The Ethiopian Commercial Code has to be amended putting into consideration a wide array of points. The law has to be drafted to enable businesses create jobs, prosperity and make innovations easy to compete in the global village, writes Yared Haile-Mekel.
At the recently held second East Africa Finance Summit, I had the chance to present a paper on the current state of share companies in Ethiopia and the risks and opportunities associated with it. My presentation and another presentation by the consultant-turned-investor Zemedeneh Nigatu triggered interests and a wide range of discussions in the media.
The topic is quite wide and it was very difficult to present this complex subject in a short presentation. Ethiopian share companies are marred with have political, economic and legal issues that need to be addressed.
The argument regarding political and economic issues can be presented in another commentary but the legal issue is important and there is a consensus for review of the Ethiopian Commercial Code.
The Ethiopian Commercial Code is 58 years old and there are some reports that the commercial code is being revised. I did not manage to get a copy of the revised draft so I could not comment on it but the revision of the code has to be done with sole purpose of enabling businesses to flourish and creating prosperity, and should not be revised with control in mind.
In this commentary I have tried to highlight some of the issues that need to be updated in the Ethiopian Commercial Code and the team that is tasked to revise the code may find it useful to check the revised code against this and any other feedbacks from stakeholders before passing the law. Special care must be given during revising the code and, in some cases; this outdated commercial code could serve better than a badly drafted new law.
Out of the 58 years the code was suspended between 1975 and 1991 during a blanket nationalization of the economy by the leftist military government.
Now, share companies are fast growing. According to the Ministry of Trade and data in regional trade bureaus, more 1,000 share companies have been licensed with an estimated aggregate capital of 80 billion birr, which is around 4.2 percent of Ethiopia’s GDP.
The world has changed. There are virtual companies, digital currencies, and electronic contracts, digital signatures, data protection, e-commerce, angel investors, venture capitals, and private equity firms, Limited Liability Partnership (LLP) etc. Hence, it is important to list shortcomings of the 1960 commercial law to propose solutions to enable businesses compete in the 21st century global economy. Achieving this aim will not be an easy task and it needs a lot of able lawmakers with a broader view of the world and in-depth intellectual capital.
The commercial code of Ethiopia was drafted in 1960 long before many of the financial innovations and technologies. By the virtue of its age it has many limitations to govern the 21st century commercial transactions through the real and virtual world.
This commercial code has 255 pages, six main titles, and 1,182 articles and many thousand sub articles. It appears that the document was prepared meticulously in 1960 to create a solid foundation for conducting modern business and it has proved to be effective in the last 58 years. In the preface, Emperor Haile-Selassie I sums the vision and the objective of the commercial code perfectly. From the benefit of the hindsight we can see how farsighted the lawyers, advisors and legislative bodies were in drafting and setting a clear objective of the code in enabling businesses; not controlling them. The Emperor wrote in the preface:
“The commercial life of Ethiopia has expanded, increasing numbers of Ethiopian and foreign companies have been formed and registered, and more complex methods of transacting business have been developed in recent years. Recognizing the impetus which a modern Code regulating the constitution and activities of all business organizations could give to the further growth of trade and commerce, We directed the Codification Commission created by US to prepare a modern Commercial Code which would serve for the present day as well as provide a solid foundation for the further refinement of laws treating of these subjects.”
The commercial code had all the elements of a modern commercial code in the 1960s, which is useful even today. Some of the examples are:
The commercial code has articles about how share companies can be formed, rules about shareholders’ meetings, agenda setting, proxy, chairman, voting rights, conflicts of interest (very limited to voting only), minutes, quorum, effect of resolution, rights to inspect documents etc. However, it does not protect shareholders interest due to lack of legal provision for disclosure of conflict of interest or make non-disclosure of undeserved benefits a criminal offense.
It also gives details about debentures and premium bonds, but the bonds can only be issued by the government. It also has articles about what needs to be done in the event of bankruptcy of the Debtor Company etc., but has no similar provision like the US Chapter 11 Bankruptcy Law and equivalent UK Insolvency Act, which provide steps to protect the interest of shareholders, debtors, employees etc.
“Chapter 11” Bankruptcy Law of the US, for example, provides protection for companies when they face financial problems and how federal bankruptcy court appoints bankruptcy administrators to balance the interest of shareholders, debtors, employees and others. The limitation of the Ethiopian Commercial code was indeed tested when Access Real Estate faced financial problems. The absence of the law forced political appointees to get involved to resolve the issue with no success in sight for many years. Many meetings were held under the stewardship of Mekuria Haile, the erstwhile minster of Urban Development and Construction, and officials from the Ministry of Trade, but it seems that no one has clues as to how to resolve the problem in the absence of clear provisions. These interventions and meetings were unnecessary if the law was amended to incorporate the modern bankruptcy protection and procedure to appoint bankruptcy administrators. Companies either make profit or incur losses. General Motors, Northern Rock Bank, AIG and many huge companies were in trouble during the credit crunch. They filed Chapter 11 to find a way of resolving their problems and come back with better financial health.
Chapter Six, Articles 452- 462, give guidelines about accounts of companies and how it should be managed, nevertheless since the 1960s a number of accounting standards have been adopted and it does not recognize or prescribe any accounting or reporting standards. Creative accounting and accountant frauds are common. For example, the US passed a law known as Sarbanes-Oxley Act, in 2002, in response to major accounting scandals at Enron, WorldCom and the subsequent market crash.
Chapter Seven addresses how the amendment to the Memorandum of Understanding (MoU) or Articles of Association (AoA) can be achieved. Nevertheless, it has a cumbersome signing process by all shareholders at the document authentication authority. For minutes to be ratified, more than 16,500 shareholders of the Habesha Cement or 9,659 shareholders of Berhan Bank had to line-up to sign.
Articles 462-494 set the rule for the right of withdrawal from the company but have no provision for secondary market. If someone wants to sell his share in a company there is no market for it and hence the intangible value of the company cannot be recognized. In fact, it requires 2/3 of the shareholders’ approval if the share is to be transferred to new shareholders rather than the current shareholder. This is often overcome by incorporating a provision in the AoA during the start-up on how share can be transferred.
It has articles about the increase of capital, but it often requires unanimity unless in the start-up MoU and AoA the shareholders have a prior agreement. It has articles about delegation of powers to directors, conditions for the issue of new shares and a preferred right of subscription etc., but it has only one class of shares. In modern economies shares such as ordinary shares, deferred ordinary shares, non-voting ordinary shares, redeemable shares, preference shares, cumulative preference shares and redeemable preference shares exist. All these have useful purposes in modern economies in helping companies raise capital and grow.
Articles 495-509 give a detailed framework for grounds for dissolution, appointment and removal of liquidators, survival of the company during winding-up, bankruptcy, duties and liability of liquidators, powers of liquidators, and prohibition from distributing assets among members before full payment of debts etc. However, the steps regarding how the companies need to be dissolved and how the court can appoint bankruptcy administrator is not included like that of Chapter 11 of the US and Insolvency Act of the UK. As a result companies like Access Real Estate are stuck in limbo for years to come with no end to the misery of homebuyers and shareholders.
Articles 521-524 address issues about share registration, but the share registration procedure is very cumbersome and some share companies like Habesha Cement, which has more than 16,500 shareholders, have to line-up and sign and this a big challenge in the modern business world.
Articles 525-538 set the rule for the appointment of managers, dismissal of managers, powers of managers, managers’ remuneration, liability of managers, modification of the AoA, right to inspect documents and auditors. However, it has no provision for disclosure of interest by the managers and directors and no criminal liability for undeserved benefits at the expense of shareholders. A certain company’s manager can set-up his own company to supply materials to a share company he is entrusted to manage without making a disclosure to shareholder. Failure to disclose benefits by the board of directors and managers is a criminal offence in many countries
Misselling, which is a deliberate, reckless, or negligent sale of products or services in circumstances where the contract is either misrepresented, or the product or service is unsuitable for the customer’s needs is not a criminal offence in the Ethiopian Commercial ode. Exaggeration is also commonplace in Initial Public Offering (IPO) and there is no requirement for IPO or at least a requirement for a signed off document by the board that the document issued is true to the best of knowledge of promoters at the time of publication.
There is no mandatory legal requirement for disclosure of risks at the time of selling. There is no liability for board of directors and promoters for abandoning share companies and destroying shareholders values and walk away.
The code has no provision for a regulatory body of share companies and there is no place to file a complaint by shareholders for mismanagement of share companies except taking the case to court. Only the financial sector is regulated by the National Bank of Ethiopia (NBE) and shareholders can file complaints and the regulatory body will investigate before take measures. There are circumstances where the NBE invalidates the election of board of directors.
The concept of “principal-agent conflict”, which is the conflict between managers and shareholders, is not addressed in the Ethiopian Commercial Code. As a result, it has exposed share companies to misuse and abuse of by agents and managers.
Articles 539-543 address issues related to accounts. Articles 544-554, relate to conversion into a private limited company, conversion of a private limited company into share company and amalgamation (merger); nevertheless, due to lack of a regulated market, mergers and acquisitions are primarily based on tangible valuation and there is no mechanism that will address goodwill, brands, patents, intellectual properties, trademarks and others intangible assets. The value of Facebook is not based on its hardware and furniture but in its intangible values such as brand and intellectual properties.
Articles 555-560, give guidance about foreign firms have their head office in Ethiopia, and firms incorporated abroad having a subsidiary office or branches in Ethiopia. However, the state of subsidiaries and group holdings are not recognized and accounts cannot be consolidated.
Overall, the commercial code was a well-drafted code at the time and happened to be useful in the last 58 years. But since the 1960s the world has moved and things that had never existed in the 1960s are often the main driving forces of businesses. The internet, e-commerce, mobile money, crypto currency, futures contract, spot contract, long selling and short selling, globalization, arbitrage fund, rent-seeking, market maker, debenture, qualitative easing, collateralized debt obligation, the credit default swap, bridge loan, mezzanine finance, broad money, base rate, capital adequacy ratio, stress test, crowding out effect, countervailing duties, invisible hands, market capitalization, recession, tax haven, tax avoidance, tax differed, money laundry, annuity, windfall gains etc. are the day-to-day terminologies of contract laws.
All these are part of modern legal contract in shaping today’s businesses since national barriers are coming down bringing global competition closer to home. As a result, even the terminology used in other countries’ contracts cannot be interpreted in the Ethiopian court of law. The law has many shortcomings, by virtue of its age, to serve the interests of businesses of today and the future.
In conclusion, the law has to be updated, but when it is updated it has to consider the above points. Above all, the law has to be drafted to enable businesses create jobs, prosperity and make innovations easy to compete in the global village.
The intelligentsias of the 1960s and advisors were very few but they have proven to be well educated to have the intellectual capital to think and draft a law that helped us regulate business effectively for 58 years. We need to recognize this achievement of the 1960s lawmakers to think deeper and work hard to have a code that will enable Ethiopian companies compete in the global economy.
If we can’t match the intellectual capital of the 1960s, then we will be disrupting businesses by setting chaos in the system. If the law is drafted with second-rate intellectuals that give little emphasis to innovation, businesses and prosperity, it will be a major impediment for the country.
There is an overriding skepticism towards the capability of contemporary lawyers, legislative drafters in drafting a 21st century commercial code or the ability of the lawmaker in scrutinizing details of the code to matching the caliber of the 1960s. This shortcoming can be overcome by using external contractors and conducting repeated stakeholders meeting to see if the new code will enable businesses in the 21st century to compete. But, we have no choice, and the commercial code has to be revised and the new commercial code must enable businesses to be innovative in creating jobs and prosperity.
Ed.’s Note: Yared Haile-Mekel, MSc, MPhil, and MBA, is the managing director of YHM Consulting. YHM Consulting and is an investment advisory service working in the area of start-ups, equity investing, debt financing and turnaround management. The views expressed in this article do not necessarily reflect the views of The Reporter. The writer can be reached at [email protected].