Russia's M&A market started 2020 with signs of growth, but then went into a nosedive following the introduction of lockdowns in major cities in March. Subsequently, however, as lockdowns were lifted across the country, M&A activity started showing signs of mild recovery.
In addition to the pandemic, transactional activity was also affected by a fall in oil prices and the effects of Western sanctions and the associated weakening of the Russian ruble.
According to a KPMG report on the Russian M&A market published in February 2021, the number of deals concluded in 2020 decreased by 15% (to 567 deals) in comparison to 2019, and their total value decreased by 13% (to USD55 billion). A few deals were put on hold due to COVID-19 logistical restrictions that did not allow for prompt due diligence. The situation improved slightly by the end of 2020, and several major deals were announced.
In 2021, most experts expect the number of M&A deals to grow as suspended transactions resume and companies adjust to new market conditions by selling off non-core assets, buying attractive targets and implementing corporate reorganisations.
Use of Russian Law
There is a growing tendency to increasingly use Russian law, instead of English law, to govern M&A and joint venture transactions in Russia. Russian law-governed transactions are becoming more sophisticated, as there are more court precedents and guidance on the application of risk-allocation mechanisms (such as representation and warranties, indemnities, escrow accounts and options) which were introduced into Russian law a few years ago.
The tendency to use Russian law is further strengthened by restrictions on the use of international arbitral institutions to resolve disputes, introduced in 2016 as part of the reforms of the judiciary that continue in certain aspects to this date. The restrictions require that disputes arising out of share purchase agreements (SPAs), shareholder agreements (SHAs) or joint venture agreements may only be referred to arbitration in Russia, and that the arbitral institution be licensed by the Russian Ministry of Justice. This substantially limits the ability of a party to refer corporate disputes to previously popular foreign arbitral institutions such as LCIA and ICC. To date, only the Vienna International Arbitration Court (VIAC) and Hong Kong International Arbitration Court (HKIAC) have been licensed. The restrictions also prohibit arbitration of certain corporate disputes altogether (eg, with respect to "strategic companies", see 2.3 Restrictions on Foreign Investments).
Western sanctions remain a key consideration in the context of cross-border M&A deals involving Russian businesses. It is standard practice for foreign investors to conduct a sanctions compliance due diligence of their Russian counterparties at the early stages of a deal. Also, it is market practice to include in transaction documents specific sanctions-related contractual arrangements, such as general compliance covenants and more sophisticated post-closing walkaway provisions if new sanctions are imposed.
In 2020, in response to the imposition of further Western sanctions against certain Russian companies and individuals, Russia passed a law granting exclusive competence to Russian state courts in respect of disputes with parties affected by sanctions. The law provides that affected parties may refer disputes to Russian courts in the event their access to justice is limited due to the sanctions (in cases where previously the parties agreed to refer disputes to foreign courts or arbitral institutions). The law undermines the stability of arbitration agreements in transactional documents, including those compliant with the new Russian arbitration rules.
Due to the above restrictions, cross-border transactions involving Russian businesses usually involve sophisticated structuring analysis to evaluate potential deal implementation risks for foreign investors.
An increase in the number of M&A deals in the IT, healthcare and pharmaceuticals, and metallurgy sectors was seen in 2020, according to KPMG. M&A activity with agriculture assets remained stable. The number of deals in the oil and gas, real estate and construction, transport and infrastructure, banking, and retail sectors decreased substantially, which reflects the overall slowdown in these areas in 2020 due to the global pandemic.
Normally, businesses in Russia are acquired through the purchase of shares or assets. Corporate reorganisations (such as mergers and consolidations) between Russian companies are less common because they take several months to implement, require the involvement of creditors, and trigger a tax audit. Russian law allows mergers/consolidations involving both limited liability companies (LLC) and joint-stock companies (JSC), but does not allow foreign entities to merge with local companies.
Share acquisition mechanics and regulatory specifics depend on the type of the target company. The two types of entities most commonly used for business operations in Russia are LLCs and JSCs.
Participants in an LLC and title to their shareholdings are recorded in the Unified State Register of Legal Entities (the "State Register"), which is maintained by the tax authorities and is publicly available. A share transfer agreement with respect to an LLC must be notarised by a Russian notary in order to be valid. It is important to note that title to the shares is acquired by the buyer only at the moment when it is recorded as a new shareholder in the State Register. The notary who certified the transfer agreement submits information on the buyer as a new participant in the LLC to the tax authority, which has a five business days statutory term to record (or reject) the title transfer in the State Register.
In contrast, share transfer agreements with respect to a JSC do not require notarisation. Shares in a JSC exist in non-documentary form as entries on a shareholder's account in a shareholders' register maintained by a professional third-party registrar or in a specialised depository. Title to a share passes when the relevant entry is made in the shareholders' register (or depository) to reflect that the share is recorded on the personal account of the buyer.
Auction processes are relatively common in private acquisitions involving sophisticated sellers, and it is common to use indicative bid letters that are non-binding. Acquisition of a major stake in a public company may also be structured as a combination of a private deal and a mandatory or voluntary offer.
Structuring the deal as a share purchase means that the buyer acquires all the historical liabilities of the target company. Thus, a thorough due diligence exercise is highly recommended.
Under the Russian Civil Code, an asset transaction may be made in the form of either an ordinary asset sale or the sale of an enterprise.
Ordinary asset sale
An ordinary asset sale enables the buyer to acquire specific assets without historic liabilities, which generally stay with the previous owner. Depending on the type and scope of the acquired assets, an asset deal may be viewed as more complex than a share deal. The transfer of certain assets may require specific registration formalities, execution of separate transfer agreements (eg, with respect to IP and real estate), and/or prior consent of creditors.
Also, certain liabilities (eg, administrative liability, tax liability, liabilities relating to employment and benefit plans, and liabilities relating to environmental activities) and state licences/permits are not transferrable. Thus, each specific case should be analysed to determine the possibility of an efficient asset transfer without any material business interruption.
An enterprise sale is a sale whereby the seller transfers to the buyer an entire enterprise, including all types of property required for its commercial activities. This includes land, buildings, facilities, equipment, tools, raw materials, inventory, claims (receivables) and debts (payables), as well as the company's name, trade marks, service marks and other exclusive rights, unless otherwise provided by statute or contract. The contract for an enterprise sale must generally be concluded in the form of a single document.
Under Russian law, an enterprise is treated as immovable property. Title to the enterprise's property passes to the buyer upon registration of the transfer with the Unified State Register of Real Estate. However, due to a rather complicated procedure for ascertaining whether a property complex is an enterprise and for registering it, the sale of an enterprise is rarely used in M&A deals.
The Central Bank of Russia (CBR) is the principal securities regulator in Russia. Public takeover bids are subject to the supervision and control of the CBR. However, it does not play an active role in private deals (unless the deal is made in the banking sector).
If a transaction is subject to a merger control clearance, the main state authority reviewing the transaction will be the Federal Antimonopoly Service (FAS).
With respect to certain transactions involving investment in industries sensitive to national security and defence and/or investments made by foreign states or companies under their control, the main regulators will be FAS and the Government Commission on Control over Foreign Investments in the Russian Federation (the “Government Commission”).
Foreign investments are not restricted in Russia, apart from customary anti-trust approvals, unless they relate to certain sensitive activities.
Acquisition of "Strategic Companies"
Under the Strategic Companies Law, foreign investment in companies doing business in certain strategic sectors of the Russian economy requires preliminary consent from the Government Commission. The list of strategic activities is rather broad and includes nuclear energy, weapons and military equipment, industrial explosives, aviation, space, cryptography, infectious agents, mass media, geological survey, exploration and development of natural resources, and several others.
The prior consent of the Government Commission is required for transactions resulting in:
Certain additional restrictions are imposed by law with respect to transactions involving strategic companies using subsoil plots deemed to be "of federal significance." The law also covers a foreign investor's acquisition of the main production assets of a strategic company whose value is 25% or more of the book asset value of the company.
"Strategic Companies" Approval Process
A foreign investor must submit an application for preliminary approval to FAS, which checks the application’s compliance with the formal requirements. After a foreign investor submits the application, FAS and the Government Commission have a maximum of 3 months to issue a final written decision. The Government Commission may extend the review period by another 3 months (6 months in total). In practice, however, the approval process might take longer and there are no official fast-track options.
FAS must be informed about the completion of transactions and other actions for which preliminary consent was obtained. A foreign investor who acquired more than 5% of the voting shares in a strategic company must notify FAS about such acquisition within 45 days.
Restrictions under the Foreign Investments Law
Investments by foreign states, international organisations and organisations under their control in Russian companies (strategic and non-strategic) are subject to additional clearance requirements under the Law on Foreign Investments. Any transaction that gives a foreign state, an international organization, or an organization under their control the right to dispose, directly or indirectly, of more than 25% of the total number of votes attached to voting shares in any Russian company, or to otherwise block decisions of the governing bodies of a Russian company, requires preliminary clearance with the Government Commission and/or FAS.
In addition, any transactions by a foreign investor with respect to a Russian company (strategic and non-strategic) may require prior approval from the Government Commission if the Prime Minister decides that such transaction may threaten national defence and state security in a broad sense. While this right of the Prime Minister was introduced in 2017, there are no publicly known instances when it has been exercised.
Other Industry-Specific Regulatory Approvals
In certain industries, such as banking, insurance and mass media, foreign investors may need consent from regulators or may be restricted from acquiring stakes beyond a certain threshold set by law.
Provided certain financial thresholds established in the law are met with respect to the aggregate balance sheet value of assets and/or the aggregate annual revenue of the buyer and the target company, prior merger control approval from FAS is required for the acquisition of:
Separate filing requirements apply for a merger of Russian commercial organisations.
Approval of Joint Activities
"Agreements on joint activities" concluded between competing entities in or outside Russia but targeting the Russian market require prior approval from FAS if the financial thresholds established in law are met. Shareholders' agreements or joint venture agreements that may be entered into in the context of an M&A deal may often fall under this category, and thus require FAS approval before execution.
In determining the threshold for asset and revenue values, FAS takes into consideration not only the acquirer and the target company, but also all persons (individuals or legal entities) in the acquirer's and target's "group of persons."
The Competition Law contains separate conditions and thresholds for the acquisition of an interest, asset or right in a financial organisation; these acquisitions should be considered on a case-by-case basis.
After an application for prior approval has been submitted by the buyer, FAS has one month to review it. If FAS believes that the transaction may lead to the restriction of competition, the review period may be extended for an additional two months, during which time FAS invites all interested parties to voice their opinions on the transaction.
Unlike some other jurisdictions, an M&A transaction in Russia does not require specific consultation with trade unions or employees. However, Russian labour law is employee-friendly and finding a legitimate ground to terminate an employee may be difficult. Thus, if a post-closing staff optimisation is planned, all associated costs (eg, severance payments agreed with terminated employees) should be assessed in advance.
A share acquisition does not affect the employment relations between the employees and the target company, since:
Under Russian law, an asset acquisition does not entail the automatic transfer of employees. Such transfer requires the employees' consent, and may only be formalised by complete termination of employment with the seller and hiring by the buyer.
Russian companies are allowed to hire foreign citizens only subject to the receipt of a working visa and a special work permit. The procedure of obtaining of a work permit and work visa normally takes up to two months. However, due to COVID-19 restrictions this currently takes around three-and-a-half months. Thus, if there is a need to appoint a foreign citizen to the target company's senior management at closing, all preparatory steps shall be made as a condition precedent to closing.
Restrictions on foreign investments in industries sensitive to national defence and security are described in 2.3 Restrictions on Foreign Investments.
Russian corporate and commercial laws were substantially modernised in 2015 and subsequent years to introduce concepts commonly used in international business and cross-border transactions, including M&A, joint ventures and private equity deals. These concepts include representations and warranties, indemnities, options, escrow accounts and more sophisticated security instruments. Corporate law has been made more flexible in many areas, particularly in relation to private companies, and the regulation of intellectual property rights has been improved. When these new concepts were introduced into Russian law, there was a lack of clarity on how they would be interpreted and implemented in practice by Russian courts.
The Supreme Court of Russia is developing court practice with the application of the new commercial and contract law rules. In recent years, its plenary sessions have issued important clarifications binding on lower courts, including on issues related to implementation of some of the above concepts, suretyships (2020), intellectual property (2019), general contract law principles, and challenges of major and interested party transactions by corporations (2018). In addition, the Judicial Chamber on Economic Disputes of the Supreme Court provides key guidance on critical issues of commercial law by resolving individual disputes in such areas as bankruptcy, commercial and corporate law, intellectual property, real estate and arbitration. While the Supreme Court of Russia has clarified positions on certain M&A legal concepts (eg, representation and warranties), Russian courts continue to interpret certain concepts (eg, disclosures) inconsistently.
Russian takeover rules are primarily embodied in the Law on Joint Stock Companies and the Securities Market Law governing voluntary and mandatory offers as well as squeeze-out demands. The law has not changed significantly since 2006, when it was first enacted. However, there are longstanding discussions and initiatives among key market players and the regulator (CBR) to reform it. A number of draft bills have been submitted to the Russian parliament, but none have been or are expected to be passed into law in the near future.
In early 2021 the CBR released a report on the reform of approaches to mandatory buyouts of securities in Russian public JSCs. The report noted a number of bureaucratic aspects of the tender offer procedure, urging for changes that would remove obsolete requirements and simplify the procedure while at the same time protecting the interests of minority shareholders. Although, the CBR is the key regulator in this area, it is unclear whether its proposal will be enacted into law any time soon.
Generally, most Russian public companies have a controlling shareholder(s) who also controls the board and management, and there are very few companies that may be taken over by a third party if the majority shareholder is not willing to allow this.
In light of this, the following transaction structures could be considered for the acquisition of a major stake in a public company in Russia.
Private Deal Plus Mandatory Offer
A buyer acquires more than 30% of voting shares in a private deal from the majority shareholder(s), followed by a mandatory offer. If the buyer, together with its affiliates, acquires more than 95% of voting shares, and if at least 10% of such shares are acquired through the mandatory offer, the buyer will be entitled to squeeze out the remaining voting shares and securities convertible into such shares from their holders.
A buyer launches a voluntary offer to acquire all voting shares and securities convertible into such shares in the target company. If the buyer acquires more than 95% of voting shares (including at least 10% of such shares through the voluntary offer), it will be able to squeeze out the remaining voting shares and securities convertible into such shares from their holders.
Merger of Companies
A merger of two or more Russian companies is a way to avoid making a costly mandatory offer, and is sometimes used for public takeovers. There is some flexibility in determining the share exchange coefficient, and the merger requires the approval of 75% of the shareholders of each merging entity. In addition, shareholders opposing the merger may need to be bought out and creditors will need to be notified of the merger. The creditors may also demand acceleration in certain instances.
In private M&A, stakebuilding strategies are not common. However, a buyer may sometimes be willing to buy the target company in stages (eg, acquiring a minority stake enabling it to block key corporate decisions, with subsequent acquisition of a controlling stake). The buyer would often also keep an option to sell back the minority stake if it does not wish to proceed with acquisition of control. Typically, this strategy is used to test the target company's performance over time and/or to gain access to its operations and books before taking a decision to go forward with the control deal.
Under Russian law, a buyer of shares in a public JSC must inform the company and the CBR once it acquires 5% or more of votes carried by the company’s voting shares. The same obligation to inform extends to a shareholder whose shareholding increases or decreases across the threshold of 5%, 10%, 15%, 20%, 25%, 30%, 50%, 75% or 95% of the total amount of votes carried by the public JSC’s shares.
A public JSC must disclose information on all its shareholders whose shareholding exceeds (or becomes less than) 5%, 10%, 15%, 20%, 25%, 30%, 50%, 75% or 95% of the total number of votes carried by the company’s voting shares. Thus, if a buyer acquires a stake exceeding 5%, and it notifies the company of the acquisition (or the company becomes aware of such fact from its share registrar), the company will be obliged to disclose the relevant information in a press release and on its website.
When determining whether a threshold has been passed, a buyer must also take into account the voting securities held by its controlled persons and the parties with whom it has entered into a contract to exercise rights carried by such voting securities.
Generally, the above requirements apply to Russian public JSCs that have a registered prospectus regardless of whether they are currently listed.
Reporting rules for public JSCs are mandatory and, generally, the parties are not allowed to deviate from them.
In private companies, the shareholders typically enjoy rights of first refusal to acquire shares proposed for sale by other shareholders and may additionally set in the company's charter a requirement to obtain consent for the transfer of shares to third parties. This ensures the stability of the shareholding structure when a company is closely held.
Dealings in derivatives are allowed in Russia. However, derivatives are typically used only as financial instruments by professional securities market participants and are rarely seen in an M&A context.
Professional securities market participants (eg, banks, brokers, dealers, depositaries, etc) must report their derivative transactions pursuant to the Securities Law. Non-professional participants are subject to reporting requirements if their derivative transactions exceed certain thresholds.
As noted, derivatives are rarely used in an M&A context. When they are used, the general shareholding disclosure requirements apply (see 4.2 Material Shareholding Disclosure Threshold).
Generally, buyers are not obliged to disclose the purpose of their acquisition or their intention regarding control of the target company. However, a buyer may be required to explain the purpose of the planned acquisition when obtaining anti-trust or foreign investment clearance with FAS or the Government Commission. For example, a foreign investor is required to submit a draft of its business plan for the target company when applying for prior approval from the Government Commission.
In public tender offers, a buyer is required to disclose its existing shareholding in the target company (including shares held by its affiliates) as well as the major shareholders of the buyer itself. In addition, the buyer may, but is not required to, include in the offer information about its plans in respect of the target company and its employees.
In public M&A, a target Russian public JSC is required to disclose the receipt of a public takeover bid from the bidder (including any amendments to the bid). In addition, a public company should make disclosures according to general disclosure requirements (see 4.2 Material Shareholding Disclosure Threshold).
In private M&A, neither the parties nor the private target company are specifically required to disclose a deal. However, the deal may be disclosed following an anti-trust or foreign investment clearance filing made with FAS and published on its website (unless the buyer opts for a confidential review process). Direct shareholders of Russian LLCs are automatically disclosed in the State Register at the time of title transfer.
Regulatory disclosure requirements are mandatory. Thus, market practice on timing of disclosure does not differ from the legal requirements.
Scope of Due Diligence
Most target companies in Russia carry historic title, regulatory, compliance and/or tax risks; however, experienced sellers will attempt to clean-up historic issues when preparing for a sale. It is important to identify these risks, assess their impact on the target and its value, and decide whether they may be mitigated through transaction structuring. A careful due diligence exercise in many instances is critical because it enables the buyer to adjust the purchase price in line with the risks or walk away from the deal, rather than rely on recovering damages from the seller after closing and following lengthy court battles. Important information relevant for due diligence is often not publicly available and should be requested from the target or the sellers.
Ownership structures and other potential risk areas
Companies often have complex ownership structures, such as multiple layers of holding companies, offshore holdings, as well as non-transparent beneficiaries. Careful attention should be paid to financial due diligence, making sure no hidden liabilities are missed, and tax due diligence – violations of tax legislation is a widespread risk for Russian companies. The scope of the due diligence should also take into account industry specifics. By way of example, reviewing subsoil licenses is key in the due diligence of a mining or upstream oil and gas business. In healthcare or IT sectors, IP expertise is important to efficiently identify possible risks and confirm title to core assets.
Other areas of review
Some of the other most common areas of review include anti-bribery and sanctions compliance, as well as regulatory (relevant legislation may be very extensive and complex), employment, and environmental issues. In Russia, due diligence does not normally trigger obligations to report uncovered issues to regulators.
Response to Due Diligence Findings and the Impact of COVID-19
Based on due diligence findings, in order to address identified risks, parties may negotiate special closing conditions, include specific representations on facts and indemnification obligations of the seller(s), and envisage deferred payments or other security mechanisms (eg, personal or corporate guarantees) protecting the buyer.
Generally, COVID-19 has not affected the scope of due diligence. However, a number of deals have been put on hold due to the inability of the buyers to conduct a physical inspection of the target business where such inspection is critical.
In public M&As, standstill and exclusivity agreements between the bidder and the target are not standard, since the takeover is effected mainly through a detailed statutory procedure of voluntary and mandatory offers (see 4.1 Principal Stakebuilding Strategies and 5.5 Definitive Agreements).
In private M&As (including in private deals to acquire shares from core shareholders of a listed company), exclusivity provisions are commonly used at an early stage of negotiations. In an auction process, exclusivity provisions would typically be agreed upon at a later stage (eg, after submission of a binding offer).
In public M&A, it is not common for tender offer terms and conditions to be documented in a definitive agreement. Takeover bids for acquisition of shares in Russian public JSCs are made only in the form of voluntary or mandatory offers. An acceptance of the offer by a shareholder will make a binding agreement. The law regulates in detail the content of these offers, the procedure for their submission, and the takeover itself; therefore, though not formally prohibited from doing so, the buyer and the selling shareholders would not typically enter into separate definitive agreements (ie, in addition to the offer made to shareholders and accepted by them).
In private M&A, the parties usually enter into a memorandum of understanding, term sheet, letter of intent or similar instrument at the beginning of negotiations to set out the principal terms for negotiating the definitive agreements. Most of the provisions of such instrument are non-binding, except for certain specific provisions (eg, on confidentiality, exclusivity, break fee (if any), governing law and dispute resolution provisions). The main terms of the deal normally become binding upon the signing of the definitive agreements (eg, share purchase agreement, shareholders agreement, etc).
In private M&As, the length of an acquisition process may vary significantly from a few months to one year and more, depending on such factors as:
In practice, a transaction timeline may take one to two months if negotiations are constructive and there is no need for governmental approvals, or three-twelve months if the negotiation process is more complicated and/or regulatory approvals are required.
The COVID-19 measures generally did not affect the parties' ability to close deals, as electronics means for signing and closing have become standard practice. Where closing required physical presence (eg, for notarial or registrar's actions) parties were still able to proceed on the basis of proxies. However, in some cases the inability to physically inspect the target business has led to delays in the transaction process.
In public M&A, the timeline of an acquisition through a public tender offer is regulated by law. In particular, the time period for acceptance of the offer must be stipulated in the bid, but cannot be less than 70 days or more than 90 days from the date of receipt of the offer by the target.
Mandatory offer rules apply only to acquisitions of voting stock in Russian public JSCs.
If a person (together with affiliates) acquires more than 30% of the ordinary and voting preference shares of the target company, it must submit a mandatory offer to acquire all remaining voting shares and securities convertible into such shares from the other shareholders. The same rule applies when a person acquires more than 50% and 75% of the voting stock.
Cash is the prevailing type of consideration in a private M&A. A combination of cash and shares in the acquiring entity is sometimes used (particularly, if the buyer is a listed company), but is generally viewed as an exception. Post-closing price adjustment arrangements are quite common in Russian private M&A deals.
In public M&As, cash is also the prevailing type of consideration, although the takeover law allows the use of securities or a combination of cash and securities as consideration.
In public M&A, the buyer is free to make the voluntary offer subject to certain conditions precedent, such as a minimum acceptance level, merger control clearance, and a material adverse change condition. A mandatory offer, however, must be unconditional and must be in respect of all voting shares and securities convertible into such shares.
A minimum acceptance condition is occasionally included in voluntary takeover offers. Most Russian public companies have a controlling shareholder(s) who would normally sell their shares to the buyer through a private deal. For this reason, voluntary offers are typically used by already controlling shareholders to reach the necessary 95% threshold allowing them to squeeze out the remaining shareholders (see 6.10 Squeeze-Out Mechanisms).
In a rare case of a takeover of Russian public company with dispersed shareholding the buyer would be interested in a minimum acceptance level such that it would hold more than 75% of the voting stock allowing it to control key corporate decisions (such as amendments of the articles, liquidation, reorganisation, etc) or, in any event, more than 50% of the voting stock giving it control rights over all other corporate decisions.
Public takeover bids (voluntary and mandatory offers) must be accompanied by an irrevocable bank guarantee providing for the bank’s obligation to pay for the securities should the buyer breach its payment obligations. The bank guarantee should cover all the securities subject to the bid.
In private M&A, the parties may agree that the closing of the deal is conditional on the buyer obtaining the required financing.
In public M&A, deal security measures would not be typical because the entire process is regulated in detail by the takeover law (see 5.4 Standstills or Exclusivity).
In private M&A at the early stage of negotiations the parties may sometimes enter into binding arrangements securing the deal before definitive agreements are signed (eg, break-up fees and exclusivity). It has become common to include in the definitive agreements provisions taking into account COVID-19 restrictions, in particular their potential effect on closing and the ordinary course of business in the period before closing (eg through MAC clauses drafted to take into account the possible impact of COVID-19 restrictions on the business).
A buyer who acquires less than 100% of a private target company would typically enter into a shareholders' agreement with the remaining shareholders. The parties would agree on such additional governance rights as the nomination of directors and key employees, approval and veto rights, provision of information, share transfer restrictions, liquidation preference and anti-dilution protection (if relevant), etc. Also, the law allows shareholders to allocate voting rights disproportionate to the actual number of shares owned by them.
Voting by proxy is allowed. Note that proxies issued outside of Russia must be notarised and apostilled (legalised) in the country of their issuance.
A squeeze-out mechanism is available only for public JSCs. A buyer will be able to squeeze out the residual holders of voting shares and securities convertible therein if:
If the above criteria are met, the buyer will be entitled, within six months of the voluntary or mandatory offer, to buy out all other holders of the remaining ordinary and voting preferred shares and other securities convertible into such shares. However, if the 95% threshold is achieved during a voluntary/mandatory offer, but less than 10% of shares are acquired in the offer, the minority shareholders can put their securities on the bidder, but the buyer will not be entitled to squeeze them out.
Non-voting shares are not subject to a squeeze-out. If the buyer’s ultimate goal is to become a sole shareholder of the target and there are several holders of the target’s non-voting shares, the buyer would need to explore additional structuring options, eg, converting the non-voting shares into voting ones that are eligible for a squeeze-out.
In a public M&A, it is not common to obtain irrevocable commitments from principal shareholders of the target company to vote, as the voluntary and mandatory offers do not require approval of the shareholders. Commitment to sell the shares would typically be obtained from the principal shareholders through a private acquisition deal prior to launching a tender offer with respect to the remaining shareholders.
In a public M&A, a target Russian public JSC is required to disclose a public takeover bid when it receives it from the bidder.
In a private M&A neither the parties, nor the private target company are specifically required to disclose a bid. However, the deal may be disclosed as a result of the governmental approval process (see 5.1 Requirement to Disclose a Deal).
Issuance of shares in a private company does not require disclosure (however, for LLCs, the issuance of new equity will be recorded in the State Register and become public). Public JSCs must register a prospectus when securities are to be distributed through an offering to the public.
A buyer is not required to produce its financial statements in the course of an M&A deal, except in certain industries (such as acquisitions of banks).
Transaction documents do not have to be disclosed. However, in the context of a public takeover, voluntary and mandatory tender offers are subject to disclosure by the target companies. Disclosure may also be required as part of the approvals process with FAS.
The CEO, members of the board of directors and members of the management board have fiduciary duties obliging them to act in the company's interests reasonably and in good faith. The fiduciary duties of these managers are to the company as a whole, rather than to the particular shareholder(s) who appointed the relevant manager. The obligation to act reasonably and in good faith implies that managers should take actions that are necessary and sufficient to achieve the purposes for which the company was established, including ensuring that the company complies with the requirements of applicable law and duly discharges its public duties.
At the same time, the senior management of the target company does not play a decisive role in the acquisition process, since most companies have concentrated shareholding structures and deals are negotiated directly between the buyer and the controlling shareholders of the target. For this reason, managers' duties of the target are not generally implicated in majority of M&A deals.
In public takeover offers, the board of directors of the target company has a duty to provide recommendations to the shareholders that evaluate the price of the offer, its potential change following the acquisition, and plans of the buyer in respect of the target company and its employees. However, such recommendations are not binding on the shareholders in their decision on whether to accept the offer or not. In addition, certain actions by the public company require special approval of the shareholders while the offer is pending (see 9.2 Directors' Use of Defensive Measures).
Public companies commonly establish regular committees, within the board of directors, responsible for specific matters (eg, audit committees, appointments and remuneration committees, strategic development committees, etc). In addition, the procedure for approval of related party transactions rules out voting by directors having a conflict of interest (see 8.5 Conflicts of Interest).
At the same time, since management of the target company does not play a decisive role in the acquisition process, it is not common for the target's board of directors to establish special or ad hoc committees that would evaluate a particular proposed business combination.
Since management of the target company does not play a decisive role in the acquisition process, courts do not defer to the judgment of the target's board of directors in takeover situations. When the board of directors is required to provide recommendations to the shareholders on the public tender offer (see 8.1 Principal Directors' Duties), failure to adequately asses the offer could potentially entail the liability of the board vis-à-vis shareholders. However, this issue has not yet been subject to judicial scrutiny.
Since management of the target company does not play a decisive role in the acquisition process, it is typically not necessary and not common for the target's directors to seek outside advice.
Russian corporate law regulates in detail the process of entering into transactions that involve a conflict of interest of directors or controlling persons of a company (related party transactions). As a general rule, such transactions do not require prior approval, but they should be timely disclosed to the company's board of directors and shareholders, following which an approval may be requested.
Hostile tender offers are not common in Russia, because most Russian public companies have a controlling shareholder(s) (see 4.1 Principal Stakebuilding Strategies).
Directors' defensive measures are not standard in Russia since, on the one hand, the majority of M&A activity is done through privately negotiated deals between the buyer and the principal shareholders and, on the other hand, any public takeover offers are strictly regulated and depend very little on the actions of directors of the target.
Although directors' defensive measures are not common, the takeover law rules out certain actions that could otherwise hinder a public bid. In particular, upon receipt of a voluntary or mandatory offer, the managers of a public company may not, without the approval of the shareholders:
These limitations cease to apply after expiry of the term for acceptance of the offer.
Directors' defensive measures are not standard in Russia.
Directors' defensive measures are not standard in Russia, therefore directors' fiduciary duties are not generally implicated in the context of public and private M&A deals.
However, directors could potentially be subject to liability for providing inadequate recommendations to shareholders on a public tender offer (see 8.3 Business Judgement Rule).
Directors of the target company have little control over the acquisition process.
In public M&A, any involvement of directors would be limited to reviewing the takeover offer and providing recommendations to the shareholders. The shareholders are free to accept or decline the offer regardless of the directors' view on the offer. Private deals are typically negotiated directly with the principal shareholders of the target, and its management does not have a decisive role.
Normally, parties try to settle their disputes arising in the context of M&A deals amicably, especially in big or mid-size deals. Such deals usually refer disputes to arbitration, which involve substantial trial costs and a lengthy dispute review and enforcement process. Thus, the parties are often motivated to find a mutually acceptable solution at a pre-trial stage. However, Russian state courts review a substantial number of court cases on disputes arising out of SPAs and SHAs, predominantly under small-size deals.
Disputes in connection with M&A deals typically arise after closing and often relate to calculation of purchase price adjustments and claims under the warranties and indemnities. Less often, disputes may arise with respect to pre-contractual liability where the deal falls apart due to fault or bad faith of one of the parties (see 10.3 "Broken-Deal" Disputes).
In 2015 the Russian Civil Code was amended to introduce the concept of pre-contractual liability for actions in bad faith in the course of negotiating a deal. Generally, the claimant must prove that the other party acted in bad faith. For example, a party would be acting in bad faith if it enters into negotiations knowingly without intention to reach an agreement and/or only to cause harm to the other party (eg, by receiving its commercial information or by hindering a deal with a third party).
Importantly, however, certain actions are now presumed to be in bad faith such that the defendant would have to prove it acted with good faith. These actions broadly include provision of incomplete or unreliable information to the other party and abrupt and unjustified cancellation of negotiations when the other party could not reasonably anticipate it.
The above rules continue to be tested in Russian courts and there is a growing level of scrutiny applied to determine the parties' expectations as to a deal's certainty during negotiations, and whether specific actions by the party who walked away from the deal were in bad faith.
Shareholder activism is not very common in Russia.
Most Russian public companies have concentrated shareholding where a small number of principal and often affiliated shareholders control the company's management. With a few exceptions, minority shareholders often take a passive role and do not get involved in the company's management. Activism on the part of minority shareholders, if any, would typically be aimed at challenging the company's transactions or corporate resolutions that they believe negatively affect the company. Minority shareholders may also seek provision of information from the company and compensation of damages caused by the actions of the company's management.
In closely held companies, shareholder activism would typically only take place in case of a corporate conflict between the majority shareholder and the minorities.
Activists do not seek to encourage companies to enter into M&A transactions, spin-offs or major divestitures. This is because management is typically controlled by the majority shareholders and any efforts of the activists to propose a course of action would be futile in most cases.
Activists do not seek to interfere with the completion of announced takeover transactions.
Russia's promising M&A went into a nosedive in 2020 following the introduction of lockdowns that came in response to the surging COVID-19 pandemic. Additionally, transactional activity was also affected by a fall in oil prices, the effects of Western sanctions and the consequent weakening of the Russian ruble. In the second part of 2020, however, as lockdowns were lifted across the country and Russian economy demonstrated better results than originally predicted, M&A activity started showing signs of a mild recovery and several major deals were announced. In 2021, experts expect new deals implementing corporate reorganisations, sales of non-core businesses, acquisitions by market players least affected by the pandemic, and the resumption of suspended transactions.
From the legal perspective, the key trends in 2020 included increased use of Russian law in M&A deals and comprehensive deal structuring in the context of the recent arbitration reform. Western sanctions also impact the terms and structure of transactions.
Increased Tendency to Use Russian Law in M&A Deals
Until recently, risk-allocation instruments that are typical for international M&A deals (such as representations and warranties, indemnities, call and put options, tag-along and drag-along rights, escrow accounts, etc) were not known to Russian law. As a result, in most cross-border M&A deals involving Russian businesses, parties historically opted for foreign law (generally English law) to govern transaction documents, and referred disputes to international arbitration institutions, seeking the safety of more sophisticated and predictable regulatory regimes.
In 2014-15, Russian corporate law and commercial law were substantially modernised to include concepts commonly used in international business and cross-border transactions, including in M&A, joint ventures and private equity deals. Corporate law has been made more flexible in many areas, particularly in relation to corporate governance and share disposal arrangements in private companies. However, although the new concepts were introduced into Russian law, there was no clarity on how they would be interpreted and implemented in practice by Russian courts.
Currently, the Russian regulatory framework for M&A deals may be viewed as slightly unbalanced and somewhat more buyer-friendly. The new legal concepts introduced into Russian law (ie, representations and warranties, indemnities) primarily focus on guaranteeing to the buyer the quality of the acquired shares and assets/business. Normally, however, the seller expects to be able to balance its obligations under the warranties and indemnities with specific contractual provisions limiting its liability to the buyer. Common legal tools for limiting the seller's liability in M&A deals such as:
Possible approaches to their implementation in transaction documents governed by Russian law have been developed by market practice, but have yet to be tested by Russian courts.
In 2015-20 Russia's Supreme Court issued a number of important clarifications that are binding for lower courts, on several of the above M&A concepts as well as suretyships, general contract law principles and corporate approvals for major and related party transactions.
Result of reforms
As a result of the legal reforms, there is a growing tendency to increasingly use Russian law, instead of English law, to govern M&A and joint venture transactions. Russian law-governed transactions have become more sophisticated, as there are more court precedents and guidance on the application of risk allocation concepts that have been introduced into Russian law.
Is Foreign Law Still an Option?
Although more and more deals are governed by Russian law, it would be premature to say that the Russian M&A market has completely "turned away" from foreign law. Foreign investors still often seek to apply the legal framework they are more familiar and comfortable with and which they use for other deals internationally. English law continues to be the law of choice for very large deals/projects, including for major Russian companies. The final decision on the choice of foreign vs Russian law to govern a deal currently requires a thorough review of local regulatory specifics in the context of each particular project.
As a general rule, parties may select foreign law to govern an SPA or SHA with respect to a Russian company, provided there is a "foreign element" in the relationship (eg, one of the counterparties is a non-Russian entity).
If a contract is governed by non-Russian law, however, its provisions will be unenforceable in Russia to the extent that such provisions are contrary to mandatory rules of Russian law (eg, corporate governance rules, procedures for share transfers, etc). Thus, as a matter of practice, if the parties decide to have an SPA or SHA governed by English law, their various clauses falling under mandatory local rules would need to be carefully drafted with the involvement of Russian counsel, or extracted entirely (which means that the entire SPA or SHA will be governed by foreign law, but certain clauses will be drafted to be compliant with Russian law requirements or extracted from the foreign-law-governed contract entirely and incorporated into a separate Russian law governed document). Thus, the final set of transaction documents may be more complex.
Recent Arbitration Reform
The final choice between Russian and foreign law for a Russian M&A deal will mainly depend on the jurisdiction where the parties would like to have their disputes resolved and enforced. In 2017, Russian legislation on international arbitration was modified, providing that all "corporate disputes" (the term being broadly defined in Russian law, covering most disputes arising under SPAs and SHAs) with respect to Russian companies will be resolved by:
Importantly, certain corporate disputes (eg, with respect to business entities of strategic importance to the defence and security of Russia, the so-called "strategic entities") cannot be referred to arbitration and fall within the exclusive jurisdiction of Russian state courts. For other types of corporate disputes, additional requirements may apply, eg, that the institution has a seat in Russia, and that the dispute be resolved under special rules that apply to the arbitration of corporate disputes.
International arbitration institutions
Most of the well-known and recognised international arbitration institutions (eg, LCIA, ICC) currently are not compliant with the above criteria. Initially, only the International Commercial Arbitration Court at the Chamber of Commerce and Industry of the Russian Federation (ICAC), as well as some other Russia-based arbitration institutions, were qualified from the standpoint of Russian law to resolve "corporate disputes" with respect to Russian companies. In 2019, two non-Russian arbitration institutions – the Hong Kong International Arbitration Center (HKIAC) and the Vienna International Arbitration Center (VIAC) – were accredited by Russian authorities to resolve Russian "corporate disputes". However, neither HKIAC nor VIAC issued and approved special internal rules on the arbitration of corporate disputes (as required by Russian law for the resolution of certain types of corporate disputes) and their capacity to resolve Russian corporate disputes is currently limited. For example, they are not permitted to resolve disputes relating to appointment of the company's governing bodies.
If enforcement is most likely to take place in Russia against a Russian counterparty, an award of an arbitration institution that does not meet the requirements of the new Russian law on international arbitration will most likely be unenforceable in Russia. Also, even if an award is issued by HKIAC or VIAC, a Russian counterparty may attempt to challenge its enforceability in a Russian court by arguing that such award was made in breach of Russian "public policy".
Common Deal Structuring Considerations
These new regulatory requirements make a deal structuring exercise often very specific and tailored to the parties' key business needs and their dispute or walk-away strategy in each deal.
In particular, if enforcement actions or specific performance (eg, for the enforcement of restrictions on share transfer rules, exercise of put and call options, compliance with corporate governance principles, etc) are required in Russia, a foreign investor may either agree to refer disputes:
In the first case, it would be more practical to have transaction documents governed by Russian law, since Russian judges are not familiar with foreign law and may be expected to apply foreign law in an unpredictable way. This approach is quite often used in small-size deals and/or in joint ventures (JVs) with a foreign investor having a strong majority shareholder role. The second option is commonly followed when the parties are willing to choose foreign law and wish to limit exposure to Russian state courts. However, such exposure will not be fully excluded as an award may require enforcement actions in Russia.
An alternative option may be followed if the Russian counterparty has substantial assets outside of Russia and contractual damages would be a sufficient remedy. In such an event, parties may wish to govern their transaction documents under foreign law and disputes can be referred to any international arbitration institution the parties are comfortable with (including one that is not "permitted" to resolve corporate disputes with respect to Russian companies) – in which case, to the extent the Russian counterparty has assets outside of Russia, damages would be recoverable against such assets under the arbitration award outside of Russia.
In reality, most transactions require legal remedies allowing both specific performance in Russia and contractual damages claims. Thus, in practice we have seen parties rely on a combination of the above-mentioned structuring options in recent Russian M&A deals. For example, in some deals, the parties executed several transaction documents, splitting them into separate sets:
Such two-tier contractual structure would allow a party to:
Western Sanctions Risks – Impact on Transaction Process and Documentation
Western sanctions that target certain Russian entities and individuals remain a key consideration in the context of cross-border M&A deals involving Russian businesses.
The sanctions were first introduced by the USA and the EU, and several other countries followed suit by introducing similar restrictions. The measures target specially designated persons ("DP" in the EU, "SDN" in the USA), as well as key sectors of the Russian economy (so-called "sectoral sanctions"). US sanctions also provide for the possibility of imposing so-called secondary sanctions on foreign (non-USA) companies and individuals for conducting certain activities that are contrary to US foreign policy and national security interests.
In order to comply with the sanctions, it is important to determine whether a particular transaction may be affected by the sanctions (eg, whether it involves sanctioned persons and/or products). It is standard practice for foreign investors to conduct a sanctions compliance due diligence of the target company to assess its supply model, including all third parties and intermediaries.
It is key to have clarity on the shareholding structure of the Russian counterparty, including full identity of its UBOs, at an early stage of the deal. A "sanity check" based on publicly available information may be a first step, followed with a comprehensive due diligence involving investigators if public sources do not provide sufficient clarity.
Russia does not recognise Western sanctions, and the negotiation of contractual mechanisms to mitigate sanctions risks for a foreign investor may face resistance from Russian counterparties. It should be noted that specific sanctions-related contractual arrangements are very common in transaction documents. In addition to standard general compliance covenants, the parties often negotiate more sophisticated contractual provisions governing a situation when the current sanctions regime is modified or new sanctions are imposed which negatively affect the transaction, the target company and/or the parties involved.
Contractual arrangements may provide for a special interim period allowing the parties to consider the new sanctions regime and its possible impact on the deal. Normally, such interim periods are set up in relation to new sectoral sanctions – ie, when new restrictions affect the target company's products or industry, but do not prohibit any dealing with the Russian counterparty. The parties may request an independent expert opinion (eg, from a law firm) confirming changes in the sanction's regime and the application of new restrictions to the target company's business.
After the expert opinion is issued, the parties agree to discuss and negotiate possible modifications to the transaction terms to ensure the target business is compliant with the new restrictions and/or to apply to the government authorities of the country that imposed the sanctions for a licence granting a special sanctions exemption for the parties. If such negotiations are unsuccessful and/or the license is not granted, the parties will have a walk-away right vis-à-vis the transaction, either by annulling the transaction documents, liquidating the target company, or exercising put/call options.
More complex contractual arrangements may be required to address the possible risk of new sanctions making a Russian counterparty or the target company a DP or an SDN – ie, prohibiting any dealing with such persons. In this case a foreign investor may ask for a right to annul the transaction documents at a pre-closing stage or, if new sanctions affect an existing JV with a Russian partner, to immediately walk away from the JV (eg, by selling its stake to a third party unrelated to the sanctioned Russian partner). The walk-away contractual provisions shall be thoroughly analysed and carefully drafted with the involvement of sanctions experts to avoid the risk of their interpretation by the authorities as an arrangement in circumvention of sanctions.
The Lugovoy Law
In June 2020, in response to the imposition of further Western sanctions against certain Russian companies and individuals, Russia passed a law, the "Lugovoy Law", granting exclusive competence to Russian state courts in respect of disputes involving Russian persons affected by sanctions. The law provides that affected parties may refer disputes to Russian courts in the event their access to justice is limited due to the sanctions (in cases where previously the parties agreed to refer disputes to foreign courts or arbitral institutions). If an affected Russian person is sued or about to be sued in a foreign court or arbitration proceeding in breach of the new Russian law, it may request an anti-suit injunctive order from a Russian court.
Any party breaching such anti-suit injunction may be fined by the Russian court for the full amount of the claim plus the opponent's legal costs. There is no developed practice of implementation of this new law by Russian courts, but its provisions should be considered when structuring M&A transactions.
New Legislative Initiatives Aimed at Relocation of Offshore JVs to Russia
Historically, due to the lack of developed M&A and JV legal concepts in Russian law (see above) joint ventures involving Russian business were commonly structured through the incorporation of two companies – a JV company registered outside of Russia in a tax-efficient jurisdiction holding 100% in the Russian operational company (the so-called "offshore JV structure"). Such offshore structures involving Russian business were negatively viewed by Russian state authorities. Russian legislation has been amended to motivate Russian companies and individuals not to structure their operations in Russia through offshore vehicles. As a result of such measures taken by the Russian government, now Russian partners are often reluctant to accept an offshore JV structure.
Renegotiation of double-tax treaties
In 2020, Russian authorities made further steps aimed at motivating JV partners to relocate their existing offshore joint venture structures to Russia. In particular, Russia announced renegotiation of double-tax treaties with several jurisdictions most commonly used for setting up offshore JV structures, and has successfully renegotiated treaties with Cyprus, Luxembourg and Malta by increasing the applicable withholding tax rates and making offshore JV structures financially less beneficial. As of March 2021, talks on treaty renegotiation with the Netherlands are still ongoing.
New regulations on SARs
Also, in 2020 a new regulation on Special Administrative Regions (SARs) came into force. The new law aims to motivate Russian businesses to relocate their holding structures from offshore jurisdictions to Russia. Under the new law, an existing offshore company may be registered in Russia in the special corporate form of an "international company" in one of several special zones: Oktyabrskiy Island in the Kaliningrad Region, located in the Western part of Russia, or Russkiy Island in the Russian Far East. The SAR regime allows the relocation of a JV company to Russia under a special legal regime - the existing SHA and applicable corporate governance rules of an offshore jurisdiction may apply to the relocated company during a transition period (ie, until 2029). Some major Russian businesses have commenced relocation to a SAR recently.
Because of these recent regulatory changes, foreign investors may face requests by their Russian JV partners to relocate existing JVs from offshore jurisdictions to Russia.