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Do you think it is difficult to avoid fulfilling obligations under the contract, declaring it null and void at your will? Or, maybe, it`s easier than retaining permanent control by an official over a state share in the Limited Liability Company (hereinafter referred to as LLC) via issuance of an irrevocable power of attorney for thousand years in favor of your relative? How can you hide the true beneficiary behind an irrevocable power of attorney, indicating ‘dead souls’ as nominee owners in the register? How to conceal real financial status of business from the creditors, providing them with honest but useless information about the size of charter capital? On these and other issues the deputies gave us articulate answers on 06.02.2018 by adopting The Law of Ukraine “On Limited and Subsidiary Liability Companies” entered into force since 17.06.2018 (hereinafter – “the Law on Companies”). This comment is not aimed at covering all and every novelty of the Law on Companies, we shall focus on some key provisions instead.

• Significant Transactions

You have entered into supply contract with a schedule line. Did you check the size of the counterpart’s net assets by end of the previous quarter? You have supplied the goods, and the counterpart has not paid and is not going to, claiming the contract had not created any obligations for him. Yes, this is the 401th relatively honest way of subtracting money from the population.

The Law on Companies (Art. 44, 46) stipulates that a significant transaction (exceeding 50% of the net assets of the company by end of the previous quarter or another transaction in accordance with charter threshold), that is concluded without consent of the company`s general meeting or supervisory board (or not approved afterwards), does not create any binding obligations for the company.

It means that everyone will have to check the balance sheets and charters of their counterparts on a quarterly basis and also demand respective decisions to be adopted by general meeting for almost all contracts in any case. Even rendered decision of the general meeting does not guarantee the validity of the agreement, as if conducted with procedural violations it may entail additional risks for transactions. Consequently, it will also be necessary to verify compliance of convening and decision-making by the general meeting although there are no means for such verification by the company’s contractors.

Art. 44 (4) of the Law on Companies also stipulates that if company`s several transactions could make one significant transaction, then each such transaction is considered as significant one. At the same time, the period for which the company could make such transaction is formally unlimited. Thus, there is a risk of exceeding of aggregate supplies 50% of its net assets, hence all previous deliveries will be considered significant and require respective approval.

These norms are dream of Mr. Ostap Bender (i.e. fraud). They bring back the long-standing practice of avoiding the performance of obligations by appealing their validity due to absence of approval. Moreover, they enable artificial creation of such defects aiming to avoid fulfillment of contract in future. As a result, the Law on Companies significantly reduces the protection of the creditors` rights of LLCs and subsidiary liability companies (hereinafter referred to as SLC).

• Corporate Agreements

In 2018 first time ever the right of LLC and SLC participants to enter into a corporate agreement has been introduced into legislation.

A corporate agreement may provide an obligation of the participants to exercise their rights and powers in a certain way or refrain from their realization (see Art. 7 (1) of the Law on Companies). In particular, corporate agreement may contain conditions under which a participant is obliged to buy or sell share in a company (see Art. 7 (3) of the Law on Companies). Corporate agreement may provide participant`s waiver from pre-emptive right to acquire company share of another participant that is sold to a third party (see Art. 8, 20 of the Law on Companies).

The Law on Companies leaves a lot of matters for discussion regarding possibility of consolidating the rights and obligations of participants in a corporate agreement. On the one hand, Art. 5 (2) and Art. 6 (2) of the Law on Companies indicate that the rights and obligations may be stipulated by law or charter without mentioning a corporate agreement other than those provided in Art. 5 (1) and Art. 6 (1) of the Law on Companies. On the other hand, concept of a contract in its essence implies emergence of rights and obligations of the parties on its basis. It should also be added that a corporate agreement is more appropriate instrument than a charter for establishing participants` rights and obligations in relation to each other and owed to company. For example, it would be more sound to determine the schedule, size and procedure of increasing the statutory fund via making additional contributions by participants in a corporate agreement in accordance with the financial development plan of the company.

The previous editions of the draft Law on Companies also provided that a corporate agreement may impose duty for its parties to vote in a certain way at the general meeting of participants, conduct other actions related to company management, peculiarities of exercising pre-emptive rights to purchase a share of another member of Company or its part, as well as the obligation to refrain from exercising the pre-emption rights, agree on the alienation of shares, refrain from alienation of shares before some circumstances occur, and carry out other actions connected with management of the company, its activity, termination and liquidation. Although these norms are not included in the later text of the Law on Companies, essence of corporate agreement implies including the mentioned provisions.

We pay special attention to risk arising from Art. 7 (6) of the Law on Companies, according to which an agreement entered into by a party to a corporate agreement in violation of such a corporate agreement is null and void if the other party under the contract knew or should have known about such a violation.

Theoretically, one can agree that contracts entered into by a person must not contradict its agreements concluded before that. However, this is the first time when the Ukrainian legislation connects the nullity of a contract due to its non-compliance with another private agreement. The application of this rule provides wide opportunities for fraud and manipulation: unscrupulous participants will be able to evade fulfillment of their obligations under contracts with third parties, referring to nullity of contract as it contradicts to corporate agreement. For instance, we may refer to application of the consequences of a void transaction to a mortgage agreement entered into by a participant, who, under a corporate agreement, was obliged to transfer the relevant property without encumbrances as an additional contribution to charter capital. It should also be added that a corporate agreement is executed in written form without notarization and state registration. It remains only to prove that the mortgagee knew about the corporate agreement concluded by the mortgagor. Though do you remember all the documents you have ever been reported about?

In addition to the given example, we may also predict a lot of manipulations around the terms of corporate agreements that allow broad interpretation. For example, the duty of a participant to refrain from actions that may directly or indirectly harm the interests of a company. Interpreting such wording, we may say it`s violated in case of the participant`s property mortgage, which should have been transferred to Company under the corporate agreement. You can come up with many other common and broad wording.

It is not quite clear how the situations in which a counterpart under the agreement “knew or should have known” about the restriction under a corporate agreement would be interpreted in practice. As in accordance with of Art. 7 (5) of the Law on Companies, content of corporate agreement is not subject to disclosure and is confidential unless otherwise provided by law or agreement. Does it mean that wording “should have known” implies obligation of the parties to commercial contract to verify/ ask their counterpart about his participation in companies and require an acquaintance with content of the corporate agreement?

The Law on Companies does not specify what happens to a corporate agreement in the event of share sale by a participant as there are no rules on the automatic replacement of a party to corporate agreement. Considering the general principles of civil law, a corporate agreement will not enter into force for a participant without his consent. Thus, a way to avoid fulfilling obligations under a corporate contract may be selling of share by unscrupulous participant to affiliated person not bound by provisions of the corporate agreement.

In addition to consent of new participant to join the corporate agreement, we may find need for consent of other (original) participants to replace the party to agreement as well. First, according to of Art. 520 (1) of the Civil Code of Ukraine, the debtor may be replaced by another person only by the consent of the creditor, unless otherwise provided by law. Secondly, the essence of corporate rights implementation is closely related to person of the participant. Therefore, initial members of the Company may disagree to perform the obligations under the corporate agreement in favor of the new participant (for example, to disclose sensitive information to such a new participant regularly).

The consequences of failure to comply with the terms of corporate agreement are not clarified in the law as well. The previous draft Law on Companies provided that in case of violation of the contract, party at fault should recover damages and pay off penalties if provided by contract. Even in the absence of these provisions in the final draft a corporate agreement may include such terms following the general rules of the Civil Code. At the same time, the question remains unsolved whether the participant’s non-compliance with the terms of corporate agreement on voting would be recognized as the basis for invalidating the decisions of company’s bodies (if so, it aggravates vulnerability of the company`s creditors even further).

It should be noted that in fact, the participant may avoid fulfilling obligations under the corporate agreement (for example, regarding subsequent investments) in case of his withdrawal from the company without consent of other participants. The participant`s right to withdraw in accordance with Art. 24 of the Law on Companies cannot be limited by the charter or corporate agreement. In fact, this means a one-way waiver of the contract.

• Irrevocable Powers of Attorney

Imagine that an official authorized to manage state or municipal shares in LLC gets informed about approximate dismissal or retirement due the end of term for which he was elected. Well-tried corruptive schemes for money laundering will be lost or caught up by successor. Such ‘instability’ will be prevented by Art. 8 of the Law on Companies, which introduces the possibility of company members to issue irrevocable powers of attorney that cannot be withdrawn during its validity period. Such a power of attorney may be issued for fulfilling or ensuring the fulfillment of obligations of the parties to the corporate agreement (another one in the Law on Companies), the subject of which are the rights to a share in charter capital or authorities of the participants. Such obligations under a corporate agreement may be defined very widely, for example, ‘the duty to participate in the management of a company properly through participation in general meetings and other forms of decision-making in Company’. Such a wording will not raise questions and give grounds for issuing an irrevocable power of attorney to enforce and secure such a duty under a corporate agreement with practically unlimited authority of a participant.

The irrevocability of power of attorney contradicts the general principle of fiduciary relations (from Latin fiducia means ‘trust’) with regard to the possibility of their termination at any time by a principal or trustee who has been kept since the Roman law. So, if the principal loses his trust in the attorney, his power could be terminated at any moment. It makes sense whereas the principal will be responsible for actions committed on his behalf by such a confidant. Instead, irrevocability will be a guarantee of preserving the powers of attorney even in a conflict with the principal, which is contrary to the very nature of these relations based on trust.

How did the ancient people not invent such a simple thing as an irrevocable power of attorney? This is perpetuum mobile power. It is necessary to introduce this novelty for both state-owned enterprises and joint stock companies – do they differ significantly from LLC with a state share? Someone may have an irrevocable power of attorney in Naftogaz. While such an invention has not been implemented there, it is still possible to reorganize them into LLC. Do not stop there: this progressive instrument is worth introducing into the Civil Code and Constitution of Ukraine.

Right after the entry into force of the law, head of the parent company representing the legal entity-participant may issue an irrevocable power of attorney to the person controlled by him and guarantee himself control over the subsidiary company even in the event of his dismissal from the parent company. Thereby he deprives new management of the parent company of real ability to manage its affiliated structures. Get prepared, heads of the holding boards – you can ensure irrevocability of your powers on managing the company subsidiaries even after your dismissal!

Imperfect safeguard of abuse via irrevocable power of attorney is laid down in Art. 8 (2) of the Law on Companies according to which if the rights and interests of principal are violated, the authorized person has a right to cease using the irrevocable power of attorney and withdraw it upon request of the principal. If dispute arises the irrevocable power of attorney may be cancelled by the court though only if it is proved that authorized person had violated rights and interests of the principal, e.g. voting for ‘special’ candidate to the LLC director. It is interesting that irrevocability itself is contrary to the principal`s interests as provides retaining of authority regardless of the principal`s will. The discursive mistake constitutes the essence of such a power of attorney: it cannot be withdrawn by the principal acting in his interest vs the representative ceases to use power of attorney in case of violation of the principal`s interests. The obvious practice of this norm would be ignorance to the principal`s requirement to “cease to use” the power of attorney and the emergence of a new array of lawsuits on the cancellation of irrevocable powers of attorney.

It should be noted that the introduction of irrevocable power of attorney was not provided in the initial edition of the draft law. As it is seen from the explanatory note dated May 13, 2016, authors refused to use the power of attorney as an instrument of proving the formed will of a company`s participant because of the high risks of participant`s will distortion, difficulty of monitoring representative`s compliance with the restrictions imposed on his authority and the emergence of conflicts and litigations on this basis. The refusal of power of attorney was proposed to be substituted by absentee voting. However, the last text of the draft law included not only the provision regarding absentee voting, but the irrevocable power of attorney as well.

The Law on Companies does not provide exclusivity of an irrevocable power of attorney. There is also no answer to the question of resolving the conflict between the actions of various representatives by irrevocable powers of attorney from one participant. We are waiting for an even more impressive spectacle of parallel meetings of LLC with opposing decisions. An exciting rider game will get a new breath.

• Nominal Participants

If you are an official who does not want to disclose your affiliation with the LLC, then this law is for you, especially in the context of more and more complex hiding behind offshore companies after recent scandals with the leak of information and all the deeper information exchange co-operation between these jurisdictions. Comprehensive interpretation of Art. 7, 8 of the Law on Companies makes it possible to make a preliminary judgment on the introduction of company`s nominee members. The point is that the nominal participant will be able to issue an irrevocable ‘general’ power of attorney to the real beneficiary, which will make all decisions about the company, while remaining ‘in the formal shadow’. State register will include the information about the nominee participant, but not the real beneficiary, since data about the issued powers of attorney is not public.

An irrevocable power of attorney will work in conjunction with a corporate agreement, according to which the nominee members of company may be obliged to sell their share on specified terms. Theoretically, it may be a duty to sell the whole share for a minimum amount at the first demand of the real beneficiary. Such shareholder contracts may be also concluded in advance in order to make any changes to the register at any time.

Obviously, the legalization of nominal participants eliminates transparency in Ukrainian business, which has been achieved after public disclosure of information about beneficiaries of legal entities and electronic declaration, as well as encourages concealment of the corporate ties by high-ranking officials.

• Number of Company`s Participants

The current legislation provides that the maximum number of participants of the LLC may reach 100 persons (Art. 50 (2) of the Law of Ukraine ‘On Business Companies’). Earlier, from 2007 to 2010, the maximum number of participants in the company was only 10 people.

The Law on Companies provides unlimited number of LLC and SLC participants (Art. 4 (1) of the Law on Companies). As a justification for the changes, the explanatory note outlined the actual failure of state authorities to monitor compliance with limitation by the companies and low social danger of such violations.

Companies in the form of LLC and SLC are characterized by a high level of involvement of participants in company management and their intensive interaction (especially under the Law on Companies, which provides a lot of cases where decisions must be adopted by all participants unanimously). Obviously, the LLC and SLC are not the optimal forms for companies with a significant number of participants, as opposed to private joint-stock companies (hereinafter – PrJSC). However, instead of simplifying the regulation of PrJSC activities and enhancing the attractiveness of this form of business, the legislator decided to abandon the regulation of number of participants in the LLC/ SLC, that would not facilitate market structuring.

• Content of the Company`s Charter

The information that must be specified in the charter was reduced to a minimum and include: the name of the company, the management bodies of the company, their competence, decision-making procedure, the procedure for joining the company and withdrawal from it (Art. 11 (5) of the Law on Companies).

Nevertheless, there are still some provisions in Ukrainian legislation with requirements to data to be provided in company`s charter that remain in force even after adoption of the Law on Companies. According to Art. 82 (2, 4) of the Commercial Code of Ukraine provides that charter of company shall include information about the type of company, the object and purpose of its activities, composition of the founders and participants, composition and competence of the company and its decision-making procedures, including the list of issues that require unanimity or a qualified majority of votes, size of the shares of each participant, procedure of forming the charter capital and making contributions to the charter capital, their size and form, distribution of profit and losses, provisions on reorganization and liquidation of the company.

A LLC charter may contain rules departing from the standard provisions of the Law on Companies in many occasions. However, it often requires the unanimous consent of all company`s participants.

• Withdrawal of Company`s Participant

The procedure of the participant`s exit from the company is simplified. A participant with a share of less than 50% may leave the company at any time, without notice and consent of other participants (Art. 24 of the Law on Companies). The current legislation stipulates that the participant has the right to withdraw from the company, declaring it no later than in three months before the exit, unless otherwise provided by the charter (see Art. 148 (1) of the Civil Code). In accordance with the Law on Companies, in fact, company`s participants may be able to find out the withdrawal of one of them from the Unified State Register, since on the basis of his own application the participant is entitled to register changes in membership of the company independently.

At the same time, information about size of charter capital is still to be outlined in the charter, as it has been mentioned above. If there are a lot of LLC participants, it creates a necessity for its executive body to monitor any changes in the Unifies State Register regarding change of participants for respective introduction of amendments to the charter.

It should be noted that the exit of a participant with significant share in the company may lead to serious negative consequences. In the widespread situation, when the assets of a company are mostly in non-monetary form, and funds are in circulation and cannot be withdrawn upon the first requirement, the company will be forced to sell part of its assets. An unpredictable significant reduction in the company’s assets may lead to a collapse of business, the depreciation of shares of other participants and even bankruptcy.

Although withdrawal from company is currently recognized as a participant`s right, in essence, it is similar to a unilateral refusal of a commitment which is not allowed under the general rules of civil law. The provisions of the Law on Companies aimed at maximized simplification of the party`s exit may lead to the fact that loan funds or leased fixed assets for company will become more reliable basis for business than contributions from its own participants.

• Exemption from the Company

The rule under which the participant may be excluded from company if he ‘systematically does not perform or improperly performs duties or prevents to achieve the company`s goals by his actions’ (see Art. 64 of the Law of Ukraine ‘On Business Companies’) is no longer provided in the legislation. In previous versions of the draft law there were proposals of mandatory redemption of shares in such cases. However, these norms were not included in the latest version.

Incidentally, there are still false references to these norms in the Transitional Provisions of the Law on Companies, which introduced amendments to the Law of Ukraine “On State Registration of Legal Entities, Individual Entrepreneurs and Public Associations”.

The Law on Companies provides the possibility of excluding a participant only if he has an arrears in contributing (Art. 15 (2; 1) of the Law on Companies) or in the case when the heirs (successors) of the participant within a certain period do not apply for participance in company (Art. 23 (2) of the Law on Companies). The decision to exclude a participant is taken by the general meeting and cannot be adopted via the survey (Art.36 (2; 6) of the Law on Companies).

Although the Law on Companies contains many novelties, some issues to be properly regulated are still unclear for business. What does happen if the participant is excluded from the company by decision of the general meeting? Should the company pay to such participant the cost of his share? If so, how should this cost be calculated? Is there a change in the size of charter capital?

• General Meeting

The Law on Companies still maintains quite archaic requirements on procedures for convening a general meeting, ignoring the current level of communication development, electronic document circulation and electronic digital signatures. Instead, provisions of the 90s on need for the physical presence of all participants in one place, prior notification of the participants to hold meetings in a month at least, etc. are repeated. The rules regarding absentee voting by the participant or adoption of general meeting`s decision through the survey and others do not particularly facilitate the situation being cumbersome as well.

There is no secret that for the majority of LLC conduct of general meeting means signing by all participants of the general meeting`s minutes in a convenient mode, without observing terms of notice or other requirements. Instead of effort to legitimize the actual state of affairs and optimize business, the state continues to ignore well-known paths of the society and builds freeways where no one travels. Therefore, there is a high probability that the proposed norms will not be implemented in practice with a risk of questioning any decision of the general meeting, approved with deviation from the procedure.

Many issues of the company`s activities under the Law on Companies are decided solely by unanimous decision of general meeting, in which all the company`s participants take part. This may be problematic, especially for companies with a large number of participants. In particular, full consensus is required to approve the monetary valuation of a nonmonetary contribution, establish and modify restrictions on the change in the ratio of participants` shares, introduce changes of term provided by law for making contribution (including an additional one) to charter capital by company`s participant, change the procedure for exercising company`s participants preemptive right, approve distribution of an alienated share (or its part) among other members of the companies, establish procedure of refusal to exercise company`s participants preemptive right or stipulation of its absence, approve consent of company`s participants for alienation or mortgage of share (or its part), etc.

The Law on Companies provides the possibility to conduct general meeting outside the territory of Ukraine by unanimous written consent of all company`s members for the first time ever (Art. 33 (7) of the Law on Companies).

• Supervisory Board

The Law on Companies provides possibility to establish a supervisory board in LLC, which controls and regulates activities of the company`s executive body for the first time ever (Art. 38 of the Law on Companies). The supervisory board of company may be vested with some powers of general meeting, excluding questions referred to its exclusive competence.

The decision on the election and termination of the powers of supervisory board members is adopted by general meeting and can not be approved by the poll (Art. 36 (2; 1) of the Law on Companies).

• Officials

The Law on Companies defines the list of those who are officials of the company. Thus, officials of company are ‘members of the executive body, the supervisory board, as well as other persons stipulated by the company charter’. Therefore, according to approach laid down in this norm, if the company’s charter does not explicitly state that appointment to a particular position makes that person an official then this person who is not a member of the executive body or supervisory board does not acquire this status.

With this approach, such a novelty may have an impact on the situation where it is necessary to determine who is an official of the company (for example, when bringing an official to responsibility for an administrative offense). Usually officials are persons who perform organizational, administrative and commercial functions in the company. For example, the head of a department may also be recognised as an official due to his specific functions and certain sphere of activity.

In practice a company`s charter does not contain detailed instruction or list of certain positions referred to the category of ‘official’. Consequently, the absence of necessary wording in the charter and existence of an exclusive list of officials in the Law on Companies may lead to dodging the resposibility by offenders without status of official, and all liability will automatically shift to members of the executive body. In the light of new definition of ‘official’, a separate analysis of the application of administrative and criminal legislation in relation to responsibility of officials will be necessary.

• Liability of Officials

The Law on Companies tightens civil liability of company`s management.

In particular, officials being in charge of violations of procedure on entering into significant and interested party transactions bear joint and several responsibility for losses inflicted by the company (Art. 44 (5), Art. 45 (4) of the Law on Companies).

Officials being in charge of misleading company`s members regarding its financial status via submitting (including) inaccurate information to the company`s documents that led to unlawful payments bear joint and several responsibility on return of such payments to the company (Art. 26 (5) of the Law on Companies);

Members of an executive body may hold joint and several responsibility under the company`s obligations if not convening general meeting timely, when value of net assets of the company decreased by more than 50% compared with this indicator as of the end of previous year and in three years since such decrease company goes bankrupt (Art. 31 (3, 4) of the Law on Companies).

• Notification of Creditors Regarding Reduction of Charter Capital

Art. 19 of the Law on Companies obliges to notify creditors about the reduction of charter capital (as well as the current Law “On Business Associations”, Art. 2). At the same time, the legislator ignores the fact that the size of charter capital is not an indicator of company`s property status and its ability to fulfil obligations to creditors. The value and structure (liquidity) of net assets of the company may serve as more reliable indicators. Moreover, the Law on Companies itself links the size of company’s net assets with the definition of a significant transaction and creates risks for creditors in the form of dismissing the debtor from obligations that were not duly approved.

Nevertheless, the Law on Companies does not oblige to inform creditors about the reduction of net assets of a company more than twice. There is only a need to discuss this issue in a narrow circle of participants. Does it make sense to inform creditors about the reduction of charter capital even for a kopeck and not report even about double reduction of net assets?

• Notarization of Decisions

The Law on Companies provides introduction of provisions to the Law of Ukraine ‘On Notary’ that notaries certify the decisions of bodies of legal entities, in respect of which the law establishes a mandatory notarial form or other decision at the request of legal entity participant.

It should be noted that in some cases the current legislation provides mandatory notarization of authenticity of signatures on decisions (in particular, decisions of the authorized body of a legal entity submitted for state registration of changes to information about a legal entity in the Unified State Register). Mandatory notarial form is established, for example, for some transactions, powers of attorney from individuals, etc. However, no law has established a mandatory notarial form for decisions of legal entities` bodies.

With regard to it, in the previous versions of the draft law more amendments to the Law of Ukraine ‘On Notary’ were proposed, which included a notarial form of a decision of legal entity`s body. However, these provisions were removed from the latest version of the draft law, but mention about the notarization of decisions was mistakenly left.

Such a mistake in terms made in the Law on Companies may lead to refusal to notarize authenticity of signatures on the decisions and requirements for issuance of decisions in a notarial form. At the same time, verification of authenticity of signature is carried out with another ident inscription. Any mistake in the certificate insert may lead to refusal of the state registrar and further complicate the companies` activities.

• Appeal against Decisions of General Meeting

The Law on Companies excludes provision of Art. 98 (5) of the Civil Code of Ukraine, namely ‘the decision of general meeting may be appealed by the company`s participant to the court’. Such an exception is reasoned by the fact that in the previous versions of the draft law a separate article was proposed to introduce along with the norms on invalidity and nullity of decisions of general meetings that are contrary to law. However, this norm was not included in the latest version of the draft law.

In any case, right to apply to the court still exists in view of Art. 55 of the Constitution of Ukraine and Art. 16 of the Civil Code of Ukraine, according to which the rights and freedoms of a person and a citizen are protected by court. Each person has a right to apply to court for protection of his personal non-property or property rights and interests.

A special reduced one-year claim date shall be applied for requirements of invalidation of company`s general meeting decision (added Art. 258 (2; 8) of the Civil Code of Ukraine).

The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.

Kind regards,

© WTS Consulting LLC, 2018