Russian Federation: Legislative Update: Proposed Amendments to the Limited Liability Company Law Would Eliminate Right of Withdrawal

By Evgenia M. Korotkova and Natalia Stenina

The Russian Federation ("RF") State Duma is currently preparing for a second reading of a draft law which would amend the RF Law 'On Limited Liability Companies' (the "LLC Law") (the "Draft LLC Amendments"), significantly affecting the legal status and procedures governing LLCs in the RF. The most significant changes proposed are summarized below.

Under the LLC Law, an LLC is liable for the obligations of its founders related to the establishment of the LLC only if the founders' actions are subsequently approved by the general participants’ meeting. The Draft LLC Amendments limit the liability of founders to 1/5 of the paid in charter capital of the LLC.

The Draft LLC Amendments would extend the list of issues to be approved by the founders of an LLC at the foundation meeting, stipulating that the founders should elect at the meeting, if required, the audit committee (or auditor) and the external auditor. Also, the majority required to elect such auditing committee (or auditor) and the external auditor, as well as the management bodies of the LLC, would be increased from 2/3 to 3/4 of all of the founders' votes.

The Draft LLC Amendments establish that if a founder of the LLC does not make the required contribution to the charter capital within one year after the LLC's establishment, then the unpaid portion of the participatory interest would be transferred to the LLC and sold within six months after such transfer to other participants or, if not prohibited by the LLC's charter, to third parties.

Under current Russian law, an LLC must have two constituent documents, which consist of the foundation agreement and the charter. According to the Draft LLC Amendments, the constituent document of an LLC will comprise only the charter. In addition, the Unified State Register of Legal Entities, rather than the charter, will include information on the size and nominal value of the participants' participatory interest in order to avoid the need to amend the charter each time there is a change in the participatory interests. The Draft LLC Amendments propose to replace the foundation agreement with an "Agreement on the Establishment of a Company" (the "Agreement on Establishment"), similar to the Law on Joint Stock Companies, which would not be considered a constituent document. The Agreement on Establishment would be executed by the founders and determine, inter alia , the joint activity of the founders related to the establishment of the LLC, the size of the charter capital, the nominal value of the participatory interests, and the procedure and schedule for the payment of contributions.

The LLC Law currently permits the reorganization of an LLC into a joint stock company, a different liability company or a manufacturing cooperative. The Draft LLC Amendments would add partnership to the list of permissible entities into which an LLC may be reorganized.

One of the most significant changes proposed by the Draft LLC Amendments is the deletion of Article 26 from the LLC Law, which would eliminate the right of a participant to withdraw from the LLC at any time and receive the actual value of its participatory interest in the LLC. If Article 26 were removed, should a participant decide to leave the LLC, its participatory interest must be sold to the other participants, third parties or the LLC, depending on the circumstances, in compliance with the right of first refusal rules. The elimination of this provision will likely encourage investors, particularly in closely held companies, to set up companies in the LLC form, instead of the joint stock company form, as the LLC form provides greater flexibility to shareholders in terms of corporate governance and eliminates the need to comply with securities law requirements. In the past, some investors have avoided the LLC form due to concerns about the possible economic impact of another participant withdrawing from the company and through a put of its participation interest to the company.

The Draft LLC Amendments would affect the right of first refusal rules. In particular, the Draft LLC Amendments clarify that the charter of an LLC may (i) provide for a disproportionate right of first refusal of the participants and (ii) establish a preliminary price at which the right of first refusal may be exercised by a participant or the LLC (currently, the right of first refusal may only be exercised at the price established for a third party sale). These rules may be provided for in the charter of the LLC at the time of its establishment or in amendments to the charter upon approval by a unanimous decision of the general participants’ meeting. The Draft LLC Amendments indicate that if a participant does not exercise its right of first refusal, the other participants may purchase such participatory interests in proportion to their respective participatory interests. Such changes would provide greater flexibility to owners to agree on an exit strategy.

The Draft LLC Amendments propose a number of changes to the interested party rules, most of which clarify existing provisions. One of the newly proposed rules would permit the general participants’ meeting of the LLC to pre-approve an interested party transaction which may be concluded in the future. In such case, the general participants’ meeting must agree on a maximum threshold amount for the transaction, and the decision would be effective until the next general participants’ meeting. This again would provide greater flexibility to owners, who are often hampered by the interested party transaction rules which create uncertainty about subsequent approval of contemplated agreements with the owners, such as loan agreements or management support agreements.

The Draft LLC Amendments would make the general director jointly liable for increases in the charter capital made by increased valuation of the company's property. The general director must sign the application for the registration of the amendments to the charter of the LLC related to such increases in the charter capital. This application would serve as confirmation that the company has fulfilled its obligation related to such increases in the charter capital of the company (i.e., determination of the amount by which the charter capital may be increased through increased value of the company's property). Together with the company, the general director will be jointly liable in the amount of the value of such portion of the property which has not been transferred to increase the charter capital within three years after the registration of the increase of the charter capital.

The Draft LLC Amendments are currently being prepared for their second reading in the Russian State Duma, which is expected to occur sometime near the end of June.

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