Expropriation and other recent measures aimed at foreign investors in Russia
Market Insight 14 March 2022 14 March 2022
UK & Europe
As a reaction to the international sanctions following the Russian invasion of Ukraine, the Russian government enacted several economic retaliatory measures that could significantly impair foreign investments in Russia or contracts concluded with Russian companies.
Below, we outline the various measures currently discussed and/or already in force and provide you with information on investment protection and related legal instruments at your disposal if you are affected by these measures.
The situation regarding the various measures in force or in preparation is very much in flux and not entirely transparent. There are different draft laws, decrees, and announcements in circulation. The overview below is therefore only a snapshot as of 14 March 2022. We will update this briefing as the situation evolves.
Potential nationalisation of foreign businesses and their assets
Already on 10 February, the legislative commission of the Russian government approved a set of legislative measures that could eventually lead to the nationalisation of foreign companies that leave Russia or suspend their business operations. Once approved by the Duma and Senate, these measures seek to nationalise companies that are held by foreign parent companies (more than 25 % share ownership) from countries of “unfriendly governments”. The legislative draft is already available for review and foresees that external management can be installed in the companies for the purposes of their nationalisation. Considering the current political situation, we expect that the law will be enacted in a matter of weeks.
In relation to foreign owned assets within the Russian jurisdiction more broadly, clearly there are increased risks, for example, there are indications of action in relation to the aviation sector and it is worth keeping an eye on how this plays out.
Potential restriction of patents and IP rights
The government has implemented a framework that essentially allows for the restriction of patents registered in Russia. Until recently, the state could take over a foreign patent, but would have to pay mandatory royalties. Such mandatory royalties are no longer required, which has been made possible through enactment of Government Decree 299 (dated 6 March 2022) in conjunction with Decree 1761 (dated 18 October 2021) as well as Article 1360 of the Russian Civil Code. Taking over foreign patents under this framework could effectively destroy their value.
Moreover, the Russian Government and various legislative committees of the Russian parliament are currently discussing the restriction of IP rights for computer software. The plans seem to be a direct reaction to the announcements of large foreign software companies not to renew existing licenses.
Special regime for disposing of assets
With Decree of the President of the Russian Federation dated 1 March 2022 (N 81), foreign natural persons and legal entities connected to “hostile” states may not conclude or perform certain contracts without permission from the Special Commission. Contracts falling into the scope of the special regime are credit and loan agreements (in RUB), transfer of securities or real estate.
Restrictions related to government bonds
On 1 March, Russia’s central bank has announced that it will stop paying coupons on Federal Loan Obligations (OFZs, also known as Rubel bonds) to foreign investors, who hold bonds exceeding USD 25 billion. This would essentially devaluate the OFZs. Since the announcement, this measure has somewhat evolved, and a more indirect restriction seems to be contemplated now where RUB coupon payments on Russian securities held by foreign nationals are to be made to special “S” accounts. Transfer of funds from “S” accounts is restricted. The extent of this restriction as well as the overall legal regime for “S” accounts is not entirely clear yet.
Adding to this situation, the credit rating of Russia has recently been downgraded by all three major credit rating agencies (Fitch, S&P and Moody). Fitch has recently even downgraded Russia’s creditworthiness to the second lowest C-level, reflecting their view that sovereign default may be imminent.
Prohibitions on trading stock
On 28 February, Russia’s central bank prohibited brokers to execute sell orders from foreign investors until further notice. It will therefore be impossible for foreign companies to divest and sell shares traded on the Russian stock exchange until this prohibition is lifted. In any case, the Russian stock exchange has remained closed for the third week since the Russian invasion.
There are, however, legal instruments aimed at protecting foreign investments still in place.
Most importantly, Russia has concluded several Bilateral Investment Treaties (BITs) with other countries, such as, for example, with Germany (1989), Turkey (1997), United Kingdom (1989), Sweden (1995), Japan (1998) which protect – among others – against unlawful expropriations, arbitrary restrictions on the movement of capital and other discriminatory measures. Some of those treaties are narrower (e.g., only providing for arbitration to determine the amount of compensation following an expropriation) and others – the more recent treaties – tend to contain wider investor-state arbitration clauses submitting to arbitration any dispute related to the investment and protected under the respective treaty. There may also be the possibility to invoke the Energy Charter Treaty (ECT) in case of with pre-2009 investments in the Russian energy sector. However, Russia has never ratified the ECT and there is considerable dispute over its provisional application.
Looking at the restrictions imposed on government bonds, patents/IP rights, stock transfer and the planned nationalisation of foreign held companies, the implemented and/or envisaged retaliatory measures may very well constitute, among others, a direct or indirect expropriation as well as a breach of the Fair and Equitable Standard (FET) protected under most BITs. Similar claims arose out of Argentina's enactment of legislation concerning the restructuring of its public debt, leading to the Government's default in sovereign bonds in late 2001 (see Abaclat and Others v. Argentine Republic, ICSID Case No. ARB/07/5).
Such claims can be brought in international arbitration proceedings based on the respective BIT, providing for a neutral forum to resolve the dispute and claim compensation. If successful, it provides the affected foreign investor with an arbitral award against the respondent state.
Such awards can be enforced under various international instruments. Even though Russia has not ratified the 1965 Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention), arbitral awards against Russia can be enforced under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention, NYC), to which Russia is a contracting state. Currently, 168 states have signed the NYC.
Although enforcing against Russian assets may seem a daunting undertaking looking at the international sanctions in force, there will likely be mechanisms instituted in the future to lift those sanctions (frozen assets) for enforcement purposes. Moreover, third party funders may be interested to buy favourable awards and wait for enforcement possibilities in the long term.
If you have any questions on investment protection, please get in touch with:
Georg Scherpf (Clyde & Co, Hamburg)
For a detailed analysis of investment protection in the CIS region, please see the article published by Georg Scherpf (Clyde & Co) and Nikita Kondrashov (External) in the German Arbitration Journal (Investment Protection and Arbitration in the CIS Region (SchiedsVZ 2020, 8 - beck-online).
For an overview of Clyde & Co’s international arbitration team in Germany, please see here: https://www.clydeco.com/en/insights/2021/06/arbitration-germany.