Russia: Merger and strategic enterprise control

Author: | Published: 1 Oct 2011
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Most enterprises and financial institutions have long since expanded beyond national boundaries into neighbouring and other countries and now operate all round the world, this having increased the globalisation of business relations. Russia, just like any other modern-day country, is interested in attracting foreign material and financial resources, state-of-the-art equipment, technology and management experience to promote its social and economic development. To this end, it has been making efforts to create a favourable investment climate, ensure stable conditions for foreign investors, and comply with legal regulations and international business cooperation practice.

Pursuant to the Federal Law on Foreign Investments in the Russian Federation, the legal treatment of foreign investors' activities and use of profits generated by investments may not be any less favourable than that enjoyed by Russian investors, subject to exceptions established by federal laws.

Foreign investors may invest in Russia using any means not prohibited by Russian legislation, set up Russian commercial entities with foreign investments or branches of foreign legal entities, and transfer their rights and obligations to any third parties in accordance with the law or under a contract. They may purchase and sell shares and other securities, land plots and other immovable property, and participate in privatisation of state and municipal property in Russia. Foreign investors' property is protected against nationalisation and confiscation; they are otherwise entitled to compensation for its cost and losses. Foreign investors holding more than a 25% interest in a Russian commercial entity and engaged in priority investment projects included on the list approved by the Russian government enjoy a stabilisation clause in respect of customs duties, federal taxes and levies payable to state extra-budgetary funds (with certain exceptions) throughout the investment project payback period (usually seven years). Income, profits, dividends, interest, payments under transactions and other such payments received by foreign investors may be freely transferred from Russia after relevant taxes and levies have been paid. Investment disputes with foreign investors are resolved in Russian courts or through international arbitration in accordance with Russia's bilateral or multilateral international treaties and federal laws.

Merger clearance

Antitrust requirements on activities by foreign companies are an important factor in Russia's investment climate. They are primarily determined by the Federal Law on Protection of Competition.

The Federal Law on Foreign Investment in Business Entities of Strategic Importance for National Defence and State Security also plays a significant role in the legal requirements on foreign investments in Russia.

For effective operation of the commodity markets, foreign business entities (companies, individual entrepreneurs, and so on) must comply with Russia's anti-monopoly laws and refrain from indulging in unfair competition and restrictive business practices in Russia.

It is important to bear in mind that, if an international treaty concluded by Russia stipulates otherwise than the Federal Law on Protection of Competition, the provisions of the treaty will apply. This applies, for instance, to the competition requirements established by the Treaty on Conducting Coordinated Antimonopoly Policies dated January 25 2000 between Russia, Belarus, Kazakhstan and a number of other countries, as well as by the Agreement on Unified Principles and Rules of Competition, dated December 9 2010, between Russia, Belarus and Kazakhstan within the Customs Union and the common economic space, under the auspices of the Eurasian Economic Community. Russia, including the Russian Federal Anti-monopoly Service (FAS) as the authorised federal executive body, has entered into a number of bilateral treaties on cooperation in the antitrust area with other states, including their antitrust bodies.

Russian law on protection of competition applies equally to Russian and foreign business entities.

It covers any agreement or action performed in Russia or beyond between Russian and/or foreign companies and other parties, if such agreements and actions relate to Russia-based fixed assets, intangible assets, shares (ownership interests) in business entities, rights in relation to commercial organisations operating in Russia or in any other way influence competition in Russia.

The main concepts used in the Russian legislation on protection of competition are well known to foreign companies operating globally, since they are consistent with the general definitions of relevant terms in international antitrust regulation practice. For example, goods (including work or financial or other services) are items, covered by civil law rights, intended for sale, exchange or other means of circulation. The concepts of commodity market, unfair competition, monopoly activity, acquisition of shares and company stakes are also essentially similar.

Russian legislation on protection of competition prohibits (among others):

  • abuse of a dominant position by a business entity (the relevant requirements do not apply to actions under exclusive rights to intellectual products);
  • agreements and concerted actions between business entities restricting competition;
  • unfair competition;
  • acts, actions (or omissions), agreements and concerted actions restricting competition by federal executive bodies, government bodies of constituent entities of the Russian Federation and local government authorities;
  • actions that lead or might lead to prevention, restriction or elimination of competition during tenders; and
  • inappropriate use of government or municipal benefits.

In this connection, it should be noted that prohibitions on actions or omissions by companies and individual entrepreneurs established in the competition protection area also apply to actions or omissions by a group of persons. Yet a group of persons is defined in Russian antitrust law in a rather general way and, from the legal point of view, includes a considerable number of companies and individuals, which needs to be taken into account when executing relevant transactions and other actions (omissions).

An important function of the antitrust authorities in Russia is to exercise government control over economic concentration, including with respect to use of subsoil or other natural resources, requiring prior consent or subsequent notification in certain cases of set up, consolidation or merger of companies, acquisition of shares or ownership interests in companies or assets of business entities (depending on the companies' total assets or revenues, degree of involvement in a company, share of assets acquired, attribution to a single group of entities).

Together with its application for/notification of transactions or other steps subject to state control, the applicant should file with the antitrust authority:

  • notarised copies of constituent documents (if a corporation) or details of the applicant (if an individual);
  • documents and/or information describing the subject and contents of the transactions or other steps subject to state control;
  • information about types of activity the applicant has carried out over the last two years and copies of documents confirming its right to engage in operations requiring a special permit in Russia;
  • information about products manufactured and sold by the applicant over the last two years;
  • information available to the applicant regarding the core operations and main products of the other entities involved for the last two years or a statement from the applicant that it has no such information at its disposal;
  • the applicant's balance sheet as of the most recent reporting date;
  • statement of the aggregate book value of the assets of the applicant and its group;
  • information about the aggregate book value of the assets of the entity whose shares, ownership interests, property or assets or the rights to which are being acquired and its group of companies, or a statement from the applicant that it has no such information at its disposal;
  • a list of companies in which the applicant possesses, on any grounds, more than 5% of the shares or ownership interests or a statement from the applicant that it holds no such shares or ownership interests;
  • a list of companies possessing, on any grounds, more than 5% of the shares or ownership interests in the applicant entity;
  • a list of the persons belonging to the applicant's group, indicating also the reasons for their membership of the group;
  • a list of persons belonging to the group of relevant involved entities, indicating also the grounds for their membership in the group or a statement from the applicant that it has no such information at its disposal;
  • information about persons for the benefit of which nominees hold more than 5% of the interests in the applicant, including offshore residents; and
  • certain other documents, depending on the specifics of the transaction or other controlled steps.

Notice should be taken that, upon filing an application for or notification of set up, consolidation or merger of companies, the applicant will also need to submit to the antitrust authority the above documents and information about other persons involved in the set up, consolidation or merger.

Numerous Russian and, especially, foreign companies have spoken out for reducing dramatically the list of documents and information to be submitted together with an application for, or notification of, transactions or other steps, being convinced that is too broad. This has not elicited any response from the Russian FAS so far, yet a Federal Law has been adopted under which a document (for instance, a special permit to engage in certain operations or a balance sheet) not submitted by the applicant but available to other government authorities is to be provided by the competent state body at the request of the FAS.

Failure to meet the government control requirements, that is to obtain prior consent or submit a notification, may result in invalidation of the set up, consolidation or merger of businesses or acquisitions of property, shares or other interests following a lawsuit filed by the antitrust authority provided the aforesaid actions have lead to or may lead to restrictions of competition.

Strategic enterprise control

As mentioned already, state control is also exercised in Russia over foreign investments in Russian entities of strategic importance for national defence and state security, the relevant Federal Law stipulating certain restrictive exceptions for foreign investors and their group entities. Notably, for the purposes of this federal law, foreign investors include Russian entities controlled by foreign investors and the term "group of entities" is, again, treated broadly, as defined by the Federal Law on Protection of Competition.

No transactions leading to a foreign investor's (or its group's) control over strategically-important Russian entities may be made until a resolution of the Russian FAS is available giving prior consent to the transaction. The authority, in turn, adopts the resolution on the basis of a decision of the Government Commission for Control over Foreign Investment in the Russian Federation, chaired by the Russian Prime-Minister.

Under the law, state control is exercised over foreign investments in shares or ownership interests in the authorised capital of Russian strategic entities and over other transactions resulting in foreign investors or their groups obtaining control (including indirect control) over such companies.

It should be pointed out that the provisions of the relevant federal law also cover transactions and agreements made outside Russia if these result in control over such Russian entities passing to foreign investors or groups, including indirectly.

In addition, the concept of control over a Russian strategic entity is defined by the law very broadly, enabling the authority to qualify numerous and various transactions and other situations as requiring prior consent. For instance, the law identifies foreign control over a strategically important company in situations when the controlling entity is authorised or entitled, under an agreement or for other reasons, to determine decisions of the controlled company, in particular to direct its business. This provision may actually be interpreted that, if a foreign investor for any reason obtains the right to control decisions of any governing bodies (general meeting, board of directors, management board or general director) pertaining to business operations of a strategically important Russian company, it must obtain prior consent from the FAS. This suggests, for instance, that a need to apply for a prior consent would need to be scrutinised for the majority, if not all, shareholder and participation agreements, including ones concluded by foreign companies or made abroad, if these arrangements in any way determine business decision-making by a strategically important Russian company.

Pursuant to the law, any Russian company involved in at least one type of activity listed in the relevant Federal Law is deemed strategically important for national defence and state security. There are 42 types of activity that are of strategic importance for Russia though the number is in fact higher, since, for instance, one of the types (services rendered in the natural monopoly spheres) effectively consists of 10 independent types of activity. Expressly strategic types of activity include arms, nuclear materials and equipment, space, aviation equipment, geological exploration of the subsoil, prospecting for and extraction of minerals in subsoil areas of federal significance, pipeline transportation of oil, petroleum products and gas, railway transportation, extraction of aquatic biological resources, and TV and radio broadcasting covering more than half the population of Russia.

The long list of strategic types of activity creates, in certain instances, unreasonable difficulties in engaging foreign businesses to work in Russia or modernising relevant branches of the national economy. A draft law is pending with the Russian Parliament that would narrow their scope somewhat, as control will not apply to:

  • activities relating to use of infectious disease agents of pathogenicity group IV (at creameries, dairy plants, and so on);
  • operation of radiation sources falling under potential radiation hazard category 4 (such as X-ray and dental equipment, defect detectors, and luggage inspection equipment); and
  • banking activities in the encryption sphere (with the exception of banks with state participation).

For reasons of national importance, however, the requirement persists to obtain prior consent for transactions made by foreign countries, international organisations or organisations controlled by them and resulting in acquisition of the right to dispose, directly or indirectly, of more than 25% of the votes attached to voting shares (ownership interests) in a Russian business entity or otherwise block the decisions of the governing bodies of such a business entity.

A source of many complaints by both Russian and foreign companies relates to the continuing severe restrictions on foreign participation in Russian companies involved in geological exploration of the subsoil and prospecting for and extraction of minerals in subsoil areas of federal significance. These areas, automatically making a Russian company working on them strategically important, include subsoil plots:

  • containing deposits and occurrences of uranium, diamonds, highly pure raw quartz, the yttria group of rare earths, nickel, cobalt, tantalum, niobium, beryllium, lithium and platinum group metals;
  • containing, starting from January 1 2006, recoverable oil reserves of 70 million metric tonnes or more, gas deposits of 50 billion cubic metres or more, vein gold reserves of 50 metric tonnes or more and copper deposits of 500 thousand metric tonnes or more;
  • belonging to Russia's inland sea waters, territorial seas and continental shelf; and
  • utilisation of which requires use of plots belonging to lands for defence and security.

The list of subsoil areas of federal significance has been officially published. Once included on the list, the areas retain the status of federally significant subsoil areas irrespective of any changes in the criteria for classing the subsoil as federally significant.

Moreover, if, during geological exploration of the subsoil (including under a combined licence) a subsoil user that is a legal entity with participation of foreign investors or a foreign investor identifies a mineral deposit that meets the above criteria, the government may refuse to grant the right to use the relevant federally significant subsoil area or may terminate the right to use it for prospecting and extraction of minerals, should it identify a threat to national defence or state security.

The costs incurred in finding and evaluating the discovered mineral deposit and the one-off payment for use of the subsoil area under the combined licence to entities refused the right to use the subsoil area for prospecting and extraction of minerals in a federally significant subsoil area and remunerations to the entities are to be paid from the federal budget as prescribed by the government.

The applicable rules, including the compensation procedure adopted by the Russian government, do not entirely meet the interests of foreign companies that might potentially invest in geological exploration of the subsoil under a relevant licence and discover a deposit making their licensed subsoil area federally significant.

Even so, a few, be they insignificant, steps are being taken to simplify foreign participation in Russian strategic entities involved in subsoil use. The above-mentioned draft law under consideration by the Russian Parliament stipulates that investors will no longer be required to apply for prior consent to acquire shares (ownership interests) in a business entity using a subsoil area of federal significance if this does not increase the foreign investor's ownership interest in the business entity (even if additional shares are issued).

Some other excessive administrative barriers to foreign investors engaging in strategic activities are being lifted.

In general, the competitive requirements and other legal conditions for foreign investment in Russia are nothing out of the ordinary and are, in many respects, similar to those established by other countries in this sphere.

As can be seen from practice, foreign investors in Russia demonstrate an understanding of these requirements and operate in compliance with them.

About the author

Evgeny Danilov is head of group at Goltsblat BLP and an expert in civil law and legal regulation of subsoil use. He has been engaged in legal analysis of the application of effective legislation on legal entities, including with respect to natural resources such as oil and gas. He took part in discussions of the draft concept for the development of corporate law in Russia and measures to implement it. He has also been directly involved in the drafting of new Russian laws in the field of economics, international and foreign trade contracts and agreements.

Danilov’s practical experience includes providing legal support for complex investment projects; rendering legal assistance for restructuring projects, predominantly for mineral resource companies; creating and providing legal support for foreign-invested companies; advising clients on privatisation matters; representing clients before the antitrust authorities and in court; and provision of other legal services for business.

As head of the Research Advisory Council of the Constitutional Commission and deputy head of the Federative and Interethnic Relations Department of the Russian Parliament, he took an active part in drafting the Federative Treaty (1992) and the Russian Constitution (1993) and was responsible for relevant legal matters arising during that difficult period in Russia’s history. Danilov was later appointed head of the State Duma Legal Department.

Danilov has spoken and debated at many international conferences in Russia and worldwide.

Contact information

Evgeny Danilov
Goltsblat BLP

Capital City Complex Moscow City Business Centre
8, Presnenskaya Nab., Bldg.1, Moscow, 123100, Russia

T: +7 495 287 4444
F: +7 495 287 4445
E: evgeny.danilov@gblplaw.com
W: www.gblplaw.com

About the author

Anton Sitnikov is partner and head of corporate/M&A at Goltsblat BLP. He focuses on corporate/M&A projects, private equity, restructuring projects, complex cross-border transactions, capital markets, competition, including disputes with authorities, joint-venture set up, and HR legal advisory, including pension plan arrangements. He has supervised acquisitions of companies operating in various sectors, with particular emphasis on the oil and gas sector, mining, food industry, services sector, banking and finance, telecoms, and industrial manufacturing.

Sitnikov has handled corporate restructuring projects including pre-IPO and pre-private equity, involving due diligence on groups of companies, identification of risks, development of solutions for optimising corporate structure and implementation of restructuring programmes. In particular, restructuring plans were developed for Russia’s biggest diamond producer, a large Russian food producer, one of the biggest European retail companies, and an oil and gas group of companies.

He supports set ups of various joint-venture projects, predominantly in the mineral resources and oil and gas sectors,has rendered advisory services in relation to the issue and circulation of securities and has represented sector leaders in their disputes with antitrust authorities.

Among many other projects Sitnikov has led are advice to Sberbank of Russia in relation to the Sportloto joint venture with Russkoye Loto Group, helping LG International with its investment projects in the Russian coal mining industry, assisting IKEA on its joint venture with Belaya Dacha to set up Mega Belaya Dacha, one of Russia’s largest malls, advising Prof-media in consolidating its printing and editorial companies into Russian publishing house-Komsomolskaya Pravda (now to become Russia’s biggest newspaper).

Contact information

Anton Sitnikov
Goltsblat BLP

Capital City Complex Moscow City Business Centre
8, Presnenskaya Nab., Bldg.1, Moscow, 123100, Russia

T: +7 495 287 4444
F: +7 495 287 4445
E: anton.sitnikov@gblplaw.com
W: www.gblplaw.com