Incorporation of legal entity

IN RUSSIA

Russian legislation provides for both commercial and non-commercial legal entities

Currently in Russia, investment business projects are mostly realized via incorporation of commercial legal entities.
 The Civil Code of the Russian Federation establishes among others the following types of commercial legal entities:

• General partnerships
• Limited partnerships
• Limited liability companies
• Additional liability companies
• Joint stock companies

Moreover, there are also special federal laws which regulate the establishment of limited liability companies (“LLC”) and joint stock companies (“JSC”) notably the Federal Law No. 14-FZ “On Limited Liability Companies” dated 8 February 1998 (as amended) (the “LLC Law”) and the Federal Law No. 208-FZ “On Joint Stock Companies” dated 26 December 1995 (as amended) (the “JSC Law”).
LLC and JSC are the most popular forms of commercial legal entities among foreign investors. Please see below our analysis on the provisions of the LLC Law and the JSC Law.

Choosing between LLC and JSC

Notwithstanding a significant number of similar features, LLC and JSC are not identic types of legal entities and have a lot of peculiarities and differences (systematized below) which affect the choice of legal entity’s constitution before its incorporation.

1. Property rights on the shares and access to register of shareholder (participants)

According to Articles 44, 45 and 46 of the JSC Law, property rights over shares are registered in the shareholders register which could be held by (a) the joint stock company itself (if the amount of shareholders is equal to or less than 50) or (b) by an independent registrar. Cession of shares should be fixed in the register and does not lead to the introduction of amendments to the company’s Charter. There is no information in the Charter of JSC on the number and names of its shareholders. Access to the register is strictly regulated by law and is limited for the shareholders and third parties.
Under the recent amendments to the LLC Law (which come into force on 1 July 2009), information on the participants of LLC is registered in the Uniform State Register of Legal Entities and is available to the public. Therefore, any person would be able to receive an extract from the Uniform State Register of Legal Entities with all requested information on LLC and its participants that may jeopardize business security.

2. Alienation and pledge of shares

According to Article 2 of the JSC Law, alienation and pledge of shares in JSC could be freely performed and do not require approval of shareholders or JSC, except for the alienation by the way of shares sale in the closed joint stock company where under Article 7 of the JSC Law, the shareholders have preemptive rights to buy shares to be sold by another shareholder proportionally to the number of shares  owned by them at the price offered to third parties.

Alienation and pledge of participatory interest in LLC have more restrictions.
According to the recent amendments to the LLC Law, transaction aimed at alienation of participatory interest in LLC should be notarized.
As well as in closed joint stock company, in LLC its participants have preemptive rights to buy participatory interest to be sold by another participant proportionally to their participatory interest at the price offered to third parties.

Under Article 22 of the LLC Law, pledge of participatory interest in favor of the participant or third party could be performed only after the approval of general meeting of LLC participants. Furthermore, the Charter of LLC may prohibit pledge of participatory interest to third party.
Although, the restrictions above allow LLC to protect itself from unwilling changes in the structure of the Charter capital and, therefore, from redistribution of influence among the participants, they complicate to the participants the process of leaving the business and its transfer to third parties.

3. Withdrawal from a company

If a shareholder of JSC intends to leave the company, for instance, due to the absence of dividends, the only way for this is to sell his/her/its shares since, as a matter of Russian law, there is no option for the shareholder to request division of participatory share. However, if the company is not public, it would be rather difficult for minority shareholders to find a buyer and agree on the fair price. In practice, in such companies dividends are not paid since the majority shareholder controlling the financial flows of the company gains income by other ways.
Under the LLC Law, LLC participants would be able to leave the company by the way of division of participatory interest notwithstanding the approval of other participants or the company if such an option is provided by the LLC’s Charter.

4. Exclusion of a participant/shareholder

Shareholder is able not to exercise its rights such as take part in the shareholders meetings and nominate candidates to the management bodies and not to perform its obligations including inform the register's administrator on the changes of his/hers/its details. Nobody can divest shareholders of its rights which are validly held. Even if majority shareholder lost the interest in the company and, for instance, divested  the company of its assets, and does not take part in the management of the company he will lose his shares only in case of company's bankruptcy.
In contrast, according to Article 10 of the LLC Law, participant(s) whose interest in the company is more than 10 per cent. can demand in court to exclude a participant who outrages his participants' obligations or by his activity (inactivity) makes the company's business activity impossible or difficult. This rule provides defense to LLC from an unfair participant.

Besides the above, there are some other distinctions between LLC and JSC.

Our services at the incorporation stage are as follows:

Entity incorporation process includes the following stages:

1) structuring an entity, determination of its participants and optimization of its managing bodies, selection of a candidate for such entity’sGeneral Director;

2) drafting all required documentation to achieve the state registration of an entity. This stage includes:

• drafting entity’s Charter
• drafting entity’s foundation agreement
• opening of entity’s settlement account with a credit institution
• drafting the documents required for entity’s state registration
• getting FAS’s permission (if necessary)

3) entity’s state registration (at least 50% of the Charter Capital of LLC must be paid before filing the documents with the registering authority). This stage includes:

• support of the entity’s state registration process
• support of the entity’s registration with the non-budgetary funds (the RF Social Security Fund, the RF Pension Fund, the Compulsory Medical Insurance Fund) Mosgorstat
• drafting the documents required for manufacturing of the entity’s seal

4) share state registration (only for joint stock company). This stage includes:

• drafting the Decision on share issuing
• drafting the Securities Prospectus (if necessary)
• drafting other documents required for the state registration of a share issue
• drafting Report on the results of share issuing
• support of the process of state registration of a share issue

Preliminary time frames for creation of a limited liability company are as follows:

1. drafting the required documentation - 2 weeks

2. entity’s state registration - 1 week

3. entity’s registration with the non-budgetary funds (after creation of the LLC) - 1 week

Preliminary time frames for creation of a joint stock company are as follows:

1. drafting the required documentation - 2 weeks

2. entity’s state registration - 1 week

3. entity’s registration with the non-budgetary funds (after creation of the LLC) - 1 week

4. state registration of shares (after filing required documents) – 1 month
 

IN UKRAINE

Ukrainian legislation provides for both commertial and non-commertial legal entities. In Ukraine most investment projects are realized through incorporation of a commertial legal entity.

The Civil Code of Ukraine, the Commercial Code of Ukraine, and the Law of Ukraine No. 1576-XII “On Business Associations” dated 19 September 1991 establish the following types of commercial legal entities:

• general partnerships;
• limited partnerships;
• limited liability companies;
• aditional liability companies;
• joint-stock companies.

Moreover, there is also a newly adopted Law of Ukraine No. 514-VI “On Joint Stock Companies” dated 17 September 2008 (the “JSC Law”) which will regulate the establishment and functioning of joint stock companies (“JSC”) when entering into force on 30 April 2009.

Besides other novels, the JSC Law introduces the new classification of the joint stock companies – public and private ones, which, however, are much alike to open and closed JSC presently specified by the legislation in force. The main difference between the two types of companies is that shares in an open JSC may be distributed via the public offering and are allowed to be traded on a stock exchange, whereas shares in a closed JSC are distributed initially between its founders.

LLC and JSC are the most popular forms of commercial legal entities among foreign investors. Please see below our analysis on the provisions of the applicable laws.

Choosing between LLC and JSC

Notwithstanding of a significant number of similar features, LLC and JSC are not the identic types of legal entities and have a lot of peculiarities and differencies (summarized below) which affect the choice of legal entity’s constitution in the time of its incorporation.

1. Property rights on the shares and access to register of shareholder (participants).

The legislation in force stipulates that shares may be issued both in certificated and uncertificated form. Thereby shares issued in uncertificated form and property rights thereon shall be accounted by the depository on the securities account, whereas shares issued in uncertificated form and property rights thereon are registered in the shareholders register which can be hold by (a) the joint stock company itself (unless the amount of shareholders is more than 500) or (b) by an independent registrar. However, according to Article 20 of the JSC Law coming into force on 30 April 2009 shares may be issued only in uncertificated form, and, therefore after the said law comes into force the shares existing in certificated form shall be transferred to uncertificated form.

The alienation of shares issued in certificated form shall be fixed in the register. The alienation of shares issued in uncertificated form is carried out by the means of their transfer to the securities account of the buyer and does not require any additional registration. In any event changes in the shareholding structure do not lead to the introduction of amendments to the company’s Charter. There is no information in the Charter of JSC on the amount and names of its shareholders. However, Article 4 of the Law “On Business Associations” stipulates that the company’s charter shall comprise the information on the founders and participants of the legal entity. Whereas this provision regulates the activity of all types of business entities, the charters of the joint stock companies registered since 1991 were required to contain the information on their founders. Moreover, according to the Law of Ukraine No. 755-IV  “On the State Registrtion of Legal Entities and Private Entrepreneurs” dated 15 May 2003 (the “State Registrtion Law”) the Uniform State Register of Legal Entities contains the information on the founders (participants) of a legal entity irrelevant of its type, and is available to the public. Though the JSC Law does not require the information on the founders of the JSC to be included into the JSC’s charter, it is likely that state registration authorities will require to provide these data within the procedure of state registration of JSCs untill the State Registrtion Law is amended.

JSCs are also obliged to submit quarterly and annual reports to the State Commission on Securities and Stock Market. These reports include, inter alia, the information on the shareholders owning more than 10% of the company’s shares. Therefore for the purpose of shareholders details protection shares are often purchased in the name of beneficiary shareholder‘s overseas affiliates. Access either to the register and the details of the securities account is strictly regulated by law and limited for the shareholders and third parties.

According to the State Registration Law the information on the participants of LLC is registered in the Uniform State Register of Legal Entities and available to the public. Therefore, any person would be able to receive an extract from the Uniform State Register of Legal Entities with all requested information on LLC and its participants that may create problems for business security.

2. Alienation of shares

Alienation of shares of a public (open) JSC is free and a shareholder wishing to sell its shares doesn’t have to obtain approval of the other shareholders (part 1 Article 81 of the Commercial Code, part 1 Article 7 of JSC Law). By contrast, the shareholders of a closed JSC have the pre-emptive purchase rights for shares offered for sale by the other shareholders (part 2 Article 81 of the Commercial Code). However, the JSC law makes this provision optional, specifying that such pre-emptive right may be outlined in the charter of a private JSC (part 2 of Article 7 of the JSC law).

There are no provisions in Ukrainian company law which would specifically outline the issue of the pledge of shares. However since there are no restrictions for the pledge of shares, the approval of the other shareholders is not required for such pledge creation.

Alienation and pledge of equity interest in LLC are more restricted.
As in the case of a closed joint stock company, shareholders (participants) of LLC have pre-emptive purchase rights for equity interest offered for sale by the other shareholders (participants). Moreover, the LLC’s charter may contain the prohibition on alienation of equity interest to the third parties. 

The issue of pledge of the equity interest is rather a contradictory one. Generally, it is considered that pledge may be created not in relation to the equity interest but to the shareholder’s (participant’s) rights. As it was mentioned above, alienation of equity interest to the third parties may be prohibited by LLC’s charter. Therefore, pledge enforcement may appear to be impossible. Moreover, the transfer of the pledged equity interest (shareholder’s rights) may actually be carried out exlusively through bringing amendments to the company’s charter which requires the relevant decision to be taken by the General meeting of participants. Unless the said decision is taken voluntarily, the judicial enforcement will be the only available means for pledge enforcement.

All restrictions mentioned above put obstacles in the way of restructuring the LLC’ capital and make businees more solid. But, on the other hand, a process of leaving business becomes more difficult as well as shares of LLC appear to be less liquid.

3. Leaving a company

If some shareholders of JSC wish to leave the company (for instance in case if they are disappointed with dividend policy of the company), they can only sell their shares. Shareholders are not entitled to claim the apportionment of the charter fund unless the company is declared bankrupt.

For participants of LLC the legislation provides several options for leaving the company:

a. Alienation of the share. Unless the LLC’s charter prohibits the alienation of the equity interest to the third parties, the participant may leave the company by alienation of its equity interest via sale contracts, barter contracts, donation or other types of transactions providing the transfer of the ownership title.

b. Withdrawal from the membership. According to Article 148 of the Civil Code of Ukraine the participant of the LLC may withdraw from the memdership in the LLC subject to the three-month prior notification of the company on such withdrawal. The consent of other participants is not required in this case. The participant withdrawing from the LLC is entitled to obtain the part of the company’s property proportionate to its share in the charter fund of the company. However, such apportionment may not take place unless the relevant decision is taken by the General meeting of the participants.

c. Exclusion of the participant. Nobody can divest shareholders of their property rights on completely paid shares, event if they loss their interest in the company’s future and don’t meet their obligations as shareholders.

By contrast, for LLC the legislation provides some special ways to support the company and to defend fair participants. According to Article 64 of the Law “On Business Associations”, a participant who systematically fails to perform its obligations or obstructs the achievment of the companie’s purposes may be exluded from the company upon the decision of the participants owning cumulatively more than 50 % of the companie’s votes. This rule aims to provide the defence of LLC from an unfair participant.

There are also some other distinctions between the LLC and the JSC.

Our services at the incorporation stage are the following:

Entity incorporation process which includes the following stages:

1) structuring an entity, determination of its participants and optimization of its management bodies, selection of a nominee for such entity’s Director;

2) drafting all documents required for the state registration of an entity. This stage includes:
• drafting the entity’s Charter;
• drafting the entity’s articles of incorporation;
• opening the entity’s settlement account with a bank;
• drafting the documents required for entity’s state registration, and
• getting the Antimonopoly Committee of Ukraine permission (if it is necessary)

3) entity’s state registration (at least 50% of the Charter Capital of LLC must be paid before filing the documents with the registering authority). This stage includes:

• legal support of the entity’s state registration process;
• legal support of the entity’s registration with the non-budgetary funds (Social Insurance Fund on industrial accidents and industrial diseases of Ukraine, Social Insurance Fund on temporary disablement, Compulsory State Social Insurance Fund, Pension Fund, State Statistics Committee), and
• drafting the documents required for manufacturing of the entity’s seal.

4) state registration of the equity issue (only for joint stock company). This stage includes:

• drafting the Decision on the equity isuue;
• drafting other documents required for the state registration of the equity isuue;
• drafting Report on the results of the equity isuue and
• legal support of the process of state registration of the equity isuue.

Terms of entity creation as a limited liability company are the following:

1. drafting the required documentation - 2 weeks;

2. entity’s state registration - 1 week, and

3. entity’s registration with the non-budgetary funds (after the entity’s creation) - 1 week.

Terms of entity creation as a joint stock company are the following:

1. drafting the required documentation - 2 weeks;

2. entity’s state registration - 1 week;

3. entity’s registration with the non-budgetary funds (after the entity’s creation) - 1 week,

4. the equity isuue (after filing of the required documents) – 1 month.
 



For more information please refer to our legal experts:

IN RUSSIA:

Alexander Timofeev - Alexander.Timofeev@lp.ru
Mihael Malinovskiy - Mihael.Malinovskiy@lp.ru
Anna Burkova -  Anna.Burkova@lp.ru 
phone: +7(495)664-28-90

IN UKRAINE:

Radmila Hrevtsova - radmila.hrevtsova@lp.com.ua
Svetlana Dovbnya - svetlana@lp.com.ua
phone: + 38 044 492 7794