Since as early as 1994, Russian corporate legislation has been comparatively strict in cases where the net assets of a company turn negative:
- if the net assets of a company fall below its the registered share capital, the share capital was to be decreased to the level of the actual net assets,
- if the net assets of a company fall below the statutory minimum share capital, the company was to be liquidated.
Inconsistency in Enforcement of the Share Capital Rules
Legislation did not provide any qualifications or mandatory procedures to be applied in the above cases. This lead to a contradictory situation: on the one hand, many companies with negative assets have carried on business without taking the steps required by law; on the other hand, certain public authorities have had the authority to file a law suit in cases where the net assets of a company fell below the share capital, but have not always done so. Recently the situation was brought to a head due to the tax authorities taking a more aggressive approach to filing suits for liquidation of the companies with the negative assets.
The Constitutional Court of Russia has taken a reasonable approach, maintaining that the rules stated above are applicable if the company’s net assets situation has persisted for a substantial period of time and there is no reasonable expectation for improvement.
Legislation Amended to Comply with the Prevailing Practice
As of 31 December 2009, legislation has been amended to reflect this more reasonable approach with regard to Russian joint stock companies (AO):
- Starting from the company’s second and each following financial period, if the net assets of a company fall below its share capital, the board of directors is to include the issue of net assets in the agenda of the annual general meeting of shareholders. The board must include the reasons for the situation and recommend a course of action to correct it. If the situation persists in the next financial period, the company is to make a decision to decrease the share capital or liquidate the company.
- If the net assets of a company fall more than 25% below its share capital (and if this takes place during the financial period following the period when the company’s net assets first turned negative), the company must publish a notification on the decrease of its net assets.
- If the net assets of a company fall below the statutory minimum share capital, the company is to be liquidated.
Finally, the law has specified that the Federal Tax Service is the competent state authority to file a law suit on liquidation of a company if the company has not taken the steps required by law due to a negative net assets situation.
Creditors’ Right to Request Premature Performance of Obligations Weakened
In share capital decreases, all creditors could previously request premature performance of obligations from the company (and the company was obliged to inform the creditors of a capital decrease). This creditors’ right is now subject to counter-arguments by the company. If the company proves that:
the rights of the respective creditor are not jeopardised following the share capital decrease, the security provided for the due performance of the respective obligation is sufficient, the court may reject the creditor’s claim for premature performance of the obligations of the company.
The same rule is applicable to decreases of the net assets of a company if the decrease exceeds the 25% threshold stated above.
Creditors Must Remain Alert
The reformed law provides for a shorter statutory limitation period within which the creditor is entitled to file a law suit, i.e. six months from the last announcement by the company of a capital/net assets decrease published in the manner prescribed by the law.
Since 31 December 2009, joint stock companies that have decided to decrease their share capital are not obliged to notify all their creditors of the decision. Instead, the companies must notify the authorities responsible for the state registration of legal entities (the Federal Tax Service) and publish respective notices in specialised mass media twice (but only once a month).