Doing business in Russia 2010_DLA Piper

doing business

in Russia

doing business

in Russia June 2010

TABLE OF CONTENTS From the quality of our legal advice and business insight to the efficiency of our legal teams, we believe that when it comes to the way we serve and interact with our clients, everything matters.

Introduction................................................................................................................................................................................................... 03 Establishing a legal presence...................................................................................................................................................................... 04 Foreign investment in Russia......................................................................................................................................................................12 Mineral resources laws................................................................................................................................................................................19 Taxation.......................................................................................................................................................................................................... 21 General principles of Russian contract law........................................................................................................................................... 33 Competition laws......................................................................................................................................................................................... 39 Real estate...................................................................................................................................................................................................... 46 Public private partnerships and infrastructure development............................................................................................................ 55 Intellectual property rights and franchising........................................................................................................................................... 58 Employment................................................................................................................................................................................................... 67 Dispute resolution........................................................................................................................................................................................71 Insolvency....................................................................................................................................................................................................... 74 Contacts......................................................................................................................................................................................................... 81

02â&#x20AC;&#x192; |â&#x20AC;&#x192; Doing Business in Russia

INTRODUCTION

I am delighted to present to you DLA Piper’s brochure “Doing Business in Russia”. Since 1999, Russia has been one of the fastest growing economies in the world. In this period, foreign investors have poured into the country, attracted by, amongst other things, the huge reserves of natural resources, a well educated workforce and seemingly insatiable consumer demand. As with most economies, Russia has not been unaffected by the recent global economic downturn. Nonetheless, the opportunities remain.

In drafting this brochure we have relied upon our in-depth understanding of the core Russian industry sectors and our vast experience in acting in multi-jurisdictional transactions providing advice specially adapted to requirements of Russian legislation. Now more than ever such knowledge is invaluable. I hope that you find this brochure useful and informative. Of course, please do not hesitate to contact me or one of my fellow partners if you require any further information.

This brochure provides an overview of the key legal and business issues that any foreign investor should be aware of, whether they are a first time entrant or an established player in the Russian market. The issues covered herein include: how to establish a legal presence; foreign investment rules; mineral resources laws; general principles of contracting; antimonopoly regulation; real estate; PPP and infrastructure development; intellectual property rights; franchising; employment regulation; dispute resolution; and insolvency. Constantine Lusignan-Rizhinashvili Managing Partner, Russia and CIS T +7 495 221 4444 constantine.lusignan-rizhinashvili@dlapiper.com

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ESTABLISHING A LEGAL PRESENCE

Establishing a legal presence in Russia and choosing the appropriate corporate form to register is one of the most important stages before undertaking business activity in Russia. The corporate form chosen will influence all activity, including financial and tax reporting, customs and currency control. Therefore, any foreign investor should give careful consideration as to which type of corporate form will best further its investment goals, whilst at the same time meeting all legal requirements.

A branch is a subdivision of a foreign legal entity, which may undertake commercial activity and fulfil all or part of the functions of its founding foreign legal entity. This may inter alia include the employment of a sales force and conduct of sales activity.

In Russia, a foreign investor may either establish a representative or branch of a foreign legal entity, or establish a Russian registered legal entity.

Since a representative office or branch do not have separate legal identity, the founding foreign legal entity will bear full liability for the actions and obligations of the representative office or branch.

ESTABLISHING A REPRESENTATIVE OFFICE AND/OR A BRANCH OF A FOREIGN LEGAL ENTITY IN RUSSIA Legal status A representative office is an officially recognised extension of a foreign legal entity, which represents that foreign legal entity’s interests in Russia. In Russia, representative offices are officially not allowed to undertake commercial activity under the Civil Code of the Russian Federation (“Civil Code”). Instead, their main purpose is generally to promote commercial relations between the foreign legal entity which they represent and Russian enterprises, and to gather information about the Russian market. Given that a representative office does not, in theory, undertake commercial activity, it will not be subject to profits tax, unless its activities give rise to a “permanent establishment” for tax purposes (eg if a foreign legal entity engages in regular commercial activity (eg selling goods or providing services) through a representative office). The advantages of operating through a representative office, compared to a Russian registered joint stock company or limited liability company are that: ■■

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it has fewer administrative, tax and accounting obligations; foreign employees may obtain personal accreditation, which confers some practical benefits; it is considered to be a non-resident for currency control purposes; and it is possible to benefit from a relevant double tax treaty.

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The representative office or branch must have a manager or head of the office/branch, who acts on the basis of a power of attorney that is granted by an officer of the founding foreign legal entity.

Registration Representative offices and branches are approved by an appropriate accrediting body. There are various appropriate accrediting bodies for representative offices, of which the most commonly used are the Chamber of Commerce and Industry of the Russian Federations (“CCI”) and the State Registration Chamber at the Ministry of Justice of the Russian Federation (“SRC”). However, certain industries also have their own particular accrediting bodies, for example the Central Bank of the Russian Federation which accredits representative offices of foreign banks. Branches may only be accredited by the SRC in accordance with the Federal Law On Foreign Investments in the Russian Federation dated 9 July 1999. In order to accredit either a representative office or a branch, an application letter must be submitted to the appropriate accrediting body. This application must be accompanied by the following documents, of which any documents from a foreign legal entity must be notarised and apostilled/legalised in the country of execution and any documents supplied in a language other than Russian must be accompanied by a translation which has notarised certification: ■■

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the charter and articles of incorporation (articles of association or equivalent) of the founding foreign legal entity; the registration certificate, certificate of incorporation, or extract from the trade register of the founding foreign legal entity certifying that it is validly existing under the legislation of its home country;

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the resolution of the founding foreign legal entity resolving to establish the representative office in the Russian Federation and to appoint the chief representative(s) or, in the case of a branch, simply to establish the branch in the Russian Federation;

Additionally in respect of applications submitted for a branch, the application letter will also have to be accompanied by: ■■

the regulations which will govern the operation of the representative office or branch; a bank letter confirming the good credit standing of the founding foreign legal entity; a document confirming coordination with the regional authorities of the Russian Federation on the establishment of a representative office or branch (although this is not required for representative offices or branches to be located in Moscow); the general power of attorney issued to the chief representative(s) of the representative office or the general power of attorney issued to the director of the branch; the power of attorney for filing the application for accreditation on behalf of the founding foreign legal entity; the accreditation card containing information on the representative office or branch, filled out in accordance with a sample form from the particular accrediting body and signed by an authorised representative of the foreign legal entity; certification from the tax authorities in the country of the foreign legal entity’s incorporation confirming that it is registered as a taxpayer and specifying the taxpayer identification code; two letters of recommendation from Russian trading partners (preferably Government bodies, social organisations or 100 per cent Russian-owned legal entities) on the official letterhead of the recommending organisation; and a copy of a lease agreement or lessor guarantee letter, together with confirmation of the lessor’s right to the property to be leased by the representative office.3

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expert opinions from the respective ministries of the Russian Federation (the Ministry of Energy, the Ministry of Natural Resources, etc) as required by the statutes of the Russian Federation for certain types of activities; documents confirming payment of the registration fee; and the state duty for branch accreditation.

In addition, accreditation bodies also charge a processing fee depending on the period of accreditation (from one year up to five years respectively). Following accreditation, the representative office or branch must carry out a number of post-accreditation procedures before it becomes fully operative, including registration with the State Statistics Committee, with the tax authorities and with the Russian social benefits funds. ESTABLISHING A RUSSIAN LEGAL ENTITY – LIMITED LIABILITY COMPANIES AND JOINT STOCK COMPANIES Types of legal entities There is no special legal form of legal entity for foreign investment in Russia. Foreign investors can choose from the following types of commercial legal entities: ■■

Joint Stock Company (“JSC”): – Open Joint Stock Company (“OJSC”) (in Russian Открытое Акционерное Общество (“ОAО”)) – broadly equivalent to a public company. – Closed Joint Stock Company (“CJSC”) (in Russian Закрытое Акционерное Общество (“ЗАО”, or “ZAO” in English transliteration)) – broadly equivalent to a private company.

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Limited Liability Company (“LLC”) (in Russian Общество с ограниченной ответственностью (“ООО”)). Additional Liability Company (“ALC”) (in Russian Общество с дополнительной ответственностью (“ОДО”)). Full Partnership (in Russian Полное товарищество). Limited Partnership (“kommandit” partnership) (in Russian Товарищество на вере (коммандитное товарищество)).

It is the LLC and the JSC that are the most popular with foreign investors and we will focus on these types of companies. All Russian legal entities are subject to state registration and are considered created from the date of the relevant entry in the Unified State Register of Legal Entities. The Federal Tax Service of the Russian Federation has authority for the state registration of legal entities and for their registration as tax payers in Russia. Generally, the submission of the following documents is necessary for registration purposes: ■■

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of LLCs or JSCs are not liable for the obligations of the companies and bear the risk of losses related to company activities only to the extent of the value of their contributions (share value). Founders, participants or shareholders may however be held liable for the obligations of an LLC or JSC if they had the right to give mandatory instructions to such companies, and caused the insolvency of, or losses to, the latter. LLCs The establishment and operation of LLCs is governed by the Civil Code and the Federal Law On Limited Liability Companies dated 8 February 1998 (as amended) (“LLC Law”) Key features ■■

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a standard form application (the signature of the person signing the application has to be notarised);

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the protocol of the founders’ meeting or, if the LLC or JSC has only one founder, the resolution of the sole founder on the establishment of the company;

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the charter of the LLC or JSC; confirmation of the legal status of the founder(s) (eg extract from the state register, trade register and/or certificate of good standing); and

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confirmation of payment of the state registration fee.

All documents from a foreign legal entity must be notarised and apostilled/legalised in the country of execution and any documents supplied in a language other than Russian must be accompanied by a translation which has notarised certification. LLCs and JSCs are able to engage in all types of commercial activities not prohibited by the laws of the Russian Federation. Certain types of activities may be conducted only upon receipt of a special permission (license). LLCs and JSCs are liable for their obligations with all of the assets and property belonging to them. Generally, the founders, participants or shareholders

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May be established by one or more persons (the “participants”), but not more than 50. The charter capital is divided into “participation interests”. Information about the participants and their participation interests is recorded in a list of participants maintained by the LLC and in the Unified State Register of Legal Entities. All transactions in connection with the transfer or pledge of participation interests in LLCs have to be notarised. Participants have certain rights (eg to participate in the management, to share distributed profits, to sell their interest, etc) which are set out in the LLC Law and the company charter. Participants have certain obligations (eg to contribute to the charter capital, to maintain confidentiality, etc), which are set out in the LLC Law and the company charter. The minimum charter capital is RUB 10,000. At least 50 per cent of the charter capital must be paid in by the date of the LLC’s registration and the balance must be paid in full within the first year of its operation.

Management structure ■■

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General Participants’ Meeting – the highest body of an LLC. Board of Directors (optional) – matters delegated from the General Participants’ Meeting. Executive Body – day-to-day management of the LLC.

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Participants An LLC may be established by one or more persons (the participants), however, it should be noted that: ■■

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the LLC may not have as its sole participant another business entity consisting of a sole participant; and if the number of participants exceeds 50, the LLC must be reorganised into an OJSC (or a production cooperative) within one year.

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participate in the management of the LLC in accordance with procedures established by the LLC Law and the company charter;

enter into binding shareholders’ agreements in which they are able to agree on the exercise of voting rights, sales of participatory interests and other matters that may be regulated in such agreements.

With regard to the LLC’s General Participants’ Meeting granting additional rights to the participants: ■■

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Rights of participants The participants in an LLC have the right, amongst other rights granted by the LLC Law and any additional rights set forth in the company charter, to:

withdraw from the LLC by selling its participation interest back to the company (if this right is expressly stipulated in the charter), or to require the company to buy-out their participation interests where such right is set out in the LLC Law; and

the decision of the LLC’s General Participants’ Meeting must be unanimous; and additional rights granted to a particular participant in the LLC do not transfer to any party acquiring all (or part) of that particular participant’s participation interest if it is transferred.

Obligations of participants The LLC participants also have various obligations, which include, amongst other obligations contained within the LLC Law and any additional rights set forth in the company charter, the following: ■■

obtain information concerning the activities of the LLC and have access to its accounting and other documents in accordance with the procedures established by the company charter;

to make contributions to the charter capital as specified in the LLC Law and the foundation agreement (or in the decision on the establishment of the LLC, if there is only one participant in the LLC) and within the time period specified in the LLC Law; and

participate in the distribution of profits;

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sell or transfer their participation interests in the LLC charter capital, or a part thereof, in accordance with the procedure established by the LLC Law and the company charter;

With regard to the creation of additional obligations by the LLC’s General Participant’s Meeting on the LLC participants:

receive a portion of the assets left after settlement with creditors in the event of the liquidation of the company; demand the expulsion of any participant who grossly violates his obligations as a participant, or whose actions (or lack thereof) substantially hinder the LLC or make its activity impossible;1

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to keep confidential all information concerning the activities of the LLC.

such a decision of the LLC’s General Participants’ Meeting must be unanimous; if additional obligations are imposed on a particular LLC Participant, such decision must be made by a two-thirds majority vote of the total number of votes held by the LLC Participants, provided that the LLC Participant on whom such additional obligations are imposed voted in favour of such a decision or consented to it in writing; and

Available to participants who either individually or collectively hold at least a 10 per cent interest in the LLC’s charter capital.

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additional obligations imposed on a particular participant in the LLC do not transfer to any party acquiring all (or part) of that particular participant’s participation interest if it is transferred.

any agreements with such organisations or persons (this is commonly referred to as appointing an “external” management company or manager); ■■

Charter capital ■■

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The charter capital of an LLC consists of the nominal value of the participation interests of the participants and should be denominated in Russian Roubles. The initial charter capital may not be less than RUB 10,000. At least 50 per cent of the charter capital must be paid by the date of the LLC’s registration and the balance must be paid in full within the first year of its operation. Contributions may be in cash or in kind and certain customs benefits may be available for in-kind contributions made by foreign investors. The charter capital may be increased only after the original charter capital has been paid in full.

Participation interests A participation interest in an LLC is not considered a security under current Russian legislation and therefore, unlike shares in a JSC, no registration with the securities regulator is required. Transactions in connection with the transfer or pledge of participation interests in LLCs have to be notarised. The Federal Tax Service of the Russian Federation has to be informed of any transfer of the participation interests. Information on the participants and their participation interests is recorded in the list of participants maintained by the LLC and in the Unified State Register of Legal Entities. Participation interests may be sold to third parties, but are subject to the right of pre-emption of the existing participants on the same terms upon which the participation interests are offered to third parties. Management structure The General Participants’ Meeting has the right to: ■■

amend the charter;

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define the basic goals and directions of the LLC;

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delegate to a commercial organisation or to an individual entrepreneur the authority reserved to the LLC’s Executive Body and approve the conditions of

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assign supplemental rights and duties to the participants in the LLC; approve the annual financial report and distribution of profits; alter the amount of the charter capital; approve regulations governing the internal activities of the LLC; and reorganise or liquidate the LLC, appoint a liquidation commission and approve the liquidation balance sheet of the LLC.

A LLC charter may provide for the establishment of a Board of Directors. The competence of the Board of Directors should be set out in the charter and can include such issues as determination of the basic goals and directions of the LLC, appointment of the executive bodies and early termination of their powers, decisions on major and interested party transactions, establishment of representative offices and branches, approval of internal regulations and other issues. The Executive Body is responsible for all matters which do not fall within the competence of the General Participants’ Meeting (or the Board of Directors if there is one). Generally this comprises the day-to-day management of the LLC. Usually, the day-to-day management of the LLC is carried out by a general director, but sometimes this may be in conjunction with a collective executive management board (in Russian “правление”, or “pravlenye”), in which case the general director becomes the chairman of the management board. Alternatively day-to-day management may be delegated to an external commercial organisation (management company) or to an external individual manager, in both cases on a contractual basis. A LLC charter may also provide for the establishment of an Auditing Commission (or Internal Auditor). The creation of the Auditing Commission is mandatory if the LLC has more than 15 (fifteen) participants.

– Shareholders have no pre-emptive rights to acquire shares offered by other shareholders for sale to third parties.

JSCs The establishment and operation of a JSC is governed by the Civil Code, the Federal Law On Joint Stock Companies dated 26 December 1995 (as amended) (“JSC Law”) and the Federal Law On the Securities Market dated 22 April 1996 (as amended).

– The initial charter capital may not be less than an amount equal to 1,000 times the Russian statutory monthly minimum wage, at the date of this publication RUB 100, making the minimum initial charter capital RUB 100,000.

Key features ■■

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One of the most important corporate forms for doing business in Russia.

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– The number of shareholders may not exceed 50 (a CJSC must be transformed into an OJSC within one year should the number exceed 50).

Issues shares to raise capital for its activities. The founders of the JSC must pay in 50 per cent of the JSC charter capital within three months following its state registration, with the balance payable in full within the first year.

– Shareholders have pre-emptive rights to acquire shares offered for sale by other shareholders to third parties. – Shareholders have pre-emptive rights to acquire newly issued shares that are to be privately placed, in proportion to their existing shareholding.

Management structure ■■

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General Shareholders’ Meeting – almost exclusive competence for all matters set out in the JSC Law.

Internal Auditing Commission or an Internal Auditor – oversees the JSC’s financial and economic activities, members of which must be elected by the shareholders.

Two types of JSC ■■

– The initial charter capital may not be less than an amount equal to 100 times the Russian statutory monthly minimum wage, at the date of this publication RUB 10,000.

Board of Directors (optional for CJSCs and OJSCs with less than 50 shareholders, but compulsory for OJSCs with 50 or more shareholders) – authority defined in the charter. Executive Body (general director, sometimes in conjunction with a collective executive management board, a правление” or “pravlenye” ) – day-to-day management.

Formation of a JSC Individuals or legal entities may be founders of a JSC. A JSC’s foundation document, the charter, must include the following information: ■■

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OJSCs (open joint stock companies): – May have an unlimited number of shareholders. – Shareholders are freely entitled to dispose of their shares. – Shareholders have pre-emptive rights to acquire newly issued shares that are to be privately placed, in proportion to their existing shareholding. – Shareholders have pre-emptive rights to acquire newly issued shares that are to be publicly placed, in proportion to their existing shareholding.

CJSCs (closed joint stock companies)

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the name, legal address and type of JSC (i.e. OJSC or CJSC); the amount of the charter capital; the quantity, nominal value, categories (common or preferred) of shares and classes of preferred shares issued and distributed by the JSC; the rights of the holders of shares of each category; the structure and competence of the governing bodies of the JSC and their decision making procedures; the procedure for preparing and holding the General Shareholders’ Meeting, including a list of issues requiring either unanimous consent or a resolution adopted by a qualified majority of votes;

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information on branches and representative offices; information on the existence of any special right of participation in the management of the company (a “golden share”) vested in the Russian Federation, a constituent entity of the Russian Federation or a municipality of the Russian Federation; and other provisions required by law.

The charter may include other provisions, provided that they comply with the applicable Russian legislation. Shares and other types of securities A JSC can issue securities in the form of shares, bonds and issuer’s options. Generally, the issuance of securities must be registered with the competent regulatory body, which is the Federal Service for the Financial Markets of the Russian Federation (“FSFM”). A JSC can issue common shares and/or several classes of preferred shares, however the total value of the preferred shares must not exceed 25 per cent of its charter capital. A fractional share can come into existence when it is not possible to acquire the whole share during the consolidation of shares, when a shareholder exercises its pre-emptive right or in the course of acquiring additional shares. A fractional share grants its owner the same rights that are granted by the whole share of the corresponding category or class, on a pro rata basis. Management structure The General Shareholders’ Meeting is the highest governing body of the JSC, whose authority is outlined in the JSC Law and cannot be substantially altered. Each common share carries one vote at the General Shareholders’ Meeting (except for cases of cumulative voting where provided for in the JSC Law). Most decisions are made by a simple majority vote, although for certain key decisions a supermajority of 75 per cent is required. The daily management of the JSC is the responsibility of the Executive Body. The most standard Executive Body is a general director, however sometimes this will be in conjunction with a collective executive management board (in Russian “правление”, or “pravlenye”), in which case the general director becomes the chairman of the management board. Alternatively the General Shareholders’ Meeting may (by majority vote) choose to delegate the powers of the Executive Body to an external commercial

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organisation (management company) or to an external individual manager, in both cases on a contractual basis (however this decision may be taken only pursuant to a proposal from the Board of Directors if the company has a Board of Directors). Registration The only additional requirement in respect of JSCs is the registration of the issuance of the JSC shares with the FSFM, which is obligatory upon the establishment of the JSC. Choosing between an LLC or JSC Historically, the LLC has been the preferred form of legal entity for foreign investors looking to establish a wholly owned subsidiary in Russia. This is because the procedure for establishing, operating and transferring participation interests in an LLC were simpler than for a JSC. However, the 2009 amendments to the LLC Law have imposed greater administrative regulation of LLCs, for example LLCs are now obliged to maintain and update a register of participants, and share purchase agreements and pledge agreements connected with participation interests in LLCs must now be notarised in Russia. Both the shareholders of a JSC and the participants of a LLC can enter into binding shareholders’ agreements in which they are able to agree on the exercise of voting rights, sales of shares (participatory interests) and other matters. Other aspects of the LLC, which may be a benefit or a hindrance depending on the aims of the foreign investor, are that: ■■

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participants (members) of an LLC who either individually or collectively hold at least a 10 per cent interest in the LLC’s charter capital may apply to a court seeking the expulsion of another participant. To succeed the participant(s) seeking the expulsion must prove that the other participant substantially hindered the company’s operations or materially breached its obligations; if this right is expressly stipulated in the charter, participants may withdraw from the LLC by selling their participation interest back to the company; and

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the LLC Law sets forth a large number of matters which require a unanimous voting decision of all of the LLC participants. This could be a disadvantage for a joint venture partner with a majority participation in the LLC.

Full and limited partnerships The principal features of a partnership are the personal contribution by the partners to the partnership’s business activity and the unlimited liability of at least some of the partners. A full partnership is similar to the American general partnership, in which partners bear full joint and several liability for the partnership obligations. A participant in a full partnership may not be a full partner in any other partnership.

Partnerships under Russian law are generally regarded as legal entities and are taxed accordingly. Contractual agreements for joint activity do not create a legal entity, although they share some of the characteristics of a general partnership, and there are special rules governing their tax treatment. Partnerships are not generally used in Russia because of the unlimited liability of the partners in the full partnership and of certain partners in a limited partnership. There are also tax disadvantages to the use of partnerships, which do not allow for the flow through of taxation from the partnership to the partners.

A limited partnership, which is closer to the European Kommandit partnership, has both full partners and partners whose liability is limited to amounts equal to their contributions. A full partner in a limited partnership may not be a full partner in another partnership and its liability is the same as for full partners in a full partnership.

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FOREIGN INVESTMENT IN RUSSIA

LAW ON FOREIGN INVESTMENTS The purpose of the Law on Foreign Investments2 is to encourage foreign investment by attracting foreign materials, financial resources, technology and management skills into Russia. The Law on Foreign Investments guarantees the right of foreign investors to invest and to receive revenue from their investments. It sets forth the terms for foreign investors’ business activity in Russia and stipulates that, subject to certain exceptions, foreign investors are to be treated no less favourably than their Russian equivalents and are permitted to invest in most sectors of the Russian economy. Both federal and regional legislation are tasked with ensuring the realisation of this objective. The exceptions where foreign investors may be treated less favourably than their Russian counterparts are where priority is given to the protection of the Russian constitutional system, and the safeguarding of the morality, health and rights of the Russian people or state security and defence. In this area, detailed provisions regarding foreign investment in industries of strategic national importance have recently been introduced (see section on “Foreign Investment Control Law” further on). The “Grandfather Clause” One of the key features of the Law on Foreign Investments is the tax stabilisation clause or “Grandfathering Clause”, which prohibits increases in the rates of certain import duties and federal taxes for qualifying companies and projects until such time as the initial investments have been recouped (up to a maximum period of seven years from the date of the initial investment). The Grandfathering Clause applies to: ■■

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foreign investors implementing “priority investment projects”; Russian companies with more than 25 per cent foreign equity ownership; or Russian companies with any foreign participation that are implementing “priority investment projects”.

A “priority investment project” is defined as a project with foreign investment of at least RUB 1 billion or in which a foreign investor has purchased an equity interest of at least RUB 100 million. Such investments must be included in a list of projects approved by the Russian government. However, the benefits of the Grandfathering Clause to foreign investors are undermined by a number of exceptions. Such exceptions including protective customs tariffs on commodities, excise tax, VAT on domestic goods and pension fund payments, as well as a broader exclusion relating to the protection of certain public or state interests. Generally as in other countries the Grandfathering Clause raises issues of coordination and consistency with the general tax laws. FOREIGN INVESTMENT CONTROL LAW The Foreign Investment Control Law3 sets out conditions and procedures allowing the Russian government to restrict, on a case-by-case basis, the right of foreign investors to take control of, or gain influence (even through a minority stake) over, companies holding certain assets or being engaged in certain activities deemed strategically important for Russia’s national defence or security. The key provisions of the Foreign Strategic Investments Law are those related to the definitions of “foreign investor”, “strategic activities” and “control”. The concept of “Foreign Investor”, “Strategic Activities” and “Strategic Companies” under the Foreign Investment Control Law ■■

The Foreign Investment Control Law provides for the following two types of foreign investors (both “Foreign Investors”): – Private Foreign Investor – an investor, which is (i) a legal entity or an organisation such as a partnership incorporated or otherwise established outside Russia irrespective of whether it is ultimately controlled by a Russian or a foreign investor; (ii) a Russian entity under the control of a

Federal law On Foreign Investment in the Russian Federation of 9 July 1999. Note that certain types of foreign investments, such as the investment of foreign capital in banks, credit organisations, insurance companies and non-commercial organisations, are regulated under different Russian legislation.

Federal law On the Procedure of Foreign Investment in Commercial Organizations of Strategic Importance for the National Security and Safety of the Russian Federation of 29 April 2008.

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legal entity or an organisation listed in item (i) above; and (iii) a foreign individual. Private Foreign Investors do not include state-controlled companies; – Foreign Sovereign – an investor, which is (i) a foreign state; (ii) an international organisation; (iii) a foreign or Russian company under the control of a foreign state and/or an international organisation.4 ■■

The Foreign Investment Control Law lists 42 activities deemed strategically important (“Strategic Activities”) (see full list on pages 17 and 18). The list includes, amongst other activities: – the nuclear industry;

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Control may be gained by the Private Foreign Investor through, amongst other things: ■■

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– aerospace and aviation activities; – broadcasting and mass media; ■■

– fisheries; and – telecommunications. If a company carries out Strategic Activities, then it will be presumed to be a “Strategic Company” in which case foreign investment will be subject to regulation under the Foreign Investment Control Law. The concept of “Control” under the Foreign Investment Control Law The concept of “Control”, for the purposes of identifying those investments which will lead to a Foreign Investor gaining direct or indirect control of a Strategic Company (thereby requiring governmental approval), is construed widely. “Control” may be exercised directly or indirectly by the Foreign Investor doing, amongst other things, any of the following: ■■

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exercising the rights attached to the voting shares of the Strategic Company;

acting as the external management organisation of the Strategic Company.

The criteria for establishing Control depends on the type of Foreign Investor potentially acquiring such Control.

– arms production (and other military activities);

– exploration and extraction of natural resources from “fields of federal importance”;

exercising the right to determine the Strategic Company’s decisions, including the conduct of business (inter alia by virtue of an agreement); and

an acquisition of more than 50 per cent of the shares (or an equivalent participation interest in the charter capital) in the Strategic Company; a right to appoint or elect the sole executive body and/ or 50 per cent or more of the board of directors and/or the unqualified right to elect 50 per cent or more of the board of directors or other managing body of the Strategic Company; and for a company engaged in the exploration for, appraisal of and production of mineral resources within a field of federal importance (“Subsoil Company”) the threshold is 10 per cent instead of 50 per cent.

However, this is not an exhaustive list and acquisitions of smaller holdings can still be covered. Typical shareholder agreement terms, such as provisions for reserved matters, could grant a Foreign Investor de facto “Control” of the Strategic Company for the purpose of the Foreign Investment Control Law. A special regime applies to investments made by a Foreign Sovereign: ■■

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the Foreign Sovereign is deemed to obtain Control if it acquires (i) a blocking interest (i.e. 25 per cent plus one share) in a Strategic Company or (ii) a 5 per cent or more interest in the Subsoil Company; and such investor is completely prohibited from acquiring Control over a Strategic Company (i.e. a Foreign Sovereign is not allowed to directly or indirectly acquire Control in a Strategic Company or any other rights mentioned in this section under the description of “control” above).

participating in the board of directors or other management bodies of the Strategic Company; The regulations governing a Private Foreign Investor under the foreign Strategic Investments Law differ from the regulations related to a Foreign Sovereign.

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SPECIAL CASES OF APPLICATION OF THE FOREIGN INVESTMENT CONTROL LAW Subsoil companies The Foreign Investment Control Law will apply only to Subsoil Companies engaged in the exploration for, appraisal of and production of mineral resources from “fields of federal importance”. The list of criteria for determining which fields constitute “fields of federal importance”, include, inter alia: ■■

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areas containing uranium, diamonds, nickel, cobalt, tantalum, niobium, beryllium, lithium or platinum; areas containing 70 million tonnes or more of oil productive capacity; areas containing 50 billion cubic metres or more of gas; subsoil plots containing 50 tonnes or more of vein gold; mines containing 500,000 tonnes or more of copper; subsoil fields located in inland sea waters, territorial seas or on the continental shelve; and areas used for defence and security purposes.

Offshore holding companies The provisions of the Foreign Investment Control Law apply equally to the acquisition of control of any offshore company that would give the Foreign Investor indirect control of a Strategic Company. Foreign subsidiaries of Russian companies The Foreign Investment Control Law extends to investments made by foreign subsidiaries of Russian companies and joint venture companies incorporated in foreign jurisdictions. This therefore affects the common practice of using offshore holding companies for Russian joint ventures. Group of foreign investors A special regime applies when Control is acquired not by a single Private Foreign Investor or Foreign Sovereign, but by a group of Foreign Investors. For example, the acquisition of separate stakes in a Strategic Company by several companies (including Foreign Investors) belonging to the same group, in which each individual stake does not

14 | Doing Business in Russia

form Control but together the stakes constitute Control, will fall under governmental consent requirements of the Foreign Investment Control Law. Exceptions to the requirement for pre-approval A Foreign Investor does not require consent if at the time of the investment it (or its group) already holds (directly or indirectly) 50 per cent of the shares/participation interests of the Strategic Company. In respect of Subsoil Companies, a Foreign Investor may acquire up to 49 per cent of the shares/participation interests where the Subsoil Company is majority-owned either directly or indirectly by the Russian Federation. This exception does not however extend to investments made by Foreign Sovereigns. However, the Foreign Investor should note that under no circumstances does the Foreign Investment Control Law alleviate the Foreign Investor from the obligation to obtain all other regulatory consents for the relevant investment (eg approval of FAS (see chapter on “Competition Laws” starting on page 39). Procedure for obtaining consent Any transaction related to the acquisition of Control over Strategic Companies shall be made only upon preliminary consent of the Russian Federal Antimonopoly Service (“FAS”), on the basis of a decision of the government commission for control of foreign investment in the Russian Federation (“Commission”), which is headed by the Head of Government of the Russian Federation. The procedure by which a Foreign Investor may gain consent is as follows: ■■

■■

The Foreign Investor submits an application to FAS. The application must be in the prescribed form and include: constitutional documents; documents evidencing group structure, group activities for the previous two years and the terms and conditions of the proposed investment; and a draft business plan for the Strategic Company. The authorised agency may deem that no “Control” is to be acquired, in which case the Foreign Investor will be free to proceed. Alternatively, FAS may deem that an acquisition of “Control” is likely to result, in which case it shall then submit a request to the Federal Security Service (“FSB”) for their opinion as to whether the proposed investment would have an

adverse effect on State security. FAS will conduct its own further enquiries and may invite the Interdepartmental State Commission on the Protection of State Secrets to conduct its own investigation. ■■

Once all necessary state authorities have given their input, FAS will submit the application, plus the opinions of the relevant state authorities to the Commission, which will make the final decision. The Commission may accept, reject or allow the proposed investment subject to the fulfilment of certain conditions.

The whole process must be concluded within three months from the date of submitting the application to FAS, although this period may be extended in exceptional circumstances. There are limited rights of appeal: ■■

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the decisions and actions of FAS may be appealed in the courts; and a refusal by the Commission to grant consent may be appealed only in the Higher Arbitrazh Court of the Russian Federation.

Failure to comply An investment entered into in breach of the Foreign Investment Control Law will be deemed to be void. This will include both an investment entered into where the Commission refused consent and the situation whereby a Foreign Investor failed to comply with any conditions that the Commission placed upon the proposed investment. SPECIAL ECONOMIC ZONES (“SEZ”) LAW The SEZ Law5 states that an SEZ is a Russian territory which benefits from a preferential regime for conducting business in that territory, thereby encouraging investment in the territory. SEZs are selected by the Government on tender bases from proposals submitted by the regional authorities. The term for which a territory will benefit from SEZ status depends upon the type of business activity for which SEZ status was granted; this maybe up to 20 years for high-tech industry and health and recreation industry or up to 49 years in respect of investment in transport infrastructure.

There are various types of SEZ: High Technology Incubation Zones (“TIZs”) Existing TIZs are located in the Moscow Region (Dubna (nuclear technology, energy saving, aerospace and civil engineering) and Zelenograd (microelectronics, nanotechnologies and medical studies)), St Petersburg (computer programs, databases and complex equipment) and Tomsk (new materials, micro- and nano electronics). Industrial Production Zones (“IPZs”) Existing IPZs are located in the Lipetsk Region (consumer appliances, electronics, machinery and construction materials) and in Yelabuga (Republic of Tatarstan) (components for the automotive industry and petrochemicals). IPZ residents have to invest at least EURO 1 million during the first year of their project and at least EURO 10 million during the overall term of their project. Zone of Tourism and Recreation (“ZTR”) Existing ZTRs are located in the Republics of Altai and Buriatia, in the Krasnodar, Stavropol and Altai Territories and in the Kaliningrad and Irkutsk Regions. These ZTRs are expected to start operating by 2012 and receive over 1 million visitors annually. There is also a newly created zone on Russian Island (“Ostrov Russkyi”) near Vladivostok. Port Zones (“PZs”) At the time of publication two PZs are in existence: the Ulianovsk airport and a seaport in the Khabarovsk Territory. Other zones are currently being examined. It is also likely that territories may be selected for international river cargo as well. The activities to be conducted in PZs will include load discharging, warehouse services, transportation and forwarding, ship chandler services, ship maintenance and technical support, wholesale trade, simple assembling, packaging and marking, procession of sea products and operation and maintenance of the PZ. PZ residents have to invest at least EURO 100 million if they are developing new international cargo sea port infrastructure, EURO 50 million if developing a new river- or airport, and at least EURO 3 million if reconstructing the infrastructure of an existing sea-, river- or airport.

Federal Law On Special Economic Zones in the Russian Federation dated 22 July 2005.

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More information on SEZ development can be found at www.rosez.ru. The benefits of SEZs only apply to foreign investors upon the creation of a Russian subsidiary, as only Russian legal entities may make an application to become an SEZ resident. Russian legal entities interested in participating in an SEZ should make an application to obtain the status of an SEZ resident. The application should be supported by a business plan. A special SEZ Council decides on whether the applicant qualifies as an SEZ resident based on a scoring system that takes into account, amongst other things, the prior expertise of the applicant or its founder in the relevant industry, the investment recoupment period envisaged, competition in the relevant market, etc. SEZ residents benefit from a number of tax benefits with regard to property tax, land tax, corporate profits tax and other taxes. In addition, to the SEZs considered above, other legislation has been enacted with respect to specific free economic zones. An example of such legislation is the Federal Law On the Special Economic Zone in the Kaliningrad Region of 10 January 2006 and the Federal Law On the Special Economic Zone in the Magadan Region of 31 May 1999. Also, it may be noted that all gambling business were to be transferred to four areas in the Primorskiy, Altai and Krasnodar Territories and the Kaliningrad Region by 1 July 2009, although these zones will not enjoy any particular special tax benefits.

16â&#x20AC;&#x192; |â&#x20AC;&#x192; Doing Business in Russia

REGIONAL LEGISLATION When a foreign investor is considering investing in a particular Russian region, it is important to examine not only the relevant federal laws, but also the relevant regional laws. As the various regions of Russia compete to attract foreign investors, each have passed numerous laws, regulations and other legal measures aimed at improving the particular social and economic conditions in their region. For example, the Leningrad Region in 1997 enacted a law which provided additional guarantees of state support to investors involved in investment projects, which have a major economic and social importance for the region. In St Petersburg, a number of additional tax incentives have been introduced. Other pro-investment regions that have succeeded in attracting significant amounts of foreign capital include the Samara, Saratov, Nizhnii Novgorod, Sverdlovsk, Novgorod Regions and the Krasnodar, Perm and Khabarovsk Territories. The regulatory framework for SEZ is also established at both federal and regional levels. The Lipetsk, Moscow and Tomsk Regions, the Republic of Tatarstan and St Petersburg have already introduced tax incentives relating to SEZs at a regional level.

LIST OF STRATEGIC ACTIVITIES 1.

Work which actively affects hydro-meteorological processes and events.

Work which actively affects geophysical processes and events.

Activities connected with the use of agents of infectious disease.

Placement, construction, exploitation and de-commissioning of nuclear facilities, radiation sources, nuclear and radioactive materials and storage facilities for radioactive waste.

Treatment of nuclear and radioactive materials in the course of research on, and extraction of, uranium; and in the course of producing, using, processing, transferring and storing nuclear and radioactive materials.

Treatment of radioactive waste during its storage, processing, transportation and disposal.

Use of nuclear and radioactive materials in scientific and engineering research.

Designing and engineering nuclear facilities, or other facilities which are sources of radioactivity or radioactive materials, and storage facilities for radioactive waste.

Engineering and producing equipment which are sources of radioactivity or radioactive materials, and equipment for storage facilities for radioactive waste.

10.

Examining project, engineering and technical documentation certifying the safety of nuclear facilities, radioactive materials and storage facilities for radioactive waste, or relating to the treatment of nuclear and radioactive materials and waste.

11.

Engineering and producing encryption devices or devices using encryption (cryptographic means) to protect information or communications, when such activity is licensable.

12.

Distribution of licensable encryption devices.

13.

Technical maintenance of licensable encryption (cryptographic) devices.

14.

Providing services in the area of encryption of information.

15.

Activities connected with detecting electronic devices designed for eavesdropping or secret information gathering (except when such activities are carried out for the internal needs of a legal entity).

16.

Engineering, production, sale and purchase for further re-sale of devices designed for eavesdropping or secret information gathering by commercial legal entities.

17.

Design of weapons and military equipment.

18.

Production of weapons and military equipment.

19.

Repair of weapons and military equipment.

20.

Disposal of weapons and military equipment.

21.

Trade in weapons and military equipment.

22.

Production of weapons and their parts (except for production of knives and blades, or weapons for civil or official use).

23.

Production of cartridges and their parts (except for production of cartridges for civil or official use).

24.

Trade in weapons and their parts and cartridges and their parts (except for trade in knives and blades, weapons for civil or official use and cartridges for civil or official use).

25.

Design and production of ammunition and its parts.

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26.

Disposal of ammunition and its parts.

27.

Production and distribution of explosive materials for industrial use.

28.

Activities relating to aircraft safety.

29.

Space activities.

30.

Design of aircraft and equipment for aircraft including dual purpose aircraft.

31.

Production of aircraft and equipment for aircraft including dual purpose aircraft.

32.

Repair of aircraft and equipment including dual purpose aircraft (except for the repair of parts undertaken by civil aviation organisations).

33.

Testing of aircraft and equipment including dual purpose aircraft.

34.

Television broadcasting where the “footprint” includes territories where at least 50 per cent of the citizens of a particular constituent entity of the Russian Federation reside.

35.

Radio broadcasting where the “footprint” includes territories where at least 50 per cent of the citizens of a particular constituent entity of the Russian Federation reside.

36.

Provision of services by registered natural monopolies in the industries listed in Article 4(1) of the Federal Law On Natural Monopolies dated 17 August 1995, except for electrical and postal communication services, energy transmission services, and electricity supply services.

37.

Activities carried out by a company included in the register of monopolies where the dominant position in question is in the Russian communication services market (except for internet access services); or in the fixed-line telephone markets of Moscow or St Petersburg; or in the fixed-line telephone markets of at least five constituent entities of the Russian Federation.

38.

Activities carried out by a company holding a dominant market position in the production and sale of metals and alloys having specific characteristics and used in production of weapons and military equipment.

39.

Geological exploration and extraction of natural resources on subsoil plots of federal significance.

40.

Extraction of biological resources in waters.

41.

Printing activities, if potential output exceeds 200 million pages per month.

42.

Publishing activities, if the aggregate circulation of each issue published exceeds one million copies.

18 | Doing Business in Russia

MINERAL RESOURCES LAWS

Today Russia is one of the largest mineral producers in the world. Russian deposits contain approximately 15 per cent of the world’s global mineral deposits and Russian mineral resources are an important component of its wealth. SUBSOIL USE REGIME The Russian Subsoil Law6 provides for a general licensing regime with respect to the exploration for and production of mineral resources in the Russian Federation. Under the law, there is no private ownership with respect to mineral deposits and the state owns the subsoil and mineral resources located therein, irrespective of who has the title to the relevant land plot or holds the relevant permit to use the mineral resources. A company exploring and developing any subsoil product in Russia does not own any subsoil product until it is extracted from the ground. The Constitution of the Russian Federation stipulates that subsoil-use legislation falls within the joint competence of the federal and regional state authorities. However, in practical terms, the regional authorities have competence over deposits of certain widespread mineral resources and insignificant subsoil deposits. The overall natural resources management is currently centralised within the federal government. The government entity granting the rights to use underground resources (mineral rights) is the Federal Agency for Subsoil Use (a division of the Ministry of Natural Resources and the Environment) “Rosnedra”. Rosnedra grants the mineral rights to commercial entities pursuant to a mineral license which constitutes an administrative act.

granted for 20 or 25 year terms and can generally be extended. Possession of a geological survey license does not guarantee its conversion into a production license upon a commercial discovery, although it is most likely to be granted in the absence of fraud or breach of the exploration license. The procedures for granting mineral rights (mineral license) may differ depending on the type of mineral rights sought. Generally, a production or combined license is awarded through a tender or auction. Auctions are now more common for awarding production and combined licenses. The Subsoil Law provides for the possibility of utilising production sharing agreements (“PSAs”). However, currently the special legal regime for PSAs is being abolished, except in “exceptional cases” (i.e. the existing “grandfathered” projects, and certain new offshore shelf and perhaps some other Far North projects). The transferability of mineral rights in Russia is restricted by law The transferability of mineral rights in Russia is restricted by law. Such restriction is effective for all subsoil users regardless of their nationality, Russian or foreign. Mineral rights may only be transferred in very limited circumstances. These exceptions relate primarily to: ■■

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Permit to use mineral resources The Subsoil Law provides for three types of mineral licenses (i) geological survey licenses; (ii) exploration and mining/production licenses; and (iii) combined licenses under which simultaneous exploration and production are possible. A geological survey license may be granted for a maximum period of five years (10 years for offshore projects) and can be extended if needed for completion of the works. Exploration and mining/production licenses and combined licenses can be issued for a term equal to the life of the project, however in practice they are usually

■■

a license-holder’s corporate reorganisation: transformation, merger, takeover or spin-off (except for the transformation, in all other cases the new company must be Russian incorporated.); establishment by the license-holder of a 50 per cent-plus Russian subsidiary; transfer of the mineral license from the parent company to its subsidiary and vice versa (provided that the entity acquiring the mineral license is a Russian legal entity); or acquisition by the Russian company of production assets of the license-holder if the latter goes bankrupt.

In each case the transfer of the mineral rights is performed by the licensing authorities by issuing a new mineral license to the new subsoil user; the terms and conditions of the previous mineral license do not change.

Federal Law On Subsoil of 21 February 1992, substantially restated by Federal Law of 3 March 1995 and then subsequently amended.

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Because of the limitations of the transfer of the mineral rights mineral licenses cannot be assigned as security or pledged with a bank or any other legal entity. The “sale” of the mineral license is only possible through a sale of the licensee’s shares. A sale of or pledge over the shares of a subsoil company operating in a “field of federal importance” to a foreign investor may result in the Foreign Investor obtaining “Control” over such subsoil user and therefore, may be restricted or prohibited by law (see chapter on “Foreign Investment in Russia” starting on page 12). Obligations of the subsoil user The subsoil user (i.e. license-holder) generally undertakes certain commitments under the mineral license, including to meet certain annual production targets (applicable only to production and combined licenses), to keep environmental contamination within specified limits and to remedy environmental contamination. The license-holder may also be obliged to fulfil certain social obligations in the area to which the mineral license relates, such as paying compensation to local indigenous groups and providing other types of support.

Additional Licenses If the activities associated with the subsoil field development are licensable activities, the holder of a mineral license must obtain such licenses if it carries out those activities independently. Activities that are subject to licensing are set out in the Licensing Law. Native Title Issues Russian law provides for certain protections of the indigenous people of the Russian Far North, Siberia and the Far East, which may entail additional obligations for a subsoil user carrying out activities within the indigenous people’s territories. Failure to comply and termination of the mineral rights Failure to comply with the terms of the mineral license (or with the provisions of the Russian law or implementing regulations) can lead to penalties, suspension of operations and revocation of the license. Under the Subsoil Law, a mineral license may be revoked by Rosnedra if, inter alia: ■■

Additional authorisations Land rights The issuance of a mineral license requires the prior consent of the land resources management body or the owner of the relevant land plot. The use of the land must be in line with the relevant purpose of the land. Mining allotment The holder of a mineral license may commence production operations within the license area only after the mining allotment with respect to the subsoil plot has been determined, based on an expert report on the field development plan. Environmental aspects Prior to exploration and development of a subsoil field, the project is subject to an expert’s environmental examination.

20 | Doing Business in Russia

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there is an immediate danger to human health due to the operations in the field; there is a violation of the essential terms of the mineral license; there is a state of emergency (natural disasters, military activities); the licensee fails to commence operations within the time stated in the mineral license; or the licensee is liquidated.

If a mineral license is terminated, all production facilities in the relevant licensing area, including underground facilities, must be liquidated or undergo conservation.

TAXATION

CORPORATE PROFITS TAX

Tax incentives

General

Profits tax incentives and exemptions can be provided through federal or regional legislation.

The Russian tax system is based on the principle of world-wide taxation of income. Under this principle, Russian corporate tax residents pay profits tax in Russia on their world-wide income, whereas foreign legal entities pay profits tax only on income derived through Russian permanent establishments (see section on “Permanent establishment” on page 32) or on passive income derived from a Russian source. Currently, tax residency status is based on registration. An entity is considered to be a Russian tax resident if it is registered as a Russian legal entity in accordance with Russian corporate law. There are no “place of control and management” rules established for tax residency purposes, although the Russian government is considering introducing such legislation in future. Controlled-foreign company (CFC) rules are not yet introduced in Russia. Due to recent amendments made in response to the financial crisis, Russia operates with a moderate rate of profits tax, currently 20 per cent. Profits tax is charged on income less duly documented business expenses. Each legal entity is responsible for the fulfilment of its tax obligations. No tax consolidation within a group of companies is allowed.

Currently profits tax exemptions at the federal level are provided only to certain state corporations, investors residing in “Special Economic Zones” (see section on “Special Economic Zones” on page 30) and are not generally available to other investors. At a regional level, authorities have limited powers to grant profit tax incentives and are only authorised to grant a reduction of the profits tax rate (in the part payable to the regional budget) by 4.5 per cent (i.e. down to 13.5 per cent from 18 per cent) for any period they consider necessary. Such incentives are generally granted to major investors or to entities operating in a particular industry. However, given that the criteria for the application of such incentives can be discretionally set by the regional authorities, the reduction in profits tax can be potentially available to any group of investors (taxpayers). Withholding taxes Passive Russian-source income of a foreign legal entity (not attributed to its Russian permanent establishment) is subject to profits tax in Russia at the following rates: ■■ ■■

Tax exempt income Certain types of income are exempt from profits tax: ■■

gratuitous receipts of cash or property by a Russian entity from its “50 per cent plus” shareholder or from a subsidiary where the Russian entity owns more than 50 per cent of shares;

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contributions to the charter capital;

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income from revaluation of fixed assets and securities;

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income received by a shareholder upon distribution of its subsidiaries’ assets (within a contribution limit); and special purpose financing from state funds.

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15 per cent on dividends and other investment-income; 20 per cent on passive income (including royalties and interests); 20 per cent of revenue or capital gain from the sale of immovable property located in Russia or shares in Russian subsidiaries where the immovable property located in Russia represents more than 50 per cent of assets; and 10 per cent on freight income in international traffic.

Taxation of profits (rather than the gross amount of income received) is possible only if expenses are properly documented. Tax must be withheld by a tax agent from income payable to the foreign legal entity. Reduced tax rates or full protection from withholding can be available under an applicable double tax treaty between Russia and the state of tax residence of the foreign legal entity. To benefit under the applicable double tax treaty the foreign legal entity must provide a duly documented tax residency certificate prior to the first payment.

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Thin capitalisation and interest taxation Generally, interests on similar loans borrowed in the same quarter are fully deductible. If there are no similar loans or, at the choice of a taxpayer, interest is deductible within the following limits: ■■

■■

for loans denominated in Russian Roubles: the Central Bank of the Russian Federation refinancing rate multiplied by 1.1; and

■■

for foreign currency loans: 15 per cent.

Thin capitalisation rules restricting deductibility of interest also apply to “controlled debt”. According to the Tax Code of the Russian Federation (“Tax Code”), a loan (or any debt) is “controlled” if: ■■

A standard 9 per cent profits tax rate applies to dividends received by a Russian legal entity. To make Russia an attractive location for holding companies, a special exemption from profits tax was recently introduced for dividends received from a “strategic investment”. An investment is deemed “strategic” if it meets the following criteria:

the loan is granted by a foreign legal entity which owns, directly or indirectly, more than 20 per cent of the capital of the Russian borrower or by a Russian affiliate of such foreign legal entity; or the loan is guaranteed or otherwise secured by a foreign legal entity which owns, directly or indirectly, more than 20 per cent of the capital of the Russian borrower or by a Russian affiliate of such foreign legal entity.

Interest charged under a controlled debt will be fully or partially re-classified into dividends for tax purposes if the amount of controlled debt exceeds net assets by more than three times (12 times for banks and leasing companies). If the tax payer has negative net assets, then the whole amount of interest will be treated as dividends for taxation purposes (i.e. they will be non-deductible and subject to withholding tax). Taxation of losses Russian tax rules allow tax losses to be carried forward for a period of ten years without limitation (loss carry back is not available). Losses from the sale of securities can be credited only against future income from the sale of the same type of securities. Losses from the disposal of fixed assets are recognised evenly over the remaining useful life of the assets. Taxation of dividends As a general rule dividends paid by a Russian entity to its foreign parent are subject to 15 per cent withholding tax at source. However, a reduced rate (minimum 5 per cent) may apply under an applicable double tax treaty. 22 | Doing Business in Russia

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the Russian legal entity receiving the dividend owns at least 50 per cent of the capital of the paying entity (or owns depository receipts entitling it to receive at least 50 per cent of the total amount of paid dividends); the participatory interest or depository receipts have been owned for at least 365 days on the day dividends are declared; and the value of the investment is at least RUB 500 million, (this requirement is not applicable from 2011 in respect of dividends distributable from 2010 onwards).

To prevent “treaty-shopping”, dividends received from foreign entities located in offshore-zones (the list of territories treated as “offshore-zones” for this purpose is set by the Ministry of Finance of the Russian Federation) are not eligible to this exemption. For example, Cyprus continues to be “black listed” and it is not known if and when Cyprus will be excluded from the list set by the Ministry of Finance. Transfer pricing rules Russian transfer pricing rules are established by two articles of the Tax Code and is rather simple in comparison to the Organisation for Economic Co-operation and Development (“OECD”) transfer pricing principles. Despite numerous legislative attempts, it generally remains unchanged since 1999, when it was first introduced. Under the Tax Code, the tax authorities are authorised to control prices in the following cases: ■■

transactions between related parties;

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barter transactions;

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foreign trade (cross-border) transactions; and

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transactions in which the prices fluctuated by more than 20 per cent within a “short period of time”,

thus, the Russian transfer pricing rules apply to a rather wide range of transactions and are not limited to related parties transactions.

Once a transaction falls into the scope of the controlled transactions noted in the immediately preceding paragraph, the tax authorities are entitled to adjust the price of the transaction and charge additional tax liabilities (plus late payment interest and fines) in respect thereto only if the contract price deviates by more than 20 per cent from the market price. The market price shall be defined on the basis of information obtained from “official sources”, but as the list or definition of such sources is not defined, potentially information on market prices from any source can be ignored by court. This is one of the major obstacles for the successful application of the transfer pricing rules in practice. If the application of the method for determining market price described in the immediately preceding paragraph is not possible, then the Tax Code envisages three methods to determine the market price which shall be applied in the following sequence: ■■

■■

Comparable uncontrolled price method: under this method, the market price is determined on the basis of transactions executed between unrelated parties involving identical (homogeneous) goods under comparable economic conditions. Re-sale minus method: under this method, the market price is determined as the difference between the sale price applied by the company which further resells the product (“Reseller”) and: – the “reasonable costs” incurred by the Reseller to resell the product to the final consumer; plus – the “average profit”, applicable to the area of commercial activity of the Reseller.

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Cost plus method: under this method, the market price is determined as the sum of costs incurred by the company being examined by the tax authorities and the average profit, applicable to the area of commercial activity of such company. Under this method “reasonable” direct and indirect costs incurred to produce and sell the product (including transportation, storage, insurance and other similar costs) must be considered.

Unlike the OECD rules, the Tax Code does not envisage symmetrical adjustment of tax liabilities for both parties to a transaction. This allows the tax authorities to impose additional tax liabilities for a seller without the corresponding adjustment of the cost base for a buyer. It is anticipated that the rules may change in 2011. The State Duma of the Russian Federation has adopted a new transfer pricing bill in the first reading. VAT Taxable base Generally, VAT must be levied on sales of goods, works and services supplied in Russia. There is also a list of other VAT-able operations including transfer of property rights, certain self-supplies, etc. Import of goods into the customs territory of Russia and supply of the related services are also subject to VAT, but payable to the customs authorities. The VAT rate is 18 per cent though certain goods and services (including, certain goods for children, food product, etc) are subject to a reduced VAT rate of 10 per cent. Export sales of goods and certain types of services is subject to a 0 per cent VAT rate, provided that they are supported by the required documentation. Generally, VAT is a major source of revenue for Russia’s federal budget. A significant proportion of tax disputes in Russia relate to VAT issues. Specifically, there is vast court practice considering the application of the 0 per cent VAT rate, recovery of construction input VAT, application of VAT exemptions, legitimacy (from the standpoint of the VAT Chapter of the Tax Code requirements) of the source documents, etc. VAT taxpayers VAT taxpayers are determined as follows: ■■

Russian and foreign companies;

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private entrepreneurs; and

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any person, importing goods to the customs territory of Russia.

Legal entities and entrepreneurs may apply for an exemption from VAT, if: ■■

their aggregate revenues for three consecutive months (excluding VAT) do not exceed RUB 2 million; and

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no sales of goods subject to excise operations were made during the three preceding calendar months.

This exemption is not applicable to the import of goods into the customs territory of Russia. Taxpayers operating under certain special tax regimes (eg simplified taxation system, etc) are not considered as VAT taxpayers (save for the import of goods into the customs territory of Russia).

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Output VAT – taxable operations Russia is considered as the place of sale of goods for VAT purposes provided that any of the following circumstances exist: ■■

■■

are located in Russia at the moment of dispatch.

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The Tax Code provides for a number of specific rules determining the place of supply for VAT purposes with respect to certain services, which include inter alia the following: ■■

■■

services relating to immovable property and movable property are subject to VAT if the property is situated in Russia; cultural, sport, artistic, educational or tourism services which are deemed to be supplied at the location where these services are performed; transportation, freight services and other related services are subject to VAT if the point of departure or destination is located in Russia and provided that these services are supplied by Russian entities or entrepreneurs;

24 | Doing Business in Russia

provision of personnel (provided that they work at the place of business of the buyer); consulting, legal, accounting, engineering, advertising, marketing, information-processing, research and development, and software development, modification and adaptation services; and the transfer of intellectual property rights are subject to VAT provided Russia is considered as the place of business activity of the buyer.

There are a number of other transactions specifically listed by the Tax Code which are subject to VAT, such as:

the goods are located in Russia and are not being transported; or

Unless specifically listed in the Article 148 of the Tax Code, works and services are subject to VAT if Russia is considered as the place of business activity of the supplier. In this context, the place of business activity is defined as the place where the supplier is registered. In the absence of state registration of the supplier, the place of its business is determined as the location of its management and executive body, the place indicated in its incorporation documents or where the permanent establishment of the supplier is located (if the relevant works or services are connected with the activity of that establishment).

leases of movable property (except for motor vehicles);

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sale of goods, or the provision of work or services for no consideration; performance of construction and installation work for the taxpayer’s own consumption; and internal consumption of goods, works and services produced by the taxpayer provided associated costs are not deductible for Profits tax purposes.

Generally, output VAT is reported on an accrual basis. At the same time, advance payments are also VAT-able (save for advances related to 0 per cent VAT sales, VAT exempt operations and those related to the sale of goods with a technological process of production exceeding six months). VAT payable to the customs authorities Import of goods to the Russian customs territory is subject to VAT payable to the customs authorities. The taxable basis is determined as the contract value of goods increased by the amount of related services (eg transportation, insurance, etc), customs fees, excise and allocable royalty payments, if applicable. Generally, customs authorities have the right to check the customs value of goods from a market level requirements standpoint as well as the inclusion of all the related services and payments (applying the methodology envisaged by the Russian customs law) and charge an additional amount of customs VAT if a deviation is identified.

VAT zero-rated supplies

Reverse charge VAT

The Tax Code envisages the application of 0 per cent VAT with respect to the certain operations, including, inter alia the following:

If a foreign legal entity, which does not have Russian tax registration, provides work or services in Russia subject to VAT (based on the criteria envisaged in article 148 of the Tax Code) the remittance of VAT is made through a withholding mechanism. The buyer of these works or services is required to withhold VAT from the amount payable to the foreign supplier and remit the withheld tax to the budget.

■■ ■■

export sale of goods; and provision of certain services “directly related to the production sale of such goods”.

The Tax Code lacks a clear definition (list) of the services which can be considered as “directly related to the production and sale of the exported goods”. This uncertainty gives ground for numerous disputes between the tax authorities and taxpayers (when the tax authority either challenge the application of 0 per cent VAT with respect to certain types of services (eg storage of goods) or undertake an alternative approach and challenge the recovery of 18 per cent input VAT in the hands of the buyer) and also between the service providers and buyers (eg when a buyer challenges the application of 18 per cent VAT by a service provider applying the “unjustified enrichment” legal concept). The law states that the application of 0 per cent VAT also applies to services involving the forwarding, transportation, loading and transport of goods exported from the Russian customs territory or imported into Russia which are performed by Russian organisations (except for railroad carriers) and other similar services and services related to the processing of goods placed under the customs regime of processing of goods on the Russian customs territory. The taxpayer must prove the legitimacy of the application of the 0 per cent VAT rate. In order to do so, the taxpayer shall provide the tax authorities with supporting documents, which include the following: ■■

■■

■■ ■■

the contract for the provision of the qualifying services; a bank statement confirming the receipt of income for these services rendered; a customs freight declaration; and copies of the transport, shipping and/or other documents confirming that the goods have actually been shipped out of the Russian customs territory or imported into Russia.

Input VAT The amount of input VAT charged by the suppliers for goods (work, services) which are acquired to be used for VAT-able operations is generally recoverable from the budget in the hands of the purchaser. The VAT charged by the supplier for goods (work, services) which are acquired to be used for VAT exempt operations or operations considered to be out of scope for VAT purposes is generally treated by the purchaser as a tax deductible expense. The rules stated in the immediately preceding two paragraphs are also applicable to the capital construction input VAT (i.e. such VAT can be recovered in the course of the construction assuming that the construction will be used for VAT-able operations). VAT withheld and paid to the budget by a Russian buyer when making payments to a foreign service provider (see section on “Reverse charge VAT” on top of this column) can be recovered by the Russian buyer subject to the general rule stated in the first paragraph of this section on “Input VAT”. Generally, input VAT is recoverable on an accrual basis (i.e. when respective purchases are booked). Confirmation of actual payment of input VAT is required only with respect to VAT paid upon the import of goods into Russia (i.e. paid to the customs authorities), VAT accounted for by tax agents (i.e. reverse charge VAT), as well as VAT on business trips and entertainment costs. VAT charged on advance payments is recoverable in the hands of the payer in the tax period when the advance payments were made. This is the case on condition that a VAT invoice is obtained from the supplier and the advance payment is provided for contractually. This input VAT, however, should be reversed by the buyer when the

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respective purchases are booked (i.e. when the right to VAT recovery on the purchases arises), or when the advance payment is returned. VAT incurred on purchases and expenses which relate to both VAT-able and non-VAT-able activities must be apportioned. There is a separate accounting records requirement for VAT-able and non-VAT-able operations (save for the periods when the total expenditure on non-VAT-able operations does not exceed 5 per cent of the total production expenditures). Failure to do so may result in the disallowance of input VAT recovery. Input VAT related to zero-rated supplies should also be separately accounted for. In some cases, input VAT recovered in the previous periods must be reversed. The reversal can be partial or full, depending on specific cases and circumstances. These cases include in-kind contributions to the charter capital of a legal entity and operations of a taxpayer using the respective assets for VAT-exempt transactions or those considered as being Russian VAT out-of scope transactions. VAT payable to the budget Generally, the amount of VAT payable to the budget is calculated as the difference between the output VAT charged by the taxpayer on transactions subject to VAT and input VAT charged to the taxpayer by its suppliers and service providers. Any excess of input VAT over output VAT should be refunded to the taxpayer from the budget. The excess of input VAT over output VAT should either be offset against the taxpayer’s current VAT and other federal tax liabilities or refunded in cash after the taxpayer has submitted a written application. From 1 January 2010, the following categories of taxpayer may apply for an accelerated VAT refund procedure: ■■

■■

corporate taxpayers whose aggregate liability for VAT, excise duties, profits tax and mineral extraction tax for the three calendar years prior to the year in which the refund application is made is at least RUB 10 billion and the entity was incorporated at least three years prior to the date the refund application is made; and taxpayers who submit a bank guarantee from a bank approved by the Ministry of Finance of the Russian Federation.

26 | Doing Business in Russia

VAT invoices In order to recover the charged VAT, a customer must obtain a VAT invoice (known as a “schet-factura”) indicating the input VAT invoiced by the supplier. For this purpose certain specific information must be indicated in a schet-factura, in particular, VAT invoices must be issued in Russian and must bear the original signatures of both the head of the company and the company’s chief accountant. From 1 January 2010, errors in VAT invoices which do not relate to the identification of the supplier, buyer, costs of goods (work, services or property rights supplied), as well as the VAT rate and amount, are not legal grounds for denying VAT recovery. This is in line with the approach already applied by most Arbitrazh Courts on tax disputes relating to VAT. VAT exemptions The Tax Code contains a list of VAT exempt operations, which includes without limitation, the following operations: ■■

■■

lease of office space and accommodation to registered foreign representative offices and foreign individuals (provided the same exemption is envisaged by the legislation of the respective foreign state); medical services and the sale of certain medical equipment;

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banking and insurance services;

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interest on monetary loans; and

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sale of land and residential buildings and premises or any interest in such property and some others.

Additionally, there is a list of equipment (analogies of which are not produced in Russia) which are subject to VAT-exemption when imported to Russia. This list is maintained by the State Customs Committee, and at present includes high-technology equipment (particularly if that equipment is used for manufacturing or research and development) and specialised and public transport, telecommunications, and medical equipment. Special VAT exemptions apply to certain organisations and operations associated with the preparation and conduct of the 2014 Sochi Winter Olympic Games.

PERSONAL INCOME TAX Taxable income and applicable tax rates Russian tax residents are subject to Russian personal income tax (“PIT”) on their world-wide income, both earned in Russia and abroad. The tax rate applicable to most types of income earned by residents, including employment income, is generally a flat tax rate of 13 per cent. Taxable income may also include in-kind income such as payment of goods or services in favour of the taxpayer, subject to certain exceptions. The dividends income is subject to a tax rate of 9 per cent. Certain types of income are exempt from PIT. These include, inter alia, the income from the sale of real estate and other property, except for securities, owned by the taxpayer for at least three years prior to the sale. Individuals, not qualifying as Russian tax residents, are subject to PIT on their Russian-source income only. The tax rate applicable to all types of such income is a flat rate of 30 per cent, except for Russian-source dividends which are taxable at rate of 15 per cent. Definition of tax resident An individual is deemed a Russian tax resident if he/she stays in Russia for at least 183 days during any 12 consecutive months. The qualifying 183 days period is computed as the total number of days when an individual is physically present in Russia. The law does not require an individual to stay in Russia 183 days continuously without a break to qualify as a tax resident. Payment and reporting of tax The procedure for reporting and paying PIT depends on the specific source of the income received by the taxpayer. Where the taxable income is received from a Russian legal entity or a foreign legal entity having tax registration in Russia (for example, employment income or dividends), the paying entity is generally deemed a withholding agent. The withholding agent is required to deduct the applicable PIT from the income paid to the taxpayer and pay it to the Russian budget. The amount of paid income and PIT is to be reported to the tax authorities by the withholding agent. Where the applicable PIT was not paid by the withholding agent, the taxpayer is required file a tax return and pay the tax due himself/herself. As a general rule, a tax return is to be filed by 30 April of the year following the reporting

period, which is a calendar year. The tax due under the tax return is to be paid by 15 July of the year following the reporting period. There is an exception to this that applies to foreigners terminating their taxable activity in Russian and leaving Russia. Such foreigners are required to file a tax return at least one month prior to their departure and pay the tax due within 15 days after filing. SOCIAL INSURANCE CONTRIBUTIONS Base for calculating contributions and applicable rate Employers or other entities paying out income in cash or in-kind to individuals engaged under employment or certain civil law contracts are required to pay social insurance contributions. These include contributions to statutory pension, medical and other social insurance funds. Insurance contributions are treated as tax deductible expenses in the hands of the paying entity. Insurance contributions apply to the individual’s annual income only up to an established cap of RUB 415,000 subject to an annual review by the Government of the Russian Federation. An annual income exceeding the given cap is exempt from insurance contributions. The aggregate applicable rate of insurance contributions is 26 per cent for 2010, but from 2011 this rate will be increased to 34 per cent. Income paid under employment or civil law contracts to foreign nationals staying in Russia on the basis of a visa is exempt from insurance contributions. Payment and reporting of contributions Insurance contributions are to be paid and reported by employers or other liable entities separately to each social insurance fund. The payment is due on a monthly basis no later than the 15th day of the following month. The reporting period for all insurance contributions is a calendar quarter. For insurance contributions payable to pension and medical insurance funds, the amount of accrued income and insurance contributions is to be reported no later than the 1st day of the second month following a calendar quarter. The due date for reporting insurance contributions payable to social insurance fund is the 15th day of the month following a calendar quarter.

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OTHER TAXES Excise duties The sale or import of certain excisable goods (oil, tobacco, alcohol products, motor vehicles, etc.) is taxed with excise duties. The tax base is determined as the quantity of excisable goods or the value of such goods. The excise rates depend on the category of excisable goods. Export of excisable goods outside of Russia is exempt from excise duties if certain requirements are met by the taxpayer. The taxpayer may offset the amount of excise duties payable to the budget by the amount of excise duties paid on the purchase or import of excisable goods used in the production of the excisable goods. The excise duties are paid on a monthly basis. However, the tax payer is required to make advance excise payments (via purchase of an excise stamp) in order to sell or import certain types of excisable goods. Property tax Property tax is imposed on movable and immovable property located in Russia and owned by any Russian or foreign legal entity (subject to certain exemptions). The tax base is determined based on the book value of the property reflected on the taxpayer’s balance sheet and treated as fixed assets according to the Russian accounting rules. However, foreign companies with no Russian permanent establishment pay property tax only on their immovable property located in Russia. Intangible assets, work-in-progress, inventories, natural resources are not subject to property tax. The maximum rate of property tax is 2.2 per cent. Regional authorities have a right to reduce the 2.2 per cent rate or to provide full exemption at their discretion. Property tax is paid on an annual basis with advance payments made every quarter. Regional authorities can exempt certain types of taxpayers from the obligation to calculate and make such advance tax payments. Land tax All legal entities and individuals who own land or have a permanent right to use it or lifelong heritable possession are considered taxpayers (subject to certain exemptions).

28 | Doing Business in Russia

The tax base is established as the cadastral value of the land. The tax rates are set by the local (municipal) authorities, however such rates shall not exceed: ■■

0.3 per cent of the cadastral value of land which is either: – used for agricultural purposes, or – occupied by residential properties or utilities; or

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1.5 per cent of the cadastral value of any other land.

The local (municipal) authorities have a right to reduce the above rates or to provide full exemption at their discretion. Land tax is paid on an annual basis with advance payments made every quarter (save for individual taxpayers who pay land tax once a year). The local (municipal) authorities can exempt certain types of taxpayer from such advance tax payments. Transport tax Transport tax is imposed on legal entities and individuals registered as owners of “transport vehicles” (cars, motorcycles, ships, aircraft, etc.), although this is subject to certain exemptions. Tax rates depend on the type of vehicle and are determined according to horsepower. Regional authorities have a right to reduce/increase the tax rates but by no more than 10 times or to provide full exemption at their discretion. Transport tax is paid on an annual basis with advance payments made every quarter (save for individual taxpayers who pay transport tax once a year). Regional authorities can exempt certain types of taxpayer from such advance tax payments. Mineral Extraction Tax (“MET”) Legal entities and private entrepreneurs that extract minerals from the subsoil and produce waste under a license are subject to MET. MET base varies depending on the type of mineral extracted and is calculated based on the either the physical quantity of the extracted mineral resources or their physical quantity and value (sales price excluding excise and VAT). If no sales were made during a tax period, taxpayers determine the value of the extracted minerals based on their production costs.

Certain types of extracted resources are subject to a 0 per cent tax rate (for instance, mineral water used in a recreational sphere without subsequent sale and underground water used for agricultural purposes only). MET is paid on a monthly basis. Water tax Legal entities and individuals who perform special and/or distinct water consumption in accordance with Russian law are considered taxpayers. Legal entities and individuals who consume water: ■■ ■■

under water consumption agreements; or pursuant to decisions on the provision of water objects for use that were concluded/issued after the enactment of the Water Code of the Russian Federation,

shall not be deemed taxpayers. The water tax base is determined depending on the exact type of water consumption. The tax rates are established depending of the type of a water resource (lake, river, sea, etc.). Water tax is paid on a quarterly basis. SPECIAL TAX REGIMES The Tax Code envisages special tax regimes pursuant to which a taxpayer is obliged to pay only one specific tax instead of a number of taxes. Such special tax regimes include: a simplified tax system; tax on imputed income; unified agricultural tax; and tax on production sharing agreements. A taxpayer can apply a particular special tax regime if certain requirements are met.

Foreign legal entities, Russian legal entities with branches and legal entities where more than 25 per cent of their capital is owned by other organisations are not permitted to use the simplified tax system. Moreover, this special tax regime does not apply to certain types of business including, but not limited to, insurance agencies, banks and investment funds. The simplified tax replaces profits tax, VAT (except for import) and property tax. The simplified tax rate is: ■■ ■■

6 per cent if a taxpayer selects revenue as a tax base; or 15 per cent if a taxpayer selects “income less deductible expenses” as the tax base.

Tax on imputed income Specific types of business activities (for instance, provision of public services such as catering, retail trade) mainly performed by small or medium sized legal entities are subject to tax on computed income. Companies where more than 25 per cent of its capital is owned by other organisations or which employ more than 100 people and some other categories are not permitted to apply the tax on computed income. A taxpayer is exempt from profits tax, VAT (except for import) and property tax. The tax on imputed income rate is 15 per cent and is imposed on the amount of the “imputed revenue” established for each specific type of activity per month adjusted by special coefficients. Usually it involves a very immaterial tax base and is advantageous to taxpayers operating on the basis of the imputed income tax system.

Simplified tax system

STATE DUTY

A company can apply a simplified tax system if the following conditions, inter alia:

A legal entity that performs certain legal actions is required to pay state duty. The Tax Code provides for a list of state duties including, but not limited to, the following duties levied for:

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the company’s annual turnover does not exceed a certain threshold (RUB 60 million from 1 January 2010 until 2013); the net book value of fixed and intangible assets does not exceed RUB 100 million; and the company employs less than 100 people.

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the state registration of a legal entity; the registered of branches and representative offices of a foreign legal entity;

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obtaining a license to conduct certain activities;

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initiating a court action; and

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MISCELLANEOUS TAXES The Russian tax law provides for additional taxes and levies that may exist such as: duties for the use of water and natural resources, pollution levies and tax on gambling. SPECIAL ECONOMIC ZONES There are several types of special economic zones (“SEZ”) in Russia that feature favourable tax treatment: ■■

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authorities may sometimes choose to audit one or several particular taxes. The duration of an on-site tax audit is limited by law to a maximum of two months. However, this period may be prolonged to four months, and in “exceptional” cases even to six months. The tax authorities have the right to suspend an audit for the purpose of: ■■

“technical research and implementation zones” for scientific projects;

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“industrial production zones” the development of industrial production;

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“tourism-recreation zones” for the development of Russian tourism; and “port zones”.

SEZ residents are entitled to a number of tax benefits, such as exemption from property tax and land tax, reduction in social security payments and exemption from customs duty and VAT in some cases. Often additional benefits (for instance, reduction of the profits tax rate by 4.5 per cent and exemption from vehicle tax) are provided to SEZ residents on a regional level. TAX ADMINISTRATION Tax audits Russian law provides for two types of tax audits that may be conducted by the tax authorities: ■■

in-house tax audits; and

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on-site tax audits.

In-house tax audits are performed with respect to tax returns filed by taxpayers. These audits are carried out solely on the basis of such tax returns and other documents submitted by a company within three months from the date of when the respective tax return was filed. An in-house tax audit covers only one tax and one period reported in the submitted tax return. In addition to in-house tax audits, the tax authorities are allowed to perform on-site tax audits of a company to review the three calendar years proceeding the period in which the tax audit is being performed. Generally, an on-site tax audit covers all taxes. However, the tax

30 | Doing Business in Russia

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collecting information on the company under audit from its contract parties or other entities; collecting information on the company under audit from foreign tax authorities; gaining an expert opinion; and/or translating documents presented by the company under audit.

Generally, the suspension may not last for more than six months (an additional three months are available to the tax authorities if the requested documents are not presented by the foreign tax authorities). It is not unusual for a tax audit to last for as long as a year. It is prohibited to conduct repeated tax audits (i.e. a tax audit generally cannot cover an earlier audited period with respect to the tax in question). However, there are three exceptions to this rule and the tax authorities may conduct a repeated tax audit if: ■■ ■■

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the company files an amended tax return; the repeated tax audit is conducted by a higher tax authority; and the company is being reorganised or liquidated.

As a result of both in-house tax audits and on-site tax audits the tax authorities are obliged to issue an act reflecting the results of the respective audit. According to Russian law, the audited company is entitled to object to the act in writing and to defend its position at the proceedings held by the tax authorities. Based on the act and on the proceedings the tax authorities then issue a decision, which, in practice, generally repeats the wording of the act issued by the tax authorities. According to Russian law, a company may challenge the decision of the tax authorities through an appellate procedure by filing a petition with the higher tax authority. From 2009, such administrative proceedings have been obligatory before the company may go to court. The higher tax authority has to issue its decision within one

month from the date of receiving the petition, this period may be prolonged by 15 business days. Only as of this moment will the decision of the higher tax authority come into force. If the decision is endorsed by the higher tax authority, the company may challenge the decision by filing a court claim with the relevant Arbitrazh Court. The claim may be accompanied by an application requesting an injunction from the court which, if granted, shall disallow the tax authorities from unilaterally withdrawing the amounts equal to the sum of the charges from the bank accounts of the company. Reclassification of transactions for tax purposes The tax authorities have the right to revise the legal qualification of deals concluded by taxpayers and to contest the status and nature of taxpayer activities. Pursuant to article 45 of the Tax Code, the tax authorities can recover the amount of taxes and penalties surcharged as a result of such a qualification. This reclassification, however, is only possible following legal proceedings. The tax authorities have recently changed their focus from reviewing mainly defects in accounting business operations for tax purposes to disregarding the legal form of a contract when making a tax re-assessment. In its Ruling No. 53 of October 2006, the Plenum of the High Arbitrazh Court specifically stated that the courts should take into account that transactions not compliant with the law or other legal acts, as well as sham and fictitious transactions, are to be deemed void with tax implications arising therefrom regardless of their recognition by courts. The same ruling has also formulated a different concept that if the court has decided, on the basis of evidence submitted by the tax authorities and the taxpayer itself, that the taxpayer has accounted for business operations not in accordance with its actual economic meaning, then the court “shall define the scope of the rights and obligations of the taxpayer based on the true economic content of the business transaction”. In such a case, the court can find a tax benefit unjustified and disallow such benefit received by the taxpayer if the transaction concerned: ■■

is lacking economic substance and legitimate business reasons other than obtaining a tax benefit (“business purpose principle”); or

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was recorded for tax purposes not in accordance with its actual economic substance (“form over substance principle”).

Obtaining a tax benefit per se may not be deemed a legitimate business reason. Tax penalties The carrying out of business activities without registration with the tax authorities is subject to a fine equal to the higher of either RUB 20,000 or 10 per cent of the respective income. Such fine is increased up to the higher of either RUB 40,000 or 20 per cent of the respective income if such business activities are carried out for more than 90 days. Non-payment of a tax as a result of reduction of the tax base is subject to a fine in the amount of 20 per cent of such unpaid tax. The fine may be increased up to 40 per cent if the violation is intentional (rarely used in practice). Late payment of tax is subject to an interest equal to 1/300 of the effective rate per day of the Central Bank of the Russian Federation. Late submission of a tax return is subject to a fine equal to 5 per cent of the tax due under such tax return per calendar month (full or partial). For delays in excess of 180 days, the fine is calculated at 30 per cent of the tax due, plus 10 per cent for each additional calendar month. SPECIFICS OF TAXATION OF FOREIGN LEGAL ENTITIES OPERATING IN RUSSIA Tax registration A foreign legal entity is required to register with the tax authorities if it carries out economic activity or intends to carry out such activity in Russia through a “fixed place of business” during a period exceeding 30 calendar days (continuously or with interruptions). This is regardless of whether the activity of the foreign company in Russia is taxable or not. If a foreign company carries out activity in more than one location in Russia, it must register separately in each such location. Therefore, any branch or representative office set up by a foreign legal entity in Russia requires tax registration. Furthermore, each: ■■

building site; or

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item of immovable property,

must also be separately registered with the tax authorities. In addition, if a foreign legal entity opens a bank account with a bank in Russia, it is also obliged to notify the tax authorities. In order to be registered with the tax authorities a foreign company should submit the list of documents as specified by Russian tax law. The tax registration itself takes five business days. As a result of tax registration, the tax authorities will provide a foreign company with a certificate of registration containing an individual tax identification number which allows such taxpayer to be identified within the Russian tax and payment systems. Permanent establishment Generally, according to the Tax Code, if a foreign legal entity performs commercial activity in Russia on a regular basis, such “regular activity” (subject to certain exceptions envisaged by the Tax Code) is considered as giving rise to a permanent establishment (“PE”). Income earned by a foreign legal entity from such an activity is subject to profits tax. The Tax Code lacks a clear definition of the term “regular activity”. In practice, the tax authorities use for these purposes “a 30 calendar days” criterion. The definitions of PE contained in the Tax Code are generally in line with those in the various double tax treaties between a foreign states and the Russian Federation (“DTTs”), however in the event of discrepancies between the two the definition in the applicable DTT should prevail. Certain types of business activities performed by a foreign company which are of a preparatory or auxiliary nature do not lead to a PE in Russia. The list of such activities is established in the respective DTT. Conducting business through a dependent agent may also create a taxable PE in Russia. A foreign legal entity is considered to run a business in Russia through a dependent agent if such an agent acts on behalf of the foreign enterprise, has and regularly exercises the authority to conclude contracts on behalf of that enterprise or has the authority to negotiate substantial elements of the contracts on behalf of that enterprise.

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According to the DTTs, if a person who is a resident of a contracting state to a DTT carries on activities in the other contracting state to such DTT through an agent, that person shall be deemed to have a PE in that other contracting state in respect of any activities which the agent undertakes for that person, if such agent meets each of the following conditions: ■■

he has an authority to conclude contracts in that other contracting state in the name of that person;

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he habitually exercises that authority;

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he is not an agent of an independent status; and

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his activities are not limited to preparatory or auxiliary activities.

If the activities of a foreign company in Russia constitute a PE, such company is liable for profits tax. The tax base is determined as income attributable to the PE less certain deductible expenses. Most DTTs provide that a foreign legal entity operating in Russia via a branch or representative office can deduct for profits tax purposes certain expenses incurred abroad by its head office and attributable to the PE. No specific payment requirements are established for foreign legal entities with a PE in Russia compared to Russian legal entities. However, a foreign legal entity is exempt from the duty to make monthly advance payments and, thus, may pay profits tax on a quarterly and annual basis only. In addition to the requirement to file tax returns, a foreign company is required to submit an annual statement on its activity in Russia.

GENERAL PRINCIPLES OF RUSSIAN CONTRACT LAW The general principles of Russian contract law are contained in the Civil Code, the structure of which follows a pattern common to European codified legal systems, in particular that of the Netherlands and Germany. These general principles are supplemented by various specific federal laws which govern specific aspects of contract law and/or certain types of contract.

different rules apply to advertisement in retail. If, however, a proposal contains the essential terms of a contract and it is evident that the party making the proposal intends to enter into such contract with any other party, such proposal will be deemed a public offer and will bind the offeror.

CONTRACT FORMATION

An acceptance is the response of the offeree, which is communicated to the offeror, indicating full and unconditional acceptance of the offer, this may be through words, direction of a written document or actions (eg the dispatch of relevant goods or the rendering of the relevant works or services).12 Silence cannot constitute acceptance unless stated by law, or if it has been established in the course of dealings between the parties or is customary in the context of the relevant business/industry.13

Russian contract law proceeds from the basis of freedom of contract.7 Independent parties, both legal entities and individuals, are, within the parameters of the law, free to contract at their own risk and upon terms agreed amongst themselves, with the aim of deriving profit from the use of property, sale of goods or performance of works and services. Contracts may be bilateral or multi-lateral,8 conditional or unconditional, written or (in a rather limited number of cases) oral. Binding contracts are formed through a valid acceptance of an offer. While the principle of freedom of contract is enshrined in the law, it is prudent to remain within the confines of generally understood and regulated forms of contract (and in particular those specifically listed by the Civil Code). Russian courts when not familiar with new or unusual forms of contract may be reluctant to interpret them and therefore desired predictability may be difficult to achieve. Offer An offer is a proposal, addressed to one or more specific persons, which is sufficiently comprehensive (i.e. containing the essential terms of the would-be contract) and which expresses the intention of the offeror to enter into the contract.9 The offer shall commit the offeror from the moment of its receipt by the offeree.10 Advertisements or other proposals addressed to an unspecified group of persons, as a general rule, shall be regarded as an invitation to make offers, based on the contents of the advertisement or other proposal,11 although 9 7 8

12 13 14 15 16 10 11

Acceptance

The possible term during which the acceptance must be made may be included in the offer itself. An acceptance of an offer which seeks to vary the terms of the initial offer shall be deemed a counter-offer and will require acceptance by the original offeror in order to conclude the contract.14 Contract terms â&#x20AC;&#x201C; imperative and dispositive norms Certain rules (imperative norms), which are specified by law will apply to a contract regardless of its terms and conditions and may not be contracted out of by the contracting parties.15 If any terms or conditions of a contract conflict with an imperative norm, those terms and conditions will be deemed null and void and the imperative norm shall apply. Under Russian law the severability principle applies and the invalidity of a term of a contract does not lead to the invalidity of the whole contract, provided that one may presume that the contract would have been made even without the inclusion of the void term.16

Civil Code, article 421 Civil Code, article 154.1 Civil Code, article 435.1 Civil Code, article 435.2 Civil Code, article 437.1 Civil Code, article 438.1, 438.3 Civil Code, article 438.2 Civil Code, article 443 Civil Code, article 422.1 Civil Code, article 180

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An example of an imperative norm would be that the terms of a contract may not seek to limit liability for an intentional breach by a contracting party.17 Certain rules (dispositive norms) apply to contracts unless the contract provides otherwise. An example of a dispositive norm would be that title to goods transferred under a contract shall pass from the seller to the purchaser at the moment of the actual delivery (unless the contract provides otherwise18). Consideration/payment/price Under Russian law, contracts may be “pecuniary” or “gratuitous”. A pecuniary contract is one under which a contracting party shall receive from the other contracting party remuneration of some sort for the discharge of its duties.19 A gratuitous contract is one under which a contracting party assumes an obligation to provide something to the other contracting party and receives no remuneration for doing so.20 As a general rule, contracts shall be presumed to be pecuniary, even if no price has been stipulated.21 Where the price of a pecuniary contract has not been stipulated and cannot be defined from the contract terms, the contract shall be compensated by reference to comparable contracts for the same goods, works or services.22 However, the practical application of this rule is limited. For instance, it will not apply, if by virtue of law a contract cannot be concluded without parties reaching an agreement on its price. An example would be that in order to enter into a binding sale and purchase agreement relating to immovable property, parties would need to determine its price, as the latter is considered to be an essential term of this type of contract.23 Oral contracts Contracts in general may be made orally unless: ■■ ■■

19 20 21 22 23 24 25 17

at least one contracting party is a legal entity; the sum of the contract is more than or equal to ten times the minimum wage fixed by law (presently the equivalent of RUB 1,000); and Civil Code, article 401.4 Civil Code, article 223 Civil Code, article 423.1 Civil Code, article 423.2 Civil Code, article 432.3 Civil Code, article 424.3 Civil Code, article 555 Civil Code, article 159.2 Civil Code, article 165.2

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law prescribes a written form for this particular type of contract,

in which case a written form of contract becomes mandatory. It maybe noted that certain contracts that meet the above criteria can still be made orally, for instance most of those contracts that are performed at the moment of their conclusion,24 however these are the exception. State registration and notarisation of contracts Conclusion and/or performance of certain contracts must in certain cases also involve state registration or notarisation, for example: ■■

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sale and purchase agreements relating to immoveable property; lease agreements relating to buildings, constructions, premises and land plots for a term of more than one year; license and assignment agreements relating to certain intellectual property rights; sale and purchase agreements relating to participation interests in LLCs (from 1 July 2009); and pledge agreements relating to participation interests in LLCs (from 1 July 2009).

Failure to observe requirement of notarisation of a contract shall cause the relevant contract to be considered null and void, while failure to register a contract with the state will render it not concluded or (if expressly required by law) will lead to the same negative consequences as the non-observance of the notarisation requirement. If one contracting party has fully or partially performed its obligations arising out of a contract requiring notarisation, while the other contracting party to the contract refuses to procure such certification, the court shall have the right to rule such contract legitimate even in the absence of its notarisation.25

As to contracts that are subject to the state registration, the court shall have the right to order the state registration of a contract, if one of the parties evades its state registration, provided the contract has been made in a due form (eg a simple written form).26

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not conclude the contract; or

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conclude the contract on substantially different terms.

However, in practice courts rarely fall back on the provisions on “essential change of circumstance”.

In both instances described in the two immediately preceding paragraphs, the offending party will also be obliged to compensate the other party for losses suffered due to the delay in obtaining the relevant notarisation or registration.27

In certain cases Russian law permits unilateral termination and amendment of a contract in an extrajudicial (out-ofcourt) procedure. For instance, an entrepreneurial contract may vest in one of the parties the right to amend and/or terminate the contract out-of-court by way of a unilateral refusal.

Contract conclusion

As a general rule, unless the contract or law provide otherwise, after a contract has been terminated the parties shall have no right to claim the return of that which has been discharged by them before the contract’s termination.31

The contract is deemed concluded once the parties have agreed on its “essential terms” in the required form for the relevant type of contract.28 The moment of conclusion in general is taken to be when the party making the offer receives the other party’s acceptance. Amending or terminating a contract As a general rule, a contract may only be amended or terminated by the agreement of the parties to it or by the courts. Upon the application of one contracting party, a court may amend or terminate a contract:29 ■■

if the other contracting party commits a fundamental violation (i.e. a violation which entails losses for the non-defaulting contracting party which to a considerable extent deprive it of the benefit which it contracted to receive);

■■

pursuant to a provision of the contract; or

■■

pursuant to another provision of law.

Unless otherwise stipulated in the contract itself or unless it can be derived from its contents, a contract may also be amended or terminated due to an “essential change of circumstance”, such changes being those which, if the parties had envisaged at the time of concluding the contract, would have caused the parties to either:30 28 29 30 31 32 33 34 35 26 27

Third party rights Under the Civil Code, a contract cannot seek to bind a third party who is not a party to it. However, if provided by the law or agreed between contracting parties, a contract may confer rights on third parties.32 For example, X may contract with Y that X shall buy goods from Y, but that Y shall deliver the goods to Z (who is not a contracting party, but will have a right to demand the delivery).33 CONTRACT PERFORMANCE The parties are obliged to discharge their respective obligations under a contract in conformity with the terms of the contract and the requirements of law or, in the absence of any contractual terms or legal requirements, in conformity with established relevant business practice and standard requirements.34 Where a contract does not specify a particular time, date or period during which a contracting party’s obligations must be discharged, the default position is that obligations must be discharged within a “reasonable term after the inception of the obligation”.35 The failure of a contracting party to discharge its obligations within a “reasonable

Civil Code, article 165.3 Civil Code, article 165.4 Civil Code, article 432.2 Civil Code, article 450 Civil Code, article 451.1 Civil Code, article 453 Civil Code, article 308.3 Civil Code, article 430.1 Civil Code, article 309 Civil Code, article 314.2

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term”, as a general rule, permits the non-defaulting contracting party to demand the discharge of obligations within seven days of the presentation of a claim for discharge.36 The above rules will not apply if, by virtue of law, a contract cannot be made without parties reaching an agreement on the terms for performance of the obligations under it. For instance, a contract for the performance of works may not be concluded, unless the parties have determined the term for the completion of works, as the latter is considered to be the essential term of this type of contract.37 Where a contract, law or business custom does not specify a place where the obligations must be discharged, the main default positions will be as follows:38 ■■

■■

an obligation to transfer real estate (land plots, buildings and other immoveable property) is discharged at the place of location of the relevant real estate; an obligation to transfer goods requiring shipping is discharged at the place where the goods are transferred into the possession of the first shipper for forwarding to the creditor; an entrepreneurial obligation to transfer goods which do not require shipping is discharged at the place of manufacture or storage of the goods if this place is known to the creditor at the time of entering into the contract; in general, an obligation to pay (i.e. a pecuniary obligation) is discharged upon receipt into the creditor’s bank account (correspondent account) of the relevant sums; and most other obligations are discharged at the debtor’s location.

COURT INTERPRETATION OF CONTRACTS Russian courts interpret contracts on a literal basis, in contrast to the interpretive approach of many western jurisdictions. Only where the literal meaning of contractual terms is vague shall such terms be interpreted by reference to other terms of the contract or in the 38 39 40 41 36 37

Civil Code, article 314.2 Civil Code, article 708 Civil Code, article 316 Civil Code, article 330 Civil Code, article 330 Civil Code, article 333

36 | Doing Business in Russia

context of the contract as a whole. Only in the rarest of cases do courts undertake any analysis of the parties’ intentions when interpreting contracts. This rigid interpretation of contracts necessitates precise drafting of Russian contracts, so that the intention of the parties is perfectly reflected in the terms of the contract. SECURING THE PERFORMANCE OF OBLIGATIONS Contracting parties may protect themselves against the failure of the other party to discharge its obligations through various contractual mechanisms: Penalty A penalty, sometimes referred to as a fine or forfeit, is a sum of money which the debtor is obliged to pay to the creditor in the event of its failure to discharge its obligations (for example late or non-delivery).39 The creditor, in making a claim under the penalty, does not need to prove that it has actually suffered any loss, but merely has to provide evidence that the violation covered by the penalty has occurred.40 There is no requirement that the penalty be a genuine pre-estimate of loss as with the similar concept of liquidated damages under English law. At the same time, the court has discretion to reduce the penalty if it is manifestly disproportionate to the consequences of the actual breach.41 Russian courts often resort to this measure and this in practice may render provisions establishing disproportionately high penalties inefficient. Pledge (or Mortgage) A creditor may secure performance of the debtor’s contractual obligations by way of a pledge (or mortgage) over certain property of the debtor. The pledge guarantees the creditor a right to satisfy its claims from the proceeds of sale of the pledged property or, in certain cases, by way of a transfer of the pledged property into the ownership of the creditor. Upon the debtor’s breach, the creditor may foreclose on a pledged property either in court, or, if agreed with the pledgor and permitted by law, in an out-of-court

procedure. Following the foreclosure (a pre-requisite for the pledge enforcement), the pledged property may be sold at an auction, however, in certain cases the creditor and the pledgor may revert to other forms of sale such as the transfer of the pledged property into the ownership of a third party or the creditor itself. Retention A creditor, legitimately having in its custody property (tangibles) to be handed over to the debtor or a person designated by the debtor, shall have the right to retain such property in the event that the debtor fails to discharge its payment obligations relating to the property (including payment of maintenance costs and compensation of losses).42 The right of retention may extend also to property which is not related to the obligation which the debtor has failed to discharge, provided that the obligation is of a business related nature (i.e. the contracting parties act as entrepreneurs). Surety A third party may be brought into the contractual relationship as a surety.43 In the event of the debtor’s failure to discharge, or its improper discharge, of the obligation secured by the surety, the surety and the debtor shall be jointly liable to the creditor unless the surety agreement or law provide for secondary liability.44 The surety shall be liable to the creditor to the same extent as the debtor, including the payment of any interest due, compensation for any court expenses involved in the enforcement of the debt and for all other losses incurred by the creditor as a result of the debtor’s non-compliance with its contractual obligations.45

Security Deposit A written security deposit agreement may be drawn up between the contracting parties pursuant to which a party makes an advance payment of a deposit to the other party as security for the discharge of the paying party’s obligations under the contract and as proof of the conclusion of the contract.47 A security deposit agreement may constitute part of the main contract, and in any event shall expressly denote the payment as a payment of the security deposit as, if any doubts arise, the payment of the security deposit may be deemed to simply be an advance payment under the main contract. In the event that the paying party fails to fulfil its contractual obligations, the receiving party shall be entitled to retain the money advanced under the security deposit agreement.48 If, however, the non-performance of the contract is attributable to the receiving party, the receiving party shall be obliged to refund double the amount of the security deposit to the paying party.49 In addition, the defaulting party must compensate the non-defaulting party for any other losses incurred as a result of the non-execution of the contract.50 If the contract, to which the security deposit agreement is ancillary, is terminated by mutual agreement of the parties or as a result of it having become impossible to perform, the advance shall be returned to the paying party.51

Bank Guarantee A bank or other credit institution or insurance company may issue, at the request of the debtor and for consideration, a written guarantee to pay the creditor (in conformity with the terms of the guarantee) a certain amount of money upon the presentation of a written demand for payment by the creditor.46 44 45 46 47 48 49 50 51 42 43

Civil Code, article 359 Civil Code, article 361 Civil Code, article 363.1 Civil Code, article 363.2 Civil Code, article 368 Civil Code, article 380.1 Civil Code, article 381.2 Civil Code, article 381.2 Civil Code, article 381.2 Civil Code, article 381.1

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Other types of security The Civil Code also permits the use of other security mechanisms that are not expressly provided for by law. However, the latter should be used with caution and the relevant drafting has to ensure full compliance with the imperative norms of law.52 RESPONSIBILITY FOR BREACH OF CONTRACTUAL OBLIGATIONS When a contracting party breaches its obligations under a contract, either through the non-performance or the improper performance of its obligations thereunder, that contracting party is obliged to compensate the non-defaulting contracting party for the full amount of losses caused by the contractual breach. Losses in this respect include any expenses that the non-defaulting contracting party has incurred or will have to incur in order to rectify the breach, the loss or damage caused to its property and any loss of profits. Generally if there is a penalty (as discussed on page 36), the non-defaulting contracting party may only recover those losses which are not satisfied by the payment of the penalty. However, the parties are free to contract otherwise, and in some cases the law also provides otherwise, to the effect that the full amount of the losses may be recoverable in addition to the penalty or, alternatively, that only the penalty may be recoverable, with nothing over and above the specified sum being recoverable.

another date as the reference date for determining the applicable rate (for instance the date of the relevant court decision). The creditor, in making a claim under the statutory interest rate does not need to prove that it has actually suffered any loss, but merely has to provide evidence that the violation has occurred. If the contract provides for a penalty for a violation of a monetary obligation, the creditor may claim either such penalty or the statutory interest rate.53 LIMITATION PERIODS Russian law provides for a general limitation period (the period within which a claim for breach may be brought) of three years. As a general rule the limitation period starts to run from the date when the party claiming the breach knew or should have known about the breach. In exceptional cases provided under Russian law the limitation period may be more than three years, and there are instances when it is less. The expiry of the limitation period constitutes a ground for the court to reject the claim, if a party to the dispute makes the relevant application.

A statutory rate of interest applies to the late payment of sums due under a contract or otherwise, unless law or a provision of the contract provide to the contrary. The applicable statutory rate is defined as the discount rate of bank interest of the Central Bank of the Russian Federation existing on the date of payment of the relevant sum due under the contract. For the purposes of judicial enforcement the court shall have the right to choose

Civil Code, article 329.1 Decree of the Russian Supreme Court and Supreme State Arbitrazh Court No. 13/14 dated 4 December 2000, item 6

52 53

38â&#x20AC;&#x192; |â&#x20AC;&#x192; Doing Business in Russia

COMPETITION LAWS

ANTIMONOPOLY LEGISLATION The basic law for antimonopoly regulation in the Russian Federation is the Federal Law On Protection of Competition dated 26 July 2006, as amended (“Competition Law”). The Competition Law regulates competition, under the auspices of the Federal Antimonopoly Service (“FAS”), in both the commodities market and the financial services market and includes seven areas of particular interest to foreign investors: ■■

establishment of companies;

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mergers and acquisitions;

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agreements limiting competition;

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abuse of a dominant position;

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unfair competition;

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state aid; and

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The founders of a new company must obtain prior approval of the FAS for the establishment of a new company only if the charter capital of the new company is paid by contribution of shares, participation interests and/or property assets (excluding cash assets) of another legal entity (“Target”) (unless such legal entity is a “financial organisation”54), if the newly established company acquires: more than 25 per cent of the shares of the Target (if the Target is a JSC and the charter capital of the newly established company is paid by contribution of shares in the Target); or

more than one-third of the participation interests of the Target (if the Target is an LLC and the charter capital of the newly established company is paid by contribution of a participation interest in the Target); or more than 20 per cent of the book value of the main production (fixed) assets and intangible assets of any of its founders,

and if: ■■

■■

selection of a financial organisation by subjects of natural monopolies and various states and municipal bodies.

ESTABLISHMENT OF COMPANIES

■■

the balance sheet value of the total aggregate assets of the founders (including their respective “groups of persons”55) and the Target (including its groups of persons) exceeds RUB 7 billion; or the aggregate revenue earned by the founders (including their respective groups of persons) and the Target (including its groups of persons) from the sale of goods in the past calendar year exceeds RUB 10 billion; or the Target is included in the FAS Register of dominant entities or legal entities with a Russian market share exceeding 35 per cent.

The establishment of a new company whose charter capital is paid by contribution of shares, participation interests and/ or property assets of a financial organisation will require the prior approval of the FAS if the balance sheet value of the total aggregate shares, participation interests and/or property assets of such financial organisation exceeds an amount that is established by the Russian Government.56 MERGERS Entities (except financial organisations) involved in a consolidation, affiliation or a merger must obtain the prior approval of the FAS57 if: ■■

the balance sheet value of the total aggregate assets of the merging entities (including those of their respective groups of persons) exceeds RUB 3 billion; or

Meaning an individual or legal entity rendering financial services, including credit organisations, insurers, stock/currency exchange organisations, pension funds, investment funds, etc.

In determining the threshold for asset values and aggregate revenues in the context of mergers and acquisitions, the FAS takes into consideration not only the purchaser and the target, but also the persons (individuals and legal entities) in their respective “groups of persons”. The broad term “group of persons” means all persons and/or entities that directly or indirectly control the company, are directly or indirectly controlled by the company or are under common control with this company and/or entities directly or indirectly controlled by it. For the purpose of the definition of the group of persons, “control” means holding of any of the following: (i) over 50% of votes (including combined participation), (ii) CEO position; (iii) rights to give to a company binding instructions; (iv) right to appoint CEO; (v) right to appoint over 50% of the management board and/or the board of directors.

This amount differs depending on the type of financial organisation.

Preliminary FAS approval is not necessary if: (i) the consolidation, affiliation or the merger is going to be performed between the parent company and its subsidiary; (ii) entities, participating in the consolidation, affiliation or the merger belong to the same group of persons, information on which was disclosed within a special procedure, provided by the Competition Law; (iii) the consolidation, affiliation or the merger is stipulated by the acts of the President or the Government of the Russian Federation.

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■■

the aggregate revenue earned by the merging entities (including those of their respective groups of persons) from the sale of goods during the last calendar year exceeds RUB 6 billion; or either of the merging entities (including their respective groups of persons) is included in the FAS Register of dominant entities or legal entities with a Russian market share exceeding 35 per cent.

Consolidations, affiliations or mergers of financial organisations will require the prior approval of FAS if the total value of the entities’ assets exceeds the amount established by the Russian Government.58 ACQUISITIONS Acquisition of participation interests in a Russian company (LLC) Preliminary approval of FAS is required where a purchaser, be it an individual or legal entity and its group of persons, acquires: ■■ ■■

■■

Acquisition of shares in a Russian Company (JSC) Preliminary approval of FAS is required where a purchaser, be it an individual or legal entity and its group of persons, acquires: ■■ ■■

■■

more than two-thirds (on a first or any further acquisition),

■■

of the target LLC’s total participatory interests, and if (unless the purchaser is a financial organisation):59 ■■

■■

the balance sheet value of the total aggregate assets of the purchaser and the target LLC (including their respective groups of persons) exceeds RUB 7 billion and the balance sheet value of the total aggregate assets of the target LLC (including its group of persons) exceeds RUB 250 million; or the aggregate revenue earned by the purchaser and the target (including their respective groups of persons) from the sale of goods in the past calendar year exceeds RUB 10 billion and the balance sheet value of the total aggregate assets of the target LLC (including its group of persons) exceeds RUB 250 million; or

more than 25 per cent (on a first acquisition); or more than 50 per cent (on a first or any further acquisition); or more than 75 per cent (on a first or any further acquisition),

of the target JSC’s total share interests, and if (unless the purchaser is a financial organisation59):

more than one-third (on a first acquisition); or more than a half (on a first or any further acquisition); or

either the purchaser or the target LLC (including their respective groups of persons) is included in the FAS Register of dominant entities or legal entities with a Russian market share exceeding 35 per cent.

■■

the balance sheet value of the total aggregate assets of the purchaser and the target JSC (including their respective groups of persons) exceeds RUB 7 billion and the balance sheet value of the total assets of the target JSC (including its group of persons) exceeds RUB 250 million; or the aggregate revenue earned by the purchaser and the target (including their respective groups of persons) from the sale of goods in the past calendar year exceeds RUB 10 billion and the balance sheet value of the total assets of the target JSC (including its group of persons) exceeds RUB 250 million; or either the purchaser or the target JSC (including their respective groups of persons) is included in the FAS Register of dominant entities or legal entities with a Russian market share exceeding 35 per cent.

Acquisition of assets in a Russian company Preliminary approval of FAS is required where a purchaser, be it an individual or legal entity and its group of persons, acquires the right of ownership or the right to use the main production (fixed) assets (except for land plots or non industrial buildings, unfinished buildings,

This amount differs depending on the type of the financial organisation.

58 59

For financial organisations the thresholds in this regard are: the balance sheet value of the total aggregate assets of the financial organisation exceeds the amount established by the Russian Government. This amount differs depending on the type of the financial organisation.

40 | Doing Business in Russia

structures, constructions, premises and parts of premises) or intangible assets of an entity, if the acquired assets account for more than 20 per cent of the book value of the main production (fixed) assets and intangible assets of another legal entity (the Owner), and if (unless the Owner is a financial organisation):59 ■■

■■

the aggregate book value of the assets of the purchaser and the Owner (including their respective groups of persons) exceeds RUB 7 billion and the balance sheet value of the total assets of the Owner (together with those of its group of persons) exceeds RUB 250 million; or the aggregate revenue earned by the purchaser and the Owner (including their respective groups of persons) from the sale of goods in the past calendar year exceeds RUB 10 billion and the balance sheet value of the total assets of the Owner (together with its group of persons) exceeds RUB 250 million; or either the purchaser or the Owner (including their respective groups of persons) is included in the FAS Register of dominant entities or legal entities with a Russian market share exceeding 35 per cent.

Acquisition of rights in a Russian company Preliminary approval of FAS is required where a purchaser, be it an individual or legal entity and its group of persons, acquires rights conferring the ability to determine the commercial behaviour of the target company (including as a result of change of indirect control over a Russian target company) or of the right to perform the functions of its executive bodies. Such persons, entities or group of entities involved in the acquisition must receive prior approval from FAS if (unless the purchaser is a financial organisation):59 ■■

■■

the aggregate book value of the assets of the purchaser and the target (including their respective groups of persons) exceeds RUB 7 billion and the balance sheet value of the total assets of the target (together with those of its group of persons) exceeds RUB 250 million; or the aggregate revenue earned by the purchaser and the target (including their respective groups of persons) from the sale of goods in the past calendar year exceeds RUB 10 billion and the balance sheet value of the total assets of the target (together with its group of persons) exceeds RUB 250 million; or

■■

either the purchaser or the target (including their respective groups of persons) is included in the FAS Register of dominant entities or legal entities with a Russian market share exceeding 35 per cent.

In practice, FAS supervises those offshore mergers or other transactions involving the acquisition of shares, as a result of which indirect control over a Russian entity changes. It is presumed by FAS that as a result of an indirect change of control of a Russian legal entity, the foreign entity acquiring the shares would obtain rights over the Russian entity which would allow it to determine the conditions of the Russian entity’s own business activity. Exemptions from rules on application for prior approval The Competition Law provides several exemptions from the obligatory rules on obtaining preliminary FAS approval: ■■

■■

the acquisition will be performed between a parent company and its subsidiary; or the entities participating in the acquisition belong to the same group of persons, information on which has been disclosed within a special procedure provided by Article 31 of the Competition Law; or the acquisition is stipulated by the acts of the President or the Government of the Russian Federation; or

Post-completion notification procedure Any proposed transaction that meets the relevant conditions and thresholds (as described in the preceding paragraphs of this section on “Acquisitions”) will generally require preliminary FAS approval. However, in exceptional cases it may be permissible to notify FAS post-completion of such transactions provided that: ■■

■■

the parties to the transaction belong to the same group of persons and information on such group was disclosed under the special procedure, provided by the Competition Law; and the parties to the transaction are parent company and its subsidiary.

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Please also note that post-completion notification is also required with respect to those transactions in which the aggregate assets and the aggregate revenue of the purchaser and the target company (including their respective groups of persons) is over RUB 400 million and, in addition, the aggregate value of assets of the target company and the companies of its group exceeds RUB 60 million.60 Procedures and timing After all the required documents have been submitted, FAS has 30 days to review the application or notification. If FAS believes that the transaction may lead to restriction of competition, the review period may be extended for an additional two months, during which FAS places information about the transaction on its official website and invites all interested parties to send their opinions on the transaction. Any company established, either as a new company or as a result of a merger, consolidation or affiliation, without the requisite prior approval of FAS can be liquidated or reorganised if it is determined that its establishment has led or may lead to the reduction of competition, in particular as a result of the emergence or strengthening of a dominant position. Any acquisition made without the requisite prior approval of FAS shall be declared invalid if it is determined that its establishment has led or may lead to the reduction of competition, in particular as a result of the emergence or strengthening of a dominant position. As for post-completion notification, the deadline for its submission is 45 days from the completion date of the respective transaction. AGREEMENTS AND CONCERTED ACTIONS LIMITING COMPETITION The Competition Law prohibits agreements, concerted actions or other business activities that lead or may lead to the following: ■■

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control or fixing of prices, discounts, bonus payments or surcharges; increase or reduction of prices or the manipulation of prices at tenders;

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the division of the market by reference to territories or according to the volume of sales/purchases, the range of marketable goods or the range of sellers or purchasers; refusal to enter into a contract with particular sellers or customers without economic or technological justification; imposition of contractual terms that are disadvantageous to the other party or do not relate to the subject matter of the contract; setting different prices on the same goods without economic or technological justification; discontinuance or reduction of production of goods for which there is a consumer demand if it is possible to produce them on a profitable basis; restriction of access to the market or the removal from the market of other entities that sell or purchase particular products, etc.

The Competition Law further prohibits other agreements if such agreements lead or may lead to the limitation of competition. These bans are not applicable to agreements if they qualify as “vertical agreements”. Vertical agreements are agreements between economic entities not competing with each other, one of which acquires goods or is the potential acquirer, while the other supplies goods or is the potential seller. The Competition Law enacts only two per se bans applicable to vertical agreements: setting resale prices and exclusivity (i.e. contractual ban on selling competing goods). However these bans do not apply to vertical agreements which are either vertical agreements between economic entities where the market share of each one is less than 20 per cent or vertical agreements in a written form which are commercial concession agreements. It means that vertical agreements between two parties none of which has a market share in excess of 20 per cent are exempt from all bans of the Competition Law applicable to the agreements. In certain cases activities which would prima facie seem to limit competition may be permitted if it can be proved that the positive effects of the action, including any positive socio-economic effects, outweigh its negative consequences, or if the relevant Government Regulation

Provided that the prior approval thresholds (as described in the preceding paragraphs of this section on “Acquisitions”) are not met.

42 | Doing Business in Russia

permits such agreements or business activities. Such Government Regulations exist for vertical agreements61 and for agreements between credit and insurance companies.62 In this context it is worth mentioning that if the parties intended to enter into an agreement have certain doubts as to its compliance with or permissibility under the Competition Law they have the right to file the draft of such agreement with FAS and ask FAS to give its opinion on whether or not the agreement complies with the Competition Law requirements (Article 35 of the Competition Law). This filing procedure is possible with respect to specific agreements between specific parties only (i.e. no blanket clearances). In addition, in approving agreements, FAS may issue binding prescriptions designed to ensure competition in the market. Anti-competitive agreements are deemed by the Competition Law as the severest violation. Each company being a party to an anti-competitive agreement can be subject to turnover-based fines varying from 1 per cent to 15 per cent of the party’s turnover in the market to which the agreement in question relates. At the same time the maximum fine to be imposed on the violator cannot exceed 4 per cent of the violator’s total turnover on a worldwide basis. Please also note the company’s officers can be also penalised or even subjected to criminal liability.

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For those in a dominant position, the Competition Law prohibits any of the following activities: ■■ ■■

■■

In addition, the Competition Law also prohibits the so-called “coordination of economic activities”63 amongst economic entities, if such coordination may lead to restriction of competition.

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ABUSE OF A DOMINANT POSITION

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Determining whether a particular entity, group of entities and/or their respective groups of persons enjoy a dominant position involves a complex evaluation of various factors, most notably the relevant entity’s market share: ■■

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For entities with a market share of more than 50 per cent there is a presumption of market dominance.

For entities with a market share less than 35 per cent, there is a conclusive presumption of non-dominance, with several exceptions provided by the Competition Law for entities and financial organisations and oligopoly markets.

■■

setting and/or support of monopoly high or low prices; withdrawal of goods from circulation if the result of such withdrawal is a rise in the price of the goods; creation of conditions that place one or more business entities in an unequal position as compared to other entities in their ability to access the market for particular goods (i.e. discriminatory conditions); the imposition of contractual terms by one contracting party on another that are either disadvantageous to the other contracting party or which do not relate to the subject matter of the contract; discontinuance or reduction of production of goods for which there is a consumer demand if it is possible to produce them on a profitable basis;* unjustified refusal to enter into a contract with particular customers if it is possible to produce or deliver the relevant goods to such customers; setting different prices for the same goods where it is not economically or technologically necessary to do so. creation of discriminatory conditions;* creation of barriers to market entry or market exit for other business entities;* and violation of pricing rules.

* Activity may be allowed if the dominant entity can prove that the positive effects of a particular activity outweigh its negative consequences.

Entities with a market share of between 35 per cent and 50 per cent (inclusive), may be deemed dominant by FAS on the basis of an investigation into the relevant market.

Government Decree On Cases of Permissibility of Agreements between Business Undertakings dated 16 July 2009.

Government Decree On Cases of Permissibility of Agreements between Credit and Insurance Organisations dated 30 April 2009.

“Coordination of economic activities” is understood to be the coordination of the actions between economic entities who are not a “group of persons” (i.e. one economic entity coordinating its activities with one or more third party economic entities).

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UNFAIR COMPETITION The Competition Law prohibits unfair competition in Russia. That is, any actions of commercial entities aimed at acquiring competitive advantages in commercial activity, which contradict the Competition Law, business customs, the requirements of good-faith, reasonableness and fairness, which have caused or may cause losses to other competing legal entities, or damage their business reputation. Typical activities that would constitute unfair competition for the purposes of the Competition Law would include: ■■

■■

the distribution of false, inaccurate or distorted information by a commercial entity, which may cause losses to or otherwise damage the business reputation of another commercial entity; the misleading of consumers about the nature, method and place of production and quality of a commercial entity’s goods; the incorrect comparison by a commercial entity of goods produced or sold by it against those of another commercial entity; the sale of goods by a commercial entity in contravention of certain intellectual property rights (eg abuse of trademarks); and the abuse by a commercial entity of certain commercial secrets (i.e. the receipt, use or disclosure of such information without the relevant consents).

STATE PREFERENCES State preferences are new to Russian competition legislation and were introduced by the Competition Law. In accordance with the Competition Law, state (or municipal) preferences consist of granting economic entities certain privileges ensuring that such economic entity has more favourable conditions for their activity by transferring state (or municipal) property and/or civil rights or by granting a material privilege.

44 | Doing Business in Russia

The Competition Law regulates the procedure of providing state (or municipal) preferences for the following purposes: ■■

ensuring the livelihoods of the population in the Arctic regions and equivalent areas;

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development of education and science;

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conduct of scientific research;

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environmental protection;

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conservation, usage, popularisation and state protection of the cultural heritage (historical and cultural monuments) of peoples of the Russian Federation; development of culture, arts and conservation of cultural values;

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development of physical fitness and sports;

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ensuring defence powers and security of the state;

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agricultural production;

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social protection of population;

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labour protection;

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health care of citizens;

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support of small and medium businesses; and

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other purposes, defined by the legislation of the Russian Federation.

State (or municipal) preferences shall be granted with the preliminary written approval of FAS, unless such preferences are directly granted by federal law, a law of a constituent entity of the Russian Federation or a regulatory act of the local government on the budget, or are granted from the reserve funds for financial security of extraordinary expenses in compliance with budgetary legislation of the Russian Federation or in the amount which does not exceed limits established by the Central Bank of the Russian Federation for settlements in cash in the Russian Federation between legal entities, if such preferences are granted not more frequently than once a year for a certain entity.

In order to provide state (or municipal) preferences, the authority intending to grant the preferences must submit an application to FAS in order to obtain FAS approval to the granting of such preferences together with: ■■

■■

FAS shall make a decision on the application within one month from the date it is submitted together with all necessary documents. FAS may extend the period for its review of the application for a term of up to two months.

a draft act which provides for the granting of the state preferences with an indication of the goals and the amount of the preferences; a list of the beneficiary entity’s activities over the two years preceding the date of the FAS application; and other information as provided for by the Competition Law.

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REAL ESTATE

Both the Constitution and the Civil Code uphold the right to private ownership of real estate. These rights are set forth in the Land Code of the Russian as amended (“Land Code”) and its associated legislation. In Russia, the term “real estate” is widely used to signify not only land, but also buildings and other structures located on a particular “land plot”, with the term “land plot” being used to denote a specific piece or area of land. However, in terms of the treatment of real estate under Russian law, land is treated separately to buildings and other structures located on or within the particular land plot. There is a drive towards treating real estate as a singular object, however further legislative changes will be required for this to become an established practice. RIGHTS OVER REAL ESTATE Ownership of land The Constitution sets forth the principle of private ownership of land, but the detailed regulations governing this principle are contained in the Land Code. The Land Code is supplemented by regional laws and other regulations (although the Land Code prevails in the event of any inconsistencies). Some specialist land types have their own additional specialist legislation, for example agricultural land. Foreign investors are generally granted the same rights to own land in Russia as Russian legal entities and individuals. However, there are some specific restrictions on the rights of foreign investors to own land in Russia, notably: ■■

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Foreign investors may not currently own any land situated in border areas. Although this restriction is intended to only apply to certain border areas, the President is yet to draw up the list of border areas which are to be included within the restriction, thus at present all border areas are subject to the restriction. There are also other special territories in which land ownership by foreign investors is restricted. Foreign investors may not own agricultural land. The Federal Law On Circulation of Farm Land dated 24 July 2002 as amended specifies that foreign investors, be they individuals or legal entities may only lease agricultural land. This restriction extends to Russian legal entities in which a foreign investor has a holding of more than 50 per cent.

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Foreign investors may not own land located within the boundaries of sea ports.

Further, any rights to land acquired by foreign investors must always be paid for and can never be granted free of charge. Ownership of buildings Foreign investors are generally granted the same rights to own buildings located on land plots in Russia as Russian legal entities and individuals. In general, the rules relating to the use, disposal, sale and purchase of buildings are contained in the Civil Code, which guarantees the freedom to sell, rent and carry out other transactions with buildings. The acquisition of buildings through privatisation is an important concept in Russian law. Generally, provided that the building in question was recorded on the balance sheet of a state-owned enterprise at the time it was privatised and was included in the privatisation documentation, the private sector successor “inherits” the right to own the building from the state-owned enterprise. The Federal Service on State Registration, Cadastre and Cartography must issue an ownership certificate certifying the right of ownership of the buildings, structures, etc by the private sector successor. Before an ownership certificate is issued, the local real estate inventory body, which in many regions of Russia is called the Bureau of Technical Inventory (“BTI”), must carry out a detailed measurement of the building and produce updated BTI documentation for it. Leases of Land or Buildings In general, leases are governed by the Civil Code and Land Code. Foreign investors may be granted leases of either land or buildings. Leases for state or municipally owned real estate are usually based on a standard local form, whereas leases of private real estate are freely negotiable subject to the applicable Russian laws. The common features of Russian leases of real estate are outlined below. Term ■■

The general rule is that the parties are free to agree to any length of term, but, in some cases specifically provided for by law, a maximum term of lease is

stipulated. For example, for land plots in Moscow and St Petersburg (and for land plots of agricultural designation in the Krasnodar Territory), the maximum lease term is 49 years. ■■

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Termination

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– The lessee causes substantial deterioration to the building. – The lessee fails to pay rent on two successive occasions following the expiry of the relevant payment date.

Leases of real estate entered into for one year or more must be registered (see section on “State Registration of Rights to Real Estate” on page 49) and are deemed to be concluded and have legal force from their date of registration.

The Civil Code provides that the lessee has a pre-emptive right to renew the lease for a new term, provided that the lessee has properly fulfilled its obligations under the lease.

Where a lessee substantially breaches its obligations under a lease, the lessor may apply to the court for termination of the lease. Court procedures will generally last from three to nine months. If the court deems that the particular breach by the lessee is insufficient to warrant termination of the lease, the court will specify a remedy and the lease will remain in force. Presently, the law provides the following grounds for a lessor to terminate a land lease:

Presently the law provides for the following grounds for the lessor to terminate a building/premises lease: – The lessee does not use the building in accordance with the conditions of the lease or the designation of the building.

To date, it is common for office and retail-sector leases to have a five-year or ten-year term. Longer leases of 15 years or more are commonly found in the industrial sector.

Security of Tenure

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– The lessee fails to carry out a major repair of the building, when the lessee is liable for such repair. ■■

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The parties may agree on other grounds for terminating the agreement in court or setting out the right of either party to terminate the agreement out of court through a termination notice. Government or local authority requirements involving compulsory purchase.

Compulsory purchase powers exist and, if the real estate is compulsorily purchased, the lease will come to an end. In particular cases, for example when the leased real estate is a public asset or its use is against the public interest, the lease may be terminated by a court decision (the appropriate court proceedings being initiated at the request of the government or local authority). Rent and Costs under Commercial Leases ■■

The Civil Code provides for different ways of calculating rent:

– Misuse of the land plot by the lessee.

– as a fixed sum (eg per square metre, per annum);

– Use of the land plot by the lessee that results in a decline in the fertility of agricultural land.

– as turnover rent; or – as “rent in kind” (such as rent to reflect services rendered by the lessee, rent to reflect improvements made in the property by the lessee or a combination of these).

– Use of the land plot by the lessee, if designated for industrial use that results in a material deterioration in the environmental situation. – Failure by the lessee to correct a range of intentional environmental violations of applicable land use regulations. – Failure by the lessee to use the land plot for its designated purpose for a period in excess of three years.

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The level of rent payments for the majority of leases granted by the state or municipalities is set by a local decree. The level of rent for leases between private legal entities or individuals may be freely negotiated and can be altered by mutual agreement of the parties, but, as a general rule, the rent cannot be changed more than once a year.

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Common Indexation Methods ■■

Rent indexation depends on the form of the rental payment, for example, the indexation can be linked to changes in market rentals for the same type of property, inflation rates or the Consumer Price Index.

Right to Assign and Sub-let ■■

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Common Expenses Connected with the Lease. VAT ■■

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Common expenses, such as maintenance costs and utilities, are usually paid by the lessor and reimbursed by the lessee in proportion to the area leased. VAT, with certain exceptions such as for an accredited foreign representative office, is normally payable on the rent.

Responsibility for the Leased Real Estate For a lease of land or a building, the Land Code and Civil Code provide a lessee with certain basic rights. When the property is transferred, it must be in the condition stipulated by the lease. Thereafter, unless the lease specifies otherwise, the lessor is liable for capital repairs of the leased real estate and the lessee must carry out current repairs and must bear expenses relating to the maintenance of the leased real estate. If the lessor fails to carry out the necessary repairs, the lessee may seek compensation and has the right to terminate the lease.

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Improvements to the leased real estate are divided into separable and inseparable improvements.

The most common types of guarantee are: ■■

Bank guarantees;

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Rent deposit arrangements;

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Insurance deposits.

Other Interests in Real Estate The Civil Code provides for the following limited property rights to real estate where the holder of such rights is not the owner of the real estate: ■■

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Separable improvements (for example furniture) can be performed by the lessee without the consent of the lessor and remain in the ownership of the lessee. Inseparable improvements (for example repair of the building) can be performed only with the lessor’s consent and, after termination of the lease, the lessee is entitled to compensation for such improvements, unless otherwise provided for in the lease.

Restrictions on the Lessee’s Right to Use the Leased Real Estate The leased real estate must be used in accordance with statutory safety regulations and the provisions of the lease relating to the use of the leased real estate. If the lease contains no such provisions, the leased real estate must be used in accordance with the designation/permitted use.

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The lessee may sub-let the leased real estate, subject to the lessor’s prior consent, except where the lease specifically prohibits sub-letting. Any sub-leases are subject to the lease term under primary lease and any contractual restrictions in the primary head-lease.

Standard Guarantees

Lessee’s Improvements ■■

The lessee may assign his rights under the lease to a third party subject to obtaining the prior consent of the lessor.

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In relation to land, an “inheritable” right of possession of real estate for an individual’s life, whereby the person who holds such a right is entitled to use and possess it during their lifetime, but does not have the right to dispose of it. This right is passed on to an individual’s heirs. A “perpetual” right to use land, which may only be granted to state and municipal institutions, federal government enterprises and state and municipal bodies. Under this right, the institution or other body has the right to use and possess the land plot, but not to dispose of it. Legal entities with existing rights of perpetual use must re-register them (at their option) as either lease or ownership rights by 1 January 2012. Russian law provides for an administrative fine of RUB 20,000 to 100,000 for legal entities which fail to re-register their rights of perpetual or indefinite use by the relevant deadline. Such fine shall apply from 1 January 2013. “Easements” over real estate, whereby in certain cases the rights of the owner to a land plot or other form of real estate can be encumbered with third party rights of limited use, such as a right of way over the land

plot, a right of limited use of the real estate by the owner of communications, drains or other services passing through it or telecommunications cables, etc. ■■

STATE REGISTRATION OF RIGHTS TO REAL ESTATE ■■

A right of economic management (“npaво хозяuсmвенноsо веdенuя”) and a right of administrative management (“nраво oneраmuвноsо уnравленuя”). These can be granted to special legal entities only (state and municipal enterprises, institutions) and permit the right-holder to use and dispose of the property subject to certain restrictions.

Pre-emptive Rights to Real Estate In rare cases mandatory pre-emptive rights apply to the sale of real estate assets. ■■

Pre-emptive rights of public authorities or bodies. – When agricultural land is sold, a federal or municipal authority has a pre-emptive right to purchase the land plot, unless it is sold by public tender.

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– a record of the various encumbrances over real estate; and

Pre-emptive rights of private entities

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Where a land plot being sold is state or municipal property, the tenant of such land plot has a pre-emptive right to purchase it. The owner of buildings located on a privately-owned land plot has a pre-emptive right to purchase or lease the land plot beneath such buildings. Such owners also have the right to use the land plot in a manner necessary to use the owner’s particular building. For state owned land the owner of a building enjoys an exclusive right to purchase /lease the land underlying the building and necessary for its use.

The registration authorities maintain the Unified State Register of Real Estate Rights and Transactions (“Register”), which contains: – the history and the current legal status of the real estate;

– When historical or architectural monuments are sold, the state has a pre-emptive right to purchase the property in question.

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Rights to real estate such as ownership, leasehold for a term of more than one year or mortgage arise only on their state registration. Further, certain real estate transactions are only valid and enforceable once they have been registered. The registration process is carried out by the registration authorities at the location of the relevant real estate. State registration of a right to real estate or a real estate transaction should take one month (although in practice it often takes much longer). The Federal Law On State Registration of Real Estate Rights and Transactions dated 21 July 1997 specifies the grounds for refusal of state registration. If registration is refused it can be contested only through the courts.

– information on state-registered real estate transactions. ■■

The registration authorities issue a certificate in a prescribed form that certifies the rights to the real estate. This is also included in the Register. Basic information on the right holder(s) and encumbrances of such rights is publicly accessible and can be provided in the form of an extract for a fee to any person within five business days of submitting a written application to the registration authority.

Where part of a common property (such as a building divided in to apartments) is sold to a third party, other owners of the common property have a pre-emptive right to buy the part being sold.

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Real estate property is also required to undergo cadastral registration. The procedures and rules for the state cadastral registration of real estate are outlined in the Federal Law On the State Cadastre of Immovable Property dated 22 July 2008 (“Cadastre Law”), which entered into force on 1 March 2008. Before the approval of the Cadastre Law only land plots were subject to cadastral registration. The Cadastre Law provides for a unified system of state registration for all basic types of real estate, including land plots, buildings, premises, unfinished construction, (although, the Cadastre Law will not apply to forests, perennial plantations, bodies of water, subsoil, marine vessels or aircraft). The State Cadastre contains detailed information on real estate property, its location, borders, registered proprietary rights, registered encumbrances etc. The registration is performed by the Federal Service on State Registration, Cadastre and Cartography. The State Cadastre is publicly accessible and the information, upon written application to the appropriate state authority, may be provided in the form of cadastral plan copies. However, the creation of the new cadastre is a lengthy and time consuming exercise requiring significant preparatory work, therefore a transition period has been established until 1 January 2013, during which not all of the new rules will apply.

MORTGAGE OF REAL ESTATE The Federal Law On Mortgage (Pledge of Real Estate) dated 16 July 16 1998 (“Mortgage Law”), which has been amended on many occasions, including on 7 July 2009, significantly improves the potential of mortgages as an instrument for investments. Under Russian law, a mortgage is an encumbrance of the mortgagor’s title to real estate. Mortgaged Real Estate ■■

– it must be freely disposable; and – the mortgagor’s title must be registered with the Register. – According to the Mortgage Law, the following types of property can be subject to a mortgage: ■■

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RESIDENTIAL REAL ESTATE Until the early 1990s, most apartments in Russia were state or municipally owned. However, many, if not most, apartments have since been privatised or newly constructed by private investors. Relations arising in connection with residential real estate are regulated by the Housing Code of the Russian Federation as amended (“Housing Code”). The Housing Code defines categories of residential property, which include a residential house, part of a residential house, an apartment in a multi-storey building, or part of such apartment, as well as various forms of rights to residential real estate. The Housing Code prohibits the use of residential property for purposes other than residence by individuals.

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Under Russian law, real estate must meet certain requirements before it can be mortgaged:

land plots (with those exceptions stated in the Mortgage Law); enterprises registered as real estate; buildings, structures and other immovable property that are used for business activities (provided that buildings can only be mortgaged together with the land plots on which they are located); residential houses, apartments and parts thereof, consisting of one or several separate rooms;

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cottages, garages and other structures for personal use;

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aircraft and space objects;

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sea and river vessels; and

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a lessee’s interest in leased real estate, which may be the subject of a “leasehold mortgage”.

Mortgage Terms and Conditions ■■

Under Russian law, a mortgagee secures loan agreements or other obligations, such as obligations arising from a sale and purchase agreement or a lease or the performance of contractual obligations. The mortgage is deemed to cover: – the payment of the principal debt (in whole or in part, as provided by the mortgage agreement);

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State Registration of Mortgages ■■

– the interest accrued on the principal debt;

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The terms and conditions of a mortgage may restrict the owner’s or user’s ability to dispose of the property and/or lease it to third parties. If there is a valid mortgage, a sale or lease can be executed only with the consent of the mortgagee. Even then, notwithstanding such consent, the mortgage will bind the property unless and until the primary obligation secured by the mortgage is performed and the property is released from it.

Contractual Mortgages and Legal Mortgages ■■

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A mortgage may be created by a mortgage contract (contractual mortgage) or in certain cases by law (legal mortgage). Under Russian law, a contractual mortgage must be in writing and contain the following mandatory terms in order to be valid and effective: – a description of the mortgaged property; – the title of the mortgagor to the property and the registration authority that performed the registration of the mortgagor’s title; – an appraisal of the mortgaged property; – description and nature of the obligation secured by the mortgage, specifying the amount of the obligation, its basis and maturity date; and

A mortgage right becomes an encumbrance on the ownership title upon: – the date when the mortgage contract is registered with the state (contractual mortgage); or

– compensation for damages and/or liquidated damages to the extent of a delay in payment or other breach; and – litigation, enforcement and/or foreclosure expenses.

An example of a situation in which a legal mortgage could arise is that in which an apartment is purchased, in full or in part, using loan funds. In such a case a mortgage is deemed to arise from the moment the purchaser registers his title.

– the date when the ownership title to the property is registered with the state (legal mortgage). ■■

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A mortgage contract which has not been registered is invalid and void. If the mortgage contract is related to a loan or other agreement, such agreements must be included in the registration package. The state duty for the state registration of the mortgage contract is RUB 1,000 for natural persons and RUB 4,000 for legal entities.

Obligations of the Mortgagor Insurance of the Mortgaged Property Unless otherwise stipulated by the mortgage contract, the mortgagor is obliged by law to insure the mortgage property to its full value from the risk of loss or damage. Alienation with Consent The mortgagor may sell or otherwise dispose of the mortgaged property only with the mortgagee’s consent. In the case of sale, the mortgage encumbrance follows the property and is passed onto the acquirer, who becomes the mortgagor. If a mortgaged property is sold or otherwise disposed of without the mortgagee’s consent, the mortgagee may at his choice demand: ■■

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invalidation of the sale or other disposal and restitution of the real estate; or early repayment of the loan or other secured obligation and foreclosure on the mortgaged real estate.

– other necessary terms stipulated by law, depending on the circumstances.

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occurred under the secured obligation. Although the new rules are now widely applied by the parties in the agreements, they have not been tested yet in practice, and their implementation may be complicated due to a number of loopholes in the law regulating such foreclosure.

Mortgage Certificate ■■

The “mortgage certificate” is a security document under Russian law that confirms: – the right of the mortgagee to payment of the loan or other secured obligation without presenting any other document evidencing such right; and – the mortgagee’s right under the mortgage to the mortgaged real estate.

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The mortgage certificate is issued to the mortgagee by the state registration authority upon registration of the mortgage. Mortgage certificates are transferable with the effect that all the rights certified by the mortgage certificate are transferred to the transferee. A mortgagee is entitled to enforce a mortgage if the debtor under a secured obligation is in default. Events of default can be set out in both the loan agreement and the mortgage agreement. Typical events of default include non-payment of interest or principal loan repayments and insolvency. There are two types of foreclosure on mortgaged property: judicial and extra-judicial. It is a general rule that a mortgage is subject to judicial foreclosure by means of a court order. The mortgaged assets are then sold at public auction held by the court authorities. Extra-judicial foreclosure is possible on the basis of an agreement between the mortgagee and the mortgagor. This agreement may be concluded with the notarised consent of the mortgagor. However, Russian law does contain a list of certain property which may not be the subject of extra-judicial foreclosure (eg where the object of mortgage is agricultural land, an enterprise (a portfolio of real estate assets), residential premises owned by individuals, state owned land, or certain other categories of real estate specified by law). In case of extra-judicial foreclosure the mortgaged assets may be sold either: (i) at public auction; or (ii) by taking possession of the asset and simultaneously offsetting the purchase price against the debt secured by the mortgage. However, under the law a mortgagee cannot be the purchaser of a mortgaged land plot. Notably, that the Mortgage Law was recently amended and now provides that an agreement on extra-judicial foreclosure can be concluded by the parties at any moment. The previous rule provided that such agreement can be concluded only after a default has

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Mortgages of Residential Property The Mortgage Law provides that foreclosure by the mortgagee on a mortgaged residential house or apartment and disposal of such property constitutes grounds for terminating the occupancy right of a mortgagor and the family members residing together in such residential house or apartment, provided that this residential house or apartment was mortgaged under a mortgage agreement to secure the return of a loan granted for the purchase or construction of such residential house or apartment. This means that a mortgagee can now demand that a mortgagor vacate the mortgaged property if the mortgagee intends to foreclose on it. It is also important to note that those individuals who occupy mortgaged property pursuant to a lease or a “hiring” agreement (under Russian law, a specific type of residential lease where the lessee is a private individual) cannot be evicted upon foreclosure on the mortgaged property. Such a lease or a “hiring” agreement concluded prior to the mortgage agreement will remain in force and can be terminated only under specific circumstances provided for by the Civil Code or applicable housing legislation. Mortgages of Newly Constructed Buildings According to the Mortgage law, the existing mortgage of a land plot is automatically extended to cover a building or structure erected on a land plot by the mortgagor, unless otherwise provided by the mortgage agreement. This rule does not apply were construction is carried out on the land which is leased to the mortgagor. INVESTING IN RUSSIAN REAL ESTATE ■■

Commonly, foreign investors looking to invest in Russian real estate use one of two legal structures: – the direct purchase of real estate (“asset deal”); or – the direct purchase of a company holding real estate (“share deal”),

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in either instance the purchase may be made from abroad by the foreign legal entity itself or through the foreign legal entity’s local permanent establishment (representative office or branch) or through a registered Russian legal entity (i.e. a subsidiary of the foreign legal entity). Generally, most sales are structured as share deals rather than asset deals, given the generally more favourable tax treatment enjoyed by the former, but ultimately the decision always depends on the particular transaction. The majority of Russian inbound investments are currently routed through Cyprus because of the combination of relatively low domestic taxation in Cyprus and the favourable double taxation treaty with Russia. Other jurisdictions, such as the Netherlands and Luxembourg, are also often used to hold Russian real estate assets either in a corporate or branch form.

Typical Real Estate Principal Agreement A typical principal agreement for the purchase of real estate contains the following fundamental provisions: ■■

a description of the property;

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the purchase price;

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the procedure for transferring the title;

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the rights and obligations of the parties;

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the liability of the parties;

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provisions for terminating the agreement; and

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Special Requirements for Certain Transactions ■■

Due Diligence Typically potential investors carry out legal due diligence on the title, building permits, leases and contracts relating to the real estate that is the subject of the proposed acquisition. Due diligence is carried out before the purchase of the real estate asset, typically after the signing of a preliminary agreement, where the conclusion of the principal agreement depends on the results of the due diligence. Under a Russian law governed preliminary agreement, the parties undertake to conclude the principal agreement at a future date on conditions broadly set out in the preliminary agreement. If one of the parties fails to conclude the principal agreement, the other party has the right to enforce it through court proceedings. A party failing to conclude a principal agreement without sufficient grounds must compensate the other party for all resulting losses and damages.

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The content of the principal agreement is negotiable, however a statement of the purchase price and precise identification of the real estate (along with the cadastral data) are essential elements in the absence of which the agreement will be deemed invalid.

If the sale or lease is deemed a major or related party transaction, it shall require the corporate approval of the board of directors or of a shareholders’ meeting (depending on the constitution of the company or other relevant entity). Where the book value of the real estate (excluding land plots and non-industrial property) acquired by the purchaser is more than 20 per cent of the book value of the seller’s fixed and tangible assets, anti-monopoly clearance may be required, subject to the criteria and thresholds established by the Competition Law (see chapter on “Competition Laws” starting on page 39). A sale of any real estate by a married individual requires the consent of his or her spouse (this consent must be certified by a notary).

Seller’s Warranties ■■

Structure of the Principal Agreement (Asset Deal) Formal Requirements Regarding the Content of the Principal Agreement

force majeure circumstances (i.e. certain circumstances beyond the control of the parties, which make performance of the agreement impossible).

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The Civil Code requires the seller of any real estate to transfer the real estate free from the rights of any third parties, except where the purchaser agrees to accept the real estate encumbered with third party rights. The parties can agree that the real estate will be encumbered by third party rights or agree that it will be sold subject to certain defects. However, the warranty relating to the ability of the seller to transfer the property belonging to him under the title cannot be changed by agreement of the parties.

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The general limitation period for making a claim involving real estate is three years, however, it may vary in certain cases, for example the limitation period for declaring a transaction invalid following failure to comply with corporate approvals requirements is one year.

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Purchaser’s remedies for misrepresentation In the event of misrepresentation by the seller, the purchaser has the following rights: ■■

to unilaterally rescind the agreement and have the purchase price returned;

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to claim compensation for damages incurred;

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to claim a reduction in the purchase price;

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to have any defects in the property remedied without cost to the purchaser within a reasonable period; and other remedies can be agreed between the parties and included in the principal agreement, provided that such remedies do not conflict with any other provisions of Russian law.

Public Law Considerations when investing in Russian Real Estate The following legal requirements should be verified by the purchaser: ■■

Zoning and town planning provisions: The intended use for the property should comply with the permitted use indicated in the local Land Use and Development Rules. These are now being developed in relation to all areas. The permitted use (both in the case of new developments and in relation to existing buildings) can be changed by way of a designated procedure. This procedure is relatively complicated, including public hearings and requiring an official decision from the local authority;

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Building permits and licenses: The buildings must comply with building permits and it should be checked that all building works were carried out with proper authorisation; Construction requirements: It should be checked that all construction requirements relating to the buildings were complied with prior to the commencement of the use of the buildings; Fire prevention provisions: The buildings must comply with current fire prevention rules and standards; and Environmental requirements: The buildings must comply with environmental protection law (obtaining the approval of state environmental inspection, compliance with the permitted levels of industrial activities, etc). Under the Federal Law On Environmental Protection dated 10 January 2002 as amended, an entity which has caused damage to the environment must pay compensation for such damage. In practice it can be very difficult to trace the person or company that actually caused the damage, thus the liability can be imposed on the owner of real estate even if the damage was caused by a third party.

Transaction Costs Transaction costs normally consist of notary fees, state registration fees, lawyer fees, technical consultant fees for due diligence and estate agent fees. There is no common practice as regards sharing transaction costs between purchaser and seller. This is subject to negotiation by the parties.

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PUBLIC PRIVATE PARTNERSHIPS AND INFRASTRUCTURE DEVELOPMENT The Russian government has announced plans to spend about USD 1 trillion over the next ten years on improving its infrastructure. The infrastructure programme is one of the largest programmes outside China. A significant part of this investment will be in the form of public private partnerships (“PPPs”), to harness the private sector and bring in additional funding. A series of high-profile PPPs are already underway in Russia. These include major road, rail and air transport projects such as the Western High Speed Diameter (“WHSD”) Motorway, Pulkovo Airport and Nadzemny Express rail line in St Petersburg and the Moscow to St Petersburg and Moscow to Minsk toll roads. These public tenders, launched in 2007–2008 represent the first real test for the Russian framework for PPPs, which, as in other emerging markets, is still in an embryonic state. A PPP project is generally achieved through a long-term agreement between the public sector and the private sector to deliver a service traditionally provided by the public sector. PPPs can be a way of both increasing access to financing options and delivering efficiency gains while maximising the quality of service. At present Russian PPP legislation is aimed at simply the procurement of infrastructure rather than, as with many European counties where PPP is well established, efficient long term provision of public services over the lifetime of the procured infrastructure. However, if Russia is to reap the full benefits of PPP (particularly increasing foreign investment) the State will have to be prepared to relinquish greater control of the procured public services/ infrastructure to the private sector. LEGAL FRAMEWORK The legal framework for Russian PPPs is currently provided by the Federal Law On Concession Agreements dated 21 July 2005 as amended (“Concession Law”), together with a series of model concession agreements for different types of infrastructure. In certain cases the Concession Law has been supplemented by ancillary legislation adopted at lower government levels, for example the Law on the Participation of St Petersburg in Public Private Partnerships of 2006 (“St Petersburg PPP Law”).

Concession Law The Concession Law applies to thirteen types of infrastructure including, amongst others, motorways, roads, railways, underground, pipelines, sea ports, airports, communal services, and various cultural, sporting and tourism facilities. The Concession Law includes provisions on: ■■

entities involved in the concession granting process;

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concession facilities;

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tender and selection procedure;

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concession agreements; and

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certain guarantees for the private entities and public bodies.

Generally the Concession Law is flexible and does not impose rules on how relations between the public and private bodies will be conducted during the concession period, these relations are to be governed by the detail of the concession agreement itself once concluded. However, the Concession Law contains numerous short comings: Ownership of the Facility There are various models for the ownership of a facility built as part of a PPP. However the range of PPP models available to public bodies under the Concession Law is limited. The Concession Law provides for Build-Operate-Transfer (“BOT”) and Rehabilitate-Operate-Transfer (“ROT”) models. Under these models, the private entity builds/ rehabilitates the facility and upon completion transfers ownership of the facility to the public body. Thereafter, the private entity takes over the operation and maintenance of the facility under a lease back from the public body for the contract period. Other PPP models that incorporate ownership of the real estate object by the private entity (for example BOOT64) are not provided for under the Concession Law. Models whereby the private entity retains ownership of the facility, provide the private entity with a greater incentive to build a facility of good quality, maintain its good condition and optimise maintenance costs.

In a Build-Own-Operate-Transfer (“BOOT”) project the private entity carries out the capital investment in construction of the facility, which it then owns and operates for a period specified in the contract. Following the expiration of that period the facility is returned to the public body.

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Security

Dispute Resolution

More so than ever in the current financial climate, a robust security package is crucial in PPPs to secure the calibre of financing necessary for such large projects. However, the Concession Law restricts two of the most common means of providing security in PPPs, the ability of the private entity to:

Russian policy favours the jurisdiction of the Russian court for the resolution of contractual disputes. However, for various reasons (see chapter on “Dispute Resolution” starting on page 71), being amongst other things the lack of transparency and perceived lack of independence of the courts, most international PPP participants would prefer dispute resolution to be conducted through recognised international arbitration institutions. Although it may be noted that in a number of current projects, the public body did opt for internationally recognised arbitration.

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pledge the projects assets; or pledge or assign the rights under the concession agreement.

Alternative security instruments are available in Russia, such as a pledge of shares in the private entity, but the aforementioned restrictions are a significant hindrance when it comes to structuring the security package and finding lenders. Documentation The first version of the tender documentation published for the WHSD Motorway did not allow bidders to submit a mark-up of the concession agreement with its bid. Instead, bidders were obliged to sign the version of the concession agreement published with the initial tender package. Bid procedures have since been modified to allow bidder mark-ups and to facilitate post-tender negotiation of key terms (for example the time schedule to close the deal), but bidders are still bound to the published version of the concession agreement and exposed to potential liability if unwilling to sign it in its published form, with very limited carve-outs. Also, it may be noted that step in rights are prohibited until construction is completed, which again can prove a significant hindrance when it comes to finding lenders. Construction and Design Development In order to maximise the potential of PPPs, private entities should be allowed and encouraged to apply their experience, know-how and capacity for innovation to the project in order to make it cost-effective for the public, the public body and themselves. However, the extent to which this potential of PPPs can be maximised depends on the flexibility given to the private entities at the design stage. Currently the approach of the public bodies in Russia is very prescriptive, with rigid specifications set out in tender documentation, with little scope for private entities to vary the design and implement “value engineering” through their bids.

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St Petersburg PPP Law The St Petersburg PPP Law was enacted in response to the shortcomings of the Concession Law and is aimed at better facilitating the St Petersburg administration’s pipeline of PPP projects, which is regarded as one of the most advanced in Russia. The principal features of the St Petersburg PPP Law, which improve on the Concession Law, are: ■■

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There is no restriction on the use of PPP models under which the private entity retains ownership of the facility. Various PPP models are available to the public body. There is no restriction on the right to pledge the projects assets or to pledge or assign the rights under the concession agreement as part of the security package. There is greater flexibility for the private entity to negotiate and mark-up bid documentation.

PPP FINANCE INSTITUTIONS In November 2005 the State Investment Fund (“SIF”) was established by the Russian government, signalling another move towards PPP. The SIF is intended to be one of the state’s primary PPP funding sources and to act as a catalyst in attracting private investment. For 2008, the SIF’s volume reached USD 3 billion. Investments to be made from the SIF may take the form of, among others: ■■

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funding up to 75 per cent of project capital costs as equity investment or financing the acquisition of certain assets in exchange for ownership title to the assets; or a guarantee of up to 60 per cent of the borrowings of the project, but only for up to five years.

To qualify for SIF support, an investment project must: ■■

have a value in excess of USD 200 million;

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comply with public sector priorities;

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generate social benefits; and have a negative stand-alone net present value (“NPV”), but generate economic profit (i.e. a positive NPV) if the support is included.

In May 2007, the Federal Law On the Russian Bank of Development dated 17 May 2007 created Vnesheconombank (“VEB”). VEB is a state owned banking institution tasked with promoting Russian infrastructure and in particular, with supporting and developing PPP projects. VEB is currently considered as one of the institutions that will play a key role in the further development of Russian PPPs. In this regard a PPP task force has recently been created within the VEB to study, standardise and promote PPP practices in Russia. The European Bank for Restructuring and Development and the VEB have agreed to explore the possibility of co-financing projects in certain areas and in February 2008 a memorandum of understanding in this regard was signed. Their priority sectors include transport infrastructure, energy and municipal services and those with significant environmental and energy efficiency potential. With the help of other interested organisations, the two institutions will also consider setting up a unit to help manage the project preparation process for PPPs in infrastructure, a move that could be extremely beneficial in attracting investors. In August 2009, VEB signed a formal agreement with a private infrastructure fund to become the fund’s joint manager and cornerstone investor with a commitment of USD 200 million. Other investors in the fund include the IFC (USD 100 million), the EBRD (USD 100 million) and the Kazakh development institution Kazyna Capital Management (USD 30 million) as well as private sector investors. The fund expects to invest in PPP projects such as Pulkovo airport, and the Moscow to St Petersburg and the Moscow to Minsk toll roads.

WIDER ISSUES/RISKS Notwithstanding the notable limitations of the Concession Law, there are additional issues which have the potential to undermine the appetite of international private entities to engage in Russian PPPs: ■■

considerable corruption at municipal, regional and federal levels (which notably acts as an impediment to a clear and transparent bid process);

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market volatility and currency risk;

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political risk and state intervention;

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laws governing budget regulation, tax issues, licensing and antimonopoly regulation which have an adverse effect on PPPs; geographical concentration of the major projects; and potentially negative attitude of consumers being charged for services that used to be free, for example through the introduction of toll roads.

FUTURE OUTLOOK In the short term, private investment in Russian infrastructure is bound to suffer as a result of the global economic downturn. However, the Russian government has not indicated any weakening of its commitment and expectations for the long term development of Russian infrastructure. Notably, the success of Sochi in winning the bid for the 2014 Winter Olympics will undoubtedly stimulate much infrastructure rejuvenation in the Krasnodar Territory. One major project which has been proposed is for a new offshore terminal in Sochi’s port capable of docking 3,000-person capacity cruise ships. To ensure that the area is ready for the 2014 Games, the Federal Target Programme for the Development of Sochi was initiated by the Russian Government in 2006. The Krasnodar territorial government plans to spend USD 11.7 billion on development projects. It is expected many of the proposed projects will be run as PPPs.

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INTELLECTUAL PROPERTY RIGHTS AND FRANCHISING is necessary to register an application with the Federal Service for Intellectual Property, Patents and Trademarks, commonly known as “Rospatent”.

RUSSIAN IP LAWS IN GENERAL ■■

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Intellectual Property Rights (“IPR”) in Russia are governed by a variety of laws, but the primary rules are found in Part IV of the Civil Code. For the most part, Russian intellectual property rules are not inconsistent with international norms as Russia is a member of the major international intellectual property conventions, such as the Universal Copyright Convention,65 the Berne Convention for the Protection of Literary and Artistic Works,66 the Paris Convention for the Protection of Industrial Property,67 the Patent Cooperation Treaty,68 the Madrid Agreement on International Registration of Trademarks and the Protocol to the Madrid Agreement.69 One must keep in mind that Russian intellectual property rules are a work in progress and that the system has not been in place for long. This means that one can expect rapid and profound changes in the rules as well as in the interpretation and application of these rules. Therefore, we strongly advise to seek competent legal counsel with regard to intellectual property issues. IPR are generally split into two broad types: “exclusive rights” and “author’s rights”. Most works or “objects of intellectual property rights” will have some exclusive rights and some author’s rights associated with them. Exclusive rights are essentially the rights for use and other economic exploitation while author’s rights are the rights of the specific creators to be recognised as creators of the relevant work or invention. Exclusive rights may be assigned or licensed relatively freely while author’s rights are inalienable and cannot be transferred.

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Foreign persons and companies may establish or acquire IPR under law.

PATENTS ■■

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As in most jurisdictions, the primary method for establishing IPR to a technical invention in Russia is through registration of a patent. Patent protection may be extended to inventions, utility models and industrial designs. Patent rights are established only through registration of a patent application with Rospatent. No legal rights are considered to be established until such registration is completed. The period of validity of patent rights will depend upon the type of patent (invention, utility model or industrial design). Once registration is completed, the patent owner will enjoy the exclusive rights, including those to use the patent, to license the patent rights and to assign the patent rights. Such exclusive rights to use the patent include importation, manufacture, application, offer for sale, sale, other introduction into commercial interactions or storage of patented objects. It is possible to assign or license rights to a patented object. Such assignment and license agreements must be registered with Rospatent. The assignment or license will not be valid until the date of registration of the agreements. Unregistered license or assignment agreements are not valid under law and do not result in any transfer of rights.

Registration is a key element for establishing IPR to trademarks (including service marks), appellations of origin and patents. In order to establish these rights it

The Universal Copyright Convention, adopted in Geneva in 1952, is one of the two principal international conventions protecting copyright (the other is the Berne Convention).

The Berne Convention for the Protection of Literary and Artistic Works, usually known as the Berne Convention, is an international agreement governing copyright, which was first accepted in Berne, Switzerland in 1986.

The Paris Convention for the Protection of Industrial Property, signed in Paris, France on 20 March 1883, was one of the first IPR treaties. As a result of this treaty, IPRs, including patents, of any contracting state are accessible to the nationals of other states that are a party to the Convention.

The Patent Cooperation Treaty, concluded in 1970, is an international patent law treaty, which provides a unified procedure for filing patent applications to protect inventions in each of the states which are a party to the treaty.

The Madrid Agreement on International Registration of Trademarks and the Protocol to the Madrid Agreement provide the framework for the Madrid system, which is the primary international system for facilitating the registration of trademarks in multiple jurisdictions around the world.

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Patenting Inventions ■■

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An “invention” is a technical solution in any field relating to a product (including a device, substance, microbial strain, cell culture of plants and animals) or a process. There are several elements which must be satisfied for an invention to be eligible for patent protection: – “novelty”: an invention is “novel” if it is not known in the body of existing knowledge in the particular technical field, this is often referred to as “prior art”;

Patenting Utility Models ■■

– “inventiveness”: an invention is “inventive” if is shows an inventive step forward in the particular technical field, if such a step could not be have been deduced by another specialist in the particular technical field from previous inventions; and – “industrial utility”: an invention has “industrial utility” if it is capable of some kind of practical application in the particular technical field. ■

– “industrial utility”: as for inventions (see above). ■■

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– scientific theories; – mathematical methods; – rules and methods of games;

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A “utility model” is a technical solution pertaining to a device, such devices generally being less complex than an invention and in the mechanical field only. Patent protection is given to a utility model, if it is: – “novel”: as for inventions (see above); and

Certain works are not patentable subject matter, including: – discoveries;

Patent protection for an invention is granted for 20 years from the date that the application is filed. The term of patent protection for an invention related to a medicine, pesticide or agrochemical, the use of which is subject to obtaining special permission, may be extended at the request of the patent owner for a period not exceeding five years.

Thus, utility model patents do not require the element of inventiveness as with the patenting of inventions, and consequently, the procedure to obtain patent protection for a utility model is shorter and more simple than for an invention. Patent protection for a utility model is granted for ten years from the date that the application is filed and may be extended for an additional period not exceeding three years.

– intellectual and commercial activity;

Industrial Designs

– conceptions consisting of the presentation of information only;

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– solutions protected under other IPRs; and

An “industrial design” is an artistic and design solution that determines the outer appearance of a product. An industrial design may be patented if its essential features are:

– solutions running counter to public order.

– “novel”: as for inventions (see above); and

The right to obtain a patent, by filing an application with Rospatent, belongs to the inventor, his/her employer (in the case of any employee’s invention) and their assignees (so long as there is a clear record of such assignment). Rospatent examines the application and grants the patent if the invention meets the relevant criteria, subject to payment of annuities.

– “original”: an industrial design is “original” if its essential properties (i.e. the features determining the aesthetic and/or ergonomic peculiarities of the particular product’s appearance, in particular the form, configuration, ornament and combination of colours) determine the creative features of the product in question.

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Patent protection for an industrial design is granted for 15 years from the date the application is filed with the possibility of extension for an additional period specified in the application, but not exceeding ten years.

TRADEMARKS ■■

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Trademarks (including service marks) are protected under Russian law through registration of the mark either through direct registration with Rospatent or through international registration through the Madrid System. Unregistered trademarks generally have no legal protection (with one exception for “well-known” trademarks described below). Trademarks are designations which distinguish the source of particular goods or services. A trademark may be represented by words, letters, numerals, pictures, three-dimensional designs or any other design or combinations thereof, in any colour or combination of colours. In most cases, a trademark is considered in the context of its word elements and graphic elements. Trademarks may contain only word elements, only graphic elements or both. Trademarks are registered in association with specific classes of goods and services. Legal rights to the trademark are limited only to those classes of goods and services for which it is registered, so it is important to include all relevant classes when planning registration. “Well-known” trademarks enjoy special protection under law. A well-known trademark is one which is associated with a brand of such strength that the mark is so famous throughout Russia that registration of any other trademark in any class of goods and services would be likely to confuse the public. Well-known trademark status is extended only to extraordinarily famous brands listed on a specific register. Wellknown trademark status may be obtained through a special procedure which involves providing specific evidence of the mark’s fame throughout Russia. The exclusive rights granted to trademarks include the right to use the mark in association with the relevant classes of goods and services, the right to import branded products, the right to license the use of the trademark and the right to assign the trademark.

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Trademark protection is valid from the date of registration and is granted for an initial period of ten years from the date that the application is filed. Trademark registrations may be renewed for subsequent ten year periods without limitation. It is necessary to actually use a trademark in Russia in order to maintain exclusive rights. Any failure by a trademark owner to use its trademark for an uninterrupted period of three years following registration will leave the trademark subject to a non-use cancellation action in association with some or all of the classes of goods and services for which it is registered. Under such an action, another party claims that the trademark was not used for the relevant classes of goods and services for a three-year period and the burden of proof lies with the trademark holder to show the proper use of the trademark during the alleged period of non-use. A non-use cancellation may be brought in relation to some or all of the classes of goods and services for which the mark is registered. A trademark may be assigned or licensed through written agreements registered with Rospatent. These agreements will enter into force upon the date of such registration. Unregistered agreements are not valid and will transfer no legal rights.

APPELLATION OF ORIGIN OF GOODS ■■

An appellation of origin is a geographical indication used to identify the geographic origin of certain goods, the specific features of which are mainly or exclusively determined by natural conditions or human factors which are characteristic of that geographical area. However, goods which represent or contain the name of a geographical area, but whose name has become generic for goods of a certain kind and which do not fulfil these geographical criteria, may not be protected by an appellation of origin indication.

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Legal protection is given to an appellation of origin upon its registration with Rospatent. An appellation of origin may be registered in the name of one or more persons. Person(s) with a registered appellation of origin obtain a right to use such appellation of origin in association with the relevant products, provided that the goods produced by such person(s) satisfy the aforementioned criteria. The right to use an appellation of origin is not exclusive to one producer. An appellation of origin may be granted to any legal entity or individual which produces goods from the same geographical area if those goods meet the same specific criteria within the same specific geographical area. The term of protection given to an appellation of origin is ten years from the date of filing the application and may be renewed for subsequent ten year periods. The owner may not grant licenses for the use of the appellation of origin.

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As a means of distinguishing a company in the marketplace, a company name is protected by IPR. Company names, however, are often confused with “trade names” under Russian law. Under law, a company name refers to the company’s official registered name, while a “trade name” is a less formalised designation used by the company in commerce.

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A company name must consist of two parts: – an indication of the form of business legal structure (for example, Limited Liability Company or Joint Stock Company); and – the distinctive name of the company.

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A company name should be unique to that company and only that company should use it as such. Another company should not be able to register an identical name (although many companies have in practice registered very similar names) and any use of another company’s name is, among other offences, an infringement on the rights of the company which has properly registered the name. In such cases, the proper owner of the company name may seek compensation for damages associated with the improper use of its name.

The right to a company name arises from the moment of state registration of the company. A company name owner may use its company name or individual elements of it as part of its trade name or a trademark belonging to the company name owner. A company name incorporated in a trade name or a trademark is protected regardless of the protection of the trade name or the trademark itself. There are strict restrictions on the use of the words “Russia”, “Russian Federation” or derivations of these words, so it is wise to seek advice of competent legal counsel before using any name which includes “Russia” or anything similar.

TRADE NAMES

COMPANY NAMES ■■

A company name owner may not alienate or license its company name in favour of another party.

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“Trade names” are protected under the Civil Code and the Paris Convention for the Protection of Industrial Property. Trade Names (sometimes referred to as “commercial designations”) are recognised under law as a way to distinguish a source of goods and services in the marketplace and thus are protected under law and international treaty as a form of intellectual property. The concept behind legal protection for a trade name is that businesses often use informal names in commerce and can become well known in the marketplace under the informal name (often even more so than under the formal company name). Unlike a company name which is the official registered name of a company, trade names do not require registration and are not considered the official formal name of the company. The owner of a trade name enjoys the exclusive right to use its trade name for identifying itself in the marketplace without any special registration but this exclusive right terminates if the owner of the trade name fails to use it for a continuous one-year period. A trade name owner may pass on the right to use its trade name to another person under a lease of enterprise agreement or a “commercial concession” agreement (see section on “Franchising” on page 63).

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While a trade name is not subject to registration, it is wise for any company seeking to use a trade name as part of its branding to register that trade name as the word element of a trademark. Registration of the trademark will provide much more tangible legal protection than one would have relying upon the trade name alone.

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Copyright protects works of science, software, literature and the arts and affords protection to the rights of creators of works (generally referred to as “authors”). Copyright protection arises by virtue of the creation of the relevant work, without any requirement for registration or fixing of the work on a tangible medium. Unlike other copyright protected works, software may be registered under an optional registration system provided for under law. Since this registration system is optional and copyright protection is legally established without it, the registration system is rarely used in practice. An author enjoys both exclusive rights and “author’s” (moral) rights. As noted above, exclusive rights are proprietary rights for economic exploitation, including rights to reproduction, distribution, importation, public demonstration, public performance, translation, modification, licensing and assignment. Exclusive rights can be licensed, assigned or otherwise alienated or burdened under law. Author’s rights, on the other hand, are personal moral rights belonging to the author and they cannot be alienated. Author’s rights include the right to be recognised as the author of the work, the right to public disclosure of authorship of the work and the right to protect the integrity of the author’s reputation. The term of copyright protection for all works, including software programs or databases, shall be the lifetime of the author, plus 70 years after his/her death. The author’s moral rights are protected perpetually. As copyright protection is established at the time of creating the work rather than through registration, an author must amass evidence to prove the timing of the creation of the work, which can be a difficult task. Therefore, it is wise to carefully document the creation of valuable works.

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“Neighbouring rights” are IPR to the results of a performance, sound recording, broadcast or transmission of television or radio programs, contents of database and also scientific, literary and artistic works published for the first time. Holders of neighbouring rights can be performers, producers of phonograms and broadcasting or cable distribution organisations. In a general sense, to understand the distinction between copyright and neighbouring rights, a composer will hold the copyright to the piece of music, while the musician will hold the neighbouring right to his/her performance of that piece of music. Like copyright, neighbouring rights include an exclusive right as well as personal non-property (moral) rights, of which the exclusive rights may be licensed or alienated and the non-property rights remain personal to the performer (or other rights holder). Neighbouring rights are created at the time of the performance, broadcast or publication of the work and remain in place for fifty years from the date of the first performance, broadcast or publication.

DOMAIN NAMES ■■

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All “.ru” domain names are registered in Russia on a first-come, first-served basis by several registrars. When registering a domain name, the registrars neither check nor require that the domain name applicants prove that they have a legitimate right to the names that they are seeking to register. Part IV of the Civil Code specifies that the exclusive right to a trademark may be exercised, in particular, by application of the trademark on the internet, including its application in domain names and other means of addressing. However, Part IV of the Civil Code prohibits the registration of trademarks that are identical to domain names if those domain names have an earlier priority.

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There is no procedure similar to UDRP70 in Russia, therefore, all domain name disputes that are not amicably resolved need to be taken either to a Court of General Jurisdiction (for individual defendants) or an Abitrazh Court (for legal entity defendants).

– marking the media carrying the confidential information as “trade secret”. ■■

TRADE SECRETS AND KNOW-HOW ■■

“Trade secrets” are protected under Part IV of the Civil Code and by the Federal Law On Trade Secrets dated 29 July 2004 (“Trade Secrets Law”). Not all confidential information qualifies as a trade secret under law. Information may be treated as a trade secret only if the following criteria are met: – the information has actual or potential commercial value due to the fact that it is unknown to third parties; – the information is not freely accessible to other parties using lawful means; – the owner has taken reasonable measures to protect the confidentiality of the information, including legal, organisational, technical and other measures; and – the confidentiality of the information allows, under the existing or potential circumstances, an increase of revenue, the avoidance of unnecessary expenses or the receipt of other commercial benefits.

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As part of the criterion for establishing legal rights (as described in the immediately preceding paragraph), the owner of the confidential information must establish and observe a “trade secrets regime”, which should include the following five measures: – compiling a list of the confidential information; – establishing a procedure to limit access to this information; – maintaining a record of persons who have received access to the information; – entering into confidentiality agreements or inserting into the relevant information confidentiality clauses into agreements with employees and others to whom access is granted; and

If any of the steps required to establish a trade secrets regime are not taken, legal protection of the trade secrets may be denied. Therefore, it is important to carefully follow the requirements set forth under law.

ENFORCEMENT OF IPR Under law, infringement of IPR can bring civil, administrative and criminal liability. A holder of IPR may pursue a civil claim while administrative and criminal cases may be brought by state officials. In practice, it can be useful to try to combine all three of these approaches, but pursuing enforcement of IPR is never an easy undertaking. It is important for any holder of IPR to carefully watch the market to catch and act against infringements as early as possible. FRANCHISING Franchising is a commonly used and a growing business model in Russia, although the format for franchise relationships can vary. While a form of franchising structure, known as a “commercial concession” is established under Russian law, not all franchise relationships are structured as commercial concessions. Many franchise transactions are structured as trademark licenses or through other types of agreements, depending upon the specifics of each situation. There are advantages and disadvantages to each approach and selecting the appropriate structure is one of the first issues to consider in planning a franchise transaction. Commercial Concession ■■

The closest approximation to a franchise agreement as understood in other jurisdictions is the commercial concession established under the Civil Code. In its essence, a commercial concession is a license agreement under which the franchisor grants a “complex” of rights to a franchisee to use in a business which will be associated with the franchisor’s brand and the franchisor’s business.

The Uniform Domain-Name Dispute-Resolution Policy (“UDRP”) is a process established by the Internet Corporation for Assigned Names and Numbers for the resolution of disputes regarding the registration of internet domain names. The UDRP currently applies to all .biz, .com, .info, .name, .net and .org top-level domains and some country code top-level domains.

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The defining feature of a commercial concession is that several types of rights are granted to the franchisee (i.e. the “complex of rights”). These rights must include rights to use a registered trademark and can additionally include rights to use know-how, a trade name, rights to other types of intellectual property (such as copyright protected works, patents and software) or other rights recognised under law. The one obligatory element in the complex of rights is the trademark, so it is necessary to be sure that the franchisor holds relevant trademark rights for the mark in Russia. Without such rights, it will not be possible to enter into a commercial concession agreement.

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Commercial concession agreements may be made either directly through the rights holder or through a master licensor/franchisor. A “commercial concession agreement” is a commercial agreement and may be entered into with legal entities or individual entrepreneurs properly registered as such. There is no restriction on whether foreign parties may enter into commercial concession agreements either as the grantor or recipient of rights. Commercial concession agreements may be governed by either Russian or foreign law, but they must comply with certain mandatory provisions of Russian law. Commercial concession agreements may be subject to dispute resolution in Russian courts, foreign courts, Russian arbitration or international arbitration. Commercial concession agreements may be signed in Russian or a foreign language, but for registration, the agreement must at least be translated into Russian with a certified translation. Commercial concession agreements must be registered with Rospatent in order to be valid. Unregistered commercial concession agreements are not legally valid and do not convey any rights under Russian law. A commercial concession agreement will come into force in Russia as of the date of its registration. Any amendment to a registered commercial concession agreement must be registered with Rospatent in order to be valid.

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Any termination of a commercial concession agreement must be registered with Rospatent, so automatic termination provisions are unlikely to be themselves effective. A commercial concession agreement is considered terminated as of the date of the registration of the termination. As Rospatent generally prefers to register mutually agreed terminations of commercial concession agreements, unilateral termination provisions should be carefully drafted to increase the likelihood that the termination will be accepted by Rospatent. For registration of a commercial concession agreement, the full chain of title to the trademark or to the master franchise rights must be registered in Russia. This means that the trademark itself must be registered and if the franchisor will not be the trademark owner itself, the agreements granting rights to the franchisor must also be registered with Rospatent so that the chain of title can be traced back to the ultimate owner. It is necessary for the franchisor to either own or hold rights to license each of the rights to be conveyed in the commercial concession, so in cases where the rights are held by affiliates of the franchisor, it may be necessary to enter into specific agreements clearly granting rights to the franchisor before the commercial concession may be entered into. While it is possible to enter into a commercial concession or a trademark license agreement for an indefinite term, in the vast majority of cases, the parties provide some limit to the term of the agreement and we almost always advise clients to do so.

Features of a Commercial Concession – Liability ■■

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Commercial concession relationships have some special features which may lend certain advantages and disadvantages in specific cases. One of the most notable features of a commercial concession is that the franchisor bears some additional liability exposure for the quality of goods and services provided by the franchisee under the commercial concession.

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Under both a trademark license and a commercial concession, the licensor or franchisor will hold joint and several liability with the licensee or franchisee for products liability associated with branded goods, but a commercial concession has an added liability exposure.

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Under a commercial concession, the franchisor is held to secondary liability (subsidiary liability) for lapses in the quality of branded goods and services supplied by the franchisee. The extent of this risk exposure should be assessed in each case.

Features of a Commercial Concession – Competition Rules ■■

Features of a Commercial Concession – Renewal Rights

Russian law is generally very strict in prohibitions on restraints of trade, but the law permits certain restrictions on competition in the context of commercial concession agreements. For example the commercial concession agreement may limit the rights of the parties thereto, such as:

Franchise Fees and Royalties ■■

– an undertaking by a franchisor not to grant franchises to other franchisees or to directly compete with the franchisee for a given period and/ or in a given territory; – an undertaking by a franchisee not to compete with the franchisor’s business or to work for competitors in an agreed territory. ■■

The law explicitly prohibits a franchisor from determining or dictating to the franchisee:

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– the price of goods to be sold and/or services rendered by the franchisee; – the upper or lower limit of prices; or – prohibiting the franchisee from serving a specific group of customers or limiting its sales only to certain customers located or residing in a defined territory. ■■

While some special rules for commercial concession agreements apply, one should be very careful about any provisions involving a possible restraint of trade under Russian rules, as there are limitations to the application of the exceptions for commercial concession agreements.

Under a commercial concession, a franchisee has certain advantages in renewal of the agreement after expiration. Where a franchisee has properly fulfilled its obligations through the initial term of a commercial concession, if within three years the franchisor offers similar terms for a franchise to another franchisee without first offering the extension to the initial franchisee, the initial franchisee may initiate a claim for damages from the franchisor.

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Regardless of whether a franchise relationship is made under a trademark license or a commercial concession, the amount and types of royalties or other fees may generally be freely agreed upon by the contracting parties. A fee may be structured as lump sum, a royalty based on sales or other measures, a commission deduction from any sales proceeds or mark-up earned by the franchisee, through any product imported and sold by the franchisee from the franchisor or other commercially negotiated terms. However, a franchise agreement should not be concluded without charge, as Russian rules prohibit gratuitous transfers between companies, even where this involves affiliated companies. If the tax authorities or other authorities consider a royalty structure to be commercially unrealistic, they may impute what they would consider to be a market rate for the royalty. This is to be avoided, so best practice is to use a realistic and justifiable royalty rate for all franchise transactions. Where a license or franchise relationship involves the importation of goods, there may be additional customs considerations involved in the royalty rate. Customs authorities currently seek to include the royalty rate in the customs value of imported goods (eg to prevent a designer handbag selling for USD 800 retail, being imported at its material cost of USD 100 with a separate USD 700 license fee to the foreign franchisor). While this is common under many customs regimes, the Russian authorities sometimes try to apply it to service businesses as well, for example claiming that a license fee for a branded concept restaurant should be applied to the customs

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value of small items (eg coffee or marketing materials) imported as part of the relationship. The best practice to deal with this is to first apply a justifiable royalty rate and then to separate out the royalty rates for trademarks or other rights unrelated to the branded goods being imported. ■■

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Where the licensor or franchisor is a foreign party, royalties and other franchise fees may be calculated and paid in foreign currency, so long as Russian currency control laws are followed. If both parties are Russian entities, the payments must be calculated and made in Russian Roubles. Royalties are generally treated favourably from a tax perspective. A franchisee should be able to fully deduct for profits tax purposes any royalties paid under a valid franchise agreement (either as a Trademark License or Commercial Concession). A foreign franchisor can generally avoid the need to register any local business or tax presence in Russia (provided that they do not themselves engage in the franchise business locally) and can receive the royalties fees free of any withholding tax provided that the franchisor is based in one of the many countries with which Russia has a double taxation treaty providing for no withholding tax on royalties.

Disclosures and Other Regulatory Requirements Aside from the registration requirement for a trademark license or commercial concession, Russian law does not impose any other registration or regulatory requirements on franchise offerings. There are currently no specific disclosure requirements or approvals needed for a franchisor to offer and sell franchises in Russia. Sub-Franchising ■■

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Sub-franchising is expressly allowed under law and is commonly used in Russia. Under law, a sub-franchisor is held to secondary liability for any damage caused to the franchisor by the sub-franchisees, unless otherwise provided for in the master-franchise agreement.

Timing of franchise fees or royalties should be carefully planned, as trademark license agreements and commercial concession agreements will not become legally valid until registration with Rospatent. In many cases, is it possible to have the terms of these agreements apply back to an earlier date before registration (this should be carefully planned with legal counsel), but the payments generally may not begin under an agreement until the agreement is legally valid and registered. In some cases, it is possible to work out structures for earlier payment flows, but this must be carefully planned with advice of competent legal counsel.

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EMPLOYMENT

Employment relations in Russia are governed primarily by the Labour Code of the Russian Federation (“Labour Code”), along with the Federal Law On Trade Unions, Their Rights and Guarantees of Activities dated 12 January 1996 and legislation on minimum wages, labour safety and other related law and regulations. Russian employment law applies to all levels of employees, including managers and general directors of Russian companies, heads of representative offices and branches of foreign companies registered in Russia, and foreign nationals employed by Russian companies or foreign legal entities in Russia. THE EMPLOYMENT AGREEMENT ■■

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A written employment agreement in Russian, setting out the basic terms and conditions of the employment relationship, must be entered into with each employee working in Russia. The Labour Code provides all employees with mandatory minimum guarantees and employment-related benefits and compensation that cannot be superseded by agreement between the employer and the employee. Accordingly, any provisions in an employment agreement that impair an employee’s position compared with that set forth by the provisions of the Labour Code will be invalid. As a general rule, employment agreements are to be entered into for an indefinite term. A definite fixed-term employment agreement may be concluded, but cannot be for a term longer than five years and it may only be concluded in the circumstances specifically provided for by Article 59 of the Labour Code. Such circumstances usually occur when the nature or conditions of work make it impossible for the parties to enter into an indefinite term agreement. Further, an employee cannot be prohibited from holding a second job in addition to his/her full-time employment, with certain limited exceptions and restrictions provided for by the Labour Code and other federal laws. Under Russian employment law, the relevant employment duties and obligations must be expressly defined in the employment agreement. It is important that these duties and obligations are defined broadly enough, as an employee cannot be required to perform tasks outside of the scope of the employment duties expressly described in his/her employment agreement. Employers cannot expand or otherwise modify the

duties and obligations set out in the employment agreement unilaterally. Indeed, subject to very limited exceptions, the written agreement of the employee is required for any amendment whatsoever of the employment agreement. Even in exceptional cases where the employer is permitted unilaterally to amend the employment agreement, it must notify the employee two months in advance of such amendment and follow all other formalities stipulated by law. EMPLOYMENT RELATED ORDERS Russian employers are required to issue an internal order each time an employee is hired, transferred to a new position, granted a vacation, subjected to disciplinary action or has his/her employment terminated, as well as in certain other cases. LABOUR BOOKS A labour book is the principal document containing the formal record of a person’s employment history, along with certain other information. The employer must record the employment of any employee employed for more than five days. The labour book is vital for each employee as it confirms the employee’s right to a state-provided pension and other social benefits. Employers are responsible for the maintenance of the labour book and may receive penalties if they fail to do so. PROBATION Any employer has the right to establish a three-month probationary period for a newly hired employee, with a six-month period allowed for employees hired for certain executive positions, such as general directors and their deputies, heads of representative offices, branches or other structural subdivisions, or chief accountants and their deputies. The imposition of a probationary period must be specifically stated in the employment agreement as well as in the order on hiring. During the probationary period, if the employer determines that the employee does not meet the criteria established for the role for which he/she was hired, the employee can be dismissed by the employer without severance pay and with only three days’ written notice. Importantly, such notice to the employee must provide the reasons why the employee is deemed to have failed to pass the probation. Conversely, the employee is

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also entitled to resign during the probationary period, without stating any reason, by providing three days’ written notice to the employer.

hourly rate thereafter. Upon an employee’s written request, the employer must compensate overtime work by granting the employee additional time off in lieu of payment, which should be no less than the overtime worked.

MINIMUM WAGE ■■

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Wages for full-time employees may not be lower than the minimum monthly wages stipulated in the relevant Russian legislation. Currently, the amount of the minimum monthly wage, as indexed by the Russian government from time to time, is RUB 4,330 per month. The amendment to the Labour Code pursuant to a Federal Law dated 20 April 2007, introduced a new article which provides that representatives of regional authorities, regional trade unions and a regional employers association may execute an agreement establishing minimum regional wages for their particular constituent regions of Russia. These minimum regional wages will even apply to all employers in the region who do not participate in the regional employers association, unless they have opted out within 30 calendar days of the official publication of the relevant minimum wage. To date, agreements on minimum regional wages have been executed in some constituent entities of Russia and it is likely that in the next one to two years, the majority of constituent entities of Russia will also adopt such minimum wages, which are always higher than the minimum federal wage and are tied to the regional minimum standard of living.

WORKING TIME ■■

Employers are required to keep a record of all the time worked by each employee, including any overtime; the regular working week being 40 hours. Anytime worked over 40 hours is classed as overtime and may only be demanded by employers in extraordinary cases, as specified in the Labour Code, and in most cases only with the employee’s prior written consent. The Labour Code limits the total amount of overtime for each employee to 120 hours a year and an employee cannot be required to work more than four hours of overtime in any two consecutive days. Overtime, must be paid at a rate of 150 per cent of the regular hourly rate for the first two hours of overtime worked during one day, and a rate of 200 per cent of the regular

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Certain limitations regarding overtime apply to protected employee categories, which include employees under the age of 18, pregnant women, women with children under the age of three, disabled employees and certain other categories defined by federal law.

PUBLIC HOLIDAYS ■■

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Russia currently has 12 public holidays annually. Weekly time off at weekends must be for an uninterrupted 42 hour period. Employees may only be required to work on a public holiday or other non-working day (i.e. a weekend) in extraordinary circumstances, as specified in the Labour Code, and only then with the employees’ written consent. Employees must be paid at a rate of 200 per cent of the regular hourly rate for any work performed on a public holiday or other non-working day, alternatively they may be given time off in lieu of the holiday/non-working days worked.

HOLIDAY LEAVE Employees in Russia are entitled to an annual paid holiday of at least 28 calendar days per year of employment. An employee is entitled to use the holiday leave in full once he/she has worked for six months for the particular employer. The Labour Code requires that the dates of the annual holiday of each employee should be indicated in the schedule of holiday leave for the calendar year, which the employer must approve by mid-December of the preceding year. The Labour Code further requires that the employee notifies his/her employer in writing at leased two weeks before commencing the holiday leave. An employee’s holiday allowance should be paid to the employee at least three days before the holiday is due to start. Where an employee does not use the annual holiday allowance in the current calendar year the unused annual holiday allowance shall be transferred to the next year and the employee shall maintain the right to use the unused annual holiday allowance during the next calendar year.

Also, upon the written application of an employee part of the annual holiday in excess of 28 calendar days may be replaced with monetary compensation.

DISMISSAL ■■

SICK LEAVE ■■

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Employees are required to submit a medical certificate for any absence only after their recovery and return to work. Generally, an employer cannot terminate an employee’s employment while that employee is absent on sick leave. Employees are entitled to receive statutory sick leave compensation, which is covered by the Russian State Social Insurance Fund, which in turn is funded by the employer’s mandatory contributions paid as a percentage of its employees’ salaries in the form of Unified Social Tax. The duration and amount of sick leave compensation will vary according to the grounds for the sick leave. In cases of a labour-related injury or occupational disease, the amount of sick leave compensation is 100 per cent of the employee’s average earnings. In other cases sick leave compensation may not exceed the maximum established by federal law.

– the employee’s repeated failure to perform his/her employment duties without a justifiable reason (if the employee was lawfully disciplined during the preceding 12 months); or – the employee’s unjustified absence from the workplace for more than four consecutive hours during one working day. ■■

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MATERNITY LEAVE ■■

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Paid maternity leave begins to accrue no later than 70 calendar days prior to the birth and continues for 70 calendar days thereafter, although the period may be extended in the event of a multiple birth and/or complications during birth. The amount of maternity leave compensation is established by federal law and is subject to annual review. A person caring for a child, be it the child’s mother, father, or any relative who is actually taking care of it, may request to be partially paid childcare leave until the child is three years old. The employee retains the right to return to work during the entire period of the maternity or childcare leave and the full leave period is included when calculating the employee’s term of service.

The Labour Code sets out the specific circumstances in which an employer may terminate the employment of one of its employees, which include, but are not limited to, the following:

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Employment cannot be terminated by the employer at-will, except in the case of a general director of a company, whose employment can be unilaterally terminated at-will by the company owner(s), provided that the departing general director is paid severance compensation in an amount equal to a minimum of three average monthly earnings. Employers must strictly comply with specific procedures and documentary requirements provided for by the Labour Code when the employment of any employee is terminated. Certain categories of employee stipulated by the Labour Code enjoy additional protection, these include, amongst others, minors, female employees, employees with children and trade union members. Employees are entitled to terminate their employment at any time, without stating any reason and by providing only two weeks’ written notice to the employer.

REMUNERATION Salaries must be paid to employees at least once every half month. Employers are obliged to pay the salary and other employment-related payments on the dates set by their internal labour regulations or in the individual employment agreement. Employers are required to compensate employees, by paying interest, for any delay in the payment of salary and/or other employment-related payments. Employees have the right to stop working, upon

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providing prior written notice to their employer, if their employer has delayed payment of their salary by more than 15 days. Salaries and other compensation shall be paid to employees in Russian Roubles. Payment of any employment-related compensation in a foreign currency, whether made in cash or by bank transfer, is generally prohibited.

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EMPLOYMENT OF FOREIGNERS ■■

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Before foreign nationals (except for citizens of the Republic of Belarus) may be employed and/or actually commence working in Russia, all employers must obtain the relevant documents. These documents consist of the document under which the employer is granted permission to hire foreign nationals, and the work permit and work visa for the employee. In Moscow, the procedure for obtaining such documents may take five to six months to complete, although this process may be faster in other Russian regions. The requirements with regard to the employment of foreign nationals apply equally to accredited representative offices and branches of foreign legal entities, which also must obtain a personal accreditation card from the relevant accreditation body of the relevant representative office or branch in order to apply for work permits and work visas. Employers are also required to provide financial, medical and social guarantees in respect of their foreign employees and must comply with the general migration monitoring requirements and file notifications of foreign employees’ travel both into and out of Russia in accordance with the statutory procedure. Under Russian law, there are severe penalties for non-compliance with the regulations on the employment of foreigners.

TRADE SECRETS ■■

Pursuant to the Trade Secrets Law and Part IV of the Civil Code, if an employer desires to protect its trade secrets from unauthorised disclosure by employees, it should implement the statutory procedures comprehensively set out in the “trade secrets regime” (see section on “Trade Secrets and Know-How” on page 63).

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In order to implement the trade secrets regime, an employer should determine a list of trade secrets, restrict access to them and include in the employment agreements the necessary provisions relating to the trade secrets. Employees should be notified, against their signed receipt, of the trade secrets directly related to their employment and of their liability for violating the trade secrets regime. Also, the employer is required to provide conditions necessary for the employees to observe the trade secrets regime. The employees must observe the trade secrets regime and refrain from disclosing trade secrets. If employees are guilty of disclosing any trade secrets, they are liable to the employer for damages caused by such disclosure, provided that all statutory procedures were properly implemented by the employer. Part IV of the Civil Code has extended the protection of trade secrets beyond the termination of the relevant employment relationships and forbids employees from disclosing the relevant trade secrets for as long as the employer has an effective exclusive right to the trade secrets.

DATA PROTECTION Pursuant to the Federal Law On Personal Data dated 27 June 2006, employers are required to obtain the prior written consent of their employees in order to process their personal data (i.e. transferring sensitive data to third parties). Such requirements are important for foreign legal entities with subsidiaries, representative offices or branches in Russia, which often process the personal data of their Russian employees from a central location outside of Russia. The provisions are also important with regard to the transfer of any personal data to law firms, accountancy firms and other providers of professional services.

DISPUTE RESOLUTION

THE RUSSIAN JUDICIAL SYSTEM ■■

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The Russian judicial system consists of Federal Courts and Courts of the Constituent Entities of the Russian Federation. The Federal Courts are: – the Constitutional Court of the Russian Federation; – Courts of General Jurisdiction; and – Arbitrazh Court.

The Courts of the Constituent Entities of the Russian Federation are: ■■

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Constitutional Courts of the Constituent Entities of the Russian Federation;

One advantage of Arbitrazh Courts is the relatively short trial period. Under current regulations, Arbitrazh Courts must consider cases within three months of receiving the claimant’s application.

Magistrates; and The Constitutional Court generally resolves issues relating to compliance of federal and regional laws and regulations with the Russian Constitution. Courts of General Jurisdiction and Magistrates hear criminal cases, civil disputes involving individuals and disputes arising from administrative relations between individuals and state bodies. Commercial litigation (i.e. disputes regarding business activity) takes place before Arbitrazh Courts and thus it is the procedure of the Arbitrazh Courts which is generally of the most interest to foreign investors.

ARBITRATION ■■

ARBITRAZH COURTS ■■

The procedural rules applicable in Arbitrazh Courts are set out in the Arbitrazh Procedural Code of the Russian Federation (“Arbitrazh Procedural Code”). Generally these rules are based on the general principles adopted in continental Europe. Arbitrazh Courts favour written, documentary evidence rather than the examination of witnesses, experts and audio/video recordings, and the procedure relies upon verified documentation for almost any fact asserted. As a difference to common law jurisdictions, the procedure does not feature much court-sponsored disclosure or discovery.71

Arbitrazh Courts are sometimes referred to as Arbitration Courts, however this is a misnomer as Arbitrazh Courts are the general commercial courts and not third-party arbitration venues.

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As an alternative to litigation in Arbitrazh Courts, foreign investors may refer disputes to arbitration,72 including ad hoc arbitration73 and institutional arbitration tribunals located either within or outside the Russian Federation. Almost any disputes may be referred to arbitration, with the exception of those arising from administrative relations (eg tax and customs) or which fall within the exclusive jurisdiction of Arbitrazh Courts (eg disputes arising from bankruptcy proceedings or other disputes specifically reserved in the Arbitrazh Procedural Code or other Russian laws). The principal rules of arbitration are governed by the Federal Law No. 5338-I On International Commercial Arbitration dated 7 July 1993; such rules are identical to the provisions of the Model UNCITRAL Law.74 In

“Disclosure” (UK)/ “discovery” (US) is the pre-trial process in common law jurisdictions whereby parties inform each other as to the existence of any relevant documents that are, or have been, in their control. This procedure is aimed at allowing the parties to identify the specifics of the claim which are agreed and those which remain in dispute. This procedure often allows the parties to agree as to the relative strengths and weaknesses of each other’s case, which in turn often results in a settlement and thus eliminates the expense and risks of litigation in court.

“Arbitration” is a non-court procedure for resolving disputes using one or more neutral third parties (the arbitrator or arbitration panel). Arbitration uses rules of evidence and procedure that are less formal than those followed in courts, which in theory leads to a faster, lessexpensive resolution.

“Ad hoc arbitration” is arbitration that is not conducted under the supervision of any arbitral institution, with reference to established international rules.

The Model UNCITRAL Law is designed to assist States in reforming and modernising their laws on arbitral procedure so as to take into account the particular features and needs of international commercial arbitration. It covers all stages of the arbitral process from the arbitration agreement, the composition and jurisdiction of the arbitral tribunal and the extent of court intervention through to the recognition and enforcement of the arbitral award. It reflects worldwide consensus on key aspects of international arbitration practice having been accepted by States of all regions and different legal or economic systems of the world.

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addition, the international commercial arbitration provisions of various international treaties to which Russia is a signatory are also applicable where foreign investors seek to refer disputes to a private arbitration tribunal. The most notable of these international treaties are:

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– New York (United Nations) Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958 (“New York Convention”); and – European Convention on International Commercial Arbitration of 1961. ENFORCEMENT OF JUDGMENTS AND ARBITRAL AWARDS ■■

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Judgments of the Courts of General Jurisdiction and of Arbitrazh Courts are enforced through the state bailiff service. A foreign court judgment may be enforced in Russia only if such judgment has been recognised by a Russian court. Such recognition is available only if it is allowed by a relevant international treaty and/or an applicable federal law. Russian courts may recognise and enforce foreign court judgments on the basis of reciprocity. To prove reciprocity an applicant should demonstrate to the court that a foreign court actually enforced a Russian civil law judgement (proving the possibility of such enforcement does not suffice). In practice, there have been very few cases in which Russian courts have enforced a foreign court judgement in the absence of a treaty. Russia is a party to the regional (CIS countries) Kiev Agreement on the Procedure for Resolving Disputes Relating to Business Activities and the Minsk Convention on Legal Aid in Civil and Family Disputes and Criminal Prosecution, according to which judgments rendered by the state courts of certain CIS nations are enforceable in Russia. Russia is also a party to a number of bilateral agreements concerning the recognition and enforcement of court judgments. Amongst other countries, Russia has signed bilateral agreements with Greece, Italy, Spain, China, Cyprus and the Czech Republic.

Foreign arbitral awards are recognised and enforced based on the New York Convention. Russian courts may not review any foreign arbitral award on its merits. The grounds for refusal to recognise and enforce foreign arbitral awards are based on Article V of the New York Convention grounds. In practice, foreign investors should be aware that enforcement in Russia of foreign arbitral awards can raise a number of delicate legal and practical issues.

ALTERNATIVE DISPUTE RESOLUTION (“ADR”) Although mediation75 and other forms of ADR are widely used in the legal community, there is no established practice for invoking such procedures in Russia, nor is any legislative regulation available for any kind of ADR other than arbitration. There is no statutory provision, for example, that states documents received by the parties in the course of mediation may not later be used as evidence in courts, or that the ADR mediator may not subsequently be called as a witness in legal proceedings between the parties. DISPUTE RESOLUTION OPTIONS FOR FOREIGN INVESTORS ■■

A foreign investor entering into an agreement with a Russian entity will need to include some provision for the resolution of any disputes should they arise between the parties. Under Russian law, as Arbitrazh Courts are the courts which have jurisdiction over commercial matters involving international parties, this would be the default provision (for example if the relevant agreement was silent on this matter). However, it is entirely possible for the parties to stipulate in the relevant agreement another means of dispute resolution. The main options to consider are for the relevant agreement to refer any disputes to one of the following: – litigation in Russian courts (Arbitrazh Courts); – international arbitration; – litigation in courts of a jurisdiction other than Russia; or – arbitration in Russia (the International Commercial Arbitration Court of the Russian Chamber of Commerce and Industry (“ICAC”)).

“Mediation” is a process of informal negotiation and settlement discussion, conducted by a trained neutral mediator.

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Litigation in Russian courts involves a court system which is very much different to that which most foreign investors are used to, especially those from common law jurisdictions (see section on “Arbitrazh Courts” on page 71). To many foreign investors the system seems to be opaque and not entirely reliable. As Russia is a member of the New York Convention, an arbitral award issued by a foreign tribunal is capable of being enforced in Russia. It is not generally advisable to refer disputes to courts of another jurisdiction (other than Russia) because Russian courts will not readily enforce foreign court judgments if there is no treaty allowing the enforcement.

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Arbitration in Russia at the ICAC, for most foreign investors, is a (distant) second choice to the application of international arbitration. The ICAC has qualified arbitrators and provides for the possibility to choose an arbitrator whose particular specialty is the subject of the dispute. The well-established standing of the ICAC guarantees that its awards are normally enforced both in Russia and abroad, which makes the ICAC a natural choice for quite a number of parties involved in disputes, if the selection of a more widely established forum is blocked by the other party.

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INSOLVENCY

– the aggregate amount of the outstanding indebtedness exceeds RUB 100,000 for a corporate entity or RUB 10,000 for an individual.

LEGISLATIVE FRAMEWORK The statutory framework for insolvency (bankruptcy) in Russia principally consists of the Federal Law On Insolvency (Bankruptcy) dated 26 October 2002 as amended (“Insolvency Law”) and the Federal Law On Insolvency (Bankruptcy) of Credit Institutions dated 25 February 1999 as amended (“Bank Insolvency Law”). The 2009 changes in the Insolvency Law76 (“2009 Changes”) introduced substantial amendments to the previously existing insolvency rules, including the rules on the transactions which may be challenged during an insolvency procedure and the rules on the role of the insolvency manager (including its rights, duties, liabilities, remuneration, expenses and admission requirements), and moreover provided for the establishment of a national union of self-regulated organisations of insolvency managers. The 2009 Changes further made some amendments to the insolvency procedure and introduced certain additional rights for the creditors’ meeting (for example the right to determine and increase remuneration of the insolvency manager). Finally, following the 2009 Changes key information about on-going insolvency proceedings will now be recorded in the Unified Register of Insolvency Information.

These conditions vary where the insolvency of a credit institution is being considered (see section on “Provisions of the Bank Insolvency Law” on page 79). ■■

TYPES OF INSOLVENCY PROCEDURE ■■

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The Insolvency Law sets out the conditions that must be met before insolvency proceedings may be commenced against a debtor, who, subject to certain exceptions (for example Vnesheconombank, State Corporation “Rosatom”, State Corporation “Rostekhnoligii” amongst others) may be any form of legal entity. Insolvency proceedings may be commenced against a debtor where such debtor fails to satisfy any obligation to pay its creditors under a contract or any other legal ground (“monetary claims”) or make any tax, stamp or duty payment to a budget of any level within the budget system of the Russian Federation (“obligatory payments”):

The Insolvency Law provides for different types of insolvency procedures: – supervision; – financial rehabilitation; – external management; – liquidation; and – amicable agreement.

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COMMENCING INSOLVENCY PROCEEDINGS ■■

Insolvency proceedings may be initiated upon petition by the debtor itself or by any of its creditors with claims confirmed by an effective court judgment or by the tax authorities. Such petition must be made to the Arbitrazh Court where the debtor is located.

Each type of insolvency procedure under Russian law is run and controlled by the court from beginning to end, with the court being assisted in this role at various stages by the creditors’ meeting and the insolvency manager.

SUPERVISION ■■

If the court decides that a petition against the debtor is well founded and the debtor meets the relevant insolvency conditions (see section on “Commencing Insolvency Proceedings” on this page) the court will introduce supervision in relation to the debtor and appoint an insolvency manager (known in this procedure as the “temporary manager”). Supervision may be introduced for a maximum period of seven months after the date of the insolvency petition.

– within three months of the respective due date; and

Federal Law On the Amendments to the Federal Law “On Insolvency (Bankruptcy)” dated 30 December 2008; Federal Law On the Amendments to Certain Legislative Acts of the Russian Federation dated 28 April 2009; Federal Law On the Amendments to Certain Legislative Acts of the Russian Federation dated 19 July 2009; Federal Law On the Amendments to Articles 20.6 and 20.7 of Federal Law “On Insolvency (Bankruptcy)” and Article 4 of Federal Law “On the Amendments to the Federal Law “On Insolvency (Bankruptcy)” dated 17 December 2009.

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Upon the commencement of supervision:

will consider the findings of the insolvency manager, decide on the further proceedings to be taken in relation to the debtor, appoint a creditors’ committee and make other decisions on the future of the debtor. The court will further examine the findings of the insolvency manager and resolutions of the creditors’ meeting and decide on further actions in relation to the debtor.

– any enforcement proceedings regarding collection of funds and assets from the debtor must be suspended; – a debtor company may not allow any of its participants to leave the debtor company or pay to a participant the value of its participation if such participant decides not to participate in the capital of the company and to leave it; – a debtor company may not buy shares from its shareholders;

FINANCIAL REHABILITATION ■■

– a debtor company may not make any dividend distribution or analogous payments to its shareholders or participants; and – a set-off of counter claims of the debtor against the claims of its creditors is prohibited if it breaches the priority ranking of creditors claims as set out in the Insolvency Law (as described in section on “Liquidation” on page 77). ■■

Although the commencement of supervision does not lead to immediate dismissal of the debtor’s management, the following transactions will require the insolvency manager’s consent:

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– an acquisition or sale of property with a value of more than 5 per cent of the total book value of debtor’s assets; and – a loan, provision of suretyship or guarantee, any assignment of rights or transfer of debt or the establishment of trust in relation to the debtor’s assets. Moreover, some decisions of the debtor’s management (for example, on re-organisation or liquidation of the debtor, establishment of a subsidiary, branch or representative office, participation in other companies, associations and holding companies) are prohibited during the period of supervision. ■■

The court will examine all claims against the debtor. The insolvency manager will identify all the creditors, examine all claims, maintain the register of creditors’ claims against the debtor, examine the financial standing of the debtor and convene the first creditors’ meeting. At the first creditors’ meeting, the creditors

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If the debtor’s shareholders, owners or any third parties are prepared to support the debtor’s obligations under the debt repayment schedule produced by the insolvency manager and this is approved by a decision of the first creditors’ meeting convened as part of the supervision procedure, the court may decide to introduce the procedure of financial rehabilitation for the debtor. The court order establishing the financial rehabilitation should approve a repayment schedule and appoint an insolvency manager (known in this procedure as the “administrative manager”). The maximum duration of financial rehabilitation is two years. Financial rehabilitation may be supported by security in the form of a pledge (mortgage), bank guarantee, state or municipal guarantee or surety or another security provided by the relevant shareholders or owners of the debtor or other parties. Upon the commencement of financial rehabilitation: – all injunction orders previously issued in relation to the debtor or its assets are terminated; – any enforcement proceedings regarding collection of funds and assets from the debtor must be suspended; – a debtor company may not allow any of its participants to leave the debtor company or pay to a participant the value of its participation if such participant decides not to participate in the capital of the company and to leave it; – a debtor company may not buy shares from its shareholders;

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– a debtor company may not make any dividend distribution or analogous payments to its shareholders or participants; – a set-off of counter claims of the debtor against the claims of its creditors, compensation arrangements and other transactions breaching the priority ranking of creditor claims as set out in the Insolvency Law (as described in section on “Liquidation” on page 77) or leading to preferential discharge of claims against the debtor are all prohibited;

acquisition or sale of certain assets of the debtor; the assignment of any rights; the transfer of any debt or the raising of loans by the debtor from other parties. The debtor’s management may be dismissed for the improper performance of its obligations upon the application of the creditors or the insolvency manager. ■■

– default interest and penalties on non-performing obligations of the debtor are not charged from the date of the commencement of financial rehabilitation; and – interest, at the interest rate fixed by the Central Bank of the Russian Federation, will accrue on any monetary claims and obligatory payments payable under the debt repayment schedule. ■■

Although the debtor’s management retains control over the debtor company during the period of financial rehabilitation its authority is limited as follows: – the following actions to be undertaken by the debtor company require the consent of the creditors’ meeting or the creditors’ committee: any corporate re-organisation (corporate merger, accession, division, separation or transformation); any acquisition or sale of property with a value of more than 5 per cent of the total book value of the debtor’s assets; the advancing of loans by the debtor to other parties; the provision of any suretyship or guarantee; the establishment of any trust in relation to the debtor’s assets; or the creation of any new obligations where the amount of the debtor’s obligations created after the date of the commencement of financial rehabilitation exceed 20 per cent of the aggregate amount of the creditors’ claims recorded in the register of creditors’ claims; and – the following actions to be undertaken by the debtor company require the consent of the insolvency manager: any transaction increasing the debtor’s indebtedness by more than 5 per cent of the aggregate amount of the creditors’ claims at the date of commencement of financial rehabilitation; the

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The insolvency manager will convene creditors’ meetings, maintain the creditors’ register, control performance of the debt repayment schedule and update the creditors on the performance of the debt repayment schedule. The insolvency manager will review the report on the debt repayment produced by the debtor and submit it to the court, following which the court will then decide on any further action to be taken in relation to the debtor. Financial rehabilitation may be terminated upon satisfaction of the creditors’ claims in accordance with the debt repayment schedule.

EXTERNAL MANAGEMENT ■■

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External management, as with financial rehabilitation is a procedure aimed at restoring the debtor’s solvency. External management may be introduced by the court on the basis of a decision of the creditors’ meeting and may last for up to 18 months with an option of extension for a further six months. Financial rehabilitation and external management cannot last for more than two years in aggregate. Upon the commencement of external management: – a moratorium shall be set on any further discharge of the monetary claims against the debtor and obligatory payments due from it; – default interest and penalties on non-performing obligations of the debtor are not charged from the date of the commencement of external management; – interest will accrue on all creditors’ claims at the interest rate set by the Central Bank of the Russian Federation; and – the debtor’s management shall be dismissed and the insolvency manager (known in this procedure as the “external administrator”) will accept the

debtor’s property for management and elaborate an external administration plan for restoration of the debtor’s solvency. ■■

the filing of the insolvency petition are paid first, with all other claims then being satisfied in the following order:

The external management plan may provide for different actions including:

– claims for compensation for injury to health or loss of life or compensation for moral damage/ emotional suffering;

– recovering debts due from third parties;

– employees’ salaries, severance payment and remuneration under copyright agreements (for example intellectual property royalties); and

– changing the scope of the debtor’s business; – issuing additional shares; and – selling the debtor’s business (or parts thereof). ■■

The external administrator will submit to the creditors’ meeting a report on the debtor’s business conditions. The creditors’ meeting will review the report, decide on further actions to be taken in relation to the debtor and make recommendations to the court. The external management may result in a decision by the court either to terminate the insolvency proceedings or to place the debtor into liquidation.

– all other claims (including taxes and other mandatory contributions imposed by the State). ■■

LIQUIDATION ■■

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Liquidation is the main insolvency procedure, which is focused on selling the debtor’s assets and on satisfying the claims of the creditors. Once the court is satisfied that the debtor is insolvent and is unable to discharge of all its monetary claims and obligatory payments it must issue a ruling placing the debtor into liquidation. The initial duration of liquidation is six months, but may be extended by the court for a further six months. Under liquidation the debtor’s business is “wound-up”, all the debtor’s assets become part of the insolvency estate, which is then used to satisfy the claims of the creditors. It is the role of the insolvency manager (known in this procedure as the “liquidation manager”) to take measures to repossess the assets of the debtor which are in the possession of third parties. The claims of the creditors are satisfied according to the priority ranking set out in the Insolvency Law. Claims of each ranking must be satisfied in full before payments to creditors of the subsequent ranking. If the insolvency estate is insufficient to satisfy all creditors of one ranking, payments to such creditors shall be made on a pro rata basis. Court expenses, remuneration of insolvency managers, insolvency expenses and claims of creditors that arose after

During liquidation the insolvency manager must provide monthly reports to the creditors’ meeting. At the end of liquidation, the insolvency manager is obliged to produce a final report on the results of the liquidation. The court, having considered the insolvency manager’s report, will issue a ruling on the completion of the insolvency procedure, and the insolvency manager will give notice of this ruling to the Unified State Register of Legal Entities within five days. Based on the insolvency manager’s notice, the liquidation of the debtor is entered into the state register and, by this, the “winding-up” is completed.

AMICABLE AGREEMENT ■■

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The Insolvency Law lists amicable agreements as another type of insolvency procedure. However, an amicable agreement is in fact an opportunity to bring the insolvency procedure to an end by an agreement of the parties at any stage during the insolvency procedure (but not earlier than the first creditors’ meeting convened as part of any supervision procedure). In order to be effective, an amicable agreement shall be approved by the creditors’ meeting and the court. The court will approve the amicable agreement when the claims of creditors of the first and the second ranking have been paid (see section on “Liquidation” on this page). The insolvency proceedings terminate upon approval of an amicable agreement by the court.

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– transactions where one party’s consideration is incommensurate to the other party’s, including those where the terms are worse for the debtor than those in similar transactions in comparable circumstances; and

RESTORATION OF THE DEBTOR’S SOLVENCY In order to prevent insolvency proceedings against a debtor, the debtor’s shareholders or owners or any third parties may at any stage of the insolvency proceedings provide the debtor with financial assistance sufficient for the repayment of its entire indebtedness. On this basis, once all creditor claims are discharged, the relevant shareholders, owners or third parties who provided such financial assistance become the only creditors of the debtor.

– transactions made with the intention to harm creditors’ legitimate rights and interests. ■■

SECURED CREDITORS ■■

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The Insolvency Law provides that judicial (court) and extra-judicial (out-of-court) security enforcement (see section on “Mortgage Certificate” on page 52) is prohibited upon commencement of supervision. However, judicial enforcement is now possible at the early stages of insolvency proceedings (financial rehabilitation and external administration), unless the debtor proves that such enforcement would make it impossible to restore its ability to pay its debts. Sale of secured property during financial rehabilitation, external administration and liquidation is made by a courtappointed insolvency manager through public auction. All proceeds from the sale of the pledged property during financial rehabilitation and external administration are applied directly towards the discharge of the secured claims of the pledgor. During liquidation, only 80 per cent of proceeds of sale (but not more than the aggregate amount of principal and interest) are used to repay claims of the secured creditor under a credit agreement and 70 per cent of proceeds are paid to the secured creditor, in all other cases. The remaining part of the proceeds is applied towards the discharge of the first and second ranking claims, court expenses and the fees and disbursements of the insolvency manager.

SUSPICIOUS PREFERENTIAL TRANSACTIONS ■■

The Insolvency Law introduces the concept of “suspicious transactions” which may be challenged during the insolvency proceedings. At present, the Insolvency Law distinguishes two types of suspicious transactions which include:

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Courts can declare debtors’ transactions that fall into the first category described in the immediately preceding paragraph void if these are made within one year before an insolvency petition is filed, or after such filing. Courts can declare debtors’ transactions that fall into the second category described in the immediately preceding paragraph void if all of the following three conditions are met: – the debtor entered into the transaction not earlier than three years before filing for insolvency or at any time thereafter; – the transaction harmed creditors’ rights and interests; and – the transaction intended to harm creditors where the other party to it knew or should have known of the debtor’s intent.

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The Insolvency Law establishes four alternative tests for voiding a transaction that results in giving preference to one creditor before others: the transaction secures the debtor’s or a third party’s obligation that arose before such transaction; the transaction led or may lead to a change in the priority of satisfaction of a creditor claim under obligations that existed before such transaction; the transaction led or may lead to the satisfaction of claims not yet mature, whereas obligations to other creditors are still outstanding; and the transaction led to a preferred satisfaction of pre-existing creditor claims in an order of creditor claim priority different to the order that would be applied if such a transaction was not concluded.

Courts may generally deem such transactions void if they are made at least one month before an insolvency petition is filed, or after such filing. However, in certain cases transactions made six months before a filing may also be challenged. ■■

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The petition to declare a transaction void must be filed by the external administrator or liquidation manager, who can act independently or in accordance with the resolution of the creditors’ meeting or creditors’ committee. If the court deems a transaction void on any basis described above in this section, then the transaction will be reversed so that everything the debtor transferred (or which was transferred on the debtor’s behalf) returns to the insolvency estate. The creditor concerned will acquire a claim against the debtor that will be satisfied in the order of priority as set out in the Insolvency Law. Creditor claims arising out of voided transactions made with the intent to harm other creditors’ interest, and certain voided transactions that give preference to certain creditors will be satisfied only after all other creditor claims, irrespective of priority, have been satisfied.

CONTROLLING PERSONS LIABILITY ■■

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The Insolvency Law provides for the concept of a “controlling person”, which it defines as a person who exercises, or exercised for at least two years prior to filing for the debtor’s insolvency, the right to give directions binding on the debtor or otherwise direct its actions. As an example of a controlling person the Insolvency Law names members of the liquidation commission, persons authorised to enter into transactions on the debtor’s behalf or the person who had the right to dispose of at least 50 per cent of voting shares in a joint stock company or more than 50 per cent of the participatory interests in a limited liability company.

accounting records and reporting before the court orders the debtor to be placed under supervision or declared insolvent. PROVISIONS OF THE BANK INSOLVENCY LAW ■■

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The Bank Insolvency Law establishes the procedure and conditions for implementing measures to prevent the insolvency of credit institutions and specifies the grounds and procedures for declaring credit institutions insolvent and subsequently liquidating them. The Bank Insolvency Law provides that insolvency proceedings may be commenced against a credit institution where it fails to: – satisfy the monetary claims of its creditors or make any obligatory payments within 14 days after they are due; and/or – if, after the revocation of its banking license, the value of its property (assets) is not sufficient to satisfy the monetary claims of its creditors and/or make any obligatory payments.

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Insolvency proceedings in relation to a credit institution may start only after the Central Bank of the Russian Federation has revoked the banking license of the credit institution. After the license is revoked the court may order the credit institution to be liquidated. Insolvency proceedings for credit institutions differ from the general rules under the Insolvency Law. Banks and other credit institutions may only be subject to liquidation, other insolvency procedures are not available.

The controlling person may be held subsidiarily liable for the debtor’s obligations incurred in connection with damage caused to the debtor’s creditors, if the damage resulted from following the controlling person’s directions and if the debtor’s property is not sufficient to cover its liabilities. The Insolvency Law also makes the debtor’s chief executive officers subsidiarily liable for the debtor’s obligations in case of an absence or falsification of www.dlapiper.com | 79

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The Bank Insolvency Law envisages certain insolvency-prevention measures which may be implemented before the withdrawal of the banking license and the commencement of any insolvency proceedings. These measures shall be performed without the involvement of the courts and include: – the financial rehabilitation of the credit institution; – the appointment of a provisional administration for the credit institution; and – the re-organisation of the credit institution.

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The priority ranking for the discharge of the creditors’ claims is similar to that described in section on “Liquidation” on page 77, with the following exceptions: – the first priority group includes claims of individual depositors (if the credit institution had the relevant license to attract deposits from individual depositors), the Deposit Insurance Agency and the Central Bank of the Russian Federation; and – subordinated claims must be repaid only after payments to all other creditors have been completed.

CONTACTS

Please do not hesitate to contact the following lawyers at our offices in Moscow and Saint-Petersburg.

Delphine Nougayrède Partner, Moscow Head of Corporate and M&A, CIS T +7 495 221 4422 delphine.nougayrede@dlapiper.com

Olga Litvinova Office Managing Partner St. Petersburg T +7 812 448 7200 olga.litvinova@dlapiper.com

Igor Venediktov Partner, Moscow Tax T +7 495 221 4199 igor.venediktov@dlapiper.com

Ruslan Vasutin Partner, St. Petersburg Tax T +7 812 448 7200 ruslan.vasutin@dlapiper.com

Vyacheslav Khorovskiy Partner, Moscow Banking and Finance T +7 495 221 4477 vyacheslav.khorovskiy@dlapiper.com

Alexander Klochkov Partner, Moscow Corporate T +7 495 221 4488 alexander.klochkov@dlapiper.com

Scott Antel Partner, Moscow Real Estate, Franchising T +7 495 221 4411 scott.antel@dlapiper.com

Denis Sosedkin Partner, St. Petersburg Corporate, Commercial T +7 812 448 7200 denis.sosedkin@dlapiper.com

Igor Panshensky Partner, Moscow Corporate, Competition T +7 495 221 4466 igor.panshensky@dlapiper.com

Alexey Kolegov Partner, Moscow Real Estate T +7 495 221 4420 alexey.kolegov@dlapiper.com

Yaroslav Moshennikov Partner, Moscow Dispute Resolution T +7 495 221 4434 yaroslav.moshennikov@dlapiper.com

Pavel Bakoulev Partner, Moscow Energy T +7 495 221 4455 pavel.bakoulev@dlapiper.com

Michael Malloy Counsel, Moscow Intellectual Property and Technology T +7 495 221 4175 michael.malloy@dlapiper.com

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This brochure does not constitute professional advice and has been produced for the purposes of general information only. The information contained herein should not be acted upon without first obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy of the information contained herein. To the extend permitted by law, DLA Piper, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained herein or for any decision based on it.

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www.dlapiper.com DLA Piper rus limited is part of DLA Piper, an international legal practice, the members of which are separate and distinct legal entities. For further information please refer to www.dlapiper.com/structure | A list of offices across Asia, Europe, the Middle East and the US can be found at www.dlapiper.com Switchboard +7 495 221 4400 (Moscow) +7 812 448 7200 (St. Petersburg) Copyright © 2010 DLA Piper. All rights reserved. | JUL10 | 1852268