Legislative Developments: Corporate Contracts

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The urgency of legislatively regulating such an extremely important and new instrument for Ukraine as corporate agreements—known in international practice as “shareholder agreements”— was driven by existing gaps in the regulation of relationships among company participants (shareholders).

On March 23, 2017, the Law of Ukraine “On Amendments to Certain Legislative Acts of Ukraine Regarding Corporate Agreements” No. 1984-VIII (hereinafter “Law No. 1984”) was adopted, which was signed by the President only on February 16, 2018.

Until that time, the only provision governing the right of shareholders (i.e., regulation existed only for joint-stock companies) to enter into a shareholders’ agreement was the provision of the seventh paragraph of Part 1 of Article 29 of the Law of Ukraine “On Joint-Stock Companies”, which stipulates that a company’s articles of association may provide for the conclusion of an agreement among shareholders that imposes additional obligations on the shareholders—including the obligation to participate in general meetings—and establishes liability for noncompliance. However, experience has shown that the application of this provision is ineffective due to insufficient legislative regulation of the procedures for concluding such agreements and inconsistencies with other legislative acts.

Changes to the legislation regarding corporate agreements are being adopted very slowly in business practice. To this day, most companies have been established using boilerplate documents. Of course, this isn’t always a bad thing—after all, why waste effort creating something fundamentally new if you have a standard business model and need standard documents that will pass registration without any issues, allowing you to get down to business? But in situations where the business involves manufacturing—especially innovation or IT technologies—or when it is necessary to attract investors, or when several partners are working together, each contributing to the joint venture, in such cases, it is essential to carefully consider the corporate structure, allocate rights and establish responsibilities, define a system for managing the company, agree on the right to sell shares, agree on the terms of permissible corporate control, and provide for penalties for breaching the agreements. As you can easily guess, all of the above steps must be properly completed before the legal entity is established. The purpose of the corporate agreement is to allocate rights and obligations both in advance and during the course of the company’s business operations, and to agree on terms that are acceptable to all parties for conducting future or existing business.

Under Law No. 1984, a corporate agreement may be entered into only by business entities: limited liability companies and joint-stock companies. From a technical standpoint and in light of the provisions of Article 65 of the Law of Ukraine “On Business Entities,” the legal regime governing companies with additional liability is identical to that governing limited liability companies, with certain exceptions. Therefore, an agreement on the exercise of participants’ (founders’) rights may also be used to regulate the relationships among participants (founders) in companies with additional liability.

Law No. 1984 introduced two concepts covered by the term “corporate agreement,” and, taking into account Article 65 of the Law of Ukraine “On Business Entities,” this list has been expanded to three:

- an agreement on the exercise of the rights of members (founders) of a limited liability company;

- an agreement on the exercise of the rights of members (founders) of a limited liability company with additional liability;

- an agreement among the shareholders of a company.

Form of a Corporate Agreement

A corporate agreement must be executed in writing by drafting a single document. This does not mean that it must consist of a single copy. There may be multiple copies, at the discretion of the parties. The requirement for a single document is merely a stricter formal requirement for the agreement. For corporate agreements, the “offer and acceptance” format—where one party mails a signed agreement to the other party, and the other party returns the agreement signed on its end—is not permitted. The authenticity of the signatures of the participants (founders, shareholders)—who are natural persons—in such a contract must be certified in accordance with established procedures; pursuant to legal requirements, such certification must be performed by a notary in compliance with the rules governing notarial acts. Therefore, the personal presence of the signatories is required to sign a corporate agreement. Given the content of the provisions governing corporate agreements, it appears impossible to “acced” to a corporate agreement—a practice that is, for example, permitted and even common in English corporate law. If a new participant (shareholder) joins, a new agreement must be entered into. Furthermore, the agreement among the founders is the first document setting forth the basic terms of operation, the procedure for incorporation, and the subsequent allocation of responsibilities. Thus, corporate agreements may be entered into not only after the company’s incorporation.

An irrevocable power of attorney, notarized by a notary public, should serve as a guarantee of the fulfillment of obligations under the corporate agreement.

The Relationship Between the Articles of Association and the Corporate Agreement

Previously, the provisions of a corporate agreement could not apply to management bodies, which made it impossible to challenge decisions made by those bodies.

Thus, in Recommendations No. 04-5/14 dated December 28, 2007, (now repealed), the Higher Commercial Court noted that corporate governance issues may be regulated by an agreement concluded between shareholders only in cases expressly

provided for by Ukrainian legislation. Agreements between shareholders (members of business entities) may not alter the provisions of the law or the company’s articles of association, nor may they restrict the rights of other shareholders (members) of the company. If such agreements are concluded on matters that are subject to regulation by law or the company’s articles of association, these agreements may be declared invalid by a court.

A similar opinion was expressed by the Plenum of the Supreme Court of Ukraine in Resolution No. 13 dated October 24, 2008, noting that the relationships between the founders (members) of a business entity regarding the formation of its governing bodies, the determination of their powers, the procedures for convening general meetings, and the determination of the decision-making process at such meetings are governed by the provisions of the Civil Code. By their nature, these provisions are mandatory, and failure to comply with them constitutes a violation of public order.

However, with the adoption of Law No. 1984, the corporate agreement—to which all members of a business entity are parties—is becoming more akin to the articles of association and may, in certain provisions, supersede them. Currently, there is no established practice of applying this approach, and it appears that in the near future, the prevailing approach will be one under which the terms of the corporate agreement cannot contradict the articles of association, since limited liability companies, companies with additional liability, and joint-stock companies operate on the basis of their articles of association (Article 4 of the Law of Ukraine “On Business Entities”).

At the same time, a unanimous corporate agreement (entered into by absolutely all participants in the company) may, to a certain extent, duplicate and/or overlap with the provisions of the company’s articles of association. The structure of the governing bodies and their powers, the procedure for convening and holding general meetings and board of directors meetings, and the procedure for the transfer of shares and equity interests are regulated with a sufficient degree of flexibility (at the discretion of the parties). Consequently, shareholders may agree on certain provisions not in the articles of incorporation but in the corporate agreement.

In fact, Law No. 1984 allows for a departure from the previously mandatory “one share—one vote” rule, which was typically stipulated in articles of association. A system of disproportionate voting may be set forth in the corporate agreement. However, it should be understood that the terms of the corporate agreement do not apply to transactions with third parties unless it is proven that such a party knew or should have known about these restrictions. All provisions concerning relations with third parties must be as public as possible and, therefore, must be included in the company’s articles of association. Since the articles of association are a public document, their provisions apply to all third parties, whereas obligations under a corporate agreement are not disclosed at all (except for public joint-stock companies) and apply only to the parties to the agreement (Article 51-1 of the Law of Ukraine “On Business Entities” and Article 26-1 of the Law of Ukraine “On Joint-Stock Companies”).

It should also be noted that the provisions of the company’s articles of association are familiar and understandable to the Ukrainian business sector. However, a corporate agreement offers a number of advantages. A corporate agreement allows for a specific scope of rights to be assigned to a particular shareholder, rather than to any shareholder. Provisions of the articles of association typically apply equally to all shareholders (erga omnes patres), whereas a corporate agreement may stipulate that the preferential right on a particular set of issues belongs specifically to the shareholder holding 5% of the voting rights, rather than to any shareholder whose stake amounts to 5%.

What are the consequences of a conflict between the corporate agreement and the articles of association? Law No. 1984 does not establish any legal consequences for cases of conflict between the articles of association and the corporate agreement. Moreover, Law No. 1984 provides broad discretionary authority to regulate relations among shareholders. It follows logically that a conflict between the corporate agreement and the articles of incorporation cannot serve as grounds for challenging the corporate agreement or declaring its provisions invalid. If the two documents conflict, a decision must be made based on the provisions of the document created most recently. Here, the Roman law principle “Lex posterior derogat lex prior” applies—a later law supersedes an earlier one (in those provisions where they conflict). For the same reason, the provisions of Law No. 1984 must take precedence over the older provisions of special laws. However, this rule applies only to the relationship between the corporate agreement and the articles of incorporation. A corporate agreement entered into by some, but not all, participants (shareholders) will not take precedence over the articles of incorporation, even if such an agreement was entered into after the articles of incorporation and contains provisions that conflict with them.

However, only future practice and the application of the law will determine whether this approach will be recognized or whether the principle of the articles of incorporation taking precedence over the corporate agreement will ultimately prevail; and the guiding principle will be that a corporate agreement sets forth the parties’ obligations to exercise their powers in a specific manner (specific provisions), while the powers of the parties themselves may be established only by law and the articles of association.

Contents of a Corporate Agreement

A corporate agreement is an agreement between a specific group of participants (shareholders) that represents their interests. It can be interpreted as a special legal instrument. This document can contain much broader and more detailed provisions than the company’s articles of incorporation.

Thus, a corporate agreement allows the parties to agree on a whole range of conditions:

- the procedure for managing the company;

- voting procedures;

- the distribution of profits;

- methods of protecting minority shareholders;

- the balance of shareholders’ interests;

- procedures for providing financing and monitoring its intended use;

- approval of the financial plan and oversight of production;

- procedures for approving major transactions;

- Terms for shareholders’ (participants’) exit: drag-along right, tag-along right;

- prevention of deadlocks;

- the procedure for liquidation and distribution of assets.

For example, a corporate agreement may contain detailed provisions regarding the acquisition and disposal of shares, increases in the company’s authorized capital, and so on. For example, it may specify the circumstances under which members must refrain from selling a share or stock. A corporate agreement may set forth the procedure for forming the company’s governing bodies. It can be used to specify how many “independent” directors the company will have. The company may well face various complex and contentious situations, such as when one group of shareholders holds a large block of shares or a significant stake, or even a scenario where two different groups of shareholders are in a “50-50” deadlock. In such cases, attempts are made to “divide” the company from within. A corporate agreement can serve as a useful tool to anticipate such situations. It will prove helpful when the composition of shareholders changes. Regarding the management of ownership interests, a corporate agreement may be entered into among minority shareholders or shareholders who hold small stakes. For example, several shareholders who each hold an 8% stake can enter into an agreement and act jointly on internal company matters.

Law No. 1984 also contains an exception to what may be included in the terms of a corporate agreement: the subject matter of a corporate agreement among shareholders (founders, shareholders) of a company may not include an obligation for a party to the agreement to vote in accordance with the instructions of the company’s governing bodies regarding the shares for which the agreement is concluded, except in cases where a party to the agreement is a person who is simultaneously a member of such company’s governing body.

Confidentiality of Corporate Agreements

Different confidentiality requirements for corporate agreements apply to limited liability companies, companies with additional liability, and joint-stock companies.

Article 51-1 of the Law of Ukraine “On Business Entities” provides that, unless otherwise provided by law or by an agreement on the exercise of the rights of members (founders) of a limited liability company, information regarding the content of an agreement on the exercise of the rights of members (founders) of a limited liability company shall not be subject to disclosure and shall be confidential. Thus, this establishes the highest level of confidentiality for the terms of corporate agreements of limited liability companies and companies with additional liability.

The issue is regulated differently for private and public joint-stock companies.

Specifically, Article 26-1 of the Law of Ukraine “On Joint-Stock Companies” states that information regarding the conclusion of an agreement between shareholders must be reported to the company by one of the parties to the agreement within three business days from the date of its conclusion.

Consequently, a joint-stock company must be aware of any agreement entered into within the company, but the content of the corporate agreement need not be disclosed—only the fact of its conclusion.

Similarly, it should be assumed that shareholders who were unaware of the existence of the agreement may recover damages from the shareholders who entered into such an agreement; however, it is not entirely clear how the amount of damages should be determined in this case.

A public joint-stock company discloses information regarding the existence of an agreement among shareholders in accordance with the procedure established by the Law of Ukraine “On Securities and the Stock Market” for the disclosure of specific information about the issuer.

It is not necessary to disclose all details; however, in the event of acquiring corporate control, the shareholder who has acquired such control must disclose this information to the company, and the company must notify the National Securities and Stock Market Commission.

Unless otherwise provided by law or by the shareholders’ agreement, information regarding the content of the shareholders’ agreement is not subject to disclosure and is confidential.

However, it appears that the provision regarding the confidentiality of a corporate agreement conflicts with the provision allowing for the nullification of an agreement entered into by a party to the corporate agreement in violation of such corporate agreement, provided it is proven that the other party to the contract knew or should have known of such a breach. Thus, given the complete prohibition on disclosing the contents of a corporate agreement, 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 contract concluded in violation of the corporate agreement in order to have it declared null and void, which will limit the ability to enforce the corporate agreement.

Agreements Between Members and Third Parties

Law No. 1984 provides that creditors of a company may enter into an agreement with the members of a limited liability company, under which the members, for the purpose of safeguarding the legally protected interests of such third parties, undertake to exercise their corporate rights in the manner provided for in such an agreement, or to refrain from (waive) exercising them, including voting in the manner provided for in such an agreement at the general meeting of members of the limited liability company, to coordinate other actions related to the management of such a company, to acquire or sell shares in its authorized capital at a specified price or upon the occurrence of circumstances specified in the agreement, or to refrain from disposing of shares until the circumstances specified in the agreement occur. The general provisions governing agreements on the exercise of rights by members (founders) of a limited liability company apply to such an agreement, unless otherwise provided by law or implied by the nature of the parties’ relationship.

A similar provision applies to joint-stock companies.

An agreement between the company’s members and creditors is fairly predictable. For example, creditors anticipate a situation in which the company becomes a debtor. The corporate agreement sets forth the terms for this scenario—whether the members will sell their shares, and if so, under what conditions, or whether they will refrain from selling their shares. However, the clause regarding “third parties” provides that some of the company’s management functions may be transferred to “third parties,” who may be neither partners nor shareholders of the company. And they will manage the company’s functions solely on the basis of the corporate agreement, the terms of which are confidential and not subject to disclosure.