Contesting major and interested-party transaction

25.07.2018

Legal update No 645

This update draws on legal acts in effect as of 26 June 2018

Contesting major and interested-party transaction

Bryan Cave Leighton Paisner (Russia) LLP advises that, on 26 June 2018, the Plenum of the Russian Supreme Court passed Resolution No. 27 “On contesting major and interested party transactions” (the Resolution).

It explains the updated provisions of the Federal Law1 “On Joint-Stock Companies” (the JSC Law) and the Federal Law2 “On Limited Liability Companies” (the LLC Law) about companies making and contesting major and interested-party transactions (Extraordinary Transactions) that came into effect on 1 January 2017.

The most important explanations are discussed below.

General provisions on contesting Extraordinary Transactions

The Resolution validates the correlation between the JSC and LLC Law provisions and the Russian Civil Code (the RCC) rules applicable to contesting Extraordinary Transactions. The general rule is that major transactions are contested under RCC Article 173.1 and interested-party transactions under RCC Clause 2, Article 174, in consideration of the specifics stipulated by the JSC Law and LLC Law in this context3.

The Resolution also emphasises that dismissal of a lawsuit for invalidating an Extraordinary Transaction or failure to contest a transaction does not deprive interested parties of additional remedies, such as

  1. recovery of damages inflicted on the company by guilty persons; and
  2. a claim for a person that concluded an Extraordinary Transaction to the detriment of the company, instructed that it be concluded or voted in favour of it at a General Meeting to be excluded from the company.

Criteria for recognising a major transaction

The Resolution emphasises that a transaction is a major one if two attributes are identified at the time it is made:

  1. quantity (value): the transaction deals with property with a price or book value above 25% of the company’s asset book value (before factoring in claims that might be brought for failure to discharge or duly discharge obligations under the transaction); and
  2. quality: the transaction is beyond the scope of normal business operations.

As an example of a major transaction beyond the scope of normal business operations, the Resolution gives a company key business asset being disposed of or transferred for use by others. Unfortunately, the Resolution fails to resolve the general issue of how the major transaction quality criterion is to be applied in the absence of any statutory guidelines.

The Resolution also introduces the presumption of a transaction being within the scope of normal business operations. This presumption now has to be refuted by a claimant contesting a major transaction with reference to this criterion. This approach is precisely the opposite of that established previously by the SCC Plenum, which imposed the burden of proving a transaction was part of normal business operations on the defendant4.

Quantity criterion for periodical payment agreements

The Resolution explains how the quantity criterion is to be applied to agreements providing for periodical payments (such as leases, service and insurance agreements, etc.). Such agreements will be recognised as major transactions if the total payments made throughout their duration exceed 25% of the company’s asset book value. An agreement concluded for an indefinite term will be recognised as a major transaction if the total annual payments thereunder exceed 25% of the company’s asset book value.

Agreements providing for non-standard price determination mechanisms, such as share price adjustments according to whether or not certain targets are met, remain an open issue.

Major interested-party transactions

The Resolution provides additional explanations regarding approval of transactions that are both major and interested-party. Particularly, approval of this kind of Extraordinary Transaction may be examined as a separate matter on the agenda or as two additional matters, for each type of transaction. If a non-public company’s Articles rule out the need for approving interested-party transactions, the transaction is to be approved only as a major one.

The Resolution clarifies that if approval of an Extraordinary Transaction as a major transaction falls within the remit of the Board of Directors, it is to be approved by the Board of Directors (as required by the major transaction rules) and by the General Meeting (as required by the interested-party transaction rules), providing a relevant request has been made.

Protection of third parties in Extraordinary Transactions

The Resolution affords additional protection to third persons party to Extraordinary Transactions by confirming that no third party is required to check whether:

  1. the transaction is an Extraordinary one for the company (particularly, there is no duty to study accounts, the list of affiliates, controlling and controlled parties or the company Articles); or
  2. the Extraordinary Transaction has been approved by the company as appropriate.

Third parties may also rely on the Companies Register for data about the persons authorised to act for the company and thus having the power to enter into Extraordinary Transactions.

Absolute protection is not granted to third parties if they were aware that the transaction made by the company demonstrated signs of being a major or interested-party one.

Approval of an interested-party transaction does not preclude it from being contested subsequently

A claim seeking to have an interested-party transaction invalidated may not be dismissed merely because it was approved. Absence or lack of approval only affects whether the company would bear the burden of proving damage inflicted thereon by the transaction. Lack of approval means that the damage will be presumed and the claimant will only need to prove that the counterparty knew of the conflict of interest. If the transaction was approved, the claimant itself would need to prove damage to the company interests.

Articles extending the ambit of Extraordinary Transaction rules/excluding rules on interested-party transactions

The Resolution allows companies to extend the list of transactions they treat as major and/or interested-party ones in their Articles, clarifying that these transactions will be contested on the basis of RCC Clause 1, Article 174.

If the Articles of a non-public joint-stock company or limited liability company do not include rules on interested-party transactions, the Resolution states that such transactions must be contested under RCC Clause 2, Article 174, disregarding the special provisions of the JSC Law and LLC Law.

Worth particular mention is the explanation that interested-party transaction approval rules included in non-public company Articles prior to 1 January 2017 should be regarded as rules establishing a different transaction approval procedure. At the same time, the Resolution specifies that, if the range of transactions to be approved as interested-party transactions is wider than under the current rules, such transactions should be contested on the basis of the RCC Clause 1, Article 174, i.e., damage to the company need not be proven, among other circumstances. As, in practice, the Articles of many non-public companies reiterate the old provisions of the law on interested-party transactions, this will inevitably give rise to disputes over whether the old rules modify just the procedure for approving interested-party transactions or also the range of such transactions, for instance, by extending the list of interested parties.

Major transaction rules modified by Articles

Unlike interested-party transactions, for which non-public joint-stock companies and limited liability companies are allowed to introduce different completion and/or approval rules in their Articles, major transactions may not follow rules differing from those stipulated by the JSC Law and LLC Law. Nor may company Articles rule out the need for their approval. Since completion of a major transaction might have a substantial effect on company operations, a corporation member must at all times be guaranteed the right to decide whether it should be made.

Controlled persons deprived of voting rights when approving interested-party transactions

The provisions of the JSC and LLC Laws only mention controlling persons among those recognised as interested in making a transaction and not allowed to vote when the transaction is approved. Upon literal interpretation of these legal provisions, a controlled party itself is not suspended from voting in this case, even though it might be a direct party to the transaction. This issue has been resolved by the Resolution stating that legal entities controlled by an interested party are equally not entitled to vote when an interested-party transaction is approved.

Statute of limitations for contesting Extraordinary Transactions

The Resolution offers three options for estimating the reduced, one-year statute of limitations for contesting Extraordinary Transactions. The statute of limitations runs from:

(1) the date the party acting as the sole executive body (SEB) learned or should have learned of the Extraordinary Transaction made in contravention of the statutory requirements;

(2) if the party specified in (1) above acted in collusion with the other transaction party, the date another party acting as the company SEB learned of the transaction (yet the Supreme Court passed over the issue of the CEO’s imputed knowledge of the approval procedure being breached if it executes the transaction itself but is not in direct collusion with the other party);

(3) if no party specified in (2) above is involved, the date the company participant or member of the Board of Directors contesting the transaction learned of the transaction.

A public company member is deemed to have learned of the transaction when a public announcement is made prompting a conclusion that the transaction has occurred.

Moreover, if a participant refrains from taking part in General Meetings or requesting information about company business for two or more years running, it is deemed to have learned of the transaction more than a year ago and thus to have missed the time for contesting it.

_____________________

1Federal Law No. 208-FZ dated 26 December 1995 “On Joint-Stock Companies”

2Federal Law No. 14-FZ dated 8 February 1998 “On Limited Liability Companies”

3In an earlier Resolution, No. 28 dated 16 May 2014 “On Certain Aspects of Contesting Major and Interested-Party Transactions”, the Russian Supreme Commercial Court Plenum (the SCC Plenum) specified that the JSC and LLC Law rules were specific in relation to those of RCC Article 173.1 and Clause 3, Article 182 in the context of challenging Extraordinary Transactions.

4Item 6 of the SCC Plenum Resolution.

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