M&A in Russia

Since the renowned political turmoil of 2014-2016 (including continued geopolitical tensions and budgetary problems, low oil prices, Ruble exchange rate instability and sanctions) certainly have an effect on the Russian investment climat, however, recent activies to invest in Russia can be seen (please read our blog news). The key to that activity is availability of attractive investment projects with a predictable rate of return.

The private M&A market in Russia is still favourable to investors as a result of the “deferred potential” in the market.

We also see a number of restructuring transactions involving Russian groups (please read our blog news) who originally let major investors/lenders acquire shares in foreign holding companies of the debtor group, in exchange for financing for such debtor groups’ subsidiaries. Some of those debtor groups (who frequently have no or very limited access to gaining export foreign currency proceeds) have further difficulties with repaying the debt, and as a result are now involved in restructuring arrangements.

Speaking of interest in private companies such as LLCs (“OOO” in Russian) there are two common ways for foreign investors to get their feet into the Russian market – either to go direct and set up shop or to acquire stock in the russian target LLC (normally via purchasing it’s offshore holding company’s shares). In other words…

1. An acquisition of an offshore holding company that holds Russian subsidiaries (also known as a “two-tier” structure). This structure is usually followed where a sale and purchase agreement (SPA) and a shareholders’ agreement would be governed by foreign law.
2. A direct purchase of a Russian target (also known as a “one-tier” structure).

A direct acquisition of Russian shares normally involves an SPA subject to Russian law. In the context of an acquisition of a participatory interest in a Russian Limited Liability Company (in case there is a sufficient foreign element, such as a foreign purchaser or seller, involved), it is not uncommon to use a combination of an English law framework SPA and a Russian law instrument of transfer (the latter being a brief Russian law SPA certified by a Russian notary, as required for transferring a participatory interest in a Russian company). Such a framework agreement would normally cover provisions customary for foreign law M&A deals that are not sufficiently covered with the same degree of certainty by a Russian law SPA (such as warranties, indemnities, conditions precedent, post-closing adjustment provisions, negative covenants, put and call options, tag along and drag along mechanics, escrow provisions, and so on).

Direct purchases of Russian assets or businesses (as opposed to shares) are less common, given that they are usually not so tax efficient, require third-party consents and are generally difficult and time-consuming to implement. Generally, a share deal may be preferable for the seller where the seller is a foreign legal entity since, according to Russian tax legislation, capital gains from the sale of shares are tax-exempt unless more than 50 percent of the assets of a Russian target company consist of immovable property located in Russia.

If the owners of your business are Russian tax residents please note that as of 1 January 2015, the following amendments to the Russian tax legislation came into effect as part of the Russian De-offshorization  Law:

  • controlled foreign company (CFC) rules
  • definition of ‘tax residency’ based on place of effective management
  • disclosure of information about beneficiaries of companies

As of 1 January 2016, a ‘controlling person’ for Russian tax purposes is a Russian tax resident (company or individual) that owns directly or indirectly more than 25 percent of the CFC’s capital (more than 50 percent for 2015, or more than 10 percent if the equity interests of all persons who are Russian tax residents exceed 50 percent).

Purchasers tend to more actively require deferred consideration mechanics and post-closing adjustments linked to certain parameters of the target to be confirmed or achieved after the first closing. Agreements tend to involve greater investor protection, such as, in particular:
– Incremental investments in Russian targets.
– Wider range of put options.
– Deferred consideration payment by the investor linked to the investor confirming certain warranties.
– Drag-along right of the investor even when it holds a minority stake.
– Wider investor’s veto rights.
– Anti-dilution and subscription protections.