Russian Federation: Russia - Private Equity 2017

Last Updated: 20 November 2017
Article by Zhanna Tomashevskaya and Roman Nikolaev

1 Overview

1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current state of the market for these transactions? Have you seen any changes in the types of private equity transactions being implemented in the last two to three years?

The most common types of private equity (PE) transactions in Russia are angel investing, venture capital and minority investments in portfolio companies. Private equity investors also continue to have a strong interest in distressed investments, which are still popular to an extent.

Notwithstanding the uncertain economic conditions over the last years, a reasonable level of PE activity remains, as investors with substantial amounts of undeployed capital continue to seek opportunities in the region. The PE market remained, however, the same.

The pattern of how investors structure PE transactions has not changed significantly over the last few years. Investments are typically made through a special purpose vehicles (SPV) established by the market players in a tax-friendly jurisdiction with the purpose of providing unleveraged private equity financing in exchange for a minority- or majority-controlled stake. However, the "anti-offshore" law that aims to retrieve Russian capital back from offshore zones, the development of Russian corporate and contract law and other stimulus measures of the state have been changing the structuring landscape to a certain extent.

1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions in your jurisdiction?

There is still a considerable uncertainty around the Russian economy. The main reasons being: the total revaluation of assets caused by the devaluation of the rouble; and international tensions and sanctions. Many PE funds are more engaged today with the active management of portfolio companies, than in the search of new sources of investment.

At the same time, during the last years the Russian Parliament has put a lot of effort to improve the legal tools which are used in PE transactions, making them more flexible and accorded with international best practice. It is worth mentioning the Civil Code of the Russian Federation (the "Russian Civil Code") amendments, some of which are quite revolutionary (e.g., an implied obligation to act in good faith; conceptually new indemnity analogous instruments) which are detailed in the later sections of this chapter.

These amendments are clearly a positive sign of progress and an ambition to create a more predictable and flexible legal environment for all concerned.

2 Structuring Matters

2.1 What are the most common acquisition structures adopted for private equity transactions in your jurisdiction? Have new structures increasingly developed (e.g. minority investments)?

The Russian PE market has adopted several standard structures that are used by most of the market players. Typically, it is one or more off-shore SPVs incorporated in a tax-friendly jurisdiction which act as a parent/holding company through which investors contribute and control their investments into Russian operating companies. This structure varies depending on the industry (FMCG, TMT, Oil&Gas), level of maturity of the target and its expansion plans, type of investor and its status as tax and currency resident in Russia. For most of the transaction documents English law is still used rather than Russian law. Investments which relate to projects with state participation in the equity or under public-private partnership seem to have a greater involvement of onshore arrangements (Russian law applied to the transactions). In these cases, it is typical to structure the investment through an onshore joint venture vehicle (usually in the form of a joint stock company or limited liability company) or an investment partnership.

Since 2012, Russian law has underestimated vehicles for investments. The investment partnership – which can be used in PE more actively – is a good vehicle because it minimises the defects of the most popular domestic schemes of investments, including Russian mutual funds (паевой инвестиционный фонд) and ordinary or trust partnerships (простое товарищество или товарищество на вере), and attracts more investors (major and minor) into the market.

The investment partnership (IP) establishes the legal grounds for joint corporate investments by introducing a new business structure created through an investment partnership agreement (IPA). This vehicle is similar to an English limited partnership and represents a marked improvement over the existing structure for fund vehicles in Russia. Investors, both foreign and Russian, who wish to use a Russian investment structure can move their off-shore vehicles into (or create investment vehicles under) the jurisdiction of the Russian courts. An IP is not a separate legal entity and thus does not require any registration or any licence. This vehicle also allows for the introduction of specific provisions in the IPA which are available in no other structure, such as the size and type of the contributions, capital call procedures, default contribution rules, conduct of the IP's business (management and decision-making procedures, or establishment of an investment committee), distribution of profit rules, assignment of rights and obligations rules, and exit rules.

2.2 What are the main drivers for these acquisition structures?

The fundamental drivers for the above acquisition structures are tax efficiency, cost performance, the regulatory regime, corporate governance and shareholder protection, including enforceability of contractual and corporate rights.

2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)?

PE investors typically invest through a combination of ordinary and preference equity along with shadow equity participation in the form of bonus payments calculated with reference to the share price or other financial indicators. The final structure of the instruments depends largely on the nature of the investor, value drivers for the target company and the level (jurisdiction) of structuring.

It is also often the case that the standard instruments of investments are combined with liquidation preferences, ratchets, down round protections and pre-negotiated exit terms in the form of redemption rights, put options, drag-along rights or rights to force an IPO or strategic sale following a prescribed holding period. Carried interest is a rarely-used tool in relation to Russian targets structures. Only 2-5% of PE transaction structures apply this approach.

Equity participation for management may be structured through share options, performance/restricted shares, option to SPV shares, phantom option and shares, and equity-linked bonuses (deferred).

2.4 What are the main drivers for these equity structures?

The principal drivers for these equity structures are: tax efficiency; the need to secure the priority of return of the private equity investor's capital, and to facilitate the ability to return capital to shareholders; and the desire to incentivise management.

With respect to management, it should be noted that there is no existing Russian legislation which clearly regulates management programs, thus giving sufficient freedom when developing the conditions of the program. The mechanisms for the implementation of such management program must therefore be carefully chosen. Successful introduction of the management program depends not only on its correctly constructed motivational component, but also on how the legal mechanism, which is its cornerstone, can fully realise the program's conditions. Moreover, it is also necessary to resolve the tax issues concerning the realisation of the program beforehand. These questions arise not only for the company, but also for the participant(s) of the program. Thus, in developing a model of long-term remuneration of management, the company inevitably faces a question of the legal and tax mechanisms of her realisation.

2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions?

In recent years, different approaches have been tested by the PE market players. Vesting linked to a company operating metric is becoming more popular. Time-based and performance-based vesting are both commonly used for Russian management equitylinked programs. Equity-linked programs are usually subject to good and bad leaver concepts under which such equity may be acquired at either fair value or at a cost, and a drag in the event of an exit by the private equity investor. Since most equity-linked compensation regimes for Russian portfolio companies do not result in actual shares being issued to management, there is not typically a compulsory acquisition requirement. The only exception would be if management held stock in a public company which is under a compulsory acquisition regime (the Joint-Stock Company Law provides a buyout right for minority interest holders when a person has acquired an interest in all or most of the securities in a class). This right allows the remaining holders of shares to require the major interest holder to purchase their securities.

2.6 If a private equity investor is taking a minority position, are there different structuring considerations?

Minority investments usually take the form of convertible debt or/and shares carrying preferential rights over the class of shares held by the founder and other shareholders. The key minority investor considerations would be governance and the need to ensure preferred returns. As mentioned previously, preference shares may be issued with fixed or variable liquidation preferences, preferences in respect to dividends, and preferences with ratchets that modify as the financial health of the company changes.

Minority investors also often negotiate representation on the board (this ensures that entities in the group do not take actions that are reserved matter actions in contravention to the minority investor's reserved matter veto rights); pre-emption rights in respect to new issuances of shares; lock-ups and prohibitions against changes of control at the majority shareholder level; reporting and inspection rights giving the minority shareholder regular access to the financial accounts of the company.

Another effective tool for minority investor interests are reserved matter approval/veto rights.

3 Governance Matters

3.1 What are the typical governance arrangements for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction?

The corporate governance regime has become considerably more flexible and accorded with international best practice following amendments to the Russian Civil Code, Joint-Stock Company Law and Limited Liability Company Law introduced over the last three years. These new rules have given PE investors an ability to structure their interest over participation in the composition and functioning of the board of directors, along with the shareholders' meeting. Typically, governance arrangements include an offshore holding company, its board of directors or shareholder advisory board, which takes all principal decisions pursuant to the company's articles of association and/or shareholders agreement, which typically set out reserved matters through which PE investors exercise control and veto rights. This governance regime then gets pushed down to the Russian operating company level through mirrored provisions in the operating company's charter/constituent documents or as a limitation or grant of authority on the operating company's general director.

Usually the governance arrangements with more than one shareholder are usually set out in a shareholders' agreement. Such agreements are not required to be filed with the state bodies and are generally not required to be made publicly available. Other arrangements will also be set out in the constitution documents of portfolio companies, which are made available to an extent to the public upon filing with the Uniform State Register of Legal Entities.

3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy?

A veto right is one of the main and most effective tools which PE investors acquire over the governance arrangements.

In Russia, a veto over fundamental acts in the corporate structure can easily be accomplished. Current Russian law provides for shareholder participation in fundamental corporate acts, such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, etc. A charter provision requiring unanimity for all shareholder action or for those particular acts will provide for each shareholder an effective veto over certain corporate changes. Similarly, a provision requiring approval of holders of a high percentage of the shares for a shareholder's action can be used to provide a veto over fundamental acts.

High voting requirements for shareholders' action, however, usually do not give the power to veto important policy matters such as operational issues or the day-to-day conduct of business. To provide a veto over those kinds of decisions, unanimity or a high vote must be required for director action, and the shareholders for whom a veto is sought must be assured representation on the board of directors. Further, it may be necessary to define narrowly in the charter the authority and duties of corporate officers; otherwise corporate officers may be given the authority to perform, without director approval, acts against which a veto is desired. Whenever a shareholder has sufficient voting strength to keep a representative on the board, a requirement of unanimity for board action, of course, gives that shareholder the effective power to veto action within the province of the board.

Another possible method of assuring that a PE shareholder will control the fundamental acts in the company is the nomination of two general directors (analogous to the CEO). This arrangement results in the concerted acts of the original and second CEO (nominated by the shareholders) in the day-to-day conduct of business. The volume of veto rights depends on the pre-deal negotiations. Generally, the size of the stake in the company will not change the situation around veto rights dramatically.

3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed?

Generally, there are no limitations on these rights. On the contractual level, shareholder veto arrangements are binding obligations that courts may generally enforce. However, if management act against the shareholders' agreement and the agreed veto rights, such actions would not be invalid corporate resolutions as such and only contractual damages can be sought from the defaulting shareholder(s).

In Russia, board members are not considered representatives of benefit of the target company in all circumstances (the priorities of which may differ from that of a specific shareholder). To the extent the board is required under law to take a certain resolution (e.g. due to insolvency concerns), no contractual arrangement may force the board to act differently. Where there is a concern that the directors' ability to exercise their veto rights may be limited by their fiduciary duty owed to the company, such concern is often addressed by giving such veto rights to the shareholders instead of the directors.

3.4 Are there any duties owed by a private equity investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed?

Under Russian law, there are no specific duties owed by a PE investor as a management shareholder to minority shareholders. However, there are minority protection rules i.a. under which the shareholders must be treated equally and shareholders or directors may not undertake any measures that would give an undue advantage to a shareholder or other person to the disadvantage of the company or another shareholder. Shareholders in Russia also can be held liable for any damage caused to the company by their actions beyond the ordinary course of business. This scope of liability cannot be eliminated by a contract.

Also, a PE investor that acquires more than 30%, 50% or 75% in a public company is obliged to make a mandatory offer to the remaining shareholders. An acquisition of more than 95% of the shares also triggers mandatory buyout requirements.

3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)?

Russian law accepts that contractual arrangements between two or more shareholders may be governed by laws other than Russian law as long as they are not against the mandatory rules or the moral standard of the general public and involve a so-called "foreign element" (i.e. when one of the parties is non-Russian). The same applies to the applicable courts and the relative clauses. A striking example is an issue related to a unilateral (optional, alternative, hybrid) arbitration clause. The approach to these clauses varies from jurisdiction to jurisdiction. In 2012, the Supreme Arbitration Court of Russia (a state court), in Russian Telephone Company v. Sony Ericsson, declared a unilateral arbitration clause invalid. The decision attracted the attention of arbitration participants both in Russia and abroad.

While non-compete and non-solicit clauses are used and generally permissible, one has to be very careful in their drafting, as an overexcessive provision can make the whole provision invalid or hardly enforceable.

PE investors have to, therefore, observe certain formalities in order to have a valid jurisdiction and choice of law provision.

3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards of portfolio companies under corporate law and also more generally under other applicable laws (see section 10 below)?

Some companies specify requirements for nominees like education shareholders, but rather persons who primarily need to act for the and professional experience. However, the practice of enforceability of these clauses is rather controversial. The law also provides binding qualification requirements for the members of the board in particular business areas like insurance, banking and securities. The Russian code of corporate governance (a source of soft law) states that companies should have a few independent directors. This rule is usually recognised as binding in corporations with state participation, private equity funds and public companies listed at the Moscow exchange.

Members of the board of directors owe the duties of care and loyalty (Russian Civil Code, art. 53.1). They also can be held liable for any damage caused to the company by their actions beyond the ordinary course of business. This scope of liability cannot be eliminated by a contract. The same liability is provided for a person or a legal entity who de facto has influence on the legal entity or board members. Though Russian law prohibits a company from indemnifying a director for actions that result in the company's breach of its legal obligations, it is quite common for PE investors to indemnify their nominated director or to insist that the portfolio company obtain directors and officers liability insurance to protect against risks associated with director decision-making liability.

3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other portfolio companies?

Company statutes supplement the general duty for directors and the CEO to act in the company's best interest with the concept of an interested-party transaction. The board or the shareholders must approve interested-party transactions.

A company is obliged to inform on the transaction in which there is an interest from board members (the supervisory board) of society, members of the collegiate executive body of society, and in case all board members (of the supervisory board) of society are interested in the commission of such transaction, or in case this formation is not provided by the law or the charter of society. Shareholders in the order provided for by holding a general shareholder meeting, if an order is not provided by the charter of society, are also obliged to be informed. By the charter of society, the duty of notice of the shareholders along with board members (of the supervisory board) of society can be provided.

The people specified in paragraph 1 of article 81 of the JSC law, within two months from the date when they learned or had to learn about the approach of circumstances owing to which they recognised interest in the commission of transactions by society, are obliged to notify society:

  • about legal entities concerning which they, their spouses, parents, children, full and not full brothers and sisters, adoptive parents and the adopted and (or) their under control organisations are the controlling persons or have the right to give obligatory instructions;
  • about legal entities in which governing bodies they, their spouses, parents, children, full and not full brothers and sisters, adoptive parents and the adopted and (or) their under control persons hold positions; and
  • about the made or estimated transactions known by him in which they can be recognised as interested persons.

4 Transaction Terms: General

4.1 What are the major issues impacting the timetable for transactions in Russia, including competition and other regulatory approval requirements, disclosure obligations and financing issues?

The major issues affecting the timetable for Russia PE transactions include: (i) the extent to which any restructuring of the target group is required (which is very often the case); (ii) the level of due diligence to be carried out; (iii) the complexity of the transaction structure and terms; and (iv) the extent to which the transaction will require notification or approval by the Russian government. Acquisitions may be subject to anti-monopoly control by the Russian Federal Antimonopoly Service (FAS) when certain control thresholds are reached. This also applies to indirect acquisitions through off-shore holding companies. Obtaining preliminary FAS consent to a transaction normally takes 30 days.

Approval will be required where the transaction structure includes: (a) a foreign acquisition of more than 50% in a protected sector (natural resources, defence, nuclear energy, certain transportation businesses, certain telecommunications and media, certain power businesses, aviation, fishing and metals processing) or more than 25% in the mineral resources sector; or (b) where the acquirer is a foreign state or international organisation and such acquirer will control more than 25% of a business in one of the protected sectors mentioned in (a) above, or 5% in the mineral resources sector. Russian public deals structured as direct acquisition of shares may be subject to voluntary or mandatory buyout offers when the acquired stake exceeds 30%, 50% or 75% of the voting shares and, subject to meeting certain statutory requirements, possible squeezeout of minorities if a shareholder acquires more than 95% of the company's shares.

Starting from 1 January 2016, foreigners are not allowed to acquire, directly or indirectly (including through controlled persons or entities where foreign ownership exceeds 20%), more than 20% of shares in a shareholder of a media founder, media editorial office or broadcasting company.

Disclosure of information on material facts is applicable to public companies.

There are also special pre-completion requirements applicable to transactions in the banking industry.

4.2 Have there been any discernible trends in transaction terms over recent years?

Many of the recent PE transactions are being carried out in sectors where the business strategy of the portfolio company involves some form of global expansion and is not solely Russian-facing or dependent on Russian consumers or the growth of the Russian economy. But in the last few years we have witnessed an overall trend of the decline in the volume of PE transactions, due in part to a combination of sanctions, asset freezes, perceived limited economic growth prospects, low oil prices, rouble depreciation, capital flight, deoffshorisation policies and other factors.

5 Transaction Terms: Public Acquisitions

5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with?

This type of transaction is not common for the Russian market. In any case, there are general takeover rules binding on all investors acquiring public companies in Russia. The public-to-private transactions are mostly conducted through: (i) a first step tender offer; and (ii) a squeeze-out of the remaining minority shareholders. In addition, prior to making a tender offer, investors often acquire the stock from the company's majority shareholders under a privately negotiated deal.

5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed and what is the general range of such break-up fees?

Russian law does not prohibit break-up fees or similar payments. At the same time, there is no particular regulation. In practice, public company transactions in Russia do not include break-up fees, particularly since this might give rise to a conflict of interest between the personal interests of the major selling shareholders (who might also be the company's board members) and the interests of the target company. Alternatively, it is more common for an acquirer to prenegotiate terms and required approvals with shareholders holding significant stakes in the public company to ensure that its bid will be successful.

6 Transaction Terms: Private Acquisitions

6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction?

All the main forms of payment structures are used by PE investors in Russia. Private equity investors on the sell-side tend to prefer all cash consideration structures that are subject to adjustments based on completion accounts to be prepared post-completion.

Buy-side private equity investors also tend to prefer all cash consideration structures, and typically require an escrow amount to be set aside for warranty claims. Earn-out payments or profit guarantees are also preferred mechanisms to bridge valuation gaps. Assumption or repayment of debt is also common in PE deals, convertible debt and stock.

6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management team to a buyer?

The package of warranties/representations is contractually negotiated and varies from transaction to transaction, heavily depending on stake size, but usually includes customary warranties (and, very rarely, representations) regarding title (to shares and assets), liabilities, and regulatory as well as typical transactional warranties – such as capacity. Private equity sellers would typically seek to limit their warranties and/or indemnities to warranties on title, capacity and authority. Where management holds a significant stake, they are expected to give comprehensive warranties to the buyer, together with management representation made to the private equity sellers. Indemnities are rarely given by PE sellers. When they are given, they are normally limited to specific risks identified in the buyer's due diligence or they relate to corporate structuring and tax compliance issues that cannot be easily remedied by the company.

6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer?

In an acquisition agreement governed by foreign law, private equity sellers typically agree to a set of undertakings as to the conduct of business pre-completion in order to ensure the business is carried on in the ordinary course and to minimise any value leakage. A PE seller might also be asked for non-compete covenants, the enforceability of which is, however, questionable from the Russian law perspective. Often the same may be asked from the top-management team. In addition to that, the acquisition agreement typically includes the full range of conditions precedent expected in any other jurisdiction (e.g., third-party consents, antitrust and other government approvals, accuracy of representations and warranties (subject to materiality tests), and performance of pre-completion undertakings).

6.4 Is warranty and indemnity insurance used to "bridge the gap" where only limited warranties are given by the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies?

The warranty and indemnity insurance tools structured under Russian law are still almost untested. The most common way to bridge any warranty gap used in Russian deals is to reduce the purchase price to address a specific potential liability.

6.5 What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings?

Foreign law-governed acquisition agreements prevail in Russian PE deals. We can see that no limits usually apply for title warranties, claims for business warranties are usually time-barred after one year, tax warranty limitations often follow the statutory period for tax authorities to bring claims in that jurisdiction, and caps range from 10% to 100% of the purchase price. The threshold for bringing claims is generally between 1% and 5% of the purchase price or from $100,000 to $1,000,000 depending on the transaction.

Limitations on the seller's liability in Russian law-governed acquisition agreements are quite narrow and usually only concern the type of damages that may be claimed by the buyer (as a rule, indirect damages, such as loss of profit, are excluded from Russian deals). Caps and baskets could be structured under Russian law but these have not yet been properly tested in the courts. The limitation period for bringing claims for breach of contract (which is generally three years) cannot be increased or decreased by an agreement governed by Russian law.

6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)?

Generally, PE sellers do not provide security for warranty claims. However, the final structure of security depends on the parties respective bargaining strengths.

Escrow arrangements are common for PE transactions, particularly where pricing is subject to adjustments and/or is linked to the future financial results of the portfolio company or some other variable that is not possible to determine at the time of closing.

Since the last amendments to the Russian Civil Code, domestic escrow instruments have become involved in the security schemes. New provisions on escrow accounts allow parties to open a special bank account to hold money in escrow until obligations are performed. Specific conditions may be set out in a contract, upon satisfaction of which the bank is authorised to release payment, i.e. the change is primarily oriented towards contractual rather than statutory regulation. Escrow agents' obligations may be set out in a separate escrow agreement or in other agreements. Unless stated otherwise in the respective contract, until such time as the specific contractual conditions are fulfilled, neither party (depositor or beneficiary) is allowed to dispose of the funds in the escrow account. The bank's fees also cannot be deducted from the escrow account unless specifically provided otherwise in the contract.

6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)?

Transaction documents typically include a commitment or warranty from the PE investor that it has sufficient financial resource to complete the transaction. A bank commitment letter may also be provided in certain cases. Such commitments are generally enforceable by the seller against the private equity fund, but bank commitment letters are only intended to provide soft comfort to sellers and are usually not enforceable against the bank. In addition to that, it is common to check the ultimate beneficial owners and decision-makers to define the risks associated with doing business with them. Therefore, PE investors are usually asked to provide information about their group structure and persons who have decision-making powers. Where only Russian buyers are involved, sometimes parent company/PE fund guarantees the seller by suretyship.

6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers' exposure? If so, what terms are typical?

This type of compensation is illustrative for a transaction that involves a strategic investor or where, given the nature of the transaction, it may be impossible to determine the quantum of damages that would be suffered if the target company backed out of the deal. Usually, reverse break fees are payable when the deal is not completed, e.g., owing to the buyer's failure to obtain financing and/or corporate or regulatory approval for the deal, however, they are not common within the Russian market. When it comes to the deal, the size of the fee is negotiable and usually varies between 3–5% of the transaction value.

7 Transaction Terms: IPOs

7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit?

PE investors should be aware that the current market conditions are tied to currency devaluations and other geopolitical factors which may influence timing horizons for a possible IPO, making them longer than in other jurisdictions. This is perhaps the most important consideration in the Russian market at the moment.

As a basic rule for all PE transactions, inclusion of appropriate rights and protections in shareholders' agreements is critical to facilitating a clean exit under an IPO, since the interests of PE investors are not always aligned. In particular, in order to ensure that the shareholders' agreement allows for an exit plan, detailed obligations would normally need to be imposed on minority shareholders in respect of an IPO. Those often include the minorities' obligations to swap their shares for shares in an IPO special purpose vehicle, the obligation to give all consents and pass all resolutions required to effect the IPO, as well as the obligation to escrow a portion of their shares in an IPO exit.

Thorough consideration needs to be given by a private equity investor to factors that may complicate the exit, such as a non-cash consideration or complex capital structures.

7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit?

When Russian companies place their stock on overseas stock markets, it is customary for PE sellers to lock-up or escrow all or part of their stock in the listing vehicles for a period of 180 or 90 days post-listing. For IPOs on the Russian stock exchange, the lockup period is normally the same.

Under one of the latest deal on the MICEX — IPO Russneft — one of the major shareholders and its subsidiary selling shares of Russneft have assumed obligations not to sell shares for 180 days after the offer. Another shareholder of the company — Glencore plc — also agreed to the 180-day ban on the sale of shares.

7.3 Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO?

Within dual-tracking, the seller of a company pursues IPO and M&A deals simultaneously. The dual-track exit process was a feature of the Russian market a number of years ago. As noted, IPO deals are currently limited in Russia by several factors (costs, sanctions). Optimism for a return of IPO activity, including dual-track exits has since subsided. Recently, most dual-track deals have been realised through a sale and not an IPO.

8 Financing

8.1 Please outline the most common sources of debt finance used to fund private equity transactions in your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (particularly the market for high yield bonds).

Traditional bank financing remained the most common source of debt finance for private equity transactions in Russia prior to the imposition of economic sanctions, which curtailed their investment activities. Convertible loans and mezzanine finance have been used regularly, especially by foreign banks with a presence in Russia. Nowadays, financing tends to be attracted from other sources to fund the acquisition and sometimes the working capital needs of the target. We are seeing more Russian investment funds and strategic players actively competing with foreign investment funds in the financing area.

8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt financing) of private equity transactions?

Generally, debt financing of PE projects is not limited by any special legal requirements or restrictions. Thin capitalisation rules apply where a Russian borrower seeks debt financing from its owners based in another jurisdiction.

There are also no special rules preventing a PE investor from giving financial assistance to a target. However, under Russian civil law financial assistance cannot be made in the form of a gift by one profit-making company to another (article 575 of the Russian Civil Code). Russian tax law allows for financial assistance if either the company providing financing owns over 50% of the shares or participatory interests of the company being financed or vice versa (article 251 of the Russian Tax Code). Thus, a transfer free of charge may be transferred for the purpose of being redistributed within a group of companies in pursuance of the group's common economic objectives.

9 Tax Matters

9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common?

Key tax considerations for private equity investors and transactions in Russia include:

  • Anti-avoidance rules.
  • CFC rules.
  • Transfer pricing rules.
  • Comprehensive transfer pricing provisions, which are substantially in line with OECD principles, apply.
  • Thin capitalisation rules.
  • Currency control regulations.

Residents and non-residents can hold bank accounts in any currency. Russian residents (as defined under the Russian currency control legislation) are required to notify the tax authorities upon opening, changing or closing personal accounts with banks located outside of Russia. Residents are also required to notify the tax authorities about the movement of funds in their foreign bank accounts (e.g., deposits).

  • Exchange of Financial Account Information executed by the RF Tax authorities (CRS).
  • General tax burden (Russian profit tax (20%), payment of Russian VAT (18%/10%), social security contributions).
  • Withholding tax.
  • Dividends paid to a foreign entity or to a non-resident individual are subject to a 15% withholding tax, unless the rate is reduced under a tax treaty.
  • Interest paid to a non-resident is subject to a 20% withholding tax, unless the rate is reduced under a tax treaty.
  • Royalties paid to a non-resident are subject to a 20% withholding tax, unless the rate is reduced under a tax treaty
  • Application of DTTs and allowance for repatriation of profit (particularly where the PE investor has invested through an off-shore holding entity).
  • Regional and industry tax incentives.

Various types of tax incentives are available in Russia. For example, a reduction in the profits tax rate (to 0%, in certain cases), along with other benefits, is available for investment projects in many regions. Certain tax preferences (e.g., a reduction of the federal profits tax rate) are granted to residents of territories of advanced social and economic growth. Companies that participate in the Skolkovo Innovation Center may benefit from a 10-year tax holiday. Technology and software companies may benefit from reduced social security rates. A 0% profits tax rate applies to a range of educational and medical services. A 150% deduction for profits tax purposes is available to all companies with qualifying R&D expenditure. Foreign investors invest in Russia through a company established in a country that has a double tax treaty with Russia (Cyprus, Luxembourg, the Netherlands) often having a holding in an offshore jurisdiction.

9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their investment into a new acquisition structure?

  • Taxation of dividends:
    Dividends received by a Russian entity from Russian and foreign entities generally are subject to tax at a rate of 13%.
  • Capital gains:
    Capital gains are taxed as ordinary income at the normal corporate rate of 20%.
  • Participation exemption:
    To qualify for the participation exemption with regard to dividend income, a Russian company must hold a participation of at least 50% for at least 365 days in a calendar year. A foreign investee must not be a resident in a "black list" jurisdiction. A participation exemption is available for capital gains realised on the sale of unlisted shares and participations in Russian companies, and listed shares in high-technology Russian companies acquired after 1 January 2011 and held for more than five years.

9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private equity portfolio companies (such as growth shares, deferred / vesting arrangements, "entrepreneurs' relief" or "employee shareholder status" in the UK)?

Equity participation for management is typically structured through phantom share, share appreciation rights, or equity linked bonus regimes due to a quirk in Russian securities law regulations, and unclear tax law treatment.

Management teams typically do not hold their interests in shares of the portfolio company and prefer to receive phantom shares or equity-linked bonuses to mitigate risk being taxed upon the granting of such rights.

  • Granting of phantom shares:
    Phantom stock should be non-taxable until the cash is paid, generating ordinary income for the employee and a deduction for the company. Phantom stock is a way to share a stake in a business while avoiding the need for the new "owner" to invest cash or suffer taxable income.
  • Share appreciation rights (SARs):
    SARs offer the right to the cash equivalent of value increases of a certain number of stocks over a predetermined time period. This bonus is almost always paid in cash; however, the company may pay the employee bonus in shares. In most cases, SARs can be exercised after they vest; when SARs vest, it simply means that they become available to exercise. SARs are generally issued in conjunction with stock options in order to assist in funding the purchase of options or to pay off taxes due at the time the SARs are exercised.
  • Equity-linked bonuses:
    The analysis of the tax consequences for employees in relation to employee share plans is based on a reasonable interpretation of how the provisions of Russian Securities Market Law may apply. The Ministry of Finance has issued several private rulings on this issue, providing clarification that stock options are not taxable at grant (only at exercise) as long as they are not deemed as financial instruments under the Russian Securities Market Law.

The employment income of highly-qualified foreign professionals is taxable at a rate of 13% (even during periods of non-residence for tax purposes), rather than the 30% rate that otherwise would apply).

9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any anticipated?

The most significant tax changes affecting the PE industry have been in relation to recent deoffshorisation policies set out in Federal Law No. 376-FZ, 24 November 2014 which introduced substantial changes to the rules governing the reporting and taxation of participation interests held by Russian tax residents in controlled foreign companies (CFCs). Following the adoption of the law, profits generated by a CFC will be imputed as taxable profit of Russian tax residents who control the CFC at a rate of 20% for legal persons and 13% for natural persons, which has made the treaty benefits previously enjoyed by Russian investors who structured their investments off-shore no longer possible.

The Federal Law No. 376-FZ of 24 November 2014 law introduced a number of key principles new to Russian tax law, including CFC rules, beneficiary ownership, as well as tax residency for legal entities. On 12 May 2016, Russia signed the multilateral competent authority agreement on the exchange of financial account information, thereby joining the Standard for Automatic Exchange of Financial Account Information (Common Reporting Standard, the CRS).

Joining the CRS will enable Russian tax authorities to obtain information on financial accounts held by Russian tax-resident individuals and legal entities abroad (in jurisdictions which havealso signed up to the CRS, i.e. "partner jurisdictions") from the tax authorities of the relevant countries. The Russian tax authorities will also be obliged to provide similar information to the tax authorities of partner jurisdictions regarding financial accounts held by tax residents of those jurisdictions with Russian financial institutions. The exchange of information will occur automatically on an annual basis. The first exchange of information with partner jurisdictions will occur in 2018.

10 Legal and Regulatory Matters

10.1 What are the key laws and regulations affecting private equity investors and transactions in your jurisdiction, including those that impact private equity transactions differently to other types of transaction?

There is no special state authority or professional self-regulatory organisation supervising off-shore PE funds' activities. The main source of regulation of such activities in Russia is the Russian Civil Code and laws on joint stock companies and limited liabilities companies, which regulate all main forms of Russian commercial legal entities and their business operations. After certain amendments, the Russian Civil Code contains norms which are frequently used in PE transactions, such as commercial representations and warranties, the principal of good faith negotiations. It also introduces a number of legal instruments, such as irrevocable powers of attorney and escrow accounts, which bring Russia's legal environment more in line with continental European jurisdictions.

10.2 Have there been any significant legal and/or regulatory developments over recent years impacting private equity investors or transactions and are any anticipated?

Over the last three to five years, Russian legal regulation of business operations has undergone a number of massive and substantial revisions. This resulted in most laws and regulations being in line with international best practices and has made the Russian PE market more attractive to foreign and local investors.

The Russian Civil Code has been revised to include concepts used in PE deals on other markets but previously arguable under Russian law. The significant changes that have already come into force include the concepts of irrevocable powers of attorney and escrow arrangements. Russia introduced shareholder agreements and the court's capacity to lift of corporate veil. Shareholders are able to choose the governing law of their shareholders' agreements in respect of Russian companies.

As for contractual instruments, the Russian Civil Code introduced indemnities, warranties, potestative clauses, option, waiver, etc. There are also new types of securities: security deposit; and an independent guarantee issued by a bank or corporation. The other thing that changed the landscape of law enforcement was the landmark directive issued by the High Arbitration Court. It states that any rule contained in law is non-mandatory if otherwise is provided.

10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted in-house?

Due diligence processes and the relevant requirements in Russia are laregely dependent on the size, type and location of the relevant company. Private companies are generally even more skittish about sharing information and may need a fair degree of prodding before they will do so.

Generally, Russian targets present a number of specific challenges that may significantly complicate the due diligence process. This goes partially from the fact that the legal framework relating to the ownership and use of land and other real property, and the proper recording of title to shares and participatory interests in Russian companies, are not yet sufficiently developed.

Foreign investments in certain sectors are also subject to multiple and often ambiguous prohibitions and restrictions. And finally, Russian legal and accounting regimes are developing at a very rapid pace, so just keeping up with the changes and figuring out how they might impact an investment is itself a challenging task.

Most PE funds outsource this function to modern Russian law firms or international law firms that jointly carries out financial, business and legal due diligence with auditors, since guidance from experienced, knowledgeable advisors is crucial to success at the stage of PE investment.

10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors' approach to private equity transactions (e.g. diligence, contractual protection, etc.)?

Russia is still considered a "high-risk" country from an anti-bribery and anti-corruption perspective, despite the fact the Russian anticorruption legislation has gone some way to creating an ostensibly comprehensive framework of anti-corruption rules. The main law regulating corruption issues in Russia is the Federal law "On Combating Corruption" dated December 25 2008, which provides the definition of corruption. Anti-corruption is also regulated by a number of specific laws, such as the prohibition of state officials to accept gifts with a value exceeding RUB3,000, and the Federal Law "On the State Civil Service", which establishes rules for accepting presents by state civil servants. Money laundering is separately regulated by the Federal Law "On Combating the Legalisation of the Proceeds of Crime (Money Laundering) and Terrorist Financing" dated August 7 2001. The Russian Code concerning administrative violations and the Russian Criminal Code set out administrative and criminal liability respectively for failure to comply with anti-bribery and anti-money laundering rules, with sanctions ranging from fines to imprisonment. As a result, the price of non-compliance with antibribery and corruption legislation in Russia can be high, both in monetary terms and reputation. Directors of Russian companies may be subject to criminal and civil liability for breach of anticorruption legislation.

Therefore, PE investors should usually perform anti-corruption due diligence, introduce anti-corruption related warranties and indemnities, and most routinely require the portfolio company to implement an anti-corruption policy as a condition precedent to its investment if it does not already have one. Representations, warranties and covenants dealing with anti-corruption, anti-bribery and other compliance matters are more and more common in deals involving foreign PE buyers due to this legal regime.

10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the liabilities of another portfolio company?

In Russia, the doctrine of "piercing the corporate of veil" started to be widely discussed in connection with the famous ruling of the Supreme Arbitration Court in relation to "Parex Bank" (Latvia), where this doctrine was directly mentioned by the court for the first time. For many years, the Russian courts were, however, reluctant to "pierce the corporate veil" and generally refused to hold a parent or controlling company liable for the debts of its subsidiaries or affiliates.

Nowadays, an investor can be held liable if he de facto has influence on a legal entity or board members for any damage caused to the company by his actions. This scope of liability cannot be eliminated by a contract (article 53.1 of the Russian Federation Civil Code). This measure also applies to cases of bankruptcy. An investor may be held severally and jointly liable for the liabilities if he caused the status of insolvency.

As a general rule, different portfolio companies are not liable for the wrongdoings of another portfolio company unless they meet certain criteria mentioned above. Therefore, PE investors in Russia should diversify their investments so as to exclude crossing liabilities.

11 Other Useful Facts

11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction?

Russia is a large and still growing investor-friendly market, full of potential opportunities. Most laws and regulations are in line with international best practices, and should not cause too much concern on the part of experienced private equity investors. Last year, Russia significantly improved the process of setting up new enterprises and the customs regulation. The next "growth zone" for Russia is reform of international trade rules and construction licence regulations. These movements over the last year allowed Russia to appear in 40th place in the Doing Business Rating. Achieving a higher position in the rating is still the main task in President Decrees. Russia has the aim of moving to 20th place in 2018, despite sanctions by the US and Europe and countervailing sanctions by Russia. But PE investors must be wary of potential pitfalls and be extra vigilant during the due diligence process in order to minimise risks to the greatest extent possible. Guidance from experienced, knowledgeable advisors is crucial to success in this land of still relative uncertainty.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions