NEW LEGISLATION: Changes to the Regulation of Limited Liability Companies and Companies with Additional Liability

The Verkhovna Rada of Ukraine adopted, in a repeat second reading, the Law of Ukraine “On Limited Liability and Additional Liability Companies” (Bill No. 4666 http://w1.c1.rada.gov.ua/pls/zweb2/webproc4_1?pf3511=59093), with 285 deputies voting in favor. The adopted law is currently awaiting the President’s signature. However, the relevance of this legislative initiative makes it urgent to analyze the changes that businesses can expect in the near future should the President sign the law on limited liability companies and additional liability companies.

The explanatory note to Bill No. 4666 states that “the purpose of the bill is to improve the regulation of relations related to the formation, operation, and dissolution of limited liability and additional liability companies. It aims to eliminate significant shortcomings in the current legislation and bring it into line with the standards and conceptual approaches characteristic of the legislative acts of the European Union and EU member states. The adoption of a separate comprehensive law on limited liability companies and related additional liability companies will be a logical continuation of the path of development of Ukrainian legislation, as established by the adoption of the Law of Ukraine “On Joint-Stock Companies,” will make it possible to regulate the relevant relationships with an appropriate level of detail, ensure the necessary regulatory flexibility, eliminate duplications and inconsistencies in current legislation, and will significantly improve the investment climate and conditions for conducting business.”

From a technical standpoint, the legal framework governing companies with additional liability (hereinafter “CALs”) is identical to that governing limited liability companies (hereinafter “LLCs”), with the exception that:

a) an SLL bears additional liability for potential debts upon liquidation;

b) under current legislation, certain types of activities may be carried out exclusively by TDLs (for example, insurance).

Accordingly, all changes set forth in the new law apply equally to both LLCs and TDLs.

Therefore, let us examine the most significant changes introduced by the legislature to the provisions governing the activities of limited liability companies and additional liability companies.

1. Lack of Definitions

The new Ukrainian law “On Limited Liability and Additional Liability Companies” (hereinafter—the Law) does not define the terms “limited liability company” and “additional liability company.” The legislature’s reasoning in this regard is that it is impractical to include a list of all characteristic features in the definitions of these terms, since all such features are specified in the text of the law and reflected in the regulatory provisions. To a certain extent, this contradicts the established traditions of legislative drafting that have developed in Ukraine, since the definition of a specific concept is intended to establish a conceptual framework and facilitate the understanding of that concept, which does not require listing absolutely all characteristic features, but only the most essential ones. Moreover, the definition of concepts in legislative acts is necessary for use within Ukraine’s legal framework, in particular, to establish a unified approach and understanding of legislative categories, as well as a uniform judicial practice, which cannot allow for differing interpretations of the same terms.

2. Changes to the Minimum Number of LLC Members

Throughout the history of independent Ukraine, legislative provisions regarding the number of members in an LLC have constantly changed. This Law is no exception.

Thus, Article 4 of the Law does not set any limits on the number of members of an LLC (Article 50 of the Law of Ukraine “On Business Associations” previously set a limit of 100 persons). Since there were no such restrictions for joint-stock companies (JSCs) previously, the regulations in this regard have not changed for them; rather, they have simply been clearly articulated and codified in the law.

This is a positive development, since, in practice, government agencies did not monitor whether the maximum number of LLC members was exceeded, and no clear mechanisms for doing so were provided.

3. A new provision has been introduced—the corporate agreement

Attempts to legislatively regulate corporate agreements—an instrument that is both extremely important and new to Ukraine, known in international practice as “shareholder agreements”—date back to early 2017. Specifically, this refers to the draft Law “On Amendments to Certain Legislative Acts of Ukraine Regarding Corporate Agreements” No. 4470 dated April 19, 2016, which was passed by 279 deputies on March 23, 2017, but was never signed by the President.

Thus, a corporate agreement establishes a clear distinction between the subject matter of the corporate agreement and that of the law and the articles of association: the corporate agreement sets forth the parties’ obligations to exercise their powers in a specific manner, while the powers of the parties themselves may be established by law and the articles of association.

Of course, a corporate agreement is an effective means of protecting the rights of company shareholders and a convenient tool for effectively regulating the specifics of corporate governance within a particular company. However, in Ukraine, the corporate agreement is a new phenomenon, and given that Article 7 of the Law sets forth the conditions for concluding this type of agreement “in general,” establishes the confidentiality of the terms of the corporate agreement, provides for the possibility of concluding such agreements in simple written form, and accordingly leaves the determination of nearly all material terms to the discretion of the parties, this may create conditions for abuse in this area, particularly corporate raiding.

It also appears that the provision regarding the confidentiality of a corporate agreement contradicts the provision allowing for the nullification of an agreement concluded by a party to the corporate agreement in violation of such corporate agreement, if it is proven that the other party to the agreement knew or should have known about such a violation. Thus, if the disclosure of the contents of a corporate agreement is completely prohibited, it will be difficult for a party to the corporate agreement whose rights have been violated to prove the bad faith of both parties to the agreement concluded in violation of the corporate agreement, in order to have it declared null and void, which would limit the possibilities for implementing the corporate agreement.

An irrevocable power of attorney, as provided for in Article 8 of the Law, should serve as a guarantee of compliance with the terms of the corporate agreement.

Therefore, it is still too early to speak of the effectiveness of corporate agreements in practice in Ukraine.

4. The list of information that must be included in the articles of association of an LLC or a joint-stock company has been reduced

In particular, Article 11 of the Law does not require the inclusion of information regarding the amount of the authorized capital or the list of company members among the details that must be specified in the articles of association. Nor does the Law require the company’s location to be specified in the articles of incorporation.

The absence of this information in the text of the articles of incorporation simplifies the procedure for amending information regarding the authorized capital, the list of members, and the company’s location, and eliminates the need for additional steps such as notarization and or registering amendments to the company’s articles of association—which, in addition to organizational inconveniences, typically resulted in additional time expenditures that are often of critical importance to investors and business entities.

5. Changes have been made to the procedure for forming the authorized capital (contribution of shares by members) when establishing an LLC or a Joint-Stock Company

The current Law of Ukraine “On Business Entities” contains a provision setting a one-year deadline from the date of the company’s registration for members to form the authorized capital.

Thus, Article 14 of the Law establishes a general rule stipulating that each member of the company must fully contribute their share within six months from the date of the company’s state registration, unless otherwise provided by the articles of association. The relevant provisions may be included in, amended, or excluded from the articles of association by a unanimous resolution of the general meeting of members, in which all members of the company participated.

Thus, the general deadline for forming the authorized capital has been shortened; however, by a unanimous decision of the general meeting of members, in which all members of the company participated, this deadline may be extended or shortened, which must be reflected in the articles of association. In other words, determining the timeframe for members to contribute their shares to the authorized capital is a discretionary right of the company’s members.

In addition, Article 15 of the Law refines the procedure for making decisions if a member has failed to make a contribution to the authorized capital by the due date. In such a case, the company’s executive body is required to send the member who is in default a written notice of default. The notice must include information regarding the contribution or portion thereof that was not paid on time, as well as the additional period granted to settle the debt. The additional period granted to settle the debt is set by the company’s executive body or the company’s articles of association, but may not exceed 30 calendar days.

6. Detailed Procedure for Increasing and Decreasing the Authorized Capital

Part 2 of Article 16 of the Law stipulates that an increase in the authorized capital of a company that holds a stake in its own authorized capital is not permitted.

The procedure for increasing the authorized capital without additional contributions and through additional contributions is regulated

The rule regarding the preservation of the proportions of participants’ shares when increasing the authorized capital without attracting additional contributions (i.e., at the expense of the company’s retained earnings) and when the authorized capital is reduced by a resolution of the company, the ratio of the shareholders’ stakes in the authorized capital remains unchanged (Articles 17 and 19 of the Law).

7. Significant changes have been made to the regulation of shareholders’ preemptive rights, the procedure for a shareholder’s withdrawal from the company, the mechanism for expelling a shareholder from the company, and the procedure for the inheritance of shares

In particular, the conditions that must be met for a shareholder to exercise their preemptive right are specified (timeframes and procedures for notification, granting consent, and concluding a share purchase agreement). Part 6 of Article 20 provides that the company’s articles of association may establish:

a) a different procedure for exercising shareholders’ preemptive rights, for distributing the transferred share (or portion of a share) among the other shareholders, or for waiving the exercise of shareholders’ preemptive rights;

b) that the members of the company do not have a preemptive right;

c) the obligation of a member intending to sell a share (or portion of a share) to a third party to first negotiate its sale with the other members of the company.

Part 2 of Article 23 of the Law provides that in the event of the death of a member who is a natural person, a court declaration of such member as missing or deceased, or the dissolution of a member that is a legal entity whose share in the company’s authorized capital is less than 50 percent, and if, within one year from the expiration of the statutory deadline for accepting the inheritance, the heirs (legal successors) of such a member have not filed an application to join the company in accordance with the law, the company may expel the member from the company. Such a decision is made without taking into account the votes of the member being expelled. If such a member’s share in the company’s authorized capital is 50 percent or more, the company may make decisions related to the company’s liquidation without taking into account the votes of that member.

However, in light of the provisions of the Civil Code of Ukraine regarding inheritance, this provision violates a person’s right to inherit the decedent’s share in the company’s authorized capital and is illogical, since the Civil Code of Ukraine does not set any deadlines for obtaining a certificate of inheritance. Thus, pursuant to Article 1296 of the Civil Code of Ukraine, an heir who has accepted an inheritance may obtain a certificate of inheritance. The absence of this certificate does not deprive the heir of the right to the inheritance. Furthermore, there is no time limit for issuing a certificate of inheritance (Article 1298 of the Civil Code of Ukraine). Consequently, Article 23 of the Law regarding the consequences of “prolonged inactivity” on the part of an heir or the legal successor of a company participant requires harmonization with the provisions of the Civil Code of Ukraine concerning inheritance.

It is also worth noting that the time limit for accepting an inheritance is established by the Civil Code of Ukraine, specifically Article 1270 of that Code, and therefore the legal concept of “the time limit for accepting an inheritance established by law,” used in the text of the second part of Article 23 of the Law, is inconsistent with the provisions of the Civil Code of Ukraine.

At the same time, Article 24 of the Law provides for specific provisions regarding the acquisition of a company participant’s share by an heir or legal successor in accordance with the articles of association.

Thus, the company’s articles of association may provide that, in the event of a member’s death or termination, the member’s share in the company does not pass to their heir or legal successor, or that the heir or legal successor may join the company in the cases and in the manner established by the articles of association.

In other words, Article 24 of the Law contains an exception to the general rule established by Article 23 of the Law; however, Article 23 of the Law itself makes no mention of possible exceptions that may be provided for in the articles of association.

Consequently, the Law contains internal inconsistencies, which do not meet the requirements for the quality of laws in the context of the rule of law (Article 8 of the Constitution of Ukraine).

Article 25 of the Law provides that a shareholder whose stake in the company’s authorized capital is 50 percent or more may withdraw from the company only with the consent of the other shareholders. This protects the rights of the company’s other shareholders and minimizes the risk of such a decision by a single shareholder causing negative consequences for the company.

8. Dividend Payments

In particular, Article 28 of the Law provides that a company may not decide to pay dividends or pay dividends if:

1) the company has not settled accounts with its members in connection with the termination of their membership in the company or with the successors of the members in accordance with this Law;

2) the company’s assets are insufficient to satisfy creditors’ claims or will become insufficient as a result of a decision to pay dividends or the actual payment of dividends;

3) other grounds provided for in the articles of association.

A company may not pay dividends to a shareholder who has not fully or partially contributed their capital.

9. General Meeting of Members: Grounds, Timeframes, Procedure for Convening, and Decision-Making

These provisions are set forth in greater detail compared to existing legislation, addressing gaps that had been resolved in practice but were not explicitly provided for by law.

Grounds for convening a general meeting of members:

1) in cases provided for by law or the company’s articles of association;

2) at the initiative of the company’s executive body;

3) at the request of the company’s supervisory board;

4) at the request of a shareholder or shareholders of the company who, as of the date of the request, collectively hold 10 percent or more of the company’s authorized capital.

A general meeting of shareholders may be held via teleconference, videoconference, or using other means of electronic communication, provided that each shareholder can participate simultaneously with all other shareholders in the discussion and voting on matters submitted for consideration by the general meeting.

The law provides for the option to waive the use of a power of attorney as a means of communicating a participant’s decision on a specific issue to the company, since a power of attorney is not actually intended for this purpose. If a participant’s decisions on agenda items have already been formed, the participant should be given the opportunity to vote in absentia by expressing their will in a written document. This is stipulated in Article 36 of the Law.

The procedure for adopting decisions at a general meeting of members through a poll is also detailed for LLCs and limited liability companies (Article 37 of the Law) and generally mirrors the provisions of the Law “On Joint-Stock Companies.” A general meeting in this form may be initiated by individual participants; however, a decision may be adopted only by a unanimous vote of all participants. The requirement for a unanimous vote by participants is intended to eliminate the risk of abuse associated with this form of voting.

Article 38 of the Law sets forth the specific procedures for holding a general meeting of shareholders by a company with a single shareholder, namely, decisions on matters falling within the competence of the general meeting of members are made by that sole member of the company individually and formalized in a written resolution by such member—a practice that was followed in practice but was not codified in law.

10. Conflict of Interest

The Law aims to identify and resolve issues related to conflicts of interest. However, following the example of legislation in developed countries, the Law does not establish a strict prohibition on the participation of a person with a conflict of interest, but rather imposes an obligation on a member of the executive body to notify the body responsible for electing members of the executive body (the general meeting of participants or the supervisory board) of the existence of such circumstances (Article 43(6) of the Law). A breach of this obligation by an officer constitutes grounds for the company to terminate an agreement (contract) with such a person without payment of compensation.

11. A list of documents that the company is required to retain has been established

The company is required to retain the following documents: the minutes of the meeting of the company’s founders (decision of the sole founder); the company’s articles of association and amendments thereto; minutes of the general meeting of participants; company documents governing the activities of the company’s governing bodies, and amendments thereto; regulations on the company’s branches (representative offices), if established (opened); minutes of meetings of the company’s supervisory board and collegial executive body, as well as orders and directives of the company’s executive body; audit reports and results of other audit services; annual financial statements; reporting documents submitted to the relevant government agencies; documents related to the issuance of securities; other documents required by law, the company’s articles of association, and resolutions of the general meeting of participants, the supervisory board, and the company’s executive body; documents confirming the company’s rights to property; accounting records.

12. The categories of “significant transaction” and “transaction involving a conflict of interest” are introduced

 

The rules set forth in Articles 45 and 46 of the Law provide that the executive body may not enter into material transactions or related-party transactions on its own initiative, but must obtain special authorization by securing approval from the general meeting or the supervisory board (with voting conducted in accordance with special rules).  This means that if the requirements of Articles 45 and 46 of the Law are not met, the executive body did not have the authority to enter into the transaction; and therefore such a transaction is deemed not to have been entered into, and the contract, accordingly, is deemed not to have been concluded—that is, it does not produce the legal consequences for which it was intended.

A material transaction or a transaction involving a conflict of interest, entered into in violation of the procedure for adopting a resolution to grant consent for its execution, may subsequently be approved by the company in accordance with the procedure established for adopting a resolution to grant consent for its execution.