Russian Federation: Company Formation In Russia

Last Updated: 28 April 2014
Article by Valentin Petrov and Petr Shevtsov

Types Of Business Entities

This article contains a brief description of corporate vehicles commonly used for doing business in Russia, being (i) a Russian joint stock company, (ii) a Russian limited liability company and (iii) a non-Russian company with a wholly-owned Russian operating subsidiary. Also it discusses some regulatory issues which may arise.

  • RUSSIAN JOINT STOCK COMPANIES

Russian corporate law provides for two types of joint stock companies ("JSCs"):

  1. open joint stock companies ("OJSCs" or "OAO" in Russian); and
  2. closed joint stock companies ("JSCs"or "ZAO" in Russian).

The main distinctions between the two are:

  • CJSCs may not have more than 50 shareholders;
  • CJSCs may not issue shares by open subscription i.e. a public offer of shares;
  • acquisitions of more than 30% of voting shares in an OJSC trigger mandatory tender offer requirements; and
  • shareholders in a CJSC have pre-emptive rights (i.e. rights of first refusal) to acquire shares sold by the other shareholders to third parties.

Importantly, the latter rule applies regardless of whether a proposed transferee is affiliated with the selling shareholder and, therefore, transfers to affiliates are subject to the general right of first refusal of the other shareholders.

With respect to most other corporate matters Russian corporate law does not distinguish between OJSCs and CJSCs and, in general, provides for the same high level of corporate formality for closely held companies in the form of CJSCs and companies in the form of OJSCs. Equity securities of both OJSCs and CJSCs and any subsequent changes in their capital structure must be registered with the Russian Central Bank ("Central Bank") even where a CJSC has only one shareholder.

The management structure of a OJSC or CJSC can have two or three tiers: (a) general meeting of shareholders, (b) board of directors (optional for the JSC with less than 50 shareholders) and (c) the executive (chief executive officer ("CEO") and/or management board).

Russian corporate law provides relatively little flexibility in the CJSC context with respect to structuring shareholder relationships and procedural matters. For instance, shareholders may not change quorum and voting requirements prescribed by law for shareholder meetings or modify the list of reserved matters prescribed by law which fall within the competence of the shareholder meeting. As a general rule, shareholder decisions require a simple majority (50% +1 share) of shareholders participating in a meeting. The presence of shareholders holding more than 50% of the company's voting shares is sufficient for quorum purposes.

  • RUSSIAN LIMITED LIABILITY COMPANIES

Compared to a Russian closed joint stock company, a Russian limited liability company ("LLC" or "OOO" in Russian) is in many respects a less regulated and rigid corporate vehicle. Unlike shares in Russian joint stock companies, issuance of equity or changes in capitalization of an LLC do not require registration with the Central Bank. The law provides LLC participants with more flexibility in managing their internal affairs and structuring corporate governance (including with respect to quorum and voting arrangements, other procedural issues, allocation of profit and financing mechanisms). However, it is often hard to predict whether a Russian court would be prepared to recognize uphold any "novel" or "untraditional" arrangements or even those that merely deviate from the express provisions of the law. To date there is insufficient court guidance on many fundamental issues concerning LLCs, adding uncertainty in the joint venture context.

LLCs can have a two- or three-tier management structure: (a) general meeting of participants, (b) board of directors (optional) and (c) the executive (CEO and/or management board). In contrast to joint stock companies that operate on the basis of a one-share – one-vote principle, the number of votes held by LLC participants may be disproportionate to their respective participation interests. The law provides LLC participants with significant possibility of allocation of authority among corporate governance bodies in an LLC.

As a general rule, a transaction aimed at the transfer of participation interest requires notarial certification. It is very unlikely that a Russian notary will certify a sale and purchase agreement if it is governed by any law other than Russian law. It is important to keep in mind that Russian law does not have concepts of representations, warranties, indemnities and some other which a foreign investor expects in a share purchase agreement. Hence, an on-shore Russian joint venture in form of LLC will not allow choosing English or other foreign law as a governing law for sale of participation interest.

LLC participants have pre-emptive rights with respect to participation interests of the other participants. Like in CJSCs, this rule applies regardless of whether a proposed transferee is affiliated with the selling participant and, therefore, transfers to affiliates are subject to the general right of first refusal of the other LLC participants. However, based on a Russian court precedent, it may be possible to bypass the right of first refusal requirements by structuring the transfer of a participation interest other than as an outright sale.

  • RUSSIAN JOINT VENTURES

Joint ventures with Russian companies are quite common and generally they are formed based on one of the two main approaches – using an on-shore Russian joint venture vehicle or incorporating the joint venture outside of Russia which operates in Russia through a wholly-owned Russian subsidiary.

The preference for one of the two alternatives is typically determined by a variety of factors, including sophistication of the joint venture parties, real and perceived cost and efficiency trade-offs, share ownership percentages, commercial interests and negotiation leverage between the parties, concerns over the protection of shareholder/participant rights, etc.

A Russian party may insist on using a Russian joint venture vehicle on grounds that it is arguably a cheaper alternative and a format that the Russian side is more familiar with. It is important to keep in mind, however, that Russian corporate vehicles may not offer the level of commercial flexibility and certainty that a foreign investor expects in a joint venture setting. In addition, Russian courts do not have a good record of protecting shareholder/participant rights generally and foreign investors rights in particular.

  • NON-RUSSIAN JOINT VENTURE VEHICLE

Due to Russian law issues described above, a significant number of joint venture vehicles are incorporated outside Russia in jurisdictions that are familiar to the joint venture partners and that offer reliable legal protection of shareholder rights and make most sense from the corporate governance and tax stand point. For example, it is very common to set up Russian joint ventures in Cyprus and the British Virgin Islands and have their shareholders or joint venture agreements governed by English law with dispute resolution clauses providing for international arbitration (e.g. LCIA, ICC or UNCITRAL). Such joint venture companies then form or acquire operating subsidiaries in Russia.

  • RUSSIAN REGULATORY ISSUES

The proposed establishment of a Russian joint venture (even if an off-shore joint venture vehicle is used) may require a preliminary approval or subsequent notification of the Russian antimonopoly authorities.

The Russian antimonopoly filing requirement may be triggered in case of (i) incorporation of a subsidiary that involves contributions of fixed assets or shares of another company, (ii) acquisition of more than a 25% stake in an existing CJSC or 1/3 of participation interests in an existing LLC or (iii) transfer to a subsidiary of a certain amount of fixed assets. In addition, acquisition of control over an existing JSC or LLC operating in one of strategic business sectors (such as natural resources, aviation, weapons, mass media, telecommunications, etc.) will require preliminary consent of the Government Commission under the Federal law "On the procedure for effecting foreign investments in commercial entities that have strategic importance for the national defence and security of the state".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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