Christopher Rose of Partner, Squire, Sanders & Dempsey L.L.P. -

Bureaucracy and corruption in Russia are touted as the greatest threats to foreign investors, but a lack of familiarity with Russian corporate and contract law can put you just as much at risk.

Take, for example, an investment into a Russian company. You would probably expect to enter into a share purchase agreement containing warranties protecting you from everything from the accuracy of financial statements, through tax liabilities, to the absence of litigation. However, you could be in for a rude shock as these warranties are probably unenforceable.

The problem is that the Russian Civil Code says that while warranties pertaining to the subject matter of a contract - in this case the shares being acquired - are enforceable, warranties covering the company, its business and other issues not directly relating to the status of the shares themselves are not. While the actual interpretation of the law is not entirely clear, a Russian court would probably strike down any claims based on these warranties.

By the same token, if you hope to protect your investment into a Russian company with a shareholder agreement, you could find yourself in deep water if you ever need to resort to that agreement in a dispute. Under Russian law, provisions contained in any agreement that conflict with Russian legislation - including drag-along rights, put/calls, and other staples of Western-style shareholder agreements - are unenforceable. Even if the agreement is governed by foreign law and provides for offshore arbitration, an arbitral award attempting to enforce such conflicting provisions in Russia could be put aside by a Russian court as contrary to public policy.

While current Russian legislation makes implementing the protections normally expected by international investors difficult, it is possible to work around the shortcomings of Russian law by ticking off the following items:

1. Invest through an offshore holding company: Structuring your investment through an offshore holding company increases the likelihood that your negotiated rights will be enforceable. Because of beneficial tax treaties with Russia, favourite foreign domiciles for offshore companies are Cyprus, Luxembourg and the Netherlands. Similarly, tax-free jurisdictions like the British Virgin Islands (BVI) are also popular. These jurisdictions have robust bodies of corporate law and flexible forms of companies. However, because both Cyprus and the BVI are common law jurisdictions with corporate laws based on the English Companies Act, the legal systems in these countries are significantly more flexible in terms of administration and governance than their civil law counterparts.

2. Restructure the target group (if necessary): Investing through an offshore company will provide you with a basis for enforcing your rights. However, for tax reasons and otherwise, Russian holding structures frequently resemble an inverted family tree, comprising a series of sister companies and affiliates owned directly or indirectly by the founders. To ensure that your governance and economic rights reach all parts of the target group, it is often necessary to restructure the business to provide for a vertical holding structure whereby each subsidiary is wholly owned, directly or indirectly, by the top-level holding company in which you are a shareholder.

3. Govern your agreements by English law: Used in combination with an appropriate offshore company, governing your agreements by English law can dramatically increase the chances that your rights will be enforceable. Be sure, however, that your counsel works with an advisor from the applicable offshore jurisdiction to make sure that the English law agreements do not conflict with any mandatory provisions of local law.

4. Conform the articles to the shareholders agreement: Incorporate the provisions of your shareholders agreement, to the extent possible, into the memorandum and articles of association of the offshore company. This is easier to do in common law jurisdictions than civil law jurisdictions, hence the preference for Cyprus and BVI. The benefit of including these features into the articles is that, while a violation of the shareholder agreement is a breach of contract, subject to the remedies available under the governing law of the agreement (ie. damages or specific performance), a violation of the company's articles can be grounds for invalidation of the action itself.

5. Ensure that major shareholders cannot circumvent the shareholders agreement by using an SPV: Finally, if a major shareholder uses a special purpose vehicle to hold his investment, make sure that he (or an affiliate with other significant tangible assets) is liable for the SPV's non-compliance with the terms of the shareholder agreement. This includes restricting changes of control of the ownership of the SPV. Without this provision, your partner could lawfully exit from the business by selling his shares in the SPV without giving you the ability to consent to such transaction or elect to exit with him.

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