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Foreign Business Within Russian Laws

Despite Western sanctions imposed on Russia, foreing companies continue to successfully do business in Russia. How does foreign business community operate within Russian laws? How often do foreign clients engage legal consultants? What method of dispute resolution is preferred by foreign business people in Russia? These and other topics have been covered in our conversation with Aleksey Ivanovich Moroz, Managing Partner, Exiora Law Firm.

Ed.: Aleksey Ivanovich, how seriously have the current economic downturn and the international sanctions imposed affected the Russian market for legal consulting services? Is that true that the number of disputes has risen?

A.I.: Undoubtedly, the number of litigations including those involving foreign entities has escalated due to the economic crisis, however, the demand for legal consulting services has nonetheless been relatively stable. Major investment projects just cannot be wound up in a day; market participants are not saying “no” to projects, they are adjusting to the new economic reality. This results in the need to restructure relations, which, in turn, requires involvement of legal professionals.

Ed.: What would you name as specifics of investment projects implemented in Russia?

A.I.: It can be said that the key feature of the Russian market is that the state is the main player on it. Thus, in 2015 the volume of state purchases, including purchases by state-owned corporations, amounted to 30 trillion rubles or 25% GDP. Construction contracts make half of state purchases. So, the state, on the one hand, is the biggest participant on the construction market in Russia, and on the other hand, that same state, being the regulator of legal relationships, sets the rules of the game on this market.

Therefore, even if a project is not supposed to be budget-funded, you have to be aware that the rules existing in the area of public procurement tend to impact the relations formed when implementing private projects.

Ed.: Does that imply that a foreign contractor which undertakes to perform works for state needs is initially vulnerable as compared to the customer, that is, the state?

A.I.: That is not quite so. Russian laws are generally well-balanced and take into consideration the interests of all participants of an investment project. The other side of the story is that when performing works in Russia, you have to comply with statutory formalities all through the way. Contractors often tend to ignore them hoping that issues that arise in the course of a project will be then settled with the customer as work proceeds. A failure to comply with such formalities, should a dispute occur, may put the contractor in a disadvantageous position, however, even under these circumstances, a court will consider all the facts of the case, including whether the parties acted in good faith while performing the contract.

Ed.: But if a dispute involving a state-owned entity is heard by a state court, would not it be biased towards the contractor? Can it be referred for consideration by, say, a commercial arbitration court, which will be more independent?

A.I.: Russian laws do not allow disputes arising from contracts for performance of works for state and municipal needs to be referred to a commercial arbitration court. Although the fact that a case is heard by a state court does not imply that it will be biased. This year we acted for a major German contractor in its dispute with the state which amount exceeded 7 bln rubles. And courts of three instances supported the contractor by dismissing unjustified claims of the state customer which attempted, under false grounds, to recover the monies paid for the works performed and hi-tech equipment supplied.

Ed.: And when a project is financed privately without any involvement of the state, may a foreign participant be protected by including an arbitration clause or subjecting the contract to a foreign jurisdiction?

A.I.: Private companies are free to choose both the governing law and a commercial arbitration court to which a dispute arising from the contract they entered into will be referred to.

Referring a dispute to commercial arbitration allows the parties to select arbitrators and nominate candidates who enjoy the status of being a recognized authority in a particular area of jurisprudence. In state arbitration courts disputes are also tried by judges having expertise in a certain category of cases, however, the parties are not entitled to select a judge they trust, since cases are distributed between judges by an automated system. Another benefit of arbitration proceedings is the confidentiality principle established by law. The electronic case files in state arbitration courts may be accessed by any person and provide information on what disputes a company participated in and what the outcome was. Conversely, arbitral awards are not publicly accessible.

If a party against which the arbitral award is issued does not execute it voluntarily, the other party may refer to a state court for an enforcement order so that the arbitral award is enforced. The currently existing practice on this matter is quite extensive, and the institute of enforcing arbitral awards works effectively enough.

As for the issue of subjecting a contract to foreign laws, you cannot be too careful here. Firstly, even a contract involving private companies may entail the need to perform a whole set of public requirements established by domestic legislation. Differences between private foreign laws governing the contract and public Russian laws which the parties are obliged to follow when performing the contract may cause lots of troubles to the project participants. It is especially true for the construction industry where mandatory public requirements are particularly numerous.

The second reflection to be kept in mind when selecting the governing law is what happens further to the consideration given under the contract (goods, works or services). For instance, in one of the cases we faced a situation where an Italian company entered into a license agreement with a German partner under the Italian laws, and the latter, in its turn, concluded a sublicense contact with a Russian company to be governed by Russian laws. The consequences for the sublicensee flowing from the termination of the license agreement raised multiple questions with the court.

Ed.: Selecting an arbitrator in a commercial arbitration court can be said to be a temptation. Why do disputing parties refer their disputes for consideration by state courts?

A.I.: There are various reasons for it. For one thing, resolving a dispute through an international arbitration court is not inexpensive. Businesswise, it is unreasonable to refer a small claim to a commercial arbitration, and the degree of trust to arbitration courts of lesser prominence is not sufficiently high.

Secondly, an arbitral award may affect not only the direct participants of arbitration proceedings, but other parties as well, i.e., subcontractors, suppliers of materials and equipment, etc. If, say, a commercial arbitration court satisfies the customer’s claims to the general contractor as to the quality of works, then, when submitting similar claims to the subcontractor immediately engaged in the performance of such works through a state court, the general contractor will once again be forced to prove the circumstances previously established by the commercial arbitration court. If the customer’s dispute with the general contractor is heard by a state court, the subcontractor may be involved in the proceedings as a third party, and the facts established by a case once adjudicated need not be proved again in a dispute between the general contractor and a subcontractor.

Thirdly, the state system of justice presupposes a sequential appeal of a judgment in three higher instances. Thus, if the first instance makes a mistake when resolving a dispute, such mistake may be corrected at further stages of legal proceedings. And an arbitral award may be reversed by a state court only if it contradicts some fundamental principles of Russian laws. However, the possibility for reversing an arbitral award by a state court sometimes serves as a deterrent for project participants to include the arbitration clause in a contract. But, as our practice shows, such reversal of an arbitral award happens extremely, extremely rarely.

Ed.: Aleksey Ivanovich, is the taste of winning stronger when you have to deal with a complicated case?

A.I.: I believe there are no simple or uninteresting cases. If a case goes to trial, it means the parties have not been able to find an alternative solution to their problem. And each dispute is challenging in its own manner. The complexity of some cases is about the parties’ involvement in implementation of hi-tech or science-intensive projects. When engaged in disputes like that, lawyers have to work with huge volumes of design, technical, construction, accounting documentation, hire experts specializing in niche areas for solution of tactical tasks.

By contrast, the complexity of other cases may be about the lack of sufficient evidence to support the position of a client that did not show enough forethought when performing a contract. A lawyer’s mission in such cases is to provide such line of argument which, though based on indirect evidence, will be able to convince the court that the client’s legal position is justified and to rebut the arguments supplied by its adversary.

Oftentimes, the complexity of a case is caused by the fact that a certain matter is not sufficiently settled by law or a controversial court practice has been established in relation to such matter. Then a legal action sometimes transforms into a scientific debate.

The above complexities tend to become most apparent in insolvency and bankruptcy cases. Here, there is a need to build a complex line of defense based on the analysis of large volumes of documents, to provide legal support to separate disputes related to various types of contracts, to challenge transactions entered immediately before bankruptcy which prejudice the interests of creditors, etc.

Ed.: How often do foreign businesses in Russia have to face bankruptcy?

A.I.: Lately, it is more often than not. Naturally, we are not talking about foreign businesses going bankrupt in Russia, but about cases when a Russian counteragent of a foreign company becomes bankrupt.

Unfortunately, today obtaining a judgment or an enforcement order in your favor is not enough to satisfy property claims against a partner who does not act in good faith. Sometimes, unwilling to perform its obligations to creditors, a debtor initiates bankruptcy proceedings. Under the present circumstances, bankruptcy is perceived by unscrupulous market players as a way to avoid paying debts. However, Russian laws provide for a wide range of tools available to creditors to satisfy their claims to debtors, including where a debtor has neither funds, nor any other property left as of the date of instigating bankruptcy proceedings. Such tools include, in particular, challenging transactions entered into by a debtor on the threshold of bankruptcy which prejudice the interests of creditors and returning the debtor’s property transferred under such transactions into the bankruptcy assets, bringing the debtor’s controlling persons to vicarious liability for its obligations and even individual bankruptcy of the debtor’s directors and members. Thus, if your counterparty files for bankruptcy, it does not necessarily mean it is time to report a loss.

Ed.: Yes, for unscrupulous Russian companies bankruptcy is a way to avoid paying debts. Maybe foreign investors need to think about minimizing their risks and engage foreign partners for implementing projects?

A.I.: Unscrupulous market participants are rather an exception than a rule. The overall majority of companies, both Russian and foreign, strive to duly perform their obligations to business partners and count on a long-term and mutually beneficial collaboration.

Risks related to potential non-performance or improper performance of contractual obligations can be efficiently mitigated by incorporating in a contract a well-balanced system of security measures, starting from payment procedure which is made dependent on the proper performance of obligations to bank guarantees, liens, personal surety provided by shareholders.

Examples of unscrupulousness, sadly, can be seen both among Russian and foreign companies. For instance, when implementing a major project in Russia, a German investor was forced to terminate a contract with a German company responsible for the construction side of the deal because of its improper performance of the obligations assumed by it, and to engage a Russian engineering company to finalize the project. Therefore, selecting business partners, naturally, must be based not on what jurisdiction they belong to, but whether they possess the required qualification, experience and resources.

Ed.: When initiating an investment project, nobody plans for any disputed situations or lengthy litigations, but they nonetheless arise What would you recommend to foreign investors to avoid such complications?

A.I.: Naturally, preventing potential legal problems from occurring is much easier than having to tackle them later. That is why the main way to avoid a legal minefield in future is to take care to mitigate legal risks well in advance, when entering into a contract and in the course of its performance. If, when starting a project, its participants discuss in sufficient detail ways of resolving issues which may arise when implementing it and then meticulously comply with what they have agreed on, the potential for a dispute arising between them which will eventually end up in court is minimal.

Besides, you should not ignore the possibilities for an out-of-court settlement of whatever differences you may have. Our experience, in particular, evidences that many disputes may be settled without resorting to court, exclusively through negotiations. And negotiations appear to be more efficient in terms of resolving disputes between Russian and foreign businesses, while Russian companies involved in a dispute among themselves tend to utilize judicial resources.

The most obvious advantage of settling a claim out of court is the possibility of preserving partnership relations between the parties to allow them to cooperate in future.

Ed.: Thank you, Aleksey Ivanovich, for a most interesting conversation. See you in next LiveLawyer publications.