Oda Russian Commercial Law 2007-1

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management of the company is entrusted to a management company on the basis of the resolution of shareholders, and this company acts as a collective executive body. The general director is appointed by this company.167 The Uni ed Energy System has a collective executive body in the form of a management council. Members of its board of directors include the president and vice president of the company and representatives of the government.168

(d)The relationship between the board and the executive body

The Law is almost silent on the relationship between the board of directors and the executive body. In a book published in 2000, Russian experts raised a question – on whose behalf and against whom does the board perform a supervisory function?169 In Germany, the supervisory board oversees the board of directors. In Russia, this is not possible, since the board of directors and the supervisory board are one and the same body. Therefore, if the board is to have any supervisory function as its title in brackets suggests, it has to be supervising the executive bodies. It was only by the 2001 amendment that a provision to the effect that the executive bodies are subordinate to the board of directors and the general shareholders’ meeting was introduced (Art.69, para.1). However, this provision is not speci c enough. For example, does the fact that executive bodies are accountable to the other bodies mean that the general director should attend the meetings of the other bodies and give reports from time to time?170

In reality, executive bodies, in principle, are controlled by no one, except that they are appointed and dismissed by the board of directors.171 It is pointed out in Russia that an unsupervised executive body will sooner or later start ignoring the interests of the company which it manages, increasingly subjecting their activities to their own interest which it places above the interests of the company. If appropriate measures are not taken, the nancial state of the company will start deteriorating.172

The same applies to the relationship between the single and collective executive bodies. A Russian specialist suggests that in practice, the collective executive body has failed to become an independent executive body; it continues to be a body subordinated to the single executive body – the general director.173

167www.severstal.com

168www.rao-ees.ru

169Krapivin and Vlasov, rst edition, supra, p.163.

170Krapivin and Vlasov, supra, p.247.

171Krapivin and Vlasov, rst edition, supra, p.163.

172Ibid., p.164.

173S.Mogilevskii, supra, pp.144-145.

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Under the socialist system, state enterprises were run by the general director under the “one man management” system, assisted by some of cers. There was no effective control over the management. After 17 years, this system seems to be continuing under a different name.

(e)Liability of Directors and Executive Of cers

Members of the board of directors, a single executive body (director, general director), and members of the collegiate executive body (management council, directorate) are under a general obligation to act in the interest of the company, and to exercise their rights and ful l their duties in relation to the company conscientiously and reasonably (Art.71, para.1). Directors and others listed above are liable vis-à-vis the company for the loss caused by them to the company by their fault (this includes both acts and omissions). In collective bodies such as the board of directors and the collegiate executive body, those members who voted against the decision which caused the loss, or did not take part in the vote, are exempted from liability (Art.71, para.2). When determining the basis and scope of liability, the normal terms of commercial practice and other circumstances which have relevance to the case must be taken into account (ibid., para.3). If several persons are liable, they bear joint and several liability (ibid., para.4).

As cited above in various cases, abuse of power by directors and members of the executive body are not rare in Russia. Here is another example:

Adirector of a company, Zavod keramzitovogo graniia’, concluded an agreement of pledge (zalog) on behalf of the Zavod with Stroitel’nyi Bank in order to guarantee a debt of a third party, an individual entrepreneur, who had nothing to do with the company. The agreement was concluded without the consent of the management council or the general shareholders’ meeting. The Zavod brought the case to court, asking the agreement to be recognised null and void. However, courts of rst instance and the appellate instance rejected the claim. The Supreme Commercial Court quashed the decision and remanded the case to the rst instance court on the ground that “such a transaction could lead to gratuitous assignment of the company’s property without the consent of the shareholders”.174

The liability of these persons can be pursued by the company itself (Art.71, para.5). In such an action, the single executive body is to act on behalf of the company without power of attorney. If the liability of the single executive body itself is pursued, a power of attorney is issued to another person by the resolution of the general shareholders’meeting, the board of directors, or the collegiate executive body.

174 Decision of the Presidium of the Supreme Commercial Court, March 10, 1998, No.7422/97.

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Shareholders who hold 1% or more of the shares are entitled to pursue the liability of the directors and others (ibid.). This “indirect action” has apparently been modelled on the system of derivative action in the United States. However, this provision merely outlines the general right of shareholders to pursue liability of directors and executive of cers but fails to give details. The wording of this provision is ambiguous in the sense that the nature of this action is not clear. It is not explicitly provided that this action is not for the interest of an individual shareholder, but for the interest of the shareholders as a whole or the company and that the damages are payable to the company and not to the plaintiff shareholder. There is no procedural provision either. In order for shareholders to initiate an action, they may need the minutes of the meeting of the executive body. However, access to such documents is granted only to shareholders with 25% or more of the shares.

In reality, there has been no reported case of indirect action. Presumably, the time and cost involved as weighed against the gain – even if the plaintiff wins, the damages will go to the company – discourage the shareholders.

(f) Restraints on the Power of the Executive Bodies

As mentioned above, abuse of power by the management of the company at the cost of shareholders is not uncommon in Russia. The Law accommodates two speci c means of control over the activities of the management, namely the executive bodies.

(i)Major Transactions

Approval of the board of directors or the general shareholders’meeting, depending on the value of transaction, is required in effecting transactions which qualify as “major transactions (krupnyie sdelki)”. Major transactions are de ned by the Law as a transaction or several related transactions by the company involving direct or indirect acquisition or disposal or the possibility of acquisition or disposal of the property whose value is 25% or more of the book value of the assets (Art.78, para.1).

Before the 2001 amendments, the scope of major transactions was not clear. The de nition of major transactions has been criticised in Russia as having serious shortcomings since it provides ambiguous criteria.175 After the 2001 amendment, the provision has become more speci c. Now, borrowing money, extending loans, and providing security and guarantees are explicitly acknowl-

175 G.S.Shapkina ed., supra, p.219.

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edged as transactions in the context of this provision. In addition, according to the Supreme Commercial Court, assignment of claims, assumption of debt, investment in another company in exchange for shares can be major transactions if the amount exceeds the limit.176 On the other hand, the previously controversial problem of issuing of shares and securities which are convertible to shares of over 25% of the already issued shares was explicitly excluded from major transactions. This is now regulated by other provisions.

Still, there are some ambiguities which are abused. One of the problems is the “interrelated transactions”.177

Open joint stock company Moskovskii Avtoservis sold pieces of real estate in a series within two years to various juridical persons. The transactions were authorised by its general director. The total value of the property amounted to 48% of the assets on the balance sheet. Then the company brought an action in court vis à vis the buyers and the Moscow Registration Of ce in order to deny the validity of the sale. The rst instance court acknowledged the claim, but the appellate court overruled this decision. This was supported at the cassation instance. However, the Supreme Commercial Court found that these properties were part of the property complex and were therefore all interrelated. Furthermore, in the end, all the properties now belonged to a single person. Thus, these transactions as a whole were interrelated, and were subject to the approval of the board. In this case, the board of directors had disapproved these transactions due to the “critical nancial situation” and actually prohibited the general director from disposing of assets without the approval of either the board of the general shareholders’ meeting. The court also pointed out that the market value of the properties was three times as high as the price stipulated in the contracts, which meant that they were sold to the disadvantage of the company.

As criteria of interrelatedness, the court takes into account various circumstances including the common goal which the conclusion of these transactions aims to achieve, the intention of the parties, similarities of the obligations of the parties in different transactions, and so on. Contracts of pledge were found to be interrelated, since they were concluded to secure the same basic obligation.178

By Law, transactions effected in the course of normal economic activities, such as the sale of property which the company had purchased in the course of business, are excluded, even if the value exceeds 25% of the assets. In one case, a company took out a loan, but later claimed that this was a major transaction

176Decision of the Plenum of the Supreme Commercial Court, November 18, 2001.

177S.L.Budylin, “Krupnye sdelki khoziaistvennykh obshchestv”, Arbitrazhnaia praktika, 2005, No.2, p.4.

178Lomakin, supra, pp.257-261.

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since the amount exceeded 25% of the book value of the assets, but the general director had taken out the loan without necessity. The intention of the company was to invalidate the contract and return the money with an interest calculated by the statutory rate rather than paying the interest at the agreed rate. The court found that the company took out the loan with a view to purchasing commodities. This was part of its business activities as provided by the Articles of Incorporation. Therefore, the court concluded that the loan was taken out in relation to the performance of the company’s current economic activities.179 Another case involved a UK company:180

A British company sold pharmaceutical products to a Russian company. The Russian company was heavily in debt to the supplier – over one million dollars. In order to reschedule the debt, an agreement was reached to return the products and repay the debt. However, the Russian company never returned the products or repaid the debt. The British company took the case to court. The Russian company presented a counter-claim, arguing that the agreement had been concluded by a person in excess of his power. The court of rst instance found this agreement to be a major transaction. This was overruled by the appellate court and the court of cassation supported this decision. The Supreme Commercial Court upheld this decision on the ground that the agreement was intended for the rescheduling of debts emerging from a previously concluded contract. This meant that the agreement was concluded in the normal course of business. Besides, the products, according to the agreement, still belonged to the British company and therefore, there was no question of the disposal of the property of the company.

Major transactions must be approved either by the board of directors or by the general shareholders’ meeting (Art.79, para.1). Whether a transaction is major or not depends on its value. Major transactions with a value of between 25% and 50% of the company’s assets on the balance sheet need to be approved by the board of directors unanimously. If unanimity cannot be reached, the matter can be referred to the general shareholders’meeting, which may approve the transaction by a simple majority (ibid., para.2).

A shareholder brought an action in court for the invalidation of a major transaction by the company on the ground that one director was absent from the board meeting, and that a person with a power of attorney voted on behalf of another director who was absent. The plaintiff argued that the Law requires unanimity of all directors, not just the directors who were present at the meeting. The rst instance court dismissed the claim on the ground that unanimity meant the consent of all the directors

179Budylin, supra, p.4.

180Ibid., p.5.

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who were present. The appellate court quashed this decision on the ground that the Law required the unanimity of all directors. In other words, the quorum for a board meeting which approves a major transaction has to be all existing members of the board. The court also added that each and every member of the board is required to take part in the vote in person and is not allowed to delegate this duty to another person.181

By the 2001 amendments, this was accommodated in the relevant provision by inserting a clause that “all members of the board take part” in the decision (Art.79, para.2). Transactions with a value of more than 50% of assets require a quali ed majority of the general shareholders’meeting (ibid., para.3).

The law provides that the value of the assets should be determined in accordance with Article 77 which, in turn, provides for the determination of the market value of the assets by the board of directors. It sets a criterion for the determination of the price of assets when the Law requires the board of directors to determine the price. A joint decision of the Plenum of the Supreme Court and the Supreme Commercial Court of the Russian Federation gave an interpretation that the value of the property which is the object of the transaction should be determined by the actual sale or purchase price of the assets as entered in the latest balance sheet, and thus gave some objectivity to the “market value”,182 but such prices may not always be available. Following the 2001 amendment, the Law now provides that the price of property which is sold or has the possibility to be sold should coincide with the value in the balance sheet, and that the value of property to be acquired is the price of its acquisition (Art.78, para.1). It is possible to have an independent valuer involved, but this is not mandatory.

When the board determines the price, there is a possibility that a person who has an interest in one or several transactions is, at the same time, a member of the board. In such cases, the price is determined only by the members who do not have an interest in the transaction (Art.77, para.1).

Major transactions involving a property with a book value between 25% and 50% of the assets of the company, must be approved unanimously by the board of directors, without the director proposing the transaction voting. If a unanimous approval is not obtained, the matter can be transferred by the board to the general shareholders’ meeting (Art.79, para.1).

In cases where the object of the transaction has a value of more than 50% of the book value of the company’s assets, the decision is adopted by the general

181Item 9, Information Letter of the Presidium of the Supreme Commercial Court No.62, March 13, 2001.

182Krapivin and Vlasov, rst edition, supra, p.184.

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shareholders’meeting by a three quarter majority of those who are present (ibid., para.2).

Prior to the 2001 amendment, there was no explicit provision regarding the effect of major transactions that have been carried out without the required approval, and there was controversy as to whether such a transaction would be null and void or voidable. Some decisions of the court found such transactions to be null and void:183

A closed joint stock company, Rosinka Odin, brought an action against an open joint stock company, Russkaia Berezka, at the Moscow City Commercial Court, asking for part of an additional agreement attached to the contract to be declared void. Russkaia Berezka and a third party, Stels Plius, concluded a contract of sale of securities on May 27, 1996, according to which Russkaia Berezka sold Stels Plius shares of various companies to the total sum of 1,121,712,160 roubles (before devaluation).An additional agreement of June 14, 1996 was concluded between the above two companies, plus Rosinka Odin which provided that Rosinka Odin guarantee the performance of the obligation by Stels Plius vis-à-vis Russkaia Berezka by transferring Russkaia Berezka shares held by Rosinka Odin as pledge.

Rosinka Odin’s argument was that although this transaction was a major transaction, the necessary procedural requirements were not ful lled and therefore, the supplementary agreement of pledge was null and void.

The rst instance court rejected the claim of the plaintiff. The appellate instance upheld this and so did the court of cassation. However, the Supreme Commercial Court overruled the judgment of the lower court. The Court found that the relevant clause of the additional agreement was null and void, since the transaction had been effected without the approval of the board of directors or the shareholders’meeting at Rosinka Odin as required by Article 79 of the Law on Joint Stock Companies despite the fact that the value of the pledged shares had exceeded the assets of the company.

Now it is explicitly provided by the Law that such transactions are voidable, i.e. such transactions can be invalidated by the company or a shareholder (ibid., para.6).

(ii)Transactions with interested parties

In Russia, it is not uncommon for board members and executive of cers to abuse their position and pursue their own interests rather than the interests of the company by effecting transactions not at arm’s length, but in favourable terms with interested parties:

183Decision of the Presidium of the Supreme Commercial Court, February 23, 1999, Case 6115/98.

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Joint stock company Lensnabpechat’ brought an action against a limited liability company Interspekt, asking the court to invalidate a contract of sale of the production base at Shvalovo. On July 1996, Polikarpov, the general director and the chairman of the board of directors of the plaintiff company and at the same time, acting on a power of attorney issued by the defendant company, signed the contract selling this production base. Polikarpov turned out to be simultaneously one of the founders of the defendant company and in fact, held 20% of its capital. A representative of the defendant company, who held 20% of the capital of the defendant company and one of its founders, was at the same time, the deputy general director of the plaintiff company. The Federal Commercial Court of the North-West District found that the transaction was in apparent excess of power by the general director and therefore, void. The argument of the defendant company that the defendant was not aware and could not have been aware of the restrictions on the power of the general director was not accepted by the court.184

The Law on Joint Stock Companies contains provisions designed to prevent such transactions. These provisions were substantially streamlined by the 2001 amendment.

Transactions (including extending of loans, borrowing money, pledge and guarantee) in which the following persons have an interest must be effected in accordance with procedure set by the Law. The Law rst de nes the scope of interested parties, imposes an obligation on the interested parties to disclose information to the company and sets the procedure for the approval of such transactions.

The provision covers the following persons (Art.81, para.1):

i) members of the board;

ii) a person who is the single executive body of the company; iii) members of the collective executive body;

iv) a person or organisation which is entrusted to manage the company;

v) a shareholder who, together with af liated persons, holds 20% or more of the voting shares;

vi) a person who has the right to give binding instructions to the company.

These persons are regarded to have an interest in a transaction with the company, if such a person, his spouse, parent, child, sister or brother, parent or child by adoption, or an af liated person:

184Arkhiv Federal’nogo arbitrazhnogo suda severo-zapadnogo okruga, Kassatsionnoe delo

No.1664/96 (cited in Bushev and Skvortsov, supra, pp.157-159).

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i) is a party, bene ciary, intermediary, or representative in the transaction; ii) holds 20% or more of the shares in a juridical person which is a party, bene -

ciary, intermediary, or representative in the transaction, or

iii) occupies a position in the management body of a juridical person which is a party, bene ciary, intermediary, or representative in the transaction, or occupies a position in the management of the organisation which is entrusted to manage the company;

iv) other occasions as provided by the Articles of Incorporation.

The above persons are under an obligation to provide the board of directors and audit committee, as well as the auditor of the company, with the following information (Art.82):

i) on juridical persons in which the person on his own, or jointly with an af liated person, holds 20% or more shares;

ii) on juridical persons in which he holds a position in its management body; iii) on the transaction which the person has effected or intends to effect in which he

may be regarded as an interested party.

However, this provision on disclosure of information is obviously insuf cient. Firstly, the timing of disclosure is not clear. Ideally, these people, when they are appointed, or come to hold 20% of the shares, should disclose the information to the board and other bodies. Secondly, the list of information which is to be disclosed is insuf cient. The list does not cover all circumstances where a person may become interested. Thirdly, the procedure for disclosing the information is not provided.185

Transactions are required to be approved in advance by the board of directors or the general shareholders’ meeting (Art.83, para.1). In a company with a number of shareholders with a vote up to 1,000, such transactions are required to be approved by the board of directors by a majority of directors who do not have any interest in the transaction. If the number of non-interested directors is below the quorum, the transaction can only be approved by the general shareholders’ meeting (ibid., para.2). In companies with more than 1,000 shareholders, the transaction is required to be approved by a majority vote of independent directors. If all directors are regarded as having an interest in the transaction, and/or are not independent directors, the transaction has to be approved by the general shareholders’ meeting (ibid., para.3).

185 Krapivin and Vlasov, second edition, supra, pp.291-292.

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In this context, “independent directors” denotes directors who are not, and have not been, for the past one year preceding the adoption of the decision, to approve the transaction (Art.83, para.3):

i) a single executive body, or a member of the collective executive body, or held a position in the management body of the managing organisation;

ii) a person whose spouse, parent, child, brother or sister, parent or child by adoption occupies a position in the above body of the company, management company, or an individual manager entrusted to manage the company, or

iii) an af liated person of the company (except the member of the board).

Approval of the general shareholders’ meeting by a majority vote of the noninterested shareholders is required, in addition to the above situation where the board cannot meet the quorum, in cases such as where the object of the transaction or several interrelated transactions represents 2% or more of the assets of the company in the accounts of the last nancial period (ibid., para.4). On the other hand, these transactions do not need the approval of the general shareholders’ meeting, if the terms of the transaction do not substantially differ from the transaction between the company and the person with an interest, effected between the same parties in the course of normal commercial activities of the company before this person was recognised as a person with an interest in the transaction (ibid., para.5).

If a transaction with an interested party was effected in violation of the above provisions, the transaction is voidable. As is the case with major transactions, there was controversy as to whether this was a null and void transaction or a voidable transaction, but the 2001 amendment made it clear that this is a voidable transaction, which can be invalidated by the company as well as shareholders. The person with an interest is liable to the company for the damage resulting from the transaction (Art.84). The ground for the liability is the failure of these persons to provide the information to the company as required in Article 82.186 There is a criticism that the liability of those who allowed such transactions to proceed, particularly when the disadvantage of the transaction to the company was obvious, should be pursued as well.187

There are various examples of interested party transactions.

An open joint stock company “Informenergo” brought an action against a limited liability company “Gala Inform” at the Moscow City Commercial Court, asking the court to declare void the contract of sale of part of a building of 2,975.7 square

186Mozolin and Iudenkov, supra, p.378.

187Krapivin and Vlasov, second edition, supra, pp.297-298.