As follows from the explanatory note to the Draft Law (“Explanatory Note”), the proposed amendments are due to the need to eliminate the significant shortcomings in the regulation of takeovers identified as a result of 15 years of law enforcement experience; therefore, the Draft Law is aimed at improving the regulation of the procedure for acquiring large shareholdings in PJSCs.
The authors of the Draft Law believe that the abovementioned changes will help boost investor confidence in the Russian financial market.
If the Draft Law is adopted and signed by the President of the Russian Federation, it will enter into force on 1 October 2024.
We have analysed the Draft Law and provide a brief overviewFor convenience, hereinafter in this overview: (i) a person acquiring a large stake in a PJSC (more than 30%, 50% or 75% of the voting shares in a PJSC) will be referred to as a “majority shareholder”; and (ii) other shareholders of a PJSC will be referred to as “minority shareholders” of its most significant provisions below.
1. Category of “affiliates” will be replaced by the category of “connected persons”Chapter XI.1 of the JSC Law currently provides that when establishing rights and obligations related to a takeover, one should take into account the shares owned by both the majority shareholder and its affiliates. The authors of the Draft Law write in the Explanatory Note that the legislator currently views the majority shareholder and its affiliates as a single entity, assuming that they form a group with a unity of will and economic interests.
At the same time, as stated in the Explanatory Note, the concept of “affiliates” is contained in article 4 of Law of the RSFSR No. 948-1 “On Competition and Restriction of Monopolistic Activity on Product Markets” dated 22 March 1991, which defines affiliates as individuals and legal entities capable of influencing the activities of individuals and/or legal entities engaged in entrepreneurial activity. The application of this approach to the definition of affiliates in relation to takeover transactions is also confirmed by court practiceSee, for example, Resolution of the Arbitrazh Court of the Western Siberian District No. F04-383/2022 dated 3 March 2022 in case No. А75-5496/2021; Resolution of the Arbitrazh Court of the Western Siberian District No. F04-5931/2018 dated 5 February 2019 in case No. А45-1224/2018. According to the authors of the Draft Law, the current definition of affiliates assumes that they are independent entities and may have their own economic interests.
Taking this into account, the current approach makes it simple to create artificial affiliation, whereby, for example, a formally unaffiliated but friendly investor may acquire more than 10% of newly issued shares through closed subscription. Subsequently, after the shareholding is diluted in favour of the friendly investor, the majority shareholder may make a voluntary offer and solely acquire more than 10% of shares from the friendly investor, thus becoming the owner of more than 95% of shares, which in turn will enable it to squeeze out minority shareholders as envisaged under article 84.8 of the JSC Law.
In this connection, it is proposed that the category of “affiliates” be replaced with the category of “connected persons”, i.e., persons acting jointly in economic relations and determining each other’s will. The majority shareholder’s connected persons will be determined based on several criteria:
- kinship criterion: spouses, parents, children, brothers, sisters, adoptive parents and adopted children of the majority shareholder, and their controlled persons;
- control criterion: persons controlled by the majority shareholder and persons controlling it, as well as persons controlled by such controlling personsThe Russian Federation, a constituent entity of the Russian Federation and a municipality are not recognised as controlling persons;
- contractual relationship criterion: persons who have entered into (i) a property fiduciary management agreement, (ii) a simple partnership agreement, (iii) an assignment agreement, (iv) a shareholders agreement and/or (v) another agreementThe burden of proving the existence of such an agreement in the event of a legal dispute rests with the claimant with the majority shareholder, the subject matter of which is the acquisition of control over the relevant PJSC.
2. Indirect acquisition of a large shareholding in a PJSC will trigger a mandatory offer obligationFor a long time, the legal community has been discussing the issue of making a mandatory offer in case of the acquisition of indirect control over a PJSC. Some members of the legal community believed that the provisions of the JSC Law do not unambiguously indicate that a mandatory offer may be triggered by the acquisition of indirect control, while others, on the contrary, expressed the opinion that such offer should be made upon acquisition of indirect control. Some took a neutral position on the approach to the interpretation of the JSC Law, but noted that if it is assumed that the acquisition of indirect control should not trigger the mandatory offer procedure, then the acquisition of indirect control may become a malicious way of circumventing the mandatory offer obligation.
For a long time, the practice of Russian courtsSee Resolution of the Federal Arbitrazh Court of the Moscow District No. F05-3782/14 dated 8 May 2014 in case No. А40-107280/13; Resolution of the Arbitrazh Court of the Moscow District No. F05-24774/2021 dated 6 October 2021 in case No. А40-168415/2020; Resolution of the Arbitrazh Court of the Moscow District No. F5-7689/2019 dated 16 March 2020 in case No. А40-126276/2018 has generally assumed that in such a situation there is no obligation to make a mandatory offer, since such obligation arises upon acquisition of shares in a PJSC itself, rather than upon acquisition of a participation interest (or shares) in a shareholder of such PJSC.
The Explanatory Note also states that the current version of the JSC Law does not require that a mandatory offer should be made in the event of acquiring indirect control over a PJSC, which is why this approach needs to be improved, since in the case of indirect voting, a person who does not own a large shareholding in a PJSC receives all the advantages and benefits associated with having a high level of corporate control and is not required to make a mandatory offer. The Draft Law proposes to expressly state in clause 1 of article 84.2 of the JSC Law that a mandatory offer shall be made by a person who, alone or together with its connected persons, becomes the owner of more than 30, 50 or 75 percent of the total number of voting shares in a PJSC.
If the Draft Law is approved, this elaboration will eliminate the doubts and discussions that existed around the interpretation of clause 1 of article 84.2 of the JSC Law in terms of indirect acquisition of shares and will suggest that a direct obligation to send a mandatory offer exists in such cases.
At the same time, the definition of “connected persons” proposed in the Draft Law (see paragraph 1 of this review for details) does not seem to be completely clear, which gives more discretion to courts in deciding whether a mandatory offer should be made in certain circumstances. Furthermore, the burden of proving that a connection exists in case of an agreement to acquire control over a PJSC in court proceedings will be placed on the claimant, i.e., in the case at hand, on the person proving that the majority shareholder has an obligation to make a mandatory offer.
Legal practitioners have also repeatedly pointed out the need to raise the threshold at which a majority shareholder is obliged to make a mandatory offer, since the acquisition of more than 30% of shares does not always imply actual control over a PJSC. The authors of the Draft Law did not provide for a corresponding amendment, but included the grounds for exempting a majority shareholder from the mandatory offer obligation (see paragraph 6 of this update for more details).
3. Time limits for sending a mandatory offer are extended and elaboratedThe Draft Law proposes to extend the mandatory offer period from 35 days under the current version of the JSC Law to 50 days (clause 1 of article 84.2 of the JSC Law).
The authors of the Draft Law propose to consider the possibility of extending the mandatory offer period in the event that the prior consent of an antimonopoly (competition) authority and/or a decision on prior consent of the federal executive body performing functions of control over foreign investments in the Russian Federation is required for the purposes of acquiring shares. Such period may be extended by the Bank of Russia at the request of the majority shareholder for a period required to obtain the relevant consent/decision.
Importantly, the issues related to obtaining regulatory approvals are not covered by the current version of the JSC Law, which suggests that the Draft Law eliminates the legal gap in this area.
4. Rules for acquiring large shareholdings in PJSCs will be extended to other categories of shareholdersAt present, the mechanisms provided for in the JSC Law aimed at protecting minority shareholders’ rights only apply to the shareholders owning voting shares in PJSCs. In turn, the Draft Law proposes to extend such mechanisms to:
- shareholders owning non-voting preferred shares of PJSCs; and
- holders of securities convertible into shares in PJSCs.
5. Methods have been determined to protect minority shareholders’ rights if the procedure for acquiring a large shareholding in a PJSC is violatedThe Explanatory Note points out that the current laws do not have any effective measures to enforce compliance with Russian laws during the takeover process, which is why the authors of the Draft Law suggest the following ways to protect minority shareholders’ rights:
I. General methods to protect minority shareholders’ rights
If the majority shareholder fails to make a mandatory offer, the minority shareholders to whom such offer is to be made have the right to require that the majority shareholder:
- make a mandatory offerPreviously, there was no unified position in court practice on the possibility of forcing a majority shareholder to make a mandatory offer. At the same time, the prevailing practice was that such a requirement was impossible (see, for example, the ruling of the Moscow District Arbitrazh Court dated 3 June 2016 in case No. A40-159967/2015, the ruling of the Moscow District Arbitrazh Court dated 11 January 2018 No. F05-19557/2017 in case No. A40-59285/17), while the opposite position was found in isolated cases (see, for example, the ruling of the Moscow District Arbitrazh Court dated 24 December 2019 No. F05-22575/2019 in case No. A40-5109/2019);
- compensate for any damages caused; and/or
- acquire all or some of the minority shareholder’s securities at a price equal to the higher of:
- the weighted average price of shares on a stock exchange over the six months prior to the date of the mandatory offer; or
- the price determined by an appraiser (if the shares are not listed on a stock exchange or have been traded for less than six months).
However, the price so determined may not be lower than the price at which the majority shareholder acquired or agreed to acquire PJSC shares or control of PJSC shares.
In addition, the minority shareholders are also entitled to seek damages caused by the relevant acts or omissions of the majority shareholder.
II. Majority shareholder disenfranchised
The current version of the JSC Law contains provisions limiting the majority shareholder’s voting rights prior to making a mandatory offer, namely, the PJSC shares owned by it over the threshold of 30% of the PJSC voting shares are disenfranchised and are not counted in the quorum (Clause 6 of article 84.2 of the JCS Law). However, the Explanatory Note says that this measure is not effective, as the minimum quantity of shares that a majority shareholder is entitled to vote with (30%) still secures a majority of votes for such person when adopting resolutions at a general meeting of shareholders; therefore it does not incentivise such person to make a mandatory offer. This is why the Draft Law establishes the following thresholds to restrict the majority shareholder’s votes until the shareholder makes a mandatory offer:
- if the majority shareholder became the owner of more than 30% of a PJSC’s voting shares, to no more than 3/7 of the total number of the other shareholders’ votes;
- if the majority shareholder became the owner of more than 50% of a PJSC’s voting shares, to no more than 50% of the total number of the other shareholders’ votes; and
- if the majority shareholder became the owner of more than 75% of a PJSC’s voting shares, to no more than 75% minus one vote of the total number of the other shareholders’ votes.
6. Grounds set for the exemption from the mandatory offerThe authors of the Draft Law note that in practice there are situations where an increase in corporate control is not intended, and the person who becomes the owner of a large shareholding in a PJSC has no intention to exercise such control. However, the current version of the JSC Law does not take such cases into account.
In this connection, it is proposed to envisage grounds for exempting the majority shareholder from the mandatory offer obligation. In particular, this happens if the majority shareholder makes a transaction that would result in the percentage of its direct or indirect interest in the PJSC falling below the thresholds imposed by the JSC Law (30%, 50% or 75% of the PJSC’s voting shares) (“Transaction”), provided that the following conditions are met simultaneously:
- the majority shareholder gives notice to the Bank of Russia and the PJSC of the intention to enter into the Transaction;
- the majority shareholder makes the Transaction within three months after the expiry of the mandatory offer periodSuch period may be extended by the Bank of Russia if the majority shareholder applies for the consent of the government authorities and/or the Bank of Russia to the acquisition of the relevant voting shares for the period needed to obtain such consent;
- the majority shareholder gives notice to the Bank of Russia and the PJSC of the Transaction no later than 14 days after it is made; and
- the majority shareholder does not take part in adopting resolutions by a general meeting of shareholders in respect of any votes exceeding the thresholds specified in paragraph 5(II) above.
7. Minority shareholder may refuse to accept a voluntary offer or mandatory offerThe Draft Law provides that the minority shareholder and the majority shareholder (who wishes to make a voluntary offer or is required to make a mandatory offer) may conclude an agreement whereby the minority shareholder will waive, in whole or in part, its right to accept the voluntary or mandatory offer. Therefore, no voluntary or mandatory offer will be made in respect of the shares held by such minority shareholder.
Pursuant to the minority shareholder’s order/instruction, an entry will be made on the minority shareholder’s account that a restriction exists on the disposal of the shares covered by the agreement. Such restriction will be lifted without an order/instruction to that effect:
- on the date of expiry of the voluntary or mandatory offer period; or
- if no such offer is sent, upon the expiry of the 50-day period after such restriction was imposed (unless the order/ instruction specifies a longer period).
8. Extension of methods used to secure obligations arising pursuant to a voluntary or mandatory offerThe current version of the JSC Law requires that the majority shareholder making a voluntary or mandatory offer provides a bank guarantee meeting certain conditions (Clause 5 of article 84.1 of the JSC Law; clause 3 of article 84.2 of the JSC Law).
The Draft Law, in its turn, supplements the current security arrangements (bank guarantee) with additional methods of securing the majority shareholder’s obligations (which may be used both separately and jointly):
- an independent guarantee, which is subject to the following requirements:
- it should be issued by a credit institution or other commercial organisation which meets the regulatory requirementsThe Bank of Russia also has the right to impose the relevant requirements in relation to credit organisations which are entitled to issue independent guarantees of the Bank of Russia;
- it should contain certain conditions listed in the Draft Law;
- a request for payment of a sum of money under an independent guarantee and the accompanying documents (as listed in the Draft Law) should be submitted to the guarantor by the PJSC’s registrar acting on behalf of and in the interests of the minority shareholders, or, if the registrar fails to fulfil this obligation, by the minority shareholders themselves; and
- if the guarantor fails to fulfil its obligations to pay for the shares acquired pursuant to a voluntary or mandatory offer, the minority shareholders to whom such offer made have the right to take legal action to recover the funds owed to them by the guarantor; and/or
- a pledge of government securities of the Russian Federation, which shall be subject to the following requirements:
- the pledgor under the pledge agreement may be a majority shareholder or any other person;
- the subject of pledge may beRegulations of the Bank of Russia may provide for other listed securities which may be pledged Russian government securities free from any third party rights, listed and traded on a stock exchange for at least six months, for which the stock exchange calculates the weighted average price;
- substitution of the subject of pledge is not allowed;
- the pledge agreement should contain certain conditions set out in the Draft Law;
- a record of the pledge of shares in the account in which the pledgor’s rights are recorded shall be made before a voluntary or mandatory offer is submitted to the Bank of Russia. After such record is made, their owner shall not have the right to dispose of such securities;
- the securities pledge arises on the date on which the voluntary or mandatory offer acceptance period expires;
- the pledgee’s powers are exercised by the PJSC’s registrar; the record of securities pledge specifies certain information on the pledgee listed in the Draft Law;
- a record of termination of the securities pledge is made by the registrar or a securities depository in the pledgor’s account without the pledgor’s order/instruction no later than the next business day after the PJSC’s registrar and securities depository give notice that all securities being purchase have been paid for; and
- the pledged securities are to be enforced in an out of court procedure.
9. Measures taken to protect minority shareholders’ rights in the event of a compulsory acquisition of PJSC shares by the majority shareholderThe current version of the JSC Law stipulates that a person who has become the owner of 95% of a PJSC’s shares has the right to buy out the remaining shares only if such person has previously acquired at least 10% of the PJSC’s shares as a result of a voluntary or mandatory offer (Clause 1 of article 84.8 of the JCS Law).
As we noted earlier (see paragraph 1 of this update), in practice such conditions are often created artificially by selling shares to a person not formally affiliated with the majority shareholder, followed by the majority shareholder purchasing the shares from such person to reach the 95% threshold.
In order to eliminate such practice, it is proposed that an express prohibition be introduced on taking into account the shares acquired from connected persons for the purposes of compulsory acquisition.
In the context of changing the approach to persons affiliated with the majority shareholder, this proposal appears to be logical and to strengthen the protection provided to minority shareholders in situations where the thresholds are exceeded through the involvement of friendly investors.
10. Removal of mechanism for notifying shareholders of their right to demand that their shares be bought outThe current wording of the JSC Law requires the majority shareholder owning more than 95% of the PJSC shares to give notice to the other shareholders that they are entitled to demand their shares be bought out (Clause 2 of article 84.7 of the JCS Law).
The Explanatory Note points to the need to eliminate such mechanism because it is barely used in practice. Alternatively, the Draft Law provides for the right of minority shareholders to independently require their shares be bought out.
Such proposal correlates with the overall idea of the authors of the Draft Law aimed at optimising the costs associated with the conduct of the procedures provided in Chapter XI.1 of the JSC Law.
ConclusionsThe Draft Law fills many legislative gaps and eliminates the discussions that have long been held in the legal community (e.g., extending the mandatory offer obligation to situations when indirect control over a PJSC is acquired), and removes ambiguities in the interpretation of certain provisions of the JSC Law.
At the same time, the Draft Law provides more detailed regulation of certain institutions and proposes some new alternatives to that extent. For example, the Draft Law not only expands the list of security methods, but also imposes more formal and precise requirements on their content and the procedure for obtaining them. In this regard, there are doubts as to how quickly market participants will be able to accommodate to such innovations.
The Draft Law was introduced to the State Duma in late December 2023 and to date has not passed through the first and subsequent readings, which is why we can expect amendments to the Draft Law to be proposed in the near future. We will follow the further development of the Draft Law and keep you informed.