2013 marks a turning point in the phased overhaul of the Russian Civil Code (the “Civil Code”). The first phase of the reform package, which introduced in particular the duty of good faith in civil relations, came into force on 1 March 2013. The second reform phase, with most changes effective from 1 September 2013, focuses on transactions. It also contains provisions affecting resolutions of general meetings, powers of attorney and limitation periods.
Overall, the second set of amendments (the “Amendments”) are aimed at modernising the regulation of transactions and enhancing the protection of good faith counterparties. Certain Amendments endorse court practice through codification, while some introduce new rules or concepts, or remove outdated ones.
Below is a brief overview of selected changes that are likely to have an impact on business.
1.1 Challenging transactions in court
New rules on challenging the validity of transactions, the most significant of which are outlined below, will apply to transactions concluded from 1 September 2013. They are designed to prevent challenges being made on purely technical grounds.
Who can challenge a transaction?
At present, the right to challenge the validity of a transaction is open to any interested person. Case law has developed the concept of what constitutes an interested person.
Under the Amendments, a claimant will need to:
- be either (i) a party to the transaction; or (ii) a person expressly entitled to challenge the validity of a transaction by statute; and
- prove that the disputed transaction violates its rights or legally protected interests.
The introduction of this general rule is in line with court practice. However, as it seriously limits the scope of persons who may file an invalidity claim, it should provide greater legal certainty and help protect parties from various forms of abuse.
In addition, the court’s discretion in challenging a transaction on the ground of its nullity has been limited in scope. Under the Amendments, it can apply its discretion in cases expressly envisaged by law or when the public interest is threatened. The notion of public interest is quite vague in Russian civil law. Generally, public interest can be identified in any civil law relationship that affects the general public and requires the interference of the authorities. Thus, in practice, the extent of the limitation will depend on the development of case law.
Void vs. voidable
The general trend is to limit the cases when a transaction is null and void from the outset. That would mean imposing a greater burden of proof on the party challenging the transaction.
New requirements aimed at preserving transactions
The following rules have been introduced to prevent transactions from being challenged or having the consequences of invalidation being applied to them:
- When a party has acted in a manner leading another party/other parties to believe that a transaction was valid, that party will not be entitled to challenge the transaction in court.
- A third party, corporate managing body, or state or local authority whose consent to a transaction is required by law may not challenge this transaction if it knew or should have known of the grounds upon which it now intends to challenge the transaction when it gave consent.
- The court will have the right to refrain from applying the consequences of invalidation if it finds that applying them would be contrary to public interest.
- A transaction entered into under mistake will not be invalidated if the misleading party affirms the terms of the transaction which the mistaken party relied upon.
Refined invalidating grounds
The Amendments have, in particular, refined the invalidation regime of transactions for mistake and fraud.
For a transaction to be set aside for mistake, the mistake needs to be material. An objective reliance test is provided in the revised Civil Code: a mistake will be deemed material if, based on a reasonable and objective assessment of the situation, a party would not had entered into it had it known the actual state of affairs.
In addition, five instances deemed to constitute material mistake (unless otherwise proven) are listed in the revised Civil Code. These include an obvious typographical error, a ‘slip of the tongue’ or ‘of the pen’, a mistake as to the identity of the counterparty or a person connected with the transaction, etc.
The aggrieved party will only be able to claim compensation for actual damage when its counterparty knew or should have known of the mistake (potentially reducing the circumstances in which damages will be awarded).
The revised Civil Code provides for a new specific case when the concept of fraud applies to the conclusion of a transaction. This occurs when a counterparty intentionally fails to mention facts that would normally be expected to be mentioned in the normal course of business conducted in good faith.
A party (including a company) will be considered to be aware of a fraud, if the fraud is caused by its representative, employee or even a person assisting with the transaction. This presumption is irrebuttable.
Therefore, intentional silence regarding circumstances that otherwise would have to be disclosed based on the degree of good faith that is expected from a person will equate to fraud. However, evidential difficulties are likely to arise for the alleged defrauded party.
Changes in the regime of limitation of authority for corporate representatives for the purpose of invalidating transactions
Current protection against corporate managing bodies by-passing restrictions on their authority and concluding transactions in breach thereof has been broadened so as to apply to heads of representative offices and branches. The Amendments also specify the corporate managing body to which protection applies: the legal entity’s general director (or equivalent representative entitled to act without a power of attorney).
In addition, the scope of documents containing restrictions of authority that may be enforceable against a counterparty has been increased to include not only a contract and constituent documents, but also internal documents regulating the legal entity’s activities.
In practice, this means that the parties to the transaction will need to demonstrate a higher degree of diligence and request from each other not only the constituent documents and powers of attorney, but also internal regulations that may limit the authority of their representatives.
New invalidating ground for transactions concluded on behalf of a legal entity
If a transaction was concluded on behalf of a legal entity not in breach of an express restriction of authority, but that entity still wants to challenge the validity of the transaction as being detrimental, then it will be able to do so if it successfully proves that:
- the transaction impairs its interests, and
- the counterparty to the transaction (i) was in collusion with the claimant’s representative, or (ii) knew or should have known that the transaction was obviously harmful for the legal entity.
Anachronistic ground for invalidating foreign trade transactions removed
Failure to effect a foreign trade transaction in simple written form will no longer mean that it is voidable. The written form requirement was not in line with international law and modern commercial practice.
However, the immediate impact of the repeal of this outdated requirement is expected to be limited in practice due to the specificities of Russian customs, tax and currency control requirements, where the written form still rules.
Limitation period for third party claims
At present, the three-year limitation period for third party nullity claims runs from the date when performance started. Under the revised Civil Code, the period will start running from the time when the third party claimant had actual or constructive knowledge of the start of performance of the transaction. It will be subject to a ten-year cut-off period, which is to run from the date of actual start of performance regardless of whether the third party had actual or constructive knowledge of the start of performance of the transaction.
1.2 Ratification of a transaction entered into by an unauthorised person
Even though not expressly limited to legal entities, one more Amendment affecting them has been adopted regarding transactions made in excess of authority (ultra vires transactions).
Under the Amendments, a good faith party to a transaction concluded ultra vires is granted the right to terminate the transaction unilaterally (provided it has not been ratified) and to claim compensation for losses. At present, ratification is allowed under the Civil Code. However, there is no time-limit or mechanism for the ratification, leaving the good faith counterparty ‘in limbo’.
It will become possible for the good faith counterparty to initiate the ratification process by requesting that the counterparty on behalf of which the transaction was supposedly entered into does so. If the latter refuses to ratify or no reply is received within a reasonable time, then the initiating party may either (i) require the unauthorised representative to perform the transaction or (ii) terminate it unilaterally and claim damages.
Damages may be recovered provided that the claimant neither knew nor should have known that the representative had no authority or exceeded its authority. In our view, the claimant would be regarded as having constructive knowledge if it failed to request the counterparty’s constituent and internal regulations and these contained limitations of authority. In these circumstances, we believe the claimant would have its claim rejected.
1.3 Legally significant notices
The revised Civil Code contains a new general rule for delivering notices carrying civil-law consequences (for example, a right to demand the transfer of goods, a duty to pay for goods, etc.). Previously, this issue was not regulated in the Civil Code.
Under the Amendments, any legally significant notice will be deemed to have been legally delivered when it has arrived at the location of the addressee. In this case, the Civil Code does not require confirmation of actual receipt of a notice by the addressee or the addressee having actually reviewed it. Under the new rule, if a sender can prove that it has duly sent a notice, the only means by which the addressee can rebut the presumption of receipt will be to prove that circumstances beyond the addressee’s control actually prevented (i) the notice from being handed over to the addressee or (ii) the addressee from reviewing the notice.
This novelty creates a greater burden for notice addressees. The rule can be varied by statute, agreement of the parties, custom or the parties’ usual dealings.
1.4 Notarisation of transactions
A transaction needs to be notarised when required by law (e.g. the sale of a participatory interest in an LLC). The parties to a transaction can also agree to have the transaction notarised.
At present, when a Russian notary certifies a transaction, he/she merely acknowledges the authenticity of signatures and the proper authority of those who sign a document in a representative capacity. The notary’s duty will be extended to verifying the legality of the transaction.
It is expected that the list of transactions subject to mandatory notarisation, as well as the extent of the notary’s duties and liability, will be determined in subsequent specialised legislation.
2. Resolutions of general meetings
The adoption, challenging and nullity of resolutions taken at meetings of groups of people organised under various legal forms are regulated under a new chapter of the Civil Code (9.1). These provisions, including a general rule that resolutions bind all those entitled to attend irrespective of their actual attendance, apply in cases where there is no specific regulation by statute.
The existing rules on resolutions of the general meeting of participants/shareholders of commercial companies provided in the relevant federal laws will continue to apply in so far as they do not contradict the provisions of Chapter 9.1.
3. Powers of attorney
3.1 Lighter formal requirements
From 1 September 2013, delegating authority should become easier due to the entry into force of the following rules:
- Authority will no longer have to be delegated under a separate power of attorney. Instead, it will generally be sufficient to incorporate the relevant provisions in an agreement or a corporate resolution. In these circumstances, the agreement/resolution will need to comply with the Civil Code provisions on powers of attorney.
- The requirement to affix a company’s seal on a power of attorney issued in its name will no longer apply.
- Sub-delegating authority by corporate representatives, heads of representative offices and branches will generally no longer require notarisation; simple written form will suffice.
- Powers of attorney may be issued for a term exceeding the current three-year maximum. If the term is not stated, the current one-year default term will still apply.
- A single power of attorney may be issued by several principals or to several representatives. However, if at least one of the principals revokes the power of attorney, it will cease to have effect in its entirety. As a result, the other principals who have not revoked this power of attorney will have to issue a new power of attorney.
3.2 New type of power of attorney
Irrevocable powers of attorney are introduced in Russian law as part of the strategy to develop Russia as an international financial centre (as per the legislator’s explanatory note on the Amendments).
This type of power of attorney is only revocable in limited circumstances. It is issued to perform or secure the performance of obligations arising in connection with business activities. For example, such a power of attorney may be issued to vote at a specific general meeting or to sell a particular asset in order to secure a loan.
Within the scope of the obligation to be performed or secured, an irrevocable power of attorney actually grants unlimited powers to the agent. The agent is not restricted to the actions expressly listed in the power of attorney (as in the case of a standard power of attorney).
This entails certain risks, as the agent may act contrary to the principal’s instructions under such a power of attorney. The legislator has tried to reduce this risk by (i) requiring notarisation of such a power of attorney; (ii) prohibiting sub-delegation of the relevant authority when the power of attorney is silent on sub-delegation; and (iii) allowing the principal to revoke the power of attorney when there is an abuse by the agent or a high risk of such abuse.
4. Limitation periods
The official rationale behind the Amendments relating to limitation periods is the need for more objective criteria to make periods clearer to compute.
For claims that are not time-barred as at 1 September 2013 (as per the rules in force before that date), the situation will be as follows:
- Even though the existing general three-year limitation remains, the legislator establishes a final cut-off period of 10 years, i.e. after that period it will be impossible to protect one’s violated right.
- As a general rule, the limitation period will start when a claimant (i) knew or should have known about the violation of its rights; and (ii) has identified a proper defendant (which will presumably occur after it has found out about the violation of its rights and interests). The second limb of this general rule is an entirely new concept under Russian law.
- The provisions on limitation period suspension have been reworded. Arguably, the most interesting development for corporate claimants is when the parties resort to the out-of-court dispute resolution mechanisms provided for by law. In these circumstances the limitation period is suspended for six months from the start of the relevant mechanism (unless another term is set by law). This Amendment is aimed at encouraging use of these mechanisms.
There is no doubt that the depth of the changes introduced by the Amendments should be carefully reviewed by each Russian company, as the extent of their impact on transactions will vary based on size, corporate culture and sector. This analysis should ensure optimisation of the new legal opportunities and prevent new requirements or any relevant increase in burden of proof from being overlooked.
The new regime for challenging transactions is aimed at creating more stable civil relations. As the regime contains a number of new concepts, it will be difficult to assess whether this aim has been attained until court and business practice has developed.
However, as an immediate step companies are strongly advised to enhance their pre-transaction due diligence of counterparties, particularly in respect of limitations of authority contained in internal corporate regulations. Companies who do so can expect to benefit from increased contractual protection.
The new rules for the computation of limitation periods mean that they will be extended (pursuant to the second computation element). However, to counterbalance the interests of all those involved, the new ten-year cut-off date does provide clarity.
The Amendments on resolutions of general meetings may indirectly affect the transactions requiring corporate approval. These potentially fall within the scope of corporate governance.
The work to reform the Civil Code is still on-going. In particular, on 21 June 2013, the State Duma adopted in third reading amendments affecting certain aspects of movable and immovable things, securities and business reputation. These are expected to come into force on 1 October 2013. Moreover, further amendments relating to the creation, liquidation and bankruptcy of legal entities, as well as intellectual property, are still awaiting parliamentary review. We will keep you informed of the most important developments in this area.