KPMG: Conversion of Debt into Equity

On December 27, 2009 the new Federal Law No. 352-FZ on Amendments to Certain Legislative Acts of the Russian Federation to Revise the Restrictions for Formation of the Corporations’ Charter Capital (the “Law”) was adopted. It came into force as of December 31, 2009.

Irina Narysheva
Director Tax&Legal
KPMG in Russia and the CIS

Anna Rogach

Artem Filchenko
Senior Legal Consultant

The Law amends major corporate legislative acts such as the Russian Civil Code, the Federal Laws on Joint-Stock Companies, on Limited Liability Companies, on the Securities Market, on Banks and Banking Activities etc.

Amongst the most material amendments, introduced by the Law, is the right to convert debt of a company towards the shareholder or a third party into equity in the same company. Although the vehicle of such conversion is widely known and used globally, the Russian law heretofore prohibited payment of shares through the set-off of the company’s debt. Currently, this way of restructuring of a company’s debt is available by setting-off the obligation of the shareholder/third party to pay for shares issued within the procedure of charter capital increase against an amount owed by the company to such shareholder/third party under any civil law agreement (e.g. loan, supply of goods, licensing, etc.).

Under the Law, the option to settle the indebtedness of the company through conversion of the owed amount into shares in the charter capital is available for both join stock companies (JSC) and limited liability companies (LLC).

This option is granted to current shareholders and third parties joining the company by acquisition of additional shares.

In order to covert debt into the shares in a JSC, the shareholders or the board of directors of the JSC (as established by the Charter) must pass a resolution on the increase of its charter capital through private placement. The documents formalizing the charter capital increase (such as for instance the decision on increase of the charter capital, the decision on placement of shares, subscription agreement) should state that the shares will be paid for though the debt set-off.

In respect to LLCs, acquisition by the shareholder or the third party of additional participation shares through setting-off of the debt owed by the LLC to the acquirer requires unanimous approval of all shareholders of the LLC.

Implementation of the new set-off procedure may raise certain practical questions. For instance, at what exchange rate the debt nominated in foreign currency should be set-off against the shares nominated in Russian rubles. It is believed that such matters should be decided upon and specified by the respective corporate bodies in the decisions on approval of the charter capital increase and set-off method of payment.

The Law prohibits conversion of debt into equity in respect to banks or other financial institutions.