Russian Federation: Legislative Developments, Enforcement Practice, Trade Law, Merger Control And Notification Versus Approval In Intra-Group Transactions

Last Updated: 22 July 2011
Article by Igor Panshensky and Alexander Egorushkin

LEGISLATIVE DEVELOPMENTS

The Third Antimonopoly Package: Key Developments

According to the Federal Antimonopoly Service (FAS), amendments to the Law on Competition (the "Competition Law," the Code of Administrative Offenses and the Criminal Code, comprising the so-called "third antimonopoly package," have been substantially agreed with the Russian government and will soon be submitted to the State Duma. FAS estimates that the package will be adopted before the State Duma's 2011 summer recess.

On balance, these amendments will add clarity, and, consistent with other government initiatives, will eliminate criminal liability in certain cases, which should improve the business environment for M&A in Russia.

We set out below some of the key developments in the third antimonopoly package that have been approved by the Russian government.

Changes to the definition of "concerted actions." A new mandatory criterion has been added to the definition of a concerted action, namely that actions deemed "concerted actions" must be "known in advance to each of the business entities participating in them, due to one of them publicly announcing that such actions were being carried out." This should at least partially change the judicial interpretation of concerted actions, in which courts held them to be practically equivalent to the concept of "parallel conduct" by market participants. The amendments also introduce a "safe harbor" for concerted actions where the combined market share of the participants is less than 20%, provided that no participant's individual share exceeds 8% of the relevant market.

Changes in the evaluation of anticompetitive agreements and concerted actions. An absolute prohibition has been proposed on such agreements and actions, albeit only if they are concluded among competitors (i.e., against cartels). However, in vertical agreements, it is still prohibited to set resale prices and enter into exclusive distribution arrangements. Under the current law, any agreements and concerted actions between companies in the same corporate group (connected through actual control, for example, between a parent and a direct or indirect subsidiary) cannot be deemed to be anticompetitive. Finally, it is proposed to remedy the shortcomings of the so-called "impermissibility mechanism" related to coordinatory and other technical discrepancies in the current law.

Changes in merger control regulations. Acquisitions of foreign companies that have no assets in Russia but sell their products in Russia, where the Russian sales of such companies exceed RUB 1 billion, will be subject to a new clearance criterion. The list of documents required to be submitted when making applications or notifications to FAS has also been updated. The requirement for financial organizations to provide FAS with copies of all agreements they have concluded with each other will also be completely eliminated.

Procedural innovations. The clarifications recently issued by FAS in relation to its decisions and prescriptions are to be formalized and a mechanism for reissuing FAS decisions and prescriptions in the event of newly-discovered circumstances will be formulated.

Mitigation of liability. The new amendments will eliminate criminal liability for concerted actions and vertical agreements. In addition, "turnover-based fines" will now only apply to cases of abuse of a dominant position that result in (or may result in) the prevention, restriction or elimination of competition. If this abuse results in the infringement of a third party's rights and is not related to the restriction of competition, then the maximum fine for such abuse will be RUB 1 million.

We can provide more detailed information on each of the developments mentioned above as required, as well as the other developments proposed as part of the third antimonopoly package.

LAW ENFORCEMENT PRACTICE

Interaction of FAS and the Ministry of Internal Affairs in the Initiation of Criminal Cases regarding the Violation of Antimonopoly Legislation

Amendments to Article 178 of the Criminal Code entered into force on October 30, 2009. Before being amended, this article was rarely used due to its clumsy wording. We will not address the issues related to the new wording of Article 178 here but rather will focus on issues related to its application following the enactment of the amendments.

At the end of 2009, FAS prepared internal instructions on applying Article 178. According to these instructions, FAS's legal department is obliged to gather information from all the Russian regions and use it to maintain a database of company officials upon whom administrative liability has been imposed for the abuse of a dominant position. Any case in the database that FAS opened to impose administrative liability for abusing a dominant position on officials on whom such liability had already been imposed twice within the preceding three years, is to be closed and FAS is to transfer the file to the Economic Security Department of the Ministry of Internal Affairs in order for the Ministry to open a criminal case under Article 178 of the Criminal Code.

Should FAS decide, after closing an antimonopoly case, that an anticompetitive agreement was concluded or that concerted actions were taken, the file for that case will be transferred to the Economic Security Department of the Ministry of Internal Affairs to open a criminal case if (i) the decision in the FAS antimonopoly case is not challenged within three months of being issued; or (ii) a court decision upholding FAS's decision in the case has entered into force.

Should the Economic Security Department of the Ministry of Internal Affairs refuse to open a criminal case, FAS must open a case in relation to the applicable administrative offense. In order to facilitate interaction between FAS and the Ministry of Internal Affairs, FAS regional departments must develop joint orders with the regional internal affairs authorities to regulate the procedures for interaction.

Despite the interaction procedures developed by FAS and set out above, the internal affairs authorities remain formally independent when opening criminal cases. As a result, the internal affairs authorities can open criminal cases and conduct investigations before FAS issues a decision establishing a violation of antimonopoly legislation. There are precedents for this: for example, in a recent case opened by FAS against the coal producers SUEK, Russky Ugol, and Stroiservice, FAS's finding that there was collusion between these companies was based on conversations between representatives of the companies recorded and provided to FAS by the internal affairs authorities (see, for example, http://www.fas.gov.ru/solutions/solutions_31954.html) . Another example is the case opened by FAS's Chelyabinsk office regarding collusion at auction. The antimonopoly authorities proved collusion on the basis of recorded conversations between auction participants, obtained by the internal affairs authorities as part of an ongoing criminal case (see http://chel.fas.gov.ru/news.php?id=675).

The Novo Nordisk Case: Selection of Distributors

In October 2010, FAS issued a decision in relation to Novo Nordisk LLC, held to be dominant in the wholesale market for certain medicines, which is an important factor in FAS's practice under Article 10 of the Competition Law. This decision may impact the practice of many companies selling products through a selective distribution network, even if they are not held to be dominant.

The background to this case is that in 2008 Novo Nordisk LLC ("Novo Nordisk") a Russian subsidiary of Novo Nordisk A/S, a Danish, pharmaceutical company) restructured its distribution network, reducing the number of distributors from 20 to five and conferring the status of permanent partner on the distributors. The selection of these distributors was based on their conformity to the requirements of a Novo Nordisk policy (including compliance with anticorruption laws) and was subject to a complex screening procedure. All other wholesale buyers—including its former distributors—not selected as permanent partners were invited by Novo Nordisk to enter into contracts with Novo Nordisk's permanent partners, and, if these potential buyers insisted upon a direct contract with Novo Nordisk, Novo Nordisk proposed that the buyers undergo the screening procedure. None of the applicants, other than the five permanent partners, successfully completed the screening.

FAS reviewed this case and concluded that Novo Nordisk had infringed Clauses 5 and 8 of Article 10.1 of the Competition Law (unjustified refusal to enter into contracts and the creation of discriminatory conditions). FAS's conclusion was based in particular on FAS's view that Novo Nordisk did not have any criteria for assessing potential distributors in terms of their conformity to its requirements and some of those requirements (e.g., regarding the transportation and storage of products) duplicated the requirements for the issuance of a license for pharmaceutical activities, which each of the applicants already held, meaning that Novo Nordisk was thereby effectively arrogating the functions of the licensing authority to itself. FAS believed that applying these requirements created the possibility that Novo Nordisk would evade concluding agreements with wholesale buyers other than its five permanent partners. FAS issued a prescription to Novo Nordisk requiring Novo Nordisk to repeal any requirements Novo Nordisk had imposed on distributors that are "not provided for by [Russian] law."

It is noteworthy that FAS deemed it impermissible for a dominant supplier to include in its distribution agreements requirements for distributors to provide sales reports or forecasts. FAS stated that this was a service "which can be rendered on the basis of separate service contracts and shall be subject to 18% VAT." It could be argued that FAS was thereby arrogating to itself a fiscal function that does not properly belong to it.

Based on its review of the case, FAS imposed a fine on Novo Nordisk in the amount of 1.6% of the total proceeds from sales in the markets to which the violation applied (1.5% of total sales proceeds), which amounted to RUB 85,934,025.

FAS's decision in the Novo Nordisk case left open the question of whether FAS permits the use by a dominant undertaking of any legitimate criteria for selecting distributors. This decision might have become a precedent not only in the context of dominance but also in the context of applying Article 11 of the Competition Law to interaction between manufacturers and distributors, because Article 11 bans an activity analogous to that banned in Clause 5 of Article 10.1 of the Competition Law (unjustified refusal to enter into agreements). Nevertheless, there remain reasons to believe that clear and well established selection criteria and transparent procedures for assessing compliance mitigate the risk of violating Article 10 and/or Article 11 of the Competition Law.

TRADE LAW

Article 9 of the Trade Law: Discounts

One of the many controversial issues regarding the 2009 law "On the Fundamentals of the State Regulation of Trade Activity in the Russian Federation" (the "Trade Law") is the question of whether one can use discounts not tied to volume of sales in food product supply agreements. This issue has been raised and discussed on multiple occasions in both expert committees and inquiries to FAS and the Ministry of Industry and Trade ("Minpromtorg") without any clear resolution.

In response to an inquiry by the Alcoholic Beverages Committee, Minpromtorg stated in September 2010 that "the question of [the permissibility of] the grant of discounts for the performance of obligations arising from the terms of a supply agreement is not addressed by the Trade Law"; in other words, there are no restrictions on using discounts. Earlier, in February 2010, FAS had expressed its position on this issue to the effect that it is permissible to include unconditional fixed discounts in food product supply contracts "provided that the price of the food product supply contract is set in the contract as of the moment (date) of the contract's conclusion based on the price of the total shipment (quantity) of goods to be supplied, taking into account the discounts granted to the buyer." In other words, any conditional discounts (except for volume-based discounts) must be excluded. Obviously, such a loose construction of Article 9 of the Trade Law is at odds with the position of Minpromtorg.

Subsequently, FAS effectively retracted this interpretation by invoking its lack of authority to interpret Article 9 of the Trade Law. However, it seems that now the situation is being reversed. In late December 2010, changes were introduced into the Code of Administrative Procedure according to which FAS was designated as the agency in charge of enforcing Article 9 of the Trade Law, which implies that FAS is now vested with the authority to provide guidance on the application of Article 9. This in turn may mean that FAS interpretative statement quoted above is becoming de facto the official interpretation. However, FAS's by-laws do not yet provide for this authority, so the overall position remains somewhat unclear.

MERGER CONTROL

Acquisition by PepsiCo of the Wimm-Bill-Dann Group of Companies

The most notable event in the M&A and merger control area in Russia in early 2011 was the completion of the acquisition by PepsiCo, Inc. ("PepsiCo") of control over the group of companies known as Wimm-Bill-Dann for approximately $3.8 billion. This transaction, the purchase of shares of open joint stock company Wimm-Bill-Dann ("WBD") from its shareholders, as well as the purchase of related ADRs and GDRs on foreign stock markets, was approved by FAS on January 27, 2011. In fact, FAS approved the acquisition of 100% of WBD, taking into account that PepsiCo was obliged to make a mandatory offer to the remaining shareholders of WBD to purchase their shares in accordance with the Law on Joint Stock Companies. FAS also issued two prescriptions, one in relation to the resultant entity's juice business, and one in relation to its dairy business.

The transaction is noteworthy in the context of merger control and the Competition Law for two reasons. First, FAS approved the deal very quickly, particularly when one considers that two companies of the WBD group met the criteria to be considered strategic companies under Federal Law No.57-FZ and so the deal also required the approval of the Commission for Foreign Investments. FAS decision coincided with the start of the World Economic Forum in Davos, and the speed of the regulatory review can be explained primarily by the Russian government's positive reaction to the deal and resultant desire that the deal close quickly.

The second noteworthy aspect was the substance of the prescriptions issued by FAS to PepsiCo. It should be noted that the transaction was potentially problematic since both PepsiCo (through its subsidiary Lebedyansky) and WBD had sizable juice businesses with an aggregate market share close to 50% at the federal level. By contrast, there was no overlap between the companies in the dairy market, since PepsiCo did not operate a dairy business in Russia prior to its acquisition of WBD and indeed was acquiring WBD primarily for WBD's dairy business. Despite the different situations in the two lines of business, FAS issued prescriptions in relation to them both. If issuing a prescription in relation to the juice business was inevitable (in the event that the deal was approved), since the deal was going to lead to a substantial increase in PepsiCo's market share and a reduction of the number of independent players in the juice market (and thereby constitute a restriction of competition under Russian law), the rationale for the prescription in relation to the dairy business was not obvious.

In fact, FAS's only written rationale for issuing the prescription to PepsiCo in relation to the dairy business was a reference to the possibility of PepsiCo's share in the dairy market increasing as a result of its future investment into the target, which is not a compelling argument in light of the fact that WBD's share in the federal market for any dairy product did not exceed 25%. Although WBD was included in the regional section of the Registry of Undertakings as having a market share of over 35% in the market for the procurement of raw milk in two regions (i) this fact was in no way related to or affected by the deal, and (ii) the prescription was issued to PepsiCo in relation to the entire federal market and not just the regional markets in question.

Moreover, the two prescriptions issued by FAS to PepsiCo de facto impose on PepsiCo a legal regime analogous to that applicable to a dominant entity without PepsiCo's having established a dominant position in any market in Russia. Even if dominance is established or strengthened as a result of an M&A transaction, FAS is only entitled to issue a prescription with the objective of securing competition in the market but not to protect certain categories of parties or to obtain general control over the acquirer's group. There are already many precedents involving companies successfully challenging FAS prescriptions in court on the grounds that they are not in compliance with this framework.

Applying Post Factum Notification Procedures (as opposed to Preliminary Approvals) with Respect to Intra-Group Transactions

Transactions involving shares, participatory interests, or assets executed within one group of entities fall under antimonopoly control provided that certain economic thresholds are met. Before the amendments that comprise the so-called "second antimonopoly package" entered into force in 2009, all such transactions had to be approved in advance by FAS, except in cases where the structure of the relevant group had been disclosed to FAS earlier in accordance with a certain procedure. After the "second antimonopoly package" was enacted, transactions between parties where one party owned more than 50% of the shares or participatory interests of the other were excluded from the scope of preliminary approval procedures: these transactions now merely required that FAS be notified. According to a formal interpretation of this new rule, this exception only applies to transactions between subsidiaries and a direct parent company.

The limitations of this interpretation were evident, and FAS officially clarified that this exception also extends to companies within a chain of companies owning a more than 50% stake of participatory interests or shares in each other. In other words, following a literal reading of the FAS clarification, transactions where each company owns more than 50% in the other and the companies are in the same vertical shareholding chain of control within a group are eligible for exemption from the need to seek FAS's preliminary approval.

However, it remains unclear how to treat transactions among companies within parallel branches of the same group, i.e., between "sister" companies. In effect, such transactions in no way differ from transactions among companies within the same vertical branch of the group. Neither the law, nor FAS's clarification mentioned above, provide a direct answer to this question. Meanwhile, in practice, several transactions between "sister" companies have undergone the notification procedure successfully, i.e., FAS de facto acknowledged that they are exempt from any requirement for preliminary approval. The rationale for applying the notification procedure, rather than the preliminary approval procedure, was that these transactions are in effect transactions among companies within the same chain of companies where each company holds more than 50% of the others, the chain between the parties to the transaction being formed by a combination of direct and or indirect parent companies (i.e., the chain is V-shaped).

Although this justification has been accepted by FAS on more than one occasion, it is still advisable to apply to FAS for preliminary consent for intra-group transactions among "sister" companies, as there is no guarantee that FAS's practice will not change, as has occurred previously. In these situations, we would suggest using the notification procedure only when there is no realistic possibility of obtaining preliminary approval from FAS for the transaction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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