. Shareholders’ Agreement: Foreign Law and Russian Practice
Shareholders’ agreements are a tool for the contractual regulation of relations between shareholders/participants of companies and are widely used in jurisdictions of the Anglo-Saxon legal system (in particular, the UK and the US), but also recognized and regulated by the laws of countries that have continental legal systems (including Russia, Germany and Italy).
The core value of this tool is that it allows for:
- redistributing the rights of shareholders in the domain of corporate governance, regardless of the number of votes that a particular shareholder is granted under the law based on the number of shares owned by said shareholder;
- increasing the liquidity of shares of non-public companies by granting to shareholders additional rights to dispose of their shares under certain circumstances and by establishing corresponding obligations of other shareholders for the acquisition of such shares;
- providing for the undertakings of shareholders related to the promotion of business development, competitiveness and the economic security of a company that cannot be established by the articles of association and internal documents of the company;
- stipulating mechanisms for settling disputes among shareholders out of court or through arbitration.
The concept of a shareholders’ agreement (as applicable to joint stock companies) and an agreement on the exercise of participants’ rights (with respect to limited liability companies) was first enshrined in Russian law in mid-2009:
- Article 8 of the Federal Law dated 8 February 1998 No. 14-FZ,”On Limited Liability Companies” (hereinafter – the “LLC Law”) was supplemented with a provision on the right of a company’s founders (participants) to enter into an agreement on the exercise of participants’ rights1;
- the Federal Law dated 36 December 1995 No. 208-FZ,”On Joint Stock Companies” (hereinafter – the “JSC Law”) was supplemented by Article 32.12, which provides for the right of shareholders to enter into a shareholders’ agreement pertaining to exercising of the rights granted by shares.
Prior to these legislative amendments, although it had generally been possible to enter into agreements between shareholders/participants governed by Russian law on the basis of the principle of freedom of contract established by Article 421 of the Civil Code of the Russian Federation (hereinafter – the ‘Civil Code’), Russian investors and their foreign counterparts chose (and still often choose) the law of England and Wales or the law of the country of incorporation of a foreign invest to regulate their relations within joint ventures.3
Following the resonant judgements of Russian courts in 2006 that rendered invalid shareholders’ agreements governed by foreign law due to the fact that their provisions violated the imperative rules of Russian civil and corporate law (Decision of the Federal Arbitration Court of Western-Siberian District, dated 31 March 2006, No.F04- 2109/2005(14105-А75-11) regarding the case of ‘Megafon’ JSC, and the Decision of the Moscow City Arbitration Court4 on the case of ‘RusskiyStandartStrakhovaniye’ JSC, dated 26 December 2006, No. A40-62048/06-81-343), the enforcement of such agreements in Russia became doubtful. Along with tax incentives provided by double taxation agreements between Russia and a number of countries, the judgement was one of the reasons for establishing multilevel holding structures that allow for entering into shareholders’ agreements under English (or another foreign) law at the level of companies established in foreign jurisdictions, such as the Republic of Cyprus. Since the entry into force of amendments to the JSC and LLC laws, which introduced the concept of a shareholders’ agreement and an agreement on the exercise of participants’ rights (hereinafter – a “participants’ agreement”), the respective agreements governed by Russian law have been actively employed by companies alongside state participation (in particular, ROSNANO OJSC, companies belonging to the VTB group), investing in innovative and/or fast-growing businesses as minority shareholders/participants.
At present, however, the courts’ practice in Russia regarding disputes arising from shareholders’ agreements and participants’ agreements has not yet been established.5 With respect to participants’ agreements, the most prominent is the decision of the Arbitration Court of Moscow, dated 24 November 2010 regarding case No. A40-140918/09-132-894 on rendering invalid the participants’ agreement of VerniyZnak LLC, which was further upheld by other judicial instances, including the Highest Arbitration Court of the Russian Federation (hereinafter – the ‘HAC’). The following provisions of the agreement were deemed invalid as contradicting to the imperative rules of the Civil Code and LLC Law:
- In terms of company management:
- an obligation of the parties to unanimously vote on all issues on the agenda of the general meeting;
- especial procedure for convocation (including a shortened notice period) of the general meeting of participants;
- the right of one participant to take decisions at the general meeting regardless of the will of another participant;
- In terms of the rights and obligations of participants:
- the exclusive right of one participant to nominate the executive body and deprivation of another participant of the right to vote against such a nomination;
- disproportionate distribution of the company’s profits among the participants (e.g., 90% and 10%);
- restriction of the right of a participant to exit the company;
- restriction of the right of a participant to dispose of their share in the charter capital;
- In terms of the consequences of a breach of the agreement and liability of the parties:
- the invalidation of a transaction entered into by a participant in a breach of the agreement upon demand of another participant;
- deprivation of the right to vote at extraordinary general meetings, the right to a share in the charter capital or to distribution of the company’s profits;
- transfer of the share of one participant to another participant for a breach of the agreement;
- In terms of the ‘deadlocks’ settlement:
the obligation of a participant to transfer his share to another participant at a price no more than 50% of the company’s net profit for a financial year in the event of the impossibility of taking a decision at the general meeting on the agenda due to voting against such a decision by one of the participants.
The abovementioned provisions were as well clearly inconsistent with the fundamental principle of Russian civil law – the equality of parties. Additionally, as it was noted by the parties to this case in a public announcement, the case was initiated solely for the purpose of establishing the position of Russian arbitration courts with respect to the relevant terms of the participants’ agreement, whereby no evidence had been provided for proving that either party to the agreement had actually intended to perform their undertakings with another party.6
In relation to shareholders’ agreements, exemplary among these is the Decision of the Federal Arbitration Court of Volga District on case No. A57-7487/2010, dated 7 September 2010, regarding the shareholders’ agreement of Agro JSC, the terms and conditions of which were rendered invalid by the court in the first instance, since they were aimed at alteration of the procedures and methods of corporate governance of the company, while some also contradicted the principle of the balance of interests of the parties, in particular:
- In terms of company management:
- the appropriation of the general shareholders’ meeting competencies by one shareholder;
- the right of the company’s owner to appoint/dismiss at its sole discretion directors, their deputies and chief accountants;
- the right of one shareholder to determine a list of transactions that require prior written approval by all the shareholders, including the transactions of subsidiaries and affiliates of the company;
- the right of one shareholder to establish a new temporary managing body for the company endowed with the right to appoint by its decision a temporary sole executive body of the company;
- alteration of the procedure for convening the general meeting of shareholders of the company and alteration of its quorum to a 2/3 majority vote;
- In terms of the rights and obligations of shareholders: a waiver of one of the shareholders of the right to participate in the distribution of profits, dividends, bonuses and other payments in favour of another shareholder.