Update on Russian Counter-Sanctions − New Regulations to Prevent Withdrawal of Foreign Investment

published on 3 June 2024 | reading time approx. 9 minutes

The recently ordered placement under state administration of the respective Carlsberg and Danone subsidiaries in Russia once again highlights how difficult and risky managing Russian subsidiaries for Western companies can be. In particular, attempts to withdraw from the Russian market or to shut down business operations can already be threatened with drastic measures by the Russian state. This situation is not likely to improve in the foreseeable future; on the contrary, the market situation is becoming continuously more difficult, especially for Western groups of companies. Specifically, a government resolution was issued on 7 July 2023, which provides for new regulations and restrictions with regard to foreign investment shares in Russian companies and, above all, is intended to make it even more difficult for Western companies to withdraw from the Russian market.

New Government Resolution

Background of the new legal situation is Resolution No. 171/5 of the Subcommittee of the Governmental Commission on Control of Foreign Investments in the Russian Federation dated 7 July 2023 (hereinafter referred to as the "Resolution"). The translated text of the Resolution is attached to this article.

The Resolution provides for new requirements regarding the granting of state permits to foreign investors in two basic areas:

sale of shares in Russian companies by foreign persons
distribution of dividends from Russian companies to foreign persons

The respective requirements are discussed in more detail below.

Sale of Shares in Russian Companies by Foreign Persons

In connection with the issuance of a required permit by the Russian government for the sale of shares in Russian companies by foreign persons, in particular in the case of persons from "unfriendly states", the Resolution set out various requirements under several points, which can be summarized as follows:

1. Existence of Market Value Appraisals

The market value of the assets to be sold must, on the one hand, be determined by an "independent appraisal", which needs to be conducted an expert from a list published by the government. On the other hand, an expert opinion must also be obtained, whereby the expert must again be included in a list determined by the government.

2. Sale with Discount

The assets must be sold at a discount of at least 50 percent of the market value estimated in the "independent appraisal".

3. Voluntary State Levy

The parties must agree to pay a "voluntary" levy to the Russian state budget in the amount of 5 to 10 percent of the appraised market value. The amount of this levy depends on whether the discount on the sale price is above or below 90 percent of the market value.

4. Placement of Acquired Shares at Auctions

If shares are acquired that relate to the share capital of a public joint stock company, or if a public joint stock company is to be converted or liquidated, up to 20 percent of the shares concerned must be placed at an organized auction.

5. Definition of KPIs for Acquired Companies

The purchaser of a company must establish KPI values for the acquired company, which should ensure the existence and continued operation of the company's business.

6. Restrictions on Buy-Back Options

When a buy-back right is exercised, the market value of the assets at the time the right is exercised is decisive for the purchase price. In addition, the maximum duration of a buy-back right is generally limited to two years.

7. Execution of Transactions

When executing transactions, certain restrictions arise with regard to the payment of the purchase price. Payments to persons from "unfriendly states" may only be made to type C accounts, quasi blocked accounts. This means that no payment may be made abroad. Otherwise, payment in rubles remains possible, but also without payments abroad. However, payments abroad should also remain possible, as long as they are made in installments.

8. Existence of Other Approvals

Finally, all other approvals required for the processing of a corresponding transaction must also be obtained.

Distribution of Dividends From Russian Companies to Foreign Persons

If dividends of Russian companies are to be distributed to foreign persons, the following points must be observed in order to obtain a permit for this purpose:

1. Amount of the Dividend

The amount of the dividends to be distributed may not exceed 50 percent of the amount of the net income of the distributing company for the previous year.

2. Recording of Previous Distributions

A so-called retrospective analysis of the distribution of dividends in prior periods must be carried out and recorded.

3. Continuation of Business Operations in Russia

Despite the dividend payment, the shareholders of the distributing company must show willingness not to give up business operations in Russia, but to continue them.

4. Consideration of the Significance of the Company

The Russian Government and the Bank of Russia may take a position on the significance of the activities of the distributing company in relation to "the technological and production sovereignty of the Russian Federation and the socio-economic development of the Russian Federation", which will also be taken into account in the approval decision.

5. Fulfillment of KPI Values

The Russian government or the Bank of Russia may make the approval for a dividend distribution dependent on the fulfillment of KPI values of the company.

6. Distribution on a Quarterly Basis

Dividends can be distributed on a quarterly basis if the defined KPI values are met.

What should be considered?

The legal consequences of the Russian requirements outlined above include in particular the restriction of possible buy-back rights to a maximum of two years and the linking of the purchase price to the current market value of the assets, should such a buy-back right be exercised. As a result, the purchase price to be paid would not only include any increase in value but would also be dependent on Russian appraisers should they estimate the market value.

Also, the obligations to place a portion of acquired shares in Russian public joint-stock companies should not be ignored, which may lead to further difficulties in structuring transactions related to public joint-stock companies.

Restrictions on purchase price payments in the context of sales transactions must be observed as well. Payments abroad, especially to "unfriendly countries," are severely limited; only installment payments abroad are to be possible. Whether this exception for installment payments also applies to payments to "unfriendly countries" or only to other third countries, and how exactly these installment payments must be structured in order to be covered by this exception is not clear from the Resolution. Further developments in practice will have to be observed and the respective individual cases will have to be examined in detail.

Recommendations

Against this background, we recommend all the more that transactions involving Russian assets are closely scrutinized to ensure that the transaction does not fail due to one of the numerous approval hurdles or suddenly incur unexpected costs due to "voluntary" payments to the Russian state or obligatory resale of the shares just acquired.

In particular, the balancing act between compliance with these Russian counter-sanctions, which are intended to make it as difficult as possible for Western companies to withdraw from the Russian market, and the Western (UK, US, EU) sanctions, which severely limit activities in Russia, can lead to situations that are extremely difficult to resolve. In order to navigate safely through such dilemmas and to minimize the considerable risks of possible sanctions violations, a detailed and continuous legal examination of the corresponding projects is indispensable.

Annex¹

Extract from Resolution No. 171/5 of the Subcommittee of the Governmental Commission on Control over the Exercise of Foreign Investments in the Russian Federation of 7 July 2023

1. Taking into account the discussion that took place and in implementation of item 2 of the List of Instructions of the President of the Russian Federation as a result of the Meeting on the Strategy of Work with Foreign Assets and Improvement of Regulation of Legal Transactions between Residents and Non-Residents of 11 April 2023 (No. Pr-1114 of 4 June 2023), the Subcommittee on Settlement (Execution) of Legal Transactions between Residents and Non-Residents of the Russian Federation has unanimously decided to consider the issue of issuance of permits by the Subcommittee on Settlement (Execution) of Legal Transactions between Residents and Non-Residents of the Russian Federation. June 2023), the Subcommittee has adopted a unanimous decision, when considering the issue of issuance of permits by the Subcommittee for the settlement (execution) of legal transactions (transactions) aimed at the sale of securities, including shares, shares (participations) in the share capital of Russian economic companies (hereinafter referred to as "assets") by foreign persons connected with foreign states which take unfriendly actions with respect to the Russian Federation, Russian legal entities and natural persons (inter alia, if such foreign persons have the citizenship of these states, or if their place of registration is located in these states, or if they conduct their business activities primarily in these states or if the profit from their activities is obtained primarily in these states) or by persons under the control of such foreign persons regardless of the place of registration or the place of priority conduct of activities (hereinafter "persons of foreign states committing unfriendly acts"), as a rule, it shall be assumed that it is expedient to establish the conditions (listed below) for the settlement (implementation) of such legal transactions (transactions):

the existence of an independent appraisal of the market value of the assets carried out by a pri¬vate appraiser included in the list of appraisers (appraisal organizations) recommended by the Subcommittee for carrying out such an appraisal or by an appraiser who has concluded an em¬ployment contract with a legal entity included in this list (hereinafter referred to as the "inde¬pendent appraiser's appraisal");
the existence (in addition to the independent ex¬pert appraisal) of an expert appraisal prepared by one or more experts of an expert self-regula¬tory organization in accordance with Article 17.1 of Federal Law No. 135-FZ "On Expert Activities in the Russian Federation" dated 29 July 1998. The following organizations are included in the list of self-regulating organizations of experts recommended by the Subcommittee on Expert Opinion Preparation in accordance with Article 17.1 of Federal Law "On Expert Activities in the Russian Federation" No. 135-FZ dated 29 July 1998;
Sale of the assets at a discount of at least 50 percent of the market value of the assets in question according to an independent expert ap¬praisal;
The existence of an obligation to voluntarily transfer funds to the federal treasury in the amount of 10 percent of one-half of the market value of the assets in question as set forth in the independent appraisal estimate (if the sale of the assets is at a discount of less than 90 per¬cent of the market value of the assets in ques¬tion according to the independent appraisal estimate), or at least 10 percent of the market value of the relevant assets according to the in¬dependent appraisal (if the sale of the assets is made at a discount exceeding 90 percent of the market value of the relevant assets according to the independent appraisal), within three months from the date of settlement (execution) of the le¬gal transaction (transaction);
In case of acquisition of shares constituting the share capital of a public joint stock company, placement of up to 20 percent of the acquired block of shares of a public joint stock company at organized auctions, whereby:

a) The period until the beginning of such place-ment may not exceed one year from the date of settlement (execution) of the legal transac¬tion (transaction) and the duration of the placement may not exceed three years from the beginning of the placement;

b) In case of transformation of a business com-pany in the form of merger into a public joint-stock company: placement of shares of the public joint-stock company to which the mer¬ger took place, at organized auctions, in a number corresponding to up to 20 percent of the shares of the merged company, taking into account the coefficient of conversion of shares of such companies upon merger, shall be made within three years from the date of settlement (execution) of the legal transaction (transaction);

c) In case of termination of the public joint stock company status or liquidation of such company as a result of settlement (execution) of the legal transaction (transaction): Placement of up to 20 percent of the shares of the public joint-stock company (newly established or as a result of acquiring the status of a public joint-stock company) at organized auctions, the period for acquiring the status of a public joint-stock company and carrying out such placement being a maximum of three years from the date of settlement (execution) of the legal transaction (transaction);

d) Setting KPI values for the purchasers and/or the business company to be acquired by them, which must provide, inter alia, for the preservation of the technological potential and the main type of activity of this business company, the preservation of jobs and the fulfillment of obligations arising from contracts with other legal entities, sending a recommendation to the federal executive authority to exercise control over the achievement of these KPI values;

e) Repurchase of assets at the market value on the date of exercising such option, existence of economic benefit for the owner of the assets (resident), as well as limitation of the period of validity of the authorization (usually not more than two years from the date of settlement (execution) of the original legal transaction (transaction) - for legal transactions (transactions) providing for repurchase of assets;

f) Transfer of funds in the case of legal transactions (transactions) with persons of foreign states committing unfriendly acts to type C accounts; or settlements of legal transactions (transactions) in rubles in the banking system of the Russian Federation without transfer of funds abroad; or in the case of transfer of funds from legal transactions (transactions) with foreign persons to the accounts of such persons in banks or other financial market organizations outside the Russian Federation: existence of installment payments;

g) Existence at the applicant of other permits required for the execution (implementation) of the legal transaction (transaction) for which the applicant has submitted information.

2. The Subcommittee has taken note of the information provided by the Ministry of Finance of Russia and the Bank of Russia on the approaches to adopting resolutions on granting permission to distribute profit (dividends) to foreign creditors in the cases established by the decrees of the President of Russia (hereinafter, "foreign creditors"), as a rule, subject to compliance with the following conditions:

The amount of profits to be distributed (dividends) shall not exceed 50 percent of the amount of the net profit of the previous year;
Recording of the results of a retrospective analysis of the distribution of profits (dividends) for prior periods;
Willingness of the partners (shareholders), who are foreign creditors, to continue the business activity in the Russian Federation;
Consideration of the positions of the federal executive authorities and the Bank of Russia on the assessment of the importance of the enterprise's activity and the impact of the activity carried out by the enterprise on the technological and production souverity of the Russian Federation and the socio-economic development of the Russian Federation (the subjects of the Russian Federation);
Fulfillment of the obligations assumed by the applicants to comply with the KPI values, confirmed by the federal executive authorities (Bank Russia);
Possibility to carry out the distribution of profits (dividends) on a quarterly basis under the condition of compliance with the established KPI values.

3. Annulment of the minutes of the subcommittee meeting No. 118/1 of 22 December 2022 and No. 143/4 of 2 March 2023.

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¹ No guarantee is given for the accuracy of the translation of the relevant Russian government resolution included here.