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A law has been adopted that contains mechanisms for blocking the actions of foreign companies that may pose a threat to the uninterrupted and rational use of subsoil resources or of facilities of cross-border gas transportation infrastructure

08.07.2022
16 min read
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Pepeliaev Group advises that on 6 July 2022 the State Duma of the Federal Assembly of the Russian Federation adopted a Law[1] that provides for a mechanism for the mandatory transformation of a branch (representative office) of a foreign company whose activity relates to using subsoil resources into a Russian limited liability company (an LLC), and for a mechanism limiting the rights of foreign investors having membership of a Russian company whose activity relates to using subsoil resources.

The Law is aimed at the uninterrupted and rational use of subsoil resources and preserving stability in this sphere[2]

At present the Law is being examined by the Federation Council and after approval it will be submitted to the Russian President for signature. 

Mandatory transformation of a branch (representative office) of a foreign company into a Russian LLC

A branch (representative office) of a foreign legal entity may be transformed into a Russian LLC if the foreign entity meets all of the below requirements[3]

  1. it is linked to a “hostile” state[4]

  2. has not more than 50 members/shareholders;

  3. is not a public company whose shares circulate freely or are traded on an organised exchange; 

  4. at least 25% of the membership interests in the issued capital (shares) of the foreign entity are owned by persons linked to Russia (the “persons linked to Russia”), specifically: 
    • Russian nationals; and/or
    • Russian legal entities (if their controlling persons or persons having at their disposal, in the aggregate directly or indirectly, at least 25% of the votes in the supreme management body, are not foreign persons linked to “hostile” states); and/or
    • legal entities controlled[5] by a Russian legal entity with respect to which the Russian Federation, a constituent entity of the Russian Federation or a Russian national has the right to dispose, directly or indirectly, of at least 25% of the votes in its supreme management body;

  5. has the right (a licence) to use Russian subsoil resources or owns facilities of cross-border gas transportation infrastructure in Russia.
A branch (representative office) of a specified foreign entity may be transformed into a Russian LLC in accordance with a court decision with the items of civil law rights and the rights and obligations of the foreign person relating to the performance of its activity in Russia being transferred to such LLC[6]

If the foreign entity has more than one branch (representative office) in Russia, such branches (representative offices) may be transformed into a single LLC[7]

The grounds for a court to make a decision to transform a branch (representative office) are as follows[8]

  1. the foreign entity refusing to use (evading using) the property it owns in accordance with its intended purpose and/or the foreign entity refusing to manage (evading managing) the property it owns if the relevant actions (an omission) have (has) resulted or may result in a complete or partial termination of the branch’s (representative office’s) activity;

  2. the actual termination of the management of the branch’s (representative office’s) activity[9]

  3. a decision has been made to liquidate (shut down) the branch (representative office);  

  4. the foreign entity commits actions (an omission) that may result in the termination of or substantially hamper the activity of the branch (representative office) in using, without interruption and rationally, subsoil resources or facilities of cross-border gas transportation infrastructure in Russia[10]
The court makes a decision based on an application[11]
  • of members of the foreign entity who are linked to Russia and own in the aggregate at least 25% of the membership interests in the issued capital (shares) of the foreign entity; or
  • of a single-member executive body of the foreign entity; or 
  • of the last appointed head of the branch (representative office).
The Commercial Court for Moscow Region[12] examines cases relating to the transformation of branches (representative offices) into LLCs in accordance with the rules of the Russian Commercial Procedure Code and the specifics established by the Law[13]

The application to transform the branch (representative office) should be accompanied, among other things, by data that the applicant has with respect to the following assets to be transferred to the LLC[14]
  • the rights and obligations resulting from the activity of the branch (representative office); 
  • the items of civil rights that were used in connection with the activity of the foreign entity in Russia; 
  • other obligations of the foreign legal entity. 
Whether proceedings regarding the transformation application should be commenced is to be decided by the court on the day when the application is submitted[15], and the case should be resolved within a month from the date when the application is accepted[16]. Following the examination of the case the court hands down a decision that the branch (representative office) should be transformed into an LLC or that the application should be denied[17]

Before the court makes a decision on transformation the foreign entity may appeal to the court with a petition to terminate the proceedings in the case and undertake to resume and/or continue the foreign entity's activity in Russia.  When the court receives such petition it may deny termination if persuasive evidence is provided of actions having been performed to eliminate the circumstances that served as a ground for filing the application[18]

A court decision for transformation is a ground for the registration authority to register the LLC's formation[19]. In addition, the decision should contain the data that is necessary for an LLC to be formed, including the amount of the issued capital, the members, the contents of the charter and the single-member executive body[20]

The rights and obligations resulting from the activity of the branch (representative office) and the rights to the items of civil rights that were used in connection with the activity in Russia (with the encumbrances being retained) pass to the established LLC by way of universal succession[21]

The licences and other permission documents that were previously used when the business activity of the foreign entity and/or its branch (representative office) was carried out in Russia pass to the established LLC by way of succession and shall be re-issued on a mandatory basis not later than 12 months from the date of the transformation[22]

If the foreign investors that are linked to the “hostile” states, when the branch (representative office) is transformed, acquire at least 25% of the membership interests in the LLC in accordance with an application of members of the LLC who own in the aggregate at least 25% of the LLC or of the single-member executive body of the LLC, the court, at the same time as it distributes the membership interests in the LLC, may decide to suspend the rights of the foreign investors resulting from their membership of the LLC on the grounds specified below. 

The limitation of the rights of foreign investors 

In accordance with the Law a Russian business entity is “significant” if[23]
  • it has not more than 50 members/shareholders; and
  • is not a public company whose shares are circulated freely or are traded on an organised exchange; and
  • has a licence to use Russian subsoil resources or owns facilities of cross-border gas transportation infrastructure in Russia. 
Such “significant” companies will include, among others, LLCs established by way of the transformation of branches (representative offices) of foreign entities. 

With respect to foreign investors that are linked to “hostile” states and have at their disposal, in the aggregate directly or indirectly, at least 25% of the membership interests in the issued capital (voting shares) or at least 25% of votes in the supreme management body of the “significant” company or have another option to exercise the voting right[24] attached to such membership interests (shares) or the option to actually terminate or substantially hamper the activity of the company, the court may decide to suspend the rights resulting from their membership of the company on the following grounds[25]:  

  1. the investor refusing to perform in good faith (evading the good-faith performance of) obligations and/or the investor refusing to exercise (evading the exercise of) the rights of a member (shareholder) of the significant company if such actions/an omission have/has resulted in or may result in the impairment of the company’s uninterrupted operation; 

  2. the investor committing actions (an omission) aimed at hampering the management of the significant company  or preventing it from carrying out ordinary business activity;

  3. the investor performing other actions (an omission) that may result in the termination or suspension of the activity of the company or its liquidation or bankruptcy[26].
The above actions (an omission) may become grounds for a decision to be made to suspend the rights if they were committed by the investor in the period from 24 February 2022 until 31 December 2022 and are directly grounded in restrictive measures having been taken with respect to Russian nationals or Russian legal entities, or have been committed without any clear reason and/or in the absence of any obvious economic reasons (grounds)[27]

An application to suspend the rights may be filed with the court by[28]

  1. a member/shareholder or members/shareholders who own in the aggregate at least 25% of the membership interests in the issued capital (of the shares) of the significant company;

  2. a member of the board of directors (supervisory board) or a single-member executive body of the significant company.
The Commercial Court for Moscow Region examines the cases on the suspension of the exercise of the rights of foreign investors relating to the membership of significant companies in accordance with the rules of the Russian Commercial Procedure Code and the specifics established by the Law[29]

The court decides whether or not to commence proceedings with respect to the application to suspend the exercise of the rights, on the day when the application is received.   In addition, the court is to examine the specified application not later than within a month from the date when the court accepts it[30]

The court may decide, among other things, to suspend the payment of dividends/profits and to suspend the disposal of membership interests in the company[31]

The suspension of the exercise of the rights of membership of significant companies is established for the period determined by the court decision, but, as a maximum, until 31 December 2023 inclusive[32]

The provisions of the Law do not apply to the production of liquefied natural gas as part of a production sharing agreement 

The above provisions of the Law on the transformation of the branch (representative office) and on the limitation of the rights of foreign investors do not apply to companies that are implementing projects to produce liquefied natural gas that are being carried out as part of production sharing agreements[33]

What to think about and what to do

Since the Law is highly likely to come into force in the near future, we recommend considering its provisions carefully and taking them into account when planning activity relating to the use of subsoil resources. 
We recommend that foreign legal entities which have the right (a licence) to use subsoil resources in Russia or have their own facilities of cross-border gas transportation infrastructure in Russia should check on a regular basis whether they meet the conditions provided for by the Law with which compliance may result in:  (i) such entities being subject to the mechanism for the transformation of branches (representative offices) into a Russian LLC; or (ii) their rights of membership of Russian companies being suspended.

If a foreign legal entity may be subject to the application of a mechanism for the transformation of branches (representative offices) or a mechanism for suspending the rights of membership of a Russian company, we recommend that such entity, in order to avoid such a transformation (suspension of membership rights), should not (should cease to) commit such actions (omission) that serve(s) as a ground for the court to make a decision to transform the branches (representative offices) or a decision to suspend the rights of membership (for example, actions that may result in the termination of the activity of the branch/representative office or a Russian company, respectively). 

We recommend that the members of the foreign entity who may file with the court an application to transform the branch/representative office of the foreign entity should assess (on a regular basis) whether there are circumstances that serve as a ground for such application to be filed with the court, and if such circumstances exist, also assess whether it is feasible to file such application with the court.  

We recommend that the members of Russian significant companies who may file with the court an application to suspend the rights of membership of such company should assess (on a regular basis) whether there are circumstances that serve as a ground for such application to be filed with the court, and if such circumstances exist, also assess whether it is feasible to file such application with the court.

Help from your adviser

Pepeliaev Group’s lawyers are ready to provide legal assistance to companies with respect to the application of the provisions of the adopted Law, which includes:
  • providing legal advice on the application of the provisions of the Law; 
  • assessing the risks of the possible application of the mechanism for the transformation of branches (representative offices) or of the mechanism for a suspension of the membership rights, which includes checking whether or not there are conditions for the relevant applications to be filed with the court and assessing the prospects of the court resolving the relevant cases, and proposing ways to minimise the specified risks (if any);
  • conducting court cases on the transformation of branches (representative offices) and on the suspension of membership rights;
  • providing assistance with re-issuing licences and other permission documents if the court decides to transform the branch (representative office) of the foreign entity.

[1] https://sozd.duma.gov.ru/bill/1197674-7#bh_histras.
[2] Article 6(3)(4) and article 14(4)(3) of the Law; https://iz.ru/1360044/dmitrii-alekseev/sobstvennyi-interes-prava-inostrantcev-v-nedrorazrabotkakh-mogut-ogranichit-po-sudu.
[3] Article 5(1)(1) and article 6(1) of the Law.
[4] A state that performs hostile actions with respect to Russia and Russian persons (article 6(1) of the Law). The presence of a link may be evidenced, in particular, by the specified states being the place of the registration of the foreign legal entity, the place where it performs most of its business activity or the place where it generates most of its profit, or by the members (shareholders) of such entity including persons that are linked to the specified states and that jointly own at least 25% of membership interests in the issued capital (of the voting shares) (article 6(2) of the Law). 
[5] Within the framework of the Law, in order to determine whether control is exercised, the provisions are applied of article 5(3)(1-4) of Federal Law No. 57-FZ dated 29 April 2008 “On the procedure for making foreign investments in business entities of strategic importance for ensuring national defence and state security”.
[6] Article 6(1) of the Law.
[7] Article 7(3) of the Law.
[8] Article 6(3) of the Law.
[9] The management is deemed to have been terminated also in the case when the head of the branch (representative office) left Russia after 24 February 2022 or actually ceased to exercise his or her powers (article 6(3)(2) of the Law).
[10] The presence of the listed grounds may be evidenced, among other things, by the fact that after 24 February 2022 a foreign entity or its members/shareholders that are linked to “hostile” states, for no obvious reasons: made a public statement that activity in Russia is terminated and/or suspended and committed actions/an omission relating to such statement, including a failure to exercise the rights of a member/shareholder; terminated contracts of significant importance for performing the activity to use subsoil resources or facilities of cross-border gas transportation infrastructure in Russia; through their actions/omission prevent the activity of the foreign entity or of its branch (representative office) from being carried out in Russia or substantially hamper such activity (article 6(4) of the Law). 
[11] Articles 7(1) and 7(2) of the Law.
[12] Article 8(1) of the Law.
[13] Article 8(2) of the Law.
[14] Article 8(7) of the Law.
[15] Article 9(1) of the Law.
[16] Article 11(1) of the Law.
[17] Article 11(6) of the Law.
[18] Article 11(7) of the Law. 
[19] Article 11(8) of the Law.
[20] Articles 12(2), 12(3), 12(5) and 12(6) of the Law. By default one of the current (one of the last appointed) heads of the branch (representative office) is specified as the first single-member executive body. The members of the established LLC are the members (shareholders) of the foreign entity specified in the decision (article 13(1) of the Law). 
[21] Article 12(9) of the Law.
[22] Article 12(16) of the Law. However, before the re-issuance the LLC may perform its activity based on the permission documents and licences that were issued previously to the foreign entity and/or its branch (representative office). 
[23] Article 5(1)(2) of the Law.
[24] Apparently, the right should include at least 25% of votes.
[25] Articles 14(1) and 14(4) of the Law.
[26] The above grounds may be evidenced, in particular, by the fact that after 24 February 2022 the investor made a public statement regarding the termination of the company’s activity or its participation in it, and committed actions (an omission) relating to such statement; terminated contracts that are significant for the company’s activity to be carried out, or without any grounds terminated or suspended the performance of its obligations under such contracts; committed actions aimed at compliance with restrictive measures introduced by “hostile” states with respect to Russia and Russian persons.
[27] Article 14(6) of the Law.
[28] Article 14(3) of the Law.
[29] Article 15(1) of the Law.
[30] Article 16(1) and article 17(1) of the Law.
[31] Article 18(1) of the Law.
[32] Article 18(8) of the Law.
[33] Article 19(3) of the Law.

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