New instruments of corporate security under the New Law on LLCs

Strong oversight of corporate security and risk-taking is surely one of the most critical component of companies’ management process. We are no longer talking about whether or not boards should implement corporate governance and compliance policies: in the current climate we are grappling with the issue of all-round companies’ protection, which raises a much more meaningful set of questions.

Following the pretty successful ease of doing business reforms, in June 2018 Ukrainian Parliament adopted a long-awaited Law of Ukraine “On limited and additional liability companies” (hereinafter – the “Law”) believed to be a turning point in improvement of the corporate governance of the most common form of business corporation in Ukraine – limited liability company (hereinafter – the “LLC”). It is remarkable that this Law was drated with engagement of leading lawyers so it resolves the real, outstanding needs of business. Considering that corporate governance is one of the key elements of corporate security, adoption of the Law is definitely a great step to strengthen the investment climate in the country and to protect investors.

In particular, the new rules and regulations provide LLC owners with wider discretion and multiple options to protect their interests and to avoid deadlock situations with business partners. The Law introduces certain mechanisms that can be used for ensuring corporate security of LLCs from both internal and external risks of legal nature, on top of which are without doubt hostile takeovers. Most effective ones are described below.

Shareholders’ agreement

A key feature is that shareholders’ agreement may be constructed with consideration of relevant international practises and may be maximally close to the shareholders’ agreement under the English law. It allows implementation of mechanisms like put and call options, tag-along and drag-along rights aimed to prevent corporate conflicts and deadlock situations between shareholders. The agreement may stipulate obligation to vote in a certain manner, obligation or prohibition to sell or purchase shares, etc. The parties of the agreement may inform the LLC and other shareholders about its conclusion. However, it is only their right but not an obligation as far as the Law allows the agreement to be confidential.

One should note that Ukrainian shareholders` agreement per se has only compensatory nature. This means that in most cases it will be impossible to force the shareholder to perform his obligations under such agreement, even pursuant to a court order.

In order to enforce and/or secure the performance of obligations under the shareholders` agreement, the Law introduces irrevocable powers of attorney (hereinafter – the “PoA”) attributed to corporate rights. Exercising granted powers the holder of PoA may convoke general meeting of shareholders and adopt desirable resolution or to perform other actions on behalf of the PoA issuer. Notwithstanding the possibility to issue an irrevocable PoA, it is recommended to include penalties to the agreement for breaching by a party of its conditions.

Asset protection

Owners of LLCs were finally provided with legibly prescribed mechanism to secure assets of such LLC. Namely, the Law established mandatory obligation of the executive body to obtain prior approval of general meeting of shareholders to perform any transactions attributed to the company`s movable/immovable property, if the value of such asset exceeds 50 % of net assets value of the company.

Shareholders were also given a wider discretion to limit the powers of the executive body through establishing other terms and thresholds for entering into transactions on behalf of the company.

Also certain criteria for implementation of transactions with affiliated persons were determined and require prior approval from the general meeting of shareholders. However, such rule is optional and takes place only in case it is directly prescribed by the charter.

Notwithstanding the abovementioned, it wouldn't go amiss to secure company’s assets through other means. As an example, often businesses choose to secure their real estate by mortgaging it under intercompany loans or otherwise impose encumbrances on the property, preventing it from hostile expropriation.

Convocation and holding of general meeting

Significant changes have been stipulated in decision making process of LLCs. Former regulations in relation to adopting decisions by the general meeting of LLC’s shareholders were pretty straightforward and did not give many options. However, the situation changed to better. First of all, the requirement on the stipulated amount of quorum to hold the general meeting of shareholders has been removed. Let us remind that earlier the problem with the quorum lied in the fact that quorate calculations were carried out of the total amount of votes of all shareholders. Thus, the quorum necessity in certain cases resulted in paralysis of the company’s activity when the majority shareholder died or initiated a corporate conflict.

Furthermore, the Law provided more discretion in relation to defining the required amount of votes for adoption of general meeting’s decisions. The Law also enabled to hold the general meetings of shareholders remotely by means of videoconferences, absentee voting or written polls. Such changes may be considered as good anti-raider measures, enabling the shareholders to react effectively, in cases when quick actions are badly required to protect the business from takeover.

Termination of participation in business and transfer of shares

It is no secret that recently one of the most popular and effective hostile takeover schemes was exclusion of an LLC’s shareholder on the grounds of non-performance of his obligations. The Law greatly limited this option. Yet only two grounds when a shareholder can be excluded are envisaged: a) when a shareholder fails to perform his obligation to make his contribution to the charter capital; b) when a heir or successor did not come into the inheritance within the terms determined by the law.
Another positive thing is that an LLC’s shareholder possessing more than 50 % of shares can not terminate his participation (withdraw from the company) without consent of the general meeting of shareholders. Such rule significantly protects business partners from suffering losses in equity in case the majority shareholder wishes to withdraw from business.

Accession to the heirship procedure attributed to the shareholder`s interest has been also improved providing that the heir or successor exercises his pre-emptive right to join the company without consent of other shareholders. Previously, the cancelled requirement to receive other shareholders’ consent for accession of the share in LLC’s charter capital usually was the reason for exclusion of successors from business, legally depriving them of their rights.

Supervisory board

Another significant step towards improvement of corporate governance and corporate security was the stipulated possibility of establishing a supervisory board as an authority regulating and controlling the executive body of an LLC. Former, the legal control over the executive body could have been made only by means of decisions of the general meeting of LLC’s shareholders. Of course, it was not comfortable and sometimes even impossible to conduct general meetings for adoption of quick decisions. Such gap in corporate governance has been resolved. The supervisory board may be vested with certain powers assigned to the competence of the general meeting, except for the issues, being the exclusive competence of the later. For instance, the general meeting may delegate to the supervisory board a power to appoint and withdraw the director and to approve certain transactions conducted by the director, etc. Supervisory board may consist of one or several members both Ukrainians and foreigners who do not need to be employed to the company. Establishing a supervisory board is a good solution for international business willing to control local top management.

Duties and liability of officials

Understanding the most vulnerable spots in corporate governance, the parliament significantly extended liability of company’s top management for damage caused to the company. Accordingly, officials of the company, namely members of the executive body (directors), members of the supervisory board and some other officials henceforth bears joint and several liability in cases:

• for misleading shareholders of a company regarding company’s financial status, in particular by including of inaccurate information to the company's documents that result in implementation of unlawful payments of dividends – in amount of such unlawful payments that are subject to return;
• for damages caused to a company by guilty actions or inactions – in amount of sum of damages.

Company executives were obliged to inform shareholders on significant reduction of net assets (50 % and more) and to convoke the general meeting of shareholders in order to adopt essential decisions for improvement of business activity.

In contrast theretofore, now the Law contains provisions applicable to the top management on non-competition, non-disclosure as well as stipulates requirements regarding conflict of interests, non-compliance with which is considered as an unconditional ground to terminate the labor agreement (contract) with such official without payment of compensation (6 monthly salaries). The Law also obliged the director to be responsible for storage of company’s documents. Violation of the storage requirements may lead to administrative (if such violation is unintentional) and criminal (in case of deliberate destruction, damage or concealment of the documents) liability of the official.

To date we have received a number of new tools and mechanism to protect businesses and to ensure corporate security in certain manner. Their proper usage indeed will increase Ukraine’s status as a reliable jurisdiction for building international structures. Notwithstanding all of the mentioned, the biggest positive effect of these mechanisms is that they can be used by business already, not awaiting for middle- or long-term perspective, which is definitely a great step to strengthen the investment climate in the country and to protect investors.

The article was published in Ukrainian periodical “The Ukrainian Journal of Business Law”