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Russia and the CIS



a publication of the florida bar international law section •

Vol. XXX, No. 4

21st Century Litigation in Russia By Eugene Perkunov, Moscow, Russia

In This Issue: 21st Century Litigation in Russia..................................... 1 International Arbitration in Russia: The Current State of Affairs............................ 1 Message from the Chair................ 3 From the Editor.............................. 5 World Roundup.............................. 6 Tax Climate in Russia: Global Warming or Still an Ice Age?.... 21 An Overview of Kazakhstan’s Investment Laws and its Investor-State Arbitral Awards...................................... 25 Doing Business in Russia............ 34 Section Scene............................. 40 Russian Parties in English Courts....................................... 42 Interim Measures in Ukraine........ 48 Exhaustion of Trademark Rights, Parallel Imports and the Customs Union of Russia, Belarus and Kazakhstan............................... 50 Development of the Beneficial Ownership Concept and a New Tax Exemption for Eurobond Structures in Russia................. 54 Russia’s Accession to the WTO: Consequences for Foreign Investors................................... 57 Combating Fraud in Russia......... 61

Vol. XXX, No. 4

I. Introduction Russia’s legal system and the role of courts Russia has a so-called “civil” or “continental” legal system, meaning that the main source of law in Russia is legislation adopted by the Russian parliament and executive authorities. The Russian system therefore differs from those countries of the world with a common-law system based on court precedent. Courts and court precedent in Russia play a lesser role in “forming the law,” although that role is increasing. The highest source of Russian law is the 1993 Constitution of the Russian Federation, adopted following the breakdown of the USSR when

Russia became an independent state and successor to the USSR. The Constitution sets out the basic tenets of the state’s organization and powers, including human rights, local government bodies, and the court system. Next in the hierarchy of sources of law are international treaties to which Russia is party, followed by federal laws (statutes) adopted by the Russian Parliament (consisting of the State Duma, or the lower chamber of the Parliament, and the Federation Council, or the upper chamber of the Parliament), and then sub-legislative acts such as presidential decrees and resolutions of the Russian federal government. See “Litigation in Russia,” page 4

International Arbitration in Russia: The Current State of Affairs By Roman Zykov, Helsinki, Finland and Anna Tumpovskiy, Miami, Florida

I. Introduction Russian parties have made many headlines for their involvement in some of the largest and most complex commercial disputes in international arbitration history. Ironically perhaps, Russia itself is perceived by many as unfriendly to arbitration. Thus, the trend has been for Russians to arbitrate their disputes abroad. Recent

changes in the Russian legal landscape caused by the rise of arbitration as the preferred dispute resolution mechanism among Russian businesses and international businesses dealing with Russia, however, might alter this trend. This article will cover the basics of Russian legal practice

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See “International Arbitration,” page 13


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Message from the Chair This is an exciting time for international arbitration. It is an even more exciting time to be a practitioner of arbitration in Florida. Hard to believe, but ICCA 2014 in Miami is only a year away. For the first time in twenty years, the Congress will be held in the United States. As the host state, Florida will be featured prominently before the international community as a top option for international arbitration. In R. Lorenzo

South Florida, I have been working closely with MIAS (Miami International Arbitration Society) in coordinating conference-related efforts.

I want to challenge our section members to think ahead in preparation for the conference. There will be many opportunities to participate, whether writing for the program book or volunteering on the ground at the event. As leaders of the international arbitration movement for The Florida Bar, it is up to us to be prepared to seize the opportunities that will present themselves. In anticipation of ICCA 2014, our section will be actively keeping our members informed on ways to get involved. All of these efforts are geared towards making sure that when the spotlight turns to Florida in 2014, we are ready for the events, media inquiries and potential business opportunities. I encourage each and every one of you to do the same as individuals. Luck favors the prepared. In line with being prepared for ICCA 2014, this issue of the ILQ provides in-depth and substantive coverage—as it always does—on a region that continues to develop and evolve before the world community: Russia and the Commonwealth of Independent States. With the promise of Winter Olympics next year and the reemergence of its main stock exchange, post-communist Russia is experiencing successful milestones. We know that this issue will become the “bible” for practitioners involved in this extraordinary part of the world. In closing, the next issue of the International Law Quarterly will be the Thirtieth Anniversary Special Edition, and we are looking forward to marking that milestone with the unveiling of an exciting new look for our section’s magazine. Thank you for your continued involvement in The Florida Bar’s International Law Section. — Richard C. Lorenzo, 2012-13 Chair

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litigation in russia,  from page 1

The International Law Quarterly is prepared and published by the International Law Section of The Florida Bar. Richard C. Lorenzo, Miami Chair C. Ryan Reetz, Miami Chair-Elect Peter A. Quinter, Miami Secretary Eduardo Palmer, Miami Treasurer Nicolas Swerdloff, Miami Immediate Past Chair Mark R. Weiner, Tampa CLE Chair Alvin F. Lindsay, Miami Editor-in-Chief Yara Lorenzo Editor Mimi Hobbs Copy Editor Angie Froelich, Tallahassee Program Administrator Lynn M. Brady, Tallahassee Layout Elizabeth Ortega Media Contact, ECO Strategic Communications Articles between 7 and 20 pages, doublespaced, involving the various disciplines affecting international law may be submitted via email in MS Word format (with the use of endnotes, rather than footnotes). Please contact for submissions and for any questions you may have concerning the Quarterly.

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As noted above, Russian courts are increasingly “creating,” not just “interpreting,” law. Although judgments of the Russian courts are not deemed by the Constitution and federal laws to be formal sources of law, in practice the judgments are having a more and more significant effect on the law. The most vivid example of the trend is certainly the Russian Constitutional Court, which can directly amend legislation by verifying the lawfulness of Parliament’s acts and verifying the decrees of the Russian president as consistent with the Russian Constitution. Judgments of the other Russian courts are more relevant in interpreting Russian law rather than creating rules of law, although sometimes the interpretations given by Russian courts do in fact create law. Equally, the courts are granted powers to check consistency of various sub-legislative acts with Russian statutes and, if necessary, to repeal these acts in whole or in part. Structure of Russian courts The judiciary in Russia is split into three branches: the Constitutional Court of Russia; the courts of general jurisdiction, with the Supreme Court at their head; and the commercial courts system, with the Supreme Commercial Court at its head. This has been the case since the 1990’s when the USSR broke up, and Russia became an independent state adopting the 1993 Constitution. Except for a system of military courts, there are no special courts—such as employment or patent courts—in the Russian civil justice system. The primary task of the Constitutional Court is to verify that Russian legislation is consistent with the Russian Constitution. In its decisions, the Russian Constitutional Court frequently relies on judgments of the European Court of Human Rights, as Russia is subject to that court’s jurisdiction. Generally speaking, the courts of general jurisdiction deal with civil disputes between individuals involving employment, family and inheritance issues. They also hear consumer claims. They do not hear matters involving business or commerce. The commercial courts are known in

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Russia as the arbitrazh courts, although it is important to note that they are state courts and not “arbitration” tribunals (they are called “commercial courts” in this article to avoid confusion). They have jurisdiction over disputes that relate to business activities and are between legal entities, or between legal entities and individual entrepreneurs. Certain matters also expressly fall within the exclusive jurisdiction of the commercial courts, including the reorganization or liquidation of companies, even when an ordinary individual is involved. Where a natural person is involved in a dispute, the Russian commercial courts assert jurisdiction if the individual is a registered entrepreneur, or if the law specifically establishes that the dispute falls under the jurisdiction of commercial courts. There are three primary sources of procedural law for Russian courts and litigants: (1) for the Constitutional Court, there is the Federal Constitutional Law “On the Constitutional Court of the Russian Federation”; (2) for the Russian commercial courts, there is the 2002 Commercial Procedural Code; and (3) for the courts of general jurisdiction, there is the Civil Procedural Code. In addition, certain matters of civil procedure are regulated by federal laws, including the Federal Constitutional Law “On the Commercial Courts of the Russian Federation,” and the Federal Law “On Enforcement Proceedings.” Courts of general jurisdiction Russian courts of general jurisdiction have four instances or levels. The majority of cases are heard at first instance by district courts located in Russian cities or small districts. Claims with a value below a certain level (around US$1,600), and claims related to certain family law and labor disputes, however, are heard by Justices of the Peace at the first instance. Decisions of the district courts may be appealed (second instance) or may be reviewed at cassation level (third instance) by the courts of the member states of the Russian Federation. Finally, in certain circumstances, the Supreme Court may re-examine decisions of the lower courts at supervisory review level (fourth instance). See “Litigation in Russia,” page 63

From the Editor . . . This issue was conceived after a “breakfast” presentation (complete with Russian vodka and caviar) given by Eugene Perkunov last year in Madrid. Avoiding the vodka, I found Eugene’s preA. Lindsay sentation on litigation in Russia fascinating and asked if he would be interested in writing an article for us on the subject. But Eugene did us one better and agreed—along with our Russia regional editor Anna Tumpovskiy—to help us produce this entire special issue on Russia and the Commonwealth of Independent States. As you will see, Eugene and Anna really came through with an outstanding slate of authors and articles, and we give our heartfelt thanks to everyone involved in this issue. Of course, Russia is a great power. The country has one of the world’s fastest growing economies as well as the world’s largest reserves of mineral and energy resources. It is a permanent member of the United Nations Security Council, a member of the G8, the G20, the Council of Europe, the Asia-Pacific Economic Cooperation, the Shanghai Cooperation Organization, the Eurasian Economic Community and the Organization for Security and Cooperation in Europe, as well as the World Trade Organization. Russia is also the lead member of the Commonwealth of Independent States (CIS), formed during the breakup of the Soviet Union in 1991 and open to all republics of the former Soviet Union. Currently the CIS includes nine full member states: Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Uzbekistan, as well as Russia. Thus, Russia and the CIS is certainly an excellent topic for a special issue. Appropriately, Eugene’s and Anna’s own articles lead off the issue, with Eugene providing his excellent primer on litigation in Russia, and Anna, along with Roman Zykov, doing the same with their article on the current state of international arbitration in Russia. Yana Proskurina, leader of the tax dispute-resolution group at PricewaterhouseCoopers Legal in Moscow, then provides an overview of Russia’s tax climate

that will be important for anyone representing investors in the country to understand. Leonid Shmatenko—currently a university research fellow in Germany—follows with his insights on oil-rich Kazakhstan’s investment laws, focusing on the outcomes of the only publicly available investor-state arbitration awards. Alexander Scard and Alexandra Dolinskaya then provide the fundamentals of what international corporate attorneys will need to know, including corporate and partnership formation, in their article on doing business in Russia. Russian oligarchs have recently been involved in a number of high-profile (and high-dollar) disputes in the UK. Julia Zagonek, Artem Doudko and Alexander Muksinov provide a report from London on these cases and how they may differ from the more run-of-the-mill English litigation. Seeking a preliminary injunction, or interim measures in international parlance, is often critical to litigants. The Russian and Ukrainian team of Andrey Astapov, Oleh Beketov, and Oleksiy Zorin provide the roadmap for obtaining interim measures in Ukraine. Russian IP lawyer Natalia Gulyaeva then examines the issue of importing trademarked goods into Russia without due authorization by the trademark owner, which has been a hot topic given certain proposed amendments to the Russian Civil Code

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relating to the exhaustion of trademark rights after products are introduced into commerce. Moscow lawyer Dr. Kirill Vikulov, who advises clients on how best to structure investments for tax purposes, writes on the development of the beneficial ownership concept and a new tax exemption for Eurobond structures in Russia. Brussels-based Edward Borovikov then reports on Russia’s recent accession to the World Trade Organization, another important aspect of the nation’s economic growth and prominence on the world stage. Ivan Tyagoun, partner at KPMG in Moscow, rounds out the issue with an important topic for everyone doing business in Russia to understand: the issue of combating fraud. Ivan defines the types of frauds to look for and the reasons behind them, while providing controls that companies should consider to avoid being on either side of such allegations. With this esteemed lineup of authors reporting on such important topics, this issue will undoubtedly be required reading for years to come for any international practitioner who works or may work on issues relating to Russia and the CIS. Safe travels, Alvin F. Lindsay Hogan Lovells US LLP Editor-in-Chief

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World Roundup Africa Pierre M. Gaunaurd Brazil cancels or restructures debt for twelve African nations.

The BBC reports that Brazil will cancel or restructure $900 billion dollars worth of debt for twelve African countries, including Tanzania, Senegal and the Ivory Coast. Trade between the South American nation and the African continent has multiplied in the past decade by more than 500% according to the report, and Brazil is looking to increase its investment in the region. As described by Reuters, the move to cancel outstanding debts allows Brazil the opportunity to invest further in the region and make new loans under Brazilian law restricting foreign aid. Some of the African countries involved are rich in natural resources, such as Congo and Zambia, and the opportunity to develop closer relations with them by introducing new development aid is expected to benefit Brazil’s increasing need for products like oil and metals. Zimbabwe awaits elections under new constitution.

After almost five years of a coalition government in Zimbabwe, reports Bloomberg, the Zimbabwean Constitutional Court cleared the way for new presidential elections to occur this summer. According to the report, President Robert Mugabe, who is eighty-nine years old and has been president since 1980, will be able to campaign for re-election against his 2008 opponent and the current Prime Minister, Morgan Tsvangirai, who is also likely to run again. Under the new constitution, approved by popular referendum this past March, any future president is limited to two terms in office, but the BBC reports the clause is not retroactive to include Mr. Mugabe. In addition, several measures

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intended to curb public corruption are part of the country’s new governing document, including the amendment of existing anti-corruption and national election commissions. Mr. Tsvangirai is opposed to the expedited election schedule and Constitutional Court decision according to The New York Times, which quotes him as saying the Court is powerless to make such a decision. Trade at center of increased conflict in Sudan.

The first five months of 2013 have witnessed a resurgence of violence in the Darfur region of Sudan, notes a report by the BBC. The report quotes a United Nations official as saying 300,000 people have been displaced by the new violence. One factor at the heart of conflict in the region is the struggle for control of valuable natural resources, such as gold. These resources also include acacia trees, which are used to produce gum arabic. Found on the ingredient lists of popular products worldwide, such as Coca-Cola, gum arabic is used for a variety of purposes ranging from adhesives to flavoring. Recent attacks between tribes fighting to maintain control of acacia tree fields have already left more sixty people dead, reports The Guardian. Violence across Sudan involving government and rebel forces, as well as fighting between tribes seeking to control the gold trade, have contributed to a new refugee crisis that threatens recent positive developments in the region, according to The New York Times.

Asia – China Mikki Canton China’s new leader charts a new course.

All eyes are on China’s new leader, Xi Jinping, as he tests the conventional wis-

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dom regarding Chinese lack of flexibility when it comes to engaging both at home and abroad. His domestic policies are somewhat outside the box and still untested for the most part, but his global focus seems to be driven more by a business mentality than sheer politics. Xi Jinping’s recent travels through Latin America and the United States paint a picture of a man willing to engage on a broader business platform than his predecessor and to reach out to all countries along The New Silk Road, not just to “the usual suspects” such as Brazil, Chile, Venezuela, Argentina and, of course, Cuba. The President’s attempt to garner goodwill with different countries in Latin America and the Caribbean is part of a broader strategy to continue to make “friends” anywhere and everywhere that China can. And not visiting the traditional “big government” players this time around has no real impact on those relationships, which China has not only nurtured but built upon for many years now. Xi Jinping’s visits are not strictly governed by a clear strategy to open up new markets in Latin America and the Caribbean. Rather, he is very much playing the part of senior statesman and global patriarch, spreading China’s largess to touch people’s lives, as well as their pockets by, for example, giving Trinidad a $250 million dollar loan to build a children’s hospital. He is also sending a clear message to the United States that it cannot sit on its laurels when it comes to Latin America. This leader of China is different; he is inclusive and knows how to add to China’s already impressive list of grateful and committed global team players. He is not ignoring the smaller kids on the block, like Antigua, Barbados, Jamaica and others, whose trade with China is growing annually. In unity is strength— and big economic numbers.

Australia Peter Anagnostou Australian Arbitration Act declared constitutional.

Australia’s highest court has confirmed the constitutionality of the country’s International Arbitration Act 1974 (Cth), which “gives the force of law” to the enforcement provisions of the UNCITRAL Model Law. The High Court of Australia unanimously rejected a challenge to the Act in TCL Air Conditioner (Zhongshan) Co. Ltd. v The Judges of the Federal Court of Australia [2013] HCA 5. The judgment confirms that Australia is an arbitration-friendly jurisdiction and that the Act does not inhibit the judiciary’s power in a manner inconsistent with the constitution. In its ruling, the court distinguished between judicial power and arbital authority, noting that the first is conferred and exercised by law, independent of the consent of the parties, while the second is based on the voluntary agreement of the parties. Thus, the arbitral award made pursuant to the Model Law did not amount to an impermissible exercise of the judicial power of the Commonwealth. United Nations’ report critical of Manus Island detention center.

The United Nations’ refugee agency, the UNHCR, has released a report about Manus Island detention center in Papua New Guinea. The report expresses serious concerns with the current conditions and processes at the center and includes a series of recommendations to the Australian and PNG government. More than 270 asylum seekers are currently being housed at the temporary facility on Manus’ Lombrum Naval Base as part of the Australian government’s policy of mandatory detention.

UNHCR’s main concerns are: • The processing of asylum claims in the Manus Island detention center has not begun, and the UNHCR was given no indication when processing would begin; • Papua New Guinea lacks an adequate national legal framework to begin processing claims for asylum and fulfill its obligations under the UN Refugee Convention; • Conditions in the camp are harsh; • There are thirty-four children on Manus Island; • Asylum seekers expressed varying degrees of confusion and frustration over processing arrangements; and • Under current policy and practice, all asylum-seekers are detained on a mandatory and indefinite basis, without an individual assessment or the possibility for review. This amounts to arbitrary detention and is inconsistent with the obligations of both Australia and PNG under international human rights law.

Caribbean Sandy Jones WTO body authorizes Antigua and Barbuda to ignore U.S. intellectual property rights.

In 2003, Antigua and Barbuda asserted that the U.S. was in violation of various provisions of the General Agreement on Trade in Services (“GATS”) by disallowing online betting with gambling operators based in the Caribbean nation while allowing U.S.-based operators to offer off-track betting operations. In 2007, the World Trade Organization (“WTO”) authorized Antigua and Barbuda to sanction U.S. services, copyrights, and trademarks up to $21 million dollars per year. On 28 January 2013, after spending nearly ten years in the WTO panel process used in cross-border disputes, Antigua and

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Barbuda requested the Dispute Settlement Body (“DSB”) to authorize the suspension of concessions and obligations to the U.S. regarding intellectual property rights. The request was granted, and Antigua and Barbuda may now sell copyrighted works online without compensation to U.S. copyright holders, which is a valuable tool in its negotiations with the U.S. Raul Castro announces plan for succession in Cuba.

In February, Raul Castro announced his plan to step down in 2018, and Miguel Diaz-Canel was effectively named his successor. Diaz-Canel is currently Castro’s top lieutenant and the highest-ranked Cuban official without direct participation in the revolution. Castro intended DiazCanel’s promotion to lieutenant to be a “definitive step in the configuration of the future leadership of the nation through the gradual and orderly transfer of key roles to new generations.” Along with a new leader, Castro intends to leave behind age caps and two-term limits, though he maintains the nation’s commitment to socialism. Since Raul Castro succeeded his brother, Fidel Castro, Cuba has experienced gradual privatization of real estate and private enterprise along with the loosening of travel restrictions. The promised changes in leadership, paired with political changes seen in recent years, may lead to the end of the U.S. economic embargo on Cuba.

Central America Daniel Cervantes Nicaraguan law against violence toward women receives support through social media.

In April 2013, a campaign called “I Support Law 779” was launched through social media to promote new legislation, titled “Integral continued, next page

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World Roundup Law Against Violence towards Women,” that is aimed at protecting the physical, psychological and moral integrity of women. Supporters were asked to write a supportive phrase, take a photo with the phrase, and upload it with the tag #yoapoloylaley779 (#Isupportlaw779). The law’s prohibition on mediation (often perceived as resulting in re-victimization) between victims and aggressors provoked religious leaders and members of the Supreme Court of Justice (CSJ) to promote reform of the law. Nicaraguan officials capture “Top 10” F.B.I. most-wanted fugitive.

On 22 April 2013, Nicaraguan officials detained Eric Justin Toth, a former teacher and suspect in a child pornography investigation in a private elementary school called Washington National Cathedral. Mr. Toth had not been seen since June 2008, when he was escorted off campus after another teacher reported finding sexually explicit photographs in Mr. Toth’s possession. Honduran Congress suspends officials for notoriously deficient law enforcement.

In April 2013, the Honduran Congress suspended the country’s Attorney General and his assistants and appointed a commission to run the prosecutor’s office for sixty days. Honduras has a homicide rate of 91 per 100,000 residents and is often seen as one of the most violent countries in the world. On average, prosecutors solve approximately 20% of homicides. Guatemalan Ex-President is extradited to the United States to face corruption charges.

In May 2013, former Guatemalan President Alfonso Portillo, who led Guatemala from 2000 to 2004, was extradited to New York to face money-laundering charges. Mr. Portillo pleaded not guilty.

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El Salvador High Court upholds abortion ban.

In May 2013, El Salvador’s High Court upheld a law banning abortions under any circumstances, without exception for life-saving abortions. National doctors say that “Beatriz” (an alias) suffers from a series of medical conditions that will likely kill her if she carries her pregnancy to term. Beatriz challenged the law banning abortions, but the Constitutional Chamber of El Salvador’s Supreme Court denied the challenge, ordering doctors to continue monitoring Beatriz’s health and to provide her with “proper medical treatment” according to “medical science.” El Salvador is one of five Latin American countries that still bans abortions under any circumstance. Former Costa Rican Foreign Minister elected President of the U.N. International Law Commission.

In May 2013, former Costa Rican Foreign Minister Bernd Niehaus was elected president of the United Nations’ International Law Commission. The Commission is composed of thirty-four members with the mission of promoting the development of international law. In a press release, the Foreign Ministry said, “Niehaus is the first Costa Rican to reach the highest position in one of the most prestigious institutions in the creation of international law.”

European Union Santiago Cueto Spain implements entrepreneurship law and introduces new form of LLC.

Spain’s Cabinet recently passed a sweeping “Entrepreneurship Law” that the government claims will help eliminate red tape and make it much easier for entrepreneurs to start businesses. Under the new simplified frame-

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work, which the government intends to have in place later this year, entrepreneurs would be able to obtain all the necessary permits in one place—in most cases within twenty-four hours—according to government officials. In addition, the new law introduces a new form of limited liability company, which Madrid says will ease the start-up process and provide tax incentives for new businesses. The measure is intended to help small and medium-sized companies win more public contracts and expand their business outside Spain. New German online copyright law extends publisher rights.

On 1 August 2013, a new German copyright law will take effect, extending the rights publishers have over their own content. Under the new law, publishers will have the exclusive right to the commercial use of their publications on the internet. The new rule is a watered-down version of a controversial online copyright bill originally drafted to give publishers the right to charge search engines a fee for republishing short texts of the kind used in Google News. The final draft of the law states that publishers have the exclusive right to commercialize their products, or parts thereof, except in the case of single words or very small snippets of text. While the exemption of single words and snippets was added to benefit search engine providers, it remains to be seen how the new law will impact the publishers. Italian cruise disaster lawsuit belongs in Italian court, according to Florida court.

A judge in Florida has dismissed a lawsuit filed by Italian businesses against Miami-based Carnival Corporation over a cruise ship accident with fatalities off of Italy’s coast. U.S. District Judge Robin Rosenbaum agreed with Carnival that the lawsuit should be filed in Italy, not the United

States. Up to 1000 businesses on the island where the Costa Concordia ship ran aground had sought to sue Carnival, Costa’s parent company, in United States courts. Motions have been filed to consolidate the cases before a single judge. United Kingdom signs FACTA enforcement pact with the United States.

The UK and US entered into a bilateral agreement to allow for the enforcement of a law that targets offshore tax evasion. The UK is the first country to agree to implement the tax-reporting requirements under the 2010 Foreign Account Tax Compliance Act (“FACTA”). The agreement is aimed at creating a new global regulatory system to prevent Americans from dodging taxes through foreign accounts The FATCA rules, requiring foreign financial institutions to report detailed information about US account holders to the IRS and possibly withhold taxes on individual accounts, are expected to be finalized in coming month. But they are not expected to be fully implemented until 2014. The agreement is reciprocal, allowing US financial institutions to share information on UK residents. Other agreements may not allow for such exchanges.

Japan Mahesh H. Nanwani Employment terminations of multinationals on the rise.

Of growing interest worldwide is the trend to discharge employees as a consequence of the global economic downturn. Given its pivotal position as one of the key business centers of Asia, Japan is home to many multinationals. In recent months, there has been a deluge of cuts in Japan, especially in the financial sector, which is dominated by global players. The rise in terminations applies to both domestic

hires as well as to foreign employees hired abroad and transferred to branch offices in Japan. Multinationals need to be aware that Japanese labor law is notoriously employer-unfriendly. Japanese law sets out specific prerequisites and procedures for terminating an employee, including requirements for notices and timing, as well as requirements for documentation and justifications. Making matters worse for employers, the impact of the current economic downturn is significant in Japan so that Japan operations are forced to “push the envelope” in terms of tactics and strategies, invariably inviting trouble. Consequently, the number and breadth of illegal employment terminations in Japan have increased tremendously. As in other areas, the Japanese are extremely meticulous in applying employment laws. Companies are well advised to tread very carefully in Japan with respect to employment termination matters. According to one published source, many of the claims that are formally lodged by terminated foreign employees in Japan are successful.

Korean Peninsula Patrick Talbot Tensions rising between North and South.

The most significant news on the Korean Peninsula is, of course, the escalating tension between North and South Korea in recent months. This tension culminated in threats by the North’s leader, Kim Jung Un, of a missile attack against the South in early March. The threats came on the heels of a renewed call for deeper U.N. sanctions against North Korea, which even China supports publicly, after a third round of nuclear tests by the North in February. Joint military exercises conducted annually by the United States and South Korea in early March, and concluding only

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recently, likely contributed to the tensions between North and South Korea. By many accounts, however, rhetoric by the North has significantly toned down. Observers in the South seem accustomed to the threats but continue to monitor the situation with caution. In the meantime, the Kaesong Industrial Complex (“KIC”), a joint commercial venture between the North and the South (and located in the North) has expelled almost all South Korean companies and employees from the complex, essentially shutting down this joint economic enterprise. The move is a surprise to many, since the KIC served as one of the few legitimate means to bring technical skill, know-how, and much needed economic growth into North Korea. Upcoming talks provide hope for a resolution. President Park, Geun-hye, who was elected as South Korea’s first female president in December 2012, has denounced the North’s evictions of South Korean businesses from the KIC. Mrs. Park is the daughter of Korea’s former (and autocratic) President, Park Chung-hee, whom many credit for Korea’s early economic turnaround prior to his assassination in 1979. As a result of the North’s changed policies in the KIC, one of South Korea’s larger banks, Woori Bank, has also just closed its only branch in North Korea. In more positive news for South Korea, its FTA with Turkey went into effect on 1 May 2013, with hopes of bringing positive economic benefits to both countries.

Mexico A. Renee Pobjecky Mexico takes steps to modernize its public education system.

With the high-profile arrest of teachers’ union leader Elba Esther Gordillo, President Enrique Peña Nieto has vowed to end corcontinued, next page

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World Roundup ruption in Mexico’s educational system by signing a constitutional amendment that will allow key education reforms. The amendment has been approved by Mexico’s three largest political parties, but doubt remains about implementation. The amendment establishes mandatory teacher evaluations and creates merit pay for teachers based on an evaluation process. Schools now have the authority to fire under-performing teachers which is an important factor since Mexico has long faced declining education standards and corruption. In recent evaluation tests, more than half of Mexico’s teachers could not solve basic math and science problems. U.S./Mexico tomato war ends.

In February, the U.S. Commerce Department announced a proposed agreement on fresh tomatoes imported from Mexico that would strengthen anti-dumping enforcement and re-set minimum wholesale prices. The proposal would replace a pact that has been in place for sixteen years but will allow the U.S. tomato industry “to compete on a level playing field,” according to U.S. Agriculture Secretary Tom Vilsack. The agreement with Mexico’s tomato industry would suspend an investigation initiated after Florida tomato growers complained that Mexican producers were selling fresh tomatoes for less than the production cost. U.S.-produced fresh and processed tomatoes account for more than $2 billion in cash receipts. Mexico’s tomato trade with the U.S. was worth more than $1.8 billion in 2011. “Get current” tax amnesty program enacted.

Mexico enacted a temporary tax amnesty program for fiscal year 2013. The Federal Fiscal Revenue Law applied to certain unpaid tax amounts that may or may not have been pending resolution in administrative proceedings before Mexican tax authorities. This program included those

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cases awaiting the issuance of a judgment by a competent court. The program ended 31 May 2013 and was an effort by Mexico’s new federal administration to clear up tax liabilities and collect potential revenue with respect to outstanding tax liabilities.

Middle East Omar K. Ibrahem U.S. court denies Abu Dhabi Investment Authority’s motion to vacate arbitration award.

The Abu Dhabi Investment Authority (“ADIA”) commenced arbitration proceedings in 2010 against Citigroup, Inc., seeking $4 billion in damages from its 2007 investment in Citigroup. ADIA claimed that its $5.7 billion investment in Citigroup was based on Citigroup’s fraudulent statements. The arbitration tribunal found in favor of Citigroup and denied ADIA’s claim. ADIA then commenced proceedings in New York to vacate the award based on the tribunal’s application of the wrong substantive law and various adverse discovery rulings. Citigroup moved to confirm the award. The United States District Court for the Southern District of New York denied ADIA’s vacatur motion and confirmed the award, finding that the tribunal did not violate the Federal Arbitration Act in applying New York law as the substantive law and that ADIA could not turn a “discovery dispute into an issue of fundamental due process sufficient to set aside the award.” Volkswagen and its former distributor in Qatar in arbitration.

Volkswagen and its former distributor in Qatar, Saad Buzwair Automotive (“SBA”), are in arbitration over Volkswagen’s cancellation of SBA’s import licenses for Audi and Volkswagen and its award of the license to a different company

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in Qatar. SBA is seeking over $140 million in damages from Volkswagen. Dubai group settles with banks that commenced litigation in London.

In September 2012, Royal Bank of Scotland, German lender Commerzbank, South Africa’s Standard Bank, and, later, Egypt’s Commercial International Bank, initiated London-based court proceedings against Dubai Group, a unit of Dubai Holding (the investment arm of Sheikh Mohammed bin Rashid al-Maktoum). Dubai Group was hit hard by the global financial crisis in 2008. Since 2010, it has been locked in talks with its lenders to extend repayment deadlines. All four banks were part of a group of unsecured creditors that negotiated with Dubai Group but which then initiated court proceedings after the Dubai government walked away from the negotiations. Terms of the settlement are not available, but the settlement could embolden other creditors seeking concessions. The lawsuit was a first and marked a major change in the way lenders have dealt with sovereign-linked Dubai debt. Peru and Qatar agree to avoid double taxation.

Peru and Qatar have a reached a preliminary agreement to sign a bilateral treaty to avoid double taxation for their citizens. Negotiations are ongoing, but the two sides appear to be very close. The countries are hopeful that such an agreement would encourage foreign investment between them. Qatar Airways files arbitration claim over delayed airport opening.

Qatar Airways has initiated a $600 million claim in arbitration against Lindner Depa Interiors (“LDI”), a German-Dubai joint venture, for construction delays related to the opening of Doha’s new international airport. LDI was awarded a $250 million contract to build nineteen airport lounges by the middle of 2012 but failed

to complete the project on time. According to LDI, the delay was due to the fact that it was denied full access to the site for the first nine months of the sixteen-monthlong project. Turkish power company files ICSID claim against Pakistan.

Turkish power company Karadeniz Holding AS (“Karadeniz”) has initiated a claim against Pakistan with the International Center for Settlement of Investment Disputes for seizing two of its electricitygenerating ships. Karadeniz sent two ships with 330 megawatts-generating capacity to Pakistan in 2009 to supply electricity for up to five million people, and both sides signed a $564 million, five-year contract. After fuel prices rose, however, Pakistan did not supply fuel to the ships to fire generators, nor did it make rental payments to Karadeniz. Karadeniz terminated the contract, but Pakistan kept the ships. Pakistan alleges that it was Karadeniz who breached the contract and has commenced court proceedings in Pakistan against it.

 South America –  Northern Cone Daniel E. Vielleville Colombia adopts arbitration statute based on the UNCITRAL Model Law.

L a s t O c t o b e r, L a w 1563/2012, regulating domestic and international arbitration in Colombia, entered into force. The new statute replaces a rather disorganized and confusing set of rules spread among different legal instruments; particularly Law 315/96 which dealt with international arbitration in an inefficient manner. Generally, the most welcome feature of the new statute is the adoption of the 1985 UNCITRAL Model Arbitration Law with its 2006 amendments (the “Model Law”). Many positive changes are brought by

Law 1563/2012. For example, the new statute: (1) recognizes both institutional and ad hoc arbitration; (2) acknowledges the power of arbitrators to issue interim or conservatory measures; (3) provides clear definitions of what constitutes an arbitration agreement, the principle of separability of the arbitration agreement and the power of the arbitrators to decide on their own competence (kompetenzkompetenz), including the negative effect of such authority. Thus, a court seized with a dispute subject to an arbitration agreement must immediately refer the matter to arbitration upon a party’s request. More specifically to international arbitration, Law 1563/2012: • adopts an economic criterion of when arbitration is “international,” by including any dispute affecting the interests of international trade. Therefore, arbitration proceedings with seat in Colombia between Colombian entities could be deemed international if the dispute affects cross-border trade. Even in those cases, however, the arbitral award shall be deemed domestic and thus exempted from recognition proceedings and subject to direct execution in Colombia. • adopts the principle of international arbitration wherein a sovereign State or an entity owned or controlled by a State, cannot invoke its own legislation to challenge its capacity to enter into an arbitration agreement. Colombia joins countries like Switzerland, France and Spain in accepting this valuable precept. • adopts the most modern trends in electronic commerce and technology with respect to what represents an arbitration agreement in writing. • admits electronic communications as a valid method of service and notification when contained in the main contract. • authorizes the objecting party, in the case of denial of preliminary objections to the arbitral tribunal’s jurisdiction, to challenge the decision only at the time of seeking annulment of the final arbitral award. • clarifies the effects of a successful chal-

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lenge under each instance of annulment provided for in Article V of the New York Convention. Although Colombia’s adoption of the Model Law is praiseworthy, a few negative observations could be made. First, Law 1563/2012 has no provisions regarding non-signatories to the arbitration agreement. Other countries, like Peru, have adopted rules allowing the possibility under certain circumstances of adding non-signatories to an arbitration proceeding. Second, the new legislation could have been clearer in defining a domestic court’s role in reviewing an arbitration agreement. Further, Law 1563/2012 fails to follow suit with respect to similar modern legislations like those of Spain and Peru that have adopted the conflict rule in favorem validatis. According to this rule, the arbitration agreement shall be deemed enforceable if its validity is supported by either (i) the law applicable to the arbitration agreement, or (ii) the law applicable to the substance of the dispute, or (iii) domestic law.

 South America –  Southern Cone Julio Barbosa Argentina is censured by IMF for economic data.

On 1 February 2013, the International Monetary Fund’s Executive Board censured Argentina for not providing accurate data on inflation and economic growth. The declaration of censure was based on the managing director’s report on Argentina’s progress in implementing remedial measures to address the quality of the official data reported to the Fund for the Consumer Price Index for Greater Buenos Aires (“CPI-GBA”) and Gross Domestic Product (“GDP”). Bloomberg reports that Argentina is the first nation censured by IMF for economic data. continued, next page

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World Roundup According to IMF press release 13/33, the Executive Board found that Argentina’s progress in implementing the remedial measures since the 17 September 2012 Board meeting has not been sufficient. The Board called on Argentina to adopt the remedial measures “to address the inaccuracy of CPI-GBA and GDP data without further delay, and in any event, no later than September 29, 2013.” The measures applicable to the CPI-GBA and GDP aim at aligning these indicators with international statistical understandings and guidelines that ensure accurate measurement. Although the decision has no immediate effects, it takes Argentina a step closer to sanctions that include being barred from access to IMF loans and having its voting rights suspended. Further, if no remedial measures are taken, Argentina can be ousted from the IMF. Bloomberg reported that the United States Treasury voiced support for the IMF’s decision and urged “Argentina to work closely with the IMF in the months ahead to rectify these matters.” Argentina has been blocked from borrowing from international markets since its 2001 default on $95 billion of debt and has recently been ordered by the United States District Court for the Southern District of New York to pay $1.2 billion to the bondholders that did not agree to its 2005 and 2010 debt restructuring. Uruguay and Canada sign a tax information exchange agreement.

On 5 February 2013, Canada and Uruguay signed a tax information exchange agreement that shall enter into force “on the date of the later notice by which each party has notified the other of the completion of its necessary internal procedures for entry into force.” The agreement was signed by Uruguay’s Foreign Minister Luis Almagro and Ambassador of Canada Claire Poulin. Almagro said that the goal is to attract investment and facilitate financial flows between the two countries

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and also highlighted the commitment of Uruguay to fight tax evasion and reach tax transparency in international matters. The Canadian ambassador commented on the excellent bilateral relationship between the countries and noted that Uruguay and Canada are united in the international commitment to fight corruption.

USA Peter A. Quinter

Check-cashing stores allegedly used for money laundering in Florida.

Homeland Security Investigations has executed numerous search warrants and made several arrests in Florida for persons allegedly engaged in money laundering through the use of check-cashing stores. In one unique case in Miami, the specified unlawful activity resulting in the money-laundering charge involved U.S. dollars imported from Mexico being used to pay illegal immigrants in Florida.

Arrests made in Florida in connection with the illegal export of motor vehicles.

U.S. Customs and Border Protection (“CBP”) has investigated and arrested numerous Florida individuals for the alleged illegal export of motor vehicles. Buyers from dealerships allegedly made false statements that the vehicles were not going to be resold internationally when in fact they attempted to export the vehicles. Moreover, one exporter allegedly made false statements to CBP that the vehicles were used when in fact they were brand-new vehicles. False declarations on the rise regarding country of origin for imported merchandise.

With the numerous new free-trade agreements, especially the U.S.-Colombia Free Trade Agreement that went into effect on 15 May 2012, many U.S. importers are attempting to import merchandise with false declarations to the CBP that the imported merchandise originated in a country with a free-trade agreement with the United States. For example, clothing from Colombia that was allegedly made in Colombia was, in actuality, made in China, transported to Colombia and then on to the United States. CBP pursues fraud penalties against the U.S. importer for such false statements. The same is true for violations of the NAFTA or DR-CAFTA.

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international arbitration,  from page 1 involving international arbitration as well as new trends in legislature and case law.

II. The Basics Russia, as the USSR, was an original signatory to the New York Convention in 1958.1 The 1993 Law of the Russian Federation on International Commercial Arbitration (“ICA”) governs international commercial arbitration throughout Russia, unlike other countries such as Canada or the United States where internal states adopt their own local arbitration laws. Russia’s approach seeks to unify and harmonize legal practice over its vast territories. ICA is largely a mirror image of the UNCITRAL Model Law on International Commercial Arbitration and marks out Russia as a country with modern arbitration legislation. Additionally, growth of domestic and international arbitration cases has boosted the number of recognition and enforcement proceedings brought to the state courts. Based on reported cases, the Supreme Arbitrazh Court (Supreme Commercial Court) outlined the non-binding guidelines for the setting aside, recognition and enforcement of arbitral awards. Knowledge of these guidelines, discussed below, is important for navigating the Russian arbitration system. Arbitrability According to the ICA, any disputes of a commercial nature involving a foreign party, as well as commercial disputes where at least one party is a Russian company with foreign investments, can be referred to international commercial arbitration.2 The law does not specify the required level of foreign participation in a Russian company with foreign investments for a dispute to be eligible for international arbitration. In practice, even nominal foreign investment in a Russian company can satisfy this requirement. Notably, commercial disputes arising out of insolvency, registration, reorganization and liquidation, protection of business reputation, or competition issues do not qualify as arbitrable disputes.3 Arbitration Agreement ICA requires that an arbitration

ment be in writing. Exchanges of letters, faxes, email and other means qualify as evidence of a written arbitration agreement.4 Even without any written document, however, submission by the parties of their statements of claim and response without further challenge to the jurisdiction of the arbitral tribunal may effectively evidence the existence of an agreement to arbitrate,. There are several reported court cases analyzing the existence and validity of arbitration agreements. Defects in arbitration agreements often are used as grounds for challenging arbitral awards in the state courts. Among the most frequent grounds for challenges are an incorrect or incomplete name of an arbitration institution, and a lack of reference to the exact set of procedural rules of an institution (arbitration or conciliation). For this reason, these basics should be carefully considered when drafting an arbitration agreement. Russian courts recently held that reference should be made to a particular arbitral institution and not just its rules. On 13 March 2012, the Moscow Circuit Commercial Court confirmed the lower court’s decision to annul an award from the International Commercial Arbitration Court at the Russian Chamber of Commerce and Industry (“ICAC”) because the arbitration clause in question provided for the resolution of disputes under the ICAC Rules. This, the courts concluded, meant that the dispute should have been resolved by an ad hoc arbitral tribunal acting under the rules of the ICAC, rather than administered by the ICAC itself. A careful drafting of international arbitration clauses is therefore imperative in Russia, as is true for other jurisdictions. Arbitration and arbitrazh There is a clear understanding in Russia that arbitration is a separate apparatus from the state court system as it stems from the parties’ decision to submit their disputes to a private dispute resolution mechanism. In Russia, arbitration should not be confused with arbitrazh courts, which are the state courts dealing with commercial disputes. Despite the fact that the terms

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bear a phonetic resemblance, arbitration and arbitrazh courts are two separate and independent systems of dispute resolution. Arbitrazh courts derive from the Soviet period, fall within the state judicial system and, other than being authorized to set aside or recognize and enforce arbitral awards, have little to do with arbitration. An arbitral tribunal, in practice, is often referred to as treteyskiysud—meaning private, selfregulating dispute-resolution mechanism. Enforcement of foreign arbitral awards The legal basis for enforcement of foreign arbitral awards in Russia is the New York Convention. The USSR took a very active role in drafting the Convention and had already ratified it by 1960. There was not, however, a single reported instance of court enforcement of foreign arbitral awards under the Convention in Russia until 1992. One reason could be the fact that the parties were state enterprises and were bound to comply voluntarily with arbitral awards. Russian courts now annually consider anywhere from fifty to seventy applications to gain recognition and enforcement of foreign arbitral awards under the New York Convention. Presumably, the rest of the awards are complied with voluntarily. Recognition and enforcement of foreign arbitral awards is still the Achilles’ heel of the Russian judicial system. The state courts have little knowledge of and, therefore, little trust in international arbitration. This explains the significantly lower ratio of enforced awards than in Europe or the United States, but these circumstances appear to be changing through judicial education and a unified court system. Nevertheless, when handling the enforcement of a foreign arbitral award in Russia, one should seek the assistance of experienced local counsel to ensure that all formal and procedural requirements of the state courts are met. Excessive damages as contrary to public policy The Supreme Arbitrazh Court rendered two important (yet conflicting) decisions continued, next page Page 13

international arbitration,  from previous page concerning enforcement of international arbitral awards. In both cases, enforcement applications were challenged as contrary to public policy on the grounds of excessive damages. According to the Information letter of the Supreme Arbitrazh Court, “Public policy includes the principle of proportionality of the awarded damages to the prejudice suffered, having regard to fault.” In Oil & Natural Gas Corporation (ONGC) v. OJSC Amur,5 however, the Supreme Arbitrazh Court found otherwise. In that case, the parties entered into a contract to build a seismic survey vessel for the total contract price of US$89.9 million. As a result of Amur’s demands for an increase of the contract price due to vessel design changes, ONGC rescinded the contract and retained the full amount of the bank guarantee of US$8.99 million paid by Amur. In the award dated 11 April 2009, rendered by an arbitral tribunal under the Indian Arbitration and Conciliation Act, ONGC was awarded damages in excess of US$57 million, which represented the actual prejudice suffered by ONGC, including, inter alia, the costs of chartering vessels from third parties for a period of nine months up to the date of the rescission of the contract with Amur. ONGC brought enforcement proceed-

ings in Russia, but Amur raised objections based on proportionality of damages and prejudice. The Supreme Arbitrazh Court confirmed the lower courts’ decisions. The courts decided that the arbitral award failed to take into account specific contractual provisions for consequential damages, which included penalties fixed at 3% of the contract price for each month of delay in performance, but in no event greater than 10% of the total contract price. The courts reasoned that the penalties awarded to ONGC, representing over 63% of the total contract price, were excessive. Further, the courts held that the amount of the bank guarantee (being 10% of the contract price) retained by ONGC was sufficient compensation. The Supreme Arbitrazh Court therefore denied recognition and enforcement of the arbitral award. In Odfjell S.E. v. Sevmash (Case No. A05-10560/2010), however, the court reached the opposite conclusion. The parties entered into three shipbuilding contracts concerning design and construction of twelve tankers. As a result of a delay by Sevmash in the performance of the first contract, Odfjell rescinded all three contracts. Sevmash returned to Odfjell the advance payment plus interest. The SCC arbitral tribunal awarded damages to Odfjell that amounted to the difference

The Supreme Arbitrazh Court of Vologda Region. Other than being authorized to set aside or recognize and enforce arbitral awards, arbitrazh courts have little to do with arbitration.

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between the contract price and the price of acquisition of substitute vessels. In the course of enforcement proceedings brought by Odfjell in Russia, Sevmash raised a proportionality of damages argument. The court of first instance held, and the appellate courts as well as the Supreme Arbitrazh Court confirmed, that the objections raised by Sevmash amounted to a demand to review the arbitration award on the facts and on the merits, which was contrary to the applicable procedural laws. The courts also held that Sevmash did not satisfy the burden of proof and failed to show the lack of proportionality between the awarded damages and the prejudice suffered as a result of the contract breach. Consequently, Sevmash was ordered to pay the damages pursuant to the arbitral award. In this case, it should be noted, the contract did not provide for any specific method of damage calculation or for any liquidated damages or penalties.

III. Trends to Note Changes to the law Russia has been a UNCITRAL Model Law jurisdiction since 1993 when the ICA first came in effect. As Russia is also a member of the UNCITRAL Working Group II on Arbitration and Conciliation, recent changes to the Model Law eventually will be implemented in the ICA. In fact, the Model Law-based amendments to the ICA passed first reading in the State Parliament in January 2012. The draft law envisages new provisions regarding arbitration agreements, tribunals’ powers to render interim measures of protection, as well as courts’ powers to order measures of protection in support of arbitration proceedings taking place in Russia and abroad. The draft, likely to be implemented in 2013, expands the provisions on arbitration agreements to cover any disputes, be it contractual or non-contractual, that the parties agreed to refer to arbitration. The draft preserves the required written form of the arbitration agreement but adds that the parties may also conclude it by exchange of emails. The draft provides an elaborate set of

international arbitration,  from previous page rules on the granting of interim measures of protection. A temporary measure may be taken by a tribunal upon the request of one of the parties to arbitration at any time prior to issuance of the final award. The measures shall be adequate and maintain the status quo pending determination of the dispute; shall prevent a party from taking action that is likely to cause current or imminent harm or prejudice to the arbitral process or a party; and provide means of preserving evidence or assets out of which a subsequent award may be satisfied. The interim measures of protection can also be requested ex parte prior to the active phase of arbitration, but this is done only in exceptional circumstances. An order granting provisional measures is binding on the parties and valid for twenty days but has no force or effect of an award and is not enforceable through the system of state courts. The party against which the measures of protection are taken has an opportunity to present its case at the earliest practicable time and request the tribunal to amend or annul the measures. The draft also provides that the tribunal may ask the requesting party to provide appropriate financial security in case the party against which the measures are sought will be harmed. Thus, in the event such a party encounters costs or damages as a result of the measures taken, the tribunal may award such costs and damages at any point during the proceedings. Worth mentioning is the fact that the drafters foresaw provisions on the authority of the state courts to grant interim measures of protection in support of arbitration seated abroad. Hence, a foreign arbitral tribunal seated outside Russia may request a Russian competent court to grant any measures deemed necessary that are available under Russian rules of civil procedure. The authority of Russian courts to issue interim measures of protection in support of arbitrations abroad has been heavily debated. Formerly, local courts would not grant interim measures in support of arbitrations outside Russia, even though the assets or a party against which the measures were sought were located in Russia. The courts based their reasoning on a narrow

terpretation of the Arbitration Law and the Commercial Procedural Code (“CPC”). In particular, it was argued that Article 90(3) of the CPC allowed granting interim measures only in aid of domestic arbitration but not international commercial arbitration. That all changed in April of 2010 when the Supreme Arbitrazh Court issued a groundbreaking decision in relation to a London-based LCIA arbitration between Edimax (Cyprus) and a Russian national named Shalva Chigirinsky, whereby it confirmed the applicability of Article 90(3) of the CPC to arbitrations taking place outside Russia. Partly because of the court’s ruling, the provisions on the powers of state courts to order interim measures of protection in aid of arbitration taking place outside Russia were included in the draft arbitration law (draft article 17). Both the court’s decision and the legislative proposal illustrate the change in state policy towards arbitration. This position is supported by recent case law that will be discussed in more detail below. One of the most important amendments to the ICA is that the parties may agree to exclude the arbitral award annulment procedure in the state courts. In order to do so, the parties must include specific language in their arbitration agreement stipulating that the arbitral award shall be final. If the parties explicitly provide for the finality of the arbitral award, the notion of annulment under Article 34 of ICA will not be available to the losing party. After the new law is passed, this is certainly an issue to consider when entering into an arbitration agreement that names Russia as the place of arbitration. Specialized court for arbitration matters Matters concerning enforcement and setting aside are decided by the state arbitrazh courts at the place where the enforcement is sought or arbitration proceedings took place. There are around eighty arbitrazh courts across Russia responsible for hearing such matters. Because of the absence of precedents in the Russian legal system, the courts frequently come to different conclusions, even in cases with similar back-

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grounds. Despite the fact that the Presidium of the Supreme Arbitrazh Court has the authority to review cases as a final instance and draw specific guidelines for particular groups of matters, in reality it is the lower courts that shape the law. This system obviously does not encourage uniformity prior to a case being tried in the Supreme Arbitrazh Court and can become an issue for the annulment or recognition and enforcement of arbitral awards in various regions. To safeguard uniformity, the possibility has been raised of having a single unit within the system of state arbitrazh courts that would be responsible for setting-aside and enforcement cases. The new structure could reduce the number of instances reviewing the case to one (now there are at least three instances where a case can be appealed) and reduce the procedural times required for enforcement of arbitral awards. Ultimately, this could also contribute to the development of conclusive, sustainable and consistent case law on arbitration. Optional jurisdiction clauses Expansion of foreign law firms into Russia in the 1990’s was a prerequisite to the wide use of foreign laws in business transactions. Foreign legal systems (primarily English corporate, finance and banking laws) left a significant footprint in the body of contracts concluded by Russian companies during the past twenty years. Foreign law firms, retaining a lion’s share of large companies as clients, have been incorporating foreign legal concepts in the contracts they draft. Some of the concepts have been absorbed by the developing Russian legal system while others have yet to be put to the test by Russian courts. Among the latter was the admissibility of optional jurisdiction clauses in Russia. Local courts with similar cases reached different conclusions. In one case, a dispute resolution clause in the agreement between Red Burn Capital (UK) and ZAO Factoring Company Eurocommerz (Russia) provided that disputes be submitted to LCIA arbitration and that if Red Burn objected to arbitration prior to appointing its arbitrator, it continued, next page Page 15

international arbitration,  from previous page could seek to have the dispute referred to a state court. The application was rejected in the first instance but allowed by the appellate court. The court of first instance took a formalistic approach based on the provisions of Article 148 of APK, which requires that courts dismiss the case if there is a valid arbitration clause. Despite the fact that the jurisdictional clause was onesided in that it granted Red Burn broader rights in choosing a forum, the court of appeal—the Federal Arbitrazh Court of Moscow District—took into account the risks borne by Red Burn as a creditor and confirmed the adequacy of the optional jurisdiction clause.6 In the second case, ZAO Russian Telephone Company and Sony Ericsson Communication Rus concluded a distribution agreement. The distribution agreement provided for a panel of three arbitrators under the ICC Arbitration Rules with a seat in London. In addition, Sony Ericsson Communication Rus had an option to refer disputes to any competent state court for claiming compensation or debts due under the contract. Two years later ZAO Russian

Telephone Company filed suit in the Moscow Arbitrazh Court seeking a judgment to replace the defective mobile phones. The Moscow Arbitrazh Court, and later the Ninth Appellate Arbitrazh Court, refused to hear the case and referred the parties to arbitration based on the assumption that the parties provided for arbitration. The claimant submitted that the optional jurisdiction clause violated the principle of equality of judicial protection of the parties. The Supreme Arbitrazh Court pointed out that the principle of equality gives the parties the same opportunities to protect their rights and, therefore, the jurisdiction clause cannot provide one party with rights outweighing the rights of the other party. The court held that such clauses are commonly viewed as invalid. Considering the precedential importance of the case, the Supreme Arbitrazh Court decided to submit the case for review by the Presidium of the Supreme Arbitrazh Court. On 19 June 2012, the Presidium of the Supreme Arbitrazh Court decided that optional dispute resolution clauses violate the principle of procedural equality of the

parties. Interestingly, the court supported its findings by referring to the holdings of the European Court of Human Rights in the cases of Batsanina v. Russia, Sokur v. Russia and Steel and Morris v. The United Kingdom. The court held: Having the general principles of protection of civil rights, a dispute resolution agreement may not grant exclusively one party the right of recourse to a competent state court and divest the other party of a symmetric right. If such an agreement is concluded, it shall be invalid because it violates the parties’ equality. Consequently, a party whose right is breached by such dispute resolution agreement shall have the right of recourse to a competent state court on equal terms as the counterparty.7

Impartiality of arbitrators Independence and impartiality of arbitrators is a fundamental principle of arbitration found in the majority of arbitration laws and rules. At the same time, neither the laws nor the rules establish specific criteria for independence and impartiality. The problem arises when the setting aside

Aballí­Milne Kalil, P.A. is a Miami legal boutique, now in its nineteenth year, which focuses its practice on international commercial litigation, international business transactions, tax and estate planning, and domestic real estate transactions. The firm’s attorneys are fluent in a number of languages including English, Spanish, Portuguese and French, and have connections with a strong network of capable lawyers across the United States, Europe, Latin America and the Far East.

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international arbitration,  from previous page or recognition and enforcement of arbitral awards is sought in local courts. Whether participation at a conference sponsored by one party’s counsel affects the impartiality of an arbitrator has been a hot topic in Russia since 2007. That year, the Supreme Arbitrazh Court, in the case of OAO NK Rosneft v. Yukos Capital S.a.r.l., ruled that arbitrators must disclose their connection to the legal counsel of the other party at the time of their appointment. The facts of the case suggested that one of the arbitrators spoke at a conference organized and sponsored by the law firm representing Yukos Capital S.a.r.l. in the arbitral proceedings. Russian law stipulates that an arbitrator must disclose any and all circumstances that may give rise to justifiable doubts as to his/her impartiality or independence. Based on such disclosure, a party to the arbitration may decide whether to challenge the arbitrator. The arbitrator’s failure to provide such information at the time of appointment may serve as grounds for appealing an arbitral award in the future. The court in Rosnef set aside the arbitral award but did not explicitly rule whether participation in such conferences per se affects the impartiality of arbitrators. This led to a discussion regarding whether arbitrators are biased if they appear at academic events organized and sponsored by a party’s law firm. There was no subsequent case law regarding this matter until the Court of Cassation of the Moscow Federal Circuit recently rejected— based on a similar set of facts—a claim regarding the partiality of an arbitrator. In Erick van Egeraat Associated Architects B.V. (Netherlands) v. Capital Group, LLC (Russia),8 Capital Group LLC alleged that a co-arbitrator once spoke at a conference organized and sponsored by the law firm of the opposing party’s counsel. In addition, Capital Group LLC reported that the counsel representing Erick van Egeraat also spoke at the same conference. The court rejected Capital Group LLC’s claim, basing its ruling on two specific arguments. First, it was established that the law firm acted only as a so-called “information sponsor” (promoting the conference

among its clients and partners) and certainly had no influence on either the conference program or on the speakers’ list. Second, the participation of the co-arbitrator in the conference did not create any dependence or commercial interest with the counsel. Therefore, the arbitrator fulfilled the impartiality criteria under international law and the SCC Arbitration Rules. The decision of the Court of Cassation of the Moscow Federal Circuit is timely and long awaited as it brings some clarity to the issues of arbitrators’ impartiality. Russian courts adopted the position that an arbitrator’s involvement in academic events must be made known to the other party; otherwise, this could be a ground for setting aside an award. Yet, the court here did not answer the question of whether merely participating in a conference biases an arbitrator. According to this recent decision, the test for impartiality turns on whether or not the interaction creates dependence or commercial interest between the counsel (law firm) and the arbitrator. The court is to then determine in each individual case whether the specific form of sponsorship could affect an arbitrator’s partiality. In this particular case, the court ruled that “information sponsorship” does not create any special relationship between the counsel (law firm) and arbitrator. Arbitrability of real estate and corporate disputes Arbitrability of real estate and corporate disputes, including disputes between shareholders arising from shareholder agreements, were questionable due to uncertainty in the provisions in the Arbitrazh Procedure Code. The position of the public authorities was built on the premise that an arbitral award is binding only upon the parties to the arbitration agreement. At the same time, the outcome of arbitral awards regarding the change of title to real estate, shares or even internal corporate affairs requires state registration that involves actions by competent state authorities. As state authorities are not a party to arbitration, the authorities argued that arbitral awards are not binding on them and cannot be the basis for actions—for example, state

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registration of title to real estate. That position led to the conclusion that such disputes are non-arbitrable. Based on the ambiguities in the procedural law, the courts followed a course whereby all real estate disputes fell within the exclusive jurisdiction of the state arbitrazh courts. To put an end to this uncertainty, in 2011 the question was submitted for clarification to the Russian Constitutional Court for resolution. In Resolution No. 10-P, the Constitutional Court found that arbitration is one of the forms of judicial protection of civil rights, including the rights connected with real estate. The court therefore ruled that the arbitral awards concerning real estate disputes shall be equally enforceable and that they constitute a ground for the registration of real estate rights in the state real estate register (title, pledge, etc.). A highly controversial case on arbitrability of corporate disputes is Novolipetsky Metallurgicheskiy Kombinat (NMLK) v. Nikolay Maksimov. In that case, the arbitrazh courts denied the arbitrability of corporate disputes because they did not relate to the domain of civil law relations and involved public interest. In 2007, Maksimov sold 50% plus one share of Maxi Group Holding Company to NLMK. As a condition of sale, the contract provided for an additional issue of shares and included terms of payment for such additional issue of shares. The stipulations of the agreement, as well as its performance, provoked multiple controversies. On 21 June 2011, Moscow Commercial Court annulled an ICAC arbitral award of 31 March 2011 awarding Mr. Maksimov the remainder of the payment (some US$287 million). The court found that the subject matter of the dispute was not capable of settlement by arbitration and that, consequently, the award contravened Russian public policy. The court of appeal upheld this decision, ruling that corporate disputes are non-arbitrable because they belong exclusively to state commercial courts. In January 2012, the panel of three judges of the Supreme Arbitrazh Court upheld this decision. In another case, NLMK applied to Moscontinued, next page Page 17

international arbitration,  from previous page cow Commercial Court to invalidate the agreement with Maksimov, seeking restitution of the amount paid under such agreement (approximately US$232 million). The court dismissed the case because the parties provided for arbitration in their contract. The court of appeal, however, found that the dispute was non-arbitrable because the dispute was not “international,” and Articles 33.1.2 and 225.1.3 of the Arbitrazh Procedural Code (“APC”) established exclusive competence of the state commercial courts over commercial disputes. Maksimov subsequently applied to the Constitutional Court arguing that under Article 33 (1)(2), in combination with Article 225.1 of the Commercial Procedural Code (CPC), the Supreme Arbitrazh Court’s decision could be interpreted as prohibiting arbitration of corporate disputes and violated his right to judicial protection and his freedom to choose how to protect his rights. The Constitutional Court, however, refused to consider the application on formal grounds: “CPC rules cannot be regarded as violating the constitutional rights of the applicant. . . . The right to judicial protection does not imply a choice of specific forms and methods of implementation of such right.” In our view, the rulings of the Constitutional Court are ambiguous, and the Court will probably have to revisit arbitrability of corporate disputes in the near future. At this time, while real estate disputes can be considered arbitrable, corporate disputes involving corporate governance, internal affairs and transfer of shares are not, at least under the current law. Third-party rights The courts recently examined the question of third party rights affected by arbitral awards. The Russian Constitutional Court (Case No: 377-O-O) considered a claim that challenged whether certain judicial procedural norms were in line with the Russian Constitution. In their claim, a number of individuals asserted that a non-party to an arbitration agreement may not challenge an arbitral award.The claim arose out of the Kursk Arbitrazh Court’s decision to set aside a domestic arbitral award at the Page 18

request of the Kursk Regional Unit of the Agency for Federal Real Estate Management. Despite the fact that the agency was not a party to the arbitral proceedings, its interests were directly affected by the award. By virtue of the award, the claimants were granted the property registration right to a land plot possessed by the state agricultural company Nadezhda, which in fact meant the transfer of the title from the state to the private persons. The decision was upheld by a court of higher instance. The cassation court held that a non-party to the arbitration proceedings may request the setting aside of an arbitral award if its rights are affected by the award. Such affirmation is based on a procedural rule that any person may seek protection of rights in the state courts. The court held that as long as there is no other way of intervening in an arbitration proceeding, the appeal to set aside an award is the only method available for the protection of rights. The arbitrazh court also noted that the arbitration was unreasonable. In this case, it appeared that the sole arbitrator later represented the respondent in the state court proceedings; of course, raising suspicion as to his impartiality. The court also noted that disputes arising from the titles to real estate fall within the exclusive jurisdiction of the state arbitrazh courts, and thus the case could not have been arbitrated in the first place. Disagreeing with the arbitrazh court’s rulings, the claimants brought before the Constitutional Court the constitutionality of the following procedural rules: “an interested party may appeal to the court for protection of its rights,” and “a person whose rights are affected by a court decision may challenge such decision.” In essence, the claimants argued that the procedural rules invoked by the courts in their decisions restricted their freedom to enter into an arbitration agreement and prevented them from effective legal protection. The claimants noted that the appeal to set an award aside is available only to the parties of the arbitration. The right to challenge the award therefore could not have been extended to the Agency.

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The objective of the Constitutional Court is to examine the constitutionality of certain norms of Russian law. Thus, it did not review the merits of the dispute. The Constitutional Court held that the mere fact that one person would seek judicial protection does not breach the constitutional right of the other person to judicial protection. Interference of a third party does not preclude the other party from protecting its rights in the same case. Further, if an award is annulled, there is always the possibility of re-arbitrating or litigating the dispute to protect the infringed rights. The Constitutional Court therefore dismissed the claim. Decisions of courts do not have precedential value in Russia. Striving for uniform application of the laws, however, the courts in practice closely follow the decisions of their colleagues. There is no question that this case presents another obstacle for the development of arbitration. Arguably, the claimants chose a dubious approach. Since the challenged provisions of the Arbitrazh Procedural Code echo the constitutional principle of judicial protection, the claimants in essence attacked the Constitution itself. Therefore, it could have been anticipated that the Constitutional Court would dismiss the claim. More importantly, the case opens up for discussion the protection of third parties from awards of corrupt tribunals. Despite heavy criticism of the ratio decidendi of the decisions of the arbitrazh courts and the Constitutional Court, this decision seems to be the only protection available under Russian law to third parties whose interests are impacted by arbitral awards. Presumably, more claims of this type will be filed in the future, especially in “shareholders vs. management” and real-estate disputes.

IV. Conclusion: The Future of International Arbitration in Russia The number of Russian-related commercial disputes arbitrated outside Russia has increased in recent years. According to statistics of the SCC, each year approximately 20% of all international disputes involve a Russian party. Around 15% of the requests filed in the LCIA, it is said,

international arbitration,  from previous page are also connected to Russian companies or private persons. Finally, about twenty-five Russian-related requests are filed under the Arbitration Rules of the ICC annually. Other major arbitration centers have similar statistics. What are the possible reasons behind this trend? First, strong economic growth and the overall globalization of business increased the number of B2B disputes. Besides, Russians have become quite a litigious society, filing perhaps more commercial claims than the state courts can adjudicate. Such claims increase the courts’ workload, impacting procedural deadlines and the quality of the decisions. Sometimes, even political risks are viewed as a reason for avoiding domestic litigation. Another factor is the popularity of structuring a business entity through commercial companies abroad. For obvious reasons, Cyprus and the British Virgin Islands (“BVI”) are two of the most commonly used jurisdictions. Foreign lawyers involved in the operations of Russian overseas companies naturally opt for the arbitration centers they know best, such as the SCC, ICC and LCIA. It is not uncommon to see an arbitration dispute between Cyprus and BVI parties with mailing addresses in Moscow. This is because state arbitrazh courts are required by law to decide commercial disputes relatively quickly, and many cases are decided on the basis of written evidence with little or no live testimony. Such circumstances may be suitable for simple debt collection cases but not cases with complex issues. So, the choice to seek the world’s leading arbitration centers for resolution of complex disputes seems natural. More importantly, disputants are looking for arbitration procedural law and judicial practice that is stable and predictable. Parties are therefore turning to foreign jurisdictions such as the UK and France. But Russian law is changing to reflect the new needs of the international business society. Precedent is becoming a part of the practice, and that trend is likely to continue. The perception that Russia’s approach to

international arbitration is far from straightforward has courts feeling the pressure to render arbitration-friendly decisions while maintaining a conservative line. As a new generation of Russian lawyers (and judges) schooled in international arbitration emerges, outdated practices and laws are bound to change. Russian lawyers are forming their own international arbitration societies and coalitions, bringing to light new developments in the law and judicial practice. Arbitral institutions such as the ICC are opening branches in Russia so arbitration is more accessible to the Russian business society. Making international arbitration more accessible, homogeneous and predictable in Russia is a high priority for lawyers and their clients. Hopefully, Russia’s legislative and judicial bodies will continue to work toward the same goal. Roman Zykov is a Moscow-based independent arbitration practitioner acting both as counsel and arbitrator in commercial and sports law cases under the ICC, SCC, LCIA, VIAC, HKIAC, R. Zykov SIAC and other arbitration rules. Roman is a Russian-qualified attorney, holds a Ph.D. from Kazan State University and an LL.M from Erasmus University. Roman is the proprietor and chief editor of the Russian Online Arbitration Review ( Anna Tumpovskiy is a Miami-based international business attorney and founder of the Tumpovskiy Law Group, which assists American and Russian investors in their international business A. Tumpovskiy needs. Anna holds her J.D. degree from St. Thomas University School of Law and her LL.M in International Arbitration from the University of Miami School of Law. She recently completed her

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internship at the Arbitration Institute of the Stockholm Chamber of Commerce in Sweden. Anna’s professional experience includes advising international clients in complex business transactions, litigation and arbitration matters as well as drafting of contracts and dispute resolution clauses. Anna is a member of the ICC YAF, LCIA, ICDR and also serves as a regional editor for the International Law Quarterly. Endnotes: 1 Original text of the Convention, available at pdf. After the USSR, Russia continued membership in 1991. 2 Art.1 of the ICA. 3 Russian Federal Law on Insolvency provides: “(1) A bankruptcy case shall not be submitted to arbitration tribunal; (2) After a bankruptcy procedure is initiated by the court, any claim against the debtor can be filed and heard only within the bankruptcy procedure and is not arbitrable anymore.” Russian Commercial Procedure Code, Article 248 provides: “Some disputes relate to exclusive jurisdiction of Russian arbitrazh courts, such as: the disputes on the title to real property located in the Russian territory; the disputes relating to the registration of intellectual property rights; public law disputes.” Russian Constitutional Court in 2011 explained: “The provision means merely that such disputes may not be heard by foreign state courts.” See also Novolipetsky Steel Mill v. Maximov (case No. A40-35844/2011-69-311). 4 Art.7 of the ICA. 5 Oil & Natural Gas Corp.(ONGC) v. OJSC Amur, Sup. Arbitrazh Ct., Case No.: A731288/2009. 6 See generally Fed’l Arbitrazh Ct. of Moscow Dist., Case No: A40-59745/09-63-478. 7 Presidium of the Sup. Arbitrazh Ct., Res No: 10-P 26.05.2011. 8 Erick van Egeraat Assoc’d Architects B.V. v. Capital Group LLC, Court of Cassation of the Moscow Federal Cir., Case No. А40-51596/0968-437.

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Moscow office at a glance The Hogan Lovells Moscow office is consistently ranked by major international legal directories as one of the leading providers of legal services in the Russian market. Our team consists of eight partners, three counsel and 34 associates and other fee earners. Over the past two decades, we have advised Russian and international companies on some of the country’s landmark projects, in fields ranging from metals and mining, telecommunications, financial institutions, media and technologies, pharmaceuticals, and energy to automotive and insurance. Our practice areas are: • Corporate/Mergers and Acquisitions • Intellectual Property, Media and Technology • Antitrust, Competition and Economic Regulation • Dispute Resolution • Capital markets • Banking • Business Restructuring and Insolvency • Commercial • Employment • Real Estate Oxana Balayan Managing Partner

We have eight English-qualified lawyers in Moscow, helping you navigate Russia’s environment with a world-class international background. Awards and rankings: “Russia Law Firm of the Year”, Euromoney European Women in Business Law Awards 2011 Recommended law firm in Russia for Corporate and M&A, Intellectual Property, Private Equity, TMT, Banking and Finance, Capital Markets, Dispute Resolution, Employment and Real Estate, and by the major independent international legal guides Chambers Global and Chambers Europe, PLC WhichLawyer? and Legal 500 Winner of the ‘Trademark Excellence’ category in the WORLDleaders International IP Awards, for work in representing the Swedish retailing giant Hennes & Mauritz (H&M) in a dispute against a holder of the H&M trademark in Russia Finalist in the ‘Russian Legal Adviser of the Year’ category, Financial Times and Mergermarket M&A Awards, 2011

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Tax Climate in Russia: Global Warming or Still an Ice Age? By Yana Proskurina, Moscow, Russia In 2012, the World Bank ranked Russia 102 out of 181 in terms of “simplicity of tax payments.” This year’s rank is 64, up 38 from the previous report. So what is going on in Russia with regard to taxation? Has the environment actually changed so dramatically that it is not a sticking point for investors anymore? Positive changes obviously have occurred, but there is still room for improvement in many areas. Russian tax legislation: still rather recent Tax rules in Russia are outlined in the Tax Code, consisting of two parts. The first—containing the rights and obligations of taxpayers and tax authorities, rules for conducting audits, etc.—was adopted in 1999. The second part—describing specific taxes, rates and assessment details—was adopted gradually, beginning in 2001. The rules for assessment of taxes are not too complex, and the rates are not high. The corporate income tax rate is 20% and can be as low as 15.5% in some regions. VAT is 18%—10% on some goods. PIT is one of the lowest in the world—only 13%. Russian legislators, drawing on the wisdom of foreign experience, are constantly improving Russian tax legislation by introducing new concepts and rules that are well known in the West. The most significant modification is undoubtedly the new transfer pricing rules in effect since 2012. While the new rules correspond generally to the OECD rules, there are some essential differences—specifically, Russian domestic transactions are controlled. In order to help counter tax evasion, there were plans to introduce CFC rules and incorporate the term “beneficial owner” in the legislation. It remains to be seen how long will it take for this legislation to be finalized. As a general rule, Russian tax legislation is understandable and balanced. The tax climate, however, is adversely influenced by frequent changes to the law, inconsistent implementation of legislation, and complex tax administration.

Frequent changes and inconsistent implementation Over the past 12 years, more than 250 amendments have been introduced to the Tax Code. The number may look significant, but for rather recent and developing legislation, it is not unreasonable. Clearly, not all amendments are equally important, but significant changes still occur once or twice a year. Futher, comments provided by the Ministry of Finance, which has the authority to clarify tax legislation, are often unclear and consist mostly of quotations from the Tax Code. Essentially, there is no practice of obtaining rulings. (In theory, it is possible to make a transfer pricing APA, but none has actually ever been made.) The Ministry of Finance’s positions are often inconsistent, which confuses taxpayers and causes frequent disputes with the tax authorities. The courts also change their positions on tax issues fairly often. Although Russia does not have case law, the courts still play a very important role in interpreting legislation. Specific positions of the Russian Supreme Arbitrazh Court (“SAC”) are considered and employed by all lower courts. And while legislative changes apply only in future cases, changes in the SAC’s position on an issue are effective retroactively.

provides for two types of audit: desk and field. The purpose of desk audits is to audit a particular tax return, usually to ensure that it contains all necessary information, has been filled in correctly and that its calculations are accurate. There are exceptions, such as when the accuracy of the tax assessment for the period indicated in the tax return is checked during a desk audit. The purpose of a field audit is to check whether the assessment is correct and whether payment of all taxes has been made for a specific period. Field audits are the primary method of assessing additional taxes. During field audits, tax authorities may check all taxes assessed and paid for the continued, next page

Tax audits—how do they work? Tax authorities in Russia focus on additional assessment of taxes, which can occur only following the results of a tax audit. The types of tax audits and the rules for conducting them are prescribed in Part One of the Tax Code. The Code

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tax climate in russia,  from previous page three years preceding the year in which the decision was made to conduct the audit, as well as for the year in which the decision was made. For example, in 2012 the correctness of the assessment and payment of all taxes for the years 2009, 2010, 2011 (as well as 2012) may be checked. The tax authorities usually conduct a field audit once every two years and check the two previous years (for example, in 2012 they check the years 2010 and 2011; in 2014 they check the years 2012 and 2013, etc.). Often, all taxes are checked at once, though sometimes only certain taxes (e.g., profit tax and VAT) are checked. Following field audits, the tax authorities nearly always levy additional taxes on taxpayers. The audit, as a rule, takes place on the taxpayer’s premises and ordinarily takes two months, although this period can be increased to four and then six months. In addition, an audit may be suspended for nine months; therefore, the maximum length of time of an audit is fifteen months. In practice, a typical field tax audit (taking into account any suspension) takes six to eight months. Tax authorities’approach Tax authorities commonly take a very formal and detailed approach to auditing taxpayers. They carefully scrutinize all documentation that supports the taxpayer’s economic activity and pay close attention to detail with respect to any data in documents submitted by the taxpayer. In this regard, it is important to note that the tax authorities usually request not only a formal packet of documents to confirm proper accounting (for tax purposes), but also “back-up” documentation related to agreements. Taxpayers should be prepared for this scenario and ensure they have collected all of the documents confirming, for example, that services were actually provided (e.g., correspondence and reports).

If the tax authorities decide that a taxpayer has failed to supply them with the necessary documents and details, they usually consider these documents to be missing and assess additional taxes based on this assumption. Tax authorities have also recently implemented certain new procedures such as interviews, both with employees of audited companies as well as with other individuals. Authorities also have begun more frequent use of expert reviews during field tax audits, which can involve both technical and economic perspectives. The exchange of information between Russian and foreign tax administrations is provided for in treaties on double taxation. At this time, however, Russian tax authorities do not frequently request information from foreign tax administrations because a mechanism for such requests has not yet been agreed upon. The information exchange will be one of the key directions of Russian fiscal policy in the coming years, and this mechanism is expected to be widely used by the Russian tax authorities. For many years, the tax authorities’ key objective was to charge additional tax, not to audit a taxpayer. Remuneration of inspectors depended on amounts charged, irrespective of whether the money would ever be recovered. Not surprisingly, given this situation, the tax authorities disputed everything, often groundlessly. Taxpayers were visiting the courts regularly and won over 75% of cases. By 2007, the number of court disputes initiated by taxpayers reached 63,000 a year. When scheduling these tax audits, the tax authorities pay special attention to large taxpayers and member companies of multinational groups. In the Moscow Region, the average amount of additional assessment following a field tax audit is around US$1 million; it may be considerably larger in some cases. In recent years, audit objectives have


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changed. If the goal before had been simply to charge additional tax, then it was not important whether tax authorities could defend their position in a dispute. Now the primary objective is to actually recover the tax. Tax authorities therefore must both charge the additional tax and be able to defend their positions in court. As a result, disputes are fewer but more complex. Methods of appeal In Russia, there are two key methods of dispute resolution: appeal to the higher tax authorities (a pre-trial procedure) or to a court. The pre-trial procedure is mandatory for tax decisions carried out by tax authorities following the results of tax audits. A claim with higher tax authorities is usually filed within ten working days after the result obtained from the lower tax authorities and is reviewed for approximately one to two months. The funds are not written off while the claim is considered. In practice, the higher tax authorities have (at least up until recently) tended to support the lower tax authorities, and disputes between taxpayers and the tax authorities are for the most part resolved in court. The next step is to file a lawsuit. The taxpayer can file a lawsuit within three months after obtaining the decision from the higher tax authority. Arbitrazh courts are comprised of the first instance, the appellate and the cassation. Usually, a tax dispute goes through all three. The SAC, the highest judicial authority in tax disputes, rarely considers cases. A tax dispute takes an average of nine to twelve months to move through all three courts (first instance, appellate and cassation). This is quite fast, thus making this method of dispute resolution very popular considering that the taxpayers’ chances of winning were 62% in 2011. Counting on a pre-trial resolution Despite the gradual decrease, the number of cases in courts is still high, and steps are being taken to reduce this burden on the judicial system. This effort is supported by the tax authorities, as well as by lawmakers and the courts. Initiatives are being proposed to

tax climate in russia,  from previous page shift tax dispute resolution from the courts to the pre-trial stage. Recently, Russian tax authorities have become noticeably more efficient. Higher tax authorities are now more objective, and they more frequently uphold the taxpayer’s position and claims at the pre-trial stage. In addition, lawmakers are attempting to introduce new methods of dispute resolution. For example, currently the pre-trial procedure is required only with respect to decisions of the tax authorities passed after tax audits; a new bill, however, is being discussed that would require the pre-trial procedure to be applied to all tax disputes. A legislative framework for using the mediation procedure in tax disputes is also under discussion. Is settlement with tax authorities possible? In practice, a settlement agreement concluded in court between the taxpayer and the tax office may be used as an alternative method of dispute resolution. The settlement agreement may be concluded between the taxpayer and tax authorities at any stage during court proceedings or enforcement of the judicial act. This agreement then must be approved by the court where the case is pending. The introduction of new transfer pricing rules in 2012 has enabled advance pricing agreements (APAs) between taxpayers and the tax authorities to become an option. This alternative is expected to lead to a reduction in the number of tax disputes going to trial. Eventually, the mutual agreement procedure (MAP) in treaties will also likely become a more popular method of dispute resolution. Additionally, the concept of a consolidated group of taxpayers was introduced, which should prevent some transfer pricing disputes. In summary, the disputes are gradually shifting from judicial to pre-trial, and the number is generally decreasing which surely is a positive trend. But this is only the beginning of a long process. Primary focus of tax authorities— six standard issues: Russian tax authorities have started to

focus on more complex issues during tax audits, moving away from simplistic approaches and instead embracing more advanced concepts. These include, but are not limited to, transfer pricing, place of management/permanent establishment, and anti-avoidance mechanisms. The tax authorities are also focused on the following priority areas: • Application of the “substance over form” concept In 2006, the SAC issued Resolution No. 53 which gives a general outline of the “substance over form” concept. During taxpayer audits, Russia’s tax authorities have long tried to focus on the real substance of transactions rather than on their form. The tax authorities, however, have recently started to pay even more attention to this concept as well as to relatively new, related issues such as determining the beneficial owner, transitional payments, and back-to-back payments. This focus on financial realities has evolved into a clear trend, and one that will likely continue. • Economic justification of expenses The economic justification of expenses is the mandatory criterion used to account for any costs when calculating the profit tax. Since companies’ expenses decrease the profit tax base, tax authorities have tended to pay special attention to this issue, particularly in the following situations: a company that is just launching its business activity and therefore incurs overall losses; a company incurring losses as the result of a particular transaction; a company whose expenses are suspected of being economically advantageous or beneficial to third parties (other groups, companies, individuals, or counter-parties) rather than the taxpayer. • Cross-company charges During taxpayer audits, the Russian tax authorities continue to focus on a variety of cross-company charges (e.g., fees paid under management, consulting, secondment and intergroup agreements). This attention usually results in challenging the deduction of the respective fees.

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Some recent trends include the following: (1) Pricing of fees Russian tax authorities generally do not recognize cost-sharing agreements. Taxpayers using this pricing mechanism therefore should be ready to put forward convincing evidence to prove their position in court. The new transfer pricing rules further complicate the matter. (2) Reality of services During tax audits, the tax authorities usually request not only a formal package of documents to confirm proper accounting (for tax purposes) of cross-company arrangements, but also “back-up” documentation relating to intergroup agreements. Taxpayers should be prepared for this scenario and ensure they have collected all the documents (e.g., correspondence and reports) confirming that services were actually provided. If the tax authorities decide that a taxpayer has failed to provide them with the necessary documents and details, the taxpayer may be forced to go to court. • Tax treatment of interest payments; thin cap issues One of the hot topics arising in court practice is the tax treatment of interest payments. The main issue here is application of thin-capitalization rules. As in many other jurisdictions, Russian tax legislation sets forth thin-cap rules for certain financing arrangements, specifically when a Russian borrower’s controlled debt to a defined category of lenders exceeds its equity capital by more than threefold. Under these laws, the interest charged on such controlled debt cannot be deducted in full, and a certain part of this interest should be treated as dividends. Before November 2011, the courts applied the non-discrimination provisions of the relevant double-tax agreements (“DTAs”). As a result, taxpayers were allowed to deduct interest in full on this controlled debt. In November 2011, however, the Russian SAC Presidium interpreted the non-discrimination provisions of DTAs as in no way preventing the application of continued, next page Page 23

tax climate in russia,  from previous page domestic thin-cap rules. The Russian SAC’s decision is evidence that court practice on the thin-cap issue is changing, which results in an increased tax burden for business. VAT refunds VAT recovery is one of the most common issues challenged by the tax authorities. Until recently, tax authorities have generally refused taxpayers’ VAT refund requests. As a result, taxpayers have had to apply to courts to seek redress. Lately, the situation has improved and the tax authorities have started to refund VAT in most cases. The tax authorities, however, are also conducting detailed tax audits of both VAT returns and the documents provided. As a result, in order to receive a VAT refund in Russia, taxpayers should collect and carefully check a comprehensive set of supporting documentation, such as invoices, contracts, acts of delivery and reports. Bad faith suppliers In the ordinary course of business, com-

panies interact with numerous suppliers. A risk arises, however, that the company will encounter a “bad faith supplier.” This could lead to increased taxes for the buyer, although the impact may vary depending upon claims of the tax authorities. Under the best case scenario, the buyer will have to settle the dispute with the tax authorities. Under the worst case scenario, the buyer will have to pay additional taxes, late payment interest and fines should the tax authorities acknowledge the supplier, or relationship to the supplier, as non-existent or artificial. As a result, ensuring the “good faith” of a supplier before entering into any commercial relationships is of particular importance for a company. The main indicators of a supplier’s “bad faith” are often failure to pay taxes, failure to submit tax returns and the absence of capital assets or employees. Has the ice been broken? Compared to other countries, Russia’s tax climate looks quite comfortable. The tax rules are slightly unstable, but as mentioned above, Russian tax legislation is still recent and is not yet fully evolved.

No matter how polished the legislation is, the tax climate depends on the simplicity of the tax administration, and this needs improvement in Russia. There are still many disputes with the tax authorities, the courts’ positions are not always predictable, and ruling practice has not yet been adopted in Russia.The ice has been broken, but more time is needed for relations with the tax authorities to warm up. Yana Proskurina, a director, leads the tax dispute resolution group at Pricewaterhouse Coopers Legal CIS B.V. Yana has over 12 years of experience in tax dispute resolution inY. Proskurina volving a broad range of industries, including the manufacture of consumer and industrial products, automotive, oil and gas. She also has extensive experience in representing client interests in Russian arbitrazh courts.

Astigarraga Davis is a boutique law firm focused on international and other business disputes. The firm has an extensive cross-border practice, its lawyers having handled business disputes emanating from virtually every country in the Western Hemisphere as well as elsewhere in the world. Its clients include primarily multinational companies, financial institutions, other public and non-public companies, as well as sovereign states and their instrumentalities. The firm’s strengths focus on international arbitration, international litigation and financial services litigation including creditors’ rights, bankruptcy, and class actions. It has an international arbitration practice handling cases before the major international arbitral institutions, including the International Chamber of Commerce and the International Centre for Dispute Resolution. As a testament to its dedication to its clients, in 2011 the firm was presented with the Outstanding Client Service award for the Chambers Latin America region. With its international network of lawyers worldwide, the firm manages complex disputes in foreign jurisdictions for its clients, including in developing and executing strategies for multi-jurisdictional cases and high-profile controversies, particularly in Latin America and the Caribbean. The firm has an asset recovery team that seeks to pursue fraudsters and corrupt officials around the world to recover misappropriated assets, particularly from fraudulent transactions originating in Latin America and the Caribbean. 701 Brickell Avenue, 16th Floor, Miami Florida 33131 U.S.A. Tel: 1-305-372-8282 Contact: José Astigarraga Email:

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An Overview of Kazakhstan’s Investment Laws and its Investor-State Arbitral Awards By Leonid Shmatenko, Düsseldorf, Germany a homogeneous investment policy in all areas; e.g., banking, production of goods, the service sector, and especially the exploration, extraction and refinement of oil and noble metals.12

I. Introduction In recent years, the landlocked former Soviet Republic of Kazakhstan has substantially improved its oil and gas prospects.1 Being a rich supplier of oil and gas serves to attract foreign direct investments, but the prospect of such investments is diminished by the government’s policy of confiscating the property of foreign direct investors to “protect its subsoil sector.” As a result of such expropriation, to date Kazakhstan has faced thirteen known investment arbitrations.2 Five proceedings are still pending,3 one has been discontinued pursuant to Rule 43, para.1 of the ICSID Arbitration Rules,4 three awards are confidential and not available to the public,5 and four awards are publicly available.6 These numbers demonstrate Kazakhstan’s efforts to maintain its economic and political integrity by avoiding transparency in its investment policies. This article will analyze the investment laws of Kazakhstan, as well as give an overview of the awards that are publicly available. Finally, the article will outline the problems that foreign investors face in investment arbitrations against the Republic of Kazakhstan.

II. History of Kazakhstani Investment Law The development of Kazakhstani investment law: First Stage The period spanning 1990 to 1994 represents an important stage in the development of the independent Kazakh state. While the process was slow and left many areas unregulated, a series of legislative acts propelled the transition from a centrally planned economy to a market economy.7 Second Stage The second stage began on 27 December 1994. This date marked the introduction of

Fourth Stage

a Kazakh Foreign Investment Law8 (“FDI”) and the Civil Code and was the beginning of the formation of an independent area of law that did not previously exist in Kazakhstan. Although the FDI quota remained low in the first years of the new laws,9 growth eventually occurred.10 The reasons for a low FDI quota were comparable to those of other CIS countries; e.g., an economic crisis, inflation, and an immense increase in public debt. The Kazakh Republic realized it had to take measures to encourage foreign direct investment, leading to the next stage in the evolution of Kazakh Foreign Direct Investment Law. Third Stage On 28 February 1997, the Kazakh government introduced an additional law “On the Support of Foreign Direct Investment”11 that initiated a new period of legislation to attract foreign investors in areas that urgently needed stimulation such as technology and production. To this end, the Republic of Kazakhstan attempted to establish different types of securities, such as tax benefits and legal guarantees. This third stage of development therefore represented the realization of the importance and significance of investment law for Kazakhstan, and the introduction of

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The fourth and most important development stage took place in 2003. On 8 January 2003, the Republic of Kazakhstan introduced a new investment law, the “Law on Investments” (“kzLOI”),13 that made the previous laws obsolete. This regulation led to a boon in foreign direct investments, doubling the investments from US$4.6 billion in 2003 to US$8.3 billion in 2004 and US$18 billion in 2010.14 Today Kazakhstan is party to more than twenty BITs,15 is a signatory to the ICSID-Convention,16 and is party to the ECT.17 Current Situation The “Law on Investments” abolished use of the terms “foreign investment” and “foreign investor” and introduced a common term: “investor.”18 The law also abolished the “most favored nation” treatment, which had been the prevailing approach. This is certainly a positive change as it implies equal treatment for national and foreign investors.19 Article 3 kzLOI, in its newest amendment of February 2012, allows foreigners to invest in every kind of legal object, except where the laws of Kazakhstan limit investments (Article 3, para. 2 kzLOI). As there are numerous limitations in Kazakhstan’s Law on Licenses (“kzLOL”),20 the impact of Article 3 kzLOI could be described as rather insignificant. Article 11 kzLOL contains twenty-four exceptions, including those in the nuclear energy sector, mass information media, and construction. The limitations have been adjusted over the years, but the most significant investment sectors still require a license. continued, page 27

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Kazakhstan’s Investment Laws,  from page 25 Additionally, the Law on Concessions21 (“kzLOC”) plays a major role. Article 4 kzLOC provides that “[c]oncessions might be distributed in every branch of the economy, except for those objects, which are included in the list22 defined by the President of Kazakhstan.” Despite these downsides, the law provides certain guarantees and standards of protection for foreign investors. According to Article 4, para. 1 kzLOI, the state provides full protection of investments under the scope of the Constitution as well as under the scope of international treaties. In the case of violation of these principles, the investor is entitled to damages pursuant to Article 4, para. 2 kzLOI. Although Article 4, para. 3 kzLOI provides a guarantee for the stability of contracts of investors concluded with state entities, it somewhat inconsistently includes a broad exception; namely, under Article 4, para. 3, nos. 1 and 2 kzLOI the guarantee is excluded if Kazakh and/or international legislation is amended to ensure national security, ecological security, public health or morality. Hence, under Article 4, para. 3, nos. 1 and 2 kzLOI, the Kazakh legislature has carte blanche to amend laws and thus undermine investments. At the same time, the Law on Investments eliminates the “grandfather clause”23guarantee against adverse changes in legislation.24 Article 5 kzLOI guarantees the possibility of income, and Article 8 kzLOI provides a guarantee for investors against nationalization and expropriation. Although it refers to exceptional circumstances (para. 1) and promises reimbursement of the market value (paras. 2 and 3), it is unclear when such exceptional circumstances occur and how they might be defined. Regarding dispute resolution, the kzLOI sets forth in Article 9 that the parties shall resolve disputes by negotiations (para. 1). They also may derogate from national courts and resolve their dispute by means of international arbitration. Chapter 3 provides for state support for investments made in Kazakhstan. Investors may receive, inter alia, tax holidays according to Article 13 kzLOI, natural subventions through state in-kind grants according to Article 18 kzLOI, and other benefits (Articles

18-1 and 18-2 kzLOI). The requirements for these benefits are set forth in Articles 19 to 22 kzLOI, and these also provide for termination of such contracts. Chapter 4, Article 23, para. 1 kzLOI provides a kind of a “stability clause” stating that “[b]enefits given on the basis of the investment contracts with the authorized bodies concluded earlier than this Law has come into force shall maintain the effect up to the cut-off date stated in such investment projects.” Strategic objects Similar to the Russian Federation,25 Kazakhstan pursues a certain line of protectionism with regard to some sectors. The introduction of a new Article 193-1 into the Civil Code of Kazakhstan26 limited various possibilities to buy or own a “strategic” object. According to the legal definition of Article 193-1, para. 1 of the Civil Code, a strategic object is a property having social and economic importance for the stable development of the Kazakh society, the ownership and (or) use and (or) disposing of which may impact the state of the national security of the Republic of Kazakhstan.27Article 193-1, para. 2 of the Civil Code of Kazakhstan contains a non-exhaustive list of “strategic objects.”28Additionally, Article 193-1, para. 3 of the Civil Code of Kazakhstan provides for further limitations in the chemical industry, the transport business, electricity production and military branches. For instance, the definition of Article 193-1, para. 1 of the Civil Code of Kazakhstan is once again a blanket clause for the government to issue legislative acts (even using its power retroactively) allowing the acquisition of “strategic objects” in its discretion. Every object can be declared to be a “strategic object,” without the opportunity for court review. Additionally, the state has an option right, thus making any investments in the “strategic sector” subject to jeopardy.29 Taking a closer look at the regulations provided in Article 193-1, para. 1 of the Civil Code of Kazakhstan regarding “strategic objects,” one can see several problems. First, it is not clear how a public law regulation can make its way into the Civil

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Code. Second, as mentioned above, this regulation leads to legal uncertainty as it authorizes the state to confiscate private property related to “strategic objects” without defining “strategic object.”30 Special Economic Zones Today, Kazakhstan has nine Special Economic Zones (“SEZ”).31 The concept of SEZ is common in Eastern European countries.32 According to Article 3 of the Law Concerning SEZ,33 the aim of the law is to foster fast development of highly productive and competitive industries, promote investments and transfer of new technologies, and create employment opportunities. The law itself covers a wide range of issues relating to the establishment and operation of SEZs (chapters 3 and 4 of the law).34 The law distinguishes between prioritized and adjuvant activities. Only companies that engage in prioritized activities may become real SEZ participants, obtaining benefits from their status. Companies engaged merely in adjuvant activities—i.e., not serving the purposes of the SEZ—do not receive the same favorable conditions as prioritized companies.35 Articles 9 to 14 of the law set forth the requirements that applicants have to meet to become a prioritized company. The administration of the SEZ is centralized, thus diminishing bureaucracy. In addition, SEZ participants may be permitted to bypass the search for employees on the national job market and may directly employ foreigners.36 Energy and Subsoil Sector The old Kazakh “Law on Subsoil and Subsoil Use”37 experienced several modifications in recent years. With Kazakhstan being one of the most important oil countries of the former Soviet Union, it is clear that this law plays a major role in investments made to the energy and subsoil sectors. Introduced in 2007, Article 45-2 permitted Kazakhstan unilaterally to cancel subsoil use contracts in order to “restore the economic interests of the Republic of Kazakhstan,” presupposing that mining in areas of strategic importance leads to a subcontinued, next page Page 27

Kazakhstan’s Investment Laws,  from previous page stantial change in the country’s economic interests that endangers national security. The “Law on Subsoil and Subsoil Use,” however, was replaced by a new “Law on Subsoil and Subsoil Use”38 in 2010, the aim of which is the consolidation of the relevant laws and the “greatest possible protection of the interests of the nation as the owner of the subsoil.” Although a company that has prospected an oil or gas reservoir will still be privileged as a contractor when the reservoir in question is to be exploited, there is no proviso for contracts that cover both prospection and exploitation of subsoil minerals.39 Exceptionally, such comprehensive contracts may be concluded by decision of the Kazakh government if the reservoir in question is of strategic importance or the geologic conditions are uncommon.40 Other peculiarities Kazakh law, as is the case with Ukrainian and Russian law, has several peculiarities regarding investments in certain branches. For example, under Article 74, para. 4 of the Law “On the Use of Air and Air Traffic,”41 only up to 49% of the nominal capital of a joint-stock company may be possessed by foreign natural or juridical persons. Under Article 24, para. 6 no. 3 of the Law “On the National Security of the Republic of Kazakhstan”42 and Article 5 para. 2 of the Law “On Mass Information,”43 a foreign natural or juridical person is not permitted to own directly or indirectly more than 20% of a legal entity in the mass media sector. But this brief list represents only a small percentage of peculiarities in Kazakh investment law, so it is advisable to check the relevant laws before making investments in the Kazakh economy. Notwithstanding, these regulations are less severe than in the Russian Federation where, for example, the Law “On Mass Media”44 provides in its Article 7 that foreign citizens are not allowed to possess any mass-media companies.

III. Analysis of Investor-State Arbitral Awards The following section will discuss the four publicly available awards: CCL v. The Republic of Kazakhstan; AIG CapiPage 28

tal Partners and CJSC Tema Real Estate Company v. The Republic of Kazakhstan; Rumeli Telekom A.S. v. The Republic of Kazakhstan; and Caratube International Oil Company LLP v. The Republic of Kazakhstan. As a complete analysis would exceed the length of this article, only certain issues will be addressed. CCL v. The Republic of Kazakhstan The government of Kazakhstan had 87.9% of shares in a Kazakh company that owned an oil refinery. Before being restructured into an open joint-stock company under the laws of Kazakhstan, the refinery was a state enterprise from 1978 to 1994.45 In 1997, CCL (claimant) and Kazakhstan (respondent) entered into several concession agreements regulating the claimant’s right to possess and use respondent’s shares.46 Before the concession agreement was signed, a financial analysis made the parties aware of an outstanding debt of the Kazakh Company and pending court proceedings.47 The concession agreement included an arbitration clause referring all disputes in connection with “foreign investment” to the Arbitration Institute of the Stockholm Chamber of Commerce. All other disputes were subject to national courts.48 On behalf of claimant, the operation of the refinery was transferred by a lease agreement to a new “Kazakh Company.” Another company, “Company X,” acquired by court actions the right to attach and take over ownership of the refinery’s assets to satisfy its claims against the Kazakh Company. Additionally the General Prosecutor of Kazakhstan obtained a decision from the Kazakh courts that terminated the lease agreement. The Ministry of Finance of Kazakhstan consequently issued an order to terminate the agreement.49 Following these actions, claimant submitted a request for arbitration. The first issue addressed by the tribunal was the definition of the term “foreign investor” under Kazakh law. After evaluation of the complex shareholding structure, the tribunal found that under the clear wording of the kzLOI 1994, the claimant qualified as a foreign investor thereby affording the

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tribunal jurisdiction to decide the dispute. The court’s reasoning was also underlined by the wording of the BIT.50 Another issue in the case was the definition of the term “national of another country.” The tribunal addressed Article I, para. 1, Article I, para. 2, and Article VI, para. 8 of the U.S.-Kazakhstan BIT and held that “when reasonable doubt has been raised as to the actual ownership of and control over the company seeking protection,”51 the burden of proof regarding nationality shifts to the claimant.52 The court found that the claimant had not met this burden.53 Nevertheless, the tribunal held that it had jurisdiction over the case according to the kzLOI.54 On the merits the claimant argued that several measures undertaken by Kazakhstan amounted to expropriation and thus violated Article 7 kzLOI 1994 and Article VIII of the U.S.-Kazakhstan BIT.55 Among these measures were mandatory deliveries of oil products to the state-owned agricultural companies, the court proceedings, the court proceedings initiated by the General Prosecutor and the subsequent re-transfer of the management to the respondent.56 AIG Capital Partners Inc. and CJSC Tema Real Estate Company v. The Republic of Kazakhstan57 Between 1999 and 2000, AIG Capital Partners Inc. and a Kazakh company initiated a joint venture, CJSC Tema Real Estate Company, for the development and construction of a residential housing complex in Almaty, Kazakhstan. Subsequently, the claimants purchased property, signed construction contracts and began work. Sometime later, the government of Kazakhstan sought to cancel the project because the property was required for a national arboretum.58 In March 2000, the Almaty Oblast demanded, by resolution of the municipal government, transfer of the property without compensation to the City of Almaty. Ignoring the resolution, claimants tried to resume the construction. The city authorities and the police, however, expelled the claimants from the site. In February 2001, the property was finally confiscated by the City of Almaty.59

Kazakhstan’s Investment Laws,  from previous page Claimants had to face several hurdles— jurisdictionally and substantively—in the arbitration proceedings. The first issue was whether their investments qualified as “investments” under the U.S.-Kazakhstan BIT. By “investment,” the BIT means “every kind of investment in the territory of one Party owned or controlled directly or indirectly by nationals or companies of the other Party.” Kazakhstan, however, pleaded that the BIT jurisdiction had been purposely limited to “genuine U.S. Investors.”60 Additionally, it claimed that the relationship between AIG and the joint venture did not qualify AIG and CJSC as claimants under the BIT. The tribunal held, however, that investments originating from U.S. companies and routed through a chain of other companies, whether U.S. or not, are considered to be “indirectly U.S.-controlled” and therefore protected by the BIT. According to the tribunal’s view, the fact that Kazakh citizens owned a part of the company did not preclude its jurisdiction, as the chain of control extended to U.S.-based corporations where the investments originated.61

As to the expropriation issue, the tribunal held that the claimants’ investment was expropriated in the sense of Article III, para. 1, U.S.-Kazakhstan BIT, through the methods mentioned above. Thus, the tribunal awarded US$9,951,709 plus interest to claimants.62 The real issues arose when claimants tried to enforce the award in Kazakhstan. Kazakhstan’s authorities invoked the state’s absolute immunity and denied enforcement, a position supported by Kazakh legal scholars.63 Following this, the claimants applied for enforcement against Kazakhstan and the Kazakh National Bank and the national funds at the Supreme Court of the United Kingdom. Their reasoning was that the United Kingdom was party to the ICSID Convention and, thus, the award should be enforceable against it. Particularly, claimants wished to obtain “a final third-party debt and charging orders against cash and securities that are held in London by the third parties . . . , pursuant to a Global Custody Agreement dated 24 December 2001 with the National Bank of Kazakhstan.”64

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Invoking sections 13, para. 2 b, and 14, and para. 4 of the State Immunity Act, the Kazakh National Bank moved to discharge both orders, arguing that the property of the National Bank should be subject to state immunity. Kazakhstan and the third party did not maintain a contractual relationship; thus, the claimant’s orders were discharged. Kazakhstan, therefore, and not the National Bank of Kazakhstan was the judgment debtor. The third parties held cash accounts in London in the name of the National Bank, not Kazakhstan. These cash accounts represented the property of the National Bank under Section 14, para. 4 of the Immunity Act, thus making all assets immune from enforcement in the UK. This result did not change even though Kazakhstan enjoyed the benefits of the cash accounts. The court held that: [t]he property of a state’s central bank enjoys immunity from enforcement in the UK. This includes any asset in which the central bank has some kind of property interest. Restrictions on the right of a party to enforce a judgment against the property of a central bank continued, next page

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imposed by the State Immunity Act were legitimate and proportionate. The assets were not intended for use for commercial purposes [under Section 13, para. 4 of the Immunity Act].65

Such a view is also reflected in Article 429 of Kazakhstan’s Civil Procedure Code,66 which states that “[a]n agreement of the state to derogate its juridical immunity does not imply its immunity from enforcement proceedings.” The view is shared by legal scholars.67 Rumeli Telekom A.S. v. The Republic of Kazakhstan The dispute arose out of investments made by the claimants Rumeli Telekom A.S. and Telsim Mobil TelekomunikasyonHizmetleri A.S.,68 both incorporated under Turkish laws in the mid-1990’s. Rumeli joined with a local Kazakh in a joint venture called KaR-Tel. The aim of this joint venture was to bid for a GSM mobile telecommunications license in Kazakhstan. When the license was obtained, the joint venture received several perks including a five-year tax holiday. The dispute itself, however, involved the termination of an investment contract that had subsequently led to the redemption of the investor’s shares in a telecommunications enterprise.69 Regarding the jurisdictional objections, respondent claimed that the kzLOI 1994 was not applicable since new legislation had entered into force. The cornerstone of this dispute was the applicability of Article 6, para. 1 kzLOI 1994, including the “grandfather clause.”70 The tribunal agreed with the claimants and confirmed its jurisdiction by the application of the kzLOI1994 (that shall be applicable until 31 June 2009). Additionally, the tribunal found that Article 6, para. 1 kzLOI, as well the principles of good faith, estoppel and venire contra factum proprium led to the same result.71 Another issue was Kazakhstan’s attempt to have the tribunal “pierce the corporate veil,”72 referring to the cases TokiosTokeles73and Barcelona Traction.74 According to Kazakhstan, the true claimant was the “Turkish Savings Deposit Funds” Page 30

(“TSDIF”), an agency of the Turkish State, which, as a state entity, does not have permission to initiate proceedings at the ICSID. The situation regarding ownership was, indeed, very complicated. When the Uzan family owned Imar Bankin Turkey and encountered several problems, the Turkish Parliament decided to enact various laws empowering the TSDIF to take over control of several companies that the Uzan family had previously controlled either directly or indirectly. Additionally, the laws allowed the TSDIF to take over the management of these companies. As Rumeli and Telsim belonged to the Uzan companies, the TSDIF was entitled to appoint managers. The tribunal, however, declined to examine whether public entities could be subsumed under the term “investor” found in the ICSID Convention. Instead, the tribunal made a formal analysis of claimants’ status and held that they were permitted to initiate the arbitration. Although the tribunal made reference to TSDIF’s manager appointments, it stated that they were not at odds with the claimants’ corporate existence.75 On the merits, the tribunal found several violations. The first violation mentioned by the tribunal was the contract termination on the grounds of an alleged failure to file reports. In this regard, the investment committee violated an obligation to suspend a contract initially and notify the investor of the reasons for such suspension.76 The second violation of the standards of protection was the Ministry of Industry and Trade’s appointment of a Working Group whose task was to examine whether the investor had fulfilled its investment obligations. Since the Working Group simply confirmed the contract termination and did not allow the investor an opportunity to present its case, the tribunal held that, due to transparency issues and due process, the decision violated the standard of “fair and equitable treatment” of the most favored nation (“MFN”) clause in the U.S-Kazakhstan BIT and customary international law.77 As to expropriation, claimants alleged that several actions by respondent constituted expropriation78 under Article III of the Turkey-Kazakhstan BIT and the kzLOI.

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Respondent, however, denied that it had expropriated claimants’ investments.79 The tribunal evaluated the circumstances and found that: this was a case of “creeping” expropriation, instigated by the decision of the Investment Committee which was then collusively and improperly communicated to Telcom Invest and its shareholders before Claimants were made aware of it, and which proceeded via a series of court decisions, culminating in the final decision of the Presidium of the Supreme Court.80

Thus, the tribunal awarded the claimants US$125 million plus interest for violating the “fair and equitable treatment duty imposed by the MFN clause contained in Article II, para. 1 of the Turkey-Kazakhstan BIT and for the expropriation of the claimants’ investments without following the requirements set forth in Article III, para. 1 of the Turkey-Kazakhstan BIT.81 Caratube International Oil Company LLP v. The Republic of Kazakhstan In this case 82 the investment dispute arose out of the authorities’ termination of a contract for exploration and exploitation of the Caratube oil fields. Allegedly, the claimant—Devinicci Salah Hourani, a U.S. citizen who owns 92% of the Caratube International Oil Company—breached the contractual obligations in 2008.83 According to the claimant, the contract with Kazakhstan violated the U.S.-Kazakhstan BIT. Particularly, Caratube claimed that it suffered discrimination and unlawful expropriation. Additionally, the Kazakh authorities threatened Mr. Devinicci Hourani, his family and his employees.84 Respondents alleged that the tribunal lacked jurisdiction over the case because the claimant was not a national of another contracting state for the purposes of Article 25, para. 1 of the ICSID Convention.85 Claimant, however, contended that because he was a U.S. national, the tribunal had jurisdiction over the case by virtue of Article VIII of the BIT and Article 25, para. 2 b of the ICSID Convention After evaluating a rather complex

Kazakhstan’s Investment Laws,  from previous page

shareholding structure and numerous sales and purchases of Caratube’s shares, the tribunal held that it had no jurisdiction, as the claimant did not qualify as an “investor.” Contrary to earlier decisions, the tribunal stated merely that there should be only some economic link between the investor and his investment.86 Referring to the preamble of the U.S.-Kazakhstan BIT, the tribunal held that owning shares of the company for the company does not constitute an investment. The investor has to prove how much it contributed to the company, and claimant failed to prove these jurisdictional requirements.87 The tribunal therefore denied jurisdiction. As a result of the unsuccessful claim, the tribunal ordered Caratube to pay Kazakhstan US$3.2 million as compensation for arbitration costs. On 5 October 2012, however, Caratube filed for Annulment Proceedings at the ICSID.

process of expropriation is non-transparent and happens in increments that can be, if needed, accompanied by harassment and violence. Finally, Kazakhstan’s approach to state immunity is more than problematic. Even when an investor obtains a favorable award, its enforcement is far from certain. In summary, investments in Kazakhstan carry the possibility of big economic benefits but with attendant high risks.

IV. Conclusion


By setting forth protected areas and by providing certain benefits to investors, the Kazakh investment laws, on the one hand, afford a minimum level of legal certainty. The drawbacks might be found in broad formulations of exceptions to the protections, the lack of a systematic approach, and the confusion of public and civil law that give the government wide discretion to make expropriations without providing restitution to the investor.88 Further, the removal of the “grandfather clause” underlines Kazakhstan’s more restrictive approach to foreign investments. On the other hand, the investor-state arbitration practice demonstrates how investors can seek to arbitrate against Kazakhstan to receive restitution for expropriated investments. Complex shareholding structures, involving the inclusion of Kazakh citizens, can make the determination of “foreign investors” difficult. This can be seen in AIG Capital Partners Inc. and CJSC Tema Real Estate Company v. The Republic of Kazakhstan, Rumeli Telekom A.S. v. The Republic of Kazakhstan and Caratube International Oil Company LLP v. The Republic of Kazakhstan. Sometimes the

1 Wakeman-Linn, J., et al., Oil Funds in Transition Economies: Azerbaijan and Kazakhstan, in Fiscal Policy Formulation and Implementation in Oil Producing Countries 340 (Davis, J.M., Ossowski, R., and Fedilino, A., eds. IMF 2003).

Leonid Shmatenko studied law at the Heinrich-Heine-University of Duesseldorf, Germany, focusing on international law and arbitration. Currently, he is a junior research L. Shmatenko fellow, teaching assistant and doctoral candidate at the Heinrich-Heine-University.

2 Biedermann Int’l, Inc. v. The Republic of Kazakhstan and The Ass’n for Social and Economic Development of Western Kazakhstan “Intercaspian” (SCC Case No. 97/1996); CCL v. The Republic of Kazakhstan (SCC Case 122/2001); Caratube Int’l Oil Co. v. The Republic of Kazakhstan (ICSID Case No. ARB/08/12); KT Asia Investment Group BV v. The Republic of Kazakhstan (ICSID Case No. ARB/09/8); AES Corp. and Tau Power BV v. Republic of Kazakhstan (ICSID Case No. ARB/10/16); Türkiye Petrolleri Anonim Ortaklığı v. Republic of Kazakhstan (ICSID Case No. ARB/11/2); Enrho St Ltd. V. Republic of Kazakhstan (ICSID Case No. ARB/02/11); AIG Capital Partners, Inc. and CJSC Tema Real Estate Co. v. The Republic of Kazakhstan (ICSID Case No. ARB/01/6); Rumeli Telekom AS and Telsim Mobil Telekomunikasyon Hizmetleri AS v. The Republic of Kazakhstan (ICSID Case No. ARB/05/16); Liman Caspian Oil BV and NCL Dutch Investment BV v. The Republic of Kazakhstan (ICSID Case No. ARB/07/14); Ruby Roz Agricol and Kaseem Omar v. The Republic of Kazakhstan, UNCITRAL; World Wide Minerals v. The Republic of Kazakhstan, UNCITRAL; Ascom S.A. v. The Republic of Kazakhstan (SCC Case No. N/A). 3 Ascom (SCC Case No. N/A); Ruby Roz Agricol UNCITRAL; KT Asia Investment Group (ICSID

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Case No. ARB/09/8); AES Corp. (ICSID Case No. ARB/10/16); Türkiye Petrolleri Anonim Ortaklığı (ICSID Case No. ARB/11/2). 4 Enrho St Ltd. (ICSID Case No. ARB/02/11). 5 Biedermann Int’l, Inc. (SCC Case No. 97/1996); World Wide Minerals, UNCITRAL; Liman Caspian Oil (ICSID Case No. ARB/07/14). 6 CCL (SCC Case 122/2001); Caratube Int’l Oil Co. (ICSID Case No. ARB/08/12); AIG Capital Partners (ICSID Case No. ARB/01/6); Rumeli Telekom (ICSID Case No .ARB/05/16). 7 S. P. Moroz, Lectures on Investment Law at KOU (2008). 8 Zako Respubliki Kazahstan ot 27.12.1994 “Ob innostranyhinvesticiyah” [Law of the Republic of Kazakhstan of 27 December 1994 “On Foreign Investments”]. 9 Cf. U.N. Econ.& Social Comm’n for Asia & the Pacific, Investment Climate in Kazakhstan, Country Report 4 (2003) (prepared by K. Umurzakov). 10 Id. at 4. 11 Zakon Respubliki Kazahstan ot 28.2.1997 No. 75-1 “O gosudarstvnnojpoddrezhkepryamyhinvesticij” [Law of the Republic of Kazakhstan of 28 January 1997 “On the State Support of Foreign Direct Investments”]. 12 Moroz, supra note 7. 13 Zakon Respubliki Kazahstan ot 8.1.2003 “Ob investiciyah” [Law of the Republic of Kazakhstan of 8 January 2003 “Law on Investments”] <http:// uploads/Site/inkv.pdf>. 14 Cf. official data of the Payments Balance of the National Bank of RK at + < ion=4&itemid=75>. 15 Cf. the overview of the University of Kiel: < id=165>. 16 See the official list of signatories at <http:// Type=ICSIDDocRH&actionVal=ShowDocumen t&language=English>. 17 See details about signing and ratification at < php?id=312&L=0#c951>. 18 Cf. A. Nukusheva, The concept of foreign investor under the legislation of Kazakhstan, in Legal Aspects of Investment Contracts, 105 (A. Trunk and A. Aliyev eds. 2009). 19 Nukusheva, supra note 18 at 106. 20 Zakon Respubliki Kazakhstan ot 11.01.2007 No 214-III “O Licenziyah”posostoyaniyuna 10.07.2012 [Law of the Republic of Kazakhstan of 11 January 2007 No 214-III “On Licenses” as amended on 10 July 2012], <http://www.zakon.

continued, next page Page 31

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kz/141150-zakon-respubliki-kazakhstan-ot-11. html>. 21 Zakon Respubliki Kazakhstan “O Koncessiyah” ot 07.07.2006 No 167-III posostoyaniyuna 12.01.2012 [Law of the Republic of Kazakhstan “On Concessions” of 7 July 2006 No 167-III as amended on 12 January 2012]<http://www.>. 22 Ukaz Prezidenta Respubliki Kazakhstan ot 5 marta 2007 goda N 294 “O perecheneob’yektov, ne podlezhashihperedache v koncessiyu [Decree of the President of Kazakhstan of 5 March 2007 No 294 “On a list of objects, which are not subject to concessions,” 7 SAPP Respubliki Kazahkstan 80 (2007). < fa7625804f02e47ba6dbbf384bda0235/ U070294_20070305.htm?MOD=AJPERES&use DefaultText=0&useDefaultDesc=0>. 23 For an overview of the “grandfather clause,” see M. Suleymenov, “Grandfather clause” v. “adaptation clause”: new developments in the legislation of Kazakhstan, in Legal Aspects of Investment Contracts 219 (A. Trunk & A. Aliyev eds. 2009). 24 Baker & McKenzie, Doing Business zakhstan 8 (2012).



25 For an overview of the Russian Law on “Strategic Sectors,” see T. Gati, Russia’s New Law on Foreign Investment in Strategic Sectors and

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the Role of State Corporations in the Russian Economy, < Strategic%20Sectors%20-%20by%20Toby%20 T.%20Gati.pdf>; W. E. Pomeranz, Russian Protectionism and the Strategic Sectors Law, 25:2 Am. Univ. Int’l Law Review 213 (2010). 26 Grazhdanksiy Kodeks Respubliki Kazakhstan ot 27.12.1994 No 269-XII posostoyaniyuna 22.06.2012 [Civil Code of the Republic of Kazakhstan of 27 December 1994 No 269-XII as amended on 22 June 2012]<>. 27 Amended translation as provided in S. Akhmetova, Review of the draft Law “On alteration of Amendments and Supplements in the Law “On Subsoil and Subsoil Use” [sic], <http://www.>. 28 These are, inter alia, trunk railway networks, oil and gas pipelines, the national electricity network, telecom services, mail services, international airports, sea ports with an international importance, the air traffic control system, navigation marks regulating and providing safety of navigation, nuclear facilities, space facilities, water facilities, public highways, and shares in legal entities having ownership in the aforementioned sectors. See also OECD Investment Policy Reviews: Kazakhstan 2012, 51 et seq. (2012). 29 Cf. Akhmetova, supra note 27; L. Chanturia, Sachenrecht in den Staaten des Kaukasus und

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Zentralasiens, at 14, < http://www.cac-civillaw. org/beitraege/>. 30 Such a view is also taken by S. Akhmetova, supra note 27. 31 See overview at Kazkhinvest of the Ministry of Industry and New Technologies of the Republic of Kazakhstan,< ontent&section=3&itemid=105>. 32 Federal’nyi Zakon “Ob Osobyh Ekonomicheskih Zonah v Rossiyskoy Federacii” N 116-FZ ot 8 iyulya 2005 goda [Federal Law “On Special Economic Zones in the Russian Federation” No 116-FZ from 8 July 2005]< cgi/online.cgi?req=doc;base=LAW;n=123058>. 33 Z a k o n R e s p u b l i k i K a z a k h s t a n “ O special’nyhekonimicheskihzonah” v Respublike Kazakhstan No. 469-IV ot 21.07.2011 s izmeneniyamiot 12.01.2012 [Law of the Republic of Kazakhstan “On Special Economic Zones” No 469-IV of 21 July 2011 with amendments as of 12 January 2012]< Document/?doc_id=31038117&search=469-IV>. 34 D. Marenkov, Investitionsrecht in Kasachstan, < Trade/Recht-Zoll/wirtschafts-und-steuerrecht, did=600586.html>. 35 Id. 36 Id. 37 Z a k o n R e s p u b l i k i K a z a k h s t a n “ O nedrahinedrapol’zovanii” ot 27.01.1996 No 2828

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s izmeneniyamiidopolneniyamiposostoyaniyu 24.10.2007 [Law of the Republic of Kazakhstan “On Subsoil and Subsoil Use” from 27 January 1996 No 2828 with amendments and additions as of 24 October 2007]< LawBase/Files/ZRK2828.htm>.

52 Id.

78 Id. ¶¶ 688–690.

53 Id.

79 Id. ¶¶ 695–697.

38 English Version of the Law of the Republic of Kazakhstan from 24 June 2010 No 291-IV “On Subsoil and Subsoil Use,” < and%20Subsoil%20Use(1).doc>. For an overview of the Law, see A. Mokrousov and A. Neovius, Kazakhstan’s new Subsoil Law, <>; N. B. Abdreyeva, New subsoil law overhauls contracting environment, <> (free access after registration).

57 AIG Capital Partners, Inc. and CJSC Tema Real Estate Company v. Republic of Kazakhstan, Award of 7 October 2003, (ICSID Case No. ARB/01/6), 11 ICSID Reports 3 (2007).

39 Marenkov, supra note 34. 40 Id. 41 Zakon Respubliki Kazakhstan ot 15.07.2010 s izmeneniyamiidopolneniyamiposostoyaniyuna 10.07.2012 No 339-IV “Ob ispol’zovaniivo zdushnogoprostranstva Respubliki Kazakhstan ideyatel’nostiaviacii” [Law of the Republic of Kazakhstan “On the use of air space and aviation business” of 15 July 2010 with amendments and additions as of 10 July 2012 No 229-IV], <http://>. 42 Zakon Respubliki Kazakhstan ot 6 yanvarya 2012 goda No 527-IV “O nacional’noybezopasnosti Respubliki Kazakhstan” [Law of the Republic of Kazakhstan of 6 January 2012 No 527IV “On national security of the Republic of Kazakhstan”],< index.php?option=com_content&view=article&i d=263&Itemid=209&lang=ru>. 43 Zakon Respubliki Kazakhstan ot 23.07.1999 No 451-I “O sredstavahmassovoyinformacii” [Law of the Republic of Kazakhstan of 23 July 1999 No 451-I “On Mass Media”],<http://www.pavlodar. com/zakon/?dok=00084>. 44 Zakon Rosiyskoy Federcii “O sredstavahmassovoyinformacii” ot 27.12.1991 N 2124-1 [Law of the Russian Federation “On Mass Media” of 27 December 1991 N 2124-1],<http://www.>. 45 CCL v. The Republic of Kazakhstan (SCC Case 122/2001), 2005:1 Stockholm Int’l Arb. Rev. 123, 124 (2005). 46 Id. 47 Id. 48 Id. 49 Id. at 125. 50 Id. at 144 et seq. 51 CCL v. The Republic of Kazakhstan (SCC Case 122/2001), 2005:1 Stockholm Int’l Arb. Rev. 123, 124 (2005).

54 Id. at 151. 55 Id. at 169. 56 Id.

58 Id. at 4. 59 Id. 60 Id. at 38. 61 Id. at 48 et seq.

80 Id. at ¶ 708. 81 Id. at Award ¶¶ 1– 4. 82 Caratube Int’l Oil Co. v The Republic of Kazakhstan, Award of 5 June 2012, (ICSID Case No ARB/08/12). 83 Id. at ¶ 383. 84 Id. at ¶ 2. 85 Id. at ¶ 310. 86 Id. at ¶ 355.

62 Id. at 3 and 117, note 2.

87 Id. at ¶¶ 468 – 469.

63 M.K. Suleimenov, State Immunity: absolute or limited?,< php?page=1&newsid=208826>.

88 See also R. Kreindler, Avoiding Disputes in the Context of Subsoil Exploitation Agreements, 2012: 6 Yurist, <>.

64 AIG Capital Partners and Anr v. Kazakhstan and Anr, Decision of 20 Oct. 2005, [2005] Arb. L. R. 3. 65 Id. at 4. 66 Grazhdanskiyprocessual’nyikodeksRespubliki Kazakhstan ot 13.07.1999 No 411-I s izmeneniyamiidopolneniyamiposostoyaniyu 10.07.2012 [Civil Procedure Code of the Republic of Kazakhstan from 13 July 1999 No 411-I with amendments and additions as of 10 July 2012]<http://online.>. 67 With further references: M. K. Suleimenov, supra note 51. See also R. Hausmann, Investment Contracts with Foreign Investors, in Legal Aspects of Investment Contracts1 (10), (A. Trunk & A. Aliyev eds. 2009).

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68 Rumeli Telekom A.S. and Telsim Mobil Telekomunikasyon Hizmetleri A.S. v. Republic of Kazakhstan, Award of 29 July 2008, (ICSID Case No.ARB/05/16). 69 For a complete overview of over the facts, see id., ¶ 100 et seq. 70 Id. ¶ 308. 71 Id. ¶ 333 et seq. 72 For an extensive overview of the doctrine of “piercing the corporate veil” in international arbitration, see L. Shmatenko, “Piercing the Corporate Veil” is relative, 4 Young Arb. Rev. 25 (2012). 73 TokiosTokelės v. Ukraine, Award of 26 July 2007, (ICSID Case No. ARB/02/18). 74 Barcelona Traction, Light and Power Co. (New Application: 1962) (Belgium v. Spain) Second Phase, Judgment of 5 Feb. 1970,<>. 75 Rumeli Telekom A.S. and Telsim Mobil Telekomunikasyon Hizmetleri A.S. v. Republic of Kazakhstan, supra note 68, ¶ 310 et seq. 76 Id. 77 Id. ¶ 609 et seq.

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Doing Business in Russia By Alexander Scard and Alexandra Dolinskaya, Moscow, Russia

Introduction Russia is an opportunity-rich country with both enormous growth potential and a government that is actively looking to improve the investment climate. President Vladimir Putin recently stated that his goal is for Russia to rise from 120th to 20th in the World Bank’s investment attractiveness index, and ministries in different sectors have been instructed to develop road maps for change. Investors traditionally have been cautious about investing in Russia. Concerns center on transparency issues, corruption, bureaucracy and heavy regulation. Despite this, investments have increased and government-backed funds have taken prominence. With significant changes being made to the relevant legal framework—and with other developments such as Russia’s accession to the WTO—the Russian government is sending clear signals that it is open to further investment. This article gives an overview of some of the basic legal considerations that investors should be aware of when investing in Russia, discusses some of the more prominent reforms in the last year or two, and considers the impact that these may have on the investment climate.

Investor basics Legal forms of companies Up to now, a private investor interested in business in Russia has been primarily concerned with joint-stock companies or limited liability companies. Joint-stock companies are divided into two distinct groups. They can be either open-stock companies or closed-stock companies. Apart from closed-stock comPage 34

Moscow International Business Center

panies, the other type of company that represents a private firm with a limited number of shareholders is a limited liability company. The only companies that can offer shares to an unlimited number of people or entities are open-stock companies. Also, only shares in an open-stock company can be listed on a stock exchange. According to general corporate rules, the shareholders of a joint-stock company or a limited liability company are not responsible for such company’s obligations to its creditors. The company itself bears sole responsibility for such obligations. This rule is not necessarily applied, for example, in the case where shareholders have not fully paid for shares in their possession. Also, a shareholder may be obliged to take responsibility when a company faces bankruptcy if it is shown that the culpable actions of a shareholder have directly resulted in the company’s bankruptcy. Regulatory aspects Russia’s economy is heavily regulated, affecting activity in many spheres. Besides licensing and permitting issues, the demands of such regulation can require the disclosure of company information, can impact accounting procedures and the execution of transactions, and can even affect

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the choice of both management and individual employees. Importantly, certain companies, depending on their sphere of activity, can face additional demands from government regulation. Affected entities include, among others, credit or insurance organizations, companies investing in the stock market, and business in certain industries. The following sections look at two of the key regulatory factors—competition and strategic enterprises—followed by a review of typical considerations in investment structuring. Competition issues Russian antimonopoly law concerns activities that affect competition or foster monopolies in the Russian market. The law has a wide scope and includes issues such as control over corporate reorganizations and the acquisition of shares and assets. In accordance with the law as it currently stands, participants in such transactions must obtain prior or subsequent clearance from the Federal Antimonopoly Service (“FAS”) by filing a petition or notice. Please refer to the box entitled “Merger Control” on page 36 for further information on transactions that require antimonopoly clearance and the applicable thresholds. In practice, more or less every transaction that meets these thresholds will require an application to FAS for clearance. If transactions or other relevant actions have not been cleared with the FAS, they can be invalidated in court by the FAS if such transactions or actions led or may lead to the restriction of competition in the Russian market, including the creation or strengthening of a dominant position. In the event the relevant thresholds are

doing business in russia  from previous page met, non-submission of the documents for the antimonopoly clearance may lead to an administrative fine on the legal entities of up to RUR 500,000 (currently approximately US$16,000) and up to RUR 20,000 on their officers (currently approximately US$600). Investment in “strategic” companies Special restrictions apply to investments by foreign investors in companies that are deemed to be “strategic.” Foreign investors in these companies must obtain prior Russian government clearance before, or submit a notification after, entering into certain transactions. The FAS is a competent authority with regard to strategic clearances as well as with regard to antimonopoly issues. In some cases, a foreign investor will be prohibited from making an investment altogether. Strategic companies are companies carrying out business activities in strategic sectors, including services provided by

natural monopolies (for instance, trunk pipeline transportation of crude oil and oil products, pipeline transportation of gas, or transportation by rail), television and radio broadcasting in territories where more than 50% of the population is covered by the broadcaster, and certain other sectors. In addition, the foreign investments law establishes special additional regulations for strategic companies involved in mining exploration activities and/or the exploitation of subsoil plots, which have federal status. The concept of “strategic” is not confined, therefore, to industries that are of particular military or national security significance to Russia, but extends to sectors that are key drivers of the Russian economy or are of importance to national infrastructure. Please refer to the box entitled “Foreign Investor Going Strategic” on page 36 for further information on transactions that are subject to foreign investments law. A transaction made without prior clear-

ance, where such clearance is required, is void. The parties to such transactions will be ordered to return everything received as a result of the transactions. If it is not possible to effect a complete return, the court may deprive the defaulting foreign investor of voting rights at general meetings upon a claim by the FAS. Investment structuring issues Russian corporate legislation contains a large number of mandatory rules, which often makes it difficult to be flexible with regard to various aspects of running a company. Investors must be aware of the constant need to comply, strictly, with corporate governance rules at all times. As a result of the potential pitfalls, many foreign investors decline to work directly with Russian companies, preferring to maintain an indirect relationship with the support of other continued, next page

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doing business in russia  from previous page jurisdictions and laws. A number of investors operate in Russia through partnerships or investment holding companies established in offshore jurisdictions. A typical holding structure for a private investment involves one or more “vehicle” companies, incorporated in a jurisdiction with a favorable tax regime. Historically, Cyprus has tended to be the most popular jurisdiction, mainly because it has concluded a favorable double-taxation treaty with Russia and also operates a flexible corporate governance regime. Quite commonly, deals involving Russian assets effectively take place at the level of the ultimate holding company (for ex-

ample, the Cyprus parent company). Nevertheless, other jurisdictions have emerged. The Netherlands is an increasingly popular jurisdiction for setting up joint ventures because it is a well-established European jurisdiction with a flexible and developing company law regime. A current widespread practice is for Russian companies, or their immediate foreign holding companies, to enter into foreign law shareholders’ agreements concluded at the level of an offshore investment vehicle. Issues regulated by a shareholders’ agreement usually include management, nomination of officers, voting, profit sharing, pre-emption rights, provision of additional

Merger Control • Initial clearance threshold is set for 25% (a joint-stock company) or one-third (limited liability company) of voting shares depending on the legal form of the Russian target. • Clearance is required where balance sheet value of assets and turnover of acquirer and the target and their groups is above certain amount (risk zone starts from US$8 million for the target group). • Indirect acquisitions and foreign-to-foreign transactions are within the scope of Russian laws. • Clearance is to be obtained within one to three months and is typically a condition precedent for closing. • It is the duty of the acquirer to obtain the clearance; failure to do so may lead to fines, invalidation of the transaction and, in certain cases, criminal liability.

Foreign Investor Going Strategic • Strategic clearance is different from merger clearance but may be done in parallel; the time frame for obtaining the strategic clearance is the same. • Thresholds vary depending on the target’s business area (there is tougher control over mining companies) and the interest in the acquiring entity held by a foreign state. • Non-state entity must obtain the clearance in the case of an acquisition of more than 50% of voting shares in a regular strategic company or more than 25% in a mining strategic company. • Strategic clearance also applies to acquisition of control and to the right to appoint members of corporate bodies.

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information, certain veto rights, and noncompetition covenants. Such shareholders’ agreements are usually entered into with the purpose of imposing requirements supplementary to those set out by Russian law, or to alter the procedures or rules laid down by Russian law and the company’s articles of association. In most cases, the shareholders’ agreement is governed by foreign law and includes an arbitration clause providing for arbitration in a foreign seat and under the auspices of a reputable international arbitration institute. International arbitration lends itself as a dispute resolution mechanism due to the better prospects of enforcing in Russia an arbitral award under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (to which Russia is a party) than a court judgment rendered in a foreign state (the enforceability of which will depend principally on the existence of a bilateral enforcement treaty between Russia and the state in question). Even if the parties agree to make use of foreign law and jurisdiction in their transaction, certain mandatory provisions of Russian law still have to be respected. These include provisions on taxation, bankruptcy, insolvency, liquidation, preemption rights and corporate governance where Russian entities are involved. Some of these mandatory provisions are restrictive. For example, according to Russian law, the provisions of the shareholders’ agreement cannot amend the functions of the Russian company’s governing bodies. Foreign law will be applied by a Russian court only to the extent that its provisions do not contradict mandatory rules laid down by Russian legislation. In 2008-2009, Russian company laws were changed significantly. The changes included the possibility for the participants of a limited liability company to enter into an “agreement on exercising participants’ rights” or, in other words, a shareholders’ agreement at the level of a Russian operating or holding company. Since 9 June 2009, shareholders of Russian joint-stock companies may, as well, set certain internal rules in relation to the

doing business in russia  from previous page performance of rights attached to the shares that they own, including issues regarding voting at a general meeting of shareholders, obligations to sell or buy shares at a predefined price and other similar matters. In recent practice, shareholders’ agreements under Russian law have been concluded mainly by state-owned corporations, but their effectiveness is not yet completely clear. Private investors still seem to be reluctant to invest directly in Russian companies while court practice is perceived to be unfavorable or while Russian laws still do not explicitly provide for a number of concepts typically used for highend international transactions (for example, put or call options) or provide the same level of comfort as some foreign laws.

Potential game changers Civil Code changes The proposed changes to the Russian Civil Code are of a revolutionary nature. The draft of the law proposing substantial changes to the Civil Code was approved in the first reading by the lower house of

the Russian Parliament, the State Duma, in April 2012. The second reading is scheduled for November 2012. The proposed changes have been developed over a period of four years and affect all parts of the Civil Code. The most significant changes are as follows:

shareholders of a company will have the right to enter into an agreement for the exercise of their corporate powers. This will be known as a “corporate agreement.” At this stage, it is unclear how a shareholders’ agreement and a corporate agreement will correlate.

• Business entities may exist in the form of business partnerships or companies. All Russian companies are going to be reclassified as public or non-public companies. Two forms of companies can be created in the future; namely, the limited liability company and the public joint-stock company. Two forms of companies will cease to exist and may no longer be created; that is, the closed joint-stock company, which duplicates the features of limited liability companies in most instances, and the additional liability company, as this form of legal entity is rarely used in practice.

• The Civil Code will introduce the concept of statements about facts, which is similar to that of warranties and representations under English law. The changes provide that a party making a misleading statement to another contracting party about material facts will be obliged to reimburse its counterparty for the loss arising from the misleading statement. The non-defaulting party will have a right to terminate the contract if such statement was of a significant nature. In addition, the proposed changes introduce the concept of indemnification for the loss suffered.

• Legal entities may be registered with a standard form charter. Such standard form charter must be approved by the designated state authority. In addition,

These changes involve many concepts that are new to Russian law but well established in other jurisdictions. From an continued, next page

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doing business in russia  from previous page investment point of view, these are positive steps towards creating a more businessfriendly environment. Investment partnerships and business partnerships In the last quarter of 2011, laws were adopted creating two new legal structures: investment partnerships and business partnerships. Russian law already had the concept of a so-called special partnership (tovarischestvonavere), which is not a separate legal entity. This arrangement, however, was not successful, with less than 700 special partnerships registered since 1994. The lack of success was probably due to taxation at both the company level and member level, and due to a restriction preventing the managing partner from being a member of more than one partnership. With the support of the Russian government, the new investment partnerships and business partnerships are expected be more successful. Investment Partnerships The investment partnership law came into effect on 1 January 2012 and introduced a vehicle for joint investment activity. The law was based upon U.S./English limited partnership law and introduces the concepts of a general partner (who manages the operations) and a partner (who provides financing to the business). Foreign entities with no permanent presence in Russia can act only as limited partners, not general partners. A limited partner’s liability in the ordinary course of business is limited to the amount of its paid-up share, while general partners potentially bear liability with regard to all of their property. The key features of an investment partnership are: • It is not a separate legal entity, and the parties are taxed only once. • The maximum term of the partnership is fifteen years with a limit of fifty partners (there are no foreign ownership restrictions on limited partners). • The scope of activities is limited to buying, selling and holding non-publicly traded shares, other securities and shares Page 38

in the capital of business partnerships. • Limited partners can contribute only monies, while general partners can contribute assets, knowledge, skills and business reputation. • The partnership agreement (including the identity of the limited partners) is confidential. Business partnerships The business partnership law came into force on 1 July 2012 and introduced a vehicle suited for investments in start-ups, venture capital and innovation projects. The key features are: • The partnership is a separate legal entity. • The partnership term is unlimited, and there is a fifty-partner limit (foreign ownership restrictions may occur). • Partners can contribute monies or property rights having monetary value. • The corporate governance regime is far less regulated when compared to existing corporate vehicles. The management of a business partnership will be set out in its charter (a public document) and a business partnership agreement (a private and confidential document). The business partnership agreement can cover the management of the company, restrictions on partnership interest transfers and non-compete obligations. A partner’s liability in the ordinary course of business is limited to the amount of its paid-up share in the partnership assets. Russian Direct Investment Fund The Russian Direct Investment Fund (“RDIF”) is a US$10 billion fund that was set up in 2011 to co-invest, alongside some of the largest and most sophisticated investors, in the Russian economy. Prospective investors must either have assets under management exceeding US$1 billion (for financial investors) or revenues over US$1 billion (for strategic investors). The priority of the fund is to deliver excellent returns to the Russian state and to facilitate equally strong returns for co-investors. The idea behind the RDIF is simple:

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security, market knowledge and local presence. The fund provides the security of investing alongside a government-backed fund, and the co-investors benefit from the fund’s knowledge of the Russian market and local presence. In addition to bringing funds, the co-investors also bring their knowledge of the international markets. Like other funds in Russia, the RDIF is not limited to particular sectors or industries. Ten sectors, however, have been identified as requiring investment by the RDIF—five for modernization and another five for innovation. The modernization sectors identified as requiring investment by the RDIF include advanced processing of natural resources; agriculture and food retailing; and transport and logistics. The advanced processing of natural resources is likely to focus on energy efficiency or clean power rather than traditional oil and gas investments. The identified innovative sectors requiring modernization include aerospace, pharmaceuticals, health care, telecommunications and IT. The RDIF, along with co-investor EBRD, made its first investment in January 2012, and it plans to make thirty to forty investments in the next seven years. Its first investment was in MICEX–RTS, Russia’s main stock exchange (formed in December 2011 by the merger of Russia’s two leading Moscow-based stock exchanges). This merger correlated with another of the Russian government’s stated aims: to transform Moscow into a leading international financial center by creating one stable and well-recognized stock exchange. MIFC In 2008, then-President Dmitry Medvedev initiated the Moscow International Financial Centre (“MIFC”) project. According to the website (, MIFC is: the core of the Russian financial system and an integral part of the global interaction between investors and companies seeking to raise capital. MIFC is an ongoing process, a community effort by the business, the government and the Russian society in general. The catalyst of the project is the desire of

doing business in russia  from previous page professional financial market players to improve the business climate, make the Russian financial market a viable part of the global market, and boost its attractiveness for foreign investors and issuers.

In 2010, to help the progress of the MIFC, President Medvedev passed a decree to form a special task force. The main objective of the task force is to prepare and submit MIFC development plans to the President and to manage joint MIFC efforts by the state authorities and professionals in financial markets. The task force itself is subdivided into six distinct working groups: • Financial infrastructure and financial market regulation; • Corporate law and governance; financial transaction taxes; • Administrative procedures; • CIS / Eurasian Economic Community / EEC Customs Union cooperation; • Moscow infrastructure development; • Moscow educational, health, cultural and social infrastructure development.

should contribute to a more transparent and predictable investment climate. Key changes include: • Telecoms. Increased market access to the telecoms sector with the current limit of 49% foreign equity ownership being phased out within four years from accession. Russia has also agreed to the WTO’s Basic Telecommunications Agreement aimed at promoting fairness and competition. • Insurance. Increased market access for foreign insurance companies. • Financial services. A liberalization of the financial sector, including allowing 100% foreign ownership of banks and investment companies (subject to certain restrictions). • Goods. A general reduction in tariffs, with the average falling from 10% to 7.8%. Russia has committed to join the Information Technology Agreement which provides for duty-free treatment of relevant goods (computers, etc.) within three years.

Although, the objectives of the MIFC project are commendable (i.e., stable and modern financial system, improved business and investor climate, development of Russian regions, and market liquidity increase, to name a few), the real results of the MIFC work are yet to be seen.

Some analysts are estimating that Russia’s WTO membership will result in a gain of at least US$50 billion a year. Whatever financial gain there is, WTO membership should have a positive effect on trade and transparency and give the comfort of an integrated rules-based system to foreign investors.



On 16 December 2011, after eighteen years of negotiations, Russia became a member of the World Trade Organization (“WTO”). Ratification occurred in July 2012, and Russia will be bound by a series of trade rules and commitments creating investment opportunities. This

Despite the relatively short period of time since the fall of communism, Russia has emerged as a significant market economy that foreign investors and producers cannot afford to ignore. While concerns remain about the country’s natural resources dependency, the heavy presence of the

State in certain sectors, and issues such as bureaucracy and corruption, it is clear that initiatives are being taken on a number of fronts to make business in Russia more open and investor-friendly. Whether some of these new legal structures and instruments will actually lead to significant and lasting improvements to business in Russia remains to be seen. Since the new investment structures are untried, foreign investors are likely to prefer the more traditional models until the new ones have been thoroughly tested in the courts. In practical terms, the key to success for the foreign investor remains being able to align its interests with those of its Russian based co-investors/partners. The heightened interest of the Russian government in trying to create the right investment climate should provide some basis for optimism. Alexander Scard is counsel in the dispute resolution practice of Hogan Lovells’ Moscow office. Alexander specializes in international arbitration and has experience A. Scard handling disputes in a variety of sectors, including commodities, financial services, marine, oil & gas, sport and telecommunications. Alexandra Dolinskaya is a trainee solicitor in Hogan Lovells’ Moscow office, handling matters in the corporate, capital markets and dispute resolution practices. Alexandra primarily focuses on M&A and private equity transactions, domestic and offshore joint venture arrangements, and international commercial arbitration.

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Section ILQ Authors Receive Awards Presented at ILS Executive Council Meeting Office of Hogan Lovells US LLP, Miami, Florida, October 2012

Al Lindsay, Editor-in-Chief of the International Law Quarterly, presents a Best Article Award to Rafaela Vianna.Vianna’s article was entitled “Ethanol: Sweetening the Deal Between the U.S. and Brazil” and appeared in the fall 2011 special Brazil issue.

Al Lindsay presents a Best Article Award to Nicholas Ware. Ware’s article was entitled “China Factory Investigation Ride Along” and appeared in the fall 2010 special China issue.

Al Lindsay presents a Best Article Award to Omar K. Ibrahem. Ibrahem’s article was entitled “Unchartered Waters: The Kishanganga River Project Dispute and Arbitration Under the Indus Water Treaty” and appeared in the winter 2011 special international litigation and arbitration issue.

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Scene ILS Reception Mint Leaf Indian Brasserie Brickell Miami, Florida October 2012

(L-R) Regan Kruse of Astigarraga Davis, Daniel Cervantes of Hogan Lovells US LLP, Yara Lorenzo of Hogan Lovells US LLP, and Kristina Klykova, Visting Assistant Professor at the University of Miami School of Law.

Santiago Cueto (left) of Cueto Law Group with Al Lindsay, Hogan Lovells US LLP.

Nicholas Ware (second from left) of SAP and Arnie Lacayo (on right) of Astigarraga Davis, with friends.

Clarissa Rodriguez (on left) of Gomm & Smith, P.A., with friend.

Shelly Garg (middle) of Sandler, Travis & Rosenberg, P.A., with friends.

Andrew Riccio (on left) of Assouline & Berlowe, with friends.

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Russian Parties in English Courts By Julia Zagonek, Artem Doudko and Alexander Muksinov, London, England In the past decade, English courts have become a prominent platform for the resolution of commercial disputes involving parties from Russia, the CIS and other countries of the former Soviet Union (“FSU”),1 with the number of cases involving such parties increasing every year. The choice of England as a dispute resolution forum is not surprising, if not predictable, and reflects both the traditional perception of London as a neutral setting as well as the current shift of Russian capital to London. While some disputes are obviously Russian on their face (either because the parties are Russian companies or Russian individuals), there is also a significant number of disputes involving non-Russian corporate entities— Cyprus, BVI and Cayman being some of the most favored jurisdictions—that are, in fact, owned and/or controlled by Russian parties. A number of features distinguish Russian disputes from their Western counterparts. First, the disputes often arise at the level of individual beneficial owners, a reflection of the fact that some of the largest Russian businesses are ultimately owned by one person or a few individuals. Consequently, such disputes often involve deeply-rooted personal relationships and partnerships between individuals of high net worth, and they concern businesses in key industries worth billions of dollars. Second, Russian disputes almost always arise, at least in part, out of oral contracts with undocumented and informal arrangements. Witness evidence is therefore at the forefront of such disputes, with cases often turning on credibility of testimony. Third, Russian disputes are commonly loaded with interim applications (frequently in several jurisdictions) for worldwide freeze orders, disclosure orders and preservation orders. Finally, the high monetary values involved in Russian disputes—combined with the prominence of the participants—means that the best and the most expensive barristers are usually hired. Russian parties seem to like litigating in London. Apart from being perceived as an indicator of a particular social status—on par with owning luxury real estate, yachts Page 42

Above: Roman Abramovich and Boris Berezovsky. Right: The Rolls Building, part of the Royal Courts of Justice, London.

and private jets—litigation in London offers Russian parties the benefit of experienced and qualified English lawyers, often Russian-speaking, able to understand the commercial realities of Russian business relationships and to demystify them for an English court. The availability of equitable relief and the flexibility of the English courts are also perceived as advantages of English litigation. While such advantages are fairly obvious, one considerable disadvantage is the uncertainty of enforcement of English courts judgments. This factor has contributed to the noticeable shift towards international commercial arbitration. There is no bilateral agreement between the UK and Russia for mutual recognition and enforcement of judgments. One recent Russian court decision2 on this issue, however, indicates that Russian courts may be prepared to enforce English court judgments on the basis of reciprocity. This short article deals with two distinct categories of Russian cases heard by English courts: the high-profile and high-value disputes involving prominent individuals known as oligarchs; and disputes involving lesser known parties but giving rise to precedent-setting decisions on various points of English law.

High-profile disputes Berezovsky v. Abramovich3 One of the most prominent high-court

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litigations of 2011/2012, Berezovsky v. Abramovich educated the world (the case was meticulously reported by both the English and the Russian press) on how multi-billion fortunes were created in postsoviet Russia in the 1990’s. The dispute between two Russian billionaires, Boris Berezovsky and Roman Abramovich (owner of the Chelsea Football Club), concerned substantial shareholdings in a major Russian oil company, Sibneft, and the largest aluminium producer in the world, RusAl. Mr. Berezovsky’s claim in this case was believed to be the highest value claim of any description that has been litigated in the world to date, as its value exceeded US$5.6 billion. This was one of the first disputes heard in the newly built Rolls building, part of the Royal Courts of Justice in London. The trial lasted for four months and concluded in January 2012. Large teams of lawyers were involved on both sides: Mr. Abramovich’s legal team was led by Jonathan Sumption QC in his last case as counsel, having recently been appointed a Supreme Court judge. The eagerly awaited executive summary of the judgment was handed down by Mrs. Justice Gloster on 31 August 2012, and the full judgment was released on 21 September 2012. Mr. Berezovsky’s claims have been dismissed in their entirety. Gloster J. remarked on the impression left by Mr. Berezovsky’s evidence, finding

russian parties in english courts,  from previous page it wholly unreliable: I found Mr. Berezovsky an unimpressive, and inherently unreliable, witness, who regarded truth as a transitory, flexible concept, which could be moulded to suit his current purposes. . . . At times the evidence which he gave was deliberately dishonest; sometimes he was clearly making his evidence up as he went along in response to the perceived difficulty in answering the questions in a manner consistent with his case; at other times, I gained the impression that he was not necessarily being deliberately dishonest, but had deluded himself into believing his own version of events.

Cross-examination revealed that some of Mr. Berezovsky’s witnesses were to gain financially from an outcome in his favor, a factor that may have influenced the judge’s decision. By contrast, Gloster J. considered Mr. Abramovich to be a credible witness: “Where he had relevant knowledge, he was able to give full and detailed answers; he took care to distinguish between his own knowledge, reconstructed assumptions and speculation. He was not afraid to give answers which a less scrupulous witness would have considered unhelpful to his case.” The full judgment is over 500 pages but does not set any legal precedent as it seems to turn on the particular facts of the case, especially the parties’ recollections of business dealings that took place almost ten years ago. Mr. Berezovsky’s lawyers, it was widely reported, were acting on a conditional fee agreement and had secured insurance to cover their losses in the event Mr. Berezovsky was unsuccessful in the litigation. Mr. Abramovich’s costs in this case reportedly reached £40 million and, pursuant to the English Civil Procedure Rules, would be payable by Mr. Berezovsky as the unsuccessful party in the litigation. In March of this year, Mr. Berezovsky was

found dead in his London home—an apparent suicide, say detectives. Berezovsky v. the Estate of Patarkatsishvili and Others4 This case concerned another multi-billion-dollar claim by Mr. Berezovsky, this time against three defendants: Russian

Mr. Patarkatsishvili, as well as assets held by Mr. Anisimov and Salford, were in fact part-owned by Mr. Berezovsky. On 13 September 2012, shortly after Mr. Berezovsky’s claims against Mr. Abramovich were dismissed by Gloster J. in the case described above, a statement was issued by Mr. Berezovsky’s solicitors that Mr. Berezovsky had withdrawn his claims against Mr. Patarkatsishvili’s estate without admission of liability by any of the parties. According to the statement, Mr. Berezovsky also “confirms that he has no claim to any interest in any of the assets currently managed by [investment company] Salford.” The terms of the settlement have not been revealed to the public. Cherney v Deripaska5

metal magnate Vasily Anisimov; the estate of Mr. Berezovsky’s former business partner Badri Patarkatsishvili, who had been Georgia’s richest man; and an investment company named Salford. In his claim brought in the Chancery Division of the High Court, Mr. Berezovsky alleged that a substantial proportion of assets and funds worth between US$2 billion and US$3 billion (£1.3 billion and £1.9 billion) held by the Patarkatsishvili estate, or a large number of trusts and funds set up by

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This is another dispute regarding shares in RusAl. The claimant, Michael Cherney, alleged that Oleg Deripaska held 20% of RusAl shares (worth approximately US$4 billion) on his behalf and that Mr. Deripaska breached an alleged agreement to dispose of the shares and to account to Mr. Cherney for the proceeds. The factual background of the case was lengthy, complicated, and disputed by the parties. Central to the dispute was a meeting of the parties at a London hotel in March 2001. Mr. Cherney alleged that two agreements were concluded at that meeting. Under the first “agreement,” Mr. Deripaska allegedly agreed to pay Mr. Cherney the sum of US$250 million for his shares in an aluminium company that had transferred its assets to RusAl. Under the second “agreement,” Mr. Deripaska allegedly agreed to hold 20% of the shares in RusAl in trust for Mr. Cherney and then sell them and account to Mr. Cherney for the proceeds less the US$250 million. Mr. Deripaska submitted that the paycontinued, next page Page 43

russian parties in english courts,  from previous page ment made under the first document was protection money and denied that the second document dealing with the shares in RusAl was produced at the meeting. At the outset of the dispute, Mr. Deripaska attempted to challenge the jurisdiction of the English court but did not succeed in having the case removed from the English court. Clarke J. held that even though England was not the natural forum, the risks to the claimant that were inherent in a trial in Russia including, allegedly, assassination, were sufficient to make England the proper place for the determination of the claim. He therefore granted permission to serve the claim form out of the jurisdiction. This decision was subsequently upheld by the Court of Appeal. Hearings in the case commenced in the High Court in the beginning of May 2012.

Mr. Cherney was allowed to give evidence by video link from Israel because of an outstanding Interpol arrest warrant against him which meant he would be detained if he travelled to the UK. As in the case of Berezovsky v. Abramovich, it was anticipated that the outcome would turn on witness evidence. The case, however, was settled in September 2012. The terms of the settlement have not been made public. PCP Capital Partners Ltd. & anr v. Bogolyubov & ors6 This case involves a claim by PCP Capital Partners, an advisory firm owned by UK financier Amanda Staveley, against one of the Ukraine’s richest men, Gennady Bogolyubov, for a commission involving the acquisition from the Dubai government of One Trafalgar Square, a Victorian office

building on the famous Trafalgar Square in London. PCP alleges that in spring 2010, it was retained—by legal entities linked to Mr. Bogolyubov—to perform services in connection with the acquisition of the landmark property for an initial price of £165 million. The claimant alleges that although the property was not for sale, the claimant’s connections in the Dubai government ensured that the seller became receptive to Mr. Bogolyubov’s proposal. PCP further alleges that a £3 million success fee was agreed to and that a bid to acquire the property for £173 million was submitted by PCP on behalf of Mr. Bogolyubov in June 2010. In early August of the same year, PCP discovered that another bid was submitted on behalf of Mr. Bogolyubov by a different property investment consultancy, Michael

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russian parties in english courts,  from previous page Elliott, and accepted by the seller. In November of last year, the parties reached a “mutually satisfactory agreement.” In addition to the foregoing highly publicized cases involving prominent individuals, there are also a number of cases involving Russian and other FSU parties that are precedent-setting in various areas of English law. Some of the most recent cases are described below.

Precedent-setting cases VTB Capital plc v. (1) Nutritek International Corp; (2) Marshall Capital Holdings Ltd; (3) Marshall Capital LLC; (4) Konstantin Malofeev7 The case involved a successful challenge to the jurisdiction of English courts to hear claims worth around US$350 million. The issue before the Court of Appeal was whether it is possible to “pierce the corporate veil” in order to hold the controller of a company liable as a party to a company’s contracts and, on this basis, to exercise English court jurisdiction over parties located outside of England. The dispute involved both contractual and tortious claims by VTB against four defendants: two BVI companies; one Russian company; and Mr. Malofeev, a Russian resident. VTB alleged that it had been defrauded by the defendants into entering a loan agreement with a Russian company, Russagroprom (“RAP”). The loan agreement provided for English governing law and for English court jurisdiction. VTB sought to “pierce the corporate veil” of RAP and hold the defendants liable under the loan agreement between VTB and RAP. VTB alleged that the fourth defendant, Mr. Malofeev, was the owner and controller of the three other defendants and RAP. VTB also brought tort claims in deceit and conspiracy. The Court of Appeal held that VTB’s contract claim was not founded on a cause of action known to English law. According to the decision, it was appropriate to “pierce the corporate veil” only where special circumstances existed indicating that it was a mere facade concealing the true facts. Once

the veil was pierced, however, the court could not treat those in control of the company as themselves parties to its contracts. According to the Court of Appeal, the claimants had an arguable case that its loss was sustained in England, but other elements of the torts occurred elsewhere. Under the circumstances, there was no presumption that England was the natural or appropriate forum. The decision of the first instance judge who set aside permission to serve the proceedings out of the jurisdiction was upheld. Since the court lacked jurisdiction, the freezing injunction against Mr. Malofeev was also discharged. VTB appealed the decision of the Court of Appeal to the Supreme Court, which upheld, on 6 February 2013, the Court of Appeal’s decision as to piercing the corporate veil and as to jurisdiction.. Yukos Capital SARL v. OJSC Rosneft Oil Company8 This case is an important authority on the Act of State doctrine, which precludes an English court from adjudicating on acts of a foreign state within its own territory. In March 2007, Yukos Capital began enforcement proceedings in the Netherlands of four arbitration awards against Rosneft for over US$400 million (“Russian Awards”) issued in September 2006 by an arbitral tribunal sitting in Moscow. In May 2007, the Russian Arbitrazh (Commercial) Court set aside the Russian Awards (“Russian Annulment Judgments”). In April 2009, the Amsterdam Court of Appeal allowed enforcement of the Russian Awards and refused to recognize the Russian Annulment Judgments on the basis of “partial and dependent” judicial process in Russia in these proceedings. Subsequently, in 2010 Rosneft paid the principal sum under the Russian Awards. Yukos Capital then applied to the English Court to enforce the Russian Awards to recover outstanding interest of over US$160 million. Accordingly, by the time of the English enforcement proceedings, the English Court had before it: (a) the Russian Awards (enforced in the Netherlands); (b) the Russian Annulment Judgments (not recognized

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by the Dutch court); and (c) the Amsterdam Court of Appeal finding that the Russian Annulment Judgments were a result of a partial and dependent judicial process. In support of its contention that the Russian Annulment Judgments were “partial and dependent,” Yukos Capital argued that the Russian state, through its tax authorities and courts, had pursued an unlawful conspiracy to destroy Yukos Oil Company. Rosneft contended that this allegation was barred by the Act of State doctrine. The English Court of first instance found that: (1) the Act of State doctrine applied only where a litigant was challenging the validity or efficacy of a foreign act of state but not where the act of state was alleged to be unlawful, wrongful or improper; and (2) the decision of the Amsterdam Court of Appeal meant that Rosneft could no longer deny that the Russian Annulment Judgments were “partial and dependent” because this issue has already been decided by another court (issue estoppel). Rosneft appealed. The Court of Appeal considered the two issues and disagreed with the first instance judgment on both. As to the first issue, to which the majority of the judgment was dedicated, the Court of Appeal delivered a landmark ruling. The court held that the Act of State doctrine covered questions of unlawfulness and wrongfulness, clarified that court decisions do not constitute acts of state for the purposes of the doctrine and concluded that the English court is entitled to examine the substantial justice available in the courts of foreign jurisdictions. Naturally, the English courts will require cogent evidence for any allegation that a foreign court decision should not be recognized on the grounds of a failure of substantial justice, but the Court of Appeal emphasized that it was a matter of evidence and argument, not a matter of any immunity or doctrine of non-justiciability. On the second issue, the Court of Appeal found there to be no issue estoppel. This was because the Amsterdam Court of continued, next page Page 45

russian parties in english courts,  from previous page Appeal was guided by considerations of Dutch public order, whereas the English court would have to form its own view in line with any relevant issues of English public policy. The conclusions of the Court of Appeal on this issue are not surprising, given that under English law: (a) the courts have historically been required to consider whether proceedings before foreign courts complied with English concepts of natural justice; and (b) it is ultimately for the English court to decide the question of whether, on grounds of public policy, to withhold recognition of a foreign judgment, since accepting the decision of a third country on the matter would be an abdication of responsibility on the part of the English court in that it would necessarily entail acceptance that the scope of English public policy was the same as that of the third country. Fiona Trust & Holding Corp. and Others v. Privalov and Others9 This dispute concerned fraudulent conduct and corruption in the shipping industry. The claimant, Fiona Trust, brought proceedings after parent company Sov-

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comflot Group (“SCF Group”), a Russian shipping business, uncovered irregularities in charter parties that had been concluded with various subsidiaries of the group. The claimants alleged that the charter parties had been procured by bribery and contained terms highly favorable to the defendants, which included the former managing director of Sovcomflot UK, Yuri Privalov. Smith J. held that defendant Yuri Nikitin was liable for conspiracy to injure the SCF Group. Mr. Nikitin was found to have been involved in fraudulent conduct between 2001 and 2004, including the bribery of Mr. Privalov, and of collaboration and conspiracy with Mr. Privalov and certain individuals at two leading London ship brokers. The judge found that as a result of those conspiracies, “commissions” on various transactions were wrongly diverted from the brokers’ principals for the benefit of Mr. Nikitin. JSC BTA Bank v. Mukhtar Ablyazov10 The litigation between the Kazakhstan state-owned bank and its former boss has been proceeding for over two years, result-

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ing in over twenty judgments of the English High Court and the Court of Appeal. The bank claims that Mr. Ablyazov misappropriated more than US$5 billion of the bank’s funds. In February 2012, Mr. Ablyazov was sentenced to prison for contempt of court after he was found to have broken a worldwide freeze order against him. The High Court held on 6 February 2012 that Mr. Ablyazov was in contempt of court because he failed to disclose the full extent of his assets and dealt with his assets in breach of the freeze order. Mr. Ablyazov disappeared shortly after he was found guilty of contempt of court. He is believed to have fled to France. BTA had also applied to have the court force Mr. Ablyazov’s solicitors to disclose his whereabouts after he failed to appear in court on the day the committal order was handed down. This application was dismissed on the ground of privilege. The Court of Appeal separately accepted for consideration a challenge to a committal order against Mr. Ablyazov holding that the court in principle had jurisdiction to prevent a person found guilty of contempt

russian parties in english courts,  from previous page of court from pursuing his appeal against a committal order, but the power was not to be exercised in this case. In November 2012, the Court of Appeal dismissed Mr. Ablyazov’s appeal against the committal order. The Court of Appeal stated in its decision condemning Mr. Ablyazov’s conduct: Mr. Ablyazov has been unconscionable in his refusal to abide by the orders of the court. . . . It cannot be just or fair, or proportionate, to permit a contemnor to avoid the consequences of his contempt by the expedient of disappearing from sight (but not from the ability to communicate with his lawyers). . . . It is difficult to imagine a party to commercial litigation who has acted with more cynicism, opportunism and deviousness towards court orders than Mr Ablyazov.

The Court of Appeal decision debarred Mr. Ablyazov from defending against the bank’s claim, and the bank could now enter judgment against him and enforce the judgment against his assets. On 21 February 2013, the Supreme Court refused Mr. Ablyazov permission to appeal, and the Court has since authorized BTA to sell some of the defendant’s UK properties. JSC BTA Bank v. Alexander Stepanov11 This is another high-value case, involving recovery of funds from the defendant under a loan agreement and a personal guarantee, where a freeze order was obtained by the BTA Bank against the defendant. In October 2009, the bank obtained a High Court judgment against Mr. Stepanov for the sum of US$468 million and then sought to enforce it. Freezing and disclosure orders were subsequently obtained against the defendant, but Mr. Stepanov failed to comply with the orders. In March 2010 Mr. Stepanov was found guilty of contempt of court on the basis of his failure to comply with the orders and was sentenced to two years in prison. Ferrexpo AG v. Gilson Investments Limited and ors12 This recent case provides landmark authority on the issue of jurisdiction of the

English courts in disputes related to the validity of organs of legal entities incorporated outside the EU. The English Commercial Court has stayed proceedings against an Englanddomiciled defendant on the ground that the subject matter of the proceedings was the validity of shareholder resolutions of a Ukrainian company. The court held that the exclusive jurisdiction provisions of Article 22 of the Brussels Regulation (EC No 44/2001) should be given “reflexive effect” in favor of non-EU state courts where the subject matter of the dispute falls within one of the grounds for exclusive jurisdiction under Article 22. This is the first case where an English court has ruled that it can stay proceedings brought in England against a defendant domiciled in England where the dispute relates to the validity of decisions of the organs of a company in a non-EU state. The Commercial Court also stated obiter that it would have a similar power to stay proceedings where the other party has started earlier proceedings—in the non-EU state—that are sufficiently related to give rise to a risk of conflicting judgments. This brief overview of the most high-profile and most important recent decisions involving Russian and CIS parties in English courts demonstrates how Russian-related disputes can influence the development of English law. The recently completed Rolls building,13 it would seem, will continue to be the place for resolution of Russian disputes for some years to come. Julia Zagonek is an English solicitor-advocate with White & Case LLP who specializes in international arbitration. She has worked for a broad spectrum of international clients, including high netJ. Zagonek worth individuals and multi-national corporate entities. Advising on a wide range of jurisdictional and conflict-of-law issues, Julia has had experience with LCIA, ICC, AAA, SCC, and ad hoc arbitrations.

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Artem Doudko is an associate in the London dispute resolution practice of White & Case LLP. Artem specializes in advising Russian-speaking clients in international arbitrations. He repA. Doudko resents both corporations and high net-worth individuals. Advising on a wide range of jurisdictional and conflict-of-law issues, Artem has had experience with LCIA, ICC, AAA, SCC, and ad hoc arbitrations. Alexander Muksinov is an associate in the London dispute resolution practice of White & Case, LLP. Alexander focuses on international arbitration and litigation involving a Russian or CIS A. Muksinov element. Alexander’s experience includes international commercial arbitrations in corporate and financial services areas, investment disputes and international fraud and asset tracing litigation. Endnotes:

1 For the sake of convenience, use of the term “Russian” in this article is intended to include CIS and other countries of FSU. 2 Decision of the Moscow Circuit Court in case no. А40-119397/11-63-950, Boegli-Gravures S. A. V, Darsile-ASP, dated 12 April 2012. 3 [2012] EWHC 2463 (Comm). 4 Claim Nos. HC08C03549, HC09C00494 and HC09C00711. 5 [2008] EWHC 1530 (Comm). 6 HC10C04464. 7 [2011] EWHC 3107 (Ch). 8 [2012] EWCA Civ 855. 9 [2010] EWHC 3199 (Comm). 10 [2012] EWCA Civ 1411. 11 [2010] EWHC 2908 (Ch). 12 [2012] EWHC 721 (Comm). 13 The Rolls building is part of the Royal Courts in London. Home to the Chancery Division, the Admiralty and Commercial Court and the Technology and Construction Court, it is the largest specialist centre for the resolution of financial, business and property litigation anywhere in the world.

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Interim Measures in Ukraine By Andrey Astapov, Moscow, Russia; Oleh Beketov, Kyiv, Ukraine; and Oleksiy Zorin, Kyiv, Ukraine In general, interim measures in Ukraine may be defined as procedural actions taken to guarantee the effective enforcement of a creditor’s claim at a later date. These measures anticipate a final judgment on the merits and seek to ensure that it will be possible to enforce that judgment. Interim measures in Ukraine are regulated by the following legal sources:

ferred, concealed or otherwise disposed of or demonstrates that it will be impossible or very difficult to enforce the court decision in the future. Interim measures that are requested by the interested party shall be consistent with the claim and factual background (e.g., the total amount of attached funds shall not exceed the total amount of the respective claim).

• The Commercial Procedural Code of Ukraine of 6 November 1992;

Procedural issues

• The Civil Procedural Code of Ukraine of 18 March 2004; • The Code of Administrative Procedure of Ukraine of 6 July 2005. In Ukraine, interim measures may be applied in three different types of litigation, namely: • commercial litigation (where the parties to the dispute are exclusively legal entities and/or physical persons-entrepreneurs and/or state bodies); • civil litigation (where at least one natural person is involved in the dispute, notwithstanding the participation of legal entities, state bodies and private entrepreneurs); • administrative litigation (where an interested party challenges an act or an omission to act by the state authorities).

Unique features Interim measures in Ukraine, as set forth in the Commercial Procedural Code of Ukraine, Civil Procedural Code of Ukraine and Code of Administrative Procedure of Ukraine, may be divided into two main categories: • injunction to perform a certain action (e.g., prohibition to make payments, to transfer property, etc.); • attachment of assets (e.g., attachment of property, securities, funds etc.). The court may apply interim measures provided the interested party demonstrates by proper evidence that there is a probable risk that assets of the debtor will be transPage 48

A party to a dispute is entitled to request interim measures at any stage of a court proceeding. The application for interim measures may be considered by the court on either an ex parte or inter-party basis. After consideration of the application, the court renders an interlocutory judgment whereby it grants the application of the interim measures or dismisses it. The requesting party is not prohibited from resubmitting an application, provided the court dismissed the application for the first time.1 The interlocutory judgment is subject to appeal within five days. Filing of an appeal shall not result in suspension of interim measures enforcement.

Affect of the type of litigation Interim measures may have different features depending on the type of litigation. Civil litigation The list of interim measures is not exhaustive, and the court has the authority to apply several kinds of interim measures simultaneously.2 Interim measures shall be comparable with the claimant’s demands.3 Commercial litigation Injunction may be granted with respect to third persons to prohibit such persons from performing any actions that relate to the subject matter of the dispute.4 Interim measures cannot be applied if they prohibit or restrict shareholders’ corporate rights (e.g., to participate in general meetings, to provide information, etc.).5

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Administrative litigation Interim measures may be applied in order to suspend the acts of authorities (or certain provisions of the specific act). Interim measures cannot be applied if they (a) seek to suspend the acts of the Verkhovna Rada of Ukraine, the President of Ukraine and the High Council of Justice of Ukraine, or (b) seek to influence the election process.6

Enforcement The interlocutory judgment rendered by the court based on consideration of the application on interim measures is the enforcement document provided for in the Law of Ukraine “On Enforcement Procedure” dated 21 April 21 1999. Such document is subject to immediate enforcement. Interlocutory judgment shall be filed with the respective local branch of the State Enforcement Service, jurisdiction of which covers the place where the debtor is located. The state enforcement officer shall initiate enforcement procedure within one day from the date of receipt of the enforcement document.7 Details regarding enforcement of an interlocutory judgment depend on the type of interim measures granted by the court. If the court granted attachment of funds, the state enforcement officer issues a demand and sends it to banks where the debtor has an account. The demand shall contain a prescription to freeze the debtor’s accounts in the amount of the sums indicated in the interlocutory judgment.8 In the case of enforcement of interlocutory judgments, whereby the debtor is obliged to do or not to do certain actions, the state enforcement officer brings to the notice of debtor the prescription of interlocutory judgment and makes a formal note thereof. Interim measures in support of arbitration and/or foreign litigation Article 9 of the Law of Ukraine “On International Commercial Arbitration” provides for the possibility of using interim

interim measures in Ukraine,  from previous page measures in arbitration procedures. At the same time, neither the Code of Civil Procedure, nor Code of Commercial Procedure, nor Code of Administrative Procedure provides for the possibility of seeking interim measures in support of arbitration and/or foreign litigation. This situation will likely change in the future, however, and it is almost certain that revisions will be made to the procedural codes to enable applicants to request interim measures in support of arbitration and foreign litigation. Applications to enforce foreign arbitral awards or foreign court judgments Prior to September 2011, a party seeking recognition and enforcement of a foreign court judgment or arbitral award in Ukraine could not apply for interim measures in support of its motion. The situation drastically changed in September 2011 when amendments were introduced to the Civil Procedural Code of Ukraine. In particular, the court, upon request of the seeking party, may apply one of the types of interim measures specified by the Civil Procedural Code of Ukraine. Thus, a party filing an application on recognition and enforcement of a foreign arbitral award/foreign court judgment may ask the court to freeze the assets of the debtor in order to ensure that it will be possible to enforce the respective

award/court decision in the future. These changes—those in effect and those anticipated—will secure the interests of the party seeking recognition and enforcement of foreign arbitral awards/foreign court decisions in Ukraine and will make Ukraine more “arbitration friendly.” Andrey Astapov is managing partner and head of the resolution department of AstapovLawyers International Law Group. He specializes in international arbitration, international litigation, A. Astapov international commercial law, investments, international trade, emissions trading, energy, oil & gas and mineral resources law. Mr. Astapov has been named an “internationally recognized and outstanding arbitration expert” by Who’s Who Legal CIS 2010-2011. Oleh Beketov is a partner and head of the international litigation department of AstapovLawyers International Law Group. He has over six years of substantial experience in both pre-litigation and O. Beketov litigation stages of outstanding debts collection. Among his core

practice areas are international commercial arbitration and litigation, commercial and civil litigation, trade law, corporate law and foreign investments.

O. Zorin

and abroad.

Oleksiy Zorin is an associate in the litigation department of AstapovLawyers International Law Group. He has substantial litigation experience in corporate, international, commercial and civil law in Ukraine

Endnotes: 1 Part 4 of the Clarification of Supreme Commercial Court of Ukraine “On some issues of court practice on application of interim measures” № 02-5/611 of 23 Aug. 1994. 2 Part 2, art. 152 of the Civil Procedural Code of Ukraine. 3 Part 3, art. 152 of the Civil Procedural Code of Ukraine. 4 Part 1, art. 67 of the Commercial Procedural Code of Ukraine. 5 Part 4, art. 67 of the Commercial Procedural Code of Ukraine. 6 Part 5, art. 117 of the Code of Administrative Procedure of Ukraine. 7 Part 3, art. 30 of the Law of Ukraine “On Enforcement Procedure.” 8 Ukrainian legislation allows for the possibility of freezing a specified amount of the debtor’s account but not of blocking the whole account.

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Exhaustion of Trademark Rights, Parallel Imports and the Customs Union of Russia, Belarus and Kazakhstan By Natalia Gulyaeva, Moscow, Russia For the past several years, parallel imports into Russia have been the subject of discussion in any conference, round table and day-to-day conversation of IP rights holders and practitioners. A parallel import is usually defined in Russia as the import of a genuine product (not a counterfeit), legally labeled with a trademark, into the country’s commerce without due authorization by the trademark owner. The topic has become even more significant since the draft amendments to Part IV of the Russian Civil Code were made available and parallel importers have been lobbying for the principle of international exhaustion of trademark rights. Parallel imports: Russian legal framework In 2002, the principle of national exhaustion of trademark rights was introduced into Russian trademark law,1 which was replaced by the provisions in Part IV of the Russian Civil Code2 in 1 January 2008. According to Article 1487 in Part IV of the Russian Civil Code, use of a trademark by other persons with regard to goods that have been introduced into commerce in the territory of Russia by or upon the trademark owner’s consent shall not be recognized as an infringement of the exclusive right to the trademark. Accordingly, only when the products are put on the Russian market by trademark owners, or with their consent, should their rights be considered exhausted. A different principle, namely the regional exhaustion of trademark rights, has been adopted by the European Union and, as of 1 January 2012, by the Customs Union of Russia, Belarus and Kazakhstan. As a result of the creation of the Customs Union, “border customs controls between these countries have been further completely abolished and import/export clearance proPage 50

cedure has been cancelled in relation to the goods of internal trade between the three member-states.”3 According to the regional exhaustion of trademark rights principle, once a product has been introduced into commerce in Russia, Belarus or Kazakhstan by or upon the consent of the trademark owner, such trademark owner may no longer rely on national rights to prevent the import of the product from one Customs Union country into another. That said, trademark owners retain the right to prevent the import of genuine goods that have been introduced into the market outside of the customs territory. Both national and regional exhaustion of rights principles differ from the international exhaustion of trademark rights principle adopted by the United States. Pursuant to the international exhaustion of trademark rights principle, once products are introduced into commerce by the trademark owner or upon his or her consent, the first sale exhausts trademark rights, and the owner may no longer prevent further imports of such genuine products bearing the trademarks. Though the regional exhaustion of rights principle is applied de facto in the Customs Union, the lobby of parallel importers— which influenced substantially the draft

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amendments to Part IV of the Russian Civil Code—is trying to introduce a shift to the international exhaustion of rights principle. The Russian Federal Antimonopoly Service is also promoting proposals that would allow the parallel imports of original goods without the authorization of holders of exclusive rights. Proponents argue that prices would become more competitive, leading to a reduction in the rate of inflation. The Higher School of Economics in Moscow researched the issue and concluded that while a reduction in prices would likely take place, it would not outweigh the increase in the importation of counterfeit goods. Further, this change could have a negative effect on the reputation of the rights holders, as the counterfeit goods are likely to be inferior to the original, and customers might not realize that the goods are counterfeit.4 Even original goods might be defective, expired or not covered by the guarantee or after-sale service, which would likewise have a damaging effect on the reputation of the rights holders. If parallel imports were permitted, rights holders with localized production in Russia would have to compete with the lower costs and higher profit margins of their own production abroad. With such disincentives at work, parallel imports could thus lead to a slowdown in local production and a reduction of foreign direct investment in Russia. Exhaustion of trademark rights: application of the principle by the Russian courts The majority of cases that relate to the exhaustion of trademark rights are heard by the Russian arbitrazh courts, a system of state commercial courts with the Higher Arbitrazh Court serving as the supreme court. Trademark owners are entitled to file administrative and civil claims with the respective court of general

exhaustion of trademark rights,  from previous page jurisdiction (considering the cases involving individuals) or arbitrazh (state commercial) court (focusing on commercial disputes involving legal entities and registered individual entrepreneurs). Russian court proceedings may be considered relatively fast since in Russia the trademark owner may usually expect to receive a court decision on the merits of a trademark infringement case in around 3-6 months after the claim is filed. In Russia, in the absence of discovery, most frequently courts would expect to have all the evidence collected by a claimant prior to a trial. In addition, a specialized court, within the system of arbitrazh courts, that will deal with IP disputes only is set to open in Russia in March 2013.5

The new IP court is expected to promote professionalism and uniformity in judicial decisions regarding IP disputes. Administrative actions Since 2002, Russian arbitrazh courts have regularly considered administrative actions initiated by Russian customs authorities against unauthorized importers. When made by a company not included in the list disclosed to Russian customs by the respective rights holder, all parallel imports were treated as illegal by Russian customs authorities and courts. Such actions have been handled primarily by customs authorities, and the role of rights holders was in practice limited to providing evidence of due registration of the respective trademark rights in Russia. As a result, from the trademark owner’s perspective, such actions represented an extremely cost-efficient measure for control over unauthorized imports into Russia. The situation changed in 2009 by the ruling of the Higher Arbitrazh Court in the “Porsche” case.6 The ruling made it unlawful to hold parallel importers liable for an administrative offense. The rationale behind the ruling was that the Porsche Cayenne automobile in question was original, and there was no illegal trademark use in the actions of the importer. In accordance with Clause 1 of Article 1484 of the Civil Code of Russian Federation, a rights holder

in whose name a trademark has been registered owns an exclusive right to use such trademark. Under Clause 3 of Article 1484 of the Russian Civil Code, nobody has the right—without the rights holder’s permission—to use designations that are similar to the holder’s trademark for the goods for which the trademark has been registered or for similar goods if such use might result in consumer confusion. Clause 1 of Article 1515 of the Russian Civil Code provides further that products, labels, and packaging that contain illegally placed trademarks or confusingly similar trademarks are counterfeit. Genuine goods imported into Russia do not amount to counterfeit goods. Balancing private and public interests, the Higher Arbitrazh Court determined that the development of public liability, including administrative, into the areas of civil liability relating to the infringement of trademark rights should be limited. According to the approach applied by the Court, not every infringement of the trademark constitutes an offense under Article 14.10 of the Russian Code of Administrative Offenses,7 which deals with unlawful trademark use. Such offense occurs only with regard to actions connected to the import of counterfeit products that create a real threat to the public interest. As a result of the Porsche case, administrative actions became practically unavailable for IP rights holders, given the judiciary’s position that public resources should not be used to protect private interests. A number of administrative proceedings have been initiated before the Russian courts following the Porsche case, including those involving Nissan,8 Honda,9 and BMW,10 all of which had the same outcome. Although the Higher Arbitrazh Court has not commented on the national exhaustion of the trademark rights principle, it opined that Russian customs authorities should refrain from initiating administrative actions against parallel importers of original (not counterfeit) goods in order to maintain a balance of private and public interests. Consequently, administrative actions remain limited to restricting the import of counterfeit products.

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Civil actions The Higher Arbitrazh Court has not overruled the exhaustion of trademark rights principle, and civil actions remain available for rights holders as a means of preventing unauthorized parallel imports violating trademark rights. Article 1515 of the Russian Civil Code provides that the trademark owner whose rights were abused has a choice of remedies, including termination of acts that violate the owner’s rights (such as ceasing import and circulation of the goods bearing the trademark), recovery of damage caused to the rights holder, or statutory compensation up to approximately US$167,000 (or 5 million Russian Rouble). In the past, case law relating to civil liability for a trademark violation was inconsistent, but recently a more uniform approach has emerged. In 2009, in the case Kayaba v. AVTOlogistika LLC,the Arbitrazh Court of Moscow 11 and the Ninth Arbitrazh Appellate Court12 refused to prohibit the importation of original shock absorbers bearing Kyband Kayaba trademarks into Russia by unauthorized importer AVTOlogistika. Kayaba argued that AVTOlogistika did not have consent for such importation, and the imported goods were not intended for the Russian market. The Higher Arbitrazh Court ruled in favor of AVTOlogistika, stressing that the goods were originally purchased from authorized distributors in the United Arab Emirates and lawfully bore the trademark. Consequently, import of the goods marked by the rights holder cannot be considered an infringement of rights. In March 2011, however, the Russian courts supported the position of the trademark owner in Heineken Ceskaepublica v. ElitVodaRu LLC (the unauthorized importer of Krusovice beer) and stated that in the absence of documents confirming the legal use of the trademark, importation of the beer cannot be considered lawful in Russia.13 The same court has ruled that the national exhaustion of rights system requires the trademark owner’s authorization for the import of products into Russia, continued, next page Page 51

exhaustion of trademark rights,  from previous page even if they have already legally been put into circulation in another country. This position was later confirmed by the Higher Arbitrazh Court.14 In the July 2012 case of Longines Watch Co., Francillon Ltd. v. Bestwatch LLC, the Federal Arbitrazh Court of the North-West Region15 supported the position of the trademark owner and ordered the unauthorized importer to cease the importation, storage and distribution of watches bearing the Longines trademark. The court recognized that the goods (watches), labeled with the trademark LONGINES, were not introduced into commerce in Russia by the rights holder or with his consent. Consequently, the court found that the defendant’s related activity violated the exclusive rights of the rights holder, and the amount of compensation recovered from the defendant was approximately US$100,000 (3 million Rouble). This ruling was later confirmed by the Higher Arbitrazh Court.16 Further, in the case of Diageo Ireland v. ElitVodaRu LLC, involving the import of GUINNESS beer without the trademark owner’s consent, the Higher Arbitrazh Court17 ordered the importer to cease the use of the GUINNESS trademark and pay compensation in the amount of approximately US$33,000 (1 million Rouble) for the violation of the exclusive rights to the trademark owned by Diageo Ireland. Despite the fact parallel importing will unlikely be recognized in Russia as an administrative offense, as the above examples show, civil claims against the unauthorized importers have a reasonable chance of success and are rather frequently used by the rights holders. Parallel imports: latest trends in the Customs Union On 1 January 2012, the Customs Union of Russia, Belarus and Kazakhstan launched the Agreement on Unified Principles of Regulation in the Sphere of Intellectual Property Rights Protection, but the details of the way customs authorities of the member states will cooperate have not been finalized. The member states are expected to take steps to harmonize their IP laws Page 52

and regulations with the requirements of the Agreement in order to grant an equal level of IP protection to all individuals and companies of the Customs Union and to comply with the major international instruments governing intellectual property rights protection, particularly in light of Russia’s accession to the WTO. The Unified Customs Register of the Customs Union was intended to come into force simultaneously with the launch of the Customs Union, but this has not happened so far. Customs registers serve the purpose of control over the import/export of goods in their respective customs territories. A rights holder interested in implementation of a customs watch in Russia, Belarus or Kazakhstan may file with the respective customs authority an application for introduction of his or her trademark/copyright into the customs register. Such customs recordal further helps the rights holder to reduce circulation of counterfeit goods by monitoring unauthorized imports and, where appropriate, take action against such imports. Currently, three local customs registers of Russia, Belarus and Kazakhstan are still in operation, together with the laws on the exhaustion of rights. Before introduction of the Customs Union, Russia and Belarus had the national exhaustion of rights principle incorporated into their legislation, whereas Kazakhstan had the international exhaustion of rights principle. Now all three countries are bound by the regional exhaustion of rights principles. This poses a threat to Russia and Belarus, as goods can enter Kazakhstan (e.g., from China since China and Kazakhstan have a mutual customs border) without the permission of the relevant rights owners because trademark rights have been exhausted by the first sale outside of the domestic territory. Further, Belarus and Kazakhstan have less rigorous customs controls than Russia, which increases the threat of counterfeit goods entry. There are additional issues to be resolved with respect to the Customs Union. First, there is no unified and cost-efficient insurance instrument that could serve as due insurance against the customs-related risks

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across all three member states simultaneously. Procedures for cooperation of the customs authorities in the member states and information sharing between the customs authorities still require fine tuning. For example, Kazakhstan customs officers have power to hold the goods temporarily but no powers to initiate an administrative action with regard to such goods, while in Russia the powers of the customs authorities are broad and also cover actions before the Russian courts. Concerning ex-officio practice (the ability of customs, at its discretion, to postpone the clearance of suspicious products), the member states were given an option to choose whether or not to implement it. The reactions of the member states differed: Belarus decided against such implementation; Kazakhstan opted for such implementation without using it much in practice; and Russia both implemented the procedure and utilizes it quite extensively. Overall, the changes are aimed at making the customs-watch mechanism more efficient. Rights holders interested in monitoring imports into Russia currently keep their trademarks recorded with the national customs registers in Russia, Belarus and Kazakhstan and look forward to the day when recordal or registration with the Unified Customs Register of the Customs Union becomes available. The above observations confirm the importance of properly established and efficient customs border measures in the Customs Union of Russia, Belarus and Kazakhstan. Without such implementation, a legal mechanism for enforcement of IP rights before the courts would be neither available nor appealing for IP rights holders. Equally important is the close attention paid by the IP community—and indeed the state authorities—to keeping the national/ regional exhaustion of trademark rights principle as a part of the national/regional laws. Transformation of the currently applicable national/regional exhaustion of rights principle into the principle of international exhaustion would endanger efficiency of customs border measures and substantially increase the risks relating to circulation of counterfeit goods.

exhaustion of tradEmark rights, from previous page Natalia Gulyaeva is a partner heading Hogan Lovells’ CIS intellectual property, media and technology practice. Natalia is recognized as a leading Russian IP N. Gulyaeva and TMT lawyer. She advises clients on all aspects of contentious and non-contentious IP and TMT work including dispute resolution, anti-piracy and transactional work. Endnotes: 1 Law of Russian Federation “On Trade Marks, Service Marks and Appellations of Origin of Goods” of 23 Sept. 1992 No. 3520-1 as amended on 11 Dec. 2002. 2 Civil Code of the Russian Federation, Part Four. Federal Law of 18 Dec. 2006, No. 230-FZ.

3 Article 13 of the Agreement on Unified Principles of Regulation in the Spheres of Intellectual Property Rights Protection of 9 Dec. 2012, amended in July 2011, in force from 1 Jan. 2012 4 Legalization of parallel import and its effect of the goods market in Russia ( National Research University “Higher School of Economics”) 14 Dec. 2011. 5 Federal Law “On Amendments to Certain Legal Acts in Connection with Establishment of IP Court” of 8 Dec. 2011 N 422-FZ. 6 Ruling of the Presidium of the Higher Arbitrazh Court of Russia of 3 Feb. 2009 No. 10458/08 on case No. А40-9281/08-145-128. 7 Code of Administrative Offenses of the Russian Federation. Federal Law of 30 Dec. 2001, No. 195FZ. 8 Ruling of the Federal Arbitrazh Court of the Moscow Region of 18 Sept. 2009 No.KAA40/9237-09 on case No.A40-13351/08-148-89. 9 Ruling of the Federal Arbitrazh Court of the Moscow Region of 19 May 2009 No. KAA40/4172-09 on case No.A40-70041/08-194-486; Ruling of the Federal Arbitrazh Court of the Mos-

cow Region of 27 May 2009 No.KA-A41/4528-09 on case No.A41-14349/08. 10 Ruling of the Federal Arbitrazh Court of the Moscow Region of 28 July 2009 No.KAA40/6922-09 on case A40-54255/08-121-422; Ruling of the Federal Arbitrazh Court of the Moscow Region of 16 April 2009 No.KA-A40/297-09 on case No.A40-42639/08-146-386. 11 Ruling of the Arbitrazh Court of Moscow of 26 June 2009 on case No.A40-2250/09-51-27. 12 Ruling of the 9th Arbitrazh Court of Appeal of 28 Sept. 2009 No. 09АП-14602/2009-ГК on case No. A40-2250/09-51-27. 13 Ruling of the Federal Arbitrazh Court of Moscow Region of 21 March 2011 No.KGA40/1705-11. 14 Ruling of the Higher Arbitrazh Court of Russia of 1 July 2011 No.VAS-5310/11. 15 Ruling of the Federal Arbitrazh Court of NorthWest Region of 18 July 2012 No.A56-31546/2011. 16 Ruling of the Higher Arbitrazh Court of Russia of 13 Sept. 2012 No.VAS-11599/12. 17 Ruling of the Higher Arbitrazh Court of Russia of 6 Sept. 2012 No.VAS-681/12.

At the 10th International Law and Arbitration Conference held in Miami in February are (from left to right): Ed Davis of Astigarraga Davis, Miami; Susana Hidvegi-Arango of Brigard y Urrutia, Colombia; Lindsay SykesPinto of the Ferrere firm, Bolivia; Nick Dunne of Walkers, Cayman Islands; Arnoldo B. Lacayo, Astigarraga Davis, Miami; and Rodrigo Callejas of Carrillo y Asociados, Guatemala.

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Development of the Beneficial Ownership Concept and a New Tax Exemption for Eurobond Structures in Russia By Kirill Vikulov, Ph.D., Moscow, Russia Russia has been slowly taking steps in the development of a national financial market. One of the declared objectives of this process is to cut the costs of Russian companies in accessing capital. But it is a long process, and Russian companies have continued to look for funds on foreign capital markets, including using Eurobonds issued by their overseas special purpose vehicles (“SPVs”). This process has not been comprehensively regulated, which in the past created risks for Russian borrowers that the tax authorities could refuse to grant an exemption from the Russian withholding tax on interest payments to overseas SPVs. New tax rules have been introduced by Federal Law No. 97-FZ in order to eliminate such risks, which increased drastically last December due to an unexpected change in the Russian Ministry of Finance’s position on the application of Russian tax treaties in the context of so-called beneficial ownership.

Historical risks arising from taxation of interest payments on Eurobonds Late last year the Ministry of Finance, acting within its authority to interpret tax legislation, issued Letter No. 03-08-13/1, dated 30 December 2011 (“Letter No. 03-08-13/1”), to the Federal Tax Service, explaining the basis for taxing interest payments made by Russian borrowers to overseas SPVs in connection with Eurobond issuances. The double-tax treaties concluded by Russia normally are based on the Model Tax Convention of the Organization for Economic Cooperation and Development (“OECD”), providing for lower tax rates or tax exemptions for payments of dividends, interest and royalties in the source country if the recipient is the beneficial owner of income. In the Russian text, “beneficial owner” is literally translated as “the person having an actual right to income,” a term that so far has not been defined in domestic Page 54

tax legislation. Under the former approach, interest payments were not subject to taxation if made to an SPV registered in a foreign jurisdiction that had a tax treaty with Russia exempting interest payments from taxation in the source state. According to the prevailing view, the SPV was considered a beneficial owner as it had legal grounds to receive the income. Explanations offered by the tax authorities were based first and foremost on the Methodological Recommendations concerning Chapter 25 of the Tax Code of the Russian Federation, dated 28 March 2003 (the “Recommendations”), under which the lender had a legal right to receive income under a contract (e.g., a loan agreement) from the date of transferring funds to the borrower. Depositaries and nominees could actually receive monetary funds due to their status but were not legal owners of income and were not treated as beneficial owners. Meanwhile, the Ministry of Finance in 2006 issued several letters concerning taxation of payments related to American depository receipts (“ADR”) structures, clarifying that the concept of beneficial ownership should not be interpreted in a “narrow technical sense.” A company could qualify as a beneficial owner if it both had the legal right to receive income and determine the “economic destiny” of such income. At the same time, these explanations focused on the idea that depositaries and nominees should not be treated as beneficial owners. Interestingly, Russia has been carefully avoiding the problem of defining beneficial owner, due in part to the need to service government bonds. The Ministry of Finance issued explanations stating that payments on such securities were not subject to taxation at source regardless of the residency of the recipient, as the Russian Federation was a public body and could not be treated as a tax agent; thus, there was no mechanism for paying taxes.

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Letter No. 03-08-13/1 effectively restates the position that a foreign company was required to have not only legal rights to receive income, but also needed to actually use it (i.e., determine its “economic destiny”). This time, however, the Ministry of Finance expressly stated that it—rather than a foreign SPV that could be treated as beneficial owner—was the holder of Eurobonds. This conclusion by the Ministry of Finance dramatically increased the risks for Russian borrowers that had outstanding Eurobonds and were paying interest to foreign SPVs. Under Russian tax laws, exemption from the withholding tax at source under a tax treaty is not granted automatically but rather depends on whether the recipient of income (beneficial owner) has a tax residency certificate. Since Eurobonds are traded on foreign stock exchanges and their owners may change many times during the course of a business day, receipt of a tax residency certificate by Eurobond holders is virtually impossible. Russian borrowers (as well as SPVs and paying agents) neither asked for, nor collected these documents, so according to the Ministry of Finance’s logic, they were obliged to withhold a 20% tax on all interest payments to SPVs (even if Eurobond holders—or a substantial part of them—were in fact residents of states with which Russia has concluded tax treaties, rather than offshore companies of Russian tycoons). Since agreements on Eurobond issuance structures would ordinarily imply that SPVs and bondholders were protected by so-called gross-up provisions at the end of the day, the burden of additional taxes was placed on Russian borrowers.

Temporary solution to beneficial ownership problem for payments on Eurobonds The appearance of Letter No. 03-08-13/1 instantly increased risks for major Russian borrowers, including Rosneft, Rusal,

eurobond structures,  from previous page bank, VTB, Gazprom, and Transneft. Representatives of major borrowers initiated a discussion of these issues at the top level. As a result, the Russian Ministry of Finance proposed a draft law (and submitted it to the State Duma, the lower chamber of the Russian Parliament) that was subsequently revised by the State Duma’s budget and tax committee. The amendments were finally adopted in Federal Law No. 97-FZ on 29 June 2012. This law essentially re-established the status quo that had existed prior to the release of Letter No. 03-08-13/1. Russia embarked on the path of many developed jurisdictions, stipulating that interest income paid under certain structured financing on foreign capital markets should be exempted from taxation at source. Technically, the tax exemption in Russia was achieved by removing the obligation of the tax agent (i.e., the Russian borrower) to withhold tax on interest paid on the following instruments: (1) payments on Russian government bonds, state bonds of federal subjects of Russia, state municipal bonds, and bonds directly (i.e., not through foreign SPVs) issued by Russian corporate borrowers under foreign law; and (2) payments under loans from foreign SPVs, provided that the following two conditions are met: (a) debt claims related to publicly-traded bonds (listed/ traded on a recognized stock exchange or registered in international clearing systems), and (b) recipients (SPVs) are permanently located in a foreign jurisdiction that has concluded a tax treaty with Russia. In practice a company is usually deemed to be “permanently located” at its place of incorporation or legal address, although this is not clearly defined in Russian tax legislation. Under the new rules, the Russian borrower is not required to withhold tax when the recipient of income (SPV) is not registered with the Russian tax authorities, resulting in the absence of a taxation mechanism for such payments (which is an essential element of taxation). No tax shall be deemed established in the absence of an essential element of taxation. Similar

reasons for absence of the Russian withholding tax were previously used by the Ministry of Finance. Why the tax relief was granted using such an unusual legal drafting technique rather than through a simple exemption from taxation at source remains unclear. And yet the final result is what matters more to the financial sector. The rules set forth in Federal Law No. 97-FZ are more favorable than those previously proposed by the Russian Ministry of Finance. In particular, under the new rules interest paid to foreign SPVs is tax exempt regardless of the tax residency of holders of bonds held through depositary-clearing systems. According to the new rules, the tax exemption also extends to income from a suretyship, guarantee or other security paid by a Russian borrower under the terms of a debt instrument (e.g., in the event of early redemption). Importantly, the exemption from Russian withholding tax on bonds and interest under loans from SPVs issuing Eurobonds will apply retroactively to interest payments made after 1 January 2007. Thus, the tax authorities will not be able to penalize Russian borrowers for the failure to withhold taxes on payments already made, as they have no right to carry out tax audits beyond the three-year statute of limitations on commencing such audits. At the same time, the rules are temporary, and the tax exemption applies only to payments of interest on securities placed before 1 January 2014. Interestingly, an amendment introducing a sunset provision was proposed at the last moment on behalf of Igor Shuvalov, first deputy Prime Minister of the Russian government, without any additional explanations. Even so, the State Duma accepted the proposed amendment. From a practical standpoint, this means uncertainty over taxation of payments on bonds and loans to SPVs in relation to Eurobond issuances to be placed after 2013. According to information in the press, the Ministry of Finance expects that it will have, by that time, developed the rules for taxation of payments on publicly traded bonds and loans to SPVs issuing Eurobonds. In drafting the rules, international experience and the position of the OECD (which is currently working on the

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report “Clarifications of the Meaning of ‘Beneficial Owner’ in the OECD Model Tax Convention”) will be taken into account according to government officials. Under Article 3 of the Russian tax treaties, any term not defined in the treaty text shall, unless the context otherwise requires, have the meaning that it has under the law of the contracting state. Introducing a definition of “beneficial ownership” into domestic tax law may therefore have far reaching implications. Meanwhile, it is still an open question whether a broad economic-based interpretation of the “beneficial ownership” concept in domestic legislation adopted post factum will contradict the very purposes and objectives of the tax treaties. Strictly speaking, the adoption of such a provision may bar the use of tax treaties with a considerable number of foreign investments having complex cross-border structures (particularly in the financial sector) and inflict material damage on the country’s ability to attract foreign capital.

Problems involved in defining beneficial ownership in relation to other structures Importantly, Federal Law No. 97-FZ deals only with the problem of beneficial ownership in the context of issuances of government bonds, bonds directly placed by Russian borrowers under foreign law, and loans granted by foreign SPVs in the context of Eurobond issuances. Provisions on beneficial ownership, however, can be found in most of the tax treaties concluded by Russia with respect to payments of dividends, interest and royalties. This covers a considerable number of cross-border structures, including intra-group loans, holding and licensing structures. Federal Law No. 97-FZ does not resolve the issues of applying the beneficial ownership concept in these situations. Given the current uncertainty, the best way for taxpayers to proceed would be to develop, either internally or with the help of outside counsel, a justified position—based on the specific facts and circumstances of their respective continued, next page Page 55

eurobond structures,  from previous page businesses—on the interpretation of the beneficial ownership concept for Russia. In determining the beneficial owner for the purposes of tax treaties, in the absence of a legal definition, the background and preparatory works related to development of the term in the tax treaties should be used as a supplementary means of interpretation. According to research conducted by prominent foreign scholars, the term “beneficial owner” was for the first time used in the 1966 Protocol to the 1945 US–UK Tax Treaty. The term was discussed by the OECD in 1968 as a solution to the overly broad use of tax-treaty benefits by agents or nominees simply because of their status as the immediate recipient of the income (according to the earlier drafts of the OECD Model Convention, tax benefits applied by reference to income “paid . . . to” recipients of income). References to “beneficial owner” for the first time appeared in the OECD Model Convention of 1977. By considering the interpretation of preparatory materials, it could be traced that the term “beneficial owner” was incorporated in the OECD Model as part of the initiative to avoid application of tax-treaty benefits to agents, nominees and other similar persons (i.e., those persons having very narrow powers that render them, in relation to the income concerned, mere fiduciaries or administrators acting on account of the interested

parties). The term developed an economic undertone spontaneously as a result of the 2003 Commentary on the OECD Model Convention. The Draft Report “Clarification of the Meaning of ‘Beneficial Owner’ in the OECD Model Tax Convention” made an attempt to return to a narrow legal understanding of the term: Since the term “beneficial owner” was added to address potential difficulties arising from the use of the words “paid to . . . a resident” in paragraph 1, it was intended to be interpreted in this context and not to refer to any technical meaning that it could have had under the domestic law of a specific country (in fact, when it was added to the paragraph, the term did not have a precise meaning in the law of many countries).

In preparing its legal position, the taxpayer should first delimit its own facts and circumstances from those set forth in the clarifications of the Russian Ministry of Finance in relation to the taxation of payments under ADR and Eurobond structures. In view of the historical “beneficial owner” interpretation and the current OECD approach, a company has a good chance to defend its position before the tax authorities or in court. But the taxpayer’s position must be comprehensive and well documented and must also include business reasons for using a particular structure (for

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example, access to global long-term financing resources and hedging, and concentration of group treasury functions) to avoid a discussion over receiving “unjustified tax benefits” or using “a conduit company.” In addition, foreign companies may argue in court a substantial increase of the aggregate tax burden on their business in Russia due to the changes in interpretation of the “beneficial owner” term and request protection on the basis of the Federal Law “On Foreign Investments in the Russian Federation” or the provisions of relevant international agreements on encouragement and reciprocal protection of investments. Despite the arguments above, the current trend towards increasing tax control over cross-border structures in Russia cannot be denied. Analysis of the practice and recent court cases suggests that the Russian tax authorities are paying more and more attention to economic relations among companies and to the actual goals and objectives of structures or legal relations. In addition, Russia has been active in renegotiating existing tax treaties and supplementing them with information exchange and limitation on benefits provisions. These changes considerably increase the risks of challenges to structures aimed at aggressive tax planning and the use of foreign companies lacking real substance to carry out sham or artificial transactions. In such circumstances, it may be important to conduct a timely internal review and revise the structure and group’s tax strategy to avoid additional tax assessments and penalties. Kirill Vikulov is an associate at the Moscow office of Baker & McKenzie. He specializes in advising Russian and foreign multi-nationals on structuring their inbound and outbound K. Vikulov investments, and in tax planning for high net worth individuals. Mr. Vikulov graduated with honors from the Moscow State Institute of International Relations (MGIMO) and is pursuing a postgraduate degree specializing in financial and administrative law.

Russia’s Accession to the WTO: Consequences for Foreign Investors By Edward Borovikov, Brussels, Belgium On 22 August 2012, the Russian Federation finally became a member (the 156th) of the World Trade Organization (“WTO”), thus concluding an accession process lasting more than nineteen years and bringing much hope to current investors in Russia as well as to potential investors. Joining the WTO is an important component of the comprehensive trade policy reform carried out by Russia in recent years that aims to transform it from a one-dimensional natural resource exporter into a diversified and attractive economy. Another cornerstone of this process has been the formation of the Eurasian Economic Community (“EurAsEC”), a forum for regional integration among Kazakhstan, Russia, Belarus and other countries of the Commonwealth of Independent States (“CIS”) to ensure free movement of goods, services, capital and labor. Eventually, the project should lead to harmonization of business and economic laws, the establishment of supra-national laws with direct impact, deeper integration of markets and united macro-economic and monetary policy. This partnership would be very similar to the European Union, which also started as a customs union (“CU”). The most advanced form of integration under the EurAsEC umbrella has been achieved thus far by Russia, Kazakhstan and Belarus, which form a CU that has now become a single economic space. Several countries, it should be noted, have expressed interest in joining the CU, while the CU itself is considering starting negotiations on preferential trade agreements with some trading partners, such as Vietnam, already in 2013. In addition, Russia has requested a seat at the table of the Organization for Economic Co-operation and Development (“OECD”) since the 1990’s. With the recent reforms carried out in the context of the WTO, this membership may be closer to becoming reality. Benefits for Russia’s investment climate With accession to the WTO, Russia has

made the commitment to comply with the entire body of WTO legislation, as well as numerous specific commitments in relation to the Russian trade regime via the Accession Protocol. Accession on its own is a significant positive signal for investors. First, Russia now must abide by the same rules and procedures as the other 155 members of the WTO, thus affording more predictability when it comes to operating in Russia. Second, with the accession there is finally a recognized and effective dispute-settlement mechanism where Russia and its trading and investing partners may settle their disputes in accordance with the rule of law. While, admittedly, the mechanism has its issues, it is a tremendous addition to previously available tools for settlement of disagreements with Russia. Moreover, Russia’s general and specific systemic commitments promise significant improvements in various areas that affect a vast variety of businesses. For example, Russia has undertaken to markedly improve operations of custom authorities, promising faster and cheaper customs procedures, while the leveling of railway charges by mid-2013 (prior to this, domestic goods for domestic consumption have been transported at lower tariffs) will lower the cost of transportation. Similarly, Russia’s commitments in the area of technical barriers to trade and sanitary and phyto-sanitary measures, as well as some licensing procedures, should make trading more efficient and predictable. Meanwhile, commitments regarding transparency in the adaptation of any new trade measures

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should ensure predictability going forward. Finally, current Russian legislation and the Accession Protocol seemingly provide investors and operators in Russia with tools to ensure predictability of the investment climate and adherence to WTO law. As described in paragraph 151 of Russia’s Accession Protocol, with the ratification of the Protocol of Accession (which includes all WTO agreements), these commitments have become an integral part of the Russian legal system, which recognizes supremacy of international treaties over domestic legislation. Interested parties may challenge any inconsistencies of Russian measures or acts by Russian authorities with respective obligations under the WTO Agreements and the Accession Protocol. This would continued, next page Page 57

russia’s accession to the wto,  from previous page have tremendous practical implications. There have already been cases in the Russian courts that have ruled against provisions of Russian law, bolstering arguments with references to WTO obligations; e.g., discriminative nature of duties inconsistent with the WTO Agreement on trade-related aspects of intellectual property rights. Nevertheless, it remains to be seen how practice will develop. The situation is slightly more difficult with regard to possibilities of challenging—in the EurAsEC Court—decisions of the Eurasian Economic Commission, which is the body that carries out Trade Defense Instruments (“TDI”) investigations and decides the imposition of respective measures in the CU. The court’s statutes do not authorize it to rule directly on WTO obligations of a party or its compliance with such obligations. The court is primarily intended to consider cases of compliance of an organization’s bodies with the international treaties constituting the legal basis of the organization, and to consider challenges to the decisions, actions or inaction of the bodies. Nevertheless, at least one constituting treaty recognizes the importance of commitments undertaken by the members of EurAsEC in the context of their membership in the WTO and of WTO supremacy over EurAsEC provisions. Thus, theoretically the

applicant could try to base its challenge of the acts/actions of the organization as incompatible with this treaty. Also, somewhat overlapping competence of the national and EurAsEC courts creates numerous questions, such as the possibility of national courts ruling on the compatibility of actions of Russian authorities implementing EurAsEC decisions with WTO obligations, or the effects of such judgments in front of the EurAsEC court. The first decisions of the EurAsEC and Russian Supreme Court will determine whether Russia will in essence join a handful of nations allowing direct application of WTO law, or whether the court (or the legislature) will develop a rationale to avoid this. Increased opportunities in Kazakhstan and Belarus While Russia’s WTO accession brings significant improvements to the investment climate in Russia, it also significantly affects its partners in the EurAsEC—Kazakhstan and Belarus. While neither Kazakhstan, nor Belarus, nor the CU is a member of the WTO, with member states sharing single economic space, having the same tariff and joint supranational institutions responsible for, e.g., adoption of tradedefense measures, both Kazakhstan and Belarus are directly affected by Russia’s

accession to the WTO. There are many nation-specific exceptions throughout the agreements forming the CU and single economic space that are to be phased out over time. Nevertheless, investors now will have access to the Belarusian and Kazakh markets with few, if any, impediments. Additional benefits to some investors While the above benefits primarily affect investors either operating in Russia or seeking to invest there, Russia’s accession also brings tangible changes to application of foreign legislation and measures towards Russia and Russian companies (investors exporting from Russia to other markets). In addition to lower tariffs (application of most-favored-nation tariff rates) both ways, changes in the area of trade remedies are noteworthy. As of accession, with regard to any new investigations (or, in the context of reviews, within the scope of a particular review), Russian/CU authorities are obliged to follow provisions of the respective WTO agreements. While the Russian/CU trade-defense legislation relies to a large extent on provisions of the WTO agreements, the same cannot be said about the practice of authorities in applying this legislation. Actions of authorities have often drawn criticism from trading partners claiming systemic

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russia’s accession to the wto,  from previous page disregard for procedural rights of interested parties—rights such as proper disclosure of findings and, accordingly, rights to comment on findings. Similarly, authorities have been criticized for disregard of arguments and evidence presented by interested parties, use of questionable methodologies and non-transparent calculations. Insofar as a result of accession, application of Russian/CU trade-defense measures must improve, it will be a significant gain for investors in Russia relying on access to foreign markets. These investors in the past have seen an increase in price and a decrease in choice of imports as the result of questionable actions of authorities. Moreover, according to Russia’s commitments, interested parties affected by Russian trade-defense measures adopted in investigations initiated before the accession date are entitled to request reviews in cases where they have objections about consistency of given measures. Providers of services Another group of investors who have long waited for Russia to join the WTO are various service providers eager to gain their share in the service sector that satisfies the needs of 143 million consumers. In the banking sector Russia will maintain its position allowing foreign banks to operate only through locally established subsidiaries (as opposed to branches), albeit somewhat liberalizing access for such subsidiaries. As of accession to the WTO, such subsidiaries can be fully owned by foreign parent companies or individuals. Nevertheless, the presence of such foreign capital in banks—as well as in insurance companies—in the Russian markets will

still be controlled by providing Russian authorities with certain tools; e.g., a moratorium on issuing new licenses if the aggregate foreign capital in the Russian banking or insurance companies exceeds a certain threshold against the total charter capital of the Russian banking and insurance markets respectively. Nevertheless, it is expected that the remaining restrictions will be revisited in the context of joining the OECD. Insurance and reinsurance companies will be able to open their branches (albeit only after nine years from accession and payment of a deposit); non-life-insurance providers will be allowed to be 100% foreign owned; and limitations on issuing life insurance and mandatory civil liability insurance licenses for foreign firms will also be removed in five years. Market access commitments will be bound and further liberalized in the area of professional and business services, where lawyers, architects, accountants, engineers, as well as health care professionals, etc., will be permitted to establish companies with fully foreign capital. Moreover, already the influx of foreign managers under relieved conditions after accession can be observed, with the companies trying to bring the right people to manage their investment. In the audio-visual services sector, besides significant services commitments, one may expect that all of the promised improvements and assurances given to the United States and other partners regarding protection of intellectual property will also bring tangible results. But it remains to be seen whether enforcement and fulfilment of these obligations will match the promises. Finally, one must stress the fact that Russia has decided to liberalize the market of

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telecommunication services, which will be fully opened to all foreign suppliers and their subsidiaries without any need for a mandatory portion of Russian shareholding. The limitations of shareholding are, however, kept for a list of current landline operators who will maintain Russian majority shareholders for four years following the accession. A dose of negativity While these commitments sound promising, any commitments are only as valuable as the propensity to keep them. If the first weeks in the WTO serve as any indication, Russia is not off to a good start with its membership. A week after joining the WTO, Russia introduced an additional “utilization” (recycling) fee on various vehicles—cars, commercial trucks and buses. Russia, it is expected, soon will also apply this fee to harvesting machines and tractors. In essence, the fee is presented as an environmentally friendly measure intended to ensure proper management of used vehicles. The level of fees applicable to vehicles newly introduced in the Russia Federation (no fee is to be applied to cars already placed in circulation prior to 1 August 2012) depends on the vehicle’s age and the power of its engine and might vary from €50 (for a car imported for private purposes) to €150,000 for used heavy trucks. The problem with this measure lies in the fact that manufacturers producing or assembling cars in Russia can choose not to pay the fee and instead accept an obligation of safe processing and recycling of the vehicles at the end of their life-cycle. In other words, while importing cars becomes more expensive on account of the fee, domestic producers may benefit from deferral of the fee. This particular fee has already led to protests from Russia’s trading partners who believe it is a clear violation of WTO rules and specific commitments by Russia, which was allowed to keep—until 1 July 2018—some localization programs inconsistent with the WTO, while reducing import tariff rates from 30% to 25% (which should decrease further to 15% continued, next page

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russia’s accession to the wto,  from previous page

in 2019). Moreover, the Russian Parliament has started a legislative process to extend the preferential treatment for local producers beyond 1 July 2018, in violation of Russia’s commitments in the Accession Protocol. This disregard for the “freshly” signed agreement is not encouraging for investors and trade partners seeking to ascertain the trustworthiness and future behavior of the organization’s newest member. A small trade war with Ukraine might be even more damaging than the utilization fee measure, as Ukraine seems to have quickly reached a satisfactory resolution of the dispute by adopting WTO-inconsistent unilateral measures against Russia without undergoing the necessary WTO process. Should future practice also demonstrate this to be the recipe to resolve trade disputes with Russia, it would at least partially negate the purpose of Russia’s joining the WTO and, some might argue, even endanger trust in the WTO dispute settlement mechanism. High risk, high reward The last statement may perhaps seem premature given that even eleven years after its accession, China is being sued in the WTO for breaches of its Accession Protocol. Russian authorities have lately declined numerous questionable initiatives proposed by the local industries most concerned with accession to the WTO, due to the incompatibility of these initiatives with the WTO. Therefore, there should be no exaggerated concern about blatant disregard of WTO obligations by Russia. Be that as it may, it is also clear that with the on-going process of the EurAsEC and numerous commitments undertaken and

exemptions received, it may take years for Russia’s trade regime to reach the level described in its commitments to the WTO. These years of uncertainty, however, also might be an opportunity for investors seeking higher premiums and willing to take higher risks. There is a range of domestic industries that were expected to be, are, and will be significantly affected by Russia’s accession to the WTO due to their inability to compete with the foreign competitors. At the same time, many such industries are receiving subsidies from the government, and some have even retained special exemptions for their WTO-inconsistent subsidies in the Russian Accession Protocol. Moreover, it can be expected that, in relation to some of these industries, the Russian government will not be able to hold the hard line and will have to grant some form of support on the basis of strong political pressure. Russia post-accession Membership in the WTO does not affect application of competition laws by Russia. Similarly, while adherence to WTO rules should make the process more transparent and more predictable—and reduce the risk of arbitrary actions by the authorities—it does not eradicate corruption per se. Fortunately, this appears to be well understood by Russian authorities as illustrated by the continuing effort to join the OECD and OECD’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions some months before accession to the WTO. Successful implementation of this Convention and combating corruption in general should be important priorities of the Rus-

Ethics Questions?

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sian government in order to build on WTO accession so as to achieve a climate that is attractive to investors. In this vein, the Russian government has also undertaken to join the WTO’s Government Procurement Agreement as an observer and, later on, as a contracting party. Russia’s accession to the WTO is a remarkable achievement resulting from nineteen years’ work which, for the reasons described above, has already brought tremendous improvements to various businesses. While investing in Russia still is not risk free, this is a period of significant opportunity that might disappear for those who wait until Russia completes the transformation process. They may then face fiercer competition from established investors who will be unwilling to relinquish their share of the growing market. Edward Borovikov is the managing partner in Dentons’ Brussels office with substantial experience in issues of global trade and investment, crossborder commercial regulations, and interE. Borovikov national trade policy. He has in-depth experience in WTO, EU, and Russian trade law and practice, trade policy and international trade and investment negotiations, including the EU-Russia Partnership and Co-operation Agreement and Russia’s WTO accession. The author is grateful to Ilmars Naglis, consultant with the Dentons’ Brussels office, for assistance in research and preparing this article.

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Combating Fraud in Russia By Ivan Tyagoun, Moscow, Russia

I. Introduction: Impact of the Economic Recession With the economic situation not improving in many countries around the world, fraud—for the first time in many cases— has become an issue for shareholders, regulatory bodies and the wider public. The economic recession has unveiled fraud in Russia that was latent during the time of prosperity when revenues and profits were steadily growing. In the days of stock gains and higher margin returns, the attention of shareholders and owners was not directed towards the “costs”column of income statements. Everyone was focusing on increasing sales rather than on increasing profits via implementing effective and efficient management structures and cost optimization measures. Less attention was paid to issues such as operational efficiency and internal control. Not until the first wave of the recent economic crisis did shareholders begin to scrutinize the performance of their managers and investigate where company money really goes. At the same time, the economic recession gave rise to more instances of fraud. Research conducted by the Association of Certified Fraud Examiners and aimed at identifying a correlation between economic recession and fraudulent activity showed that the intense financial pressures caused by the economic crisis led to an increase in fraudulent activity. According to the report, this increase can be explained by three main factors: • Increased pressure: organizations and individuals experience pressure of increased financial tension; • Increased opportunity: cuts in workforces result in reduced internal controls and fewer fraud prevention measures; • Increased rationalization: low financial expectations cause pessimism, isolation, and induce individuals to rationalize illegal behavior, which they previously never considered possible. All in all, the recession helped to unveil existing fraud schemes that had previously

remained under cover during the time when revenues were growing and margins were high, simultaneously creating the conditions for a further increase in fraudulent activity.

II. Fraud Specifics in Russia Once an international company launches a Russian subsidiary or buys shares in a Russian entity, it should take into consideration potential fraud risks. The most common classification differentiates three major types of corporate fraud: • Misappropriation of assets; • Bribery and corruption; • Financial statement fraud. Based on our experience in Russia, asset misappropriation and bribery and corruption are the most common fraudulent activities. Despite great effort at the very top to fight fraud, bribery and corruption remain serious problems for Russia. Financial statement fraud is a more sophisticated type of fraudulent activity and is not as high of a concern for shareholders as asset misappropriation. Having said this, we see good developments with regard to the latter. Asset misappropriation Based on our experience, asset misappropriation remains the most widespread type of fraud in Russia and the CIS. This fraud is, understandably, of extreme concern for shareholders seeking to protect their assets and profits from loss. Most often, asset misappropriation is committed by mid-level and top management. The degrees of asset misappropriation uncovered by our Russian practice are surprising in their diversity and boldness, and range from the banal use of a company’s jet for personal reasons, to the creation of a network of shell companies to issue interest-free loans; and from the selling of finished goods at below-market prices to a company owned by a fraudster’s wife, to the donation to a charitable fund owned by a fraudster’s father. The boldness of the misconduct commit-

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ted by Russian managers is preconditioned by, but not limited to, the following factors: • Numerous flaws in internal controls. Internal controls remain a major weakness in many Russian companies. • A feeling of confidence that no one will get caught or that only an insignificant punishment will follow (a reprimand, or in the worst case, dismissal). Very few companies will take a case to court due to the fact that the process will require additional time and effort, and hearings in Russian courts are often slow. The uncovering of fraudulent activity usually ends up only in the mere dismissal of a fraudster. • There is no fear regarding the loss of one’s reputation after dismissal. Even after stealing millions from one company, an “experienced” fraudster can easily find a job in another company and continue his or her illegal activities in a new place. Few companies in Russia perform proper background checks on employees and management during the recruitment process. • Focus on short-term gains. Few Russian employees and managers aspire to a long-term career within one company. • The lack of a whistle-blowing framework. Very few Russian companies have whistle-blowing hotlines. Local subsidiaries of international corporations do have these fraud detection tools, though they are rarely used by local employees. We encountered situations in which the local employees of an international corporation were unaware of the existence of a whistle-blowing framework in their company. In some instances, top managers committed misappropriation crimes without even realizing they were doing something illegal or unethical. The separation of shareholders (owners) from management (employees) that came about with the introduction of the market economy was not fully realized and settled in the minds of continued, next page Page 61

combating fraud in russia,  from previous page individuals. There is a lack of compliance specialists and of general awareness of corporate ethics among employees. The creation of compliance departments is a new practice for Russian businesses, and such departments are becoming more widely utilized. More and more attention is also now being given to codes of ethics. Bribery and corruption: easy option or prerequisite? Corruption risks primarily attract the attention of American and British corporations interested in complying with the Foreign Corrupt Practices Act (“FCPA”) and Bribery Act, respectively, that either wish to invest in the Russian economy or already have a Russian subsidiary. According to the 2011 Transparency International Corruption Perceptions Index, Russia remains one of the most corrupt countries in the world. Russia is ranked 143 (out of a total of 182 countries in the ranking) with a score of 2.4, slightly better than in 2010, when the country ranked 154 (out of 178 countries) with a score of 2.1. According to the ratings prepared by the Investigation Committee of the Russian Federation that were published in June 2012, the top three corrupt sectors in Russia are: • law enforcement; • health care; • education. Some areas of the Russian economy, such as customs services and state inspectors, also continue to show high levels of corruption. Companies operating in the Russian market face increased pressure to divert improper payments to the government and to government officials. Often companies are induced to give bribes to government officials in order to overcome bureaucracy and to speed up formal procedures. The country-specific problems that increase corruption risks are: • Companies (or a company’s employees) may be induced to pay bribes because a refusal to do so would result in significant constraints over operational activity. Page 62

• A bribe is an “easily available” way to facilitate a particular process, override bureaucracy and, sometimes, law, with little risk of punishment for the bribegiver. • With regard to bribery, law enforcement in Russia is still at an early developmental stage. According to the Criminal Code, penalties for giving a bribe can be from fifteen to ninety times the amount of the bribe; however, the penalty can be waived if the briber actively participates in the criminal investigation. In practice, the paying of a bribe is hard to prove, and bribers often do not seem intimidated by the potential punishment. • The paying of bribes in Russia comes in different forms: donations to political campaigns; gifts to government officials (expensive watches, football tickets, and the like); payment of airfares and hotel fees and vacation expenses; and facilitation payments in the form of sponsorships to events organized by government authorities. Financial statement fraud Financial statement fraud is generally encountered by forensic investigators in companies with strong internal controls. Once the risk of being caught in misappropriation crimes increases to a certain level, managers and employees sometimes resort to this more sophisticated form of fraud, trying to make sure that revenues reach the amounts set by the employer in order for the employees to receive bonuses. Financial statement fraud, however, is not necessarily driven by greed. During a recession, competition levels increase, with a corresponding increase in the risk of financial statement fraud. The pressure that a foreign parent company imposes on its subsidiary in Russia can induce local managers to engage in misconduct that they otherwise would not. We have encountered instances where experienced top managers with no track record of misconduct have manipulated financial statements, caught between the pressure of increased expectations from senior management and the reality of worsening economic conditions.

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III. Conclusion: Responding to Risks

Our experience shows that the amount of money lost by companies due to fraudulent activity often exceeds the costs that the companies save by cutting their workforce, all in the face of weakening internal controls. The majority of Russian companies do not yet have effective compliance frameworks in place, and most Russian companies are not proactive in seeking to reduce fraud risk but tend to resolve problems after they appear. We therefore recommend that companies with weak internal controls take action now to save the corporation money later by introducing proactive measures of fraud and corruption prevention. Such measures include: • Design and implementation of effective internal controls; • Design and implementation of compliance frameworks; • Introduction of whistle-blower systems; • Realistic goals for management. Russia is striving to be an attractive investment destination. In recent years there has been considerable improvement in how government authorities—on both the federal and regional levels—address the fraud issue. Positive developments are noticeable and receive strong recognition by the investment community. Such developments range from an increased number of court rulings in favor of international investors to a greater commitment by government authorities to ensure investments receive priority attention. Companies that have already invested in Russia consider Russia a strategic region for growth. Understanding the risks and rewards, they invest in establishing an environment of strong internal and compliance controls to ensure their long-term growth in Russia. Ivan Tyagoun is a partner at KPMG in forensic services for Russia and CIS. He is based in Moscow, Russia. I. Tyagoun

litigation in russia  from page 4

Commercial courts The commercial courts system also consists of four instances. The courts of first instance in each of the member states of the Russian Federation hear cases initially. In total there are eighty-one commercial courts of first instance, a number almost equal to the number of the regions into which Russia is territorially divided. Appeals are then directed to the Appeal Commercial Court of the circuit (okrug) responsible for the region in which the first instance court is located. There are twenty such Appeal Commercial Courts in Russia. Further appeals of judgments are directed to the ten Federal Commercial Courts, which serve as almost last instance for litigants. These courts review only the proper interpretation and application of the law and do not accept new evidence. The cassation courts examine decisions that have already entered into legal force. Finally, the Supreme Commercial Court also retains its function of reviewing cases in supervisory proceedings. Supervisory review is aimed at correcting a significant error of material or procedural law as well as ensuring consistency of supervised judgments with contemporary court practice. The Supreme Commercial Court also may intervene where different courts take different approaches to issues of law and the need arises to develop a uniform approach. The Supreme Commercial Court has discretion whether to review the case or dismiss the application for reconsideration of the lower court judgment. Legal profession and representation Before addressing the modern court system in Russia, it is worth reviewing who can work as a legal practitioner in Russia. Participation in civil legal practice in Russia is not subject to any special legal regulation. Anyone graduating as a lawyer from an educational institution may work as a lawyer and provide legal services (with the exception of some services that can be rendered only by qualified advocates). Generally, there is no legal requirement

Constitutional Court of Russia

to be represented by a lawyer in civil dispute resolution. The status of “advocate” may be obtained by completing a two-year training course as a lawyer or by working in an advocate’s office for at least one year. In either case, an advocacy state exam must be passed. Only advocates are entitled to represent defendants in criminal proceedings, and advocates are also granted certain protections, including professional secrecy (discussed below) and state protection of advocates and their family members. Companies may be represented in court by their own lawyers, outside counsel, and by advocates. Russian legislation requires strict proof of the authority given by a company to its representative in court proceedings. The authority must be confirmed by a written power of attorney. Attorney-client and work-product privilege In Russia there is no concept of privilege, including attorney-client and work-product privileges. Nor are there any generalized obligations of disclosure, as in AngloAmerican procedure. A concept that partly overlaps with the attorney-client privilege, however, is the principle of professional secrecy, whereby advocates may not be interrogated about matters that have become known during the rendering of advocate services. This applies only to advocates. Therefore, communication with Russian counsel is, in theory, not protected from disclosure in relevant court proceedings. Given the undeveloped character of disclosure principles, however, the risk of

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disclosure is actually quite remote with respect to Russian court proceedings. The danger, however, of potentially having to disclose the receipt of commercial information to Russian police and the prosecutor’s office is higher in criminal proceedings. The latter are entitled to search for and receive information without practically any limits in the course of criminal investigations. Such investigations frequently are used in Russia as a tool against one’s competitor.

II. Key Features of Litigation in Modern Russia Public nature of court proceedings In Russia, as in most countries, arbitration is generally private, and litigation is public. In theory, any member of the public may attend court proceedings. Those court hearings that attract much public attention are frequently covered by television and newspaper journalists, although the number of people can be limited by the physical capacity of the courtroom. Video recording of court hearings in Russia by the press is subject to the judge’s approval. Russian court proceedings may be closed to the public, however, if the hearing could result in disclosure of state secrets. A proceeding may also be held privately upon petition of the parties if the proceeding may result in the disclosure of business, professional or other protected secrets. The judge makes the final decision on whether a hearing is to be public or private. Filing a lawsuit Traditionally in Russia, a statement of claim was brought by delivering it to the relevant court’s office. Since 2010 a claimant in Russian commercial courts is allowed to submit the claim and all associated documents electronically through the relevant court’s website. This procedure is not available in courts of general jurisdiction. Electronically submitted documents must be continued, next page Page 63

litigation in russia,  from previous page scans of the original claim. Other documents filed by post or in person must be uploaded through the website of the commercial court. There is, however, one important exception: applications for interim relief or injunctions cannot be filed electronically. A hard copy must be delivered to the court. Once the party has been duly served by the court of first instance, it must follow the status of the case on the court’s website. There is no obligation for the claimant to notify the defendant of the claim in courts of general jurisdiction. Just as in the commercial courts, however, the court must serve the summons on all persons participating in the dispute; otherwise, the court decision may be overturned on appeal. Timetable for proceedings Within two months from the date the claim was filed, the court prepares for the main hearing and arranges preliminary hearings. Within one month thereafter, the final decision should be issued. These are the standard rules as to how the case

should proceed through the first instance commercial court in Russia. In practice, however, the courts do not always comply with these deadlines, and the most complicated cases may last for a year or more. During the preliminary hearing, the court verifies the relevant facts, collects the evidence presented, listens to the arguments of the parties, encourages the parties to settle their dispute amicably, determines if other parties must participate in the proceedings, rules on any applications made by the parties, and conducts other preparatory work. The parties may provide evidence, make petitions and present arguments. Evidence and disclosure During the preliminary hearing, the parties must exchange all evidence on which they intend to rely in support of their claims or defenses. Importantly, Russian procedural rules do not have the disclosure requirements that exist in the US and UK. The general rule is that each party may rely only on evidence in its possession and

which it is able to present to the court. This reflects the general principle of Russian law that each party is bound to prove evidence on which it relies in support of its claim and bears the risk of not presenting the relevant evidence. A party that is not in a position to obtain particular evidence may ask the court to request this evidence from another party. In order for such application to succeed, the party must be very precise in indicating the location of the evidence and in describing the evidence itself and the relevant circumstances. If the application is granted, the person to whom it is addressed must deliver the evidence to the court. Failure to comply subjects the party to a fine for non-compliance with a court order. In practice, the period during which parties to a dispute present their evidence is usually quite long and may in fact exceed the maximum time period prescribed by the court for resolution of the dispute. Another important feature of litigation in Russia is that, historically, witnesses

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litigation in russia,  from previous page are very rarely called by the courts to give testimony. This is partly explained by the formalistic nature of Russian law, which requires most commercial transactions to be executed in writing, and partly by the traditional approach of Soviet/Russian courts to base judgments on the written evidence. When so doing, witnesses ordinarily must provide their testimony in person in the courtroom. To give false evidence is a criminal offense, and witnesses must confirm that they understand this before testifying. Anyone may appear as a fact witness (there are no restrictions on, for example, employees of one of the parties appearing). A witness must first respond to questions put by the court; then the parties have the right to examine the witness, starting with the party at whose request the witness was summoned. Interim measures A party can apply for an interim attachment or a preliminary injunction at any stage of the proceedings, including before the proceedings have started. The purpose of interim measures is to secure the performance of the future judgment on the claim and to mitigate the risk of damage to the interests of the claimant. As such, applications for interim measures may be made without notice to the defendant. Measures of preliminary relief that are usually available include an attachment of monetary funds or personal or real property owned by the defendant to secure the claim, a transfer of disputed assets into the custody of the claimant or a third party, and an injunction prohibiting the defendant or other persons from taking certain actions in connection with disputed assets. The court has wide discretion regarding the type of measures it may order. Costs A filing fee is paid by the claimant upon filing the claim. The size of the filing fee is stipulated by the Russian Tax Code and is usually a percentage of the value of the claim. For any monetary claims, however, the maximum amount of the filing fee is around US$6,000. Non-monetary claims are subject to small fees not exceeding

US$150. Judicial costs, such as costs for expert witnesses, are paid by the party that applied to the court for them. Depending on the outcome of the case, the court can order the losing party to reimburse the successful party for its litigation expenses, in full or in part, including the legal fees paid by the successful party. Russian courts, reimburse only reasonable legal fees. The court order of reimbursement usually does not explain how the court arrived at the amount to be reimbursed. Generally, fees awarded by commercial courts tend to be low. There are no provisions in Russian law that entitle the defendant to request that the claimant provide security for the defendant’s costs. Settlement Parties may settle the dispute at any stage of the proceedings, including the enforcement stage. Such settlement must be approved by the court. The court will reject any amicable settlement that violates the rights and interests of third parties or contravenes the law. Judgments and enforcement Enforcement of judgments is made through a writ of execution after the judgment comes into force. There are two methods of enforcing a writ of execution. First, if the judgment orders the defendant to pay a certain monetary amount, the claimant can simply deliver the writ to a bank where the defendant has an account. The bank must then debit the defendant’s account and remit the sum owed to the claimant within three working days. In all other cases, the claimant must submit the writ of enforcement to the office of the court bailiffs. A court bailiff then initiates enforcement proceedings, beginning with an offer to the defendant to satisfy the writ of execution voluntarily within five days. The court bailiff will search for and attach assets of the defendant. If the defendant fails to satisfy the writ, the bailiff conducts sales at auction of the defendant’s assets and remits the proceeds to the claimant. Where the court decision consists of an order for the defendant to act, the bailiff informs the defendant of a deadline for

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voluntary compliance. If the defendant fails to comply, the bailiff may impose a fine that will be followed, in the event of further default, by administrative or criminal sanctions. In general, court bailiffs have two months to enforce a writ of enforcement.

III. Modern Trends in Litigation in Russia Corruption/undue influence issues In modern Russia, it is widely accepted that corruption is one of the main obstacles to the country’s economic and social development. According to some expert estimates, the market value for corruption in the country exceeds US$300 billion per year. Russian courts and judges are often blamed for corruption. Despite all the talk of judicial reform by high-ranking politicians, and despite some modest progress, very little practical steps have been taken to combat corruption, leaving a lot of room for improvement. Indeed, this is unlikely to be accomplished in the abstract with a general fight over corruption in Russian society. Western society and media have developed strong opinions about flaws in the Russian legal system. Russian judges are subject to various forms of undue influence. The practice of “telephone justice” where a senior regional or federal official calls and tells a chairman or deputy chairman of the court—or sometimes even tells a judge—how to rule is one of the most notorious examples. Another example of corruption is direct bribery of judges. In each region of Russia, it is possible to find intermediaries who assist in obtaining favorable outcomes. Judges in Russia are appointed by the decree of the Russian president. In 2008 Yelena Valyavina, first deputy chairman of the Supreme Commercial Court, stated publicly that the Kremlin had pressured and threatened the Russian judiciary in an effort to secure favorable rulings. The above factors have diminished the trust of Russian citizens towards the judiciary. A recent exit poll conducted by a repucontinued, next page Page 65

litigation in russia,â&#x20AC;&#x201A; from previous page table institute in July 2012 showed that only 24% of the interviewed persons approved of and had confidence in Russian judges. For the last several years, Russian business owners have begun to use foreign courts and foreign law in their disputes. Once out of Russia, they try to shield themselves from liability for their conduct at home by portraying themselves as victims of biased prosecution or a biased judiciary. This argument can now be found in almost every significant legal dispute between Russian business people in Western courts. Highly ranked Russian officialsâ&#x20AC;&#x201D;including Chairman of the Supreme Commercial Court, Mr. Anton Ivanov, and current Prime Minister and former President, Dmitry Medvedevâ&#x20AC;&#x201D;recently proposed measures (discussed in further detail below) to limit Russian-related disputes from being heard abroad. Such measures, however, would unlikely be productive. In recent years, the system of commercial courts has become more transparent. Any judgment issued in any commercial court case is subject to public disclosure and can be discussed by the legal community. There are signs that the level of corruption in modern courts in Russia is decreasing, but it may take many years for Russian courts to achieve independence and gain the respect of citizens and companies. Much will depend on the Russian political democracy and the social and public development of Russian society. Claim involving a foreign company Over the past decade, Russian legislation and court practice have tended to expand the variety of disputes that may be considered by Russian courts where foreign companies are involved as either plaintiffs or defendants. At present, there is an extensive list of disputes that a Russian commercial court may adjudicate. Suit against a foreign company in Russia is permitted even when that entity has a small presence in Russia. Other circumstances in which local commercial courts have jurisdiction over disputes involving foreign entities or nationals include where: (1) the defendant is located in Russia; Page 66

(2) the defendant has assets in Russia, including funds in bank accounts or any movable/immovable property; (3) the defendant has a representative office or branch in Russia; (4) a dispute arose from an agreement that was performed or should have been performed in Russia; (5) a tort or unjust enrichment occurred in Russia; (6) there is a close connection between the disputed legal relationship and Russian territory (this is a discretionary test to be applied by the Russian judge). Russian courts are entitled to hear cases involving foreign companies where there is a jurisdictional clause in favor of the Russian court. There is also a special list of disputes falling within the exclusive jurisdiction of the Russian courts. These disputes can be considered only by a Russian commercial court, and any judgment of a foreign court on the same subject matter would not be recognized in Russia. Russian law provides that the following categories of disputes must be exclusively litigated in Russia: (1) d i s p u t e s r e l a t i n g t o p r o p e r t y owned by the Russian state (including disputes relating to privatization of state property and compulsory acquisition of property for state purposes); (2) disputes relating to immovable property in Russia or related property rights; (3) disputes relating to issuing or registering patents, trademark certificates, industrial designs and utility models, or registration of other IP rights, which require issuing or registering patents or certificates in Russia; (4) disputes concerning requests to invalidate entries in state registers made by the competent Russian agencies that maintain these registers; (5) disputes involving organizing, registering or wrapping up legal entities in Russia and challenging resolutions of boards and executive bodies of legal entities in Russia; 6) cases involving foreign legal entities and individuals, arising from administrative matters and other public rela-

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tions (for example, public misfeasance). Russia is a party to the 1954 Hague Convention on Civil Procedure, 1965 Hague Convention on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters (Hague Service Convention) and a number of bilateral international agreements. There are also several international agreements on legal assistance among the Commonwealth of Independent States (CIS) countries. Requests for legal assistance (for example, relating to service of process or taking evidence) require diplomatic or other official channels (through the Ministry of Justice). International agreements may also allow foreign courts to send requests directly to a Russian court. Having received the request for service, a Russian court summons the party to be served, serves the documents and returns the confirmation of service through the appropriate channels. Trial of Russian-related claims abroad Large and mid-sized Russian businesses tend to avoid Russian courts in favor of courts (often arbitral tribunals) located in foreign jurisdictions. Corporate deals related to assets in Russia are overwhelmingly made through offshore jurisdictions, under foreign governing law and offshore corporate schemes. Due to the current political situation and the likely lack of impartiality in Russian courts, foreign forums are often chosen for resolution of disputes. As previously noted, there is a list of disputes that under Russian law must be resolved by making a claim in Russian courts. All other disputes, however, potentially can be litigated outside of Russia. Moreover, personal claims of Russian oligarchs are often made in England or other countries in which they live. Recently, Russian authorities sent a signal to the legal community that they want to stop the trial of Russian-related disputes in foreign courts. At the International Legal Forum in St. Petersburg in May 2012, Mr. Anton Ivanov, Chairman of the Supreme Commercial Court, said that Russian courts should be granted powers to set aside

litigation in russia,  from previous page eign court judgments and international arbitration awards that prejudice the interests of Russian parties. By adopting a special law, Ivanov said that Russia wants to guarantee its companies and individuals protection against unfair competition of legal systems of other states. The guarantee must cover the actions of foreign states, their bodies and officers, as well as the actions of legal entities and individuals who resort to rival legal systems. Ivanov explained that he objected to the submission of Russian-related cases to the jurisdiction of foreign courts, as well as anti-suit injunctions rendered by foreign courts prohibiting parties from participating in court proceedings in Russia. He also condemned instances where foreign courts order the seizure of assets belonging to the Russian state in support of the enforcement of arbitral awards against Russia. Ivanov complained of “a union” between arbitral tribunals and state courts in a number of jurisdictions, which makes it “virtually impossible to cancel an arbitral award in state courts of such countries.” Admitting that Russian legislation does not provide for “measures to fight against such issues,” he suggested a number of procedures that could help to protect the interests of Russian parties. In the course of such proceedings, the Russian court would have to decide whether the foreign court or arbitral tribunal had exceeded its jurisdiction by accepting the case against the Russian party and whether it had rendered an unjustified judgment or award against it. If these questions were answered in the affirmative, the court could not only cancel the award or judgment, but order the recovery of any “unjust enrichment” that the prevailing party had received. The court could also bar the judges, arbitrators, lawyers or parties to the proceeding from entering Russia to seize and confiscate Russian assets belonging to them. Ivanov’s proposals caused alarm among foreign delegates to the forum, namely United States Attorney General Eric Holder, Vincent Lamanda who is head of the French Cour de Cassation, and Kenneth Clarke QC who is the UK’s Lord Chancellor and Secretary of State for Justice.

Russia’s Prime Minister and former President, Dmitry Medvedev, however, declared support for Ivanov’s words. Medvedev recognized that the ineffectiveness of a domestic legal system sometimes drives parties to use foreign or international courts or tribunals, but said this was no reason for making them “subject to an alien legal system.” Medvedev added that Ivanov’s proposed measures were a “civilized means of resolving issues” and that “all other means are worse.” Ivanov’s proposals raised serious concern in the Russian business and legal communities, though the views expressed in May 2012 have not materialized into concrete legislation or, it seems, even a proposed draft. Accordingly, the opinion expressed by the Chairman of the Supreme Commercial Court may more likely be simply a signal to Russian oligarchs to limit the number of their disputes and to resort to Russian courts more often. Recognition of foreign judgments Another important change seen in Russian courts over the last several years is their attitude toward enforcement of judgments issued by foreign courts. Generally, Russian courts will recognize and enforce judgments of foreign courts only if provided for either in federal law or in an international treaty to which Russia is a party. In fact, Russia is a party to only a few such international treaties; in Western Europe, the only countries that have concluded such treaties with Russia are Greece, Italy, Spain and Cyprus. Consequently, foreign contracting parties often prefer to include arbitration clauses in their contracts, as arbitral awards may be easier to enforce. (Russia is a signatory to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.) In the past, the existence of the international treaty rule had been interpreted by Russian courts to preclude enforcement of foreign judgments in Russia in the absence of a reciprocal treaty for the enforcement of judgments with the state where the judgment had been delivered. Russia has no bilateral treaty for judicial enforcement and

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cooperation with the United States. Recent case law of the Russian courts, however, now appears to permit—on the basis of international law principles of “reciprocity and comity between nations”—the enforcement of judgments rendered by foreign courts, even where no relevant treaty exists. In Rentpool B.V. v. OOO PodyemnyeTekhnologii (7 December 2009), the Supreme Commercial Court (the ultimate appeals court in Russia for commercial matters) confirmed that a judgment given in a state which itself enforces Russian judgments (the Netherlands, in that particular case), should be enforceable in Russia subject only to the limited defenses set out in the Russian Commercial Procedural Code. This position was upheld by the three judges of the Supreme Commercial Court on 26 July 2012, in decision no. VAS-6580/2012, which dismissed to reconsider enforcement of the English court’s judgment in the case Boegli-Gravures S.A. v. Darsail-ASP, Mr. Andrei IvanovichPyzhov. Recognition and enforcement of foreign court judgments is mandated by the general international law principle of reciprocity even where there are no treaties. According to Article 15.4 of the Russian Constitution, generally recognized principles and rules of international law and international treaties constitute an integral part of the Russian legal system. One such principle is international comity (comitasgenitium), which prescribes that states recognize foreign executive, legislative and judicial acts. The principle of reciprocity, originating from the principle of international comity, is widely interpreted as stipulating that foreign law is subject to mutual application for the purpose of developing cooperation between countries. One jurisdiction shall therefore extend certain courtesies to other jurisdictions or nations by recognizing the validity and effect of the latter’s executive, legislative and judicial acts. To date there are no examples of successful enforcement by Russian courts of judgments handed down by courts in the United States. Indeed, to the contrary, there continued, next page Page 67

litigation in russia,  from previous page have been a few examples where enforcement of such judgments has been denied. These rulings, however, predate the apparent change of approach of Russian courts. Therefore, unless a case arises where a Russian judgment is not enforced by a United States court (which can negatively affect the reciprocity concept), there is a good chance that United States judgments will be enforceable in Russia in future. Electronic proceedings In recent years, Russian commercial court facilities have seen substantial improvements in physical spaces, technical facilities and electronic proceedings. First, a uniform legal database of all court rulings issued by the Russian commercial courts was created and is available online through the official website of the Supreme Commercial Court. Court rulings are published in this database immediately after their issuance and are open to any member of the public. Second, electronic filing of lawsuits, appeals and other procedural applications became possible and was made quite easy. The only material requirement is that the originals of the relevant documents and exhibits must be further presented during the court hearing. Third, it is now possible to participate in proceedings in Russian commercial courts through videoconferencing. Russia is a large country with eight time zones, so it is potentially more convenient for litigants in different parts of the country to participate in court proceedings through video link. Videoconferencing can be organized only using facilities of the commercial courts in different regions, so one party must ask its local commercial court, and the court must coordinate such participation provided it has the technical facilities. The above changes are highly welcomed in Russia and constitute real improvement to the conditions of litigating in Russian commercial courts. Page 68

Class or collective actions in Russia Russia (and previously the USSR) did not recognize the concept of class or collective actions until 2009. The concept of procedural joinder existed, which allowed several plaintiffs to bring the claim simultaneously against several defendants. In addition, what might conceivably have been considered a quasi-class action in Russia was an action for protection of public interests by state authorities and non-commercial organizations. In the absence, however, of genuine class or group litigation, scholars and legal practitioners paid little attention to this form of redress. The move in Russia toward class actions began in 2007 when Russian legislators initiated a legislative campaign against the corporate raiders who were threatening Russia’s business environment and, ultimately, national security. The new legislation, known as the “anti-raiders package,” was intended to combat hostile takeovers, reduce the number of corporate conflicts and protect the rights and legitimate interests of shareholders and investors. Two years passed before the anti-raiders package containing amendments to seventeen Russian laws was enacted in 2009. The law introduced Chapter 28.2,”The Consideration of Cases Regarding the Protection of Rights and Legitimate Interests of a Group,” to the Russian Commercial Procedural Code, thus adding a form of legal redress previously unknown in Russian civil procedure. The class action introduced by the amendments is an action by a legal entity or an individual brought for itself and on behalf of a minimum of five other persons for the protection of violated or disputed rights arising out of a common legal relationship. Such an action may be filed in relation to corporate disputes, capital markets disputes and other commercial disputes (meaning a dispute that ordinarily falls within the competence of the commercial court; that is, disputes that relate to business activities and are between legal entities, or between legal entities and individual entrepreneurs) subject to the conditions required for a class. While the amendments to the Commer-

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cial Procedural Code are undoubtedly of a progressive nature, they cannot be applied in a wide range of situations. Consumer class actions, including product liability claims, are not yet permitted under Russian law. In addition to aforementioned class actions, Russian procedural law recognizes group actions and representative actions. Class action is based on a mixed model, with elements taken from both “opt in” and “opt-out” systems. A person can join the claim of the initial claimant by submission of the relevant motion (opt-in mechanism). Judgment in a class action has binding effect only on the members of the group, which is also typical for an opt-in mechanism. There is a restriction for filing a separate claim, however, if there is a judgment rendered in a class action with the same grounds and subject matter. There are no specific rules for funding a class action. Accelerated procedures Russian law provides for an accelerated procedure in the commercial courts where one of the parties has applied for it and the other has not objected, or upon the court’s initiative if the parties agree to it. Such procedure may be adopted only if the claim is recognized by the defendant, the claim is made for a small sum or the claim is of an indisputable nature. The parties are not required to attend, and the trial is heard by one judge only. There is no similar procedure in the courts of general jurisdiction. Aside from this, there is no procedure equivalent to “summary judgment” in the United States or in English litigation, where the plaintiff can apply for an accelerated procedure without the defendant’s consent.

E. Perkunov

Eugene Perkunov is a senior associate in the Moscow office of Hogan Lovells. He is an experienced Russian litigator, dealing with various commercial disputes in Russian courts since 2000.

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The International Law Quarterly

Russia and the CIS 062013  

International Law Section special issue

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