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INCREASE IN JOINT STOCK COMPANY'S OBLIGATIONS IN CONNECTION WITH BORROWINGS
Nurlan Sholanov, Partner Kirill Greshnikov, Associate AEQUITAS Law Firm
Corporate Requirements When a joint stock company borrows funds, one of the issues important for all parties involved is the issue of proper corporate approval of such operation by the borrowing joint stock company. Depending on the conditions of a specific credit agreement (amount of loan, interest rate for credit, forfeit, other charges and sanctions and charges in connection with a breach of obligations, bank commissions, insurance costs, etc.), such borrowing may represent an increase in obligations of a joint stock company or a major transaction. Accordingly, the borrower must issue corporate approvals at a proper level:
All other transactions, the parameters of which are lower than the established thresholds, may be effected based on the executive body's resolution (unless the constituent documents of a joint stock company provide for any other requirements). According to the existing practice, qualification of a credit transaction and correct determination of the required level of corporate approval give rise to certain issues, specifically, as follows:
Borrowing Conditions, which May Affect the Amount of Obligations Credit agreements may provide not only for the granting of traditional credits, but also for loans in the form of revolving and non-revolving credit lines. Credit agreements may provide for a possibility to file creditor's claims for early repayment of credit, payment of increased interest or forfeit, compensation for losses and expenses incurred in connection with debt recovery. According to Article 268 of the Civil Code of Kazakhstan, «pursuant to an obligation, one person (debtor) shall take certain actions in favor of another person (creditor), such as to … pay money.»At the same time, the definition of an «obligation» is also included in the Law on Accounting and Financial Reporting, pursuant to which an obligation is an existing duty of an individual entrepreneur or organization arising out of past events, the settlement of which will lead to a decrease in assets containing economic benefits (Article 13.1 of the Law on Accounting and Financial Reporting). In turn, the Law on Accounting and Financial Reporting refers an obligation to one of elements of financial reporting. According to provisions of the Civil Code, obligations stem from an agreement, fact of causing harm or any other grounds established by legislation. As a rule, based on conditions of a credit agreement, obligations of a borrower encompass payment of the principal debt, interest and other payments stipulated by the agreement. We believe that in order to determine the amount of a credit transaction it is necessary to consider obligations from both legal and accounting viewpoints. This is to say that, when entering into a credit agreement, it is necessary to consider both the obligations originating at the time of entering into the agreement, and all potential obligations, which may be reflected in the accounting and financial reporting as the obligations within the credit term. Accordingly, in order for BD to issue a resolution on increase in the company's obligations by the amount equal to 10% of its own capital or more, all other obligations, both existing and potential, must be taken into consideration together with the initial total credit amount. For the purpose of determining the credit transaction amount, which is necessary to qualify the transaction and correctly determine the required corporate approval level, the following borrower's obligations must be taken into consideration:
We will consider the procedure for determining the amounts of the above obligations in the next section. Procedure for Determining the Obligation Amount under a Credit Agreement We mentioned above that in order to qualify a credit transaction and correctly determine the required level of corporate approval, when calculating obligations, it is necessary to take the amount of the principal debt, interest and amount of other expenses of a JSC under a credit, which must be calculated for the entire period of the agreement to be entered into based on the agreed credit repayment schedule. If the total amount of such obligations exceeds the established 10%, to enter into a transaction it will be necessary to issue a relevant resolution of BD. As a rule, everything is simple with the amount of the principal debt. This amount is known right after entering into an agreement and, accordingly, there is no specific procedure for determining the principal debt amount. It is worth separately considering a situation where a borrower is granted not a traditional credit, but a credit line, which may be of two types: revolving[1] and non-revolving[2]. In case a credit line is a non-revolving one and its amount exceeds (subject to other obligations) 10% of the company's own capital, to receive such credit line it is necessary to issue a relevant resolution of BD. If a credit agreement provides for a revolving credit line, we believe that if the maximum amount of the credit line exceeds (subject to other obligations) 10% of the company's own capital, regardless of the amount of a separate credit, it is necessary to issue a resolution of BD. In this case, it is necessary to consider not every credit separately, but the maximum possible loan under the credit line. In case of presence of the BD's approval of the whole transaction on granting of a credit line, it will not be necessary to obtain a new approval of BD in each case in a situation where the amount of another tranche may exceed 10% of the current value of the JSC's own capital at a relevant moment. The situation with the interest under a credit agreement is similar. When calculating the interest, both fixed and floating rate may be established. If there is a fixed interest rate in an agreement, there should be no difficulties in determining its amount. However, in certain cases, when entering into a credit agreement, a floating rate is applied, which is determined as the sum of the base index and interest spread rate, in nominal value, calculated as the percentage points (paragraph 2 of the Resolution No. 119 of the Management Board of National Bank of Kazakhstan dated 30 June 2017). In other words, a floating rate is systematically reconsidered within certain periods of time and depends on the situation on the credit market. In light of the fact that it is not possible to calculate the maximum possible floating rate when entering into a credit agreement, we believe that for the purposes of corporate approval it is necessary to take the interest amount known at the time of entering into the agreement. However, it is necessary to concurrently consider the payments payable in case of a failure to perform obligations. Since it does not seem possible to determine the amount of such payments and the time of a failure to perform obligations, in our view, one should take the worst scenario possible – maximum expenses potentially threatening a debtor based on the available transaction parameters (and based on the existing practice of the creditor's recovery proceedings), which will be incurred in connection with a breach of obligations. Payments payable in case of event of default are often expressly set out in an agreement. We believe that the procedure for calculating such payments may be defined as follows:
Another potential payment under a credit agreement may be a certain commission. In case a credit or a credit line provides for any commissions, we believe that such commissions will also serve as a variety of an obligation, which must be performed by a borrower. Accordingly, when calculating the amount of obligations, it is necessary to take into consideration all potential commissions pertaining to the credit, which a borrower may potentially pay in the future. In this case, when calculating the commission, it is necessary to consider the maximum amount, which a borrower may pay under a specific credit agreement. If it is impossible to calculate the amount of commissions, a creditor should determine the amount of payment, based on its own practice of dealing with similar agreements. Thus, the amount of obligations under a credit line required to determine the necessity of corporate approval must be determined as the aggregate of principal debt, amount of interest, amount of potential fine sanctions (subject to the conditions unfavorable for a borrower to the maximum extent possible), amount of commissions and other payments under an agreement (if any). Application of the Principle of Cumulativeness when Calculating Obligations It is worth mentioning that the Kazakhstan legislation does not contain any legal rules, which would determine the procedure for calculating the increase in the company's obligations, in which connection we believe that it is possible to apply analogy of law in this case. If there are no rules of law regulating specific public relations, analogy of law must be applied (Article 13.2 of the Law on Legal Acts). Analogy of law is the application of the rules of law regulating similar relations to public relations not regulated by law (Article 1.10 of the Law on Legal Acts). We believe that similar public relations are the regulation of major transactions in a JSC. Accordingly, the approaches used to determine the scope of major transactions may be used to determine the amount of increased obligations. Major transaction is a transaction or the aggregate of inter-related transactions, following which a company acquires or alienates (may acquire or alienate) property with the value of 25% of the total balance sheet value of the company's assets or more (Article 68.1.1 of the JSCs Law). It follows from the said definition that in order to calculate the transaction amount (and calculate the resulting obligations) it is necessary to consider the maximum values of any available transaction parameters, because this meets the statutory condition «may be acquired or alienated.» Inter-related transactions are:
Despite the fact that these criteria are expressly referred to major transactions, we believe that they may be applied by analogy for the purposes of Article 53.2.16 of the JSCs Law. Thus, we recommend applying the principle of inter-relation to calculate the amount of increased obligations. In case transactions fall under the inter-relation criteria and their total amount exceeds the threshold of 10%, to enter into such transactions it is necessary to obtain a resolution of BD. The current legislation of Kazakhstan does not provide for the term, for which transactions may be recognized as inter-related. This gives rise to the risk that transactions may be recognized as inter-related transactions for any period in case such transactions somehow fall under the inter-relation criteria established by Article 68 of the JSCs Law. Failure to Fulfill a Requirement on Increase in the Company’s Obligations To date, the Kazakhstan's judicial practice lacks sufficient number of judicial cases involving invalidation of transactions entered into in violation of Article 53.2.16 of the JSCs Law. In light of this fact, we cannot decide on the position of local courts on this issue and precisely outline the position to be upheld by courts when considering such case. However, when speaking about validity of transactions entered into in violation of requirements of Article 53.2.16 of the JSCs Law, it is worth mentioning that a failure to comply with requirements stipulated by the JSCs Law, when entering into a major interested-party transaction and other transactions in violation of requirements of the Kazakhstan legislation, may entail invalidation of such transactions in court upon a claim from a party concerned under the procedure and based on the grounds stipulated by the Kazakhstan legislation (Article 74.1 of the JSCs Law). In light of the fact that the JSCs Law expressly stipulates that increase in the company's obligations by the amount equal to 10% of the company's own capital or more is referred to the exclusive competence of BD (unless any other body is established by the constituent documents, obtainment of a resolution of BD is a mandatory requirement for such transaction. If failing to comply with this requirement, the parties concerned may challenge the transaction. Such parties concerned are the persons whose rights and legitimate interests have been or may be violated as a result of transaction (Article 157.3 of the Civil Code). At the same time, in addition to a party concerned, a proper governmental agency or a prosecutor may file a claim for the transaction invalidation (paragraph 1.2 of the Normative Resolution No. 6 of the Supreme Court of Kazakhstan dated 7 July 2016). The ground for consequences in the form of transaction invalidity will be the absence of the BD's resolution. Since such transaction is voidable, for the purpose of its invalidation a party concerned must apply to court with a relevant claim according to the rules for determining jurisdiction over cases. As part of judicial proceedings, the court will establish the fact of absence of a resolution of BD and issue a judgment on invalidation of such transaction. If there are judicial proceedings with respect to such transaction, which do not relate to the transaction invalidation, during which the court establishes that the transaction is voidable, the court will provide the parties with clarifications concerning the right to apply to court with an independent claim for invalidation of such transaction, which may finally lead to the transaction invalidation in the future. Therefore, when a joint stock company decides to obtain a credit, it is necessary to consider both immediately originating obligations and all potential obligations, which may be reflected in the accounting and financial reporting as obligations under credit agreements. When deciding on the issue of necessity to obtain the BD's resolution on increase in the company's obligations, subject to consideration must be the initial full amount of a credit line (credit), amount of interest which will be accrued before expiration of the credit repayment term, commissions, payments and fines, which the borrower will (potentially) have to pay over the entire term of a credit agreement in connection with this very transaction entered into at a particular time.
www.aequitas.kz 47 Abai Ave., Office 2, Almaty 050000, Republic of Kazakhstan +7 727 3 968 968
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[1] Borrower may receive funds periodically when the need arises within the predetermined limit, after which the borrower may repay the total debt or only a part thereof and borrow again within the effective term of a credit line. [2] Borrower may receive monetary funds within the limit established by an agreement at any time within a certain term. Repayment of debt does not increase the available limit.
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