Major Reforms for Limited Liability Companies

March 2009

On December 30, 2008, Russian President Dmitri Medvedev signed into law significant amendments (the "Amendments") to the legislation governing Russian limited liability companies ("LLCs"). These changes are quite important, since approximately 80 percent of all Russian legal entities are LLCs. This popularity has been explained by the relative flexibility of LLCs as compared to other forms of legal entities, such as stock companies. However, the Russian authorities were concerned about a number of issues connected with LLCs, including a lack of clarity in the procedures for sale of equity interests in LLCs, increasing the risks of ownership disputes or fraudulent transactions. The new reforms are designed to address these matters.

The Amendments will become effective on July 1, 2009, and the corporate documentation for existing LLCs must be amended to conform to the new rules by January 1, 2010. Nonetheless, current company documents will remain valid to the extent consistent with the Amendments.

The following are some of the key changes introduced by the Amendments:

Shareholder Agreements

From July 1, 2009, owners of equity interests in LLCs (called "participants," since technically speaking LLCs do not have shares) will be expressly allowed to enter into agreements contractually regulating their respective legal rights and duties. These may include many of the features of shareholder agreements common in international practice, including voting arrangements, restrictions on transfers of ownership interests, and other provisions relating to the management and operation of the LLC. Previously, the legal status of such agreements has been unclear.

Simplified Corporate Documents: No Foundation Agreement

A "foundation agreement" will no longer be required as one of the constituent documents of an LLC. Henceforth, the Charter is the only constituent document of an LLC. This will simplify corporate paperwork and result in the documentation for LLCs being closer to that used for stock companies.

Corporate Governance

Under the current LLC law, there is considerable uncertainty about the allocation of authority between the board of directors (which is an optional governing body, in any case) and the General Meeting of Participants (i.e., the formal assembly of equity owners). This issue has generated extensive discussions about the relative competences of the board of directors and the participants, and generally increased the risk of governance disputes.

Happily, the Amendments have removed this ambiguity by allowing the board of directors to make decisions concerning a broad range of matters, as long as the Charter specifies that the board has such authority. Certain important issues remain "reserved matters" for the equity participants to decide (for example, amendments to the Charter, profit distribution, reorganization and liquidation). All other matters may be handled by company management, if desired. The result is a clearer allocation of decision-making powers and greater flexibility than previously.

Withdrawal Right of Participants Not Mandatory

The Amendments have changed the rules on the withdrawal of equity owners from an LLC. Under current law, an equity owner may decide to exit from the company at any time without cause, and the company is required to redeem his equity interest by paying its "actual value." This right to exit is not waivable. Depending on the circumstances, such an exit may disturb the business operations of the LLC or even put the company into financial trouble.

Under the Amendments, the withdrawal of an equity owner will be allowed only if expressly stated in the LLC's Charter. Accordingly, in appropriate cases it may be desirable to amend the Charters of existing companies to prohibit such withdrawal.

New Right of Obligatory Redemption

The Amendments also seek to protect minority owners who dissent from key decisions that adversely affect their rights, by granting them a new right of mandatory withdrawal. The company is obliged to redeem the equity interest of any participant who voted against certain transactions (such as an increase in charter capital to which all participants may contribute, or a "major transaction" exceeding certain thresholds), or did not participate in the general meeting at which such decisions were made, upon written request. The withdrawing participant will be entitled to receive an amount equal to its pro rata portion of the aggregate book value of the LLC's net assets in redemption of its ownership interest (although the actual payment of the redemption price is subject to certain limitations depending on the amount of net assets and the charter capital of the LLC, and certain considerations related to bankruptcy).

Transfer Restrictions and Rights of First Refusal

Under current law, the Charter of an LLC may fully prohibit transfers of equity interests to third parties, or make them subject to the prior consent of other participants in certain cases (generally with respect to transfers other than sales). These rules are not sufficiently flexible to meet the needs of modern commercial and investment practice.

Under the new Amendments, the flexibility to design transfer and buy-sell rights has improved. The Charter of an LLC may now require the prior consent of other participants and/or the company for any transfer of an ownership interest, including sale to a third party. In other words, a "lock-up" provision will be enforced if expressly set forth in the Charter.

Present law already allows each participant to have a right of first refusal to purchase the interest of a fellow participant before it is sold to a third party, at the same price. However, the Amendments introduce a new alternative: if desired, in such cases the company's Charter may set a fixed price for the sale, rather than imposing the price agreed by the third party. (This provision may be useful to deter sales to hostile third parties, among other possibilities.)

The Amendments also allow the non-selling participants to exercise their rights of first refusal for only a portion of the interest being sold; previously the entire interest had to be acquired. These rights must be specified in the Charter.

Notary Certification for Transfers; Register of Participants

To reduce fraud, the Amendments require notarization for transaction documents effecting a transfer or pledge of participatory interests in an LLC (with certain limited exceptions). Failure to comply will render the transaction null and void. In addition, the notary is required to inform the central state registry (called the Unified State Register of Legal Entities) of the transaction, and to take certain other actions designed to guard against improper transfers and increase transparency.

Finally,  the Amendments have eliminated the requirement to list the participants' information in the LLC's Charter and amend it each time such information changes. Instead, LLCs must maintain a formal "register of participants," containing certain basic information such as the names, addresses and amounts of equity interests owned. However, in case of any discrepancy between the company register and the information set forth in the Unified State Register, the latter will prevail.

Although the Amendments will generate additional paperwork for existing companies (who must redo their Charters by January 1, 2010), they have substantially improved the legal protections for investors in LLCs. In addition, the greater flexibility provided will enhance the ability of both foreign and Russian domestic investors to use LLCs as vehicles for joint ventures.