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Frequent
Legal Issues for Contractors on IV. Drafting a Company Charter Presented by Sergei L. Lazarev, Partner of the firm’s Russian Practice Group and Executive Director of the firm’s Moscow office. A specialist in Russian civil and corporate law, tax and labor law, as well as in litigation and dispute resolution, Mr. Lazarev has over 10 years experience in advising foreign and Russian companies on structuring and operating investments in Russia. Together with other Russin & Vecchi attorneys, Mr. Lazarev has worked on numerous issues related to Sakhalin oil and gas exploration and extraction projects, including: obtaining government approval of a PSA for a Sakhalin off-shore development project, and assisting with complex permit and licensing requirements for large-scale equipment delivery and beaching operations. Mr. Lazarev has assisted clients in reconciling the latest state of the art drilling waste disposal technologies with Russian environmental law and PSA-related requirements, and advised on Russian and international oil spill containment requirements. He is a 1983 graduate of the Law Faculty at Moscow State University and in 1990 defended his dissertation “Arbitral Settlement of Interstate Disputes” and earned a Ph.D. from Moscow State University. In 1993, he completed his study at The George Washington University National Law Center (USA) under the Edmund S. Muskie Graduate Fellowship Program. Foreign investors should be aware of several fundamental requirements regarding the structure and function of Russian limited liability companies. These include obligatory forms for management structures, the role of the General Director, procedures for transfer of shares, participant withdrawal, distribution of profits, and investments in the property of an LLC. As LLCs are the most widely used type of commercial legal entity in Russia, this article will cover issues related to LLCs, rather than Joint-Stock Companies, although in many instances, they are similar. Russian law provides little freedom in drafting LLC charters.(14) Most LLC activities are set forth by law and can be varied only in cases specifically provided for by the law. In this regard, many schemes that are successfully employed in foreign practice, may be unenforceable in Russia. The main law regulating activities of LLCs in Russia is the Federal Law On Limited Liability Companies No. 14-FZ dated February 8, 1998 (the “Law on LLCs”). Although the Law on LLCs is not new, court practice in interpreting its provisions is still quite limited. The main court act which clarifies provisions of the Law on LLCs is the joint Enactment of Plenums of the Highest Arbitrazh Court and Supreme Court of Russia No.90/14 dated December 9, 1999 "On Some Issues of Applying Provisions of the Federal Law On Limited Liability Companies." Management For the majority of foreign investors operating in Russia, the most critical question usually pertains to control, or who is playing the management role. Russian law provides a detailed scheme of LLC management structure, which include the following bodies:
Most LLCs may successfully operate without forming optional bodies. If a company has many participants or anticipates conflict, then it may be advisable to consider forming optional bodies. Russian legislation stipulates that a participant of an LLC is not its body and can take part in its management only through a GMP. In this regard, granting to some participants the right to appoint general directors, members of the BOD or the EC, is unenforceable. However, Russian law provides the possibility to grant additional rights or obligations to some LLC participants, subject to unanimous consent of the other participants. Whether a grant of additional rights or an imposition of additional obligations is appropriate should be verified in every specific case, in light of other imperative norms of Russian law, which may not be deviated from, even with consent of the participants. General Meeting of Participants (GMP) The GMP’s decision-making procedures are defined in detail in the Law on LLCs. Every participant has equal authority to propose issues for the GMP agenda and to vote on all issues.(16) In this regard, charter provisions that empower one participant to nominate a general director are void and unenforceable as limiting the rights of other participants. The GMP generally forms all other bodies of the company. Although the GMP adopts most decisions by a simple majority of votes of all participants of the LLC rather than by a majority of those participants who attend the GMP, the charter may provide for a qualified amount of votes for some or every GMP decision.(17) According to the Law on LLCs, decisions to amend a foundation agreement or to liquidate or reorganize an LLC must be adopted unanimously, and decisions to amend a charter must be adopted by a 2/3 majority of votes. The charter may not reduce these qualified amounts of votes, which are established by law. Despite these limitations with regard to voting, upon unanimous decision of the participants, a charter may provide for a division of votes disproportional to shareholding. (18) Russian law sets forth extremely strict requirements regarding the procedure for calling a GMP. A GMP may be called by other bodies of the LLC or by participant(s) who have invested at least 10 of the charter capital of the LLC.(19) A body or person calling a GMP is obligated to notify all participants at least 30 days prior to holding the GMP, unless the charter provides for a shorter term. (20) All participants have the right to propose additional issues to the GMP’s agenda at least 15 days prior to the GMP, unless the charter provides for a shorter term. (21) Such proposals must be included in the agenda unless they contradict Russian legislation or do not fall within the GMP’s competence. Other participants must be notified regarding such additional issues at least 10 days prior to holding the GMP. Shortening the notice period for calling the GMP (and all related deadlines) rather than applying the legal defaults affords participants greater control over the timing of decision-making. Sole Executive Body The sole executive body, which is the general director or president (GD), conducts the day-to-day operations of the company. Only the GD may sign agreements, hire employees and operate the monetary assets of the company without a power of attorney. The GD’s powers are limited by the Law on LLCs with respect to the conclusion of large-scale transactions (valued at least 25% of the company’s assets) and transactions in which he is an interested party (with affiliated persons). (122) The charter may also limit the GD’s power, for example, by prohibiting the GD from concluding transactions exceeding a certain sum without the GMP’s consent. However, transactions concluded in breach of such charter provisions can only be declared void within one year of their conclusion, and only if the company or its participants can prove that another party to the transaction knew or should have known about such limitations. (23) A GD’s rights may also be assigned to a Managing Company by a decision of the GMP, as long as the possibility to do so is clearly established in the Charter. (24) Collective Executive Body The Collective Executive Body, or the Executive Committee (EC), is used very rarely in an LLC. Russian law regulating the EC is not well defined, other than to state that it should conduct its activities in accordance with the charter. Thus, participants have much freedom in respect to this body. The EC Chairman is the GD, who retains his main authorities and signatory powers. As a result, the EC, which is considered an optional body, is in most instances not necessary. Board of Directors (BOD) The Board of Directors is also an optional body. If a BOD is established in the charter, however, the following issues may be granted to its consideration: electing and terminating executive bodies of the company (GD, EC or Managing Company), the conclusion of large-scale or interested transactions, and issues related to preparing, calling and holding the GMP. Members of the BOD have no signatory powers and are elected by the GMP. (25) Granting participants the right to nominate specific numbers of BOD members is unenforceable. Establishing a BOD is not necessary and makes sense only in specific cases, such as, for example when participants seek to have greater control over the GD. Audit commission (Auditor) The audit commission conducts
inspections of the LLC’s financial
activities. This body is optional unless an LLC has more than 15 participants,
in which case, an audit commission is obligatory. We generally do not
recommend using this body unless there are certain fears with respect
to other participants or the executive bodies of the LLC. As mentioned above, the GD is responsible for the day-to-day management of the LLC. In particular, the GD concludes transactions, issues powers of attorney on behalf of the LLC and conducts other activities, which are not transferred to the competence of the BOD or EC. The GD’s powers may be limited only by the charter and not by a decision of the LLC’s participants. The GD must have signatory power with regard to the LLC bank account and must sign the bank cards enabling an account to be opened. Russian banks have different, and sometimes contradicting, policies with respect to signatures on the bank cards, specifically regarding whether the bank will accept documents certifying the GD’s signatory powers abroad. In this regard, if at all logistically possible, it is advisable to have the general director present to open the LLC bank account. The LLC charter should provide a term of validity for the GD’s authorities. (26) There are no limitations for such term and in practice this term generally varies from 1 to 5 years. During this time, the GD may transfer his powers based on a power of attorney and at any time revoke such power of attorney. The GMP (or BOD, if it is provided for in the charter) may at any time terminate the GD’s powers. However, due to the somewhat complicated procedures for calling a GMP, such termination usually cannot be accomplished immediately. Alienation of shares By default, any participant of an LLC may alienate its shares to another participant or to third parties. According to Russian law, the sale of a participant’s share to third parties is not subject to the consent of the LLC or other participants. However, other participants, and the LLC itself, if provided for by the charter, have the right of first refusal to purchase the share being sold, in proportion to the shares held by remaining participants.(27) Russian law provides the following options in this regard, provisions for which must be expressly included in the charter: 1. Alienation of shares to other participants may be made subject to approval of the LLC or other participants. (28) 2. Alienation of shares to third parties may be prohibited. (29) 3. Alienation of shares to third parties in a manner other than through a sale may be made subject to approval of the LLC or other participants. (30) Unless otherwise provided in the charter, the transfer of shares to heirs and legal successors of a former LLC participant is not subject to the consent of other participants. (31) A participant may mortgage its shares to other participants without limitation, however, a mortgage of shares to third parties requires approval of the GMP and may be prohibited by the charter. (32) The methods set forth above for limiting the manner in which shares may be alienated may be recommended in instances where the founders would like to maintain control over the entry of other participants to the LLC. Withdrawal The founding participants of an LLC should be aware that participants have the right to withdraw from the company at any time. Within six months from the time of the withdrawal, the LLC is obligated to pay the withdrawing participant the actual value of its share. (33) The right to withdrawal can be a double-edged sword. On one hand, the foreign investor enjoys the freedom to withdraw from the company at any time. On the other hand, if the foreign investor established an LLC with a Russian partner, one day this foreign investor could find himself alone in the joint venture if his Russian partner decides to suddenly withdraw. If the Russian partner was needed for Russian Content purposes in the context of the Sakhalin PSAs, the Russian partner’s withdrawal could result in the loss of a contract. The right to withdraw from the LLC cannot be prohibited by the charter. Distribution of profits By default, LLC profits are distributed in proportion to the participants’ share ownership. Upon unanimous decision of the participants, this procedure may be amended. Russian law affords opportunities to establish shares with varying attributes, including profit distribution that differs from shareholding. Amending or deleting such provisions from a charter must also be accomplished by unanimous decision. (34) Investments to LLC property The LLC’s charter may include a provision obligating the participants to make additional investments to the LLC’s property. Respective provisions of the charter should be adopted by unanimous decision of the GMP. Decisions on each additional investment must be adopted by a qualified 2/3 majority of votes, if the charter does not provide a greater amount of votes. (35) Unless the charter provides otherwise, investments must be made proportionally to share ownership. The charter may also specify a maximum amount of investment applicable to all, or to specific individual, LLC participants. (36) If participants plan to invest assets in the company, in addition to those contributed to the charter capital of the company, it is reasonable to include such provisions in the charter. List of Company Activities According to Russian legislation, an LLC may perform any activity not prohibited by law. Although a charter need not provide a list of planned activities, it is general practice to include them. Conclusion Although impossible to analyze all aspects of Russian LLC law in the
confines of a short article, this article is intended to provide a general
overview of some of the main aspects of legal practice related to LLCs,
which should be considered by foreign investors who plan to enter a JV
with a Russian partner. Where foreign investors set up Russian subsidiaries
with 100% foreign ownership of one participant, some of the issues described
above are less significant. (14)
There is little freedom in drafting Joint-Stock Company charters as
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