Question-Answer: disposition by a non-resident of its membership interest in the authorized capital of a Belarusian resident

Description of situation:
Members of a Joint Limited Liability Company (hereinafter – the JLLC) registered in the Republic of Belarus are:
1. LLC – resident of the Republic of Belarus (membership interest - 59, 66%); 
2. LLC – resident of Russian Federation (membership interest - 40, 34%).
The Articles of Association of the JLLC provides for the preemptive right of the Members and the Company itself to acquire a membership interest; also, disposition by the Company Member of its membership interest to third parties is permitted only with the unanimous consent of the General Meeting of the Members.
The LLC – Russian resident was recognized as insolvent (bankrupt); therefore, in accordance with the Russian legislation its membership interest in the JLLC is to be sold at an auction. The starting selling price of the interest far exceeds its fair market value. It seems highly probable that the interest will be sold at the first auction.
The LLC – Belarusian resident is not interested in new persons to become members and in payment for the interest at market value.

Question №1: What actions can the LLC – Belarusian resident take (its membership interest in the authorized capital of the Company is 59, 66%) if an auction is held to sell the membership interest in disregard of the preemptive right to purchase the membership interest?

The membership interest (part of it) in the authorized capital of the Company shall be sold in accordance with the requirements of the legislation, Articles of Association and the shareholders'/members’ agreement (if any), taking into account the prohibitions and restrictions stipulated in the said documents. Preemptive right of the members to acquire the membership interest cannot be cancelled by the Articles of Association or a Resolution of the General Meeting of the Company Members. The Member shall not be entitled to assign its preemptive right to acquire the membership interest either to other members, the Company or third parties . When selling the membership interest (part of it) in the authorized capital of the Company in violation of the preemptive right to purchase the membership interest (part of it), any Member of the Company and (or) the Company itself shall have a right, within three months from the time when they discovered or should have discovered such violation, to seek in court to transfer them the rights and obligations of the buyer . When selling the membership interest (part of it) in the authorized capital of the Company in violation of the Company’s right to purchase the interest (part of it) of the Member, the Company shall be entitled, within three months from the time when it discovered or should have discovered such violation, to seek in court to transfer the rights and obligations of the buyer  to the Company. 

Thus, having analyzed applicable laws of the Republic of Belarus, it may be concluded that when the preemptive right of the Member or the Company to purchase the membership interest in the authorized capital of the Company is violated and such membership interest is sold at an auction, the Member or the Company itself can apply to the court and require to transfer them the rights and obligations of the buyer of such interest  under the terms and conditions offered to the participants in the auction. 

Question №2: What are other possible consequences of the preemptive right violation (recognition of an auction as invalid, payment of fair market price for the membership interest, or etc., that will result in sale of the interest for less than the amount set at an auction), besides a request of the Member (or the Company) to transfer them the rights and obligations of the buyer at the price determined pursuant to an auction?

• Recognition of the membership interest purchase and sale transaction as null and void:

A transaction not complying with the legislative requirements shall be recognized as null and void, unless the legislation establishes that such a transaction is voidable or provides for other consequences of violation.

With regard to violation of the preemptive right to purchase the membership interest by the Member or the Company itself, since the Law on business entities provides for other consequences of violation, the agreement for sale and purchase of an interest (part of it) concluded by the Company Member in violation of the legislative requirements  for the preemptive right of other Company Members or the preemptive right of the Company itself to purchase such interest (part of it), as well as the agreement for  sale and purchase of an interest of the Company concluded by the Company Member in violation of the legislative requirements for the Company’s right to purchase such interest (part of it), will not be recognized as void.

• Recognition of the interest sale and purchase agreement as invalid in case the prohibition on disposal of interest to third parties stipulated in the Company’s Articles of Association is violated: 

If the Company’s Articles of Association prohibits to sell the membership interest to third parties (it is allowed only with the consent of the General Meeting of the Members), and the Member has anyway sold its interest in the authorized capital of the Company, the sale and purchase agreement can be recognized as invalid (void) as not complying with the legislative requirements .  In case the transaction is recognized as invalid, each of the parties shall return to the other everything received according to the transaction, and if it is impossible to return that received in kind, - to compensate its value in money, unless other consequences of invalidity of the transaction have been provided for by the Civil Code of the Republic of Belarus or other legislative acts . Thus, if the court recognizes the interest sale and purchase agreement as invalid, such interest will be returned to the Member-bankrupt. If such Member obtains no consent of the General Meeting of the Members to dispose its interest to third parties and other Company Members withdraw from its purchase, the Company shall pay the Member its fair value or, with the consent of the Member, issue the assets in kind equivalent to such value. Fair value of the membership interest (part of it) in the authorized capital of the Company shall be determined on the ground of the balance sheet for the last reporting period preceding the date on which such a request was made by the Member (under the ledger of income and expenditure as at the first day of the month in which the Member made its request). In such a case, the membership interest (part of it) in the authorized capital of the Company is transferred to the Company from the date when the fair value of the interest (part of it) is paid to the Member or the Member receives the assets in kind equivalent to such value.

We think that, where the prohibition stipulated in the Company’s Articles of Association to dispose the membership interest to third parties is violated, the interest sale and purchase transaction can be recognized as invalid in the eye of the Belarusian law, and in such a case the Member-bankrupt can receive the fair value of its interest. 

• Recognition of the auction as invalid:

If the Member of JLLC– resident of the Republic of Belarus intends the auction to be recognized as invalid, according to the jurisdiction rules the Member shall apply to the court at the defendant’s location, i.e. to the court of the Russian Federation. In consideration of this dispute the law of the Russian Federation will apply. The law of the Russian Federation provides for the open list of grounds on which the auction can be recognized as invalid. The auction conducted in violation of the rules stipulated by the laws can be recognized by the court as invalid against the claim of the interested person within one year as from the date of the auction. The auction can be recognized as invalid in the event: 
- somebody has been unreasonably excluded from participation in the action; 
- the highest offered price was groundlessly not accepted; 
- the sale was made earlier than the date stated in the notice; 
- other material violations of the procedure for conducting the auction were made, which resulted in improper determination of the selling price; 
- other violations of the rules stipulated by the law. 

Recognition of the auction as invalid results in invalidity of the agreement concluded by the person who won the auction and application of consequences provided for when the transaction is recognized as invalid.

Case law on this issue in Russian Federation is the following: when selling property of the company declared bankrupt, a special procedure applies. The membership interest owned by the bankrupt company in the authorized capital of another company is comprised in the property of that bankrupt company, and therefore, this special procedure, mandatorily provided by bankruptcy law with regard to sale of property belonging to a person declared insolvent (bankrupt), shall apply. Any other procedure is not subject to application.

According to the above mentioned statutory provisions of Russia, we can make a conclusion: the situation at hand is not explicitly referred to the list of cases when auctions are declared invalid. When disposing interest of the bankrupt in the authorized capital of another company at the auction, the Russian legislative practice provides for application of the special regime, and adherence to the preemptive right to purchase the interest is not pertinent to it. Therefore, it does not seem possible to refer the case in question to other violations of rules stipulated by the law. In this regard, we think that the LLC – resident of the Republic of Belarus, being a member of the JLLC registered in Belarus, will fail to make the auction be declared invalid.

Prepared by:
Certified Lawyer of Collegia Law Firm Yuliya Ostreiko,
Tel.: +375 (17) 287-80-88
E-mail: ostreiko@collegia.by