July 17, 2019

Corporate management in Ukraine is getting more flexible

In 2018, the Law “On Companies with Additional and Limited Liability” (LLC law) came into force in Ukraine. It cleared up the legal status of most companies in the country (those registered in this form) and made relations between members more flexible. Before this, LLCs used to be regulated by outdated rules that not only stifled but often even blocked altogether all initiatives of the owners. Now, a culture of civilized corporate relations is starting to take shape.

What the new LLC law actually does

The law removes restrictions on the number of participants, allows them to sign corporate agreements among themselves and better defines the increase of authorized capital. As for the system of governing bodies, it can now be tailored for your needs, such as by establishing supervisory boards and other regulatory bodies, introducing your own rules for the general meetings, voting and so on. All these mechanisms are meant to protect investors and business as a whole.

One of the most important changes brought by the new law is a detailed description of withdrawal from business. It is now possible to answer the question how to get out of an LLC and not lose your money in the process.

As before, there are two ways to handle this situation: by selling your stake in the authorized capital and by exiting the LLC. The first option remains unchanged - the seller must first offer his stake to other owners. If none of them agrees to buy it, you can sell your stake to other people or companies - on the same terms as with your partners.

Withdrawing from business with a 50%+ stake, however, is no longer possible without the consent of business partners. This requirement protects the company and its lenders, since exiting owners of large stakes take a significant part of the company’s assets with them, which could negatively affect the company’s performance as a whole. Naturally, other partners will be reluctant to give their consent in these circumstances, because reducing assets would not be in their best interest.

Therefore, an owner of a large stake will find it easier to find a buyer - or, if the decision to leave is due to disputes with the partners, to sign a corporate agreement with other owners, determining in the text how controversial points in business management should be settled.

The option to enter into corporate agreements with with other LLC members is another big step in the development of a business culture in Ukraine. This will significantly expand the opportunities of joint business in the country and might even save some companies from collapse. Now co-owners have more tools to create sustainable management models, formalize existing or future agreements (regarding roles, contributions, rights and obligations in management, on withdrawal from business and distribution of profits, etc.). It is also important that minority members now have a better chance of getting real authority, if they take the time to discuss this and put it in the charter and the partnership agreement.

Our clients used to turned to lawyers for help already at the stage of latent or open corporate war, when the stakes and risks are extremely high. However, 2018 saw these requests gradually changing toward preventing such conflicts, formalizing agreements between partners, evaluating contributions and mediating negotiations.

New tools for protecting foreign investments

When business owners cannot agree on something, the entire company stops in its tracks, since a lot of decisions must be made as a collective, according to the law and the charter. This, of course, affects profits and inevitably leads to stagnation, absorption or disintegration.

It is possible to mitigate the destructive force of a corporate conflict if you think through the charter and corporate agreement at the birth of the partnership. All corporate conflicts and their causes are fairly standard, and lawyers know the formulas for their prevention and resolution.

In the past, the owners often did not bother recording practical details or agreements, partnerships and profit distribution, since legislation did not fit the needs of the business. Such agreements depended on the goodwill and honesty of the partners. However, with society changing, new, more mature and constructive methods of doing business appear, gradually transforming the entire sphere of corporate relations in the country.

The partners can now choose the most convenient and profitable patterns of behavior for a specific situation - and put them in the charter or corporate agreement. The prospects and potential for resolution of future disputes will depend on how well you have formulated these patterns. A highly detailed corporate agreement, on the one hand, provides immunity and longevity to a business, and on the other - serves as the foundation for the partners’ mutual trust. After all, general declarations that are obvious to everyone at the start (such as “everyone should do everything in their power to help the business grow”) over time dissolve and break on the rocks of reality.

In this sense, an agreement not only serves as a legal instrument for conflict resolution but also shows the partners’ true needs and intentions. Indeed, negotiations could reveal that there were never any common interests in the first place. It is much easier and cheaper to walk away from a joint business when the stated and actual goals are two different things.

If the parties do not want nor care to agree in principle, one of the outcomes may be redemption of a partner’s stake by the other party. The procedures that make this transaction as honest and transparent as possible have long been in use in English law (Russian roulette, Texas shoot-out, dutch auction, etc.), and thanks to the introduction of corporate agreements are now also available in Ukraine.

How to control the CEO in Ukraine effectively

It often happens that the founder of a Ukrainian company primarily lives outside Ukraine, while the CEO stays in Ukraine with unlimited powers and essentially without any supervision from the owner. These situations usually get exploited by competitors and corporate raiders who will attempt a hostile takeover. Such raids would typically look like this:

  • In agribusiness, the CEO transfers all land to a new company and leaves the old one, now stripped of key assets.
  • The CEO transfers the rights to use the intellectual property to another company.
  • The CEO steals the customer base/team in a service business.

Sometimes the CEO is simply negligent - for instance, when he gets dismissed and the company has no one else with the right of signature and the authority to manage finances. As a result, the company becomes a headless chicken with its operations temporarily on hold. The new law opens up a lot of options for protecting your investment and the business itself from such situations.

Company management structure usually looks like this:

1. Main governing body - which in an LLC is normally the general meeting of founders (members). This body can decide on any matter, but since the time of business partners is expensive and it is not always possible to bring them together, these opportunities are primarily used for the most strategic issues for the company (appointment, motivation and dismissal of top managers, adoption of the company's development strategy and new products, opening of new branches/offices and profit distribution).

2. Executive body - CEO or board of directors. This body is responsible for the current/operational management of the company. The CEO makes day-to-day decisions, hires people, signs contracts and other documents, and speaks with the authorities on behalf of the company.

3. A company can have another level of management - the supervisory board. This is an intermediate link between the general meeting and the executive body, that is, between investors and the directorate. It is a more flexible governing body than the general meeting (it is easier to assemble, which means decisions can be made more quickly). The supervisory board usually represents and protects the interests of the owners and supervises the CEO’s activities. For instance, the supervisory board can greenlight large transactions and decide on other financial issues.

Thanks to the mechanisms proposed by the new LLC law and provided they are used wisely, you can considerably reduce the likelihood of a hostile takeover. For this, you must first of all put special provisions in the charter and the employment contract with the CEO.

It is necessary to determine sensitive areas where the director could abuse his powers under pressure, and to make the decision-making process more complicated, for instance, by requiring the CEO to go through the general meeting or supervisory board first. Thus, if the CEO wants to sell real estate that belongs to the company, he would need to have the consent of the general meeting - and a protocol, where the price would be indicated. You can limit the amount of transactions which the CEO can conduct on his own, or specify that all transactions must be first discussed with the supervisory board, which represents the owners.

Current Ukrainian legislation also allows for a quick change of CEO if the owners ever suspect him of foul play. Generally speaking, dismissal of a CEO is the general meeting’s function. However, when a director suddenly withdraws money from the company and sells its property, you don’t always have the luxury of gathering the owners, while the CEO has to be replaced urgently. To do this, it is possible to put a provision in the corporate agreement that states: if the issue of replacing the CEO arises, the general meeting must be held on the next day after receiving the relevant notification. If someone is unable to be present at the meeting, an irrevocable proxy would prove most useful.

Sometimes even members of the general meeting can be influenced by malevolent parties. For a co-owner residing in another country, it is an extra risk. However, as of 2018, even this scenario can be prevented with a smartly drawn charter and corporate agreements between owners. For example, if raiders are able to manipulate two members of an LLC who own 60% of the votes and thus can appoint a CEO that suits their needs, the charter should require 70% of the votes for the appointment and dismissal of a CEO (instead of the standard majority 50%+). It would also be prudent to specify in the corporate agreement that 2 members cannot make such a decision without the third one. The raiders would have to look for leverage against the third member, which would mean extra resources and effort. The same strategy can be used with business transactions. Decisions are usually made by simple majority. However, if you raise the number of necessary votes in the charter or indicate that decisions must be taken unanimously, the raiders would need to influence everyone, which is no easy task.

All this suggests that it is already possible to create a flexible and secure management system in Ukrainian companies. When drawing key company documents, it is important to pinpoint critical aspects for a particular company, find vulnerabilities and reinforce them.