Russian civil and corporate laws are undergoing significant changes that will have an impact on M&A deals involving Russian companies. This article provides a quick overview of those amendments, which are likely to be relevant for private equity firms active in Russia.
Changes Affecting Transaction Documents and Negotiations
Acting and Negotiating in Good Faith
Russian law now has an explicit general principle of acting in good faith that applies to all civil law relations, including corporate governance. In particular, it is prohibited to enter into or continue negotiations without an intention to reach agreement, to remain silent about material conditions or to provide incomplete or incorrect information, to cease negotiations abruptly and unreasonably and to use information provided by the other party to the negotiations in an improper fashion in one’s own interests. A party breaching these provisions is liable to compensate the other party for its losses arising from the breach.
Representations, Warranties and Indemnities: Now Possible Under Russian Law
Amendments to the Civil Code, which came into effect on June 1, 2015, introduced a number of provisions that are quite novel for Russian law and permit parties to agree and enforce representations on a wide variety of matters, including business representations, compliance and authority. A misrepresentation entitles the other party to claim compensation for losses or payment of damages set out in the contract and, in certain cases, rescission of the contract. The Civil Code now also contains provisions governing “indemnification of losses,” which allow the parties to agree in a contract that one party will indemnify the other for losses arising from circumstances set out in the contract (other than a willful breach of the contract by a party, where other available remedies, such as damages, continue to apply). Such circumstances may include an inability to perform a contract, or claims from third parties or governmental authorities against a party to the contract or a third party, e.g., a subsidiary. The amount of the indemnity or the procedure for its calculation must be set out in the contract. The amendments have also introduced additional flexibility into contractual undertakings subject to conditions, where it is now possible to have a condition solely dependent on the will of one of the parties, and also in relation to option agreements, which were not previously expressly regulated by law.
New provisions now govern “corporate agreements,” which will apply to any shareholders’ agreement, whether in respect of a limited liability company or a joint stock company. In particular, it is now expressly provided that creditors and other third parties can be party to corporate (shareholders’) agreements. Furthermore, resolutions of a company’s governing bodies can be invalidated if taken in breach of a shareholders’ agreement, provided that all shareholders of a company are party to the agreement, which is often the case in joint ventures and private equity deals. Similarly, transactions by a party to a shareholders’ agreement that are in breach of such agreement can be invalidated, provided that the counterparty knew or should have known of the limitations in the shareholders’ agreement. From this standpoint, investors will need to consider if information on the shareholders’ agreement should be publicly disclosed.
Changes Affecting Corporate Governance
Public and Non-Public Companies
There is no longer a division of joint stock companies into closed and open joint stock companies. Russian corporate entities are now divided into public and non-public entities. Under the Civil Code, joint stock companies can be public or non-public, while limited liability companies can only be public.
As would be expected, the corporate governance of non-public companies is more flexible than for public companies. By way of example, a non-public company need not have a board of directors; the corporate powers of its shareholders’ meeting may be expanded or restricted; statutory rules for holding board and shareholder meetings can be amended by a company’s charter; the charter may restrict the maximum number of shares or votes held by one shareholder. This flexibility is beneficial as it allows shareholders to fine-tune various corporate rules to better reflect their specific needs.
Until recently, the only person authorized to represent a Russian company, without a power of attorney, was its sole executive body (the CEO or the General Director). A company can now have several persons, acting either jointly or independently, to represent the company vis-à-vis third parties without a power of attorney.
Can a Shareholder/Participant Be Expelled From a Company?
The Civil Code now allows any shareholder in a non-public company to demand that another shareholder be expelled from the company, via a court procedure, if the actions or inactions of the shareholder result in damage to the company, or otherwise materially complicate or jeopardize the activities of the company or the attainment by the company of the purposes for which it was established, including through gross violation by such shareholder of its obligations under the law or the company’s charter.1 An expelled shareholder is paid the “actual” value of its share in the company by the company. The Civil Code does not specify how actual value is calculated; however, precedent suggests it will be calculated based on the value of the company’s net assets. The operation of these provisions has not yet been tested and will require further study and clarification.
Liability of Persons Able to Exercise Influence Over a Company
As a result of recent amendments to the Civil Code, a person that is effectively capable of determining the actions of a legal entity, including the right to give directions to its governing bodies, must act in the interests of such legal entity, reasonably and in good faith. A person that fails to do so can be held liable for damages to the company. This is a general principle, the implementation of which remains unclear and will to a significant extent depend on court practice; therefore, investors in a Russian company will need to carry out a careful analysis to ensure that this risk is properly understood and addressed to the extent possible.
Broader Rights of Board Members
The Civil Code now explicitly provides that a board member is entitled, among other things, to receive information about the company, to file claims on behalf of the company for damages caused by wrongful actions of the controlling shareholder or other members of the company’s governing bodies or to challenge transactions entered into by the company in breach of its charter. This is in contrast to the previous regulations where a director could not meaningfully assist shareholders enforcing actions in the event of a corporate conflict.
Matters Affecting Due Diligence Review of Russian Companies
Shareholders’ Registers to Be Held by Independent Registrars
Until recently, joint stock companies having fewer than 50 shareholders were allowed to hold and keep their shareholders’ registers themselves. Share registers of all joint stock companies, whether private or public, must now be held by licensed registrars, which should provide additional comfort to investors confirming title to shares.
Principles of State Registration of Rights to Property
The Civil Code now contains the basic principles of state registration of rights to property where such registration is required by law, which would cover, for example, rights to real estate, intellectual property rights and rights to participatory interests in a limited liability company. Recently introduced provisions are aimed at promoting a presumption of public accuracy of state registers while also permitting notices of objection and challenge to be entered on the register. These changes are intended to ensure that any party conducting a due diligence review of a Russian company will be able to rely on the information contained in public registers.
This summary does not cover all of the recent amendments to Russian corporate and civil law, but highlights some matters of interest to private equity investors. It is also important to note that Russian law continues to undergo significant changes, and it is therefore important to monitor future amendments.
1 Note that under the amended Civil Code shareholders are obliged, among other things, to participate in making decisions without which a company cannot continue to operate; and not to disclose confidential information about the company; not to take actions or inactions that make it impossible for the company to reach the goals for which it was created.