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Considerable and "Conflict" Transactions in JSC Business Activity: Save the Shareholder

There is a very substantial amount of transactions in day-to-day activity of JSC, where the market value of goods or services that are its object, is more than 10% of cost of assets of JSC itself, and it obviously needs from a Board and/or its lawyer the deep understanding of international and domestic regulation and practice of these ("considerable") transactions to avoid any felonies and penalties and loss of profit then.

I'll be happy if some of my thoughts and experience will help inhouses and corporate lawyers to secure the rights of their shareholers clients and/or Supervisory Boards.

What about legal transactions in relation to feasance of that there is the personal interest ('conflict' transactions), it’s also a new institute, which got its legal regulation after the adoption of the mentioned above law and is also a part of the recent corporate reform. As considerable legal transactions, this type of transactions is also very important for the business activity of joint-stock companies and ignoring or wrong understanding of legal regulations of this institute may cause a serious problem for a company and leads to the claims about acknowledgement this transaction invalid in court and to the other negative consequences; as example can be provided the decision of the Commercial Court of Kyiv in the case N at 5011-75/10112-2012 11.02.2013, and further decision of the Appellate Commercial Court of Kyiv from 05.06.2013 and the decision Supreme Commercial Court of Ukraine from 16.07.2013. All of these decisions acknowledged the transaction invalid and the cause of it was ignoring of the legislature on this type of transactions.

Yes, the illegal exclusion of the property of the company is one of the most common brake of the law in the practice of business entities, and I think that my thoughts and some experience can be used by joint-stock companies to avoid this.

The importance of specific regulation of the procedure of performing significant transactions and transactions in relation of feasance of that there is personal interest is also connected with the necessity to secure rights of shareholders and third parties and because of that it's particularly purposeful for securing of gaining profit from shares in joint-stock companies.

According to the part 1 of article 70 of the law of Ukraine «On Joint-Stock Companies», the considerable transaction is that, market value of property or services that are its object, presents from 10 to 25 percents of cost of assets from data of the last annual financial report of joint-stock company . It can also be stated the other additional standards for attributing the legal transaction as significant.

It's necessary to pay attention that the mentioned value of the transactions object is market value, it's prohibited for parties to state the value by themselves or use the balance value, and it makes impossible to use less value of the property or services than its real market value. Also it's prohibited to divide the object of the trasation into parts in order to avoid the procedure of acceptance of the considerable transaction. Although, it's not mentioned what is properly the division of the object: does it bans the division of the object of transaction with concrete party, or it concerns the same object in few trasactions with different parties?

There is also a question about the assets of the company according to the annual financial report, for example, what should be done if the new financial period begun, but there's not financial report yet, or if the annual report doesn't consider the market value of the assets, or if the cost of the companies assets has substantively changed from the previous reporting period? The answer probably may be in the regulation these issues on the local level: they must be solved even before the adopting the statute of the JSC.

Due to the value of the property and services which are the object of the transaction, there are several types of the procedure of acceptance of this transaction.

Firstly, if the value of the object of the transaction is from 10 to 25 percents of cost of assets from according to the last annual financial reporting of joint-stock company, this transaction must be accepted by supervisory board of the company []. In case of non-acceptance of this transaction by supervisory board, the issue can be driven to the shareholder meeting.

The acceptance of the considerable transaction, the market value of the object of which is more than 25 percent of cost of assets, has to be made by shareholder meeting after the giving of the supervisory board.

A decision about the settling of a considerable legal transaction, if market value of property, works or services which are object of this transaction, is more than 25 percents, but less than 50 percents of cost of assets of joint-stock company, is accepted by majority of votes of shareholders, who have registered for participating in shareholder meeting and are voting through this question stock holders.

A decision about the settlement of a considerable legal transaction, if market value of property, works or services which are object of this transaction, is more than 50 percents of cost of assets of joint-stock company, is accepted more than by 50 percents of votes of shareholders from their general amount.

So, we can see that the main and, actually, the one criteria of considering a legal transaction as significant (considerable), is its value. Although, analysis of practice of companies of foreign countries lets us see that there is much more important issues. For example, there is a method to add to the list of considerable transactions all the transactions with third parties, if the value of services or property is more than established sum, for example, one million US dollars. EU joint-stock companies, for example some of Germany corporations, usually add to this list also transactions with third parties considering Corruption Perception Index maintained by Transparency International, because in this case there is higher risk of breach of a contract or corruption and bribery practices, and a corporation makes an attempt to avoid unreliable counteragents . It’s also common to treat acquisitions of assets or equity interests of a third party entity and co-promotion and co-marketing agreements as considerable transaction.

Good or bad practice? Depends on who's your client :)

Next. If in the day of shareholder meeting it’s impossible to determine which considerable transactions will be made by joint-stock company in the course of current economic activity, the law stipulates the possibility to shareholder meeting of passing a decision on the preliminary approval of significant transactions that can be made by a company for not more than one year from the date of such decision/ Some questions are raising in relation to this issue: whether the term "significant transaction approval" and "preliminary approval of significant transaction" are identical, and whether shareholder’s vote at the shareholder meeting against the preliminary approval of considerable transactions is the legal reason for granting him the right to request a mandatory redemption of his shares?

This is a very important practical question, because it directly affects ability of shareholders to protect their interests linked with share income. The Unified State Register of Court Decisions captures a wide array of solutions after claims of shareholders request redemption of shares in connection with his voting against preliminary approval of considerable transaction in Ukraine (sorry guys for Ukrainian experience again :) ).

In 2010-2013 there was a fact of unequal decision-making by the courts on this issue, as an example can be shown the decision of the Supreme Economic Court of Ukraine of 24th May 2012 in case number 7/5005/13431/2011and the decision of the Supreme Economic Court of 23th January 2013 in the case number 07/5026/796/2012.

After an application for review of a decision of the Supreme Economic Court of Ukraine on the grounds of unequal application of the court of the second paragraph of Article 68 of the Law of Ukraine "On Joint Stock Companies" the Supreme Court of Ukraine at 21-th of May 2013 has given a definite answer to these questions: these concepts are not identical and shareholder’s voting at the shareholder meeting against the preliminary approval of significant transactions doesn’t give to him the right to request a mandatory redemption of his shares. In particular, the resolution stipulates the following: “The legislator distinguishes the terms "approval of significant transaction" and "preliminary approval of significant transaction". Thus, the decision of the shareholder meeting to approve a significant transaction corresponds to executives the obligation to commit a particular considerable transaction. At the same time, the decision of the shareholder meeting to preliminary approve significant transactions that can be committed by JSC during the year, it is only consent to the possibility of committing significant transactions in the future. It hasn’t a consequence of the onset of the real legal fact with which the law binds the obligation of the JSC to make mandatory redemption of shareholder’s shares ”.

Now what about the issue of legal transaction in relation to feasance of that there is Personal Interest. This institute has emerged approximately in XIX century in USA and firstly was related only to managers and directors. In present, the 71-th article of the mentioned above Law stipulates main issues of this type of transaction and there is stated the list of persons, who can be considered as that who has a personal interest. There are i) an official of institutions of JSC, ii) a member of his family: the husband (wife), parents (adoptive parents), guardians (trustees) , brother, sister, children and their husbands (wives), iii) a legal entity in which an official of JSC or his family members have 25% or more of shares, iv) and also the shareholder who alone or together with his family members owns 25% or more of shares of JSC if this person is i) a party to the transaction or a member of the executive body of the legal entity that is a party to the transaction or ii) receives an award for the implementation of such a transaction from the company (the company's officers) or from a person who is a party to the transaction, or iii) acquires the property as a result of such transaction or iv) is involved in the transaction as a representative or intermediary (except of the representation of JSC by its officials). The law stipulates the obligation of such person to inform the company within three working days from the moment of the occurrence of personal interest. Executive body of the company shall within five working days of notify receipt on the possibility of a transaction with respect to which there is an interest must provide to the Supervisory Board, and in case of absence of the Supervisory Board to each shareholder individually the information about the transaction in which there is a personal interest. In particular, the executive body must inform about the subject of the transaction, the unit cost of goods or services, the total amount of the transaction for the acquisition, disposal or possibility of disposal of property etc and about the person who has an interest in such transaction.

The Supervisory Board of the JSC may prohibit the transaction in relation of feasance of which there is personal interest if it violates interests of JSC. The Supervisory Board can also make consideration of this issue at the shareholder meeting. The Supervisory Board must take a decision to commit this particular transaction or to refuse to commit such a transaction within five work days from the date of receipt of the executive body of information about the transaction in which there is an interest. If the person who has interest in the transaction is a member of the Supervisory Board, he can’t participate in the voting on this issue. If a majority of the members of the Supervisory Board are interested in such a transaction, or if the Supervisory Board isn’t created yet or has not taken any decision about consent or refusal of the commitment of the transaction, this issue must be driven to shareholder meeting. All these provisions are not valid concerning additional issue of shares, redemption of shareholders’ shares in accordance to 66-th article of the mentioned above Law, separation and termination (including liquidation) of JSC, in cases of providing warranty, surety, mortgage by official of a company or by shareholder who separately or together with affiliated entities owns 25% or more of shares in a loan transaction of JSC. The second article of the Law of Ukraine "On the Joint-Stock Companies" relates to the category of affiliated entities that entities if one of them has control over the other or both are under the control of a third party, and the individual members of the family: the husband (wife) and parents (adoptive parents), guardians (trustees), brothers, sisters, children, and their husbands (wives) of individuals and their families and legal persons, if such individuals and/or their family members have control over the legal entity .


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