Written by: Andrey Goltsblat, Managing Partner at PGP Law.

In its more than 10 years of reforms, Russia has made noticeable progress in setting up a legal framework for investments. Quite an important role is still played by direct investments made through purchasing blocks of shares. Legal regulation of mergers and acquisitions is becoming increasingly adapted to economic reality.

There is still, however, some inconsistency between the law, its spirit and its enforcement. A lot of effort has been put into establishing a regulatory framework, but a lot still needs to be done to make it fully operational. Legal, political and psychological factors should complement one another. For instance, if the intention expressed by the Russian president of introducing a three-year statute of limitations for privatization transactions (instead of the current 10-year period) is translated into law, it will be quite a positive sign not only for businessmen who have already put their money into investment projects but also or those who are still considering this possibility.

In general, M&A transactions still encounter quite a number of obstacles in Russia.

Here are a few crucial problems that might be resolved by amending the legislation:

The first important problem is insufficient liability of the top executives of a target company for management oversights and for false information included in the financial statements. This applies to cas4es when, after the acquisition is completed, hidden liabilities of the company emerge owing to distortions in its reporting documents and the new owners have to fulfill obligations that should have been revealed during the due diligence.

The second problem is the lack of effective and convenient mechanisms for paying for shares or assets. By that we mean something like escrow accounts, which are quite commonly used in the West. One instrument of payment could be, for example, a letter of credit, but not many banks are prepared to apply this instrument in practice.

The third problem and another obstacle to the fast development of M&A practice in Russia is that major shareholders (or quite often the sole owner of a large block of shares or sole participant in a limited liability company) are not held sufficiently liable for the activities of associated companies, the state of affaires an hidden risks arising from the company’s operations. One consequence of this insufficient liability is that effective use cannot be made of the mechanism of representations and warranties, which is used quite often by Western companies.

Finally, there is the problem of a lack of effective and flexible mechanisms for establishing control over the acquired company. If, for example, we acquired the number of shares we deemed necessary on the stock exchange, we would need to wait for quite a long time before we could hold a shareholders’ meeting and change the CEO or, say, the board of directors. Of course, as an alternative, we could insist that the previous owners call a meeting of shareholders in order to make sure that we establish operational control as soon as possible. In this case, however, the only legal way for the new owner to vote would depend on powers granted by the previous owner. Thus, the new owner would be acting on behalf of the previous one. Moreover, the legal basis for the powers of the new owner would remain quite vulnerable under Russian law and could be revoked at any time.

Good progress has been achieved with the recent amendments to the law, which came into force on July 1.

The law introduces a minority squeeze-out mechanism, under which a major shareholder owning more than 95 percent of the company’s shares can compel minority shareholders to sell out.

The current impossibility of buying out minorities is the reason many potential M&A transactions never take place. The mechanism to be used will not infringe on the minorities’ rights, as they will receive a fair price for their shares.

Thus, we are still facing quite serious challenges. The Russian legal system is being gradually streamlined, opening up new possibilities for economic development and creating a m\normal business environment. There are still many things to be changed, and I would like to believe that the forthcoming changes will continue along the path that was chosen 10 years ago.