New opportunities for corporate governance: how different models work

24.11.2023, LIGA.Business

If earlier JSCs could operate only with a two-tier model—an executive body and a supervisory board—now they can also adopt a one-tier board structure where managerial and supervisory powers are combined in a single body.

Together with Deloitte experts Oleksii Voychyshyn, Yuliia Kvyatkovska, and Olga Dyma, we will look into the difference between the two modes of corporate governance.

How does corporate governance work in Ukraine?

Before the year end 2022, the two-tier governance structure was the only admissible model for Ukrainian joint-stock companies (JSCs). As from 1 January 2023, a one-tier board was introduced for limited liability companies (LLCs) and additional liability companies (ALCs).

JSCs may decide to switch from dual to unitary board model and vice versa, with such transition being not considered a reorganization. However, there may be cases (to be provided for by ad-hoc regulations which have not been defined yet) where the one-tier structure is mandatory, and cases where the two-tier corporate governance structure remains mandatory for certain types of companies, including state-owned banks, which are required to have a supervisory board.

Moreover, JSCs are subject to the «one-tier model presumption» meaning that in the absence of supervisory board the JSC is presumed to have chosen a one-tier governance model unless and until they arrange their activities as required by the Law of Ukraine «On Joint Stock Companies».

In such JSCs, boards of directors are vested with managerial and supervisory powers and act as a collegial executive body; however, despite their combining both functions in a single body, the law considers them as an executive body. This may primarily be due to practical considerations, but the legal status of the board of directors remains the subject of further discussions.

One-tier corporate governance system

The JSC’s one-tier corporate governance system provides for general meetings and a board of directors only. Since there is no supervisory board in this governance model, the responsibility for two key functions—management and supervision—rests with the board of directors, which is possible, in particular, due to the distinction made between executive directors and non-executive directors. Below is a list of roles constituting the board of directors and their key functions.

Key roles of the Board of Directors

Other persons may also be invited to participate in the Board of Directors’ meetings in an advisory capacity. The board of directors is accountable to the general meeting and resolves all issues related to the company’s activities (except for matters within the exclusive competence of the General Meeting). The board members are elected by the general meeting, at which a quorum of three or more persons must be present, for a term of up to three years and may be reelected unlimited times.

A private JSC with up to 10 shareholders may have a sole executive body.

Key roles of the Board of Directors

In a two-tier model, the governing bodies are the general meeting, the supervisory board, and the executive body.

The day-to-day management of the company’s activities is the responsibility of the executive body, which is accountable to the general meeting and the supervisory board and ensures the implementation of general meeting’s and the supervisory board’s decisions.

The dual nature is determined by the division of functions: the executive body is responsible for managing the company’s operating activities whereas the supervisory board supervises and regulates activities carried out by the executive body and other managers.

The Supervisory Board is composed of shareholders or shareholder representatives and/or independent directors, who should cover at least one third of the board seats in public JSCs.

In a JSC where 50% of shares or more belong to the state, independent directors should account for the vast majority of the board. Members of the Supervisory Board are elected by the General Meeting for a term not exceeding three years.

In Ukraine, the two-tier governance structure is used in joint-stock companies, state-owned enterprises (SoEs), and banking institutions, for which the establishment of the supervisory board is mandatory.

Setting up committees is a separate component of the boards of directors’ and the supervisory board’s activities. The types, size, setting up procedure, frequency of meetings and participation on committees may be set forth in a separate provision.

Flexible choice between the corporate governance modes for LLCs and ALCs

The concept of an «independent member of the company’s board» has been introduced for the one-tier board in LLCs and ALCs. Similarly to this role in JSCs, these are board members whose decisions are not influenced by others. Independent board members may not represent the company’s interests before third parties; in addition, they act based on civil law contracts, not employment contracts. If LLCs and ALCs have a supervisory board, such board may include independent members as well.

In case a collegial executive body is set, it may be composed of executive and non-executive directors (who may be independent). Similarly to the practice adopted in JSCs, a non-executive director is responsible for supervision, risk management and monitoring the activities of the company and executive directors; however, a non-executive director may not interfere in the company’s day-to-day activities.

The legislation regulates the procedure for managing LLCs and ALCs in less detail; however, we believe, companies of such types may rely on the provisions for JSCs set out in the Law, to build their corporate governance model.

For LLCs and ALCs, the «grey area» may be the election of the chairman of the board of directors and the chief executive officer. Unlike detailed regulation of these matters for JSCs contained in Article 65 of the Law regulating these issues for JSCs in detail, the laws on LLCs and ALCs leaves this area unregulated, singling out only the head of the collegial executive body of LLCs and ALCs.

Delimiting the roles of the Chief Executive Officer and the Chairman of the collegial body is in line with the best practices in corporate governance and is applicable not only to JSCs but also to other types of joint-stock companies.

At this stage, LLC and ALC can resolve uncertainty as to their top managers in two steps: 1) define in detail the legal statuses of the CEO and the chairman of the collegial body by making relevant provisions in their charters; 2) get these provisions approved by the state registrar and ask the latter to reflect them in the Unified State Register. In view of the above, the legislation will need amending to clearly define the key management roles in LLCs and ALCs in the future.

Corporate Governance in the Public Sector

JSCs with a state share of more than 50% require particular attention. The law does not prohibit their transition to a one-tier model. However, this applies only to those JSCs that are not subject to the mandatory establishment of a supervisory board, which is required by the Law of Ukraine «On the Management of State-Owned Property».

Corporate governance has not been fully introduced across the public sector yet, which entails, among other consequences, a nontransparent management appointment process and conflict of interests between the management and management entities, as well as lack of internal management structures—the supervisory board, independent directors—to oversee their activities.

Draft Law No. 5593-D is intended to settle these challenges, among other things, by bringing the corporate governance of state-owned enterprises in line with the OECD guidelines. In particular, it provides for the mandatory implementation of a comprehensive internal control system (including internal audit, compliance and risk management) and vests supervisory boards with powers to appoint and dismiss the management in SoEs and JSCs where 50% of shares or more belong to the state, aiming to make the process of managing companies clearer and more transparent for, in particular, international partners during large-scale privatization, and strengths the company management’s independence from management entities.

How to implement a one-tier corporate governance system?

As mentioned above, JSCs are required to bring their charters and internal regulations into compliance with the Law by the end of 2023.

Although there is no liability for failure to update the charter, in practice it can have significant negative consequences and obstacles to further work. For example, the risk of challenging a decision made on the basis of such a charter, refusal to provide banking services, termination of contractual relations with counterparties, difficulties with participation in public procurement, etc.

If the company’s participants decide to switch to a one-tier governance model, its implementation will require to:

1. determine the size of the board of directors (including seats for independent non-executive directors), as well as the eligibility requirements for the board members. At this stage, it is also advisable to consider potential candidates for the first composition of the board of directors;
2. determine the competences of the board and delimit its powers from those of the general meeting, the head of the company, and other bodies;
3. draft relevant amendments to the company’s charter and other internal documents. According to the Law, activities of the board of directors and committees may be governed by separate provisions, while main provisions that determine the competences, composition and decision-making procedure of the board of directors must be included in the charter;
4. hold a general meeting to approve the updated charter, regulations on the board of directors, committees (if any); to elect the first composition of the board of directors, to authorize a representative to sign contracts with board members;
5. formalize relations with members of the board of directors: executive and non-executive directors may be offered either an employment contract or a civil law contract whereas, as mentioned above, only civil law contracts may be concluded with independent non-executive members. The terms of such contracts must be approved by the general meeting. If foreign nationals hold seats on the board of directors under employment contracts, the company must also obtain permits for the employment of foreigners;
6. perform all required registration and post-registration actions, such as state registration of the new version of the charter and information about the executive body, as well as notification of banks and other entities.

After the Law enters into force, companies can choose the governance structure that is more attractive to foreign investors in their industry. Moreover, Ukrainian companies that are part of international groups of companies may now adopt groupwide governance practices at the local level. Due to the limitations of the national legislation, the adoption of a one-tier governance system was possible only in other jurisdictions (for example, Cyprus).

A one-tier governance structure may be attractive to business owners who continue to actively participate in the day-to-day management of the company’s activities and are considering the gradual transfer of powers to the collegial body and the division of powers.

At the same time, a clear two-tier governance model may be more acceptable for companies with a large number of participants.

Source: LIGA.Business