Russia:

From Legal Nihilism to Rule of Law

Legal Issues and the Economic Crisis

Presented by:

Laura M. Brank – Partner, Head of the Russia & CIS Practice

Chadbourne & Parke LLP

Philadelphia
February 26, 2009

Riverside Towers 45 King William Street

52/5 Kosmodamianskaya Naberezhnaya Regis House
Moscow 115054 London EC4R 9AN
tel.: +7 (495) 974-2424
from outside the CIS: +1 (212) 408-1190 tel: +44 (20) 7337-8000
fax: +7 (495) 974-2425 fax: +44 (20) 7337-8001
from outside the CIS: +1 (212) 408-1199 lbrank@chadbourne.com
 Introduction

I. Recent Anti-Crisis Measures

¾ Banking
¾ Industrial Support
¾ Unemployment Compensation

II. Out-of-Court Foreclosure and Other Related Positive Developments

¾ Historical Background
¾ Major Changes to Laws Governing Secured Transactions

III. Strategic Sectors Law – Application and Effect on Investment

IV. Conclusion

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 I. Recent Anti-Crisis Measures
Banking

„ Central Bank Loans

¾ To support the Russian financial system, the Central Bank of the Russian Federation
(“CBR”) was empowered by Federal Law No. 171-FZ, dated October 13, 2008, to grant
unsecured loans in Rubles to any Russian credit institution having a positive rating (as
determined by the CBR Board of Directors) with a maturity period not exceeding six
months. The CBR clarified this amendment in a regulation (CRB Regulation No. 323-P,
dated October 16, 2008), which includes a standard form agreement for concluding such
transactions. These loans are granted by tenders arranged via electronic trade in the ZAO
Moscow Inter-Banking Stock Exchange.
¾ The ceiling for such unsecured loans is RUB3.5 trillion (approximately USD96.4 billion as
of February 25, 2009). To date, RUB1.7 trillion has reportedly been granted (approximately
USD47.1 billion as at February 25, 2009). The term for loans has been increased to up to
one year. 143 banks are entitled to obtain such loans, and reportedly 124 credit institutions
have already received such loans.
¾ The conditions for extending loans secured by certain types of pledge have been relaxed.
Using the above-mentioned measures, the CBR will be able to deposit with banks up to
RUB1.5 trillion (approximately USD41.6 billion as of February 25, 2009). Approximately
RUB350 billion has already been deposited (approximately USD9.7 billion as at February
25, 2009).

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 I. Recent Anti-Crisis Measures
Banking (cont’d)

„ Compensation of Losses
¾ The CBR has been granted the right to partially compensate commercial banks’ losses
resulting from operations on the interbank loan market, provided that such losses are
caused by a revocation of a counteragent bank’s license.
¾ The CBR apparently has entered into loss compensation agreements with several Russian
banks (e.g. ZAO Raiffeisen Bank, Sberbank, OAO MDM-Bank, VTB and ZAO Russian
Standard Bank).
„ The CBR’s Right to Demand Charter Capital Decreases in Russian Banks
¾ The CBR has established a procedure under which, as one of the measures to help to
prevent banks from going bankrupt, the CBR may demand that a bank decrease its charter
capital to the value of its own assets (capital) without the usual right of creditors to demand
early repayment of obligations (CBR Directive No. 2108-U, dated October 29, 2008;
Federal Law No. 175-FZ ‘On Additional Measures for Stabilization of the Banking System
for the Period until December 31, 2011’, dated October 27, 1008).
„ Refinancing Rate
¾ The CBR refinancing rate was increased from 11% to 13% starting from December 1, 2008
(CBR Directive No. 2135-U, dated November 28, 2008).

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 I. Recent Anti-Crisis Measures
Banking (cont'd)

„ Reorganization of Banks
¾ Detailed requirements on the procedure for reorganization of credit institutions through
consolidation (sliyaniye), merger (prisoedineniye) and reorganization (preobrazovaniye)
have been introduced (by Federal Law No. 315-FZ, dated December 30, 2008) relating to
the disclosure by the bank of information on its reorganization by way of, inter alia,
notification to the CBR, and publication of the notice of reorganization on the bank’s
website in order to notify creditors, etc.

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 I. Recent Anti-Crisis Measures
Industrial Support

„ Vnesheconombank’s Loans
¾ Until December 31, 2009, the State Corporation “Bank for Development and Foreign
Economic Affairs” (Vnesheconombank) may grant foreign currency loans to Russian
companies to refinance or repay loans from foreign lenders under loan/credit facility
agreements concluded before September 25, 2008. Vnesheconombank has already issued
resolutions to grant USD13.3 billion in loans, with a reported USD9.1 billion already
released (Federal Law No. 173-FZ, dated October 13, 2008).
¾ The CBR will deposit up to USD50 billion with Vnesheconombank for a one-year period in
order to provide funding under this program.

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 I. Recent Anti-Crisis Measures
Industrial Support (cont'd)

„ The RF Government has created a list of approximately 300 entities (including

major holding companies) having substantial socio-economic importance and who
are major employers. These entities will receive governmental support at the
national level, including subsidized interest rates on loans, and the State’s acquiring
a share in the charter capital of troubled companies, and/or guaranteeing
borrowings.
¾ This list is approved by the Governmental Committee for the Improvement of the Stability
of the Development of the Russian Economy. The list is not exhaustive and may be
adjusted by the Committee.
¾ The fact that an organization is included in the list does not guarantee that any financial
support will be provided to this organization. The purpose is to improve the market position
of such organizations, by using not only credit instruments, but also other measures such
as state guarantees, subsidizing interest rates, restructuring of tax arrears, customs and
rates policy, etc.
„ A similar list of entities will be created separately on the regional level.

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 I. Recent Anti-Crisis Measures
Industrial Support (cont'd)

The list of approximately 300 entities includes, for example:

„ Oil & Gas
¾ OAO Bashneft
¾ OAO Gazprom
¾ OAO NK “Rosneft“
¾ OAO NK “LUKOIL“
¾ OAO TNK-ВР Holding
¾ OAO Surgutneftegaz
¾ OAO Rusneft
„ Metal & Mining
¾ OAO GMK “Norilskiy Nikel“
¾ OAO Severstal – Rossiyskaya Stal
¾ OAO OK “Rusal“
¾ OOO Evraz Holding
¾ OAO UK “MMK"
¾ OAO Novolipetskiy Metallurgicheskiy Kombinat
¾ OOO UK “Mechel"
¾ OOO UK “Metalloinvest“
¾ ZAO Alrosa

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 I. Recent Anti-Crisis Measures
Industrial Support (cont'd)

„ Automotive & Mechanical

¾ OAO AvtoVAZ
¾ AMO ZIL
¾ OAO KamAZ
„ Transport
¾ OAO Rossiyskie Zheleznie Dorogi
¾ OAO Aeroflot – Rossiyskie Avialinii
¾ OAO Aviokompania “Uralskie Avialinii”
„ Media
¾ OAO Svyazinvest
¾ OAO VimpelCom
¾ OAO Megafon
¾ OAO Perviy Kanal
¾ FGUP TTC “Ostankino”

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 I. Recent Anti-Crisis Measures
Industrial Support (cont'd)

„ The following top-priority sectors will receive various types of support on the
national level:
¾ Oil industry
¾ Car manufacturing industry
¾ Agricultural engineering industry
¾ Military-industrial complex
¾ Small- and medium-sized businesses
¾ Air transportation
¾ Retail trade
¾ Agribusiness industry
¾ Infrastructure projects
„ The Profit Tax Rate
¾ The Profit Tax Rate was decreased from 24% to 20% as of January 1, 2009 (Federal Law
No. 224-FZ, dated November 26, 2008, Article 2).

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 I. Recent Anti-Crisis Measures
Employment

„ Unemployment Compensation Increased

¾ The maximum amount of monthly unemployment compensation for 2009 has been
increased from RUB3,400 (approximately USD94 as of February 25, 2009) to RUB4,900
(approximately USD136 as of February 25, 2009) (RF Government Resolution No. 915,
dated December 8, 2008).
„ Foreign Employees
¾ The quotas for attracting foreign labor in Russia have been decreased
(www.http://premier.gov.ru/crisis).

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Historical Background

„ Limited ability of creditors to foreclose on security out of court

„ Valuation of collateral
„ Security over participatory interests in limited liability companies (LLCs)
„ First and secondary pledges

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Major Changes to Laws Governing Secured Transactions

Amended Legislation
„ At the end of 2008, a number of important statutes with some bearing on security were
amended in Russia, including:
¾ Civil Code
¾ Law “On Pledge”
¾ Law “On Mortgage (Pledge of Real Property)”
¾ Law "On Limited Liability Companies“

Main Changes
„ The amendments introduce the following main changes to the regime of security in
Russia:
¾ Broadening of Out-of-Court Foreclosure Procedures
¾ Methods for Sale of Assets in Out-of-Court Foreclosures
¾ Mandatory Valuation of Security for Out-of-Court Foreclosures
¾ Pledges of Participatory Interest in LLCs — Formalities

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Major Changes to Laws Governing Secured Transactions (cont'd)

Out-of-Court Foreclosure – ‘Enforcement Agreement’

„ The ability of a creditor to foreclose on security out of court has been
broadened.
„ Previously:
¾ if related to real property, a separate notarized agreement entered into after an
event of default was required; and
¾ if related to movables, out-of-court foreclosure was permitted, but there was no
protection in law for pledgee where pledgor does not comply with the out-of-court
procedure.

„ Now:
¾ pledgor and pledgee may enter into an out-of-court foreclosure agreement (via
the main pledge/mortgage agreement or a separate document, the ‘Enforcement
Agreement’) prior to an event of default; and
¾ executive signature (“исполнительная подпись”) of a notary may be applied for
in cases where the pledgor fails to discharge its obligations under the
Enforcement Agreement.

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Major Changes to Laws Governing Secured Transactions (cont'd)

Out-of-Court Foreclosure. Sale of Assets

„ In out-of-court proceedings for pledges of movable assets, the following is available:
a) public sale
b) transfer of the ownership of pledged assets to the pledgee
c) sale of the pledged assets to third parties without public sale (either by pledgee or
through a commission arrangement)
¾ b) and c) – may apply only to transactions by commercial entities (or registered
‘entrepreneurs’) and only if the Enforcement Agreement so provides. The Enforcement
Agreement may be set out in the actual pledge/mortgage agreement or entered into as a
separate document
„ In out-of-court proceedings for mortgages (real property), the following is available:
a) public sale
b) auction
c) transfer of the ownership of pledged property to the pledgee
d) sale of the pledged property to third parties without public sale (through a
commission arrangement)
¾ Note: the Enforcement Agreement may not provide for the transfer of ownership of land by
the pledgee

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Major Changes to Laws Governing Secured Transactions (cont'd)

Out-of-Court Proceedings. Mandatory Valuation of Security

„ Russian law now prescribes that in an out-of-court foreclosure, assets over
which security is granted must be appraised by an independent appraiser in
certain cases. Examples:
¾ assets with a value exceeding RUB500,000 (approximately USD13,900 as of
February 25, 2009)
¾ a pledge of unlisted securities or proprietary rights in case of mortgage – rights
under lease agreements or claims in relation to construction financed by future
property owners (“dolevoye stroitelstvo”)
„ The starting sale price of the pledged property is established at 80% of the
price in the appraisal report (unless otherwise specified in the pledge
agreement).

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Major Changes to Laws Governing Secured Transactions (cont'd)

Foreclosure: Other Changes and Notes

„ Out-of-court Foreclosure
¾ Instances where out-of-court enforcement is prohibited (e.g., no ‘agreed feasible’
foreclosure mechanism, mortgage of state or municipal property).
¾ Upon commencement of the supervisory stage of insolvency proceedings,
foreclosure over pledged assets in out-of-court proceedings is not allowed.

„ Mandatory Tender Offer ("MTO") Exemption

¾ Until January 1, 2010, MTO requirements established by the Federal Law "On
Joint Stock Companies" do not apply if a credit organization and/or a third party
acquires, pursuant to enforcement proceedings, shares in an open joint stock
company pledged to secure a borrower's obligations under an agreement with
the credit organization.
„ Note: out-of-court foreclosure is not available for pledges of interests in
LLCs.

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 II. Out-of-Court Foreclosure and Other Related Positive Developments
Major Changes to Laws Governing Secured Transactions (cont'd)

What creditors may wish to do in the light of changes to the laws:

„ Amend pledge agreements securing loan agreements (with amortizing repayments) to
allow foreclosure even if a breach has only occurred once
„ Amend pledge agreements to allow the debtor (legal entities and individual
entrepreneurs) to discharge secured obligations by transferring ownership of the
pledged property to the pledgee/allow the pledgee to sell the property
„ Amend pledge agreements to regulate the initial sale price (in cases of mandatory
determination of the price by the independent appraiser)
„ Describe the extrajudicial foreclosure procedure in the pledge agreement

Note that since the recent amendments are untested it remains unclear whether the new
procedures will work in practice

__________________________________
*Such examples are not deal specific and amendments to actual pledge/mortgage agreements should be 18
considered on a case by case basis
 III. Strategic Sectors Law – Application and Effect on Investment

Introduction
„ Nine months ago, the long-awaited Strategic Sectors Law came into effect. This law
will have a significant impact on investment in Russia over the next few years and is
already having an impact on investment into and financing of strategic companies.
„ The Foreign Investment Law already contained a general principle that foreign
investment could be restricted for defense and national security, among other reasons.
However, the Strategic Sectors Law clarifies:
¾ to which (42) sectors the restrictions will apply;
¾ who will be considered “foreign” for the purposes of the law; and
¾ (to some extent) how the approval process will work going forward.
„ Further regulations will be needed to clarify certain requirements of the Strategic
Sectors Law.

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 III. Strategic Sectors Law – Application and Effect on Investment

Sectors Covered by the Strategic Sectors Law Include:

„ aviation technology and air safety;
„ geological study and exploration/extraction in subsoil areas of “federal
significance” (“Strategic Deposits”);
„ industries registered as a “natural monopoly”, except certain
monopolies;
„ entities with a dominant market position in fixed-line
telecommunications;
„ media-related activities such as television and radio broadcasting to
more than half the population in the RF, or printing/publishing
publications with a circulation of greater than a million;
„ military technologies, ammunition or explosives;
„ encryption; and
„ use of nuclear facilities, radioactive materials or waste, or the
construction of nuclear facilities.

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 III. Strategic Sectors Law – Application and Effect on Investment

Transactions Requiring Approval

„ A foreign investor appears to be any:
¾ non-resident of the RF entitled to invest in Russia under the laws of the jurisdiction in
which they are resident; or
¾ company established in the RF operating under the control of foreign investor(s), where
“control” is defined broadly to include management control.
„ Approval is needed for any transaction:
¾ resulting in a foreign investor controlling a Strategic Company;
¾ resulting in a foreign investor owning shares in a Subsoil Strategic Company, provided
that the acquirer already has the right to dispose of 10% or more of the voting shares of
such a “Subsoil Strategic Company”;
¾ resulting in a foreign investor gaining control over third parties that directly or indirectly
control a Strategic Company; or
¾ made outside the RF but resulting in indirect control of the shares of a Strategic
Company (note: negative control may be deemed control).
„ Approval is needed for any transaction where:
¾ the foreign investor already owns more than 50% of the voting shares of the Strategic
Company (except for “Subsoil Strategic Companies”);
¾ the RF Government has the right to dispose of (own), directly or indirectly, more than
50% of the voting shares of the given “Subsoil Strategic Companies”; or
¾ the transaction completed prior to May 7, 2008.

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 III. Strategic Sectors Law – Application and Effect on Investment

Approval Requirements
„ The transaction will need the preliminary approval of the Government Commission for
Control over Foreign Investments in the RF (“the Commission”).
„ Any transaction entered into in breach of the Strategic Sectors Law will be deemed
void and may be unwound as a result. Other measures, including limitation of voting
rights, could also be imposed.
„ In addition, the Strategic Sectors Law mandated that by November 7, 2008, foreign
investors were required to notify the Federal Antimonopoly Service (“FAS”) of each
interest in which they directly or indirectly hold more than 5% of the voting shares or
participation interest in a Strategic Company.
„ However, the order setting forth the notification procedure came into force after the
November 7 deadline had passed, and to date there is no officially published list of
Strategic Deposits.
„ As a result:
¾ Strategic Companies were unable to notify FAS before November 7 in accordance with
any established procedure; and
¾ some subsoil companies are not certain whether their deposits will be considered
strategic.

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 III. Strategic Sectors Law – Application and Effect on Investment

Case Study 1: Acquisition of Strategic Companies “By State-Owned Entities” –

25% Rule for Foreign States and International Organizations
„ Two such approvals have been granted to date:
¾ The acquisition of 25%+1 share of CJSC "Grazhdanskiye samolety Sukhovo"
by World's Wing S.A. (a subsidiary of the Italian corporation, Alenia
Aeronautica) was approved by the Commission on August 10;
¾ On February 4, 2009 OJSC Hartron, a company controlled by the Ukrainian
Government, was apparently allowed to acquire an additional stake of shares of
a new issuance in International Space Company CJSC Kosmotras. As a result,
the shareholding of OJSC Hartron will increase to 49.74%. The company
appears to be engaged in military rocketry disposal activities.

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 III. Strategic Sectors Law – Application and Effect on Investment

Case Study 2: Acquisition of Subsoil Strategic Companies

„ DeBeers
¾ The Commission approved the acquisition by Archangel Diamond Investment (a
subsidiary of De Beers) of 49.99% of the shares in the diamond mining company
OJSC "Arkhangelskgeologodobycha,” controlled by LUKoil.
¾ De Beers and LUKoil reached an initial agreement in mid-April about the
transaction after a meeting of their senior executives and President Putin to
resolve disagreements over the Verkhotinskaya diamond field.
¾ After the passage of the SS Law, the parties agreed to extend the deadline for
executing the agreement from June 1, 2008, to December 31, 2008.
¾ The Commission reportedly required DeBeers to process rough diamonds in
Russia in amounts to be agreed with the RF Government, and to comply with
certain other requirements.
¾ However, DeBeers appears to have cancelled the acquisition due to an apparent
unwillingness to meet the requirements imposed by the approval with respect to
the terms of sale of diamonds.

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 III. Strategic Sectors Law – Application and Effect on Investment

Case Study 2: Acquisition of Subsoil Strategic Companies (cont'd)

On February 4, 2009:

„ Barrick Gold Limited, controlled by Barrick Gold (Canada) was apparently allowed to
acquire 30 percent of the additional shares in CJSC Fedorovo Resourcing, thereby
increasing its share from 50% to 80%. The founders of the CJSC Fedorovo Resources
are Barrick Gold and Open Joint Stock Company “Pana”.
„ On the same date, TNK BP’s application to increase its shareholding in OJSC
Verkhnechonskneftegaz from 68.5% to 73.98% was supposed to be considered.
However, the application was apparently put on hold until the next meeting of the
Commission (the date of which has not been announced yet).

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 III. Strategic Sectors Law – Application and Effect on Investment

Case Study 3: Other

On February 4, 2009:

„ Universal Cargo Logistic Holding B.V. (Cyprus, Beneficiary: Mr. V.S. Lisin) was
apparently allowed to acquire 100% of the shares in OJSC Taganrog Ship-Repairing
Factory (Taganrogsky Sudoremontny Zavod).

26
 III. Strategic Sectors Law – Application and Effect on Investment

Strategic Sectors Law Conclusions

„ The list of strategic sectors in Russia has finally been defined by law, providing greater
certainty to foreign investors. The list is longer and broader than expected, containing
42 sectors (cf. eight or nine in other countries).
„ The Strategic Sectors Law does not prohibit investment in strategic companies, but it
does potentially severely restrict it. The Strategic Sectors Law has already caused
companies to reconsider investments in the subsoil sector in Russia.
„ The Strategic Sectors Law is vague in certain areas; for example:
¾ it is susceptible to possibly broad interpretations on restrictions on foreigners;
¾ the list of subsoil areas of federal significance is not yet approved; and
¾ it has not fully grandfathered existing foreign investors in the sector.
„ The Strategic Sectors Law will cover realization by banks of shares in strategic
companies that have been pledged, and may also apply when a bank is deemed to
have negative control over the borrower.
„ As a result, banks may find it too burdensome to obtain a pledge over shares in a
strategic company, and consequently may not provide financing.

27
 Conclusion

„ The RF Government, the CBR and other state bodies have moved quickly to try and
support the Russian economy by implementing various measures, including measures
intended to fund banks, to protect important industries, and to give some comfort to
investors and workers.
„ The changes to the laws governing secured transactions are generally favourable,
however, it remains to be seen how they will work in practice.
„ At the same time, while the Strategic Sectors Law is a step in the right direction in
terms of making the system more transparent, the law is too broad and ambiguous and
is causing investors and banks to re-consider investments in such companies,
particularly subsoil companies, at a time when the RF Government should be trying to
attract such investors.

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