Russian Federation: Conflict Of Interests Director vs. LLP Interests

In the modern business environment, the issues of ethics and compliance with corporate governance rules are becoming key aspects of the successful functioning of enterprises and organisations. Article 55 of the Law on Limited Liability Partnerships¹ (hereinafter, the "Law") is an essential framework for regulating conflicts of interest between a director as a sole executive body or members of a collegial executive body and the partnership (LLP) itself. This article stipulates, among other restrictions, a prohibition on entrepreneurial activities that compete with the partnership's activities. However, the Law does not clarify, for example, which forms of director's activities are covered by the prohibition of competition with the LLP.

In this article, we will consider whether such forms are recognised or not as competition in court practice.

Director of Another LLP with the Same Type of Activity as the First LLP

The plaintiff brought a claim against the LLP (the defendant) where he was a director, claiming, inter alia, reinstatement of his employment. The plaintiff was dismissed from his position due to the fact that he was the director of several companies engaged in freight transport. Moreover, he was an individual entrepreneur with a similar type of business to the defendant.

All of the plaintiff's claims, including reinstatement, were dismissed because the court confirmed that the management of several LLPs, as well as the status of an individual entrepreneur with a similar type of business activity in relation to the defendant, constituted competing business activities and violated Article 55(1)(4) of the Law².

Sole Participant with 100% Interest in Another LLP

The plaintiffs brought actions against the defendants, including two LLPs and, respectively, the director of the first LLP and the sole participant of the second LLP as one person. The plaintiffs demanded, inter alia, that the supply contracts between the two LLPs be recognised as invalid.

By these supply contracts, the director disposed of the LLP's property in an amount exceeding fifty-one percent or more of the total balance sheet value of the partnership's assets. Although this action falls within the exclusive competence of the general meeting of the partnership participants.

The court satisfied these claims, pointing to the fact that at the time of the transactions the same person was a director of the first LLP and at the same time the sole participant with 100% ownership interest in the second LLP. This violates the requirement of Article 55(1)(4) and Article 51(2) of the Law concerning the director's obligation to act in good faith and reasonably in the interests of the partnership³.

Individual Entrepreneur With the Same Business Activity as the LLP

Two members of an LLP with 50 % interest each filed a lawsuit against the director of the LLP.

The principal business activity of the Partnership is the retail sale of fish, crustaceans and molluscs in specialised shops and the retail sale of beverages in specialised shops. The claimant states that in November 2019 it became aware that the director was registered as a sole trader from 17 July 2015 with the same business activity as the LLP. The claimant, therefore, requested to recover damages from the defendant in favour of the Partnership.

Pointing out that this fact is a violation of the non-competition requirement, the court noted that the following conditions must be met to impose liability: (i) the presence of harm, (ii) the wrongfulness of the action (inaction) that caused the harm, (iii) the causal link between the action (inaction) and the result (harm), and (iv) the guilt of the inflictor of harm. Only the presence in the aggregate of these conditions gives the court the right to decide on bringing to liability.

Therefore, the plaintiff failed to provide the necessary evidence in the aggregate to bring the defendant, as the executive body of the partnership, to liability by way of compensation for damages⁴.

Consequences of Violating the Prohibition on Engaging in Entrepreneurial Activities that Compete with the LLP Business Activity

Based upon Kazakhstan's judicial practice in Kazakhstan, the consequences of violating Article 55(1)(4) of the Law on LLP (prohibition of competition with the LLP), in addition to early termination of labour relations, are as follows:

• recognition of the relevant transactions as invalid⁵; and
• recognition of the director's actions as unlawful and causing harm to the partnership and its participants⁶.

Therefore, the activities of the director as the sole executive body (or a member of the collegial executive body) that are deemed by the courts in Kazakhstan as competing with the partnership's activities include the following:

• employment as a director of another LLP with similar type of business activity;
• holding a 100% interest in another LLP with which voidable contracts have been entered into;
• acting as an individual entrepreneur with a similar type of business activity.

Footnotes

1. Law of the Republic of Kazakhstan dated 22 April 1998 No. 220-I "On Limited and Additional Liability Partnerships".

2. Decision of the Baykonyr District Court dated 19 December 2022 in case No. 7145-22-00-2/3014.

3. Decision of the Judicial Board for Civil Cases of the Nur-Sultan Court of 10 February 2021 in case No. 2a/7620.

4. Decision of the Specialised Interdistrict Economic Court of Almaty dated 28 May 2020 in case No. 7527-20-00-2/1931.

5. Decision of the Judicial Board for Civil Cases of the Nur-Sultan Court of 10 February 2021 in case No. 2a/7620 (supply contracts at the time when a person was a director of an LLP and simultaneously the sole participant with 100% interest in another LLP).

6. Decision of the Specialised Interdistrict Economic Court of Kostanay region of 18 May 2020 in case No. 3971-20-00-2/888.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.