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How to Avoid Mistakes When Forming a Partnership

20.09.2018

Yevgen Solovyov, Attorney at Law, Insolvency Receiver

Source: Business Censor

The co-founders of LLC often make typical mistakes which might lead to corporate conflicts.

The reasons of corporate conflicts are virtually the following:

Equal distribution of shares between the members (for example, 50/50), while only one member participates in the direct management of the limited liability company (LLC) (for example, as a company director). At the same time there is no restriction imposed on the director’s authority and powers to enter into agreements and perform other actions on behalf of LLC. In fact, in such situation one of the members has no opportunity to influence the adoption of any decisions.

Many future partners do not conclude a proper agreement before starting a joint venture and/or before considerable assets are accumulated. It should be noted that before the Law of Ukraine On Limited Liability Companies came into force such opportunities were limited by legislation containing many imperative norms. However, a number of things could nevertheless be foreseen in the company’s founding and other documents, and it was also possible to structure the ownership of participation interests with a help of jurisdictions which have actively enforced equity agreements (for example, English law).

Today, there is a possibility of LLC members in Ukraine to enter into corporate agreements, issue and use the irrevocable power of attorney in order to fulfill or ensure the fulfillment of obligations of the LLC member as a party to the corporate agreement. With the enactment of the Law of Ukraine On Companies with Limited and Additional Liability on 17 June 2018 the significant changes were introduced in the procedure for the LLC incorporation and operation. The regulation became more flexible, and many dispositive norms are now included into the charter of LLC (i.e. many provisions of the charter may be set forth by the members at their own discretion, rather than at the discretion of the legislator).

The possibilities to enter into corporate agreements, issue and use the irrevocable power of attorney in order to fulfill or ensure the fulfillment of obligations of the LLC member as a party to the corporate agreement are directly foreseen. The number of LLC members is not limited now, and the members can determine the terms of payment of their contributions to the authorized capital within the period of LLC incorporation; moreover, there is no need for the LLC to wait 3 months for the decision on the reduction of the authorized capital to come into force. The member with more than 50% shareholding may withdraw from the LLC and register the relevant changes in the register on its own, not depending on the approval by the company of the relevant decisions. The cases of exclusion of the LLC member are now minimal and directly envisaged by the law. For instance, this may happen if the member has failed to pay its contribution.

From now on there are a number of issues the decisions on which must be taken unanimously by the members, and the notion of quorum is now removed from the law. In the event of peer partnership the decision-making process at the level of the general meeting of members shall require consensus. After all, a member who resists making additional contributions may also have convincing arguments for the said position. For instance, the second member is also a company director and, according to the first member, improperly disposes of the company’s money.

By mutual consent the members may arrive at a compromise, including as related to the sale of a share or interest in business by one of the partners. If there is no equality and no compromise has been found, then one member, subject to the availability of the required number of votes, may take certain actions. For example, the general meeting of members may decide to increase the authorized capital of LLC. At the same time, a member which is not ready for further investments may not exercise its preemptive right to make an additional contribution within the amount of the authorized capital increase in proportion to its share in the authorized capital.

Thus, an increase in the authorized capital may take place without its participation, but the share of such member will be accordingly reduced.

How is the profit divided?

If we talk about the ways explicitly envisaged for these purposes by the law, then the profit is divided by way of dividends payment to the members.

The payment of dividends in the LLC is carried out at the expense of the company’s net profit to the entities/persons being the company members as of the day when the decision on dividends payment is taken, proportionally to the amount of their shares. The company pays dividends in cash unless otherwise unanimously decided by the general meeting of all members of the company. Unless otherwise provided for in the company’s charter, the dividends may be paid for any period divided into quarters.

The dividends are paid within a period not exceeding 6 months from the date when the decision on their payment is taken, unless another period is envisaged by the company’s charter or decision of the general meeting of company members.

It is worth noting that the company has no right to take decision on dividends payment or to pay dividends if:

● the company failed to make payments to the company members in connection with their withdrawal from the company or to the successors of the company members in accordance with the Law of Ukraine On Limited Liability Companies;
● the company’s property is not sufficient to satisfy the claims of creditors under obligations due or will not be sufficient after the decision to pay dividends or make payments is taken;
● the company charter may additionally provide for other terms and conditions under which the general meeting of members can not make decision to pay the dividends or under which the dividends can not be paid;
● the LLC has no right to pay dividends to the member that has not paid its contribution in full.

When talking about withdrawal from the LLC by way of sale of the share, the following should be noted:

● the company member has the right to alienate its share (part thereof) in the authorized capital of the company for value or free of charge to other members of the company or third parties;
● the company charter may provide that the alienation of a share (part thereof) is allowed with the consent of other members only. The said provision may be included into the charter or excluded therefrom by unanimous decision of the general meeting of all company members;
● the company member has the right to alienate its share (part thereof) in the authorized capital of the company in the amount proportional to contribution paid.

By default, the LLC member has a preemptive right to purchase a share (part thereof) of another company member that is being sold to a third party (i.e., for example, such preemptive right does not apply to giving a share or part thereof as a gift).
A member that wants to sell its share (part thereof) to a third party is obliged to inform thereof other company members in writing, specifying the price, size of the share and other terms of sale.

If within 30 days from the date of receipt of such notice none of the members has informed in writing of its intention to use its preemptive right, it is considered that such member has expressed its consent on the 31st day from the date of receipt of such notice, and the share (of thereof) may be alienated to a third party on terms communicated to the company members.

The company charter may provide for another procedure for the exercise of the preemptive right by the company members, distribution of the alienated share (part thereof) among other company members, and refusal to exercise the preemptive right of the company member. The charter may envisage that the company members have no preemptive right. The charter may also provide for the obligation of the company member, which intends to sell its share (part thereof) to the third party, to initially negotiate its sale with other members of the company. Such provisions may be introduced into the charter, amended or excluded from it by unanimous decision of the general meeting of all company members.

The preemptive right of a company member does not apply if it is not envisaged by the corporate agreement to which such member is a party. The corporate agreement may also provide for other aspects related to the business division between the company members. Talking about the so-called ‘clear’ withdrawal from the LLC membership, the following should be mentioned. The company member with less than 50% shareholding may at any time withdraw from the company. The company member with more than 50% shareholding can withdraw from the company with the consent of other company members only. The decision granting consent to the member’s withdrawal from the company is approved within one month from the date of application submission by the member, unless otherwise is provided for by the charter. If the member’s withdrawal from the company requires consent from other members of the company, such member can withdraw from the company within one month from the date when the last company member granted its concern for the same.

The member is considered to have withdrawn from the company from the date of the state registration of his withdrawal. It is forbidden to withdraw from the company, if as a result of such withdrawal no member is left in the company. Not later than 30 days from the day the company found out or should have found out about the member’s withdrawal, it is obliged to inform the withdrawing member of the cost of its share, provide a reasonable calculation and copies of documents required for the calculation.

The cost of member’s share is calculated as of the day preceding the one when the respective application was submitted by the member in accordance with the procedure prescribed by the Law of Ukraine On State Registration of Legal Entities, Individual Entrepreneurs and Public Organizations. The company shall pay to withdrawing member the cost of its share within one year from the date it found out or should have found out about the member’s withdrawal.

The company charter effective at the time of member’s withdrawal may set forth another term for such payment. The cost of a member’s share is determined on the basis of the market value of all shares of the company members in aggregate, in proportion to the size of the member’s share. With the consent of the withdrawing company member and the company itself, the obligation to pay in cash may be replaced by an obligation to transfer any other property. The company pays to the withdrawing member the value of its share or transfers the property proportionally to the member’s share paid in full.

The company is obliged to provide the withdrawing member with an access to financial reporting and other documents necessary to determine the value of its share. The company charter may provide for other terms and conditions, procedure, size and method of settlement with the withdrawing member of the company, as well as the procedure for selecting the licensed appraiser. The relevant provisions may be introduced into the charter, amended or excluded therefrom by unanimous decision of the general meeting attended by all members of the company.

 
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