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The Draft Law of Ukraine “On Amendments to Certain Legislative Acts of Ukraine Regarding Protection of Investors’ Rights”

On September 17, 2013, the Verkhovna Rada of Ukraine adopted in the first reading the Draft Law “On Amendments to Certain Legislative Acts of Ukraine Regarding Protection of Investors’ Rights” as a framework document. This Draft Law provides for making amendments to the Commercial Procedural Code of Ukraine, the Civil Code of Ukraine, the Law of Ukraine “On Business Companies,” and the Law of Ukraine “On Securities and Stock Market”.

The analysis of the Draft Law shows that the amendments are designed for tackling the issue associated with the protection of investors’ rights by granting each participant (shareholder) of a business company the right to go to court on behalf of the company for holding officers of the company liable for damages caused by illegal acts committed by such officers. In particular, the Draft Law provides for the introduction of a new tool for protection of investors’ violated rights, namely a derivative lawsuit. 

The Draft Law amended Article 1 of the Commercial Procedural Code of Ukraine. According to this article, in cases provided by legislative acts of Ukraine, state and other authorities, individuals who are not engaged in entrepreneurial activities and participants (shareholders) of business companies shall also have the right to apply to a commercial court. Thus, individuals who are participants in business companies are recognized as parties to commercial litigation (involving a certain category of disputes). 

It is known that at the end of 2006 amendments were made to the Commercial Procedural Code which specified that commercial courts shall have jurisdiction over corporate disputes. Since that time, individuals who are participants in business companies may act as parties to commercial litigation. Thus, the suggested amendments to Article 1 of the Commercial Procedural Code of Ukraine are introduced for the purpose of aligning the earlier made amendments with the content of other provisions of the Commercial Procedural Code of Ukraine

The Draft Law suggested to supplement the Commercial Procedural Code of Ukraine with Article 48 “Official Publication of Announcements in Matters Regarding the Indemnification for Damages Caused to a Business Company by Its Officers”. In particular,announcements shall be officially published no later than seven days prior to the court hearing date, except for the announcements regarding the commencement of proceedings for indemnification of damages caused to a business company by its officers, which announcement shall be publishedno later than 20 calendar days prior to the court hearing date. All announcements relating to the respective case shall be posted on a single webpage specifying the name, registered address and identification code of the plaintiff, the amount and number of claim, and the date of publication of each announcement. Other information to be posted on the Internet shall include information on commencement of proceedings in a case, postponement of proceedings, adjournment of a hearing, suspension and resumption of proceedings in a case, dismissal of a claim, termination of proceedings in a case, acceptance of an appeal for consideration, acceptance of a cassation appeal for consideration, rendering of judgments on the merits, and applications of participants (shareholders) for participation in the case on behalf of the plaintiff, etc.

We believe that this novelty will be quite useful and justifiable. In this way, Ukraine is approaching international standards in the corporate governance practice and in the protection of investors’ interests. The key factor contributing to real protection of investors’ rights is corporate governance transparency, accessibility of information on the activities of both the Company and its officers. By using the abovementioned resource, investors will be able to obtain reliable information on the possible negative dealings in the professional background of officers of business companies, which will help investors make informed staff decisions and assess risks.

Annexes to Article 12 and Article 14 of the Commercial Procedural Code of Ukraine provide that disputes between a business company and its officers regarding indemnification for damages caused by the officer to the business company, based on a claim of the said company or its participant (shareholder) acting on behalf of such business company, shall fall within the competence and territorial jurisdiction of commercial courts.  Such disputes shall be handled by commercial courts at the seat of the respective business company as specified in the Unified State Register of Legal Entities and Individual Entrepreneurs. Amendments were also made to Article 21 of the Commercial Procedural Code of Ukraine. In particular, defendants in a commercial case will now include officers of business companies against whom the claim was filed — in disputes regarding indemnification for damages caused by such officers to the business company.

At the same time, the rules of the Civil Procedural Code of Ukraine will now apply to disputes in a lawsuit brought by participant(s) of the company who hold(s), in the aggregate, five or more percent of the companys authorized capital and applied to a court (except as provided by law) on behalf of the company for indemnification of damages to the company where such damages were caused to the company by the acts (omissions) of its officers, the so-called derivative lawsuit.

The suggested procedure for resolving derivative lawsuits in the civil litigation process is quite strange. The fact is that such dispute is, in its essence, a purely commercial dispute: the subject matter of the claim is the damages caused to the company by illegal acts (omissions) committed by the company’s officers. It would be more expedient for such disputes to fall within the jurisdiction of commercial courts at the seat of the company.

Besides, the establishment of the legal procedure for holding the officers of business companies liable for damages will not address a number issues relating to the scope of such liability and peculiarities of the legal status of certain officers of the company. The head and members of the company’s executive body are employees of the Company who work under an employment contract. The peculiarities of holding the employees materially liable are expressly prescribed by the Labor Code of Ukraine. The Draft Law, however, does not specify whether the abovementioned restrictions and warranties will continue to apply when holding the officers liable where such officers are employed by the Company. In other words, the applicability of these rules of law is again to be decided by a competent court at its discretion.

Besides, the lawmaker introduced certain peculiarities associated with procedural rights and obligations of the parties in a dispute regarding the indemnification for damages caused to business companies by their officers. In particular, the abandonment of claim, the reduction of claims, the change of the subject matter or cause of action, an amicable settlement between the parties, the withdrawal of an appeal or a cassation appeal shall only be possible with the written consent of all the participants (shareholders) of the company who participate in the respective case on behalf of the plaintiff.

Amendments were made to the Commercial Code of Ukraine, namely part 2 of Article 89 “Management of Business Companies” was extended. Pursuant to the abovementioned article, officers of the business company shall include individuals Chairman and members of the Supervisory Board, executive body, Audit Committee, Auditor of the company and Chairman and members of the companys other body provided that the establishment of such body is prescribed by the constitutive documents of the company. However, the analysis of the suggested amendments shows that the term “companys officersis repeated in Articles 23 of the Law of Ukraine “On Business Companies” and in Article 2 of the Law of Ukraine “On Joint Stock Companies”. This means that the abovementioned rule of law is not new.

The Draft Law provides that officers of a joint stock company shall be held fully materially liable for damages caused to the company during the discharge of their duties. However, this mechanism is not well regulated and its function of protection is rather dubious. First, the plaintiffs are now left with a rather heavy burden of proving that damages have actually been caused to the company, that there is a cause and effect relationship between the actions of a certain officer and his or her illegal acts or omissions. The legislation does not cover the issue relating to the division of material liability where the damages are caused by acts (omissions) of the officers of a collegial body (whether such officers will be held jointly and severally liable or whether it will be necessary to determine the degree of guilt of each member of the collegial body or whether those officers will be materially liable who voted against the decision, which resulted in the damages, or who never participated in the discussion of such decision).  Second, the decision to recover damages will not restore the rights and legitimate interests of investors unless such decision is actually executed. If we take into consideration that individuals are defendants in the case, it is quite easy to guess that the defendants will not need to invent mechanisms for avoiding the actual execution of the respective court decision in this situation.   

Following the general analysis of the Draft Law, a conclusion suggests itself that amendments made to legislative acts do not offer a real legal mechanism enabling to protect the rights of participants (shareholders) of joint stock companies and actually prevent holding the officers acting in bad faith against the interests of the company liable for their acts. However, only time will show how effective this procedure will be in practice.