Although the tendency has been for joint investments in Russian companies to be structured through offshore entities, there are many occasions when this is not possible or appropriate. Agreements regulating direct shareholdings in Russian entities are therefore regularly used in Russia. However, one of the principal shortcomings of Russian law in the context of shareholders agreements was the fact that it seemed foreign law could not be chosen by the parties to regulate such an agreement in relation to a company incorporated in Russia, even where one or more shareholders was foreign. Regardless of whether there are actual defects implicit in a Russian law-governed shareholders agreement, adapting commonly understood English model documents to Russian law has not been easy; the resulting documentation is lacking in familiarity and has not generally been preferred (even by Russian clients).
It is therefore much to be welcomed that the fourth set of amendments to the Russian Civil Code (the “Amendments”) – which are entirely devoted to conflict of laws – expressly provide that, as long as at least one party to a shareholders agreement is a foreign person, such agreement can be subject to foreign law. The Amendments came into force on 1 November 2013. This does not mean that the mere choice of foreign law will exclude the relevance of Russian law. The detailed provisions of any joint investment made directly into a Russian legal entity will still be different from those applicable to an investment into an offshore holding entity (the commonly used structure where it is available) even where the same foreign law is used in each instance. In other words, the foreign law precedent commonly used in international JVs will still need some adaptation, but importantly, large swathes of familiar boiler plate and other provisions can now be retained.
- Form of a foreign-law shareholders agreement
Under the express provisions of the Amendments, the choice of foreign law in relation to a Russian direct investment does not apply to the form of the shareholders agreement. This means that Russian law must always apply to the form of a shareholders agreement entered into in relation to a company incorporated in Russia. Accordingly, it must be signed by all the parties as a single document. This can be a logistical headache these days when the ability of parties spread across the world to sign by counterparts is normally assumed.
- Mandatory rules
Foreign law cannot disapply the personal law of a legal entity (lex societatis) in respect of the issues that fall within its scope – which was extended on 1 November 2013 – as these issues are ‘mandatory rules’.
Relevance of mandatory rules – Common law approach
The idea that a foreign-law shareholders agreement cannot override the ‘mandatory rules’ of local corporate law is not an alien concept even for common law jurisdictions. It is not possible for example to have a dividend policy in relation to an English company that conflicts with the UK Companies Act rules on unlawful dividends. Likewise, the scope for the company itself to be a party to a shareholders agreement is technically limited under English law to the extent that a provision would constitute an unlawful fetter on its statutory powers – such as the power under Section 617 of the UK Companies Act to increase its share capital by special resolution.
Relevance of mandatory rules – Russian law approach
Under Russian law, the mandatory rules are a little more extensive. With particular relevance to shareholders agreements, Russian mandatory rules include all the legal norms governing “internal relations, in particular the relations of the company with its shareholders” (article 1202 of the Russian Civil Code).
There are no comprehensive criteria for determining what constitutes internal relations with regard to a Russian company. However, it is a fair assumption that the provisions of a shareholders agreement that would normally be reflected in the charter (for example, qualified majorities, management structures, casting votes, quorums, etc.) are ‘internal relations’. In contrast, those operating purely on the shareholder level, such as voting agreements, options, dispute resolution processes and the like, would not be. Only the first type of provision therefore need to be made consistent with Russian mandatory rules and can only be as flexible as Russian mandatory rules allow.
Some flexibility with management bodies and qualified majority voting
In respect of shareholders agreement clauses on the management bodies of a company and those providing minority protection through qualified majority voting, the mandatory rules are far more flexible in relation to a Russian limited liability company (an “LLC”) than for a joint-stock company (a “JSC”). For this reason, the LLC is now the much more commonly chosen vehicle for direct as well as indirect joint investments. Indeed our experience is that most of the usually encountered veto and qualified majority voting rights found in an English law-governed shareholders agreement can be created in the case of an LLC. Only with a JSC vehicle does the Russian mandatory regime tend to prove too restrictive.
The company cannot become a party to the shareholders agreement
Mandatory rules are also relevant to the joinder of the company as a party to the shareholders agreement. This is commonly used in other jurisdictions, both to ensure that the company itself is bound by obligations which might otherwise have appeared in the charter and to oblige the directors indirectly to give effect to the obligations in the shareholders agreement (e.g. by refusing to approve a transfer of shares). However, Russian corporate law provides that a Russian company cannot be a party to a shareholders agreement. As this concerns the relations of the company with its shareholders, this seems to be a mandatory rule and will continue to apply notwithstanding the choice of foreign law. Neither does it appear from the language of the Amendments themselves that the company can be a party to and bound by the ‘choice’ of foreign law.
- Options, drags and tags
Since foreign law can now govern an agreement in relation to participation in a Russian company, it follows that there is now scope, at least, for options to be incorporated into the terms of the agreement. That said the Amendments have not removed all legal and practical obstacles to the use of drags and tags as well as other types of option arrangements that are widely used in shareholders agreements. Although the amendments made to Russian corporate law in 2009 specifically introduced the concept of both put and call options as applied to Russian shares and participatory interests, it was quickly observed by academic commentators that an option, when analysed as a conditional contract dependent on the will of one party, is not consistent with the Russian Civil Code. As a result, practitioners have tended to take the cautious approach that options of any sort are not enforceable under Russian law insofar as they relate to participation in a Russian entity. Therefore, for as long as foreign law could not be adopted for Russian shareholders agreements, any option-type structures have had to be created separately from the shareholders agreement without an enforcement right in Russia, and with only damages outside Russia as a remedy. Now that the Amendments have permitted the shareholders to choose foreign law to govern their agreement, it appears that an option will be capable of being valid (under that foreign law) as a term of the shareholders agreement, notwithstanding it directly concerns participation in a Russian entity.
On the other hand, a number of existing practical limitations remain. An option concerning a participatory interest in a Russian LLC still has to comply with the mandatory Russian law requirement introduced in 2009, for all agreements relating to the transfer of participatory interests to be notarised – the transfer only becoming effective upon notarisation. It is now well accepted that, as enacted, the notarisation requirement means that conditional agreements of any kind for the sale and purchase of participation interests (including options) cannot be made under a Russian law-governed contract. Instead, they have to be structured via a foreign law-governed sale and purchase agreement as well as a Russian notarised transfer document, and this is established market practice. The Amendments have improved the situation cosmetically since it is now possible to include the option as part of the shareholders agreement itself, but a further Russian notarised transfer agreement is still required.
- Choice of dispute resolution forum
The choice of foreign law usually entails a choice of non-Russian venue for the resolution of disputes. A number of high profile cases in which Russian courts proved to be unsuitable for the resolution of intricate foreign-related shareholder disputes – Farimex Products Inc. v Telenor being a fine example – firmly entrenched a preference for foreign arbitration for this type of dispute.
The Amendments, however, do not deal with the choice of forum. Even if a foreign-law shareholders agreement concluded after 1 November 2013 contains a clause referring disputes to a foreign arbitral tribunal and an arbitral award is granted, an application to enforce the award will generally need to be filed in Russia. As the law currently stands, the Russian state courts are likely to refuse to allow enforcement. Even though Russian case law is not entirely consistent on the issue, Russian courts tend to qualify disputes concerning shares in JSCs and participatory interests in LLCs as ‘corporate disputes’. Following amendments introduced into the Russian Commercial Procedural Code in 2009, corporate disputes can only be heard by Russian state commercial courts.
The Amendments are part of an on-going reform process of the Russian Civil Code and are a considerable step forward. No legislation is going to solve all the problems all at once, but we can see the landscape changing positively. It is not always an efficient solution to structure a Russian joint investment through offshore holdings. Therefore, it is good that legislators have now allowed parties to choose non-Russian governing law as a further step toward making domestic joint ventures and other co-investments the norm. However, the freedom to choose foreign law only benefits transactions with a genuine foreign element. Thus, for the time being, Russian-Russian co-investments will continue to be either Russian law-governed or taken offshore.
Where the jointly owned entity is a Russian LLC, the mandatory rules normally allow for some flexibility in practice, for most purposes of a conventional joint investment. We are quite used to creating qualified voting and management rights in that context – although this is a rather technical process requiring specific expertise. It is much more difficult to do this satisfactorily with a closed JSC, which is becoming an increasingly redundant corporate form.
Despite the progress achieved by the Amendments and previous sets of amendments to the Civil Code1, a number of key issues affecting the development of shareholders agreements for Russian legal entities remain problematic. These are: (i) the mandatory rules on joining the company as a party, which is often important for minority participants in a joint venture; (ii) the complexity of transferring participatory interests in an LLC, including under drag and tag options; and (iii) the relevance of Russian court jurisdiction to shareholder disputes. Therefore, we do not see an immediate change to the tendency to structure Russian joint investments offshore. That said we do recognise this new legislation as an important move toward bringing more of them home.