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LLC Participants' Rights Agreement
Fundamentally new institute that was introduced in Russian legislation on July 01, 2009.
Over a relatively short period of time the Russian corporate legislation has been continuously developing becoming more complex and accomplished. With respect to this a particular attention should be payed to the Legal Entity Legislation Development.
Concept  being a part of the Civil Legislation of the Russian Federation Development Concept framed by the Research Center on the Private Law affiliated to the President of the Russian Federation in pursuance to the Russian Federation Presidential Edict №1108 dated July 18, 2008 «Оn Improvement of the Civil Code of the Russian Federation». In pursuance to the Legal Entity Legislation Development Concept the Federal law №312-FZ was adopted and came into force «Оn Amendments to Part I of the Civil Code of the Russian Federation and Certain Legislative Acts of the Russian Federation » dated December 30, 2008 .
This federal law introduces a fundamentally new institute to the Russian legislation – Procedure for Exercise of LLC Participants' Rights Agreement. It should be taken into account as well that the Federal law №115-FZ «Оn Amendments to the Federal law «On Joint Stock Companies» and Article 30 of the Federal law «Оn Securities Market»  introduced the similar modifications to the joint stock company legislation: the Shareholders Agreement are given birth.
Until 2009 the Procedure for Exercise of LLC Participants' Rights Agreements between the participants of the Russian legal entities did not comply with the law and were considered inadmissible in general: a respective test case is that known as «Megafon Case», which for a long time discouraged the corporate lawyers to use such a technique for formalization of shareholders' and participants' understandings. In this case the Russian courts held illegal an agreement between several Megafon OJSC foreign shareholders on the procedure for exercise of shareholders' rights to management of Megafon OJSC (governed by the foreign law) as being in conflict with the binding rules of the corporate legislation of the Russian Federation .
The very Shareholders Agreements are adopted by our legislation from the foreign law, first of all, common law system (however being recognized in some continental law countries, particularly Germany, France, Switzerland) .
Common law system is more precise and flexible in regulation of the partners' relations in course of conducting business. Particularly, the British law within the framework of SHA (Shareholders Agreement) admits a possibility for setting various rules with connection to company management relations:
а) lock-up period – refers to the period of time during which neither one of the participants
(or one of the participants, or a group of participants) is not authorized neither to dispose in any manner nor encumber the company participation interests owned by them. The named restraint apply both to disposition in favor of the other participants and the third persons;
b) contractual restraint on particular decisions, which can significantly influence the company operating. It might be preservation of general company activities, restraint on change of the company charter capital or amendment of the company constituent documents, rules for option granr or non-grant, waiver from decisions on the dividend payout and other matters;
в) procedures for extra financing of the company activities. It might be gratituous measures (for example, additional contributions to the charter capital or contributions to property) as well as repayment financing (for example, loan). Furthermore, the amount of company participant's financial obligations does not necessarily corresponds to its participation: the disproportion principle in this case can be implemented on the consent of the parties to the agreement ;
c) procedures for formation of the company management bodies, herewith the Shareholders Agreements may amend and extend the respective provisions of the company Charter. The principle of «disproportion» between the amount of participation interest and volume of powers with regard to formation of the management bodies could be implemented, for example, by the following procedure for nominating the members of the board of directors (or collegial executive body): under the condition the Shareholders Agreement participants own equal participation interests in the company charter capital during the elections to the board of directors including three members, two of them are elected from the nominees announced by one party and one – from the nominees announced by the other party. The delegation of the tie-breaking vote to the chairman of the board of directors is possible as well, etc.;
d) really important are the rules admitted by the European laws for deadlock surmounting. The Shareholders Agreement may provide for the effects of the company participants general assembly's failure to decide on any or particular issue: for example, in event if the participation interests in the charter capital equal 50/50. One of the possibilities for deadlock surmounting is a right of any participant to send a mandatory offer for participation interest purchase to the other participants or offer for participation interest purchase at price which is defined in accordance with the provisions of the agreement ;
е) options, which are possible in two forms:
- Call option is an option which is without being an obligation authorizes its holder to purchase a participation interest in a company charter capital at agreed price on particular date or before this date. The person which granted this option is binded by it to sell a participation interest.
- Put option is an option which is without being an obligation authorizes its holder to sell a participation interest in a company charter capital at agreed price on particular date or before this date. The person which granted this option is binded by it to purchase a participation interest.
Even such a brief overview of foreign laws shows that the Russian corporate laws provide to the participants (shareholders) much less tools and possibilities to settle their relations. All of these are the trends for improvement of the Russian corporate laws.
Thus, in the common law system Shareholders Agreement is a separate branch of law being regulated by a set of rules provided by the laws as well as the other regulations and inclusive of a vast case law.
The RF legislation in effect introduces a LLC shareholders agreement by a single rule — Art. 8.3 of the Federal law on LLC: The company's founders (participants) may enter into an agreement on the exercise of their rights as the company participants, whereby they undertake to exercise and/or to refrain from exercising their rights in a certain manner, inter alia, to vote at the company's general participants'meetings in a certain manner, to agree upon voting options with other participants, to sell their participation interests or portions thereof at a certain price as fixed in the agreement and/or upon the occurrence of certain conditions or to refrain from disposing their participation interests or portions thereof pending the occurrence of certain conditions, and to take other concerted actions associated with the management, establishment, operations, reorganization, and liquidation of the company. The agreement is to be in writing and to be made through the execution of a single document signed by the parties.
It should be pointed that the definition of the Shareholders agreement recently introduced by Art. 32.1 of the Federal law «On JSC» almost literally reproduces the definition concerned. It is obvious that this rule provides just for the scope of agreement (exercise of one's rights and (or) negative covenant with regard to the respective rights), and its written form: apparently it is not enough for normal use of this new for our legal system concept. The JSC Shareholders agreement the law regulates in more details. Particularly, the law additionally provides that the scope of shareholders agreement can not include the obligations of a party to the shareholders agreement to vote in a manner instructed by the management bodies of company with regard to which shares a shareholders agreement is executed (Аrt. 32.1.2 of the Federal law «On Joint Stock Companies»). Furthermore, the law separately provides that the shareholders agreement must be executed with regard to all the shares owned by a party to the shareholders agreement (Art. 32.1.3 of the Federal law «On Joint Stock Companies») .
Such a succinctness of legal regulating gives birth to various questions related to the application of a new legal concept. Particularly, the rule-maker did not vote for necessity to define the co-relation between an Exercise of Participants' Rights Agreement and a company charter including other possible exercise of participants' rights agreement executed by other participants. The default of any rules for securing the participants' obligations under the agreement we consider to be the principal gap in the law. Neither the law provides any procedure for enforcement of the Exercise of Participants' Rights Agreement.
In order to answer the questions in issue we need to refer to the general rules of the RF civil laws.
According to the general principle of the freedom of agreement (Art. 421 of the Civil Code of the RF) as far as the Federal law № 312-FZ does not otherwise provided for the exercise of LLC participants rights the following conclusions could be made:
First, the number of participants agreement is illimited. It entails a problem which is not settled by law – legal effects for the company participant in case he is a party to several agreement which are in conflict. In any case, the participants agreements are ordinary deals, documents of the same legal effect, therefore the court does not have any legal ground to attach more legal value to either of them. Accordingly, the conflict of the participants agreement does not provide a sufficient ground to hold invalid either of them (in whole or in part).
Second, each particular agreement can be executed by any two (or more) company participants – the law does not require mandatory participation of all the participants.
Third, the execution of any agreement (participation in it) is a right and not an obligation of a participant, therefore there is no possibility for coercion to execution of agreement (for example, by making a respective provision in the foundation agreement).
With regard to the Shareholders Agreement the rule concerned is explicitly provided under the law — Art. 32.1.4 of the Federal law «On Joint Stock Companies».
And, finally, every particular agreement binds just the participants who signed it. It corresponds to Art. 308.3 of the Civil Code of the RF providing that the obligation shall not create the duties for the persons, who do not participate in it in the capacity of the parties (for the third persons).
One of the major application issues of the agreements concerned is that while introducing this type of agreement the legislator failed to bring in line with Art. 8.3 of the Federal law «On Limited Liability Companies» the rules of the very Federal law «On Limited Liability Companies»: there is an evident conflict between Art. 8.3 of the Federal law «On Limited Liability Companies» other provisions of the federal law.
For example, subject to provisions of Art. 8.3 of the Federal law «On Limited Liability Companies», the agreement may set for a certain procedure for a participant to exercise of his rights (accordingly, inclusive of the right to company management). However, Art. 8.1 of the Federal law on LLC provides that a participant is entitled to to participate in the management of the company in the manner established by this Federal Law and the company charter (but not the participants agreement).
Pursuant to Art. 8.3 of the Federal law «On Limited Liability Companies», this agreement may provide for additional obligations of a participant (for example, to refrain from disposition of a participation interest until occurrence of the specified conditions), when according to the Federal law «On Limited Liability Companies» the additional obligations might be set for only by the charter (Art. 9.2 of the Federal law concerned).
The problem of a system level is the Federal law's № 312-FZ failure to set the co-relation between the charter and Exercise of Company Participants' Rights Agreement.
This problem is aggravated by the fact that the application scope of the participants agreements, subject to provisions of Art. 8.3 of the Federal law «On Limited Liability Companies» (first of all – to the extent of exercise of company management right), mostly overlaps with the company charter provisions that entails a conflict with the rules of the Federal law «On Limited Liability Companies».
It should be taken into account that pursuant to the law the procedure for decision of specified questions could be set for by the charter only and not by a participants agreement:
а) different quorum requirements for passing of decisions (more severe compared to those provided under the law) — shall not be set for under the participants agreement in view they could be provided by law or the Company Charter solely (Art. 37.8.3 of the FZ on OOO): the other decisions (except for those which are passed unanimously) are passed by majority vote of the total number of votes held by the company participants unless a greater majority vote for such decisions is required under the Federal law or a company charter.
b) impossibility to provide for non-ratio procedure for profit distribution because it shall be provided only by company charter (Art. 28 of the FZ on LLC).
c) non-ratio vote during the general meeting of participants («decisive vote»), secured appointment of the company sole executive body by one of the participants, secured election to the board of directors the independent directors solely, veto right (non passing of a decision by the general meeting of participants in event of objection of a particular participant) - could not be provided under the participation agreement because it shall be provided only by company charter (Art. 32 of the FZ on LLC).
d) procedure for disclose of the information on the company operations also shall be provided only by company charter (Art. 8.1 of the FZ on LLC).
e) additional participants' rights and obligations shall be provided only by company charter (Art. 8.2 and 9.2 of the FZ on LLC respectively).
The following situation is representative: for example, under the participants agreement the participants are entitled to agree that during a certain period of time they will not sell their participation interests (to each other or third parties if provided under the company charter). However, in event if a participant sells his participation interest his actions (breach of agreement) even implicitly do not constitute the breach of law as far as: sell or other alienation of a participation interest in company charter capital or a portion thereof to the third party is allowed in accordance with the requirements of this federal law unless it is prohibited by company charter (Art. 21.2 of the FZ on LLC). In other words, the law does not take at all into consideration the provisions of the participants agreement.
While supplementing the Federal law «On Limited Liability Companies» with Art. 8.3 the rule-maker could and should have respectively amend the other provisions of the Federal law concerned. Obviously such legal regulation significantly restricts the exercise of participants agreement if not questions its existence.
The second major problem to face in connection with participants agreements is a default of effective ways of securing the participants' obligations.
The breach of the Exercise of Company Participants' Rights Agreement in practice is possible in two ways: as a deal (for example, disposition of participation interest when a participant agreed to refrain from selling it in a participants agreement) or decision of a company participants' general meeting (if in a participants agreement the participants agreed to refrain from voting on a particular issue or vote against a particular issue). However, the law does not provide neither for possibility to challenge a deal , nor to challenge a decision of a company participants' general meeting executed (passed) in violation of the agreement.
As a general rule (Art. 168 of the civil Code of the RF), the deal which does not meet the requirements of the law or other regulations is invalid (void). Inasmuch as a participants agreement is neither a law nor a regulation a deal which breaches the participants agreement is valid.
Besides there is a possibility to challenge a validity of deal in pursuance of the Art. 174 of the Civil code of the RF which allows to invalidate (declare voidable) a deal if the powers of the person for effecting the deal have been restricted by agreement...and while effecting the deal, such person have trespassed the borders of such restrictions...only in cases, when it has been proved that the other party to the deal has known, or should have known of the said restrictions.
Nevertheless we believe in this case it is difficult to apply Art. 174 of the Civil Code of the RF considering the requirement of prooving that «the other party to the deal has known, or should have known of the said restrictions». In view that a participation agreement is not registered anywhere and not available to the third parties in practice it is almost impossible to prove that the other party to the agreement has known of the restrictions provided by agreement.
Second, we believe that the provision of the agreement that a participant shall not execute the specified deals does not deem a restriction to effect a deal in terms of Art. 174 of the civil Code of the RF. The restriction of powers means that a person is not authorized for effecting a deal due to objective causes irrespective of his will. In event of signing agreement providing for obligation to refrain from specific deals a participant voluntary undertakes to refrain from a deal, however his right to effect a deal is not objectively restricted, he has powers (has a full power) to effect a deal.
The similar is the case when in violation to the agreement a participant vote for a specified decision of a company's general participants' meeting: the law does not provide for possibility to challenge a decision of a company's general participants' meeting passed in violation of the agreement. A decision of a company's general participants' meeting passed in violation of any of the requirements set forth in this Federal Law, other applicable legal acts of the Russian Federation, or the company charter and infringing the rights and legal interests of a company participant may be invalidated in court upon a claim of the company participant (Art. 43.1 of the FZ on LLC).
In other words in order to declare a specified decision of a company's general participants' meeting two requirements should be met taken together:
а) violation of laws or company charter.
б) infringing to the rights and legal interests of a LLC participant.
To the extent that a participants agreement neither relates to the laws nor constitutes a part of company's charter, a decision passed by passing by a company's general participants' meeting in violation of participants agreement fails to provide legal grounds for declaring a decision of a company's general participants' meeting invalid .
No possibility for immediate restraint of agreement violation by invalidating either a deal effected in violation of agreement or a decision of a company's general participants' meeting passed in violation of agreement forces the corporate lawyers to seek for by-pass ways of securing provisions of agreement.
Nevertheless the laws in effect and arbitrazh practice do not allow to provide in agreement any effective securing measures which could incite the participants of agreement to meet its provisions.
Without any doubt in event of default on obligations provided under the participants agreement the general remedies apply: recovery of forfeit (Art. 330 of the Civil code of the RF), and compensation of losses (Art. 15 of the Civil Code of the RF) .
However with respect to the forfeit it should be pointed that, first, recovery of forfeit is just a sanction, it does not allow to restore the right that has been infringed and cure the violation. Second, recovery of forfeit is only possible by judicial means, furthermore, the court on its own discretion can reduce the amount of forfeit due to «its disproportion to the effects of a breach of obligation» (Art. 333 of the Civil Code of the RF). And, finally, by the moment the case is heard by all the judicial instances and comes into effect, the trespasser could have no property (assets) for real recovery of the forfeit amount.
The same drawbacks are inherent to such a remedy as compensation of losses. Certainly, the court has no powers to reduce the amount of damages proved by the plaintiff in the procedure of Art. 333 of the Civil Code of the RF, however it is really difficult to prove the particular amount of damages in corporate disputes. As a rule the effects of participants' breaching the agreement are of intangible nature, therefore difficult to prove in pecuniary amount.
Apart from the ordinary (general) sanctions provided by law there are more exotic ones, for example, compulsory disposition of a participation interest at a fixed price to other participants by a participant who breached the agreement.
Unfortunately we believe this legal concept is not in compliance with the laws of the RF, it cannot be treated as inchoate contract (under suspensive condition) in view that there is no inevitableness (obligatoriness) of its execution. An inchoate contract shall provide for the term within which the parties shall execute the principal contract. If such term is not provided under the inchoate contract, the principal contract shall be subject to execution in the course of one year upon the date of execution of the inchoate contract (Art. 429.4 of the Civil Code of the RF). The obligations stipulated under the inchoate contract shall terminate in event the parties fail to execute the principal contract within the term provided under the inchoate contract for execution of the principal contract, or if one of the parties does not provide to the other party an offer to conclude this contract (Art. 429.6 of the Civil Code of the RF). Furthermore, the arbirtazh practice proceeds from the presupposition that with respect to the deal under condition (Art. 157 of the Civil Code of the RF) a «suspensive condition» deems event beyond of the control of the parties to the deal. Default on agreement is evidently a personal discretion of either of the parties to the agreement.
Therefore, introduction of participants (shareholders) agreements to the Russian corporate laws is a definite pace towards their development and improvement. However, in this particular case the rule-maker introduced it to the corporate laws by incorrect and peacemeal approach, without considering the legislation system character, without bringing in line Art. 8.3 of the Federal law «On Limited Liability Companies» with other rules of laws. Taking into account these issues the participants agreements are not provided with real enforcement devices, in fact they are deprived of legal remedies, therefore we believe they won't find wide application in the Russian business practices.
 The Concept is available at http://privlaw.ru/
 See the Order of the Federal Arbitrazh court of the West Siberia District №F04-2109/2005 (14105-А75-11) dated March 31, 2006, F04-2109/2005 (15210-А75-11), F04-2109/2005 (15015-А75-11), F04-2109/2005 (14744-А75-11), F04-2109/2005 (14785-А75-11) case №А75-3725-G/04-860/2005.
 The current Russian legislation authorizes as well so-called «contributions to the Company's property» (Art. 27 of the Federal law «On Limited Liability Companies»), however in order to effect them just the execution of the shareholders' agreement is not enough. The contributions to the company property are effected subject to condition such a possibility is provided under the Company charter – the respective amendment to the company charter should be approved unanimously. Moreover, a respective decision of the company participants' general assembly on contribution to the company's property is required approved by at least three thirds of participants votes.
 The Russian corporate laws are also going this direction: Art. 21.4 of the Federal law «On Limited Liability Companies (in effect as amended by the Federal law №312-FZ) provides for the possibility for a participant to purchase a participation interest at «a price which has been set in the company charter». However this right is provided by law just for the case the participants and (or) the company exercise their preemptive right to purchase a participation interest which is offered to the third party.
 We doubt the necessity for this rule to be provided by law due to its obviousness. Considering that a party to the Shareholders Agreement is naturally a shareholder and not the shares he owns, by entering into a Shareholders Agreement a shareholder in any case has a right to vote (use for implementation of the Shareholders Agreement) just all of his shares.
 The law provides a different rule for the shareholders agreements: an agreement executed by a party to the shareholders agreement in violation of the shareholders agreement my be invalidated in court upon a claim of an interested party to the shareholders agreement only if it is proved that the other party knew or should have known about the restrictions provided under the shareholders agreement (Art. 32.1.4 of the Federal law «On Joint Stock Companies»). In fact the rule-maker applied the rules of the Art. 174 of the Civil Code of the RF to the shareholders agreements.
 The similar rule is provided under the law with regard to the shareholders agreements: violation of a shareholders agreement cannot be a legal ground for declaring invalid decisions of the company's bodies (Art. 18.104.22.168 of the Federal law «On Joint Stock Companies»).
 With respect to the shareholders agreements the law explicitly provide for possibility to fix in them the certain ways of securing obligations as well as civil sanctions for default on obligations: shareholders agreement may provide for the ways of securing obligations arising under the shareholders agreement, and civil sanctions for default on or improper performance of such obligations. The rights of the parties to the shareholders agreement arising from this agreement, inclusive of the right to claim indemnification of damages caused as a result of breach of agreement, recovery of forfeit (fine, penalty), recovery of compensation (in fixed amount of money or amount determined in a manner subject to provisions of the shareholders agreement) or other sanctions in connection with the breach of a shareholders agreement, are subject to judicial protection (Art. 32.1.7 of the Federal law «On Joint Stock Companies»).