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Managing Partner, ILF
Partner, Innovation Officer, ILF
On the Establishment of Supervisory Boards in Ukrainian LLCs and Their Benefits
Although it has technically been possible to form a supervisory board in Ukrainian LLCs for a while, the ability to run it effectively did not arrive until June 2018, when the Law of Ukraine On Limited and Additional Liability Companies came into force, dedicating an entire separate provision to the issue.
Since then, many Ukrainian companies have established such boards to make business management more effective, and many others are seriously considering it. In this article, we’ll look at the circumstances under which a Ukrainian company should create a supervisory board, go over this body’s functions and powers and to also clarify who can be its members and on what terms.
What a Supervisory Board is
A supervisory board is a corporate governance body which reports to the general meeting of shareholders and supervises the activities of the CEO.
When it is Time to Form a Supervisory Board
There are a few situations that have already become classic examples, due to how common they are, of supervisory boards becoming an effective governing body in a company.
The Ukrainian offices of foreign companies were the first to establish supervisory boards after the adoption of the aforementioned law. Many foreign businesses are divided into clusters, which may encompass several countries. Employees of each country’s office are not necessarily, or not exclusively, subordinate to the CEO of that office, but may also report to an appropriate supervisor in the cluster. Thus, one of our clients, international tech company CMO Ukraine, reports to the company’s Israeli office, which coordinates all of the company’s marketing departments in the EMEA region, rather than to the CEO of the Ukraine office. Such a structure used to have no legal basis and hinged on the trust between stakeholders for each other and for corporate rules. Now, however, the actual state of affairs can finally be given a legal form, which will certainly make managing these companies easier, more effective and less stifled by red tape.
Another classic example comes into play when the founders step away from day-to-day management. This could happen when a business is transferred to heirs, or when the founders decide to take on some other project. In this case, by switching from an executive body to the supervisory board, they can retain the ability to influence policy and development without having to be constantly involved in day-to-day operations.
The following are not so common scenarios that have served as a prerequisite for the establishment of supervisory boards in recent years.
Thus, the supervisory board is a useful tool for involving investors (after attracting investment) in the company’s affairs. In recent years, all kinds of instruments have been gaining popularity in Ukraine for attracting investment at the early stages of a project, such as SAFE or convertible loans. Yet, the main way to attract large sums still involves an investor’s entry into the company’s authorized capital. As members of the supervisory board, investors can watch over their money and monitor the company’s activities without interfering with routine management, benefiting day-to-day operations by bringing in consultants and experts that are necessary for the project at hand. This scenario is particularly widespread among Ukrainian IT companies. There have also been more and more cases when an outsourcing company’s pet project grows into a separate entity with its own employees and executives. A supervisory board could help the parent company support and assist a fledgling company like that.
Hence the next reason for creating boards. A notion has been gaining traction lately that the purpose of a supervisory board is not so much in supervising the company’s managers but in serving as a way to support them and help them achieve growth. Such supervisory boards consist of experts that help out with strategic tasks, also mentoring managers and helping with their development. The functions of such boards include evaluating and training managers, ensuring a succession of authority, selecting candidates for executive positions from among the employees, providing advice in crisis situations, etc.
The final reason is the desire to consolidate management. Businesses often operate as groups of several Ukrainian LLCs and companies incorporated in other countries, to optimize tax or administrative aspects based on the needs of the business and its customers. Local companies are run by local managers, but the owners of the group, if they are actively involved in operations, seek to maintain control over management while avoiding control over current business transactions, which may conflict with compliance requirements in certain states. In a situation like this, having a supervisory board can help to ensure a single vector for all companies in the group.
It should be noted that these scenarios are quite arbitrary and that, in most cases, the creation of a supervisory board involves multiple prerequisites and advantages, some of them too specific for this general overview.
How a Supervisory Board is Established
The decision to form a supervisory board is made by the general meeting of shareholders. Its status and functions are prescribed in the company’s charter and can be elaborated on in dedicated regulations.
By mentioning only key, strategic functions in the charter, the company avoids the need to rewrite it every time the board’s functions or model of operation change, which is important given the expectation that a supervisory board is supposed to be as flexible a body of corporate governance as possible.
The body’s name might suggest that it must be collegial, but that is not necessarily the case. The supervisory board of LLCs can have any number of members, starting with a single person. One-person boards are often created in companies with two owners, with one of them nominating the CEO and the other – the member of the supervisory board.
Functions and Powers of a Supervisory Board
By law, the supervisory board controls and regulates the activities of a company’s executive body. However, in practice, the board also determines the main guidelines of the company, evaluates and approves the goals and key performance indicators, also evaluating and adopting the strategy and business plans for the company’s main activities.
In addition to standard powers, such as hiring and firing CEOs, paying bonuses, preparing general meetings, approving contracts, arranging audits (selecting auditors and signing contracts with them), the board’s functions encompass:
- Ensuring compliance of the CEO’s decisions with the interests of the owners. It’s also possible to determine what kinds of transactions the CEO can go through only with the board’s blessing.
- Monitoring implementation of the adopted strategy. The CEO, being immersed in day-to-day affairs, can sometimes forget the overall strategy, and the board’s task is to bring the big picture back into focus.
- Protection against the impact of corporate disputes. Conflicts between partners can interfere with general meetings of shareholders. The supervisory board can handle things in the meantime, as it has the authority to make decisions and oversee management.
- Ensuring succession of executive bodies. When a key executive quits, it could damage the business, in terms of funds, structure or morale. To prevent this from happening, the supervisory board nominates reserve candidates for these positions.
- Protection against external threats. Since the board monitors the CEO’s decisions, this mitigates the risk of corporate raiding. If the CEO loses the trust of shareholders or the ability to act, the board can step in and assume his/her functions.
Who Can be a Member
There are several ways to form a supervisory board:
- It can consist entirely of company employees. If your company has a sufficient number of qualified staff, and if you approve of their performance and are confident in their abilities, they can be your supervisory board. The main advantage of this solution is having members that are familiar with the company’s inner workings.
- The board can also consist of independent members brought in from outside. In this case, the board will be focused on the company’s overall activities, from a high level of abstraction, rather than on the minute details of its activities.
- It’s also possible to combine outside experts and company employees, making use of the benefits offered by both of these categories. A mixed board will understand the company’s inner processes and will also be able to see them with fresh eyes. On the other hand, it could spark conflicts within the board due to the division between “our own” and “outsiders”.
The board can include various experts as well as CEOs, presidents or owners of other companies that you consider to be role models. You can also bring in marketers, lawyers, auditors – all those whose expertise can help evaluate the CEO’s actions and seek out effective solutions.
A civil or employment contract can be concluded with members of the supervisory board; they can work with or without remuneration.
To sum up, a supervisory board is an instrument which a business can use to address a multitude of tactical and strategic tasks, and this instrument is becoming increasingly popular in Ukraine, evolving with each passing day.