LLCs: Russia gives way to shareholders agreements

Federal Law #312-FZ "On Amendments to Part One of the Civil Code of the Russian Federation and other Legislative Acts of the Russian Federation" which comes into force on July 1, 2009 announces a small revolution in the regulation of limited liability companies.

The most remarkable change, of course, is an attempt to bring into light a shareholders' agreement, a stepchild of the Russian law.

Generally speaking, Russian legislation takes a liberal approach to what entities can agree upon. According to article 421 of the Civil Code contracts sui generis are perfectly acceptable. In reality, however, the judges take a rather strict view and relatively easily set aside contracts that stand out of line. It is, therefore, not surprising that the agreements between shareholders were met with a frown.

In the famous Megafon case (N F04-2109/2005(14105-A75-11)) a group of companies sought to have an agreement between the shareholders of JSC Megafon declared void. Interestingly, none of the claimants was a shareholder of Megafon nor were they a party to the agreement. The agreement contained detailed regulation of relationship amongst shareholders including restrictions on transfer of shares, a non-competition clause as well as various issues of the company's management. Like a red rag was the fact that the contract was governed by Swedish law and disputes were referred to international arbitration.

The judges established that the agreement including the question of its validity must be governed by Russian law. Moreover, it was stated that agreement to the contrary contradicts public policy. Secondly, a shareholders' agreement can regulate only those issues that are directly allowed by domestic legislation. Thirdly, provisions of such contract must be in line with the corporate law and the company's founding documents. Fourthly, the judges came to the conclusion that the agreement was de facto binding to the minority shareholders who were not a party to it. Finally, a rather sceptical view was expressed about the very possibility of shareholders agreeing on how they are going to execute their rights because an agreement to act in a certain way would constitute an unlawful restriction of civil rights.

Later the same year Moscow Arbitrazhniy Court in the case Russkiy Standard Strakhovaniye JSC v. Cardif S.A. et al. went even further and declared the shareholders' agreement to be the founding contract, a specific contract which is required on the setting up of a company. Such an interpretation did not give the agreement a chance since to begin with the parties were not the founders of the company and because the founding contract cannot be governed by foreign law as was the case.

It became clear that Russian courts would not enforce shareholders' agreements nor would they recognise arbitration awards issued by international or domestic tribunals.

Indeed, in Stroyservis Ltd. v. Zhitkov (A40-27193/06-30160) Moscow Arbitrazhniy Court refused to enforce an award of the domestic tribunal on the grounds that disputes among shareholders of a limited liability company are subject to the exclusive jurisdiction of the state arbitrazhniy courts.

The deadly embrace of the courts did not turn Russians away from the shareholders' agreements but was taken as another reason to move offshore. Ironically, the judiciary's desire for more control over the business brought this control to the minimum, eventually turning domestic authorities into silent observers.

The Federal Law # 312-FZ attempts to breathe life into what seemed a dead structure. According to article 3 (2) shareholders of a limited liability company are entitled to enter an agreement to regulate how the rights of a shareholder can be executed. It is clear that the shareholders' agreement will be recognised in Russian law. However, what can be the scope of such an agreement might be less clear.

The law specifically mentions that the agreement can deal with the execution of voting rights at the meetings of shareholders, including the right to agree to vote in a particular way. Also, the agreement can include a provision for a conditional obligation to sell shares for the pre-determined price or, vice versa, not to sell shares while certain conditions are true. Finally, the law makes a general statement that shareholders can agree on other matters related to the management of a company, its incorporation and activity as well as reorganisation and liquidation.

The positive sign is that the legislator is trying to draw a line between the relationship of shareholders among themselves and the relationship between the shareholders and the company. It is quite clear that the agreement is seen as a contractual relationship between shareholders and as such it should be perceived to be less incorporated into the company law than it is seen now. The remedy for the breach of the shareholders' agreement is payment of damages; decisions of the company's management bodies can not be changed.

The law does not give an answer as to whether disputes arising from the shareholder's agreements can be referred to arbitration. Although the answer should be 'yes', in practice most likely it will be 'no'.