2019: Review of the Corporate Law Developments in Ukraine
2019 was a year of several substantial developments in Ukrainian corporate law and practice. Here is a glance over some of the most interesting developments from our Corporate Law team.
Directors’ Liability Tested in Civil Action
On 26 November 2019, the Supreme Court of Ukraine approved the decisions of lower courts on holding a former director of an LLC liable for causing a financial loss to the LLC. This decision was apparently the first time an LLC was able to recover damages in civil proceedings without having to establish the illegality of the director’s actions within criminal proceedings. The amount claimed and awarded by the court was UAH 1.5 million (about EUR 57 thousand).
In 2012, the LLC in question obtained a license for oil and gas extraction (“subsoil use permit”). In 2015, the director signed a document allowing transfer of the license to another legal entity. Later it was revealed that the new owner of the license had been ultimately owned by the same director.
Shareholders filed a claim for damages in the amount of the initial purchase price of the license, claiming that:
- the director exceeded his powers envisaged by the charter, in particular, acting without obtaining approval of the general shareholders’ meeting;
- the director breached fiduciary duties by knowingly conducting a non-arm’s length transaction favouring an affiliated third party strongly linked with the director.
Having analysed the case facts and circumstances, the courts of all instances established that the LLC’s director abused his powers; the courts indicated that the director acted not in the interests of the LLC, but in the interest of his proxy company. Therefore, there is a direct link between the actions of the defendant and the damages caused by the loss of the license.
This decision marks an important development in Ukrainian case law, providing the company (and ultimately the company’s shareholders) with a practical remedy to recover damages caused by illegal actions of its director within a civil action.
Previously, it was a common practice that the fact of a director’s wrongdoing – of any nature – had to be proven by a verdict of a court in criminal proceedings to enable a company to claim recovery of damages. This made the whole procedure rather difficult, lengthy, and damaging to the reputation of all parties involved; the efficiency of such action was further undermined by Ukrainian law enforcement’s relative weakness in investigating white-collar crimes in the private sector. Now companies and their shareholders have an option to make a direct civil claim, bypassing criminal procedure.
For directors, who used to be somewhat immune to claims for financial liability caused by their actions, this development means that they have to act more responsibly, ensure full compliance of their actions with the charter and other company regulations, and seek professional advice when in doubt.
The text of the Supreme Court decision is available here (in Ukrainian).
2. Bankruptcy Code Takes Force
From 21 October 2019 the new Bankruptcy Code has become fully effective. The Code significantly overhauled Ukraine’s insolvency legislation and introduced inter alia, the following important changes:
Lessened requirements to commence corporate insolvency. No more minimum monetary threshold required for initiating corporate bankruptcy proceedings. From now on bankruptcy proceedings may be commenced if there is an outstanding obligation that the debtor cannot fulfil and the creditor shall only need to prove that: a) the debtor is unable to pay such debt; b) its claims are non-disputed.
Increased power of creditors over a bankruptcy administrator. The bankruptcy administrator may be dismissed at the creditors committee’s discretion. Previously, court approval was required to dismiss an administrator.
No suspension for bankruptcy proceedings. The newly introduced provisions of the Code prohibit courts from ruling to suspend bankruptcy proceedings. Legislators expect that such provisions should help accelerate bankruptcy proceedings, which often lasted for years while company assets deteriorated or where exploited by the bankruptcy administrators without any benefit to the creditors.
Extended claw-back period. The period during which a debtor’s transactions may be challenged by creditors or the bankruptcy administrator has been extended from one to three years. Certain debtor transactions during the hardening period, specified in the Code, may be challenged if they caused damage to creditors or the bankrupt debtor.
Online assets sale procedure. A debtor’s assets shall be sold at auction through the publicly accessible online electronic trade system, e.g., ProZorro. This should help to lower corruption as well as prevent selling off property at a fraction of market price.
Fewer grounds for cassation appeals. The list of court decisions, which may be challenged with the Supreme Court, is now limited. The following decisions may not be challenged: a) invalidation of the debtor’s agreement; b) dismissal of the bankruptcy administrator; c) moving to the next bankruptcy stage; d) approval of the financial recovery plan. As a result, bankruptcy proceedings should become more expeditious.
Natural person insolvency. The Code presents the long-awaited procedure for the bankruptcy of individuals. However, such proceedings can exclusively be initiated by the debtor if one of the following events occurs:
- the amount of debt exceeds the equivalent of 30 minimum wage allowances;
- the debtor ceased payments of more than 50% of the outstanding debt amount for over 60 days;
- the absence of assets subject to seizure is duly confirmed in the due course of enforcement;
- other reasoned circumstances confirming a short-term risk of insolvency.
The introduced changes should positively impact the business environment in terms of clarity and expeditiousness of insolvency proceedings. Of course, much also depends on the state of the court system that is responsible for proper application of the law.
3. New LLC Law Takes Full Force
The deadline for bringing the wording of Ukrainian LLC charters in compliance with the 2018 LLC Law expired on 17 June 2019.
After 17 June 2019, provisions of the LLC Law have priority over the provisions of a company’s charter. Accordingly, if not properly amended, the company’s constituent document may contain provisions that are obsolete and/or unenforceable. In practice, this means that each time a corporate governance decision is to be made, the company’s officers and shareholders have to compare both the text of the law and of the charter and find out which rule of the charter may be applied and which may not. Failure to act in accordance with the law may result in a challenge of such a decision in a court.
On the positive side, the new LLC law provides for increased freedom and flexibility for corporate governance rules that may be established by shareholders in the company’s charter.
Additionally, the Cabinet of Ministers approved the wording of a Model LLC Charter on 27 March 2019. Opting for a Model Charter allows for a somewhat simplified incorporation procedure, and the text may serve as a guidance for shareholders to draft their own version of the charter.
If your Ukrainian LLC still has pre-2018 charter wording, it is highly advised to update the charter.
For additional information on the new requirements for an LLC charter, read our dedicated legal alert by our Corporate Law specialists Taras Tertychnyi and Anastasiya Chernoshtan.
4. Squeeze-out Procedure – less questions on the principle, more attention to specific situations
The issue of the constitutionality of the squeeze-out procedure is not in question anymore.
The Constitutional Court of Ukraine refused to consider the constitutionality of the laws governing the procedure for the mandatory sale of shares at the request of the owner of more than 95% of the shares of a company (squeeze-out). The ruling of the court dated 10 October 2019 is available here (in Ukrainian).
The squeeze-out procedure is a major recent phenomenon in Ukrainian corporate law and practice. It was first established in 2017, and since then over 300 joint stock companies went through a squeeze-out procedure, buying out thousands of their minority shareholders, usually individuals who received their shares as the result of privatisation of the state-owned enterprises in the early 1990-ies.
The procedure, generally endorsed by experts and the market, raised a number of conflicts, in particular, about the fair price of the shares.
Holding the procedure to be non-constitutional could have served as a ground for reversal of all procedures. That risk is now eliminated.
However, there is still at least one pending dispute before the Supreme Court of Ukraine regarding the claim of minority shareholders that the procedure set out by the law, as applied in their case:
- constituted unlawful alienation of property; and
- was committed in violation of the Constitution of Ukraine.
So far, the commercial court of the first instance and the court of appeal rejected the claim, holding the procedure as being in compliance with the Constitution.
The Supreme Court will definitely take into account the decision of the Constitutional Court on matters related to the constitutionality of the procedure. Still, there may be some venue for shareholders attempting to dispute the correctness of the share evaluation procedure in each particular case.
5. Tightening Ownership Registration Procedures
On 2 November 2019 a Law on Amendments to Certain Legislative Acts of Ukraine on Protection of Property Rights (the “Law”) took force. The Law aims at elimination of the main legal loopholes that contributed to the violation of real estate ownership and corporate rights ownership during the last years. The main safeguards introduced by this Law are the following:
Obligation to determine the legal capacity during state registration procedures. From now on the State Registrar must conduct the capacity verification of a Ukrainian legal entity by obtaining from the Company Register of Ukraine information about the legal entity, including its incorporation documents.
Verification of a non-resident legal entity must be conducted on the basis of a document confirming the formation of such legal entity in the country of its registration (extract from the commercial / bank / judicial register, etc.) and its constituent documents (their copies) which are legalized and apostilled in accordance with the established procedure unless otherwise stipulated by valid international treaties of Ukraine.
Compulsory notarization of a power of attorney for the state registration procedures. A legal entity wishing to authorize another person to act on its behalf for state registration or bringing changes to such registration should have its power of attorney notarized. It is implemented as a fraud-deterrent safeguard to ensure that the power of attorney is authentic and can be trusted.
Use of special notary forms. The Law sets out the need to apply special notarial forms for documents leading to formation changes in companies, in particular:
(a) the minutes of the general meeting of participants on determining the size of the authorized capital and the size of a participant’s share,
(b) the minutes of the general meeting of participants on exclusion of any member from the company,
(c) the application for becoming a participant of a company,
(d) the application for the termination of participation in the company,
(e) the share transfer certificate.
Mentioned safeguards will likely complicate activities of foreign companies and citizens that conduct business in Ukraine as they will have to ensure that an authorized proxy expresses their will before a Ukrainian notary. Moreover, special forms will make it impossible to hold the general meeting of participants abroad and exclude the possibility of signing decisions of governing bodies of a legal entity outside the notary office.
Simultaneous notary actions. This approach stipulates that notarial and registration actions regarding immovable assets are conducted by a single notary who executes these actions one by one. Furthermore, the state registration of the change, termination or encumbrance of property rights over real estate can only be carried out by the notary that certified the transaction itself, unless:
- the transaction which legal consequence is connected with the occurrence of a pre-emptive and/or future circumstance or action (for example, formation (creation) of immovable property prior to notary action);
- the notary in question cannot complete registration actions for health reasons or due to the termination or suspension of his powers.
Expected results of the new rules:
- reduction in the number of fraudulent take-overs of real estate and company shares;
- increase in the cost of notary services;
- increase in the time spent on registration actions.
For more information on the new legislation on protection of property rights please read the alert prepared by our Litigation specialist Andrii Chornous.
If you have any further questions on this article, please contact Taras Tertychnyi (email@example.com) at our office.