Corporate Legislation Reform and Judicial Practice in Ukraine: Analysis of the Perspective

Nowadays a multi-vector update of Ukrainian corporate legislation is one of the most-promising aspects of legal reform with a global aim in foreign investment activity stimulation. To our mind, improving the clarity of legislation, the quality of law enforcement and judicial practice provides an opportunity to increase the level of trust and confidence of foreign partners in Ukraine. On the other hand, the above-mentioned processes are stimulated by the growing interest of strategic partners in cooperation with Ukraine whose European vector is beyond any doubt.

For that reason, further improvement of the mechanism of corporate legal relations regulation is of a paramount importance due to the objective necessity of legal reality. Moreover, it is worth stressing that significant attention in Association Agreement between Ukraine and the European Union of 27 June 2014 is paid to various aspects related to company law and corporate governance.

In general, priority area includes problematic aspects of protection of the rights of shareholders, creditors and other stakeholders, implementation of international standards in the field of accounting and auditing, further development of corporate governance policy in accordance with international standards and more. Undoubtedly, the achievement of all these tasks will result in creation of necessary conditions for the functioning of the single market and the development of trade relations between the European Union and Ukraine.

However, a special attention should be paid to the fact that achieving the goals defined in Association Agreement between Ukraine and the European Union is possible not only by amending the acts of corporate legislation of Ukraine. The formation of a unified and stable case law on the application of corporate legislation is one of the most important elements for the development of legal certainty and the rule of law. To our mind, the most significant decisions of the Supreme Court in the field of corporate law of Ukraine and some regulation novels are worth stressing. 

Long-Awaited Delay

The Law of Ukraine On Prevention and Counteraction to Legalization (Laundering) of Criminal Proceeds, Terrorist Financing and Financing of Proliferation of Weapons of Mass Destruction (hereinafter – the Law No. 361-IX) states that legal entities registered before the entry into force of this Law shall submit to the state registrar information on the ultimate beneficial owner in the amount specified by this Law and the ownership structure within three months from the date of entry into force of the regulatory act approving the form and content of ownership structure.

At the same time the Law No. 361-IX enshrines that ultimate beneficial owner is considered to be any individual who exercises decisive influence (control) on the activities of the client and/or the individual on whose behalf the financial transaction is conducted. Thus, for legal entities the ultimate beneficial owner is any individual who exercises a decisive influence on the activities of a legal entity (including through the chain of control/ownership).

To our mind, it is worth stressing the difference between direct decisive influence and indirect decisive influence. A sign of direct decisive influence on the activity shall be direct ownership by an individual of at least 25% share of the authorized (contributed) capital or voting rights of a legal entity. When it comes to indirect decisive influence, signs of it is at least the possession by an individual of no less that 25% share of the authorized (contributed) capital or voting rights of a legal entity through related individuals or legal entities, trusts or other similar legal formations, or the exercise of decisive influence by exercising the right to control, own, use or dispose of all assets or their shares, the right to receive income from the activities of a legal entity, trust or other similar legal formation, the right to decisive influence on the formation of the composition, the voting results of management bodies, and carrying out of transactions that make it possible to determine the main conditions for the economic activity of a legal entity, or the activity of a trust or other similar legal formation, or approve binding decisions that have a decisive influence on the activities of a legal entity, trust or other similar legal formation, regardless of formal ownership.

Nevertheless, the person who has a formal right to 25% or more of the authorized capital or voting rights in a legal entity, but is a commercial agent, nominee owner or nominee holder, or only an intermediary in relation to such right, shall not be an ultimate beneficial owner.

According to the provisions of the Law No. 361-IX the Ministry of Finance of Ukraine has adopted the Order No. 163 On Approval of the Regulations on the Form and Content of the Ownership Structure. As the mentioned above Order was registered by the Ministry of Justice, all legal entities registered in Ukraine had only 3 month period (since 11 July 2021 till 11 October 2021) to submit to the state registrar information on the ultimate beneficial owner.

Taking into account the enormous number of legal entities and paramount importance of submitting the information on the ultimate beneficial owner in time the whole legal community was concerned about the extremely tight deadline, which was next to impossible to meet.

Fortunately, on 8 October 2021 the Verkhovna Rada of Ukraine adopted a law No. 1805-IX On Amendments to the Law of Ukraine On Prevention and Counteraction to Legalization (Laundering) of Criminal Proceeds, Terrorist Financing and Financing of Proliferation of Weapons of Mass Destruction (hereinafter – the Law No. 1805-IX). The Law No. 1805-IX increased the term for fulfillment of the obligation by legal entities to submit information on the ultimate beneficial owner and ownership structure to the state registrar from three months to one year – till 11 July 2022. 

Doctrinal Issue – Practical Outcome

The Grand Chamber of the Supreme Court, considering the case No. 916/2813/18, in its decision of 29 June 2021 concluded that a private enterprise should not be interpreted as a separate organizational and legal form of legal entity, but only as a qualifying feature of legal entity ownership.

The significance of the above decision of the Supreme Court is difficult to exaggerate taking into account as follows. To start with, since the adoption of the Civil Code of Ukraine and the Commercial Code of Ukraine (as well as other acts of corporate legislation) there has been some inconsistency regarding the organizational and legal forms of legal entities. As a result, the issue has been repeatedly arisen in judicial practice as to in which organizational and legal forms of legal entities corporate rights and, as a consequence, corporate legal relations may arise.

Having provided an in-depth analysis of the essence of legal regulation in this area, the Supreme Court concluded that a private enterprise is not a separate organizational and legal form of a legal entity, but a classification feature of legal entities depending on the ownership form. The Supreme Court noted that a private enterprise is an enterprise operating on the basis of private property of one or more citizens (foreigners) with or without the usage of hired labor, as well as an enterprise operating on the basis of private property of a legal entity. Thus, the characteristic of a legal entity as a private enterprise is a characteristic of the property on the basis of which it was created.

According to the Civil Code of Ukraine all companies which carry out business activities for profit and its subsequent distribution among participants may be established only as business companies or cooperatives operating for profit  subjects of corporate relations. Thus, if a private enterprise is created to conduct business activities and to distribute profits among the participants (founders), then such private enterprise is a business company and is under corporate legislation.

The point is if private enterprise is a business company the relevant corporate legislation norms should be applied by the court in order to solve any legal dispute referring to private enterprise. In other words, such disputes should be treated as corporate.

The above mentioned legal conclusion of the Supreme Court allows departing from the formal legislative classification of legal entities, thereby emphasizing on the nature of the relationship between legal entity participants and the purpose of its activities. These aspects may clarify whether there are corporate relationships in particular legal entity or not in order to choose an effective regulative instruments and protection method. 

Compulsary Due Diligence

One of the most important issues referring to the acquisition of corporate rights is the possibility of checking the existence of corporate disputes over shares in the company. This, to some extent, makes it possible not only to guarantee the validity of the transaction, but also to prevent the occurrence of future litigation in advance.

The Supreme Court, considering the case No. 922/634/19, in its decision of 17 March 2021 emphasized that a legal entity that acquired a share in a limited liability company ought to exercise sufficient caution to verify the existence of a corporate dispute over its share in the company. Moreover, the Supreme Court notes that when purchasing property (e.g. shares in the authorized capital), the buyer should exercise reasonable caution and investigate the history of disposal of property from previous owners – participants of the company for at least the last three years, which is considered to be standard business practice when buying shares in the company’s authorized capital, especially in the amount of 100%.

As in the mentioned above case the plaintiff did not demonstrate good faith and reasonable prudence in acquiring a share in the authorized capital of the company, as well as a stable business relationship with a former participant of the company, due to illegal actions of which the plaintiff was deprived of ownership, the Supreme Court is critical of the complainant that the impugned decisions violate his right to peaceful possession of property and impose on him as a bona fide purchaser an individual and excessive burden, as a result of which he is forced to seek ways to compensate for his losses. 

Personal View

It is worth noting the corporate legislation reform is in process during recent years. To our mind, the formation of stable case law on corporate legislation application is one of the most important issues for increasing legal certainty. At the same time, it is difficult to overestimate certain significant steps such as the obligation of submitting information on the ultimate beneficial owner and ownership structure to the state registrar by all legal entities registered in Ukraine in order to meet international standards in money laundering sphere and corporate law.

  • Ernest Gramatskiy

    President, GRAMATSKIY & PARTNERS, attorney-at-law, PhD

Gramatskiy & Partners

ADDRESS:

16 Mykhaylivska Street, 2-4 Floors,

Kyiv, 01001, Ukraine

Tel/Fax: +380 44 581 1551

E-mail: office@gramatskiy.com.ua

Web-site: www.gramatskiy.com

Gramatskiy & Partners is known as a trustworthy law firm, which has been successful in providing legal assistance to its clients in various areas of law since it was founded. Gramatskiy & Partners is recognized as one of the leading law firms in Ukraine due to the introduction of high standards of legal services and performance of exceptional proficiency.

From the time it was founded in 1998, Gramatskiy & Partners has acknowledged business legal practice as its own professional vocation and the mission for its serving the public. The unique experience of a vast legal practice enables the firm to advise today more than a hundred Ukrainian and foreign companies providing complex aid and assistance in legal matters, combining classic legal practice traditions with modern international standards of the legal services market.

As a universal law firm, Gramatskiy & Partners has made its name as a qualified provider of comprehensive legal service. Combining a scrupulous approach with customer-centered orientation in terms of rendering legal assistance enables the firm to individualize a wide range of its services for the business of every client.

For over 26 years Gramatskiy & Partners has been successfully developing its practice in the field of business (commercial) law, foreign economic activity, and the practice of international private law.

The pride of the firm is its staff — a team of professionals who stood at the outset of the firm and have worked their way up from its foundation on the local and foreign legal service market and who continue to work for the benefit of the firm and its respected clients.

The firm’s experts provide tailor-made advice on many different practice areas, including commercial, corporate, tax, foreign economic activity and foreign investments, copyright, mass media, labor, securities and stock market, disputes resolution, mediation, insolvency. Furthermore, many of the firm’s clients have been successfully represented before public authorities and courts in civil, commercial, administrative and criminal cases.

Pragmatism and practical orientation are among distinctive features evinced by Gramatskiy & Partners in all the projects it is involved in; the firm bears responsibility for every memorandum and for every legal opinion presented to a client. Gramatskiy & Partners structures and describes every legal procedure, as if the firm itself were to implement it in practice.

Gramatskiy & Partners also pays special attention to issues of confidentiality of the projects in which it assists, because the law firm realizes the importance of confidentiality for clients.