Some Issues of Formation and Increase of Share Capital of Limited Liability Partnership

Some Issues of Formation and Increase of Share Capital of Limited Liability Partnership (hereinafter – «LLP»)

This Article addresses some issues of formation and increase of LLP share capital. At a first glance, it seems that all corporate issues themes have been already studied, but practical reality very often brings different situations and supersedes legislative solutions anticipating by this certain legislative gaps.

Share capital of LLP is formed upon initial creation of LLP by its participants by incorporation of their shares. Proportion of each participant’s contribution to the total amount of share capital is its share (on the whole or in percentage terms) in the LLP share capital. Shares of all participants and correspondingly their shares in LLP assets value (interest in estate) are proportional to their contributions to share capital, unless otherwise specified by constitutive documents of LLPitself.

In accordance with item 3 of Regulatory Resolution of the Supreme Court of the Republic of Kazakhstan dated 10 July 2008 «On Some Issues of Application of Legislation on Limited and Supplementary Liability» (hereinafter – «Resolution»), share of participant in LLP share capital is a complex of its rights and obligations in relation to LLPand its share in LLPassets and it’s aim is as follows:

• to establish resources base for performance of entrepreneurial activity of LLP;

• to ensure fulfillment of LLP obligations to creditors;

• to ensure receipt of corresponding share of net profit by shareholder;

• to give right to participant (share holder) to participate in LLP management;

• to be used as payment instrument in settlement of accounts between share holder and its business partners, if required (by means of sale, trust, pawning, etc.);

• to ensure right of share holder in case of LLP liquidation to get corresponding value of its share and cost of some assets remaining after settlement of accounts with creditors, or to get part of these assets in kind if agreed by all participants.

The deadline for making contributions to LLP share capital is established by decision of general meeting of participants or by decision of sole participant, but it should not exceed one year after LLP registration. In this case legislation of the Republic of Kazakhstan specifies clear consequences of failure to make contributions within the established deadline. In accordance with the procedure established by the Law on LLP in case of failure to perform obligation on making share contribution within the established deadline by one of participants, this share shall be contributed by LLP from its own capital resources (net assets) or LLP should decrease share capital in accordance with the contributed shares. Participant that fails to contribute its share to the share capital shall be obliged to reimburse LLP’s losses as well as to pay forfeit in accordance with Article 353 of the Civil Code of the Republic of Kazakhstan dated 27 December 1994 (hereinafter – CC of RK), unless otherwise is specified by LLP foundation agreement or charter.

In addition upon decision of general meeting of participants of LLP all share or its part not contributed to share capital by any participants within the established period of time may be distributed between them or proposed to the third parties. In this case Law on LLP describes in details procedure, in accordance with which share may be redistributed between the rest participants and sold to third parties. If it is impossible to sell unpaid share within the established period of time, share capital of LLPis decreased and shares of participants in share capital are changed correspondingly. It should be noted that in case if share capital is less than amount equal to 100 MCI (monthly calculating index) after its reduction, then in accordance with the Resolution LLP participants should make additional contributions to share capital of LLP, otherwise LLP is subject to liquidation.

In practice charter capital principally does not exist in kind and serves only for accounting purposes. In accordance with the effective legislation of the Republic of Kazakhstan initial LLP charter capital is increased in several ways. We would like to address in more details the issue of LLP charter capital increase by means of additional proportional contributions. Procedure of charter capital increase under the Law on LLP is as follows:

  1. Making of decision on charter capital increase at the general meeting of participants;
  2. Notification by LLP of body performing state registration about charter capital increase within three months from the moment of making decision on increase of charter capital (registration of changes to LLPcharter in justice authorities).

Practice shows that the most frequent reason of this procedure failure is noncontribution of all or significant part of contribution by one or several participants of LLP. Law on LLP specifies only one provision in relation to such non-performance in item 6, Article 26: «Should the charter capital increase fail, participant or third party aiming to join LLP and having paid in its contribution, shall have a right to require from LLP return of contribution and payment of forfeit in accordance with Article 353 of CC of RK or with compensation of losses including lost profit in result of impossibility to use contributed assets». Thus, Law on LLP clearly regulates only one side of charter capital increase procedure failure, namely ensuring of minimal level of interests of participants that have performed obligation on making of additional contributions, without specification what else participant and LLP itself can undertake in relation to the charter capital increase failure.

Effective legislation of the Republic of Kazakhstan has a gap with regard to consequences of failure to perform obligations of making of additional contributions by Participants, while it has clear view regarding initial formation of LLP charter capital. In connection with this and for filling this gap we may propose legal analogy applying provisions of Article 24 of Law on LLP as provisions regulating similar relations and establishing consequences of failure to make the whole or a part of share contribution to the LLPcharter by participant, namely:

  1. LLP should make contribution from own capital resources instead of participant that failed to make contribution or to decrease amount of charter capital increase to the contributed part;
  2. upon decision of general meeting of participants of LLP share or a part of it not contributed by participant within the established term may be:

o distributed between the rest participants in accordance with the procedure specified by item 1, Article 31 of the Law on LLPor LLPconstitutive documents, or

o proposed for acquisition to third parties;

o in case of failure to sell unpaid part of contribution within the established term charter capital shall be decreased by this amount, and shares of participant in the charter capital shall be decreased by this amount as well;

  1. participant that fails to make additional contribution on time shall be obliged to reimburse losses of LLP, and to pay forfeit in accordance with article 353 of CC unless otherwise is specified by LLPconstitutive documents.

It should be noted that application of similar mechanism stipulated in Article 24 of the Law on LLP may not solve all issues in some cases. Item 5, Article 26 of the Law on LLP specifies that by the moment of notification of justice authorities about charter capital increase made contributions should be not less that half of charter capital increase amount. Inthis casethisprovisionisnotefficient. First of all, the question is about half of amount.

Secondly, the Law on LLP does not require from LLP or its participants evidences of additional financing of charter capital. So much the more that the only one legislative basis for declaring charter capital increase invalid is fact of failure of LLP to notify justice authorities about charter capital increase. On the basis of the abovementioned we can make a conclusion that participant has the following option: to notify justice authorities about increase of charter capital, but not to contribute any tenge to the charter capital. In connection with this legislation does not stipulate any clear sanctions. This thought is indirectly confirmed by provisions of Article 25 of the Law on LLPthat charter capital and its interrelation with owned capital upon registration or re-registration are not verified.

Law on LLP does not clear up the issue when increase of charter capital is considered as valid. In this connection it is unclear when increase is declared invalid, and when participant can start execution of compensating rights. As it was mentioned above Law on LLP specifies the only one ground for declaring increase of charter capital invalid – failure to notify justice authorities about such increase. Unfortunately it does not cover all practical aspects. Participant and LLP itself have to define exactly when increase of charter capital should be completed in order to require from delayed participants performance of their obligations and commencement of procedure on regulation of consequences of increase procedure non-performance.

Thus, in case of uncompleted increase of charter capital under certain circumstances LLPparticipants may find themselves in a difficult situation. In this case it is necessary to find ways out of situation at hand. To my opinion this problem should be solved at legislative as well as corporate levels, namely:

I. At the legislative level

• To amend Article 26 of Law on LLP with provision that non-performance of obligation specified by sub-item 1, item 2 of this Article by LLP participants leads to consequences specified by Article 24 of the Law.

• To include to Article 26 of Law on LLP provision specifying when increase of LLP charter capital is considered as valid.

II. At the corporate level

• To solve the issue on provision to participant right to vote with regard to the part of share corresponding to the made contribution.

• To specify clearly all aspects of such increase in the decision of general meeting of participant on increase of charter capital including clear and consistent procedure; exact dates of all stages of charter capital increase (notification of justice authorities, payment of contributions); mutual rights and obligations; consequences of nonperformance of obligations.

• More efficient method is conclusion of corresponding agreement at the general meeting of participants between participants and LLP on terms of charter capital increase and consequences in case of non-performance of obligations by any participant.

• Establishment of obligation on payment of security deposit for all participants, that will be proportional to value of additional contribution specified in the abovementioned agreement. Security deposits can be accumulated in the LLP account or returned only after completion of charter capital increase or under other terms agreed by the parties. These deposits can be used for payment of the contribution remaining unpaid.