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Key risks to commercial activity connected with the Law on Corporate Agreements and the Law on Limited Liability Companies

22 March, 2018 Newsletters

Adoption of the Law on Corporate Agreements1 and the Law on Companies2 entails essential risks such as:

  • Assumption of control over affiliated companies via irrevocable powers of attorney issued by director of a holding company. Removal of holding company`s owners from control over affiliated companies.
  • Nullity and voidance of a commercial contract established by court or, in some cases, under the law, concluded with a person who is also a party to a corporate agreement, which is contrary to the commercial contract.
  • Recognition of a contract or number of contracts as non-binding ones for the company if they fall under the criteria of ‘significant transaction’ (exceeding 50% of net assets at the end of previous quarter, or another amount specified by the charter and not approved by the general meeting or supervisory board).
  • The imposition on the directors of joint and several responsibility for obligations owed to the company or even under obligations of the company itself.

You can find out more about novelties of the Law on Companies in the article “How to cheat friends (i.e. creditors) and influence people (i.e. company not belonging to you) – based upon the Draft Law “On Limited Liability Companies and Companies with Subsidiary Liability“, as well as in blog materials. It should be noted that some of risks provided herein cannot be completely overcome without amendments to the legislation. At the same time, some legal measures to minimize these risks may be already outlined.

How to avoid losing control over affiliated companies?

Commencing from 18.02.2018 directors of holding companies in the form of JSC, LLC and SLC obtained an opportunity to enter into corporate agreements and issue irrevocable powers of attorney for performance or enforcement of rights of affiliated company`s participant3. The irrevocable power of attorney cannot be canceled without the consent of authorized person or can be canceled only in cases provided in the power of attorney. The unfair use of this mechanism creates the risk of seizing control in affiliated companies via irrevocable powers of attorney, which would be extremely difficult to cancel, even after removal of the director who had issued such power of attorney.

Today right of a director to issue a power of attorney is usually not limited under the charter or other corporate documents of a company. A corporate agreement may also not fall under the charter threshold of transaction (if any exists) for which the director must obtain general meeting `s approval.

Consequently, we strongly recommend introducing to a charter articulate limitation for a director to issue irrevocable power of attorney and/or conclude a corporate agreement without prior consent of the company`s general meeting expressed via its specific decision. In addition, we also encourage establishing respective limitation of director`s authority to issue irrevocable power of attorney and enter into corporate agreements to the Unified State Register of Legal Entities in order to give notice to third parties of director`s limited authority.

In addition, upon entry into force of the Law on Companies, officials of the company will be considered as ‘members of the executive body, supervisory board, as well as other persons stipulated by the charter of the partnership’. Therefore, to ensure that in case of any violations offenders would not avoid administrative or criminal responsibility, it is appropriate to revise structure of the company’s management and provide adequate definition of ‘officials’ in the company`s charter. For example, head of a department with organizational, administrative and commercial functions may be defined as an ‘official’.

How to prevent the nullity/invalidity of a business deal?

1. Contracts in contradiction to the corporate agreement. It may turn out that your counterpart under a commercial agreement is party to a corporate agreement you are not party to, the provisions of which are contrary to the mentioned commercial agreement. If you ‘knew or should have known’ about such contradictions, your commercial contract may be declared void4. It may be even worse: the Law on Companies provides nullity of a contract entered into in violation of the corporate contract of its party5. It is a question whether ‘you knew or should have known’ about such restrictions if your counterpart mentioned them in the last year’s correspondence with one of your employees or a former director who oversaw the business then. In any case, there are a lot of opportunities for manipulation.

As a possible helpful solution reducing the risk of nullity and voidance claims based on commercial agreement`s contradiction to a corporate agreement, additional agreements on guarantees and compensations may be signed. For example, they may include reservation under which the party is obliged to report on existing corporate agreements, provide the creditor with them for review, confirm the absence of contradictions with the concluded corporate agreements, undertake not to enter into corporate agreements that would contradict the commercial contract in future and compensate for any losses if such a corporate agreement would be concluded.

2. Significant transactions. In addition, under the law a significant transaction (exceeding 50% of the net assets of the company by the 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 agreed upon afterwards), does not create any binding obligations for the company6. Due to tax consequences this risk is especially critical in case the company purchase something. Therefore, all important contracts with companies in the form of LLC or SLC will require permanent monitoring of exceeding significant transactions thresholds.

To this end, creditors will have to request information on net assets (balance sheet) of counterparts regularly (quarterly) and compare these data with contract prices. Even if there are a few typical small supplies to one contractor, each transaction shall be approved by the general meeting, provided that cumulatively their price is equal to threshold of a significant transaction that could be hypothetically concluded instead of these small ones. It will be also necessary to monitor the content of the contractors` charters regularly, while they may contain additional criteria for significant transactions that may be changed as well.

Considering complexity of checking the balance sheets, charters, and approvals of each counterpart on a quarterly basis, there is a simple decision to require corporate approval of any transaction from each counterpart (consent of the general meeting or supervisory board). It is worth mentioning that it should not be consent of general character on entering into a framework agreement only (on the basis of which, for example, some supplies are carried out). It shall be consent including specific terms of the agreement, i.e. price, quantity, quality, terms. Although even this option does not guarantee validity of the agreement implicitly, and the violation of procedure for convening and holding the general meeting will create additional risks for transactions as well. Additional agreements on guarantees and compensations may be also advised for these purposes.

How to reduce the risks for companies` directors?

From June 17, 2018, when the Law on Companies will come into force, directors of the LLC and the SLC should consider their increased civil liability (stipulated joint and several liability for obligations owed to the company or even under obligations of the company itself) and duly avoid:

  • violations of procedure on entering into significant and interested party transactions (Art. 44 (5), ч. 4 Art. 45 (4) of the Law on Companies);
  • misleading members of the company by submitting (including) inaccurate information to the company`s documents that led to unlawful payments (Art. 26 (5) of the Law on Companies);
  • violation of an obligation to convene a general meeting, if value of net assets of the company decreased by more than 50% compared with this indicator as of the end of previous year (Art. 31 (3, 4) of the Law on Companies).

We do recommend company`s managers to establish practice of preparing and retaining (even after dismissal) all documentary proofs of performance of the obligations by the managers (e.g. documents on sending members a notice of convening general meeting with an attachment description, etc.).

Our specialists have worked out effective measures against the mentioned and other risks arising from novelties according to specific situations.

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.

Footnotes:

1The Law of Ukraine “On Introducing Amendments to Certain Legislative Acts Regarding Corporate Agreements” entered into force since 18.02.2018.

2The Law of Ukraine “On Limited and Subsidiary Liability Companies” entered into force since 17.06.2018.

3Art. 26-2 of the Law of Ukraine “On Joint Stock Companies” and Art. 51-2 the Law of Ukraine “On Business Companies” as amended by the Law on Corporate Agreements.

4Art. 51-1 (5-6) of the Law of Ukraine “On Business Companies” as amended by the Law on Corporate Agreements.

5Art. 7 (6) of the Law on Companies.

6Art. 44, 46 of the Law on Companies.

Kind regards,

© WTS Consulting LLC, 2018

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