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. Last Updated: 07/27/2016

Shareholder Agreements in Light of New Legislation on Limited Liability Companies

On December 30, 2008, Federal Law No.312-FZ (the "Law") was ratified, amending the existing legislation on limited liability companies ("LLCs"). This regulatory act has been a hot discussion topic, since once it takes effect on July 1, 2009, LLCs will need to bring all their statutory documents into compliance with the new requirements.

At the same time, the new rules afford LLC shareholders ('participants') additional rights and opportunities. One of the most notable innovations of the new Law is the right of LLC shareholders to enter into a so-called "agreement on exercising company shareholders' rights." Under such an agreement the LLC shareholders may stipulate mutual obligations on exercising their rights in a certain manner, in particular:

•Voting under a certain procedure at the general meeting of LLC shareholders;

•Agreeing with other LLC shareholders as to a particular voting option on certain issues;

•Selling their share in the LLC charter capital (or part of it) for a price set in the agreement and/or upon occurrence of certain conditions, as well as abstain from alienating their share until certain conditions take place;

•Performing other actions that are tied to managing the LLC, as well as its creation, activity, reorganization and liquidation in an agreed manner.

The Law establishes that such agreements must be made in writing by drawing up a single, unified document signed by the LLC shareholders. The Law stipulates no requirements as to disclosure, registration or notarization of an LLC shareholders' agreement; hence the terms and conditions of such agreement may be of confidential nature.

It should be noted that these provisions of the Law are clearly akin to the shareholders' agreements that Russian practice has adopted from foreign legislation.

As a rule, shareholders' agreements are entered into by the company shareholders in order to provide a documented balance of mutual shares and provide stability in managing the company, or else among the minority shareholders — to consolidate their shares to have actual leverage in the company's decision-making process. The shareholders' agreements may contain, for example, the following conditions:

•An established procedure for forming the company's managing bodies — the board of directors and/or executive bodies. For example, a shareholders' agreement may determine the number of candidates to the positions in the company's management bodies to be nominated by each party to the agreement, or it may determine that the persons elected to the management body be independent, and so forth.

•An established voting procedure within the management bodies (general meeting, board of directors and/or collegial executive body). In particular, an established voting procedure may be set when adopting certain specific issues, for example, election of the board of directors, approval of major transactions, real estate transactions, and so forth.

•An established set of rules for circulation of the company's shares by the parties to the agreement. For example a shareholders' agreement may set a ban on alienation of shares by a party to the agreement within a particular time period or until certain conditions occur; or a preemptive right to purchase shares at a fixed price by another party to the agreement. Shareholders' agreements may also include non-competition terms, where the parties to the agreement are barred from participating or holding interest in competing businesses.

•An established procedure for resolving deadlock situations. Such terms are included in agreements mainly for cases where the shareholders hold equal share in the company, in particular for when the shareholders are unable to reach consensus on whatever issue (e.g. appointment of the CEO), which may bring the company to a standstill. To resolve such situations, shareholders' agreements may provide for the option of engaging an independent expert whose opinion will be binding on the parties to the agreement; or the right for a shareholder to request that their package of shares be bought out by another party to the agreement.

•An established procedure for distributing profit. Under these provisions, the shareholders may determine that within a certain time frame the fiscal profits are not distributed among shareholders, but rather are reinvested back into the business; or set a profit distribution proportion that is different from the actual proportion of share of these shareholders in the company.

Though shareholders' agreements have been widely used in legal practice, Russian legislation up to this point had not had established regulatory grounds for these agreements. Moreover, many of the terms listed above are arguable from the standpoint of compliance with the imperative provisions of Russian legislation, particularly those pertaining to joint stock companies.

For example, when establishing procedure for determining the joint stock company's management bodies, shareholders' agreement participants may discover conflict with such legislative norms as the Federal Law On Joint Stock Companies, including conflict that pertains to the procedure for adoption of such decisions by the general shareholders meeting.

Furthermore, many of the terms of a shareholders' agreement may be deemed to be a waiver of rights by the shareholders (e.g. disposal over one's share or votes at one's own discretion), at a time when such waiver under the Civil Code of the Russian Federation is null and void. Additionally, shareholders may encounter problems if attempting to implement the shareholders' agreement through court, since a court as a rule will be unable to oblige a shareholder to perform such terms of a shareholders' agreement as, for example, voting to adopt certain company resolutions.

In view of the above, in a majority of cases where shareholders of a Russian joint stock company wish to adopt a shareholders' agreement, they make such an agreement subject to a foreign law. However, as court practice shows, in such a case there is a risk that the provisions of such a shareholders' agreement may be declared void since such provisions are already subject to Russian imperative law.

With this in mind, often a mechanism is used where all the shares in the Russian company are transferred over to a foreign holding and the shareholders of the Russian company become shareholders of the holding, where they are then able to enter into a shareholders' agreement among themselves in accordance with the jurisdiction of the country where this holding is based. As a rule, countries of the British legal system are used for such purposes.

However, such a structure is generally not accessible for the majority of minor shareholders of Russian companies, especially due to the substantial expenditures involved in creating a company in a foreign jurisdiction.

Finally, we should state that even though currently there is no established common practice of such agreements being entered into by LLC shareholders, it is reasonable to expect that the provisions for such an instrument being laid down in the law regulating LLCs may become a worthy alternative to the shareholders' agreement structures under British legal system. It is especially notable that traditionally LLCs are subject to less scrutiny from state regulators, which may provide for a greater level of confidentiality of relations for the parties to such agreements.