IBA Guide on Shareholders Agreements

IBA Guide on Shareholders Agreements Ukraine Timur Bondaryev Anna Zorya Arzinger 1. Are shareholders agreements frequent in Ukraine? Shareholders agreements, being one of the most efficient mechanisms for settling relations between the shareholders, have become very popular in recent years among beneficiary owners of Ukrainian business units, especially in the course of structuring joint venture arrangements. Still, due to conservatism and inflexibility of Ukrainian legislation and existing court practice, shareholders agreements may not yet fully applied and enforced in Ukraine so far. As a starting point, there are two most typical forms of business units through which the shareholders conduct their business affairs in Ukraine, namely joint stock companies and limited liability companies. Despite existing differences in regulating the matters pertaining to the corporate governance of joint stock companies and limited liability companies, the overall statutory approach towards the shareholders agreements in respect of both these forms of business units is identical such agreements are neither prohibited, nor can they go beyond legislative prescriptions and provisions of constituent documents of the company. Notably, provisions of Joint Stock Companies Act (as of 17 September 2008 No. 514-VI, effective from 29 April 2009) do not in fact specifically refer to the shareholders agreement as one of the mechanism aiming to regulate relationships among the shareholders. By contrast, the only reference is made in the context of stipulations of the said law determining the scope of obligations of shareholders. Namely, the law provides that the charter of the company may, in principle, allow execution of the agreement between the shareholders, whereby the shareholders may be subjected to additional responsibilities compared to those set forth in the law, including their duty to participate at the general meeting, as well as liability they might incur in case of the breach of the above duty. Notwithstanding the above inferences, it is highly questionable, though, what certain type of liability might be imposed on the defaulting shareholder, considering that, for example, compulsory exclusion / sell-out of shares or, alternatively, restriction of their voting rights would likely be challenged as inadmissible deprivation / curtailment of rights, thus, having no legal effect. Apparently, current legislative framework in Ukraine substantially shifts the priority to the imperative norms, which means that while settling the relationships between the shareholders the focus is primarily made on legislative stipulations and provisions of constituent documents of the company elaborated in pursuance with legislative requirements, and only then the contractual freedom formalized in the shareholders agreement might take the lead. It is essentially to note, that the respective Ukrainian laws are not concise on whether the parties to the shareholders agreement are bound by the terms of the agreement only in their capacity as the shareholders of the company, or, concurrently, they can also be bound in any other capacity (for example, as creditors undertaking to provide funding to the company). Both the law and the respective court practice is also silent on the type of remedies the shareholders agreement (presuming that the agreement itself is compliant with imperative norms) may provide to the Page 1

shareholders in case of the breach thereof: can it be purely compensatory remedies for the breach of the contract, or can it also affect the corporate status of the defaulting party and to what extent. Further to that, existing court practice tends to substantially limit the scope of contractual regulation by saying that most of the corporate issues fall under imperative norms of the law that cannot be subject to derogation upon any private arrangements of the parties whatsoever. According to the effective interpretation act issued by the Highest Commercial Court of Ukraine, the shareholders agreement may not amend the provisions of the law and the company s charter, as well as limit the rights of other shareholders of the company. Furthermore, the existing court practice expressly forbids regulating the following issues by means of any contract whatsoever: i. relations between the shareholders, as well as relations between the shareholders and the company in respect of corporate governance matters, ii. divergent voting procedure at the general meeting, e.g. the obligation of the shareholder to vote in particular way, obligation to participate and vote at the meeting, iii. divergent decision-making and voting procedures in other corporate bodies (board of directors, supervisory board), iv. divergent procedure of appointment of directors and members of supervisory board. In general the contractual regulation in corporate domain may not amend or somehow substitute the law. Without prejudice to the above, few exceptions were made, inter alia, towards the shareholders relations as to the alienation of shares in the joint stock companies, which at the same time may not overlap the imperative norms of the law concerning the shareholders rights of first refusal. For example, such authorized exception covers the issues of drag along and tag along right. In practice, the shareholders of Ukrainian companies do not benefit from the above option, fearing that the contracting party will succeed in challenging this contract provision in the court. Also, at the fall of the year of 2014 the Highest Commercial Court of Ukraine resolved a notable controversy concerning, inter alia, validity of the agreement on corporate governance concluded between the shareholders of limited liability company. In particular, under the shareholders agreement the parties agreed to divert from the provisions of the law and the charter in a way that adoption of a decision on increase of authorized capital requires far more percentage of votes compared to those statutorily required, thereby insuring the minority shareholder from dilution of its shares. Moreover, in case of breach of any terms of the charter or agreement on corporate governance, including those relating to the qualified voting arrangement, the affected shareholder may seek the defaulting shareholder to sell its shares in favour of the former at a fair market price preliminary determined by specified appraisal. By resolving the given matter, the court opined that so far as the law does not expressly restraint the shareholders to set out higher (but no lesser) threshold for adoption of a decision at the general meeting of shareholders, the said contractual provisions cannot be deemed incompatible with the law. As a result, the court set aside the claim on invalidity of the respective provisions of shareholders agreement. Still, the above mentioned case is currently an exceptional example in Ukraine where the court reconciled the imperative requirements of the law and contractual freedom of the parties. Therefore, considering all the above, almost nothing left for contractual regulation in corporate domain. In addition, the shareholders agreements may not be governed by foreign law and the disputes may not be rendered to the arbitration court as ascribed in details in Parts 17, 18 below. In order to avoid the above restrictions, it is usually recommended to incorporate a holding company in foreign jurisdiction, whereat the owners of foreign holding structure may freely Page 2

regulate most of the matters pertaining to the functioning of the Ukrainian subsidiary company. Under common scenario, the contractual arrangements between the shareholders cover the corporate governance issues and the decisions-making process (composition of board of directors, special voting arrangements for reserved matters, veto rights), set forth additional rights vested with the minority shareholders, options for resolving deadlock events, lock-up and change of control provisions, terms and conditions for entering into specific transactions (for example, related-party transactions, transfers to affiliates), special rules for disposal of shares, arrangements for alteration of authorized capital (for example, the ways how the authorized capital can be increased by obtaining loans, or issuing new shares), etc. 2. What formalities must shareholders agreements comply with in Ukraine? As was mentioned above, due to the inflexible imperative Ukrainian legislation and existing court practice, the shareholders agreements may not be yet fully applied and enforced in Ukraine. Although the existing Ukrainian legislation doesn t directly forbid the shareholders agreements, the law doesn t stipulate any formalities in respect thereof, including those pertaining to registration formalities, as well as any other authorizations. In fact, according to the existing legislative framework, shareholders agreements are deemed to be purely the domain of private contractual arrangement negotiated by the parties. At the outset, the shareholders may freely formalize agreed terms and conditions in the agreement, but under any circumstances to the extent permitted by the law and constituent document of the company in respect of the subject matter of the agreement. 3. Can shareholders agreements be brought to bear against third parties such as purchasers of shares or successors? Apart from the fact that the shareholders agreements may not be yet fully applied and enforced in Ukraine in view of the above mentioned court practice and inflexible imperative legislation, in response to this particular question, the following should be noted: pursuant to the general principles of contractual law in Ukraine, the contract may not be binding upon any third party which is not a party to the contract. Therefore, the shareholders agreement may not be brought to bear against the third party such as purchaser, unless the latter adheres to the agreement. Moreover, considering the contract nature of the shareholders agreement, it cannot automatically be applicable and binding on the remaining shareholders of the company who have not consented to become the party to the shareholders agreement. Therefore, in light of practical considerations it is highly recommended to include separate provision (either in the shareholders agreement itself, or the contract underlying the transfer of shares), whereby the transfer of shares is contingent on the adherence of the acquiring company to the shareholders agreement. As for the legal successor, which may be established as a result of corporate reorganization (conversion, spin-off, merger, etc.), the latter assumes all rights and obligations which were previously assigned to its predecessor. Therefore, the company s legal successor becomes a fullfledged contracting party. 4. Can a shareholders agreement regulate non-company contents? Considering the fact that due to the inflexible imperative Ukrainian legislation and existing court practice the shareholders agreements may not be yet fully applied and enforced in Ukraine, the overwhelming majority of corporate issues, and also non-company contents may not be regulated by the shareholders agreement. Therefore, we recommend regulating the non-company issues by other contractual mechanisms, such as investment agreements. Page 3

5. Are there limits on the term of shareholders agreements under the law of Ukraine? The shareholders agreements may not be yet fully applied and enforced in Ukraine in view of the above-mentioned court practice and inflexible imperative legislation. The law doesn t contain any requirements or restrictions regarding the term of shareholders agreements. 6. Are shareholders agreements related to actions by directors valid in Ukraine? The shareholders agreements may not be related to the actions by directors. The scope, powers and liability of the company s directors are prescribed by the law, the company s charter and the civil-law or labour contract signed therewith. 7. Does the law of Ukraine permit restrictions on transfer of shares? The shares transfer regime may vary depending on the type of company. At that, the Joint Stock Companies Act expressly provides that the shares within the public joint stock company may be transferred freely with no concurrence of the rest of shareholders. As distinguished from the public companies, the charter of the private joint stock company may provide for the right of first refusal. In case the company s charter sets forth the right of first refusal, the selling shareholder shall at first offer the shares to the remaining shareholders and then, in case of their refusal, to the third party-purchaser. Procedure for enforcement of the right of first refusal shall be determined in the company s charter. As for the shares transfer in the limited liability companies, the latter may be fully restricted by the company s charter. Thus, pursuant to the Commercial Companies Act: the shares transfer to the third parties is allowed, unless otherwise prescribed by the company s charter, meaning that the charter of the limited liability company may provide for outright prohibition of shares transfer to the third parties. Furthermore, regardless of the content of the company s charter, the shareholders of the limited liability company are vested with the right of first refusal under the Commercial Companies Act. One more inflexible legislative provision concerns the shareholder s right to withdraw. Particularly, Ukrainian legislation vests the shareholders of the limited liability companies with the inalienable right to withdraw from the company. The withdrawal option implies that the company should repay the shareholder the value of the company s assets and part of the company s profit (gained in the same year before the withdrawal) pro rata to the amount of his share. The shareholder may not be deprived of his right to withdraw from the company either by the company s charter, or the shareholders agreement. Therefore, the remaining shareholders may not protect themselves from such withdrawal by way of setting the moratorium on transfer of share or limit this right in any other form, including the establishment of the lock-up period. The withdrawal event may be critical for the company s business in whole in case the shareholder withdraws also its contribution in kind. For instance, the situation may become critical in case the shareholder withdraws the land plot designated for further construction of the commercial property by the company. 8. What mechanisms does the law of Ukraine permit for regulating share transfers? 1) Right of first refusal. Applicable with respect to the limited liability companies, and also to the private joint stock companies provided that it is prescribed in the charter. The right of first refusal implies the obligation of the selling shareholder to offer its shares to the remaining shareholders prior to entering into transaction with the third party-purchaser. The remaining shareholders, enjoying the right of first refusal, are entitled to accept the offer Page 4

within one month term or any other term provided in the charter (in limited liability companies) and two months term (in private joint stock companies), unless the shorter term is prescribed in the company s charter. 2) Compulsory buyback. The obligation of the joint stock company to buy back the shares of the shareholder on his demand takes place in case the latter duly registered for participation at the general shareholders meeting and voted against the following agenda items: a) merger, affiliation, split-up, transformation, spin-off, alteration of the type of the company, b) execution of the material transaction by the company, c) change of the company s registered capital (either increase, or decrease). At that, redemption price cannot be lower than the market value of shares calculated as of the day preceding the date of publication of the notice on convening of the general meeting. 3) Optional buyback. The joint stock company is entitled (but not obliged) to buy back the shares by mutual consent of the selling shareholder and the general shareholders meeting. The buyback shall be carried out within the term and at the price determined by the general shareholders meeting, which at the same time may not be less than a market price. Should the shareholders accept the company s buyback offer, the company from this time onward may not revoke its buyback offer. The shares that have been bought back by the company cannot be taken into account in the event of profit distribution, voting and determination of the quorum of the general meeting. The company has to sell these shares or cancel them within one year from the date of buyback. The company has no right to adopt resolution on buyback of shares without their cancellation if upon completion of buyback procedure the portion of shares of the company in circulation becomes less than 80% of authorized capital. The optional buyback of shares is also applicable to the limited liability companies. Thus, in case the shareholder intends to sell his share, but no other shareholders express the willing to buy it out, the company may act as the purchaser and buy back such share. 4) Compulsory buyout. The shareholder (including its affiliates) upon obtaining the controlling stake (51 per cent or more) is obliged to offer to all minority shareholders of the company to buy out their ordinary shares. Such a buyout offer is public and irrevocable and concerns only the ordinary shares of the company. The buyout price should not be less than the market price determined by the independent appraisal or, in case the shares are listed in the stock exchange, as determined on a bid-ask principle. 5) Squeeze-out trend. Ukrainian legislator tends to introduce the squeeze-out procedure in Ukrainian corporate legislation. Thus, the respective draft law was elaborated in accordance with the EU Directive 2004/25/ЕС (Directive on Takeover Bids). The threshold was set up at the level of 95 per cent the percentage of shares that should be possessed by the shareholder in order to squeeze-out the minority shareholders. At time of writing, this wording of the draft law was not finally adopted by the parliament, still in view of the market needs and current debates at the parliament and regulatory authorities as well, we expect this issue to be resolved in the near future. 9. In Ukraine, do by-laws tend to be tailor-drafted, or do they tend to use standard formats? The companies by-laws used to be standard-drafted, especially in case of limited liability companies. That was because of the inflexible position of the state registers empowered to register the companies charters and amendments thereto. Lately the trend has changed slightly and the Page 5

joint stock companies onwards tend to have their by-laws tailor-made as the Joint Stock Companies Act provides for relatively large room for by-laws regulation options. The joint stock companies prefer to get the procedures overregulated to preclude any probable misuse or abuse of powers by the company s management. 10. What are the motives in Ukraine for executing shareholders agreements? In view of the above court practice, the shareholders agreements are not commonly applied in Ukraine. In order to fill the gap, the shareholders usually set up a 100 per cent holding company abroad and regulate their relations at the holding level. The main motives of such contractual regulation are providing more flexibilities and comfort for participating business partners in terms of protecting their investments against possible abuses or unconscious acts by any party engaged, preservation of each shareholder s interests, imposition of additional rights and obligation on the shareholders binding on them in their capacity as directors or creditors, prevention of deadlock events, and providing efficient dispute resolution mechanism in case of occurrence of any conflicts. In any case, the shareholders agreements provide for much more flexibility than any law whatsoever. 11. What contents tend to be included in shareholders agreements in Ukraine? Please refer to Part 1 above. 12. What determines the content included in shareholders agreements in Ukraine? Please refer to Part 1 above. 13. What are the most common types of clauses in shareholders agreements in Ukraine? Please refer to Part 1 above. 14. What mechanisms does the law of Ukraine permit to ensure participation of minorities on the board of directors and its control? In general, the law of Ukraine doesn t provide for effective mechanisms to ensure their participation in election of the board of directors or the supervisory board. Although a possibility to influence the election procedure is available in the joint stock companies through the process of cumulative voting to the supervisory board, still the cumulative voting may be easily manipulated by the majority shareholder. The law also provides for the possibility to form the supervisory board in the public joint stock companies based on the representation principle, however in practice it is not yet working for the minority shareholders. 15. Is it possible in Ukraine to ensure minority shareholder control by means of a shareholders agreement? As far as the shareholders agreements may not be yet fully applied and enforced in Ukraine in view of the above-mentioned court practice and inflexible imperative legislation, the minority shareholder may not obtain the control over the company. If the shareholders regulate their relations at the level of the foreign holding company, the shareholders agreement may theoretically provide for partial minority shareholders control through the appointment of directors in the holding company, or setting forth certain restrictions of powers of directors to act without the consent of either certain percentage of votes of shareholders, or exact shareholder. Page 6

However, we are not aware of any example of such shift of controlling powers from the majority shareholder to the minority shareholder. 16. What are the usual valuation mechanisms in connection with rights of first refusal or share transfer regulations? The valuation mechanisms in connection with the rights of first refusal are defined by the selling shareholder and usually close to the comparable market value of the shares. In case of compulsory buyback, optional buyback and compulsory buyout the purchase price shall be defined at the level of market price by the professional appraisal or, in case the shares are listed in the stock exchange, the shares value is defined on a bid-ask principle. 17. Is it admissible for a shareholders agreement clause to refer dispute resolution to the courts other than those of Ukraine and/or under a law other than that of Ukraine? The Highest Commercial Court of Ukraine in its official interpretation act (Recommendations as of 28 December 2007 No 04-5/14) expressed the position that the change of the governing law in a corporate domain is deemed as a bypass of the imperative provisions of the Ukrainian law and eventually triggers public policy considerations. The above position was also sustained by the Plenum of the Supreme Court of Ukraine (Resolution as of 24 October 2008 No 13), whereby the highest court instance of Ukraine opined that the issues on functioning of the joint stock companies registered in Ukraine, relationships between the shareholders among themselves and with the company shall be regulated exclusively by the national laws. Current court practice tends to invariably uphold the above position so far. Therefore, the change of the governing law is deemed to be a violation and therefore, any contractual arrangement aiming to regulate the relationships between the shareholders by foreign law is deemed to be null and void. 18. Is it admissible for a shareholders agreement to include an arbitration clause with seat outside Ukraine and/or under a law other than that of Ukraine? As admitted by the highest court instances (the Highest Commercial Court of Ukraine in its Recommendations as of 28 December 2007 No 04-5/14 and the Supreme Court of Ukraine in its Resolution as of 24 October 2008 No 13), any corporate disputes pertinent to the functioning of legal entities incorporated in Ukraine, including those related to the corporate governance, cannot be referred to arbitration court. Moreover, pursuant to the Tertiary Courts Act (dated 11 May 2004 No 1701), disputes arising from corporate relations, including those between the shareholders of the company, may not be submitted to the tertiary (arbitration) court. Therefore, under current state of play, neither national arbitration (tertiary) court, nor international arbitration court will be competent to settle disputes arising from shareholders agreements between the shareholders of the Ukrainian companies. Page 7