02.02.07

Common Errors in Documents of Incorporation
Ksenia Khudiakova
Legal Consultant, Alinga Consulting Group

Frequently, when establishing a new company in Russia, the founders are fully confident that the only thing between them and their new company is the registration process. Few, however, realize that before a company can be registered, the incorporation documents must first be completed, which can be a very labor-intensive task.

Of course, it is possible to take the easy road by using a standard template. There is no guarantee, though, as to how long the company will function without encountering any problems caused by errors in the incorporation documents. Templates almost never fully match the needs of a particular business. Resulting problems can be varied — ranging from conflicts between participants or stalemates in the company’s decision-making processes to an increased level of risk of takeover by competitors.

However, it is possible to avoid or minimize such problems if the incorporation documents are thoroughly and carefully formulated.

What are these common mistakes and which are the most critical? We will look at Charters and Foundation Agreements of companies (joint-stock or limited liability companies) and identify the  mistakes are most commonly encountered.

There are certain provisions that must be included in the incorporation documents of any legal entity. They include:

1. the legal form of the entity;
2. the means of formation;
3. the name of the organization;
4. the location of the organization;
5. the purposes and spheres of activity;
6. the management structures;
7. the members of each management structure; 
8. the functions of each management structure;
9. the procedure for forming each management structure;
10. who may become a shareholder of this legal entity;
11. how to become a shareholder;
12. how to exit from participation;
13. the rights and obligations of shareholders.

The absence of these provisions in the incorporation documents or the use of vague wording can lead to conflicts between participants and the interests of the legal entity and its participants/shareholders may not be fully protected. It is not enough to simply draft incorporation documents that are in accordance with federal legislation; the documents should also promote the stability of the company.

It is interesting to compare the documents of entirely Russian companies with those of companies with foreign capital. At first glance, the  incorporation documents written by foreign companies seem redundant and overloaded with regulations regarding the interactions of participants/shareholders in a variety of situations. These documents can be difficult to read and are sometimes a source of complaint. However, overly simple charters can understate the role that these documents play in the establishment of successful economic activities of the company.

A common error in the creation of a charter is directly copying articles from the law or using a template. For example, the charter of a LLC contains a list of 70 optional provisions, variations of which are determined by the company founders. It is very important to understand and effectively use these and specifically include in the Charter those which are necessary for the participants and for the company itself for defining its activities and further growth.

Another mistake occurs when determining the powers of the Board of Directors of a joint-stock company. For example, in the section of the Charter that stipulates questions to be resolved by the Board, it states "and all other questions." Many consider that in this case, the Board may solve any question stipulated by the law. This is not so. The Board has the right to make decisions only concerning those issues specified in the Charter. As such, the list of issues in the Charter should be complete and exhaustive. Thus, if a joint-stock company has fewer than 50 shareholders and the Board of Director is not elected and is not a valid body, it is necessary to indicate in the Charter that all decisions on questions under the jurisdiction of the Board of Directors also fall under the jurisdiction of the general body of shareholders (or any other body, except the executive). Such a possibility is given in Article 64 of the Federal Law "On Joint-stock Companies."

We recommend that the Charter contain a detailed list of the corporation’s activities. This can be especially useful in the event that a major transaction is considered invalid by a court, as it will be possible to refer to the Charter and prove that the transaction was part of the usual economic activities of the company. If a transaction is related to the activities defined in the Charter, then it is not necessary to seek approval for the transaction.

The Federal Laws "On Joint-Stock Companies" and "On Limited Liability Companies" is to provide founders of companies the opportunity to structure their companies "under their own terms." That is to say, founders can determine: the type of interactions between participants/shareholders; the type of administrative structure of the company; the power of the executive body; and many other provisions. Not taking advantage of this opportunity when establishing a new company will further perpetrate a common mistake.

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