Russia implements new law regarding foreign investment

EDITOR’S NOTE: In June of last year, OGFJ published an article from Vinson & Elkins’ Natalya Morozova and Rob Patterson about the Russian government imposing new constraints on foreign investment in Russia’s oil and gas sector. Since that time, several new restrictions have been imposed. This article analyzes those new restrictions and their impact on the international investment community.

On May 7, 2008, a new law “On the Procedure for Foreign Investment in Companies Strategically Important for the Defense and National Security of the Russian Federation” (the “Strategic Companies Investment Law”) came into effect, restricting foreign control over Russian companies operating in certain “strategic industries” in Russia (“Strategic Companies”).

At the same time, amendments to (among other things) the Russian Subsoil Law came into force and, together with further supplements introduced in July 2008, impose significant restrictions on the rights of foreign investors and Russian companies with foreign investment (regardless of the size of foreign investment) to deposits of natural resources that are deemed to be “of federal significance.” This article analyzes the terms of the new restrictions on foreign investment and examines the Russian authorities’ first steps towards their implementation.

The new restrictions

The Strategic Companies Investment Law establishes a new commission, the Governmental Commission for Control over Foreign Investment in the Russian Federation (the “Special Commission”), headed by the Prime Minister, for the purposes of considering proposed foreign investments into Strategic Companies. The Special Commission works closely with the existing competition authority, the Federal Antimonopoly Service (the “FAS”), to which has been assigned the technical function of collecting, processing and responding to applications.

The Strategic Companies Investment Law introduces a number of requirements for foreign investors in Strategic Companies, ranging from obtaining the Special Commission’s prior consent to the making of an investment to notifying the Special Commission of existing investments. In particular, prior Special Commission consent is required for any transaction which will result in a foreign investor having:

• 5% or more of the voting shares in a Strategic Company which is a subsoil user, if the investor is a foreign government or an international organization controlled by a foreign government
• 10% or more of the voting shares, or the right to appoint a sole executive body or 10% or more of the management or supervisory body, of a Strategic Company which is a subsoil user
• Any additional voting shares in a Strategic Company which is a subsoil user, even if the foreign investor already holds 10% or more of voting shares in such Strategic Company
• Over 25% of the voting shares, or other blocking rights, in respect of a Strategic Company which is not a subsoil user, if the investor is a foreign government or an international organization controlled by a foreign government
• Over 50% of the voting shares in a Strategic Company, or the right to appoint a sole executive body and/or more than 50% of the management or supervisory body, of a Strategic Company which is not a subsoil user
• In any other way, the ability to determine decisions taken by a Strategic Company or its management bodies.

Investments into Strategic Companies involved in subsoil use are therefore subject to significantly more stringent restrictions than those into other industries. Further, obtaining subsequent consent of the Special Commission is required if a foreign investor acquires control over a Strategic Company not as a result of a transaction but as a result of a change in voting power, e.g. due to a share buyback or share conversion. In such a case, the affected foreign investor must apply for clearance within three months after such events took place.

In addition, investors must notify the Special Commission within 45 days after acquiring 5% or more shares in a Strategic Company. Interestingly, according to the FAS’ interpretation of the Strategic Companies Investment Law, this requirement also applies to foreign investors who have obtained the Special Commission’s prior clearance to the transaction in question, apparently in order to enable the FAS to monitor whether cleared transactions have in fact been completed.

Finally, all foreign investors that held 5% or more shares in a Strategic Company as of the effective date of the Strategic Companies Investment Law were required to notify the FAS of that fact within 180 days of that date. Notably, only those transactions which were completed before May 7, 2008, are grandfathered under the Strategic Companies Investment Law.

In general terms, the Strategic Companies Investment Law requires the FAS to process an application, and the Special Commission to rule on it, within three months from the date of registration of the application with the FAS. In exceptional cases, this term may be extended by additional three months. In addition, the Special Commission has the right to grant its consent subject to conditions, which may include obligations on the applicant to (i) appoint Russian nationals to the management bodies, (ii) continue to provide goods or services for the defense industry, (iii) abstain from dismissing employees for a specified period of time, and (iv) process within Russia the subsoil resources developed by the Strategic Company. The actual obligations are incorporated within a separate agreement between the investor and the FAS, which also sets out the sanctions for non-performance, including penalties, damages and other liability. Should the applicant refuse to undertake such obligations, the Special Commission rejects the application.

If the intended transaction requires clearance pursuant to Russian competition law, the FAS delays consideration of the separate competition law application until the Special Commission’s consent is obtained.

Decisions of the Special Commission can be challenged in the Higher Arbitration Court of the Russian Federation, although we are not aware of any such challenges to date.

Early steps in implementation

According to the FAS, as at the end of 2008, 41 applications had been filed pursuant to the Strategic Companies Investment Law, with an additional four having been filed by mid February 2009 – most of these related to subsoil users. To 14 of these applications, the FAS responded that the intended transactions did not require Special Commission approval. In addition, 17 notifications regarding acquisitions of 5% or more shares, and more than 200 notices regarding existing ownership of shares/control over Strategic Companies, have been filed.

Since its formation in July 2008, the Special Commission has held only two meetings at which it has cleared six transactions. At its first meeting in October 2008, it approved the acquisition, subject to conditions, by Archangel Diamond Corp., a De Beers group entity, of a 49.99% interest in Arkhangelskgeoldobycha from Lukoil, and the acquisition by World’s Wing SA, a Swiss subsidiary of Italy’s Alenia Aeronautica, of 25% plus one share in Sukhoi Civil Aircraft Co. (SCAC). Reportedly, the first transaction has not been completed because the conditions were too burdensome for the investor.

At its second meeting, held on Feb. 4, 2009, the Special Commission considered four intended transactions, of which three were cleared without conditions, with the proposed acquisition by an entity within the Basic Element group of shares in OAO NK RussNeft being postponed. The cleared transactions were the increase to 80% of the interest of Canadian company Barrik Gold in a Russian company developing platinum and palladium on the Kola Peninsula, the formation of a joint venture by the Russian Roskosmos with a state-controlled Ukrainian company, and the acquisition by a Dutch company of the Taganrog Shipyards.

Given the lack of clarity in the Strategic Companies Investment Law itself, as well as in the thresholds set forth in the Subsoil Law, and especially given the continued failure until Mar. 5, 2009, by the Federal Agency of Subsoil Use and the Ministry of Natural Resources to finally agree and publish the list of deposits “of federal significance,” a simplified filing procedure aimed at removing a foreign investor’s uncertainty as to whether or not a proposed target qualifies as a Strategic Company, has turned out to be very useful.

The FAS is required to respond to any query with a definitive answer within 30 days from the filing. Reportedly, the FAS has so far received 11 such queries, of which seven have been answered but only one of which has been disclosed.

As the number of the cleared transactions (six) is only a small fraction of the overall number of applications filed to date (45 as of mid-February), it is clear that the Strategic Companies Investment Law is still in a state of evolution. Its requirements are not clear (either to investors or, in many respects, to the authorities themselves) and its implementation is slow and lacking in transparency.

In addition to the uncertainties of the applicable rules and lack of clarity, there remains the risk that, by giving a broad interpretation to the provisions of the Strategic Companies Investment Law, the FAS is seeking to expand its role. For example, it appears that when receiving an application with regard to a Strategic Company that is a subsoil user, the FAS typically requests the Ministry of Natural Resources to investigate whether the company complies with all the terms of its subsoil licenses. As a result, the process of considering applications under the Strategic Companies Investment Law may develop into a full-scale compliance investigation of the target companies.

About the author

Natalya Morozova is a Russian attorney and a partner in Vinson & Elkins LLP’s Moscow office. She has extensive experience in Russian mergers and acquisitions, corporate, project finance, securities, and antitrust law matters. Her corporate practice has involved many issues shaping Russia’s corporate environment, including protection of minority shareholders and structuring corporate relationships between Russian and non-Russian shareholders.