On July 13, 2021, the law on convertible loans took effect.
The convertible loan agreement is intended to become a tool for attracting investment at the initial stages of a startup. A startup borrows money from an investor and after a certain period of time either returns the loan with interest, or provides participation in its capital. Thus, the investor does not need to enter the company at the very beginning, he can assess the speed, with which the company is developing, and its prospects, and, depending on this, make a decision whether to acquire a share in the company or demand a refund. The advantage will also be that the investor can receive shares at a discount compared to the current price of the shares, since he gave a loan at the initial stage. A startup will accelerate the process of attracting investments due to the simplicity of concluding a convertible loan agreement compared to the process of the investor joining the company.
On the other hand, previously such relations were formalised by the conclusion of a regular loan agreement, a corporate agreement, and option agreements. Now, mandatory requirements have been introduced to the convertible loan agreement in the form of mandatory notarization (for LLC) and strict corporate procedures. Such requirements may lead to the impossibility of concluding convertible loans under existing schemes.
A borrower under the convertible loan agreement can be a non-public JSC or LLC, with the exception of credit organizations, non-credit financial organizations and companies that are of strategic importance for ensuring the country's defense and state security. An investor may be a participant (shareholder) of the company or a third person.
In the contract, it is necessary to agree on
1) the subject, amount, and term of repayment of the loan/circumstances, upon the occurrence of which the investor has the right to request conversion;
2) the price of placement of additional shares/the amount by which the nominal value of the share of the investor-participant of the company increases, or the nominal value of the share acquired by an investor who is not a participant of the company.
To begin with, let's consider the procedure for concluding a convertible loan agreement in LLC:
1. The participants of the LLC make a decision to increase the authorized capital of the LLC at the general meeting. At the same meeting, the participants give their unanimous consent to conclude a convertible loan agreement and approve its terms;
2. A contract is being drawn up;
3. The LLC and the investor certify the contract with a notary;
4. The notary notifies the tax authority and information about the convertible loan agreement is entered in the Unified State Register of Legal Entities;
5. When the deadline or circumstance that gives the right to convert the loan into shares comes, the investor may submit a request to the notary for an increase in the authorized capital within 3 months;
6. The notary shall notify the company of the submitted claim within 1 working day, and the company may submit objections within 14 working days;
7. If there are no objections, the notary notifies the tax authority about the increase in the authorized capital, which is recorded in the Unified State Register of Legal Entities;
8. If there are objections, the investor can challenge them in court. The decision of the arbitration court will become the basis for converting the loan into shares and making an entry in the Unified State Register of Legal Entities.
In non-public JSC, the procedure for concluding a convertible loan agreement is somewhat different:
1. The shareholders give their unanimous consent to the conclusion of the contract by making a decision on increasing the authorized capital and placing shares. The decision must specify the parties to the convertible loan agreement, the price of placement of additional shares or the procedure for determining it, other essential terms of the convertible loan agreement or the procedure for determining them;
2. A convertible loan agreement is concluded in a simple written form;
3. The JSC registers the issue of additional shares;
4. The register holder notifies the tax authority about the conclusion of a convertible loan agreement;
5. The investor submits a claim to the register holder within 3 months after the due date or circumstances for the conversion of shares;
6. The register holder notifies the JSC of the received request within 1 business day, which may object to the conversion within 14 business days;
7. If there are no objections, the register holder conducts an operation to place shares;
8. If there are objections, the investor has the right to demand the placement of such shares to him in court
Problems may arise when the investor submits a claim to the company: both the JSC and the LLC are entitled to submit objections either to the placement of shares (JSC) or to an increase in the authorised capital (LLC). At the same time, notaries and registrars are not authorized to check the submitted claim for at least technical errors and compliance with legislative and contractual requirements, so that objections and going to court can be avoided. In addition, the draft law does not provide for requirements for the company's objections, that is, the company is not obliged to justify its objections and can thus simply freeze the conversion. There is no pre-trial procedure for considering objections: they cannot be resolved through negotiations or an arbitration court, the investor can request conversion only through an arbitration court. At the same time, the court proceedings may be delayed, and when the investor already receives a positive court decision, the conversion of the loan may no longer be such an attractive option due to the changed financial condition of the company. At the same time, interest for the use of the loan and other people's funds ceases to accrue from the date of the repayment of the amount of the converted loan and until the expiration of the investor's claim for the execution of the loan agreement, that is, for the entire period of the trial. In addition, the contract of a convertible loan in an LLC must be notarized, otherwise it will be void, and the contract may also be declared invalid if the unanimous consent of the shareholders/participants was not obtained for its conclusion. You can ensure your rights and protect yourself from possible objections from the company, for example, by entering into option agreements with the participants/shareholders of the company for the purchase of shares/shares, if on a certain date the investor does not receive the shares/shares as a result of conversion.
Nadmitov, Ivanov and Partners law firm provides a wide range of services in the field of law on venture investment issues.