Category Archives: Redbridge

The structure of business models of many companies, (those which engaged in the implementation of long-term investment projects, service) are such when at the initial stage of activity companies face conditions of negative capital before receiving so-called deferred profits. In this situation many countries have adopted different approaches regarding the protection of creditors․

In the United States, corporate law provides maximum flexibility to the owners of the company, and creditors protect their interests by contract, while in Europe, the main purpose of corporate law is to protect creditors. 

One of the instruments of protection creditors by law is the rule of legal capital and its aftereffect rule recapitalize or liquidate (ROL), which means if the value of net assets falls below the minimum amount of the authorized capital, the company must be liquidated or recapitalized.        

In Armenia, generally, there is no established minimum amount of the authorized capital for companies. However, if the value of net assets is negative some consequences can be expected:

• • In the case of limited liability companies (LLC) if the value of net assets is negative the company is subject to liquidation.
  • In the case of joint stock companies (JSC), negative net asset value is admissible under certain conditions.

If the value of the company’s net assets is negative, or if the minimum amount of the authorized capital is established, the value of the company’s net assets is less than the established amount then:

• • The executive body of the company is obliged to submit to the Board of directors a request to convene an extraordinary meeting of shareholders,
  • An extraordinary meeting decides whether liquidate or continue the activities of the company,
  • A decision on continuing operations may be made if the board or the executive body has submitted a written opinion on the expediency and justification of continuing the company’s activities taking as a basis:     
•  
  • • • the directions of the company’s activities,       
      • scope of the company’s activities,       
      • its features,       
      • activity programs and other circumstances.

If such a decision is not taken, the company is subject to liquidation․

It is also should be noted, that according to the balance sheet insolvency rules, the debtor is insolvent where the liabilities of the debtor in two thousand times or more, the amount of the minimum wage established by law, exceeds the value of the debtor’s assets. Accordingly, in Armenia, the top limit of permissible negative equity is two million Armenian drams (approx. 4,170 USD).

However, some experts have suggested that legal capital rules are an ineffective and unnecessary form of creditor protection in developed economies, since the rules themselves are incapable of delivering the desired protection, and other strategies are available to provide what is necessary.

                 

Overview

The Republic of Armenia Law on Combating Money Laundering and Terrorism Financing (hereinafter referred to as the “Law”) sets forth the requirements for financial and other institutions in relation to the prevention of money laundering and terrorism financing. Under the Law several categories of institutions, including payment and settlement organizations and other financial institutions have an obligation to develop and implement anti-money laundering and terrorism financing strategies (including KYC procedures) and submit respective reports to the competent authority – the Central Bank.

Payment and settlement organizations shall undertake measures for identifying and assessing potential and existing AML risks (including most importantly a KYC procedure) and shall have efficient policies for managing and mitigating of the discovered risks, control mechanisms and procedures.

High-risk and otherwise regulated transactions. As a reporting entity, a payment and settlement organization shall report to the Central Bank on the transactions and / or business relationships subject to reporting and on all suspicious transactions (with the high-risk transactions mentioned in your inquiry potentially falling under either of those categories).

Transactions subject to reporting are non-cash transactions above the threshold of 20 million Armenian drams (approximately USD 41,650), as well as transaction with cash above the threshold of 5 million Armenian drams (approximately USD 12,250).

According to the Law, a transaction or business relationship is presumed suspicious when there are sufficient grounds to suspect that the asset has proceeded from crime or is linked to terrorism or terrorism financing, or where the transaction involves politically exposed persons or their relatives / affiliates from high risk countries (as determined by the CBA), as well as transactions with unusually high prices or otherwise unusual terms, when the economic or other lawful rationale behind it are not clear. Additionally, according to CBA regulations the following shall be criteria of high risk (which may, but does not necessarily imply that are also suspicious): transaction involves entities or arrangements that are personal asset-holding vehicles, or involves companies that have nominee shareholders or shares in bearer form, relates to businesses and business relationships that are cash-intensive, involves companies that have unusual or excessively complex ownership structure, transaction involve private banking activities, transactions are non-face-to-face business transactions or relationships.

KYC. Within the scope of the KYC procedure, the payment and settlement organization shall identify and verify the customer and the beneficiary (the individual on whose behalf or on whose benefit the customer acts and / or who actually controls the customer or the person on whose behalf or in whose benefit the transaction or business relationship is being carried out). It is generally required to identify the customer in-person, unless the payment to the customer will be made via another financial institution, in which case it is assumed that the latter will perform the in-person identification.

Outsourcing of KYC. Currently Armenian law does not allow to outsource KYC procedures to third parties. There is a possibility for allowing such outsourcing, but it is contingent on CBA regulations, and such regulations are not in place.

Preventive measures to protect companies from hostile takeover in Armenia: regional approach

Much has been written about the methods and technologies of hostile takeover. However, the issue of protection against acquisitions remains insufficiently developed. The problem is that of the companies are fully confident in their invulnerability or in the absence of potential aggressors’ interest in their companies as a possible asset, which entails neglecting elementary means of corporate protection and legal prevention. However, this often leads to the fact that the owners of the company begin to worry about protection only when the attack has already been successfully carried out and they have completely lost control over the company.

What are the main tools that can be used by a company that has become the target of an attack or may become one soon?

The system of protective measures can be roughly divided into two main blocks:

• Strategic or preventive measures aimed at creating reliable corporate protection and minimizing the risks of hostile takeover.
• Tactical or operational actions, the main purpose of which is to prevent the seizure of control over the business in the context of an attack by the aggressor.

Let’s take a closer look at preventive measures, since they are the key to ensuring reliable corporate protection. These activities include:

1. 1. Monitoring the information environment around the companies.

The emergence of unwanted interest in the business from a third party usually manifests itself in a series of characteristic signals, which, if detected in a timely manner, the business owner can take the necessary measures to repel an attack. Such characteristic indicators include attempts to buy up a part of the company’s shares, requests from minority shareholders to hold extraordinary shareholders’ meetings or to provide documents, shareholders challenging the company’s transactions, unexpected inspections by regulatory and supervisory authorities, acquisitions in each industry, etc.

1. 2. Legal diagnostics.

The beginning of any hostile takeover is the collection and analysis of information about the target company – about its corporate structure, main shareholders, management, informal leaders, assets, partners, counterparties, administrative resources, etc. The volume and quality of the collected information by 90% determines the further takeover strategy that the acquiring company will choose. Thus, the potential acquiring company conducts a kind of diagnostics of the company – the goal, and its owners and management often do not even know about it. As a result of diagnostics, the main “pain points” of the company are determined and a program of actions is developed to eliminate or minimize them.

1. 3. Business restructuring.

A weakly protected business is characterized by the consolidation of ownership, management, and operational functions in one company, which simplifies the task of the aggressor (acquiring company) – to effectively absorb the business, the aggressor needs to intercept control in one single company. Therefore, one of the most effective preventive measures aimed at protecting a company from hostile takeover is restructuring. The implementation of such a restructuring makes it possible to solve several problems at once: to remove the main production assets of the business from the risk zone, to optimize financial flows and to ensure the protection of the business owners directly.

1. 4. Amendments to the charter and other documents of the company.

All contradictions, gaps, and shortcomings of such internal documents as the charter and internal regulations on governing bodies are always skillfully used by aggressors to achieve their goals. Typical shortcomings of such documents in practice are contradictions with peremptory norms of the law, excessive procedural encumbrances, lack of proper regulation of complex corporate aspects.

1. 5. Protection of information.

This block of protective actions includes the development and implementation of a regulation on the protection of confidential information of the company. It may determine the procedure for providing documents and information to any third parties, communication with the press, etc.

1. 6. Creation of a consolidated block of shares and a “cross-ownership” scheme.

The following picture is classic for hostile takeovers: the target company has a “loose” authorized capital, in which, in the absence of a powerful consolidated package belonging to the business owner or top management, a significant number of shares are dispersed among minority shareholders, most of which are current or former “members” of the company. In this situation, the aggressors (acquiring company) simply carried out an active purchase of shares from minority shareholders, who happily got rid of unnecessary “pieces of paper”. As a result, within a short period of time, a certain block of shares required by the law was formed, allowing the aggressor to hold a repeated extraordinary meeting of shareholders and take over the management of the company.

1. 7. Legal protection of fixed assets (property).

As a rule, the end goal of the aggressor is to gain control over some attractive asset, most often real estate, and much less often the acquiring company is attracted by a working business as such. In this regard, in the complex of preventive protective measures, one of the key positions is taken by measures for the legal protection of the main property assets of the company.

1. 8. Accounts payable management.

Overdue and poorly managed company accounts payable – targets often become the main starting point at the beginning of a corporate attack by an acquiring company. The existing debt claim rights are bought by the acquiring company at a significant discount from the company’s creditors.

1. 9. Working with top management, employees, and partners of the company.

Almost any company has some actual or potential conflict, for example, a conflict between the main shareholders of the company, conflicts between shareholders and management, conflicts between management and employees. Any of these conflicts, if it is serious enough, may be used by the acquiring company which may try to activate it as much as possible and use it for its own purposes. By participating in unleashing a conflict, the acquiring company can attract one of the conflicting parties to its side or receive all the information that needs.

Private Equity and Hedge Funds in Armenia

In the western legal culture both PE and HFs are set up as either a limited partnership or limited liability corporation. The limited partnership is the traditional US instrument. Limited partnerships are also used in Europe, often with modified features to reflect the local tax and regulatory requirements․

According to the law of the Republic of Armenia “On Investment Funds” funds can be created and structured as:

• Contractual fund (majority operating in Armenia): group of assets that are pooled based on contractual investment fund management contracts; or
• Corporate fund: fund with the status of a legal entity, assets are being pooled only by the underwriting stocks or other stock securities.

In the case of HF and PEs, including VC, in addition to joint-stock companies, the organizational and legal form of a partnership founded on trust is provided by law.  Partnership founded on trust can be named as the Armenian analog of limited liability partnerships where general partners bear liability for the obligations of the partnership, and limited partners bear the risk of losses within the limits of amounts of investments provided and do not take part in the entrepreneurial activities conducted by the partnership.

What about investment structures?

• Venture capital (VC) invests in early-stage or expanding businesses that generally have limited access to other sources of funding.
• Leveraged buyouts (LBO) that tend to invest in more mature businesses, usually taking a controlling interest and leveraging their equity investment with substantial amounts of third-party debt. Buyout funds are typically significantly larger than venture funds, which reflects the relative size of their target investments.
• Growth capital refers to equity investments, most often minority investments, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change in control of the business.
• Distressed and Special situations։ Distressed or Special Situations is a broad category referring to investments in equity or debt securities of financially stressed companies.

The focus of HFs is on maximum short-term profits, so investments are primarily in highly liquid assets. Hedge funds by design are empowered to invest in a wide range of investments, with various funds focusing on derivatives, distressed firms, currency speculation, convertible bonds, emerging markets, merger arbitrage, and so on whatever the fund manager sees as offering high potential returns in a short period of time.

There are some requirements on the investment structure in Armenia:

Additional risk (HFs) and PE funds, including VC, are considered specialized funds. which means that total assets or a part thereof, but not less than 30% are targeted to be invested in certain types of assets.

In the case of the PE funds not less than 50% of the fund’s assets shall be invested in securities not allowed for sale in the regulated market.

If the PE fund acts as a VC, in the case according to the fund’s rules or charter, not less than 50% of the fund’s assets shall be invested in

• securities not allowed for sale in the regulated market and issued by organizations that are newly created or
• are in the early stage of their development, for the purpose of their growth, development or
• enabling their securities to be sold in the regulated market.

The assets of the hedge fund shall be mainly formed:

• Through issuing unlimited amount of debt and using derivative instruments and/or
• Through the sale of such assets that the fund does not possess at the time of the transaction (short sale).