Law on Strategic Foreign Investments

March 2009

One of the most important legal developments of 2008 was the adoption of the new Law on Foreign Investments in Legal Entities of Strategic Importance to the National Defense and State Security of the Russian Federation (for short, the Foreign Strategic Investment Law or "FSIL").[1] Concurrently, a number of existing laws, such as the Subsoil Law, the Stock Company Law and the Law on Foreign Investments were amended to reflect the new restrictions on foreign investors.[2] In essence, the FSIL requires prior government approval for certain foreign investments in companies or assets deemed "strategic," as explained below. The Russian competition authority (the Federal Antimonopoly Service, or "FAS") has been designated as the governmental body responsible for coordinating approvals under the FSIL,[3] although key decisions are made by a governmental commission headed by Prime Minister Vladimir Putin (the "Commission").[4]

Required Approval. The key points under the FSIL and other related legislation include the following:

• Under Article 4.1 of the FSIL, foreign investors may not acquire "control" of a company engaged in a sector of strategic importance (a "Strategic Company") without the prior approval of the Russian authorities as prescribed by the FSIL ("FSIL Approval").
• The definition of "control" is quite broad under Articles 3.1(3) and 5 of the FSIL, including ownership of over 50 percent of voting shares, rights to appoint over 50 percent of the board of directors and other means of controlling management decisions; and in some cases "control" may have other special meanings as well.
• There is even a special provision stating that "control" may exist where a foreign investor owns less than 50 percent, but nonetheless has effective control of a company because other shares are widely held.[5] (This seems especially designed for the case of publicly listed companies, among other circumstances.)
• Article 2 of the recently-amended Law on Subsoil has introduced the legal concept of a "subsoil area of federal importance" (a "Strategic Field"). A Strategic Field is any field or deposit containing over 70 million tons of recoverable oil or 50 billion cubic meters of gas; wholly or partly located in an internal sea, territorial sea or on the continental shelf; or located in an area used in connection with the maintenance of state security and defense.
• Under the FSIL, a special rule applies to companies engaged in exploration and/or production of natural resources (such as oil, gas or minerals) on a Strategic Field (a "Strategic Subsoil Company").[6] FSIL Approval is required for any acquisition by a foreign investor "directly or indirectly" of 10 percent or more of the voting shares of a Strategic Subsoil Company, or rights to appoint 10 percent or more of the board of directors or other managing body of a Strategic Subsoil Company, as well as the general director of such company.[7]
• These rules may apply even if the transaction in question is conducted outside of Russia.[8]

Strategic Companies. To determine which companies are Strategic Companies, Article 6 of the FSIL lists 42 different areas of activity that are deemed to be of "strategic importance." Along with oil and gas and other natural resources located within a Strategic Field, the categories listed include "sensitive" sectors such as defense, nuclear, certain transportation activities (including airports, seaports, rail and pipelines), certain telecommunications and media business (but excluding Internet-related business), certain electric power and heating-related companies, fishing and specialty metals.

State-Controlled Foreign Investors. Special rules apply for foreign investors who are controlled by a foreign state. In particular:

• Under Article 6 of the recently-amended Law on Foreign Investments, FSIL Approval is required for a "foreign state, international organization or organization controlled by them" (a "State-Controlled Foreign Investor") to acquire rights "directly or indirectly" over more than 25 percent of the voting shares of any Russian business entity, or otherwise to obtain veto powers to "block decisions" of the management bodies of such an entity.
• Under Article 7.1(5) of the FSIL, FSIL Approval is required for a State-Controlled Foreign Investor to acquire rights "directly or indirectly" over more than 25 percent of the voting shares of any Strategic Company, or otherwise to obtain veto powers to "block decisions" of the management bodies of such a company.
• Further, FSIL Approval is required for a State-Controlled Foreign Investor to acquire rights "directly or indirectly" over more than 5 percent of the voting shares of a Strategic Subsoil Company.[9]
• Finally, based on Articles 2.2 and 5.3 of the FSIL, it appears that a State-Controlled Foreign Investor may not acquire "directly or indirectly" rights over 10 percent or more of the voting shares of a Strategic Subsoil Company, or rights to appoint 10 percent or more of the board of directors or other managing body of a Strategic Subsoil Company, under any circumstances (the "10 percent Cap"). Also, under Articles 2.2 and 5.1 of the FSIL, a State-Controlled Foreign Investor apparently may not acquire "directly or indirectly" rights over 50 percent or more of the voting shares of any Strategic Company outside of subsoil-related or natural resource projects, or acquire other means of control (as defined in the FSIL) over such Strategic Company.

Procedures and Timing. Articles 8-12 of the FSIL explain the procedure for seeking FSIL Approval and the steps to be followed by FAS and the Commission. Generally, from the time of application the approval process should take three to six months.

Exceptions. The FSIL does contain certain "carve-outs" and exceptions. Notably, the FSIL may not apply if an international treaty provides otherwise;[10] and the restrictions relating to Strategic Subsoil Companies may not apply if the Russian Federation directly or indirectly owns over 50 percent of the voting shares of the Strategic Subsoil Company.[11] This latter rule suggests that one way to avoid the 10 percent Cap is to invest in a Strategic Subsoil Company through a joint venture with a Russian state-owned company in which the Russian state has control. However, such an approach has not been tested in practice, and difficulties may arise in presenting it to the authorities. Of course, such joint ventures raise many other issues.

Penalties. The consequences of failure to obtain FSIL Approval for a transaction, where applicable, are potentially severe. Under Article 15 of the FSIL, these may include recognition of the transaction as invalid, invalidation of the decisions of shareholders' meetings in which the foreign investor participated, and loss of voting rights. Other penalties may apply in various contexts.

Concluding Comments. The above comments are only a partial summary of the complex provisions of the FSIL, and are not comprehensive. Detailed regulations concerning the procedures for obtaining FSIL Approval have been issued only recently, and only a few approvals have been issued to date by the Commission. Accordingly, there remains considerable uncertainty about how the FSIL should be interpreted, and how the Commission will apply its provisions to specific facts and circumstances in the future.