Balancing the law and good business practice in the regulation of foreign investments in Russia
June 2013 | EXPERT BRIEFING | FOREIGN INVESTMENT
The Federal Law ‘On the Procedure of Foreign Investment in Business Entities Having Strategic Importance for the Defence of the Country and the Security of the State’ No. 57-FZ (the Law on Foreign Investment in Strategic Companies) was adopted in April 2008. It has introduced a special restrictive regime applicable to foreign investments in Russian companies. In particular, it: (i) prohibits foreign states, international organisations (other than certain multinationals which have been exempt from the restrictive regime) or entities controlled by them to acquire control; and (ii) requires a private foreign investor or a group of persons, which includes a private foreign investor, to obtain a pre-acquisition consent of a special governmental commission for the acquisition of control (direct or indirect) over Russian ‘strategic companies’ – i.e., companies engaged in certain activities that are listed in the Law on Foreign Investment in Strategic Companies as having strategic importance for Russia’s defence and national security.
In addition to imposing restrictions on foreign investors, the Law on Foreign Investment in Strategic Companies sets forth significant legal consequences of the failure by an investor to obtain a governmental consent, such as invalidity of a transaction of the acquisition of shares and (if such invalidation is not possible) deprival of the involved foreign investor of all of its voting rights in the target company forever, including the voting rights it could have acquired without obtaining a governmental consent (below the stipulated thresholds).
In general, according to the Constitution of the Russian Federation, ownership rights or freedom of entrepreneurial activities can be restricted, but such restrictions must be fair and adequate, not excessive and necessary for protection of constitutional values. However, because of the numerous ambiguities and vague or poorly worded provisions of the Law on Foreign Investment in Strategic Companies, its construction and implementation by Russian courts, as well as its utilisation by certain Russian companies in order not to respect their obligations to shareholders (not only foreign shareholders), so far, have caused severe concerns of foreign investors.
In general, there are two groups of such concerns. The first group of concerns relates to the fact that virtually any Russian target company can unexpectedly turn out to be strategic simply because it holds a licence to conduct one of the 42 very broadly worded activities listed in the Law on Foreign Investment in Strategic Companies, even though it does not conduct such activity or such activity is not its core activity. The second group of concerns relates to interpretation by Russian courts and the government bodies of the ambiguous provisions of the Law on Foreign Investment in Strategic Companies. One of the most acute problems is its interpretation in such a way that requires obtaining the governmental consent for the acquisition of a strategic company made by another Russian company, which is not controlled by a foreign investor, but has in its group of companies affiliated foreign companies also investing in different projects. Such interpretation taken by Russian state arbitration courts at all levels, and confirmed by the Constitutional Court, contradicts the interpretation of the Law on Foreign Investment in Strategic Companies by the competent governmental body and appears to be in conflict with its general declared objective.
The government has, especially recently, actively declared its objective of liberalising the procedures of control over foreign investment in Russia, in part, through improving the Law on Foreign Investment in Strategic Companies to make it more reasonable. One such step appears to be a recent bill to amend the Law on Foreign Investment in Strategic Companies. The bill was initially prepared by the Federal Antimonopoly Service (FAS), which is the governmental body administering application of the Law on Foreign Investment in Strategic Companies. It was then discussed by the government on 4 April and subsequently submitted to the State Duma on 10 April (the Bill).
The Bill introduces some minor clarifications and improvements of the Law on Foreign Investment in Strategic Companies. In particular, it exempts from the restrictive regime: (i) intra-group transfers of shares in Russian strategic companies, in which a foreign investor already owns more than 50 percent of shares (except for companies holding rights to a subsoil deposit of federal significance); (ii) acquisitions in strategic companies if the foreign investor already owns more than 50 percent of shares in the target company or more than 75 percent in the target strategic company, which holds rights to a subsoil deposit of federal significance; and (iii) acquisitions in food producing companies. But the Bill fails to amend the Law on Foreign Investment in Strategic Companies to rectify its most serious ambiguities described above.
Furthermore, while clarifying and improving the Law on Foreign Investment in Strategic Companies, the Bill incorporates a new rule, which can significantly increase the risks for foreign investors acquiring interests in Russian strategic companies. This new rule attempts to subject to the restrictive regime set forth by the Law on Foreign Investment in Strategic Companies any agreements (written or verbal) that include voting arrangements at a general meeting of shareholders, at a meeting of a board of directors or any other collegial management body of a company, as well as agreements to otherwise obtain the possibility of determining decisions made by a strategic target company, including its business decisions.
Like the Law on Foreign Investment in Strategic Companies, the Bill is so vague that it can be interpreted to cover any arrangement by unrelated foreign and even Russian shareholders in a strategic company to vote, if their aggregate voting is amounts to a controlling stake. According to the explanations of the head of the FAS, the proposed rule of the Bill is intended to cover shareholder agreements among shareholders in Russian strategic companies. Clearly, the rule will apply to the shareholder agreements where a foreign investor with a less than 50 percent share will have veto rights. It is less clear whether the rule will apply to the shareholder agreements of unrelated investors.
It often takes six or more months to obtain a prior governmental consent and a foreign investor must file numerous documents with the FAS, including the written agreement underlying the acquisition of control over a strategic company. Clearly, it would be impossible to obtain a governmental consent to the verbal voting arrangement in line with the requirements of the Law on Foreign Investment in Strategic Companies.
One sanction for failure to obtain prior consent for a voting agreement could be to deprive the involved foreign investors of all of their voting rights for an unlimited term by a Russian court, according to a claim filed by the FAS. In light of the history of the interpretation of the Law on Foreign Investment in Strategic Companies, the possibility of a very broad interpretation of the new restrictive rule appears to be likely. Abuse of the new, ambiguous provision by interested Russian investors cannot be excluded. The only available mitigation of the risk is to obtain a governmental consent, which takes months and involves preparing and filing numerous documents. The written guidance of the FAS, which can be received on a specific issue without filing for consent in accordance with the Law on Foreign Investment in Strategic Companies, may not be helpful because such guidance (if, according to the FAS, no consent is required) is not binding on the governmental commission that issues consents.
Natalya Morozova is managing partner of the Moscow Office of Vinson & Elkins LLP. She can be contacted on +7 499 270 0127 or by email: firstname.lastname@example.org.
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