Convertible Loan Agreement Rules

Convertible Loan Agreement Rules

In July, amendments to the Laws “On LLC” and “On JSC” regarding convertible loans came into force. Previously, this type of legal relationship was not singled out in law as a separate type of contract and, in fact, was not regulated in any way in Russian legislation. However, it was often used by investors and startups through a mixed loan agreement and a corporate agreement.

The main idea of a convertible loan agreement (hereinafter referred to as CLA) is the provision of funds for business development with the subsequent allocation of a share to an investor in a successfully developing organization. In other words, if a start-up company succeeds in business with the investor's funds invested in it, then there is no need to return the money, but instead it is necessary to allocate a share in the authorized capital. Conditions of "success", terms and sizes of shares should be established in the contract at the discretion of the parties.

Such opportunity allows small businesses to develop and attracts large market players who are interested in investments.

How to enter into a CLA?

  1. It is necessary to obtain a unanimous decision of the general meeting of participants (shareholders) on the conclusion of the agreement.
  2. Such a decision must be notarized, as well as any changes to the contract in the future.
  3. The parties are obliged to determine material terms of the CLA - these are the essential conditions of the loan agreement plus the mandatory conditions for converting the invested funds into the share of the startup.
  4. If an agreement is signed with an LLC, then the document itself is also subject to notarization.
  5. After the conditions happen that allow the investor - LLC or JSC - to get a share in the start-up company, the lender will need to contact a notary public or, accordingly, the holder of the register of shareholders for JSC with a requirement to increase the startup's charter capital to allocate a share to it.
  6. The notary public or the holder of the register of shares notifies the startup and, if no objections are received from the startup within 14 working days, makes changes to the Unified State Register of Legal Entities or the register of shareholders, and the investor becomes a full participant in the startup.
  7. If the startup objects, then the dispute shall be resolved through court.
  8. Information on the concluded CLA, the investor and the size of the allocated share will be displayed in the extract of the Unified State Register of Legal Entities.

In general, the regulation of the procedure and requirements for CLA solves the main problem of previously unregulated relations - it provides legal protection to investors in the event of a startup's refusal to allocate a share. Now for investors there are guarantees for the execution of the court decision, since it will be executed directly by a notary public (in the case of an LLC) or a registrar (for a JSC). The borrower is given the right to raise objections to the investor's unreasonable demand for the conversion of an earlier agreed period. It also seems legitimate that all disputes arising between the parties will be brought to commercial court.

New regulations on convertible loans should become attractive instruments for investment in the development of small and medium-sized businesses in Russia.

For proper paperwork at every stage and for professional legal support in this matter, feel free to contact TEAM!