Realization of the pre-emptive right to acquire a share in the LLC in case of alienation of a share in a way other than sale
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According to the Law on LLC[1], the LLC's members exercise a preferential right to purchase a share or part of a share of the LLC's member offered for sale to a third party. The LLC's Articles of Association (the LLC's AoA) may provide for the LLC's preemptive right for the acquisition of a share or part of a share alienated by the LLC's member. If the preferential right of the LLC's member or the LLC is violated, the member or the LLC has the right to demand the transfer of the rights and obligations of the Buyer[2]. When adjusting the procedure for exercising pre-emptive rights to purchase shares or part of the shares offered for sale to a third party, the Law on LLC uses of the word "purchase," "sale," "member who intends to sell a share", thereby indicating that the pre-emptive right is available to the non-alienating LLC's members only in the case of alienation of the share (or part of the share) based on the Purchase and Sale Agreement. However, in practice, when certifying transactions with the LLC's shares other than purchase and sale, notaries often request from the alienating member evidence of compliance with the pre-emptive right of other members of the LLC and, if applicable, the LLC itself. We do not consider this to be in accordance with the law and this article is dedicated to the reason of this vision.
Law Regulation
It follows from the provisions of the Law on LLC[3] that the Law distinguishes between the sale of the LLC member's share in the authorized capital of the LLC and its assignment (alienation) in another way. The provisions on the procedure for exercising the pre-emptive right due to the use of terminology inherent only in the purchase and sale indicate precisely the pre-emptive right to purchase a share when it is sold[4]. The law does not directly indicate the possibility of exercising a pre-emptive right in the assignment (alienation) of a share in any other way. There is logic in this: only in the case of purchase and sale, the counter provision of the transaction is the payment of funds. Money assets are the universal equivalent and can be provided to the Seller by any person. In other transactions that are possible with respect to a share in the authorized capital of the LLC (for example, under the Barter Agreement), the counter-provision is either some specific property that can be provided to the alienating member not by any person, or the counterparty to the transaction is essential for the alienating member (for example, in a donation transaction or in a transaction to transfer a share in the authorized capital of the LLC to pay for a share in the authorized capital of another LLC). The application of the pre-emptive right of other members of the LLC to acquire a share in such transactions would deprive them of any meaning.
Courts' Position
From the analysis of the above provisions of the Law on LLC, the courts conclude that the preferential right of members is valid for the alienation of a share only by sale and does not apply to other cases of alienation of a share[5]. In practice, the Parties use the following options for alienating a share in the LLC without observing the pre-emptive right of other members.
1. Making a Share as a Contribution to the Authorized Capital of a Legal Entity
Payment of shares in the authorized capital of the LLC can be carried out, among other things, by property rights or other rights that have a monetary value[6]. Judicial practice confirms that in the case of making a share in the LLC as a contribution to the authorized capital, the requirements of the Law on LLC regarding compliance with the pre-emptive right do not apply[7].
2. Transfer of Share as Compensation
As agreed by the Parties, the obligation may be terminated by the provision of compensation — payment of funds or transfer of other property [8]. With regard to disputes related to the transfer of a share in the LLC, the courts indicate that the pre-emptive right of members is valid when the share is alienated by a member of this LLC only by sale and does not apply to cases of alienation of a share under the Settlement agreement[9]. At the same time in 2020, the Supreme Court has expressed the position that the meaning of Article 409 of the Civil Code (compensation) if instead of an obligation to pay money as compensation is provided to the property in respect of which there is a preferential right to purchase, a person with this right can use the remedies provided for a breach of such pre-emptive rights[10]. Consequently, if a share in the authorized capital of the LLC is transferred as compensation instead of a monetary obligation, other members of the LLC and, possibly, the LLC itself (if provided for by the AoA) will have a preferential right to acquire such a share. If a share in the authorized capital of the LLC is transferred as compensation in return for a non-monetary obligation, the pre-emptive right of other members of the LLC and the LLC itself (if applicable) is impossible.
3. Transfer of Share under the Barter Agreement
The possibility of transferring a share in the LLC under the Barter Agreement without observing the pre-emptive right of other members is ambiguous. On the one hand, the rules on purchase and sale apply accordingly to the Barter Agreement[11]. On the other hand, as mentioned above, the Law on LLC distinguishes between the sale of a share and its assignment (alienation) in another way. The Law on LLC is a more special regulatory act in comparison with the Civil Code of the Russian Federation, and, therefore, in relation to the transfer of a share in the authorized capital of LLC, the rules established by the Law on LLC should have priority. There is a decision in which the court supported the approach according to which the preferential right of other members to acquire a share alienated under the Barter Agreement does not apply[12]. The conclusion is also supported in the doctrine[13].
For the record
It is important to pay attention to the following.
The courts allow the non-application of the pre-emptive right to acquire the alienated share in the authorized capital of the LLC, provided that the Parties really intend to transfer the share not under the Purchase and Sale Agreement.
If it is found that the share transfer transaction is a sham (covering the Purchase and Sale Agreement), then the court recognizes that there has been a violation of the pre-emptive right of other members. For example, the court pointed out that the Barter Agreement is an invalid transaction if the fact of the transfer of funds for a share is proved and it is not proved that in exchange for it, the counter-provision provided for by the Barter Agreement was actually transferred[14].
The Articles of Association or Corporate Agreement concluded with respect to the LLC may provide for a different procedure for exercising the pre-emptive right.
Thus, the right of other members may be provided for to acquire a share "with any assignment of a share" by a member, "with the assignment of a share in a way other than purchase and sale". Other formulations are also possible. At the same time, it should be regulated how the LLC's members exercising their pre-emptive right to acquire the alienated share will provide the alienating member with the counter-provision that he expected when intending to assign the share on a different basis than the Purchase and Sale Agreement, or how the monetary equivalent of such a counter-provision should be determined. Otherwise, the provisions of the AoA or the Corporate Agreement on the existence of the members (and, possibly, the LLC itself) of the pre-emptive right to acquire a share alienated in a way other than purchase and sale, will be inoperative.
Practical Conclusions
Before alienating a share in favor of a third party, it is necessary to study the provisions of the AoA and the Corporate Agreement concluded with respect to the LLC, regulating the procedure for exercising the pre-emptive right to acquire the alienated share by other members or, possibly, by the LLC itself.
The transaction for the alienation of a share in a way other than a purchase and sale should not be imaginary or feigned. The Parties shall act in good faith. Thus, share transfer agreements shall be executed according to their terms. For example, under the Barter Agreement, agreed property, not money, shall be transferred for a share in the LLC.
Since judicial practice on this issue is not numerous, it is impossible to completely exclude the risk that the court recognizes that the preferential right of other members has been violated.
[1] Para. 4 of Article 21 of Federal Law No. 14-FZ of February 8, 1998 "On Limited Liability Companies". [2] Para. 18 Article 21 of the Law on LLC. [3] Para. 2 Article 21 of the Law on LLC. [4] See, for example, paragraph 4 of Article 21 of the Law on LLC. [5] Ruling of the Supreme Arbitration Court of the Russian Federation dated 16.04.2012 No. VAS-4459/12 "On refusal to transfer the case to the Presidium of the Supreme Arbitration Court of the Russian Federation", Decision of the Supreme Arbitration Court of the Russian Federation dated 31.08.2007 No. 3590/07, Resolution of the Federal Arbitration Court of the North Caucasus District dated 11.04.2013 No. F08-1249/13 in Case No. A32-45400/2011. [6] Para. 1 of Article 15 of the Law on LLC. [7] Decision of the Supreme Arbitration Court of the Russian Federation No. 3590/07 of 31.08.2007, Resolution of the Federal Arbitration Court of the North Caucasus District No. F08-2188/12 of 31.05.2012 in Case No. A53-10853/2011, Resolution of the Federal Arbitration Court of the North Caucasus District of 11.04.2013 No. F08-1249/13 in Сase No. A32-45400/2011. [8] Article 409 of the Civil Code of the Russian Federation. [9] Ruling of the Supreme Arbitration Court of the Russian Federation dated 16.04.2012 No. VAS-4459/12 "On refusal to transfer the case to the Presidium of the Supreme Arbitration Court of the Russian Federation", Resolution of the Eleventh Arbitration Court of Appeal dated 13.09.2011 in Сase No. A65-5850/2011. [10] Para. 7 Resolution of the Plenum of the Supreme Court of the Russian Federation dated 11.06.2020 No. 6 "On some issues of application of the Provisions of the Civil Code of the Russian Federation on termination of obligations". [11] Para. 2 Article 567 of the Civil Code of the Russian Federation. [12] Resolution of the Tenth Arbitration Court of Appeal dated 25.12.2012 in Case no. A41-7351/12. [13] Preferential Right to Purchase a Share in the Authorized Capital of LLC – Implementation Options (A.A. Glushetsky, Journal "Law and Economics", No. 3, March 2017); Corporate Law: Training Course (ed. by I.S. Shitkin; preface E.P. Gubina). — Moscow: "Walters Kluwer", 2011. [14] Resolution of the Federal Arbitration Court of the North-Western District of 29.04.2008 No. A13-6080/2007.