New Risk Assessment Protocols For Foreign Investors In Russia

Many Western law firms have exited the Russian market, some in total, others transferring the practice to their Russian partners. This, coupled with a massive array of sanctions on Russia and reciprocal measures imposed by Russia have left international investors in Russia short of significant advisory about handling their business operations during these unprecedented times. Russian risk assessment has taken on a whole new due diligence and compliance scope.

We examine what the implications are from both the International, sanctions impacted view, domestic Russian perspectives, provide risk assessment and look at mitigating and protecting Russian based executives and businesses against the downsides.

International & Sanctions Risks of Operating in Russia

Criminal Liability

Foreign investors and their executives in Russia should take note of potential criminal liability for being complicit in international criminal acts, which courts outside Russia could prosecute under the doctrine of “universal jurisdiction”. 163 of the 193 UN Member States exercise universal jurisdiction over one or more crimes under international law.  There is precedent where corporate executives have been prosecuted for the supply of dual-use substances to a sanctioned nation, with the knowledge of their intended illegal use. As always, the difficulty is proving innocence with the counter argument that executives should have been aware. This means that attention to detail needs to be placed on traded items sold to Russia and especially ‘dual use’ products, including via third party countries. Product due diligence needs to be carried out.

Human Rights Violations

Foreign investors in Russia should also now be aware of new implications concerning international human rights and criminal law. This is because Corporations have a responsibility under the United Nations Guiding Principles on Business and Human Rights 2011 (UNGP) to respect human rights and could be caught up in this in respect to doing business with any Russian State and privately Russian owned businesses that are also operating in Ukraine. Prosecution is unlikely, but reputational damage for larger businesses could be serious, especially in the United States and EU. Conducting due diligence on Russian business partners therefore becomes a key point in mitigating against this.

Russian Risks Against Foreign Investors

Russia has proposed or already imposed several measures impacting foreign investors who are planning or have significantly downsized or closed their Russian operations. These include:

• The forced nationalization of foreign invested assets if they decide to permanently exit the Russia market. This legislative proposal affects companies with 25% or more equity ownership by investors from an “unfriendly country”. At present, that includes the following mandated nations: Albania, Andorra, Australia, Great Britain, Jersey, Anguilla, British Virgin Islands, Gibraltar, all  European Union member states, Iceland, Canada, Liechtenstein, Micronesia, Monaco, New Zealand, Norway, South Korea, San Marino, North Macedonia, Singapore, United States, Taiwan, Ukraine, Montenegro, Switzerland, and Japan.
• Assets may be seized and put under external management control unless the investor agrees to resume operations in Russia or to sell its interest.
• Limitations on wire and cash transfer of funds outside of Russia: Companies and individuals from certain countries (as yet unspecified, but probably linked to the ‘unfriendly countries’ list mentioned above) are prohibited from transferring wire funds outside of Russia. No one may transfer cash outside of Russia in any foreign currency worth over US$10,000.
• Restrictions on divestment by foreign investors: Foreigners are not able to sell their positions in any Russian securities, while dividends and other proceeds from Russian securities cannot be transferred to foreigners.
• Governmental approval required for certain transactions involving entities from, or controlled by, sanctioning countries: The transactions include: (i) lending rubles to foreign investors; (ii) transferring title to real estate; and (iii) transferring title to securities.
• A temporary ban of foreign investors selling Russian based assets.
• Proposed administrative and criminal liability for foreign companies and their representatives for compliance with sanctions by Western countries. Note this can place executives between a rock and a hard place as it may not be possible to be compliant on both ends of the sanction’s regulations. Caution is advised.
• IP and royalties: Russia has suspended normal compulsory IP licensing rules, meaning that Intellectual Property (IP) owners from sanctioning countries will receive no compensation instead of “reasonable compensation”. These clauses are often built into manufacturing and sales contracts, be aware these may need to be revised.

Bilateral Investment Treaty Issues

Russia and numerous international governments have signed off Bilateral Investment Treaties (BIT), which provide mutually agreed bilateral trade protection, mitigation against sanctions and potential exposure. A complete list of the BIT agreed with Russia can be found here.

BIT are typically bespoke agreements, differing from country to country, but typically include trade protection clauses that should foreign investors suffer losses, remedies may be available. With Russia’s BIT, these may be accessed through investor-State dispute resolution (ISDS) under Russia’s international investment agreements (IIAs), which also include Russia’s BIT with other countries. These vary in scope, as do their protected rights, however, examples may include the following:

Breach of the Right to Transfer Funds

Many Russian BITs require Russia to ensure that foreign investors can freely transfer funds relating to their investment out of Russia, without delay and in a freely convertible currency. The recently imposed measures inhibiting this, which restrict the movement of funds out of Russia therefore constitute a breach of this provision. Many free transfer provisions also apply “at the rate of exchange applicable on the date of the transfer”. With currently erratic Ruble-FX currency fluctuations impacting remittances, the FX implications of remitting funds needs careful consideration.

Breach of National Treatment / Most-Favored Nation Treatment Guarantees

Many Russia BITs require Russia to provide treatment to foreign investors that are not less attractive than the treatment it offers to its own nationals or nationals of other countries. Russia’s measures targeting foreign investors of so-called “unfriendly countries” may violate these protection standards as they discriminate based on nationality.

Expropriation 

This includes measures that directly or indirectly, result in the substantial deprivation of a foreign investor’s enjoyment of its investment, and which are not accompanied by prompt, adequate and effective compensation. This constitutes unlawful expropriation and is a breach of Russia’s IIAs.

These include, as mentioned earlier, the nationalization (without compensation) of foreign investors’ assets if they decide to exit Russia; measures which prevent foreign investors from disposing of their Russian assets leading to substantial deprivation of value of their investments; disregarding intellectual property rights; and Russia’s authorization of the repayment of foreign-currency debts in rubles (should this significantly reduce the value of these receivables).

Fair and Equitable Treatment  

The FET provisions within Russia’s IIAs provide foreign investors with protection against measures that are ‘unfair and unreasonable’. Investors may argue that the recent wide-ranging, and disruptive changes to the legal environment for foreign investments in Russia breach this protocol, as they substantially differ from expectations held when they first invested, including that Russia would provide a stable and predictable legal framework. Specific measures may also violate FET to the extent they may be considered arbitrary or discriminatory.

Actions using this argument are unlikely to succeed in Russia, but judgements obtained elsewhere may permit access to assets held externally from Russia.

Checklist for Foreign Investors in Russia

Given these unpredictable times and the clashing of different legal obligations, foreign executives and businesses in Russia should conduct immediate due diligence checks. These include:

• Checking the legal structure and nationality of the foreign investment in Russia to see if they are eligible for protection under any of Russia’s IIAs.
• Formally document all important internal corporate decisions, and especially concerning a potential exit from Russia. Maintain detailed written records of all discussions with the Russian government. Preserve and secure all paper and electronic documentation, and store copies of these with access to them externally from Russia, as documents may later be required in any future arbitration proceedings.
• Conduct an internal audit to value your Russia business assets, including stock, inventory, and all other assets, as a true and accurate business value as of January 1^st 2022. Again, this may be later required to prove value at subsequent arbitration.
• Assess the potential for establishing subsidiary operations in related markets, such as China, India, ASEAN and the EAEU markets. Market research and practical business operational issues can be undertaken by our Business Advisory Unit, which works on behalf on MNCs and Foreign Governments throughout the Asian region.
• Secure outstanding, including suspended contractual values and proven cashflow and audited accounts for the past three years in addition to 2022 business plans as these projections and business behavioral models may prove valuable later in assessing a potential return to the Russian market.
• Secure all internal advisory and documentation between Russian based executives and Head Office as concerns compliance with applicable sanctions.

Dezan Shira & Associates can provide practical, protective advisory and due diligence assistance for Foreign Investors in Russia, as well as assist with the establishment of subsidiary operations in Asia. Concerning parties may contact us in strictest confidence at russia@dezshira.com

Related Reading

• Actual Impact Of Banking And Financial Sanctions On Foreign Businesses In Russia
• Inconsistent Sanctions Legislation Affecting Legitimate Russian Oligarchs & Businesses Will Find Their Way To International Courts & Tribunals