Supervisory Board in LLC with a Non-resident Sole Shareholder: Complication or Effective Mechanism of Corporate Governance?

09/ 10/ 2018

Svitlana Svyrydenko. Head of Legal Department at Accountor Ukraine, Lawyer with more than 10 years of experience in international consulting, Representative of non-resident members in corporate disputes, Advocate A considerable proportion of LLCs in Ukraine prefer appointing expats as their managers, and the simplification of the procedure for employment of foreigners contributes to this trend. Although officially one foreigner (director) works in such LLCs, several employees of the shareholder (e.g. financial director) can, in practice, regulate and control LLC activity. With the entry into force of the Law of Ukraine On Limited and Additional Liability Companies (further “LLC Law”), it will be possible to provide for such corporate governance mechanism in LLC charter by setting up a supervisory board. The supervisory board has replaced the audit commission which used to be established extremely rarely although it was mandatory. Under the new rules, LLCs will themselves decide whether or not they should establish a supervisory board. They will determine their competence and how they should be elected and terminated. Setting up of a supervisory board is particularly relevant for newly-established LLCs as well as upon change of director. The term “supervisory board” seems to imply that such body should be collegial. So, if we get back to the example of the financial director above, it seems that it might be better to include other persons in the board even if only “artificially”. This is, however, a false impression. Under LLC Law it is up to the shareholder to decide how many members should be appointed to the supervisory board. In other words, this board may consist of one or several persons, and an even or odd number of persons may be appointed. How the board operates and makes decisions should be clearly specified in LLC charter. LLC Law does not restrict the selection of supervisory board members from only the shareholder’s representatives (as was the case with audit commissions) and expressly provides for the possibility of appointing independent members. However, given that supervisory board members are company officers, they will be subject to the following restrictions: Only individuals can be appointed as supervisory board members; Executive body members and director (sole) cannot be appointed as supervisory board members; Supervisory board members cannot be anonymous. The last restriction arisen from the practice of the Higher Commercial Court of Ukraine on audit commission members seems to be applicable to supervisory board members as well. LLC Law allows choosing whether the relationship between LLC and supervisory board members should be formalized by way of employment contracts or civil law contracts. The following should be taken into account when making this choice. Unlike employment contracts which are non-gratuitous, i.e. with compensation and must provide for at least the minimum wage (currently UAH 3,723 per month) for Ukrainian citizens and 10 minimum wages (currently UAH 37,230 per month = about EUR 1,140) for foreigners, civil law contracts can be either non-gratuitous (with no minimum payments) or gratuitous. Moreover, when entering into a civil law contract, foreigners do not need a work permit, whereas they need one in case of an employment contract. And, although taxation under both types of contract is the same, entering into employment contracts gives rise to additional obligations and expenses for LLC (vacation pay, sick leave, etc.) The fact that the law allows terminating the relationship with supervisory board members in the following cases is an argument for supervisory board establishment (especially for those LLCs unofficially using such corporate governance model): Performance of activity in the field of activity of LLC without shareholder consent as individual entrepreneur, participant in full partnership, full participant in special partnership, member of executive body or supervisory board of another company; Violation of obligation to submit a written notice of conflict of interest within 2 days; Violation of obligation not to disclose trade secret or confidential information that has become known in the performance of duties (unless disclosure is required by law) for the duration of the contract and for a year after contract termination (unless another time period is provided in the contract with LLC). LLC Law also provides for joint liability of supervisory board members to LLC: For damages caused to LLC through the guilty actions or inactions of supervisory board members; For damages resulting from the failure to comply with the procedure for concluding major and related-party transactions; For shareholder obligation to return unlawful payments made by LLC on account of misrepresentation of financial condition to the shareholder. In other words, LLC is entitled to demand damage compensation and reimbursement of unlawful payments, in part or in full, from guilty supervisory board members altogether or just one of them. The authority and powers of supervisory board members may be terminated by the shareholder at any time and on any grounds (with automatic contract termination). Alternatively, supervisory board members may be temporarily suspended from their duties. If we take into account (i) the considerable freedom granted to the shareholder to regulate board competence in LLC charter, (ii) the liability provided for by law for supervisory board members, and (iii) the possibility to promptly terminate the relationship with supervisory board members, setting up a supervisory board could be an effective way of regulating and controlling the activity of LLC.

Svitlana Svyrydenko

Head of Legal Department at Accountor Ukraine, Lawyer with more than 10 years of experience in international consulting, Representative of non-resident members in corporate disputes, Advocate

A considerable proportion of LLCs in Ukraine prefer appointing expats as their managers, and the simplification of the procedure for employment of foreigners contributes to this trend. Although officially one foreigner (director) works in such LLCs, several employees of the shareholder (e.g. financial director) can, in practice, regulate and control LLC activity. With the entry into force of the Law of Ukraine On Limited and Additional Liability Companies (further “LLC Law”), it will be possible to provide for such corporate governance mechanism in LLC charter by setting up a supervisory board.

The supervisory board has replaced the audit commission which used to be established extremely rarely although it was mandatory. Under the new rules, LLCs will themselves decide whether or not they should establish a supervisory board. They will determine their competence and how they should be elected and terminated.

Setting up of a supervisory board is particularly relevant for newly-established LLCs as well as upon change of director.

The term “supervisory board” seems to imply that such body should be collegial. So, if we get back to the example of the financial director above, it seems that it might be better to include other persons in the board even if only “artificially”. This is, however, a false impression. Under LLC Law it is up to the shareholder to decide how many members should be appointed to the supervisory board. In other words, this board may consist of one or several persons, and an even or odd number of persons may be appointed. How the board operates and makes decisions should be clearly specified in LLC charter. LLC Law does not restrict the selection of supervisory board members from only the shareholder’s representatives (as was the case with audit commissions) and expressly provides for the possibility of appointing independent members. However, given that supervisory board members are company officers, they will be subject to the following restrictions:

Only individuals can be appointed as supervisory board members;
Executive body members and director (sole) cannot be appointed as supervisory board members;
Supervisory board members cannot be anonymous.

The last restriction arisen from the practice of the Higher Commercial Court of Ukraine on audit commission members seems to be applicable to supervisory board members as well.

LLC Law allows choosing whether the relationship between LLC and supervisory board members should be formalized by way of employment contracts or civil law contracts. The following should be taken into account when making this choice. Unlike employment contracts which are non-gratuitous, i.e. with compensation and must provide for at least the minimum wage (currently UAH 3,723 per month) for Ukrainian citizens and 10 minimum wages (currently UAH 37,230 per month = about EUR 1,140) for foreigners, civil law contracts can be either non-gratuitous (with no minimum payments) or gratuitous. Moreover, when entering into a civil law contract, foreigners do not need a work permit, whereas they need one in case of an employment contract. And, although taxation under both types of contract is the same, entering into employment contracts gives rise to additional obligations and expenses for LLC (vacation pay, sick leave, etc.)

The fact that the law allows terminating the relationship with supervisory board members in the following cases is an argument for supervisory board establishment (especially for those LLCs unofficially using such corporate governance model):

Performance of activity in the field of activity of LLC without shareholder consent as individual entrepreneur, participant in full partnership, full participant in special partnership, member of executive body or supervisory board of another company;
Violation of obligation to submit a written notice of conflict of interest within 2 days;
Violation of obligation not to disclose trade secret or confidential information that has become known in the performance of duties (unless disclosure is required by law) for the duration of the contract and for a year after contract termination (unless another time period is provided in the contract with LLC).

LLC Law also provides for joint liability of supervisory board members to LLC:

For damages caused to LLC through the guilty actions or inactions of supervisory board members;
For damages resulting from the failure to comply with the procedure for concluding major and related-party transactions;
For shareholder obligation to return unlawful payments made by LLC on account of misrepresentation of financial condition to the shareholder.

In other words, LLC is entitled to demand damage compensation and reimbursement of unlawful payments, in part or in full, from guilty supervisory board members altogether or just one of them.

The authority and powers of supervisory board members may be terminated by the shareholder at any time and on any grounds (with automatic contract termination). Alternatively, supervisory board members may be temporarily suspended from their duties.

If we take into account (i) the considerable freedom granted to the shareholder to regulate board competence in LLC charter, (ii) the liability provided for by law for supervisory board members, and (iii) the possibility to promptly terminate the relationship with supervisory board members, setting up a supervisory board could be an effective way of regulating and controlling the activity of LLC.