JOINT VENTURES FACE EVOLVING SOVIET SYSTEM

Non-Soviet companies are driving to form joint ventures with Soviet companies and ministries even as the U.S. and U.S.S.R. superpowers struggle to prune a thicket of political, legal, financial, and economic ground rules.

About 1,300 Soviet joint ventures of all types have been formed since 1986, when no enterprise with foreign capital existed in the Soviet Union.

Only a few are energy related, but joint ventures involving oil production appear to have priority with the Soviets because of their ability to generate hard currency that can be used to repatriate western investments and profits (OGJ, Mar. 19, p. 15).

With the vast size of the Soviet market as a driving force, western entrepreneurs are hacking a path through the evolving Soviet economy and unwieldy bureaucracy by paying meticulous attention to detail in their business plans and learning from their own and others' missteps.

The information in this article and later installments was compiled from presentations made by and interviews conducted with the attributed sources in early 1990 and late 1989.

TRADE NEGOTIATIONS

Private efforts to establish joint ventures on Soviet soil are taking place as the U.S. and Soviet Union conduct high level talks aimed at forging a broad trade agreement.

The Soviets want the U.S. to cease what has been called economic warfare against them and open its markets to Soviet exports.

The 500 company National Foreign Trade Council (NFTC), Washington, D.C., is pressing the U.S. government to adopt most favored nation treatment for the Soviet Union as part of a trade agreement that opens the markets of each country to the other.

Charles E. Hugel, NFTC chairman, told the House ways and means committee the U.S. also should negotiate individual agreements on investment and taxation, change U.S. export control regulations, and remove restrictions on operations of the Export-Import Bank and the Overseas Private Investment Corp.

Hugel, chairman of Asea Brown Boveri Inc., said Soviet officials are considering significant changes in banking, taxation, arbitration, communication, and other areas.

"The dramatic economic and political developments in the U.S.S.R. and other eastern European countries in the last year have significantly changed the nature of the military threat that our national security export controls are designed to address," Hugel said.

U.S.-SOVIET TRADE

Trade talks under way between the U.S. and Soviet Union have many general business implications for U.S. energy joint venturers and the Soviets.

Frank E. Kittredge, NFTC president, told a New York seminar sponsored by the international law firm of Cole Corette & Abrutyn, Washington, and others that such major concerns as the shortage of hard currency and nonconvertibility of the ruble present major obstacles to trade development for both sides.

Among the areas Kittredge said need work are the process of accreditation for U.S. businesses in the U.S.S.R. and the critical need for a broader Soviet economic statistical base to help guide financial and investment decisions.

Jan Vanous, director of research at PlanEcon Inc., Washington, is pessimistic about near term trade prospects.

"The Soviet economy is a mess, and the situation in the near term is going to get worse, not better," he said. "You will have a highly unstable economic climate during the next few years."

Vanous said U.S. firms will not be able to get their profits out of the Soviet Union quickly, and companies can be expected to undercapitalize projects due to the probable devaluation of the ruble.

"This is a very exciting market," he said. "But I see a difficult transition the next 2-3 years."

Hugel said the measures and agreements NFTC proposed are a formidable challenge for both governments.

JOINT VENTURE IMPETUS

Creation of a joint enterprise is at present the only way for a foreign company to operate in the Soviet Union.

William E. Butler, London, said a joint enterprise, according to Soviet legislation, is a company formed in the Soviet Union and in accordance with Soviet law that is jointly owned by one or more western parties and one or more Soviet parties.

Butler is professor of comparative law at the University of London, dean of its faculty of laws, and director of the Centre for the Study of Socialist Legal Systems at University College, London. He also is special counsel to the U.S.S.R. Council of Ministers.

He said the original Soviet joint venture legislation was conceived as a basic framework to be adapted in light of experience.

Many companies that have registered joint enterprises in the Soviet Union-in effect invited to write their own ticket-have taken advantage of the period of flexibility that has prevailed since the first Soviet joint venture edict in January 1987.

Amendments have liberalized and clarified matters but in certain respects eliminated some of the flexibility originally offered, Butler said.

For example, Moscow dropped requirements that the Soviet entity own 51% or more of the joint enterprise and its director be a Soviet citizen. However, the Ministry of Finance is increasingly imposing minimum capitalization requirements due to concern about the low capitalization of many joint enterprises, Butler said.

Nevertheless, an article in a February 1990 issue of the Moscow daily newspaper Trud (Labor) said in part:

"In the entire world middle sized and small business plays an important role ... Is it reasonable from the viewpoint of foreign firms to risk large amounts of capital at a time when we still have such an unstable economic policy and when we do not have a nationwide law that protects foreign investments?"

MEETING INTERNAL NEEDS

The Soviet Union is far behind the West in providing its people with basic quality consumer items, said Richard M. Hammer, national director of international tax services, Price Waterhouse, New York.

Hammer is immediate past president of the International Fiscal Association and chairman of the tax committee of the U.S. Council for International Business.

In Soviet eyes, Butler said, the oil and gas industry promises a potentially rapid return in hard currency when compared with other investment opportunities with western partners.

"Given the urgent need to earn hard currency to meet a vast range of social needs associated with perestroika, it is likely the Soviet Union will be anxious to encourage investment from western oil and gas companies," Butler said.

Yuri V. Dubinin, Soviet ambassador to the U.S., said development of joint ventures has been slow, due in part to "the absence of a business environment conducive to foreign investments."

Dubinin added, "We see the problem, we are trying to solve it, and we are open to any suggestions."

SOVIET LEGAL PROVISIONS

The legal framework for joint enterprises is governed by a Soviet decree of Jan. 13, 1987, as amended Sept. 17, 1987, Dec. 2, 1988, and Mar. 7, 1989. Collateral legislation supplements the Jan. 13 decree.

Oil and gas companies thinking of operating in the Soviet Union need to master, not just investigate, the economic and legal framework of doing business there, Butler said.

"The legal framework for merely doing business with the Soviet Union is a very different proposition from doing business in the Soviet Union," he said.

Contacts need to be established at all levels from the ministries of oil and gas and geology to relevant industry sources in the republics.

"The political evolution within the Soviet Union will introduce in the very near future sweeping changes in the traditional administrative scheme for ruling the country," Butler said. Broad contact is needed to understand change as it occurs.

Ninel Vosnesenskaya of the U.S.S.R. Academy of Sciences said only a few of the 1,300 registered joint ventures are operating "due to a number of legal, economic, and practical obstacles arising from fairly sketchy Soviet law and uncertainties in the economic system.

"The U.S.S.R. does not yet have corporation law, bankruptcy and antitrust laws, or comprehensive investment law.

"Joint ventures will have to face new economic situations if market forces come to play a greater role in the U.S.S.R. or if economic decentralization in the country results in autonomy for the Soviet republics."

INVESTING LONG TERM

The fundamental principle of Soviet joint venture legislation is the financial self-sufficiency of each venture, said Eugene E. Madara, vice-president and chief counsel, engineering and process technology, Combustion Engineering Inc., Stamford, Conn.

Madara negotiated the first U.S.-Soviet joint venture and the largest to date.

"Your business plan, which must reconcile the often inconsistent business objectives of Soviet and western investors, has to give the joint venture a sufficiently stable financial base to permit it to succeed in a market in which profits should not be anticipated during the first quarter or even the first year of operation."

Some joint ventures have shown a profit within a year, Madara added.

"The Soviet Union is not a 'quick kill' marketplace. It requires an investment strategy based upon a long term commitment to the country.

"If you are not prepared to make that long term commitment, seriously consider whether you are wasting your time and that of the potential Soviet partner by starting something unrealistic."

FORMING ORGANIZATIONS

The board of directors of a Soviet joint venture is its highest authority.

The Soviets simply do not have the western concept of stockholders, Madara said.

Early joint ventures had to struggle with issues of majority/minority voting rights based on percentage equity ownership and played "supermajority" voting games, but recent Soviet joint venture legislation changed that.

Now joint venture boards operate on the principle of unanimity. This requires parties to work out differences and makes important technical matters such as a quorum for valid meetings, notice and agenda, and the like.

The main operating problem for boards, Madara said, is that there is no board tradition in the Soviet Union. Board meetings frequently deteriorate from senior policymaking into day to day management committees.