The end of 2008 was remarkable because of the intensive lawmaking activity in Russia, amongst which included substantial changes to Russian corporate law through the recent amendments (Amendments) to the Federal Law No. 14-FZ on Limited Liability Companies (LLC Law). The Amendments provide for significant modifications in the manner in which the rights of participants of a limited liability company (LLC) may be exercised, including the right to enter into participants’ agreements and to dispose of participatory interests in an LLC, as well as modifications that improve corporate governance procedures. The Amendments also clarify certain ambiguous provisions that exist under the current version of the LLC Law. As a result, the Russian LLC may become a more attractive vehicle for investors engaging in joint venture projects.
The following significant modifications and changes have been introduced by the Amendments:
- amended structure of constituent documents;
- right to enter into participants’ agreement;
- right to limit the ability of participants to withdraw from an LLC;
- redemption of participatory interest by an LLC;
- stricter procedure of transfer of a participatory interest;
- institution of a participants’ register;
- requirement for notary certification of a pledge of participatory interest;
- amendment of the competence of the management bodies;
- institution of a limited time period for challenging decisions of the board of directors (supervisory board); and
- regulation of interested-party transactions and major transactions of an LLC.
The Amendments are applicable to existing and newly established LLC’s and enter into force on July 1, 2009.
The purpose of this note is to provide a general overview of the recent amendments to the LLC Law.
Charter Capital and Constituent Documents
According to the Amendments, the minimum amount for the charter capital of an LLC is 10,000 Rubles. The previous version of the LLC Law provided for the minimum amount of an LLC charter capital to be equal to 100 minimum monthly wages calculated as of the date of state registration of the LLC. The Amendments do not clearly indicate the need for an existing LLC, whose charter capital is under 10,000 Rubles, to increase its charter capital in accordance with the specified amount. However, taking into account that charters of LLCs set up before July 1, 2009, must be brought into compliance with the new provisions, for the avoidance of unnecessary questions and complications, we would recommend ensuring that the charter capital also corresponds to the new provisions.
The Amendments remove the foundation agreement from the list of constituent documents of an LLC. In the past, there has been a lot of discussion on duplication of the constituent documents (i.e., the foundation agreement and the charter) which was ineffective and unnecessary. Now, the charter will become the only constituent document of an LLC.
Starting July 1, 2009, the foundation agreement will be required only at the stage of initial registration of an LLC. It has to contain information necessary for state registration, including, for example, information on the amount and nominal value of the participatory interest that will be reflected in the Unified State Register of Legal Entities (EGRUL). The foundation agreement also determines the amount, terms and conditions of payments for participatory interests in the charter capital of an LLC, and may provide for penalties for late payments for the participatory interest. The foundation agreement also addresses the issues of partial payment for participatory interests: if a participatory interest is not fully paid during the term specified in foundation agreement, the unpaid part of the participatory interest is transferred to the LLC, subsequently to be sold by the LLC on the terms and conditions specified in the LLC Law. Importantly, before a participatory interest is paid in full, participant carries voting rights only in the proportion of the paid part.
Introduction of Participants’ Agreement
The Amendments expand the participants’ rights. The LLC Law now allows an agreement to set forth participants’ rights (Participants’ Agreement). Starting July 1, 2009, participants of an LLC (including existing ones) may enter into such an agreement to regulate the way of exercising or refraining from exercising certain rights, including the following:
- voting in a certain manner at a general meeting of participants and agreeing on voting options and procedures with other participants;
- selling participatory interests or a part of a participatory interest at a price specified in the Participants’ Agreement and/or under specified circumstances, or refrain from selling under specified circumstances; and
- exercising other actions related to corporate governance, and setting-up, reorganization, and liquidation of an LLC in an agreed manner.
Notwithstanding that the Amendments for the first time in the Russian law introduce the concept of “participants” or “shareholders’ agreements” which are well known in many other jurisdictions, the LLC Law is still unclear on how such Participants’ Agreement will conform with the LLC’s charter and (which is even more important), how the Participants’ Agreement will be enforced in Russia. We expect that these and further developments in Russian legislation will simplify the process of setting up joint venture companies in Russia, thus eliminating the need of using English-law or the laws of other jurisdictions, which recognize shareholders’ agreements, for these purposes.
Limitation on the Right of Exit from a Limited Liability Company
At the moment, the right of withdrawal cannot be limited by the parties. Such ability of a participant to cash-out makes an LLC not very attractive for joint venture projects. The existing right to withdraw may affect not only the financial and other interests of an LLC and of remaining participants, but also the rights of creditors of the LLC.
The Amendments provide for limiting a participants’ right to exit from an LLC at its own discretion at any time. In accordance with the Amendments, a participant will be entitled to withdraw from an LLC only if the right to withdraw is expressly provided under the LLC charter. As to the existing LLCs, the Amendments provide that ¾ votes of all participants are required to amend the charter to restrict the participants’ rights to withdraw.
Further, the Amendments clarify that an exit of the sole participant from an LLC or an exit that leads to the absence of any participants in an LLC is prohibited.
Redemption of Participatory Interests
In accordance with the Amendments, an LLC may redeem participatory interests only in cases provided for by the LLC Law. The LLC Law has now been brought in line with the Russian Federal Law on Joint-Stock Companies (JSC Law), which provides for an obligation of a jointstock company (JSC) to acquire its shares in certain cases. The provisions introduced to the LLC Law are aimed at protecting minority participants. If a participant did not vote or voted against a major transaction or an increase of the charter capital, and the decision was nevertheless passed, the participant has 45 days after the date when the decision was adopted to demand that the LLC purchase its participatory interest. If the participant did not take part in the general meeting when one of the above decisions was adopted, it may still demand a redemption within 45 days from the date when it became aware of the decision. The participatory interest must be acquired within 3 months (unless a different term is provided under the charter of the LLC, or unless otherwise agreed on by the participants) for its actual value as per the account statements for the most recent accounting period.
Transfer of Ownership of Participatory Interests
- Notary Certification of Participatory Interest Purchase Agreements
The Amendments imply that starting from July 1, 2009, save for certain specific exceptions, all agreements regarding transfer of title to a participatory interest in the charter capital of an LLC should be notarized in order to be valid. New provisions of the LLC Law provide for a very limited number of cases when notary certification for transfer of the title is not required. These mainly include cases of redemption of participatory interests by an LLC, e.g., in the case of an exit from the LLC. Amendments provide for an obligation of a notary to verify the authority of the seller of the participatory interest and set forth the list of documents that are required from the seller as a confirmation of title to the participatory interest.
Fees charged by notaries for certification of agreement for transfer of participatory interest will be equal to 0.5 percent of the contract value, but no less than 300 Rubles and no more than 20,000 Rubles.
Documents confirming title to participatory interest acquired prior to July 1, 2009, without notary certification remain valid but title should be confirmed by certain documents in case of subsequent transfers after July 1, 2009.
The LLC Law does not provide an exhaustive list of documents required for the purpose of notary certification. Thus, in practice, some other documents may be requested by a notary public.
The Amendments provide that transfer of title to a participatory interest under an agreement certified by a notary occurs at the moment of certification, whereas in transactions where no certification is required, transfer of title occurs at the moment when the corresponding entry into the EGRUL is made.
- Amending the Procedure for the State Registration of Changes of Participants
Current regulations provide that application for amendments to EGRUL records regarding changes of participants should be filed by the general director of the LLC. The new procedure abandons the requirement of involving the general director.
In accordance with the Amendments, within three days after notary certification of the transaction on the sale of a participatory interest, the notary public is required to file an application for amending EGRUL records on title to participatory interest maintained by the registration authority, currently the Federal Tax Service of the Russian Federation (FTS). Such an application must be signed by the seller of the participatory interest in the LLC.
The new procedure for amending EGRUL records in relation to the transfer of title to a participatory interest introduces a requirement for submission of a participatory interest purchase agreement to the registration authority.
The new requirement for notary certification of participatory interest purchase agreement and its submission to the registration authorities will make transfers of participatory interests more transparent. In particular, from July 1, 2009, Russian tax authorities will have information on the payments terms, which will put them in a better position to ensure that the parties comply with applicable tax rules. Further, these requirements may result in undesirable disclosure of certain sensitive information, including the purchase price, to third parties.
- Verification of the Seller’s Title to a Participatory Interest
The notary public is required to verify the seller’s title to a participatory interest. The rights of the seller of the participatory interest in the charter capital of an LLC should be confirmed by the agreement under which relevant participatory interest was previously acquired by the seller (if acquired after July 1, 2009, such agreement should be certified by a notary public), as well as by an EGRUL extract containing information about the seller’s title to the participatory interest.
If the participatory interest was acquired under a transaction where the requirement for a notary certification did not apply, or before such certification became mandatory, the seller’s title to the participatory interest should be confirmed by a document stating the contents of the transaction, executed in written form, as well as by an EGRUL extract issued not earlier than thirty days prior to the date of the acquisition .
- Permitted Exclusion of Data on the Amount and Nominal Value of Participatory Interests
The Amendments permit the exclusion of data on the amount and nominal value of participants’ interests in an LLC from the LLC charter. The only source of information on the amount and nominal value of participatory interests of an LLC, with the exception of internal documents of the LLC, will be an extract from the EGRUL. In the past, changes in the number of participants or the value of their interests required amendments to the constituent documents. From July 1, 2009, such an amendment will not be required.
- Modifications in Regulation of the Pre-Emptive Right
The LLC Law has broadly specified the procedure for LLC participants to carry out their preemptive right in case of a sale by one of the participants of its participatory interest to a third party.
The remaining participants of an LLC may purchase the participatory interest being sold for a price different from the price offered to a third party purchaser, if it is pre-determined in the charter of the LLC. The pre-determined price may either be fixed or determined on the basis of any criteria of estimation of participatory interest value (e.g., net asset value, book value, net profit). The pre-determined price should be same for all participants, regardless of their share in the charter capital of the LLC. The price offered to third parties cannot be less than such a pre-determined price.
Institution of a Participants’ Register
The LLC Law obliges an LLC to maintain a register of participants (Participants’ Register) indicating information about each participant, its participatory interest, and any participatory interest that belongs to the LLC itself (i.e., “treasury shares”). The obligation to keep this information consistent with the EGRUL is imposed on the sole executive body of an LLC.
It appears that the Participants’ Register is of a purely informational nature and does not have the same status as the shareholders’ register in a JSC, an extract from which is a title evidencing document. Also, the shareholders’ register in a JSC contains information regarding charges over shares, while the Participants’ Register is not supposed to track this information. In case of any inconsistency, the title to participatory interests should be determined on the basis of the data indicated in the EGRUL.
Registration of Pledge of Participatory Interests with EGRUL
In accordance with the Amendments, any pledge of a participatory interest has to be certified by a notary in order to be valid. This rule is established in order to minimize the risk of illegal pledges by a pledgor of a participatory interest in favor of several pledgeholders. The notary public has an obligation not only to certify the pledge agreements, but also to file an application to the FTS about such a pledge. The registration authorities have to make a respective entry into the EGRUL in order to reflect the pledge. This is a modification to the LLC Law since currently the EGRUL does not provide for any information concerning encumbrances over participatory interests. At the same time, the Amendments are silent on participatory interest pledge agreements executed before July 1, 2009; there is no requirement to have them certified by notary or to submit the respective information to the EGRUL.
Competence of a Limited Liability Company’s Management Bodies
The Amendments addressed certain issues related to the competence of the LLC’s managements bodies. Upon entry of the Amendments into force, the participants of an LLC will have greater flexibility in allocating powers between the management bodies of the LLC. In particular, some of the issues that earlier fell within the exclusive competence of the general meeting of participants from July 1, 2009 can be delegated to other management bodies.
Limited Time Period for Challenging a Decision of the Board of Directors (Supervisory Board) of a Limited Liability Company
The Amendments state that a participant can challenge a decision adopted by the board of directors (supervisory board) of an LLC by submitting a claim to the court within two months of the date when the participant became aware of, or should have become aware of, the adoption of such a decision.
Provisions on Interested-Party Transactions and Major Transactions Brought into Consistency with the Mirror Provisions of the Law on Joint-Stock Companies
The Amendments address certain issues relating to approvals of major transactions and interested parties transactions and conform these provisions to existing provisions of the JSC Law.
One of the modifications specifies that resolutions adopted by a general meeting of participants approving a future interested party transaction, will be valid until the next annual meeting of participants, if not otherwise provided in respective resolution. Before, the absence of this provision in the LLC Law gave rise to numerous disputes, and the amended position reflects existing court practice.
The Amendments will come into effect on July 1, 2009. In order to comply with the requirements of the Amendments, we have the following recommendations:
- LLCs set up before July 1, 2009 need to bring their Charters into compliance with the Amendments. This action should be taken between July 1, 2009 and January 1, 2010. If this step is not taken, non-amended Charters will apply only to the extent not contradicting the amended LLC Law.
- In the light of the new requirements related to the verification of title to participatory interests, it is advisable to ensure that all documents and information needed to verify title are in place and duly registered before the Amendments become effective.
- If there are any contemplated transactions with participatory interests or and other changes in the participants’ structure, it is advisable to perform them before July 1, 2009 because after this date such actions will be subject to the new notary certification requirements and will require more time, money and effort.
- Major transactions or a charter capital increase (including an increase as a result of the admission of a new participant) taking place after July 1, 2009 will be subject to new redemption rules described above in paragraph Redemption of Participatory Interests.
- The LLC participants may consider the following opportunities provided by the Amendments: Entering into a Participants’ Agreement;
- Restricting or excluding the right of participants to withdraw from the LLC; and
- Altering the authorities and composition of the management bodies of the LLC.
On the one hand, the Amendments give more flexibility to participants and make an LLC more attractive for the purposes of a joint venture vehicle. This new flexibility relates to corporate governance; arrangements between partners dealing with voting or pre-emptive rights; and the ability to restrict withdrawal rights.
On the other hand, after July 1, 2009, the life of a Russian LLC will become more transparent and be subject to more strict regulations. These provisions mainly relate to the new procedure for transferring participatory interests.
The Amendments make the legal regime of an LLC similar to that of a closed joint-stock company. Thus, the question arises whether further changes in Russian corporate legislation are expected in order to make these legal forms more different from each other. Also, with the introduction of participants’ agreement in LLC, it would be reasonable to extend the same changes to closed JSCs.