Doing Business in Russia: Introduction
The Russian economy is currently seeking to develop in quite an adverse foreign political and economic environment. Despite this, Russia has continued to undertake various measures aimed at improving its investment attractiveness. In particular, as announced at the 2015 Saint Petersburg International Economic Forum, Russia is seeking to maintain economic relations with the West, but actively develop and grow its economic relations with the East.
According to the 2015 ‘Doing Business’ ratings, which measure how easy it is to conduct business operations in different countries, Russia was ranked at number 62 (having improved 30 positions compared with the previous year). In particular, Russia was quite highly ranked (34th and 12th position, respectively) when measuring how easy it is to start a business or register property.
Revision and simplification of administrative procedures have significantly increased the attractiveness of investing in Russia. It should be noted that continual improvement of the attractiveness of investment in Russia remains one of the government’s key strategies. In particular, on 27 January 2015, the Russian Government issued a decree on high-priority measures to assure stable economic development and social stability in 2015. Among the key points in the Government’s actions were moves to increase the possibility of attracting renewable investment resources of significant value to the most important sectors of the economy.
As part of increasing the investment attractiveness of the Russian economy, Russia has developed a tax incentive system (both at the federal and regional level) aimed at making the investment process more effective. The range of measures taken is quite extensive and includes developing special economic zones, creating ‘advanced development’ territories, and improving local tax incentive systems (diversifying the investment amounts needed to receive incentives, varying incentive types, etc). In addition, various measures are currently being taken to improve infrastructure in Russia.
Below is a summary of certain legal aspects that shall be taken into account by a reasonable investor contemplating doing business in Russia.
Basic Overview of the Russian Contract Law
The Russian Civil Code is the principal document establishing the Russian contract law framework. General contract law rules and principles are set out in Part I of the Civil Code. Parts II and IV of the Civil Code contain provisions applicable to specific types of contracts. Please note that the provisions of the Russian Civil Code are often very broad and/or open to interpretation. Because it is a relatively new document, Russian courts have not had a chance to interpret its provisions in a comprehensive way. This shortage of interpretive history and guidance often makes it hard to predict how a Russian court would interpret a given Civil Code provisions.
Article 421 establishes a general “freedom of contract” principle that allows the parties to enter into those types of contracts that are expressly provided by law, as well as those that are not, including “combination” contracts (i.e. contracts that combine features of several contract types). At the same time, the terms of a contract should be consistent with the mandatory legal requirements that govern the relevant type of contract and transaction. To the extent the parties try to circumvent such mandatory legal requirements by creating a contractual and transactional structure that appears to be one or a series of transactions of a seemingly different type, those risk being classified as a “sham” transaction that purports to “mask” another underlying transaction, in which case the court would apply rules usually governing the actual underlying transaction.
The parties may enter into a so-called preliminary contract whereby they undertake to enter at some point in the future into a “main” agreement on the terms set out in the preliminary agreement. For certain types of contracts, the law lists “material conditions” that must be included in the contract in order for it to be valid. A preliminary agreement must contain terms sufficient for establishing all the material terms and conditions of the “main” agreement, including the “material conditions” established by the law for such type of contracts. Such an obligation to enter into the main contract in the future constitutes an enforceable obligation and parties refusing to do so are liable for damages caused to the other party. In practice, however, such damages may be difficult to assess and prove in court.
Generally under Russian law, it is possible to terminate a contract unilaterally (whether its term is defined or not) in one of two ways: (i) outside of court or (ii) through the court. The terminology is somewhat different: (i) a unilateral termination outside of court is technically called a "refusal to perform the contract" and (ii) a through-the-court termination is called "termination".
A party willing to initiate a through-the-court termination must first notify the other party of its intention. The party willing to terminate the contract may only go to court after the other party has refused to terminate or amend the contract or, if the other party is not responding, after 30-days have passed from the notice date (a different time period may be established by law or by contract). The termination is by no means automatic, as the plaintiff would need to prove that it has sufficient grounds to terminate (such as “material breach” of contract by the other party or other grounds provided by law or by contract). A breach of contractual obligations by one party is deemed to be “material” if it results in a loss to the other side that is so significant that it deprives the other party of its reasonably expected benefit under the contract.
A unilateral termination through an out-of-court "refusal to perform" is only possible if this possibility is expressly provided for in the contract itself or in the law. With regard to out-of-court termination called "refusal to perform" there is no general rule on the termination notice period -- specific notice periods may be set out in the law (for a given contract type) and/or in the contract itself.
Company Formation In Russia
There are a few corporate vehicles commonly used for doing business in Russia, being (i) a Russian joint stock company, (ii) a Russian limited liability company and (iii) a non-Russian company with a wholly-owned Russian operating subsidiary.
Russian Joint Stock Companies
Russian corporate law provides for two types of joint stock companies ("JSCs"):
- public joint stock companies; and
- non-public joint stock companies.
The main distinctions between the two are:
- non-public JSCs may not have more than 50 shareholders;
- non-public JSCs may not issue shares by open subscription i.e. a public offer of shares;
- acquisition of more than 30% of voting shares in a public JSC triggers mandatory tender offer requirements; and
- shareholders in a non-public JSC have pre-emptive rights (i.e. rights of first refusal) to acquire shares sold by the other shareholders to third parties.
Importantly, the latter rule applies regardless of whether a proposed transferee is affiliated with the selling shareholder and, therefore, transfers to affiliates are subject to the general right of first refusal of the other shareholders.
With respect to most other corporate matters Russian corporate law does distinguish between public JSCs and non-public JSCs and, in general, provides for the less high level of corporate formality for non-public JSCs. Equity securities of both non-public JSCs and public JSCs and any subsequent changes in their capital structure must be registered with the Russian Central Bank even where a non-public JSC has only one shareholder.
The management structure of a non-public JSC or public JSC can have two or three tiers: (a) general meeting of shareholders, (b) board of directors (optional for the JSC with less than 50 shareholders) and (c) the executive (chief executive officer and/or management board).
Russian Limited Liability Companies
Compared to a Russian joint stock companies, a Russian limited liability company ("LLC" or "OOO" in Russian) is in many respects a less regulated and rigid corporate vehicle. Unlike shares in Russian joint stock companies, issuance of equity or changes in capitalization of an LLC do not require registration with the Central Bank. The law provides LLC participants with more flexibility in managing their internal affairs and structuring corporate governance (including with respect to quorum and voting arrangements, other procedural issues, allocation of profit and financing mechanisms). However, it is often hard to predict whether a Russian court would be prepared to recognize and uphold any "novel" or "untraditional" arrangements or even those that merely deviate from the express provisions of the law. To date there is insufficient court guidance on many fundamental issues concerning LLCs, adding uncertainty in the joint venture context.
LLCs can have a two- or three-tier management structure: (a) general meeting of participants, (b) board of directors (optional) and (c) the executive (CEO and/or management board). In contrast to joint stock companies that operate on the basis of a one-share – one-vote principle, the number of votes held by LLC participants may be disproportionate to their respective participation interests. The law provides LLC participants with significant possibility of allocation of authority among corporate governance bodies in an LLC.
As a general rule, a transaction aimed at the transfer of participation interest requires notarial certification. It is very unlikely that a Russian notary will certify a sale and purchase agreement if it is governed by any law other than Russian law. It is important to keep in mind that Russian law has limited concepts of representations, warranties, indemnities and some other which a foreign investor expects in a share purchase agreement. Hence, an on-shore Russian joint venture in form of LLC will not allow choosing English or other foreign law as a governing law for sale of participation interest.
LLC participants have pre-emptive rights with respect to participation interests of the other participants. Like in non-public JSCs, this rule applies regardless of whether a proposed transferee is affiliated with the selling participant and, therefore, transfers to affiliates are subject to the general right of first refusal of the other LLC participants. However, based on a Russian court precedent, it may be possible to bypass the right of first refusal requirements by structuring the transfer of a participation interest other than as an outright sale.
Russian Joint Ventures
Joint ventures with Russian companies are quite common and generally they are formed based on one of the two main approaches – using an on-shore Russian joint venture vehicle or incorporating the joint venture outside of Russia which operates in Russia through a wholly-owned Russian subsidiary.
The preference for one of the two alternatives is typically determined by a variety of factors, including sophistication of the joint venture parties, real and perceived cost and efficiency trade-offs, share ownership percentages, commercial interests and negotiation leverage between the parties, concerns over the protection of shareholder/participant rights, etc.
A Russian party may insist on using a Russian joint venture vehicle on grounds that it is arguably a cheaper alternative and a format that the Russian side is more familiar with. It is important to keep in mind, however, that Russian corporate vehicles may not offer the level of commercial flexibility and certainty that a foreign investor expects in a joint venture setting. In addition, Russian courts do not have a good record of protecting shareholder/participant rights generally and foreign investors rights in particular.
Non-Russian Joint Venture Vehicle
Due to Russian law issues described above, a significant number of joint venture vehicles are incorporated outside Russia in jurisdictions that are familiar to the joint venture partners and that offer reliable legal protection of shareholder rights and make most sense from the corporate governance and tax stand point. For example, it is very common to set up Russian joint ventures in Cyprus and the British Virgin Islands and have their shareholders or joint venture agreements governed by English law with dispute resolution clauses providing for international arbitration (e.g. LCIA, ICC or UNCITRAL). Such joint venture companies then form or acquire operating subsidiaries in Russia.
Opening And Closing Branches And Representative Offices Of Non-Russian Companies In Russia
Effective January 1, 2015, a new regulation on opening and closing branches and representative offices of non-Russian companies came into force in Russia. The new regulation significantly amended the application procedure and requirements. A separate registration procedure applies to branches and representative offices of non-Russian banks and aviation companies. The new regulation specifies that the Russian Central Bank and aviation authorities shall shortly adopt and implement relevant registration procedures.
The new application form required for registration (which is called in Russian "accreditation") of a branch/representative office shall be filed with the Russian tax authorities as opposed to the previous procedure that required filing be made with the Russian Registration Chamber. The authorities have 25 business days for review of the application form and attached documents following which they issue the registration certificate or reject registration of a branch/representative office. The new procedure does not provide for the separate registration of a branch/representative office as a taxpayer. Taxpayer registration is done automatically by the Russian tax authorities on the date of issuance of the registration certificate. The same applies to the registration with the Russian non-budget funds (i.e. Pension Fund and Social Security Fund) – within 3 business days following issuance of the registration certificate the Russian tax authorities shall transfer all the required information regarding the newly registered branch/representative office to the non-budget funds.
In order to file for the registration the applicant shall meet the following registration requirements:
- fill in the application form in a format prescribed by the Russian authorities (in Russian);
- provide the power of attorney with respect to the person who shall file the application (apostiled and with the certified translation into Russian by the public notary);
- provide the decision of a non-Russian company to establish the branch/representative office in Russia (apostiled and with the certified translation into Russian by the public notary);
- provide the by-laws and extract from the companies' register of the non-Russian company establishing the Russian branch\representative office and a power of attorney with respect to the head of branch/representative office (apostiled and with the certified translation into Russian by the public notary);
- provide internal by-laws of the branch/representative office (in Russian);
- provide comfort letter of a non-Russian bank confirming that the non-Russian company is financially stable;
- provide office cards certified by the Russian Chamber of Commerce with respect to each employee of the branch/representative office;
- provide confirmation of payment of the state duty.
The new regulation unlike previous one does not contemplate any term for the validity of registration, i.e. the term for the existence of a branch/representative office is unlimited. Once the branch/representative office is registered the registration shall not expire within any specified period as opposed to previous regulation which provided 1, 2 or 3-year registration term that required extension following its expiration.
There are certain grounds for termination of the registration that shall be noted by the non-Russian company establishing a branch/representative office. These are the following: (1) if during the 12 month preceding the decision registration termination the branch/representative office (i) has not been filing the required tax and financial reports, or (ii) the Russian authorities have not been able to reach the contact person of the branch/representative office or (iii) back accounts of the branch/representative office are inactive and (2) if the activity of the branch/representative office contradicts national security of the Russian Federation.
Anti-Trust And Strategic Approval Requirements For Investments In Russia
Like other jurisdictions, Russia has a set of requirements which may impact upon persons considering investing or investing into Russian businesses. These are: (i) Russian antitrust issues; and (ii) Russian strategic law issues that are potentially applicable to the direct or indirect (i.e. via an off-shore holding structure) acquisition of interests in Russian businesses.
Russian Antitrust Issues
Broadly speaking, Russian competition legislation (the "Competition Law") may impact upon any investor entering the Russian market provided certain financial and other thresholds are met. The proposed investment into a Russian business may require either a preliminary approval from or post-completion notification (although the number of triggering events is very limited and mostly relates to intragroup transfers) of the Russian antitrust authority (the "FAS").
The establishment of a new Russian entity through contribution of "shares (equity interests) in and/or property of another business entity" or direct/indirect acquisition of a Russian company's stake will require a preliminary approval from the FAS if one of the thresholds set out below is met and one of the following conditions is satisfied:
(A) (i) the aggregate balance sheet value of assets of the company founders (and their respective) "groups of persons") and the company whose shares are being contributed (and its respective "group of persons") exceeds 7 billion Russian roubles (approximately 135 million US dollars) and (ii) the balance sheet value of assets of the company whose shares are being contributed (and its subsidiaries) exceeds 250 million Russian roubles (approximately 4.7 million US dollars); or
(B) (i) the aggregate revenue of all the persons mentioned under (A)(i) above for the last calendar year exceeds 10 billion Russian roubles (approximately 190 million US dollars) and (ii) the balance sheet value of assets of the company whose shares are being contributed (and its subsidiaries) exceeds 250 million Russian roubles (approximately 4.7 million US dollars); or
(C) any of the above persons, whose share of a given market exceeds 35%, is included in the Russian antimonopoly register of persons
The preliminary approval requirement applies only to those contributions and/or acquisitions which exceed certain thresholds established for the acquisitions of shares. These thresholds are 25%, 50% and 75% of the voting shares in a Russian joint stock company and 1/3, 1/2 or 2/3 of the charter capital of a Russian limited liability company. Similarly, the preliminary approval requirement is triggered when the value of the contributed property (assets) exceeds 20% of the balance sheet value of the "main production assets and intangible assets" of the disposing entity.
Generally, it could take up to 3 months to obtain the FAS clearance. The sanctions for breaking Russian anti-monopoly requirements are potentially very high. Transactions that are entered into in violation of the antimonopoly clearance requirements (i.e. both preliminary consent and notification requirements) are voidable within one year.
Russian Strategic Law Issues
The framework for regulating foreign investments in strategic sectors of the Russian economy is established by certain Russian legislation (the "Strategic Investment Law"). The Strategic Investment Law applies to investments into companies engaged in activities of "strategic importance" listed in the Strategic Investment Law (the "Strategic Companies" and each a "Strategic Company"). It lists the following four (4) main categories of "strategic activities":
(A) exploration of and extraction from "subsoil blocks of federal importance". For example, oil fields with over 70 million tons of oil or gas fields with over 50 billion cubic meters of gas constitute a subsoil block of federal importance;
(B) defense-related activities;
(C) mass media; and
(D) certain monopolies and dominant market players.
The Strategic Investment Law sets out different filing and strategic approval thresholds for private foreign investors and government controlled foreign investors.
Private foreign investors
Acquisition by a private foreign investor of a controlling stake in a Strategic Company triggers a filing obligation for such private foreign investor. A private foreign investor will also require the relevant government commission's strategic approval in order to control a Strategic Company. For these purposes, "control" means:
(A) having more than 50% of the voting shares;
(B) having the right to appoint the CEO (chief executive officer) and/or more than 50% of a management board or other management body;
(C) having the right to appoint more than 50% of the board of directors; or
(D) managing or otherwise directing business operations.
Thresholds are reduced from 50% to 25% when the "control" test is applied in respect of a Strategic Company engaged in exploration of and extraction from "subsoil blocks of federal importance".
A private foreign investor who has acquired more than a 5% interest but less than a controlling stake in a Strategic Company is required to file a notification to the FAS. The notification shall be filed within 45 calendar days following completion of the acquisition.
A strategic approval requirement does not apply to acquisitions by private foreign investors of stakes in Strategic Companies operating in exploration of and extraction from "subsoil blocks of federal importance" in which the Russian government directly or indirectly owns more than 50% of the voting shares. This exemption does not apply to government controlled foreign investors.
Government controlled foreign investors
A government controlled foreign investor will require the relevant government commission's strategic approval if it decides to acquire:
- 5% or more of Strategic Companies involved in exploration of and extraction from "subsoil blocks of federal importance"; and
- 25% or more of the other Strategic Companies,
- except that no such investor is allowed to acquire more than:
- 25% of Strategic Companies involved in exploration of and extraction from "subsoil blocks of federal importance"; and
- 50% of the other Strategic Companies.
Another piece of Russian legislation (the "Foreign Investment Law") may also trigger a strategic approval requirement. Pursuant to the Foreign Investment Law, an acquisition by a foreign government controlled investor of 25% or more of any Russian company (i.e., even if the company is not a Strategic Company) requires a strategic approval.
Generally, it could take up to 6 months to obtain the relevant approval. Transactions that are entered into in violation of the strategic filing requirements may be declared void within three years. Further, if a foreign investor acquires control over a Strategic Company in a foreign-to-foreign transaction, the Russian authorities may seek the court injunction restricting the relevant foreign investor to vote its shares in the Strategic Company or challenge corporate decisions approved by the foreign investor.
Distribution Agreements In Russia
Distribution agreement is not a concept that is well-developed in Russia. There is no an established court guidance on most of the terms and conditions a reasonable non-Russian supplier seeks to include into the distribution agreement. It is common practice that a non-Russian investor is seeking to (i) fix the sale price and (ii) include territorial and customer restrictions in a distribution agreement with its Russian partner (which is not within its group). The Russian laws and court practice are not favorable to such terms and conditions.
1. Fixing the sale price
Fixing the sale price at which the distributor is required to distribute products is prohibited by Russian antitrust law. However, Russian antitrust law explicitly allows the supplier to specify the maximum sale price for products, which could be a feasible solution.
2. Territorial and customer restrictions
Including territorial and customer restrictions in a distribution agreement is subject to a number of legal considerations.
(1) Russian antitrust law allows the inclusion of territorial and customer restrictions in a distribution agreement if the agreement is: (i) a "vertical" agreement between non-competitors; and (ii) each of the parties to the agreement does not hold more than a 20% share of any Russian product market. Please note that the Russian antitrust law has been recently amended and, accordingly, currently there is very limited guidance on the implementation of Russian antitrust law provisions applicable to distribution agreements.
(i) Vertical agreement between non-competitors
Based on the existing practice of Russian antitrust authorities (the "FAS"), if the supplier sells a product to the distributor and does not sell it to customers in the same market within which the distributor operates, the supplier and the distributor will not be regarded as competitors.
However, there exists some uncertainty as to the definition of the "same market". In circumstances where the distributor's sales are limited to a certain region of the Russian Federation, it is unclear whether the term "same market" covers the whole territory of the Russian Federation or the region where the distributor operates. Having said that, the most recent approach taken by the FAS (which should be regarded as a guidance and not as an established practice) supports the latter view. If you are not proposing to sell to customers in the Russian Federation, clearly the vertical agreement test should be satisfied.
(ii) 20% or less market share
Firstly, this equally applies to the supplier and the distributor. Therefore, if either party to a distribution agreement holds more than a 20% share of any Russian product market, the incorporation of any territorial and customer restrictions into the distribution agreement is prohibited.
Secondly, the 20% test is not limited only to the product which is the subject matter of the distribution agreement and applies to any product market in which the parties to the distribution agreement operate. For example, if the supplier holds more than a 20% share in the fruit market, but less than 20% in the market of hygiene materials, it may not include any territorial and customer restrictions in a distribution agreement relating to the distribution of hygiene materials.
Accordingly, if the parties to a distribution agreement are not competitors and do not hold more than a 20% share in any of the Russian product markets, there is a good chance that the FAS will not challenge any territorial and customer restrictions in the distribution agreement.
(2) One of the aims of Russian antitrust law is to prevent a supplier from carrying out anti-competitive actions across a network. It is not rare to see that a supplier with a wide network of distributors serves letters upon prospective customers notifying them of territorial and customer restrictions, and requiring the customers to purchase products only from a certain distributor. Such practice is a breach of the Russian antitrust law. Accordingly, the supplier should not adopt any such practice.
(3) According to the Russian law, agency agreements are prohibited from containing territorial and customer restrictions. Based on the established Russian court practice, distribution agreements are treated as complex agreements with elements of both an agency agreement and a sale and purchase agreement. Accordingly, the prohibition on territorial and customer restrictions may be applicable to distribution agreements and, thus, prevent effective enforcement of respective provisions in Russia.
In order to mitigate the risk of applying agency agreement rules to the distribution agreement it is advisable to reflect in the contemplated draft distribution agreements the following points:
- the distribution agreement shall specifically provide that it is not an agency agreement and that the distributor does not act as an agent of the supplier;
- the agreement shall not contain any provisions pursuant to which the supplier rewards the distributor for the sale of a certain volume of goods and the supplier's ability to audit the sales of the distributor; and
- the agreement shall be governed by non-Russian law.
Russian Personal Data Law
The new Russian Personal Data Lawwill become effective on September 1, 2015. It will have a significant business impact on companies operating in and outside of Russia and keeping records of any personal data whether such data relates to consumers, employees, or third-party partner personal data. Below are the most significant developments in the personal data law and its anticipated effect on the activity of corporations operating in Russia.
1. Centers of Personal Data Shall be Located in Russia
The most significant change, which appears likely to have a significant business impact on companies operating in and outside of Russia, is a new requirement that "databases which are used for gathering, recording, systemizing, accumulation, storage, updating and uploading of personal data of the Russian citizens" shall be located in Russia. Under the amendments, "an operator gathering personal data, including by Internet, must ensure recording, systemizing, accumulation, storage, updating and uploading of personal data of the Russian citizens with the databases located on the territory of the Russian Federation." Hence, operators collecting data from Russian citizens will need to move their information technology infrastructure to a data center located in Russia, whether such data relates to consumers, employees, or third-party partner personal data. The amendments do not introduce additional specific liability or penalties for failure to "ensure" allocation of data centers and other physical resources for personal data processing in Russia.
In light of the amendments to the Personal Data Law a sophisticated company shall take into account the requirement to comply with protection levels of the personal data. This is the requirement of the Russian authorities that mandates operators of the personal data to introduce technical and operative mechanisms to protect personal data in accordance with protection levels. From the technical standpoint an operator of the personal data may use both cryptographic and non-cryptographic devices. Import of cryptographic devices in Russia, unless their symmetrical algorithm exceeds 56 bits or asymmetrical algorithm exceeds 512 bits, is subject to notification procedure which rather strict forward and takes approximately 7-10 business days. Import of other cryptographic devices requires special license. In addition, an operator shall note that the use of cryptographic devise may require certification with the Russian Federal Security Agency and the use of non-cryptographic shall require prior certification with the Russian Federal Service of Technical and Export Control. Unless certification is obtained neither device shall be used in Russia.
2. Introduction of the "Register of Infringers of Rights of the Personal Data Subjects"
Another significant and separate change under the amendments is the introduction of the "Register of Infringers of Rights of the Personal Data Subjects" ("Register"). The Register will list "domain names and/or webpages and weblinks on the Internet" as well as "web addresses which identify internet sites" of internet services and social networks that are deemed "infringers." No reference is made to the operators that process personal data of their employees and/or customers keeping such data in their data centers (i.e., not with a direct web access for third parties).
Any domain names and/or webpages and weblinks on the Internet may be included in the Register based on the enforceable court decision. Any physical personal who deems it personal data rights are violated may initiate relevant court proceedings. The claim may be brought against the Russian regulator (currently Roskomnadzor) and the holder of the domain names and/or webpages and weblinks on the Internet shall not be notified of the anticipated proceedings. Once the court decision comes into effect, the "personal data subject" whose rights are infringed may apply to Roskomnadzor with a complaint seeking to "restrict access to infringing information." Roskomnadzor, in turn, has three days to react to the complaint and then order the relevant internet service provider ("ISP") to block access to the domain name and/or internet site address in question. The ISP has one day to apply to the relevant domain name/website owner asking for a "voluntary compliance" with the regulator's order. After that, if no "voluntary compliance" is provided, access to the relevant domain name/website will be blocked.