Dealing with Russia

In his 2005 annual address to the Russian Federal Assembly, then-President Vladimir Putin stressed the need for more active regulation of foreign investments in areas of strategic importance to Russia. On May 7, 2008, a new federal law, "On the Procedure for Making Foreign Investments in Business Enterprises Having Strategic Importance to Secure Defence and Security of the State," known as the SIL, came into force. The Russian Federal Anti-Monopoly Service, or FAS, reviews notifications under the SIL, but a new government commission headed by Prime Minister Putin makes the decisions. The government commission has met twice, in October 2008 and in February.

The SIL requires Russian government approval -- unless an exemption applies -- for any acquisition by a foreign investor of control over an entity engaged in "strategic" activities in Russia. The SIL also requires foreign investors to notify the government of noncontrolling investments of more than 5% of Russian strategic entities and of investments in strategic entities held before the SIL's entry into force.

The SIL defines as strategic 42 sectors, divided into seven groups: (i) weapons; (ii) nuclear production and radiation safety; (iii) aviation and space; (iv) "natural monopolies," a list of which is maintained by the Russian Federal Tariff Service; (v) geological survey and-or exploration and development of the subsoil in areas of federal significance; (vi) television and radio broadcasting and printed mass media and communications; and (vii) cryptographic equipment.

Special rules apply to investments by State-controlled entities, who are prohibited from acquiring control of Russian strategic entities. Non-strategic investments over 25% are normally subject to approval under the SIL,even if the investment is non-controlling. These rules are particularly important for certain types of investors, such as sovereign wealth funds and potentially companies that are or become State-controlled as a result of State aid granted in connection with the ongoing economic crisis.

Transactions completed in breach of the SIL are void under Russian law. If a transaction cannot be voided, the Federal Anti-Monopoly Service may request a Russian court to deprive the foreign investor of its voting rights. A court order can also invalidate decisions taken after an acquisition completed is in breach of the SIL. An investor may also be deprived of voting rights for failure to comply with commitments accompanying an approval decision.

The first decisions under the SIL were adopted at the October 2008 meeting and concerned the aviation and mining sectors. Alenia Aeronautica, part of Finmeccanica SpA, received approval for its investment in Sukhoi Civil Aircraft Co., while De Beers SA received approval to acquire 49.99% of ArkhangelskGeologoDobycha, which holds the license to exploit the Verhotisnky diamond field. De Beers' application was approved subject to a commitment that all diamond processing should be done in Russia. At its second meeting, the government commission reviewed 45 applications, but information on its decisions has not yet been published.

Worryingly, the SIL does not define any standard for the assessment of notified foreign investments. The De Beers case arguably does not bode well -- the requirement that diamonds from the Verhotisnky diamond field be processed in Russia seems unrelated to security issues, but smacks of state industrial policy.

The SIL's procedures are also much stricter than those under the U.S. Exon-Florio Reform Legislation. In contrast to the SIL, notifications under Exon-Florio are voluntary -- although the authorities can initiate an investigation themselves -- and failure to notify does not itself void a transaction.

The SIL's review periods are also much longer: Notifications under the SIL require three to six months of review, while notifications under Exon-Florio get one to three months.

At its February meeting, the government commission decided the SIL should be amended to simplify the reporting procedure and to close a few loopholes. In a move that may create problems for private equity investors, the government commission apparently wants more information on the ultimate beneficiaries in foreign investors making applications under the SIL. The FAS and the Russian ministries for Industry and Energy and for Economic Development and Trade have been asked to prepare proposed amendments by April 1.

Jay Modrall is a partner in the Brussels office, and Denis Guzilov is an associate in the Moscow office, of Cleary Gottlieb Steen & Hamilton LLP.