grow in a positive way. European Union: Directive 2008/52/EC of the European Parliament and of the Council of The Mediator is an impartial professional that facilitates 21 May 2008 the communication between people with the aim of increasing the alternatives for the resolution of impasses. ART. 3 (A) ‘Mediation’ means a structured process, He/ she helps to transform relations, making it possible however named or referred to, whereby two or more to reduce the conflicts to workable levels and to build parties to a dispute attempt by themselves, on a voluntary agreements that are mutually acceptable. basis, to reach an agreement on the settlement of their Annex 9 : Sample Definitions of Mediation from Around the World VOLUME 1 79 ANNEX 9 SA M P LE D EFI N ITIONS OF M EDIATION FROM AROUND TH E W OR L D : A N N EX 9 dispute with the assistance of a mediator. This process International Chamber of Commerce — may be initiated by the parties or suggested or ordered ADR Rules and Guide to ICC ADR by a court or prescribed by the law of a Member State. ART. 5 (1) 1 For purposes of the Rules, mediation is It includes mediation conducted by a judge who is not the settlement technique in which the Neutral acts as a responsible for any judicial proceedings concerning facilitator to help the parties try to arrive at a negotiated the dispute in question. It excludes attempts made by settlement of their dispute. The Neutral is not requested the court or the judge seized to settle a dispute in the to provide any opinion as to the merits of the dispute. course of judicial proceedings concerning the dispute in To facilitate an amicable settlement, the Neutral generally question. holds joint meetings with all of the parties present and SOURCE: Directive 2008/52/EC of the European Parliament and of the may also hold separate meetings, often called caucuses, Council of 21 May 2008 on certain aspects of mediation. with each of the parties alone. These meetings permit WEB LINK: http://eurlex.europa.eu/LexUriServLexUriServdo?uri=CELEX:320 the Neutral to create an atmosphere appropriate for 08L0052:EN:NOT. negotiations, obtain useful information, identify the interests of each party and help the parties find common Hungary — Mediation Act LV of 2002 ground for the resolution of their dispute. Any oral statements or written documents provided to the Neutral CHAPTER 1, SECTION 2: Mediation is a special by one party during a separate meeting or otherwise will non-litigious procedure conducted according to this not be conveyed to the other party unless the first party Act to provide an alternative to court proceedings has explicitly authorized the Neutral to do so. in order to resolve conflicts and disputes where the SOURCE: International Chamber of Commerce Alternative Dispute parties involved voluntarily submit the case to a neutral Resolution Rules (in force as from 1 July 2001). third party (hereinafter referred to as ‘mediator’) in WEB LINK: http://www.iccwbo.org/court/adr/id4452/index.html. accordance with Subsection (1) of Section 1 in order to reach a settlement in the process and lay the ensuing agreement down in writing. Italy — ADR Center SOURCE: Act LV of 2002, Hungary. Mediation is a procedure by which the parties and their lawyers use the skills of a third party neutral in order to India — Indian Institute of Arbitration and reach a mutually acceptable solution to their dispute. Mediation (IIAM) SOURCE: ADR Center Mediation Guide. WEB LINK: http://www.adrcenter.com/doc/ADR%20Center%20 Mediation is a settlement effort, which utilizes the Mediation%20Guide%20-%20ENG%20FIN.pdf. services of an impartial, third party mediator in an effort to reach a mutually acceptable agreement. By agreeing Pakistan — Karachi Center for to mediate, parties agree to negotiate to attempt to settle Dispute Resolution their differences. It is an informal and non-adversarial process, which has the objective of helping the disputing Mediation is an ADR mechanism that may be used parties, reach a mutually acceptable and voluntary for settling disputes informally and promptly with the agreement. Neither IIAM nor the mediator has the assistance of a neutral third-party mediator. power or authority to render a binding decision or to force the parties to accept a settlement. Often disputes arise out of a misunderstanding concerning the expectations and responsibilities of the SOURCE: Indian Institute of Arbitration and Mediation (IIAM). parties. These disputes may be settled agreeably once a WEB LINK: http://www.arbitrationindia.org/. dialogue is established. Mediator does not act as a judge 80 VOLUME 1 Annex9 : Sample Definitions of Mediation from Around the World A N N EX 9 : SA M PL E D EF IN ITIONS OF M EDIATION FROM AROUND TH E WOR L D of decision maker, but as a neutral individual whose SOURCE: Centre for Effective Dispute Resolution (CEDR) purpose is to facilitate settlement between the parties. WEB LINK: http://www.cedr.com/index.php?location=/news/ archive/20041101.htm. SOURCE: Karachi Center for Dispute Resolution. WEB LINK: http://www.kcdr.org. United Nations — United Nations Commission on International Trade Law (UNCITRAL) Serbia — Serbian Law on Mediation For the purpose “conciliation” means a process, whether ART. 2 Mediation is any procedure, notwithstanding referred to by the expression conciliation, mediation or its name, whereby the parties wish to settle their dispute an expression of similar import, whereby parties request through one or more mediators assisting the parties to a third person or persons (“the conciliator”) to assist reach an agreement. Mediators shall not be authorized them in their attempt to reach an amicable settlement to impose a binding agreement on the parties. of their dispute arising out of or relating to a contractual SOURCE: Serbian Law on Mediation (2005). or other legal relationship. The conciliator does not have the authority to impose upon the parties a solution to Romania — Romanian Mediation Act the dispute. SOURCE: UNCITRAL “Model Law on International Commercial Conciliation ART.1. - (1) Mediation represents an optional modality with Guide to Enactment and Use” (adopted on 24 June 2002). to settle the conflicts in a conciliatory way, with the WEB LINK: http://www.uncitral.org/uncitral/en/uncitral_ texts/arbitration/200 assistance of a third person specialized as a mediator, 2Modelconciliation.html. under the conditions of neutrality, fairness and confidentiality. United States — International Institute for Conflict Prevention and Resolution (CPR) (2) Mediation is based on the trust that parties give to mediator, as a person able to facilitate negotiations The most widely used ADR process, mediation is a between them and to support them to settle the conflict process in which a third party neutral — a mediator — through a mutual convenient, efficient and lasting sits down with the disputing parties and actively assists solution. them in reaching a settlement. SOURCE: Romanian Mediation Act. Mediation should not be confused with binding arbitration or private adjudication. The mediation Slovakia — Slovak Act on Mediation (2004) process is non-binding, although a settlement agreement ART. I, §2 (1) Mediation means extra-judicial action resulting from a mediation usually is binding. The in which the parties settle a dispute, arising from or mediator has no authority to make any binding decisions concerning their contract or other legal relationship, or impose a resolution. The role of the mediator — and through a mediator. the goal of the process — is to help parties achieve their own resolution. SOURCE: Slovak Act on Mediation (2004). Mediation is private and generally confidential. It is United Kingdom — Centre for Effective Dispute highly flexible and informal. Typically, it is concluded Resolution (CEDR) expeditiously at moderate cost. The subject matter can be complex or simple, the stakes large or small, the number “Mediation is a flexible process conducted confidentially of parties few or many. An exchange of information in which a neutral person actively assists parties in commonly occurs in a mediation, and limited discovery working towards a negotiated agreement of a dispute or also is possible. All parties can participate in tailoring the difference, with the parties in ultimate control of the ground rules. The process typically is far less adversarial decision to settle and the terms of resolution.” than litigation or arbitration, and therefore less Annex 9 : Sample Definitions of Mediation from Around the World VOLUME 1 81 ANNEX 9 SA M P LE D EFI N ITIONS OF M EDIATION FROM AROUND TH E W OR L D : A N N EX 9 disruptive of business relationships. Since other options are not foreclosed if mediation should fail, entering into a mediation process presents few risks. SOURCE: CPR International Institute for Conflict Prevention and Resolution. WEB LINK: http://www.cpradr.org/ClausesRules Mediation Procedure/ tabid/90/Default.aspx. United States — Federal Mediation and Conciliation Service (FMCS) Mediation is a voluntary process, bringing a neutral third-party into a negotiation as a facilitator. It may or may not lead to an agreement between the parties. SOURCE: Federal Mediation and Conciliation Service (FMCS). WEB LINK : http://www.fmcs.gov/internet/ FMCS. 82 VOLUME 1 Annex 9 : Sample Definitions of Mediation from Around the World ANNEX 10 A N N EX 10 : L IN KS TO SA M PLE M EDIATION RULES AND PROCE DU R ES LINKS TO SAMPLE MEDIATION RULES Mediation Sessions are Private. AND PROCEDURES Confidentiality Stockholm Chamber of Commerce Exclusion of Liability CONTENTS Interpretation and Application of the Rules Mediation Institute Administrative Fees The Mediator Role of Mediator in Other Proceedings Confidentiality Referral to Another MMO Initiation 0f Mediation Governing Law and Jurisdiction The Proceedings Before the Mediator Termination of the Mediation Termination of the Mediation Settlement Agreements Costs LINK: http://www.medal-mediation.com/rules.html. LINK: http://www.sccinstitute.com/_upload/shared_files/regler/web_a4_ medling_eng.pdf. Centre for Effective Dispute Resolution — CEDR Solve Center for Conflict Resolution — CONTENTS Brigham Young University Mediation CONTENTS Referral to Mediation Good Faith Effort Choosing the Mediator Confidentiality Preparation for the Mediation Courtesy Documentation Role of the Mediator The Mediation Agreement Representation The Mediation Legal Counsel Confidentiality in Relation to the Mediation Termination of Mediation Conclusion of the Mediation Arbitration and Court Complaints Exclusion of Liability LINK: http://www.cedr.com/about_us/library/documents.php. LINK: http://ccr.byu.edu/index.php?option=com_contents&task=view&id= 3458&itemid=4500. UNCITRAL Medal — The International Mediation CONTENTS Services Alliance Article 1. Scope of Application and Definitions CONTENTS Article 2. Interpretation Initiation of Mediation Article 3. Variation by Agreement Appointment of the Mediator Article 4. Commencement of Conciliation Proceedings Disclosures and Replacement of a Mediator Article 5. Number and Appointment of Conciliators Representation Article 6. Conduct of Conciliation Arranging Date, Time and Place of the Mediation Article 7. Communication Between Conciliator and Parties Conduct of the Mediation and Authority of the Mediator Annex 10 : Links to Sample Mediation Rules and Procedures VOLUME 1 83 ANNEX 10 LI NK S TO SAM PLE M EDIATION RULES AND PR OC ED U R ES : A N N EX 10 Article 8. Disclosure of Information The Cairo Regional Centre For Commercial Article 9. Confidentiality Arbitration LINK: http://www.crcica.org.eg/adr_rules.html#two. Article 10. Admissibility of Evidence in Other Proceedings Article 11. Termination of Conciliation Proceedings Belgian Center on Mediation and Arbitration Article 12. Conciliator Acting as Arbitrator CONTENTS Article 13. Resort to Arbitral or Judicial Proceedings Scope Article 14. Enforceability of Settlement Agreement Confidentiality LINK: http://www.uncitral.org/pdf/english/texts/arbitration/ml-conc/ml- Request for Mediation conc-e.pdf. Answer to the Request for Mediation Effect of the Mediation Agreement International Chamber of Commerce Written Notifications or Communications and CONTENTS Time Limits Article 1. Scope Of The ICC ADR Rules The Mediator General Provisions Article 2. Commencement Of The ADR Proceedings Appointment of the Mediator Article 3. Selection Of The Neutral Replacement of the Mediator Article 4. Fees And Costs Transmission of the File to the Mediator Article 5. Conduct Of The ADR Procedure Language of the Mediation Article 6. Termination Of The ADR Proceedings Seat of the Mediation LINK: http://www.iccwbo.org/court/adr/id4452/index.html. Examination of the Case Settlement International Institute for Conflict Prevention End of the Mediation and Resolution (CPR) Nature and Amount of the Mediation Costs CONTENTS Advance On Mediation Costs Agreement to Mediate Decision On Mediation Costs Selecting the Mediator LINK: http://www.cepani.be/en/default.aspx?pid=403 Ground Rules of Proceeding Exchange of Information Singapore Mediation Centre Presentation to the Mediator CONTENTS Negotiations The Mediation Process Settlement Mediation Agreement Failure to Agree The Parties Confidentiality The Mediator LINK: http://www.cpradr.org/clausesrules/mediationprocedure/tabid/90/ default.aspx. The Centre Exchange of Information 84 VOLUME 1 Annex 10 : Links to Sample Mediation Rules and Procedures A N N EX 10 : L IN KS TO SA M PLE M EDIATION RULES AND PROCE DU R ES The Mediation Conduction of Mediation Settlement Agreement Joint Sessions and Caucus Informing the Parties about Mediation Termination Suspension And Termination Of Mediation Stay of Proceedings Grounds for Suspension of the Mediation Proceedings Confidentiality Grounds for Termination of the Proceedings Fees Waiver of Liability of the Mediator, the Mediation Center Waiver of Liability and its Employees Interpretation Mediation Fees And Expenses Determination Of Fees LINK: http://www.mediation.com.sg/mediation%20procedure_1%20 Responsibility of the Parties for the Costs of the april%202007.htm. Mediation Proceedings LINK: http://www.mediation.bcci.bg/english/index. Mediation Center with the Court of php3?vheader=charter%20and%20mediation%20rules&vfile=it5.htm. Arbitration at the Bulgarian Chamber of Commerce and Industry CONTENTS Mediation Center — Scope, Goals and Services Mediator Requirements to the Mediators Entry in the List of Mediators of the Mediation Center Deregistration from the List of Mediators Documents Forms Maintenance and Keeping of Documents Delivery and Receipt of Documents Evaluation of the Mediation by the Parties Mediation Rules — General Provisions Preparatory Activities before Conduction of Mediation Commencement Of Mediation Selection Of A Mediator Termination Of Mediator’s Functions Applicable Rules and Principles for Conduction of Mediation Applicable Rules for Conduction of Mediation Representation of the Parties and Participation in the Meetings Assistance by the Parties in the Mediation Role of the Mediator Provision of Information and Materials Confidentiality Annex 10 : Links to Sample Mediation Rules and Procedures VOLUME 1 85 ANNEX 11 TYPICAL STEPS IN M ED IATION : A N N EX 11 TYPICAL STEPS IN MEDIATION 1. Prepare (Set the stage) Meet first with each party to explore the issues and to ensure a genuine commitment to problem solving. Offer to mediate a fair, impartial discussion. Agree to confidentiality. If the parties agree to meet, clarify in advance the mediation steps. Determine a convenient time and a neutral, private, and acceptable location and any prior information exchange that would be helpful. 2. Engage (Negotiate) To begin, review procedures. Clarify the steps in the mediation. Agree to maintain confidentiality and respect diverse perspectives. Emphasize active listening and agree to norms — no interrupting, blaming, or aggressive behaviors. Facilitate an exchange of perspectives. Provide fair and balanced opportunities for each person to communicate. Questions to address include: a. From your perspective, what is the issue and why? (Define problem.) b. What is your concern? (Recognize personal and commercial interests.) c. Do you have suggestions for improving this situation? (Identify and document options.) d. Which of these proposed solutions are most useful? (Prioritize.) e. Agree to changes in practices and next steps. (Propose solutions.) 3. Review (Formalize) Clarify the terms of agreement. Anticipate barriers to progress, and discuss responses. Decide how to monitor and take action to ensure accountability. It may be helpful to write down an agreement’s terms to clearly define expectations and the next steps, or document a legally binding agreement between parties. SOURCE: Adapted from: Christopher W. Moore, The Mediation Process: Practical Strategies for Resolving Conflict. Third Edition. San Francisco: Jossey- Bass, 2003. 86 VOLUME 1 Annex 11 : Typical Steps in Mediation ANNEX 12 A N N EX 12 : TYPIC A L STEPS IN ARBITRATION TYPICAL STEPS IN ARBITRATION 1. Party (Claimant) files a Statement of Claim to request arbitration. 2. Claimant is notified that the Claim has been accepted (or has deficiencies). 3. If the Claim is accepted, the sponsoring organization receives a deposit. The final settlement of costs is determined in accordance with the Code of Procedure. 4. The other party (Respondent) is served with the Statement of Claim and Notice of Arbitration, in accordance with the Code of Procedure. 5. Respondent files a Written Response. 6. Director of Arbitration reviews the case information and documents. 7. Parties select an Arbitrator on mutually agreeable terms, or they may agree to the appointment of an Arbitrator. 8. Parties select either a Document Hearing or Participatory Hearing. 9. Parties submit documents and information to the Arbitrator. 10. Participatory Hearings generally include the following: Arbitrator, parties, and witnesses are sworn to tell the truth Claimant presents testimony and relevant documents Respondent presents testimony and relevant documents Witnesses may provide testimony Any claim or counter claim may be questioned Parties may present rebuttal evidence, if appropriate Closing statements may be presented Parties leave together at the end of the hearing Post-hearing briefs may be filed 11. The Arbitrator reviews relevant information, testimony, and document submissions. 12. Arbitrator issues an Award establishing the rights and obligations of the Parties. SOURCE: Adapted from International Chamber of Commerce, ADR Rules, July 1, 2001. Available at: www.iccadr.org. Annex 12 : Typical Steps in Arbitration VOLUME 1 87