Coded messages

Russia’s Civil Code is set for reform. Joanne Harris reports on the ramifications for the legal market

It is now two decades since the fall of the Soviet Union and the start of a free economy in Russia. Those 20 years have seen enormous changes for the jurisdiction, including the development of a vibrant, international legal market.

Despite the introduction in the mid-1990s of a Civil Code governing civil law, Russian law has not, however, taken off in the same way as Russian law firms. Major transactions, even those involving two ­Russian parties, are still mainly governed by English law.

Home rules

Corporations prefer the certainty that ­English law provides, particularly when it comes to the resolution of disputes. This reliance on English law has led to the ­dominance of international firms in Russia. But things could be changing.

“We’ve seen an interesting phenomenon in the past several years in that some of the transactional documents, even for large transactions, are governed by Russian law,” reports Cleary Gottlieb Steen & Hamilton corporate partner Murat Akuyev. “We’ve seen an interesting progression where a deal under Russian law tried to emulate some of the legal techniques that are used under English law.”

Coupled with this slow trend has been an attempt by the Russian government to reform the Civil Code. The code has been amended a couple of times since its introduction, but the reforms currently being proposed are more wide-ranging – and more controversial.

The programme began in 2009 when Russian president Dmitry Medvedev formed a council comprised mainly of ­senior legal academics to look at amending the Civil Code. The composition of the council has attracted censure from some quarters, with critics noting that the members have ties to the old Soviet regime. Others point out that the academic make-up leads to a particular viewpoint among members.

“Most of the people on this codification council are big names in civil law,” says Nikolay Solodovnikov, a partner at Pepeliaev Group. “They’re very clever guys but to make a good Civil Code you need not only to be very clever, you need also to understand business, how to understand deals and how transactions need to be driven.”

Talking up a storm

At the end of 2010 the council released ­proposed amendments to the code. This prompted a storm of debate and discussion, especially among the business ­community in Russia.

The problem of the existing code, from a business perspective, is that it is fairly inflexible and does not permit companies to use many elements of international business law including, but by no means limited to, things such as put and call options, rights waivers and the concept of misrepresentation. This rigidity, according to lawyers, is the main reason that, while Russian law is slowly gaining traction, English law still dominates.

“The reason Russian law isn’t more ­popular is that Russian companies themselves don’t trust it and aren’t comfortable,” says Brian Zimbler, a partner in Dewey & LeBoeuf’s Moscow office.

“People still have no confidence that, whatever the Civil Code may say, they’ll be able to rely on it to enforce their rights,” adds Baker & McKenzie’s Moscow office founder Paul Melling.

However, the business law community in Moscow does not feel that the changes ­currently on the table will make much ­difference. Following the publication of the proposed amendments in November 2010 Russia’s domestic law firms banded ­together to argue their case.

The effort has been led predominantly by the largest domestic firms, Egorov ­Puginsky Afanasiev & Partners and the Pepeliaev Group, but has also involved other practices. The group is arguing that the code needs to be cut, rather than added to, to allow businesses more flexibility in the way they operate.

“We took part in extensive research and made comments and counter-suggestions on the changes and to the amendments,” explains Solodovnikov. “We think that to make the civil legislation more business-friendly it couldn’t be adopted in the way it was produced by the council.”

The group’s lobbying efforts are, say ­insiders, supported by a large proportion of the government. To date Medvedev has played a ­conciliatory role, hosting a meeting of the ­various factions – the codification council, the Russian administration and the business lobby – in March.

Solodovnikov says compromises were ­discussed at this meeting, which gave rise to some optimism in law firms. However, another Russian lawyer says it was followed by an “unrealistic” executive order to push ­forward another set of amendments in a short time. At present, the plan is to put forward these amendments to Russia’s ­parliament, the Duma, in the next few months, ahead of a potential decision in the autumn. This gives the business lobby time to propose another set of drafts.

Egorov managing partner Dimitry Afanasiev says each law firm involved in the group is preparing amendments to a single chapter of the code and then circulating these between firms for consensus to optimise the work burden. He is hopeful that the process will not only help bring about the reform that the business community is looking for, but will also have a positive knock-on effect for the Russian legal market.

“For the first time the Russian domestic law firms actually have a common cause,” he says. “We’re doing something that’s helpful and useful. We have to make Russian civil law more user-friendly. I’ve been saying this to leading Russian colleagues for years. But now the Russian state seems to have heard us and understood the point. We’re getting encouragement and support from the state to come up with a product that can be ­presented to it and discussed within the legal profession. If this works – and it’s by no means yet certain that it will – the Russian legal environment should improve in the next few years as these ideas are gradually implemented.”

Yukov Khrenov and Partners partner Alexander Khrenov says the next few months are likely to bring about the ­greatest changes.

“In my view, the real answer to this question will emerge not at the present debate stage of the proposed amendments but rather at the presentation and approval of the whole roadmap of business amendment changes by the president, and also after they pass first and second reading stages in the Duma,” he says. “This is when large ­business will be able to apply its lobbying muscle to the full extent.
“Presently, however, the ongoing polemics and mutual accusations of different groups of amendment drafters aren’t promising any fundamental changes to the present state of affairs, when most deals and transactions take place in other jurisdictions and are governed by foreign law.”

Lawyers from both domestic and international firms hope sensible changes to the Civil Code could help boost the attractiveness of Russian law, although Khrenov points out that this will depend on which amendments pass into legislation. He ­singles out two in particular: proposals to revamp the registration requirements for companies and increase the amount of required capital, and rules on corporate management.

“I don’t think any amendments to the procedure of legal and corporate registration, or changes to the required amounts of initial capital will significantly impact the current situation,” he says. “As far as ­amendments to the regulation of corporate management are concerned, we believe that ­giving the law more flexibility and assigning real meaning to the freedom of contract won’t enable liberal business amendments to jump the hurdle at the legislative level.”

Others argue that the key to making Russian law more widely used is a change in attitude, rather than in the actual law.

“The job of lawyers is to be more flexible in interpreting [the law] and to afford more protection to plaintiffs,” says Yuri Monastyrsky of dispute resolution boutique Monastyrsky Zyuba Stepanov & Partners.

“There’s a desire to turn things around and make Russian law dominant in ­transactions,” adds Andrey Goltsblat, ­managing partner of Goltsblat BLP. “It’s not a matter of law, it’s a matter for ­businesses to apply the law. It will be difficult to change Russian law so it becomes as ­convenient [as English law].”

An example of how lawyers are struggling with a change that has already been made to the Civil Code is the issue of shareholder agreements. In 2008 the code was amended to allow shareholder agreements for the first time in Russian law transactions. But, as Astapov Lawyers partner Oleh ­Malskyy points out, it is still unclear as to what is governed by these.

Changing times

Katerina Haslam-Jones, of Russian-UK firm Padva Haslam-Jones & Partners, adds that the Civil Code might have introduced the concept of shareholder agreements, but mechanisms to make them work have not yet been included.

“I can’t understand how you can draft shareholder agreements if you can’t rely on certain mechanisms that aren’t available in civil law,” she says. “I think the shareholder agreements will become more ­popular, but it’s going to happen tomorrow.”

Other changes to the law have been more successful. Afanasiev points to the recent privatisation of a shareholding in VTB Bank using a new law that allows the government to appoint an investment bank as the agent for a transaction.

“We represented the government in this process and one of the elements that we achieved from a national interest point of view was to have Russian law applied to this process,” he says. “This was initially a concern to the banks and others. We’ve created history where we’ve done something important under Russian law, and I think it’s going to be the beginning of a trend.”

Afanasiev says that one of the arguments as to why Russian law is sometimes not used for a transaction is “we’ve never done it before”. He says the VTB deal proves that precedence can be set.

Many international lawyers say that the differences between the Civil Code and common law are often the reason for Russian law not being employed in deals.

“This is a civil law system, and we ­common law lawyers tend to struggle a bit in civil law systems,” notes Melling. “A lot of the complaints that I find common lawyers have about Russian law are also complaints that I hear about French law, German law or Swiss law – it’s a difference between the common law and the civil law approach.”

However, it is clear that there is a growing convergence between not only the laws used in Russia but also the two types of firms present in the legal market. John Goodwin, managing partner of ­Linklaters in Russia, says the firm’s traditionally foreign client base is becoming more local.

“When foreigners basically disappeared in 2008 a decent chunk of the gap was made up by Russian corporates taking their place,” he explains. “We were shifting it anyway to a more Russian client base. That gained momentum when it needed to and it isn’t going to change. There’ll still be a cadre of Russian investors who want to use firms like ours.”

Scott Senecal, head of Cleary Gottlieb’s Moscow office, says the Russian market is less divided than many jurisdictions, with international firms seen as being Russian by many clients. Indeed, Russians head up the key departments in most international firms.

In contrast, however, foreigners remain absent from domestic practices. But this could well change in the near future. Egorov is laying out its stall to attract ­English-qualified lawyers in a bid to carry out work on transactions (The Lawyer, 16 May) and the view in the market is that the recent merger between UK firm Berwin Leighton Paisner and a team from Pepeliaev Goltsblat & Partners has been successful.

“In the next two to three years you’re going to see major Russian firms hiring expatriate partners from international firms,” says Melling.

Afanasiev says Egorov’s move is driven by what he sees as three distinct trends in the market: the dominance of English law, the globalisation of legal skills and the fact that personal relationships matter more than institutional relationships in emerging ­markets.

“If you look at these three issues and compare domestic firms with international firms, leading domestic firms lose out on the first issue, have caught up on the second issue and win on the third,” Afanasiev notes.

He says this is encouraging Russian firms to do what they can to increase the profile of Russian law in addition to giving their lawyers basic training in English law and hiring English lawyers.

But international firms are still bullish about their position. Harvey Nugent, a ­corporate partner in Freshfields Bruckhaus Deringer’s Moscow office, agrees that domestic firms are picking up more international work, but thinks foreign firms ­continue to hold an advantage, both in terms of work and of recruitment.

“What drives people to come to us instead of Russian firms is the experience you get of international markets,” says Nugent. “We’re fishing in a pool of the best ­English-speaking lawyers.”

International investment continues to be the main source of work for lawyers in ­Russia, both inward and outbound. Nugent says inward strategic investment is returning to the market after a lull during the financial crisis, a view backed up by Zimbler.

“I’d say we’re getting to be as busy as we’ve been at times when there was a hot market in Russia,” reports Senecal. “In general the Russian economy and the amount of work we have tends to reflect the price of oil and natural resources.”

Senecal also points to the Russian ­government’s programme of ­privatisation, which covers a range of sectors, as a ­potential source of work.

New horizons

Dealflow between Russia and other emerging markets is also a topic of discussion at present, particularly involving Chinese ­companies.

“There are a lot of Russia-China deals being attempted right now but they’re ­difficult,” says Zimbler. “The Chinese are interested in investing in Russia but the Russians are reluctant to accept that investment. I think the Chinese were interested in natural resources and the Russians have put restrictions on.”

India is also a source of work, although to a lesser extent. Litigation is an increasingly important practice area for all firms in ­Russia.

“Even five years ago it was only the brave or the foolish who chose to litigate their commercial disputes in front of Russian courts; now it’s the norm,” says Melling. “All law firms here that are serving ­multinational clients have had to strengthen their ­disputes practices.”

The local disputes specialists such as Monastyrsky Zyuba Stepanov and Yukov Khrenov report plenty of activity. Monastyrsky says the past two years were the firm’s “most profitable ever”, while Khrenov says banking, finance and tax ­disputes are keeping the firm busy.

That wave of contentious activity is also spreading to other jurisdictions. As The Lawyer has reported on several occasions, the English High Court is attracting a ­significant amount of litigation involving Russian companies and individuals, in ­particular the upcoming battle between Roman Abramovich and Boris Berezovsky.

Domestically, Russia remains in a state of flux. The Civil Code reform and other ­legislative proposals are occupying lawyers’ minds, but elections this year and next means their passage into implementation is far from certain. The economic outlook is good, but M&A and IPO work in Russia is still prone to failure.

However, lawyers are confident that the future for them is bright.

“It’s likely that international investment flows will continue and continue to improve,” says Goodwin. “Add to that a more sophisticated and developing Russian ­market and you’ve got the conditions for doing business around here.”

Tax law: slow progress towards the mainstream

Streamlined and user-friendly tax systems are essential to building up a country’s business competitiveness, but Russia’s tax system is still very much a work in progress.

Rustem Ahmetshin, senior partner at Pepeliaev Group, says the country’s tax system is “developing even more than our civil legal system”.

Ahmetshin says one particular development in recent months is a discussion over new tax transfer pricing rules. These would bring Russia more into line with international practice, bringing in elements such as required documentation and reporting for the first time.

“It’s an important part of every tax system everywhere in the world but until now it’s been a weak part of the tax code of Russia,” Ahmetshin says. “Only two articles [in the tax code] are devoted to this issue. In fact, the tax authorities can’t apply all the rules in practice and the courts cancel their decisions nearly every time.”

According to Ahmetshin the debate over the rules has continued for several years, leading to little optimism they will ever be adopted. However, he says businesses in Russia can function perfectly well under the current system.

A more concrete change noted in the past couple of years by lawyers is a shift in attitude by Russia’s tax authorities. This has impacted particularly on tax litigation.

Alexander Khrenov, of Yukov Khrenov & Partners, says the tax authorities are trying to exercise their executive powers more to ensure the maximum possible budget revenue.

Both Ahmetshin and Andrey Goltsblat of Goltsblat BLP say the number of disputes in the tax arena has decreased recently. Ahmetshin puts this down to the tax authorities becoming “more client-orientated”.

“The procedure of pre-court settlement which is beginning for parties has cut the number of cases,” Goltsblat adds.

Despite the drop in court cases, Goltsblat believes law firms in Russia must now have tax practices. His firm is building up its capability in this area and he says others will follow suit.

“I think tax law in Russia is becoming similar to any other civilised place,” he says.

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