The ineffectiveness of the right of withdrawal in Colombia

Retirement law is one such topic. In legal literature, a distinction is often made between Law in Books and Law in Action to highlight situations in which the rules are written in one way but applied in another way or not at all.

Let us first analyze the right of withdrawal in books. Such a right, existing in Colombian law at least since 1995, allows associates dissatisfied with fundamental transformations in a company of which they are a part to leave the company in exchange for a sum of money representing the current market value of their contributions. In Colombia, and under certain requirements, such fundamental changes are mergers, spin-offs, transformations, global asset disposals and delisting of shares from a stock exchange. Without entering the discussion of whether these causes are all that they should be, the right of withdrawal is a legal figure that looks fair in theory, as an intermediate solution between the extremes of not giving any rights to the minority shareholders and granting them a veto right in case unanimity is required for certain decisions. In that event, the minority shareholders would be imprisoned in a corporate contract very different from the one to which they consented some time ago, and it would be unreasonable to require them to wait for the corporate term to expire or for them to find someone to acquire their securities. In the latter case, the veto right could encourage minority shareholders to demand perks in exchange for their favorable vote which, if not granted, would hinder mergers, spin-offs, transformations, or global disposals of efficient or value-maximizing assets. Likewise, from the perspective of the company and of the majority shareholders, and except in cases in which the former holds a large percentage of the capital, the benefit of the fundamental corporate change will be greater than the cost of losing some of its shareholders.

If the right of withdrawal looks so reasonable in theory, why is it almost never exercised in practice? Neither the author nor a significant number of lawyers he has consulted know of any case in which the right of withdrawal has been requested or exercised, except in situations of delisting of shares in the stock market. As additional evidence, on the occasion of a consultation by this author, and in communication with file number 2019-01-361921 and dated October 30, 2019, the Superintendency of Companies informed that, during the last five years, time for which statistics are kept, such Office has not determined either ex officio or at the request of a party the inappropriateness of the right of withdrawal when the redemption of shares, quotas or parts of interest affects the common pledge of creditors. Of course, the fact that the Superintendency of Corporations has not decided on the right of withdrawal does not mean that this right has not been exercised in amicable cases in which none of the parties request the assistance of this office, but it is a strong indication of its little or no use. Despite this lack of statistical certainty, the data of the Superintendence of Corporations plus intuition become a presumption of the practical inoperability of such right of recess.

Why is the right of withdrawal almost never exercised in Colombia? The reason is not, of course, the non-existence of mergers, spin-offs, transformations, or global disposals of assets. Other reasons, then, must be the explanation. This paper does not pretend to give the last word on the subject, because that requires empirical research with a robust statistical methodology, but it does venture some hypotheses.

A first reason lies in the law itself. According to Law 222 of 1995, exercising the right of withdrawal is not a simple procedure. Notice must be given within eight days from the date on which the decision was adopted that motivates the withdrawal of the associate, a time that seems short; the company can avoid such a recess by revoking said decision within the following sixty days, which generates uncertainty for the withdrawing member; And the Superintendence of Corporations could authorize the payment of the quotas or shares of the person leaving the company to be made not within two months, as established by law, but within a term or even determine ex officio the inadmissibility of the right of withdrawal when it is established that the reimbursement substantially affects the common pledge of the creditors. These administrative conditions could, within the short time available to decide, lead an associate to refrain from exercising the right of withdrawal, especially when he/she is a layman in legal matters and does not have easy access to legal advice. In economic terms, the transaction costs of exercising the right of withdrawal are high in Colombia.

An even more complex issue is the payment of the quotas or shares of the withdrawing associate. Either because the company or other associates acquire such securities or because they are reimbursed from a capital reduction, the great discussion revolves around the value to be paid. Most likely and based on the endowment effect whereby people value the assets they have more highly than those they do not own, the claimant will demand a very high value and the other partners or the company will offer a low figure. Except for a quick settlement, which is difficult when the different partners are at odds, only litigation can solve this problem. In fact, in the United States and especially in the State of Delaware, most of the cases on withdrawal rights have as their main legal problem the valuation of the shares (appraisal rights). In short, the associate who, like Hamlet, is pondering whether or not to withdraw will ask himself whether it makes sense to face a litigation that could determine a high price, but also a low one, that will generate legal costs, that will last at least several months, and that may then require another process, an executive one, in which the sum decided by the respective judge will be collected.

Tax regulations may be a third reason for not exercising the right of withdrawal. Exercising such right implies a disposal that generates an occasional profit or income tax, depending on the nature of the shares and the time they have been owned by the transferor. Just as many times people refrain from selling assets such as land in order not to pay the corresponding tax, the same could happen with shares, especially if the tax generated is substantial.

Finally, there are economic and psychological reasons that may motivate a shareholder not to exercise the right of withdrawal. In the first place, and especially in conflictive family companies, the shareholder who can withdraw will prefer not to do so not only to avoid the litigation required to value the securities, but also not to give his or her relatives the pleasure of getting rid of him or her so easily. In addition, if he or she has a combative and revanchist spirit and a certain amount of time available, he or she will want to remain in society to remain aware of what is happening in it and, of course, to continue fighting every decision that is made.

As a possible final cause, behavioral economics has shown that, when faced with a decision, people prefer to err by omission and not by commission, thus minimizing future regret. That is to say, the recedent would rather err by not exercising the right of withdrawal than by doing so.  

Although this brief brief began by expressing weariness with the overwhelming amount of legal analysis related to Covid-19, the temptation to comment on the subject will not be resisted. Given the large liquidity needs to be had soon, minority shareholders could take advantage of mergers, spin-offs, transformations, and global asset disposals that are perfected to exercise withdrawal rights to liquidate their investments early. This is not a prediction, but a possibility that would lead to such withdrawal right having a greater practical importance in Colombia, at least temporarily.

*Article courtesy of the “Instituto de Análisis societario”.