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Convertible loan agreements will be incorporated into Russian law


On 31 May 2017 the draft of the Federal law “On amendments to certain legislative acts of the Russian Federation” (“Bill”)1 was submitted to the State Duma of the Russian Federation for consideration. The Bill is expected to amend the Federal law No. 208-FZ of 26 December 1995 “On joint stock companies” (“JSC Law”), the Federal law No. 39-FZ of 22 April 1996 “On securities markets” and the Federal law No. 14-FZ of 8 February 1998 “On limited liability companies” (“LLC Law”).

The Bill proposes to significantly modify the convertible loan mechanism as a tool for performing investment.  

The essence of the convertible loan agreement mechanism implies, that upon execution of a loan agreement the creditor (participant, shareholder, third party) is entitled to demand return of debt from the borrower (the company), as well as its partial or full set-off notwithstanding loan maturity. Such set-off is made against making a contribution to the borrower’s share capital or payment for shares of the company.

The following amendments are expected to be incorporated into the cited Federal laws:

1. Introduction of a possibility to convert the loan into share capital in non-public joint stock companies and limited liability companies subject to entering in convertible loan agreement. Debt conversion can be carried out either by the share capital increase or by repurchasing of the company’s own shares and selling this package to the creditor. Hence, the investor (third party) becomes a new company’s participant (shareholder). Share re-purchase against debt settlement is not contemplated in the current Russian law.
2. Unlike current law provisions the Bill establishes, that convertible loan agreement shall be approved by shareholders unanimously. Non-compliance with mentioned requirement induces nullity of the provision in the agreement regarding setting off monetary claims against payment for the shares. Decisions on acquisition of shares by the company for their further disposal within convertible loan, on share capital increase, introduction respective amendments into the charter. As to the LLC decisions on determination of nominal value and size of third party’s share and on changes in the participants’ shareholding shall be adopted unanimously.
3. The Bill provides for a term to execute convertible loan with a duration of not more, than three years. Said timeline covers the following:

  • disposal of shares, acquired by the JSC for the purposes of further sale to creditor(s) under the convertible loan agreement,
  • contribution by the creditor (participant or third party) into the LLC share capital at the stage of its increase pursuant to the creditor’s application on setting off monetary claims under loan against share capital contribution,
  • allocation of additional issue shares is also done within a term not exceeding three years since issuance registration date (in this particular case up to five year extension is possible by amending issuance decision).

4. Adoption of the decision on approval of convertible loan agreement can be provided for in the corporate agreement. Further to a lawsuit filed in connection with the shareholder’s breach of the provided in the shareholders’ agreement obligation to vote on the issues of share disposal under convertible loan, the courts will be entitled to acknowledge the respective decisions of the general shareholders’ meeting as passed under the said shareholders’ agreement2. The court will be similarly empowered in respect of the decisions made by LLC general participants’ meetings3. The court will also order on the public registration of amendments into the LLC charter in case of evasion of the documents’ submission for due registration4.

Convertible loan tool is strictly speaking not a novelty in Russian legislation. It is currently provided for in clause 4 art. 19 of the Law on LLC and clause 2 art. 34 of the Law on JSC, which stipulate, that under unanimous (3/4 majority for JSC) decision of the general meeting of participants (shareholders), said participants (shareholders) are entitled to set off their monetary claims to the company against additional contributions (payment for shares). However, current law does not allow such set-off, unless availability of a respective monetary claim in respect of a mature debt. The set-off also does not enable the investor to obtain the share or demand share issuance decision-making. Said restrictions justify use of foreign law for structuring outlined transactions.

The Bill authors note, that using the new mechanism is designed to facilitate company financing procedures. The Bill is primarily aimed at making Russian law more attractive for structuring transactions. However, the Bill leaves aside a series of essential issues pertaining to practical aspects of new investment tool use, in particular methods of avoiding creditor’s share dilution, methods of estimating share value thresholds and other issues. Their resolution will highly depend on the case law and in general on the response of the courts to implementation of the new financing tool.

The Bill is currently being considered by the State Duma of the Russian Federation and will monitor its progress.

_____

1http://asozd.duma.gov.ru/main.nsf/(Spravka)?OpenAgent&RN=189256-7#utm_campaign=nw&utm_source=consultant&utm_medium=email&utm_content=body
2Clause 4.3 of article 49 of the Law on JSC in the wording introduced by the Bill
3Clause 11 of article 37 of the Law on LLC in the wording introduced by the Bill
4Clause 6 of article 24 of the Law on LLC in the wording introduced by the Bill



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