Practical Aspects of M&A Transactions in Russia
- By Nikolai Solodovnikov
- Apr. 20 2010 00:00
Head of Corporate Practice
Although 2009 was marked by a significant reduction in the number and value of M&A transactions, recent amendments to Russian legislation clearly have left their marks on certain aspects of such transactions. In this piece, we will focus on some practical legal aspects that may be important and require special attention when planning, preparing and implementing M&A transactions in Russia, especially if foreign capital is involved.
Letter of Intent
Fr om a legal perspective, any transaction starts with preliminary negotiations and certain tentative and conceptual agreements, which usually are stipulated in so-called letters of intent. When considering these documents, you need to remember certain aspects of Russian legislation.
Your advisors will most probably tell you that, under Russian legislation, such agreements have practically no legal effect. In principle, they will be right, except for certain aspects. First, a letter of intent is similar in form to a preliminary agreement (see Article 429 of the Civil Code). This is a matter of appearances in most cases, however, so there is always a risk that the other party to the agreement will try to demand in court, in the event of a dispute, that you conclude a master agreement on preliminarily agreed terms. Although this is unlikely, you should not treat the letter of intent as a meaningless piece of paper. Second, standard letters of intent contain provisions, which at least one party demands compliance with, on such issues as confidentiality and nondisclosure, allocation of expenses, exclusiveness and the terms for terminating the agreement.
To mitigate the risks related to judicial protection of such agreements, I would recommend that, first, you determine the rights and obligations of the parties in relation to these issues accurately and in as much detail as possible, so that a court can determine precisely, in the event of a dispute, the will of the parties. Secondly, conclude separate agreements on key issues, if possible; for example, conclude a separate confidentiality and nondisclosure agreement.
When planning a transaction, carefully weigh the pros and cons of such an agreement.
Regulation of Transactions by the Federal Anti-Monopoly Service (FAS)
If you plan a transaction in Russia, you need to understand that the government has paid close attention to the regulation of mergers over the past several years. Wh ereas several years ago, far fr om all agreements stipulated the need to obtain consent fr om the FAS for transactions, and sometimes the mere agreement of the parties was enough, today the situation has changed drastically owing to the immaterial level of responsibility. The consent of the regulator is now essential. Noncompliance is no longer an option, since the penalties for such violations have increased by several times. Incidentally, thresholds indicating the need to obtain consent fr om the FAS for an acquisition also have increased. Here, it should not be forgotten that the concept of “entity,” such as the acquirer, has been replaced by the concept of “entity and group of entities,” which in most cases may result in the inclusion of the seller’s assets in the calculation of threshold values, which is illogical.
Restrictions on Foreign Investments in Strategic Assets
If you plan a transaction with foreign investments, you should bear in mind that two years ago, Russian legislation imposed restrictions on foreign investments in assets of strategic importance for defense and state security. According to the legislation, a foreign investor or group of investors must obtain the consent of the government commission for preliminary approval of such transactions. The law lists strategic lines of business.
In respect to this law, there are two especially curious issues that should be kept in mind. One, you do not need to be a foreign investor to be subject to this law. Because the law uses the term “group of entities,” borrowed from the law on protection of competition, a typical Russian company or private investor with a couple of offshore companies in, for example, the Bahamas or in Cyprus, will become a foreign investor under this law in certain circumstances. Two, in principle, any small company could be referred to as a strategic company and become subject to this law in certain circumstances.
This could happen quite easily. For example, strategic lines of business include “activity relating to the use of infectious agents.” Such activity is subject to licensing pursuant to the law on licensed types of activities. Curiously, producers of fermented milk products also must obtain this license. Accordingly, a foreign investor may need to obtain the preliminary consent of the government commission to buy shares of a plant producing sour cream, kefir or cheese.
Specific Regulation of Transactions with Interests in Lim ited Liability Companies (LLCs)
After the adoption of several serious amendments to the law on lim ited liability companies, to the Civil Code and to other regulations last year, it was held that legislation had changed for the better, with the elimination of a number of drawbacks and errors. At the same time, despite all of the undoubted benefits of such amendments, some aspects are considered by the legal community to be ambiguous.
The amendments introduced mandatory notarization of agreements involving the purchase and sale of participation interests, and a participation interest is only deemed to have been transferred to the new owner after notarization of the agreement. If you plan a transaction in Russia, you need to understand the legal form of the company that you plan to acquire.
If that company is an LLC, your advisors may encounter a number of additional problems structuring the deal, as the effective legislation prohibits transactions with the participation interest in an LLC containing suspensive conditions or additional obligations. As mentioned earlier, a transaction is deemed to have been performed once the notary places a seal on the agreement — until then, the transaction is void.
This leads to several key conclusions. The shares of joint-stock companies become more attractive for transactions, as they are not subject to the lim itations imposed on the participation interest in an LLC. Also, the LLC becomes a more acceptable form for establishing a company with one participant, as the participation interest in an LLC is now well-protected from various types of abuse and fraud.
Since last year, the shareholders of joint-stock companies and participants in LLCs may conclude agreements on exercising the rights of participants and shareholders. In principle, these amendments have been needed for a long time and were attributable to the state’s intention to shift, at least partially, the regulation of relations among the owners of Russian companies from foreign jurisdictions to Russia.
However, detailed analysis of the provisions regulating such agreements shows that in general, despite fairly broad options for the freedom of agreements compared to the law, the amendments to corporate legislation in practice are not supported by amendments to civil regulations. For example, the law on joint-stock companies stipulates that the parties may establish a penalty for violations of the shareholder agreement, although Article 333 of the Civil Code allows the court to reduce the size of this penalty.
There are also doubts about the provisions of shareholder agreements that stipulate the waiver of certain rights by shareholders or participants, because Article 9 of the Civil Code states that a waiver of rights does not result in termination of these rights. In practice this means that a shareholder who, for example, agreed to vote for a particular candidate for general director pursuant to the shareholder agreement may subsequently default on this obligation. I believe that in this case, attempts to force this shareholder to execute an agreement in kind, to vote as the parties agreed, would prove abortive, as it is highly likely that the court will be guided by Article 9 of the Civil Code.
In summary, it is generally held that you should avoid becoming party to such agreements, unless there are serious grounds for doing so, until stable case law has been established on these issues.