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Legislation

Labor Relations with the Head of a Legal Entity in Kazakhstan when Changing the Composition of Participants or Shareholders

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ABSTRACT

In this article, we consider topical issues of legal execution of continuation or termination of labor relations with the head of a legal entity when changing the composition of participants or shareholders. We evaluate the action scenarios on implementation of the Kazakhstan legislation requirement to enter into a new employment contract or terminate labor relations with the head. The article also highlights certain legal risks for the parties to labor relations and ways to mitigate some of them.

1. INFLUENCE OF CHANGES IN THE COMPOSITION OF PARTICIPANTS (SHAREHOLDERS) ON LABOR RELATIONS WITH THE HEAD OF A LEGAL ENTITY

1. 1. Legal Regulation

In case of changes in the owners of shares or participatory interests in the charter capital of a legal entity (i.e. changes in the JSC shareholders or LLP participants), labor relations with employees continue without any changes (Article 47 of the Labor Code¹).

However, the Labor Code established another approach with respect to the sole executive body, head and members of the collective executive body (collectively, the "Head").

Part 2 of paragraph 2 of Article 140 of the Labor Code (the "Problem Rule") literally establishes as follows:

"In case of changes in the composition of founders (participants, shareholders), a new employment contract shall be entered into with the head of the executive body, members of the collective executive body of a legal entity or labor relations with them shall be terminated on the basis of a resolution of the founders, owner of property of the legal entity or a person (body) authorized by the founders, owner, or the authorized body of the legal entity".

The Problem Rule does not mention the sole executive body of a legal entity; however, it applies to the sole executive body to the same extent due to paragraph 6 of Article 140 of the Labor Code, making all specifics of regulating labor of the head of the executive body applicable to the sole executive body.

1. 1. Historical Aspect of the Problem Rule

The current version of the Problem Rule has been active since 2020², and previously it was set out in another way. Below we will briefly consider the occurred transformation.

Paragraph 2 of Article 140 was specifically introduced into the 2015 Labor Code to settle the issue of execution of labor relations of the sole participant/shareholder with a legal entity. Specifically, the first part of this rule says regarding the absence of the necessity to enter into an employment contract with the sole executive body of a legal entity in case such sole executive body is concurrently the sole founder (participant, shareholder). In this case, labor relations must be executed by an employer's act on hire for work containing the data determined by the Code.

Before the amendments of 2020, part 2 of paragraph 2 of Article 140 stipulated for the development of part 1 of this paragraph a solution for a situation where the sole executive body, which had had no employment contract with a legal entity before that moment, stops being its sole participant or shareholder³. In this case, it was contemplated to either enter into an employment contract with him/her (since no employment contract had been entered into previously) or terminate labor relations.

The amendments introduced into part 2 of this rule in 2020, broke this logic⁴ and created legal and practical difficulties, which will be considered below.

Specifically, the word "new" was added to the second part as applied to the employment contract; i.e. now it implies that an employment contract had previously been entered into with the Head (whereas no employment contract is entered into in the situation specified in part 1 of this clause). The members of the collective executive body were also included in this part. This completely differs from the situation set out in part 1 of this rule.

Therefore, to date, according to the current version of the Problem Rule, any changes in the composition of founders, participants or shareholders of a legal entity with one or several founders, participants or shareholders require:

1. entering into a new employment contract with the Head; OR
2. termination of labor relations with the Head –

on the basis of a resolution of the founders, owner of property of a legal entity or a person (body) authorized by the founders, owner or an authorized body of the legal entity (collectively, the "Authorized Body").

1. 1. Resolution of the Authorized Body: Right or Obligation?

The Problem Rule requires performance of the above actions (to enter into a new employment contract or terminate labor relations with the Head) "on the basis of a resolution" of the Authorized Body.

This gives rise to the first disputable issue of whether it is required to perform these actions only in case they are stipulated by a resolution of the Authorized Body. In case the resolution does not mention this issue, may labor relations with the Head be continued without changing and entering into a new employment contract?

Or must the Authorized Body adopt a resolution on one of the two mentioned actions? We tend to a greater extent to this very interpretation, because the Problem Rule is set out in an imperative manner: a new employment contract "is entered into" or labor relations are "terminated".

Such interpretation may be supported by judicial practice. As an example, we set out an abstract from the judgment of the District Court No. 2 of Kazybek bi District of Karaganda of 3 May 2022 in the case No. 3512-22-00-2/1611: "Based on provisions of the indented paragraph 2 of paragraph 2 of Article 140 of the Labor Code, it follows that the LLP […] had to enter into a new employment contract or terminate labor relations [with director] on the basis of its resolution."⁵

1. 1. Application of the Problem Rule when Changing the Composition of Participants of a Limited Liability Partnership

The second disputable issue arises with respect to changes in the composition of participants of a limited liability partnership (the "LLP"). Specifically, what are the cases of such changes that lead to the consequences stipulated by the Problem Rule?

Article 22 of the LLPs Law⁶ named "Changes in the composition of participants of a limited liability partnership" provides for the following two options of such changes:

1. acceptance of a new participant to the LLP without withdrawal of a current participant;
2. withdrawal of a current participant as a result of transfer of the right to his/her share to a new participant (e.g. as a result of sale, giving as a gift, descent of a share, recovery proceedings against the share, transfer of the right to the share to a legal successor).

Both options entail appearance of a new participant in the composition of the LLP participants and directly relate to the Problem Rule in light of actual changes in the composition of participants and the mentioned name of Article 22 of the LLPs Law.

Meanwhile, changes in the composition of participants may also take place in other cases resulting in withdrawal of a participant form the LLP:

1. alienation of the whole share by one participant in favor of another current participant;
2. purchase of the participant's share by the LLP (including compulsory);
3. re-distribution of share of a participant who failed to contribute own share in time to other participants or reduction of the charter capital for the amount of such share with changes in shares of the remaining participants; and
4. full withdrawal of a share of a participant in case of reduction of the charter capital of the LLP.

These cases are regulated by other rules of the LLPs Law and entail factual changes – reduction of the quantitative composition of the LLP participants. No new participant is accepted by the LLP. This gives rise to the issue of whether it is necessary to apply the Problem Rule in this case. Or is it stipulated only for two cases expressly specified in Article 22 of the LLPs Law?

If the Problem Rule is also applied in case of changes in the composition of participants as a result of withdrawal of any participant (which cannot be excluded), the remaining participants and the Head encounter a reasonable issue of the purpose of the Problem Rule in this situation. All remaining participants are the same persons who appointed the Head and there is no sense to enter into a "new employment contract" in this situation.

1. 1. Terms

The third group of disputable issues is about the terms.

What is the term for taking the measures stipulated by the Problem Rule? Immediately after the legal moment of changing the participants (founders, shareholders) – the same day as the changes occur?

In case of the ordinary course of business, this is not possible in most cases. Furthermore, there may be situations where a corporate resolution may not be adopted by the Authorized Body due to absence of quorum, deadlock situations or other reasons.

In a number of cases much time may pass from the actual change of participants (shareholders) and adoption of a corporate resolution on the future of labor relations with the Head.

Can this issue be solved by the LLP in advance (e.g. by signing a "new employment contract" with a deferred date of entry into force)?

Is any period of work of the Head under the "old" employment contract is allowed (and for how long)?

Another issue for the LLP is who of the participants must adopt a relevant resolution. Is it lawful to include relevant resolution in the minutes of the general meeting of participants, based on which the LLP will be re-registered, or may such resolution with respect to the Head be adopted only after re-registration of the LLP with a new composition of participants?

How an employer must act in case the Head refuses to enter into a "new employment contract" in the proposed version?

Wrong answers to these questions may affect validity of the adopted resolutions.

1. 1. Excessive Regulatory Pressure on Joint Stock Companies

In light of the Problem Rule and arising disputable issues, joint stock companies (the "JSCs") and their Heads are in a more complicated situation than the LLPs.

If applying "straightforward" interpretation of this rule, in case of each change in the composition of shareholders (which may potentially occur very often within a short period of time) the Authorized Body must make a decision on whether to terminate labor relations with the Head or enter into a "new employment contract".

The Labor Code does not divide shareholders into the holders of ordinary shares, "golden shares" or privileged shares⁷; nor distinguishes the shares under nominal shareholding. According to the Problem Rule, any changes in the composition of shareholders (including both among the holders of privileged shares and nominal shareholding) entail the considered legal consequences for the future of the JSC Head.

Unfortunately, this rule allows unfriendly shareholders, including minority shareholders, to try to hinder the work of the JSC or exert influence on the JSC by way of intentional frequent resale of shares, which entails changes in the composition of shareholders.

1. 1. Dangerous Consequences

The above legal issues entail an extremely important disputable legal issue of whether the "old" Head is a legitimate Head and representative of a legal entity (LLP, JSC, etc.) during the period from the moment of changing the composition of participants (shareholders, founders) up to the moment of entering into a "new employment contract" with the Head or execution of termination of labor relations.

May the Head sign contracts, employer's acts, tax invoices, tax reporting, or perform banking operations during this period?

There are examples where the state revenue authority excluded the amounts from deductions and setoffs under tax invoices signed by the Head whose powers were not properly executed (including by an employment contract). In light of the above, there potentially may be a situation where absence of a "new employment contract" may be considered by the state revenue authority as the absence of proper powers with the signing Head with relevant tax consequences, which may be significant.

Furthermore, there may be disputes with the Head on whether the Head's employment contract terminated at the moment of changing the composition of participants (shareholders, founders) together with all obligations and specific conditions, whether the Head was admitted to work after that moment without an employment contract, what were the Head's obligations during this period, whether the Head had the right to dispose of the company's property, etc.

If an "old" employment contract contains intentional difficulties for its cancellation (e.g. increased notice term, payment of compensation), this gives rise to the issue of whether these obstacles may be overcome on the basis of the Problem Rule (i.e. whether it is necessary to comply with the notice term in this case and whether a compensation must be paid if stipulated by an employment contract).

Perhaps, one of the purposes of the Problem Rule was the protection of the beneficiaries of business from unreasonably high "golden parachutes" included in the "old" employment contract with the Head. Nevertheless, the current version of the Problem Rule does not allow making an unequivocal conclusion that this may be performed for the new beneficiaries. On the contrary, implementation of the Problem Rule may entail the employer's obligation to provide the mentioned benefits to the Head in case of cancellation of an employment contract⁸.

As regards JSCs, the situation is worsened by the fact that an issuer of shares (JSC), as a rule, is not always able to immediately learn about changes in the composition of shareholders, specifically, if changes relate to the shareholders who are not major shareholders. Obviously, that from the practical standpoint the JSC would not ask the central depository each day to provide the list of shareholders (register of holders of shares), and notices from shareholders are stipulated by legislation not for all cases of alienation of shares. The situation becomes even less predictable in case the shares are in nominal shareholding. Such difficulties may also originate with the LLP whose register of participants is kept by the central depository.

As we will further consider, the Problem Rule may also have other unfavorable consequences for labor relations of the parties, for example, cause harm to the Head in light of "reset" of the Head's leave and multiplication of records on "dismissal" and new hire of the Head, as well as financial damages to an organization.

In view of these circumstances, it is necessary to consider how the companies may properly fulfil the requirements of the Problem Rule to mitigate legal risks. In the following sections, we will consider an opinion of the regulatory authority, options of termination of labor relations, and then – options of entering into a new employment contract with the Head in the situation at hand.

1. POSITION OF THE MINISTRY OF LABOR AND SOCIAL PROTECTION OF POPULATION OF THE REPUBLIC OF KAZAKHSTAN

A public legal database contains several clarifications regarding the Problem Rule, which mainly contain its citation and have no interpretation.

We also have a letter with the ref. No. 01-1-1-04/ЗТ-Ч-1186 of the Ministry of Labor and Social Protection of Population of the Republic of Kazakhstan (the "Ministry of Labor") of 22 December 2021 received in response to an inquiry from AEQUITAS Law Firm.

Citation:

"<…> Thus, in case of changes in the composition of founders, whether to enter into a new employment contract with the Head of the executive body or terminate labor relations with the Head depends on decision of founders.

<…> According to Article 62 of the Code, termination of an employment contract shall be executed by an employer's act. The employer's act shall specify a ground for termination of an employment contract in accordance with the Code. Thus, in case of cancellation of an employment contract, it is necessary to specify in an employer's act a reference to paragraph 2 of Article 140 of the Code.

<…> In light of specifics of regulation of labor of the Head of the executive body of a legal entity and members of the executive body of the legal entity, provisions of Article 47 of the Code shall not cover the members of the executive body".

These clarifications will be further taken into consideration.

1. TERMINATION OF LABOR RELATIONS WITH THE HEAD

1. 1. "Automatic" Termination of Labor Relations

We mentioned above that the Authorized Body specified termination of labor relations with the Head in the Problem Rule as one of potential solutions, which gives rise to a disputable issue of whether the labor relations terminate "by default" or a direct resolution of the Authorized Body is required.

This issue is more relevant for the LLPs in case keeping of the register of participants is not delegated to the central depository. Changes in the LLP participants are normally accompanied by a resolution of the supreme management body of the LLP (general meeting of participants or sole participant) on different corporate issues (at least on adjustment of the charter in light of such event).

Therefore, this gives rise to the issue of automatic ("by default") termination of labor relations with the Head from the moment of adopting any resolution of the Authorized Body relating to changes in the composition of participants, unless it is decided to enter into a "new employment contract" with the Head. We believe that such interpretation of the Problem Rule has no proper substantiation, because this ensures no unification of legal regulation for different types of legal entities. For example, such interpretation will not apply to JSCs due to freedom of sale and purchase of shares on the secondary securities market without participation of the management bodies of the JSC.

Furthermore, in this case labor relations may not be terminated "automatically". According to Article 61 of the Labor Code, termination of an employment contract must be executed by an employer's act (normally, an order) specifying a ground for termination. The specifics of signing such employer's act as applied to the Head are stipulated by paragraph 4 of Article 140 of the Labor Code. These are the rules referred to by courts in their judgments on different issues relating to termination of labor relations with the Heads⁹.

To avoid any disputes on this topic it is recommended that the Authorized Body adopts a direct resolution on termination of labor relations with the Head where this is required in connection with changes in the composition of participants (shareholders).

1. 1. Options of Termination of Labor Relations with the Head

For both LLPs and JSCs, as well as other legal entities, the Problem Rule forms another significant disputable issue of what is the ground for termination of labor relations with the Head in case of changing the composition of founders (participants, shareholders).