KPMG: Expect Radical Changes in the Civil Code

Russia's Civil Code ("CC") is one of its most stable laws, having undergone minimal change since its adoption 15 years ago. In November 2010, a bill on amendments to Parts I, II and III of the CC ("the CC bill") was published on the website of Russia's Supreme Arbitrazh Court on the instructions of the Presidium of the Presidential Council for Codification and Enhancement of Civil Legislation.

Natalia Diatlova
Head of Legal

KPMG in Russia and the CIS
+7 495 937 4477
moscow@kpmg.ru

Numerous questions regarding the CC have built up, and clearing them up would significantly improve it. The changes could of course have been introduced in a less radical way, but they do show clear evidence of a movement towards significant civil law reform. This article looks at the key changes that will apply, assuming the bill is passed.

LEGAL ENTITIES

The most significant revisions affect the CC's regulations on legal entities. These will entail amendments to a host of laws, including those on not-for-profit organizations, bankruptcy, and the state registration of legal entities. The laws on limited liability companies (OOOs) and joint-stock companies (AOs) will be replaced by a single law on companies.

Types of legal entity

Legal entities are already classed as "for-profit" [kommercheskiy] or "not-for-profit" [nekommercheskiye]; the changes will see them also classed according to their organizational structure, as either "corporate organizations (corporations)" [korporativnye organizatsii (korporatsii)] and "unitary organizations" [unitarnye organizatsii]. Members of corporations, unlike members of unitary organizations, will be entitled to participate in the organization's operational management (as a membership right). The "for-profit"/"not-for-profit" division will be retained for corporations, but unitary organizations will be not-for-profit only.

Certain familiar forms of legal structure will cease to exist: additional liability companies [obshchestva s dopolnitel'noy otvetstvennost'yu] and closed joint-stock companies [zakrytye aktsionernye obshchestva].

At the same time, a new category is planned: "public joint-stock company" [publichnoye aktsionernoye obshchestvo]. A public joint-stock company is one whose shares and securities convertible into shares are publicly offered and publicly traded under the terms of the law on securities. Special requirements will apply to the creation and activities of such companies (regarding the amount of authorized capital, keeping a register of shareholders, etc.).

Minimum authorized capital

Minimum authorized capital is to increase significantly, to 500,000 RUB for OOOs (compared to the present 10,000 RUB), and 5,000,000 RUB for AOs (compared to the present 100,000 RUB for ZAOs and 1,000,000 RUB for OAOs). For public joint-stock companies, the minimum will be 100,000,000 RUB. Moreover, the company will have to pay the minimum authorized capital in cash, and will have to pay two thirds of it before registration. These changes, which are aimed at combating "fly-by-night" companies, prompt the question of whether members of companies (particularly small businesses) will be able to pay such amounts of minimum authorized capital.

State registration of legal entities

The state registration of all legal entities will be carried out by judicial authorities rather than tax authorities. At present, the Justice Ministry is responsible for the registration of not-for-profit organizations only. The aim of the proposed changes is to make the registration of all legal entities the function of a single state authority. Readers may recall that judicial authorities registered all legal entities until 2002.

As part of the measures against fly-by-night companies, judicial authorities will examine the legality of the grounds for registration and the reliability of the information in the Unified State Register of Legal Entities, as well as whether the legal entity's charter is legally compliant. This development, which represents a move away from the application-based registration procedure, will most likely mean that registering legal entities, amending charters and entering information into the Unified State Register of Legal Entities will take longer.

The liability of a member of a company for its obligations

Another new development is that the sole member of a sole member company will be jointly liable for the company's obligations arising out of the company's performance of the member's instructions. It will be recalled that in general members are not responsible for a legal entity's obligations, and vice versa. Currently, exceptions are made for companies are cases where a parent company is jointly and severally liable for transactions by its subsidiaries in performance of the parent company's mandatory instructions, or where a founder (or member) is jointly liable if the legal entity becomes insolvent (or bankrupt) where that liability arises out of the actions of a founder (or member) entitled to issue mandatory instructions to that legal entity.

Reorganization and liquidation of legal entities

To protect creditors' rights, converting for-profit organizations into not-for-profit ones will be prohibited. Reorganizing business partnerships and companies into not-for-profit and unitary organizations will also be banned.

On the other hand, legal entities undergoing reorganization will be allowed to use a combination of methods at the same time (merger, consolidation, demerger, spin-off or conversion).

A clause on the discovery of assets of a liquidated organization is being introduced. In the event of the discovery of assets of such an organization, interested parties and government authorities have three years from when the organization's removal from the Unified State Register of Legal Entities is recorded therein to take legal action to have liquidation procedures against the organization resumed (or initiated).

The priority of liquidation claims is being altered. At all phases, creditors' claims will be satisfied only after the liquidator's costs have been paid. In addition, Phase 4 (settlements with other creditors) is being merged with Phase 3 (settlements on mandatory payments to the budget and extra-budgetary funds).

The business activities of foreign legal entities in Russia

Life will get more complicated for offshore companies (i.e., organizations registered in a foreign country that offers favorable tax treatment and/or does not require the submission or disclosure of information when financial transactions are made). To do business in Russia, such companies will have to lodge information on their founders (or members) and beneficiaries with a judicial authority. The disclosure may be voluntary. However, if a company does not disclose such information voluntarily, a court may order it to do so.

At the same time, the requirements on the liability of members and other parties that have the capacity to play a determining role in the activities of a foreign company doing regular business in Russia for the company's obligations will be set by Russian law, not the law of the country where that company is registered, must apply. The latter may be used as the choice of law only if a creditor requests.

TITLE AND PROPRIETARY RIGHTS

In addition to proprietary rights, a new concept is being introduced: possession [vladeniye], meaning factual control by a person of a thing. Possession is not subject to state registration. Any possessor may resort to special means of protection as a possessor, including legal action.

The prohibition of the alienation of land by its owner if the owner also owns buildings and structures on it, without those buildings and structures being alienated at the same time, and vice versa, is being strengthened. Such land and buildings with a single owner will be referred to as a single property, and will be treated as a single immovable property in civil transactions.

The forms of, and grounds and procedures for, restrictions on landowners' rights are being regulated. Such restrictions may be imposed in the interests of neighbors, or in the public interest (requisition, temporary occupation of the land with the owner being deprived of the opportunity to exercise the rights to possess, use and dispose of it; restrictions on the possession and/or use of land without expropriating it).

The notion of an independent mortgage is being introduced. A pledgee (usually a bank) will be able to decide independently which of the obligations of the pledger or third party (the debtor under the main obligation) to consider secured by the mortgage. The maximum term of an independent mortgage is 30 years.

Major changes are being made to the list of proprietary rights. Thus, the rights of beneficial ownership, lifetime inheritable possession, and permanent (perpetual) use will be abolished. At the same time, some new limited proprietary rights are being established: the right to permanent possession and use of land (or other natural property) belonging to another person; development rights; the right of personal use (usufruct); and the right to provision of materials. The list of proprietary rights will be exhaustive.

The right to permanent possession and use of land (or other natural property) belonging to another person is granted by the landowner to a private citizen or legal entity for the purposes of agricultural production, forestry, etc., in return for payment indefinitely or for a period of at least 50 years. At the same time, the owner retains the right to dispose of the land.

Development rights are granted by a landowner in return for payment to a holder of the right to permanent possession and use of the land, for a period of at least 50 and no more than 100 years. The owner retains the right to dispose of the land. Title to buildings and structures erected is held by the holder of development rights while they are in effect. When development rights terminate, title to the buildings and structures usually pass to the landowner.

The right of personal use (usufruct) is recognized as the right to use and possess property (including immovable property), granted by the owner of the property to a private citizen or not-for-profit organization. To fulfill maintenance obligations, a social usufruct may be created in relation to living quarters.

The right to acquire another person’s immovable property is an exclusive right to acquire immovable property (a mortgage or development rights regarding another person's immovable property), established on the basis of a contract with the owner for a maximum period of 10 years.

The right to provision of materials entitles its holder (a private citizen) to be provided on a regular basis with materials in the shape of a specified amount of goods, money, work or services by the owner of an immovable property (or of a share in the title to an immovable property), and, if such materials are not provided, to dispose of that immovable property by foreclosure, in the manner prescribed for a mortgage. This right is established for the lifetime of the private citizen, or for another period not exceeding 100 years.

TRANSACTIONS, CONTRACTS, OBLIGATIONS

Transaction formalities

The number of transactions subject to mandatory notarization will increase. Now, as a general rule, if rights subject to state registration arise, or are modified or terminate, as a result of a transaction, that transaction must be notarized, unless otherwise provided by law. In this case, the entry in the register (for example, the Unified State Register of Rights) will be made at the request of any party to the transaction through a notary.

Invalidity of transactions

Courts will be entitled to independently apply the consequences if a void transaction is declared invalid only where this is necessary to protect the public interest, or other interests prescribed by law.

Parties will be permitted to agree to prescribe other consequences if a contract, the fulfillment of which is linked to the performance by the parties of their business activities, is declared invalid.

Ways of securing an obligation

Pledge

By analogy with the rules on recovering property from a good faith purchaser, a rule is being introduced protecting the interests of good faith pledgees. If property is pledged by a person without the right to dispose of it, and the pledgee is unaware of this, and could not be expected to have been aware of it, the owner of the pledged property assumes the pledger's rights and obligations. An exception will be made for cases where the property is lost by its owner, etc.

In addition, property that the pledger will acquire in future may be pledged, as may a right arising in future out of an existing or future obligation.
An interesting development concerns the pledge of a member's OOO interest. Whereas at present the actual member (or pledger) exercises the OOO member's rights during the term of the pledge, under the bill these rights will be exercised by the pledgee.

Guarantee

The rule that only a lending institution can be a guarantor is being abolished. In other words, as well as bank guarantees, there are to be independent guarantees, allowing any private citizen or organization to be a guarantor.

Compensation for losses

By analogy with the existing provisions of Article 524 of the CC (supply contract termination losses), there is to be a general rule on compensation for losses in cases where a debtor's nonperformance or improper performance of any contract leads its early termination. A creditor that has entered into another transaction in place of that contract (a "replacement transaction"), may demand compensation from the debtor for losses in the form of the difference between the value in the terminated contract and the value of similar goods, work or services under the replacement transaction. A creditor that has not entered into a replacement transaction may still recover losses from the debtor, but this time in the losses are calculated as the difference between the value in the terminated contract and the actual value of the goods, work or services.

The notion of pre-contractual liability is being introduced. A party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party, as well as for the loss of the opportunity to enter into a contract with a third party.

Tenders

The rules for tenders are being revised. In particular, the assignment of rights and delegation of duties in respect of a contract with the winner of a tender will be prohibited if, by law, the contract cannot be entered into without holding a tender.

Special rules are to apply to public tenders (i.e., tenders for the implementation of a court ruling or enforcement documents as part of enforcement proceedings). In addition, tender organizers and participants will be able to use independent guarantees as well as deposits as collateral.

Other issues

A separate chapter is being devoted to general rules for holding meetings (of members of legal entities; owners; creditors in bankruptcy, etc.), and for disputing the resolutions/decisions of meetings.

Many gaps in securities trading regulation will be filled. Thus, there will be special articles on specific aspects of the requisitioning of certificated and uncertificated securities, the immobilization of certificated securities, the assignment of rights and assumption of encumbrances in respect of uncertificated securities, protection of the rights of holders of rights attached to uncertificated securities, and the consequences of losing data on the registration of rights attached to uncertificated securities.

Finally, it will be possible to obtain compensation for losses caused by the lawful actions of state and local government authorities. Currently, compensation can only be obtained for losses caused by unlawful actions (or inaction) of public authorities.

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