LEGAL GUIDE TO INVESTING IN RUSSIA LEGAL GUIDE SECOND EDITION

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1 LEGAL GUIDE TO INVESTING IN RUSSIA LEGAL GUIDE SECOND EDITION May 2013

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3 Contents PAGE Introduction Herbert Smith Freehills Introduction to the Russian legal system Foreign investment restrictions Establishing a legal presence Due diligence Acquisition structures Joint ventures Shareholders rights and obligations Financial services regulation Corporate governance Raising debt finance from abroad Securities and capital markets regulation Derivative instruments Taking security Acquiring and investing in real estate Subsoil natural resources Merger control Employment Share options Tax Intellectual property Insolvency Litigation Arbitration Appendix 1: Bilateral investment treaties Appendix 2: Double tax treaties Appendix 3: Main conventions Appendix 4: Abbreviations and definitions Appendix 5: Contacts... 66

4 02 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Introduction Despite the global crises in other countries, the Russian market is developing very quickly and the economy is in excellent shape. Russia was the best performer amongst BRIC countries during September and, despite a recent softening, has the best GDP growth market in Europe. Russia also has one of the best budget balances in the world. However, Russia is not an easy place to do business, it can be expensive; the business operating environment can be challenging; paperwork and bureaucracy is endemic. At first glance, the legal system in Russia the way in which investment in companies is made, the restrictions on acquiring businesses and the rules on foreign investment can seem complex. We hope that you will find this Guide useful in explaining the key legal issues affecting your planned or existing investment in Russia. It aims to clarify those legal areas for an overseas investor and also act as a glossary or step-by-step guide for the reader. It is very much an introduction to the subject and is not intended to be a comprehensive guide to all legal issues. Of course, Russian law, like all legal systems, is subject to regular change. What you read in this Guide reflects the law as at the date of publication. We intend to update the Guide periodically, but please be careful to check with us, before relying upon it, that the law as stated here is still in force. In particular, significant changes are proposed to the Russian Civil Code which will impact on the contents of the Guide. The draft changes are currently being debated in parliament but it is expected that they will be passed by late An updated version of this Guide will be published in due course once the changes are finalised. We would welcome the opportunity to discuss any of these issues with you. Please feel free to get in touch with any one of the partners named in Appendix 5. With thanks to the large team of partners, professional support lawyers and associates who have made this publication possible. Herbert Smith Freehills CIS LLP May 2013 Second edition To download a printable version please go to:

5 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 03 Herbert Smith Freehills We are one of the world s leading law firms. We advise many of the biggest and most ambitious global organisations across all major regions of the globe. Our clients trust us with their most important transactions, disputes and projects because of our ability to cut through complexity and mitigate risk. Please visit to learn more about us. See Appendix 5 for contact details of our partners in Moscow and our other offices. For all full list of publications produced by our Moscow office, visit We can help you thrive in the global economy. With 2,800 lawyers in offices spanning Asia, Australia, Europe, the Middle East and the US, we can deliver whatever expertise you need, wherever you need it. Our Moscow office combines the international expertise of around 80 lawyers offering locally based full-service Russian, English and US law advice, with an in-depth understanding of the legal issues arising in Russia. We offer domestic and international investors and financial institutions market-focused advice on a range of complex matters. We opened our Moscow office in 1999 but have been advising on deals, dispute resolution and projects in Russia since The contents of this publication, current at the date of publication set out in this document, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication. Herbert Smith Freehills LLP and its affiliated and subsidiary businesses and firms and Herbert Smith Freehills, an Australian Partnership are separate member firms of the international legal practice known as Herbert Smith Freehills. Herbert Smith Freehills CIS LLP 2013

6 04 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 1. Introduction to the Russian legal system Since the fall of the Soviet Union, the Russian legal system has operated as a civil law system. The Russian Civil Code is the primary source of civil law for Russia and came into force in four parts between 1995 and The Civil Code sets out certain basic principles: equality of all participants guaranteed by civil law; inviolability of private property; freedom of contract; free exercise of civil rights; and juridical protection of civil rights. Under Russian law, foreign individuals and companies enjoy the same rights to sue and be sued in Russian courts as Russian individuals and companies. Which court has jurisdiction over a particular dispute depends mainly upon the nature of the dispute and the applicable Russian legislation. As a general rule, economic and commercial disputes will be considered by arbitrazh courts, whilst non-commercial disputes will be considered by civil courts. DOMESTIC SOURCES OF RUSSIAN LAW Constitution Since its adoption pursuant to a referendum in 1993, the Russian Constitution is considered the supreme law of the land. Article 15 of the Constitution reads that it shall have supreme legal force and have direct effect, and shall be applicable throughout the entire territory of the Russian Federation. Courts are guided by the Constitution and it prevails over federal, regional and local laws. Statute Statutes are the predominant legal source of Russian law and may only be enacted through the legislative process. Codes are the basis for law on a matter, and they are usually supplemented by further legislation to develop certain provisions. Codes are interpreted flexibly and interpretation may be based simply on general principles. The general principles are articulated in the first section of a code and outline the reason for the legislation. Judicial system The judicial system of Russia is made up of several types of courts: arbitrazh courts (that is commercial courts), courts of general jurisdiction, the Constitutional Court, justices of the peace and military tribunals. A special Court for Intellectual Property Rights has been recently established to consider disputes relating to intellectual property rights. Parties may also agree to submit their commercial disputes to arbitration tribunals. Arbitrazh courts Arbitrazh courts are specialised courts for settling commercial disputes. They are structured as a four-tier system and have special jurisdiction over disputes arising out of the application of legislation governing corporations, shareholders and participants in Russian companies on all matters, with the exception of employment issues. Arbitrazh courts also have exclusive jurisdiction over the recognition and enforcement of foreign court decisions and arbitral awards for disputes arising out of commercial activity. Courts of general jurisdiction The jurisdiction of civil courts includes, but is not limited to: all criminal cases; disputes between individuals; appeals of administrative and other state actions that do not fall within the jurisdiction of other courts; labour and employment disputes; and family law, probate and consumer protection issues. The Supreme Court of the Russian Federation is the judicial body ultimately responsible for those cases under the jurisdiction of civil courts. For certain categories of case, it can, however, act as a court of first instance (generally those which are considered to be of special importance or special public interest ). The Supreme Court also considers the validity of rulings of lower courts (including military courts) and provides clarifications on issues of court proceedings. The Constitutional Court of the Russian Federation The Constitutional Court of the Russian Federation commenced its activities in December 1991 and was the first judicial body of constitutional review in Russia. The legal status of the Constitutional Court is characterised by a number of peculiarities. It stands apart from the other courts and reviews cases that concern the constitutionality of laws, interprets the Russian Constitution and verifies the legality of presidential impeachment proceedings. The court always limits its considerations to matters of law and refrains from examinations of facts whenever such activity falls within the competence of another court or another authority. The rulings are final and may not be appealed and the provisions of any laws declared to be unconstitutional are deemed to be, de facto, null and void, since the Constitutional Court s rulings require no further confirmation.

7 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 05 Precedent Strictly speaking, court decisions are not sources of Russian law. However, judgments of higher courts have gradually gained large significance in Russia the lower courts must follow the positions established by the Supreme Courts. What is more, the Supreme Arbitrazh Court and the Supreme Court of the Russian Federation summarise lower court practice and issue court practice explanations in the forms of information letters and overviews. Such letters and explanations are used as interpretative recommendations and guidelines for lower courts when dealing with similar issues. Application of foreign law in Russia Whilst parties are free to select whichever laws they wish to govern their contracts, there are certain mandatory rules of Russian law which parties cannot contract out of. These mandatory rules are very wide in scope, covering almost every aspect of Russian law. This therefore has a significant bearing on parties freedom to contract and how contracts governed by foreign laws will be interpreted in Russia. This should always be kept in mind when entering into any contract which may ultimately come before the Russian courts. Bilateral Investment Treaties and Conventions Russia has an extensive network of bilateral investment treaties with other countries and is a signatory to a number of conventions which impact of the areas covered by this Guide. Please see Appendix 1 for a list of the countries with which Russia has entered into a bilateral investment treaty and Appendix 3 for a list of the main conventions to which Russia is a signatory.

8 06 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 2. Foreign investment restrictions Foreign investors considering making investments in Russia will need to be aware of the regulatory restrictions which apply in certain circumstances. The key foreign investment restrictions are summarised below. CURRENCY REGULATION AND CONTROL There are no restrictions in Russia relating to currency regulation and control affecting inward or outward investment. The former restrictions were removed such that from 1 January 2007: there are no special account requirements for currency operations; non-residents can purchase Russian securities with foreign currency; and mandatory conversion requirements were abolished. RESTRICTIONS ON INVESTMENTS IN STRATEGIC BUSINESS SECTORS General The Russian Strategic Investments Law provides that the acquisition of control by foreign investors of Russian companies operating in strategic business sectors (Strategic Companies) requires government consent. The Strategic Investments Law singles out certain business sectors that are strategic to the Russian economy. These include, amongst others, the development of subsoil fields of federal significance (Strategic Fields, as described in detail in chapter 15), the nuclear industry, natural monopolies such as oil and gas pipeline transportation services and operational services in the transportation sector such as rail roads, airports and marine ports. Also covered are the military industry, the aviation industry, space activities and significant mass media. A company incorporated in Russia will be presumed to be a Strategic Company and to fall within the scope of the Strategic Investments Law if it is engaged in at least one strategic sector. Generally, any company incorporated in a jurisdiction outside of Russia constitutes a foreign investor. Therefore, the restrictions of the Strategic Investments Law may apply not only to injections of foreign capital, but also to investments made by the offshore vehicles of Russian companies and to joint venture vehicles incorporated outside of Russia. The concept of control The Strategic Investments Law gives a broad definition of the concept of control of one company (or individual) over another. Pursuant to the Strategic Investments Law, control means the ability to influence, directly or indirectly, the decisions made by a Strategic Company, through: voting at general shareholder meetings of the Strategic Company; or participation in management bodies of the Strategic Company; or acting as the external management company of the Strategic Company. The Strategic Investments Law sets out examples of circumstances when the general test of control will be deemed to be met. These include situations where a person or entity: controls more than 50% of the voting shares or participatory interests in a Strategic Company; or has the power to appoint more than 50% of the members of the board of directors (or other management body) of a Strategic Company; or controls less than 50% of the voting shares or participatory interests of a Strategic Company, but the stakes of other shareholders or participants are such that the person or entity is still able to determine the decisions of that Strategic Company; or has the power to make decisions relating to the business activities of a Strategic Company on the basis of an agreement or otherwise; or is entitled to appoint the chief executive officer of a Strategic Company; or acts as the management company of a Strategic Company. However, the Strategic Investments Law makes it clear that these examples are not exhaustive, and the presence or absence of control is to be determined on a case-by-case basis. In order to determine conclusively whether or not a person or entity has control for these purposes, it is necessary to analyse the shareholder arrangements and any agreements in place. For Strategic Companies developing Strategic Fields (Strategic Subsoil Companies), there is a special test for control. Control over a Strategic Subsoil Company is deemed to exist where a foreign investor: controls, directly or indirectly, 25% or more of the voting shares or participatory interests of the Strategic Subsoil Company; or is able, or has the power, to appoint 25% or more of the board of directors (or other management body) of the Strategic Subsoil Company; or is entitled to appoint the chief executive officer of the Strategic Subsoil Company; or has the power to make decisions relating to the business activities of the Strategic Subsoil Company on the basis of an agreement or otherwise; or

9 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 07 is acting as the management company of the Strategic Company. Acquisition of control over Strategic Companies by foreign states, international organisations, (eg the European Bank for Reconstruction and Development) or entities controlled by them is prohibited. Foreign states and international organisations are also required to obtain prior consent for the acquisition of the right to control, directly or indirectly, more than 25% of the voting shares (or the right to block management decisions) of a Strategic Company, or more than 5% of the voting shares in a Strategic Subsoil Company. In 2011 the Strategic Investments Law was amended to exempt from the consent requirement (but not from the prohibition to acquire control) international financial organisations created in accordance with an international treaty to which Russia is a party and international financial organisations that entered into a treaty with Russia. A list of such organisations has been approved by the government and includes, inter alia, the International Bank for Reconstruction and Development, the European Bank for Reconstruction and Development and the International Finance Corporation. Exemptions The Strategic Investments Law does not apply to transactions between organisations controlled by the Russian Federation. Also, the Strategic Investments Law does not apply to investment by foreign investors in Strategic Companies: which are Strategic Subsoil Companies; and in which the Russian Federation controls, directly or indirectly, more than 50% of voting shares. In addition, the law does not apply to transactions between organisations controlled by Russian nationals who are Russian tax residents and at the same time do not have dual citizenship. A further exemption relates to cases where, at the time of the proposed investment, the relevant foreign investor already controls more than 50% of the capital of the target Strategic Company. This exemption does not, however, apply to Strategic Subsoil Companies. For Strategic Subsoil Companies, if a foreign investor already owns over 25% and intends to increase its share, it is likely that any subsequent acquisition will also require consent. The Strategic Investments Law does not apply in respect of transactions by a foreign investor that already holds shares in a Strategic Company where the transaction does not increase the foreign investor s overall stake in that Strategic Company. The Strategic Investments Law does not apply in respect of foreign investments regulated by other Federal laws or international treaties ratified by Russia. Obtaining consent The Federal Antimonopoly Service (FAS) is responsible for giving consent to investment in Strategic Companies. The ultimate decision-making responsibility is with a special governmental commission presided over by the Prime Minister. Consequences of a failure to comply Transactions entered into in violation of the Strategic Investments Law are void. If a transaction is declared void by the courts, the parties involved will be restored, as far as possible, to their original positions. In such cases, the authorities are entitled to seek either, or both of, the annulment of any voting rights held by the relevant foreign investor in respect of shareholders or participants meetings, and the annulment of any resolutions or transactions of a Strategic Company adopted or entered into after control was obtained (in violation of the rules) by a foreign investor. RESTRICTIONS RELATING TO INVESTMENTS BY ENTITIES CONTROLLED BY FOREIGN STATES OR INTERNATIONAL ORGANISATIONS Pursuant to a provision of the Federal Law on Foreign Investments in the Russian Federation (Foreign Investments Law), which was introduced in May 2008, where a foreign state, international organisation, or entity controlled by any such body, effects a transaction resulting in the acquisition of a right to control, directly or indirectly, more than 25% of voting shares or participatory interests of a Russian commercial entity or the ability to block decisions of the managing bodies of a Russian entity, consent to the transaction must be obtained from the authorities. The procedure for obtaining such consent refers back to the Strategic Investments Law. Exemptions Like the Strategic Investments Law, the Foreign Investments Law was amended in 2011 to exempt transactions by those international financial organisations included in the list approved by the government from the consent requirement. REAL ESTATE For restrictions relating to foreign investors acquiring title to real estate, please see chapter 14 of this Guide. INSURANCE Pursuant to the Federal Law on the Organisation of Insurance in Russia (Insurance Law), insurance organisations must obtain the permission of the Federal Service for the Financial Markets of the Russian Federation (FSFM) in order to conduct insurance activities in Russia. The Insurance Law establishes a maximum 50% limit on the participation of foreign insurance companies in the insurance industry in Russia at any given time. Permission will only be granted to foreign companies if this limit has not been exceeded which, in practice, has not been an issue to date. Insurance companies incorporated in Russia, but whose parent company or shareholders holding jointly more than 49% of the share capital are incorporated outside of Russia, may not perform the following types of insurance activities in Russia: life insurance; any forms of insurance which are mandatory pursuant to statute; any forms of insurance which are mandatory as dictated by the state; insurance related to the supply or performance of contractual work for state requirements; or accident insurance for state and municipal organisations.

10 08 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS CREDIT ORGANISATIONS The permission of the Central Bank of the Russian Federation (CBR) is required to set up a credit organisation (the definition of which includes banks as well as non-banking credit organisations). The CBR may require that a certain number of supervisory board members are Russian citizens if the general director of the credit organisation is a foreigner. RESTRICTIONS ON FOREIGN INVESTORS ACQUIRING CONTROL OVER COMPANIES IN CERTAIN INDUSTRIES Air transportation Pursuant to the Air Code of the Russian Federation, foreign participation in Russian air carriers may not exceed 49%. Mass media Pursuant to the Federal Law relating to Mass Media: companies incorporated outside of Russia (ie foreign companies) and companies incorporated in Russia but which are more than 50% foreign owned may not establish radio, television or video networks; and foreign individuals, foreign companies and companies incorporated in Russia but which are more than 50% foreign owned may not establish organisations broadcasting over the territory of 50% or more of Russia, either by number of individual territories or by population spread.

11 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Establishing a legal presence When setting up a company in Russia, there are several structuring options available, as discussed below. Company A company is a separate legal entity incorporated in Russia in accordance with the laws of the Russian Federation. The most common forms of company are joint stock companies (JSCs) and limited liability companies (LLCs). Branch office A branch office is a separate subdivision of a company headquartered in another location. A branch can perform all the functions of a company. However, a branch office will not be appropriate in all circumstances and will not be an option if the business requires licences to be granted which can only be issued to companies incorporated in Russia. A company will be liable for the wrongdoings or debts of any branch office whereas companies will not generally be liable for the debts or wrongdoings of their Russian subsidiaries. Representative office A representative office is not a separate legal entity but an extension of a foreign company into Russia. Representative offices are not permitted to engage in commercial activity and their main purpose is to represent the company s interests and promote commercial relations between the company and its counterparties. Since a representative office is not entitled to be involved in commercial activity, it will be of limited value if the intention is to conduct business in Russia in any significant way. Simple partnership A simple partnership is an agreement between several parties to carry out jointly business in, or outside of, Russia. No new firm or business entity is formed; the partnership is in fact only a contractual arrangement. The simple partnership structure is not widely used. The liability of partners for claims arising out of the commercial activities of a simple partnership will be joint and several and this position cannot be changed by agreement between the partners. If claims are made, the partners will be liable to the full extent of all their assets (except in relation to individual entrepreneurs, for which there is a statutory list of assets against which recourse may not be sought). The legal framework The rules governing the establishment and operation of a legal presence in Russia are to be found in the following sources: Civil Code Part one of the Civil Code of the Russian Federation which came into effect on 1 January 1995; JSC Law Federal Law of the Russian Federation on Joint Stock Companies; LLC Law Federal Law of the Russian Federation on Limited Liability Companies; and Law on Registration Federal Law of the Russian Federation on State Registration of Legal Entities and Individual Entrepreneurs. Types of companies The two principal forms of a Russian company are: an LLC, where members hold participation interests ; and a JSC, where participation is in the form of shares. The only foundation document of a JSC or an LLC is its charter, which is similar to the memorandum and articles or constitutional documents of a company. JSCs issue shares which are subject to the requirements of Russian securities laws. An LLC is a more flexible alternative to a JSC. The charter capital of an LLC is represented by participatory interests, which do not constitute securities and so are not subject to the Russian securities legislation. As a general rule, for both LLCs and JSCs, the liability of its owners is limited to the nominal value of the shares or participatory interests issued to those members. However, the liability may be extended (a) in the event of the company s insolvency; or (b) in relation to transactions entered into by the company pursuant to instructions from the owner. Open and closed JSCs JSCs may be open (OJSC) or closed (CJSC). The main differences between an OJSC and a CJSC are: shareholders of a CJSC have pre-emptive rights in respect of a proposed transfer of shares; a CJSC may have no more than 50 shareholders; a CJSC may not issue shares to the public; and there are fewer public reporting requirements imposed upon a CJSC. If an OJSC is listed on a public stock exchange there will be additional filing requirements, which of course result in greater levels of transparency. Generally, a CJSC rather than an OJSC is preferred for joint ventures as the company s equity is usually intended to be closely held and not marketed.

12 10 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Proposed amendments As part of the proposed global amendments to the Civil Code, it is proposed that companies will be either public (public JSCs) or non-public (non-public JSCs and all LLCs), depending on whether their shares are offered to the public. If the amendments are adopted, existing companies will not be required to re-register immediately. Current CJSCs will be able to choose the form of LLC or will automatically become non-public JSCs. Existing OJSCs will become public JSCs if they indeed offer shares to the public; otherwise they will become non-public JSCs. LLCs will remain as they are. CJSC vs LLC In most respects, CJSCs and LLCs are similar: membership may not exceed 50 persons; shareholders and participants have rights of pre-emption that cannot be waived in the charter. Both CJSCs and LLCs may provide in their charter that the company also has the right to pre-emptively acquire any shares intended to be sold by shareholders or participants to third parties; both CJSCs and LLCs will have a two or three tier management structure the body of shareholders in attendance at a general meeting, an (optional) board of directors and an executive body responsible for the day to day running of the company (which may comprise a single individual or a management board); the minimum charter capital requirements are identical; and tax reporting, tax treatment and accounting requirements are essentially the same. One of the main differences between the two types of entity is that the charter of an LLC can impose restrictions on the transfer of participatory interests, whereas this is not possible in the case of a CJSC. Further, an LLC s charter may allow for weighted voting rights and disproportionate profit distributions. An LLC, therefore, offers greater flexibility regarding the imposition of super-majority voting and other tailored rights. However, any participant holding at least 10% of the participatory interests in an LLC has the right to apply to the court for another participant to be excluded (for further details on this right, see the end of this chapter). Participation in an LLC and a JSC An LLC or a JSC may be established by Russian or foreign natural persons or legal entities. The number of participants or shareholders in an LLC and a CJSC must not exceed 50 (otherwise the company must be reorganised into an OJSC within one year). An LLC and a JSC may not have as their sole founder another company with a sole shareholder. Charter capital The charter capital reflects the minimum level of assets that a company must have. An LLC s charter capital is formed of contributions made by participants. The charter capital of a JSC is comprised of the nominal value of the company s shares acquired by shareholders. Russian legislation stipulates the following minimum charter capital: for an OJSC RUR100,000 (approximately US$3,333); and for a CJSC and an LLC RUR10,000 (approximately US$333). Registration formalities A Russian legal entity is considered to be incorporated after it has been state registered. The registration of legal entities falls within the competence of the Russian tax authorities. General provisions relating to the registration procedure for legal entities in Russia are stipulated in the Law on Registration. When registering a Russian company, key corporate information (such as its official name, registered office, founders or participants, any registrations or licences made or granted and the name of the company s general director) is recorded in the Unified State Register of Legal Entities (the Register). While the company is in existence, it is obliged by law to register any amendments to the data contained in the Register with the tax authorities. The current status of a Russian company can be confirmed by an extract from the Register. Transfer restrictions A participant in an LLC has the right to withdraw from the LLC by putting its interests onto the LLC in return for cash or payment in kind (assessed by reference to book value) but only where such a right of exit is expressly stated in the charter of the LLC. Some vestiges of the withdrawal right remain in the form of minority protections. If the general participants meeting takes the decision to approve a major transaction (as defined in the LLC Law) or to make an equity capital call, then any minority which voted against the decision or abstained will be able to exercise their right to withdraw. There is no general right of exit in JSCs. A shareholder of a JSC may exit from the company either by way of sale of its shares to third parties (in CJSCs this is always subject to the right of first refusal of existing shareholders) or by requesting that the company acquires its shares in a limited number of circumstances, namely: reorganisation of the company; execution of a major transaction; introduction of amendments to the charter of the company which limit the right of the shareholders; or delisting of shares, provided that the exiting shareholder either did not participate in the general shareholders meeting where the decision was adopted or voted against the decision. The LLC s charter may require that a transfer to other participants or third parties is subject to the consent of all of the other participants. If such consent is required and is refused then the party wishing to transfer its participatory interests may put its interests on to the company itself. No such restrictions can be set forth in relation to transfer of shares in JSCs. Right of first refusal In respect of the disposal of existing interests (shares) in LLCs and CJSCs to third parties, there is a statutory right of first refusal, which cannot be excluded. Participants (shareholders) are entitled to purchase participatory interests (shares) at the price on offer to a third party pro rata to their holding (the charter of LLCs may also provide for a different procedure as mentioned below). There is no right of first refusal in OJSCs.

13 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 11 In both LLCs and CJSCs the charter can provide that the company itself has the right of first refusal if none of the participants (shareholders) have exercised their rights. In LLCs the price to be paid by a participant exercising the right of first refusal (and by the company if it has the right of first refusal) may be stated in the charter and may differ from the price offered to a third party. Notarial certification of transfer Certification by a notary of any transfer or pledge of participatory interests in LLCs is required. When certifying, notaries will have to check that the seller is entitled to dispose of participatory interests, which should help to mitigate the risk of transfer by unauthorised persons. Transfers or pledges of shares in JSCs are not subject to notarial certification. Title to participatory interests in LLCs will pass to the purchaser at the time of certification of the agreement by a notary, rather than when the company is notified that the transfer has taken place. Upon certification, the notary will send an application for amendment to the Register, which is the public register of title. LLCs have to create and maintain a register of members containing information on participatory interests belonging to the participants and the company. In case of discrepancies between the register of members and the Register, the latter will prevail. In relation to JSCs, title to shares will pass to the purchaser at the time when the relevant record of transfer is made to the shareholders register. Once all documents have been deliver to the registrar, the latter will have three days to effect the transfer, but in practice the transfer may even happen on the same day. Shareholders agreements Following amendments to the Russian corporate legislation in , both the JSC Law and the LLC Law permit execution of shareholders agreements (SHAs) in respect of JSCs and LLCs respectively. Although this is a positive step in the development of Russian corporate legislation, offshore alternatives to joint ventures remain a more attractive option for a number of reasons, as described below. The JSC Law and the LLC Law allow for majorities and minorities to waive their right to vote, or to agree in advance that they will cast their votes in a certain way, or to agree veto rights on business items not contemplated by the law. There is now therefore freedom to create a bespoke structure, with either total deadlock, relative minority block or majority control as required. clear that foreign-law governed SHAs are enforceable in relation to Russian LLCs or JSCs. One of the reasons why investors insert overseas holding companies into the ownership structures is to ensure that the foreign law choice of law in their SHAs is effective. Limitation period to challenge management decisions There is a two month limitation period for participants to challenge decisions of LLC management bodies (ie general meeting of participants, the board of directors, the general director, the management board or any external manager). In JSCs, the general limitation period is three months. The court may, in its discretion, uphold the decision in question if the relevant breaches are not material and the adopted decision did not result in damages or any other adverse consequences to the company or the shareholder (participant). Expulsion from an LLC A participant (or participants) holding at least 10% in the charter capital of an LLC has the right to apply via the courts for the expulsion of another participant. There is no such right of expulsion in JSCs. The grounds for expulsion are: material breach by a participant of its duties (including, presumably, pursuant to a shareholders agreement); or actions/failure to act by that participant that will lead to the inability of the LLC to conduct its business or which will significantly impede such activity. In the case of an expulsion, the participatory interest of the expelled participant passes to the company and the company is obliged to pay the expelled participant the value of the portion of the company s assets which correspond to that participant s interest in the charter capital or, with the consent of the expelled participant, to transfer to that participant assets of the same value. The value of the interest is established on the basis of the company s accounts for the last reporting period preceding the date of entry into force of the court decision on expulsion. The possibility of expulsion remains, in our view, the most significant drawback of an LLC. It should also be possible to require a commitment to sell in certain circumstances or a commitment to buy and it should be possible for participants of LLCs and shareholders of CJSCs to be explicitly subject to transfer limitations in addition to the statutorily prescribed right of first refusal. Notwithstanding these changes, Russian law is not as flexible as English law when it comes to SHAs. If parties are keen to include certain contractual provisions commonly seen in English law SHAs (such as reps and warranties, indemnities, put/call options, drag/tag along rights), it would be preferable for the SHA to be governed by English law which recognises these provisions. The parties may also be keen for the general comfort of the SHA being governed by foreign law. The choice of governing law will then in turn have a bearing on the form of corporate entity which will enter into the SHA since it is not

14 12 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 4. Due diligence Due diligence is one of the key pre-investment exercises that a potential investor needs to carry out. Due diligence investigations allow an investor to assess the legal and financial risks associated with the target business. Further, this process allows an investor to obtain sufficient information on potential partners and target companies, to evaluate the appropriate purchase price for the target and to evaluate alternative structures. As such, much of what follows applies to any investment in any jurisdiction, not just the Russian Federation. Procedure Generally, the process starts with an agreement between the investor and its legal advisors as to the scope and timing of the review and the determination of areas of major interest. A document checklist is then sent to the target company (or its owners). The review of documents usually results in requests for further information and consultations with the legal advisers of the target company. The review of documents can take place either in a physical data room or via a virtual data room. On-site due diligence generally takes place only in exceptional cases, usually in an attempt to expedite the acquisition process. In order to obtain the information required, the legal advisors of the investor may use publicly available sources (such as the State Real Estate Cadastre and the Register of Russian Trade and Service Marks). Publicly available data in Russia is of lower quality than might be expected and is sometimes inaccurate. Based on the results of the review, the investor s legal advisors will prepare a written report. Sometimes the investor will also request an outline of red flag issues prior to the report in order to understand the major issues affecting the transaction at an early stage. Scope The scope of due diligence usually depends on the type of business conducted by the target company and the thoroughness of the review expected by the investor. In general, it involves investigation of the areas listed below. Incorporation, status, licences and authorisations Verification of the due establishment of the target company involves a comprehensive examination of the incorporation documents. A Russian company may be created in a number of ways, including by the privatisation of state-owned assets, reorganisation of existing businesses or the incorporation of a new entity. The investor s legal advisors must review a set of the latest versions of the constitutional and internal documents of the target company in order to ascertain their compliance with legislation and understand the relevant management structure. Certain activities undertaken by a target company may be subject to licensing or require the authorisation of, or registration with, governmental bodies. Shareholding structure The investor should pay particular attention to various issues relating to the shares of the target company, including: issues of shares by the company: the issuance of equity in Russia is highly regulated by governmental bodies. A failure to meet the established requirements may result in the termination or cancellation of a share issue; share transfer history: the investor must ascertain the legality of the transfers and the validity of title to shares of the current shareholders of the target company in order to avoid possible challenges to title; existing encumbrances over the target s shares; any shareholders agreements; and information on the shareholders of the target company and relationships between the target and any affiliated companies. Antimonopoly and foreign control issues Russian antimonopoly and foreign control regulations involve a system of notifications and approvals required for entering into and executing transactions involving transfers of shares in Russian companies (specifically those triggering control over Russian businesses by foreign investors in sectors such as banking and insurance and in strategic enterprises). A due diligence exercise should focus on these issues since the controlling authorities may impose severe sanctions in the event of non-compliance (including the invalidation of a share transfer). Material contracts A review of the target s material contracts is undertaken to give the investor a full understanding of the matrix of relationships that underpin the business. This process will: provide details of the terms of existing contractual relationships; highlight any potential problems which may occur on a change of control; confirm the compliance of key contracts with the mandatory requirements of any relevant legislation and the enforceability of material terms; highlight any breaches and assess the potential consequences; and disclose the conditions for assigning, terminating or extending any agreements.

15 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 13 Financing and creditor indebtedness Prior to the acquisition of the target company, the investor must have a clear picture of the financial structure of the business. Legal advisors should carefully review the provisions of any loan agreements including termination and early repayment provisions and details of any security. Equally, the investor should be provided with information on amounts payable to the target company. Complete and accurate financial information is of particular importance for the investor since it will have a significant impact on the determination of a fair price for the business. Assets Prior to acquiring the target the investor should examine the target company s title to its assets. In particular, real estate and intellectual property must be considered. The legal advisors of the investor must examine in detail all documents confirming the rights of a target company to its facilities and any underlying land. This will involve tracing the history of title and looking into any transfers in order to ascertain the validity of title and evaluate the possibility of any challenges within the relevant limitation periods. Depending on the type of business, the target company s intellectual property rights (such as copyright, patents, trademarks, trade names and know-how) may be of considerable interest to the investor. The investor s legal advisors should examine the validity of such rights and the effectiveness of their protection. Where the business being acquired relies significantly upon the use of certain intellectual property rights which have been obtained from third parties, it is necessary to ensure that the purchaser is able to benefit from such rights after the acquisition has taken place. Taxation and accounting During the course of the due diligence process, an investor s legal advisors must ensure that the target company has no outstanding tax liabilities which will cause problems for the business going forward and, if any such liabilities are outstanding, ensure that they will be rectified prior to acquisition. This is a crucial area but one outside the scope of this Guide. Detailed and extensive tax due diligence, however, is usually conducted separately from the general legal review. Accounting matters may also be subject to an independent investigation by auditors. It is often the case that a target company will keep accounts only in accordance with the Russian accounting standards (which differ from international accounting regulations). Difficulties Given the lack or limitations of publicly available information, the effectiveness of a due diligence review is heavily dependent upon the co-operation of the target and the completeness and accuracy of the documents and clarifications provided. It should be noted that sellers are usually reluctant to disclose extensive information and that legal advisors may not be given an opportunity to interview, or have access to, key personnel of the target as part of the review, at least until late stages of discussions. Nevertheless, the due diligence process remains vitally important to an investor as a means of gathering information which may affect the acquisition price, the deal structure and the drafting of the transaction documents. Environmental matters If the target s business involves the operation of natural resource extraction or production facilities, the target s compliance with applicable environmental legislation, pollutant emission standards and decrees issued by monitoring authorities will be areas of particular concern for an investor. The due diligence process should involve careful analysis of the impact of failures to comply, particularly where there is a risk that licences or permits may be revoked or operations suspended. Employment Generally, it will be necessary to review a target s standard employment agreements, collective bargaining agreements, agreements with key employees and the target s major internal employment policies and procedures. Russian employment law is employee-protective, so the due diligence team should focus on the possibility of any claims from employees and the potential consequences of such claims. Proper performance of the employer s insurance obligations should also be covered by the review. Disputes and compliance with regulatory requirements Due diligence in this area does not significantly differ from similar procedures in other jurisdictions; the investor will always require, to the extent possible, knowledge of any pending or threatened litigation or arbitration by or against the target and any alleged breaches of regulatory requirements in order that the potential impact of such actions on the target can be properly analysed.

16 14 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 5. Acquisition structures As is the case in many jurisdictions, share purchases are the most common way to acquire a business in Russia. The major risk of a share acquisition is, of course, that a buyer will also be concerned with all of the target s existing liabilities. The impact of the lack of publicly available information as part of the due diligence process in Russia may mean that a target will come with unknown liabilities. An alternative method of investing in Russia is to incorporate a new company which can be used as a vehicle for the acquisition of those assets which are necessary in order to continue running the business of the target. Share purchases The main disadvantage of an acquisition of shares is that historic risks and obligations remain with the target company (subject to any contractual apportionment and post-acquisition risk mitigation strategies). This means that thorough due diligence of the historic activities of the company will usually be crucial. Russian law has not historically recognised the concept of warranties in share purchase agreements. The buyer can seek to protect itself by obtaining warranties in a foreign-law governed share purchase agreement, but potential difficulties of successfully recovering for loss or damage mean that this is not a substitute for thorough due diligence. the authorities may determine that an asset transfer constitutes a fraud on creditors if it is considered to be an artificial transaction designed to evade historic liabilities. In addition to the risks described above, the key disadvantages of a sale of assets are: administratively they are more cumbersome than an acquisition of shares; the acquisition may require obtaining new licences and permits, novation or assignment of contracts, transfer of employees, re-registration of IP rights; and the acquisition may lead to Russian VAT being payable. The suitability of each option will depend upon the particular circumstances of a transaction, including tax structuring considerations. Acquisition vehicle If the target company does not have a dedicated offshore holding company, it may be advisable to set up such a holding company to make the acquisition or, in the case of an asset transfer, to create an offshore holding company with a wholly-owned Russian subsidiary (the latter being the recipient of the transferred assets). The choice of jurisdiction will largely be driven by tax issues and corporate considerations. There are, nevertheless, numerous advantages to a share purchase structure, chief among which are: avoiding the need to reapply for licences and permits; a less complex and burdensome acquisition process; the absence of Russian VAT consequences; and avoidance of business interruption. Asset purchases Where a deal is structured as an asset transfer, the target s liabilities, including tax liabilities and penalties, should not (subject to careful structuring) transfer to the new company and the chances of avoiding historic liabilities is therefore higher. Moreover, an asset transfer affords the opportunity to start from day one with a clean business with identifiable liabilities. An asset deal is not, however, a panacea for the following reasons: there remains a risk that the Russian tax authorities could re-characterise the asset transfer as a sale of an enterprise under which historic liabilities would be treated as transferring to the new company. Further, such a transaction will be subject to additional civil law and regulatory requirements (eg notification of creditors and registration of the transaction with governmental authorities); or

17 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Joint ventures Many investors in Russia seek to harness the expertise of an established participant in the market by forming a joint venture (JV). The external investor benefits from its partner s existing relationships and experience of the market and the key market players, thus avoiding some of the potential downside associated with other investment structures. As JV arrangements have become relatively commonplace in Russia, the structures used and the principal features of the governing documentation have become familiar to the market, engendering a reasonably high degree of confidence in JV vehicles amongst the Russian business community. The typical JV structure involves holding the Russian investment through an offshore holding company, historically typically located in Cyprus or the Netherlands, although given the financial crisis in Cyprus other jurisdictions are now also used. The agreement between the shareholders of the holding company establishes the principles for the operation and management of the JV business. Where the JV is incorporated offshore, English law is commonly chosen as the governing law of the SHA. This is because the Russian legal system may not wholly recognise certain concepts (such as certain share transfer provisions) which are fundamental to SHAs. Disputes under the SHA should be resolved by arbitration, as arbitral awards (unlike overseas court judgments) are more easily enforceable in Russia. It is possible, however, that the Russian courts may decline to give effect to such awards for reasons such as public policy. It follows therefore, that the use of an English law governed SHA will not necessarily insulate the parties from some of the more general risks associated with investing in Russia (please also see the discussion on shareholders agreements in chapter 3 of this Guide). The two principal forms of Russian corporate entities that could be utilised at the operating company level are the LLC and CJSC (please see chapter 3 of this Guide for a detailed description of the differences between these entities). KEY FEATURES OF SHAREHOLDERS AGREEMENTS Pre-conditions It is essential for the operation of any successful Russian market-orientated JV that all necessary licences, consents or clearances are obtained before trading commences. Regulatory approvals from Russian governmental agencies will be necessary for the initiation of business activities and obtaining such approvals can take a significant amount of time. Approval may also be required for foreign investment (whether direct or indirect) into Russian companies (as described in chapter 2 of this Guide). Operation of a JV company SHAs normally contain detailed provisions regulating the conduct of the JV, including with respect to: dividend policy and the scope of the board s (or any Russian subsidiary board s) power to declare dividends; whether (and how) the JV should be able to accommodate the withdrawal of current participants and the arrival of new ones; minority protection provisions, including reserved matters requiring unanimous consent before action can be taken; restrictions on the authority of the members of the board of each company in the JV group structure; approval of budgets by shareholders; funding provisions to cover the manner and method of any future financing that is to be provided to the JV company; appointment rights of the shareholders to the board of the JV holding company and provisions for quorum; non-compete covenants restricting the ability of the JV partners to compete with the JV company or with each other (careful consideration will have to be given to the scope of such covenants to ensure that they do not infringe competition law); stipulation of the situations in which shares in the JV company may or must be transferred, including any rights of pre-emption and mechanisms for determining the price of shares in such circumstance. (see further below); deadlock provisions (also discussed below); default provisions to cover situations where a party to the SHA is affected by a change of control, becomes insolvent, or is in material breach of the SHA (such provisions often act as an incentive for the parties to the SHA to comply and may provide for the non-defaulting party to acquire the defaulting party s shares, so far as permitted by the applicable law, at a discount); and termination provisions. Exit The SHA should address whether the transfer of shares will be subject to any lock-in period and should contain detailed provisions regulating the transfer of shares. Frequently the non-selling shareholders will be able to exercise a right of pre-emption if one of the shareholders wishes to exit, and may also have a tag-along right under which a selling shareholder must procure that the purchaser of his shares acquires the shares of the tagging shareholder on the same terms.

18 16 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Particularly where one shareholder holds a substantial stake, the SHA may contain drag-along provisions under which that shareholder is able, upon exit, to compel the sale by the other (usually minority) shareholders of their interests to the proposed purchaser upon the same terms. This mechanism is designed to maximise value for the majority shareholder by enabling the purchaser to acquire the entire issued share capital of the JV. A common feature of JVs in the Russian market is the inclusion in SHAs of provisions which allow for the exit of a JV partner through the use of a put option (whereby one JV partner can require the other to purchase its shares) or a call option (pursuant to which one JV partner can require the other partner to transfer its JV interest to it). However, such options should be capable of being triggered at the offshore level as they are of questionable enforceability under Russian law in relation to Russian operating companies. In the context of the provisions regulating share transfers, consideration should be given to any requirement to obtain any Russian law consents (for example, due to the increase in a JV partner s indirect interest in a Russian company by way of the acquisition of further shares at the offshore level). Deadlock If any disagreement between JV partners regarding the operation of the JV cannot be resolved amicably, the SHA should provide comprehensive mechanisms to ensure that a resolution can be effected. The following provisions may be included as part of the deadlock resolution process (as a practical matter, these supplement the principles regulating share transfers because they can ultimately lead to the exit from the JV of one, or perhaps all, of the JV partners): the Chairman of the board of directors may be given a casting vote (this will clearly be unattractive in a 50:50 JV); if the deadlock arises at the board level, the matter may be referred for consideration by the shareholders; an escalation procedure may be employed, such that any disagreement may be referred to the Chairmen or CEOs of the JV s respective shareholders; reference to a mediator, expert or arbitration; the inclusion of a Russian roulette provision, whereby a shareholder may offer to buy the other shareholder s shares at a specified price. The recipient shareholder may elect to sell or to purchase the other s shares at that price (and this right to elect acts, of course, as an incentive for the party serving the Russian roulette notice to propose an appropriate price upfront); the inclusion of a Texas shoot out provision, a variant on the Russian roulette mechanism under which the recipient of a notice containing an offer for the purchase of its shares may elect to sell at the specified price or purchase the initiating party s interest at a higher price, leading to an auction or sealed bid process under which the highest bid ultimately wins; and the ability of either party to require that the JV company be wound up and that the proceeds be distributed to the shareholders, or that all of the shares be sold to a third party at an agreed price or a price based upon an agreed formula.

19 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Shareholders rights and obligations As explained in chapter 3 of this Guide, the principal forms of companies for carrying out business in Russia are JSCs and LLCs. The rights and obligations of shareholders in JSCs and participants in LLCs are regulated by the Civil Code, the JSC Law, the LLC La. and the company s charter. Shareholders or participants have numerous rights. The most important are: the right to receive a portion of distributed profits and the right to participate in the winding up of the company; the right to participate in the management of the company; and the right to information on the activities of the company. The right to receive a portion of distributed profits in LLCs and the right to dividends in JSCs arise only when the company makes a decision regarding profit distribution or dividend payment. A company may make such decisions quarterly, bi-annually or annually. Profit is distributed out of net profits of the company (and in the case of payment to owners of preferred shares in JSCs, may also be paid out of special funds created for this purpose). In a number of situations profit distribution is prohibited, for instance, until the charter capital has been fully paid up and where the company shows signs of insolvency or may become insolvent as a result of profit distribution. As a general rule, profit is distributed to shareholders or participants pro rata to their share in the charter capital of a company. However, for LLCs it is possible to set out a rule which allows a disproportionate profit distribution. The right to participate in the winding up of the company entitles a shareholder or participant to receive a portion of the proceeds in the event that the company goes into liquidation. The distribution of proceeds in JSCs is more complicated since the company may have to pay owners of preferred shares and shareholders who have demanded that the company buys out their shares (in accordance with the JSC Law). Shareholders or participants may propose candidates to the management and controlling bodies of the company. However, in JSCs this right may only be exercised by a shareholder or group of shareholders collectively holding not less than 2% of voting shares. Shareholders or participants have the right to access information and documents about the company. Both the JSC Law and the LLC Law set out a list of information which is open to all shareholders and participants and set out the procedure for accessing this information. JSC Law also sets out specific mandatory disclosure requirements to be complied with by open JSCs. Access to certain documents of JSCs, such as the company s accounts and minutes of its management board, is open only to a shareholder or shareholders collectively holding not less than 25% of voting shares. In addition to the above, shareholders in JSCs and participants in LLCs have certain rights which only arise once they hold shares or a participatory interest representing a certain percentage of the charter capital of a company. In terms of influencing the decision-making process, in a JSC a holding of 25% + one share is required to block shareholder resolutions which require qualified majority approval (such as amendments to the charter, decisions on reorganisation or liquidation, an increase in the number of authorised shares, a buy-back by the company of its own shares, an increase of the charter capital and the approval of certain major transactions). A holding of a 50% + one share allows the holder to take certain decisions at a general meeting (such as the appointment of the General Director). A holding of a 75% + one share allows the holder to take those decisions at a general meeting which require a qualified majority vote (as described above). The decisions of an LLC may be taken either by a simple majority, by a 2/3 majority or unanimously. The LLC Law allows participants either to vary voting thresholds or provide for weighted voting rights in relation to certain matters set out in the company s charter. The right to participate in the management of the company is exercised by attending the general meeting of shareholders or participants and voting on the issues on the agenda. The law sets out a number of provisions aimed at protecting the rights of minority shareholders or participants regarding management of the company. Provisions include voting thresholds (which allow the minority to veto certain decisions), a prohibition against interested shareholders voting on the approval of interested party transactions, election of the board of directors by cumulative voting (mandatory in JSCs, optional in LLCs) and the possibility to limit in the charter the number of shares or participatory interests which may belong to one shareholder or participant.

20 18 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 8. Financial services regulation Providers of financial services, such as credit institutions, insurance companies, broker-dealers, asset managers and depositories, are heavily regulated in Russia through stringent capital adequacy, behavioural and other licence eligibility and maintenance criteria. In addition, Russian legislation establishes special restrictions on the acquisition of licensed providers of financial services. BANKING REGULATION The Central Bank of Russia The Federal Law on Banks and Banking Activity (the Banking Law) and the Federal Law on the Central Bank of the Russian Federation (the CBR Law) set out the framework of the Russian banking regulatory regime and provide for the establishment, objectives and ongoing functions of the CBR, an independent regulatory body which is vested with exclusive authority to issue currency, manage currency circulation and regulate the Russian banking sector. In particular the Banking Law and the CBR Law set out: threshold conditions for authorisation and principles to be followed by Russian banks; prudential standards (including regulatory capital requirements and accounting standards); and the CBR s supervision and enforcement powers. These powers are set out in more detail in the numerous regulations adopted by the CBR. Banking licence issues Banking activities include: the opening and operation of bank accounts; currency exchange operations; the receipt of monies from companies and individuals by way of deposits and investment of these monies; the process of settlement; and certain other activities as stipulated in the Banking Law. These activities can only be carried out by a Russian legal entity holding a banking licence from the CBR with the exception of Vnesheconombank and the central counterparty in foreign exchange derivatives transactions. The options available to a foreign investor wishing to carry out banking activities in Russia are: establishing a new Russian bank; or acquiring an existing Russian bank; or entering into some form of contractual joint venture or equivalent arrangement. General A CBR banking licence can be granted to: a bank; or a non-banking credit institution. The principal difference between a bank and a non-banking credit institution is that a non-banking credit institution can only perform a limited number of banking operations. Minimum capital The minimum charter capital of a newly incorporated bank is RUR300 million (approximately US$10 million) or RUR3.6 billion (approximately US$120 million) if a newly incorporated bank applies for a licence to perform operations with individuals. There are special rules regulating which assets can be contributed to the charter capital of a bank. Foreign investment incorporation Incorporation of a Russian bank is document intensive and entails: CBR authorisation of the bank s proposed name; the founder s resolution to incorporate a bank; the submission of registration documents; bank registration and management approval; charter capital formation; and the issue of licences. In addition, in the case of foreign founders, prior to the licence application and bank establishment procedure, in principle consent needs to be obtained from the CBR, which is issued by the CBR at its sole discretion. After the submission of registration documents (which involves considerable work) the CBR has six months to consider the application and it would be prudent to allow nine months to one year for the application process to be completed. Foreign legal entities cannot obtain CBR licences and conduct banking operations. Nor is it possible for foreign banks to open branch offices in Russia. No system of sub-licensing exists in Russia.

21 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 19 Types of licences A newly created bank may generally only obtain a licence to conduct banking operations with legal entities (rather than individual retail customers) in Russian and foreign currency transactions, a Type One Licence. A Type One Licence permits the following banking operations: taking bank deposits from legal entities; investing funds deposited by legal entities; opening and maintaining the bank accounts of legal entities; effecting settlements on the instruction of legal entities (including correspondent banks) regarding their accounts; collection of monetary funds, promissory notes and bills of exchange, settlement and payment documents of legal entities and individuals; issuing bank guarantees; making transfers of monetary funds on the instruction of individuals without the requirement for bank accounts to have been opened (excluding postal transfers); and the sale and purchase of foreign currency in cash and non-cash form (if the Type One Licence permits foreign currency transactions). Thus, with regard to individual retail customers, a Type One Licence does not allow: the opening of any type of bank account; or deposit-taking. A bank that already has a Type One Licence may, two years after its state registration as a legal entity, obtain a licence permitting banking operations with individual retail customers, a Type Two Licence. A Type Two Licence may only be issued to a bank which maintains mandatory insurance of an individual s bank deposits. A newly incorporated bank may apply for a licence which allows the bank to process a full range of banking operations with corporate entities and individuals (including Type One and Type Two Licences) provided it has capital of not less than RUR3.6 billion (approximately US$120 million). A bank which has a Type One Licence and a Type Two Licence permitting all banking operations in Russian and foreign currency may obtain a general licence, provided that the bank s capital base is not less than RUR900 million (approximately US$30 million) and such bank has been operating for more than two years. This general licence allows a bank to undertake all the operations permitted under a Type One Licence and a Type Two Licence and, in addition to: establish foreign branches; and incorporate foreign banks. Foreign investment acquisition The acquisition of equity interests in Russian banks by non-residents is generally subject to the same requirements and restrictions as the acquisition by Russian residents. It is necessary to notify the CBR of an acquisition of an interest in a Russian bank of between 1% and 20% and to obtain the prior consent of the CBR in relation to the acquisition of an interest of more than 20%. Further CBR consent will be required in the event of further acquisitions that exceed: 25%, 50% and 75% of a bank s charter capital if the bank is incorporated in the form of a JSC; 1/3, 1/2 and 2/3 of a bank s charter capital if the bank is incorporated in the form of an LLC; or if an acquirer intends to acquire 100% of a bank s charter capital (applicable regardless of the form of incorporation of the target). The relevant CBR consent is valid for a period of one year. The consent (or refusal) should be issued within 30 days of the submission of the relevant documents. If there is no response from the CBR within this 30 day period, consent is deemed to have been granted. It is also likely that an acquisition will necessitate the prior consent of the FAS. Antimonopoly regulations provide that FAS consent is necessary if the assets of a target bank as at the date of the last balance sheet exceed RUR24 billion (approximately US$800 million) (this figure is periodically revised). The FAS approval process takes between one and three months. Overall, the acquisition of a bank takes approximately half the time required to incorporate a bank. However it may be difficult to find an appropriate target bank and due diligence will of course be a significant issue. The purchase of a bank s assets does not require CBR approval per se. However, in certain circumstances, the transfer of assets will require FAS consent. Any dismissal of the chairman of the management board, chief accountant and certain of his deputies requires a notification to the CBR. Any new appointment of such officers is subject to prior approval by the CBR. Maintaining a banking licence The CBR must terminate a banking licence if: the bank s capital ratio falls below 2%; the bank s capital falls below the minimum charter capital requirement; a bank fails to bring its charter capital in line with its bank capital; a bank fails to meet payment obligations (exceeding a minimum amount) within 14 days; or the bank s capital falls below the minimum requirements applicable to that bank for the relevant period prescribed by statute. There are other circumstances when the CBR may terminate a banking licence (including, for example, breach of banking regulations). INSURANCE REGULATION The Ministry of Finance and the Federal Service for Financial Markets The Ministry of Finance and the Federal Service for Financial Markets (FSFM) are the primary regulators of the Russian insurance industry. The Ministry of Finance is in charge of developing state insurance policy and the regulatory framework for insurance activity while the FSFM is responsible for the regulation of insurance market participants.

22 20 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS The Insurance Law and the Regulation on the Federal Service for Financial Markets (the Regulation on the FSFM) set out the following key functions of the FSFM: licensing insurance operations; monitoring insurance market participants compliance with the Insurance Law and other applicable regulations; monitoring the financial stability and operations of insurance companies; and approving both the increase of the charter capital of an insurance company through investment by a foreign company or its subsidiaries and the disposal of shares or participatory stakes in an insurance company to a foreign company or its subsidiary. Licensing of insurance companies The Insurance Law regulates insurance activities in Russia and provides that the FSFM will be the state agency responsible for licensing insurance businesses and monitoring participants in the insurance sector. Insurance licence issues Insurance licences are normally issued for an indefinite period of time. Upon the request of the applicant and in certain circumstances, the FSFM may issue a licence for a limited period of time. Types of licences The FSFM licences cover the following types of insurance activities: life insurance; pension insurance; medical insurance; accident insurance; motor insurance; property insurance; third-party liability insurance; all risks insurance; and all forms of mandatory insurance. The Insurance Law also regulates reinsurance and mutual insurance activities (which are also subject to licensing). Mutual insurance in this context refers to the insurance of the same object by several insurance companies. Licensing requirements In order to obtain a licence, an insurance company must: have a charter capital of between RUR60 million and RUR480 million (approximately US$2 million to US$16 million) (depending on the type of insurance activity undertaken); ensure compliance with requirements in relation to the qualification level and professional experience of the company s key officers (who must have a degree or equivalent qualification in economics or finance and at least two years of experience in the insurance business); and ensure that the CEO and chief accountant of the company are permanent residents in Russia. Maintenance of the licence An insurance licence is subject to revocation on one of the following grounds: a failure of the insurance company to commence the provision of insurance services within 12 months of the licence being issued or to perform any insurance activities for a period of one financial year; and in the event of the suspension of a licence, a failure to remedy any breaches of Insurance Law or regulations within the term specified by the FSFM. Foreign investment The Insurance Law provides certain restrictions which generally apply to the participation of foreign entities in the Russian insurance industry, including the following: insurance companies subsidiaries of foreign companies or JVs with levels of foreign ownership in excess of 49% may not perform certain types of insurance activities, including life insurance, mandatory insurance and certain types of property insurance. The Insurance Law also stipulates certain requirements in relation to the period of existence and presence in the Russian insurance market of foreign holding companies; the aggregate level of foreign investment in the charter capital of Russian insurance companies may not exceed 50%; and an insurance company or its shareholders or participants must obtain the prior consent of the FSFM for either an increase in charter capital through investment by a foreign company or its subsidiaries or a disposal of an equity interest to a foreign company or its subsidiary. REGULATION OF FINANCIAL MARKETS The Federal Service for Financial Markets The Federal Law on the Securities Market (the Securities Market Law) and Regulation on the FSFM vest the main regulatory and monitoring functions over the securities market in the FSFM. The FSFM is in charge of the following key areas: development of the Russian securities market; regulation of securities trading; investor protection; registration of statutory documents required for the issuance of securities; licensing and regulation of professional securities market participants; and regulation of the Russian stock exchanges, the largest of which is the Moscow Interbank Currency Exchange (MICEX SE). Professional securities market participants The list of professional securities market participants includes: brokers; dealers; registrars; custodians; stock exchanges (effective until 1 January 2014); and asset managers.

23 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 21 The FSFM licenses all of these market participants. Since 1 January 2013, stock exchanges and trading systems have been able to obtain a licence separate from professional securities market participants licences. From 1 January 2014, only this new type of licence will authorise an entity to engage in the organisation of commodities and securities trading. In addition to these professional securities market participants, the FSFM also licenses the activities of clearing organisations. Below is a general overview of the key issues relating to the status of each participant in the securities market and the statutory requirements which regulate their various roles. Brokers A broker is a person who trades securities at its client s expense. A broker may either trade on the stock exchange (if it is duly accredited to do so) or perform over-the-counter trading. Dealers A dealer trades securities in its own name and at its own expense through the public announcement of binding bids for the sale or purchase of securities. Registrars Registrars provide services in respect of maintaining the registers of securities and transactions with securities. Custodians Custodians provide services in the following areas: the safekeeping of security certificates; and recording of title to securities and transfer of title thereto. The custodian has no title to the securities under its control and acts on the basis of an agreement entered into with its clients (the deponents). On 6 November 2012, the National Settlement Depository obtained central depository status. The central depositary has an exclusive right to act as a nominee holder in the securities registers of reporting companies, exchange-traded mutual funds units and exchange-traded mortgage securities. In addition, only the central depository can provide safekeeping for exchange-traded bearer bonds. Euroclear and Clearstream have opened nominee accounts with the National Settlement Depository thereby getting access to trading in certain debt securities. Stock exchanges In addition to certain federal laws and regulations, the operation of stock exchanges is regulated by their own by-laws and regulations. Licensing requirements for a stock exchange are as follows: compliance with minimum equity capital requirements; compliance with the same qualification requirements as those applicable to the employees of brokers and dealers; compliance with certain requirements as to hardware and software specification; and the existence of special departments responsible for listing and de-listing operations and certain specified securities transactions. Asset managers An asset manager can manage: securities; cash to be invested into securities; and cash as well as securities that are received as a result of securities management. An asset manager acts in its own name but is obliged to disclose that it acts as an asset manager, although it is not necessary for it to name its client. Where the management activities only amount to the realisation of the corporate rights attached to the securities, no licence is required. Clearing organisation Clearing organisations determine the mutual obligations of the parties to a contract, including those as a result of netting. A clearing organisation may also act as a central counterparty or engage another legal entity to act as a central counterparty. Clearing activity is the only licensable activity on the securities market that a stock exchange can engage in if the stock exchange itself does not assume a role of a central counterparty. Maintenance of the licence To avoid the revocation or suspension of their licences by the FSFM, professional securities market participants must comply with licence requirements applicable to them. The FSFM may revoke the licence of any professional securities market participant in the event of: repeated breaches of securities market regulations within any one year period; a repeated failure to comply with anti-money laundering rules; a failure to commence the licensed activity within one year of the licence being issued; or a failure to provide the FSFM with documents confirming that breaches have been cured. Anti-Money Laundering Law The Federal Law on Anti-Money Laundering Measures (the Anti-Money Laundering Law) is the key piece of anti-money laundering legislation in Russia. The provisions of the Anti-Money Laundering Law are further developed in a number of CBR and Federal Financial Monitoring Service regulations. The provisions of the Anti-Money Laundering Law apply to any bank or non-banking credit institution, and to all professional securities market participants. The anti-money laundering legislation requires that the relevant organisations should: adopt internal regulations which set out internal control procedures; set up specific departments and appoint officials who are responsible for compliance; take measures to identify clients (and their ultimate beneficiaries); and record and submit to the relevant regulator information with respect to any qualifying transaction (generally, a transaction with a value exceeding RUR600,000 approximately US$20,000 (or its equivalent in other currencies) and having suspicion raising features). Failure to comply with any Russian anti-money laundering provisions may lead to the termination of a licence, administrative proceedings and criminal prosecution.

24 22 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 9. Corporate governance Despite significant improvements over recent years, corporate governance in Russia remains below international standards. Some Russian companies may still lack transparent ownership and operational structures and suffer from weak internal monitoring procedures. Difficulties in applying effective corporate governance techniques result from, amongst other things, imperfections in Russian legislation and the way it is applied by Russian courts. Excessive prescriptiveness in the regulation of JSCs means that investors are frequently prevented from agreeing variations to the provisions of the statutes that regulate corporate governance. The concept of independent directors and liability of directors and managers for damages caused to the company are provided for in law, but are not yet effective mechanisms of control in practice. Nevertheless, substantial developments have been made in corporate governance. Russian companies have come to understand that good corporate governance is crucial to their ability to raise foreign debt and equity capital. Accordingly, large and medium-sized Russian businesses have adopted internal codes of corporate governance and restructured so as to provide a greater level of transparency in the distribution of powers between the owners and the managers. Finally, 30 July 2010 saw the official publication of the Federal Law On counteracting the abuse of inside information and market manipulation and on the amendment of certain legislative acts of the Russian Federation which created a legal mechanism to combat abuse in the form of insider trading and market manipulation. The Code of Corporate Behaviour The Code of Corporate Behaviour (the Code) was approved by the FSFM in 2002 as a model for corporate governance relations in Russian JSCs. The Code is based on the corporate governance of countries in the West. The Code covers all spheres of corporate governance including, for example, principles of formation and operation of corporate bodies, control over business activities, major or interested party transactions, corporate conflicts, payment of dividends, disclosure requirements and so on. Although the adoption of the Code is highly recommended, it is not yet automatically binding. JSCs are, however, obliged to disclose in their annual reports whether they comply with the Code. Listing rules adopted by the MICEX SE require listed companies to comply with the principles of corporate governance corresponding to the requirements of the Code. At present, a number of Russian companies have adopted their own codes of corporate behaviour which, in general, deal with the same issues as the Code and are often based on the Code. Management structure Both a JSC and an LLC may have a two or three-tier management structure, comprising the following: the General Shareholders Meeting (GSM) (or participants meeting for an LLC); the Board of Directors (optional for an LLC and a JSC with less than 50 shareholders holding voting shares); and the executive body or bodies (an individual usually known as the General Director or both an individual and a body of directors usually known as the Management Board) (the Executive Bodies). In addition, a JSC must either establish an internal audit committee, members of which must be elected by the GSM, or elect an internal auditor to monitor its financial and economic activities. Neither the General Director nor any member of any Management Board or Board of Directors may be a member of the internal audit committee. Unless it has more than 15 participants, an LLC is not required to have an internal audit committee or an internal auditor. GSM The GSM is the highest governing body of any Russian company. Its authority, as set out in the JSC Law and the LLC Law, cannot be transferred to the Executive Bodies. Certain issues (such as the election of the General Director and the issue of certain securities) may however be delegated to the Board of Directors. The competence of the GSM in a JSC is exhaustively determined by the JSC Law and may not be extended by the JSC charter or otherwise. Any GSM resolution passed in excess of a JSC s statutory competence will be void. Conversely, the statutory competence of the GSM in an LLC may be expanded by the LLC charter. In both an LLC and a JSC a GSM must take place not less than once a year. One voting share in a JSC grants each shareholder one vote at a GSM. Each participant of an LLC has the number of votes that is proportional to its holding of participatory interests, although weighted voting rights may be provided for in the charter. Most resolutions, whether in a JSC or an LLC, are passed by a simple majority vote, although certain decisions require a qualified majority (3/4 in a JSC and 2/3 in an LLC). Unanimity is required in relation to the most important issues in an LLC (such as reorganisation or liquidation) and for one issue in a JSC (the transformation of the JSC into a not-for-profit partnership).

25 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 23 If there is a sole shareholder in a JSC or a sole participant in an LLC, all issues within the competence of the GSM may be resolved by such shareholder or participant in the form of a written resolution (ie without holding a GSM). Board of Directors The Board of Directors (also known as supervisory council) is the body responsible for the general management of the company, except in relation to those issues reserved to the GSM. A JSC with 50 or more shareholders holding voting shares must have a Board of Directors. An LLC, and a JSC with less than 50 shareholders holding voting shares (in practice this includes almost all CJSCs), may function without a Board of Directors. The LLC Law does not contain any mandatory requirements related to the number of directors, their election, term of office and decision-making procedures, or to the election of the Chairman of the Board. All these issues are regulated by the charter of the company and the internal regulations of the Board of Directors. The only restrictions provided by the LLC Law relating to ensuring the independence of the Board members from all other corporate bodies of the company are that members of the Executive Body cannot comprise more than one quarter of the Board of Directors, that the sole Executive Body cannot be a Chairman of the Board of Directors and that members of the Board cannot simultaneously be members of the Internal Audit Committee. The same restrictions apply to a JSC. Regulation of the Board of Directors in the JSC Law is much more detailed. Members of the Board of Directors in a JSC are elected by the GSM until the next annual GSM (that is, for a maximum term of one year) and may be re-elected an unlimited number of times. Unless specified in the charter of a JSC, the number of directors must be indicated in the minutes of the GSM at which the Board of Directors is being elected and cannot be less than five. A JSC with more than 1,000 shareholders must have at least seven Board members. If there are more than 10,000 shareholders holding voting shares there must be at least nine Board members. The Board of Directors in a JSC is elected by cumulative voting (each shareholder receives a number of votes equal to his voting shares multiplied by the number of directors positions on the Board of Directors, and may distribute them amongst the nominees as he wishes). The Board of Directors shall then be comprised of the nominees who have received the largest amount of votes. The GSM may dismiss the Board of Directors (as a group rather than any member individually) at any time prior to the expiration of its term of office. The competencies of the Board of Directors are specified by the JSC Law (among the most important are convening the GSM, election of the Executive Bodies (unless the Executive Bodies are elected by the GSM), creation of branches and representative offices of the company, recommendations on dividends and the approval of certain major and interested party transactions), but may be expanded by the issues specified in the company s charter. Issues within the competence of the Board of Directors may not be delegated to the level of the company s Executive Bodies. Almost all issues falling within the competence of the Board of Directors (except for calling the GSM and approval of its agenda) may, in the absence of the Board of Directors in a JSC, be vested in the GSM. This option is often used in practice to expand the competence of the GSM. As regards the voting procedures at the level of the Board of Directors, there is a wide discretion to provide for unanimity or qualified majority on almost all issues or to provide the Chairman of the Board of Directors with a casting vote. Russian law does not require the Board of Directors to form committees or to appoint a company secretary. However, the Code contains recommendations on the creation of committees and the election of the company secretary as measures aimed at improving corporate governance in the company. Membership on the Board of Directors does not lead to employment per se. However, often employees of the company are elected to its Board of Directors. The basic position is that membership on the Board of Directors is unpaid. However, the GSM may decide on the remuneration or compensation to be paid to Board members. Executive Bodies The Management Board and General Director The Executive Bodies perform executive management functions and other day-to-day activities of the company. The Executive Body of a JSC and an LLC may be either: an individual (being the General Director); or the General Director and a second executive body (the Management Board). The Management Board is an optional body (except for banks, where having the sole executive body, the Chairman of Management Board and Management Board is a requirement of the Law on Banks and Banking activity). There is neither a statutorily prescribed term of appointment nor a statutorily prescribed number of members (the only statutory requirement is that the General Director must be the Chairman of the Management Board). The procedure for appointment, the number of members and their authority are usually regulated in the charter or the relevant internal regulations. The authority of the Management Board must not overlap with the authority of the shareholders or the Board of Directors. A General Director is a chief executive officer with extremely broad powers in relation to the general management of the company (by the relevant authority of the shareholders, the Board of Directors and the Management Board). The authority of the General Director may be transferred to a management company or external manager by the GSM. The General Director has the authority to act on behalf of the company, to represent the company s interests, to conclude transactions on behalf of the company, to recruit and remove personnel, to issue powers of attorney and implement the resolutions of the GSM and the Board of Directors. Every Russian company must have a General Director. Under Russian law, the General Director has the right to act on behalf of the company and to sign agreements binding the company without any additional authorisation (except as stipulated by the company s charter) or any power of attorney. Russian law allows for the authority of the General Director to be limited by transferring some of his authority to the Management Board or by making his actions conditional on the Board of Directors approval. Any limitation of the General Director s authority must be provided for in the charter of the

26 24 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS company (for example the charter might limit the maximum value of the transactions which the General Director can enter into without the approval of the Management Board or the Board of Directors). The General Director and the members of the Management Board are employees of the company. Both the JSC Law and the LLC Law provide that the Executive Bodies are subordinate to the Board of Directors and the GSM (whose powers include the right to appoint and dismiss the Management Board and the General Director). On 9 June and 1 July 2009, laws allowing SHAs became effective in respect of both JSCs and LLCs. An SHA may include provisions concerning, for example: voting rights; transactions concerning shares or participatory interests, including their transfer; and the exercise of other measures connected with the management, creation, activity, reorganisation and liquidation of the relevant company. An SHA may also contain obligations to exercise or refrain from exercising rights in a certain way and allowing members to waive certain rights, which was previously prohibited. An SHA may bind only the shareholders or participants, not the General Director, members of the Board of Directors or members of the Management Board. A breach of an SHA cannot serve as a ground for invalidating decisions of the managing bodies of the company. The non-breaching party will only have recourse to contractual remedies. In most cases, the law does not require disclosure to the public of the terms of the SHA or the fact of its existence. However, as noted above in chapter 3 of this Guide, in practice Russian law SHAs are very rarely used by foreign investors in Russia due to inconsistent court practice or decisions which make the enforcement of many of Russian law SHA provisions problematic. As an alternative, foreign investors elect to enter into English law SHAs for foreign holding vehicles at the offshore level.

27 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Raising debt finance from abroad There are a number of different ways to raise finance in Russia, including by issuing equity or bonds to investors or using sophisticated structured finance techniques such as securitisation. However, the focus of this chapter is on general issues related to bank debt finance as well as on some key legal issues related to structuring debt transactions in the Russian market. English law as governing law Although the Russian legal framework has improved considerably in recent years and some of the larger Russian banks have started to develop syndicated loan agreements governed by Russian law, it remains the case that the great majority of large syndicated and bilateral loan financings in the Russian market are governed by English law and are documented using the standard forms of the Loan Markets Association. A Russian court would generally view the choice of English law to govern finance transaction documents as valid if: (i) one of the parties to the agreement is non-russian; and (ii) it is consistent with the mandatory choice of foreign law rules, public policy and imperative norms of Russian Law, although this is not normally an issue for loans. Types of loan facility and lender For borrowers in the resource sector, pre-export finance has been the most prominent form of lending, with lenders making a loan and taking security over the borrower s export receivables. As most foreign lenders prefer to lend in US$ or Euros, it has proved useful for them to have a security package over receivables in the same currency, thus mitigating currency mismatches. Limited recourse project financing has also proved popular in Russia, as the Russian government has encouraged the energy and infrastructure sectors to meet some of their huge investment needs by sourcing foreign debt. On such deals, a security package similar to that taken on any other international project financing is taken and there is usually a wide array of lenders, encompassing western banks, Russian banks, export credit agencies and multilateral lenders like the EBRD and IFC. Project financing allows the shareholders to finance the development or exploration of a right or an asset primarily with debt where such debt is to be repaid principally out of revenue produced by the project in question. In the case of borrowers with significant fixed assets (retailers, manufacturers, real estate developers), the most common form of financing in Russia has tended to be a hybrid structure that is somewhere between a limited recourse financing and a full recourse corporate loan. Mortgages would be given over real estate, pledges would be taken over moveable assets and assignments taken over contract rights. Finally, it is worth noting that as western bank lenders have lessened their exposure to Russia in recent years due to losses caused by the 2008 financial crisis and new regulatory capital constraints, other types of foreign lenders have stepped in to fill the vacuum. Some of the most notable foreign lenders to enter the market are the major energy traders and companies, many of whom have developed prepayment structures to finance Russian producers. Under such structures, the foreign energy traders prepay for large volumes of product and charge interest on the prepayment, thus giving the transaction the economic effect of a loan. Term loans A term loan provides a corporate borrower with a specified sum of capital over a specified term. The term of a loan for general corporate purposes is not normally more than five years, but in the Russian market the term is frequently shorter. Term loans are usually committed facilities, which means that the loan agreement contains an obligation by the lender to advance monies to the borrower at the borrower s request (provided that the borrower has satisfied certain pre-agreed conditions precedent). Under a standard term loan facility, there will be a short period at the beginning of the term during which the borrower can draw a lump sum up to a specified maximum amount, the availability period. Alternatively, a term loan can allow drawings to be made in a series of tranches when the borrower needs the finance, which means that it borrows according to its specific requirements. In any event, the loan agreement will either require repayment of the loan by instalments at specified intervals or in one sum at the end of the term. The borrower will be required to pay interest on the loan (see below). Revolving credit facilities Under a revolving credit facility (which is less common in Russia than a term loan facility), the borrower is still provided with a capital sum which is made available over a specified period. However, the main difference between a term loan and a revolving credit facility is that under the latter the borrower can draw down and repay advances of the available capital throughout the life of the loan. Each advance is usually borrowed for a short period of one, three or six months, at the end of which it is repayable. If, however, the borrower is not in default an advance can be immediately redrawn, a rollover. A commitment fee will be payable in respect of the revolving credit facility, which is usually a percentage of the undrawn facility from time to time. Bilateral and syndicated facilities Bilateral facilities involve just two parties, the borrower and the lender. They are used for smaller loans and overdraft facilities.

28 26 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Syndicated facilities are used for larger loans (for example, an acquisition funding); the finance is usually provided by a group of banks referred to as a syndicate. The syndicate members will all be party to common documentation but they may contribute different amounts and will only be liable for their own obligations. Secured and unsecured facilities Lenders will normally take security over the assets of a borrower (and potentially the wider borrower group both in Russia and offshore) in order to increase the likelihood of recovery without unnecessary delay. The taking of security is also designed to avoid the need for litigation and in addition may ensure priority over other creditors of the borrower. For more information relating to taking security in Russia, please see chapter 13 of this Guide. The loan agreement representations Put simply, representations are statements of fact made by the borrower (and other obligors, if applicable) in the loan agreement. Representations are a means of ensuring full disclosure to the lender of all relevant facts. The other main reasons for including these statements in the loan agreement are to provide for a drawstop (that is, the loan agreement provides that money can only be drawn if the representations are true, and any money already drawn may become repayable if any representation becomes untrue) and a specific contractual remedy in the event of their breach. An example of a legal representation is that the borrower has the capacity to enter into a loan agreement and to perform its obligations. An example of a commercial representation is that the borrower is not in default under any other agreements (cross default). The loan agreement events of default Events of default are circumstances which entitle the lender to terminate the loan early, cancel any commitment and demand repayment of all outstanding principal and interest. This process is known as acceleration of the loan. Common events of default in respect of borrowers include late payment, breach of a covenant and insolvency events. The loan agreement interest The interest on commercial loans payable by the borrower is usually at a floating, not fixed, rate. A floating rate of interest is normally the sum of the interbank funding rate (for example, the London Interbank Offer Rate (LIBOR) and the Moscow Prime Offered Rate (MOSPRIME)), mandatory costs (which is the cost of complying with certain regulatory funding requirements) and the bank s margin or profit. The loan agreement fees The nature of the loan facility and market conditions will determine the type of fees payable. Common examples include: front end fees payable in respect of the initial work involved in putting the loan together; commitment fees payable in respect of the undrawn uncancelled commitments (this is to cover a bank s regulatory capital requirements in respect of money which it is committed to lend but which has not yet been drawn); agent s fees payabl. to the bank which take. on the role of facility agent; and cancellation fees payable in the event that the loan facility (or part of it) is never used (for example in acquisition financing, where a company s bid for a target fails). The lender will require some of the representations to be repeated throughout the term of the facility. If the relevant repeated representation is untrue at the time of its repetition, this may trigger an event of default (see below). As in other emerging markets, the number and scope of the representations with which the borrower has to comply is quite extensive. The loan agreement covenants (including financial covenants) Covenants are promises given by the borrower to the lender in the loan agreement. Their purpose is to give the lender some control over the borrower, its assets and activities, by either requiring positive action by the borrower or by prohibiting the borrower from doing something. Breach of a covenant will (upon the expiry of any applicable grace period) trigger an event of default. Examples of non-financial covenants include information covenants (to provide regular financial information), positive covenants (to obtain and maintain insurance) and negative covenants (to refrain from making disposals of certain key assets). Financial covenants are financial targets which a borrower undertakes to meet. Their purpose is to protect the lender s capital and interest and to impose financial discipline on borrowers. The scope of the covenants will depend on the type of borrower and its business, the purpose of the loan and the level of risk.

29 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Securities and capital markets regulation Russian law regulates the issuance of Russian equity and debt instruments and Russian issuers must comply with the requirements of Russian corporate and securities laws and regulations at all stages of the issuance process. Foreign issuers may also place their securities directly with investors in Russia in which case they submit themselves to Russian securities laws and regulations. It is common for Russian companies to raise financing from foreign investors by issuing securities that are governed by foreign law (usually English or US law). These can take the form of depository receipts representing shares of a Russian issuer or notes linked to a loan to a Russian borrower, with such instruments often listed on a non-russian stock exchange. REGULATION OF SECURITIES TRANSACTIONS IN RUSSIA Domestic securities Securities that are issued by a Russian issuer and registered with the FSFM can be freely subscribed for, and consequently re-sold, in Russia. In many instances, including if an issuer wants to trade its securities publicly, it must also register a securities prospectus. An issuer must complete the placement of its securities within one year of the registration of the decision on the issuance and prospectus (if required) by the FSFM although the issuer may amend the decision on the issuance to extend this term. After state registration of the prospectus, the issuer and its agents may advertise the securities to the public provided the advertising is truthful and not misleading. Foreign securities Foreign issuers generally cannot offer their securities to the public in Russia through an initial public offering unless: such issuers are incorporated in the member states of OECD, FATF (Financial Action Task Force), Moneyval (the Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism) or Common Economic Space; such issuers are international finance organisations approved by the Russian government; there is an agreement between the governments or respective market regulators of Russia and the country of the issuer. Currently, the People s Republic of China, Cyprus, the Republic of Korea, Liechtenstein, Luxembourg, Kyrgyzstan, Belarus, Germany, France, Turkey, Oman, Syria, Venezuela, India, the UAE and Brazil have such agreements with Russia; such issuer is a member state, the central bank of a member state orthe territorial unit of a member state of OECD, FATF, Moneyval or Common Economic Space; or such issuers have securities listed on a foreign stock exchange included in the list that was approved by the FSFM. Such securities can only be offered to the Russian public through an initial public offering if they register the securities prospectus with the FSFM. As with domestic securities, publicly advertising foreign securities that have not been registered with the FSFM is prohibited. Arguably, Russian investors can subscribe for initial offerings governed by foreign law provided that the place of subscription is outside of Russia. Secondary trading of foreign securities in Russia In order to be eligible for acquisition by Russian investors, foreign financial instruments (which under Russian law include securities and derivative instruments) must have ISIN (International Securities Identifying Number) and CFI (Clarification of Financial Instruments) codes and be qualified as securities under the relevant order of the FSFM. Foreign securities that do not comply with these requirements can only be acquired by qualified investors with the assistance of Russian brokers, unless they are qualified investors by law. Qualified investors by law are specialised professional institutions, such as credit organisations, professional securities market participants, joint stock investment funds, asset management companies, insurance companies, non-state pension funds, international financial institutions and certain Russian state agencies and corporations. A commercial entity or an individual can also be considered a qualified investor if they meet certain criteria. For example, a commercial entity will be considered a qualified investor if it meets two of the following four criteria: its capital is not less than RUR100 million (approximately US$3.3 million); it effected no less than five transactions with financial instruments in each of the four preceding quarters, the total value of such deals being no less than RUR3 million (approximately US$100,000); its revenues for the last reporting year were not less than RUR1 billion (approximately US$33 million); and its asset value for the last reporting year was not less than RUR2 billion (approximately US$66.6 million). Qualified investors may also acquire other restricted securities that are not available to all investors, for example, units in certain funds or derivative instruments.

30 28 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Russian depositary receipts A Russian depositary receipt (RDR) is a form of security which represents the right to ownership of a certain number of shares, bonds or derivative securities of a foreign issuer. RDRs may only be issued by a Russian registered depositary providing depositary services for not less than three years. RDRs may be sponsored (where an issuer of underlying securities assumes responsibility for the RDRs which represent rights relating to its securities) or unsponsored. Unsponsored RDRs may only be issued if they represent foreign securities which are listed on a foreign stock exchange that is approved by the FSFM. The procedure for issuing RDRs is quicker than for the issue of shares, options or bonds of a Russian issuer. In particular, registering a report on the results of the issue is not required. The time period for placement of RDRs is not limited. If the underlying foreign securities meet eligibility criteria for secondary trading in Russia and are listed on a foreign stock exchange that is approved by the FSFM no registration of issuance or prospectus is required. EQUITY CAPITAL MARKETS Equity issuance An equity issuance can provide a corporate borrower with financing which does not need to be repaid and is tax-free. A JSC may issue either ordinary voting or preferred non-voting shares, making the investment more attractive to investors with a wide range of investment strategies. Types of equity subscriptions Both OJSCs and CJSCs may conduct private placements of their shares or securities which are convertible into shares among a group of identified persons (a placement by closed subscription). Only OJSCs may offer shares or securities which are convertible into shares publicly (meaning open subscription to an unlimited group of persons). To issue additional shares or securities which are convertible into shares, a company s charter must provide for the necessary amount of authorised shares of the relevant class and type. If the charter provides for an insufficient number of authorised shares, the shareholders may amend it by a resolution approved by at least three quarters of the votes cast. Open subscription Open subscription provides the issuer with an opportunity to offer its securities to an unlimited group of persons. An issuer is ordinarily able to exercise a degree of discretion during the allocation process. To place securities through open subscription, the issuer must resolve to increase its share capital through the placement of shares or to place securities convertible into shares, resolve to approve the issuance of securities and then file for registration of this resolution and the relevant prospectus. From 2 July 2013, certain smaller open subscriptions will be exempt from prospectus registration requirements. If the charter allows it, the board of directors may unanimously approve a resolution to issue shares (or securities convertible into shares); otherwise, the shareholders will need to approve a securities issue by a simple majority. However, if the number of ordinary shares (or securities convertible into ordinary shares) to be placed exceeds 25% of the ordinary shares already placed, approval of the GSM by at least three quarters of votes cast will be required (unless a higher threshold is set out in the charter). If shares (or securities convertible into shares) are to be placed by open subscription, existing shareholders have a pre-emptive right to acquire the offered securities pro rata to the number of securities of that class that they currently hold. The pre-emptive right to acquire shares is not waivable. The term during which the shareholders that have pre-emptive rights may elect to exercise such rights will be a period of not less than eight days (if the notification does not stipulate the subscription price and such price is disclosed according to capital markets regulations), 20 days (in other cases when the notification does not stipulate the subscription price) or 45 days from the date of notification. Such term effectively constitutes a waiting period during which the issuer may not place the new shares. Closed subscription A closed subscription allows an issuer to specify directly the prospective subscribers in the issuance decision. Only the GSM may adopt a resolution to place shares (or securities convertible into shares) through a closed subscription. In most cases, closed subscription does not require the state registration of a prospectus, unless the shares are placed to more than 500 shareholders and, from 2 July 2013, in certain other cases. Shareholders who do not vote in favour of a closed subscription or did not participate in the vote have pre-emptive rights to acquire the shares (or securities which are convertible into shares) being placed pro rata to their existing holdings of such securities. Other methods of equity issuance In the process of a reorganisation, such as a merger or acquisition, a JSC may issue equity securities in consideration for the transfer to it of assets of a merging/target entity. A JSC may also increase its charter capital at its own expense, for example, by distributing additional shares to existing shareholders or by increasing the nominal value of its shares. Finally, an entity may issue additional equity as a result of the conversion of its convertible bonds into shares or the exercise of previously issued options. The number of shares which are the subject of outstanding options of a company may not, at any time, exceed 5% of such class of shares already in circulation. There is no limit on the number of shares into which a bond may convert, though there must be sufficient number of authorised shares to allow such conversion. DEPOSITARY RECEIPTS AND OTHER FOREIGN DERIVATIVE INSTRUMENTS FSFM permission The sale of Russian securities abroad, including in the form of instruments governed by foreign law such as depositary receipts, warrants, bonds or other instruments linked to Russian securities, requires the prior approval of the FSFM. Subject to FSFM approval, up to 25% of securities of a particular class can be listed offshore in the form of derivative instruments. The limit will depend on the listing category of the securities. If the securities have an A listing on a Russian stock exchange, the limit will be 25%. If the securities have a B listing, it will be 15%, whereas if the securities have V or I listings, the limit will be 5%. However, if the place of incorporation of the issuer of foreign securities linked to the securities of the Russian company is one of the countries with which the FSFM has an agreement to co-operate, the threshold will be 25% regardless of the listing category of the securities. Notwithstanding this, if the issuer is a Strategic Subsoil Company, the limit will be 5%

31 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 29 unless by the date of application the relevant state authorities have already approved the placement of shares of such issuer abroad, in which case the limit will be 25%. Each issue of shares (including the shares underlying the depositary receipts) must be offered in Russia via a stock exchange or a broker at the same time as being offered abroad. No more than 50% of the shares of an issue can be offered abroad in the form of depositary receipts. The FSFM can waive this requirement for companies with securities which have an A listing on a Russian stock exchange if the depository and the depository program meet certain requirements. Debt capital markets instruments This form of financing involves a company (the issuer) issuing debt securities to investors in return for the loan of capital to the company. These debt securities usually provide that the issuer will repay the capital on a specified date (known as maturity) and that interest will be paid on the capital until that date. Debt securities can be sold by the original investor, and the issuer will then pay interest (and eventually repay the capital) to the owner of the debt security. A company may wish to issue debt capital market instruments to raise capital rather than enter into a loan facility. There are a number of reasons for this, including that a company may have access to a larger number and greater range of lenders (that is, investors) by issuing such instruments, the cost of the capital may be less expensive (because of the liquidity of the markets), the size and maturity of the debt can be more varied (because the market is more extensive and investors can invest in small participations) and generally the terms of a debt capital market instrument will be less onerous and restrictive than those of a typical commercial loan facility. Of course the ability to raise capital by this method (and the terms on which it can be raised) is dependent on market conditions. Bonds Raising capital through debt capital markets instruments is generally effected by the borrower (called the issuer) issuing a debt security generally known as a bond or note. The terms bond and note are often used interchangeably as there is no difference in form or content between the two (we refer to the instruments as bonds in this chapter). That said, traditionally bonds have a final maturity of seven or more years from the date of issue and floating rate instruments are referred to as notes. A bond is a certificate of debt under which the issuer promises to pay the principal amount borrowed to the lender (referred to as the bondholder) on the maturity date of the bonds. There are no rules as to when this maturity date will fall. Typically it will be more than three years after the issue date of the bonds and may be as long as 10 or 20 years thereafter. The main characteristics of a bond are: it is a debt obligation in the form of a transferable instrument with a medium or long-term maturity; it is sold to a large number of investors through a syndicate of financial organisations, or it is sold to a small group of specifically targeted investors; it is a marketable instrument (that is, it has an established secondary market); it may be listed on a recognised stock exchange; it may be unsecured; it may be rated by a credit rating agency to enhance marketability; and it will bear interest or be issued at a discounted price. Domestic bonds of Russian companies Russian JSCs and LLCs may issue bonds provided that the issuer s charter capital is fully paid. Domestic bonds of Russian issuers may be denominated either in RURs or in foreign currency. Bonds may be redeemable in cash or by payment in kind. Domestic bonds are usually issued in bearer form. There is no trustee or similar mechanism with respect to domestic bonds and in case of default the holders may enforce their rights under the bonds directly against the issuer or, if applicable, the guarantors. Unlike their western counterparts, domestic Russian bonds do not contain covenants (other than payment covenants) or other provisions that would allow the bondholders to accelerate the bonds. At the same time, put options at certain periods are a common feature of domestic Russian bonds. As with equities, the issuance of domestic bonds other than stock exchange bonds discussed below and the bonds of the CBR require registration of issuance and approval and registration of the prospectus by the FSFM before any offering to the public may be made. Stock exchange bonds Stock exchange bonds are the Russian equivalent of short-form commercial paper (being debt instruments with a term of up to one year). The holders of stock exchange bonds only have a right to the nominal value of the bonds or nominal value and fixed interest. Stock exchange bonds can be paid for only in cash and all payment of principal and interest thereunder can only be made in cash. Only companies which have existed for at least three years with available audited financial reports for two years can issue stock exchange bonds. Stock exchange bonds can be placed only through open subscription and must be admitted to the stock exchange. The main advantage of stock exchange bonds over ordinary bonds is the simplified procedure for their issue and circulation since there is no requirement to register the bonds or a prospectus with the FSFM. There are also simplified requirements relating to the content of the prospectus. In addition, stock exchange bonds do not need to be guaranteed or otherwise secured by third parties. Foreign law governed bonds linked to Russian assets A Russian company may set up a vehicle which allows it to raise finance in foreign markets, in order to obtain that financing on better terms. To raise finance offshore, Russian borrowers normally set up an offshore special purpose vehicle, which offers notes linked to a loan granted to a Russian borrower or to any other performing assets (for example, consumer credit debts owed to a Russian debtor) to international investors. The obligations under the notes normally mirror the underlying debt and it is quite common that investors are not granted direct unlimited recourse against the special purpose vehicle issuing the notes.

32 30 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS The form of a bond Bonds can be issued in one of two forms: bearer or registered. Bearer bonds these are negotiable instruments whose title passes by delivery of debt securities. This means that passing the bond certificate from one person to another transfers legal ownership and the bond certificate itself is proof of ownership. Russian publicly traded bearer bonds can only be issued where the global bond certificate has been deposited with the central depository. Registered bonds unlike bearer bonds, registered bonds are not negotiable instruments and title passes by registration of the bondholder s name in a register. Both bearer and registered bonds will generally be held in, and traded through, clearing systems. Their function is to provide safe custody for, collect payments on, and facilitate the transfer of, securities. Investment funds Russian law recognises two types of investment funds: joint stock investment funds; and mutual investment funds. The principal difference between them is that a joint stock investment fund is a licensed legal entity created for the purpose of investing in the assets while a mutual investment fund is a pool of assets managed by a trustee, which is also a licensed legal entity, for the benefit of its participants. Joint stock investment funds A joint stock investment fund is an OJSC licensed by the FSFM for the purpose of investing in assets in accordance with its investment declaration. Shares of a joint stock investment fund can be paid for in cash or by other assets allowed in its investment declaration. The investment assets of a joint stock company must be managed by a licensed asset management company. A joint stock investment fund can exist for an indefinite term. A shareholder of a joint stock investment fund does not have the right to demand redemption of its shares other than in cases prescribed by the JSC Law or in the event of an amendment of the investment declaration (provided that the shareholder voted against such amendment or did not participate in the vote). Mutual funds A mutual fund represents an asset portfolio consisting of assets placed under the management of an asset management company that is subject to the trust management rules which each fund investor agrees to. The assets of all fund investors are pooled together. The share in the funds property rights is evidenced by a participation unit distributed by the asset management company. Mutual investment funds may be open-ended, exchange-traded, interval or closed-ended. The life of a mutual investment fund can be up to 15 years. Open-ended mutual funds Units of an open-ended mutual fund can be purchased and sold at any time. The number of units in an open-ended mutual fund can therefore either increase or decrease. Open-ended funds can be funded only by cash and their assets are usually highly liquid. Exchange-traded mutual fund Units of an exchange-traded mutual fund can be sold at any time to an authorised person or at a stock exchange. The authorised person has a right to demand the redemption of the units by the trustee within a specified period of time. Exchange-traded funds can be funded by cash and other assets. Closed-ended mutual funds Such funds contain a fixed number of units which can be redeemed only upon expiry of a trust agreement or upon the occurrence of certain other events specified by applicable law. If the trust management rules allow it, a closed-ended mutual fund can distribute profit during its life. Closed-ended funds can be funded by cash and other assets, including real property. As their units do not have to be repaid in the short term, such funds often invest in illiquid assets, such as real property, mortgage loans, and venture projects. Interval funds An interval fund lies somewhere between an open-ended and a closed-ended fund. Strictly speaking, interval funds are open-ended investment funds whose units are available for purchase and sale. However, transactions with the units of such funds may only take place within certain periods. Interval funds can be funded only by cash and their assets are usually highly liquid. Qualified investors Some funds, for example, funds of direct investments, funds of risky (venture) investments, credit funds and hedge funds can be sold only to qualified investors. INSIDER TRADING AND PRICE MANIPULATION Insider trading On 27 January 2011, a new federal law on insider trading and market manipulation came into force. It applies to matters connected with actual or proposed trading in financial instruments, currencies and commodities in organised markets in Russia. Under the law, inside information is price sensitive information which: is precise, concrete, non-public information; if publicly disclosed, may substantially influence the price of financial instruments, foreign currencies or commodities; and is of a type to be set out by relevant regulations. The law provides for an extensive list of persons considered to be insiders, including issuers, their management, consultants, professional securities market participants, state agencies, etc. Insiders have certain compliance obligations. For example, the issuers need to: maintain a list of insiders; notify persons on the list of their inclusion in, and removal from, the list in the manner prescribed by the FSFM; make the list available to certain exchanges in the manner prescribed by the FSFM; make the list available to the FSFM upon demand; develop and approve the procedures for access to inside information, protection of its confidentiality and compliance with the law; set up (appoint) a unit (an officer) that will be responsible for compliance with the law; and

33 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 31 approve the list of categories of information which would constitute inside information. The issuer s categories need to correspond with the list of categories approved by the FSFM which is, in turn, similar to the list of categories of material facts. The issuers are required to publish their inside information in the same manner as material facts. Those listed as insiders by the issuer need to notify the issuer and the FSFM when they carry out a transaction in the securities of the issuer and any financial instruments linked to these securities. However, any person in possession of inside information may not use inside information in the following manner: for transactions with financial instruments, currencies or commodities for one s own or another person s account; recommending, obliging or inducing third parties to deal in finance instruments, currencies or commodities; transferring inside information to third parties other than to persons on an insiders list in connection with the performance of their obligations under the law or labour or civil contracts. Legal entities which use inside information may be liable to administrative fines equal to the illegitimate income or illegitimately avoided expenses of the entity but may not be less than RUR700,000 (approximately US$23,000). From 30 July 2013, individuals may be criminally prosecuted. repeated entering into transactions involving the same financial instruments, currencies or commodities with no intention of performing them. Stock exchanges are required to develop the test of what substantiality means in this context on the basis of the FSFM recommendations. The following actions however do not constitute market manipulation: supporting the price of securities in connection with a placement by a market maker acting pursuant to an agreement with an issuer; supporting the price of shares through a company buy-back or the redemption of closed unit investment funds; supporting the price, supply, demand or volume of trading of financial instruments, currencies or commodities by a market maker acting pursuant to an agreement with an exchange. Professional securities market participants which engage in market manipulation can lose their licences and persons engaged in market manipulation can be subject to substantial administrative fines and criminal liability. Market manipulation Market manipulation includes the following actions as a result of which the price, supply, demand or volume of trading in the relevant financial instruments deviated substantially from what it would have been had such actions not been taken. wilful distribution of deliberately false information via publicly available sources; entering into transactions involving financial instruments, currencies or commodities where the parties to the transactions have a pre-existing agreement to undertake such transaction; entering into transactions where the ultimate beneficiary on both sides of the transaction is the same person; the submission of buy and sell orders for or on behalf of the same person where the price of the buy order is equal to, or greater than, the price of the sell order; during the course of a single trading day repeated execution of transactions for or on behalf of the same person on the basis of orders having, at the moment of their submission, the highest purchase price or the lowest selling price; during the course of a single day, repeated execution of transactions on account of or for the benefit of the same person in bad faith and with the purpose of misleading other market participants about the price of financial instruments, currencies or commodities;

34 32 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 12. Derivative instruments The Russian derivatives market is still developing. New legislation has been adopted recently to deal with long-debated issues, including the judicial protection of derivative transactions, netting, enforcement, tax and accounting treatment. History of the derivative market Trading in derivatives in Russia commenced in 1992 and developed steadily until the financial crisis of 1998 caused a decline in the derivatives market. Trading in derivative instruments resumed in 2000 when the Saint Petersburg Currency Exchange (SPCEX) began trading in currency and equity based derivatives and MICEX SE opened its floor to trading in foreign exchange futures. The first derivative contracts were futures on US dollars. Gradually, derivatives emerged on indices, equity, debt and commodities. Russian market participants use a wide range of specifically tailored over-the-counter derivative instruments, mainly as hedge instruments mitigating the risks in underlying transactions. In general, the Russian derivative market remains predominantly a hedge market and the number of derivative transactions hedging risks vastly outnumber speculative deals. Derivative trading in Russia remains behind the equity and currency spot markets due, in part, to uncertainty in the application of the newly-adopted regulations. The key legal acts that regulate derivative instruments are the Federal Law on Clearing and Clearing Activity and the Securities Market Law. The FSFM gives a general description of forwards, futures and options traded on the securities and commodities markets in its regulations. The Federal Law on the Securities Market provides the definition of the derivative instruments and specifies the particular requirements for derivative trading on stock exchanges and over-the-counter and enforcement of standard documentation provisions. The Tax Code of the Russian Federation (Tax Code) regulates taxation of derivative instruments and the Civil Code deals with some issues relating to enforcement. In 2009, the Association of Russian Banks, National Foreign Exchange Association and NAUFOR (the National Association of Stock Market Participants) adopted a Russian version of the ISDA Master Agreement (Russian ISDA). Following developments in legislation, the documentation set was updated in 2011 and the latest version is available on their websites. Judicial protection Following the 1998 crisis, the largest problem parties to derivative contracts faced was the inability to enforce rights in the Russian courts. Russian counterparties refused to honour non-deliverable forward contracts and the Russian courts, including the Constitutional Court of the Russian Federation, refused to enforce them. In 2007 amendments to the Civil Code granted judicial protection to the transactions obliging a party to make a payment dependent on a change of price in goods or securities, the exchange rate of specific currencies, interest rates, inflation rates or the occurrence of other uncertain events contemplated by law. All instruments mentioned above are enforceable in courts if (i) at least one party is a legal entity with a valid banking licence or a licence as a professional securities market participant or, (ii) at least one party to a transaction concluded on a stock exchange is a legal entity that holds a licence permitting it to conduct trades on exchanges. Claims of individuals are only protected by courts if a trade takes place on a stock exchange. Regulators The primary regulators of derivative instruments are the FSFM and the Ministry of Finance. The FSFM is responsible, amongst other things, for supervising stock exchanges and self-regulatory organisations, licensing professional securities market participants and classifying various types of securities and derivatives. The Ministry of Finance, amongst other things, regulates investment by pension funds and insurance companies, including investment in derivative products. Traded derivatives Today, trading in derivative instruments in Russia takes place in the over-the-counter market and, almost exclusively, on four Russian exchanges: the MICEX SE, the MSE (Moscow Stock Exchange), the SPBEX (the Saint Petersburg Stock Exchange), and the SPCEX. The MICEX SE provides the largest trading floor. The largest traded derivatives are currency derivatives. Following the merger with the RTS, the MICEX SE offers trading in a wide range of instruments, including currency derivatives, futures based on equity, debt and commodities and on its indices. Futures based on equity are normally linked to shares of blue chip companies operating in major sectors, such as oil, energy, telecommunications, and metal. Futures and options based on debt instruments are linked mainly to federal and municipal bonds, such as Moscow City bonds and Eurobonds of the Russian Federation. Some examples of commodity derivatives would be diesel and jet fuel futures, deliverable futures on sugar, futures and options on crude oil (Urals and Brent). Other derivative instruments There are a number of derivative instruments which are specifically tailored for the particular transactional needs of clients, primarily to mitigate currency risks or manage fixed or floating assets and liabilities. The most commonly used instrument of this kind is a cross-currency swap. The most common reason for the use of cross-currency swaps

35 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 33 is to hedge foreign currency risks when a Russian entity borrows in foreign currency but its income is primarily in Russian roubles. Other popular tailored derivative instruments are interest rate swaps (where one party exchanges a stream of interest payments for another party s stream of cash flows) and future rate agreements (contracts that set the rate of interest, or the currency exchange rate, to be paid or received on an obligation with a future start date). These instruments are ordinarily governed by foreign law and incorporate terms and conditions of standard documentation, such as the ISDA Master Agreement and ancillary documents. There is, however, a growing number of agreements based on the Russian ISDA. Their enforcement is subject to legislative shortcomings as described in the Major issues section below. Standard documentation Following major developments in the derivatives legislation, the Federal Law on the Securities Market recognises the existence of standard documentation for the purposes of close-out netting (as described in the Major Issues section below). In particular, the Russian ISDA has been approved by the FSFM as qualifying standard documentation for these purposes. The Russian ISDA is not the only option, however. Russian law allows a derivative transaction with a foreign element (ie where at least one party is a foreign entity) to be governed by foreign law (usually English or New York). Normally, the parties use standard documentation developed by the International Swaps and Derivatives Association (ISDA) and the International Capital Market Association (ICMA), the two most significant of which are the ISDA 2002 Master Agreement (ISDA MA) and the Global Master Repurchase Agreement (GMRA) (regulating, amongst other things, default and close-out provisions in respect of non-deliverable forwards). The Federal Law on the Securities Market allows the parties to derivatives transactions to make reference to the model terms developed by the ISDA and the ICMA in their agreements if one of the parties is a foreign legal entity. Major issues The main problems relating to enforcement of foreign law derivative instruments are claims in bankruptcy, offering restrictions and qualification of certain terms. Claims in bankruptcy If a Russian party to a derivative transaction goes bankrupt, the court may prohibit any settlements and/or netting (close-out netting) with the creditors as violating the priority of claims, unless the agreement meets the following criteria: it conforms to the model terms of the qualifying master agreement (being a master agreement referring to the model terms adopted by a self-regulatory organisation of market participants that include termination procedures and minimal content requirements and that was approved by the FSFM or a master agreement based on the ISDA MA or the GMRA); it is entered into between qualifying parties, one of which needs to be the Bank of Russia, a Russian or qualifying foreign bank, a Russian or qualifying foreign professional securities markets participant, a qualifying foreign central bank, or international financial organisation; and the parties reported the agreement to the repository. Alternatively, the agreements need to be entered into in accordance with the relevant clearing or exchange rules. If the master agreement does not qualify for close-out netting, the counterparty of the Russian debtor may still have to pay amounts due to the debtor, at least as far as Russian law is concerned. Currently, only the National Settlement Depository acts as a repository and only keeps the records of REPO agreements and cross-currency swaps. Consequently, this risk currently exists for OTC derivatives other than reported REPO agreements and cross-currency swaps (until there is a repository that keeps the records of all types of derivatives) even though they may meet all other requirements. Furthermore, transactions entered into by the debtor after the start of bankruptcy proceedings or during the period of six months before the filing of the bankruptcy petition may be declared null and void by the court if such transactions result in the preference of certain creditors over others. Offering restrictions In addition to the rules that limit the enforceability of derivatives, certain types of derivatives may be offered only to qualified investors. This includes foreign financial instruments that were not qualified as securities under the Federal Law on the Securities Market. A more detailed description of rules that govern qualified investor status is provided in chapter 11 of this Guide. As a result, setting up an incentive scheme in the form of a share-option plan is linked with certain difficulties. As a matter of practice, share-option plans in Russia are structured through foreign securities acquisition but employees are not usually qualified investors and employers cannot offer them foreign derivatives. The FSFM in one of its regulations has said that it might view favourably the practice of granting employees foreign securities not listed in Russia as a labour compensation. However, there are still problems with this approach. First, the option needs to qualify as a foreign security including assignment of ISIN and CFI codes which is not common for share-options plans. Second, it is debatable whether the FSFM can ultimately overrule this offering restriction. So there are still certain amendments required in order to legalise fully share-option plans in Russia. Qualification of certain terms Russian courts are generally not familiar with derivative transactions and standard international documentation governing derivative transactions and may reclassify or render unenforceable some terms and conditions, such as trust provisions or pledges of cash collateral. In a recent case, the courts upheld the unilateral termination of an interest rate swap based on a master agreement and confirmation. The master agreement provided for a right to terminate the agreement unilaterally if there were no unfulfilled obligations. According to the confirmation, the parties had an obligation to pay the difference quarterly. The courts interpreted this clause as meaning that the parties did not have any unfulfilled obligations until the calculation date. Effectively the courts disregarded the confirmation as a source of continuing payment obligation which may result in effectiveness of derivatives transactions. In addition to the issues discussed above, the amendments to Russian tax legislation in relation to the taxation of derivative transactions have not yet been fully tested in practice and contain a number of uncertainties. Any derivative transaction therefore requires proper structuring and analysis from a Russian tax law perspective.

36 34 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 13. Taking security There are a range of forms of credit support available under Russian law. Taking effective security under Russian law has, however, historically been problematic. The reasons include the unavailability of security over certain classes of assets and the inadequacies of the security public record and the enforcement regime. However, the changes to the security enforcement regime introduced in 2009 and 2012 have considerably improved the position and, in particular, the protection of secured creditors. Pledge over assets A pledge grants creditors the status of secured creditors in the event of the debtor s insolvency and, accordingly, priority over the claims of unsecured creditors (up to the value of the pledged assets). The recent amendments to the regulation of pledges and mortgages ensure that secured creditors receive at least 70% of the value of the pledged assets ahead of any personal, public or any other unsecured claims in the case of the debtor s insolvency. Russian legislation provides that a valid Russian law pledge must: be recorded in writing; include certain information relating to (amongst other things) the nature of the secured obligations and details of the nature and location of the property that is the subject of the pledge; and generally, be granted by the owner of an asset. The pledge may be enforced only if the debtor under the secured obligation has failed to perform the obligation. Additional restrictions are set out in the relevant legislation. For example, the Civil Code provides that a court can refuse to order execution if the debtor s failure is insignificant and the amount of the secured creditor s claim is not commensurate with the value of the pledged property. The parties can agree in the pledge agreement that the levying of execution against the relevant property can occur without a court order. Save for limited exceptions, out-of-court enforcement of pledges will be available only on the basis of an executive endorsement of a notary. In practical terms it means that in order to initiate the enforcement of most pledges, a pledgee will have to apply to a Russian notary for an executive endorsement on the pledge agreement, which will allow for further realisation of the pledged property in accordance with the terms of the pledge agreement. The relevant legislation provides that a notarial executive endorsement may only be granted by a Russian notary in respect of pledge agreements which have been notarised. Given the resulting cost implications in most cases notarial certification is rather expensive our view is that the potential benefits of the out-of-court enforcement should be carefully considered for each transaction before a decision is taken to notarise the pledge. Recent liberalisation of the pledge enforcement regime permits the pledgee, in addition to a public sale (which was the only available enforcement option before the recent amendments took effect), to sell the pledged assets to a third party or take possession of the secured asset. These additional options are not available if the pledge is granted by an individual. Pledge over goods in turnover A pledge over goods is used where the relevant group of assets may fluctuate from time to time free from encumbrance and without the permission of the pledgee. Additional goods of similar value and characteristics must however be added to the pool of pledged goods in turnover so as to maintain the aggregate value of the pool at a certain pre-agreed level. The key to the workability of this type of security is the need, at all times, to be able to identify and keep separate the goods which are subject to the pledge and to ensure that the pledgor does not dispose of goods in contravention of the pledge agreement. Pledge over shares and participatory interests A pledge of Russian shares is subject to registration in the shareholders register and does not entail a transfer of voting rights to the pledgee. The right to receive dividends may be transferred to the pledgee. As of 1 July 2009, a pledge of a participatory interest in an LLC (in contrast to the pledge of Russian shares) has to be notarised and recorded in the public register. Mortgage A mortgage is a specific category of pledge, which is used to create security over immovable property and certain categories of movable property (such as ships and aircraft). The rules discussed above regulating pledges are also applicable to mortgages. The key difference between a pledge and a mortgage is that a mortgage becomes effective upon its state registration and, in the absence of such registration, is considered to be null and void. Recent amendments to the regulation of mortgages permit parties to enforce a mortgage without recourse to courts (unless a limited number of exceptions apply). Similarly to the position on pledges described above, the out-of-court enforcement in respect of mortgages will be available only on the basis of an executive endorsement of a notary, which may only be granted by a Russian notary in respect of mortgage agreements which have been notarised. The enforcement options which are available to the mortgagee are not identical to those available to the pledgee and include a public sale and taking possession of the secured asset (this option is not available if the mortgage is granted by an individual).

37 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 35 Security over bank accounts Russian law does not permit the taking of security over bank accounts or monies held in bank accounts. Nor is it possible to create an effective mechanism in relation to the debtor s rights to a bank account, since the mandatory provisions of Russian banking law stipulate that the rights of the holder of a bank account may not be contractually restricted. An instrument which is sometimes used as an attempt to create quasi security over bank accounts is a direct debit rights agreement, which permits the creditor, upon the occurrence of an event of default, to debit the debtor s account without a specific instruction or the consent of the debtor. This agreement, however, cannot prevent the debtor from debiting or closing the account, and, accordingly, offers little comfort to creditors. Assignment Assignment in this context means the transfer of rights but not obligations. An assignment will transfer to the new party all (or part of) the existing party s rights under the relevant agreement. Russian law has historically imposed stringent restrictions on assignment (for example the assignment of future rights and partial assignment were prohibited). This stringent approach, however, underwent changes following the Supreme Commercial Court s explanatory note issued in October 2007 which purported to liberalise Russian assignment rules. Suretyships A suretyship is an undertaking by one party (the surety) to be liable for the obligations of another party upon default by the latter. Suretyships are often given by a borrower s parent company or by another company in the same group. The surety may also be required to give security over its own assets to support its potential liability under the suretyship. The suretyship is a quasi security instrument, since it does not create a proprietary interest but merely gives a creditor a contractual right to recourse against the relevant entity. Bank guarantees A bank guarantee is another category of quasi security instrument and, in essence, is similar to a suretyship. The difference between a guarantee and a suretyship under Russian law is that only credit and insurance organisations may provide guarantees and a guarantee creates an independent obligation of the guarantor to pay the amount stipulated in the guarantee, whereas a suretyship creates a secondary payment obligation.

38 36 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 14. Acquiring and investing in real estate Property rights in Russia are governed by federal legislation (other than some more technical privatisation, planning and construction issues regulated by regional and local rules). However, despite extensive regulation, property law and practice, which is only about 15 years old, is still developing and is sometimes inconsistent. It is expected to remain so in the near future. Property transactions such as conveyancing, leases and mortgages are subject exclusively to Russian law. Acquisition of Russian real estate by foreign investors The following restrictions apply to ownership of land in Russia by foreign nationals: foreign individuals and entities are not allowed to own land in areas adjoining the borders of Russia; and foreign individuals and entities as well as Russian entities with over 50% foreign participation may not own agricultural land. Subject to the above restrictions, property can be purchased or leased by individuals and companies for their own use or as an investment. There are no specific restrictions as to lease of land or ownership or lease of buildings and facilities by foreign nationals. Types of property interests There are two main legal interests in real property: ownership full title allowing possession, use and disposal of the property, including leasing it out to tenants. Ownership rights to land extend to the surface (soil) layer of the land plot as well as to water (with some restrictions) and plants on the land plot. Subsoil is entirely state-owned; and lease interest allowing possession and use of the property for a specified or an indefinite term. There also still exist certain rights to property which are at present primarily reserved for state institutions (such as permanent use ). These are no longer granted to individuals and private entities and are non-transferable. In Russia it is not possible to separate the legal interest in property from the beneficial interest. Registration of real estate The ownership right and other rights in rem over real estate, most encumbrances and restrictions of such rights (such as long-term leases, mortgages and liens), their accrual, transfer and termination are subject to state registration in the Unified State Register of Real Estate. Some agreements under which rights in rem and encumbrances which must be registered arise are also subject to state registration (as provided by law) and are null and void without such registration. Long-term leases and mortgages are the most notable examples. The Unified State Register of Real Estate is, for the most part, a matter of public record and any person may request an extract from this register in relation to particular property. The extract will contain a description of the property (type, address, size) and reflect the type of registered right to the property, the holder of the right, as well as encumbrances and restrictions of the registered right as at the date of the extract. In addition, all real estate in Russia is supposed to be recorded in the State Real Estate Cadastre (which replaced the pre-existing State Land Cadastre concerning only land plots, not buildings). Conveyancing or encumbering land plots which have not undergone the procedure of official survey and cadastral record are deemed null and void, though forward sale and forward lease (whereby an agreement envisages conveying or encumbering title that is yet to be created) are allowed. At present, there are no similar restrictions in respect of buildings, parts of buildings and other fixed facilities. Similarly, forward sales and leases of buildings and other properties are possible. Unregistered real estate State registration is mandatory only in respect of real estate (or rights associated with real estate) where the rights were granted, or the transfers of title effected, after the Federal Law on state registration of real estate and transactions came into force in January Rights which arose prior to that date are not required to be registered and will be recognised as valid by the state. These rights must, however, be registered upon transfer or encumbrance. The holder of an unregistered right in real estate can only establish good title by producing documentation evidencing the acquisition (such as a sale and purchase agreement, inheritance certificate or privatisation documents), or records in the pre-existing regional and local registers (if any and these have now been replaced by the Unified State Register of Real Estate). In the absence of any title documents whatsoever, the proprietor may rely only on prescription, which arises where the supposed holder of title to the property has had open and continuous possession of the property in good faith for a term of 15 years or more. Lease Leases can be granted for an indefinite period of time (terminable by either party on three months notice) or for a specified (fixed) term. A fixed term lease can be long term (over one year in relation to land plots and one year or more in relation to buildings or parts of buildings

39 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 37 and immovable facilities) or short term. Commercial leases are commonly long term (five to ten years). In almost all parts of Russia the maximum lease term for land is 49 years. Long term lease agreements must be registered with the state in order to be effective. Short term lease agreements and lease agreements for an indefinite term do not require registration with the state. Commercial leases are treated very much as a matter of private concern, with a rather limited number of mandatory rules and restrictions. While most of Russia s land is still state or municipally owned, commercial property is predominantly privately held. Accordingly commercial lease terms tend to deviate from the default statutory position of equal treatment of the parties and favour the landlord or the tenant depending on their respective economic strength, negotiation leverage and market situation in a particular location. In the past few years the lease market in the developed regions of Russia such as Moscow has been heavily landlord-driven, and leases have tended to benefit the landlord (for example, the landlord having the right to terminate without recourse to the court for the most minor breaches by the tenant, with no corresponding rights for the tenant). However, as a result of the recent economic downturn the position of the landlord has been weakened and tenants have increased their negotiating power in this area. Under the general rules governing leases, the tenant has a right of first refusal to renew the lease on expiration, unless the agreement provides otherwise, but the parties are free to alter the terms and conditions of the new lease. Transfer of real estate A typical sale and purchase transaction is a two-stage process involving the execution of a sale and purchase agreement (which must be a single written document; an agreement by fax or exchange of letters is not valid) and registration of the transfer of title in the Unified State Register of Real Estate. The handover of the property is effected by completing a document which formally conveys the property from the seller to the buyer. As a general rule, if a building or other immovable facility and the underlying land are owned by the same person, sale of the building without the underlying land (and vice versa) is not allowed. If the land happens to be the property of someone other than the owner of the building, the building can still be sold, and the new owner will enjoy the same rights to use the respective part of the land plot underlying the building as the previous one. Tax implications of acquiring an interest in property Generally, commercial property transactions are subject to VAT. Presently, sale of land and residential property transactions are not subject to VAT. The sale of a Russian company by its foreign parent entity may be subject to withholding tax in Russia (depending on the relevant double tax treaty provisions) if more than 50% of the Russian company s assets are real estate. (Please see Appendix 2 to this Guide for a list of countries with which Russia has a double tax treaty.) Should the tenant continue using the property after the lease has expired and the landlord does not object, the lease is deemed to be renewed on the same terms and conditions as the old lease for an indefinite period of time (and is therefore subject to termination by either party upon three months notice). In the case of state or municipal land the tenant has, with some exceptions, a statutory pre-emptive right to purchase the land plot if it is put up for sale. Where land is privately held, a tenant enjoys a statutory pre-emptive right to purchase provided it owns a building or facility located on the leased land plot. Where the tenant does not own a building, the issue will be determined by the terms of the lease as negotiated between the parties. If leased real estate is sold by its owner, the lease survives in full. The new owner assumes the rights and obligations of the landlord by virtue of law. Proprietors of buildings or other immovable facilities situated on a plot of land owned by another person are entitled by statute to rights of use as regards the land located underneath such buildings or facilities. If the land in question is state or municipally owned, the owner of the buildings or facilities is entitled to either lease or privatise (purchase) the land. Effectively, the land follows the building. As a general rule, assignment, subleasing or mortgage of land leased by the tenant does not require the landlord s consent, unless otherwise stated in the lease agreement. Leases of state and municipal land concluded for a term of over five years do not require the landlord s consent for assignment, sublease and mortgage as a matter of law. Conversely, assignment, sublease or mortgage of real estate other than land is subject to the consent of the landlord unless the lease provides explicitly that consent is not required. Such consent may be given directly in the lease agreement.

40 38 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 15. Subsoil natural resources The Federal Law on Subsoil (the Subsoil Law) is the key law applicable to Russian oil, gas and mining industries and sets out the general framework for licensing and the use of subsoil resources. The subsoil sector is heavily regulated. The main regulators are: the Ministry of Natural Resources (MNR), which regulates subsoil use and sets the applicable policies; the Federal Agency on Subsoil Use (Rosnedra), which operates under the MNR and grants and revokes subsoil licences and supervises compliance with their terms; and the Federal Service on Supervision in the Sphere of the Use of Natural Resources (Rosprirodnadzor), which controls compliance with environmental legislation and monitors compliance with the terms of subsoil licences. LICENsING The licensing regime is the same for the oil, gas and mining sectors. Ownership of resources All subsoil resources are owned by the state and are developed by investors on the basis of subsoil licences granted by the state. Once extracted, the resource becomes the property of the licence holder. Types of subsoil licences There are three licence categories: exploration licences, which are granted for a maximum five or ten year period depending on the geographical location of the subsoil resources; production licences, which are granted for a certain period equal to the estimated term required for the full development of the field (usually not more than 25 years); and combined (exploration and production) licences, which are granted for the same term as the production licences. Combined licences are the most desirable as in most cases they guarantee that the licensee will be able to move from the exploration phase to the production phase without the need for participation in additional tenders or auctions. Strategic Fields are the exception, where the government may not allow the licence holder to move into production after exploration if there is a threat to the state s security (please see below for details). In such cases, the licence holder s expenses for exploration shall be compensated in accordance with the procedure set by the government. Licence terms Subsoil licences contain a list of terms for subsoil use, including the term of the licence, the boundaries of the field, the minimum work programme etc. The licence holder may sometimes be obliged to invest in social infrastructure in the region where the subsoil field is situated or pay compensation to local indigenous people. There is no requirement for the licence holder to provide any financial security in relation to the performance of the licence terms and in particular for the minimum work programme. Some of the licence terms may be expressly classified as material in the licence. Such terms often relate to environmental protection and industrial safety. Any breach of a material term could be used as a ground for revocation of the licence by the authorities. A breach of an ordinary term may lead to revocation where the breaches are recurring. Grant of licences Exploration licences are granted through direct application to and negotiations with Rosnedra. Production and combined licences are awarded by tender or auction organised by Rosnedra. The auction mechanism awards licences simply to the highest bidder, while tenders take into account additional criteria relating to the applicant s ability to develop the licence block. Licences in relation to Strategic Fields may be granted by a decision of the government without a tender or auction. Licence transfer Licence transfers are generally prohibited except in certain cases set out in the Subsoil Law, which include, among other things: reorganisation of the licence holder; transfers between a parent and its subsidiary or between subsidiaries of the same parent; and transfers to a majority controlled subsidiary. Usually the transactions involve sale and purchase of the licence holding companies rather than transfer of the licences. Where a company is looking to sell only part of its licence portfolio it may use the spin off mechanism transfer the licence to its newly created subsidiary and then sell the subsidiary. A licence transfer is not automatic and requires Rosnedra to cancel the existing licence and issue the new one to the new licence holder. It is prohibited to assign the subsoil licences or create security over them or the subsoil use rights in general.

41 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 39 Licence revocation There are several grounds for licence termination and these are set out in the Subsoil Law. They include, among others: failure to comply with material terms of the licence; recurring breach of subsoil use rules; failure to carry out the work programme in a timely fashion; danger to life or health of people working or living near the subsoil field; and emergency. Potential revocation of a subsoil licence is one of the major risks faced by any licence holder in Russia. Rosnedra is normally reluctant to resort to licence revocation unless the breaches are material and tries to cooperate with the licence holder if it shows determination to cure the breaches. Relinquishment and decommissioning The licence holder may at any time relinquish the licence by giving six months prior notice to Rosnedra. The licence holder will be required to perform the obligations set out in the licence in respect of early relinquishment (eg properly seal the wells, rehabilitate the land, settle any outstanding tax payments) and to decommission the relevant infrastructure. There is no specific obligation of the licence holder to finalise the minimum work programme prior to early relinquishment. The Subsoil Law requires the licence holder to perform decommissioning works after the termination of the licence. The legal regime on decommissioning is, however, generally underdeveloped and there is no requirement to set up a decommissioning reserve fund or continuing liability of the previous licence holders. Strategic Fields Access for foreign investors to the development of Strategic Fields is restricted. Currently the following fields are regarded as Strategic Fields: fields with recoverable reserves of: (i) 70 million tonnes or more of oil; (ii) 50 billion cubic metres or more of gas; (iii) 50 tonnes or more of vein gold; or (iv) 500 thousand tonnes or more of copper; fields containing deposits and occurrences of rare metal; offshore fields (located in inland sea waters, the territorial sea and continental shelf); and fields whose development requires the use of classified (defence and security) land. For details in relation to restrictions on investment in companies developing Strategic Fields, please see chapter 2 of this Guide. Offshore projects Offshore licences for the development of the continental shelf may only be issued to entities meeting all of the following criteria: incorporated in Russia; at least five years presence and experience in operation on the continental shelf; and Russia directly controls more than 50% of shares and/or directly or indirectly controls more than 50% of voting rights in such entity. At the moment, the only entities meeting the above criteria are Rosneft, Gazprom, Zarubezhneft and their selected subsidiaries which have been engaged in offshore operations for sufficient periods of time. Despite these restrictions, foreign investors are able to participate in offshore projects through upstream joint ventures with special contractual operatorship arrangements with the Russian state companies. Production sharing agreements Russian law recognises production sharing agreements (PSAs) in the Federal Law on Production Sharing Agreements and the Tax Code. However, no PSAs have been entered into since the adoption of the PSA Law (the few PSAs which are currently in effect in Russia were concluded prior to the adoption of the Law on PSAs). TRANSPORTATION Russia has a developed system of pipelines and railroads most commonly used for the transportation of oil, gas, coal and other commodities. These services and their tariffs are regulated and set by the government. Access to the oil pipeline network and its export capacities is required to be granted to any applicant on a non-discriminatory basis proportionately to the applicant s production volumes. A refusal to grant access may be appealed in court. The non-discriminatory access also applies to the domestic gas transmission pipeline system. Gazprom, however, holds the monopoly to export gas. The oil and gas of various producers is usually transported in a commingled stream and there is no quality bank, so producers are not compensated for any loss in quality of their oil or gas resulting from the commingling during transit. TAXATION SPECIFICS Besides the general taxes which are applicable to almost all industries, such as profits tax and VAT (please see chapter 19 of this Guide for details), oil and gas and mining companies are subject to mineral extraction tax (MET) payable based on the value (for ore, peat, precious metals, precious stones, mineral salt and some others) or the volume (for coal, crude, natural gas and gas condensate) of extracted minerals. Tax rates vary depending on the type of extracted minerals. Certain exemptions are available. In particular, exemptions are provided to oil producers extracting crude oil in certain specific areas or under certain specific conditions and to liquefied natural gas producers. There are plans to introduce further incentives, in particular, for offshore projects. Export of crude oil is subject to export duties which represent a significant burden to oil producers involved in exports (although certain exemptions are also available). Such export duties are established on a monthly basis based on the market price for Urals brand crude oil and a specific formula established by legislation. Generally, the higher the market price is for Urals brand is, the higher export duty rate is established based on the formula.

42 40 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 16. Merger control The core piece of Russian merger control legislation is the Federal Law on the Protection of Competition dated 26 July 2006 (the Antimonopoly Law) which was significantly amended on 23 August 2009 and on 6 December The aim of the Antimonopoly Law is to encourage competition in Russia. It applies to actions and transactions affecting competition in Russia, irrespective of whether the actions are taken in Russia or abroad and the nationality of the parties. The Antimonopoly Law extends, in particular, to acquisition by Russian or foreign entities of any of the following: (i) shares or participation interests in Russian companies (whether direct or indirect through a chain of ownership); (ii) fixed production assets located in Russia, and (iii) shares or participation interests in companies which are active in Russia and whose Russian turnover exceeds RUR1 billion (approximately US$33 million); as well as any other actions which may otherwise affect competition in Russia. The prudent view is that it should be left to the Federal Antimonopoly Service (FAS) to determine whether a particular agreement reduces competition levels, rather than the parties themselves making this determination. Forms of control The Antimonopoly Law envisages two main forms of merger control by the FAS: prior FAS consent; and subsequent FAS notification. Broadly speaking, these forms of FAS control apply to: transactions involving or affecting shares or participatory interests in, rights in respect of, or assets of, business entities; the reorganisation of business entities; and the creation of business entities where the charter capital is paid by shares or property. FAS consent is required only if the following tests are met: the aggregate worldwide turnover of the acquirer group and the target group of entities exceeds RUR10 billion (approximately US$330 million) or the worldwide aggregate asset book value of the acquirer group and the target group exceeds RUR7 billion (approximately US$230 million); and the worldwide asset value of the target group is more than RUR250 million (approximately US$8.2 million). Alternatively, FAS consent is required if any of the acquirer group or target group entities is included in the Russian register of entities having a market share of more than 35%. Lower thresholds apply in case of a subsequent FAS notification. Procedure The following basic checklist should be kept in mind when seeking to enter into any arrangement which involves Russian assets: determine whether a particular action falls within the scope of FAS control; determine who is responsible for filing the application for consent or making a notification; prepare the documents and information which are to be submitted to the FAS (if any); submit the documents to the FAS or notify the FAS, as the case may be; and obtain FAS consent or refusal. Russian antimonopoly legislation provides for a number of exemptions from the general rules. The most relevant is where transactions triggering FAS consent are concluded between a parent and subsidiary (where the requirement for prior consent is substituted with a subsequent notification requirement). Other intra-group transactions are subject to a subsequent notification requirement and not subject to prior consent requirements provided: (i) the parties group charts are disclosed to the FAS at least one month prior to closing; (ii) the group structure has remained unchanged during this one month period; and (iii) the group charts are subject to public disclosure by the FAS. FAS filings (either for prior consent or subsequent notification) require significant preparation and disclosure of information. Timing for FAS consent The FAS has 30 days to consider an application and to issue a written response. This period can be extended by the FAS by another two months. Where the FAS decides to extend the initial period, it will typically disclose the transaction to the general public and invite comments from interested parties. FAS consent is valid for one year from the date of its issuance. If an approved transaction is not concluded within that period, a fresh consent will need to be obtained from the FAS. Consequences of non-compliance The consequences of proceeding without the necessary FAS consent, or without having made the relevant notification, include any or all of the following: the relevant transaction may be invalidated in court if the FAS proves its actual or potential anti-competitive effect; and a fine may be imposed.

43 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Employment Compliance with local employment and immigration laws remains an area of increasing interest to Russian regulatory authorities and, consequently, for companies operating in Russia. International players shall have to pay more attention to the employment and immigration aspects of their local operations. The Labour Code The central piece of Russian employment legislation is the Labour Code of the Russian Federation (the Labour Code). It was initially adopted on 30 December 2001 replacing the old Soviet Code of 1971 and has been amended several times since then. The last substantial amendments to the Labour Code were introduced on 30 June 2006 and came into effect on 6 October One of the basic rules of the Labour Code is found in Article 9. It provides that any provision in an employment agreement that worsens the position of an employee in comparison with his/her position under the Labour Code will be invalid and the provisions of the Labour Code will prevail. The Labour Code contains minimum guarantees and protections for employees that are mandatory and from which parties are not permitted to depart. As a result, the position of employees in Russia is quite strong as compared with the position of employers. In this sense, the new legislation does not represent a departure from the historically employee-friendly approach. Even where an employment agreement is governed by a foreign law the position will be the same. Russian courts will most likely disregard a foreign governing law clause which worsen an employee s position and apply the minimum standards granted by the Labour Code instead. Employment agreement An employment relationship arises between an employee and an employer either: on the basis of an employment agreement; or upon the actual commencement of work even in the absence of any written employment agreement. In the latter case an employer is obliged to conclude an employment agreement within three business days of the employee s actual commencement of work. During the period when an employee works without an employment agreement, the Labour Code will effectively constitute the terms and conditions of the employment agreement. Generally, an employment agreement will be for an indefinite term. A fixed term employment agreement (for up to five years) may be concluded only when expressly permitted by law, eg for temporary replacement of an employee or for performance of temporary (up to two months) or seasonal work, or for individuals who are sent to work abroad etc. In the event of a dispute, the employer bears the burden of proving the need for the agreement to be for a fixed term. Probation period A probation period for a maximum of three months is permissible but must be stipulated in the employment agreement. A six month probation period is only permitted for heads of a company (ie CEO), their deputies, chief accountants and their deputies as well as the heads of a branch office, a representative office and separate structural departments of such entities. Pregnant women, women with children aged up to one and a half years, and certain other categories of individuals cannot be subjected to a probation period. During the probation period the employment agreement can be terminated by the employer on three days notice stating the reasons why the employee failed to pass the probation period. An employee under probation may terminate an employment agreement by giving the same three days notice. Labour books A labour book, (trudovaya knizhka) which is a document recording an employee s employment history from first employment until retirement, shall be issued to all employees in Russia (including, arguably, foreign employees). The labour book must contain records of employment, the position held, dates of joining and termination, etc. If an employee has been subjected to disciplinary sanction this will not be recorded in labour book unless such sanction is a dismissal. The Labour Code obliges an employer to keep a labour book in respect of any employee who works for longer than five days. All employers are responsible for keeping their employees labour books and recording all required information in a timely manner and in conformity with the required format. Employees prefer to have their labour books clean, ie without any record of disciplinary sanctions or termination by the employer on grounds that might make it difficult to find a job in future. As addressed further below, this is often used by an employer as a negotiation tool during termination discussions. Employment orders It is a legislative requirement for employers to issue an internal order (prikaz) each time an employee is hired, granted a new position, granted a vacation, paid a bonus, disciplined or dismissed, and in certain other cases. Managing these administrative duties represents the bulk of time spent by any human resources department in Russia. Internal regulations An employer is required to adopt certain internal regulations (localnie normativnie akti) relating to labour discipline, remuneration systems, the processing of personal data, employee performance appraisals, bonus policies etc. Some of them are mandatory, some are not. These internal regulations must be: (i) in Russian; (ii) approved by the head of a company locally; and (iii) acknowledged by all the employees against their signatures. If any one of these requirements is

44 42 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS not complied with, the internal regulations will be invalid. Having the company s policies displayed on the company s intranet is generally not sufficient for making them binding. Again, the internal regulations should not worsen an employee s position as compared to his/her position under the Labour Code. If there is any conflict, the statutory rights will prevail. Working hours A normal working week cannot exceed 40 hours irrespective of a five- or six-day week. Any additional time worked is classified as overtime, which employers may request only in circumstances expressly specified by the Labour Code. In most cases (ie if and when business so requires from time to time) an employer must receive the employee s prior written consent for such overtime work. The general rule is that overtime work must not exceed four hours for each employee in two consecutive days and must not exceed 120 hours per year. Overtime work must be paid: for the first two hours of work at a rate of 150% of the regular hourly rate; for subsequent hours at a rate of 200% of the regular hourly rate. Overtime work may also be compensated by granting an employee additional rest time which cannot be less than the amount of overtime hours worked. Overtime work is prohibited for pregnant women, minors and certain other categories of employees. Written consent for overtime is not required where an employee works under the so-called irregular working regime (nenormirovanniy rabochiy den). Such employees may be required to work overtime at the employer s discretion. This regime cannot apply to all but only to specific categories of employees as set out in the company s internal regulations. It should also be noted though that it is unlawful to require an employee to work overtime on a daily basis (rather than from time to time and under certain circumstances only). Employees working under the irregular working regime are entitled to at least three additional days of holiday per year which must be expressly stated in their labour contract. The employer is obliged to keep a record of all time actually worked by each employee, including overtime and irregular working time. Breaks in work, days off and public holidays The Labour Code provides that an employee must be given a break for rest and meals during the working day. Such break time is not included in the working time and must not be less than 30 minutes or greater than two hours. All employees must be provided with days off (two days off for a five-day week, and, one day off for a six-day week). The length of days off (time off between working days) may not be less than 42 hours. There are currently eight official paid public holidays in Russia, which give employees 14 days off. These days are: 1 8 January, 23 February, 8 March, 1 and 9 May, 12 June and 4 November. If a holiday falls on a weekend, the next business day after the public holiday day will usually be a paid day off. Employees salaries are not affected as a result of such holidays. As a rule, employees are not permitted to work on days off and public holidays unless they provide their written consent and then only in a very limited set of circumstances. In extraordinary cases specified by the Labour Code (eg catastrophe, disaster, fire, flood, earthquake etc) they may be required to work without providing prior written consent. An employer must issue an internal employment order when keeping employees at work on days off and public holidays. Holiday The minimum holiday entitlement is 28 calendar days per year of employment. Public holidays, if they fall during an employee s annual holiday, will not be counted as part of his/her minimum annual holiday entitlement. The Labour Code provides for additional holiday time as compensation for some special conditions of work. An employee is entitled to take vacation days during the first year of work upon the expiry of six months from the commencement of his/her employment (unless otherwise agreed between an employer and an employee or when an employee is a pregnant woman, minor, etc). Holiday time for the second and subsequent years of work may be taken at any time during the working year in accordance with the holiday schedule. Such schedule shall indicate each employee s holiday days for the calendar year and must be prepared and approved by the employer no later than two weeks before the succeeding year. Where there is no company holiday schedule, an employee has the right to apply to an employer for vacation time at any time. An employer may recall an employee from holiday only with the employee s written consent. Such recall is prohibited with respect to minors, pregnant women, and employees working in harmful and/or hazardous employment. Upon an employee s request, in some cases (eg an employee s sickness) unused holiday shall be carried forward to the next year. Moreover, where the granting of vacation time to the employee in a current year might affect the normal operation of the employer s business, such vacation may be postponed by the employer and carried forward to the next year with the employee s written consent, but such holiday time must be used within 12 months following the end of the current year. The employer is prohibited from denying the relevant employee vacation time for two consecutive years. Further, on termination of employment the employer is obliged to pay the employee compensation for all accrued but unused holiday time. Sickness and maternity leave In case of sickness employees are required to provide an employer with a medical certificate after their recovery and return to work. As of 1 January 2007, sick leave compensation and maternity leave compensation are regulated by Federal Law No. 255 FZ On the Provision of Sick Leave and Maternity Leave Compensation to Citizens Eligible for Mandatory Social Insurance dated 29 December According to this law, sick leave compensation must be paid inter alia to an employee in the event of his/her illness, injury, and when an employee is caring for a sick family member. The amount of sick leave compensation and the period of time for which such compensation is payable will vary according to the grounds for the sick leave. In the event of an employment related injury or any occupational disease, the amount of sick leave compensation is 100% of the employee s average earnings for the two preceding years. The same applies to maternity leave compensation. If the employee s total work history is less than six months, the maximum sick leave compensation cannot exceed the minimum monthly wage. Pursuant to this law, an employer is obliged to pay an employee sick leave compensation only for the first three days of sick leave. Further sick leave allowance is payable out of the Russian State Social

45 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 43 Insurance Fund, which is funded by the employer s mandatory social security contributions paid as a percentage of each employee s salary. The Labour Code provides that women shall be granted maternity leave at their request and on the basis of a medical certificate. Maternity leave is also payable out of the Russian State Social Insurance Fund. Paid maternity leave starts to accrue no later than 70 calendar days prior to birth, and continues to accrue for additional 70 calendar days thereafter. Paid maternity leave is provided for a longer period in the event of complications while giving birth or in cases of multiple births. Medical examination The Labour Code provides that the employer has to carry out, at its own expense, medical examinations of employees working in harmful and/or dangerous conditions (the same applies, with certain exceptions, to candidates applying for a specific position). Russian legislation is very strict in defining which working conditions should be regarded as harmful/dangerous. In order to determine whether medical examinations are necessary, the employer, together with a special organisation (holding a relevant licence), is obliged to conduct an assessment of the certain types of workplace expressly specified by the law that relate to an employee s work with, or use of, certain equipment, machines etc. A workplace assessment is not required in relation to an employee s work with just computers or copying machines. If dangerous factors are revealed, the employer is obliged to conduct the assessment at least every five years. The frequency of the medical examinations for employees working on a particular workplace is determined as a result of the assessment in accordance with a special schedule adopted by the respective state authority. Usually the examinations should be carried out no less than once every two years. Compensation and minimum wage Salaries must be paid to employees in Russian currency (in RUR) no less than twice a month. Though not expressly stipulated in the Labour Code salaries must also be fixed in employment agreements in RUR. The date of the payment is fixed by the internal labour regulations of each employer or by the employment agreement. A monthly salary may not be lower than the minimum monthly wage established by Russian law. The amount of the minimum monthly wage is subject to regular indexation and at the time of writing is RUR5,205 (approximately US$173). An employer is obliged to pay compensation for any delay in salary payments and other employment-related payments in accordance with the rules provided for by Article 236 of the Labour Code (in an amount not less than 1/300 of the refinancing rate of the Central Bank of the Russian Federation (currently 8.25% per annum)). The employer s authorised personnel who are responsible for the payment of salaries and have breached the payment rules may be exposed to administrative and even criminal liability. Additionally, under Article 142 of the Labour Code, upon written notice, employees may stop working where salary payments have been delayed for more than 15 days until they have received payment of all sums in arrears. Employees are not compensated for the period in which they stop working. An employer is also obliged to adjust yearly salaries paid to its employees in accordance with the increase of consumer prices on goods and services. Russian legislation does not provide for any specific procedure and rules relating to such adjustment. Failing to comply with this statutory duty may result in claims for recovery of increased salaries. Disciplinary sanctions An employee may be sanctioned by an employer in the event of a failure to perform his/her employment duties or in the event of improper performance of such duties. The Labour Code provides three types of disciplinary sanctions: warning; reprimand; and dismissal. An employer cannot apply more than one sanction for any one breach. Before the imposition of any disciplinary sanction the employer must request from the employee an explanation in writing (refusal to provide such explanation should be documented and is not considered an obstacle to imposing a disciplinary sanction). An employee can be disciplined within one month from the date of discovery of the breach, but not later than six months from the date of the breach. An internal employment order for the imposition of a disciplinary sanction must be issued and delivered to the employee who must acknowledge receipt of it within three business days from the date the order was issued (this time period does not include the employee s absence from work). The disciplinary sanction is deemed annulled if the employee is not disciplined again within one year from the date of the sanction having been imposed. An employee is entitled to appeal against the disciplinary sanction by applying to a court or an internal tribunal (which can be created in each company on the basis of equal representation of the employer and employees on the tribunal). Termination of employment An employee may terminate the employment agreement at any time by providing two weeks written notice. This right cannot be contracted out and any agreement to the contrary will be disregarded by a Russian court. The agreement may be terminated prior to the expiry of the two week notice period with the employer s consent. At any time before the expiry of the notice period, the employee may withdraw the application for termination, provided that the employer has not already become bound by law to enter into an employment agreement with another employee by virtue of Russian law. If, upon the expiry of the notice period, the employment agreement has not been terminated and the employee does not insist on such termination, the employment agreement will continue in force. The employment agreement can be terminated by the employer only on the exhaustive list of grounds specified in the Labour Code. This list applies to all individuals except for heads of a company and the equivalent whose employment agreements may contain contractual grounds not specified by the Labour Code. In particular, the employer may terminate an employee s employment agreement: pursuant to a redundancy procedure or in the event of the company s liquidation; for incapacity/incompetence due to the employee s bad health or insufficient qualifications; for repeated non-performance of employment obligations without valid cause when one disciplinary sanction has already been in effect against such an employee;

46 44 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS for a single material violation of an employment agreement by an employee (eg absence from work without valid cause for a period of four consecutive hours during one business day, appearance at work in a state of intoxication etc); and for several other rarely invoked grounds. It is prohibited to terminate the employment of an employee who is sick or on vacation and to dismiss pregnant women except in the event of a company s liquidation. The Labour Code stipulates detailed procedures for terminating employment. Such procedures differ depending on the ground for termination. If an employer fails to comply with the termination procedures set out by law, the termination may be held invalid by a court. Cases relating to termination of employment of heads of a company and equivalent posts could be heard before courts of general jurisdiction and commercial (arbitrazh) courts. The choice of court depends greatly on the circumstances of the case. Disputes with other employees are heard only before courts of general jurisdiction. An employee is generally entitled to the following remedies: reinstatement at work; salary for the period of forced absence from work; and compensation for moral harm. Russian courts look closely at whether the relevant procedure has been complied with and if not, tend to rule in favour of the employee. Severance payments and market practice Where an employer terminates an employment agreement due to the company s liquidation or due to redundancy, the employer must give the employee two months notice. The employer is further obliged to pay a severance payment equivalent to two months salary. It may also have to pay a further month s salary, provided the discharged employee (within two weeks after the termination of his/her employment agreement) registers himself with an employment agency and has not yet found new employment. Since five months salary is the maximum exposure, (the two month notice period; two months severance payment; and one additional month in specific cases only) usually an employee will be encouraged to resign against receipt of compensation ranging from two to four months salary. Redundancy must be based on some valid managerial or economic reasons and should not be aimed at termination of the employment of a particular employee. If there is a dispute the employer bears the burden of proving that the redundancy was business driven. Given the employee-friendly nature of Russian labour legislation employers prefer to terminate employment relationships by entering into agreements with an employee whom they wish to dismiss. This usually involves negotiating a settlement amount which typically ranges from two to four months salary for ordinary employees and from three to six months salary for heads of a company, and senior management. One of the arguments typically used by employers to persuade employees to resign or to receive less compensation is that in return the employer will keep the employee s labour book clean. Liability It is the employer who is liable to third parties for damage caused by its employee. An employer who compensates a third party has a right of recourse against the employee who caused the damage to the third party. The employee is also obliged to compensate damage caused to the employer itself. However, the employee s liability in both cases is limited by the Labour Code to an amount equivalent to the employee s monthly salary. Limitation of liability does not apply where damage was caused by an employee under intoxication, or when such damage amounts to a criminal or administrative offence etc. In certain cases, provided by the Labour Code the employee may be obliged to compensate damage caused to the employer and/or damage caused to a third party which the employer had to account for in full. Such full liability provisions: can only apply to particular categories of employees specified by Russian legislation (heads of a company, his/her deputies, chief accountant etc); and must be expressly stipulated in the employment agreement. Restrictive covenants Since Russia is a civil law jurisdiction, common law concepts such as post termination non-competition clauses, garden leave, non-solicitation, and non-dealing covenants are not covered by Russian employment law and would, most probably, be unenforceable or take a different shape. Garden leave is not expressly provided for by the Labour Code, and whilst an employer could attempt to enter into such an arrangement it would be highly unlikely to be enforceable if breached. Post termination non-competition covenants are unlikely to be enforceable in Russia since imposing such a limitation would be likely to be deemed an infringement of the constitutional principle of freedom of employment. Non-solicitation and non-dealing covenants are also unlikely to be enforceable for the same reasons. The effect of non-solicitation and non-dealing covenants could, however, potentially be achieved by different means, namely in the context of confidentiality. A properly drafted Russian employment law agreement could contain confidentiality provisions covering, in particular, information relating to the company s employees and clients. Moreover, each employer should also establish a proper trade secret regime. In the event of a dispute, these measures could be used to, effectively, achieve the same result as non-solicitation and non-dealing clauses. However, there are very few precedents enforcing such provisions in the Russian courts. Confidentiality Under the Trade Secrets Law No. 98 FZ dated 29 July 2004 a company may classify certain information as trade secrets and oblige its employees not to disclose it. A number of formalities should be complied with in this regard. The employer should adopt special internal regulations in relation to trade secrets, which should necessarily contain a list of information classified as trade secrets and procedural requirements in relation to handling this information and keeping it secret. These provisions could also be included into the employment agreements with the employees. The employer must also comply with some other

47 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 45 formalities (for instance, the employer is obliged to keep a list of persons who have received access to trade secrets). In the event of disclosure of a trade secret, the employee may be subject to: damages for civil liability; disciplinary sanctions (during the employment); administrative liability; or criminal liability. Each employee is also obliged to comply with his/her confidentiality obligations in relation to trade secrets upon his/her dismissal. The limitation period for an employer to bring a claim against an employee in this regard is limited by the time when information classified as a trade secret becomes publicly available. Foreign personnel, work permits etc While Russian and non-russian personnel have to be treated equally from an employment law perspective, the employment of foreign individuals brings with it additional difficulties as the law requires both the employer and the employee to obtain special permits from the migration authorities (representative or branch offices of foreign companies are also subject to this requirement). In 2010 significant amendments to Russian laws were passed which aimed at facilitating foreign white collar work in Russia. A new category of foreign employee was introduced into Russian legislation the highly qualified specialist (HQS), who enjoys significant advantages over non-hqs foreign employees. To qualify for HQS status, a foreigner must be an experienced specialist with skills or achievements in a specific area (which is a more formal requirement), and earning at least: (i) RUR1,000,000 (approximately US$33,300) per year for HQSs if they are scientists or lecturers who have been invited by scientific institutions, state academies or higher education institutions; or (ii) RUR2,000,000 (approximately US$66,600) per year for other HQSs. The requirement as to the minimum yearly salary does not apply to HQS invited for work on the Skolkovo project. The advantages that the HQSs enjoy include: their employers are not required to obtain employment permits; invitations and work permits issued to HQSs and members of their families will not count towards quotas that limit issuance of these documents; they enjoy an accelerated procedure for obtaining work permits (14 business days); the maximum term for a work permit and employment visa for them is three years (both documents may be extended when their term expires); their work permits allow them to work in multiple Russian regions; they and members of their families are required to register with Russian migration authorities only after expiration of 90 days following their arrival to Russia; and they and their families can get a Permanent Residence Permit (vid na zhitelstvo) without having to live for a year in Russia; instead the Permanent Residence Permit will be issued for the term of the work permit of the HQS. To make use of these benefits the employers, being either Russian companies or accredited branches of foreign companies (representative offices of foreign companies are excluded), must file an application to the Federal Migration Service to employ an HQS. Permission should be granted almost automatically unless some documents are missing or where the employer has been subject to administrative sanctions for the unlawful employment of foreigners during the two years preceding the filing of the application. The procedural requirements relating to employment of non-hqs employees are more complicated and may take additional time. For instance, in addition to a work permit, (also required for HQSs) employers in Russia wishing to employ non-hqs employees must also obtain an employment permit from the migration authorities. Moreover, foreign non-hqs employees will need to undergo health examinations (including blood tests). These health examinations may also take place in foreign medical clinics provided the documents issued are duly certified for use in Russia. Moreover, according to recent changes, all foreign employees (including HQSs) are subject to fingerprinting. Engaging foreign personnel without an employment permit or employees working without a work permit may result in various sanctions, including fines of up to RUR800,000 (approximately US$24,000) for the company and its officials and the foreign employee. In extreme cases, the employee may be deported from Russia. Personal data protection The issues of personal data protection are governed mainly by the Personal Data Law No. 152 FZ dated 27 July Personal data is any information directly or indirectly relating to the identified or identifiable individual including his/her full name (first name, patronymic, and family name), date and place of birth, address, marital and social status, education, occupation etc. This list is not exhaustive. Personal data processing is regarded as any operation involving personal data, including its collection, systematisation (such as organisation or classification), accumulation, storage, correction (such as renewal or alteration), use, dissemination (including transfer), depersonalisation, blocking and destruction. Any person engaged in personal data processing is deemed an operator of personal data. Unless otherwise provided by the law, an operator has to obtain an individual s consent to personal data processing. The Personal Data Law does not provide any specific requirements as to the form of the consent, save for in three specific situations that require mandatory written consent of the respective individuals: (i) the processing of biometric data; (ii) a cross-border transfer of personal data to jurisdictions which do not provide an adequate level of protection for personal data; and (iii) the processing of data in relation to an individual s race, nationality, political, religious and philosophical views, health or private life. Such consent may be revoked by the individual at any time. The conclusion of an employment agreement is assumed to constitute consent for the processing of personal data so far as and no further than is necessary for the employer to comply with applicable legislation. The Labour Code contains a number of requirements which must be met by an employer when processing an employee s personal data. In particular, an employer must: (i) obtain an employee s consent for any operations in excess of those specifically required by applicable legislation; and (ii) provide adequate protection of an employee s personal data against its unauthorised use.

48 46 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS An employer may only transfer an employee s personal data to a third party subject to the written consent of such employee. This consent should contain, inter alia, the list of such third parties (including other companies of the same corporate group). The Federal Service for the Supervision of Communication, Information Technologies and Mass Communication carries out general supervision and is authorised to carry out audits of companies and keep a register of personal data operators. A company must inform this state authority on its intention to process personal data. This requirement does not apply if the company only processes personal data relating to its employees and contractual counterparties. Violation of personal data processing may result in various sanctions, including fines of up to RUR5,000 10,000 (about US$ ). The state intends to increase these fines shortly. The Federal Labour Inspection The Federal Labour Inspection (FLI) is the Russian regulator in charge of supervision and control over employers as regards their compliance with Russian labour legislation. The FLI is also responsible for: investigating work accidents; considering cases of administrative offences in relation to the violation of employment legislation; considering applications and complaints of individuals in relation to the violation of their employment rights etc. In practice, the FLI may come to the employer s office at any time without notice and conduct an inspection. FLI inspectors may stay in the employer s office and the law provides them with the right to request and receive (at no charge) from employers documents, explanations and information to enable the conduct and monitoring of the inspection process. Employers are obliged to comply with the FLI inspectors requests. If in the course of an inspection/investigation the FLI inspectors discover breaches of Russian labour legislation, they will typically issue an order: requiring rectification of such breaches by the employer and restoration of the employees rights; and imposing fines on the employer and/or its officials (eg the heads of HR services). Employers can appeal FLI orders through the courts.

49 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Share options This chapter concentrates on options or long term incentive awards granted by Russian or non-russian companies to Russian employees. Employee tax A personal income tax liability will arise on the date an employee exercises his option, or on the date his free share award vests. It is calculated by reference to the amount by which the market value of the shares at the date of exercise or vesting exceeds the acquisition price of the shares. That amount is regarded as taxable income and is therefore subject to tax at a fixed rate. Russian residents are subject to income tax at a rate of 13%. Non-residents are subject to tax at a rate of 30%, unless an applicable tax treaty provides for an exemption or a lower rate. Employers which are either Russian companies or non-russian companies operating through a branch or a representative office in Russia and are the source of the employee s taxable income are liable for withholding personal income tax from any cash payments due to an employee. If the tax may not be withheld for any reason, the employer is obliged to report this to the Russian tax authorities and the employee will be personally liable for this income tax. In addition, employees are personally liable for payment of tax if shares or income are received from a foreign company without representation in Russia (and so does not qualify as a tax agent and cannot withhold tax). Employer s Social Security Charges Any compensation of the employee under an employment agreement not exceeding RUR568,000 (approximately US$19,000) per year is subject to social security charges in the form of mandatory contributions to different funds at an overall rate of 30% in Annual compensation of the employee exceeding RUR568,000 (approximately US$19,000) is subject to social security charges at a rate of 10%. This threshold is subject to adjustment each year. Additionally, compensation is subject to contributions for insurance for work-related injuries and diseases at rates ranging from 0.2% to 8.5%, depending on the types of activities carried out by the employer (please see chapter 19 of this Guide for more details). Therefore, if an option providing for the grant of shares is deemed to be a part of the compensation package as contemplated by the employment agreement or collective bargaining agreement then the employer will be liable to make social security payments upon the exercise of the option. Tax deduction for the employer The cost of a long term incentive award is generally tax deductible for the employer (if the employer is a Russian company or a non-russian company acting though a permanent establishment in Russia) so long as it is contemplated by the employment agreement and/or collective bargaining agreement. However, the employer will need to be able to justify the business need for granting a long term incentive award in order for it to be tax deductible. Since it is consistent with market practice, incentivising employees in this way should generally qualify as an economically justified expense. If the option is included in the employment package contemplated by the employment contract or collective bargaining agreement, the tax costs of the shares (and the expenses related to acquisition and disposal of the shares) can generally be deducted. Capital gains realised by a Russian company or the permanent establishment of a non-russian company upon the sale of shares or options to employees are taxable in Russia at a rate of 20%. Exchange control issues Russian residents and non-residents may freely transfer funds in connection with the acquisition and disposal of shares into and out of Russia. All transfers should be made through bank accounts. If a Russian national wishes to open a bank account with a non-russian bank, special reporting requirements apply. Employment law Russian employment law does not specifically regulate share option plans or similar incentive programmes. The long term incentive award may be provided in the employment agreement, collective bargaining agreement or an internal resolution of the employer. If the purchase of shares under a share option plan is structured as a partial payment of an eligible employee s salary via shares (which is relatively rare), compliance with certain Russian employment law requirements will be necessary. In this case, the granting of shares to employees under a share option plan should be treated as part payment of the employee s salary in non-monetary form. That part of the salary paid in non-monetary form should not exceed 20% of the full amount of the employee s monthly salary. Another possibility is to make deductions from eligible employees salaries where employees do not automatically receive shares as part of their salary (as in the case described above) but, rather, obtain the right to purchase these shares in the future. Deductions from an employee s salary can be made only pursuant to a written request by an employee. Alternatively, deductions may be formalised in a bilateral instrument signed by both the employee and the employer. The aggregate amount of deductions from an employee s salary cannot usually exceed 20% (although, they can be up to 50% or 70% in specific cases where a higher cap is specifically allowed by law). Data Protection The transfer of personal data is restricted and may be affected only with the consent of an employee. No exemptions are provided in respect of employee share schemes. In addition, restrictions apply to the transfer of information outside of Russia.

50 48 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 19. Tax On acquiring a business or a company or investing in Russia, specialist tax advice should be sought at an early stage. The following is intended to be an overview of the most relevant areas of tax law. THE MAIN RUSSIAN TAXES Profits tax Russian companies pay profits tax on their worldwide profits (calculated as gross income minus deductible expenses). Foreign companies with a permanent establishment in Russia pay profits tax on their taxable profits that are attributable to their permanent establishment. Most business expenses are deductible for profits tax purposes, provided that they are economically justified and properly documented. However, certain expenses (such as advertisement expenses and interest) are deductible only within certain established limits. Profits tax rate is 20%. Regional authorities have a general right to provide incentives to certain categories of taxpayers by reducing this rate to 15.5%. Further profits tax incentives are available to specific categories of taxpayers listed in the Tax Code (for instance, to residents of special economic zones). For some categories of taxpayer (educational or medical organisations), the profits tax rate is 0%. Certain types of income are also subject to reduced rates. For instance, dividends received by Russian companies from Russian and foreign subsidiaries are subject to a 9% dividend tax. Furthermore, profits tax on dividends can be eliminated if participation exemption conditions are met. In order to qualify for this exemption, a Russian company must have held at least a 50% stake in the relevant subsidiary continuously for at least one year. If the subsidiary is a non-russian legal entity, it must not be incorporated in a country that appears on the black list published by the Russian government. VAT VAT is charged on: goods, work and services supplied in Russia; and imported goods. Goods are deemed to be supplied in Russia if they are actually located in Russia and not transported or if goods are located in Russia at the point of initial transportation. The place of the supply of services is determined by the place of supply rules. The general rule is that services are deemed to be supplied in Russia if the seller of services carries out its activities in Russia. However, specific rules apply to certain types of services. For instance, consulting, legal, accounting, marketing, engineering, information processing services and IP licences are deemed to be supplied in Russia if the purchaser or recipient of those services carries out its activities in Russia. The standard VAT rate is 18%. A 10% rate applies to certain food products, goods for children, certain mass media items (such as newspapers) and medical goods. The export of goods is zero rated. Certain VAT exemptions are also available (eg for certain banking operations, the sale of land, the sale of housing facilities and the import of certain technological equipment which has no Russian equivalent). A company s VAT liability is generally calculated as its output VAT invoiced to customers minus the value of input VAT invoiced to the company by suppliers or paid to customs upon the importation of goods. If the amount of input VAT exceeds the amount of output VAT then the difference is recoverable. Personal income tax Russian tax residents (as a general rule, these are the individuals who, regardless of their citizenship or domicile, are physically present in Russia for at least 183 days in any consecutive 12 month period) are subject to tax on their worldwide income. Non-residents are only subject to tax on income from Russian sources. Employers are generally required to withhold personal income tax from wages. Personal income tax is withheld from the income of Russian tax residents at a rate of 13% for most types of income (special rates apply to dividends, stimulating lottery winnings and certain other types of income) and at a rate of 30% for Russian-sourced income of non-residents (although dividends payable by Russian companies to non-residents are subject to a rate of 15%). Employment-related income of non-resident individuals who are treated as high quality personnel are subject to 13% personal income tax. Social security charges Employers and self-employed individuals (such as private entrepreneurs) are subject to social security charges payable on their employees and individual contractors remuneration. Employees are not subject to social security charges. The employer is obliged to pay contributions to specific social security funds through: contributions to the Pension Fund at a rate of 22% for employees remuneration not exceeding RUR568,000 (approximately, US$19,000) per year and 10% for employees remuneration in excess of the above amount; contributions to the Medical Insurance Fund at a rate of 5.1% for employees remuneration not exceeding RUR568,000 (approximately, US$19,000) per year (any excess of the above amount is not subject to these contributions); and

51 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 49 contributions to the Social Security Fund at a rate of 2.9% for employees remuneration not exceeding RUR568,000 (approximately, US$19,000) per year (any excess of the above amount is not subject to these contributions). The above threshold is reconsidered on an annual basis. Additionally, employers are required to make contributions to the Social Security Fund for insurance for work-related injuries and diseases at rates ranging from 0.2% to 8.5%, depending on the types of activities carried out by the employer. Contributions to the funds are administered by the respective funds and not by the Federal Tax Service. The funds in question have the right to audit the taxpayers. Property tax As a general rule, Russian companies are liable to pay property tax on the average annual net book value of the fixed assets on their balance sheet. However, all movable fixed assets acquired after 1 January 2013 are exempt from property tax. This narrows the application of this tax to immovable fixed assets and movable fixed assets acquired before 1 January Foreign companies with a permanent establishment in Russia are subject to tax on immovable and movable fixed assets attributable to such permanent establishment (subject to the above exemption for movable fixed assets acquired after 1 January 2013). Foreign companies without a permanent establishment in Russia are subject to property tax on immovable property only. Land is exempt from property tax and may be subject to a separate land tax. The standard property tax rate is 2.2%. However, regional authorities may reduce that rate or even provide a full exemption for all or certain categories of taxpayers. Land tax Land tax applies to land owners at the rate determined by the municipal authorities. Land tax is assessed on the registered value of the land, which is often substantially lower than its actual market value. Land tax rates may not exceed 0.3% of the registered value of agricultural and residential land. With respect to other land plots, the maximum rate is 1.5% of the registered value. The Tax Code permits the municipal authorities to establish tax incentives for certain categories of taxpayers. Notably, businesses leasing land are not subject to land tax. Instead, they are liable for the land lease payments established by federal, regional or local authorities or other land owners. Mineral extraction tax Companies and individual entrepreneurs that extract commercial minerals must pay mineral extraction tax. In particular, this tax is levied on the extraction of coal, peat, crude, gas, ferrous and precious metals and precious stones. Excises Certain activities with respect to alcoholic drinks, tobacco, transportation vehicles and oil products are subject to excise duty payable by companies and individual entrepreneurs. Transportation tax Transportation tax is payable by persons in whose name a taxable transport vehicle is registered and is payable at the rate established for that type of transport vehicle. Regional governments are permitted to establish tax incentives for certain categories of taxpayers. Generally, transportation tax is not a great burden on businesses. Stamp duty Relatively small transactional fees apply to, among other things, the notarisation, registration and filing of legal documents and the issue of securities. Other taxes Other taxes include water tax, gambling tax and levies for the use of fauna and for the use of aquatic biological resources. Certain specific tax regimes are available to small businesses. Taxation of non-resident companies Non-Russian companies with a permanent establishment in Russia pay profits tax on their taxable profits that are attributable to their permanent establishment. They also pay other Russian taxes in a similar way to any company that is incorporated in Russia. Non-Russian companies without a permanent establishment in Russia only pay profits tax on certain types of income originating from Russia (including dividends, royalties, interest, liquidation proceedings and capital gains on the sale of immovable property located in Russia and shares of Russian companies, the assets of which mainly (ie more than 50%) consist of immovable property located in Russia). This tax is withheld by the Russian company, or foreign company with a permanent establishment in Russia, that pays the income. Dividends, interest and royalties Dividends paid by Russian companies to foreign shareholders are subject to a 15% withholding tax, subject to reduction under applicable double tax treaties. The minimum possible dividend withholding tax rate under certain treaties concluded by Russia (for instance, those with the Netherlands, Germany and Cyprus) is 5%. Russia does not impose dividend withholding tax on the distribution of profits from the Russian branch of a foreign legal entity to its headquarters. Interest paid to non-russian companies is subject to a 20% withholding tax. However, this tax can be reduced (and even eliminated) under the relevant double tax treaties. Royalties paid to non-russian companies are subject to a 20% withholding tax. However, this tax can be reduced (and even eliminated) based on applicable double tax treaties.

52 50 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Thin capitalisation rules These rules apply if a Russian company: borrows from a foreign company which has a direct or indirect participation in the same Russian company which exceeds 20%; or borrows from a Russian affiliate of a foreign company which has a direct or indirect participation in the same Russian company which exceeds 20%; or has loans which are guaranteed in any form by the above foreign company or its Russian affiliate. In these three cases, the thin capitalisation rules only apply if the Russian company s debt to equity ratio exceeds three to one (12.5 to 1 for banks and leasing companies). Interest attributable to the portion of the debt which exceeds the ratio is not deductible for the Russian borrower and is taxed as a dividend. The portion of the interest not taxed as a dividend is deductible up to the threshold set out in the Tax Code. Thin capitalisation rules do not apply to Russian branches of foreign legal entities. Controlled foreign company rules Currently Russia has no controlled foreign company rules. However, the Government plans to introduce such rules in the future. Transfer pricing Russia introduced new, more complex, transfer pricing rules on 1 January Generally, transfer pricing control applies to certain transactions between interdependent persons and certain transactions which, for the purposes of transfer pricing control, are treated similarly to transactions with interdependent persons. In particular, all transactions between interdependent persons where one of the parties is a non-russian person are subject to such control. Imports and exports On 1 January 2010 Belarus, Kazakhstan and Russia established the Customs Union. Starting from 1 January 2012, the three states established a single economic space. Within the framework of the Customs Union there is a list of goods that are subject to import duties. Import duties are charged on a wide range of imported goods on an ad valorem, per unit or combined basis. The list of goods that are subject to import duties is approved by the Council of the Eurasian Economic Commission. Ad valorem rates range from 0% to 80%. Various exemptions may apply. For example the import of assets by foreign companies as part of a charter capital contribution to Russian companies is exempt from import customs duties. Customs processing fees and certain other charges may apply in connection with customs clearance, customs storage and transportation of goods. The export of certain goods is subject to export duties. In particular, such export duties apply to oil and oil products, gas, wood and some other products. Double tax treaty network As of 1 January 2013, Russia has double taxation treaties with 80 countries. (For a full list of countries with which Russia has a double tax treaty, please see Appendix 2 to this Guide). Taxpayers are obliged to report to the tax authorities on all transactions which are subject to control. The tax authorities are allowed to conduct transfer pricing control audits. If the price of a controlled transaction deviates from the market price and such deviation results in the reduction of taxes owed to the state budget, the tax authorities are able to assess additional tax liabilities to respective taxpayers. That said, only profits tax, mineral extraction tax and VAT may be assessed as a result of the above control.

53 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Intellectual property It is often the case that intellectual property rights constitute a considerable part of a company s assets. Investigating the status of intellectual property rights is important not only when acquiring such assets, but also when acquiring shares of the company or its business as a whole. The following is an outline of the main intellectual property rights that exist in Russia. All of the intellectual property rights referred to here can be assigned, licensed in whole or in part or have charges taken over them. The legal framework The law governing intellectual property rights in Russia is found in: Part four of the Civil Code; and the Federal Law on Commercial Secrecy. Russia is also a party to the Berne Convention for the Protection of Literary and Artistic Works 1886, the Paris Convention for the Protection of Industrial Property 1883 and other major international treaties relating to intellectual property. Subject to certain conditions, the intellectual property rights of foreign companies and individuals are therefore protected in Russia. (For further information about conventions to which Russia is a party, see Appendix 3 to this Guide). Intellectual property rights Intellectual property rights may arise: when the relevant right is registered with the state (such as in the case of patents and trademarks); as a result of the creation of objects to which intellectual property rights attach (ie copyright in respect of a publication); or as a result of the creation of information from which the owner may derive a commercial benefit. The Federal Service for Intellectual Property (Rospatent) is the governmental body authorised to register intellectual property rights, grant patents and issue relevant registration certificates. The transfer or creation of any encumbrance over registrable intellectual property must be registered with Rospatent in order to be effective. The holder of intellectual property rights is entitled, at his own discretion, to use such rights and to allow and restrain third parties from using them. Enforcement Intellectual property rights can be enforced through administrative or court proceedings (both civil and criminal). A special Court for Intellectual Property Rights was established in February 2013, and this court is expected to start working in The court will be reviewing cases related to the protection of intellectual property rights. Patents Patent law protects inventions, utility models and industrial designs. Patentability In order to be patentable an invention must: be new; have an inventive element; and be capable of industrial use. In order to be patentable a utility model must: be new; and be capable of industrial use. In order to be patentable an industrial design must: be new; and be original. How to obtain a patent Obtaining a patent involves: filing an application for a patent with Rospatent; an examination of the application by Rospatent; a decision by Rospatent to grant a patent; the entry of the invention, the utility model or the industrial design in the relevant register; the issuance of the patent; and the publication of certain information on the granting of the patent in the official bulletin. The above procedure involves payment by the applicant of certain fees, such as filing, registration and patent maintenance fees. Length of protection Generally the protection of: an invention lasts for 20 years from the date of filing; a utility model lasts for 10 years from the date of filing; and an industrial design lasts for a maximum of 15 years from the date of filing.

54 52 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Eurasian patent Russia is a party to the Eurasian Patent Convention An applicant may file an application with Rospatent for a Eurasian patent to protect an invention. Once issued, a Eurasian patent is valid in all nine countries which are party to the Eurasian Patent Convention without any subsequent national registrations for a maximum of 20 years (assuming that certain fees are paid annually). TRADE MARKS Registrability One of the main criteria for the registration of a trade mark is novelty. That is, the mark must not be so similar to any trade mark that has already been registered in Russia or in accordance with the international treaties to which Russia is a party, so as not to be confusing. How to register a trade mark The procedure for state registration of a trade mark generally consists of the following stages: filing an application with Rospatent for registration of a trade mark; an examination of the application by Rospatent; an examination by Rospatent of the sign to be registered; a decision by Rospatent to register the trade mark; the entry of the trade mark in the relevant register; the issue of the trade mark certificate; and the publication of certain information on registration of the trade mark in the official bulletin. The above procedure involves payment by the applicant of certain fees, such as filing and registration fees. Length of protection Protection of a registered trade mark lasts for ten years from the date of filing. This term can be prolonged for a further ten years upon the submission of an application to Rospatent by the owner of the trade mark. Such an extension may be applied for an unlimited number of times, subject to payment of renewal fees. Moral rights Moral rights cover the following objects: performances (such as a performance by an artist); sound recordings; radio and television broadcasts; database contents; and scientific, literary and artistic works that have been disclosed to the public after they have become public works. Length of protection Subject to certain exceptions, protection lasts for a maximum of 50 years from 1 January of the year following the year in which the object becomes a public work. Protection of the creator s rights to a database lasts for 15 years from 1 January of the year following the year in which the database was created. Know-how Subject to certain exceptions, any information from which the owner may derive commercial benefit can be protected as know-how, provided that the owner of such information: specifies the list of information comprising a trade secret; limits access to such information by establishing rules for use of such information and procedures for compliance control (internal regulations); keeps a record of persons who were granted access to such information; includes provisions stipulating the rules for use of such information in employment agreements with its employees and in commercial agreements with its counterparties; and marks all documents or any other material objects containing such information with an inscription clearly stating that it is confidential, as well as with the full name and address of the owner. Length of protection There is no fixed term of protection, although the information must remain confidential for it to be protected. Copyright Copyright attaches to certain original works, such as literary (including software), dramatic, musical (with and without text), photographic, artistic and other original works, including derivative and compound works. No registration required A work is deemed to be protected by copyright from the time of its creation. Copyright is therefore not subject to any official registration. An author is allowed, however, at his own discretion, to register a computer programme or a database with Rospatent. Length of protection Subject to certain exceptions, copyright protection lasts for 70 years after the creator s death. After expiration of the protection period, the work becomes a public work and can be used by any person for free and without the need for approval.

55 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Insolvency The principal source of insolvency regulation in Russia is the Federal Law on Insolvency (Bankruptcy) (the Insolvency Law). This act provides the general rules for bankruptcy (the terms insolvency and bankruptcy are synonymous in Russian law) for all legal entities and individual entrepreneurs. Additional legislation addresses specific issues relating to the insolvency of certain types of companies such as credit institutions, insurance companies and strategic entities. Initiation of insolvency proceedings Russian arbitrazh courts have exclusive jurisdiction to deal with the insolvency of Russian companies. The Insolvency Law envisages the following five procedures with respect to a legal entity in financial difficulties: supervision; financial rehabilitation; external management; liquidation; and amicable settlement. Insolvency proceedings can be brought by a creditor, the debtor company itself (voluntary insolvency) or the Federal Tax Service on behalf of the Russian Federation. A creditor may only file an insolvency petition with an arbitrazh court if the requirements of the Insolvency Law and all of the following conditions are met: the specified indebtedness is greater than RUR100,000 (approximately US$3,300); the specified indebtedness is outstanding for more than three months after it became due and payable; the specified indebtedness is confirmed by a judgment which has entered into force, or a decision of the relevant tax or customs authorities (levying execution on the debtor s property); and 30 days must have elapsed since a decision of the relevant tax or customs authorities was taken. The application must be approved by the arbitrazh court which will either introduce a supervisory procedure and appoint an interim manager for the debtor company or dismiss the petition. Supervision and filing of claims Within 30 days of accepting the petition, the arbitrazh court begins the first stage of the insolvency proceedings (supervision) and appoints an interim manager. The main purpose of supervision (which can take up to seven months) is to assess the financial condition of the debtor, to consolidate the claims of various creditors into a single register of claims and to make a recommendation as to the future of the debtor. In order to participate in the first creditors meeting, creditors must file their claims against the debtor within 30 days of the publication of the notice of commencement of supervision. The claim of a particular creditor may be challenged in court by the debtor, the interim manager or other creditors. If no challenge is made, the arbitrazh court will include the claim in the creditors claims register and that creditor then becomes entitled to participate in and vote at creditors meetings. The Insolvency Law permits creditors to file their claims during all stages of the insolvency process. This means that if a creditor has not filed its claim at a particular stage in the proceedings it may do so at the next stage. Creditors claims should in any event be filed before the closing of the creditors claims register, being no later than two months after the introduction of liquidation (and the recognition of the debtor as insolvent). Proceedings against the debtor initiated before the commencement of insolvency proceedings will continue. However, the resulting judgment or award cannot be submitted for enforcement against the debtor. Instead it will need to be submitted in the insolvency proceedings to the relevant arbitrazh court as supporting evidence of the claim to be prepared and submitted for consideration by the court, and entered into the creditors claims register. From the date of the arbitrazh court s ruling on the commencement of supervision, the following consequences arise: all subsequent monetary claims and mandatory payments which became due on the date of commencement of supervision against the debtor must be made in accordance with the provisions of the Insolvency Law; enforcement proceedings in respect of most types of claims are suspended and freezing orders over the debtor s assets are lifted; shareholders or participants are prohibited from extracting their participatory interests from the estate of the debtor and the debtor is prohibited from buying out its placed shares or paying-out the real value of participatory interests; payment of dividends and distribution of profits to shareholders or participants is prohibited; and termination of monetary obligations by means of set-off (where it infringes the ranking of creditors established by the Insolvency Law) is prohibited (with the exception o. derivatives, repo transactions or other types of contracts governed by master agreements which are

56 54 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS either exchange-traded or, if entered into over-the-counter, reported to the qualified repositories) Commencement of supervision does not mean that the debtor s management personnel will be automatically removed, but their powers will be limited. For example, certain types of transactions, such as loans, guarantees and assignments, may only be entered into with the written consent of the interim manager. Financial rehabilitation This stage follows the supervisory stage, subject to a resolution being passed at the creditors meeting at the request of either the debtor s shareholders or any third parties with the agreement of the debtor. Financial rehabilitation is aimed at restoring the debtor s solvency and achieving the repayment of debts under a debt repayment schedule. It is for the requesting third party to secure the repayment of debts by the debtor. The debtor s assets cannot be used to create security. External management During the external management stage, an arbitrazh manager takes over the management of the debtor and undertakes procedures, the aim of which is to repay the debtor s debts and the restoration of its financial condition. External management will be introduced by a court ruling, at the creditors request, for a period not exceeding 18 months (this term can be extended for a maximum of six months). The total period for financial rehabilitation and external management may not exceed two years. External management is conducted in accordance with the external management plan approved by the creditors meeting by a majority vote of all creditors. The external management plan should contain appropriate measures to restore the company s solvency (such as the sale of the debtor s assets or an increase of the charter capital) and details on how these measures are to be implemented. The introduction of external management has the following basic consequences: the authority of the management bodies of the debtor is suspended and responsibility for management of the debtor s assets is transferred to the external manager; measures in relation to securing creditors claims are revoked; all monetary claims against the debtor that matured before the introduction of external managemen. (save for those claims which arose after the commencement of supervision) are subject to a moratorium; the property of the debtor may be seized; and creditors consent is required for major and interested party transactions, unless otherwise provided in the restructuring plan. The external manager is empowered to investigate the debtor s past and current transactions to assess if any are, or were, at an undervalue or unduly preferential. Those that are found to have been so can be set aside by order of the arbitrazh court. In particular, transactions which entail the preferential treatment of one creditor over another can be invalidated at the request of the external manager acting on its own initiative or at the request of the creditors. New rules for the invalidity of transactions in the event of insolvency came into effect from June Transactions where one creditor has benefited from preferential treatment at the expense of another must have been completed within one month before, or at any time after, the date on which the insolvency filing became effective in order for them to be set aside (in exceptional circumstances the applicable hardening period (ie the period during which the transaction is vulnerable to challenge) may be extended to six months). Furthermore, specific hardening periods of one and three years are applicable to transactions at an undervalue and any transactions which were entered with the intention of damaging the interests of other creditors. In certain circumstances, the external manager also has the power to refuse to perform transactions entered into by the debtor. Before the expiry of the approved external management period, the external manager must submit a report to the creditors presenting the results of the external management proceedings. The creditors meeting will consider the report and decide whether or not the company is solvent once more. The decision of the creditors meeting and the report of the external manager must then be submitted to the court. If the creditors decide that the debtor has failed to perform the external management plan, the court will normally order the liquidation of the debtor. Liquidation Under a liquidation process the debtor will be declared insolvent and a liquidator, appointed by the arbitrazh court, will be put in charge of the repayment of creditors claims, preparation of liquidation balance sheets, distribution of assets and filing a report of the results of the liquidation with the arbitrazh court. This stage of proceedings should not usually exceed six months, but an extension of a further six months is possible. Liquidation gives rise to the following consequences: the business of the company ceases, except to the extent necessary for it to be liquidated; all monetary obligations of the debtor company become due and payable; all creditors claims in relation to monetary obligations and other claims may be presented only during the liquidation procedure; and the liquidator replaces the management of the company, performing its duties, and has the authority to deal with the company s assets to satisfy the creditors claims. Upon commencement of liquidation, the liquidator must compile a list of all of the debtor s assets, including those located abroad. The liquidator should submit the terms and conditions of sale of the debtor s assets for approval by the creditors at the creditors meeting. The value of assets to be sold will be determined by an independent appraiser. The Insolvency Law stipulates that current claims have priority over all other claims and are satisfied in the following order of priority: the court fees incurred in connection with the insolvency proceedings and the fees of any interim manager and any agents engaged by the interim manager in the course of the insolvency proceedings, where their engagement was required by law; the wages and salaries that are due to the company s employees and the fees of the interim manager s agents which do not fall within the first category; current public utilities and operational expenses of the debtor; and other current claims. After satisfaction of claims in the above categories, all other claims are ranked in the following order of priority: personal injury claims (first priority);

57 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 55 salaries, severance and copyright payments (second priority); and all other claims (third priority). Tax or other governmental claims rank equally with third priority claims. Claims secured by a pledge (mortgage) are satisfied in priority to all other claims in relation to up to 70% (or 80% in the case of secured claims arising under loan agreements) of the proceeds of the sale of such secured assets at a public auction. The liquidation of the company is only final when the arbitrazh court issues a ruling that the liquidation has been completed. Amicable settlement Insolvency proceedings may be terminated at any stage by means of an amicable settlement reached with creditors and approved by the arbitrazh court. Having approved the settlement agreement, the court will terminate the insolvency proceedings. Enforcement of foreign court judgments in insolvency matters A foreign court s decisions in respect of insolvency are recognised in Russia in accordance with international treaties relating to the enforcement of decisions of foreign courts to which Russia is a party. In the absence of such a treaty these decisions are recognised on the principles of reciprocity, unless otherwise provided by the federal law. Russia is not a party to any international treaty dealing specifically with insolvency matters. There is also very little precedent as to the application of the reciprocity principles when enforcing foreign court judgments in insolvency matters. Since court practice is inconsistent on this matter, it is difficult to predict the position which would be taken by the Russian courts in any given case. Under the Insolvency Law, a settlement agreement must provide a procedure for the settlement of creditors claims in cash. Typically, the settlement agreement will provide for a debt repayment schedule over a period of several years, with a significant discount and a low rate of interest. However, with the creditors consent, the settlement agreement may provide for debt novation, debt securitisation or forgiveness of the debt. Cross-border insolvency issues Russian legislation does not contain special rules dealing with international insolvencies. As a matter of practice, certain issues described below may arise in Russia. Insolvency of foreign companies with assets in Russia Russian law is not familiar with the concept of a cross-border corporation and does not regulate bankruptcy proceedings of such entities. To the extent that any such corporation conducts business in Russia other than through a Russian legal entity (which would be unusual), the insolvency of that foreign entity would be governed by the relevant foreign law. Russian law would accept the foreign governing law and follow the directions of the foreign company s administrators (subject to providing sufficient evidence of their powers) regarding the assets of that company in Russia. If the cross-border corporation operates through a Russian subsidiary, the insolvency of that subsidiary will be governed by Russian insolvency laws without regard to the insolvency of its parent. No local insolvency proceedings can be initiated in Russia against a company which has no place of incorporation in Russia.

58 56 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS 22. Litigation On acquiring a business or company in Russia there may be continuing litigation which will need to be considered. Similarly, during the course of running a business, litigation may occur with private parties or state authorities. Court system The structure of the court system Russia has a dual court system consisting of two independent branches of courts of law: the courts of general jurisdiction and the arbitrazh courts. The courts of general jurisdiction deal with disputes involving private individuals (family, housing, inheritance, labour etc). The arbitrazh courts deal with disputes of a commercial nature between legal entities or registered individual entrepreneurs. The arbitrazh courts also resolve disputes involving insolvency matters, shareholder disputes and challenges to the validity of state legal acts of an economic nature. The size or amount of the claim is not relevant in determining the jurisdiction of each court system. A specialised Intellectual Property Court is expected to be launched within the Russian arbitrazh court system in It will consider intellectual property disputes regardless of whether such disputes involve private individuals or commercial entities. Both court branches operate on the basis of their respective procedural codes the Civil Procedure Code and the Arbitrazh Procedure Code. Judges and juries Russia has adopted an inquisitorial court system where the judge investigates the arguments and evidence presented by the parties and, if needed, requests that the parties supply additional evidence. The judge plays an active role in the proceedings. In the courts of general jurisdiction, civil cases are resolved by professional judges only, usually by either one judge or a panel of three. Juries are not involved in civil actions. The same applies to the arbitrazh courts, except that when a party makes an application (and substantiates that the case is particularly difficult or requires specific knowledge in economics, finance or management), a case in the court of first instance may be decided by one professional judge and two arbitrazh jurors registered with the court. The arbitrazh jurors and the judge have equal powers to decide the case. Limitation periods timeframes for bringing civil claims Most limitation periods are laid down by the Civil Code. The basic rule for actions based on contract or tort is that the claimant has three years from the date the claimant became aware or should have become aware of the wrong suffered. The limitation period established by law cannot be changed by agreement between the parties. However, the limitation period may be suspended where, for example, a force majeure event occurs, or can be restarted in certain circumstances such as when a claim is brought or when the debtor behaves as if he has acknowledged the debt. An expired limitation period may, in very few cases, be reinstated by the court if it finds a compelling reason to do so. Pre-action behaviour Where the law specifically requires, or the parties agreement provides for specific pre-action behaviour, and the claimant files a claim without complying with such behaviour, the claim will not be processed until the claimant is able to show compliance with the pre-action behaviour. Starting proceedings Filing a claim with the court is not in itself a sufficient trigger for proceedings to be deemed to have been commenced. Under Russian law, proceedings are commenced upon the court rendering a ruling on acceptance of the claim and initiation of proceedings. This applies to both arbitrazh courts and courts of general jurisdiction. For a statement of claim to be accepted by the court it must contain a number of items and a number of attachments that are specified by the procedural code. Among other things, payment of state duty (dependent on the amount in dispute) is necessary. The state duty is capped at RUR200,000 (approximately US$6,700) in the arbitrazh courts and at RUR60,000 (approximately US$2,000) in the courts of general jurisdiction. If the statement of claim does not contain the required information, or if the required attachments are missing, the court will allow the claimant a period of time to rectify the claim during which the case will not progress. If not rectified, the claim will be returned to the claimant. If rectified, the claim is considered to have been filed with the court on the date of its initial filing. If a case reaches the Courts of Appeal, Cassation or Supervision (whether arbitrazh or of general jurisdiction), it must be considered by a panel of three or more judges.

59 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 57 There are other grounds on which the statement of claim may be returned to the claimant before the merits of the case are considered. These include filing a claim in the wrong court (failure to comply with the venue rules). Timetable After the statement of claim is accepted by the appropriate court, the court proceeds with the preparatory stage of the judicial proceedings culminating in a preliminary court hearing. In the arbitrazh courts the case must be considered on its merits within three months of the date of filing of the claim with the court. The overall procedure for the case to be examined by all four levels of the arbitrazh court system takes roughly one year. The timeframe for judicial examination of a case in the courts of general jurisdiction is slightly less as the case must be examined (including the preparatory stage) and the judgment rendered within two months of the statement of claim being filed with the court. On average, proceedings from filing a claim to obtaining a judgment in the court of general jurisdiction vary from two to three months. The total term for the case to pass through all judicial levels is about one year. However, this estimate is subject to a number of circumstances which might cause delay, such as: filing a statement of claim or an appeal that is inconsistent with the procedural code requirements (which triggers a period for rectification of the defects of the claim or the appeal); third party interventions in the proceedings (which may result in the whole judicial examination starting again from the beginning); or one of the parties to the case being a foreign company or a foreign citizen (in which case it is probable that a complex and time-consuming procedure for service of judicial documents abroad will apply). These circumstances may significantly extend the duration of the proceedings. A judgment can be enforced after it enters into force. As a general rule, a judgment enters into force within one month of it being issued by the court of first instance (both in arbitrazh courts and in courts of general jurisdiction) unless an appeal is filed. If appealed, a judgment enters into force immediately after the court of appeal upholds it. It therefore usually takes no more than six months to obtain an enforceable judgment. The court of cassation and the supervisory court (the third and the fourth judicial levels) review judgments that are already in force. Case management control over the case The procedural codes establish the rights attaching to certain steps and timeframes for exercising these rights. It is up to the parties to decide whether to make use of these procedural steps or not. In this sense the parties can control the proceedings. The procedural time frames may also be extended by the court upon a party s application. Parties appeals against various procedural rulings may also extend the timetable significantly. Evidence Submission of evidence in support of the claim is mandatory for the parties in the court of first instance both in arbitrazh courts and courts of general jurisdiction. Parties do not have a duty to disclose evidence against their own case. A party may refer only to the evidence that was disclosed to the other party before the hearing. In any subsequent appeals, new evidence is accepted by the court only if there is a reasonable justification as to why this evidence was not provided to the court in the first instance. Privilege A Russian court is entitled to require production of any documents from a party to a dispute if they are relevant to the proceedings. It would be quite unusual for the court to require documents containing legal advice or similar documents to be produced. Legal advice from an in-house lawyer (whether local or foreign) or outside counsel will not be privileged from a Russian law perspective. In a limited number of cases, documents held by Russian advocates (regulated legal practitioners) may be protected by professional privilege. However, this does not preclude mandatory disclosure by the clients themselves. Witness and expert evidence Russian procedural rules provide for witness and expert evidence. Witnesses are required to appear in court in person in order to give oral evidence. Experts normally give evidence in writing but may be requested by the court to give oral evidence as well. There is a greater tendency to use witness evidence in the courts of general jurisdiction than in the arbitrazh courts. Proceedings in the arbitrazh courts are mainly based on documents. Interim remedies The court has wide powers to order various interim remedies including seizure of property belonging to a party, prohibiting a party or any third party from performing certain actions in relation to the subject matter of the dispute and requiring the defendant to perform particular actions in order to avoid damage to the claimant. The general test to determine if interim relief should be granted is whether there is a risk that, in its absence, the enforcement of a future judgment would be more difficult or impossible. The arbitrazh courts may also consider the probability of major losses being incurred by the applicant if interim relief is not granted. Interim relief may not be sought from the Russian courts in support of foreign court proceedings. Seeking interim relief in support of arbitral proceedings is possible subject to the general terms and conditions for taking interim measures established by the arbitrazh procedural code. Remedies General remedies available under Russian law include in particular: recognition of a right; restitution; invalidation of a voidable transaction; declaration of the invalidity of an act of state agency; specific performance; damages as compensation; recovery of a penalty;

60 58 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS compensation for moral harm; and various others. In a monetary claim the court may order payment of interest. Enforcement Judgments are enforced under the procedure established by the Enforcement Proceedings Law dated 2 October 2007 (Enforcement Proceedings Law). The Enforcement Proceedings Law provides that the judgments of Russian courts are enforced on the basis of enforcement documents issued by the courts. Essentially, these are writs of execution issued by the court on the basis of the judgment and other court orders. Generally, judgments are enforced by submitting the enforcement document to the State Bailiffs Service which then initiates enforcement proceedings. The enforcement proceedings essentially consist of locating and seizing the debtor s assets and selling them at public auctions, the proceeds of which go to the creditor. Costs The losing party must pay the court s costs, consisting of filing fees and court expenses. The losing party must also reimburse the legal fees of the successful party within reasonable limits. What is reasonable is determined by the court at its discretion, although usually the sums awarded are low. Foreign judgments Previously, foreign court judgments were only recognisable and enforceable in Russia as provided for in international treaties for mutual legal assistance with Russia. Such treaties only exist with certain former socialist countries, a few Western jurisdictions and CIS countries. However, quite recently Russian courts have started enforcing foreign judgments based on the reciprocity principle as well as international treaties of general nature (such as the European Convention on Human Rights). One could say there is a positive trend in this regard. (For further information about conventions to which Russia is a party, see Appendix 3 to this Guide). Subject to the above, a Russian court will recognise and enforce a foreign court judgment without reconsidering the case on its merits, unless one of the grounds for refusal exists (such as inconsistency with the public policy of Russia or the exclusive jurisdiction of Russian courts). If the Russian court recognises a foreign court judgment, it will issue a writ that can be submitted to bailiffs for enforcement. This writ will be enforced in the same manner as any other writ issued by the Russian court in domestic proceedings. The court may also impose court costs upon a party which has abused its procedural duties (for example protracting, delaying or disrupting the proceedings) regardless of the outcome of the case. Fee arrangements Russian law has not adopted a unified approach relating to fee arrangements between the client and its lawyers. However, the available precedents indicate that Russian courts look rather negatively at no win, no fee agreements. Parties may bring proceedings using third-party funding. The distribution of the proceeds of the claim between the litigating and the funding party will be a matter for agreement between the parties themselves. Appeals Each party may appeal a court decision to a higher court. There are potentially four levels for review of a case.

61 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA Arbitration Russia is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). Therefore, international arbitration is an attractive option as a means of dispute resolution in contracts with Russian parties or with parties whose assets are located in Russia. (For further information about conventions to which Russia is a party, see Appendix 3 to this Guide). UNCITRAL MODEL LAW International commercial arbitration in Russia is governed by the Law on International Commercial Arbitration 1993 (the International Arbitration Law) (largely based on the UNCITRAL Model Law) and the Arbitrazh Procedural Code. Domestic arbitration is governed by the Federal Law on Arbitral Tribunals (the Domestic Arbitration Law). This deals purely with domestic arbitrations between Russian parties and is not based on the UNCITRAL Model Law. The focus of this overview is on the International Arbitration Law. Arbitrable disputes The general position is that any type of civil dispute can be submitted to arbitration unless the law provides otherwise. The following categories of disputes are usually considered not arbitrable (the following list is not exhaustive): insolvency cases; disputes about registration and granting of IP rights in Russia; disputes about invalidation of entries in Russian state registers; and disputes about establishment, liquidation or registration of legal entities or individual entrepreneurs in Russia. In addition, there is recent court practice in Russia suggesting that corporate disputes are not arbitrable. Arbitration agreements formal requirements An arbitration agreement may be in the form of an arbitration clause in a contract or in the form of a separate contract. In whatever form, the arbitration agreement must be in writing and must: contain an explicit statement that disputes should be submitted to arbitration; define the legal relationships and the disputes which should be arbitrated; and correctly specify the arbitral institution that should resolve the disputes, or refer to ad hoc arbitration. If an action is brought in a matter which is the subject of an arbitration agreement, the Russian court must, upon the respondent s request, stay the proceedings and refer the parties to arbitration unless it finds that the arbitration agreement is null and void. Choice of arbitrator In the absence of an agreement between the parties, the default number of arbitrators is three. In an arbitration with three arbitrators, each party appoints one arbitrator and the two arbitrators so appointed (or failing this, the president of the Chamber of Commerce and Industry (CCI) of Russia) appoints the third. In an arbitration with a sole arbitrator, if the parties are unable to agree, then the arbitrator is appointed by the president of the CCI. An arbitrator s appointment may be challenged if circumstances exist that give rise to justifiable doubts as to his independence or impartiality. An arbitrator s mandate can be terminated: in the event of voluntary withdrawal; by agreement of the parties; where he is unable to perform his duties (due to death, illness etc); or if he fails to act without reasonable delay. Procedure The parties are free to agree on the procedure to be followed by the arbitral tribunal in conducting the proceedings. Failing such agreement, the arbitral tribunal may conduct the arbitration (in terms of procedural and evidential matters) in such manner as it deems appropriate. The parties are free to agree the seat of arbitration and, in the absence of such agreement, the arbitral tribunal will determine the seat having regard to the circumstances of the dispute and convenience of the parties. In the absence of agreement between the parties regarding the language of the proceedings, it will be determined by the arbitral tribunal at its discretion. The International Commercial Arbitration Court (ICAC) of the CCI is the major institutional arbitration centre in Russia. It should be noted that in arbitrations to be conducted under the ICAC Rules the default language of the arbitration is Russian and, although the parties may choose to hold hearings abroad, the seat will always be Moscow. Court intervention The court s role is supportive and there is minimal intervention by domestic courts in the arbitral process. However, courts may interfere in the following instances: courts may consider a jurisdictional challenge brought against an interim award which confirms that the arbitral tribunal has jurisdiction;

62 60 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS courts may grant interim measures (such as freezing injunctions and other injunctive relief); courts may assist the arbitral tribunal with the taking of evidence; and courts may set aside arbitral awards on certain grounds. Interim relief Unless otherwise agreed by the parties, the arbitral tribunal may, at the request of a party, order interim measures and require any party to provide appropriate security. However, such an order is not subject to compulsory enforcement. The limitation period for submitting a foreign arbitral award to a Russian court for recognition and enforcement is three years. A party seeking to enforce an international arbitral award must file a written application with a competent court. After considering the application in a hearing, the Russian court renders a ruling declaring the award enforceable and issues a writ of enforcement. There is a right of appeal. Costs The arbitral tribunal rules on the allocation of fees and costs between the parties and has discretion to award legal costs to the winning party within reasonable limits. In addition, a party to arbitration may apply to a Russian state court for interim measures in support of such arbitration. Award The arbitral award must: state the reasons for the decision; be in writing; state the date and place of arbitration; and be signed by the arbitrator(s). The arbitral tribunal must deliver an executed copy of the award to each party. The International Arbitration Law does not specify time limits for rendering the award, but ICAC rules provide that the ICAC should take measures to complete arbitral proceedings within 180 days of the composition of the arbitral tribunal. Appeals As a general rule, an arbitral award cannot be appealed. An international arbitral award made in Russia may be set aside by the Russian state courts. An award made outside Russia may not normally be set aside in Russia. The grounds for setting aside an arbitral award provided by Russian domestic law are similar to the grounds in the New York Convention and include the following: the arbitration agreement was not valid; a party was not given proper notice of the proceedings or was unable to put its case forward properly; the award was made regarding a dispute not falling within the scope of the arbitration agreement; the composition of the arbitral tribunal or procedure was not in accordance with the agreement between the parties; the subject of the dispute is not capable of settlement by arbitration under Russian law; or the award is in conflict with Russian public policy. There is no right to apply to the court on a question of fact. Enforcement Generally, Russian courts tend to look favourably on the enforcement of arbitral awards. However, the relevant laws are not always consistently applied.

63 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 61 Appendix 1: bilateral investment treaties Set out below are the bilateral investment treaties to which Russia is a party Abkhazia (disputed region) Albania Algeria (signed: 10/3/06; not in force) Angola Argentina Armenia Austria Belgium and Luxembourg Bulgaria Canada China Croatia (signed: 20/5/96; not in force) Cuba Czech Republic Denmark Ecuador (signed: 25/4/96; not in force) Egypt Equatorial Guinea (signed: 6/6/11; not in force) Ethiopia (signed: 10/2/00; not in force) Finland France Germany Greece Hungary India Indonesia Italy Japan Jordan Kazakhstan Kuwait Laos Lebanon Libya Lithuania Macedonia Moldova Mongolia Namibia (signed: 25/6/09; not in force) Netherlands Nicaragua (signed: 26/1/12; not in force) Nigeria (signed: 24/6/09; not in force) North Korea (signed: 28/11/96; not in force) Norway Philippines (signed: 12/9/97; not in force) Poland (signed: 2/10/92; not in force) Portugal (signed: 21/7/94; not in force) Qatar Republic of Cyprus (signed: 11/4/97; not in force) Romania Singapore Slovakia Slovenia (signed: 8/4/00; not in force) South Africa South Korea South Ossetia (disputed region) Spain Sweden Switzerland Syria Tajikistan (signed: 16/4/99; not in force) Thailand (signed: 17/10/02; not in force) Turkey Turkmenistan Ukraine United Arab Emirates (signed: 28/6/10; not in force) United Kingdom United Republic of Yugoslavia (Serbia and Montenegro) USA (signed: 17/6/92; not in force) Uzbekistan (signed: 22/12/97; not in force) Venezuela Vietnam Yemen Zimbabwe (signed: 7/10/12; not in force)

64 62 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Appendix 2: double tax treaties Set out below are the countries with which Russia has signed a double tax treaty Albania Algeria Argentina Armenia (further protocol signed 24/10/11 which is not yet in force) Australia Austria Azerbaijan Belarus (further protocol signed) Belgium Botswana Brazil Bulgaria Canada Chile China Croatia Cuba Cyprus (further protocol signed) Czech Republic (further protocol signed) Denmark Egypt Estonia (signed: 5/11/02; not yet in force) Ethiopia (signed: 26/11/99; not yet in force) Finland (further protocol signed) France Georgia (signed: 4/8/99; not yet in force) Germany (further protocol signed) Greece Hungary Iceland India Indonesia Iran Ireland Israel Italy (further protocol signed) Japan Kazakhstan Korea (People s Republic) Korea (Republic) Kuwait Kyrgyzstan Laos (signed: 14/5/99; not yet in force) Latvia Lebanon Lithuania Luxembourg (further protocol signed: 21/11/11 which is not yet in force) Macedonia Malaysia Mali Malta (signed: 15/12/00; not yet in force) Mexico Moldova Mongolia Montenegro (as successor to former Yugoslavia) Morocco Namibia Netherlands New Zealand Norway Oman (signed: 26/11/01; not yet in force) Philippines Poland Portugal Qatar Romania Saudi Arabia Serbia (as successor to former Yugoslavia) Singapore Slovakia Slovenia South Africa Spain Sri Lanka Sweden Switzerland (further protocol signed) Syria Thailand Tajikistan Turkey Turkmenistan Ukraine United Arab Emirates (signed: 7/12/11; Not yet in force) United Kingdom United States Uzbekistan Venezuela Vietnam

65 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 63 Appendix 3: main conventions Set out below are the main Conventions to which Russia is a signatory UNCITRAL 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) 1980 United Nations Convention on Contracts for the International Sale of Goods (CISG) Hague Conference on Private International Law Convention of 1 March 1954 on Civil Procedure Convention of 5 October 1961 Abolishing the Requirement of Legalisation for Foreign Public Documents Convention of 15 November 1965 on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters Convention of 18 March 1970 on the Taking of Evidence Abroad in Civil or Commercial Matters WIPO Paris Convention for the Protection of Industrial Property (1883) Berne Convention for the Protection of Literary and Artistic Works (1886) Patent Cooperation Treaty (PCT) (1970) Madrid Agreement Concerning the International Registration of Marks (1891) and the Protocol Relating to that Agreement (1989) Patent Law Treaty (PLT) (2000) Carriage of Goods (by sea, rail, road) International Convention for the Unification of Certain Rules of Law relating to Bills of Lading ( Hague Rules ) (as amended by 1979 Protocol) European Agreement Concerning the Work of Crews of Vehicles Engaged in International Road Transport (AETR) (Geneva, 1970) Agreement on International Goods Transport by Rail of 1 November 1951 (SMGS Agreement) Convention on the Contract for the International Carriage of Goods by Road (CMR) (Geneva, 1956) Convention on International Transport of Goods Under Cover of TIR Carnets (TIR Convention) (Geneva, 1975) Aviation Convention for the Unification of Certain Rules Relating to International Carriage by Air (Warsaw Convention) (1929) Nuclear (IAEA) Convention on Nuclear Safety (CNS) (Vienna, 1994) Vienna Convention on Civil Liability for Nuclear Damage (1996)

66 64 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Appendix 4: abbreviations and definitions ABBREVIATIONS DEFINITIONS Antimonopoly Law Banking Law CBR CBR Law CCI CEO CFI Civil Code CJSC Code Federal Law on the Protection of Competition Federal Law on Banks and Banking Activity Central Bank of the Russian Federation Federal Law on the Central Bank of the Russian Federation Chamber of Commerce and Industry Chief Executive Officer Clarification of Financial Investments Civil Code of the Russian Federation Closed Joint Stock Company Code of Corporate Behaviour Enforcement Proceedings Law Enforcement Proceedings Law (2/10/07) Executive Bodies FAS FLI FSFM General Director GMRA GSM HQS ICAC ICMA Insurance Law ISDA ISDA MA ISIN JSC JSC Law JV Labour Code LIBOR LLC LLC Law Management Board MET Body performing executive management functions and other day-to-day activities of a JSC or LLC Federal Antimonopoly Service Federal Labour Inspection Federal Service for the Financial Markets of the Russian Federation Individual acting as the Executive Body in the management structure of an LLC or JSC Global Master Repurchase Agreement General Shareholders Meeting Highly qualified specialist International Commercial Arbitration Court International Capital Market Association Federal Law on the Organisation of Insurance in the Russian Federation International Swaps and Derivatives Association ISDA 2002 Master Agreement International Securities Identifying Number Joint Stock Company Federal Law of the Russian Federation On Joint Stock Companies Joint Venture Labour Code of the Russian Federation London Interbank Offer Rate Limited Liability Company Federal Law of the Russian Federation On Limited Liability Companies Body of directors acting with the General Body as the Executive Body in the management structure of an LLC or JSC Mineral extraction tax

67 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 65 ABBREVIATIONS MICEX SE MNR MOSPRIME OJSC PSA RDR Register Regulation on the FSFM Rosnedra Rospatent Rosprirodnadzor RUR Securities Markets Law SHA SPBEX SPCEX Strategic Companies Strategic Fields Strategic Subsoil Companies Subsoil Law Tax Code UNCITRAL US$ VAT DEFINITIONS Moscow Interbank Currency Exchange Ministry of Natural Resources Moscow Prime Offered Rate Open Joint Stock Company Production Sharing Agreement Russian depositary receipt Unified State Register of Legal Entities Regulation on the Federal Service for Financial Markets Federal Agency on Subsoil Use Federal Service for Intellectual Property Federal Service on Supervision in the Sphere of the Use of Natural Resource Russian Rouble Federal Law on the Securities Markets Shareholders Agreement Saint Petersburg Stock Exchange Saint Petersburg Currency Exchange Russian companies operating in strategic business sectors Subsoil fields of federal significance Strategic Companies developing Strategic Fields Federal Law on Subsoil Tax Code of the Russian Federation United Nations Commission of International Trade Law US Dollars Value Added Tax

68 66 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS Appendix 5: contacts CONTACTs Russia Corporate Alexei Roudiak Managing Partner Russia Head of Corporate Russia T [email protected] Earns praise from market sources for his commercial acumen Chambers Europe 2013 One of the smartest in town Chambers Global 2011 A commercial partner who can do anything Chambers Europe 2011 View full profile Mark Geday Partner, Corporate T [email protected] A first-class lawyer The Legal500 UK 2012 Praised by clients for his commerciality Chambers UK 2012 View full profile Danila Logofet Partner, Corporate, Energy, Mining T [email protected] One of the best energy lawyers in Russia The European Legal Leaving aside the knowledge and skills, what we appreciate most was his availability and commitment Chambers Europe 2013 View full profile Olga Revzina Partner, Corporate, Infrastructure and Transport T [email protected] Top ranked in Chambers Europe for PPP in Russia since 2007 A particularly business-oriented lawyer who is extremely knowledgeable and knows the market very well Chambers Europe 2013 View full profile Tomasz Woźniak Partner, Corporate T [email protected] Tomasz Wozniak has impressed peers with his hands-on involvement and thorough understanding of transactions Chambers Europe 2009 Ensures high standards of service on private equity deals Chambers Europe 2010 View full profile

69 HERBERT SMITH FREEHILLS LEGAL GUIDE TO INVESTING IN RUSSIA 67 Capital markets Allen Hanen Managing Partner - EMEA, Capital Markets T [email protected] Listed in The Lawyer s Hot Listed in The Best Lawyers in Russia 2013 View full profile Evgeny Zelensky Partner, Capital Markets T [email protected] Clients praise him as an impressively skilful lawyer, highlighting his attention to detail and excellent team management skills Chambers Europe 2013 Listed in The Guide to the World s Leading Capital Markets Lawyers as one of the best capital markets lawyers in Russia since 2009 View full profile Dispute resolution Vladimir Melnikov Partner, Dispute Resolution T [email protected] Listed in The Best Lawyers in Russia 2013 The best young lawyer I ve seen in 30 years of working with law firms his skills in interacting with government agents are truly exceptional The European Legal View full profile Alexei Panich Partner T [email protected] Listed in Leading Individuals for dispute resolution in Russia The European Legal A tenacious litigator; someone who has a lot of respect in the market Chambers Europe 2013 View full profile Finance Edward Baring Partner Head of Finance Russia T [email protected] Clients love working with him. He is also valued for his practical service and thorough knowledge, combined with top-quality negotiations skills Chambers Europe 2013 An absolute star in the market, very good, always leads on deals, very commercial IFLR View full profile Artjom Buligin Partner, FInance T [email protected] Finds great ways of explaining complex terms clearly Chambers Europe 2013 Highly efficient, smart and always to the point Chambers Global 2012 View full profile Olga Davydava Partner, Finance T [email protected] Very devoted to the project with a willingness to see it through no matter what a client s letter 2011 View full profile

70 68 LEGAL GUIDE TO INVESTING IN RUSSIA HERBERT SMITH FREEHILLS TAX Oleg Konnov Partner T [email protected] Top ranked in Chambers Europe for Tax in Russia since 2008 Very professional and business-oriented The European Legal View full profile CONTACTs GLOBAL Finance London John Balsdon Partner T [email protected] Excellent strategic adviser who speaks the language of a problem solver Chambers Global 2011 He is able to address an issue from all the angles Chambers Global 2011 View full profile Finance Moscow/Dubai Alexander Currie Partner T [email protected] Clients entrust him with their most valuable mandates, citing his pragmatic approach and industry knowledge Chambers Global 2013 He is very approachable, commercially aware and a tough negotiator when he needs to be Chambers Global 2011 View full profile Dispute Resolution London Matthew Weiniger Partner T [email protected] Has a terrific reputation in investment treaty arbitrations Chambers UK 2013 Knowledgeable, and gives practical advice The Legal500 UK View full profile Corporate London Nicholas Moore Partner T [email protected] Sources appreciate his confident manner and solid negotiating style, as well as his creative and practical approach Chambers Europe 2013 He is a frequent contact for clients with aspirations of working in Russia for the first time Chambers Europe 2012 View full profile

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72 HERBERTSMITHFREEHILLS.COM ABU DHABI r T F BANGKOK T F BEIJING Representativ T F BELFAST T F BERLIN T F BRISBANE T F r r r r reehills td DOHA T F DUBAI T F FRANKFURT r T F HONG KONG reehills T F JAKARTA Hiswar T F LONDON T F r r r r andjung MELBOURNE reehills T F MOSCOW T F NEW YORK r T F PARIS T F PERTH T F SEOUL C T F r r reehills r or egal e SHANGHAI Representativ T F SINGAPORE r T F SYDNEY T F TOKYO T F r reehills reehills BRUSSELS T F r MADRID T F r Herbert Smith Freehills 2013 NPB