Analysis by Anna Vlasiuk, KSE legal expert, with humble contributions from Nataliia Shapoval
Current regulatory framework in Russia represents the following hurdles for international banks:
(i) Restriction on banks’ ability to repatriate investments and proceeds therefrom
(ii) Indirect expropriation through introduction of restrictive measure regarding disposal of shares in Russian businesses
(iii) Growing risks of direct expropriation or seizure of banks by Russian authorities
(I) Restriction on Banks’ Ability to Repatriate Investments and Proceeds Therefrom
Based on presidential Decree No 618 of September 8, 2022 and presidential Decree No. 520, companies in Russia, including banks, are significantly restricted in their ability to withdraw funds from Russia.
The said decrees impose restrictions on funds distributions to entities from “unfriendly countries” in relation to the liquidation of a company, the reduction of the share capital of a company, and procedures related to bankruptcy, and on paying out loans and other financial liabilities.
According to the decrees all funds transfers exceeding RUB 10 million a month, or an equivalent in a foreign currency can be made only after authorization of the Russian Government Commission or to a special type of bank account opened with an authorized Russian bank.
(II) Indirect/Creeping Expropriation
Pursuant to presidential Decree No. 520 of 5 August 2022 it is prohibited to enter into any transactions resulting, directly and/or indirectly, in acquisition, modification, termination, or creation of any encumbrance over the rights to own, use, or dispose of: securities issued by certain Russian legal entities; participation interests in the charter capitals of certain Russian legal entities in Russia without approval from the president of RF.
The decree explicitly imposes restrictions on Shares (participation interests) in Russian credit organizations (e.g., banks) according to the list approved by the president. Such list was latter issues in a separate presidential decree of 27 October 2022.
(III) Growing Risks of Direct Expropriation or Seizure of Banks by Russian Authorities
On 8 April 2022 the Russian Parliament introduced a draft law allowing Russian government to expropriate the property of foreign nationals/companies from “unfriendly countries”. As far as we are aware the bill was not voted into law and is being reconsidered. Based on various press reports and general sentiment of Russian commentators, there are grounds to believe that similar law can be adopted in near term.
The draft law stipulated the following:
▪ Russian courts are authorized to appoint an ‘external administrator’ of a foreign-owned Russian company if 25% or more of that company’s shares are owned by foreign shareholders from “unfriendly” states, and the company has either exited Russia or taken actions to terminate its business in Russia
▪ A Russian state entity, or other Russian entities can be appointed as external administrators
▪ The external administrator shall have a mandate to liquidate the company and transfer all of its assets to a new company
▪ The shares and assets of the new company would then be transferred and disposed of by way of public auction
▪ The original shareholders shall not be admitted to the auction.
▪ If no bidders submit their proposals, the Russian government may purchase the shares, at a price to be set by the Ministry for Economic Development
▪ The bill explicitly stipulates that original shareholders’ right of ownership over the company is to be annulled
▪ The bill further states that the confiscation shall be carried out without any compensation
Therefore, we believe there is a strong business case for terminating business operations in Russia as soon as possible. There is a clear trend for adverse changes in regulatory regime in Russia and exits are becoming increasingly more difficult and cost consuming.
Given the above, we propose that banks pursue the following course of action:
▪ actively seek to sell Russian business and apply for newly introduced permitting procedures
▪ substantially scale back operations in Russia up until voluntary winding up
▪ initiate investment arbitration proceedings against Russian federation
Scaling back operations in Russia and until voluntary winding up (“liquidation”):
Even though procedure of voluntary winding up of a bank implies considerable supervision firm Russian authorities, it is still more manageable and streamlined than bankruptcy procedure. The liquidation procedure includes the following steps:
▪ Bank shareholders adopt a decision on initiating liquidation procedure and send notification to the CBR
▪ Bank files a motion to CBR to terminate banking licence
▪ Establishment of liquidation commission, composition thereof needs to be approved by the CBR
▪ Liquidation commission takes over the bank form the management team
▪ Public announcement about bank’s entering liquidation procedure, announcing timeline for creditors to make their claims
▪ Audit of banks assets with the purpose of satisfying creditors’ claims
▪ Audit of banks assets after satisfying creditors’ claims, result of such audit are to be approved by CBR and bank shareholders
▪ Transfer of surplus funds to the shareholders
▪ Filling to the CBR to adopt the decision to liquidate the bank
Prior to restrictions of 2022, the liquidation procedure took around 12 months in Russian federation. We expect that such procedures are considerably delayed under current regulatory regime. However, under Russian law, one of the first steps that banks must undertake is filling for annulment of CBR licence. After annulment is granted by CBR, the bank is precluded from engaging in business activity. At this stage Russian law allows only “special purpose” activity related exclusively to liquidation procedure. Therefore, even though the banks may face protracted procedures they will have solid legal ground to terminate all business operations in a relatively short term.
Investment arbitration proceedings
Based on the preliminary analysis, it appears that Russian restrictive measures violate nearly all internationally accepted standards of investment protection, incorporated in majority of BITs, such as: fair and equitable treatment of investors, protection from unlawful expropriation (direct and gradual), protection from abrupt change in legislative regime.
Therefore, we recommend that banks take advantage of applicable BITs and initiate investment arbitration proceedings against Russia. We also recommend considering the possibility of creating a “consortium” of claimants on a pre-arbitration stage of a dispute in order to exercise pressure on Russian government.
Divestment from Russia: Legal Aspects, Recourse Through International Investment Arbitration
- RF regulatory measures to limit divestment
RF restrictive regulations were adopted in several stages and based on our analysis up until September and October 2022, foreign companies could find legal solutions to exit Russia by structuring indirect sales of Russian assets through third jurisdictions. With respect to banks and other financial institutions, the restrictions described below are applicable in addition to regular requirements to obtain clearance from Russian central bank (CBR). Pursuant to the federal law “On Central Bank of Russian Federation” transactions leading to the change of ownership of up to 1% in Russian credit institution require prior notification of CBR, and transactions leading to change in ownership of at least 10% in Russian credit institution require prior approval of CBR.
Milestones in RF restrictive regulations:
1 March 2022- public announcement by Russian Prime Minister Mikhail Mishustin that the government had drafted a bill to ban foreign companies from withdrawing their investments. Mishustin claimed that foreign businesses plan on exiting Russia because of political pressure, and mass exodus of international companies will lead to increased unemployment and distribution in supply chains.
5 August 2022- presidential Decree No. 520, “On Application of Special Economic Measures in Financial and Fuel and Energy Sectors in Connection with Unfriendly Actions of Certain Foreign States and International Organizations”.
The Decree prohibits any transactions resulting, directly and/or indirectly, in acquisition, modification, termination, or creation of any encumbrance over the rights to own, use, or dispose of: securities issued by Russian legal entities; participation interests in the charter capitals of Russian legal entities; and participations interests, rights and obligations held by parties to production sharing agreements, joint operating agreements, or other agreements under which investment projects are implemented in Russia without approval from the president of RF.
The Decree applies if the above assets are owned by non-Russian entities form the “hostile states” or by persons who are under control of such.
The prohibition specifically applies to the following assets:
- (i)Shares in the so-called “strategic stock companies” listed in Presidential Decree No. 1009 dated August 4, 2004, “On Approval of the List of Strategic Enterprises and Strategic Stock Companies”.
- (ii)Shares (participation interests) in entities in which the above strategic stock companies own any shares (participation interests), directly or indirectly.
- (iii)Participation interests, rights, and obligations of the participants in the certain production sharing agreements.
- (iv)certain entities in energy sector.
- (v) Shares (participation interests) in Russian credit organizations (e.g., banks) according to the list approved by the president.
According to the Decree transactions executed in violation of the prohibition shall be null and void. Initially, the restriction was effective until December 31, 2022 with possibility of prolongation. As of now, it applies until December 31, 2023.
List of hostile jurisdictions: more than 50 states and territories, including the United States, all EU member states, the United Kingdom (including all British Overseas Territories and Crown Dependencies), Australia, and Canada.
Commentary: The broad wording of the decree includes not only direct disposal or shares but also indirect transactions such as shareholders’ agreements, options, and so on. Based on our analysis the Decree of 5 August did not affect overseas transactions with holding companies. Importantly, the Decree is applicable only to the banks listed in a separate presidential decree, and such decree was not issued until 27 October 2022.
8 September 2022- presidential Decree No.618 “On a special procedure for the implementation (execution) of certain types of transactions (operations) between certain persons” introduced a restriction, whereby transactions between foreign entities and/or persons connected to hostile jurisdictions and other foreign entities, that result directly and/or indirectly, in acquisition or other change in title to shares and/or participatory interests in Russian incorporated entities can be executed only upon approval by RF Foreign Investment Commission. The Decree explicitly states that it does not apply to credit organizations (banks).
27 October 2022- presidential Decree, which was issued in addition to Decree of 5 August 2022 and stipulates the list of banks subject to restrictions. The list encompasses 45 entities including Credit Suisse, Citibank, , OTP Bank, Raiffeisenbank, RN Bank, Sumitomo Bank, Toyota Bank, Unicredit Bank, , BNP Paribas, J&T Bank, Deutsche Bank, ING Bank, J.P. Morgan Bank International, Credit Agricole, Mercedes-Benz Bank, American Express Bank, BMW Bank, Goldman Sachs Bank, PayPal RU, Ozone Bank, UBS Bank, HSBC Bank.
2. Investment Arbitration: Preliminary Overview of Substantive Standards of Protection Violated By RF
RF has over 60 Bilateral investment treaties (“BIT”) in force with most EU members (such as Austria, Belgium, Bulgaria, the Czech Republic, Cyprus, Denmark, Finland, France, Germany, Greece, Hungary, Lithuania, Italy, Luxembourg, the Netherlands, Norway, Romania, Slovakia, Spain, and Sweden) and other countries such as Canada, Japan, Korea, Switzerland, the UK. There is no BIT between RF and the United States, but U.S. companies may nonetheless initiate investment arbitration if they structured their investments in Russia through a jurisdiction that does have a Russian BIT.
Based on the preliminary analysis, it appears that Russian restrictive measures violate nearly all internationally accepted standards of investment protection, incorporated in majority of BITs, such as: fair and equitable treatment of investors, protection from unlawful expropriation (direct and gradual), protection from abrupt change in legislative regime.
Fair and equitable treatment. Many RF BITs. contain rather standard clause requiring each party to “accord in its territory fair and equitable treatment to investors of the other. state.” This standard implies prohibition of discrimination. The measures in question manifestly discriminated between investors from “hostile” states and other jurisdictions and between entities specifically listed in presidential decrees and other companies.
Expropriation. International investment protection regime in general and RF BITs in particular prohibit expropriation or nationalization of investments except against prompt and adequate compensation, for a public purpose, in accordance with due process, and on a non-discriminatory basis. Notably, according to the international arbitration tribunals such prohibition includes not only direct expropriation, but also a broad spectrum of measures often termed “creeping expropriation”. Therefore, even if every measure taken separately may appear legitimate, if taken in conjunction such measures undermine the economic value of a protected investment, such measures can be found to violate prohibition on expropriation.
Investors’ Legitimate Expectations, and Stability of the Business and Legal Environment. This standard of protection is considered to be an evolution of fair and equitable standard. There is established case law in application of the standard, especially in recent cases regarding curtailing feed-in-tariff for renewable energy in certain jurisdictions.
