Update: Russia Adopts Law Removing ‘Unfriendly State’ Holding Companies from Shareholding in Certain Russian Companies

A new law signed by Russian President Vladimir Putin allows changing the shareholding structures of Russian economically significant organizations whereby parent companies from “unfriendly states” will be removed from the shareholding.

The Russian president signed federal law No. 470-FZ, “On Specifics of Corporate Governance in Business Companies Which Are Economically Significant Organizations,” (the Law) on August 4, 2023. The Law, which will come into force on September 4, 2023, concerns Russian entities that are deemed economically significant organizations (ESO), whose non-Russian parent company is connected with an “unfriendly state” [1] and, in turn, has sizable, but not necessarily controlling, Russian shareholding.

The purpose of the Law is to take away the corporate control of such parent company over an ESO and to transfer the Russian persons’ indirect shareholding in the ESO to Russia, whereas the non-Russian persons are not allowed to do the same. As a result, the non-Russian persons will lose their indirect shareholding in, and to the extent they controlled the ESO, control over, the ESO. The procedure will not be fully transparent to the non-Russian parent company and its non-Russian shareholders.

Further, the Law does not require Russian persons to exchange their shareholding in the non-Russian parent company against the shareholding in the ESO, effectively enabling Russian persons to bypass the non-Russian parent in respect of its shareholding in ESO but to also continue being shareholders in the non-Russian parent.

Russia has already adopted and enforced several measures allowing the Russian authorities to seize control of, or shares held by, “unfriendly foreigners” in certain entities, including under presidential decrees No. 416 of June 30, 2022, No. 723 of October 7, 2022, and No. 302 of April 25, 2023. These measures alter the core principles of Russian corporate law shareholder protections. The Law follows the same approach. The procedures envisaged by the Law are novel and the wording of the Law poses a substantial number of open questions.

WHAT IS AN ESO?

The Law states that any Russian limited liability company or joint stock company (entity) may be considered an ESO if it is included in the ESO list by the Russian government and satisfies all of the following criteria:

1. Quantitative Criteria: [2] The entity meets at least one of the following:
   1. The aggregate revenue of the entity and all other Russian entities within its group of persons as defined under the Russian competition law (Russian group) exceeds 75 billion rubles as of the end of the most recent financial year.
   2. The number of employees of the Russian group exceeds 4,000.
   3. The aggregate value of the assets of the Russian group exceeds 150 billion rubles as of the end of the most recent financial year.
   4. The amount of taxes and levies paid by the Russian group to any budget with the Russian Federation budget system during the preceding calendar year is at least 10 billion rubles.
2. Significance Criteria: The entity or any of its subsidiaries meets at least one of the following:
   1. As of February 1, 2022, it was the so-called “subject of the critical information infrastructure” under Russian law.
   2. As of February 1, 2022, it was a city-forming enterprise material for regional development.
   3. It implements technology and/or software for socially important services and/or provides information technology (IT) or communication services.
   4. It is involved in creation and modernization of high-productivity and/or highly paid jobs.
   5. It is a systemically important credit institution.
3. Russian Indirect Shareholding Criteria: A “connected” with an “unfriendly” state foreign holding company (FHC) owns at least 50% of voting shares [3] in the entity, provided that the direct or indirect participation of Russian nationals and/or Russian residents (Russian persons) in such FHC:
   1. exceeds 50%;
   2. exceeds 30%, if the Russian persons were in position to determine a decision of the most recent general meeting of the FHC that preceded the inclusion of the entity into the ESO list; or
   3. exceeds 20%, if the entity itself or any direct or indirect shareholders in its FHC who hold individually or in aggregate at least 20% shares in the FHC, are subject to US or any other state or international organization blocking sanctions.

The Russian indirect shareholding criteria appears to be the vaguest. The Law contains several broad criteria to determine who could be viewed as having indirect participation in an ESO, and these criteria go beyond the notion of just being a holder of the FHC shares. Among other things, the Law contains examples of when a holding company is deemed connected with an unfriendly state, although they are not exhaustive.

Additionally, “direct or indirect participation” is likely to cover effective economic share of the persons of concern in the ESO’s equity capital, as the Law does not specifically mention voting shares or voting power here, so the possible implications for holding structures with different classes of shares or non-voting shares are not clear.

It appears that the Law allows the government to exercise discretion in deciding whether to list an entity as the ESO. Importantly, once an entity is listed, the Law specifically states that inclusion in the list cannot be appealed to a court. Hence, the ESO criteria are just guidance for the government, and neither the entity nor its shareholders can challenge the entity being listed as the ESO in court. This in itself is a significant departure from the core principles of Russian laws.

WHAT ARE THE TRIGGERS FOR DEPRIVING FHC OF CONTROL OVER ESO?

The Law does not use the word “deprive.” Instead, it uses the notion of “suspension of exercising the corporate rights” by an FHC. The Law lists circumstances that may lead to the suspension. These circumstances are broad and vaguely drafted and include the following three categories:

1. An FHC avoiding or refusing to exercise corporate rights and/or perform in good faith the shareholder’s obligations with respect to the ESO, or there is a possibility of the same
2. An FHC’s actions or failure to act aimed at impeding the management of the ESO and/or its ordinary course of activity, including where the ESO’s sole executive body (the general director, for example) or the collegial bodies (the board of directors (supervisory board) or the management board) cease to exercise their managerial functions when such bodies are appointed (elected) in any part at the FHC’s proposal
3. Other actions or failure to act by the FHC that may result in termination or suspension of the activities, liquidation, or insolvency of the ESO

Importantly, the Law specifically states several instances when the above circumstances are presumed if they occurred after February 24, 2022. Among such instances is when the FHC or the ESO’s bodies made public announcements about terminating the activities of the ESO or upon exiting the ESO, terminated or stopped performing agreements material for the ESO, notified more than one third of the ESO’s employees about staff redundancy, or made anything aimed at compliance with the sanctions against Russia or Russian persons.

WHAT IS THE PROCEDURE?

The decision on “suspension” of the FHC’s rights with respect to any ESO is taken only by one court specifically named in the law: the arbitrazh court of the Moscow oblast (a Russian state commercial court otherwise for commercial disputes in that region and certain other disputes; MO Court).

Any of the below persons may file an application to the MO Court requesting the “suspension”:

1. A federal executive body authorized by the Russian government
2. Any direct shareholder of the ESO
3. The sole executive body or any member of the board of directors (supervisory board) of the ESO
4. The Russian persons with direct or indirect participation in the ESO as described in the Russian indirect shareholding criteria above

Further, the Law suggests that the Russian president may issue a decree listing ESOs whose governing bodies must file such applications to the MO Court (in other words, there will be no need to determine any of the triggering circumstances to deprive the ESO’s FHC of its rights).

The procedure for the MO Court to follow under the Law deviates significantly from the usual court procedure. The Law sets forth expedited terms for the MO Court’s accepting the case (the same day when the application is filed) and making the decision (as early as five days but no later than one month from accepting the case).

Neither an applicant nor the MO Court needs to ensure that the FHC (or its shareholders) receives notice of the case to be able to participate. The Law states that the FHC is deemed to be informed within five days after the applicant sent a copy of application to an address of the FHC last known to the applicant, which could be an email address.

The Law allows imposing immediate interim injunctive measures against the FHC, such that while the application is being considered by the MO Court, the FHC can already be deprived of its voting and any other corporate rights (including right to receive dividends) and will not be able to divest its shareholding in the ESO. Further, while the MO Court decision on “suspension” of the FHC’s rights can be appealed, the implementation (enforcement) of the decision is not halted for the duration of the appeal procedure.

WHAT ARE THE CONSEQUENCES FOR THE FHC?

While the Law uses the term “suspension”, the actual implications for an FHC go beyond just temporary restriction of rights and include the following:

1. The FHC loses voting rights at any ESO shareholder meeting. It is not allowed to participate in the meeting or request the meeting to be held, nor can it exercise any other corporate rights, including right to receive dividends or preemption right (right of first refusal).
2. The FHC can no longer dispose of its shares in the ESO, and no such shares can be sold or redeemed other than as specifically permitted by the Law.
3. All of the FHC’s shares in the ESO are transferred to the ESO itself, and the Russian company registration authority or ESO’s registrar—as the case may be—must record such transfer within a week’s time.
4. The Russian persons who the ESO determines as indirect shareholders of the ESO must become the direct holders of shares in the ESO pro rata to their participation in the FHC, and the ESO should distribute to them, or to such other Russian persons as they may nominate, the shares in ESO from the shares formerly owned by the FHC.
5. Persons connected with unfriendly states cannot become direct holders of shares in the ESO.

The Law is silent on what happens with direct or indirect shareholding in the FHC. In general, such shareholding continues as it was before the suspension.

The Law leaves many open questions about the mechanics of voting at an ESO’s general meeting after the MO Court makes the suspension decision. However, it is clear that FHC will have no say in the governance of the ESO and will lose all protections of its rights as a shareholder, including against dilution. Consequently, direct and indirect non-Russian shareholders of the FHC will be adversely affected as well.

The Law also states that the MO Court may impose the above consequences to apply until December 24, 2024 only. However, this time limitation appears to be of no practical value to the FHC, given that it loses its shares in the ESO, and also because the Law could be amended to extend this deadline.

Under the Law, an FHC will not be able to reinstate its shareholding in the ESO in full even once the suspension expires or is otherwise lifted. Rather, it is entitled to receive only such portion of shares that was not distributed to the Russian persons and dividends declared and not paid in respect to such shares. However, the FHC will lose this entitlement if the FHC claims compensation for the shares from the ESO. Whether this entitlement is of value is doubtful, as the FHC has no protection against dilution.

The Law states that the ESO or an interested party may apply to the MO Court to permit FHC to exercise certain transactions or corporate rights during the suspension period as an exemption, provided it will not cause any impediments to the activities of the ESO. The Law provides no criteria or grounds for the merits of such application, so the MO Court will have full discretion whether to grant an exemption.

CONCLUSION

The Law is complex and vague, subject to various and conflicting interpretation, and its application depends upon the geopolitical situation. The Law affects non-Russian shareholdings in many entities and joint ventures. It is part of the recently emerged body of law known as the Russian counter-sanctions laws.

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