business in russia 062807

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ESTABLISHMENT OF LEGAL PRESENCE IN RUSSIA Randolph M. Wright & Simon Edelstein Berry Moorman P.C.


ESTABLISHMENT OF LEGAL PRESENCE IN RUSSIA • How to Structure the Business or Deal • Choice of legal entity • Use of offshore entities • Franchising • Dispute enforcement and enforcement of awards



How to Structure the Business or Deal : 

How to Structure the Business or Deal Formal registration in Russia may or may not be required depending on extent of business presence in Russia May need to be registered in Russia for tax purposes if a “permanent establishment” in Russia Establishing a legal presence in Russia may be necessary for operational reasons and legal recognition A number of options for establishing a legal presence in Russia

How to Structure the Business or Deal: 

How to Structure the Business or Deal Does a foreign entity need to form a Russian legal entity or a Representative Office: • If a foreign company plans on bringing a significant amount of equipment or cash into Russia to pursue its business, it should consider setting up a legal entity • The foreign company can set up a Russian company: Equipment or cash can be contributed as charter capital to the newly formed Russian company free of VAT If cash is contributed, it can be used to purchase or manufacture equipment in Russia

How to Structure the Business or Deal (cont’d…): 

How to Structure the Business or Deal (cont’d…) The Russian company can be set up by the foreign company alone or together with a Russian partner A Russian partner may be necessary for a foreign company that seeks business in “Russian content” restricted work A Russian legal entity provides another layer of limitation of liability • If a foreign company is largely in the business of selling equipment (or in a few situations services) outside Russia (to Russian buyers), a Representative Office is a better option - a Representative Office is not a separate legal entity. Instead, it is the “face” (including eyes and ears) of a foreign company in Russia

How to Structure the Business or Deal (cont’d…): 

How to Structure the Business or Deal (cont’d…) Where a foreign company sells equipment, (or certain services) outside Russia, the Representative Office merely provides information and support The Representative Office cannot sign contracts in its own name – it is the foreign company itself that has the capacity to enter into contracts This method is advantageous to a foreign seller because sales can be made in convertible currency, and the Russian buyer must deal with customs and other import formalities If information and support leads to a “permanent establishment,” a Representative Office must register with the Tax Inspectorate even if it is not liable (or thinks it is not liable) for Russian taxes




Limited Liability Company ("LLC") Open JSC Closed JSC Joint Stock Company ("JSC") Russian Subsidiary Separate Legal Entity Representative Office Branch No Separate Legal Entity Choice of Legal Entity


Branch/Rep Office Branch office and representative office often used for same purposes Less regulatory control Bookkeeping simpler Possible exemption from value added tax on leases of residential and nonresidential premises Facilitation of activities and dealing with Russian government agencies and local businesses Ability to obtain visa for expatriate employees Russian Subsidiary May be necessary for joint ventures Certain operations may require Russian entity Tax planning Limiting liability of non-Russian parent Choice of Legal Entity


LLC Based on civil law system More private form of company Statutory minimum authorized capital is RUR10,000 (~$315 USD) A less formal and a more flexible alternative to a JSC, with some characteristics of both a partnership and a corporation Simpler management structure and greater flexibility (e.g. fewer management bodies required) All participants have limited ability like shareholder, but their participation interests do not constitute securities and are not subject to Russian securities laws Provides significantly less protection to minority participants than JSC Subject to an accreditation procedure with the State Registration Chamber operating under the Russian Ministry of Justice JSC Similar to common law system (like English companies or US corporations) and may be either open (public) or closed (private) Statutory minimum authorized capital is RUR 10,000 (~$315 USD) An open JSC must make public its annual report, balance sheet and profit and loss statement Both closed JSCs and open JSCs shares constitute securities and are therefore subject to regulation under Russian securities laws Subject to more extensive information disclosure requirements than an LLC Provides certain additional protection for minority shareholders Choice of Legal Entity


A legal presence in Russia may be established as a result of acquisition by a foreign investor of a asset or stock in an existing Russian company. Under Russian law, two main methods of purchasing assets are available: ● Asset acquisition Stock purchase Asset acquisitions are frequently employed in Russia and have their advantages. Asset acquisitions greatly simplify the issue of hidden liabilities or “stealth” creditors. Stock or equity acquisitions is most common form acquisitions of legal entities. Stock acquisitions are especially favored for large industrial targets, where asset acquisitions would be particularly cumbersome and not very tax efficient. Law establishes procedures for notification and prior clearance with Federal Anti-Monopoly Service (FAS) transactions aimed at acquiring major blocks of shares or ownership interest in business entities or significant portions of their assets. Choice of Business Arrangement – Joint Ventures


The joint activity is taxed at the level of its participants (with the exception of value-added tax) Must be registered with the tax authorities, the State Registration Chamber for representative offices, and the various social funds. If JV to be implemented, following elements are suggested: “Waterproof” contracts, by-laws, etc. Availability of home office resources to support the deal especially at the early stage Strong local support from advisors Existence of the general (but flexible) plan Maximum ownership control (at least have a blocking vote) Financial control Staff control Choice of Business Arrangement – Joint Ventures


Always risk when enter into joint venture with foreign partner Russia has historically posed some significant joint venture risks, many due to problems with corporate governance, including: dilution of shareholdings through issue of new shares violation of shareholders rights on corporate re-organizations asset stripping (moving profitable assets to other companies and leaving existing shareholders with liabilities) transfer pricing: including funneling off funds to corporations not owned by all shareholders Choice of Business Arrangement – Joint Ventures

Choice of Business Arrangement - Specific Issues for Foreign Investors: 

Choice of Business Arrangement - Specific Issues for Foreign Investors Contractual relationships are preferable compared to ownership participation Avoid JVs unless there is a good business reason to enter into one Maintain tight cost control Build personal relationships Make sure all formalities are complete



Use of Offshore Entities: 

Use of Offshore Entities Most foreign investors choose to use a holding company in a low-tax OIFC through which to finance a Russian involvement The primary reasons companies employ offshore investment and offshore company structures are as follows: Offshore Asset Protection Financial Privacy International Business Company Creation International Investment Options intra-group financing tax planning cross-border trade and investment holding and managing assets asset protection financing the holding, managing, and licensing trademarks, copyrights, and other intellectual property Typically, a Russian investor will use an offshore company to hold business operations or assets whether in Russia or abroad

Use of Offshore Entities (cont…): 

Use of Offshore Entities (cont…) Russian investor re-investing overseas assets into Russia the use of a holding company or financial intermediary in one of the offshore jurisdictions with a good Russian tax treaty - for instance Cyprus or Luxembourg to allow the remittance of Russian profits, royalties or interest with minimal tax cost Offshore companies used in Russian business practices typically do not have any identifiable business in the country of establishment, and all or major part of their commercial operations are performed in Russia Management decisions made on behalf of foreign companies are adopted and exercised in Russia by Russian authorized individuals being either directors or persons acting on the basis of a general power of attorney Business functions of a foreign company are typically exercised by Russian employees of affiliated companies (drafting contracts, conducting correspondence, negotiations in the name of the foreign company) Signing of contracts is normally performed by nominee directors abroad

Use of Offshore Entities - Nominee Directors: 

Use of Offshore Entities - Nominee Directors This is erroneously believed to be a guarantee against a permanent establishment risk (triggers tax consequences) This is a standard “packaged” service upon a purchase of an offshore company and is typically provided by local registered agent or secretarial firm Instructions and relevant documentation are typically provided by beneficiaries and real decision makers from Russia to the nominee director for signature As a rule, a nominee director is not responsible for his actions before third parties as he does not in fact make business decisions Instructions and assignments (“recommendations”) from entitled Russian persons to nominee directors provide evidence of a factual place of management in Russia Use of nominee directors of a foreign company does not necessarily reduce the risk of a permanent establishment in Russia



Franchising : 

Franchising Franchising legislation was formally adopted in 1994 by the Russian Civil Code, specifically in Chapter 54 where franchising is defined as a “Commercial Concession” Franchising business model is rapidly growing in significance in Russia, particularly in the restaurant, fast food, retail clothing and service (hotels, copying, cleaning) sectors Under the Civil Code, the legal elements of the definition of “franchise” are the granted rights and the required payments. Under a franchise, the franchisee is granted a “complex of rights” owned by the franchisor, which may include the franchisor’s firm name, protected commercial information (know-how) and other exclusive rights, e.g., trade, service marks, etc. In return, the franchisee is required to make payments to the franchisor


Franchising In order for the franchisor to enjoy protection of its trademark licensed under a franchise agreement in Russia, such a trademark must be either officially registered under Russian law with Rospatent ( Russian Patent Office) or registered under the Madrid Convention on trademark registration with an extension of coverage to Russia Many foreign franchisors have found when looking at Russia as a possible new franchise market that their trade names, marks, web sites and other intellectual property have been registered (“squatted”) by small unknown groups, which may prevent them from immediately licensing the intellectual property to a potential Russian franchisee until litigation has been successful to recover the rights, this can be costly and time consuming, typically taking more than a year to resolve Any potential franchisor or franchisee should consider this point closely and take such steps to preserve their IP protection in Russia well in advance of concluding any contracts for franchise


Franchise agreements may be entered into by commercial entities or individuals as independent entrepreneurs A franchise agreement must be in written form and be executed, failure to comply with this requirement will make the agreement null and void The franchise agreement may be concluded for a fixed or indefinite term; however, to the extent that no specific term is given to the agreement, it shall be deemed as entered into for an indefinite period, which can pose problems for a party seeking to terminate the franchise relationship The Civil Code requires parties to register signed franchise agreements with two state authorities: the tax authorities and the Federal Service for Intellectual Property, Patents and Trademarks (Rospatent) Franchising


The amount and type of fees for remuneration under a franchise agreement may be freely agreed upon by the contracting parties A fee may be structured as lump sum, a royalty based on sales or other measures, a commission deduction from any sales proceeds or mark-up earned by the franchisee, through any product imported and sold by the franchisee from the franchisor or other commercially negotiated terms One of the most alarming aspects of the Russian franchise legislation for franchisors is the Civil Code requirement that the franchisor to be held to secondary (subsidiary) liability for acts of the franchisee with respect to the inadequacy or other liability caused by the sale of goods, performance of works or rendering of services under a franchise relationship, as well as the imposition of joint and several liability for the franchisee’s manufacture of defective goods under a franchise agreement Franchising


The Civil Code franchise legislation envisages a number of mandatory obligations between parties: - The franchisor must transfer to the franchisee technical and commercial documentation and provide information necessary for the franchisee to exercise its rights under the agreement, instruct the franchisee and his employees on issues related to the execution of these rights and, if the parties do not regulate the issue or agree otherwise, the franchisor must render continuous technical and consulting assistance to the franchisee, including training of employees, and supervision of the franchisee’s quality of goods, works and services - The franchisee specifically must use the franchised trademark in accordance with the franchise agreement; ensure compliance of the quality of goods, works and services with the franchisor’s brand standards, including appearance of the store, its design, etc.; preserve the franchisor’s know-how and trade secrets or other commercial information; and inform customers that the franchisee is providing the goods/services acting on the basis of a franchise relationship, etc. In the latter case this is usually done via a small sign or small print on the contract for sales Franchising


Either party to a franchise agreement is entitled to unilaterally terminate an agreement concluded for an indefinite term subject to giving six-months notice As for statutory grounds for termination, the franchise agreement ends when the rights to the firm name granted to the franchisee expire, unless they are replaced by other rights, the franchise agreement also ends in the case of bankruptcy of a contracting party The Civil Code requires that, upon the death of a franchisee, the franchise agreement be transferred to the heir of the franchisee provided that the heir registers as an entrepreneur; otherwise the franchise agreement is terminated Another interference in the commercial decisions of parties to a franchise, particularly the franchisor, is the provision that on the expiration of a franchise agreement entered into for a defined term, the franchisee is entitled to automatically renew the agreement on the same terms and for a similar term length provided that the franchisee has historically met and performed its obligations under the expiring franchise agreement, no provisions for changed economic markets or circumstances, inflation increases, etc. are provided by the rigid renewal provision Franchising


BUSINESS IN RUSSIA – OPPORTUNITIES AND CHALLENGES Dispute Resolution and Enforcement of Awards

Dispute Resolution and Enforcement of Awards: 

Dispute Resolution and Enforcement of Awards Courts versus Arbitration • Russia is a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958), but not a signatory to the Hague Convention on the Recognition and Enforcement of Foreign Judgments in Civil and Commercial Matters (1971) • Russia does have bilateral treaties on the enforcement of judicial decisions with a limited number of countries (mostly former socialist countries) • As a result, a judgment from a foreign arbitral tribunal (UNCITRAL, LCIA in London, AAA in New York) can be enforced against a Russian party in Russia, but a Russian court is not required to enforce a decision of a foreign court against a Russian party in Russia

Dispute Resolution and Enforcement of Awards: 

Dispute Resolution and Enforcement of Awards • What about Russian courts? A foreign company doing business in Russia can certainly bring a lawsuit against a Russian party in a Russian court (unless a contract between the parties provides otherwise) • Note the arbitrage (misnomer – they are judicial) courts – specialized to deal with commercial disputes • What about corruption in Russian courts? Of course it exists (indeed President Putin recently formed a new federal agency to deal with it), but it is incorrect to automatically assume it in every case


Still major problem for foreign investors in Russia: court system can be slow and corrupt Russian laws have many holes and uncertainties which makes resolution of disputes more difficult law still requires major revision Arbitration is preferred route for most western parties using recognized arbitration rules Dispute Resolution and Enforcement of Awards

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