Last May, the President of Russia signed into law the long-awaited bill “On the Procedure of Foreign Investment in Business Entities Having Strategic Importance for the Defence of the Country and the Security of the State” No. 57-FZ (the Strategic Law). In broad terms, the Strategic Law requires foreign investors to obtain prior consent of a special governmental commission established pursuant to the Strategic Law, headed by the Prime Minister and called the Governmental Commission for Control Over Foreign Investment in the Russian Federation (the Commission). The Commission’s consent is required for the acquisition of control over Russian companies engaged in certain industries that are listed in the Strategic Law as having strategic importance for Russia’s defence and national security. In the absence of the required consent, the relevant transaction is deemed null and void.

The governmental body entitled to handle applications for the acquisition of control over "strategic" companies and to forward them to the Commission is the Federal Antimonopoly Service (FAS). So far, reportedly, the FAS has received about 45 applications from foreign investors, most of which related to the acquisition of control over subsoil users, and the Commission has conducted two meetings at which it has cleared six transactions in total.

Two transactions approved at the first meeting of the Commission were the acquisition of 49.99 percent of Arkhangelskgeoldobycha by Archangel Diamond Corporation, an entity within De Beers group, and the acquisition of 25 percent plus one share in Sukhoi Civil Aircraft Company by World’s Wing S.A., a Swiss subsidiary of Italy’s Alenia Aeronautica.

At its second meeting in February 2009, the Commission approved the acquisition by Barrick Gold (Canada) of up to 80 percent of the shares in a platinum and palladium producer on the Kola Peninsula; the acquisition by a Dutch company of shares in Taganrog Ship Repairing Plant; and the acquisition by OAO Hartron (Ukraine) of shares in ZAO International Space Company Cosmostrans. The Commission has postponed consideration of the application by Basic Element for the acquisition of shares in the Russian oil company RussNeft, which holds a subsoil license to the Varieganskoye field, qualifying as a field of federal significance. The reasons for such postponement cited by the media are confusing.

Based on the experience to date, the need to obtain the Commission’s consent is a serious obstacle to foreign investors still wishing to acquire control over Russian "strategic" companies. The Strategic Law is clearly in the early stages of its evolution, and there are too many ambiguities surrounding its implementation. The following are examples:

Scope of strategic industries, companies which qualify as strategic. The list of strategic industries, although exhaustive, is broadly drafted and as a result covers entities that are unlikely on any reasonable interpretation to have strategic importance for Russia’s national security. For example, companies dealing with cryptography are deemed strategic; however, the question has arisen whether banks that have licences to deal with means of cryptography are also to be treated in this way.

Constructive control. Generally, the Strategic Law defines "control" as the ability of a foreign investor holding more than 50 percent of the voting shares in a "strategic" company to determine decisions made by that company. However, the Strategic Law also includes the concept of control by a foreign investor if it holds less than 50 percent of the voting shares, but nevertheless has voting control compared to all other shareholders. The Strategic Law does not set forth any specific criteria to be used, nor any clear threshold below which a foreign investor is deemed not to have control.

Timing issues. It is not clear whether or not, and how, the Strategic Law applies to situations in which a Russian company controlled by a foreign investor becomes "strategic," for example, by beginning to perform strategic activities or due to the reassessment of its subsoil resources.

At the second meeting of the Commission, its head, Prime Minister Vladimir Putin called for closing the loopholes in the Strategic Law that allow investors to evade clearance for the acquisition of control over "strategic" companies. It is not clear what loopholes he had in mind, but Mr. Putin also stated that the Strategic Law has to be amended to simplify the rules for "conscientious" investors to make Russia a more attractive place to invest. The FAS has now been instructed to draft the relevant amendments.

The impact of the Strategic Law on direct foreign investment in Russia is somewhat difficult to assess, as the adoption of the Strategic Law coincided with many other factors that had an extremely negative impact on sentiment towards Russia. There is no doubt, however, that the practical implementation of the Strategic Law is far from perfect. Potential investors are often unclear whether a permission of the Commission is necessary in their case, have no time to use their statutory right to inquire of the FAS on whether or not they need clearance, and are very cautious about progressing transaction if the Commission has resolved to subject the acquisition to conditions. Many foreign investors are also intimidated by the Strategic Law’s requirement to submit a draft business plan for the target to the FAS and the Commission to consider the applications, and by the dire consequences of non-compliance with the Strategic Law.

It remains to be seen whether the amendments to the Strategic Law, that are yet to be drafted by the FAS, will clear the ambiguities of the Strategic Law and help improve the badly hit investment climate in Russia.

For more information on this topic, please contact V&E Russia/CIS lawyers Natalya Morozova or Maria Shangina. Visit our website to learn more about V&E's Russia/CIS practice.