Shareholders' Agreement: Key provisions for investor protection

Shareholders' Agreement: Key provisions for investor protection

Practical Guide for Business Owners and Investors in Russia and CIS

Mainstream

The Shareholders’ Agreement in Russia and the CIS is not just a formal document. It is the main tool for protecting the rights of investors, especially in jurisdictions with high corporate and sanction risks.

The key question is not whether a corporate contract can be signed. The key question is whether its provisions will provide real protection of control over society, return on investment and effective exit from the project.

Effective investor protection begins with three checks:

• Do investors have veto rights sufficient to block decisions that can destroy the value of the business?
• Is there a working mechanism for resolving corporate deadlock?
• How the contract will be implemented in the Russian or other jurisdiction of the CIS and whether it can be enforced.

If these three issues are not resolved before the transaction, the investor can get a “beautiful” contract that will not save from the dilution of the share, the withdrawal of assets, or corporate seizure.

When an investor needs a shareholders’ agreement

A full corporate contract is required if:

• you are part of the authorized capital of the existing business as a minority or majority investor;
• a joint venture (JV) with a local partner in Russia, Kazakhstan, Uzbekistan or another CIS country is established;
• a holding company with several levels of ownership is structured;
• The transaction involves venture or direct investment;
• You have no operational controls, but you have significant investments.
• Partners have different views on strategy and profit distribution;
• business is subject to sanctions restrictions;
• You plan to exit in the future through a sale to a strategic investor or IPO.
• It is necessary to protect the rights when changing control over a partner or inheriting shares.

The mistake most investors make

Many investors start with a request:

“Send a standard corporate contract.”

That's the wrong first step.

The right question is:

What specific risks should I face in this business should I cover the shareholders’ agreement and what legal mechanisms do I actually have in place in the relevant jurisdiction?

Sometimes the best protection is not a long template, but a point-by-point veto rights, fixed not only in the contract, but also in the charter. Sometimes a detailed deadlock resolution procedure. Sometimes - rigid security structures with a personal guarantee of the controlling partner. Sometimes, the choice of foreign arbitration with interim measures on assets in a friendly jurisdiction.

Investor protection does not require standard documentation, but a strategy structured for a specific business and specific assets.

Step 1. Determine the objectives and structure of the investment

Before developing a contract, it is necessary to clearly state:

• the size of the share and ownership structure (direct / through the holding);
• method of making investments (money, assets, intellectual property);
• The role of the investor: Passive portfolio investor, active strategist, venture fund;
• expectations for return on capital (dividend policy, exit schedule);
• investment horizon;
• the level of permissible control over operating activities;
• the presence of a local partner of personal assets that can serve as collateral;
• jurisdiction of the holding company and operating assets.

Without this, the shareholders’ agreement becomes an abstract document, untethered to the economics of the transaction.

Step 2. Establishing corporate governance mechanisms

The charter and the contract should describe in synchronized terms:

• composition of the Board of Directors (Supervisory Board) and the procedure for its election;
• quotas for nomination of directors;
• Requirements for qualified majority or unanimity on key issues
• List of issues requiring investor consent (veto rights);
• procedure for convening and holding general meetings of participants / shareholders;
• Access to information and management reporting;
• appointment of key managers (CEO, CFO);
• Approval of the budget and business plan.

The key task of a minority investor is not to participate in operational management on a daily basis, but to obtain a blocking package of solutions that can change the nature of the business or blur its share.

Step 3. Protecting the share from blurring (anti-dilution)

Anti-dilution provisions are one of the pillars of investor protection.

The shareholders’ agreement should include:

• Pre-emptive right to acquire new shares / shares (pre-emptive rights);
• Full ratchet or weighted average anti-dilution mechanism
• prohibition of additional issue or increase of the authorized capital without the investor’s consent;
• a mandatory offer to the investor when issuing options, convertible instruments;
• consequences of the violation (restore of the share, option to redeem at par, penalty).

Without such mechanisms, a local partner can blur the investor’s share to economic zero overnight – and there will be few formally legal ways to prevent this from happening in some CIS jurisdictions.

Step 4. Settlement of the procedure for the alienation of shares / shares

The investor should clearly understand how he can exit and under what conditions.

The corporate contract should include:

• Preferential right of purchase (ROFR) with a clear price determination mechanism
• right of joint sale (tag-along): If the majority shareholder sells its share, the investor has the right to sell on the same terms;
• obligation of joint sale (drag-along) – for the majority investor, with protective price thresholds for the minority shareholder;
• lock-up periods and exceptions;
• a fair valuation mechanism (independent appraiser, price formula);
• put (right to sell) and call (right to buy out) when certain events occur (violation, failure to reach KPI, partner default);
• ban on the alienation of shares to competitors and offshore structures without consent.

These provisions determine whether an investment will turn into a liquid asset or into indefinite confinement in a company that cannot be withdrawn without losing money.

Step 5. Provide mechanisms for breaking the deadlock (deadlock)

Corporate deadlock is a situation where the parties cannot agree on principled decisions.

The shareholders’ agreement should include:

• list of issues for which a deadlock is possible;
• mandatory escalation to the level of the first parties;
• mediation or negotiation with an independent expert;
• Buy-sell mechanism ("Russian roulette" or "Texas shootout") One party calls the price, the other chooses to sell or buy back.
• the right of one of the parties to initiate the sale of the business to a third party;
• consequences if the deadlock is not allowed within the prescribed time limit.

Without a deadlock mechanism, businesses can be paralyzed for years and assets can be devalued. Courts in the CIS countries do not resolve corporate impasse on the merits, so contractual instruments are critical.

Step 6. Include protective covenants (protective covenants)

Protective covenants are restrictions imposed on a company and a majority partner.

These may include:

• prohibition of major transactions and transactions with interests without the investor’s consent;
• obligation to direct net profit to dividends (compulsory dividend policy);
• prohibition to change the charter, rights on shares, capital structure;
• Limitation of debt burden (incurrence covenants);
• prohibition of the alienation of key assets;
• Obligation to provide regular audited reporting (IFRS) to the investor;
• restrictions on transactions with affiliated persons;
• Covenants for the preservation of key managers and founders;
• compliance with sanctions legislation and prohibition of transactions with sanctioned persons.

In case of violation of the covenant, there should be clear legal consequences: from the right to appoint its CFO to the option to buy out the infringer’s share at a discount or the right to demand the sale of the entire business.

Step 7. Determine the applicable law and dispute resolution

For investments in Russia and the CIS, the choice of law and forum is a matter of practical feasibility of the contract.

It is necessary to record:

• applicable law: Russian, English, and other jurisdictions;
• dispute resolution authority: State Court, International Arbitration (ICC, LCIA, SCC, SIAC, Hong Kong or Dubai arbitration);
• the place of arbitration;
• language of the proceedings;
• Exclusivity or alternative jurisdiction;
• the possibility of taking interim measures in support of arbitration through state courts;
• The Emergency Arbitrator (Emergency Arbitrator)

For assets in Russia, it is necessary to take into account that not all terms of the corporate contract subject to foreign law will be recognized by Russian courts as binding for the company. Therefore, a two-tier structure is often used: Corporate agreement under Russian law between the participants and the shareholder agreement under English law between the holdings.

Step 8. Settlement of liability and sanctions for violation

The contract should not only describe the rights, but also contain a real mechanism of liability:

• penalty (fixed or periodic) for failure to fulfill key obligations;
• option to buy the infringer’s share at a reduced price;
• the right of the investor to sell his share to the partner at an increased price (put option in case of violation);
• the right to claim full damages;
• loss of voting rights or dividend rights for the period of infringement;
• Personal guarantee of the violating beneficiaries.

It is especially important to remember: In some CIS countries, recovery of losses from the controlling person remains a complex process, so other property sanctions are preferred - options, penalties, security mechanisms.

Step 9. Provide for regulation in the event of significant events

Events that change the structure of control or the legal capacity of the parties:

• Change of control (change of control)
• bankruptcy or insolvency of one of the parties;
• Imposition of sanctions against the investor, partner or the company itself;
• death of the participant - an individual, entry into inheritance;
• Loss of licenses or critical permits;
• liquidation decision.

Each of these events should give the investor the right to withdraw on predetermined terms, and in the case of sanctions – the ability to quickly and lawfully transfer the share to a neutral loop without violating the restrictions.

Step 10. Ensure the Enforcement of the Corporate Contract

Executability is a weak link in many shareholders’ agreements concluded in relation to Russian and CIS assets.

For real protection, it is necessary to:

• synchronize the provisions of the contract and the charter of the company (as far as possible);
• include in the charter a direct reference to the corporate contract and the obligation to comply with it;
• Provide mechanisms that work without going to court: pledge of shares, irrevocable powers of attorney, the right to give instructions to the director, security payments for escrow;
• to keep original contracts and corporate approvals;
• obtain the opinion of local lawyers on the admissibility and enforceability of key provisions;
• for a foreign award – to assess in advance the prospects for its recognition and enforcement in the countries where the assets are located;
• Consider parallel protections: options at the level of a foreign holding company, personal guarantee, independent guarantees.

Winning a dispute against an unscrupulous partner is half the battle. It is important that the mechanisms of the corporate contract work without multi-year courts.

Corporate contract or charter: more effectively

In practice, maximum protection is achieved by a combination of: mandatory and protective provisions are included in the charter, and all commercial arrangements, sanctions and options are included in the shareholders’ agreement.

How to strengthen the position of the investor before signing the contract

The best protection begins at the due diligence and structuring stage.

Before signing the shareholders’ agreement, it is necessary to:

• conduct a full legal and financial audit of the company and its beneficiaries;
• Check whether the business is under threat of sanctions restrictions;
• Identify all related parties and hidden obligations;
• Determine which assets are outside the company.
• to fix all the principal protective mechanisms in the term sheet;
• agree on the personal composition of the management and the board of directors;
• Determine the “right” ownership structure: holding in a friendly jurisdiction vs. direct ownership;
• Check the partner’s personal assets to secure the obligations.

The more problems are identified before the deal, the less chance of fatal surprises after.

Common Mistakes in Reconciling Shareholders’ Agreements

1. Using a template without taking into account local specifics

English law is fine, but provisions that are unenforceable in Russia or Kazakhstan will create the illusion of protection.

2. Disagreement with the statute

If the charter permits what the contract prohibits and the charter takes precedence, the investor is left without protection.

3. No consequences of the violation

Rights without sanction are not rights, but wishes.

4. Ignoring the deadlock mechanism

Without it, any conflict becomes a war without rules.

5. Blurred wording of veto rights

“Investor consent is required on strategic issues” is not a defense. A closed list of specific solutions is needed.

6. Lack of regulation in case of sanctions

In the CIS, this can completely block the management and exit.

7. Weak interim measures

If the partner does not have personal assets to seize, options and penalties may be empty.

8. Trusting the "honest word"

Even between partners with long-term relationships, the contract should be designed for the worst-case scenario.

Investor checklist

Before signing a shareholders’ agreement, make sure you have the answers to 15 questions:

1. Who is the party to the agreement and who are the ultimate beneficiaries?
2. Is the share and procedure of investment fixed?
3. What questions do you need to have your unanimous consent?
4. Are you protected from the dilution of your share?
5. Is there a tag-along and drag-along with clear pricing conditions?
6. What is the resolution mechanism for deadlock?
7. What are the penalties for breach of contract by a partner?
8. What covenants are imposed on the company and majority shareholders?
9. What is the law governing the contract and where are disputes resolved?
10. Is there synchronization with the statute?
11. Are there measures in the event of bankruptcy, death or sanctions?
12. Is there a personal guarantee or other security?
13. Where are the key assets and how do you get there in case of conflict?
14. Is the enforcement strategy realistic in the right jurisdiction?
15. Does the contract give you real control over the fate of the investment or just an illusion?

What a strong protection strategy looks like through shareholders’ agreements

A strong strategy is built on five levels:

1. Ownership structure

Choosing the right ownership contour, excluding direct seizure and sanction locks.

2. Charter protection

The establishment of qualified majority, veto and other mandatory barriers in the charter.

3. Contractual protection

Detailed shareholders’ agreement with options, covenants, sanctions and deadlock mechanism.

4. Interim measures of protection

Personal guarantee, pledge of shares, irrevocable power of attorney, escrow.

5. Enforcement strategy

Pre-prepared enforcement plan in specific asset jurisdictions, including arbitration, security arrests and recognition of awards.

If at least one level is missing, the investor’s protection is incomplete.

FAQ

Can a shareholders’ agreement be concluded under foreign law in relation to a Russian company?

You can, but with limitations. A corporate contract subject to Russian law has a better chance of direct enforcement against the participants. Foreign law is permissible for an agreement between holdings that own a Russian asset, but direct regulation of internal corporate relations of an LLC or JSC in Russia is only within the framework of Russian law.

Does the Russian roulette mechanism for deadlock work?

It works if it is correctly formulated in the corporate contract under Russian law. Important: The court will not force the sale of the share unless the mechanism is designed as a clear option construction with predetermined nouns.

How to protect a minority investor from asset withdrawal?

Protection is built through veto rights to transactions with assets, covenants, mandatory audit under IFRS, the right to appoint a CFO, as well as a personal guarantee majority shareholder and an option to sell a high-coefficient share if a withdrawal of assets is detected.

What if a partner violates a corporate contract?

Immediately fix the violation, send a formal claim, use interim measures through court or arbitration (arrest of shares, prohibition to vote), initiate the procedure of forced ransom or recovery of penalties. The speed of the reaction is fundamental.

Can a mandatory dividend be included in the contract?

In the Russian corporate contract, yes, through the obligation to vote in a certain way for profit distribution while respecting financial performance. Direct coercion of the company to pay dividends is difficult, so it is important to combine with the mechanisms of responsibility of participants.

Do I need to disclose a corporate contract?

As a general rule, no, unlike the charter. For the LLC, information about the contract is not published. For non-public companies, a similar regime applies. This is one of the key advantages of the contractual form of protection.

Related services

• Corporate Law, M&A and Joint Ventures in Russia and CIS
• Structuring investments and protecting investors’ rights
• Resolving Corporate Disputes and Protecting against Unfriendly Acquisitions
• International Arbitration and Cross-Border Litigation
• Sanctions Compliance and Protection Against Sanctions Risks
• Due Diligence and Corporate Investigations

Related material

• How to choose a jurisdiction for a holding company under sanctions
• Corporate contract under Russian law: Limits of Freedom and Peremptory Limitations
• Protection of a minority investor in a joint venture: Ten Unobvious Risks
• How to exit a joint business without loss: options and fair price
• Execution of arbitration awards in Russia and CIS under sanctions
• Deadlock in JV: Legal mechanisms to break the corporate impasse
• Anti-sanctions clauses in corporate contracts and M&A transactions
• Personal guarantee of the beneficiary: How to make it a real security

Conclusion

Shareholders’ agreement for business in Russia and CIS is not just a legal document, but an investor protection architecture.

A strong position is built on five elements: The right ownership structure, statutory barriers, contractual veto and options, property security and a realistic enforcement plan.

In corporate conflicts, the winner is not the one who has a “good relationship”, but the one who, when entering into a transaction, provided for exit, blurring, conflict of interest, deadlock and unfair behavior of the partner.