LawFlash

Update: Draft Law on External Management over Certain Foreign-Owned Companies Submitted to Russian Parliament

April 20, 2022

The draft law on external management was submitted to the Russian Parliament and differs considerably from the previous version. The new draft provides for the establishment of a special interdepartmental commission that will have broad powers to impose external management on any company as it deems necessary. The law is still proposed to apply to circumstances that occurred from February 24. If adopted, the law will create further uncertainty in Russian markets.

Reportedly, the State Duma will schedule the first reading of the draft law for the second half of May 2022, following the May holiday break in Russia. View the previous LawFlash, “Russia Considers Imposing Special External Management over Certain Foreign-Owned Companies” for information on the original draft of the law.

WHAT IS EXTERNAL MANAGEMENT?

The concept of external management (external administration) is similar to the court-appointed administration of an insolvent company. In effect, the external management is designed to take over the management of an affected foreign-controlled company to keep it as a going concern or to divest its assets to a Russian buyer.

Under the draft law, the external management may be exercised in one of the following types: (1) an external manager takes control of all or part of the shares (equity interest) in an affected company by receiving such shares in the so-called “trust management”; and (2) an external manager receives powers of the executive body of an affected company.

The draft law also provides a procedure to convert external management type (1) to external management type (2).

External management type (1) is similar to a regular Russian-law trust management agreement and is set to be performed for the benefit of the shareholders (participants) of the affected company, provided, however, that the external manager bears no liability towards the shareholders to the extent the external manager acted in the best interests of the affected company. Under the draft law, the external manager may not vote on the matters of the company reorganization, liquidation or changing the charter capital of the company, nor may the external manager engage in any transactions that may result in alienation of shares. This is proposed still to be within the decision-making capacity of the shareholders.

External management type (2) leads to the following consequences:

  • Powers of the affected company’s executive body are passed to an external manager, and the powers of its other governing bodies (e.g., the board of directors or shareholder meeting) are suspended.
  • All powers of attorney issued by the affected company prior to the date of the external management introduction cease to be effective.
  • The external manager does not need to make mandatory bankruptcy filings under Russian bankruptcy law.
  • All previously adopted corporate decisions on voluntary liquidation, reorganization, dividend payment, share buybacks, amending constitutional documents, limiting powers of executive bodies and certain others, cease to be effective.
  • No redemption of shares by a shareholder is permitted.
  • The distribution of the dividends is not allowed.
  • The repayment of preexisting debt to the shareholders, creditors, and other third parties is not allowed (with certain exemptions).
  • If the affected company’s charter imposes limitations and restrictions on the powers of the sole executive body beyond the statutory ones, such limitations and restrictions cease, and the powers of the external manager are determined under the standard provisions of law.
  • The affected company’s counterparties may not exercise contractual rights to unilaterally terminate or amend a contract by notice: all amendments or termination must be done via a Russian court only.
  • An affected company’s counterparty that is an IP owner connected to the so-called “unfriendly countries” is not permitted to terminate IP rights (including under licenses and franchises) granted to the company; any IP rights terminated after February 24, 2022 will be reinstated without any fees due to the IP owner until the end date of the external management.
  • The external manager may terminate any contract of the affected company within three months from institution of the external management, if such contract has not been fully or partially performed and if such contract contradicts the external management purposes.
  • The draft law suggests that the Ministry of Economic Development will create a special supervisory body: the interdepartmental commission. This commission will have broad powers. For example, all significant decisions of the external manager require prior consent of the interdepartmental commission, including entering by the affected company into major or interested-party transactions, or must be in line with the regulations to be adopted by the interdepartmental commission.

External management type (2) also allows the external manager to act in a manner similar to bankruptcy managers. Among other things, an external manager can “spin off” the affected company’s assets into a separate company and sell that company at public trades. Once the sale is completed, the external manager will file with a Russian court for bankruptcy or liquidation of the affected company.

WHAT COMPANIES MAY BE AFFECTED

The new version of the draft law removes the asset value and employee number criteria, and institutes more broadly drafted and discretionary criteria. Further, in addition to Russian companies, Russian branches of non-Russian companies may be affected.

As currently drafted, an affected company could be any company located in Russia which (1) is controlled, or at least 25% owned (directly or indirectly, in aggregate), by persons residing in, registered in, having their main place of business in, or main source of income from any of the “unfriendly states;” and (2) has material significance for economic stability, business, protection of rights and interests of citizens in Russia or in a Russian constituent territory (the Significance Criterion).

The law, if adopted, will not apply to the companies owned or indirectly controlled by the Russian Federation or by beneficiaries who are Russian citizens not connected with the “unfriendly states” (even if such Russian citizens exercise control via foreign legal entities connected with the “unfriendly states”).

The draft law further clarifies the Significance Criterion and lists circumstances when a company is considered to have the requisite material significance, as follows:

  • a company produces and/or sells goods (or renders services) which are considered socially significant (i.e., food and other essential goods or goods with the state-regulated prices);
  • a company produces and/or sells goods (or renders services) under a natural monopoly regime or is recognized as dominating pursuant to the Russian antimonopoly law;
  • a company is an exclusive producer on the market of certain types of goods (e.g., medicines or medical tools) or an exclusive supplier of the goods that do not have analogues on the Russian market and is included in the Russian register of exclusive suppliers pursuant to the Russian law on contractual system in the sphere of procurement of goods, works, and services for governmental and municipal needs;
  • the number of the company’s employees is at least 25% of the working population of the settlement where such company is located;
  • termination of the company’s activities (or disruption of the company’s functioning) may cause industrial or environmental disasters or death of people, shutting down operations of the life support facilities, transport or social infrastructure, energy, industry or communications facilities, as well as other socially significant facilities;
  • termination of the company’s activities (or disruption of the company’s functioning) may cause destabilization and an unreasonable increase in retail prices for the essential goods (works, services) produced (performed, rendered) by such company or other companies for consumers in the Russian Federation or in a constituent territory of the Russian Federation;
  • the company participates in the chain of socially significant production and termination of the company’s activities (or disruption of the company’s functioning) may lead to the termination of activities (or disruption of the company’s functioning) of other organizations that have material significance for economic stability; or
  • when the interdepartmental commission rules that a company is of material significance even in the absence of the above specific circumstances.

The proposed draft states that a “branch of an organization” may be treated as an affected company. The broad language suggests that a Russian branch of a non-Russian company meeting the above-described criteria might be covered too.

Various publications suggest that about 10% of Russian foreign-controlled companies may be affected. There is no list of potential targets but judging from the Significance Criterion, industries of concern would include, among others, automotive, retail chains, pharmaceutical, food, and other fast-moving consumer goods.

WHEN THE EXTERNAL MANAGEMENT COULD BE INSTITUTED

An affected company may be subject to external management if any one of the below conditions is met:

  • The company management de facto ceased exercising its powers in breach of the Russian laws (e.g., since February 24, 2022, management, members of the governing bodies, and/or shareholders have left Russia and refrain from their duties to the detriment of the company’s interests, or caused the company to suffer substantial loss in asset value or otherwise discontinued operations in breach of the Russian laws).
  • The company management, members of the governing bodies and/or shareholders act in such a manner that is likely to cause the company to cease its operations, go into bankruptcy or liquidation or cause damages to the company (e.g., after February 24, 2022, such persons publicly announced termination of the operations in the absence of apparent economic grounds, or terminated material commercial contracts, or notified more than one third of the employees of their dismissal).
  • The activities of the company were terminated or suspended or its functioning was disrupted (in full or in part), and/or the production or sale of products or services were significantly reduced (e.g., there was at least 30% decrease in sales for the three consecutive months compared to the previous three months and/or for the same period of the previous year).
  • The continuance of the company’s operations without external management is likely to result in circumstances which serve as grounds for introduction of the external management under the draft law.
  • Funding from the budget of the Russian Federation and/or the budget of constituent territory of the Russian Federation may be needed to eliminate the consequences which would otherwise require introducing the external management in certain cases.

HOW THE EXTERNAL MANAGEMENT MAY BE INITIATED

Under the draft law, the interdepartmental commission will have the power to consider introducing external management at the request of a local governor, a federal ministry, or a body overseeing the industry in which an affected company operates, or due to other grounds as may be identified by the Russian government (notably, labor authorities and a state prosecutor's office are no longer listed among potential requestors in the draft law).

Once the interdepartmental commission determines that external management is needed for a particular affected company, it must seek consent from a local governor concerning the interdepartmental commission’s decision about an organization to serve as the external manager and the type of external management to be introduced (i.e., to control the shares via trust management or to serve as the executive body). If the local governor disagrees, the Russian government makes the requisite decision.

After the decision on the external management is made, the interdepartmental commission authorizes the tax authorities to apply to the Commercial (Arbitrazh) Court of the City of Moscow (the Court) to rule on introduction of the external management. The draft law introduces a short deadline for a local governor and tax authorities to process the case: just one business day. On the date of the application to the Court, the tax authorities must also make an entry about introduction of the external management in the state companies’ register, and notify both the affected company and the proposed external management company.

The Court must decide on accepting the case on the date of its submission and must rule on the case no earlier than five and no later than seven business days from accepting the case. The Court may also impose interim restrictive measures on the affected company, until the final decision on external management is made.

These measures include prohibitions on

  • acquiring or alienating assets (other than in the ordinary course) by the affected company,
  • the affecting company dismissing employees,
  • the affecting company terminating material contracts, and
  • transacting with shares (equity interests) in the affecting company.

Additionally, upon application of the tax authorities, the Court may also adopt the following measures against the affected company:

  • transfer the powers of the sole executive body to the external manager;
  • suspend all operations on the bank accounts;
  • authorize the external manager to have free excess to the assets of the affected company; or
  • authorize the external manager to take any such actions as may be required to safekeep and maintain the affected company’s assets, financial records, and intellectual property.

The decision of the Court to introduce the external management can be appealed by the shareholders or the executive body of an affected company proposed to be replaced by an external manager.

An employee of VEB.RF, Russia’s state development corporation, or of another organization identified by a decision of the interdepartmental commission may act as an external manager for the affected company. (When interacting with VEB.RF, the direct and indirect impact of sanctions imposed by several countries must be assessed as well. It should be noted that VEB.RF has been directly sanctioned in several jurisdictions.)

СAN EXTERNAL MANAGEMENT BE PREVENTED?

Before the date of a Court hearing, the general director (the executive body) of an affected company or its shareholders holding individually or collectively more than 50% of votes may file to the Court an application against the external management and provide an undertaking to resume and continue the affected company’s operations or take other actions to remedy the grounds for introduction of the external management.  

The draft law suggests certain examples of possible undertakings, including a sale or transfer to trust management of the affected company’s shares to a person who is not connected with any “unfriendly state” (such sale or transfer to be completed within three months from the Court decision), or providing the Court with convincing arguments that the circumstances causing the application to be filed will be terminated.

CAN EXTERNAL MANAGEMENT BE DISCONTINUED?

The external management may be discontinued by the Court if the affected company’s shareholders holding individually or collectively more than 50% of votes apply to the interdepartmental commission to terminate the external management and provide an undertaking or take actions as described above, and pay the external manager’s fees. The Court must consider this within 10 business days.

Within six months upon the early termination of external management by the Court, the external manager will have the right to request documents from the affected company or from the purchaser or trust manager, as the case may be, to check compliance with the terms and conditions on which the external management had been terminated.

HOW A SALE VIA PUBLIC TRADES WORKS

The external manager in external management type (2) is entitled to sell assets of an affected company at public trades. The procedure will generally follow the rules on public sales in a bankruptcy context, with several specifics. For example, the affected company's foreign shareholders from “unfriendly states” holding 25% or above shares (equity interest) will not be able to participate in such trades. Certain preemption rights (right to match) will be given to bidders operating in the same industry as the affected company.

The winning bidder will enter into a purchase agreement with the external manager, under which the winning bidder must undertake to preserve no less than two thirds of the jobs of the affected business and to ensure the continuation of operations for at least one year. The external manager retains a right to verify compliance of the purchaser with the conditions imposed by the purchase agreement.

The new version of the draft law also suggests that an external manager may participate in the trades and bid itself.

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CONTACTS

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Ukraine Task Force
Giovanna M. Cinelli
Joanna Christoforou
Bruce Johnston
Sabine Konrad
Grigory Marinichev
Michael Masling
Kenneth J. Nunnenkamp
Georgia M. Quenby
Christina Renner
Melanie Ryan
Peter Sharp
Vasilisa Strizh
Pierre Trippel
Carl A. Valenstein
Heather Sears
Alexey Chertov
Jiazhen (Ivon) Guo
Katelyn M. Hilferty
Nicola Kelly
Christian Kozlowski
Daniel Lopez Rus
Maximilian Pika
Charles C. Rush
Eli Rymland-Kelly
Polina Sizikova
Dr. Axel Spies