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 Code[1]).

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.

 

1.2      Historical Aspect of the Problem Rule

The current version of the Problem Rule has been active since 2020[2]. It previously referred to 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 shareholder.

The 2020 amendments broke this logic and created legal and practical difficulties, which will be considered below.

To date, according to 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").

 

1.3      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.  May labor relations with the Head be continued without changing and entering into a new employment contract in case a resolution is silent on this issue?

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 in view of examples of judicial practice (please see the full version of this article).

 

1.4      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 Law[3] 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. Both options entail appearance of a new participant in the composition of the LLP participants and directly relate to the Problem Rule.

Meanwhile, changes in the composition of participants may also take place in other cases resulting in withdrawal of a participant form the LLP: (a) alienation of the whole share by one participant in favor of another current participant; (b) purchase of the participant's share by the LLP (including compulsory); (c) 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; and (d) 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.  It is not possible to exclude the necessity to apply the Problem Rule in such cases as well, although practicability of this is doubtful. 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.

 

1.5      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, which is impossible 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.

  • 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.

 

1.6      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 shares; 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.

 

1.7      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.

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, and whether the Head had the right to dispose of the company's property.

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.  However, 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 contract[4].

As regards JSCs, the situation is worsened by the fact that its Authorized Body is not always able to immediately learn about changes in the composition of shareholders.  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.

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.

 

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

We 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.

 

3.        TERMINATION OF LABOR RELATIONS WITH THE HEAD

 

3.1      "Automatic" Termination of Labor Relations

The Problem Rule specified termination of labor relations with the Head as one of potential solutions for the Authorized Body.

We believe that in this case labor relations may not be terminated "automatically" from the moment of adoption of a corporate resolution on changes in the composition of the LLP participants.  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[5].

Therefore, it is recommended to the Authorized Body to always adopt a direct resolution on termination of labor relations with the Head, unless it is contemplated to continue them.

 

3.2      Options of Termination of Labor Relations with the Head

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)[6].

If the Head has no intention to further work for an organization after changes in the composition of participants (shareholders) and submits a relevant notice, the employment contract is cancelled with the Head on his/her initiative[7].  

Otherwise, the Authorized Body must select another ground.

  • Option of Termination of Labor Relations No. 1.  It is possible to cancel an employment contract on the employer's initiative – in case of early termination of powers of the Head based on a resolution of the Authorized Body of a legal entity (sub-paragraph 23) of paragraph 1 of Article 52 of the Labor Code).
  • Option of Termination of Labor Relations No. 2.  It follows from the previously mentioned letter of the Ministry of Labor that the Problem Rule may be considered as a separate ground for termination of labor relations.

However, such approach is inconsistent with Article 52 of the Labor Code, which provides for an exhaustive list of grounds for cancellation of an employment contract on the employer's initiative.

This entails a risk that the Head may challenge cancellation of his/her employment contract.

For example, the court of Baikonyr District of Nur-Sultan specified in its judgment of 15 October 2020 in the case No. 7145-20-00-2/2237:

"Termination of powers of the claimant was executed by a proper order; however, the employer's act does not specify the ground for termination of the employment contract with a reference to the rule of Article 52 of the Labor Code, only to the rules of paragraph 2 of Article 140 of the Labor Code.

<…> subject to condition that the employer could have mistakenly specified a reference in the order to a wrong ground of the Labor Code; however, in light of presence of a ground for cancellation of the employment contract on the employer's initiative due to subparagraph 23) of paragraph 1 of Article 52 of the Labor Code, the court comes to conclusion to dismiss the claim with regard to recognition of the order as illegal.

This argument of the court is in line with the clarifications given in paragraph 31 of the Normative Resolution No. 9 of the Supreme Court of the Republic of Kazakhstan of 6 October 2017 "On Certain Issues of Applying Legislation by Courts When Resolving Labor Disputes", according to which, in case the court recognizes when resolving a dispute on reinstatement at work that an employer had a ground for termination or cancellation of an employment contract, but an order mistakenly contains a reference to a wrong ground of the Labor Code or another law, the court shall dismiss a claim.  At the same time, in the analytical part of its judgment, the court shall indicate a specific ground of the Labor Code or another law, under which the employment contract was subject to termination or cancellation".

Thus, in this specific case the court came to conclusion that the employment contract with the Head was actually cancelled according to Option of Termination of Labor Relations No. 1, which was considered above, i.e. on the basis of the ground stipulated by subparagraph 23) of paragraph 1 of Article 52 of the Labor Code, although the order was executed according to the Option of Termination of Labor Relations No. 2.

  •  Option of Termination of Labor Relations No. 3.  Literally, the Problem Rule provides for termination of labor relations.  This gives rise to an issue of whether we should consider the Problem Rule as an additional ground for termination of an employment contract, which is not its cancellation.

Among the grounds for termination of an employment contract, Article 49 of the Labor Code provides for its cancellation and other grounds, which are not cancellation.  The list of such grounds is also exhaustive, and it does not contain any references to an additional ground in the form of the Problem Rule.  Therefore, application of the Option No. 3 bears the risks similar to the risks of the Option No. 2.

From the practical standpoint, Option No. 1 (direct application of sub paragraph 23) of paragraph 1 of Article 52 of the Labor Code) with an additional reference to the Problem Rule seems to be the safest and most substantiated option from all options considered above in case the Authorized Body decides not to continue labor relations with the Head and subject to absence of other grounds for this.

We also deem it possible to reach an agreement with the Head on cancellation of his/her employment contract (sub-paragraph 1 of Article 49 of the Labor Code) as a method for the parties to keep maximum distance from the contradictions of the Problem Rule and its risks.

 

4.        NEW EMPLOYMENT CONTRACT IN CASE OF FURTHER LABOR RELATIONS WITH THE HEAD

 

4.1      Further Labor Relations with the Head

If the Authorized Body of a legal entity does not wish to terminate labor relations with the Head, according to the Problem Rule, an employer[8] must enter into a "new employment contract" with the Head.

In this case, the law-maker requires to enter into a "new employment contract" with the current Head in such a crafty manner allowing not to terminate labor relations with the Head, because these are two separate situation development scenarios.

 

4.2      Options of Entering Into a "New Employment Contract"

Below we will consider four options of solving this issue.

  • Option of Entering Into a "New Employment Contract" No. 1 – to sign a "new employment contract" and include a clause in it that the "old" employment contract loses its force.  Such method of the agreement termination is often used in civil relations, but it does not apply to labor relations.

Most obvious disadvantages of this option are:

a)          absence of such ground for termination of an employment contract in the Labor Code (which may result in recognition that the "old" employment contract was not terminated and is still in effect);

b)          absence of a clear response on how to "terminate" the "old" employment contract in the UASEC[9] without selecting any legal ground for its termination;

c)          this clause may also mean that the parties cancel the "old" employment contract by agreement of the parties, which will require issuance of an order on its cancellation and will give rise to the consequences stipulated by the Option No. 2, which will be considered below;

d)          termination of an employment contract means termination of labor relations (which does not suit us); and

e)          such option is inconsistent with another rule - paragraph 3 of Article 140 of the Labor Code.

We cannot recommend Option No. 1 for application.

  • Option of Entering Into a "New Employment Contract" No. 2 – to terminate the "old" employment contract applying a more common legal ground (e.g. by agreement of the parties or on the basis of a resolution of the Authorized Body on the employer's initiative, normally according to subparagraph 23) of paragraph 1 of Article 52 of the Labor Code) and immediately (e.g. starting the next day) enter into a "new employment contract" with the Head.

Labor relations will actually be uninterrupted as a general legal category (in case of absence of a pause between the effective period of the "old" and "new" employment contracts).  However, in this case:

a)          specific labor relations with the Head (determined by the conditions of a specific employment contract) will legally terminate concurrently with the "old" employment contract, which is inconsistent with the Problem Rule.  New labor relations will originate starting from the moment of entry into force of the "new employment contract";

b)          this option is unprofitable for the Head and deprives him/her of the legitimate right to the annual paid labor leave, because the Head will receive a monetary compensation in lieu of the days of leave when terminating the "old" employment contract, and the days of leave will "reset".  This will always happen in case of changes in the composition of shareholders, participants or founders.  In a hypothetical situation of frequent changes of participants or shareholders this will inevitably result in impossibility for the Head to "physically" use the annual labor leave in the form of rest[10] and may cause harm to his/her health and, consequently, to business of organization;

c)          record (or multiple records) on termination of an employment contract with him/her will appear in the labor history of the Head;

d)          this option is uncomfortable for an employer, because apart from the "new employment contract" and mandatory corporate resolution, it will be necessary to draft the full set of documents for "dismissal" and new hire, including an order on cancellation of the employment contract, introduction of information into the UASEC, document confirming labor activities, order on hire for work, etc.; and

e)          as regards the Head whose candidacy is subject to approval with the authorized regulatory agencies (e.g. for banks), this gives rise to a disputable issue of whether it is necessary to obtain a new approval prior to entering into a "new employment contract".

  •  Option of Entering Into a "New Employment Contract" No. 3 – without executing a separate "new employment contract", to enter into a supplementary agreement to the "old" employment contract to set out a revised version, without termination of labor relations, and with a reference to the Problem Rule, paragraph 2 of Article 33 and paragraph 3 of Article 140 of the Labor Code.

Such approach stems from paragraph 3 of Article 140 of the Labor Code, according to which in case of appointing (electing, approving in a position) the Head for a new term, relevant amendments must be introduced into the employment contract, i.e. it implies entering into a supplementary agreement to the employment contract, but not into a "new employment contract".

In our view, this option could meet the interests of the parties. However, it is inconsistent with the Problem Rule (which literally requires a "new employment contract", but not a supplementary agreement to the "old" one); therefore, it is highly probable that the regulatory authority and court will not be able to support it.

  • Option of Entering Into a "New Employment Contract" No. 4 – worst option – just enter into a "new employment contract" and forget about the old one.

This option will lead to accumulation of the Head's employment contracts both actually, legally and in the UASEC.  In case of a dispute, the Head may reanimate them (e.g. claim for payment of salary under such contracts or payment for the forced absence, challenge dismissal, etc.).

We cannot recommend the Option No. 4 for application.

 

4.3      Formation of Practice on the Issue of Further Head's Work When Changing the LLP Participants

In practice known to us, the parties prefer acting in accordance with the Option No. 2 (cancellation of an employment contract on the basis of a resolution of the Authorized Body, adoption of a corporate resolution on appointment (election) of the Head for a new term and entering into a "new employment contract")[11].  It is considered as a safer in case of infrequent changes in the business beneficiaries.

At the same time, business does not understand the purpose of the Problem Rule and believes that it is excessive.

Furthermore, confident Heads have already started using the oddities of the Problem Rule and sometimes claiming from the new participants for a better "package" when entering into a "new employment contract" threatening to refuse to sign it.


4.4      Foreign Head

The situation becomes more complicated when the Head is a foreigner, because he/she falls under the legislation in the migration sphere.

If a foreigner is a citizen of the EAEU member state, to obtain a permit to temporary residence in the Republic of Kazakhstan (the "TRP") it is necessary to submit a copy of an employment contract, information about which is introduced into the UASEC.  The TRP cannot exceed the term of an employment contract.[12]  Therefore, entering into a "new employment contract" with the Head gives rise to a disputable issue of whether TRP previously issued to the Head under the "old" employment contract will lose its force "automatically" and will be subject to revocation.  Is it necessary to notify the migration authority and obtain a new TRP?

Some experts recommend notifying the migration authority of termination of the "old" employment contract and obtaining a new TRP under a "new employment contract" to avoid any risks for the foreign Head and his/her employer.

The situation with the foreigners obtaining visas to enter Kazakhstan on the basis of an employment contract develops the same way.

 

5.        CONCLUSION

The Law No. 480-V of the Republic of Kazakhstan "On Legal Acts" dated 6 April 2016 (paragraph 3 of Article 24) requires setting out of the text of a regulatory legal act (including a code) in compliance with the rules of legal language and legal technique.  It is not allowed to repeat a rule of law in another structural elements of the same act.  Provisions must be as short as possible, and must contain clear sense not subject to different interpretation.

In our view, the text of the Problem Rule violates these requirements, including as follows:

  • substantially repeats other rules of the Labor Code with respect to the right of the parties to change an employment contract by agreement of the parties or to its termination;
  • has unclear sense allowing for different interpretation; and
  • is inconsistent with other provisions of the Labor Code and specific laws (particularly, the JSCs Law and the LLPs Law).

We believe that the Problem Rule creates excessive regulatory impact, gives rise to many legal risks and practical difficulties for all parties to labor relations.

Although there are certain examples where the Problem Rule turned to be helpful[13], it may entail unjustified consequences for the Head and an employer.

Therefore, it would be reasonable to significantly reform paragraph 2 of Article 140 of the Labor Code, including the Problem Rule, subject to the accumulated practice and science-based approaches to rectify the existing drawbacks.

So far, the companies that encounter changes in the composition of shareholders, participants or founders should not ignore the existing requirement of the Labor Code, but should also seek for acceptable and less risky options to fulfil such requirement[14].

 


[1]    "Labor Code" – Labor Code No. 414-V of the Republic of Kazakhstan dated 23 November 2015, as amended.

[2]    The current version of the Problem Rule was formed as a result of amendments introduced into the Labor Code by the Law No. 321-VI of the Republic of Kazakhstan dated 4 May 2020.

[3]    LLPs Law – Law No. 220-I of the Republic of Kazakhstan "On Limited and Additional Liability Partnerships" dated 22 April 1998, as amended.

[4]     For example, in the judgment No. 3310-22-00-2/1015 of 13 January 2022, the city court of Taldykorgan of Zhetysu Oblast recognized an order on termination of an employment contract as illegal and reinstated at work the dismissed director of an LLP for a number of reasons, including incorrect indication in an order of the ground for cancellation of the employment contract and violation by an employer of an additional (as compared with the Labor Code) requirement of the employment contract on at least 1 month prior written notification of the employee of cancellation of the employment contract.

[5]    You can find the examples in the full version of this article.

[6]    In this article, we will not consider the issue of specifics of application of the Problem Rule to the Head who had been the sole participant or shareholder of a legal entity prior to changes in the composition of participants/shareholders and had not have an employment contract.

[7]     We believe that an employee (Head) may not be deprived of the constitutional right to freedom of labor and other legitimate rights in the labor sphere. For example, such approach is applied by the District Court No. 2 of Kazybek bi District of Karaganda in the judgment of 30 January 2023 in the case No. 3512-22-00-2/9075. At the same time, the Problem Rule is not consistent with other rules of the Labor Code.

[8]    In this case, an employer is a legal entity, but not specific participants, founders or shareholders.

[9]    "UASEC" is the unified accounting system of employment contracts on the Internet resource https://hr.enbek.kz/.

[10]   In this case it is possible to grant to the Head an additional paid labor leave (which entails additional expenses of an employer) or an unpaid leave (in case of such request from the Head), so that the Head could actually have rest in lieu of the "expired" days of mandatory paid annual labor leave.

[11]   Please note that the Labor Code contains special requirements to an employment contract with the Head and persons signing such contract and establishes requirements to other formalities relating to entering into an employment contract, which must also be complied with.

[12]   Part 5 of paragraph 10 of the Rules for Entry and Stay of Immigrants in the Republic of Kazakhstan, and Their Exit from the Republic of Kazakhstan, as approved by the Decree No. 148 of the Government of the Republic of Kazakhstan dated 21 January 2012, as amended.

[13]   Specifically, the Problem Rule was applied by courts together with other rules of legislation in situations where the Heads claimed for termination of labor relations with them when changing the composition of participants of a company.

[14]   This article (a) reflects the author's opinion, which may differ from the opinion of authorized governmental agencies, court and other persons; (b) may not be treated as a legal advice or a reason for making specific decisions on the Kazakh law issues, or considered as a recommendation on how to execute, change or terminate labor relations with the Head.