Russian M&A Deals in the Context of the Arbitration Reform

Сourt of arbitration
Сourt of arbitration

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On 1 September 2016, new Russian arbitration legislation (the Reform Legislation) came into force, with significant consequences for Russian M&A deals.

Under the Reform Legislation, disputes arising out of M&A agreements involving Russian companies and shares / participation interests therein (the shares) are deemed corporate. Such disputes can be referred to arbitration starting from 1 February 2017 subject to the conditions discussed below.

The purpose of this information letter is to summarise your possible legal exposure, and offer high-level practical guidance and update you on the most recent relevant developments in respect of arbitration in Russia.

Corporate Disputes: What Is Included and Excluded

A corporate dispute as defined in the Reform Legislation effectively means any dispute relating to the incorporation, reorganisation or liquidation of a Russian company or its management, or to the ownership, encumbrance or transfer of its shares (Article 225.1(1) of the Arbitrazh Procedure Code of the Russian Federation (the APC)). The term arguably covers any and all types of dispute arising out of SPAs, SHAs/JVAs, and, potentially, other types of M&A contracts such as share options, irrespective of the subject matter of the dispute. However, a corporate dispute within the meaning of the Reform Legislation only arises where a dispute (and, by extension, an M&A contract) involves a Russian company.

Consequently:

  1. Disputes arising under sale and purchase agreements (the SPAs), share pledge agreements, shareholders’ agreements, joint venture agreements (the SHAs) and other M&A agreements directly involving Russian target companies and their shares are corporate disputes according to a conservative interpretation of the Reform
  1. Disputes arising under SPAs, share pledge agreements, option agreements and similar contracts relating to shares in a foreign company holding shares in a Russian company (e.g., an offshore holding company that holds shares in a Russian target) are not corporate for Russian law purposes, subject to the limitations and risks discussed
  1. Disputes arising under SHAs involving foreign companies which:
  • establish the management structure and regulate corporate management issues of a Russian target could potentially be recognised as corporate disputes;
  • regulate some issues indirectly affecting Russian targets (e.g., reserved matter clauses which pre-determine future corporate decisions in the target company) could qualify as corporate disputes according to a more conservative interpretation of the law, although this remains more of a grey
  1. Disputes arising under security instruments (other than a Russian share pledge), for example, a deed of guarantee relating to a Russian M&A transaction, are potentially also a grey In our view, there is a strong argument that they should not be deemed corporate disputes.
  1. Finally, disputes arising under framework agreements and other similar umbrella instruments could be deemed corporate to the extent they contain Russian corporate governance or Russian share disposal

The corporate dispute test is substantive and is driven by the target, i.e., the qualification of disputes as “corporate” for the purposes of the Reform Legislation does not depend on the applicable law of the contract, nor does it depend on the nationality of the parties to the contract.

Arbitrability,  Carve-Outs  and Restrictions

The default position under Russian law is that corporate disputes relating to Russian companies shall be resolved in the Russian state commercial (arbitrazh) court at the location of the company. Under the Reform Legislation, corporate disputes can also be resolved by domestic  or international  commercial  arbitration,  subject  to the restrictions below:

  1. Disputes relating to a Russian target company (or shares in a company) that is deemed strategic (as defined under Federal Law 57-FZ dated 29 April 2008 On Strategic Foreign Investments (the Strategic Law)) are non-arbitrable, unless a dispute is (a) solely about the ownership of shares in a strategic entity and further provided that (b) the dispute has not arisen out of a transaction requiring clearance under the Strategic Law (Article 225.1(2) of the APC). The status of the target as strategic is tested at the start of arbitration. This means that if a target company is rendered strategic (e.g., by means of obtaining a sensitive licence) after it becomes subject to an arbitration clause in an SPA/SHA but prior to the relevant dispute being brought to an arbitration tribunal, the relevant arbitration clause would become unenforceable from a Russian law perspective.
  1. Corporate disputes may only be submitted for arbitration and arbitration clauses may only be entered into after 1 February 2017 (Article 13(7) of Federal Law No. 409-FZ dated 29 December 2015 On Amendments to Certain Legislative Acts <…> in Connection with the Adoption of the Federal Law On Arbitration… (the Law on Amendments)). While this condition is now satisfied, there is uncertainty as regards pre-existing arbitration clauses – see the Existing Arbitration Clauses: Mitigating Factors and Techniques section
  1. The arbitration must be institutional, which means that the arbitration process for a corporate dispute shall be administered either by (a) an arbitration institution which has obtained a special permit from the Russian Government; or (b) by the International Commercial Arbitration Court at the Russian Chamber of Commerce and Industry (the ICAC), which is exempt from the requirement to obtain a permit (Article 225.1(5) of the APC, Article 44(3) of Federal Law No 382-FZ dated 29 December 2015 On Arbitration in the Russian Federation (the Law on Arbitration)). Permits may be obtained not only by Russian but also by foreign arbitral institutions. We understand that some of the leading non- Russian arbitral institutions are considering applying for such permits but it remains unclear whether any of them will eventually do so and become eligible from the Reform Legislation perspective to administer Russian corporate disputes. Arbitration of Russian corporate disputes by ad hoc tribunals is
  1. For disputes arising under an SHA and most other types of corporate dispute, the seat of arbitration must be in Russia (Article 225.1(3) of the APC). There are exceptions, for example, there is no requirement for the seat of arbitration to be in Russia for disputes under SPAs and share pledge
  1. Disputes under an SHA and most other types of corporate dispute shall be arbitrated under special “corporate arbitration rules” (the CAR) to be adopted by each eligible arbitral institution. The Reform Legislation requires, among other things, that CAR ensure that (i) information on the dispute is shared with the Russian target company to which the dispute relates and (ii) other shareholders are notified of the dispute and have the right to join Currently, several arbitral institutions in Russia (among them, the ICAC and the Russian Arbitration Association (the RAA)) have adopted d CAR, which tend to be very detailed and technically complicated compared to “ordinary” arbitration rules of the same or other arbitral institutions. Certain types of dispute (most importantly those arising under SPA and share pledge agreements) are exempt from the requirement to apply CAR and may be arbitrated under the regular arbitration rules of eligible arbitral institutions.
  1. In order for disputes relating to the management of a Russian company or the challenging of transactions entered into by such company to be eligible for arbitration, the arbitration clause must be endorsed / acceded to by the target company and all of its shareholders, as well as all other parties to the dispute (Article 225.1(3) of the APC). One way of ensuring that the arbitration clause is binding on the Russian target company and      its shareholders is by adding an arbitration clause to the charter (corporate articles of association) of the Russian target company which requires the unanimous vote of all Arbitration clauses may not be included in charters of Russian public joint   stock companies and joint stock companies with no fewer than 1,000 shareholders holding voting shares (Article 7(7) of the Law on Arbitration). According to a conservative interpretation, the requirement to have the target company and all its shareholders accede      to the arbitration clause would apply not only to disputes between shareholders and the   target company but also to private disputes under SHAs and “umbrella” framework agreements relating to the management of Russian target companies despite the fact that     the target company and its other shareholders would often have no meaningful legal     interest in the dispute. Disputes arising under SPAs and share pledge agreements are     exempt from this requirement. In view of this, it may be prudent to keep any Russian share transfer and pledge provisions separate from any framework agreements or SHAs dealing with Russian  corporate  management issues.

Existing Arbitration Clauses: Mitigating Factors and Techniques

The Reform Legislation provides that arbitration clauses made before 1 February 2017 in relation to corporate disputes are unenforceable (i.e.: “incapable of being performed” – Art. 13

(7) of the Law on Amendments). There are two grey areas around this:

— it is not entirely clear whether arbitration clauses made after 1 September 2016  but before 1 February 2017 are permanently unenforceable or if they are deemed cured/enforceable after 1 February 2017 (according to a conservative interpretation,  the  former  would apply);

— it is also unclear whether the provision in question means that arbitration clauses in pre-reform (pre-1 September 2016) agreements are deemed unenforceable and/or invalid. There is a reasonably strong argument that the provision in question has no retroactivity and that the validity and enforceability of older arbitration clauses will be tested under the arbitration laws that were in force at the time such clauses were made. Still, there is a risk that this provision will be interpreted by Russian courts to the effect that such pre-existing arbitration clauses are unenforceable (considering the fact that pre-reform Russian court practice deemed corporate disputes to be non-arbitrable).

The Reform Legislation offers no clear mechanism to cure/remove the risks of non- enforceability of pre-existing arbitration clauses relating to Russian corporate disputes. In order to mitigate the risks contractually after 1 February 2017 for pre-existing arbitration clauses in Russian M&A deals, one may consider:

— re-executing the arbitration clause following 1 February 2017;  or

— introducing additional agreements offshore and/or additional security such as a deed on indemnity with a counterparty’s ultimate beneficiary to secure the counterparty’s obligations under the existing Russian M&A deal.

Such mitigating techniques would only be available with a counterparty’s cooperation, and would require careful drafting and risk analysis.

It is worth noting that if an existing arbitration clause provides for arbitration outside     Russia (e.g., an LCIA or ICC arbitration with its seat in London or Paris), arbitrators in such foreign-seated arbitration are bound by the arbitration laws of the seat of arbitration but      not necessarily by the arbitration laws of Russia. It is entirely possible that a foreign-seated arbitral tribunal would not consider itself bound by the Reform Legislation and would  proceed to issue an award in relation to a Russian M&A deal even if the requirements of the Reform Legislation are not complied with. While enforcement of such award in Russia would most likely be denied, it may be possible to enforce it outside Russia (e.g., against an opponent’s foreign-based assets). A careful analysis of potential legal risks is required on a case-by-case basis as, inter alia, the opponent may use the Reform Legislation to start the proceedings in Russia in contravention of the existing arbitration    clause.

 

How do I Negotiate Arbitration Clauses in New Russian M&A Deals?

When negotiating Russian M&A deals after 1 February 2017, one can include arbitration clauses that would be deemed fully enforceable from a Russian law perspective. However, under the Reform Legislation, the choice of eligible arbitration institutions is now limited    to the ICAC and other permitted Russian institutions (see New Developments in Russia below for more details). It would also be possible to refer a dispute to an eligible foreign   institution but it remains uncertain whether any of the leading foreign arbitration    institutions will apply for the Russian permit that would make them eligible. Furthermore, arbitration clauses will have to comply with the strict requirements described above.

One may consider alternative options or mitigating techniques, for example:

— referring disputes to a Russian state commercial (arbitrazh) court, which would remove all of the above risks but may be unacceptable   commercially,

— restructuring a transaction (e.g., disposing of shares in an offshore entity rather than Russian shares), and/or

— adding non-Russian instruments such as a beneficiary’s personal guarantee in order to obtain additional enforcement instruments which are unlikely to be affected by the Russian corporate arbitration rules.

It is also likely that many parties will continue referring Russian corporate disputes to non- eligible foreign arbitral institutions which may proceed to render arbitration awards. As described in the last paragraph of the Existing Arbitration Clauses: Mitigating Factors and Techniques section above, such awards are unlikely to be enforceable in Russia and may be of little use against companies without assets abroad.

New Developments in Russia

The Russian arbitration institutions and rules are currently a moving target. As required under the Reform Legislation, all Russian arbitral institutions that intend to remain in the business are now reforming their arbitration rules and a number of them are developing CAR which are required to administer SHA disputes and some other corporate disputes. In addition, all Russian arbitration institutions except the ICAC have to apply for a government permit and will not be able to continue administering arbitrations unless they obtain such permit by 1 November 2017. This creates a lot of uncertainty around eligible arbitral institutions and applicable arbitration rules, and may mean that specialist advice will be required when drafting new arbitration clauses in order for them to comply with the Reform Legislation.

Here are the most important recent developments:

  1. The ICAC has just adopted revised institutional arbitration rules, as required under the Reform These include separate rules for international and domestic arbitrations as well as CAR. With this new set of rules, the ICAC now provides the necessary infrastructure for corporate arbitrations (with the seat of arbitration in Russia). We plan circulating more detailed comments on these new rules in due course.
  1. The RAA, established in 2013 by Moscow’s leading law firms (including ourselves), provides an alternative arbitration venue for complex commercial and corporate disputes. It is going to apply for the government arbitration permit, and has just   adopted its own   CAR and unique rules for the arbitration of venture disputes (including corporate and non- corporate). We have participated in the drafting and expect the RAA arbitration, including in respect to corporate disputes, to become a viable alternative to the ICAC
  1. Other new arbitration centres and rules are emerging domestically and there is a chance that some foreign institutions will apply for the Russian governmental permit, thereby becoming eligible to administer Russian corporate

Finally, a commentary on the Reform Legislation (including under the aegis of the RAA) is being developed, and court practice under the Reform Legislation may start emerging.

These developments should be monitored carefully.

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