Business structures in Russia

CMS Cameron McKenna

Introduction

In the last few years Russia has introduced extensive corporate legislation governing the creation, management and liquidation of a range of legal entities and other structures through which business may be carried on. These include public and private companies, branches and representative offices and limited and unlimited partnerships. A basic description of each of these forms is set out in the Civil Code of 1994 and, in respect of some of the structures, further, more detailed regulations are set out in the laws governing particular types of structure, for example, the Law on Joint Stock Companies of 1995 and the Law on Limited Liability Companies of 1998.

The structures most commonly used or encountered by foreign investors are the representative office, the limited liability company and the joint stock company (of which there are two forms ? "open" or public and "closed" or private). This chapter will focus on these principal forms.

Representative Office

Status

A representative office with accredited status has been traditionally viewed as the simplest form of business presence that a foreign company could establish in Russia. In the USSR it was the only vehicle available to foreign companies and although foreigners can now set up a wholly owned subsidiary company and may participate on an equal basis in the various forms of partnership prescribed under Russian law, a representative office remains an effective first entry vehicle either alone or in conjunction with a company of some form. Some of the reasons for this are explained below.

A representative office is not a separate legal entity but an office of the parent entity that is set up in Russia to represent the interests of that parent. Although a representative office may in practice conduct business in Russia and may be treated by the tax authorities as a separate profit centre from its parent company, the fact that as a matter of civil law, a representative office does not have its own separate legal identity limits the types of business for which a representative office may be useful. For example, a representative office may not import goods for purposes other than its own needs, nor may it register title to immovable property in its own name. A representative office may also experience difficulties in obtaining licences and permits to conduct certain types of business.

A representative office may however, carry out representative functions on behalf of its parent, including arranging marketing and advertising in Russia, negotiating the terms and conditions of agreements on behalf of the parent entity and facilitating the execution of those agreements by the parent company. It may also help in other commercial and legal transactions between the parent and Russian organisations, including the rental of property.

At one time an accredited representative office enjoyed a range of benefits that were not available to branches or companies. These benefits have been gradually withdrawn, for example customs exemptions on equipment imported for the use of the representative office were withdrawn in February 1999. Foreign employees of a representative office may still obtain personal accreditation which confers certain practical benefits such as the right to import and export personal effects free of customs duty and VAT and which assists with obtaining multi-entry visas. There has been considerable debate about whether accredited employees of a representative office require work permits but in practice having a work permit should avoid difficulties with Russian state and local migration authorities.

A significant advantage of a representative office is that it is not deemed to be resident for Russian currency purposes and, therefore, its foreign currency receipts are exempt from the mandatory requirement to convert those receipts into roubles. A representative office may have a number of different types of bank account: a foreign currency account; a rouble “conversion” account (referred to as a type "K" account) and a rouble “non-conversion” account (known as a type "N" account). These accounts enable the representative office to make payments in Russia to both residents and non-residents subject to certain currency control restrictions established by the Central Bank regulations and other applicable legislation. Proceeds from business operations may be accumulated either in a type “K” or type “N” account (depending on the type of proceeds) or, after conversion into foreign currency, may be transferred abroad.

Liability

As a representative office is merely an extension of its parent, the parent remains responsible for the debts and liabilities of the representative office.

Management

A representative office is managed by the AHead of the Representative Office”, who is empowered to conduct the business of the office, and so to represent the foreign parent company by way of a power of attorney. A representative office should also have a AChief Accountant”. There is no requirement for either the Head of the Representative Office or the Chief Accountant to be a Russian national although an accountant who understands the intricacies of Russian tax and accounting law is a practical necessity. Since the foreign parent company is fully liable for the debts and obligations of the representative office, some consideration should be given to the management of the office and any internal controls that may be appropriate to mitigate the exposure of the parent company.

Setting up a representative office is often the first step that foreign companies take when entering the Russian market and may be used for certain service industries on an on-going basis. For companies in many other business sectors, however, a representative office is not on its own sufficient although one may form part of a larger structure including one or more companies or other entities.

Limited Liability Company (“Obshestvo s Ogranichennoi Otvetstvennostyu”)

Status

A limited liability company is designated by the letters “OOO” before or after its name. It is the simplest form of Russian company and for that reason is often used for wholly owned subsidiary companies of foreign investors. It is similar in concept to a German GmbH or limited liability company.

The establishment of a limited liability company is governed by Part 1 of the Civil Code and by the Law on Limited Liability Companies of 8 February 1998. It shares many similarities with another form of Russian company, the closed joint stock company, which is described below. The most significant difference between a limited liability company and a closed joint-stock company is that a limited liability company does not issue shares. The charter capital is instead divided into Aparticipations” or Ainterest” units (“doli”). Unlike shares issued by a joint stock company, these interest units are not considered to be securities and, therefore, do not need to be registered with the Federal Commission for the Securities Market, which goes some way to reducing the expenses of registration and also the level of bureaucracy to be dealt with by the company. Each holder of an interest unit is referred to as a “participant”. The liability of participants in the company for the debts and obligations of the company is, as a general principle, limited to the amount of their respective contributions.

A limited liability company may be wholly owned by another business entity provided however that entity is not itself wholly owned by a legal entity or individual. At the other extreme, if the number of participants in the company exceeds fifty then, unless the number of participants is reduced, the company is obliged to re-register as an open joint stock company within a year.

Management

The management structure of a limited liability company is relatively straightforward and may consist of a general director and the meeting of participants. A board of directors is not required but can be provided for by the terms of the charter.

Although a participant of a limited liability company is generally entitled to the number of votes at the general meeting of participants which represents the value of his contribution to the company's capital, this principle can be changed in the company's charter either when establishing the company or by subsequent amendment to the charter which requires the approval of two thirds of the company's participants.

Transfer of interest units

Interest units or participations in a limited liability company are freely transferable, subject to a statutory right of pre-emption in favour of the other participants. This right cannot be excluded from a company's charter. Thus, a transfer to a third party can only take place once the other participants have had the opportunity to purchase the interest. The procedure for offering the interest units to the other participants and for determining the price at which the units are offered is usually set out in the company’s charter.

The charter may even prohibit the transfer of an interest to a third party in which case, if the other participants decline to purchase units offered to them, the company itself is obliged by the Law on Limited Liability Companies to purchase this interest. Payment may be in cash or, with the agreement of the transferring participant in kind. The participant has the right to receive payment for its interest within 6 months (unless a shorter period is provided for in the charter) of the end of the accounting year in which the participant offered its interest for sale.

Right to withdraw

Every participant of a limited liability company has the right to withdraw from the company, at any time without the consent of any of the other participants or of the company. If a participant exercises this right then, the interest unit is transferred to the company with effect from the time the withdrawal notice is served on the company. The company is then obliged to pay the exiting participant the “actual value” of his portion of the capital in cash. The “actual value” of the participant’s interest will be calculated as a proportion of the net value of the company’s assets equal to the proportion of the Company’s participation interests that he holds. Payment, however, is required to be made within six months after the end of the company's financial year in which the withdrawal notice was served. The company may pay the exiting participant its entitlement in kind provided the participant agrees to this.

This right to withdraw from a limited liability company cannot be excluded by the charter. Any provisions eliminating or limiting the right to withdraw are null and void. Although difficulties in valuing a participant’s interest units and the procedure for re-payment provides some practical disincentive to withdrawal, the existence of the right may undermine the usefulness of this type of corporate vehicle for anything other than a wholly owned subsidiary.

Open and closed joint stock companies

Status

The legislation governing a Russian joint stock company is to be found in the Civil Code and the Joint Stock Company Law of 26 December 1995. The latest Law on Amendments to the Joint-Stock Company Law was published on 27 February 2003.

A joint stock company can either be “open” or “closed”. An open joint stock company, (“otkrytoye aktionernoye obshestvo”) is designated by the letters “OAO” and a closed joint stock company (“zakrytoye aktionernoye obshestvo"), by the letters “ZAO” which appear either before or after the company’s name. The distinction between the two corporate vehicles can be likened to that between a private company and a public company in jurisdictions such as England and Wales. The open joint stock company is the form used for public companies as it can issue shares to the public and such shares are freely transferable without any pre-emption rights in favour of other shareholders or the company. A closed joint stock company, on the other hand, is designed for private or closely held companies and so, for example, cannot issue shares to the public.

Like a limited liability company, a joint stock company may not be wholly owned by another business entity, which in turn is wholly owned by an individual, or a single legal entity.

The maximum number of shareholders for a closed company is 50. If this number is exceeded the company is obliged to re-register as an open joint stock company. There is no limit to the number of shareholders in an open joint stock company.

Management

The management structure of a joint stock company consists of three bodies: (i) the general meeting of shareholders; (ii) the board of directors; and (iii) the executive body, which can be either collective (e.g. a management board or board of directors), or a single individual, the general director.

The general meeting of shareholders is the supreme corporate body of a joint stock company and must be held annually. Extraordinary meetings may be called by the board of directors on its own initiative or on the initiative of the auditing commission, the independent auditor or a holder(s) of more than 10% of voting shares. The Law on Joint Stock Companies defines certain decisions which are within the exclusive authority of the general meeting of the shareholders and which may not be delegated to any other management body within the company.

The board of directors is responsible for the general management of the company and has authority to decide on almost any issue except those within the exclusive competence of the general meeting of the shareholders. In a joint stock company with less than 50 shareholders, the functions of the board of directors may be performed by the general meeting of shareholders and authority to run the day-to-day business of the company can be delegated to the General Director. Directors are elected by the general meeting of shareholders usually for the period of one year but they may be re-elected any number of times.

The executive body of a joint stock company may consist of one person, the General Director, or of a General Director and a group of persons acting as a collective executive body. The executive body is responsible for the day-to-day management of the company. The executive body of the joint stock company is elected by the general meeting of shareholders unless the charter of the company transfers this authority to the competence of the board of directors.

Issue and Transfer of shares

An open joint stock company may make public offerings of its shares, which are freely tradable on the market. There are no pre-emption rights or restrictions on the transferability of shares in an open joint stock company as there are for closed joint stock companies.

The shares of a joint stock company, whether open or closed, are treated as securities and, as such, are subject to the registration requirements of the law on Securities Market of 22 April 1996. When issuing new shares therefore, all joint stock companies must prepare and file with the Federal Commission for the Securities Market, a copy of any decision to issue shares, a report on the results of the share issue and, in certain cases, a prospectus for the share issue.

Title to shares in a joint stock company is determined by reference to the register of shareholders, which all joint stock companies are required to maintain. Share transfers take effect on their entry into the register and the shareholders’ entitlement to participate in shareholders meetings is determined by the register. The register may be kept by the company itself or by an independent registry company duly licensed by the Federal Commission for the Securities Market. If the company has fifty shareholders or more then the register must be kept by an independent registrar.

Shares of a closed joint stock company may be distributed only to a limited group of persons. A closed joint stock company may not publicly offer its shares or otherwise offer them to an unlimited number of investors.

The transfer of shares in a closed joint stock company is subject to pre-emption rights in favour of other shareholders. The procedure and terms for the exercise of pre-emption rights should be specified in the company's charter subject to the overriding requirements of the Joint Stock Company Law which provide that these rights must be exercised within not less than 10 and not more than 60 days from the time the shares are offered for sale and at the same price as offered to any third person.

The sstrengthening of shareholders’ rights is seen as a priority issue and there are a number of legislative and quasi-legislative initiatives under way to address the many concerns that investors have expressed about the corporate regulatory environment in Russia. The amendments made in August 2001 to the Joint Stock Company Law tidy up and clarify the procedures for approving what are known as “major” and “interested party” transactions by establishing more precise rules for conducting such transactions. Another major development in Russia has been the publication of a draft “Code of Corporate Conduct” which the Federal Commission for the Securities Market introduced in 2003.

The Code is based around the general principles set out in the OECD Principles of Corporate Governance and is presently recommended for use by large joint stock companies. Like Corporate Governance Codes in a number of other countries, the Russian Code will not be legally binding, although it is expected that major joint stock companies will incorporate most of the provisions of the Code into their internal documents.

Recently, the Federal Commission for the Securities Market issued a number of documents governing particular issues related to the conduct of general meetings and other issues relevant to corporate governance. By expanding in greater detail some of the basic rights that shareholders are entitled to, such regulations should play a significant role in strengthening the protection provided to minority shareholder interests.

Other entities

The Civil Code provides for a range of other entities including branches and simple partnerships, which are not legal entities as well as full, and limited partnerships and additional liability companies which are legal entities. There are also non-commercial organisational forms that may be used for charities, trade associations or other not for profit organisations.

For further information please contact David Griston at [email protected] or on +7 095 258 5000.