Corporate Agreement in View of the Provisions of the New LLC Law

One of the important changes in Ukrainian legislation is adoption of the new Law of Ukraine No. 2275-VIII On Limited Liabili­ty Companies as well as Additional Liability Companies of 6 February 2018 (hereinafter — the Law). The new law came into force on 17 June 2018.

This Law introduces certain novelties to Ukrainian legislation. One of them is the emergence of a new type of agreement in Ukrainian legislation, which directly corresponds to the activity of the Limited liability companies as well as Additional liability companies, namely — a Corporate Agreement. It is better known around the world as a “Shareholder agreement”.

This type of agreement came to Ukraine from Western countries, where it is widely used. Such agreements aim to provide more flexible management of a company, since it allows to regulate the relationship between the parties to an agreement in more detail. As a rule, the Charter of the Company contains the main principles of the Company’s governance, and the Corporate Agreement can specify the provisions of the Charter in concreto.

Before, Company governance in Uk­raine was regulated only by different laws as well as by the Civil and Commercial Codes of Ukraine. These regulations were far from perfect and contained obvious inaccuracies. For example, the Business Entities Law pointed out that the Audit Commission of the Company should consist of 3 participants. There is no explanation of the legal position in cases when the Company had only one or two participants in the Company. Now, due to the enactment of the Law, this problem has been solved.

The provisions of the Law do not stipulate the mandatory form of a Corporate Agreement. In general, the legal wording of the provisions of the Law, which refers to a Corporate Agreement, do not have a rigid imperative, allowing flexible application of these norms. For example, it is not explicitly indicated who can be parties of the Corporate Agreement. In other words, the parties of the Corporate Agreement may be not only the participants of the LLC, but also other persons.

The reasons for concluding a Corporate Agreement quite often include the desire to resolve the bonus payment issue for LLC officials (for directors, members of the Board of Directors, members of the Supervisory Board, etc). In this case, the Corporate Agreement describes in detail the conditions under which the participants should vote “for” in the issue of giving bonuses to the above-mentioned persons. In addition, participant-individuals in the Corporate agreement often state a commitment to vote “for” in matters regarding the succession of such an individual in the event of his/her death.

The Corporate Agreement is not mandatory and interesting primarily to those persons who want to regulate certain aspects of a company’s management in more detail.

Content of a Corporate Agreement and its Scope

As mentioned above, the Law does not directly specify the parties to the Corporate Agreement. Therefore, the range of persons who can enter into a Corporate Agreement is wide enough. It is common practice to conclude the Corporate Agreement between active participants and a person who plans to join the Company. In such case, in the Corporate Agreement the parties shall resolve the voting procedure, which may, for example, indicate that active participants must vote in favor of the issue of admission of a third party to the Company.

The Law also provides for the possibi­lity of establishing conditions on which the participant has the right or obligation to buy or sell a share in the Charter capital, as well as to determine the cases when such right or obligation arises. This could be, for example, a description of the condition when one of the participants gets married (if an individual) or takes out a significant loan (if a legal entity). The abili­ty to regulate relations in this way in detail is important, and can reduce the number of corporate conflicts. It should also be noted that the officials of a Company often act as a party of Corporate Agreements.

It happens frequently that one of the participants is also the director of the Company, and if such participant has taken steps that could be described as “unfriendly” in relation to the Company, it would be very difficult to reduce the undesirable activity of such participant. So, with the number of votes allowed, such a participant could be dismissed from the position of director, but at the same time this person remained a participant and had certain opportunities that enabled him/her to be “informed” about the Company’s business. For example, the participant has the right to receive financial statements for familiarization and other “sensitive” information.

Now, the parties can establish in a Corporate Agreement, for example, the follo­wing provision: if, after the carrying out of an audit, it is discovered that the Company, under the management of such a participant-director, was not completely honest with losses that could have been avoided, then such director would be obliged to sell his or her share in the Share capital of the Company to other persons. The use of such a mechanism in practice does, of course, require a more detailed description of each step, but in general it gives an insight into the opportunities that a Corporate Agreement provides to its participants.

Does the Corporate Agreement prevail over the Company Charter?

The answer is “No”. The Corporate Agreement may not contradict the Charter of the Company or, moreover, the Law. In this context, the following comparison comes to mind: the football team coach’s plan for a game cannot contradict the ge­neral rules of the game of football.

The Charter of the Company (as well as the Law) establishes the general content of the rights and powers of the Company’s participants. In its turn, the Corporate Agreement is a detailed description of the application and implementation of the rights and powers of such participants.

For example, the Charter establishes the number of votes required to adopt a decision to conclude a loan agreement with the bank. Such a number of votes is unchanged. For example, you need 95% of the vote “for” to adopt a positive decision. In a Corporate Agreement it is possible to establish the following terms and conditions: if there is an issue on whether to conclude a loan agreement with bank “A”, then the participants should vote “against”, and if the choice is bank “B”, then they shall vote “for”.

It must be understood that the main documents that establish the basic “rules of the game” for a specific Company is its Charter and the Law. The Corporate Agreement cannot contradict them.

In addition, the Law indicates that a Corporate Agreement which establishes the obligation of the participants to ensure voting in accordance with the instructions of the governing bodies of the Company, is null and void. In other words, it is impossible to establish a position where the Director or Supervisory Board will imperatively indicate to the participants of the Company how they should vote. It is simply impossible, since the highest body of the Company is the General Meeting of participants and nothing else.

It is important to realize that the Charter and the Corporate Agreement have very different subjects of regulation. The Charter regulates the basic provisions, while the Corporate Agreement regulates the mechanism for implementation of such provisions.

Responsibility under a Corporate Agreement

This is a very important issue as the Corporate Agreement is, in fact, an agreement between the parties. The parties may establish liability for violation of the terms of the Corporate Agreement, including in the form of fines. Such a regulation cannot be established in the Charter of the Company.

Moreover, it should be taken into account that the fact of violation of the terms of the Corporate Agreement (for example, with regard to voting on the alienation of a share to a third party where the participant, in accordance with the Corporate Agreement, had to vote “against”, but voted ‘’pro”) does not lead to “cancellation” of the agreement concluded with a third party.

Such a contract will come into force. Even if the participant has violated the voting procedure, his vote would be counted, and the decision of the General Meeting of the Company’s participants would also come into force. But there is a consequence. If such penalties were described in the Corporate Agreement, such party may be subject to the penalties for this. For example, if a participant in a pre-determined Corporate Agreement voted “for”, although he was supposed to vote “against”, he would be fined in the amount of, for ­example, USD 1 million. Such provisions may be reflected in the Corporate Agreement.

Violations of a Corporate Agreement cannot entail the decision of the General ­Me­eting of the participants of the Company to be declared invalid in the event of a breach by the party of such a commitment (that is, if he did not vote as stated in the Corporate Agreement).

This is to say that a Corporate Agreement cannot replace the Charter, but it is intended only to describe more flexibly the relationship between the participants of the Company.

Also it can be established: if a party of the Corporate Agreement does not hurry to pay for the purchased share in the Company, then it will be obliged to pay a specified penalty.

The Corporate Agreement does not require consideration. It means that none of the parties can buy or sell something. The Corporate Agreement is aimed at recording agreements reached between the parties regarding the Company’s management, but not for any direct cash benefits.

Therefore, the conditions under which a party of such a Corporate Agreement incurs financial responsibility, most likely in the form of a fine, should be stipulated in detail in the Corporate Agreement itself.

Taking in consideration the above-mentioned, we recommend that you pay attention to the preparation of the Corporate Agreement and get assistance from qualified lawyers.