Russian arbitration reform: impact on arbitration clauses in agreements with Russian target companies
July 2018 | EXPERT BRIEFING | LITIGATION & DISPUTE RESOLUTION
Russia updated its arbitration legislation in 2016, with various provisions entering into force throughout 2017. One of the most relevant changes so far appears to be the new treatment of the arbitrability of ‘corporate disputes’.
What is a ‘corporate dispute’?
Under Russian procedural law, a ‘corporate disputes’ means any dispute relating to the establishment, governance or participation in a Russian legal entity. The recent arbitration law reform legislation, which entered into force on 1 September 2016, updated the rules on the arbitrability of corporate disputes.
In short, ‘corporate disputes’ were divided into three categories. The first includes non-arbitrable disputes, usually those with some type of public element. The second concerns disputes in relation to ownership over shares, including disputes arising out of share purchase agreements (SPAs) as well as disputes arising out of various security arrangements, e.g., pledge agreements, in relation to the shares. Such disputes can only be referred to administered, as opposed to ad hoc, arbitration. The third category includes disputes with multiple contracting parties; importantly, disputes arising under the shareholders’ agreements. Importantly, under the updated laws, an arbitration agreement with respect to any category of corporate dispute is only enforceable if entered into after 1 February 2017.
Issues arising out of the new rules on arbitrability of corporate disputes
While the arbitrability of corporate disputes has been questionable since at least 2011, the new rules may raise further uncertainties for market participants.
Enforceability of pre-reform arbitration clauses
First of all, it is not entirely clear what happens to arbitration agreements concluded prior to 1 February 2017. In reality, it was not uncommon for foreign acquirers of Russian targets to insist on including arbitration clauses, usually tied to the London Court of International Arbitration (LCIA), even prior to the recent arbitration reform. There were at least two reasons for this. First, the arbitrability of such disputes was far from settled, as there were cases which considered corporate disputes arbitrable. Second, due to a number of very unfortunate but widely reported cases, Russia has never been considered a pro-arbitration jurisdiction for enforcement purposes. Therefore, many foreign parties accepted the risk that awards may be unenforceable in Russia, regardless of the arbitrability of the underlying corporate dispute. Consequently, a significant number of arbitration agreements were entered into before 1 February 2017.
While the transitional provisions of the arbitration reform legislation state that arbitration agreements in relation to corporate disputes entered into before 1 February 2017 are deemed unenforceable, questions remain as to whether this also applies to the pre-reform arbitration clauses. Arguably, arbitration clauses concluded before 1 September 2016 – when the reform legislation entered into force – should remain as valid and enforceable as they were under the legislation applicable at the time of their conclusion. However, there have only been a few cases dealing with this issue to date, and the position remains unclear.
Categorising corporate disputes
Currently, categorising certain corporate disputes is a daunting task. For example, disputes in relation to ownership of shares fall within the second category, but disputes arising under shareholders’ agreements fall within the third category. Depending on the category they fall within, they may be governed by different rules.
Difficulties arise when an agreement contains different types of obligations. For example, it is common for shareholder agreements to include call and put options which can be executed by either of the parties in certain circumstances. It is unclear, however, to what extent the courts would be guided by the nature of the obligations in question, rather than the type of agreement in which the relevant obligations are to be found. Thus, if the nature of the obligations was put to the test, call and put options would likely fall within the second category. However, it is also likely that Russian courts would take a conservative approach and be guided by the label parties place on their agreement. This would lead to the conclusion that if the put and call options are included in a shareholders’ agreement, they need to be characterised as disputes falling within the third category, just like any other obligation under a shareholders’ agreement.
Agreeing on foreign arbitral institutions
While disputes falling within the third category, particularly disputes arising from shareholders’ agreements, have to be seated in Russia and resolved in accordance with specific rules, disputes relating to the sale and purchase of shares do not have to be seated in Russia. However, the question remains whether they could be arbitrated under the rules of any of the major international arbitral institutions, such as the LCIA, the International Chamber of Commerce (ICC) or the Singapore International Arbitration Centre (SIAC).
The reform legislation allows second category disputes to be resolved by arbitration only if administered by a ‘permanent arbitral institution’. This is the defined term under the new legislation, which encompasses only arbitral institutions which have obtained a governmental permit to administer cases in Russia. Such a permit is only necessary for Russian-based arbitral institutions. While foreign institutions may obtain one, they are under no obligation to do so. At the same time, a conservative interpretation suggests that only arbitral institutions holding a governmental permit may be entitled to administer such disputes.
At the moment, only four Russian arbitral institutions are authorised to administer arbitrations in Russia. No foreign arbitral institution has obtained a governmental permit to date. Furthermore, it appears unlikely that any such permit will be granted in the near future. By implication, there is uncertainty as to whether disputes can be referred to arbitration under foreign arbitral institution rules.
There is a significant category of Russian legal entities which are considered ‘strategic entities’ – operating in sectors which the Russian legislator considers of particular importance to the security of the state. These include telecom, oil and gas and subsoil. According to Russian law, control over such entities by foreign and foreign-controlled companies is restricted by what is commonly known as Federal Law No. 57-FZ.
The reform legislation prohibits arbitration of almost all disputes in relation to ‘strategic entities’. Accordingly, when a contract relates to shares in such a ‘strategic entity’ arises, no arbitration clause can be included. This scenario becomes more complicated when the target is not the ‘strategic entity’ itself, but a company holding shares in such an entity. Such a transaction would also be captured by Federal Law 57-FZ, which also deals with acquisition of indirect control over ‘strategic entities’. However, prohibiting arbitration of disputes in relation to a ‘strategic entity’ is phrased in such a way as to capture only situations where the entity itself is the direct target.
In terms of the enforceability of arbitration agreements prior to 1 February 2017, one solution is to conclude new (post 1 February 2017) arbitration agreements in relation to existing contracts. However, in many cases, this may be impractical or unsatisfactory. For example, although it would require the agreement of both parties, one may use the situation as an opportunity to change dispute resolution provisions in favour of Russian courts. It is difficult to say to what extent this approach is popular, if at all.
Another possible solution, which is used rather extensively, is to include waterfall dispute resolution provisions. In a nutshell, parties include reference to several dispute resolution mechanisms in order to resolve disputes which may arise under a particular agreement. They start with the preferred option, but seek alternatives (including Russian state courts) if their original choice is unavailable.
The inherent difficulty with these types of clauses is that they almost invariably lead to a jurisdictional dispute. Given the uncertainties outlined above, there would almost always be room for argument, such as whether a particular dispute falls within or outside the jurisdiction of a particular tribunal. The only uncontroversial element of such a clause is the jurisdiction of a Russian state court, which is not always a desirable outcome.
With Russian rules on the arbitrability of corporate disputes only dealing with disputes relating to direct shareholding of a Russian company, one of the best ways to address this issue may be to introduce, where possible, a non-Russian holding company into the deal structure. This way, a dispute would be beyond the scope of Russian law. This, at least, is the case under current legislation and court practice. However, there is no guarantee that this approach will not change in future.
When acquiring shares or interests in Russia legal entities, great care needs to be taken when structuring transactions, with new rules on the arbitrability of corporate disputes kept firmly in mind.
Andrey Panov is a senior associate at Norton Rose Fulbright (Central Europe) LLP. He can be contacted on +7 (499) 924 5101 or by email: firstname.lastname@example.org.
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Norton Rose Fulbright (Central Europe) LLP