Natalia Wasilenko

Better conditions for doing business in Russia-more on proposed amendments to the Russian Civil Code

The main goal of the proposal is to improve the quality of the laws governing business activity in Russia by securing greater freedom for market participants and stiffer sanctions for abuses.

As we reported previously, the draft federal law amending the Civil Code of the Russian Federation had its first reading in the State Duma on 27 April 2012. The proposal was drafted in realisation of the Conception for Development of Civil Legislation. The bill was reviewed and accepted on first reading. During the following 30-day period, over 2,000 amendments were proposed. Nonetheless, it is still possible for the bill to be adopted at the second reading in the autumn of this year and come into effect on 1 January 2013.

The proposed amendments to the bill have been extensively discussed. Among the commentators are representatives of leading Russian law firms, in a non-profit coalition known as Assistance for Development of Commercial Law. The members include the law firms Alrud, Capital Legal Services, EDAS, Egorov Puginsky Afanasiev & Partners, Goltsblat BLP, Gorodissky & Partners, Liniya Prava, Pepeliaev Group, Vegas-Lex and Yust, and the state-owned Bank for Development and Foreign Economic Affairs (VneshEconomBank).

In Russia, the Civil Code is the principal normative act governing commercial relations. Acts covering specific types of business entities only supplement the provisions of the Civil Code.

Under the bill before the Duma, there are changes affecting all four sections of the Civil Code. The proposed amendments to the bill chiefly concern the first section of the Civil Code (commercial law: legal persons, property law, legal transactions etc), the third section (private international law), and the fourth section (intellectual property law).

The proposal reflects an entirely new approach to corporate law, aimed at simplifying and unifying the status of legal persons, increasing the requirements for establishment, reorganisation and liquidation of legal persons, and stiffening the financial liability of corporate authorities.

Corporate law

1) A new classification of legal persons is introduced, divided into corporations (based on shareholding) and unitary legal persons (under Art. 65(1) of the bill, organizations whose participants are not shareholders). Commercial organisations—i.e. enterprises with the purpose of earning and distributing profit—as well as non-profit organisations (NKO) could be established in the form of corporations or unitary legal persons. In the case of corporations, shareholding is defined in the bill as the right to participate in management of the corporation’s affairs.

The proposed new system is broken down in the following table:

CorporationsUnitary legal persons

Other

Commercial organisationsCommercial companies, manufacturing cooperativesState and municipal unitary enterprisesProfessional partnership
Non-profit organisationsConsumer cooperatives, including residential cooperatives, mutual insurance companies etc.Social and charitable organisations, foundations, including autonomous non-commercial organisations etc.

This classification is important in practice, because of the uniform rights provided for members of all corporations (including non-profits) and the uniform rules for management (Art. 65(2) and 65(3) of the bill). Distinguishing corporations as specific types of legal persons would expand the rights of shareholders, including the right to participate in the management of the company, the right to obtain information about the corporation’s financial condition, and so on.

The bill introduces a firm prohibition against converting a for-profit enterprise into a non-profit organisation and vice versa.

2) The distinct “closed” and “open” types of joint-stock companies are eliminated, as is the “added-liability company,” which did not catch on in practice (only about 200 of them were established in Russia in the 18 years following adoption of the Civil Code).

3) A fixed (exhaustive) list of types of non-profit organisations is introduced for the first time.

4) Capital companies, as a subset of enterprises with the purpose of earning and distributing profit among the shareholders, are to be divided into “public” and “non-public” companies. Under current law, non-public companies are subject to regulations that hardly differ in practice from those applicable to public companies. The only companies that would remain “public” are joint-stock companies whose shares have been issued and are offered or traded publicly (excluding debt instruments). This is partially tied to the need for publication of reports on the company’s operations and its annual balance sheet. Public companies would operate on the basis of the Russian securities law.

5) Shareholders of non-public companies are afforded broad latitude in shaping their internal corporate affairs. They would be entitled to freely determine the management structure, and would have the right to:

  • Waive the appointment of a single-member executive body, and entrust this function to the supervisory board instead
  • Establish a multi-member management body (board of directors or management board) without the mandatory existence of a single-member executive body (which currently is impermissible)
  • Make a new division of authority by assigning the authority of the shareholders’ meeting to the supervisory board and the executive body
  • Change the procedure for convening, preparing and conducting shareholders’ meetings.

The shareholders would be able to establish practically any internal company regulations they wish, to be reflected in the company’s statute or in a shareholders’ agreement. A shareholders’ agreement could be concluded by all the shareholders or by only some of them, with the involvement of creditors or other third parties as well. The parties to a shareholders’ agreement would be required to notify the company of conclusion of the agreement or else would have to cover any resulting losses to the other shareholders. If decisions or resolutions of the company’s authorities or the terms of a transaction involving the parties to the agreement were contrary to the agreement, they could be invalidated. Moreover, it would be mandatory to disclose information about shareholders’ agreements in public companies.

6) The bill provides for several levels of documents governing the operations of corporate entities. The only mandatory document would be the statute of a company, or partnership agreement for a partnership. Other documents, such as internal bylaws or shareholders’ agreements, would be optional.

7) The minimum share capital would remain unchanged, at RUB 10,000 for a limited-liability company and RUB 100,000 for a joint-stock company, but in order to avoid abuses, a certain amount of the minimum share capital would have to be paid in cash.

8) The bill provides for a new form of protection of the financial interests of a corporation’s shareholders: restoring the right to participate in the corporation following an improper redemption of shares, a hostile acquisition of the shares, or other unlawful acts.

Other important innovations in the area of corporate law include:

  • Compensation for losses suffered by third parties as a result of failure to publish information in the Unified State Register of Legal Entities, late publication, or publication of false information.
  • Departure from formal tests (voting or shareholding) for classification of subsidiaries and affiliates, in favour of a uniform regulation concerning legal ties between companies: parent, subsidiary and affiliate (Art. 53(2) and 53(3) of the bill).
  • One of the most complex issues in Russian corporate law concerns affiliates. In an affiliate or subsidiary relationship, it may be necessary, for example, to obtain shareholder consent for certain transactions, or there is a risk that the transaction will be held invalid. On the other hand, the list of entities that may be regarded as affiliates or subsidiaries may be practically endless.
  • Currently, this question also includes a subjective determination by the court. Currently, the court is authorised to find a parent-subsidiary relationship between legal entities based on evidence that they have obtained the actual ability to exert influence over one another, as a result of concerted action, despite the lack of express grounds for such a finding in the Civil Code.
  • The bill (Art. 53.1 and 53.4) would reinforce the current regulations on financial liability of persons authorised to act for a legal person (i.e. individuals managing the company) and for the members of its multi-member bodies (supervisory board, management board etc.) and controlling persons (exercising actual decision-making authority over the entity).
  • All such persons would be required to make up the loss suffered by a legal person if it were proved that in exercising their rights and obligations they acted negligently or recklessly, including if an act or omission violated best practice or exceeded ordinary business risk.
  • Corporate reorganisation, previously available only to joint-stock companies, would be consolidated, and for the first time multiple legal persons, including those established under different corporate forms, could be reorganised jointly.

Legal transactions

1) The bill provides for “pre-contractual” liability, under which parties could be held liable for negotiating a contract in bad faith or breaking off negotiations in bad faith.

2) Under the proposed new wording of Civil Code Art. 380, the problem of securing a preliminary agreement with an earnest money deposit would be resolved, and the parties could use any given method to secure performance of a preliminary agreement.

3) When concluding a preliminary agreement, the parties would no longer have to agree in advance on all of the legally essential terms of the final agreement, but only the subject of the final agreement, under the proposed Civil Code Art. 429(3), thus eliminating the legal risk of a preliminary agreement being held invalid because of failure to agree on other essential terms of the final agreement.

4) The security deposit, a method of securing obligations that is widely used in practice but not specifically addressed in the Civil Code, would now be regulated in the code (Art. 381(1) and (2) of the bill).

5) In business-to-business dealings, it would become permissible to use an irrevocable power of attorney. This instrument, functioning in Poland and other systems for some time, does not currently exist in Russia. An irrevocable power of attorney would have to include a precise description of the attorney’s authority, with no right of substitution, and would have to be notarised.

6) The notion of conditional performance of an obligation is introduced. Despite the ban on performing a transaction under a condition whose fulfilment depends entirely or mainly on one of the parties, it would now become permissible to impose any condition on performance of an obligation or realisation, amendment or extinguishment of a right.

7) The provisions on damages and proof of the amount of damages would be significantly expanded:

  • The right of the court to reduce contractual penalties in commercial dealings would be limited.
  • The parties could seek damages for inaccurate representations made during or after conclusion of a contract.
  • If the exact amount of actual loss could not be determined, it would be set by the court.
  • In an important innovation, a creditor’s resort to methods to protect its rights from infringement other than rights provided by statute or contract would not deprive the creditor of the right to seek damages from the debtor for non-performance or improper performance of the obligation. Such right could be limited only by statute.
  • The concept of “full damages” would be clarified so that the creditor should be placed in the same condition it would be in if the obligation were properly performed.

8) Indemnity could be used. Under this construction, in business-to-business dealings, the parties could establish a right of one of the parties to seek damages from the other party for financial losses caused by performance, alteration or extinguishment of an obligation, including in the event of performance of lawful acts by third parties.

9) New contractual constructions would be introduced:

  • Framework agreement (a contract with open terms)
  • Option agreement (an agreement providing an unconditional right to conclude a specific contract)
  • Subscription agreement (a contract to be performed upon demand)
  • Escrow agreement (conditional deposit).

Private international law

Under the bill, there would be significant changes in private international law (i.e. choice of law) of immediate importance in legal disputes, particularly involving foreign parties:

1) Under the bill, Civil Code Art. 1191 would be amended so that the parties would no longer bear the burden of “proving” foreign law, but would only be required to “present information” about foreign law. Then it would be up to the court to determine the content of foreign law.

2) Currently, under Civil Code Art. 1202, the law governing a legal person is the law of the state in which the legal person has its registered office. A number of significant issues flow from this, e.g. concerning legal form, requirements for the name of the legal person, and issues of legal capacity. Under the bill, this provision would be expanded to make it clear that the liability of incorporators and shareholders for the obligations of a legal person is determined by the law applicable to the legal person (proposed Art. 1202(2)(9)).

The issues discussed above reflect just a portion of the many changes included in the bill before the Duma. If adopted, they will represent just the first wave of reform, to be followed by further clarifications in special acts and by interpretation in practice.

These changes are clearly designed to support business initiatives in the Russian Federation and increase Russia’s attractiveness for foreign investors. They should significantly expand the ability for foreign businesses to secure their interests in contracts with Russian partners when Russian law is applicable.

Natalia Wasilenko, Russian lawyer and consultant to the Russian Desk of Wardyński & Partners