March 3, 1997

The New Russian Law on Limited Liability Companies:

An Initial Analysis

by Ethan S. Burger, Evgeny Danilov, and Irina Paliashvili

Russian - Ukrainian Legal Group, P.A.

Introduction

As a result of the long-awaited Russian Federal Law “On Companies with Limited Liability”, (hereinafter the “LLC Law”), signed by President Yeltsin on February 8, 1998, the LLC will most likely become the overwhelming choice for foreign investors seeking to form a legal entity to conduct business in Russia, with the possible exception of those involved in joint ventures with local or other foreign partners. As a legal form, the LLC[1] has two principal advantages over the joint stock company (“JSC”) under Russian law. [2] First, LLCs allow for simple management structures suitable for wholly-owned subsidiaries and small businesses. Second, LLCs are outside the purview of Russian securities legislation (thus avoiding time-consuming and costly securities regulation). From a Russian tax standpoint, LLCs and JSCs are treated in an identical manner with the exception that a JSC must pay a 0.8% tax on the issuance of its shares (with the exception of a JSC’s initial issuance of shares). The LLC may have the added benefit for U.S. investors since, depending on how its foundation documents are drafted, it may qualify as a “partnership” for U.S. tax purposes.[3]

The new LLC Law enters into force on March 1, 1998. As of this date, the foundation documents of existing LLCs are valid only to the extent they do not contradict the LLC Law’s provisions. Existing LLCs will need to thus examine their foundation documents in light of the requirements of the LLC Law to identify provisions that will no longer be valid . Such LLCs have until January 1, 1999 to amend and re-register their charters in a manner consistent with the new requirements. Furthermore, before July 1, 1998, LLCs having more than 50 participants must either reduce the number of participants or be transformed into another legal form (LLC Law, Article 59).[4]

Background

The LLC was first recognized by RF legislation as a corporate form for conducting business more than three years ago.[5] While Russian legislation envisioned the enactment of a separate law on LLCs,[6] neither the Russian Government nor the State Duma made enactment of such a law a high priority. In the resulting legislative vacuum, LLCs were governed primarily by the Civil Code’s general provisions on legal entities and its eight specific articles on LLCs.

The absence of well-established rules did not ordinarily discourage an investor from using an LLC to establish a wholly-owned subsidiary since it could easily amend the company’s foundation documents to comply with any new requirements that in all likelihood would not be more burdensome than those for closed JSCs. The situation was different with respect to joint ventures. Not only does the LLC have features that may not be suitable for use in a joint venture, the knowledge that upon the enactment of the LLC Law, the parties would be forced to agree on amendments to the foundation documents presented a significant problem: that the underlying arrangements might have to be “re-negotiated”. Since the adoption of the JSC Law in December 1995, if one (usually the foreign investor) feared that its negotiation position might deteriorate over time (not an infrequent occurrence), rather than risk the need to reach a new understanding on the contents of the joint venture entity’s foundation documents, the foreign investor often opted for the risk adverse option of the closed JSC since the requirements for which, may not have been ideal, were at least known.

Over the last two years, with the enactment of the RF Law “On the Securities Market”, dated April 22, 1996, (hereinafter the “Securities Law”), and “Standards on the Emission of Securities During the Founding of Joint Stock Companies, Additional Shares, Bonds and Their Prospectuses for Emission” approved by Federal Commission for the Securities Market Decree No. 19, dated September 17, 1996, JSCs have had to comply with increasingly burdensome regulatory requirements.[7] Since participants in a Russian LLC hold participatory interests (doli), rather than stock (aktsiya) as is the case with stockholders of JSCs, LLCs generally remain outside the scope of Russian securities regulation.[8] As a result, LLCs can more readily and at lower cost change their charter capital.

Structure of the LLC Law

The LLC Law is divided into six separate chapters consisting of a total of 59 articles dealing with: (i) general provisions, (ii) foundation of a company, (iii) charter capital and property of a company; (iv) management, (v) reorganization and liquidation, and (vi) the law’s entry into force. Not surprisingly, many of its features will be familiar to those acquainted with the JSC Law. This is not to suggest, however, that the LLC Law merely borrows concepts and takes text from the JSC Law.

Foundation Documents for LLCs

RF legislation provides that an LLC with two or more participants has two foundation documents: a charter and a foundation agreement (Civil Code, Article 89 and LLC Law, Article 12). An LLC may have a single participant so long as such participant itself has more than one shareholder or participant (Civil Code, Article 88, Point 2, and LLC Law, Article 7, Point 2). If an LLC has only one participant, it will only have a charter (approved by an official decision of such founder). The charter governs the operation of the company and must contain certain information. [9]

An LLC’s founders set forth their agreement to establish a company and define the procedure for their joint activity in a foundation agreement. The foundation agreement must identify the founders (participants) in the company, the size of the charter capital and the participatory interests of the respective founders, the size, form, procedure and timing of their contributions to charter capital, the liability of the founders’ for violating their duty to make charter capital contributions, the rules for the distribution of profit, the management structure, and the procedure for the withdrawal of a participant from the company (LLC Law, Article 12, Point 1). Russian legislation considers an LLC’s foundation agreement a “foundation document” that survives the establishment of the company (Civil Code, Article 89 and LLC Law, Article 11, Point 1)[10], whereas the JSC Law specifically states that “the agreement on the establishment of a company is not a foundation document of a company” (JSC Law, Article 9, Point 5).

LLC Management Structure

The LLC Law provides an LLC’s participants the option of having a two- or three-level management structure: a General Assembly of Participants (hereinafter “General Assembly”), an optional Board of Directors (also called a “Supervisory Council”), and an executive body (which can be composed of a (i) single individual (e.g. a general director), or (ii) a single individual and a collegial body. If an LLC has more than fifteen participants, it must have either an audit commission or controller (revizor) verify the company’s financial records. Alternatively, the General Assembly may engage a professional auditor to perform this function (Article 32).

The General Assembly is the company’s highest body. The LLC Law places most critical issues relating to the company’s management and operation within the competence of the General Assembly.[11] Unless an LLC’s charter provides for more demanding voting requirements, most decisions of the General Assembly are adopted by a simple majority vote of all of the company’s participants with the exception of certain decisions most of which require either a two-thirds majority or unanimous vote of all of the company’s participants such as: (i) amendment of the company’s charter and foundation agreement, including changes in the amount of the company’s charter capital as well as related decisions, (ii) sale of participatory interests temporarily belonging to the Company, (iii) establishment, limitation or termination of additional rights or duties for one or more participants,[12] (iv) contribution by participants of property to the Company not included in its Charter Capital, (v) the Company’s reorganization or liquidation, (vi) confirmation of the monetary value of in-kind contributions made by a Participant to the Company’s charter capital (Articles 8, 9, 15, 18, 19, 24, 27, 28 and 37).

The LLC Law requires that the General Assembly adopt decisions pursuant to a majority or super-majority vote of all the participants, rather than those present or represented at one of its meetings (LLC Law, Article 37). This rule gives minority participants in LLCs greater protection than that enjoyed by minority shareholders in JSCs, the General Assemblies of which adopt decisions on the basis of the votes of shareholders who are present or represented at a given meeting of shareholders (JSC Law, Article 49, Point 4).

Usually, the voting power of a participant is proportional to its share of the LLC’s charter capital. Of potential importance to persons forming a joint venture, an LLC’s foundation documents may provide for a participant having a number of votes disproportionate to its percentage of the LLC’s charter capital,[13] with certain exceptions.[14] Consequently, it should be possible to prepare foundation documents where management control of an LLC is independent of ownership.

An LLC’s charter may provide for cumulative voting to elect members of the Board of Directors, executive bodies, and audit commission (Article 37, Point 9). If the LLC has a single participant, it need not follow the procedures for convoking and conducting the General Assembly and can take action pursuant to the participant’s written decision (Article 39).

As noted above, the LLC Law provides participants the option of creating a Board of Directors (Article 32). The Board of Directors’ functions in an LLC are similar to those in a JSC, such as overseeing the company’s business operations, supervising executive bodies (including, if provided in the charter, electing and replacing such bodies’ officers), and organizing sessions of the General Assembly.[15]

The LLC Law, like the JSC Law, allows a company’s charter to divide between the General Assembly and the Board of Directors the authority to approve certain (i) so-called “interested party” transactions involving potential conflicts of interest, such as those between members of a company’s executive body or Board of Directors, or certain participants in the company with the company[16] (Article 45), and (ii) so-called ‘major transactions’ concerning the acquisition or alienation of property the value of which represents more than 25% of the company’s property other than in the normal order of business. The Board of Directors, however, may not be empowered to approve “interested party” transaction if they involve an amount to be paid or property the value of which is more than two percent of the value of property of the Company. In such a case, the decision must be made only by the General Assembly (Article 45, Point 7).

With respect to major transactions, a Board of Director’s authority is limited to approving transactions the value of which is from 25% to 50% of the value of the LLC’s property – transactions above this threshold must be approved by the General Assembly. The LLC Law, however, unlike the JSC Law, allows a company to opt out of the requirements for approval of major transaction rules if so provided in its charter (Article 46, Point 6).

While the LLC Law is generally flexible with regard to structuring the company’s management, this flexibility does not extend to giving members of the company’s executive body or Board of Directors (if any) the right to transfer their right to votes at meetings to other individuals, including other members of the relevant body (Article 32, Point 5).

An LLC may have a single-person executive body that manages the company (e.g. General Director) (Article 40). Alternatively, it may have a collegial executive body and single-person executive who serves as the head of such body (LLC Law, Article 41). In addition, an LLC having a single-person executive body can hire a legal entity or outside individual to manage it, if so provided in its charter (LLC Law, Article 42).

The member(s) of an LLC’s executive bodies and Board of Directors are required by law to act in the company’s interest and perform their duties in good faith. Failure to do so can result in their liability to the company and its participants (Article 44).

Not only does the LLC Law give the founders a great deal of freedom to structure the company’s management, it also allows them flexibility in distributing the company’s profits. An LLC may pay out its profits to its participants quarterly, semi-annually or annually. While usually participants receive profits in proportion to their share in the LLC’s charter capital, another principle is permissible as long as it is set out in the company’s charter or unanimously decided upon by the General Assembly (Article 28). As noted above, the LLC Law provides the possibility for divorcing management control over a company from the amount of profit participants receive.[17] In addition, since an LLC, unlike a JSC, is not required to (but may) have a reserve fund, its participants will receive more profits than will shareholders in a legal entity structured as a JSC (LLC Law, Article 30). Of course, the lack of a reserve fund should be taken into account by persons contemplating entering into transactions with a partner organized as an LLC.

The LLC Law permits granting special rights to its participants (Article 8). Thus, an LLC’s charter may grant a participant a first right to purchase of the company’s output (which may be advantageous to provide for in a charter of a joint venture). The LLC Law also permits assigning additional duties to participants (Article 9). This permits an LLC’s charter to provide that a participant must supply inputs for production by the company at cost. While these features may be useful in structuring a joint venture vehicle, other provisions of the LLC Law may make it inappropriate for such purposes, in particular: (i) restrictions on the right to transfer participatory interests; (ii) a participant’s right to withdraw from an LLC; and (iii) the possibility that a participant might be excluded from an LLC. These issues are discussed below.

Transfers of Participatory Interests, Withdrawal from an LLC and Exclusion of Participants

In contrast to JSC shareholders which may freely alienate their shares (although possibly subject to the exercise of rights of first refusal in closed JSCs),[18] an LLC’s charter may provide that its participants may not sell or otherwise alienate their participatory interests without the consent of the other participants (Article 21, Point 5).[19]

An LLC’s charter may also provide for a company acquiring a participant’s participatory interest, if the other participants refuse to acquire it or consent to its transfer. A company can also acquire a participatory interest of a participant that has been excluded from the company. Irrespective of the manner of acquisition, the company must within one year either distribute such participatory interest among the participants, transfer it to third parties or reduce its charter capital; the company may not vote at its own General Assembly nor is it entitled to receive its own dividends. In all such cases where the company acquires a participatory interest, it must pay the participant the actual value of its participatory interest in cash or, if agreed by the parties, in kind (Articles 23 and 24).

The LLC Law grants participants the right to withdraw from an LLC at any time independent of the consent of the other participants (Article 26, Point 1). A participant withdrawing from an LLC must nevertheless fulfill any obligations it may have to contribute property to the LLC that arose prior to application on withdrawal (Article 26, Point 4). The withdrawing participant’s participatory interest is transferred to the LLC. The LLC is obligated to pay the “actual value” in cash (or, by agreement, in-kind property) of the withdrawing participant’s participatory interest. Such participatory interest is to be valued based on data from the company’s accounting records for the year within which the participant’s application on withdrawal was submitted. The Company appears to have six months from the end of the then current financial year (unless the charter provides for a shorter time period) to compensate the withdrawing participant for its participatory interest. Consequently, a participant may not view unilateral withdrawal from an LLC as a financially attractive option, but it nonetheless represents a viable option to escape an unsatisfactory joint venture (Article 26, Points 2 and 3).

The LLC Law’s rules concerning the exclusion of a participant from a company may present certain problems. Article 10 provides that:

“Participants in a company, the participatory interests of which in aggregate constitutes not less than ten percent of the charter capital of the company shall have the right to demand in a judicial procedure the exclusion from the company of a participant that grossly violates its duties or by its actions (inactions) makes impossible or makes it significantly more difficult.”

This language suggests that a participant may be excluded by a court in an action brought by a minority participant. It might have been preferable to provide that only the General Assembly would have the right to initiate a case to exclude a participant to reduce the risk of frivolous litigation.

While the potentially undesirable (and conceivably unforeseen) impact of these (and other) provisions of the LLC Law may in certain respects be reduced in well-crafted foundation documents, the parties may not override mandatory provisions affecting one’s rights (see Civil Code Article 9, Point 2 that provides that a waiver of rights by a citizen or legal entity is ineffective except in cases provided by law). For example, it would probably not be permissible to provide for mandatory mediation or cooling off periods before a participant seeks to withdraw from an LLC or brings an action to exclude one of its participants. Thus, an LLC’s founders may not make their own rules if they are unhappy with the mandatory provisions set forth in the LLC Law.

Liability of Participants for an LLC’s Obligations

A major concern to foreign investors is the degree to which they may be exposed to direct liability in Russia. The Civil Code contains a number of provisions in derogation of the general principle that a participant or shareholder in a Russian legal entity enjoys limited liability.[20] The text of the Civil Code is rather vague in defining what conduct will actually entail liability for a company’s participants. As a result, the particular language contained in the LLC Law is vitally important.

Generally, the LLC Law provides that participants in an LLC will only be secondarily liable for the obligations of the company up to the value of the unpaid part of their contribution to the company’s charter capital. It deviates, however, from this principle in certain cases that parallel those identified in the Civil Code. First, LLC Article 3, Point 3 provides:

“In the case of insolvency (bankruptcy) of a company due to the fault of its participants or the fault of other persons that have the right to give mandatory instructions to a company or in another manner have the ability to determine its actions, on such participants or other persons in the case of insufficiency of the property of the company may be imposed secondary liability for its obligations.”

While this language requires the existence of fault for liability of a participant or other person to arise, it is not as demanding a test as that found in the JSC Law which requires that a shareholder or other person “know that as a consequence of their actions the company’s bankruptcy will arise” (JSC Law, Article 3, Point 3).

In any event, LLC Law Article 3, Point 3 will need to be read in conjunction with the rules provided in the new Russian Law on Bankruptcy, dated January 8, 1998 (hereinafter the “Bankruptcy Law”). The Bankruptcy Law suggests that persons (i.e. participants, officers and directors) may face liability in instances of intentional bankruptcy (Article 10). Unfortunately, the Bankruptcy Law does not offer a definition of “intentional bankruptcy”. The Russian Criminal Code, however, defines “intentional bankruptcy” as “the intentional establishment or increase of lack of payment capacity accomplished by the head or owner of a commercial organization . . . in [his/its] own interests or the interest of others, that causes major harm or has serious consequences” (Criminal Code, Article 196).

The LLC Law also seeks to clarify those instances in which a parent company is liable for the financial obligations of its subsidiary if fault is absent. LLC Article 6, Point 3 begins by following the formulation found in the Civil Code that a parent having the right to give mandatory instructions to its subsidiary shall be jointly and severally liable with the subsidiary for transactions concluded by the latter.[21]

It also makes a parent company secondarily liable to its subsidiaries’ creditors if such subsidiary’s insolvency or bankruptcy was due to the fault of the parent (LLC Law, Article 6, Point 3). This language closely tracks the comparable Civil Code language. In addition, participants and the appraiser of an in-kind contribution to an LLC’s charter capital are jointly and severally liable to an LLC’s creditors in the event of an overstatement of the value of such contribution for a three year period from the date of its state registration (Article 15, Point 2).

In light of the above, it would appear that the LLC Law’s language exposes participants in LLCs to a slightly greater risk of liability than shareholders of JSCs. Only time will tell whether this will be in fact the case. Such risk might be addressed by using special-purpose companies to act as participants/shareholders in the newly created LLC.

Final Observation

With the entry into force of this new LLC Law, investors wishing to establish wholly-owned subsidiaries should no longer feel reluctant to use the LLC since its use avoids the need to comply with securities reporting requirements and allows for flexible management. It is more difficult to generalize whether an LLC is an appropriate vehicle for conducting a joint venture given the LLC’s rules for super-majority votes for deciding many issues and the need for unanimity on the part of the participants to amend the foundation agreement (which survives the establishment of the LLC), and potentially greater exposure to liability for participants.

Needless to say, great care will need to be taken to prepare foundation documents for an LLC being used to carry out a joint venture. Nonetheless, lawyers and businessmen alike should be pleased that yet another critical item in Russian corporate law is finally in place.

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[1] The English Public Limited Company (“PLC”), a German Gesellschaft mit Beschraenkter Haftung (“GmbH”), a French SocietJ ResponsabilitJ LimitJe (“SARL”) and the Delaware Limited Liability Company are the functional equivalents of the Russian LLC.

[2] The JSC has existed as a legal form recognized in Russia for more than seven years. The rules governing its establishment and operation were first embodied in regulations approved by Russian Soviet Federative Socialist Republic (“RSFSR”) Council of Ministers Decree No. 601, dated December 25, 1990 (hereinafter the “JSC Regulations”). The JSC Regulations were subsequently supplanted by certain general provisions of the Russian Federation (“RF”) Civil Code, dated November 30, 1994, (hereinafter the “Civil Code”), concerning legal entities (Articles 48 through 65) and certain specific provisions concerning JSCs (Articles 96 through 106) before they were replaced by rules established by the RF Law “On JSCs”, dated December 24, 1995 (hereinafter the “JSC Law”; see also RF Government Decree No. 262, March 6, 1996 that formally repealed the JSC Regulations).

[3] Whether a non-U.S. legal entity is classified as a corporation or partnership for U.S. tax purposes is determined by a “resemblance test” used for classifying foreign legal entities. Rev. Rul. 73-254, 1973-1 CB 613. The US Internal Revenue Service’s corporate resemblance test is set out in Reg. § 301.7701-2(a).

[4] If an LLC is transformed into a closed JSC, such entity will be exempt from certain provisions of the JSC Law concerning the number of shareholders it may have (LLC Law, Article 59, Point 3 and JSC Law, Article 7, Point 3).

[5] Chapter IV of Part I of the Civil Code. Although USSR Council of Ministers’ Decree No. 590, dated June 19, 1990, approved Regulations “On Joint Stock and Limited Liability Companies”, thereby establishing a legal basis for creating LLCs under Soviet legislation, Russian legislation at the time did not explicitly recognize an LLC as a valid legal form (see RSFSR Law “On Enterprises and Entrepreneurial Activities”, dated December 25, 1990). Instead, Russian legislation permitted the establishment of partnerships (tovarishchestvo) with limited liability (“LLPs”) which it recognized as the equivalent of a closed-JSC. Russia never adopted detailed rules on LLPs, and the current Civil Code does not recognize their existence. In fact, the RF Law “On Entry into Effect of the First Part of the Civil Code of the Russian Federation”, dated November 30, 1994, makes clear that LLPs are governed by the rules established for LLCs (Article 6). With the adoption of the new LLC Law, LLPs must register amended charters that conform with the Law’s requirements or risk possible liquidation (see LLC Law, Article 59, Point 3).

[6] RF Law “On the Entry into Effect of the Civil Code”, dated November 30, 1994, Article 6.

[7] For example, JSCs must observe a multi-step process for the issuance of new shares. This includes the preparation of a prospectus when (i) placing issued shares among an unlimited number of owners or holders, or when such owners or holders are known and their number exceeds 500, or (ii) the total value of shares issued exceeds 50,000 minimum monthly wages (approximately US$ 690,000 at the current exchange rates) (see Securities Law, Article 19). JSCs are also required to file quarterly and other reports with the Federal Commission for the Securities Market (see Securities Law, Article 30).

[8] See Civil Code, Articles 142 and 143. An exception to this situation exists when an LLC issues corporate bonds. In such a case it may be required to publish its annual reports, bookkeeping balances or other financial information (see LLC Law, Article 49).

[9] The items identified are: (l) full and abbreviated firm name of the company; (2) location of the company; (3) composition and competence of bodies of the company including a list of issues within the exclusive competence of the General Assembly, and also the procedure for the adoption by them of decisions, including a list of issues, decisions upon which shall be adopted unanimously or by a qualified majority vote; (4) the amount of the charter capital of the company; (5) the proportional share and nominal value of the participatory interest of each participant; (6) the rights and duties of the participants in the company; (7) the procedure for and consequences of the withdrawal of a participant from the company; (8) procedure for the transfer of a participatory interest (part thereof) in the charter capital of a company to another person; (9) the procedure for document preservation and the provision by the company of information to participants and other persons; and (10) other information provided by the LLC Law (Article 12, Point 2).

[10] The LLC Law provides that “in the case of non-conformity of the provisions of the foundation agreement and the charter of a company, the charter shall have preeminent force for third persons and the participants in the company” (Article 12, Point 5).

[11] Such issues include: (1) the determination of the principal direction of activity of the company, including adoption of decisions on participation in associations and other amalgamations of commercial organizations; (2) the change of the charter of the company, including the change of the amount of its charter capital; (3) the introduction of changes into the foundation agreement; (4) the formation of executive bodies of the company, the early termination of their authority, as well as the adoption of a decision on the transfer of authority from the single-person executive body of the company to a commercial organization or an individual entrepreneur (“manager”), approval of the manager and terms of agreement with him; (5) the designation and early termination of authority of the audit commission (controller) of the company; (6) the approval of annual reports and bookkeeping balance sheets; (7) the adoption of decisions on the distribution of the net profit of the company among participants; (8) the approval of documents regulating the internal activity of the company; (9) the adoption of a decision on the placement by the company of bonds and other securities; (10) the decision to conduct an audit, the approval of an auditor and its compensation; (11) a decision on the reorganization and liquidation of the company; (12) the designation of a liquidation commission and the approval of the liquidation balance; and (13) other issues envisioned by the LLC Law (Article 33).

[12] It is worth noting that if a participant alienates all or part of its participatory interests, any additional rights and/or obligations specifically granted to it on an individual basis by the LLC are not automatically transferred to the third-party acquirer.

[13] By way of contrast, the JSC Law provides that each common share of a company grants its shareholders an identical volume of rights (i.e. generally one vote per share each having the right to an equal amount of dividends) (Article 31).

[14] These exceptions include voting to (i) elect the Chairman of the General Assembly (where all participants have a single vote irrespective of the size of their participatory interest in the LLC, unless otherwise provided in the charter) and (ii) to approve transactions involving conflicts of interests (where a majority of disinterested participants is necessary to approve such a transaction (LLC Law, Article 32, Point 1, Article 37, Point 5 and Article 45, Point 3).

[15] The concept of an LLC having the option of having a Board of Directors was added to the law after its first reading. In fact, the Civil Code does not discuss the possibility that an LLC can have a Board of Directors.

[16] Only disinterested board members or participants may participate in such a vote.

[17] JSCs are able to achieve the same result through the issuance of both common and preferred (non-voting) shares.

[18] Participants in LLCs always enjoy such rights of first refusal with respect to sales of participatory interests; such rights, however, need not apply to other forms of alienation unless otherwise provided in the charter(LLC Law Article 21, Point 4).

[19] Similarly, an LLC’s charter may limit a participant’s right to pledge its participatory interests (Article 22).

[20] Civil Code Article 56, Point 3, which is applicable to all legal entities, provides in relevant part that:

“If the insolvency (bankruptcy) of a legal entity is caused by its founders (participants), by the owner of the property of the legal entity or by other persons having the right to give obligatory instructions to the legal entity, or in another manner have the possibility to determine its actions, then such persons in the event of the insufficiency of the property of the legal entity may be secondarily liable for its obligations.”

Given that the Civil Code contains no definition of the word "caused", Article 56, Point 3 would arguably allow a court to "pierce the corporate veil" even absent a showing of fraud or other illegal conduct by a shareholder or other participant. Since this provision refers to "other persons" having the right to give obligatory instructions to the legal entity, it may provide a basis for holding a company's officers or directors liable for its insolvency.

Russian law also recognizes the liability of a "parent" for a subsidiary under certain circumstances. The definitions used by the Civil Code are peculiar to it. Pursuant to Article 105, Point 1 a company is considered a "parent" of another if it holds majority ownership of such company or "by contract or by other means has the possibility to determine decisions adopted by such company." (emphasis added). This suggests that liability will depend on the factual circumstances in a particular case.

Article 105, Point 2 establishes that while subsidiaries bear no liability for the debts of their parents, parent companies (partnerships) which have the right to give to their subsidiary companies obligatory instructions, including on the basis of contracts with them, shall bear joint and several liability with the subsidiary companies regarding transactions concluded by the latter in accordance with such instructions. In addition, Article 105, Point 2 establishes the secondary liability of a parent company for the debts of its subsidiary in the event that the bankruptcy of the subsidiary is caused due to "fault" of the parent. It is unclear whether the word "fault" as used in Article 105, Point 2 implies a different standard of liability than the word "cause" used in Article 56, Point 3. Furthermore, Article 105, Point 3 provides: "participants (stockholders) of a subsidiary company have the right to demand compensation from the parent company (partnership) for losses caused by its fault to the subsidiary, unless otherwise established by the laws on business companies." It would seem that the specific language of the LLC Law would be followed to the extent that it can read consistently with the general language of the Civil Code with respect to any examination by a court of a participant’s liability.

[21] The LLC does not follow the JSC Law’s narrow view of what constitutes “mandatory instructions” (see JSC Law, Article 6, Point 3). The JSC Law provides that a parent company only has the right to issue mandatory instructions to its subsidiary where “such right is provided in an agreement with the subsidiary company or in the charter of the subsidiary company.” (emphasis added). Similar language was contained in the draft of the LLC that was passed on its first reading, but it was subsequently removed, perhaps to reduce the potential for abuse.