Deal Structuring in Russia under English Law.

16.06.2011

IT’S NO SECRET that for most of their M&A transactions, in terms of their worth, large Russian companies use English law while the jurisdiction of the transaction party and the target company is not particularly important.

There are a number of reasons for this. First, the current Russian legal system is not, unfortunately, able to employ the legal structures elaborated by the parties and not prohibited by corporate law but unfamiliar to the courts. The legal system cannot underpin their application because there are no relevant legal provisions and because the court system is not ready. Moreover, the mandatory nature of certain provisions of Russian law significantly limits the choices available to the parties when formalising their arrangements.

Unlike Russian law, English law allows commercial transaction arrangements to be legally implemented in full.

Here is an example

Russian law does not currently recognise indemnities as a legal concept. With regards to warranties, there are some implied warranties under the Russian Civil Code in relation to the sale of assets (which could include the sale of shares) relating to title and unencumbered ownership and some basic assumptions about the quantity and the quality of the asset. However, these principles were aimed more at consumer transactions and are fairly limited in the context of an international finance or M&A deal. They cannot be altered or extended (or reduced) by contractual agreement between the parties. Under Russian law, a seller cannot be held liable for any false statements.

Fundamental issues such as protection for liabilities cannot currently be dealt with under Russian law warranties. Also, on a sale of shares in a company, the implied warranties under Russian law will only relate to the shares themselves and not to the title, ownership, condition, etc. of the underlying business and assets of the company to which the shares relate.

As for English law – it clearly recognizes representations, warranties and indemnities. These are often essential on international finance and M&A transactions and many deals would be difficult to structure without them. In certain situations, English law may imply terms into a contract, based on usage or custom, a previous course of dealing or the intention of the parties. In addition, certain statutes provide for terms to be implied into specific types of contract, such as contracts for the sale of goods. Indemnities are agreements to compensate for loss arising from a particular liability and tend to be used where there is a known or potential, clearly identifiable liability, such as a tax liability, a potential environmental claim, or a specific issue arising from due diligence (1).

Unlike the usual position for warranties, indemnities under English law are not usually qualified or reduced by disclosures, or by the knowledge of the buyer and there is usually no duty on the part of the indemnified party to mitigate loss.

Another example

Russian law does recognize conditional contracts, but the conditions must be outside of the control of the parties. Any condition that is within the control of a party is likely to be automatically deemed satisfied. This could create problems on some finance and M&A deals, where conditions relating to Investment Committee approvals, Credit Committee approvals, board and shareholder approvals could all be argued to be within the control of one of the parties, depending on the nature of the party and its corporate structure. Some more subjective conditions, such as the availability of funding, satisfactory due diligence results, or no material adverse change, would also be grey  areas for interpretation.

Another negative business factor in Russia is the unsatisfactory legal framework for holding companies and the tax rules for them, driving Russian companies to base their structuring outside Russia where most of the transactions take place and where English law is best understood and is applied in a predictable way. Big Russian property owners still prefer offshore jurisdictions, security of business being an important consideration.

Under English law, the parties can agree to whatever conditions they like for the contract to complete. These conditions do not need to be within the control of the parties and do not even need to be realistic, provided they are clear and can be objectively assessed.

And one more general argument. English law is not set out in a single civil code. This approach has enabled English law to be flexible, adaptable and practical when dealing with the developing needs of commerce, as technology, evolving markets and new techniques all continue to revolutionise the ways in which we do business.

English courts and arbitration tribunals have a strong reputation for reaching fair, balanced and unbiased judgments and rulings and (on the whole) clear and predictable outcomes.

RUSSIAN LAW DOES PLAY AN IMPORTANT ROLE

Investors should have an insight into Russian laws too, because even though a transaction may be governed by English law the main assets of its participants remain in Russia. In this context, it is extremely risky to ignore Russian law. If there is a dispute - even if it comes to arbitration outside Russia - the courts very often need an understanding of Russian legal institutions.

Russian corporate and financial law has made significant progress in a relatively short period of time. A lot remains to be done, of course, but we can see quite clearly that Russian law is moving slowly but surely forward as confidence in the legal system grows and the courts accumulate experience and a body of practice is built up.

The Russian Civil Code was originally influenced by the German Civil Code, but that historically, court case precedent has not been recognised when interpreting provisions of the Russian Civil Code. The German system does recognise warranties, which are not set out in the German Civil Code but have developed through court case precedent. It is likely that at some point the Russian system will adopt a similar approach and there are already discussions taking place at a high level about this. We are also already seeing in practice an increase in the use of decisions of the Supreme Arbitrazh Court as guiding precedents for other Russian courts. As this develops, it will be a significant step along the road towards fully developing some of the legal techniques and practices discussed in this booklet.

The common practice of Russian-only parties using Russian law, and the insistence of state organisations on using Russian law where possible, are also very helpful in creating momentum and track record and in building confidence in the system. Over time this will lessen the need for off-shore structures on many Russian deals.

International businesses will take longer to become completely comfortable in using only Russian law and this is likely to be a slower process of development. However, English law took some 600 years to develop into what it is today and so in the last 20 years Russian law has already made some huge steps in the right direction.

(1) See: Ian Ivory, Anton Rogoza, Use of English law in Russian transactions, Moscow, Alpina Publishers, Goltsblat BLP, 2011

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