The Russia-Ukraine ceasefire and peace negotiations remain uncertain, the European Union and United Kingdom are considering more sanctions against Russia, and the US administration’s next steps are unclear. Anticipating restored United States-Russia diplomatic and trade relationships, the Russian authorities are working on legislation to regulate the potential return of foreign businesses to Russia. Businesses considering whether to engage or re-engage with Russia must be mindful of the continued need to comply with applicable US, EU, UK and other sanctions against Russia. They must also assess whether their decision to return to Russia would affect their ability to invest in Ukraine, including to participate in the reconstruction of Ukraine.
Many companies (foreign investors) have exited Russia since February 2022. Some exits were transactional in nature—for example, through sale of business to a local buyer or management, although in many cases with significant discounts and write-offs by foreign investors. Others were the result of Russian authorities removing foreign corporate control over Russian businesses. While there is no publicly confirmed interest from any exited foreign investor to return to Russia, discussions between the United States and Russia prompted President Vladimir Putin to instruct the Russian government to work on a regulatory framework for the potential return of investors. This regulatory framework, if adopted, will significantly change the existing laws governing foreign investments and will mostly affect companies from countries that imposed sanctions against Russia.
Several proposals (ranging from welcoming of foreign capital to expressly prohibiting it) by Russian ministries and local business groups have been reported in the press. One proposal reportedly already filed with the State Duma, a lower chamber of the Russian parliament, is prohibitive.
The reported proposal specifically addresses the repurchase by a foreign investor of shares (participation interests or the shares) in a Russian entity (the target entity) it sold in an exit transaction. Call options allowing foreign investors to repurchase the shares were often part of exit deals, particularly in the early stages of post-February 2022 exits, before the Russian authorities tightened the exit approval procedure and expanded the approval requirements to call options.
The proposal suggests a new article in the Russian federal law No. 160-FZ, On Foreign Investments in the Russian Federation. Key points of the proposal are as follows:
Repurchase of More Than 10% Voting Shares in a Russian Entity Requires Government Commission Approval
If a foreign investor wants to repurchase more than 10% of voting shares in the target entity, approval will be required from the government commission on control over foreign investments (the government commission), the same body currently in charge of approving exit transactions.
A Russian Party May Refuse to Sell Under the Agreed Call Option If Certain Conditions Are Met
A Russian person (the Russian party) who acquired the shares from a foreign investor (the foreign party) is permitted to refuse to sell to the foreign party under the call option agreed between the Russian party and the foreign party if certain conditions (the conditions) are met, including the following:
A Russian Party May Choose to Disregard the Call Option at Any Time
If the conditions are met, the Russian party may refuse to comply with the agreed upon call option proactively, even where the foreign party has not initiated the repurchase procedure.
Statutory Compensation to a Foreign Party
The Russian party’s refusal to perform the call option terminates the foreign party’s rights under such call option, and within one year of such refusal the foreign party may claim statutory compensation from the Russian party. The amount and payment mechanics of the statutory compensation will be determined by the Russian government. As with other similar statutory compensation, it is unlikely that this statutory compensation will be an arm’s length market value. The other similar compensation is the one envisaged for unfriendly foreign holding companies that have been “deprived of corporate rights” with respect to their interest in the so-called economically significant organizations. (See our August 4, 2023 LawFlash.)
A Russian Party May Refuse to Pay the Statutory Compensation to a Sanction-Compliant Foreign Party
A Russian court may, at the Russian party’s request, reduce or cancel the statutory compensation. The proposal suggests that this may be possible if (1) the foreign party during its exit from Russia ceased or refrained from exercising its corporate rights with respect to the target entity, or there was a threat that this could have happened, or (2) such foreign party interfered with the ordinary course of business operations of the target entity which could have resulted in cessation or suspension of business operations, winding up, or insolvency of the target entity. This provision may potentially allow the Russian party not to pay any compensation (however minimal) if the foreign party complied with sanctions, either because these sanctions applied to it or it decided to follow them anyway (self-imposed sanctions), and therefore did not participate or vote at shareholder or board meetings of the target entity, or voted against noncompliant-with-sanctions transactions, or directed or requested the local management to follow sanctions and not to enter into noncompliant transactions.
A Russian Ministry May Prohibit Exercise of Call Option
A ministry regulating the industry in which the target entity operates will be involved in cases where the target entity has a significant role in “socio-economic development” or in other cases determined by the ministry. In this case the ministry may prohibit the Russian party to comply with the call option even if the Russian party might be willing to sell. It remains to be seen whether the government commission will be involved in deciding the fate of call options as there have been proposals to that effect. The foreign party may apply to a Russian court for statutory compensation to be paid by the Russian party in this scenario, but the Russian party may still request a Russian court to reduce or cancel the compensation.
It is expected that, if adopted, this regulation will allow the Russian party and the Russian authorities to exercise discretion in weighing the pros and cons of the return of each particular foreign party on a case-by-case basis. Reportedly, Russian authorities admit that in some industries the local players in Russia need to be strongly protected against the return of foreign competition, while some other industries might benefit from foreign investment and specific expertise especially in sectors requiring advanced technology and equipment.
The current Russian countersanctions regime already has several approval requirements that apply to the exercise of call options on shares in a Russian entity between a Russian party and an unfriendly foreign party. However, the countersanctions regime is based on presidential decrees and set as a temporary measure. It appears that the above proposal aims to codify for the future a legal mechanism that would allow a Russian party to disregard the contractually agreed upon obligation to sell to an unfriendly foreign party, and will apply irrespective of the countersanctions.
Notably, many exit transactions with call options are governed by laws other than Russian, and have international arbitration as the dispute resolution forum. It is an issue under those laws whether the foreign party can have a recourse against the Russian party if the latter does not sell under the call option citing Russian laws.
Many Russian officials, when commenting on the potential return of foreign investors to Russia, emphasize that such return should not undermine the investments and business growth efforts by the Russian businesses that filled in for exited foreign companies. The authorities are also discussing amending the laws to impose specific requirements (conditions) on foreign investors wishing to do business in Russia.
Some of the proposed requirements include:
Although such legislative proposals address some aspects of future foreign investment in Russia, at the same time they do not suggest that the Russian countersanctions discontinue to apply to those investors who returned to Russia. As a reminder, the countersanctions restrict transactions with, and payments to, unfriendly persons and affect their ability to expatriate funds from Russia.
It remains to be seen whether any of the above proposals will become a part of Russian law. Much depends upon the geopolitical situation including the status of sanctions against Russia.
Morgan Lewis attorneys have extensive experience advising clients in on all aspects of foreign direct investment and sanctions laws. Given the firm’s breadth of experience with the ongoing Russian conflict, Morgan Lewis is well positioned to assist in supporting foreign investors with their exposure to risks in Russia. To learn more about this offering or discuss any specific questions, please reach out to the authors or your Morgan Lewis contacts.
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[1] Unfriendly persons are persons, whether corporate entities or individuals, connected with the so-called unfriendly states or persons who are under control of such non-Russian persons irrespective of their domicile and place of business. The list of unfriendly states is maintained by the Russian government and includes the USA, the UK, EU member states, Canada, Singapore, Japan, South Korea, Ukraine and other states which have imposed sanctions against Russia post-February 2022.