Ukraine: A new lease of life for shareholders

The Verkhovna Rada of Ukraine finally adopted the long-awaited Ukrainian law “On Joint Stock Companies”.

The idea of adopting a law along these lines is hardly new from a drafting point of view, as for many years numerous efforts to approve similar legislation have failed. The respective bill was registered on November 23, 2007 and was approved in full after its second reading on September 17, 2008.

However, the Law will not come into force until the President signs it (as he did on Wednesday 22nd October 2008) and six  months have elapsed since its official publication (existing companies then have two years to comply with it).

Adoption of the Law is a contemporary issue, as current legislation contains many gaps regarding the foundation, operation, management and termination of activity of joint stock companies.

The passing of the law raises expectations for the gradual growth of the investment appeal of Ukraine, as it provides powerful “anti-raider” mechanisms and protects shareholder rights.

The Law, in full detail, regulates issues starting from the foundation of a joint stock company (JSC) to its termination, as well asproviding for management procedures,shareholders’ rights, mechanisms for their realization and guarantees for the protection of shareholders’ rights.

The Law balances the interests of shareholders with a controlling stake (50% or more), shareholders with a majority stake (10% or more), preference shareholders and minority shareholders.

This regulation is made in line with common international principles and standards of corporate management, taking into account the peculiarities of corporate law in Ukraine.

The Law applies to all JSCs, including state-operated JSCs. What are the key changes made by the Law and their consequences for the safety of share ownership.

The Law precisely specifies the powers of the bodies within a JSC (they are now divided into private and public– which are analogous to existing closed and open joint stock companies, with some specific features and differences) and establishes mechanisms for their cooperation.

Unlike the law “On Business Entities” which provides for the formation of a supervisory board consisting only of shareholders, the law stipulates that not only shareholders in person, but also their representatives may be
elected as members of the supervisory board, as only an individual may become a member of the supervisory board. This solves the difficulty in the formation of a supervisory board in JSCs where the shareholders are legal entities.

A positive innovation is that the Law permits an unlimited number of representatives on the supervisory board, with each member having one vote.

The Law further provides that membership of the supervisory board can be made dependent upon the number of voting
shares owned by the relevant shareholder. In addition, the Law provides for the conduct of cumulative voting for the election of members of the supervisory board, under which the quantity of votes that may be made by a shareholder constitutes the number of shares they hold multiplied by the number of places on the supervisory board.

In this way, the shareholder is entitled either to make all its appropriate votes in favor of one candidate
or allocate them among several candidates. Such a voting order allows shareholders, who are not owners of a controlling stake to have their representatives on the supervisory board and, accordingly, to have control over the
activity of their company.

The Law features a number of innovations aimed to prevent corporate fraud. Acquisition of shares in a JSC by way of gift is no longer permitted. No priority right to purchase shares will exist unless they are transferred
by way of succession.

General shareholders’ meetings shall now be held only at the registered address of a company, which will prevent “raiders” from conducting alternative meetings in other places. The exception to this rule is a JSC which is
wholly (100%) owned by foreigners, people without Ukrainian citizenship, foreign legal entities or international organizations.

Securing the legal position of investors is about establishing effective protection mechanisms for their rights and legitimate interests. With this in mind, shareholders with a majority stake have been given the opportunity to exert a level of control over a JSC by the requirements stipulated by the Law for entry into large transactions (for an
amount of 10% or more of the net assets of the JSC) and transactions with interested parties (whenever an official of a JSC, its affiliate or a common shareholder holding 25% or more of the shares are personally interested in the transaction being concluded).

Under the Law, any decision on conclusion of such transactions shall be made by the supervisory board.
Shareholders with a controlling stake are protected from the risk of losing control over a JSC due to a new regulation on the procedures for purchasing a controlling stake, which should be transparent to a company and its shareholders. For this purpose, a person who intends to buy a controlling stake must, in advance, (30 days prior to the purchase date) submit to the JSC a written notification about its intention to buy, and publish this intention via the State
Commission for Securities and the Stock Market and on each stock exchange where the company is listed, and also must publish a notice in the official printed media.

A JSC in which a controlling stake is purchased cannot take measures to prevent such acquisition. However, if it does take place, the existing shareholders are entitled to demand from a shareholder with a controlling stake that their shares be purchased at market value. It should be noted that, although such procedures for the purchase of a controlling stake are covered by the legislation of many European countries, they are entirely new for Ukraine. 11/5/2008

The Law provides protection for the interests of minority shareholders. If a general meeting takes a decision on termination of the activityof a JSC (save for in the case of liquidation), conclusion of a large transaction; or change to
the authorized capital, the shareholders who participated and registered at the meeting and voted against such decisions shall have the right to demand from the JSC that their shares be purchased at market value. This procedure
for withdrawal for minority shareholders is areliable way of protecting their rights.

Despite the Law being very progressive, some pitfalls still exist. The Law lacks a clear mechanism for the transformation of a privateJSC into a public JSC and visa versa. There are no answers to such issues as:

(1) what would happen to shares issued in documentary form if their shareholders failed to transfer them into non-documentary form within two years of the Law coming into force?

(2) what would be the rights andresponsibilities of such shareholders? A separate issue related to the same
requirement of the Law is that all shares of a JSC must exist only in non-documentary form.There is a high probability that individuals who are minority shareholders (particularly thoseof retirement age) will not be able to afford the
cost of custodian services.In order to meet the standards of European legislation, the responsibility of a JSCs’
officials for any damages and losses caused to its shareholders by their activities and the possibility of bringing legal proceedings against such officials for compensation of shareholder losses should also be included.

This article was contributed by partners Oleg Batyuk and Igor Mehedynyuk of law firm Salans.