Contractual Regulation of M&A in Ukraine: How Powerful the Protection We Choose
By Anna Melnyk
Grischenko & Partners
In many instances parties
tend, when formalizing an
international M&A transaction,
to make the choice of law
to govern a respective contract.
However, regardless of the law
governing such a contract (either
a share purchase agreement, or
share subscription agreement, or
other similar instrument) the prospective acquirer and seller
should bear in mind that they would have to observe the
mandatory rules of law of jurisdictions where the business
and assets of the target are located.
In acquisitions involving a Ukrainian element it is advisable
to take into account the following rules.
Quite often in M&A transactions the sale of shares
is made on the level of a holding (or mother) company
which, in turn, directly or through other entities controls
the ultimate target company (group). Sometimes the holding
company would act as the sole shareholder of the target
and is incorporated especially for the purposes of the
planned transaction (aka “special purpose vehicle”) in
a favorable jurisdiction. Adoption of the new Civil Code
(the CCU) in 2004 introduced to Ukrainian company law
the concept of a “one-man company”. Thus, one person
may act as sole shareholder in limited liability companies
(LLC), additional liability companies and joint
stock companies (JSC) in Ukraine. At the same time, the
CCU provides for the prohibition of sole shareholding in a
Ukrainian company in cases when such a sole shareholder
is, in turn, controlled by one person. Thus, when structuring
an acquisition transaction it is necessary to take into
account that a holding company may not own 100% of the
shares of a Ukrainian company if this holding company is
formed by only one shareholder. Some practitioners are of
the view that this rule should not apply to situations when
a foreign entity formed by one person acquires control
over a Ukrainian entity. However, the absence of relevant
judicial interpretation and practice of application of this
rule proves the opposite. Since Ukrainian law is not familiar
with the concept of “nominal” and/or “beneficiary”
shareholding, it is not important from the point of view of
Ukrainian law if the sole shareholder of the holding company
is only nominal “covering” several beneficiary shareholders.
In such case the acquisition of direct control over
a Ukrainian subsidiary would not be possible and would
be rejected already at the stage of state registration of the
charter (Articles of Association) of a Ukrainian subsidiary.
Parties to an M&A transaction may prevent the above
complication if they build the “chain” of shareholdings
appropriately. Notably, should the parties choose to “give
up” a minority stake in a Ukrainian subsidiary to any related
person, the law does not set any strict threshold for
such a minority stake (i.e. it may be 1% or 0. 0001%, or any
other percentage of shares in the statutory capital).
In many acquisition transactions and, especially, in the
case of formation of joint ventures, parties try to set the rules
of future cooperation by concluding a shareholders agreement.
Such an agreement, inter alia, provides for corporate
governance rules to be applied when managing common
business and entities. It is noteworthy that on the basis of
norms of Ukrainian company law, parties may not supersede
mandatory rules of corporate governance set by law by their
agreement.
(a) In particular, this concerns the procedure of voting at
the general shareholders meeting (the GSM) in Ukrainian
LLC and JSC.
LLC. In a LLC, a majority of 50% plus one vote from the
total amount of votes is required for (i) determination of main
directions of the Company’s activity and approval of its plans
and reports on their execution; (b) amendment of the company’s
Articles, including cases of change of the authorized
capital; (c) expulsion of a shareholder from a LLC. Other decisions
on such a company can be taken by a simple majority
of votes of shareholders present at the respective GSM.
JSC. Full voting control in a JSC is secured by a 75%
block of shares, which allows approving a resolution at the
GMS on (i) amendments to the Articles, including an increase
or decrease in its authorized capital, (ii) liquidation
of a JSC. Any other decisions may be approved at the GMS
by a simple majority vote (50% plus one share) and shareholders may not change the above voting procedure by their
agreement.
Thus, a unanimous vote or veto rules which parties often
try to set in the shareholders’ agreement would not be enforceable
with respect to Ukrainian companies
(b) Another important aspect is the formation of a onetier
or two-tier structure of a company’s management since
management of the company is a key issue for any shareholder
as this provides the shareholder with operational
control.
As established by Article 145 of the CCU it is optional for
shareholders to decide which executive body will be established
in the company. However, they must determine clearly
whether it is individual or collective and a combination of
these two types is not allowed. The collective Board of Directors
(or the sole Director) is always appointed by the GMS
and powers of such appointment may not be delegated to the
supervisory board of the company.
LLC. As a general rule, a Ukrainian LLC is formed as a
one-tier company (i.e. no supervisory board is constituted).
The CCU and the On Commercial Companies Act of Ukraine
(the Act) provide that control over the financial activity of an
LLC is carried out by the Auditing Commission (the AC).
Formation of this body within the company is compulsory
as without the conclusion (opinion) of the AC a company’s
annual balance sheet cannot be approved by the GMS. The
members of the AC are elected by the GSM from the shareholders
and, as explicitly stipulated by the Act, there should
be at least 3 members in the AC. It is not quite clear in practice
how 3 members may be appointed to the AC in a company
with less than 3 shareholders. Thus, usually the members
of the AC are representatives of the shareholders. It is also
possible for the shareholders to agree on formation of a supervisory
board although there no requirement on formation
of such body in a LLC. However, the practice of formation of
such board in a LLC is not widespread in Ukraine.
JSC. A different situation appears to be common with respect
to a JSC. In a JSC, the Supervisory Council (the SC)
of the JSC represents the interests of a company’s shareholders
between the GMS. Within its powers, as defined in detail
by the company’s Articles, it supervises the activities of the
management board. In a JSC with more than 50 shareholders
formation of the SC is compulsory.
The SC in any company shall be formed from amongst
its shareholders. However, the Act does not provide for any
rules regarding proportional representation of shareholders
in the SC and, since members by the SC are appointed by
the GSM, majority shareholders often use this legal gap to
abuse their powers by not allowing minority to obtain at least
any seats in the SC. Therefore, the matter of distribution of
seats in the SC becomes one of the most important issues to
be resolved within the shareholders’ agreement.
In some instances the company may face a “deadlock
situation” when its activities are interrupted due to a corporate
conflict. There are solutions developed by corporate law
and practice to resolve the deadlock situations (e.g. Russian
Roulette, Texas Shoot-Out, Cooling Off/Mediation, etc.).
These solutions are usually stipulated in deadlock resolution
clauses of respective agreements and, indeed, provide for effective
means of settlement of such situations. Unfortunately,
in Ukrainian legal practice not all corporate conflicts are resolved
on the basis of sophisticated agreements. Hence, it is
necessary to outline some key aspects to be taken into account
by a prospective investor, namely:
• Only 60% plus one share would secure a quorum at any
GMS, and agreement of the shareholders may not change the
said quorum threshold. Therefore, a 50% plus 1 share package
does not provide its holder with ultimate protection, as
another shareholder with a smaller shareholding may block
the GMS by not showing up at the meeting;
• The Act does not provide for any solution if a quorum
is not present at two successive duly convened GSM (at the
same time not prohibiting the shareholders to decide how to
act in such a situation);
• Ukrainian legislation does not provide for an ultimate
solution, making it incumbent upon shareholders to estimate
the fair market value of their shares if such shares are alienated
(transferred) in course of settlement of a deadlock situation
(making the agreement the most workable solution).
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