The statement made by Russian President Vladimir Putin at the end of July of 2023[1] that there would be no new decisions on placing assets of “unfriendly” owners under temporary Russia-controlled management does not seem to have reassured the Western community. Foreign media continues to warn that further stay of Western companies in Russia is akin to playing Russian roulette, the companies still doing business in Russia are afraid of future “seizures” of their assets and many of them “will rush to the exit in panic.” In this article, we will examine whether there are any justifiable grounds for this.

Various estimates show[2] that, as of the end of 2022, about 9% of foreign companies have pulled out of Russia completely, the majority (75%) continue their business in Russia, and the rest either suspended financing of their Russian subsidiaries or stopped all production.

There has been much talk about possible nationalization of foreign assets since at least the beginning of Russia’s Special Military Operation in Ukraine, fueled, among other things, by the legislative initiatives introduced by the Russian State Duma in the spring of 2022, including remarkable draft laws on nationalization and external management, as well as the laws signed by the Russian President in 2023 on blocking assets of foreign entities and suspending corporate rights of foreign holding companies from “unfriendly” jurisdictions with respect to Russian economically significant organizations.

The nationalization issue is one of concern for the remaining foreign companies from “unfriendly” jurisdictions that still have assets or business in Russia. Many of them have taken a break to decide what to do next: wait for the end of the Special Military Operation, which they hope will happen soon, or get prepared for the exit after all.

Legislative initiatives

The first draft law was introduced to the State Duma by the State Council of the Republic of Crimea in April of 2022 and provided, among other things, for the seizure of “unfriendly” persons’ property in favor of the state. The list of property was not final and included real estate and movable property, cash, bank deposits, securities, corporate rights and other assets that could be seized. In April of the same year, the Presidential Council for Codification and Enhancement of Civil Legislation did not support the draft law on grounds, among others, that it could push the USA, UK and EU to follow suit by seizing the property of the Russian Federation and its residents, and that the seizure under acts of Russian constituent entities does not align with the Russian Constitution. The draft law was eventually withdrawn on March 13, 2023.

Despite the absence of legislation, this scheme was used to nationalize the property of some “unfriendly” foreign owners in Crimea. On October 18, 2022, the State Council of the Republic of Crimea first announced as property of the Republic of Crimea, and then, in February 2023, nationalized about 700 Crimean assets of foreign businessmen and Ukrainian banks, including the enterprises of businessmen Rinat Akhmetov and Igor Kolomoisky, former Prime Minister of Ukraine Arseniy Yatsenyuk, Ukrainian lawmaker Nestor Shufrych, Lithuanian businessman Kolas Igoris and others. The Kamysh-Burun iron ore plant, the Krasnoperekopsk refrigeration equipment plant, etc. also became the property of Crimea.

The second draft law was introduced to the State Duma in April of 2022 and was planned as the first step toward nationalization of the property of foreign companies exiting the Russian market. It provided for the possibility of external administration to be appointed by court order over Russian companies with more than 25% of shares held by “unfriendly” shareholders. External administration could be introduced if at least one of the following grounds exists:

• The management has ceased managing the company or has taken actions which could lead to termination of the company’s activities, its liquidation or bankruptcy or to damage being caused to the company;
• The company has terminated its operations in part or in full and/or has significantly decreased the volume of production, sale of goods, performance of works/services;
• Without the external management, there is a threat of a significant decrease in economic performance, termination or suspension of the company’s activities, disasters or deaths, termination of operations of socially significant facilities or an increase in retail prices;
• Elimination of the above grounds may require funds from the Russian federal budget or that of a constituent entity of the Russian Federation.

The external management could, for example, be the result of the company management departing from Russia after February 24, 2022 and leaving the company without management, a material decrease in the cost of the company’s assets, the company’s inability to perform its obligations, public announcement of termination of the company’s activities without obvious economic grounds to do so, termination of significant contracts, notifying over one third of employees of a layoff, to name a few.

The draft law was adopted on May 24, 2022, but only in the first reading, and was returned to be reworked. There are different opinions on why it was not given the go-ahead. Firstly, it is believed that the authorities did not dare to exacerbate the situation and launch such a serious mechanism, because foreign companies were willing to negotiate and fulfill their obligations to employees; and secondly, there is an objective concern that the new managers will hardly be able to manage the companies as effectively as the owners did.

The adopted laws 

Two laws were adopted in 2023 – on blocking assets of foreign persons and on suspending corporate rights of foreign holding companies from “unfriendly” jurisdictions with respect to Russian economically significant organizations.

The first law,[3] which will take effect on February 1, 2024, provides for blocking/freezing assets of foreign persons sanctioned in the Russian Federation, as well as a ban/restriction on financial transactions with the assets of the so-called blocked persons and to the benefit of the blocked persons. Previously, the list of sanctions did not explicitly indicate the above restrictions.

The second law,[4] which took effect on September 4, 2023, allows to suspend, by court order of the Moscow Region Commercial Arbitration Court, corporate rights of foreign holding companies (“foreign holdings”) from “unfriendly” jurisdictions with respect to Russian economically significant organizations (“ESOs”) and to introduce bans, in particular, on voting at general shareholder meetings, disposal over shares in an ESO, receiving dividends, etc. At the same time, shares in an ESO held by foreign holdings are to be transferred to the ESO, and the persons indirectly holding shares in the ESO (e.g. shareholders of foreign holdings or owners of units in foreign investment funds with assets that include shares of a foreign holding and/or securities of a foreign issuer certifying rights to shares of a foreign holding) and being citizens and/or residents of the Russian Federation must take direct ownership of such shares.

The ESO’s shares not distributed among indirect owners in proportion to their indirect ownership in the ESO are not redeemed, but become property of the ESO itself. Later, the foreign holding is entitled to demand either that the ESO pay compensation in the amount of the market value of the ESO’s shares not distributed among indirect owners or that ownership title to such shares be returned to the foreign holding.

Cases on suspension of foreign holdings’ corporate rights with respect to ESOs and related disputes fall within the exclusive jurisdiction of the Moscow Region Commercial Arbitration Court. Why exactly this court has been chosen by lawmakers is unclear.

The Russian Government will draw up an appropriate list of ESOs, but it is already obvious that the list will most likely include Russian companies which are significant for economic sovereignty and security of Russia and meet at least one of the following criteria:

• The aggregate proceeds for the preceding reporting year are over 75 billion rubles;
• The number of employees is over 4,000 people;
• The aggregate value of assets for the preceding reporting year is over 150 billion rubles;
• The amount of taxes and levies paid in Russia for the preceding calendar year is at least 10 billion rubles;
• As of February 1, 2022, it is a part of the critical information infrastructure or is a major employer having a significant impact on a region’s development;
• Participates in creating and modernizing high-performance or high-paying jobs; etc.

The law specifies a list of circumstances any one of which may serve as grounds for a lawsuit to be filed by a specially designated federal executive body, an indirect owner of shares in an ESO with a certain participatory interest, a direct owner of shares in an ESO, regardless of the number of shares, a sole executive body of an ESO, to name a few, for suspension of a foreign holding’s corporate rights with respect to an ESO:

• A foreign holding refuses/evades exercising their rights and/or performing in good faith the obligations of the ESO’s shareholder or a potential threat of same;
• A foreign holding commits actions/omissions aimed at creating obstacles for the management of an ESO and/or an ESO’s day-to-day business;
• A foreign holding commits other actions/omissions that may result in termination or suspension of operations, liquidation or insolvency/bankruptcy of an ESO.

In particular, corporate rights may be suspended if, after February 24, 2022, foreign holdings, for example, publicly announced the termination of operations of an economically significant company or their shareholding in it, terminated contracts essential for an economically significant company or for no reason terminated or suspended the performance of their obligations under such contracts, notified over one third of the ESO’s employees of a layoff, complied with foreign sanctions, restricted markets for the ESO's goods, works, services, etc.

Lawmakers believe that the law, which has already come to be known in professional circles as “the law on reregistration,” will help solve the problem of Russian companies owned, among others, by foreign holdings from “unfriendly” jurisdictions, whose actions/omissions, for example, caused by their compliance with foreign sanctions, blocked the adoption of any corporate decisions by foreign holdings or significantly complicated or made impossible the implementation of investment projects, transactions, etc., by transferring assets to the Russian jurisdiction. At the same time, the foreign holding is not deprived of its right to receive market compensation or to recover the ESO’s shares not distributed among indirect owners, which means the law is not confiscatory.

Tit for tat

Russian authorities, in particular, official representatives of the Russian Ministry of Foreign Affairs, maintain the stance that if Russia’s assets in the West are confiscated, then Russia is ready to take equivalent measures.

For now, the one and only example of tit-for-tat measures is Russian Presidential Decree No.302 “On the temporary management of certain property” dated April 25, 2023 which stipulates that if the Russian Federation or Russian legal entities or individuals are deprived or are threatened to be deprived of or restricted as to their ownership title to property abroad, the assets held by “unfriendly” persons will be placed under external management. The temporary manager of such property exercises the rights of an owner, but is not entitled to dispose over this property. These are indirect measures because they are taken in response not to the nationalization of Russian assets abroad, but to the external management imposed on such assets.

The external management first affected Russian subsidiaries of energy companies owned by Finland’s Fortum and Germany’s Uniper. By the middle of July, there followed France’s Danone, a major dairy manufacturer, and the leading Baltika Brewery owned by Denmark’s Carlsberg.

There are reasons to believe that Russia’s move to introduce external management was a response to the ongoing freeze of Russian assets and to a number of high-profile examples of former Russian companies being seized by foreign states. One of them was Securing Energy for Europe (SEFE), former Gazprom Germania, nationalized in 2022. Although Gazprom sold its shareholding interest in the German subsidiary at the end of March of 2022, the German Federal Network Agency (Bundesnetzagentur) has controlled the company as a temporary manager since April of 2022. After 7.5 months of external management, the company was nationalized on grounds of the need to protect it from bankruptcy which would have threatened the security of gas supply to Germany. The nationalization was carried out by zeroing out the existing share capital of SEFE and the acquisition by the German government of a new issue of shares of the same nominal value.

Some other Russian assets abroad are currently under external management: a Rosneft subsidiary in Germany (since September of 2022); Gazprom’s share in a joint venture in Poland (since November of 2022) – it was noted by officials that there were political reasons to do so; a Lukoil plant in Italy (since December of 2022) – the authorities denied any intentions to nationalize.

Finland, France and Denmark, unlike Germany, have not introduced external management over Russian assets abroad. We believe the Finnish company was chosen for external management in Russia because it abandoned the Hanhikivi Nuclear Power Plant construction project, where Fortum was part of the consortium, and because of its significance for the stable operation of the Russian energy sector and the plans it announced to exit Russia. The French and Danish companies were probably included in the list based on their market share, significance for the Russian economy and the social aspect of employing thousands of workers in the regions where their plants are located. At the same time, Presidential Decree No.302 does not contain any provisions allowing temporary management only over companies from states that initiated sanctions and restrictions against Russian assets, which means that any company from any “unfriendly” jurisdiction, if it is for any reason important for the Russian economy, is exposed. The principle of collective responsibility, formerly known as “covering each other’s back” is returning to the Russian political and legal context.

Our recommendations

Having analyzed the recent developments, we believe now is the point where a more active hunt for assets could begin and the focus will be on the most attractive ones. There is a substantial risk that this will follow a strict nationalization scenario where the suspension of operations or an announcement of exit will mark a starting point for interested market players or investment funds to initiate action. There is also a risk that this interest may affect not only the companies owned by individuals or legal entities from “unfriendly” states, but also the companies that, regardless of their origin, comply with foreign sanctions and have suspended their operations or want to sell their assets. And the very likely scenario will be when external management with further nationalization is introduced in case of full or partial termination of operations and/or a significant decrease in the production volume, staff downsizing, price increase, etc. 

It looks like the external management introduced over Danone and Baltika has opened a door that everyone thought was closed. Once the first two companies were placed under external management, the possibility of nationalization / transfer of assets was not obvious at all and it was hard for the market to assess. Now, the message is completely clear, and a signal to start the hunt has been given and accepted by the market. Of course, the participation in obtaining such an asset is a very risky path for those who dare to pursue it. The possibility of being included in sanctions lists (both for the purchaser’s company and personally), additional restrictions on operations with foreign companies, loss of access to foreign accounts with cash on them – all this is the flip side of the possibility of buying an asset for half of its actual value or even less. There certainly are market players who are ready to take risks, and there are reasons to believe that the assets will still eventually be owned, directly or indirectly, even after 2 or 3 sales, by those who are most interested in them and will not see the risk of negative consequences. It worthwhile to note that the transfer of Danone and Baltika took place after the tender process had already been completed and real buyers ready to pay for these companies had been found.

In addition, we believe that the list of companies whose shares are now being managed by Rosimushchestvo may be expanded to include companies that violate the requirements of the Russian legislation, in particular, the environmental law, and cause “significant environmental pollution.” As a preliminary measure, inspection/controlling authorities may be used to put additional pressure on foreign owners, which may affect the possibility of exit in general or cause a significant decrease in the purchase price, taking into account the scope of investments the new owner needs to eliminate the violations.

In view of the above, the main recommendations for those who have decided to stay in Russia may be the following:

First, continue, where possible, fulfilling your current obligations to your partners and the Russian state budget, your day-to-day operations, and do not terminate contracts with contractors without good cause. This minimizes both the risks of being nationalized and the risks of seizure of the company’s assets and the impossibility to sell the Russian business to a third party.

If the head office suspends operations of its Russian subsidiary, terminates supplies to Russia, stops financing investment projects and is unwilling or unable to invest in the further development of its Russian business, the local management must find ways to prove that the company is still active and that any actions aimed at reducing production have been the result of legislative or logistical restrictions and not of political decisions. This will help to keep the company and avoid the risk of personal liability. For example, if it is necessary to suspend production, it is possible to lease out idle facilities, sell equipment, relocate, find alternative sources of financing and supplies of raw materials and spare parts, etc.

Second, it is important to retain at least part of the staff, even if the company’s operations are suspended.

If a foreign investor does decide to leave Russia, they should view their expectations from the transaction in light of the established but ever-changing restrictions and the application review practice of the Government Commission.

In particular, we often deal in our work with a deteriorating attitude of certain relevant ministries toward the sale of an asset to the current management (so-called “management buyout” or MBO), especially with share buy-back options. These options currently can be valid for only two years and the buy-back must be made at the full market value. If the owner intends to exit the Russian market without additional complications, we recommend selling the asset to an industrial buyer who has relevant experience and resources and is able to defend its position and prove that the key activities of the asset will not only be continued, but will also be expanded, resulting in additional revenues for the state budget and workforce employment.

To date, the following is required to obtain approval from the Government Commission and enter into a transaction:

• A report of an independent appraisal of the asset’s market value confirmed by an expert from a self-regulatory organization, such appraisal to be conducted no more than 6 months prior to the date of application;
• The asset is to be sold with a discount of at least 50% off of the market value indicated in the appraisal report;
• Key performance indicators (KPIs) are established for the new asset owners, which should provide for, among others, retention of the technological potential and main type of business activity of the company being sold, retention of jobs and performance of contractual obligations, etc.;
• An option to pay the purchase price in instalments if the funds are being transferred abroad;
• Voluntary payment is to be made to the federal budget within 3 months from the date of the transaction in the amount of at least 10% of half of the market value of the asset as specified in the appraisal report (i.e. at least 5% of the market value), and if the discount on the sale price exceeds 90% of the market value, then at least 10% of the market value of the asset is to be paid to the state budget.

Given the current trends, we believe the restrictions may be tightened even further and this should be taken into account when planning and entering into transactions. For example, foreign shareholders might be then slowly excluded from the company buying the asset, except for the jurisdictions friendly to Russia (such as China). At the same time, one should not expect an upcoming liberalization of the current legal regime or reduced risks of nationalization any time soon, and it is best to choose and stick to your own path.

Under the current conditions of a dramatic transformation which follows the direction that in fact has been already set, today is a time to make quick decisions and choose reliable partners (suppliers, buyers and advisors), which is key, at minimum, to survival, and, at most, to cutting losses.

Author:

Denis Osipchuk, Principal Associate Capital Legal Services.