(see part 1)

Nature of M&A deals

A major share of acquisitions on the Russian market are direct investments, when the buyer acquires from 50% to 100% in the target company in order to be able to control its activity and the distribution of profits. Although certain steps have recently been taken by the legislator to protect interests of minority shareholders, owners of minority stock in a company are still lacking real possibilities to affect the business of their company, cash flow and profit distribution.
Russian corporate legislation

Most of the Russian company laws originated in 1990s.[3] Russia has not invented its own rules, but rather derived them from countries with established economies. However, instead of accepting a single model, such as a common law or a continental law model, a transplant of these two models was used for Russian corporate laws. They combined some regulations from the common law and certain rules from the laws of European countries. Thus, a significant part of the Russian securities law derives from the laws of the US, while some of the corporate laws are derived from Germany.

The above combination of different legal systems was not successful, and over the last ten years Russian company laws have been drastically reshaped.

Trials and tribulations of a Russian M&A law

Among the major factors to be taken into account by a foreign investor intending to acquire a company or build a joint venture in Russia are:

• general non-enforceability of shareholders agreements in Russia;
• in-depth antitrust clearance;
• detailed takeover rules.

Shareholders agreements

A shareholders agreement is a standard mechanism allowing flexible regulation of relationships between participants of a joint venture. However, this mechanism is not fit for a straightforward application in Russia.

Russian corporate legislation is quite inflexible. It includes many mandatory provisions that can not be altered by the parties. That is why there have already been cases where Russian courts have ignored shareholders agreements concluded in respect of the shares in a Russian company. The case of Megafon, one of leading mobile operators in Russia, is an example of such jurisprudence. In this case, many provisions of a shareholders agreement in respect of shares in a Russian company were declared invalid based on a premise that they violated the Russian public order. In particular, the court has declared that “…status and activity of any joint-stock company in the Russian Federation, rights and obligations of shareholders of a Russian legal entity are governed exclusively by rules of Russian law and constitutive documents. Shareholders agreements are possible only in respect of the issues expressly enabled by the law…”.[4]

There are practical ways out of this legal trap. One of them is to build a joint venture not on the level of a Russian company, but in a foreign jurisdiction which recognizes shareholders agreements. In such structure, the parties establish an overseas holding company (typically, in the UK, Cyprus or Netherlands) that technically owns the entire block of shares belonging to shareholders in a Russian operating subsidiary. A shareholders agreement is concluded at the level of a foreign holding company.

Antitrust clearance

In case where assets, revenues or market share of companies involved in an acquisition of a Russian business (combined with the worth of the target itself) exceed certain thresholds, such transaction may be subject to antitrust clearance in Russia.[5]

Interestingly, Russian antitrust legislation and practice of its application has recently changed from a formal approach to an analysis on the merits when more attention is paid to the substance of the deal than to its form. In particular, the Russian antitrust body makes an inquiry into entire chain of holding companies to identify real beneficiaries of a controlled asset. The scope of the group of persons/entities involved to be disclosed to the antitrust body is quite broad.

Today not only direct transactions with a Russian asset fall under purview of the antitrust control, but also indirect acquisitions through offshore holding vehicles, such as acquisition of shares in foreign corporations that have an interest in Russian assets.

Intra-group transfers may also be subject to antitrust clearance. However, the new Russian antitrust law allows substituting prior clearance with a post transaction notification on an intra-group transaction if certain information on the group structure was disclosed to the regulatory body before the transaction.

Liability for violation of Russian antitrust regulations has been increased. Some of antitrust violations are subject to fines calculated as a certain percentage of revenue of a company, which can be quite substantial.

Therefore, it is recommended to carefully fulfil compliance requirements before closing any M&A deal involving a Russian asset, even if the transaction is structured offshore.

Takeover rules

Primitive regulation of acquisitions of large stocks in open joint-stock companies has existed from the outset. However, the detailed takeover regulations akin to European takeover codes were introduced only recently.[6]

These procedures are triggered when cumulative number of shares after the acquisition would exceed 30%, 50%, 75% or 95% of voting shares of a Russian open joint stock company. They are aimed at the establishment of a balance of interests of majority and minority shareholders.

A person intending to acquire over 30% of voting shares in an open joint-stock company (directly or together with its affiliates) may propose to shareholders of the target company to buy out their shares (so-called “voluntary offer”).
However, when control over 30%, 50% or 75% of voting shares in an open joint-stock company is actually established (directly or through affiliates) a “mandatory offer” to buy out shares from the remaining shareholders shall be made. The buy out price shall be a fair price of shares calculated in accordance with special rules established by the law, which in certain cases require independent appraisal.

Both voluntary and mandatory offers must be secured by a bank guarantee.

The law also provides a possibility for the majority shareholder who has consolidated over 95% of voting shares in an open joint stock company by certain date or in accordance with certain procedure to “squeeze out” the remaining shareholders during a period of time established by the law. Those majority shareholders that have consolidated the above package before July 1, 2006 shall hurry to use their right to squeeze out the minority shareholders, as a deadline is set for their right for August 1, 2008.

Investors that have or will have consolidated 95% block after July 1, 2006 need to follow a special, quite complicated and lengthy procedure of consolidation of shares in order to be able to squeeze out remaining minority shareholders.

Along with the right to squeeze out the remaining shareholders after consolidation of over 95% of voting shares, there is an obligation to propose to minority shareholders to sell their shares (“sell-out”) – see discussion of mandatory offers above.
There is no established practice of application of the above takeover procedures yet. Some technical problems have been encountered by pioneers trying to go through such exercise: unavailability of public notaries in some regions (notaries must open special deposit accounts for collection of payments for shares), and practical difficulties to meet some deadlines set by the new law. According to the regulatory body on the securities market of North-Western Federal Circuit of Russia, about 90 voluntary and mandatory offers and buy-out requests were filed with the said regulatory body in 2007, which has resulted in 33 instructions of the regulatory body for remedying of various defaults in such offers.[7]

Future trends

Taking into account rather young age of Russian corporate legislation, it will continue its active development. We believe that this development is geared towards liberalization of the company law limiting government interference with private transactions. Well-merited attempts to introduce liberal changes into Russian corporate legislation are underway.

The above views represent authors’ position, which may differ from the position of EPAM.

_____________________________________________________________________________
1. Source: http://www.ma-journal.ru/statma/.
2. According to the results of 2006
3. See the RSFSR Law “On Enterprises and Entrepreneurial Activity” of December 25, 1990; Resolution No. 601 of the Council of Ministers of RSFSR “On Approval of Regulation On Joint-Stock Companies” of December 25, 1990; followed by the RF Federal Law No. 208-FZ “On Joint-Stock Companies” of December 26, 1995 (as amended) and the RF Federal Law No. 14-FZ “On Limited Liability Companies” of February 8, 1998 (as amended).
4. See Resolution of Federal Arbitration Court of West-Siberian Circuit of RF of March 31, 2006.
5. See Art. 28 – 30 of the Federal Law of the RF No. 135-FZ “On Protection of Competition” of July 26, 2006 (as amended).
6. See Chapter XI.1 of the Federal Law of the RF No. 208-FZ “On Joint-Stock Companies” of December 26, 1995 (as amended).
7. According to materials of the Conference “Practical Issues of Organization of Mandatory Buy-Out of Shares” held in St. Petersburg, Russia, on February 11, 2008.