Significant changes have recently shaken Russian corporate law: the Russian Civil Code Part I Chapter 4 which provides for the basic regulation of legal entities has been unprecedentedly restated1. The changes will ultimately affect all Russian legal entities, as well as their foreign founders (shareholders), counterparties and individuals/entities exercising control over such entities.
The conceptual idea underlying the amendments was to upgrade outdated corporate legislation that had proved inconsistent with modern requirements. The authors of the long-awaited amendments also relied on aspects of commercial law successfully utilized in other jurisdictions but unavailable in Russia.
Unfortunately, quite a number of issues covered by the amendments remain unclear until further changes to other Russian legislation and subordinate legal acts are adopted. These are necessary to shed light on the implications of new concepts and to provide guidelines on their practical implementation. Until further legislation amends and supplants existing laws in accordance with the latest changes to the Civil Code, the existing provisions apply to the extent that they do not contradict the Civil Code.
The amendments will enter into force on 1 September 2014.
The following is a brief summary of certain key changes including: (1) the compliance term, (2) new classification of legal entities, (3) foundation document requirements, (4) registration formalities, (5) charter capital, (6) participants’ rights and obligations, (7) general provisions on corporate agreements, (8) management structure and composition, (9) extension of liability, (10) auditing, and (11) reorganization.
Mandatory re-registration of existing entities is not required. However, legal entities are required to comply with the new regulations by amending their names (firm names must indicate organizational form according to Russian law) and foundation documents at the first time they register any other changes in the foundation documents.
Classification of legal entities
The Civil Code introduces a classification of legal entities previously unknown to Russian law. All legal entities are now divided into corporations and unitary legal entities. Legal entities having members or shareholders and the right of participation in governance are designated as corporations whereas entities whose founders have ownership rights over its assets are categorized as unitary legal entities. The majority of legal entities now fall under the status of corporations including both commercial and noncommercial entities such as non-profit organizations.
Commercial companies may be established either as joint stock companies or as limited liability companies. As to joint stock companies, the former classification (i.e., closed vs. open joint stock companies) has been eliminated. Instead, joint stock companies whose shares are publicly traded are referred to as public companies2. All other joint stock companies and all limited liability companies are considered non-public.
Requirements for public joint stock companies (composition of their management bodies, their authority, etc.) are rather strict and generally cannot be modified; whereas participants in non-public companies have more discretion with respect to the management and activity of their companies. Flexibility previously attributable to limited liability companies has thus been extended to non-public joint stock companies.
Companies carrying out certain types of business activities are subject to relevant licensing and membership requirements. For some regulated activities, the right to perform a business activity will depend on valid membership in professional self-regulated organizations. Failure to prove such membership or absence of a specific certificate issued by the relevant organization may serve as grounds for liquidation of the company engaged in the regulated activity.
Foundation and other regulating documents
The only foundation document of any legal entity is its charter (except for partnerships which operate based on a foundation agreement having the legal effect of a charter). In addition to significant changes to the requirements relating to the charter’s content, standard forms charters may now be used to establish legal entities. The standard forms are to be developed by the state authorities in the order set forth by the legislation. If an entity is going to operate based on a standard charter, the details specific to the legal entity (such as its name and location) are not included in the standard form and instead have to be specified in the Unified State Register of Legal Entities (USRLE).
In addition to the foundation document, the founders (participants) of a legal entity may adopt internal by-laws regulating corporate relations in the legal entity consistent with the provisions of the foundation document.
Address, registration formalities
Legal entities are no longer required to specify their full address in the foundation document. It is only necessary to indicate the name of the municipality, unless the entity uses a standard form charter where this requirement is omitted. The location and full contact address of the legal entity must be submitted to the USRLE.
Russian entities are also no longer required to specify their representative offices and branches in their foundation documents. This information now must be reported to, and reflected in, the USRLE.
Keep in mind that, according to the new rules, communications received by a foreign legal entity’s representative located in Russia will be deemed properly delivered to such legal entity.
The initial minimum charter capital requirement of a joint stock company and a limited liability company must be paid in cash (versus non-monetary contributions such as intellectual property). Unless otherwise provided by law, the founders are obliged to pay at least ¾ of the charter capital prior to the company’s state registration with the balance being due within the first year of its activity.
An additional non-monetary contribution to the charter capital of a joint stock or a limited liability company is possible but requires an assessment of the contribution by an independent appraiser.
Participants’ rights and obligations
If a corporation or its participants intend to file an action claiming compensation for damages suffered by the corporation or invalidation of a transaction entered into by the corporation, they must take reasonable measures to timely notify other participants of the corporation. If the other participants do not join the claim, they are barred from filing similar claims in the future.
If a participant in a commercial corporation has lost its participation right against its will due to unlawful actions of other participants or third parties, the participant is entitled to seek (1) restoration of its participation interest and (2) compensation of related damages from the persons liable for the loss. A participant, who is not liable for the loss, is entitled to compensation for any lost participation interest resulting from restoration to the initial owner. In certain cases, the court may refuse to restore the participation interest to its initial owner, in which case fair compensation will be paid to the claimant.
Any participant in a company (except for public entities) or a partnership is entitled to apply for court ordered expulsion of another participant in the event that the latter caused material harm to the corporation or otherwise created significant impediments to its activity and achievement of the purpose for which the company was established. Waiver or limitation of such right will be null and void.
Participants in all companies (not only limited liability companies as was the case under previous legislation) and partnerships are obliged to make investments in the company/partnership (in the form of contribution to its assets). In addition, participants of a non-public joint stock company and a limited liability company may be entitled to corporate rights exceeding their proportion of the entity’s participation interests/shares. Such rights should be specified in the entity’s charter or in a corporate agreement.
Amendments to the Civil Code have introduced general provisions on corporate agreements. These amendments supplement previous regulations relating to shareholder agreements and agreements on execution of participants’ rights. In particular, participants who are party to a corporate agreement are obliged to notify the company regarding the agreement (without disclosure of terms). As a general rule, information on corporate agreements of non-public companies is confidential and is not subject to a disclosure, whereas information on public joint stock company corporate agreements must be disclosed.
In the event that all participants of a legal entity are parties to a corporate agreement, breaching the respective agreement may serve as a basis for invalidating a company decision. Note that invalidation of a company decision does not automatically result in the invalidation of transactions entered into on the basis of the company decision.
Creditors of the company and third parties may now enter into corporate agreements with participants of the company for the purpose of securing their interests. Such agreements may oblige the participants to perform or refrain from performing their corporate rights in a certain manner including directing their votes at general meetings.
As opposed to the previous rule requiring only a single representative, Russian entities may now choose to have more than one authorized representative acting jointly (where there is a single executive body composed of multiple persons).or independently (where multiple sole executive bodies are established) on behalf of the company. The representative(s) must be specified in the foundation document and their relevant information should be entered into the USRLE.
The Civil Code provides particularly more flexibility in relation to corporate governance of non-public legal entities. Non-public legal entities are afforded greater discretion in terms of distribution of authority among various management bodies, and the order of conducting and adopting decisions at the participants’ general meeting, and at collegial management bodies (e.g. board of directors,) and collegial executive bodies.
Extension of liability
The Civil Code establishes liability for a new category of persons. A majority participant, shareholder or other person having the ability to exercise control over a legal entity by determining its actions and directing the actions of its director(s) and executive(s) is required to act reasonably, in good faith and in the interest of the legal entity. Such a person may be held liable for damages suffered by the entity as a result of his or her fault. Any agreement to eliminate or limit the liability of a person controlling the entity’s activities will be null and void. Similarly, any agreement to eliminate or limit the liability of a public company’s director(s) and management body members for bad faith and unreasonable actions shall be null and void. For non-public entities, agreements to limit the director and management body members’ liability for unreasonable acts are allowed, whereas limitation of liability for bad-faith actions is restricted.
Executing meeting minutes
New requirements for certifying quorum and decisions adopted at a company’s general meeting of participants are as follows:
- public joint stock companies – certified by an independent and duly licensed organization fulfilling functions of the registrar and a counting committee (the Counting Committee);
- non-public joint stock companies – certified by a notary or by the Counting Committee;
- limited liability companies – certified by a notary (unless other methods of confirmation are provided in the company’s charter or by a unanimously adopted decision of the participants’ general meeting).
Any joint stock company is obliged to carry out an annual independent audit review of its accounting (financial) statements.
It is now permissible to simultaneously use a combination of various reorganization methods such as merger, spin-off and transformation. In addition, the law permits reorganization of more than one entity, including entities of various corporate forms.
A legal entity is required to record the commencement of its reorganization procedures with the USRLE. Unless another term is established by law, the Civil Code now prohibits the state registration of a legal entity formed as a result of reorganization earlier than three months from the date of the relevant entry of reorganization commencement at the USRLE.
The legislators specifically focused on issues relating to the rights of creditors of a legal entity undergoing reorganization. In particular, a newly formed entity is jointly liable for the obligations of the reorganized entity (in the event it is impossible to determine the actual legal successor or in case reorganization results in an unfair distribution of assets).
In case of reorganization, a creditor’s general right to claim early fulfillment of obligations and damages may be restricted on the basis of an agreement between the creditor and the reorganized entity. Furthermore, the Civil Code has introduced the concept of sufficient security to guarantee the reorganized entity’s right against creditors’ claims.
The Civil Code also addressed the consequences of invalidating a legal entity’s decision on reorganization. Invalidation of the decision neither leads to liquidation of the newly formed entities nor may it serve as a ground for invalidating deals made by such entities. The Civil Code does simultaneously set out specific instances where the reorganization itself may be invalidated