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New law on limited liability companies – new possibilities for business

27/03/2018

On 6 February 2018, one could say, an epic event took place – the Ukrainian parliament passed the Law on Limited and Additional Liability Companies, designed to significantly reform the legislative regulatory framework for such companies. The Law was published on 17 March 2018 and comes into force on 17 June 2018.

In this article, we will review what specific novelties there will arise for limited liability companies (LLC), how they may influence business, and what opportunities will open for the corporate world in connection with the new law.

A limited liability company (LLC) is one of the most widely used corporate forms to do business in Ukraine. LLC participants find it attractive that first of all, such company is easy to set up (no minimum charter capital; no special government regulation), secondly, owners (participants) bear debt liability solely within their contributions to the charter capital, and thirdly, there is no strict government regulation of such companies (unlike joint stock companies). However, LLC advantages end here. If companies owned by one individual may find these advantages sufficient, in a situation when we are talking about structuring a business, setting up a joint venture, exercising control over management, etc. – current regulation of LLC raises multiple questions.

Disadvantages include lack of due flexibility in LLC regulation (many norms of current legislation are imperative and may not be changed upon LLC participants’ consent), no opportunity to create a supervisory board, practical impossibility to bring management to responsibility, lack of ability to “save” quite viable companies in case of slightest corporate conflicts, etc. Undoubtedly, all of this affects the development of small and medium businesses, as well as the investment attractiveness of Ukraine at large.

For such very reasons, the new law was developed and adopted.

Let us review the main important novelties that the law will bring in the legal regulation of LLC activities.

Shareholder Agreements

The law introduces the institute of shareholder agreements (“shareholder agreements”), which are standard practice in other developed countries. A shareholder agreement is an agreement, according to which LLC participants undertake to exercise their rights and powers in a certain way or to refrain from exercising them. 

In other words, this is an agreement enabling the participants to agree on the way they will perform and/or vote in this or that situation. Such agreement can also provide for an obligation of a minority participant to sell his/her/its participatory interest to third party or a majority participant at a certain moment (e.g. when inviting an external investor). This enables participants to attract different investors, implement various projects, and structure the business in a way that a holding (parent) company would be located in Ukraine (and not abroad, like it is common practice now).

Importantly, shareholder agreements are confidential.

Supervisory Board

The law introduces an opportunity for LLC to form a supervisory board (now this is possible only for joint stock companies). The goal of the supervisory board is to control performance of the LLC director (directorate).  Introduction of such body significantly enhances attractiveness of LLC corporate form for investors, especially for foreign ones. Foreign investors’ ability to create and participate in a supervisory board is part of their corporate culture, as well as one of the most effective tools of control over the company management.

It is important that creation of a supervisory board in LLC is an opportunity, a right, and not an obligation. Another significant fact is that a supervisory board may include the so called “independent members.” Supervisory board’s rules of procedure, competences, number of members and procedure for their election, remuneration and other matters are to be regulated in the LLC charter, i.e. may be determined by participants independently.

Management Responsibility and Dismissal

It is important for a business that its management, on the one part, can promptly react to every day challenges, and on the other hand, is controlled by owners, including in order to avoid fraud or other violations on the part of management. This is not a simple task to find a balance in this aspect. One of the ways to control management is having a supervisory board as we mentioned above.

Another good way is an effective mechanism to bring a director or other member of an executive body to responsibility for the damage his/her acts caused to the company, on which behalf he/she acts. The law provides in article 40 that members of a supervisory board and members of an executive board of LLC bear responsibility to the community for the damages caused by their faulty acts or omission. This norm cannot be called revolutionary (along with norms of article 89 of the Commercial Code of Ukraine and article 92 of the Civil Code of Ukraine), yet its presence in the law underlines the importance of holding management responsible for their acts. Hopefully, this will entail respective court practice, and companies will be able to recover damages from management due to their respective acts.

In addition, it is critical for a business to be able to dismiss management for no cause at any time. The new law provides for such opportunity (section 13, article 39). Notably, when dismissing a one-man executive body (director) or chairperson of a collegiate executive body (e.g. general director), another individual must be appointed to the position (to preserve the company’s capacity).

Participant’s Withdrawal from LLC

Article 24 of the law regulates the mentioned issue in an entirely new way.

First of all, a participant holding a participatory interest smaller than 50% may withdraw from LLC at any time without other participants’ consent. However, a participant holding a 50% participatory interest or a larger participatory interest may withdraw from a company upon other participants’ consent.

Finally, the date of valuation of a participatory interest of participant withdrawing from a company is established. Such date is preceding the date when a participant files a respective application according to the procedure provided by the Law of Ukraine on State Registration of Legal Entities, Individual Entrepreneurs and Nongovernmental Organizations.

In addition, the term for payment of the participatory interest value is prescribed – one year from the date when LLC learns or is supposed to learn of the participant’s withdrawal (unless another term is established by the company charter as of the time of withdrawal).

It is important that value of the participant’s participatory interest is determined based on the market value of the entirety of all participatory interests of LLC participants pro rata to the size of such participant’s interest (which allows to avoid undervaluation of minority interests).

The rules established by article 24 of the law also apply in cases of payment of participatory interest value to participant’s successors and lawful heirs.

Other Changes

In addition to those mentioned above, the law introduces other changes with respect to LLC. They include:

  • Limitation of number of LLC participants is lifted (currently, LLC may not have more than 100 participants). This is important for companies, part of interests or shares of which is distributed among a vast number of minority shareholders or participants (oftentimes, as a result of privatization procedure). Now, such companies may exist in the form of LLC without obligatory transformation into joint stock companies (due to limitation of number of participants).
  • Scope of obligatory information in the charter is reduced. Now, according to the new law, obligatory provisions of the LLC charter include the name, governing bodies, their competences, decision making procedures, and procedures for becoming a participant and withdrawing from LLC.
  • Participants register in the Uniform State Register of Legal Entities, Individual Entrepreneurs and Nongovernmental Organizations and are no longer reflected in the LLC charter. Introduction of this change will allow to change LLC participants without actual consent of all the LLC participants (whose signatures used to be required on the restated charter due to the change of participant). This change will enhance LLC attractiveness as an object of investment and simplify participatory interest circulation in Ukraine.
  • Notary certification of “title” documents to a participatory interest. The law introduces the requirement to certify with a notary all documents evidencing transfer of ownership of a participatory interest in order to minimize raider risks and to enhance protection of the right of ownership to a participatory interest in LLC.
  • Special aspects of holding a general participants meeting in LLC with the sole participant (article 38 of the law). The law provides that holding a general participants meeting in LLC with the sole participant does not require following procedures for its convocation, notification, etc.

Thus, in the near future (if the president shortly signs the law), the rules of the game for businesses in LLC form will change significantly – they will become more flexible and progressive. This will help with structuring businesses by means of using companies with Ukrainian jurisdiction, as well as will enhance the investment attractiveness of Ukraine.

Notably, the law does not require to bring the organizational documents into conformance therewith within a certain term, but for one year from the enactment of the law, businesses will not be required to pay administrative duties to register changes to the charter (restated charter).

Obviously, the companies, finding the novelties introduced by the law to be relevant, will bring their charters into conformance with the new law quickly and efficiently (less the companies in the state of corporate conflicts of various severity).

Other companies operating in LLC form may take their time and make changes to their charters when they find it convenient (along with other changes).

Find the article here (written in Russian).

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Evgenia Prudko