{"id":13600,"date":"2019-05-30T12:59:38","date_gmt":"2019-05-30T10:59:38","guid":{"rendered":"https:\/\/kmp.ua\/?p=13600"},"modified":"2019-06-20T09:05:06","modified_gmt":"2019-06-20T07:05:06","slug":"the-risk-of-invalidity-of-the-transaction-is-no-longer-hypothetical-it-has-already-been-confirmed-by-judicial-practice","status":"publish","type":"post","link":"https:\/\/kmp.ua\/en\/analytics\/exclusive\/the-risk-of-invalidity-of-the-transaction-is-no-longer-hypothetical-it-has-already-been-confirmed-by-judicial-practice\/","title":{"rendered":"The risk of invalidity of the transaction is no longer hypothetical, it has already been confirmed by judicial practice"},"content":{"rendered":"

Almost a year had passed since the Law of Ukraine \u201cOn Limited Liability and Additional Liability Companies\u201d<\/a><\/em> became effective on June 17, 2018 (hereinafter \u2013 the Law on LLC).<\/p>\n

Even before the Law on LLC was adopted, we have pointed out some significant risks to commercial activity, which were put into its text (please see \u201cKey risks to commercial activity connected with the Law on Corporate Agreements and the Law on Limited Liability Companies<\/a>\u201d<\/em>). One of such risks is the invalidation (recognition that no binding obligations exist for the company) of the agreement that meets the criteria of the \u201csignificant transaction\u201d, exceeding 50 % of the net assets of the company by the end of the previous quarter, if concluded without consent of the company\u2019s general meeting.<\/p>\n

It should be noted from the outset that we do not support such novelties since the imperative norms to have the significant transactions approved are unnecessary and considerably limit the discretion of the parties. Instead the parties, logically, should be entitled to determine by their own the model of the company\u2019s management and the degree of their involvement in the company\u2019s activities, including through approval of transactions).<\/p>\n

In addition, the application of Articles 44 and 46 of the Law on LLC impedes business transactions, as counterparties of limited liability companies must each time request and check balance sheets, to require holding general meetings (including compliance with the procedure of their convocation with the written notification of all participants in 30 days), or risk that the transaction will be further recognized as not creating rights and obligations.<\/p>\n

As of today, the first court practice on application of Articles 44 and 46 of the Law on LLC confirmed our well-founded fears.<\/strong><\/p>\n

Namely, the agreement for the supply of tobacco products and other goods for their further sale in the trade network, which was concluded between the two limited liability companies in 2018 (upon the entry into force of the Law on LLC), was declared void by the Decision of the Commercial Court of Odessa Region as of April 26, 2019 in case No. 916\/40\/19<\/a><\/em>.<\/p>\n

The ground for the invalidation of the agreement was the lack of approval of the significant transaction by the general meeting, when the amount of the supply contract (according to the bills of lading) significantly exceeded 50% of the value of the net assets of the company.<\/p>\n

In an effort to protect the validity of the agreement, the defendant (other party of the agreement) pointed out that the plaintiff’s charter did not stipulate the need to receive the consent of the general meeting for the conclusion of significant transactions (those, exceeding 50% of the value of the net assets), as well as the lack of information as to limitations on director\u2019s powers in the Unified State Register. However, these arguments were considered insufficient.<\/p>\n

As it was noted by the court, provisions of part 2 of Article 44 of the Law on LLC prescribe that decisions to approve significant transactions (if the value of the involved property, work or services of such an agreement exceeds 50% of the value of the net assets the company by the end of the previous quarter) shall be exclusively taken by the general meeting of the participants, and this norm of the substantive law is directly applicable. At the same time, in the court\u2019s view, the absence in the plaintiff\u2019s charter of the appropriate procedure for approving the disputed agreement by the general meeting of the participants does not imply that there is no need to obtain such an approval, which is clearly stipulated in Article 44 of the Law on LLC.<\/strong><\/p>\n

Therefore, the recent court practice does not support the opinion of some lawyers who argue that part 2 of Article 44 of the Law on LLC is not applicable if the company had not established in its Charter a procedure for approving significant transactions in accordance with paragraph 1 of this article.<\/p>\n

In our opinion, the position on optionality of application of the established by law procedure for approval of significant transactions is illogical, since it not only contradicts the literal meaning of part 2 of Article 44 of the Law on LLC, but also has an inherent contradiction. After all, if the legislator allowed the possibility not to provide for the approval of any transactions without specifying the certain order of their approval in the charter (which would be good), what sense would it be to require those companies that stipulated such restrictions in their charters to approve a specific type of the significant transactions exclusively by a general meeting?<\/p>\n

Therefore, part 2 of Article 44 of the Law on LLC is considered to be a self-standing imperative norm while part 1 of Article 44 of the Law on LLC allows the company to provide for the necessity of approving significant transactions on other criteria as well. This approach exactly was supported by the decision of the Commercial Court of Odessa Region from April 26, 2019 in case No. 916\/40\/19.<\/p>\n

We do not exclude the possibility that higher courts can still apply the logic of the alternative approach illustrated above, taking into account the overall absurdity of the imperative regulation of approving significant transactions, as envisaged by the lawmakers. However, this would mean that by correcting the unreasonable act of the legislator, the court itself will resort to rulemaking, regardless the constitutional distribution of powers. However, examples of such judicial rulemaking have already been in the past.<\/p>\n

Will paragraph 2 of part 3 of Article 92 of the Civil Code of Ukraine be a remedy?<\/strong><\/p>\n

According to part 3 of Article 46 of the Law on LLC, the provision of paragraph 2 of part 3 of Article 92 of the Civil Code of Ukraine is also applicable to the relations concerning the approval of significant transactions. The said norm stipulates that in relations with third parties, the limitation of powers to represent legal entity shall not be effective except for cases when legal entity would prove that the third party knew about such restrictions or could not have been unaware thereof<\/span>.<\/p>\n

Applying this provision, the courts generally agree that the limitation of powers to represent legal entity becomes legally binding for a third party if it is this third party who acted unfairly or unreasonably when entering into relations with a legal entity and concluding a contract, in particular, when it knew for certain that the executive body of the company did not have the necessary powers or had to be aware of this, if it had exercised, at the very least, reasonable care.<\/span><\/p>\n

At the same time, the assessment of whether the counterparty exercised “reasonable care” differ in the practice of various courts.<\/p>\n

For instance, in the decision of the Commercial Court of Odessa Region from April 26, 2019 in case No. 916\/40\/19<\/a> <\/em>mentioned above, the defendant also tried to defend itself, referring to paragraph 2 of part 3 of Article 92 of the Civil Code of Ukraine, arguing that it was not aware of the restrictions. However, this did not prevent the court from invalidating the agreement.<\/p>\n

Having determined part 2 of Article 44 of the Law on LLC as a directly applicable imperative norm, the court basically answered the question whether the defendant was aware of the restriction of the powers to represent the legal entity imposed by the need to have the transaction approved by the general meeting.<\/p>\n

It seems that the restriction of power of representation already exists in part 2 of Article 44 of the Law on LLC and cannot be unknown to a person who, “having exercised reasonable care” and knowing about such a restriction, should have requested the balance sheet of the counterparty.<\/p>\n

Indeed, since the limitation of powers of a director of a limited liability company is expressly provided for in the law, this excludes the possibility for a third party to refer to the fact that it was not aware of this restriction.<\/p>\n

The absence of the balance sheet at the disposal of the counterparty will be a feeble argument in favor of the validity of the transaction since reasonable care in this case requires to get acquainted with the balance sheet.<\/p>\n

At the same time, it would not matter that limitations to the director\u2019s power of representation were not noted in the company\u2019s charter or the entries of the Unified State Register.<\/p>\n

Considering the practice described, paragraph 2 of part 3 of Article 92 of the Civil Code of Ukraine may apply in cases when the counterparty was not aware of the specific requirements with regard to the approval of significant transactions, established by the company at its discretion in accordance with part 1 of Article 44 of the Law on LLC.<\/p>\n

However, when applying part 2 of Article 44 of the Law on LLC, it would be difficult to refer to the counterparty\u2019s ignorance of such a restriction.<\/p>\n

It should be specifically noted once more that current situation significantly impedes business transactions and imposes on the LLC\u2019s counterparties excessive burden of monitoring the significant transactions, exceeding 50 % of the company\u2019s net assets.<\/p>\n

In our opinion, the best possible model for business would be the one, whereby all limitations on concluding agreements would be imposed at the discretion of the company and subsequently must be reflected in the Unified State Register\u2019s entries.<\/p>\n

In turn, the care and diligence of a third party would only lie in the verification of a compliance of the counterparty with the restrictions specified in the Register, without the risk of negative consequences such as invalidity of the transaction in case of non-compliance with all other counterparty\u2019s internal procedures of the approval of the transaction (which are outside the reasonable control of the third party).<\/p>\n

How about the approval of the transaction by its execution?<\/strong><\/p>\n

In the sake of the comprehensive analysis let us also cite the recent practice of the Supreme Court concerning the approval of the transactions concluded by a representative exceeding its authority.<\/p>\n

In accordance with part 1 of Article 241 of the Civil Code of Ukraine, a transaction concluded by a representative exceeding its authority shall establish, change, terminate civil rights and obligations of a represented person only in case of subsequent approval of a transaction by that person. A transaction shall be considered approved, in particular, in case the represented person has committed actions that indicate its acceptance.<\/p>\n

Previously, the courts could refuse to invalidate the agreement if, on behalf of the company, it was entered into by a representative exceeding its powers, but for a long time the company took actions on the execution of the disputed agreement, for example, accepted the goods delivered, made partial payments under such an agreement, entered into additional agreements, etc.<\/p>\n

However, the current practice of the Supreme Court supports the logical position that the approval of an agreement should only come from the competent body of the company, while further actions to execute the agreement which were initiated by the same person who entered into a transaction exceeding its authority cannot be indicative of the approval of the transaction by the company:<\/p>\n

“The panel of judges of the court of cassation considers to be correct the conclusion of the courts of previous instances that, since the decision on the conclusion (entering into) of the disputed transaction was to be taken by the plaintiff\u2019s supervisory board, the subsequent approval of the disputed agreement, concluded between the parties, was to be carried out by the authority competent to grant such an approval\u2026”<\/span> (see the decision of the Supreme Court from February 28, 2018 in case No. 910\/2822\/16<\/a>).<\/p>\n

Conclusion<\/strong>. The latest court practice has confirmed that obtaining the consent of the general meeting of a limited liability company to enter into significant transactions, in particular those, exceeding 50 % of the net assets of the company, is a must. At the same time, arguments referring to the counterparty\u2019s ignorance of the imposed by law restrictions or the execution of the agreement by the parties will be considered as feeble by the court and will hardly avert the invalidation of the agreement. In such circumstances, it is recommended to review the standards of contractual relations with the limited liability companies and take measures in advance to protect the business from the consequences of having the agreements invalidated in the future. This problem can be properly solved only by repealing inappropriate Articles 44 and 46 of the Law on LLC. Trying to solve this problem by changing the court practice, adjusting it to the interests of business, will not only be illegal, but will also further complicate the situation.<\/p>\n

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.<\/strong><\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

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