We are glad to present to you an overview of established practices in applying the Russian law concerning M & A transactions.
Several of the recently adopted amendments to the Civil Code (the "CC"), which were introduced in two blocks (the first block containing changes to chapters 1, 2, 3 and 4 of the CC, provided by the Federal Law № 302-FZ, which came into force 01.03.2013, the second block provided by the Federal Law № 100-FZ, which came into force on 01.09.2013), mostly positively affect the parties’ ability to conduct transactions in Russia, including the M & A deals.
Below we examine the most significant amendments to the CC, as they relate to the M&A deals.
The principle of good faith
The first block of amendments entrenches the principle of good faith in establishment, execution and defense of civil rights and duties under a contract as one of the basic principles of civil law. Moreover, a prohibition on deriving of profit from illegal or dishonest behavior is established.
This principle is further developed in the second block: there appears a new provision that protects a purchaser in good faith. Under this new provision, a transaction made in violation of the prohibition on the disposition of the debtor's property imposed for the benefit of its creditors or other authorized person by court or otherwise prescribed by law, shall nonetheless remain in force if the purchaser of the property didn’t know (or should not have reasonably known) of such a prohibition.
Furthermore, a fraudulent concealment of the circumstances, of which a person should have informed its counter party in good faith required under terms of commercial intercourse, is considered to be a fraud. Accordingly, a transaction made under the influence of such fraud may be invalidated under the claim of the victim. This provision seems important in terms of M & A deals in cases when the seller intentionally does not disclose to the buyer any risks or other adverse circumstances related to the assets or stock purchased by the buyer. At the same time, according to the amendments, a transaction made under the influence of fraud by a third party, may be invalidated under the claim of the victim, only if the other party didn’t know (or should not have reasonably known) about the fraud. It is presumed that a party (e.g. the seller) knew about the fraud if a third party found guilty of defrauding was its representative or employee or otherwise contributed to the transaction.
Prevention of undue/ unconscientious challenging of the transactions
This principle, just like the principle of good faith, aims to help stabilize and encourage commerce, via simplification of conditions for the execution of commercial transactions. In accordance with this principle, a party may not challenge the deal based on the grounds or circumstances that were within his or her will and control.
Furthermore, there is a provision under which a statement of invalidity of the transaction has no legal effect if the person referring to the invalidity of the transaction acts unconscientiously, and in particular, if its behavior after the execution of the deal induced others to rely on the validity of the transaction.
This provision can be regarded as a form of estoppel, which limits the possibility of exercising the right against the party who, based on the behavior of its contracting party, had reason to believe that this right will not be exercised.
From this point of view, the general provisions contained in the second block of the amendments, seem to be important. According to them:
- person challenging the transaction must be either party to the transaction, or any other person specified by law;
- in order to claim a voidable transaction to be invalid, the plaintiff must prove that the transaction violates his rights and legitimate interests;
- any transaction violating the requirements of law or regulations shall be deemed voidable, and not void (as was the case in the prior edition of the CC);
- the court may on its own initiative enforce a void transaction only in cases where it is expressly provided by law, or in case the transaction violates public interest.
The development of the abuse of right concept
The first block of changes developed a new abuse of right concept. Particularly, it is stipulated that a complete or partial refusal of the court to protect the rights of a person, as well as an imposition of damages (payable to the person whose rights are infringed) could be used as remedies if the court finds abuse of rights on the part of one of the parties.
The principle of materiality of ignorance (mistake) when challenging transaction on the grounds of ignorance (mistake)
According to the second block's amendments, the transaction made under ignorance (mistake) may be annulled only in case such ignorance (mistake) is material in nature and the party acting under such ignorance (mistake) wouldn't have made this transaction if it had knowledge of the real circumstances.
The amendments expand the list of cases when ignorance (mistake) should be classified as material, adding in it, inter alia:
- An obvious slip or mistyping made by the party;
- mistake as to a person with whom he or she enters into a transaction or as to a person related to the transaction.
At the same time the parties have an opportunity to reaffirm the transaction on the conditions as known to the party acting under the ignorance (mistake) at the time the contract was concluded. The conditions of the reaffirmed transaction have to be listed in the court’s decision.
The above-mentioned amendment is conducive to the stability and certainty of commercial relations.
Regulation of transactions requiring consent
The changes to the CC contained in the second block also establish general rules for granting of consent to perform a transaction by third parties, state or municipal authorities or by the governing body of a legal entity when such consent is required by law. Notice of acceptance or refusal of the transaction shall be sent to the person that requested the consent or to other interested persons within a reasonable time after the receipt of the request made by the person requesting the consent.
At the same time the CC provides two types of consent: consent prior to the transaction and the subsequent consent (approval) of the transaction. The prior consent must determine the subject of the transaction for which consent is given, and the subsequent consent (approval) must specify approved transaction.
Also, the consequences of non-consent are specified (which previously were not clear due to the absence of relevant rules). As a general rule, a transaction made without the required consent is voidable. Other, additional consequences may be established by special laws. In addition, in the cases specified by law, the consequences of the lack of the required consent can also be regulated by an agreement with a person whose consent is necessary.
Undoubtedly, the provisions of the CC related to the consent to the transaction will play a significant role in structuring and timing of the M & A transactions and other sophisticated transactions requiring different types of consents.
Agency (power of attorney)
According to the second block's amendments, the authority may be granted not only by a power of attorney as a separate document, but may also be included in a contract or in a decision made during the meeting of the legal entity’s governing body. The possibility of granting the power of attorney jointly by several persons or to several agents is expressly provided. In the latter case, every agent may act on its own, unless the power of attorney stipulates that agents shall exercise their powers jointly.
The amendments also remove the limitation on the maximum period of validity of the power of attorney (3 years), allowing granting of a power of attorney for a longer period. At the same time, the possibility of granting an irrevocable power of attorney or a power of attorney that specifies the cases in which it may be revoked is introduced. Obviously, an ability to provide an irrevocable power of attorney is extremely important for M & A transactions.
However, the irrevocable power of attorney's applicability is limited: such power of attorney may be granted only for the purposes of dealing with legal entities (not individuals).
It is not yet clear how widely these new provisions can be used in terms of M & A deals. For example, can a seller can give a power of attorney to the buyer in order to authorize the buyer (or the buyer’s representatives) to attend in general meetings of shareholders of the target company during the period between signing and closing (to secure an obligation of the seller to give the buyer partial control over the target during the corresponding period)? Not clear.
The concept of legally relevant facts
The new version of the CC introduces the concept of legally relevant facts, which are defined as statements, notices, notifications, claims or other legally relevant facts to which the law or the transaction connects civil consequences for another person.
This institution covers primarily written notices, which one party to the transaction sends to the other party (other parties) and which have legal consequences, provided by law or the transaction, for the recipient(s) (for example, notification of the debtor regarding the transfer of the debt to a new creditor). It will be interesting to see how effectively the concept may be used for the purposes of the M & A deals (for example, in the context of such written reports as disclosure letters in relation to the risks associated with the asset to be sold or generally with regard to representations and warranties, which the seller gives the buyer under a corresponding contract of sale).
The status of contingent transactions (with potestative condition)
Potestative transactions (transactions under the condition, the occurrence of which exclusively or mainly depends on the will of one of the parties) are extremely popular in the context of the M & A deals (e.g., sale of shares under the condition of obtaining financing by the buyer). However, during the discussion of the second block of the amendments to the CC several proposals were made to introduce an express prohibition on such transactions. Undoubtedly, this would have seriously impaired the M & A deal-making under Russian law.
Fortunately, these proposals were rejected, but the amendments do not contain provisions on the permissibility of such transactions. As a result, the question of the admissibility of such deals is left to the courts' discretion.
We can only hope that the law enforcement practice will meet the needs of the business community and the decision on the impermissibility of such transactions will occur only in very rare cases - for example, where it is necessary to protect the public interest.
Generally, the proposed Civil Code changes are undoubtedly positive in terms of commercial deals in general and M & A deals in particular and also in terms of certainty and development of commercial relationships in Russia.