Russian Commercial Law

RUSSIAN COMMERCIAL LAW

Russian Commercial Law Second Edition

by

Hiroshi Oda Sir Ernest Satow Professor of Japanese Law, University of London (University College), Professor of College d’Europe (Brugge), Attorney at Law (Japan) Member of the ICC International Court of Arbitration

LEIDEN • BOSTON 2007

On the cover Artist: Bazopiomp Engraver: R. Watts A perspective view of the borders of the Neva going up to the Rive between the Admiralty and the buildings of the Academy of Sciences at St. Petersburg, circa 1750 From the private collection of Hiroshi Oda A CIP record for this book is available from the Library of Congress. This book is printed on acid-free paper.

ISBN 978 90 04 16253 2 Copyright 2007 by Koninklijke Brill NV, Leiden, The Netherlands. All rights reserved. No part of this publication may be reproduced, translated, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission from the publisher. Authorization to photocopy items for internal or personal use is granted by Koninklijke Brill NV provided that the appropriate fees are paid directly to The Copyright Clearance Center, 222 Rosewood Drive, Suite 910, Danvers, MA 01923, USA. Fees are subject to change. PRINTED IN THE NETHERLANDS

TABLE OF CONTENTS

ABBREVIATION OF RUSSIAN PERIODICALS FOREWORD TO THE SECOND EDITION LIST OF TABLES

1 2 3 4 5 6 7 8 9 10 11 12

1

2

xv xvii xiii

CHAPTER 1 – SOURCES OF LAW The Concept of the Law-Governed State The Federal Structure The Constitution Federal Law Law of the Constituent Entities Presidential Decrees Edicts of the Government Acts of Local Self-Governments Court Judgments Custom International Treaties Foreign Law

1 2 5 6 8 12 13 14 14 20 20 22

CHAPTER 2 – THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS The Courts 1) Historical Background 2) Commercial Courts 3) Ordinary Courts (Courts of General Jurisdiction) 4) Jurisdiction of the Ordinary Court and the Commercial Court 5) Jurisdiction of Russian Courts in Cross-Border Disputes 6) Independence of the Courts and Integrity of the Judges International Commercial Arbitration 1) Arbitration Law and Institutions in Russia 2) Statutory Framework for the Enforcement of Arbitral Awards

23 23 26 31 33 36 37 40 40 42

vi

3 4

1 2

3 4

5 6

7

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3) Judgments of the Ordinary Courts (1990–2002) 4) Decisions of the Commercial Courts 5) Decisions of the Supreme Commercial Court 6) Arbitrability of Disputes The Procuracy Legal Professions 1) Judges 2) Advocates and Lawyers 3) Notary Public CHAPTER 3 – BASIC PRINCIPLES AND RULES OF PRIVATE LAW Historical Background The Civil Code as the Primary Source of Private Law 1) The Unication of Civil and Commercial Laws 2) The Primacy of the Civil Code over other Laws in “Civil Law Relations” Basic Principles of Russian Private Law Participants of Civil Law Relations 1) Individuals 2) Juridical Persons 3) The State as a Participant of Civil Law Relations Objects of Civil Law Rights Juristic Acts 1) General 2) Forms of Juristic Acts 3) Defective Juristic Acts 4) Primary Categories of Null and Void Juristic Acts 5) Primary Categories of Voidable Juristic Acts 6) Representation and Power of Attorney Periods of Time and Limitation Periods 1) Periods of Time 2) Prescription Period for Litigation CHAPTER 4 – COMPANY LAW History of the Russian Company Law Privatisation of State Enterprises Structure of Corporate Ownership in Russia Types of Companies Common Rules on Joint Stock Companies and Limited Liability Companies

46 47 49 50 54 55 55 57 61

63 67 67 70 71 75 75 76 80 83 85 85 86 87 90 96 99 101 101 102

105 110 117 121 124

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6

7 8

1 2 3

1) Liability of Shareholders (Participants) 2) Liability of the Parent Company 3) Registration 4) Afliates of Foreign Companies Joint Stock Companies 1) Procedure of Establishment 2) Articles of Incorporation 3) The Capital and Shares 4) Bonds and other Securities 5) Dividends 6) Shareholders’ Rights 7) The Management Structure 8) Audit – Audit committee (revizionnaia komissia) and the External Auditor 9) Reorganisation of Companies The Russian Securities Market Limited Liability Companies 1) The Procedure of Establishment 2) Articles of Incorporation 3) The Rights and Duties of the Members 4) The Capital and Participatory Shares 5) Dividends 6) Issuing of Bonds and Securities 7) Rights and Duties of Members 8) Management Bodies 9) Restraints on the Power of the Executive Bodies 10) Liability of Directors and Executive Ofcers 11) Audit CHAPTER 5 – INSOLVENCY LAW Historical Background The Law on Bankruptcy The Procedure 1) Initiation of the Procedure 2) Administrators 3) Observation (nabliudenie) 4) Financial Restoration ( nansovoe ozdorovlenie) 5) External Administration 6) Bankruptcy (konkurs) 7) Amicable Settlement 8) Subsidiary Liability

vii 124 125 128 131 132 132 134 136 148 148 150 160 183 186 187 191 192 193 193 194 198 198 199 199 201 203 203

205 208 211 211 212 214 216 218 223 227 228

viii

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3 4

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6

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CHAPTER 6 – GENERAL RULES OF THE LAW OF OBLIGATIONS General Performance of Obligation 1) Manner of Performance 2) Time of Performance 3) Place of Performance 4) Currency of Performance 5) Performance by Deposit 6) Counter-Performance Obligation with Multiple Debtors/Creditors Change of the Parties 1) Assignment of Claims 2) Assumption of Debt Termination of Obligation 1) General 2) Substitute Performance 3) Set-off 4) Novation 5) Impossibility of Performance Liability for the Breach of Obligations

229 229 229 230 231 231 232 232 233 234 234 235 235 235 236 236 237 237 238

CHAPTER 7 – MEANS OF SECURING OBLIGATIONS General Real Security Rights (Pledge) 1) The Concept 2) The Laws 3) Objects of Pledge 4) Form of Contracts and Registration 5) Multiple Pledges 6) Transfer of Collaterals 7) Transfer of the Right of the Pledgee 8) Enforcement of Real Security Rights 9) Real Security Rights and Bankruptcy Procedure Atypical Security Rights Suretyship and Bank Guarantee Other Means of Securing Performance of Obligation 1) Penalty 2) Withholding of the Object 3) Earnest Money

245 246 246 248 248 251 253 255 256 256 260 261 266 269 269 269 270

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1 2 3 4 5 6

1 2

3 4

5

1 2

CHAPTER 8 – CONTRACT LAW General Freedom of Contract Conclusion of a Contract Interpretation of Contracts Revision and Rescission of a Contract Individual Contracts 1) General 2) Contract of Sale 3) Contract of Lease 4) Commission, Agency, and Mandate Contracts 5) Contracts Related to Banking 6) Concession Contracts 7) Joint Venture Contracts CHAPTER 9 – PROPERTY AND LAND LAW Ownership Right and other Real Rights The Right of Ownership 1) The Content of the Right of Ownership 2) Owners 3) Acquisition and Termination of the Right of Ownership 4) Joint Ownership The Right of Economic Management and Operational Administration Land Law 1) The Abolition of the State Ownership of Land 2) Legal Framework of the Land Law 3) The Land Code 4) Rights on Land other than Ownership 5) Land and Buildings Registration of the Right of Ownership and other Real Rights CHAPTER 10 – TORT (OBLIGATIONS ARISING FROM CAUSING OF HARM) AND UNJUST ENRICHMENT General Rules of Tort Special Rules 1) Liability for Damage Caused by a Minor Below 14 Years of Age 2) Liability for Damage Caused by a Minor Between 14 and 18 Years of Age

ix

271 271 273 274 276 280 280 280 288 293 297 302 307

309 312 312 313 316 320 321 322 322 325 327 330 331 331

339 345 345 345

x

3 4 5 6 7

1 2 3 4 5 6 7 8 9

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3) Liability for Damage Caused by Persons Who are Declared Incapable to Act 4) Liability for Damage Caused by a Person Declared Partly Incapable to Act (Limited Capability) 5) Liability for Damage Caused by a Person Who is not Capable of Understanding the Meaning of his Act 6) Liability of a Juridical Person or a Physical Person for the Damage Caused by an Employee in the Course of Discharging his Employment Duties Liability for Causing Damage to the Life or Health of an Individual Moral Damage Product Liability Government Tort Liability Unjust Enrichment CHAPTER 11 – BANKING LAW Historical Background The Emergence and Development of Commercial Banks Sources of Banking Law The Central Bank (Bank of Russia) Credit Organisations (Banks and Non-Banks) Current State of the Russian Banking System Supervision over Credit Organisations Bank Condentiality Restructuring and Liquidation of Credit Organisations 1) Financial Restoration 2) Interim Administration 3) Reorganisation CHAPTER 12 – NATURAL RESOURCES LAW The Ownership of Sub-soil Resources The Sub-soil Law Licensing System v. Production Sharing System The Production Sharing Law 1) Autonomy of the Production Sharing Agreement 2) Parties to the Production Sharing Agreement 3) Blocks available for production sharing 4) Procedure for the Conclusion of a Production Sharing Agreement 5) Terms of the Production Sharing Agreement

345 345 346

346 346 347 350 350 352

355 356 362 364 366 368 371 375 375 376 376 377

379 380 384 388 388 389 390 391 392

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5 6 7

1 2 3 4 5 6 7

1 2 3 4 5 6

7

8

6) Production Sharing and Taxes 7) Stability of the Production Sharing Agreement – Grandfather Clause 8) Dispute Resolution Pipeline Transportation and Export The Demise of the Production Sharing System Prospective Reform of the Sub-soil Law CHAPTER 13 – ENVIRONMENTAL LAW The Background to the 2002 Law on the Protection of Environment Outline of the 2002 Law Environmental Standards and their Enforcement State Ecological Review Procedural Aspects of Economic Activities Rights of Individuals and Social Organisations in the Procedure Agencies in Charge of Environmental Protection CHAPTER 14 – TAXATION Historical Background The Tax Code Taxes and Levies Basic Principles and Rules of Taxation Tax Agency The Procedure 1) Tax Inspection 2) Compulsory Collection of Taxes and Sanctions 3) Procedure for Contesting Decisions of the Tax Agency Major Kinds of Taxes 1) Corporate Prot Tax 2) Value-Added Tax (VAT) 3) Unied Social Tax 4) Tax on Assets of Organisations 5) Individual Income Tax Taxation of Foreign Companies 1) Foreign Companies with a Permanent Establishment in Russia 2) Foreign Companies without a Permanent Establishment in Russia 3) Transfer pricing

xi 393 395 396 396 397 400

403 407 410 413 416 418 421

425 428 429 430 432 434 434 435 438 440 440 442 443 444 444 446 446 446 447

xii

1 2 3 4 5 6 7 8 9 10 11 12 13

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CHAPTER 15 – THE SYSTEM OF SETTLING DISPUTES – PROCEDURE Jurisdiction Composition of the Court Parties and other Participants in the Procedure The Adversarial Principle and the Role of the Court Presentation of the Application for an Action Settlement Security Measures The Hearing Evidence Judgments and Decisions Appeal and Other Procedures Costs Enforcement of Judgments 1) General 2) Enforcement Documents 3) Enforcement Procedure 4) The Actual State of Enforcement

449 450 451 453 454 456 457 458 459 461 461 466 466 466 467 468 471

CHAPTER 16 – PRIVATE INTERNATIONAL LAW Sources of Private International Law General Rules Renvoi Personal Law Applicable Law on the Specic Issues 1) Ownership Rights and other Real Rights 2) The Form of Juristic Acts 3) Contracts 4) Obligations Arising from the Causing of Harm (Tort) 5) Unjust Enrichment 6) Competition Law

473 474 478 479 479 479 480 481 484 484 485

INDEX

487

LIST OF TABLES

Table 1 Table 2 Table 3 Table 4 Table 5

Categories of cases handled by the commercial court in 2005 Breakdown of disputes arising from civil law relations Cases Heard by District Courts in 2004 The progress of privatisation Major objects in Federal ownership and privatisation program of the 2000s Table 6 Ownership structure of Russian industrial enterprises (1) Table 7 Ownership structure of Russian industrial enterprises (2) Table 8 Comparison of Joint Stock Companies and Limited Liability Companies Table 9 Shareholder’s rights Table 10 Insolvency cases handled by the commercial court 2003-2006 Table 11 Registration of Credit Organisations as of January 1, 2006 Table 12 Measures applied to Credit Organisations in 2004

29 30 32 113 114 119 120 123 150 210 367 374

ABBREVIATION OF RUSSIAN PERIODICALS

BVS RF GiP KhiP NG PiE RG RIu SU SZ RF VE VMU VSND RF i VS RF VVAS RF VVS RFSFR VVS SSSR ZRP

Biuletten’ verkhovnogo suda RF Gosudarstvo i pravo Khoziaistvo i pravo Nezavisimaia gazeta Pravo i ekonomika Rossiiskaia gazeta Rossiskaia iustitsiia Sobranie uzakonenii i rasporiazhenii rabochekreschainskogo pravitel’stva Sobranie zakonov RF Voprosy ekonomiki Vestnik moskovskogo universiteta Vedomosti sobraniia narodnykh deputatove RF i Verkhovnogo soveta RF Vedomosti verkhovnogo arbitrazhnogo suda RF Vedomosti verkhovnogo soveta RFSFR Vedomosti verkhovnogo soveta SSSR Zhurnal rosiiskogo pravo

* Status juris Status juris of this book is March 31, 2007 ** Minimum wage Minimum wage is used as a basis for the calculation of nes and other pecuniary payments in Russian law. The current minimum wage for this purpose is set at 100 roubles (circa 4 US Dollars) by the Law No.82-FZ of June 19, 2000 as amended.

FOREWORD TO THE SECOND EDITION

“You say that rule by terror has diminished. That is for sure. But rule by terror, basically, is not the ultimate form of discipline, but rather, its failure.” Michel Foucault, Dits et écrits, Paris 1976, vol. III, p. 69.

This is a new and substantially expanded edition of the Russian Commercial Law. Since the publication of the rst edition in 2001, there has been some signicant legislative developments. The Law on Insolvency of 1998, which was known to be abused on various occasions, was replaced by a new law in 2002. The two procedural laws – the Code of Civil Procedure and the Code of Commercial Court Procedure, were both replaced by new laws in the same year. A major amendment to the Joint Stock Company Law, which took place in 2001, and was incorporated in the rst edition, has been put into practice. Compared to the rather chaotic situation in the 1990s, the system of commercial law and procedure in Russia has more or less stabilised. In the light of such developments, most chapters have been rewritten or extensively revised. However, while writing the second edition, some changes in other directions were noticeable. First, while in the 1990s, the establishment of the “law governed state” was regarded as a major goal, in the 2000s, it has become very rare to come across this term. Instead, centralisation and “discipline” seem to have become the keyword of the day. Secondly, disclosure of information by government agencies seems to have become narrower in scope. For instance, statistical and factual information regarding disciplinary actions on judges, which used to be available, is hard to get hold of now. Thirdly, as can be seen in the saga involving Sakhalin 2 and Kovikta projects, there have been cases where the stability of major foreign investment projects came to be at risk. As was the case with the rst edition, the book is intended to shed light on the actual operation of Russian law, rather than summarising or reiterating statutes. For this purpose, the support of Herbert Smith where I work as a consultant was invaluable. I would like to thank the senior partner Mr. David Gold, the

xviii

FOREWORD TO THE SECOND EDITION

Global Relationship Partner, Mr. Richard Fleck, the managing partner of the Moscow Ofce, Mr. Allen Hanen, and the Russia-related people at Herbert Smith. My gratitude also goes to the directors of the Max Planck Institute for International and Foreign Private Law, professors Klaus Hopt and Jürgen Basedow as well as Dr. Harald Baum for providing me with essential research facilities in Hamburg and to Professor Jeffrey Jowell of University College London for his unfailing warm support since my arrival in London. I also wish to thank Ms. Annebeth Rosenboom, the former editor of Martinus Nijhoff Publishers, and Mr. Peter Buschman, the current editor, and his team as well as Ms. Vera Kislova, formerly of University College London, for enabling the publication of the second edition. Finally, last but not the least, my gratitude is due to my wife Midori, who has assisted and supported me throughout the process of preparing the second edition. London, July 2007 Hiroshi Oda

1 SOURCES OF LAW

1

THE CONCEPT OF THE LAW-GOVERNED STATE

The present Constitution of the Russian Federation, which was enacted in 1993, starts with the following provision (Art.1, para.1): The Russian Federation – Russia is a democratic Federative law-governed state ( pravovoe gosudarstvo) with a republican form of government.

The concept of the law-governed state originated as the Rechtsstaat in 19th century Germany and was introduced into Russia towards the end of that century. Some Russian proponents of this concept went further than their German counterparts and supported the introduction of a democratically elected parliament and the subordination of the Tsar to the laws enacted by parliament. The Russian constitutional movement came close to fruition after the February Revolution in 1917, but the Bolshevik Revolution in October the same year thwarted all hope for the realisation of constitutionalism. The democratically elected constitutional assembly, in which the Bolsheviks were a minority, was disbanded by the Bolsheviks soon after the October Revolution.1 Under the socialist regime, the concept of the law-governed state was totally rejected as a “bourgeois ideology” which was against the dictatorship of the proletariat. It was eventually replaced by the concept of “socialist legality”. Socialist legality was ofcially dened as the “strict observance of law by administrative agencies, social organisations, government ofcials, and citizens”. This notion was totally different from the concept of a law-governed state since i) the law was not enacted through a democratic procedure – to start with, there was no democratic election, ii) the law was subordinate to political expediency

1

On the development of this concept in Germany and Russia, see H.Oda, “The Emergence of Pravovoe Gosudarstvo in Russia”, Review of Central and East European Law, 1999 No.3, p.373ff.

2

SOURCES OF LAW

determined by the Communist Party (CPSU) leadership, and iii) the CPSU leadership which actually ruled the country was not bound by any law. Furthermore, there was no independent court. It was not surprising that the coercive collectivisation of agriculture and the Great Terror in the 1930s were not regarded as breaches of socialist legality, but in fact, as the implementation of it. The concept of the law-governed state re-emerged in Russia in the 1980s in the course of perestroika. An extensive discussion on this concept began in 1987 in the CPSU ofcial periodical, Kommunist. The 19th CPSU Conference, which was convened in 1988, adopted a resolution to create a “socialist law-governed state”. Soon, the prex “socialist” disappeared.2 Since the collapse of socialism, new laws have replaced the laws enacted in the socialist period in almost all major branches of law. The Constitutional Court is in operation, and the courts in principle have gained independence. As mentioned above, the Constitution has declared Russia to be a law-governed state. Naturally, the mere fact that the concept has been enshrined in the present Constitution does not mean that Russia has become a genuine law-governed state. V.N.Kudriavtsev, who has been instrumental in reintroducing the concept of a law-governed state in the process of perestroika, pointed out in 1998 as follows: In reality, Russia in the past decades has become all too accustomed to the serious violation and agrant neglect of the rights and lawful interests of individuals. Rectifying the present situation in several years is impossible, but it is our immediate task to consistently work towards that direction.3

At present, one can say that, at least, the basic legal framework to create a genuine law-governed state is in place.

2

THE FEDERAL STRUCTURE

Russia is a Federal state. It comprises 21 republics, 6 regions (krais), 49 provinces (oblast’s), 1 autonomous province, 10 autonomous regions, and 2 cities of Federal designation (articles 5 and 65 of the Constitution). These entities are “constituent entities of the Russian Federation with equal rights” (Art.5, para.1). This means that these entities by no means form a hierarchical order; all these entities constitute the second layer of the structure of the Russian Federation.

2 3

Ibid., pp.412-415. V.N.Kudriavtsev, “Zakonnost”: soderzhanie i sovremennoe sostoianie”, ZhRP, 1998 No.1, p.7.

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3

Thus, regions do not exist within the republic, and neither do the provinces exist within the region: they all exist in a parallel manner. Below these entities is the system of “local self government” – the second layer of local governments. These are cities and towns (except Moscow and St.Petersburg which are “cities of Federal designation” and are constituent entities of the Federation), districts (counties), villages etc. They are not constituent entities of the Russian Federation as such, and are governed by the laws and statutes enacted by the constituent entities within the framework of the Federal Law on the General Principles of Organising Local Self Government in the Russian Federation and by their own statutes (ustavy). The Constitution provides that the administrative structure of the constituent entities is determined independently by themselves in accordance with the fundamentals of the constitutional system of the Russian Federation and the Principles of the Organisation of the Representative and Executive Bodies of State Power (Art.77, para.1). The majority of republics are headed by a president, while some other republics have the title of the “head of the republic”, or “chairman of the government”. Usually there is a separation of power within these entities – an executive body called the government or cabinet and a representative legislative body. Several republics have a state council as a form of government. As a legislative body, republics have a “state assembly”, “state council”, or “legislative assembly” etc. Some republics have adopted a traditional name for their legislative body such as khural in Buriatiia and Kalmykiia. The system of election also varies. On several occasions, the Federal Constitutional Court has ruled the electoral system of the republics to be against the Federal Constitution.4 In the provinces and regions, there is a governor ( gubernator), who is the highest ofcial of the administration and who represents the province or region. The governor used to be elected by a direct election of the populace for a term of four years until recent changes (see below). The system of administration comprises the apparatus of the governor, departments, committees and territorial bodies of Federal ministries. There is also a representative legislative body which is called duma, state duma, assembly of deputies, etc. Again, the relationship between the executive and legislative branches as well as the governor varies.5 Cities like Moscow and St. Petersburg have a governor (formerly called the mayor), a city government and a legislative assembly. In Moscow, the governor

4 5

M.V.Baglai ed., Konstitutsionnoe pravo Rossiiskoi Federatsii, fourth edition, Moscow 2005, pp.752-754. V.V.Lazarev ed., Nauchno-prakticheskii kommentarii k Konstitutsii Rossiiskoi Federatsii, second edition, Moscow 2001, pp.388-389.

4

SOURCES OF LAW

is the highest ofcial of the city and at the same time, the premier of the city government. The law which sets out the basic system of the legislative and executive bodies of the constituent entities was enacted in 1999.6 As part of the drive for centralisation under the Putin administration, this Law was substantially amended in 2004. At the next level following the constituent entities of the Russian Federation, there is a system of “local self-government”. The system comprises cities and towns ( gorods), districts (raions, uezds), villages (including volost’s), and rural settlements. These entities are called “municipalities” (munitsipal’nye obrazovanii). The bodies of these entities are “not part of the state system of administration” (Art.12). This system of local self-government is said to have originated from the system of local self-administration such as the zemstvo in the Tsarist period.7 The power of “local self-government” is exercised by citizens by means of referenda, elections and other forms of the direct expression of their will and through elected and other organs of local self-government in urban and rural settlements and other territories (Constitution, Art.130, para.2, Art.131, para.1). Bodies of local self-government independently manage municipal properties, formulate, approve, and implement the local budget, create local taxes and levies, implement the protection of public order and also resolve other questions of local signicance (Art.132, para.1). It is important to note that even at this level, the power to create taxes and levies is guaranteed by the Constitution. The list of taxes and levies which can be created by local self-governments is provided by the Tax Code. There is a Law on General Principles of Organising Local Self-Governments which gives further details on the system of local self-government.8 There have been intensive legislative activities, both at the Federal level and at the level of constituent entities since 1991. Between 1991 and 1998, at the Federal level, 1,504 laws (including the Constitution) and statutes (ustavy) were enacted, while there were 10,286 laws (including constitutions) and statutes, and 37,154 acts of the president and head of administration enacted at the level of the constituent entities.9 In the early nineties, the period immediately after the collapse of socialism was a period of separatism of regional entities. This period could be characterised by the “aspiration of almost all administrative units to grasp special pre-

6 7 8 9

Law FZ-184 of June 24, 1999. Baglai, supra, p.760. Law FZ-154 of August 28, 1996. V.B.Isakov, “Zakonodatel’stvo sub”ektov RF: ob”em, struktura, tendentsii razvitiia”, ZhRP, 1999 No.12, p.63.

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rogative power”. The President at that time rather imprudently urged regional leaders to grasp as much sovereignty as they could swallow. The result was a sheer chaos. The 1993 Constitution failed to solve the problem. In addition to the Constitution, there were Federal treaties concluded with the regions which provided “alternative norms” to the Constitution. The necessity of establishing a proper system of Federalism had been felt for some time. Under the Putin administration, this was realised in the form of reinforced centralisation. First, the Federal Council of the Federal legislative body was completely reorganised. An organisation called the State Council with representatives of the constituent entities was set up, but this is merely a consultative body. Secondly, the heads of the constituent entities, who were elected by the populace of the region, are now elected by the legislative body of the constituent entity. The President is empowered to propose a candidate for this position. Thirdly, the term of these heads of the constituent entities can be terminated prematurely if they “lose the condence of the President”. Fourthly, 10 positions of the President’s plenipotentiary were created to oversee the activities of the constituent entities.

3

THE CONSTITUTION

The present Constitution of the Russian Federation was enacted in 1993. The history of the Russian Constitution goes back to the early 19th century. The 1832 Digest of Laws of the Russian Empire (Svod zakonov Rossiiskoi Imperii; hereinafter, Svod zakonov) in its volume 1 contained the Fundamental Law (osnovnoi zakon) which set out the basic structure of the state. This was replaced by the Fundamental Law of 1906, which was modelled on the Prussian Constitution of 1850. The term “Constitution” was not used, since it was associated with constitutional monarchism, i.e. the idea of restraining the power of the monarch by a democratically enacted Constitution. The socialist constitutions, including the 1936 and 1977 USSR constitutions, had the term “Fundamental Law” in brackets following the term “Constitution”. The 1993 Constitution is the rst Russian Constitution without it. Unlike its predecessors, the present Constitution provides that the Constitution has “supreme legal force and direct effect” (Art.15, para.1). Laws and other legal acts must not contradict the Constitution. In order to ensure the compatibility of laws and other legal acts with the Constitution, the Constitutional Court was founded in 1990. At present, the Constitutional Court operates on the basis of the 1994 Law on the Constitutional Court.10

10

Law FKZ-1 of July 21, 1994.

6

SOURCES OF LAW

The “direct effect” of the Constitution means that without any enabling statute, the Constitution has an effect. Provisions of the Constitution can be directly invoked by the parties in court without any law. Under socialism, there were provisions in the Constitution, namely in the part regarding the basic rights of the people, which were not implemented due to the absence of corresponding laws. The Constitution itself could not be invoked to defend these rights, since its “direct effect” had been denied. Therefore, these provisions merely had a symbolic meaning. There are different procedures for the amendment of the Constitution, depending on the object of the amendment. Chapters on the foundation of the constitutional system, human rights and freedoms, and constitutional amendments can be altered only by the Constitutional Assembly. The Assembly may adopt the amendment by a two-thirds majority, or submit it to the nation-wide vote (Art.135). Amendments to the other parts of the Constitution, except for the provision on the composition of the Federation, are adopted in the same way as the Federal constitutional laws (arts.136 and 137: see below). Since its adoption in 1993, the Constitution has not been amended.

4

FEDERAL LAW

One of the basic components of Rechtsstaat is the supremacy of law (verkhovenstvo zakonov), i.e. laws enacted by the democratic representative body have supremacy over other normative acts. In the Soviet period, with various bodies enacting binding norms while clear-cut rules as to the relationship between the different levels of norms were absent, the legislation was in a state of sheer chaos. In addition to the laws enacted by the Supreme Soviet, there were decrees of the Presidium of the Supreme Soviet, edicts of the Council of Ministers, and other normative acts. Arbitrary creation of norms (normtvorchestvo) by administrative agencies created problems. There were serious overlaps and contradictions between numerous acts. During the process of perestroika, the supremacy of law came to be acknowledged as a fundamental principle of the state. The present Constitution provides that the Constitution and Federal laws have supremacy throughout the territory of the Russian Federation (Art.4, para.2). Legislative power in Russia is borne by the bi-cameral Federal Assembly (the Federation Council and the State Duma). The Federal Assembly enacts “Federal constitutional laws” and “Federal laws” in relation to matters within the jurisdiction of the Federation. These laws have direct effect throughout the territory of the Russian Federation (Art.76, para.1). Insofar as matters which fall within the exclusive jurisdiction of the Russian Federation are concerned, it

CHAPTER 1

7

is the Federal constitutional laws and Federal laws which are to regulate these matters. Federal constitutional laws have a stronger legal effect than Federal laws in that Federal laws cannot contravene Federal constitutional laws (Art.76, para.3). The legislative process for Federal constitutional laws and Federal laws differs. Federal laws are adopted by the State Duma by a simple majority and then sent to the Federation Council for consideration. If the Federation Council supports the law by a majority vote, or does not consider the law within 14 days, the law is deemed to have been approved by the Federation Council. If the Federation Council rejects the law, then both houses may set up a conciliation council to overcome the differences. Then, the law is subject to a second consideration by the State Duma. The State Duma may overcome the differences by a twothirds majority vote of all members (Art.105). The law thus adopted is sent to the president within 5 days. The president is to sign the law within 14 days. If the president fails to sign the law within 14 days, and two-thirds of the total number of members of both houses nevertheless endorse it, the president is under an obligation to sign the law (Art.107). In contrast, Federal constitutional laws are adopted by the majority of three-quarters of the members of the Federation Council and two-thirds of the members of the State Duma. The Law is to be signed by the president and promulgated within 14 days (Art.108). Thus, Federal constitutional law requires a qualied majority vote and is not subject to the presidential veto. Matters which are to be regulated by Federal constitutional law are provided in the Constitution. These include: the admission to the Russian Federation and the creation of a new entity within the Russian Federation, changes to the constitutional status of the entities within the Russian Federation, the regime of martial law and the state of emergency, procedure for the activities of the government of the Russian Federation, and the court system. At present, there are Federal constitutional laws on the Constitutional Court, the commercial court, the court system in general, the Federal government, the referendum as well as on the national ag and anthem.11 Under socialism, there were laws and other legal acts which were not published, i.e. laws “not for publication” or “for ofcial use only”. This is not permitted any more. The Constitution provides that laws are subject to publication, and that unpublished laws shall not apply (Art.15, para.3). This is reiterated in the Law on the Publication and Taking of Effect of Federal Constitutional laws,

11

N.V.Iliutenko ed., Federal’nye konstitutsionnye zakony, Moscow 2004, pp.332-334.

8

SOURCES OF LAW

Federal Laws and Acts of the Chambers of the Federal Assembly which was enacted in 1994.12 The date of the adoption of a Federal law is the date on which the Duma adopts it in its nal version, while for Federal constitutional law, it is the date of adoption by the Federal Council (Art.2). The ofcial date of publication is the date of their publication in the Rossiiskaia gazeta (RG), or Sobranie zakonov Rossisskoi Federatsii (SZ RF ) (Art.4).

5

LAW OF THE CONSTITUENT ENTITIES

Among the constituent entities, republics are entitled to have their own constitution and legislation. Other constituent entities may enact their statutes and legislation (Art.5, para.2). With the spontaneous devolution which took place in the early 1990s, the constituent entities began enacting their own constitution, codes and statutes. According to a survey conducted by the Legal Department of the Duma, the areas covered by regional law-making activities were fundamentals of the constitutional system, 15.7%, the problem of economic activities, 29.9%, nance and credit, 20.9%, labour and social policy, 8.6%, housing, 7%, and environmental protection, 6.7%. Legislation on economic activities included laws on enterprises and entrepreneurial activities, laws on industry, laws on agriculture, and laws on transport and communication.13 However, these laws were often not compatible with the Federal Constitution. For example, laws of the Republic of Bashkortostan, Tatarstan, and Sakha (Iakutsiia), declared that the Republic was a sovereign state. The Law on International Treaties of the Sverdrovsk province provided for the power of the Province to conclude international treaties. In the area of taxation, these entities often exceeded the power granted to them.14 One of the reasons for such a chaotic situation was the absence of a clearly set out order of priority between the Federal law and the laws enacted by the constituent entities. The constitutional arrangement is that the order of priority depends on the matter which is being regulated. The Constitutional Court has ruled on the compatibility of the legislation of the constituent entities and the Federal Constitution on several occasions.

12 13 14

Law FZ No.5 of June 14, 1994. Isakov, supra, pp.71-72. “Verkhovenstvo konstitutsii RF i Federal’nykh zakonov – osnovnoi pravovoi printsip”, KhiP 2000 No.1, pp.34-37.

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9

As early as 1992, the Constitutional Court found that a series of legislation of Tatarstan which claimed itself as a sovereign state to be unconstitutional. The Court found similar laws of Bashkorstan, Adygeiia, and North Osetiia to be unconstitutional in 2000.15 Matters which fall within the exclusive Federal jurisdiction are regulated by Federal laws. Matters which are to be administered jointly by the Russian Federation and its constituent entities are to be regulated by Federal laws as well as laws and other normative acts enacted by the constituent entities, but in accordance with Federal laws (Art.76, para.2). On these matters, constituent entities are empowered to enact laws and other normative acts, but these acts cannot contravene Federal laws. In cases of conict, Federal law prevails. Regarding matters which are neither within the jurisdiction of the Russian Federation or the joint jurisdiction of the Russian Federation and its constituent entities, constituent entities have an inherent power of regulation, including enactment of laws and other normative acts (residual power). This means that constituent entities may enact laws and other normative acts independently and at its discretion in this area. Laws or other normative acts of the constituent entities may not contradict Federal constitutional laws and Federal laws in the areas of exclusive jurisdiction of the Federation or joint jurisdiction of the Federation and its constituent entities. In contrast, in the area left to the constituent entities, even if the laws and other normative acts enacted by the constituent entities are different from Federal constitutional law or Federal law, these laws or normative acts still prevail. However, there is an important exception to this rule. These laws and other normative acts enacted in these residual areas are not applicable in cases where they are against the Federal Constitution, basic rights and freedoms of the people, universally accepted principles of international law and international treaties ratied by the Russian Federation (arts.4 and 15). The demarcation of competence of the Russian Federation and its constituent entities has always been a difcult matter. Before the enactment of the present Federal Constitution, the Federal Treaty – in fact there were three separate agreements – was concluded. This was signed in 1992 by the representatives of the Russian Federation and its constituent entities and was incorporated in the then Constitution (originally of 1978). The Treaty was aimed at demarcating the competence of the Russian Federation and its constituent entities. The Treaty is still valid. The present Constitution provides that the demarcation of competence

15

Decision of the Constitutional Court of June 27, 2000, No.92-O; see also Decision of the Constitutional Court of April 19, 2001, No.65-O.

10

SOURCES OF LAW

between the Federation and its constituent entities is to be governed by the Constitution as well as the Federal Treaty and other treaties.16 The Constitution lists matters which fall within the exclusive jurisdiction of the Russian Federation. These include the following (Art.71): i)

the adoption and amendment of the Constitution of the Russian Federation and Federal laws and the monitoring of compliance with them; ii) the Federal structure and territory of the Russian Federation; iii) the regulation and protection of human rights and freedoms, citizenship of the Russian Federation; iv) Federal property and its administration; v) the establishment of the legal basis of the single market; nancial, currency, credit and customs regulation; Federal economic service and banks; vi) Federal energy systems, nuclear power generation, ssile materials, Federal transport, means of communication, information and connections; activity in space; vii) Russian Federation’s foreign policy and international treaties, issues of war and peace; viii) defence and security; ix) determination of the status and protection of state borders; x) the judicial system: the procuracy; legislation in the eld of criminal law, criminal procedure and criminal execution law, amnesty and pardon; legislation in the eld of civil law, civil procedure and law of commercial court procedure; the legal relation of intellectual property; xi) adoption of the Federal law on conict of laws.

Matters which fall within the joint jurisdiction of the Russian Federation and its constituent entities include the following (Art.72): i) ii) iii) iv) v)

16

issues relating to the ownership, use and disposal of land, subsoil, water and other natural resources; demarcation of state ownership; the use of natural environment; environmental protection and the ensuring of ecological safety; the establishment of general principles of taxation and levying of duties in the Russian Federation; administrative, administrative-procedural, labour, family, housing, land, water and forestry legislation and legislation on subsoil and on environment;

A.R.Paramonov and L.Ia.Poluian, “Federativnyi dogovor”, in A.Ia.Sukharev ed., Rossiskaia iuridicheskaia entsiklopediia, Moscow 1999, pp.3067-3069.

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11

vi) personnel of judicial and law enforcement agencies; advocates and notaries; vii) the establishment of general principles for the organisation of a system of agencies of state power and local self-government.

In relation to matters which fall within the exclusive jurisdiction of the Russian Federation and the joint jurisdiction of the Federation and its constituent entities, Federal administrative agencies may establish their territorial agency in the territory of the constituent entities and appoint their ofcials. These territorial agencies of the Federal government form a single system of administration jointly with the administrative agencies of the subjects (Constitution, Art.77, para.2). This concept of joint jurisdiction in Russia is apparently an outcome of a compromise between Federal and regional power which failed to solve the problem once and for all at the time of the enactment of the Constitution. Exclusive jurisdiction and joint jurisdiction sometimes overlap. For example, protection of human rights is listed as an exclusive jurisdiction of the Russian Federation as well as a joint jurisdiction of the Russian Federation and its constituent entities. The provision is not only general and vague, but it does not always coincide with the provisions in the other part of the Constitution. For example, in the area of land law, possession, problems of use and disposal of land fall within the joint jurisdiction of the Federation and the subjects (Art.72, para.1). On the other hand, another provision of the Constitution states that the conditions and procedure of the use of land are to be determined on the basis of Federal law (Art.36, para.3). Furthermore, there is also a provision to the effect that the establishment of a single market is a matter which falls within the exclusive competence of the Federation (Art.71). Since the demarcation of competence in the present Constitution was not clear enough, the president has concluded agreements with the heads of the constituent entities. In 1999, there were around 30 of them. There are specic matters covered by the agreements, such as property relations, problems related to fuel and energy complexes, and budgetary relations.17 With the adoption of the 1999 Law on the Fundamental Principles and Procedure of Demarcating the Competence of the Agencies of State Power of the Russian Federation and the Constituent Entities, the matter has become clearer. Since the majority of the legal acts in the area of joint jurisdiction were enacted before this Law came into force, there remains the enormous task of aligning the existing laws and legal acts with this new Law.18

17 18

Baglai ed., supra, second edition, Moscow 1999, p.323. Lazarev ed., supra, pp.344-345.

12 6

SOURCES OF LAW

PRESIDENTIAL DECREES

At the Federal level, in addition to laws enacted by the representative body, some other bodies enact binding rules. In fact, in Russian terminology, laws, presidential decrees, and edicts of the government (cabinet) of the Russian Federation are put in the same category of “legal acts ( pravovye akty)”.19 Another concept, “normative acts”, in addition to these, covers acts of ministries and other Federal administrative agencies.20 By the same token, legislation (zakonodatel’stvo) in Russian includes not only acts of the legislature, but also presidential decrees and edicts of the government.21 Between 1995 and 2000, around 1,000 Federal laws were adopted, while there were 800 presidential decrees and 2,000 edicts of the government.22 The president is the head of state in Russia (Art.80, para.1) and is elected for a four year term by direct election of the citizens (Art.81, para.1). The president is empowered to issue decrees (ukazy) and orders (rasporiazheniia) (Art.90, para.1). Although it is binding in the same way as decrees, the latter normally does not have a normative character; it addresses individual matters.23 President Yel’tsin heavily resorted to presidential decrees in the early 1990s. Of the legislation enacted at the Federal level between 1991-1998, presidential decrees accounted for 14.4%, while laws accounted for 1,7%. In fact, in 1991, presidential decrees accounted for 28.5%.24 In the earlier period after the collapse of socialism, in many areas, relevant Federal laws were absent, while the legislative process was slow for various reasons. Therefore, the president utilised his power to issue presidential decrees in an extensive way. A commentator reminisces that the President had “radically changed many essential aspects of social relations in the country” by resorting to presidential decrees.25 The percentage of presidential decrees among the legislation has been in constant decline. In 1998, it dropped to 8.5%.26 Presidential decrees and orders may not contradict the Constitution and the Federal laws (Art.90, para.2). Federal laws in this context include both Federal constitutional laws and Federal laws. Particularly in the earlier days, “many of

19 20 21 22 23 24 25 26

M.I.Braginskii ed., Nauchno-prakticheskii komentarii k chasti pervoi grazhdanskogo kodeksa Rossiiskoi Federatsii, second edition, Moscow 1999, pp.43-44. Ibid., p.45. A.Ia.Sukarev ed., Rossiiskaia iuridicheskaiia entsiklopediia, Moscow 1999, pp.1009-1110. A.Makovskii and A.Silkina, “Novyi klassikator pravovykh aktov”, RIu, 2000 No.5, p.7. Baglai, supra, fourth edition, p.461. Isakov, supra, pp.63-65. B.N.Topornin ed., Konstitutsiia Rossiiskoi Federatsii: nauchno-prakticheskii kommentarii, Moscow 1997, pp.505-506. Isakov, supra, p.65.

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13

the presidential decrees were not perfect, some of them not totally coincided with the constitutional norms and previous legislation, some of them were contested in the parliament chambers and the constitutional court”.27 The Constitutional Court has the power to review the constitutionality of presidential decrees. On some occasions such as the sending of military forces to Chechnya, the Constitutional Court acknowledged the constitutionality of the relevant presidential decree, while there were other cases where a presidential decree was found unconstitutional, such as the decree establishing a new ministry by combining the Ministry of State Security and the Ministry of Internal Affairs.28 The priority between the presidential decree and legal acts of the constituent entities is decided by analogy with the relationship between Federal laws and the legal acts of the subjects.

7

EDICTS OF THE GOVERNMENT

Executive power in Russia is exercised by the government ( pravitel’stvo), which is the Russian equivalent of a cabinet (Art.110). The head of the government – the Prime Minister – is appointed by the President with the consent of the State Duma (Art.111, para.1). The Prime Minister proposes candidates of ministers to the President who is empowered to appoint and dismiss them (Art.112, para.2). The President has the right to chair sessions of the government. The government is empowered to enact edicts ( postanovlenie) on the basis of, and in implementation of, the Federal Constitution, Federal laws, presidential decrees of a normative nature and for their implementation (Art.115, para.2). In contrast to presidential decrees which the President issues on the basis of his inherent power, it is clear from this provision that government edicts derive their power from the Constitution, Federal laws, and even presidential decrees. What is more, if an edict of the government is against the Federal Constitution, Federal laws, or a presidential decree, the President is empowered to revoke it (Art.115, para.2). Federal ministries are established by presidential decrees and regulated by a statute either in the form of an edict of the government or a presidential decree. According to the Federal Constitutional Law on the Government of Russia of 1997, ministries are subordinated to the government and are responsible to the government for performing the entrusted tasks. Within their power, ministries issue instructions, circulars and other subordinate acts ( podzakonnye acty).

27 28

Ibid. Topornin ed., supra, p.507.

14 8

SOURCES OF LAW

ACTS OF LOCAL SELF-GOVERNMENTS

The system of local self-government (municipalities) falls within the joint jurisdiction of the Russian Federation and the constituent entities (Art.72). Under this provision, the Federal Law on the General Principles of the Organising of Local Self-Government was enacted in 1995. Within the framework of this Law, which is fairly general, each constituent entity regulates the problems of local self-government within its jurisdiction. Therefore, the structure of local selfgovernment varies from place to place.29 As a rule, there is a representative body and an executive body. Representative bodies are called duma, assembly, sovet, etc. The executive body is organised under the head of administration. In most places, the head of administration is elected by the populace.30 Local self-governments have a representative body which enacts their fundamental statute (ustav) and other normative legal acts.31 Local self-governments are empowered to enact such acts via a representative body, or by direct referendum on matters of local signicance, based upon the interest of the inhabitants, their historical traditions and other local traditions. This includes the creation of taxes and levies, the maintenance of law and order in the locality and the registration of inhabitants. Acts of some constituent entities and local self-governments involving these matters have been contested at the Constitutional Court.32

9

COURT JUDGMENTS

Precedents are not binding on the courts in the same way as they are in AngloAmerican jurisdictions. Under the current system, judicial precedents are not regarded as a source of law in the sense that contravention of precedents is not a ground for appeal or any other means of reviewing the judgment by superior courts. In fact, precedents are not referred to in the judgments at all. If one compares the entry of “judicial precedents ( pretsedent)” in the legal encyclopaedias published in 1984 and 1999, there is not much difference. In both publications, court precedents are primarily treated as alien institutions. The only difference is that in the 1999 Encyclopaedia, there is a brief reference to Tsarist Russia and the contemporary period, but there is no substantive discussion as to the status of court precedents as a source of law.33

29 30 31 32 33

Lazarev ed., supra, p.624. Baglai ed., supra, fourth edition, pp.773-774. I.V.Vydrin and A.N.Kokotov, Munitsipal’noe pravo Rossii, Moscow 2001, pp.178-182. Lazarev ed., supra, p.632. R.O.Khalna, “Pretsedent” in A.Ia.Sukharev ed., Iuridicheskii entsiklpedicheskii slovar’,

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15

The fact that Russian law is part of the Civil Law system does not necessarily mean that judicial precedents have not been regarded as a source of law in Russia. In fact, in many Civil Law jurisdictions, judicial precedents are considered to be a source of law. As a leading expert on comparative law has pointed out, matters are not really very different between Anglo-American jurisdiction and Civil Law countries: It is true that there is never any legal rule which compels a judge to follow the decisions of a higher court, but the reality is different. In practice a judgment of the Court of Cassation or of the Bundesgerichtshof in Germany can count on being followed by lower courts just as much as a judgment of an appeal court in England or in the United States.34

In the Tsarist period, there were different views on the status of precedents. Some people, such as N.Korkunov, acknowledged that court precedents qualied as a source of law,35 while others totally denied this.36 In the socialist period, court precedents were not regarded as a source of law. It was only natural that under a system where political power was highly centralised, law-making by lower court judges could not be tolerated. It was also noted that the system of judge made law gives opportunities to the ruling class to contradict provisions of existing legislation.37 Under socialism, theoretically, judges were supposed to apply the law in a mechanical way without exercising any discretion. There was no room for free interpretation of statutes by judges. In fact this has been a tradition since the Tsarist period. The Fundamental Law before 1906 dictated judges must apply laws in a “mechanical manner”.38 However, since provisions of the law tend to be fairly general and abstract, it was technically impossible to restrain judges from interpreting the law and, at the same time, let them apply the law to specic circumstances. The solution was to concentrate the power of interpretation to the Supreme Court, more specically to the Plenum of the USSR Supreme Court which comprised the President and his deputies as well as chief justices of the constituent republics. It goes without

34 35 36 37 38

Moscow 1984, p.296. V.V.Boitsova and L.V.Boitsov, “Pretsedent sudebnyi”, in A.Ia.Sukharev ed., Rossiiskaia iuridicheskaia entsiklopediia, Moscow 1999, pp.2385-2394. K.Zweigert and H.Kötz, An Introduction to Comparative Law, third edition, Oxford 1998, pp.261-263. N.M.Korkunov, Lektsii po obshchei teorii prava, 8th edition, St.Petersburg, 1908, pp.295298. V.V.Boitsova and L.V.Boitsov, supra, p.2387. Khalna, supra, p.296. Korkunov, supra, p.306.

16

SOURCES OF LAW

saying that the Plenum was under strict control of the CPSU. Thus, the court, even under socialism, was equipped with some power to interpret the law, not only to mechanically apply it, but such power was not given to lower courts. The device used by the Plenum of the Supreme Court at that time was its “guiding explanations”. Guiding explanations were issued in various areas of law where they were needed. Also publications entitled Sudebnaia praktika (court practice) edited by the Supreme Court were published from time to time to give guidance to lower court judges. Therefore, some people acknowledge that judicial precedents were a “de facto source of law” even under socialism. However, such views remain in the minority.39 This system of “guidance” by the Supreme Court (and the Supreme Commercial Court) still remains in Russia, but in a different format. It takes the form of the decisions of the plenum of either the Supreme Court, the Supreme Commercial Court, or the joint plenum of the both. The presidium of the Supreme Commercial Court also publishes a “review (obzor) of the court practice” covering various areas, which takes the form of an “information letter”. They are published in the ofcial periodicals of the court – Vestnik verkhovnogo arbitrazhnogo suda RF and the Biulleten’ verkhovnogo suda RF. In addition, the former publishes around 40-50 cases a month, and the latter, around 10 cases, which is quite different from the practice in the socialist period when even judgments of principal signicance were not always published. There is a view which regards the publication of the higher courts on specic cases as another form of “guidance”.40 Usually, decisions of the plenum take the form of compilations of rules. Thus, as an example from the early period, the joint decision No.6/8 of the plenum of both courts entitled “Some problems on the application of Part One of the Civil Code of the Russian Federation”, which comprises more than 50 items, provides the following in item 3: 3. In accordance with the Federal Constitution, civil legislation falls within the jurisdiction of the Russian Federation (Article 3, para.1 of the Civil Code). Provisions of civil law of the constituent entities of the Russian Federation, enacted before the Federal Constitution has taken effect, can be applied by the courts in settling disputes, if they do not contradict the Federal Constitution and the Code.

M.N.M.Marchenko, “Iabliaetsia li sudebnaia praktika istochnikom rossiiskogo prava”, ZhRP, 2000 No.12, p.12. 40 G.T.Ermoshchin, “Problemy obespecheniia nezabisimosti sudebnoi vlasti”, in Iu.A.Tikhomirov ed., Sudebnaia reforma v Rossii, Moscow 2001, pp.28-29. 39

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17

19. The list of activities which juridical persons may conduct only on the basis of a license is determined by law (Article 49, para.1, subpara.3). On this matter, the court should bear in mind that after the entering into force of the Civil Code, types of activities which are subject to license can be established only by law.41

In contrast, “review of court practice” is more specic. Usually, it is a compilation of a summary of cases. For example, in the “Review of court practice regarding the recognition and enforcement of foreign judgments, contesting of arbitral awards, and issuing of enforcement documents for the enforcement of foreign arbitral awards” adopted in 2005, 32 cases are summarised under headings such as:42 4. The commercial court is not entitled to examine the judgment of a foreign court on its merit when considering the application for its recognition and enforcement [summary of the case omitted] 28. The commercial court accepts the request for setting aside of an arbitral award if it established that the award concern a matter which falls within the exclusive competence of the commercial court of the Russian Federation. [summary of the case omitted]

By the same token, the “Review of the court practice on the application of Article 414 of the Civil Code of the Russian Federation” stipulates the following:43 1. Agreement of the parties which modies the date and procedure of payment in a credit contract does not mean that the means of performance has been modied, and therefore, is not a novation. [summary of the case omitted]

In this way the Supreme Commercial Court and Supreme Court of the Russian Federation “guide” the lower courts. The present Chairman of the Supreme Commercial Court, A.A.Ivanov, attributes the necessity of such guidance to the low quality of some of the laws:

Decision No.6 of the Plenum of the Supreme Court and Decision No.8 of the Plenum of the Supreme Commercial Court of July 1, 1996. VVAS RF, 1996 No.9, pp.6, 10. 42 Information Letter, Presidium of the Supreme Commercial Court, No.96, December 22, 2005. 43 Information Letter, Presidium of the Supreme Commercial Court, No.103, December 21, 2005. 41

18

SOURCES OF LAW

We come across them [low quality laws] literally every day at every meeting of the presidium of the Supreme Commercial Court when considering this or that case by nding apparent contradiction of provisions of various laws and in one and the same normative act. . . . If the quality of the laws were adequate, the necessity of such information letters will simply disappear.44

A commentary on the previous Code of Civil Procedure published in 1999, referring to the fact that erroneous interpretation of the law by the court is a ground of appeal, states the following: If the court does not have the possibility of utilising the result of the ofcial interpretation of the Supreme Court of the Russian Federation of one or another provision of substantive law, the court may interpret it in a wrong way. Therefore, such circumstances may serve as a ground for quashing such a judgment. It should be noted that if there is a decision of the Plenum of the Supreme Court of the Russian Federation on the problem which is being examined by the court, in order to avoid the possibility of having the judgment quashed, the court should utilise the rules set out in the given decision. If the conclusion of the court is based upon the interpretation of the norm of substantive law by the Supreme Court of the Russian Federation, the possibility of having the judgment quashed on the ground of erroneous interpretation is excluded.45

A vice president of the Supreme Court pointed out as follows: With the taking of effect of the new Federal Constitution and the increased role of the court in society and the state, also in court practice, emerged new, extremely important functions of the court. . . . despite signicant renovation of legislation and adoption of a number of laws, there are many vacuums in the legal system and many contradictions emerged. Overcoming these problems is more complicated than before and is one of the most difcult tasks of court practice. On several occasions, judgments of the Supreme Court have become sources of law.46

He also commented elsewhere that at present, courts are often forced into having to create law, otherwise, “their activities would not only be ineffective, but result in the opposite of what society legitimately expects of them; they will not defend

A.A.Ivanov, “Kachestvo zakonov i deiatel’nost’ arbitraznykh sudov”, ZhRP 2005 No.4, p.3, p.5. 45 A.P.Ryzhakov and D.A.Sergeev, Postateinyi kommentarii k grazhdanskomu protsessual’nomu kodeksu RSFSR, Moscow 1999, p.523. 46 V.M.Zhuikov, “Rol” sudebnoi praktiki v pravoprimenitel’nom protsesse”, zhuikov ed., Sudebnaia praktika po grazhdanskim delam 1993-1996, Moscow 1997, p.6. 44

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19

rights, but will facilitate their violations”.47 There are others who claim that “the courts, at present, are simply under an obligation to create law”.48 Several recent publications on the Code of Commercial Court Procedure acknowledge court judgments as a source of law. One commentary points out that “court practice is a source legal regulation and most important of these rules serve as the basis of judgments”.49 The new Code of Commercial Court Procedure allows the court to quote the decisions of the plenum of the Supreme Commercial Court in the reasoning part of the judgment (Art.170, para.4). It may be premature to say that judicial precedents have been formally acknowledged as a formal source of law in Russia. After all, acknowledging judicial precedents as a source of law is about granting the courts power to create law. The judicial system in Russia has undergone signicant changes since perestroika. The independence of judges, which has existed only on paper, is gradually gaining substance. The authority of the court is being strengthened which is demonstrated e.g. by the expansion of court jurisdiction and the abolition of “judicial supervision” by the procuracy, but still there is some hesitation with regards to ofcially allowing judges to create law: Among our judges, there are still not a small number of lawyers with a low level of qualication. Granting each of them the right to create law means to bury legalityt. . . . At present, in Russia, a “war of laws” is going on. Allowing the creation of laws by the court and the expanding of the discretion of judges will reinforce this negative process.50

However, it cannot be denied that the judgments and other instruments of the Supreme Commercial Court and the Supreme Court are expected to guide the lower courts and in reality have a signicant inuence on the practice of the lower courts. There are views which acknowledge that the Constitutional Court, by reviewing the constitutionality of normative acts, creates law, and therefore, their judgments are sources of law. But this is naturally a totally different matter.

Marchenko, supra, p.17. Quoted in I.L.Petrukhin, “Problema sudebnoi vlasti v sovremennoi Rossii”, GiP, 2000 No.7, p.19. 49 V.Iarkov ed., Kommentarii k arbitrazhnomu protsessual:nomu kodeksu RF, Moscow 2004, p.25. 50 Ibid. 47 48

20 10

SOURCES OF LAW

CUSTOM

Custom and Customary law were regarded as something backward and to be overcome in the socialist period. “Socialist states actively fought against customs which reected ignorance, inequality, exploited the status of women and against other remnants of exploiting forms”.51 Besides, under socialism, the political leadership could not tolerate the spontaneous emergence of norms outside of their control. Commercial custom was applicable only when it was sanctioned by the state such as the custom which was referred to in the Civil Code and other civil legislation.52 Custom in this context meant international commercial custom, mainly those terms covered in Incoterms, which were worked out by the United Nations, and also international custom referred to in Comecon – the Council for Mutual Economic Cooperation – General Conditions of Supply as well as some international arbitration treaties. The present Civil Code provides that commercial custom (obychai delovogo oborota) is a rule of behaviour not provided by legislation, but sufciently specic and widely applied in any area of entrepreneurial activities, regardless of whether it is xed in any document or not (Art.5, para.1). “Tradition” of performing a certain type of contract is cited as an example.53 Commercial custom is a source of law (Code of Commercial Court Procedure, Art.13, para.6; Code of Civil Procedure, Art.11, para.1). It is not applicable, however, if it is against the law. Commercial custom is applied only when there is no applicable contract or mandatory provision of the law (Code of Commercial Court Procedure, Art.13, para.6). Commercial custom is not only a source of law, but is one of the factors which should be considered when interpreting contracts (Civil Code, Art.431). Commercial custom is referred to in various provisions of the Civil Code (arts.311, 312, 314, 474, 478 etc.).

11

INTERNATIONAL TREATIES

The Civil Code provides that generally recognised principles and rules of international law as well as the treaties of the Russian Federation are the “constituent part” of the Russian legal system (Art.7, para.1). This reects the constitutional

51 52 53

R.O.Khalna, “Obychnoe pravo”, “Obychai’ in A.Iu.Sukharev ed., Iuridicheskii entsikolopedicheskii slovar”, Moscow 1984, pp.208-209. Ibid., p.209. Joint Decision of the Plenums of the Supreme Commercial Court and the Supreme Court No.6/No.8, supra, item 4.

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21

rule that if an international treaty contains a rule which is against Russian law, the international treaty prevails (The Constitution, Art.15, para.4). Principles and rules of international law must be recognised as such by the Russian Federation in order to be a “constituent part” of the Russian legal system and bind the state as well as state agencies and ofcials.54 Such principles and rules are found in the United Nations Charter, declarations and resolutions of the United Nations, documents and statements of international organisations and conferences as well as in the judgments of the International Court of Justice.55 Russia is a signatory to the Vienna Convention on the Law of Treaties. The Law on International Treaties of the Russian Federation was enacted in 1995. According to this Law, international treaties denote inter-state, inter-governmental, and inter-agency agreements in the form of treaties, conventions, agreements, protocols, exchanges of letters and notes.56 Generally, principles and rules of international law and international treaties are applicable to civil law relations in a direct way, i.e. without an enabling legislation (the Civil Code, Art.7, para.2). A potential problem is the situation where there is a conict between an international treaty and Russian law. The Constitution has an explicit provision addressing such a situation; provisions of the international treaty have priority over provisions of the laws of the Russian Federation (Art.15, para.4). Those who apply law are not only empowered to, but are under an obligation, to apply international treaties on such occasions, and parties are entitled to quote the rules of international law in order to defend their rights.57 On the other hand, this provision does not directly refer to a situation where there is a conict between an international treaty and the Constitution. There is a view that in such cases, the Constitution is understood to prevail, because of the supremacy of the Constitution within the Russian legal system, to which international treaties a constituent part.58 International treaties concluded by the USSR have been, in principle, inherited by the Russian Federation, unless these treaties were declared to have lost effect. Such treaties which have now lost effect were published in the ofcial gazette between 1989-1991.59

54 55 56 57 58 59

Lazarev ed., supra, p.101. O.N.Sadikov ed., Kommentarii k Grazhdanskomu Kodeksu Rossiiskoi Federatsii, 3rd edition, Moscow 2005, p.24. Law FZ-101 of July 15, 1995. Lazarev, supra, p.101. Ibid., p.102. Sadikov ed., supra, p.24.

22 12

SOURCES OF LAW

FOREIGN LAW

The commercial court may apply norms of foreign law on the basis of international treaties, Federal laws as well as agreements between the parties concluded in accordance with them. However, this may not contradict mandatory norms of Russian law as provided for in Book Four of the Civil Code (Code of Commercial Court Procedure, Art.13, para.5; the Civil Code, Art.1192, para.1). In applying norms of foreign law, the commercial court is to establish its content in accordance with its ofcial interpretation, practice of application, and doctrines in the respective foreign state (Code of Commercial Court Procedure Art.14, para.1). The court may seek assistance of the Ministry of Justice and other Russian and foreign organisations, or invite experts (ibid., para.2). The Code of Civil Procedure also allows the court of general jurisdiction to apply norms of foreign law in accordance with the Federal Law or international treaties (Art.11, para.5).

2 THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

1

THE COURTS

1)

Historical Background

The modern court system in Russia emerged as an outcome of the Great Judicial Reform of 1864. The pre-Reform state of affairs could best be characterised as sheer lawlessness and chaos. The court system was organised in such a way that different lines of courts adjudicated cases involving people from different classes. In civil procedure, there could be 16 instances and 30 different procedures.1 There was no independence of the courts while judges were corrupt and susceptible to pressure from outside. “Our courts have got all the shortcomings which Western European courts used to have when the inquisitorial system prevailed”.2 I.S.Aksakov, a renowned philosopher, remarked in 1884; “Old courts! Simply thinking of them, your hair stands on end and your esh begins to creep.”3 In 1864, a new Statute on Court Organisation was enacted together with the rules of criminal and civil procedure. The reformed system was modelled entirely on the Western European system which existed at that time; there was a clear discontinuity with the indigenous Russian system. Laws of France, Switzerland, Belgium, Germany, and Austria as well as England were studied. There are different views as to the origin of institutions introduced by the Reform. “The most liberal foreign institutions” served as a model. More specically, the French system had a major inuence, although some German and English elements could also be seen.4 At that time, the German judicial system was in

1 2 3 4

I.V.Gessen, Sudebnaia reforma, St.Petersburg 1905, p.65. Ibid., p.28. Ibid., p.29. F.Kaiser, Die russische Justizreform von 1864, Leiden 1972, S.407-412. See also S.Kucherov, Courts, Lawyers and Trials under the Last Three Tsars, Westport (Conn.), 1974 (reprint of the 1953 publication), pp.21-106.

24

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

the process of modernisation under the inuence of French law, and therefore, it was no wonder that the French system was preferred. Although this system was formally abolished by the October Revolution, traits of the continental judicial system and procedure still remain to this day. One of the rst decrees which the Bolsheviks enacted was the Decree on Courts by which the Tsarist Russian courts were abolished and a new system of people’s court was set up. This system was the immediate predecessor to the current ordinary court system. Commercial courts did not exist as part of the judiciary under socialism. The most important feature of the people’s court was the “democratic principle” in that the judges were all elected by the populace, but for the time being, they were being elected by the executive committee of local soviets. In addition, people’s assessors, who were laymen chosen from among the general public, sat with the judge in court. This system was consolidated in 1922 by the Law on Court Organisation.5 While at the initial stage, this system existed only in the RSFSR, after the Soviet Union was founded, the USSR Supreme Court was established in 1923. Under the socialist regime, particularly since the consolidation of power by Stalin in the late 1920s, the independence of the court remained only on paper. First, the election of judges came to be reduced to a formality. The position of a judge was on the nomenklatura, a list which contains positions which require the approval of CPSU organisations. Judges were nominated by the local CPSU organisation and the election, which allowed only one candidate for one seat, was merely a ceremony. Second, judges were under pressure from various sources in handling the cases, namely the local CPSU organisations and local government ofcials. Third, the Procuracy was vested with the power of “judicial supervision”, i.e. supervision over the legality of court judgments. In general, the prestige of the court was extremely low under socialism. Judges were not even required to have had higher legal education. CPSU organisations which nominated judges were lower in rank than those nominating procurators of the same level. In 1987, when the creation of the “law-governed state” ( pravovoe gosudarstvo) came on the agenda, one of the rst issues raised was the revamping of the court system and the increasing of the authority of the court. In 1989, the Law on the Status of Judges was enacted in order to strengthen the independence of judges and to shield them from undue pressure.6 Changes were introduced to the system of electing judges – a new system of appointment of judges by the

5 6

SU RSFSR, 1917 No.4, item 50. For the formation of the judicial system in Russia, see J.Hazard, Settling Disputes in the Soviet Society, New York 1960. VSND SSSR i VS SSSR, 1989 No.9, item 223.

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local legislative body upon recommendation by the “qualication committee”, comprising judges, was introduced in the same year. However, these changes proved to be insufcient. As one commentator put it, the 1989 Law was still prepared “in the best tradition of law creation at the time of developed socialism”.7 Therefore, after the collapse of the socialist regime, the laws enacted towards the end of socialism were replaced by new laws, such as the Law on the Status of the Judges of 1992 and the Law on Court Organisation of 1996.8 The 1993 Constitution provides that judicial power is exercised only by the court, through constitutional, civil, administrative, and criminal proceedings (Art.118). The basic law which determines the court structure and the basic system of recruitment of judges is the Law on the Court System of the Russian Federation.9 There are two systems of court which deal with civil and commercial disputes: the ordinary court system and the commercial court system. The Law on Court Organisation covers both the ordinary court system and the commercial court system. As for procedural law, each system has a separate set of laws. The procedure for the commercial court is set by the Code of Commercial Court Procedure. The ordinary court procedure is determined by the Code of Civil Procedure. In the early 2000s, in the course of judicial reform, the merger of the commercial court and ordinary court systems has been proposed, but it was strongly resisted, and in the end, the proposal failed to be realised. There is also the Constitutional Court of the Russian Federation which has jurisdiction over the compatibility of the federal laws, normative acts of the President, both houses of the Parliament, and the cabinet, as well as the constitution and laws of the constituent entities of the Russian Federation with the Constitution of the Russian Federation. It was only towards the end of socialism that an embryonic form of constitutional review emerged. In 1990, the Committee on Constitutional Supervision started operation, later to develop into the Constitutional Court.10 There is a separate Law on the Constitutional Court which was enacted in 1994.11 There are some decisions of the Constitutional Court which are relevant to commercial law e.g. in the areas of tax law and bankruptcy law.

V.Savitskii, Organizasiia sudebnoi vlasti v Rossiskoi Federatsii, Moscow 1996, p.17. For details of the reform since perestroika, see P.H.Solomon Jr. and T.S.Foglesong, Courts and Transition in Russia: the Challenge of Judicial Reform, Boulder 2000. 9 Law No.1-FKZ of December 31, 1996. 10 R.Sharlet, “Russia’s Second Constitutional Court: Politics, Law, and Stability”, V.E.Bonnell and G.W.Breslauer eds., Russia in the New Century: Stability or Disorder?, New York 2001, p.59ff. 11 Law No.1-FKZ of July 21, 1994. 7 8

26

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

There have been proposals for the introduction of a system of administrative courts for some years.12 As part of the package of judicial reform bills prepared by the government in 2001, a bill on the Law on Administrative Courts prepared by the Supreme Court was submitted to the Duma, but it has remained there for some years.

2)

Commercial Courts

Commercial courts are called “arbitrazhnyi sud ” in Russian. However, the name is more historical than a reection of the true nature of the institution. It should not be confused with arbitration institutions such as the International Arbitration Court of the Russian Chamber of Commerce or other arbitration institutions which are called treteiskii sud in Russian. In fact, at the time of preparing the 1992 Law on Arbitration Courts, some people proposed that instead of the traditional “arbitrazh”, the court should be called an economic court as was the case in the Tsarist period.13 In the Tsarist period, commercial courts were set up in St.Petersburg, Moscow and other cities in the 1830s. The system was basically German.14 There was a Statute on the Procedure of the Commercial Court and brief Rules on Commercial Bankruptcy. Institutionwise, the Great Judicial Reform of 1864 did not affect the commercial courts, but in addition to the above-mentioned Statute, the general Statute on Civil Procedure came to be applied. The 1913 version of the Svod zakonov introduced the Statute on the Procedure of the Commercial Court.15 Part one of the Statute covered the organisation of the courts, while part two accommodated provisions on the procedure, and part three dealt with commercial bankruptcy. Commercial courts continued operation until they were abolished by the Decree on Courts in 1917. After the October Revolution, already in the early 1920s, the necessity for setting up a specialised body to deal with disputes between the emerging state enterprises in the socialist sector was felt. After all, it was not practical to leave disputes between socialist enterprises to the court which was staffed with ostensibly elected judges without sufcient expertise in economic matters. By 1924, a system of arbitration commissions which handled proprietary disputes between

V.Kriazhkov and Iu.Starilov, “Administrativnye sudy: kakimi im byt’?”, RIu, 2001, No.1, pp.18-20. 13 M.Treushnikov, Arbitrazhnyi protess, Moscow 1995, p.6. 14 L.Schultz, Russische Rechtsgeschichte, Lahr 1957, S.217. 15 Svod zakonov Rossiiskoi Imperii, 1913 edition, vol.XI, part 2. 12

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state and cooperative enterprises had been established. Incidentally, even at the time of the New Economic Policy in the 1920s, private enterprises did not benet from the system; they had to go to ordinary courts, instead of the arbitration commission. After the introduction of the Planned Economy, arbitration commissions were transformed into the system of gosarbitrazh – state arbitration organisation in 1931.16 Gosarbitrazh institutions were subordinated to the Council of Ministers of the USSR and the same body at the lower level, down to the regional executive committees. They were designed to settle economic disputes between entities in the socialist sector in order to “ensure strengthening of planning and contractual discipline and economic accounting”. Separate procedural rules to civil procedure were applicable in the proceedings. A signicant difference between these rules and the ordinary court system was that there was no lay element in gosarbitrazh; the case was settled by an arbitrator and representatives of both parties, as in commercial arbitration. In fact, the primary purpose of gosarbitrazh was to ensure that the disputes were settled so that the state economic plan was appropriately carried out by state enterprises in a timely manner. Gosarbitrazh had a duty to “actively interfere with the activities of state enterprises in implementing economic plans and enforcing contractual obligations”.17 For this purpose, not only disputes arising from contracts, but pre-contractual disputes – disputes concerning the formation of contracts – fell within the jurisdiction of gosarbitrazh. The right of the parties to dispose of their rights was severely limited. Regardless of the intention of the parties, their superior agencies could bring the case to gosarbitrazh. Gosarbitrazh were even empowered to initiate the proceedings ex ofcio. The parties were not entitled to freely accept the claim or withdraw the claim.18 There have been disputes concerning the legal nature of gosarbitrazh since its inception among Western observers. Some people regarded gosarbitrazh as a specialised court, while others considered it to be an administrative agency.19 One cannot deny that gosarbitrazh was an administrative agency – it was subordinated to the Council of Ministers of the USSR and had no independence. Although they were bound by statute laws, the Law on Gosarbitrazh of 1970 provided that gosarbitrazh handled “economic disputes on the basis of laws as well as decisions of the Council of Ministers and other legal acts and in

16 17 18 19

T.Abova, Arbitrazhnyi protsess v SSSR, Moscow 1985, pp.8-11. Ibid., pp.9-10. Ibid., p.84. S.Kucherov, “The Organs of Soviet Administration of Justice: Their History and Operation”, Leiden 1970, pp.140-153.

28

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

accordance with the State Economic Plan”.20 The present author agrees with Professor D.A.Loeber, who pointed out that gosarbitrazh was an administrative agency though it acted, to a considerable extent, in a judicial manner.21 This system underwent a radical change after the collapse of socialism in 1990. In 1991, the Law on Commercial Courts (arbitrazhnyi sud ) was enacted, followed by the Law on the Commercial Court Procedure of 1992. By virtue of these laws, gosarbitrazh was transformed into a system of commercial courts.22 The 1993 Constitution refers to the Supreme Commercial Court as the highest court in settling economic disputes and other cases assigned to the commercial court (Art.127). According to the Law on the Court System of 1996, commercial courts are part of the unied court system (Arts.3 and 4). Commercial courts are independent in the same way as ordinary courts are. While gosarbitrazh had arbitrators, the commercial court now has judges who are qualied in the same manner as ordinary court judges. Commercial courts do not have the power to initiate the proceedings ex ofcio as gosarbitrazh used to. In the light of the coming into force of Part One of the Civil Code and other developments, the 1992 laws, which still had a legacy of socialism, were replaced by the Law on Commercial Courts and the Code on Commercial Court Procedure in 1995 (this Code was totally replaced by a new Code in 2002). The new commercial courts started operation in April 1992. The basic level of commercial courts comprises “commercial courts of the constituent entities of the Russian Federation”, i.e. commercial courts of the republics, regions (provinces), cities with federal status, and autonomous provinces and regions. There are 81 such courts. These courts handle cases as the rst instance court. Previously, appeals against the decisions of the rst instance court were handled by the same court, but by a different division thereof. This system was changed by the introduction of the new appellate courts. Now there are 20 appellate courts which review the legality and groundfulness of the decisions of the rst instance court. The third level courts are the Federal Territorial Commercial Courts. There are 10 such courts which handle cases as an instance of cassation in relation to the courts within the jurisdiction. The system of cassation in Russia is different from the original French system, in that in Russia, it is a system of remedy from

VVS SSSR,1979 No.49, item 844. Article 4. D.A.Loeber, “Law and Contract Performance in the Soviet Union”, in W.R.LaFave, Law in the Soviet Society, Urbana 1965, pp.131-132. 22 K.Pistor, “Supply and Demand for Contract Enforcement in Russia: Courts, Arbitration and Private Enforcement”, RCEL 1996 No.1, pp.69-70. 20 21

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the legal point of view of the decisions of the rst instance court and also of the appellate instances which have already taken effect. The highest level of commercial court is the Supreme Commercial Court of the Russian Federation. The Supreme Commercial Court comprises the Plenum, the Presidium, the Department of Civil Cases, and the Department of Administrative Cases. The Plenum is composed of all judges of the Supreme Administrative Court. representatives of the Parliament, the president of the Supreme Court, the president of the Constitutional Court, as well as the Procurator-General are entitled to attend the Plenum session. One of the most important functions of the Plenum is to issue decisions (formerly called “explanatory guidelines”) addressed to lower courts. The Supreme Commercial Court also has a Presidium which comprises the President, deputies and the heads of the department. The Presidium, among other things, reviews cases by way of supervision. In 2005, commercial courts handled a total of 1,467,368 cases. There has been a steady increase in the number of cases handled by the commercial court. In 2002, the number was less than half – 697,085. There was an increase of 24.7% between 2003 and 2004, and 39.8% increase between 2004 and 2005. These cases are largely divided into cases arising from civil law relations, bankruptcy cases, and cases involving administrative law relations. The number of cases involving civil law relations has not increased that much since 2002. There was a 10.9% increase in 2004 and 2.3% increase in 2005. In contrast, there was a signicant increase in the number of cases involving administrative law relations. A great majority of these cases are tax related cases. The commercial court handles a substantial number of cases involving the collection of arrears and nes involving tax and other mandatory payments from individuals and organizations by the tax agency. These cases accounted for more than 900,000 cases. This number has increased by 36.5% in 2004, and by 85.1% in 2005.

Table 1 Categories of cases handled by the commercial court in 2005 Disputes arising from civil law relations Disputes arising from administrative law relations Cases involving the establishment of facts which have legal signicance Insolvency cases Disputes contesting the enforcement of arbitral awards Recognition and enforcement of foreign judgments and arbitral awards

360,812 1,080,559 5,538 18,812 1,593 54

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THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

Table 2 Breakdown of disputes arising from civil law relations conclusion of, changes to, and rescission of contracts

6,085

recognition of contracts as void

5,376

non-performance or inadequate performance of contracts

379,870

recognition of the right to ownership

1,410

retrieval of property from an unlawful possessor

2,238

reorganisation and liquidation of juridica l persons securities

74,371 3,484

protection of business reputation

248

protection of intellectual property

227

violation of environmental law

3,531

compensation of extra-contractual damage

4,929

use of land

2,507

application of tax law

85,334

(VVAS RF, 2006, No.5, pp.22-39)

By virtue of the Law on Insolvency, insolvency cases fall within the jurisdiction of the commercial court. Insolvency of individual entrepreneurs is also included. It should be noted that here, the requirement that both parties be juridical persons is dropped. Thus, creditors, not only juridical persons, but physical persons, not explicitly limited to entrepreneurs, are entitled to initiate the proceedings.23 It should be noted that the commercial court handled 1,200 cases involving foreign companies in 2005, of which 363 involved parties from the CIS countries. Foreign parties won the case in 583 cases.24 Until recently, international commercial arbitration in a third country was the preferred method of dispute settlement where foreign companies were involved. The signicant number of such cases handled by Russian courts may be due to the increase in the number of disputes in the newly developed market economy.

23 24

G.A.Zhilin ed., Kommentarii k arbitrazhnomu protesseual’nomu kodeksu Rossiiskoi Federatsii, Moscow 2003, pp.90-91. VVAS RF, 2006, No.5, p.41.

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However, if at all possible, foreign entities should make efforts to avoid their disputes to be heard by a Russian court.

3)

Ordinary Courts (Courts of General Jurisdiction)

The structure of the ordinary courts is provided by the Law on Court Organisation of 1996 as well as the Law on Court Organisation of the RSFSR of 1981.25 As late as August 2006, the latter is still in force with various amendments. The basic level of the ordinary court system is the district court. District courts handle cases as rst instance courts. There are 2,440 district courts.26 In some areas, such as in Moscow, inter-district courts were formed. In relation to the justices of the peace, district courts are the courts of a higher instance. The second level of courts are supreme courts of the constituent entities of the Russian Federation as well as regional (provincial) courts, courts of cities with federal status, and courts of autonomous provinces and regions. Currently, there are 87 such courts.27 These courts handle cases as second instance courts for the judgments of district courts. In some cases, such as cases involving state secrets, these courts handle cases as a rst instance court. They are also empowered to review cases in a supervisory procedure and cases reopened on newly found circumstances. The Supreme Court of the Russian Federation is the highest court within the system of ordinary courts, i.e. in relation to the supreme courts of the subjects of the Russian Federation as well as regional (provincial) courts, courts of cities with federal status, courts of autonomous provinces and regions, and military tribunals. It also acts as a rst instance court in some limited cases, and as a second instance court in cases where supreme courts of the subjects of the Russian Federation as well as regional (provincial) courts, courts of cities with federal status, courts of autonomous provinces and regions handled the case as the rst instance court. The Supreme Court also reviews cases in a supervisory procedure and cases reopened on newly found circumstances. The Supreme Court has a Plenum, Presidium, Civil and Criminal Departments and Court Administration Department. The Plenum is composed of all judges of the Supreme Court plus the Procurator General and other ofcials. The issuing of “explanatory guidance” is its most important function. The Presidium comprises the President, deputies, heads of the departments. It reviews cases by way of supervision.

25 26 27

Law No.1-FKZ, 1996. V.I.Radchenko, “Sudebnaia reforma v Rossii”, ZhRP, 1999 No.1, p.70. Ibid., p.70.

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THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

There is a proposal to create one or two intermediate levels of court between the Federal Supreme Court and the courts of the constituent entities as is the case with the commercial court system.28 Unlike its predecessor under socialism, the Supreme Court does not have a special statute as yet. According to the 2004 statistics, district courts accepted a total of 2,300,000 civil cases. These include the following:

Table 3 Cases Heard by District Courts in 2004 Family Law Cases Establishment of Paternity

7,900

Recognition of Paternity

6,900

Deprivation of Parental Rights

63,700

Adoption

14,600

Divorce

62,200

Payment of Alimony

24,700

Inheritance

36,400

Breach of Trafc Rules and Trafc Accidents

11,300

Housing Cases Privatisation of Housing Spaces

16,600

Eviction

45,600

Other housing disputes

214,500

Employment Cases Reinstatement to Work Compensation of Loss arising from Employment Relations

28

34,000 4,600

M.I.Kleandrov, “O tselesoobraznosti kodikatsii zakonodatel’stva o sudakh I sud’iakh”, RIu 2006, No.1, p.15.

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Table 3 (continued ) Cases Arising from Public Law Relations Infringement of Voting Rights

3,300

Acknowledgement of Normative Legal Acts as unlawful

5,700

Action against Unlawful Acts of Government Ofcials

65,200

Compensation for Environmental damage

1,800

Protection of Consumers *Disputes involving the Ownership of Land

24,900 8,500 (in the rst half of 2005)

(RIu, 2005 No.6, pp.33-35, 2006 No.1, p.35: complete information is not available now)

4)

Jurisdiction of the Ordinary Court and the Commercial Court

The demarcation of competence between the ordinary court and the commercial court has been confusing from the outset. According to the Code of Commercial Court Procedure of 1995, the commercial court handled “economic disputes arising from civil, administrative and other legal relations, between juridical persons, physical persons who perform entrepreneurial activities without forming a juridical person and are licensed as an individual entrepreneur”. It had quite an extensive non-exhaustive list of economic disputes which are to be handled by the commercial court. On the other hand, the Code of Civil Procedure before 2002 provided that ordinary court has competence over “civil, family, labour, and kolkhoz related cases”. There was an overlap of jurisdiction of both courts in various areas. For example, disputes between juridical persons generally could be handled both by the commercial court and the ordinary court. Under the 1995 Law, the commercial court had jurisdiction over cases involving foreign organisations, organisations with foreign investment, international organisations, foreign citizens and citizens without nationality who perform entrepreneurial activities, insofar as there is no international agreement which provides otherwise. However, the Code of Civil Procedure also provided that ordinary courts have jurisdiction over cases involving foreign citizens, juridical persons and organisations. The Supreme Court acknowledged in 1996 that disputes involving foreign companies and organisations fall within the competence of both courts.29

29

Decision of the Civil Division of the Supreme Court, November 28,1996 in A.P.Ryzhakov and D.A.Sergeev eds., Postateinyi kommentarii: Grazhdanskii protsessual’nyi kodeks RSFSR, Moscow 1999, p.75.

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The problem was compounded by the fact that although the competence of the commercial court was fairly clear in the Code of Commercial Court Procedure, the corresponding provision in the Code of Civil Procedure was not amended after the commercial court came into operation. There was no legal basis to exclude those disputes listed in the former from the competence of the ordinary courts. Experts agreed that the provision of the Code of Civil Procedure which determines the competence of the ordinary court has “become hopelessly obsolete”.30 A joint decision of the Plenums of the Supreme Court and the Supreme Commercial Court in 1992, which, inter alia, stated that when the law does not clearly demarcate the boundary of competence of the courts, the jurisdiction should be determined primarily by whether both parties were juridical persons, or whether either of them was a non-juridical person. In the latter case, ordinary courts had jurisdiction. The solution was that the competence of courts should be determined by way of exclusion, i.e. the Code of Commercial Court Procedure is rst applied, and the ordinary court handles cases which do not fall within the competence of the commercial court determined by the Code.31 However, this solution was not really convincing. The Law on Joint-Stock Companies provides for various remedies including a shareholder’s action, i.e. an action of a shareholder vis-àvis members of the board or executive body. In such cases, if the defendant is an ofcer, i.e. a physical person, the case will be considered by the ordinary court. If the defendant is the company and the plaintiff-shareholder is a juridical person, the case falls within the competence of the commercial court.32 This is an odd arrangement – the subject matter is the same, but depending on the parties, the case is heard by different courts. If the raison d’être of a commercial court is to have commercial cases handled by specialist judges subject to special procedural rules, certainly, these cases should be handled solely by the commercial court. However, a joint decision of both courts found this to be within the jurisdiction of both courts. There was major progress regarding the jurisdictional problem with the enactment of the new Code of Commercial Court Procedure and the Code of Civil Procedure in 2002. According to the general provision on jurisdiction in the Code of Commercial Court Procedure, the commercial court has jurisdiction over “economic disputes and other cases concerning the carrying out of entrepre-

30 31 32

M.Shakarian ed., Grazhdanskoe protsessual’noe pravoe Rossii, Moscow 1999, p.129. Ibid., p.130; Ryzhakov and Sergeev, supra, pp.64-65. Iu.Mateleva, Pravovoe ppolozhenie aktionera v aktionernom obshchestve, Moscow 1999, p.175.

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neurial and other economic activities” (Art.27, para.1). The court handles cases in which juridical persons and licensed individual entrepreneurs who carry out business without forming a juridical person take part. In cases provided for by the Code and other Federal laws, the Russian Federation, constituent entities, state and local agencies etc. may also be a party (ibid., para.2). The commercial court also handles cases with the participation of Russian and foreign juridical persons, Russian and foreign individuals as well as international organisations (ibid., para.5). Following this general provision, the Code provides for the following categories of cases which fall within the jurisdiction of the commercial court: i) cases arising from civil law relations (Art.28); ii) cases arising from administrative and other public law relations (Art.29); iii)cases involving the establishment of facts which have legal signicance (Art.30); iv)cases involving contesting and enforcement of arbitral awards (Art.31); v) cases involving recognition and enforcement of foreign judgments and arbitral awards (Art.32).

The last category of cases were under the jurisdiction of both courts until these new Codes were enacted. The general provisions as well as (i) do not necessary contribute much to the demarcation of jurisdiction between the two courts, since they lack specics. What is important is the provision on “special jurisdiction” of the commercial court. This provision lists the following cases to be within the commercial court’s jurisdiction (Art.33, para.1): i) insolvency; ii) disputes involving establishment, reorganisation, and liquidation of organisations; iii)refusal and failure to register juridical persons and individual entrepreneurs; iv)disputes between shareholders and joint stock companies, between members of other commercial companies and partnership arising from the activities of the companies and partnerships, except for labour law disputes; v) protection of business reputation; vi)other cases emerging from the carrying out of entrepreneurial activities and other economic activities provided for by Federal law.

These cases are handled by the commercial court, regardless of whether the parties to the above disputes are juridical persons, individual entrepreneurs, other organisations or individuals (ibid., para.2). This provision makes the demarcation of jurisdiction much easier.

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THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

On the other hand, the new Code of Civil Procedure provides that ordinary courts are to handle cases with the participation of individuals, organisations, Federal and local agencies involving disputes arising from civil, family, labour, housing, land, environment, and other relations (Art.22, para.1). Ordinary courts also handle disputes in which foreign individuals, organisations, and international organisations participate (ibid., para.2). However, there is a provision to the effect that the ordinary courts are to handle these cases, except where Federal law or Federal constitutional law leaves it to the jurisdiction of the commercial court (ibid., para.3). At the same time, the Code provides that if there are several inter-related claims of which one falls within the jurisdiction of the commercial court and the other within the jurisdiction of the ordinary court and the claims are not separable, the case is to be handled by the ordinary court (ibid., para.4). Thus, the enactment of the new Codes, particularly Article 33, para.1, subpara.4 of the Code of Commercial Court Procedure, made the demarcation much clearer than before, but there still remains some ambiguity. For example, disputes between shareholders, shareholders and a third party etc. may fall within the jurisdiction of the ordinary court as before, insofar as they are individuals and not juridical person, as the Supreme Court pointed out in its review of cases in 2003.33

5)

Jurisdiction of Russian Courts in Cross-Border Disputes

The Code of Commercial Court Procedure has a provision on the competence of the commercial court in cases involving foreign persons (Art.247). Russian commercial courts have jurisdiction over the following cases where a foreign organisation, a foreign individual or an individual without nationality who carry out entrepreneurial and other economic activities, or an international organisation is a party: i) the defendant is located or lives in the territory of the Russian Federation, or the defendant’s assets are located there; ii) a management body, a branch, or a representative ofce of a foreign juridical person is located in the territory of the Russian Federation; iii) the dispute arose from a contract which was to be performed, or was performed in the territory of the Russian Federation;

33

S.Potapenko, “O razgranichenii podvedomstvennosti grazhdanskikh del sudam obshchei jurisdiktsii i arbitrazhnym sudam”, KhiP, 2004 No.5, pp.77-78.

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iv) the claim arose from a harm caused to property by an act or other circumstances which took place in the territory of the Russian Federation or the loss took place in the territory of the Russian Federation; v) the dispute arose from unjust enrichment which took place in the territory of the Russian Federation; vi) the plaintiff in a case involving the protection of business reputation is in the territory of the Russian Federation; vii)the dispute arose from a relationship involving the circulation of securities which were issued in the territory of the Russian Federation; viii)the applicant for the establishment of facts which have legal signicance indicates of the existence of such facts in the territory of the Russian Federation; ix) the dispute arose from the relationship involving the registration of names and other objects and providing of service through the Internet in the territory of the Russian Federation; x) Other cases where the disputed legal relation has close connection with the territory of the Russian Federation.

The commercial court also has jurisdiction in the following cases, regarding which the Code grants exclusive jurisdiction to Russian courts (Art.248, para.1): i) disputes in relation to property which belongs to the state, including disputes concerning privatisation; ii) disputes involving real property located in the territory of the Russian Federation; iii)disputes involving the granting of patents, issuing of certicates for trademarks, industrial models and other intellectual property rights which require registration; iv)disputes involving the recognition of invalidity of state registration; v) disputes involving the establishment, liquidation, or registration of juridical persons and individual entrepreneurs in the territory of the Russian Federation.

The location of juridical persons and the residence of physical persons are determined by provisions of the Civil Code. The residence of a physical person is the place where this person permanently or primarily lives. The location of a juridical person is the place where it is registered (Art.20).

6)

Independence of the Courts and Integrity of the Judges

Since perestroika, the Russian court system has undergone signicant changes. The independence of the court has been reinforced by law and the authority of the court has gradually increased.

38

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

In addition to the provision of the Constitution which guarantees the independence of the court, the Law on the Status of Judges provides for the independence of judges. This is guaranteed by the prohibition of interference with the course of justice at the pain of criminal sanction, the procedure for the termination of the power of the judges, and the principle of inviolability of judges (Art.9, para.1). According to this Law, “judges, their family and property are under the protection of the state.” Under the Criminal Code, interference with the court for the purpose of preventing justice is punishable by deprivation of freedom (Art.294, para.1). Whether or not the courts have successfully gained independence and authority in reality is questionable. Disrespect of the court is reported from time to time. In November 1999 in St.Petersburg, a group of armed and masked members of the “special division” of the Ministry of Internal Affairs forced their way into the court room and snatched a person who was standing trial. The conference of judges of St.Petersburg adopted a resolution criticising the Ministry and demanding that appropriate measures be taken by the Procurator-General.34 In 2000, it was reported that there were 22 incidents of injury to judges and 18 incidents of arson involving court buildings.35 Judges do not always behave with integrity. A judge of the regional court was assigned to a criminal case with P as a defendant. The trial was to take place in the district court of the town of K on June 30, 1999. The relatives of the victim who was killed as well as witnesses, including a close friend of the defendant, were summoned to the trial. According to the police record, this friend of the defendant was a member of a criminal group. The judge arrived in the town on the day before the trial. He was put up in a hotel, but then, moved to the house of a private entrepreneur N. The procurator and the advocate in the same case were staying in the same house. That evening, a friend of the defendant organised a banquet in which the judge, the procurator, and the advocate, together with the organiser of the banquet, took part and had a drink. On the day of trial, the judge had a serious hangover and the trial was postponed until July 1st. Members of the court did not turn up to the trial. The verdict which was eventually handed down was extremely lenient.36

It was reported that disciplinary action was brought against 310 judges and heads of the court in 2003. 240 of them, including a judge of the Supreme Court of a constituent republic, and 21 presidents of the district court, were disciplined. The

34 35 36

RIu, 2000 No.2, p.2. Ibid., p.6. “Novyi shag k otkrytnosti i glasnosti”, RIu 2002, No.11, p.99.

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terms of seven presidents of the district court and two senior judges at the higher level courts were terminated prematurely. The majority of these cases involved grave and repeated breaches of procedural law and neglect of duty, but there were some other problems. For example, a president of the district court was reprimanded for interference with the composition of the court. Two presidents and three judges of district courts were dismissed for falsication of court documents. Four criminal cases were initiated against judges, in two of which, judges were imprisoned for intentionally delivering unlawful verdicts.37 The President of the Supreme Court ofcially acknowledged that “corruption, abuse of power by judges do exist, alas, but there is nothing we can do about it.”38 There are also cases where “local pressure”, which used to be common under socialism, was exerted on the judges. The head of administration of the Volgograd province was reported to have asked the commercial court as well as the ordinary court in the capital to suspend or postpone the proceedings in and enforcement of some categories of cases in relation to the “extraordinary situation” in the region.39 A commercial court judge, who reportedly “ran afoul of the local governor”, was disqualied by the qualication committee in Primorskii Region.40 The poor nancial state of the court is also regarded as a threat to its independence. In 1998, despite the constitutional guarantee regarding the nancing of courts, the Ministry of Finance substantially cut the budget allocated to the courts. The Constitutional Court found this to be against the Constitution, but the situation was not rectied. Local courts were forced to ask for resources from the local government as well as from “commercial organisations”.41 As a result of the reform in the early 2000s, the nancial state of the courts seems to have improved. In recent years there have been some prominent cases which have raised questions regarding the independence of the court from political pressure. One such case involved Sidanco, which was the fth largest oil company in Russia. In 1998, a bankruptcy petition was led for Sidanco’s three subsidiaries, followed by a petition for Sidanco itself the next year. This was an example of the previous Insolvency Law abused as a means of corporate takeover. The

37 38 39 40 41

www.supcourt.ru. Ibid. “Verkhovenstvo konstitutsii RF i federal’nykh zakonov – osnovnoi pravovoi printsip”. KhiP 2000 No.1, p.38. RFE/RL Newsline, September 22, 2000. RIu, 1999 No.1, p.3. See also G.T.Ermoshchin, “Problemy obespecheniia nazavisimosti sudebnoi vlasti”, in Iu.A.Tokhomirov et al. eds., Sudebnaia reforma v Rossii, Moscow 2001, p.23.

40

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

insolvency procedure was handled by the local commercial court, but on various occasions, the court failed to ensure the fairness of the activities of the bankruptcy administrator, siding with a competitor of Sidanco. At one stage, Sidanco was forced to le petition for the transfer of the case to another court.42 What was more, the Supreme Commercial Court itself succumbed to political pressure and changed its position within a month. The latest case involves Iukos, another oil company, which was in the end dismantled and its assets indirectly put under state control. The company was confronted with an enormous amount of tax claims and penalties from the tax agency. It should be noted that it was not only Iukos, but also other oil companies that faced similar claims. The difference was that other companies managed to settle the claims at a signicantly low payment, whereas Iukos was not allowed to settle. Iukos brought more than 30 actions involving tax law to the commercial court, but never won a case. Even the provision of three year prescription period for tax arrears in the Tax Code was not applied to Iukos. Thus, this was a selective or discriminatory application to a company run by the president’s political opponent. This incident was an example of the strengthening of state control in the natural resources industry and seems to be nothing less than creeping nationalisation.

2

INTERNATIONAL COMMERCIAL ARBITRATION

1)

Arbitration Law and Institutions in Russia

Foreign investors have little choice when it comes to formulating a dispute resolution clause. They are understandably reluctant to have disputes submitted to Russian courts, which are not particularly known for their independence and fairness and, even if they manage to persuade the Russian party to accept the jurisdiction of a foreign court, they would be unable to enforce a foreign judgment in Russia without a treaty providing for such enforcement. Hence, lenders cannot, for example, designate New York or English courts in loan agreements with Russian entities, as they customarily do with foreign borrowers. The only realistic option available to them is arbitration. International commercial arbitration has long played an important role in settling disputed between Russian and foreign commercial entities. The two leading arbitration institutions in Russia – the International Commercial Arbitration

42

Project Finance International, June 2, June 16, October 6, December 1, 1999; New York Times, November 24, 1999; Eastern European Energy, September issue 1999, pp.11-12.

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Court (MKAS) and the Russian Maritime Arbitration Commission (MAK), both attached to the Chamber of Commerce and Industry of the Russian Federation – date back to the 1930s and have a fairly good track record in settling international commercial disputes. Since the 1970s, Russian entities have also agreed to arbitration outside Russia. Although it is called a “court” now, MKAS is an arbitration institution, and should not be confused with the “arbitration court (arbitrazhnyi sud )”, which is in fact a commercial court in Russia, as explained above. In the socialist period, occasionally, the neutrality of the Soviet arbitration institutions was questioned, but overall, these arbitration institutions maintained their credibility throughout that time.43 On the other hand, there were some inconveniences, such as the mandatory use of Russian language and the limited choice of arbitrators. In the majority of East-West joint-ventures and major projects, Stockholm, and not Moscow, was chosen as the venue of arbitration.44 A new Law on International Commercial Arbitration was enacted in Russia in 1993. This Law is applicable to commercial arbitration, including ad hoc arbitration, conducted in Russia. The Law has a preamble in which it is explicitly stated that it recognises the usefulness of arbitration as a widely applied method of settling disputes in international trade and takes account of the UNCITRAL Model Law on International Commercial Arbitration. Like the Model Law, the International Commercial Arbitration Law forbids any intervention by State courts except as provided in the Law. International arbitration institutions in Russia handle the following cases upon agreement of the parties (Art.1, para.2): i) civil law disputes which emerge in the course of foreign trade and other foreign economic cooperation in which at least one of the parties is a foreign commercial organisation; ii)disputes between companies with foreign participation, international organisations established in Russia as well as disputes between these bodies and Russian juridical persons.

MKAS handles around 500 cases every year. More than 30% of the foreign parties are from the United States and Western Europe.

See the case involving an Israeli company and a Soviet foreign trade organisation in 1958 at the time of the war in the Middle East, M.M.Boguslavskii, Mezhdunarodnoe chastnoe pravo, third edition, Moscow 1999, pp.140-141. 44 V.Viechtbauer, “Arbitration in Russia”, Stanford Journal of International Law, 1993, pp.371374. 43

42

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

If there is an arbitration clause or agreement, unless this clause or agreement is void, or has been terminated, Russian courts must terminate the procedure and refer the case to arbitration (Art.8, para.1): A Russian company brought an action to the commercial court against a French trading company for payment of compensation. Despite repeated notices in accordance with international treaties, the defendant failed to turn up in court, but instead, submitted a written objection to the jurisdiction of the court, referring to the clause in the contract which provided for an ad hoc arbitration. Russia and France are both signatories to the European Convention on International Commercial Arbitration of 1961. The Convention acknowledges ad hoc arbitration and provides the procedure for setting up an ad hoc tribunal. Under such circumstances, the Supreme Commercial Court ruled that the court must decide on its jurisdiction by taking into account the Convention and national law. According to Article 87, para.2 of the Code of Commercial Court Procedure of 1995, the commercial court must leave the case without examination, if there is an agreement between the parties to refer the dispute to arbitration and the possibility of referring the case to arbitration has not been exhausted, and further, if the party which objects to court jurisdiction, no later than its rst response in relation to the substance of the case, petitions for the transfer of the dispute to arbitration. In this particular case, the possibility of arbitration had not been exhausted, and the defendant had expressed its desire to have the case handled by international arbitration. Therefore, the Court ruled that the parties should take measures to have the case settled by ad hoc arbitration.45

The Law expressly acknowledges the freedom of the parties in choosing the applicable law (Art.28, para.1). From the time of its predecessor under socialism, the MKAS had applied foreign laws if the parties chose to do so. The parties may apply to the court to set aside arbitral awards, but only on limited grounds in line with the New York Convention and within three months after the award has been granted (Art.34, para.3).

2)

Statutory Framework for the Enforcement of Arbitral Awards

Russia is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, having succeeded the former USSR.

45

“Obzor sudebno-arbitrazhnoi praktiki razresheniia sporov po delam s uchastiem inostrannykh lits”, VVAS RF, 1998 No.4, p.52.

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The Code of Commercial Court Procedure recognises arbitral awards as a basis for enforcement in the same way as court judgments and have a chapter on the enforcement of foreign judgments and arbitral awards. However, the enforceability of arbitral awards in Russia is problematic for foreign investors. Although a former president of the Supreme Commercial Court has claimed that awards are rarely refused enforcement,46 it can be difcult for foreign parties to enforce awards regardless of whether they are awards of foreign arbitral institutions or of MKAS. Russian parties often resist enforcement by either contesting an application for enforcement by the foreign party, or by themselves applying for the award to be set aside (in the case of awards made in Russia). During most of the Socialist era, there were no statutes providing for the enforcement of foreign arbitral awards. It was only in 1988 that a decree of the Presidium of the USSR Supreme Soviet on the enforcement of foreign judgments and arbitral awards was enacted.47 This decree remained in force until the enactment of the Procedural Code for Commercial Courts in 2002. At present, there are two main laws relating to the enforcement of foreign arbitral awards. One is the Code of Commercial Court Procedure and the other is the Law on International Commercial Arbitration.48 The latter provides the following (Art.35, para.1): Arbitral awards, regardless of where they were granted, are recognized as binding and, upon the submission of an application to a competent court, shall be enforced, with consideration being given to the rules of the present provision and of Article 36.

Article 36 sets out the grounds upon which the recognition and enforcement of foreign arbitral awards may be refused. The rst paragraph of Article 36 is almost identical to Article V of the New York Convention: The court may refuse enforcement when it has been proved that: i) one of the parties did not have capacity to act, or the arbitration agreement was void; ii) the party against which the award is to be enforced was not duly informed of the appointment of the arbitrator, of the arbitration proceedings, or for other reasons, was unable to present his case;

46 47 48

Vystuplenie V.F. Iakovleva, Vestnik VAS, 2002, no.12, p.111. Vedomosti VS SSSR, 1988 no.26, item 427. A third law, enacted in 2002, regulates arbitration tribunals in Russia, but does not apply to international commercial arbitration. The text of the 1993 Law is available in English at <www.jus.uio.no/lm/russia.international. commercial.arbitration.1993/doc.htm>.

44

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

iii)the award was granted on a case which was not covered by the arbitration agreement; iv)the composition of the arbitration panel or the arbitration procedure did not coincide with the agreement or law; v) the award is not nal, was revoked, or its enforcement was suspended by the court of the country where the award was granted.

The court shall refuse enforcement when it nds that: i) the subject matter of arbitration is unable to be dealt with by arbitration under Russian law; ii)the recognition and enforcement of the award are against public policy of the Russian Federation.

The Law also lists the grounds upon which arbitral awards may be set aside, which are in line with the UNCITRAL Model Law. The Code of Commercial Court Procedure provides for the recognition and enforcement of foreign arbitral awards on the basis of either an international treaty or a Federal law (Art.241). The New York Convention is one of those treaties. Another provision lists the grounds on which the enforcement or recognition of foreign judgments and arbitral awards can be refused (Art.244 referring to Art.239). The way these provisions are organized is confusing, and judges have occasionally been misled into citing incorrect provisions.49 Further confusion is caused by yet another provision which states that the fundamental principles of Russian law (osnovo-palogaiushchie printsipi rossiiskogo prava) constitute grounds for refusing the enforcement of awards (Art. 239, para.3). A commentary has suggested that these correspond to “public order” ( publichny poriadok) as referred to in the International Commercial Arbitration Law and ultimately to “public policy” in the UNCITRAL Model Law.50 In contrast, the term used in Article 36 of International Commercial Arbitration Law, to which Article 239(4) of the Code of Commercial Court Procedure refers, is public policy. Russian lawyers and academics regard public policy and the fundamental principles of Russian law as one and the same concept. V.F. Iakovlev, then president of the Supreme Commercial Court, pointed out that the grounds upon which enforcement may be refused were “practically the same for domestic and foreign tribunals” and that this part of the Code is no different

49 50

E.g. Federal Commercial Court, Moscow District, 5 December 2003. Zhilin, supra, p.598.

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from the New York Convention.51 If this is the case, there would appear to be no reason to use different terminology. The Code of Commercial Court Procedure introduced a change concerning jurisdiction that has had a signicant impact on the enforcement of awards. The above-mentioned 1988 decree presupposed that jurisdiction over the enforcement of awards lay with the ordinary courts, since the commercial court system did not exist at that time. When the commercial courts were established in 1992, they were not explicitly given – or denied – jurisdiction over the enforcement of awards. And the 1993 Law on International Commercial Arbitration avoided the issue by merely referring to the “competent courts”. As a result, some cases reached the commercial courts, but the majority of cases went to the ordinary courts. This led to some important precedents from the Supreme Court, as opposed to the Supreme Commercial Court. The Code of Commercial Court Procedure put an end to this jurisdictional overlap. It gave the commercial courts “sole jurisdiction” over the recognition and enforcement of foreign judgments and arbitral awards (Art.32). To be sure, there is also a provision for the enforcement and setting-aside of the awards of “arbitral tribunals” (Art.31). On the other hand, the Code of Civil Procedure contains a corresponding chapter for ordinary courts. However, for commercial disputes, it is clear that the commercial court has jurisdiction now. This shift of jurisdiction on the enforcement of arbitral awards to the commercial court has brought some disadvantages. In particular, some senior commercial court judges, including in the Supreme Commercial Court, have shown hostility towards arbitration. While they were ready to enforce foreign judgments, even through a liberal interpretation of the Code of Commercial Court Procedure in the absence of an international treaty, they were generally reluctant to enforce arbitral awards. They appear to have been sceptical of non-governmental international arbitration institutions and party autonomy, and to have believed that the decisions of private institutions could not be enforced without being examined on their merits. In this respect, they differed from the judges of the courts of general jurisdiction, whose initial hesitation over the enforcement of arbitral awards was due to inexperience. In the case of the commercial courts, it was the convictions rather than the inexperience of the senior judges that made enforcement difcult. Another disadvantage of shifting jurisdiction from the ordinary courts to the commercial courts is that the experience and case law accumulated within the ordinary court during the 1990s have been lost.

51

Iakovlev, supra, p.111.

46 3)

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

Judgments of the Ordinary Courts (1990-2002)

In the early days of post-Socialism, some foreign arbitral awards were enforced in Russia. In 1991, in what was probably the rst case involving a claimant from a country outside the former socialist bloc, the Moscow City Court allowed the enforcement of an award rendered in London on the basis of the New York Convention and the 1988 decree of the Presidium of the USSR Supreme Soviet on the enforcement of foreign judgments and arbitral awards. The court’s decision was not appealed. In another case, the Moscow City Court enforced an award made in Stockholm.52 In 1998, another Stockholm award was enforced, this time in St. Petersburg. This case reached the Supreme Court, which gave a questionable ruling, but the City Court of St. Petersburg, to which the case was remanded, allowed enforcement.53 Despite these decisions, a Russian expert commented in 2001 that “many Russian courts, as before, do not understand that their power is limited by the New York Convention, and that they are not entitled to review an arbitral award on its merits”.54 And in a recent article attention was drawn to the fact that “it does not follow from the procedural Code that the Commercial Court should not review the application of substantive and procedural law by the arbitral tribunal, i.e. perform the function of the higher instance court in relation to the tribunal”.55 Russian respondents resisting the enforcement of arbitral awards often base their arguments on public policy. Most Russian lawyers agree that the concept of public policy is yet to be formulated in Russia. One commentator, taking a broad view of public policy, has suggested that it is likely to include basic anti-monopoly legislation, privatisation law, basic rules of commercial law, bankruptcy law, competition law, and town planning law.56 In the St. Petersburg case referred to above, the Russian party argued that the mandatory requirement of two signatures on the Russian side under the Soviet law on foreign trade contracts was part of public policy.

52 53 54

55

56

K.Hober, “Enforcing Foreign Arbitral Awards in Russia” Russia and Commonwealth Business Law Report, August 16, 1995, pp.8-10. A.Mouranov and N.Toupikina-Holm, “Enforcement in Russia: Chronology of a Loan Recovery” Stockholm Arbitration Report, 1999 vol.2, p.137. B.Karabel’nikov, “Problemy ispolneniia reshenii mezhdunarodnykh arbitrazhei v Rossiiskoi Federatsii” in Tikhomirov et al., eds., Sudebnaia reforma v Rossii, Moscow, 2001, pp.150156. M.A.Rozhkova, “O nekotorykh voprosakh prinuditel’nogo ispolneniia reshenii treteiskikh sudov” Vestnik VAS, 2004, no.9, p.172. V.F. Iakovlev et al., eds., Kommentarii k arbitrazhnomu protsessual’nomu kodekusu RF, Moscow, 2003, pp.622-625. N.Pavlova, “Nekotorye osnovaniia otkaza v priznanii i privedenii v ispolnenie arbitrazhnykh reshenii” Vestnik VAS RF, 1999, no.3, pp.22-23. See also T.N.Neshataeva, Mezhdunarodnyi grazhdanskii protsess, Moscow, 2001, p.166.

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The Supreme Court had made an effort to narrow the concept of public policy, which lower courts tend to interpret broadly. This is illustrated by a case between a Russian party and a German party in which the Russian party applied for the award to be set aside, arguing that there was no contract between the parties, no authenticated copy of the contract, no arbitration agreement, and that the award was based on forged documents. The Moscow City Court accepted the plaintiff ’s argument and set aside the award on the ground that the plaintiff ’s liability had not been sufciently proven and that enforcement of the award would violate public policy since it was contrary to Russian law. The Supreme Court found that the Moscow City Court had erred by reviewing the case on the merits, and ruled that it was wrong to refer to public policy.57 The Supreme Court explained that public policy of the Russian Federation should not be equated with the national legislation of the Russian Federation. Given that Article 28 of the International Commercial Arbitration Law allowed the rules of foreign States to be applied in Russia, differences between Russian law and the law of a foreign State should not serve as a ground for applying the public policy exception to enforcement, for to do so would be to deny the possibility of applying foreign law in Russia in general. It concluded that public policy of the Russian Federation meant rather the fundamental social system underlying the Russian State, and that the public policy defence should be available only when the application of foreign law would lead to a result that was unacceptable to the Russian legal consciousness. In most, if not all, published cases where Russian parties objected to enforcement on public policy grounds, the Supreme Court rejected their objections.

4)

Decisions of the Commercial Courts

In 2002, as mentioned above, jurisdiction over the recognition and enforcement of international arbitral awards and over the setting-aside of such awards shifted from the ordinary courts to the commercial courts. According to the annual report on the commercial courts, 111 cases relating to the recognition and enforcement of foreign judgments and foreign arbitral awards were heard in 2003 and 49 in 2004. It is not known in how many of these cases enforcement was allowed. In 2003 and 2004 respectively 936 and 911 awards made in Russia were set aside. These gures cover both domestic and international arbitrations.58

57 58

Decision of the Civil Law Division of the Supreme Court, 25 September 1998. “Sudebno-arbitrazhnaia statistika” Vestnik VAS, 2005, no. 2, p.37.

48

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

Public policy, interpreted broadly, remains the primary ground on which Russian parties seek to have awards set aside or refused enforcement. However, as the following illustrations show, their arguments are not readily accepted by the higher commercial courts: A French company applied for enforcement of an award by MKAS. The rst instance court in St. Petersburg rejected the application on the ground that fundamental principles of Russian law had been breached. These included failing to apply provisions of the law that should have been applied, disregarding the principle of proportionality when determining the extent of liability, and ignoring the creditor’s part in increasing the damage. The cassation court ruled that no fundamental principles of Russian law had been breached and pointed out that it was not against the fundamental principles of Russian law not to apply the law considered by the court to be applicable to the case. It thus quashed the decision of the lower court.59

In another case, again involving an award issued by MKAS, the Russian debtor argued that the award, inter alia, contravened the fundamental principles of Russian law. The court rejected this argument as unsubstantiated and commented as follows: Awards of the arbitration tribunals may be found to be against the basic principles of Russian law (public policy of the Russian Federation) when, as a result of the enforcement of the award, acts that are directly prohibited by law or harm the sovereignty or the security of the State, that affect the interests of a large social group, that are incompatible with the principles of constructing the economic, political and legal systems of the State, that harm the constitutional rights and freedom of citizens, or that are against the basic principles of the civil State, such as the equality of its members, the inviolability of property and freedom of contract, are affected.

This decision was upheld at the cassation level.60 It may be concluded from the above that, with a few exceptions, the Federal commercial courts have generally rendered positive decisions allowing the enforcement of arbitral awards. As one Russian commentator has pointed out, ungrounded references to public policy used by losing parties as a last resort are likely to nd little favour with the courts.61

Federal Commercial Court, North-Western District, 20 March 2003. See also Federal Commercial Court, Moscow District, 18 November 2002; Federal Commercial Court, Moscow District, 4 January 2003; Federal Commercial Court, North-West District, 24 April 2003. 60 Federal Commercial Court, Moscow District, 3 April 2003. 61 A.N.Zhil’tsov, “Osparivanie reshenii mezhdunarodnykh kommercheskikh arbitrazhei v sootvetstvii s rossiskom zakonodatel’stvom” Mezhdunarodnyi kommerchsekii arbitrazh, 2005, no.1, p.13. 59

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49

Decisions of the Supreme Commercial Court

The Supreme Commercial Court rendered at least ve decisions relating to international commercial arbitration between 2003 and 2005. While some of these decisions reect a positive attitude towards international arbitration, there are a couple of controversial decisions. Probably the most controversial decision was the Pressindustriia case in which an Italian company applied for the enforcement of an award rendered in an ad hoc arbitration in Stockholm in July 1997: The dispute concerned the termination of a joint venture agreement between an Italian company and a Soviet entity due to a substantial breach by the Soviet party. The agreement contained an arbitration clause entitling the parties to have recourse to ad hoc arbitration for any problem concerning the agreement and providing for the application of Swedish civil and substantive law (but not the rules of conict of law). The tribunal applied Swedish law and ordered the Russian successor to the Soviet entity to repay the Italian company’s capital contribution and expenses, which altogether amounted to some sixty-ve million German marks plus interest. The creditor applied for the award to be enforced in Russia. At rst instance, the Commercial Court of the Tiumen Province granted enforce-ment in January 1999, but its decision was overturned by the appeal court, which found that the arbitration clause did not allow the tribunal to rule on the termination of the agreement pursuant to Swedish law, since this was incompatible with the mandatory provisions of Soviet/Russian law regulating the creation and activities of joint ventures in the USSR/Russia. In July 1999, the cassation court upheld the decision of the appeal court and agreed that the arbitral tribunal did not have the power to rule on the termination of the agreement pursuant to Swedish law. Noting that the tribunal had failed to address the question of the application of Soviet/Russian law, the cassation instance held that the termination of the agreement was not subject to foreign law and was beyond the scope of the arbitration clause. It endorsed the appeal court’s conclusion that the application of Swedish law was against the mandatory provisions of Soviet/Russian legislation and referred to the New York Convention, which provides that recognition and enforcement may be refused if the award goes beyond the scope of the arbitration clause.62 It is not clear from the cassation court’s reasoning whether the unenforceability of the award was due to the tribunal’s failure to apply mandatory rules of Soviet/Russian law or to it having exceeded the scope of the arbitration clause. The case was subsequently referred to the Supreme Commercial Court. The Italian party asked the Court to specify which part of the award was outside the scope of the arbitration clause. It also pointed out that, according to the New York Convention and the Russian International Commercial Arbitration Law, even if an award exceeds the scope of the arbitration clause, any matters that are separable

62

Federal Commercial Court, West-Siberian District, 20 July 1999.

50

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

and come within the scope of the arbitration clause may be enforced. In its rather terse decision, the Supreme Commercial Court held that there was no reason to overrule the decision of the lower court, which rightly judged that the award went beyond the scope of the arbitration clause, since the dispute concerned not only the withdrawal of an original party to the joint venture but also the reorganization of that legal entity. The latter issue, it pointed out, is regulated by mandatory provisions of Russian law and the parties to the agreement were therefore entitled to have that issue determined according to Russian law.63

Although the fact that an arbitral tribunal exceeded the scope of the arbitration clause has been cited as a ground for refusing enforcement in some other cases,64 here the problem was rather that of the arbitrability of disputes to which Russian mandatory norms are applicable. Enforcement was in effect refused because the dispute was not arbitrable.

6)

Arbitrability of Disputes

Generally, arbitrability is about whether a particular type of dispute is eligible for settlement by arbitration or whether it should be reserved for national courts. Neither the New York Convention nor the UNCITRAL Model Law on International Commercial Arbitration is very instructive. The former simply refers to “a subject matter capable of settlement by arbitration”, while the latter uses the expression “the subject matter of the dispute is not capable of settlement by arbitration”. It is basically for national laws to determine the domain of arbitration, as opposed to the courts.65 The Law on International Commercial Arbitration provides that disputes resulting from contractual and other civil law relationships arising in the course of foreign trade and other forms of international economic relations in which at least one of the parties is a foreign commercial organisation can be referred to arbitration (Art.1, para.2). The Law also provides that it does not affect any other laws

Decision of the Presidium of the Supreme Commercial Court, 14 January 2003, Case 2853/00. 64 Moscow City Commercial Court, 28 April 2004. A tribunal of the International Commercial Arbitration Court held that there was no contract between the parties and, therefore, the Russian party should return what it had received from the creditor on the ground of unjust enrichment. The commercial court ruled that this decision went beyond the scope of the arbitration clause, which provided for contractual disputes. 65 A.Redfern and M.Hunter, Law and Practice of International Commercial Arbitration, 4th ed., London, 2004, p.138. 63

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prohibiting certain type of dispute from being subject to arbitration or making them subject to arbitration according to other provisions (ibid., para.4). An example is the Bankruptcy Law, which provides that cases concerning bankruptcy are to be handled exclusively by the commercial courts. Outside Russia, discussions on arbitrability normally revolve around antitrust law, securities law, and intellectual property. In the celebrated Mitsubishi Motors case, the US Supreme Court dismissed the argument that antitrust issues could not be arbitrated under the Federal Arbitration Act.66 It may be noted that although the Supreme Court saw no reason to assume that international arbitration would not be an adequate means of resolving disputes – i.e. there is no reason to assume that the dispute is not arbitrable because it involves anti-trust matters – it also pointed out that “the national courts of the United States will have the opportunity at the award enforcement stage to ensure that the legitimate interest in the enforcement of the antitrust laws has been addressed”. Thus, enforcement of arbitral awards may in such cases be refused, not because the dispute was not arbitrable, but for other reasons, such as non-application or misapplication of the antitrust law, which would probably be against public policy. In the Eco Swiss case, the European Court of Justice addressed the problem of whether the failure to apply a mandatory provision – Article 85 (now Article 81) of the Treaty establishing the European Community – could serve as a ground for setting aside an arbitral award, despite the fact that the national law provided only limited grounds for annulment. The Court ruled that Article 85 constitutes a fundamental provision for the functioning of the internal market and that it may be regarded as a matter of public policy within the meaning of the New York Convention.67 In Russia, a trend has recently emerged towards limiting the range of disputes capable of settlement by arbitration. It is supported by some senior commercial court judges who maintain that the commercial court has sole jurisdiction over the disputes listed below (Art.248 of the Code of Commercial Court Procedure) when one of the parties is a foreign person:68 i) disputes involving State property, including disputes related to the privatization of State property and the compulsory sale of property for the needs of the State;

66 67 68

Mitsubishi Motors v. Soler Chrysler-Plymouth, 437 U.S. 614 (1985). Eco Swiss China Time Ltd v. Benetton International NV, C-126/97, [1999] E.C.R. I-3055. This provision seems to have come from the Lugano Convention on jurisdiction and the enforcement of judgments in civil and commercial matters, which provides for the exclusive jurisdiction of national courts.

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THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

ii) disputes involving real property located in the Russian Federation; iii)disputes involving the registration and granting of intellectual property rights; iv)disputes involving the validity of State registration administered by a competent agency; v) disputes involving the establishment, liquidation, or registration of a juridical person in the territory of the Russian Federation and disputes involving the decisions of the bodies of such juridical persons.

The common denominator underlying this list is State registration. According to T.N.Neshataeva, a judge of the Supreme Commercial Court, if a legal relationship involves an entry in a register administered by a competent State authority, any economic disputes arising out of that relationship are to be heard only by the State courts of the Russian Federation.69 In a book devoted to legal/theoretical analyses of the use of sub-soil, the author pointed out that disputes of a public law nature concerning the use of natural resources fall under the exclusive competence of the country that owns them, and recourse to foreign courts (including arbitration) is not possible.70 However, the pendulum seems to have swung too far in favour of state courts. As an authoritative Russian article on the subject has put it, such understanding unjustiably narrowed the range of matters that can be arbitrated.71 Article 248 of the Code of Commercial Court Procedure provides for the exclusive jurisdiction of the Russian commercial courts and has nothing to do with the arbitrability of disputes.72 As pointed out in the ofcial commentary on the Code produced by the Supreme Court and the Supreme Commercial Court, the purpose of this provision is to demarcate the jurisdiction of Russian and foreign courts in cases involving foreign entities.73 Arbitrability is closely related to the question of mandatory norms in arbitration. Although conceptually different, the two are often intertwined in that the requirement to apply State mandatory law is used to justify the non-arbitrability of the dispute. This can be seen in the Eco Swiss case and in the above-mentioned Russian case concerning the termination of a joint venture. In the Russian case,

69 70 71 72 73

T.N.Neshataeva, “O voprosakh kompetentsii arbitrazhnykh sudov v RF po rassmotreniiu del s uchastiem inostrannykh lits” Vestnik VAS, 2004, No.12, pp.92-95. V.N.Konin, Nedropol’zobanie: Teoretiko-pravovoi analiz, Moscow, 2005, p.185. A.L.Makovskii and B.R.Karabelnikov, “Arbitrabil’nost’ sporov: rossiiskii podkhod” Mezhdunarodnyi kommercheskii arbitrazh, 2004, No. 3, p.27. A.Komarov, “Nekotorye aktual’nykh voporosov mezhdunarodnogo kommercheskogo arbitrazha v RF” Mezhdunarodnyi kommercheskii arbitrazh, 2004, No.1, p.16. Zhilin ed., supra, p. 632. See also Kommentarii k arbitrazhnomu protessual’nomu kodeksu Rossiiskoi Federatsii, 2d ed., supra at 770-75.

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the Supreme Commercial Court found that Soviet rules should be applied mandatorily and that the award had exceeded the scope of the arbitration agreement due to the fact that the dispute was not arbitrable. These two ndings concern the same issue: the extent to which the prerogative powers of the State should prevail over or interfere with systems of dispute settlement that are based upon party autonomy. When considering the relationship between mandatory national legal provisions and international commercial arbitration, a distinction needs to be made. According to Article 1192 of the Russian Civil Code, mandatory rules of Russian law are unaffected by choice-of-law provisions. It has been pointed out in an authoritative commentary on this provision that there are two categories of mandatory rules: mandatory rules of national civil law and meta-mandatory rules (lois d’application immediate in French law, and “absolute norms” in Swiss law). The former limits private autonomy under national civil law, but their application can be excluded by conict-of-law rules. The latter cannot be excluded at all, whether by the parties’ choice or pursuant to conict-of-law rules.74 It is only non-application of the latter category that can affect the validity of arbitral awards.75 The aforementioned decision of the Supreme Commercial Court in the Pressindustriia case was awed in this respect as well. The instrument in question was the Decree of the Council of Ministers of 1987, No.49. This was the rst decree under the Soviet regime permitting joint ventures with Western companies on Russian territory. It naturally imposed various restrictions on such joint ventures. However, there is no reason to invoke this decree as a mandatory norm in order to refuse enforcement of an arbitral award well after the collapse of Socialism. The Foreign Investment Law of 1999 has since made national treatment available to foreign investors and the provisions of the Civil Code and the company law are therefore now generally applicable to joint ventures. The special treatment given to joint ventures under the 1987 Decree has thus long lost its meaning.

74 75

A.L.Makovskii & E.A.Sukhanov, eds., Kommentarii k chasti tret’ei grazhdanskogo kodeksa RF, Moscow, 2002, pp.348-349. It should be added that Article 1192 is only applicable to cases in which the court or arbitration tribunal is seated in Russia, e.g. when an arbitration tribunal seated in Russia applies foreign law in accordance with the parties’ choice or pursuant to rules of conict, meta-mandatory rules of Russian law supersede the foreign law. See Makovskii and B.R.Karabelnikov, supra, p.35.

54 3

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

THE PROCURACY

The ofce of the procurators was created by Peter the Great in the early 19th century. The primary task of the procurators was to oversee the administration on behalf of the Tsar. After the Judicial Reform in 1864, the function of general supervision over the administration was regarded to be obsolete and was abolished. Criminal prosecution was made the procurators’ main function. The Procuracy – the ofce of procurators – was abolished by the October Revolution, but was restored in 1922 on the initiative of Lenin. However, the Procuracy which was restored was not the Procuracy of the post-Judicial Reform period, but of the period of Peter the Great. The Procuracy was entrusted with the task of overseeing the administration on behalf of the rulers – the CPSU. Although it operated as a prosecuting agency, their main area of activities was the “general supervision”, i.e. supervision of the observance of legality by administrative agencies. In the process of perestroika, there were calls for the abolition of the Procuracy, but in the end, the Procuracy survived the changes, despite some setbacks.76 Now, its authority has been restored under the Putin administration and it has again become a powerful agency. In the area of commercial law, the Procuracy is important in that i) it is empowered to bring an action in court in civil and commercial cases, and ii) it may trigger the supervisory procedure in such cases. In fact, the role of the Procuracy in “supervising” the lawfulness of the civil procedure was perceived as a threat to the independence of the court. Therefore, the role of the Procuracy in civil procedure has been gradually reduced. By the new Code of Commercial Court Procedure which was intended to align the Code with international standard, procurators may initiate an action primarily only when the matter involves public interest.77 In 2005, the commercial court heard 9,050 cases with the participation of procurators. 46.5% of the claims by the procurators were accepted.78 Sometimes, procurators are overzealous in defending public interests: A procurator brought an action against the government of a constituent entity of the Russian Federation, requesting the court to recognise the order of the local government to extend privileges to a joint venture between Russian and foreign enterprises as void, since it was against the interest of the region. The joint venture was formed

76 77 78

H.Oda, “The Re-Emergence of Pravovoe Gosudarstvo and the Russian Procuracy”, in F.J.M. Feldbrugge ed., Law in Transition, Leiden 2002, pp.157-177. A.Iakovlev and M.Iukov eds., Kommentarii k arbitrazhnomu protsessual’nomu kodekusu RF, Moscow 2005, p.5. VVAS RF 2006 No.5, p.40.

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55

by a foreign company (40% stake) and two Russian companies. Originally, the rate of payment for the use of sub-soil was set at 10%, and the rate of prot tax was 32%. The foreign company invested 40 million US dollars. Then, after one year of the commencement of business, the tax law and the Law on Sub-Soil were amended and new export duties were introduced. The foreign company asked the government of the constituent entity of the Russian Federation to decrease the scal burden to the original level. This was accepted, and an order of the government to exempt the joint venture from export duties for three years and to reduce the royalty to 5% was granted. This was contested by the procurator. The government of the constituent entity of the Russian Federation argued that this was in accordance with the Foreign Investment Law of the RFSFR and the Foreign Investment Law of the Russian Federation of 1999 which has a grandfather clause, protecting investors from the worsening of terms of investment. The commercial court found this argument to be justiable and dismissed the claim of the procurator.79

4

LEGAL PROFESSIONS

1)

Judges

Under socialism, as CPSU members, judges were on the nomenklatura, the list of positions whose appointment required CPSU approval, were directly subordinated to the local CPSU organisations and “were regarded as second grade bureaucrats”. After the collapse of socialism, changes were slow to take place.80 In 1992, the then Minister of Justice reported that 98% of judges were former communists.81 Even after the adoption of the Law on the Status of Judges in 1992, people are said to believe that “many things remain without changes to the better – people come across arbitrariness, boorishness of judges, their hunger for prots, lies and lack of ethics”.82 As of January 1st, 2000, there were 2,354 commercial court judges.83 In the commercial court, only around 500 judges out of 3,000 remain from the time of the gosarbitrazh. In the same year, in ordinary courts, there were 16,742 positions for judges at the district court level. There were 3,223 judges at higher courts.84

79 80 81 82 83 84

Information letter of the Presidium of Supreme Commercial Court, January 18, 2001, No.58. item.8. Radchenko, supra, p.55. Iu.Stetsovskii, Sudebnaia vlast’, Moscow 1999, p.102. Stetsovskii, ibid., p.92. VVAS RF, 2000 No.4, p.12. RIu, 2000 No.3, p.3.

56

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

The Constitution provides that a Russian citizen over the age of 25, who has had a higher legal education and experience in the legal profession for a minimum of 5 years may become a judge (Art.119). The Law on the Status of Judges provides for more details. i) Judge of the Constitutional Court – 40 years of age and experience of working in legal profession for no less than 15 years; ii) Judges of the Supreme Court and the Supreme Commercial Court of the Russian Federation – 35 years of age and experience of working in legal profession for no less than 10 years; iii)Judges of the courts of the constituent entities and the Federal Territorial Commercial Courts – 30 years of age and experience of working in legal profession for no less than 7 years; iv)Judges of the commercial courts of the constituent entities – 25 years of age and experience of working in legal profession for no less than 5 years.

The concept of “legal profession” in this context is fairly wide. Positions in the government and local government which require legal education are included. For example, the current chairman of the Supreme Commercial Court, A.A. Ivanov, worked in the territorial agency of the Ministry of Justice, and then in Gazprom Media, but was never a judge. The system for the appointment of judges has undergone a signicant change as a result of the Law on the Status of Judges. Candidates are required to pass an examination and receive a recommendation of the qualication committee. When there is a vacancy, the chairman of the given court informs the relevant qualication committee. Qualication committees are formed at various levels of higher courts including the commercial court. Currently there are 87 of them. The highest is the Supreme Qualication Committee, members of which are elected by the All Russian Congress of Judges. The examination is organised by an examination committee set up by the relevant qualication committee. The result is valid for three years. After passing the examination, the candidate is allowed to apply to the relevant qualication committee for the vacancy (Art.5). While judges adopted their ethical code in 1993,85 not every judge follows the code. In a case where a judge falsied a document regarding the destruction of a weapon – evidence in criminal procedure – the qualication committee found that the judge had committed an offence and discredited the judiciary, but nevertheless, merely reprimanded him, considering his long service and the fact that this was his rst offence.86

85 86

Ibid., 1993 No.23, p.31. Stetsovskii, supra, p.105.

CHAPTER 2

2)

57

Advocates and lawyers

In contemporary Russia, the term “advocates” means those people who are qualied to provide legal services and represent clients in court. “Advocates” are not the only people who are entitled to provide legal services. There are a signicant number of lawyers who either work for a law rm or have their own practice and provide legal services, but are not entitled to represent clients in court. The profession of advokat – attorneys – emerged in Russia as a result of the Great Judicial Reform of 1864. A majority of these advocates practised on their own without being a member of a law rm or consultancy. The rst legal consultancy was established in St.Petersburg in 1870. It was only in three major cities, St.Petersburg, Moscow and Khar’kov, that an association of advocates – kollegiia – was allowed to be established. Advocates practising in these cities enjoyed the privilege of being “above the hierarchical ladder”. However, those kollegiia of three major cities were supervised by the intermediate court, sudebnaia palata. There were various restrictions on the membership. Jewish people were not allowed to become full members. They were not even allowed to practice as attorneys and had to work as assistants. Women were not allowed to practise law until the February Revolution.87 During the constitutional movement in the early 20th century and in the period leading up to the February Revolution, advocates played a major role in the democratic movement, many of them being members of the Constitutional Democratic Party. They were often persecuted by the Tsarist government. S.Kucherov, who himself was an advocate before the October Revolution, quoted the chairman of the lawyers’ guild:88 With the greatest efforts, often forgetting their own interests, our colleagues in all corners of Russia fullled their modest but great ofce – the ofce of the defence of the individual against the onslaught of the state.

Probably because of such activities, immediately after the October Revolution, the kollegiia of advocates was abolished together with the Tsarist courts and the Procuracy. Although the profession itself was not abolished, the number of advocates declined from 13,000 in 1917 to 659 in 1921. In 1922, at the beginning of the New Economic Policy, the Statute on the Advocates was enacted. The practice of advocates in the traditional way was initially tolerated during this period, but later labelled “juridical kulaks”, they were collectivised into Soviet type kollegiias in the 1930s. Advocates were allowed to practice only as

87 88

M.Iu.Barshchevskii, Organizatsiia i deiatel’nost’ advokatury v Rossii, Moscow 1997, p.12. Kucherov, supra, p.312.

58

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

members of the legal consultation bureau run by the respective kollegiia in the area. The kollegiias had almost no autonomy at all. They were strictly controlled by the Ministry of Justice, and ultimately by the CPSU. In political trials, only advocates who were issued a special permit by the Presidium of the kollegiia in consultation with the KGB were allowed to take part. The judicial reform which took place after perestroika did not initially affect the advocates. The reform focussed on the courts and, to a lesser extent, on the Procuracy. However, there was an important development – the establishment of the Union of Advocates of the USSR in 1989, which was the rst independent union under socialism. Although legislative reform had been slow, major changes took place in practice. While the system of state supervision provided by the 1980 Statute still had not been formally abolished, the Ministry of Justice reluctantly gave up its supervisory power over the advocates in favour of the kollegiias. Now kollegiias have the power to decide on issues such as entry, training, remuneration, and creation of new ofces.89 The system of payment for legal services has changed from a xed fee system set by the Ministry of Justice to a system of fees negotiated with the clients. In the late 1980s, the Ministry of Justice, in order to ensure that legal services are available to small and medium-sized businesses, authorised “parallel kollegiias” to be set up in regions where kollegiias already existed.90 Local governments often supported the creation of the “parallels” in their territory. Indeed, some of them have close links with the local government. In addition to the traditional friction between the Ministry of Justice and traditional kollegiias, there were now conicts between the traditional and parallel kollegiias.91 Another important development was the emergence of private law rms. Already under Gorbachev, a new form of legal business – “legal cooperatives” which were semi-private law rms – was allowed to be set up. In the early 1990s, the Ministry of Justice permitted private law rms to be set up outside the purview of the kollegiias. These were the successors of the legal cooperatives which emerged under Gorbachev. Since the term “advocate” denoted those screened and accepted by a kollegiia of one type or another under the 1980 Statute, members of these law rms could not be called advocates, but simply lawyers or attor-

P.Jordan, “The Russian Advokatura (Bar) and the State in the 1990s”, Europe-Asia Studies, 1998 No.5, pp.769-770. 90 The then Minister of Justice cited in Barshchevskii, supra, p.199. 91 Ibid., pp.33-34. 89

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59

neys. Instead of concentrating on litigation like the Soviet advocates, members of these law rms primarily focussed on non-contentious corporate work.92 The number of advocates has substantially increased. In mid-1997, there were 26,500 advocates organised in over 100 traditional kollegiias (19,000-2000 members) and 40 parallel kollegiias (7,000 members).93 One of the problems with the profession of lawyers was that there was no formal requirement as to the qualications needed to become members of the new kollegiias as well as the newly set up law rms. This was rectied when, in April 1995, the government enacted a decree on the licensing by the Ministry of Justice of providing paid legal advice. Members of the kollegiias were exempted from the licensing requirement. By early 1997, the Ministry and local justice organs had issued approximately 8,000 licenses of which half were issued to members of private law rms.94 However, this decree was abolished and at present, there is no licensing system for lawyers working outside the kollegiias. Even with the traditional kollegiias, the requirement for qualication was not so high. The candidate must have had a higher legal education and two years” experience in the legal profession. “Legal profession” includes senior ofcers of the police, espionage and counter-espionage, and the head or experts in the legal department of central and local administrative agencies, trade unions and enterprises.95 In 1994, two drafts of the Law on Advocates were prepared by the Ministry of Justice. In 1996, a draft Law prepared by the working group of the Committee for the Judicial Reform was adopted by the Duma in its rst reading. However, in 1997, the president withdrew this draft due to “changing situations”.96 A draft Law which was submitted to the Duma in 1999 was said to be conceptually different from the earlier draft and was based upon the idea of “state regulation of the activities of advokatura”, for which it is criticised particularly by attorneys from the parallel kollegiias as destroying “7 years of existence of the system of advocates” kollegiia on the basis of democratic principles’ and was described as a return to the “administrative-command system” that existed under socialism.97 The parties involved – members of the advokatura, practising attorneys, local governments, and the Ministry of Justice – have failed to reach a consen-

92 93 94 95 96 97

Jordan, supra, p.773. Ibid., pp.771-772. Ibid., p.773. Circular Letter of the Ministry of Justice, October 10, 1995. “Advokatura – institut grazhdanskogo obshchestvo”, RIu 2002 no.6, p.19. “Zakonoproekt ob advokature protovorechit Konstitutsii Rossii i zdravomu smyslu”, RIu 1999 No.4, p.1.

60

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

sus. One advocate singled out the differences between the interested parties – i) the organisational structure of the kollegiia (whether it should be a non-prot organisation or a prot-making organisation), ii) the procedure for creating and liquidating kollegiias, iii) the number of kollegiias in each subject of Federation, iv) the mechanism of self-administration, and v) the relationship between the advokatura and the state. The Ministry of Justice turned into a strong opponent of the autonomy of the advokatura. Ofcials maintained that state control over the advokatura should be reinforced, and even proposed to have a committee of judges and procurators under the aegis of the Ministry to license advocates. “Parallel kollegiias” were also to be abolished.98 The new Law on the Advocates’Activities and Advokatura was nally adopted in 2002.99 Activities of the advocates are dened as a “qualied legal assistance ( pomoshch’) provided on a professional basis by those who have obtained the status of advocates to individuals and juridical persons in order to defend their rights, freedoms and interests, and for the ensurance of access to justice” (Art.1, para.1). The Law explicitly provides that advocates” activities are not entrepreneurial (ibid., para.2). In terms of organisation, the crucial point is that parallel kollegiias were abolished and the kollegias were reorganised into regional chambers ( palatas) of advocates set up in each constituent entity of the Russian Federation. The Federal Chamber of Russian Advocates was set up at the Federal level. There is increased state control over advocates in that the government now sends representatives to the qualication committee of advocates, although advocates still retain a majority. The Law, however, states that legal services provided by members of the legal department of juridical persons, ofcials of the agencies of state and local power, members and employees of organisations as well as individual entrepreneurs which provide legal service are not included in advocates’ activities (Art.1, para.3). Therefore, lawyers working in a law rm as a partner or an associate or working on their own are not covered by this Law. There is no requirement for license or qualication with regards to these people. Those who have nished higher legal education and have got experience in legal work for no less than two years are qualied to become an advocate, provided that they pass the examination organised by the qualication committee for advocates (Arts.9, paras.1 and 2, and 10, para.1). The qualication committee comprises seven advocates, two representatives of the territorial agency of the

“V.Smirnov, “Zakon ob advokature nado priniiat’ nesamedlitel’no”, RIu 1999 No.5, pp.12-13. See also Jordan, supra, pp.776-777. 99 Law Mo.63-FZ of May 31, 2002. 98

61

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Ministry of Justice, two representatives from the legislature of the constituent entities, one judge from the courts of the constituent entities, and one judge from the commercial court of a constituent entity. The committee takes a decision by means of a two-thirds majority (Art.33, para.2). Advocates are guaranteed independence. Interference with, or inhibition of the advocates’ activities is prohibited. Advocates are not pursued liability for the views expressed in the course of their professional activities, unless the advocate’s guilt was established by a judgement in force. Acquisition of information from the advocate or advocate’s chamber concerning a specic case is not allowed (Art.18, paras.1-3).

3)

Notary Public

The profession of notary public dates back to the 19th century. They were government ofcials – “ofcials of the 8th rank”. This system of the notary public as a state institution continued under socialism. One of the primary tasks of the notary public at that time was to check the legality of contracts concluded by state enterprises. It was another device used by the state to keep control over such enterprises. After the collapse of socialism, signicant changes took place. First of all, the scope of the activities of the notary public has become narrower; part of their activities came to be replaced by the system of registration of transactions involving immovables. Second, notaries were allowed to engage in private practice (Art.8). At present, there are state notaries public and notaries public in private practice. It is mandatory for a notary public in private practice to be a member of the chamber ( palata) of notaries (Art.56). The legal basis for the activity of the notary public is the Fundamental Principles of the Legislation on Notary Public of 1993.100 According to this Law, the task of the notary public is to defend the right and the legitimate interests of individuals and juridical persons by performing, inter alia, the following acts in the name of the Russian Federation (arts.1 and 35): i) ii) iii) iv) v)

notarisation of transactions; authentication of copies of documents and excerpts; authentication of the translation of documents; conrmation of the time of presentation of a document; accepting of money and securities as a deposit;

100 Law No.4462-1 of February 11, 1993.

62

THE SYSTEM OF SETTLING DISPUTES – INSTITUTIONS

vi) preparation of enforcement documents; vii) protesting bills of exchange; viii)presentation of cheques for payment and conrmation of the failure of payment; ix) presentation of maritime protests; x) preservation of evidence.

A notary public is licensed by the Ministry of Justice. A notary is required to have nished a higher legal education, must go through at least one year of apprenticeship, and pass a state examination (Art.2). In cases where the law mandates a transaction to be notarised, the remuneration of the notaries public in private practice is calculated in accordance with the Law on State Duties ( poshlina). Otherwise, they are free to negotiate the amount of remuneration with the client.101

101 V.S.Repin, Kommentarii k osnovam zakonodatel’stva Rossiiskoi Federatsii o notariate, Mos-

cow 1999, pp.43-44.

3 BASIC PRINCIPLES AND RULES OF PRIVATE LAW

1

HISTORICAL BACKGROUND

The rst attempt at enacting a systematic code in Russia was the Ulozhenie (Code) of 1649. Primary sources of this Code are said to be the indigenous law of Russia, which included the Sudebniki of 1497 and 1550, but mostly customary law with some inuence of Byzantine law and Lithuanian law. It comprised 25 chapters with 967 provisions including some chapters on civil law – mainly on property relations.1 Successive tsars, including Peter the Great and Ekaterina II, attempted to enact a new Ulozhenie, but all these attempts failed. In the late 18th century, another commission was set up to prepare the laws. There seem to have been two different schools of thought. One was aimed at the enactment of a new Ulozhenie, while the other sought the codication of the existing law. M.M.Speranskii, who was an active member of this commission, actually prepared a draft of part one of the Civil Code (persons) and submitted it to the State Council. This was followed by parts two (property) and three (contracts) in 1810. There was a very strong inuence of the French Code civil. However, the draft code was met with opposition; the State Council was not convinced that the new Code should be modelled on the Code civil.2 After Speranskii fell into disgrace and was expelled, it was decided that instead of borrowing from foreign codes, they should turn afresh to the investigation of law in the past, based upon the idea that the “laws which survived the years would best serve the state”.3 The 1649 ulozehnie as well as separate legislation which had been enacted since then were compiled, rst organised in a chronological way in the Complete Collection of Laws (Polnoe sobranie zakonov) and then in

1 2

3

“Ulozehnie”, in F.A.Brokgauz et al. eds., Entsiklopedicheskii slovar’, vol 34-a, St.Petersburg 1902, p.685. A.N.Filippov, Uchebnik istorii russkago prava, chast’ 1, 4th edition, Iur’ev 1912, pp.561-567; “Ulozhenie grazhdanskoe”, in F.A.Brokgauz et al. eds., Entsiklopedicheskii slovar’, vol 34-a, St.Petersburg 1902, p.692. Fillipov, ibid., p.567.

64

BASIC PRINCIPLES AND RULES OF PRIVATE LAW

a more systematic way. After his return from exile to Siberia in 1823, Speranskii was instrumental in this enormous undertaking, which nally culminated in the 15 volume Svod zakonov of 1832. In fact, Speranskii’s idea was that the Svod zakonov should be a rst step in the future enactment of the new Code, and not only a compilation of the existing law. Even in the process of preparing the Svod zakonov, Speranskii often exceeded his “humble” role as a person compiling and systematising existing law and became, occasionally and unintentionally, “the genuine creator of many of our legal norms, particularly in the area of civil law”.4 The rst part of Volume 10 of the Svod zakonov was devoted to civil law. Since the total 15 volumes were revised from 1842 and 1857, there have been two editions of Volume 10; 1887 and 1900.5 Russian Civil Law as incorporated in the Svod zakonov was primarily based upon the 1649 Code with the addition of various laws enacted at different times. It was arranged in a way similar to the Code Civil. Speranskii was familiar with Roman law, French law, Prussian law as well as Austrian law, and actually used the concepts and denitions of foreign laws in the process of compiling and editing the then existing laws. However, despite Speranskii’s efforts, the fact remained that the law was obsolete, inconsistent, full of loopholes, and casuistic. The law lacked fundamental “guiding ideas”. In fact, it was hoped that the problems which were left unsolved in the Svod zakonov would be solved in the future ulozhenie.6 Shortcomings of the civil law part of the Svod zakonov were being recognised as early as the mid-19th century. In 1869, a commission for the preparation of rules on contracts and obligation was established, followed by a commission for the preparation of the Civil Code ( grazhdanskoe ulozhenie) which was set up in 1882. By 1903, ve volumes of the draft Civil Code had been published.7 The draft Code was not entirely different from the existing Russian law. Basic principles of Russian law were preserved, insofar as they were not obsolete or failed to match the needs of modern times. In order to ll the gaps in the existing

4 5 6

7

Ibid., pp.573-574. L.Schultz, Russische Rechtsgeschichte, Lahr 1951, S.218-219. “Ulozhenie grazhdaonskoe”, supra, p.692. In fact, Speranskii prepared a draft ulozhenie based upon the Code civil in 1814. For the inuence of the French Code on Russian civil law, see A.L.Makovskii, “Code Civil frantsii i kodikatsii grazhdanskogo prava v Rossiii”, VVAS 2005 No.2, p.137ff. A.M.Guliaev, Russkoe grazhdanskoe pravo, St.Petersburg 1907, p.5. In fact, in the Russian Empire, there was no unied system of civil law. In the early 20th century, in addition to the Svod zakonov, there were the Civil Code of the Kingdom of Poland based upon Code civil, civil codes of the Baltic states, Belarus and the Kingdom of Finland. Ibid., p.3. See also Grazhdanskoe ulozhenie; proekt visochashche uchrezhdeniie Redaktsionnaia Kommisiia po sostavleniiu grazhdanskogo ulozheniia, St.Petersburg 1905.

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law, rst of all, the practice of the Russian higher courts was taken into account. In principle, the commission is said not to have accepted foreign law directly. However, the Code civil had much inuence, since it was actually being applied in Poland which, at that time, was part of the Russian Empire.8 In October 1913, part of the draft Code on the Law of Obligations was submitted to the Duma, but failed to be approved, due to the First World War.9 Thus, civil law provisions accommodated in the Svod zakonov remained in force until the October Revolution of 1917. After the October Revolution, in 1922, the Civil Code of the RSFSR was enacted.10 This was at the time of the New Economic Policy, when a market economy controlled from the “commanding heights” by Bolsheviks was allowed to operate. As A.Goikhbarg, the principal author of the Code, remarked in 1923, “until the October Revolution, there was almost, or absolutely, no theoretical work which, in a systematic way, developed and described in detail, the legal structure which was to emerge after the overthrowing of the capital”.11 It was not surprising that the draft Civil Code of the Tsarist period was extensively studied. Many provisions were taken from the draft Code, but the number of provisions was reduced from some 1,500 provisions in the draft Code to 431.12 It took only four months for Goikhbarg to prepare the draft.13 The structure of the Code closely resembled the European codes such as the BGB and the Swiss Code.14 However, there were some signicant differences. First of all, the part on family law was left out of the Code. There was a separate law – the Family and Marriage Code of 1918. At that time, civil law was thought to “wither away”, and only Family and Marriage Law would remain under socialism.15 Secondly, the Land Law was also separate – the Land Code, which was part of the administrative law, was enacted in 1922. This was because of the idea of the state monopoly of the means of production. Land was intended to be state property and was therefore not to be left to the Civil Code. Although the 1922 Civil Code was designed to give stability to the economy and commerce, it did not give any protection to pre-Revolutionary rights. Nor were the newly-acquired private rights secure. This was at the time when Lenin

W.von Seeler, Der Entwurf des Russischen Zivilgestzbuches, Berlin 1911, S.10-11. Schultz, supra, S.223. SU RSFSR, 1922 No.71, item 904. A.Goikhbarg, Khoziaistvennoe pravo R.S.F.S.R., vol.1, Moscow 1923, p.5. V.Gsovski, Soviet Civil Law, Ann Arbor 1948, pp.24-25. For the text of the Code, see T.E.Novitskaia, Grazhdanskii kodeks RSFSR 1922 goda, Moscow 2002. 14 For the codication of private law in Europe, see H.Schlosser, Grundzüge der neueren Privatrechtsgeschichte, 10 Auage, Heidelberg 2005, S.170ff. 15 M.V.Antokol’skaia, Semeinoe pravo, Moscow 1999, p.64. 8 9 10 11 12 13

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made the famous remark – “we do not allow anything private”. Goikhbarg even went further and stated as follows:16 Laissez faire, laissez passer are by no means the principle of the 20th century. This principle is even less applicable in our country, when a predominant part of economic activities is concentrated in the hands of the state agencies, and private persons and their associations are allowed limited participation in economic activities.

The basic idea was to exclude individualism as much as possible from the Code. The theory of A.Duguit, a French legal philosopher, contributed a theoretical basis. Individual rights were subordinated to the interests of the state. Article 1 of the Code proclaimed that civil law rights are protected insofar as they are exercised in accordance with their social and economic purpose. Article 30 explicitly provided that transactions directed against the interest of the state were void. One observer commented that the Bolsheviks chose to go in the direction of state capitalism. The period of the New Economic Policy ended in 1928 and under the planned economy, the drive for industrialisation began. With the demise of the market economy, some lawyers envisaged the demise of civil law as well. Their view was that civil law was based upon the exchange of goods, but now that the economic plan was to replace such relations, civil law should also be replaced by economic law. Economic law, according to E.B.Pashukanis, a prominent proponent of this view, was not really law, but administrative command, which was a transitional form of law towards its ultimate withering away. However, this view went too far towards the left at a time when the communist leadership was trying to tighten control over the nation by strengthening law and order in the early 1930s. Pashukanis was criticised for his “leftist deviation” and was executed in 1938. Nevertheless, the view that an economic code was needed in addition to the Civil Code survived the socialist period and can still be encountered. The 1922 Civil Code remained in force until the 1960s, although the relationship between state enterprises came to be regulated not by civil law, but by the Law on State Enterprises and other laws which were part of the administrative law. In 1961, the Fundamental Principles of the Civil Law of the USSR were enacted, followed by the civil codes of constituent republics.17 There was not much difference between the 1922 Code and the codes in the 1960s. One conspicuous difference was that the 1960s codes contained provisions which

16 17

Goikhbarg, supra. SZ SSSR 1961 No.19, item 685.

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consolidated the role of the state as an “organiser of civil law relations” and “ensured the primacy of plans over contracts”.18 With the transition to the market economy, these laws were naturally found to be unsuitable. In the very last year of the existence of the USSR, the Basic Principles of the Civil Legislation of the USSR were enacted in May 1991. This was a total break from the civil law under socialism; it was orientated towards the market economy, although in a primitive form. In the area of property law, the USSR Law on Ownership of 1990 was also a breakthrough, since it acknowledged, for the rst time since 1922, diverse forms of ownership, including private and collective ownership. Preparations for a new Civil Code started in the early 1990s. As was the case with the reforms before the October Revolution, the laws of various jurisdictions including the BGB, the Uniform Commercial Code, and last but not least, the legislation of Quebec, were extensively studied. In addition, indigenous laws including the draft Civil Code of the Tsarist period and the 1922 Code were also studied. In the end, the Dutch Civil Code served as a basis for the new Civil Code as a whole, although the inuence of laws from other jurisdictions can be found in various parts of the Code. The primary reason for the choice of the Dutch Code was that together with the Italian Civil Code, the Dutch Code was the latest Civil Code to be enacted in Europe. The Dutch government sent advisors to Russia to assist in the preparation of the Code. Part One of the Civil Code was signed by the President on November 30, 1994 and came into force on January 1, 1995. Part Two was adopted one year later and came into effect on March 1, 1996. Part Three was enacted in November 2001, and has come into effect on January 1, 2002. Finally, Part Four was enacted in December 2006 and is expected to take effect on January 1, 2008.

2

THE CIVIL CODE AS THE PRIMARY SOURCE OF PRIVATE LAW

1)

The Unication of Civil and Commercial Laws

The Civil Code is the fundamental legislation of Russian private law. This is supported by the fact that the Code encompasses both the civil law and commercial law and that it has priority to all other laws in the area of private law. The structure of the Civil Code is in line with the Pandekten system. The Code comprises four parts. Part One covers the General Part, property rights and

18

Forword, in M.I.Braginskii ed., Kommentarii chasti pervoi grazhdanskogo kodeksa Rossiiskoi Federatsii dlie predprinimatelei, rst edition, Moscow 1996, pp.7-8.

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other real rights, general rules of obligations and contracts. Part Two contains specic contracts and obligations arising from unlawful acts and unjust enrichment. Part Three accommodates the Law of Inheritance and rules on International Private Law. Part Four covers intellectual property law. As can be seen from the above structure, as far as parts one and two are concerned, the Russian Civil Code is very much in line with the German system.19 What is different about the Russian Civil Code from the German BGB is that it accommodates not only civil law, but also commercial law. There is no separate Commercial Code. Among the former socialist countries, Hungary takes a similar approach. Traditionally, Russian civil statutes have always contained commercial law provisions. G.F.Shershenevich, who was a leading expert on commercial law in the Tsarist period, pointed out that in Russia, there has always been an idea of “unity (edinstvo) of private law”. It was the intention of Speranskii when compiling Svod zakonov to accommodate everything which, in the West, was divided into Civil and Commercial law.20 The 1887 edition of Svod zakonov, in addition to Volume X which contained the Civil Law, incorporated the Statute on Commerce (Ustav torgovyi ), in Volume XI, part 2. Towards the end of the Tsarist period, this Statute came to accommodate provisions on commercial contracts as well as merchant shipping. There were some provisions on various types of companies, including two provisions on joint stock companies.21 However, the position of the law was not clear. Civil Law as contained in Volume X still accommodated provisions on commercial companies (primarily from the 1837 Company Statute) as well as contracts such as insurance in Book Four (obligations arising from contracts).22 The draft Tsarist Civil Code was clearly based upon the unied system. Book Five of the draft Code (Law of Obligations) which was submitted to the Duma contained provisions on commercial contracts such as contracts of storage, carriage, carrying out of works, commission, and insurance. It also had a fairly extensive chapter on commercial companies including joint-stock companies.23 The 1922 RSFSR Civil Code, despite its afnity with the German BGB in various aspects, inherited this “unity of private law”. The 1991 Fundamental Principles of Civil Legislation of the USSR followed this, and so does the present Civil Code.

19 20 21 22 23

This is more in line with the German BGB. The Dutch Code is organised in eight parts, but does not have a general part; it starts with Book One, “persons”. G.F.Sheshenevich, Uchebnik torgovago prava, seventh edition, Moscow 1914, pp.14-15. A.A.Dobrovol’skii et al. eds., Ustav torgovyi, fourth edition, St.Petersburg 1914. D.A.Nosenko ed., Ustav torgovyi, St.Petersburg 1909. V.E.Gertsenberg and I.S.Pereterskii, Obiaszatel’stvennoe pravo, Proekt, St.Petersburg 1914.

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In the early 1990s, when the enactment of a new civil code came on the agenda, some people proposed to separate commercial law from civil law.24 However, in the end, the Civil Code maintained the system of the “unity of private law”. There were several reasons for this. Firstly, this was true to the Russian legislative tradition as we have seen above. Secondly, the two latest civil codes in Europe, Dutch and Italian, had adopted this system. Thirdly, there was a strong antipathy towards those proponents of the concept of “economic law” as separate from civil law and encroaching on the area of civil law at the time of socialism. Dualism of civil and commercial law was seen to be associated with this school of thought.25 Article 2 of the present Civil Code provides as follows: Civil law determines the legal status of the participants of civil circulation (oborot), the basis for the emergence and manner of exercising the right of ownership and other real rights, exclusive rights on the results of intellectual activities (intellectual property), regulates contracts and other obligations, other proprietary rights as well as personal non-proprietary rights related to them, based upon the equality, autonomy of will, and proprietary independence of its participants.

Then, it goes further and conrms that civil law is applicable to “entrepreneurial relations”: Civil law regulates the relationship between persons who perform entrepreneurial activities, or the relationship in which they participate, based upon the premise that entrepreneurial activities mean independent activities performed at the person’s own risk and aimed at the systematic receiving of prot from the use of property, sale of goods, performance of work and provision of service by those who are registered as such by procedure established by law.

The Code seems to avoid the term “commercial (torgovyi )” and instead, uses the term “entrepreneurial ( predprinimatel’skyi )”. However, various works on commercial law (torgovoe pravo) are still being published.26

V.V.Chankin,’Torgovoe pravo: sovremennye tendentsii’, GiP 1993 No.2, pp.57-64; A.G.Bykov, “Predprinimatel’sloe pravo; problemy formrirovaniia i razvitiia”, VMU, seria pravo, 1993 No.6, pp.4-5. 25 E.A.Sukhanov, “O proekte novogo grazhdanskogo kodeksa Rossii”, VMU, seria pravo, 1993 No.5, p.5. 26 M.M.Lassolov, Kommercheskoe pravo, Moscow 2001; Iu.E.Bulatotskii and V.A.Iazeev, Kommercheskoe (Torgovoe) pravo, Moscow 2002. 24

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The Primacy of the Civil Code over other Laws in “Civil Law Relations”

The Code provides that civil legislation comprises the Civil Code and other Federal laws adopted in accordance with it. Civil law in this context includes other Federal laws (but not presidential decrees or governmental decrees).27 These laws include the following: General Part Law on Joint Stock Companies; Law on Limited Liability Companies; Law on State and Municipal Unitary Enterprises; Law on Banks and Banking Activities; Law on Securities Market; Law on Non-Commercial Organisations; Law on Religious Organisations; Law on Social Organisations; Law on Production Cooperatives; Law on Insolvency; Law on the Civil Status. Property Law Land Code; Law on the Payment for Land; Subsoil law; Law on Registration of Real Property and Related Transactions; Water Code; Forest Code; Housing Code, Law on Obligations Law on Pledge (zalog); Law on Hypothec; Law on Leasing (lizing); Law on the Protection of the Rights of Consumers; Law on Concession Contracts; Law on Foreign Currency Regulation and Control.

27

M.I.Braginskii ed., Nauchno-prakticheskii kommentarii k chasti pervoi grazhdanskogo kodeksa Rossiiskoi Federatsii, second edition, Moscow 1999, p.43.

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The Civil Code has a special status, as the very basis of private law, in relation to these laws. The Civil Code explicitly provides that norms of civil law contained in other laws should coincide with the present Code (Art.3, para.2). This principle of the primacy of the Civil Code is a signicant exception to general rules that new law breaks the old law and special law has priority to general law.28 Under socialism, the legislature attempted to “eliminate defects of economic legislation” by enacting an enormous number of laws and regulations which were not always properly coordinated. The intention of the present legislature is to avoid contradictions between various laws covering the same area by giving primacy to the Civil Code which is “unied, logically consistent, and free from internal contradiction”.29 The only exceptions to this rule are provisions of laws which have a clause “unless the law provides otherwise”. This is understood to give priority to laws other than the Code.30 However, this often creates confusion. For example, company law is part of the civil law. Therefore, the Civil Code has priority to the Law on Joint Stock Companies and Law on Limited Liability Companies. These laws have been enacted after the Civil Code, and have more detailed provisions. Nevertheless, in cases of contradiction, the Civil Code prevails. Thus, the scope of the books of accounts to which shareholders are granted access differs between the Civil Code and the Law on Joint Stock Companies, but the Civil Code is decisive.

3

BASIC PRINCIPLES OF RUSSIAN PRIVATE LAW

Part One of the Civil Code is the General Part of the Code. It sets out basic principles and rules of civil and commercial law. Article 1 of the Code lists various principles of civil law. These are: i) equality of the participants in the relationship regulated by civil law; ii) inviolability of property; iii)freedom of contracts; iv)prohibition of arbitrary interference with private persons by any person; v) recognition of the necessity of the uninhibited exercise of civil law rights; vi)ensurance of restoration of infringed rights and court protection.

28 29 30

Ibid., p.42. M.I.Braginskii and V.V.Vitrianskii, Dogovornoe pravo, obshchie polozheniia, second edition, Moscow 2005, p.53. Ibid., p.58.

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These principles are better understood when contrasted with the system under socialism, where the state played a predominant role in the economy. The equality principle primarily means that entities participating in civil circulation shall be treated in an equal manner regardless of their form of ownership, i.e. whether they are owned by the state, municipality or by private capital. The USSR Law on Ownership of 1990 provided, for the rst time since the October Revolution, that ownership rights of the state, local entities, state enterprises, private enterprises and individuals should be protected equally. The present Constitution guarantees that private, state, municipal and other forms of ownership are recognised and protected in an equal manner (Art.8, para.2). This was certainly not the case under socialism; interest of the state always had precedence over the rights of individuals. It should be added that in contrast with the 1964 Civil Code, individuals are now allowed to be involved in entrepreneurial activities. These people, and their association in the form of commercial organisations, must be treated equally with state and municipal enterprises in civil law relations. Inviolability of property is also a constitutional principle. The Constitution provides as follows (Art.35, para.3): No person shall be deprived of his property except by a judgment of the court. Compulsory alienation of property for the needs of the state shall be carried out only with prior and equivalent compensation.

This rule is also incorporated in the Law on Foreign Investment in the following way (Art.8, para.1): Property of foreign investors or commercial organisations with foreign investment is not subject to compulsory withdrawal, including nationalisation, or requisition, except in cases and on the grounds established by a Federal law or an international treaty.

The Civil Code has a provision to the effect that requisition of property for the interests of society should be allowed by the decision of a state agency in cases of epidemics, natural disasters and other circumstances of emergency based upon the manner and terms provided by law, with payment (Art.242, para.1). The uninhibited exercise of civil law rights, again, is a constitutional right (Art.34). The relevant provision of the Civil Code states the following (Art.1, para.2): Individuals (physical persons) and juridical persons shall obtain and exercise their civil law rights by their will and in their own interest. They shall be free in establishing their rights and duties on the basis of a contract and to determine any terms of the contract which are not against the law.

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Civil law rights may be restricted on the basis of Federal law and only to the extent that it is necessary for the purpose of the protection of the constitutional system, morals, health, rights and lawful interests of other persons as well as ensuring the defence and security of the State.

As an exception to this rule, the Civil Code prohibits abuse of rights, anti-competitive acts and abuse of a dominant position in the market (Art.10, para.1): Use of civil law rights by citizens and juridical persons solely with the intention of causing harm to another person, and abuse of rights in other forms are impermissible. Civil law rights shall not be used for the purpose of restricting competition or abuse of a dominant position in the market.

The rst part of this provision is thought to have originated from chikane in Roman law. An example is creating noise in a at in order to force the neighbour out of the adjacent at. One commentary quotes a novel of Gogol’, in which a farmer plants goose wheat on his land (which is perfectly in exercise of his right) solely for the purpose of causing inconvenience to his neighbour. As an example of “abuse of rights in other forms”, pollution of the environment by an enterprise is quoted.31 A foreign trading rm brought an action to the commercial court against a Russian commercial bank, claiming payment of a large amount of money based upon a bank guarantee issued by this bank for securing a foreign trade transaction. The trading rm (the beneciary) based its claim on the fact that the principal had failed to supply the products as agreed in the contract. The bank (the guarantor) refused payment, since, in their view, the basic obligation had been performed in a way satisfactory for the beneciary. In fact, in the foreign trade contract for the supply of goods, it was agreed that the seller provided a pledge for performance. The seller actually provided two ships as collateral to the buyer. According to the contract, in case of non-performance of the obligation on the part of the seller, the buyer was to obtain the right to have the claim satised from the sale of the ships. This part of the contract was governed by foreign law. The buyer paid the price when he received the collaterals. At the same time, parties to the foreign trade bank approached the commercial bank and asked the bank to issue a bank guarantee for the supply of goods under this contract. In this instance, neither the parties nor the beneciary disclosed to the bank that the foreign trade contract contained a clause on pledge and that the collateral had been provided. The bank issued a guarantee. Then, the seller failed to supply the goods.

31

Braginskii ed., Nauchno-prakticheskii kommentarii. . . . supra, pp.63-64.

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The beneciary argued that if the guarantor becomes aware that the basic obligation has been fully or partly performed, he is under an obligation to notify the beneciary without delay. The bank argued that the beneciary deceived the bank in that the latter failed to inform the bank that the claim of the foreign party to the contract had actually been performed by the sale of the pledged collateral. The bank claimed that this was an abuse of right on the part of the beneciary. The court acknowledged that the beneciary had actually had the claim satised from the sale of collaterals abroad, and therefore, there was no ground for claim on the part of the beneciary. The court found the claim to be an abuse of rights as provided by Article 10 of the Civil Code.32

In such cases, the court and the arbitration tribunal may refuse protection of civil law rights. It should be noted that restrictions on civil law rights can only be effected by Federal law (see also Constitution, Art.55, para.3). This means that these rights cannot be restricted by a presidential decree or edict of the cabinet. The above provision refers to competition law. The Competition Law was enacted as early as 1991. It can hardly be said that this law has been functioning in the way it had been envisaged. The majority of cases handled by the competition agency involve complaints by individuals against public utilities. The 1991 Law was replaced by a new law – the Law on the Protection of Competition in July 2006.33 The Civil Code lists various means of protecting civil law rights and restoring infringed rights by the court (Art.12). These include: i) recognition of rights; ii) restoration of the status quo ante and termination of acts which infringe the right or create threat of infringement; iii) recognition of contested acts as void; iv) recognition of acts of the state and municipal agencies as void; v) self defence of rights; vi) compulsory performance of obligation in kind; vii) compensation for damage; viii)imposition of penalty for delay; ix) compensation for moral damage; x) termination or alteration of legal relations;

32

33

Item 3, Information Letter of the Plenum of the Supreme Commercial Court, February 16, 1998, in Spory pri ispolneniii denezhnykh obiazatel’stv i osushchestvlenii raschetov; sbornik dokumentov, Moscow 2000, pp.60-61. Law No.135 FZ of July 26, 2006.

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xi) non-application (by the court) of the act of state agencies and agencies of local self administration which are against the law.

Some of them such as the compensation for moral damage [see Chapter 10] and self-defence are new. Self-defence is allowed, but its means has to be equivalent to the violation of rights and should not exceed the scope of acts necessary for the elimination of violation (Art.14). Court protection of these rights is now universally available. The court has the power to review the compatibility of the acts of state agencies and agencies of local self administration with the law and other legal acts and if it nds them to be incompatible, recognise them as void (Art.13). The Law on Complaints to the Court for Acts and Decisions which Violate Rights and interests of Citizens of 1993 provides for the procedure.34

4

PARTICIPANTS OF CIVIL LAW RELATIONS

1)

Individuals

The Civil Code applies to individuals (physical persons; often referred to by the Code as “citizens”, following the conventional usage) as well as juridical persons. Individuals acquire civil law capacity, i.e. the capacity to be a subject of rights and obligations, at the time of birth (Art.17). The capacity to act, i.e. the capacity to obtain and exercise civil law rights, to create civil law rights and obligations and to perform them by his or her own act, is acquired by individuals at the age of 18 (Art.21). The Constitution guarantees that every person has the right to unrestricted use of his property and assets for entrepreneurial and other activities not prohibited by law (Art.34, para.1). This is reected in the Civil Code in the following way (Art.23, para.1): Individuals have the right to participate in entrepreneurial activities without forming a juridical person from the moment of registration as an individual entrepreneur.

Individuals may invest in companies and become shareholders, participants (in the case of limited liability companies) etc., but if they are to perform business as an individual without forming a juridical person, then they must be registered.

34

Law No.4866-1 of April 27, 1993.

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The Law on Registration of Juridical Persons and Individual Entrepreneurs was enacted in 2001.35 Provisions of the Civil Code applicable to activities of commercial organisations are, as a rule, also applicable to individual entrepreneurs (Art.23, para.3).

2)

Juridical Persons

(1)

Types of Juridical Persons

A juridical person is dened as an organisation which holds certain assets under its ownership, economic management, or operational administration and is liable for its obligations with these assets, and can in its own name, acquire and exercise proprietary and personal non-proprietary rights, assume obligations, and be a plaintiff and defendant in court (Art.48, para.1). Juridical persons can be classied in the following way: Non-Commercial Organisations (pursuit of prots not as the primary goal) Consumers’ cooperatives Social and religious Organisations Foundations ( fond ) [Stiftung] Institutions (uchrezhdenie) Associations and Federations of juridical persons Commercial Organisations (pursuit of prot as the basic goal) Commercial companies and partnerships Full partnerships Limited partnerships Companies with supplementary liability Companies with limited liability Joint stock companies Production cooperatives State and municipal unitary enterprises Unitary enterprises based upon the right of economic management Unitary enterprises based upon the right of operational administration (kazennoe predpriiatie) [treasury enterprises]

35

Law No.129-FZ of August 8, 2001.

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The Law on Non-Commercial Organisations was enacted in 1996.36 This Law provides for the legal status of non-commercial organisations as well as the procedure of establishment, operation, reorganisation and liquidation of such organisations and the means of support by the government. Non-commercial organisations are dened by law as organisations whose basic purpose is not the pursuit of prot and whose received prot is not distributed among the members. Unlike the German Civil Code which has two categories of juridical persons, associations (Verein) and foundations (Stiftung), the Russian Code has an equivalent of foundations, but associations are not provided as such, and instead, subdivided into various types or organisations. The original intention of the legislature seems to have been that fonds correspond to foundations (Stiftung) in other jurisdictions. Fonds, for the purpose of the Civil Code, are non-commercial organisations without members and are set up by individuals and/or juridical persons on the basis of proprietary contributions for social, charity, cultural, educational and other socially useful purposes (Art.118, para.1). However, in practice, “with the absence of a strict division between commercial and non-commercial organisations, many fonds are actively involved in entrepreneurial activities which this juridical construction had not envisaged”.37 Of the above sub-categories of juridical persons, institutions (uchrezhdenie) are probably the most difcult to understand for lawyers outside Russia. They are organisations which are founded by the owner in order to perform administrative, social-cultural, or other non-commercial functions and are nanced entirely or partly by the owner (Art.120, para.1). The owners can be either the state, municipality, juridical or physical persons, but the “predominant category of them is governmental”.38 One commentator pointed out that these are “remnants of the previous economic system” and are mostly government or municipal agencies.39 State and municipal organisations which provide service, such as schools, museums, and hospitals are examples.40 Institutions do not have the title over the assets allocated to them; the title remains with the owner/founder. On the other hand, the owner/founder bears supplementary liability for the debts of the institution (Art.120, para.2). Production cooperatives are associations of individuals who are not entrepreneurs, established for the purpose of production or other commercial

Law No.7-FZ of January 12, 1996. Braginskii ed., Kommentarii chasti pervoi grazhdanskogo kodeksa. . . ., supra, p.149. O.N.Sadikov., Kommentarii k grazhdanskomu kodeksu Rossiskoi Federatsii, chasti pervoi, rst edition, Moscow 1997, p.161. 39 Braginskii ed., Nauchno-prakticheskii komenntarii . . . , supra, pp.212-213. 40 Sadikov, Komentariii . . ., third edition, p.337. L.L.Lopov ed., Administrativnoe pravo, Moscow 2002, p.129. 36 37 38

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purposes. Members contribute their labour and/or assets. They bear supplementary liability for the debt of the cooperative (Art.107, paras. 1 and 2). This form of organisation has long been known in Russia as artel’. It was revived in 1988 as a vehicle of private investment hitherto unknown under socialism, dropped in the 1990 Law on Enterprises and Entrepreneurial Activities of the USSR, but restored in the Civil Code. Enterprises which are directly owned by the Russian Federation or its constituent entities are called unitary enterprises. They have juridical personality separate from the state or the constituent entities of the Russian Federation. The Law on State and Municipal Unitary Enterprises was enacted in 2002.41 Unitary enterprise is dened as a commercial organisation which does not have ownership over the assets allocated to it by the owner, i.e. the state or municipality. The word “unitary” is said to be reected in the following characteristics of unitary enterprises:42 i) unitary enterprises can be set up only on the basis of state or municipal property; ii) unitary enterprises may have only one founder; iii)property of unitary enterprises is indivisible and cannot be distributed as shares or quotas; iv)the owner of the property of the unitary enterprise which it founded maintains ownership over the property and the enterprise itself has only limited real rights; v) only the owner of the unitary enterprise determines the strategy of economic development of the enterprise, gives consent to the most important activities, and controls the use and maintenance of its property; vi)the current activities of the unitary enterprise are led by a single executive body appointed by the owner.

There are two types of unitary enterprise: one is a unitary enterprise based upon the right of economic management and the other on the right of operational administration. Unitary enterprises based upon the right of economic management (khoziaistvennoe vedenie) are not entitled to sell, lease, pledge, contribute or otherwise dispose of the immovables which had been allocated to them without the consent of the owner/founder (the state or municipality). Other assets can be disposed of unless prohibited by law or other legal acts (arts.114 and 295).

41 42

Law No.161-FZ of November 14, 2002. M.Iu.Tikhomirov ed., Kommentarii k federal’nomu zakonu o gosudarstvennykh i munitsipal’nykh unitarnykh predpriiatiiakh, Moscow 2004, pp.17-18.

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Unitary enterprises based upon the right of operational administration (operativnoe upravlenie) are called treasury enterprises (kazennoe predpriiatie). They have the right to possess, use and dispose of the assets allocated to them only within the scope of law in accordance with the purpose of their activities, instructions by the owner, and the purpose of the property (Art.296, para.1). Furthermore, there is no capital set up for unitary enterprises based upon the right of operative administration. However, these enterprises [still] cannot dispose of assets without the consent of the owner in contrast to the enterprises based upon economic management (Art.297, para.1). In this sense, the right of operative administration is regarded to be narrower in scope than the right of economic management.43 Both types of enterprises are not entitled to borrow money or guarantee a debt etc. without the consent of the owner (Art.18, para.4 of the Law). The number of unitary enterprises based upon the right of operative administration is relatively small. They are limited to state enterprises in the defence industry and enterprises attached to penitentiary institutions.44 In unitary enterprises based upon the right of economic management, the owner is not liable for the debt of the enterprise, except in cases where its bankruptcy was caused by the owner (Art.114, para.7). In contrast, the state bears supplementary liability for the debts of unitary enterprises upon the right of operative administration (Art.115, para.5). The difference comes from the fact that the scope of power of the latter is narrower, more specically, there is no capital set for such enterprises, therefore, there is a necessity to protect third parties who entered into a transaction with them.45 (2)

Civil Law Capacity of Juridical Persons

The Civil Code provides that juridical persons may have civil law rights in accordance with the purposes provided in their founding documents and are liable in relation to these activities (Art.49, para.1). The 1964 Civil Code had adopted a rather strict approach to ultra vires. Under socialism, state enterprises were kept under strict supervision of the state. There was a case where a cooperative whose registered purpose was to “satisfy the needs of citizens” sold computers to various organisations. The court found the sale to be void as ultra vires.46

43 44 45 46

Ibid., p.27. Braginskii ed., Nauchno-prakticheskii komenntarii . . ., supra, p.204. Braginskii ed., Kommentarii chasti pervoi grazhdanskogo kodeksa. . . ., supra, p.145. Ibid., pp.78-79.

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The present Code still provides that juristic acts effected by juridical persons against their purposes can be voided (Art.173, para.1). The construction of the provision is different from the socialist period in that 1) only the juridical person itself, its founders, or state agencies which supervise the juridical person is entitled to bring an action, and that 2) the act can be found void only if the opposite party had known or could have known that the act was ultra vires. On the other hand, insofar as commercial organisations are concerned, the doctrine of ultra vires does not apply. This is in line with the development in most other countries. It is not mandatory for commercial organisations to register their specic purposes of activities. In fact, the Civil Code provides that commercial organisations, except for unitary enterprises, may have civil law rights and assume obligations necessary for performing all kinds of activities not prohibited by law (Art.49, para.1). As mentioned above, unitary enterprises are different and are subject to this doctrine. Unitary enterprises, in contrast with companies, have only limited civil law capacity, instead of general capacity. The Articles of Incorporation of unitary enterprises must contain information on the object and purposes of the activities of the enterprise (Art.113, para.1).47 Juristic acts in excess of such capacity are null and void (Art.168).48 Certain categories of businesses, e.g. exploration and development of sub-soil as well as banking and insurance, require a special license. The list of activities subject to license is provided by the Law on Licensing of Specic Activities.49 Juridical persons acquire legal capacity by registration. Juridical persons are subject to state registration (Art.51). There is a unied state registry of juridical persons and individual entrepreneurs which is administered by the Ministry of Tax and Levies. The Law on the State Registration of Juridical Persons and Individual Entrepreneurs was enacted in 2001.50 The Civil Code also contains provisions regarding the managing bodies, the names and locations, liability, reorganisation (merger, split, conversion etc.), liquidation and bankruptcy of juridical persons [see Chapter 4, Company Law].

3)

The State as a Participant of Civil Law Relations

The Russian Federation, constituent entities of the Russian Federation (constituent republics, regions, provinces, cities of federal designation, autonomous

47 48 49 50

See also Article 9, para.3 of the Law on State and Municipal Unitary Enterprises. Tikhomirov, supra, p.125. Law No.178-FZ of November 26, 1998. Law No.129-FZ of August 8, 2001.

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regions and provinces as well as specially designated cities), and municipal entities (entities of local self government) may be a party in civil law relations, i.e. they may acquire and exercise proprietary rights and personal non-proprietary rights and assume obligations, and be a party to litigation (Arts.124 and 125). In such cases, they act not as subjects of prerogative power, but as entities with an equal status as individuals and juridical persons. They have the same status as commercial and non-commercial organisations and individuals and therefore, civil law provisions are applicable, unless the law provides otherwise or a different treatment emanates from the special character of the subject. These entities are liable for their obligations arising from the property which belongs to them under their ownership. However, the attachment of natural resources which they own, including land, is allowed only in cases provided for by law (Art.126, para.1). The Russian Federation is not liable for the debt of the other entities, and vice versa. This effectively means that each entity at various levels has its own account (kazna). The Russian Federation and its constituent entities are, in principle, not liable for the obligation of entities such as state or municipal enterprises which they have created.51 Indeed, this has been the norm under socialism, although the state never let state enterprises default. Exceptions to this rule are unitary enterprises based upon the right of operational administration which are directly under the control of the Russian Federation. In such cases, the State bears subsidiary (supplementary) liability, i.e. if the enterprise cannot pay, then the Russian Federation will pay (Art.115, para.5). Another example are government institutions – under the Law on Non-Commercial Organisations, the government bears subsidiary liability for the debt of these institutions (Art.9, para.2). Concerning the liability of the State and other entities in civil law relations with foreign elements, i.e. with the participation of a foreign government, juridical persons, or individuals, the Civil Code refers to the forthcoming Law on Immunity of the State and its assets (Art.127). This Law is yet to be enacted. Russia has for many years maintained the absolute principle of sovereign immunity. This meant that even when the State was acting not as a subject of prerogative power, performing public functions, but was engaged in commercial activities, still, it was entitled to sovereign immunity, although in practice, the Russian State has, in the past, waived sovereign immunity by subjecting itself to international arbitration in various treaties. In other countries, this doctrine of absolute sovereignty is being superseded by the “restrictive doctrine” or “functional theory” of immunity, which does not allow immunity from foreign

51

Sadikov ed., Kommentarii k grazhdanskomu kodeksu Rossiskoi Federatsii, chasti pervoi, enlarged edition, Moscow 1999, p.263.

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jurisdictions when the state is involved in commercial activities. The US and UK statutes on sovereign immunity as well as the European Convention of State Immunity have taken this position. The United Nations International Law Commission has prepared a draft treaty to the same effect. It is now more or less accepted by the Russians that the restrictive doctrine is the commonly adopted approach in other countries. The draft Russian Law on Sovereign Immunity is said to take the same line as this draft treaty. Recently, the Supreme Commercial Court has explicitly adopted the restrictive doctrine: An information agency, Televizionnaia sluzhba novostei (“the Agency”), brought an action against an inter-governmental broadcasting company, “Mir” (“the Company”) for the return of 3.3 million US dollars worth of assets of which 1.57 million was for the value of the equipment and 1.73 million for the shares of a third party which were transferred to the Company in 2002. The Company was established by the CIS countries in 1992. An agreement signed by the participating states provided for the immunity of the Company from judicial interference and enforcement. Despite the argument of the plaintiff that in the contract of sale, the parties had agreed on the jurisdiction of the commercial court in Moscow for potential disputes, the rst instance court dismissed the claim on the ground of sovereign immunity. The appellate court as well as the cassation court upheld this decision. However, the Supreme Commercial Court quashed this decision. The plaintiff’s argument for the supervisory instance was that the Articles of Incorporation of the Company limited the application of immunity to activities of “professional nature” whereas in the present case, the Company was abusing immunity to avoid obligations emanating from a commercial contract. The plaintiff also argued that by signing a contract with a clause agreeing to the jurisdiction of the court, the Company had waived the immunity. The defendant contended that the contract of sale in question had been concluded within the scope of its professional activities. The agreement of the participating states did confer privileges and immunities to the Company. On the other hand, the same agreement granted immunity to the Company in their country “which is needed for the ensurance of business in accordance with the tasks set out in the Articles of Incorporation”. According to the court, this means that “the Company’s immunity bears a functional (limited) nature and extends only to activities for the carrying out of tasks determined by the Articles of Incorporation for which the Company was set up”. The court found that the dispute had emerged from commercial activities of the Company and that although the Agency performed its part of obligation, the Company had failed to do so. In the end, the court remanded the case to the rst instance court to examine which part of the transaction would be covered by immunity.52

52

Decision of the Presidium of the Supreme Commercial Court, January 20, 2004, Case 1311/03.

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83

OBJECTS OF CIVIL LAW RIGHTS

The Civil Code lists “things including money and securities as well as other property including property rights, works and services, information, results of intellectual activities including exclusive rights on them (intellectual property), and non-material values” as objects of civil law rights (Art.128). Things can be divided into immovables and movables. Immovables denote pieces of land, elds of sub-soil, demarcated sections of water, and other things rmly attached to the land. The latter includes multi-year plants, buildings and structures. In addition, aircraft, ocean going ships, inland water ships, and satellites are treated as immovables. An enterprise in its entirety as a “proprietary complex” is also regarded as an immovable (Art.132). Things which are not immovables, including money and securities, are movables. Ownership rights and other real rights over immovables, restriction on such rights, emergence, as well as assignment and termination of such rights are subject to state registration on the Unied State Register (Art.131). The Law on the State Registration of Immovables and Related Transactions was enacted in 1997.53 It is important to note that enterprises are now made an object of civil law rights. Enterprises are proprietary complexes used for performing entrepreneurial activities. They can be objects of sale, pledges, leases, and other transactions related to the establishment, assignment or termination of real rights (Art.132, para.2). Enterprises in this context not only means specic forms of commercial organisations such as unitary enterprises, but is much broader and means companies as a “going concern ( predpriiatie na khodu)”.54 Currency valuables are also “things”. These include foreign currencies, securities denominated in foreign currencies, precious metal and stones except for jewellery. The Law on the Control of Foreign Currency Transactions regulates transactions on foreign currency (Art.141).55 Securities also fall within the category of “things”. The Civil Code has a separate chapter on securities. Under socialism, available securities were limited to government bonds, bearer’s savings books etc. Cheques were also used for settlement of payment between juridical persons. With the transition to the market economy, the scope of securities has signicantly broadened. The Code denes securities as a document which certies in an established form and by following mandatory requirements, proprietary rights, the exercise or

53 54 55

Law No.122-FZ of July 21, 1997. Braginskii ed., Nauchno-prakticheskii kommentarii. . . ., supra, p.240. Law No.173-FZ of December 10, 2003.

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assignment of which is possible only by its presentation (Art.142). The Code lists the following securities (Art.143): i) government bonds, ii) corporate bonds, iii) promissory notes (veksel’), iv) cheques, v) certicates of deposit and savings, vi) bearer’s bank account book, vii) bills of lading, viii)shares, ix) privatisation securities, x) other documents designated as securities by law

The Civil Code only accommodates basic provisions on securities. The details are left to other laws such as the Law on the Securities Market, the Statute on Bills of Exchange and Promissory Notes, the Law on Joint-Stock Companies etc. Bills of lading are covered by the Merchant Shipping Code. The Civil Code also has a provision on “non-documentary securities”, i.e. securities without documentary embodiment, which “developed countries, including Western European countries, began to accommodate from the early 1980s”.56 In cases provided for by law or by procedure established by law, licensed persons may xate rights in bearers’ or non-bearer’s securities including those in a non-documentary form (with the assistance of “electronic-computing technology” etc.). Persons who are responsible for xating rights in this form are under an obligation to issue a document certifying the rights on request of the right-holder (Art.149, para.1). Under the Law on Joint Stock Companies the issue of non-documentary shares is allowed.57 The Law on the Securities Market also allows the issue of nominal securities in a “non-documentary form”.58 Soviet civil codes used to accommodate copyright law and patent law in them. The 1990 Fundamental Principles of Civil Legislation of the USSR also contained some provisions on intellectual property. Since then, various special laws such as Patent Law, Copyright Law, Trademark Law, Law on Semiconductor Topography, and Law on the Protection of Computer Programmes were

56 57

58

Braginskii ed., Nauchno-prakticheskii komenntarii . . ., supra, pp.258-259. G.S.Shapkina ed., Postateinyi kommentarii k federal’nomu zakonu “Ob Aktionernom Obshchestve, second edition, Moscow 2000, p.85. E.N.Tkachenko, Komentarii k zakonu ob aktsionernom obshchestve s postateinymi sudebnoi materiarami sudebnoi praktiki, Moscow 2003, p.335. Braginskii ed., Nauchno-prakticheskii komenntarii . . ., supra, p.259.

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enacted in this area. However, Part Four of the Civil Code which was adopted in 2006 and is to take effect from January 1, 2008, will replace all these laws.59 “Information” referred to as an object of civil law relations in the Civil Code, denotes business and commercial secrets. The Code provides that information is a business or commercial secret if it has existing or potential commercial value due to the fact that it is unknown to a third party, there is no legitimate free access to the information, and the holder of the information has adopted measures to protect its condentiality. Those who, by unlawful means, obtain information which comprises business or commercial secrets, are liable for compensation (Art.139). Concerning “non-material values”, the Code lists “life and health, personal dignity, honour and good name, business reputation, inviolability of personal life, personal and family secrets, the right to free movement, choice of the place of stay and residence, the right of a name, an author’s moral rights, and other personal non-proprietary rights and other nonmaterial values which belong to physical persons by birth or by law and which are inalienable (Art.150, para.1).

6

JURISTIC ACTS

1)

General

The Russian Civil Code belongs to the Civil Law system which developed out of the French Code civil. One of the fundamental concepts in this system is the concept of juristic acts (acte juridique, Rechtsgeschäft). The concept was already known during the Tsarist period. In a book published in 1907, A.M.Guliaev dened the juristic act (iuridicheskii akt) as an expression of will which is aimed at causing specific legal effects. According to the author, juristic acts comprise two factors: will and its expression.60 The concept was retained under socialism, but under a different name – transaction (sdelka). The present Civil Code continues to use the term sdelka. Sdelka (hereinafter, “juristic act”) is dened, in an identical way to the 1964 Code, as an act of a physical person or juridical person directed at the establishment, alteration, or termination of civil law rights or obligations (Art.153). It is an intentional act; it has a legal meaning only when it is externally expressed in

59 60

Law No.231-FZ of December 18, 2006. A.M.Guliaev, supra, pp.62-63.

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an objective manner.61 It is common for the civil codes to provide for basic rules concerning the form and validity of juristic acts in the general part. Juristic acts can either be unilateral, bilateral, or multilateral. Examples of unilateral juristic acts are the waiver of ownership rights (Art.236) and the granting of a power of attorney (Art.185). Bilateral and multilateral juristic acts are basically contracts.

2)

Forms of Juristic Acts

Under the socialist civil law, there were strict requirements with regards to the form of juristic acts. Notarisation was required on various occasions to enable the state to supervise transactions between state enterprises. Non-compliance with the requirements made these juristic acts absolutely void. Since 1990, there have been signicant changes. The formality of juristic acts became less stringent. Juristic acts may be effected orally or in writing. As a rule, juristic acts which, by law or by the agreement of parties, are not required to be in writing, can be effected orally (Art.159, para.1). Juristic acts which may be effected orally are also deemed to have been effected, if, from the behaviour of the person, his intention to effect the juristic act is apparent. On the other hand, silence is regarded as an expression of will only when so provided by law or the agreement of the parties (Art.158). Juristic acts in a written form can be in a “simple written form” or in a notarised form. The following juristic acts are required to be in writing (some acts may need notarisation as well): i) juristic acts between juridical persons or between a juridical person and a physical person; ii)juristic acts between physical persons with the amount not less than 10 times the minimum monthly wage and other instances provided by law.

If a juristic act was not effected in writing although written form is required, as a rule, juristic acts which fail to comply with the requirement of written form are not void, unless it is expressly provided by law or provided as such in the agreement between the parties. The Code specically provides that foreign trade transactions always have to be in writing, and the non-fullment of this requirement results in the transaction being void (Art.162). In case of non-compliance,

61

Sadikov ed., Kommentarii . . ., rst edition, supra, p.200.

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the parties will simply be deprived of the possibility of referring to witness statements in order to prove that the given juristic act has taken place with specic contents in litigation. Only written evidence, physical evidence and expert opinion can be quoted. Some juristic acts are subject to notarisation. Notarisation is necessary when the law so provides, or when it is required by agreement of the parties (Art.163). Non-compliance with the requirement of notarisation makes the juristic act null and void. Certain juristic acts are subject to registration. Juristic acts involving land and other immovables must be registered (Art.164, para.1. The scope of immovables is provided in Art.130, para.1).

3)

Defective Juristic Acts

Juristic acts are based upon the expression of will by the parties in civil law relations. A corollary is that if the expression of will is defective in one way or another, it affects the validity of the act. Juristic acts can be voidable, or null and void in such cases. In cases where the act is null and void (nishtozhnyi ), the act does not have effect even without the recognition to that effect by the court. An action by an interested party is not needed. In contrast, the effect of voidable (osporimyi ) juristic acts can only be denied on the initiative of the interested parties, but once avoided, the act is deemed not to have had any effect from the outset (Art.167, para.1). The new arrangement in the present Civil Code is based on the Civil law system, but is said to be closer to French Law (relative invalidity and absolute invalidity) than German Law.62 This distinction did not exist in the 1964 Civil Code. Under socialist law, defective juristic acts had, in principle, no effect (nedeistvitel’nyi ). This is understandable, since in voidable acts, it is left to the party, and not to the state, whether or not to take an action to void the act. This could not be tolerated under socialism. It should be noted there that although null and void acts do not have any effect even without a court action, in order to have the consequences of the invalidity applied, i.e. to restore the status quo ante, a court action by an interested party is needed (Art.166, para.2). The Code provides that in case of invalidity, each party is under an obligation to return what it has received from the other in the transaction (mutual restitution), and if returning the subject matter of the

62

A.Solotych, “Das neue russische ZGB aus rechtsvergleichender Sicht”, in F.-C.Schroeder ed., Die neuen Kodikationen in Russland, second edition, Berlin 1999, S.35.

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transaction in nature, its value should be returned. Thus, if the act is null and void, there is no need to apply to court for denying the validity of the act, but in order to have the property returned, a court action may be needed. Tomsk Neft’ brought an action against Gazprom in the Moscow City Commercial Court asking for the consequences of the invalidity of a juristic act to be applied. In the light of the agreement on the redistribution of ordinary shares of Tomskgaz which was contested by Tomskneft’, Vosotchnaia neftnaia kompaniia (which later became Yukos) and Gazprom and was found as null and void by another court, the plaintiff demanded the return of the Tomskgaz shares distributed to Gazprom. The rst instance court acknowledged the claim of the plaintiff. However, the appellate court quashed this judgment on the ground that return of the shares and the change of registration were impossible, since, when the litigation was initiated, the disputed shares had already been assigned to an individual. In such cases, in accordance with Article 167, para.1, although the shares cannot be returned, the value of the shares must be reimbursed. This was upheld at the cassation instance and subsequently by the Supreme Commercial Court.63

There is no time limit for asking the court to recognise a certain juristic act as null and void. This is because the act is regarded to have been void from the beginning even without the involvement of the court. However, an action for applying the consequences of invalidity can be initiated only within 10 years of the day when the performance of the act had started. Concerning voidable acts, actions for avoiding such acts must be brought to court within one year of the termination of the violence or threat under which the act has been effected, or the day from which the plaintiff became aware, or should have become aware of the grounds for voiding the act (Art.181). The government of the Republic of Khakasiia brought an action to the Commercial Court of the Republic against power utilities, Joint Stock Company UES and the Saiano-Shusehnskaia Hydropower Company, asking the court to apply the consequences of the invalidity of the decision of the State Committee for the Administration of State Property. The decision concerned the transfer of a hydropower plant to the UES which then set up the Saiano-Shushenskaia Hydropower Company as a subsidiary. The plaintiff demanded that the assets of the Hydropower company be returned to the Federal Government. The claim was based upon the argument that the privatisation of the power company was against a presidential decree of 1992 and the Privatisation Law of 1991 in that privatisation was carried out without the allocation of state property between the Russian Federation and the Republic of Khakasiia, while the latter should have been consulted.

63

Decision of the Presidium of the Supreme Commercial Court, September 30, 2003, Case 6802/03.

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The court of rst instance and the appellate instance court both dismissed the claim on various grounds, including the ground that the claim of the plaintiff was barred by prescription. The court of cassation quashed the decision of the appellate court and ordered the UES and the Hydropower Company to return the assets to the state. Concerning the period of prescription, the cassation court ruled that since the plaintiff became aware of the infringement of its rights in 1993, the prescription period had not expired when the plaintiff brought an action. The Supreme Commercial Court quashed the decision of the cassation court on the following grounds. The prescription period for claiming the application of the consequences of invalidity of a juristic act starts when the performance of the given act has started (Art.181, para.1). In this case, it does not ow from the date of the registration of the subsidiary, the Power Company, as ruled by the court of cassation, but from the date of the transfer of the assets to the UES. Therefore, the plaintiff is barred from action. The Court further pointed out that in any case, the privatisation was not against the presidential decree or privatisation law, since the consultation procedure had been carried out and various measures were adopted for the benet of the Republic.64

Null and void juristic acts include: i) Acts effected with the purpose against the basic principles of the legal order and good morals (Art.169); ii) Acts against the law and other legal acts, unless the law provides that it is voidable or provides for other consequences (Art.168) iii)Fictitious acts and acts which conceal another act (sham acts) (Art.170); iv)Acts effected against the requirements concerning the form, so long as the law provides that the non-compliance entails such a consequence (Art.162, paras. 2 and 3; Art.165, para.1); v) Acts effected without state registration where it is a prerequisite (Art.165, para.1).

Voidable acts include: i) Acts of a juridical person in excess of its legal capacity (Art.173); ii) Acts in excess of the limitation of power (Art.174); iii)Acts effected by mistake (Art.178); iv)Acts effected under duress, violence, threat etc. (Art.179).

64

Decision of the Presidium of the Supreme Commercial Court, October 19, 2004, Case 5905/04.

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4)

Primary Categories of Null and Void Juristic Acts

(1)

Juristic Acts against the Law or other Legal Acts

Juristic acts which do not comply with the requirements of laws or other legal acts are null and void, unless such law or legal act does not provide that they are voidable or provides for other consequences (Art.168). For example, creditors are not allowed to require of the debtor that title to the collateral be transferred to the creditor in case of default of the debtor (Art.349, para.1). A contract which contains such an arrangement is null and void. A typical case is where the transaction is in breach of privatisation legislation: A saving bank, Buriatskii Territorial’nyi Bank brought an action against a joint stock company, Sapozhok claiming repayment of the loan of 200 million roubles plus interest and penalty. The defendant submitted a counterclaim, arguing that the loan agreement and the contract of hypothec should be recognised as null and void on the ground that the general director of the company had exceeded his power in concluding these contracts. The court of rst instance accepted the claim of the plaintiff and dismissed the counterclaim. This judgment was upheld by the higher courts. However, upon protest, the Supreme Commercial Court quashed the judgment and remanded the case to a new hearing. The Court ruled that the contracts had been signed by the general director of Sapozhok. The company had been founded on the basis of a studio. Special provisions on the legal status of joint stock companies founded in the process of privatisation are applicable to this company. According to the model statute of open joint stock companies approved by a presidential decree, disposal of more than 10% of the assets fall within the exclusive competence of the shareholders’ meeting. Investment and borrowing decisions of the same amount had to be adopted by the board of directors. The creditor was aware, or should have been aware of this. Since the value of the property hypothecated exceeded 10% of the value of the assets, the decision should have been adopted by the shareholders’ meeting. The shareholders’ meeting has not approved the transaction or subsequently ratied it, and therefore, the contract of hypothec is null and void by virtue of Article 168 of the Civil Code. The board of directors did not approve or ratify the loan agreement. Thus, this agreement is also against Article 168 and therefore, null and void.65

In another case, a contractual clause which provided for disputes to be settled by arbitration was found to be null and void on the basis of Article 168 on the ground that matters involving privatisation could not be dealt with through arbitration.

65

Decision of the Presidium of the Supreme Commercial Court, March 4, 1997, Case 3326/96.

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The Privatisation Law explicitly provides that such matters should be handled by court.66 The court also ruled that a major transaction without the authorisation of the shareholders’ meeting as required by the Law on Joint Stock Companies was null and void:67 Shareholders of an open joint stock company Razvitie and the chairman of its board of directors brought an action to the Krasnogorod City Court against a closed joint stock company Volga Kredit Holding, asking the court to recognise the transfer of the company Razvitie as a property complex to the holding company. With the transfer of jurisdiction to the commercial court, the case was transferred to the Commercial Court of the Moscow Province. The rst instance court terminated the procedure on the ground that the bankruptcy procedure regarding Razvitie had been completed. The appellate court quashed this judgment and remanded the case to the rst instance court. The First instance court then dismissed the claim of the plaintiffs due to the absence of the ground to recognise the transaction as null and void. The appellate court quashed this judgment on the ground that the transaction in question was a major transaction as provided by the Law on Joint Stock Companies, but the procedure required by the Law was not observed. Besides, the protocol of the transfer of the company was signed by an unauthorised person. The court of cassation quashed the judgment of the appellate instance court. The Supreme Commercial Court quashed the judgment of the court of cassation. According to the facts established by the lower courts, Razvitie signed an agreement with the Holding in order to repay the debt owed to the holding by transferring its assets up to the amount of the debt. In execution of this agreement, assets worth 20,623,867 roubles were transferred to the Holding. The appellate instance court, on the basis of the balance sheet, found this to be a major transaction, since it exceeded 50% of the value of the assets. The Joint Stock Company Law requires such a transaction to be approved by the shareholders’ meeting. In accordance with Article 168 of the Civil Code, such a transaction without the approval of the shareholders’ meeting is null and void, since the Joint Stock Company Law does not provide that it is voidable. Furthermore, while the agreement had been signed by the general director of Razvitie, the resolution of the shareholders’ meeting which appointed this person was found to be invalid, since the meeting did not reach the quorum. The court of cassation instance ruled against the plaintiff, since, with the liquidation of Razvitie, the plaintiff had ceased to be a shareholder and therefore, lost the standing. However, in the view of the Supreme Commercial Court, the plaintiff had already brought an action to court before the liquidation of the company.

66 67

Decision of the Presidium of the Supreme Commercial Court, April 10, 2001, Case 3515/00. Decision of the Presidium of the Supreme Commercial Court, July 20, 2004, Case 3826/04.

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BASIC PRINCIPLES AND RULES OF PRIVATE LAW

Article 168 is based upon the presumption that everybody knows the law. Therefore, as a rule, “the absence of fault on the part of the party does not mean that the act is not void”.68 (2) Juristic Acts whose Aims conict with the Fundaments of Law and Order and Morals Acts contrary to the fundaments of law and order and morals are void (Art.169). This is based upon fault (vina), i.e. the act has to be intentional. This is in fact synonymous with the concept of public policy.69 It is not designed to deal with a mere breach of law; it is intended to cover those acts which intend to contradict the fundaments of legal order. Mere breaches of law are covered by the preceding provision (Art.168). One of the possible elements of this kind of act is whether the act is punishable as a criminal offence, but this is not a prerequisite.70 A commentary points out that the interpretation and understanding of the concept of fundaments of legal order represent difculties, since there are only a limited number of court decisions. Nevertheless, this commentary gives a fairly clear denition of this concept: Fundaments of legal order means basic norms established by the state concerning the social, economic and communal structure of society which aim to facilitate the observance of and respect for such structures as well as to ensure legal norms and protection of the basic rights and freedom of individuals.71

This provision is often resorted to by the tax agency aiming to annul a particular transaction and conscate the proceeds from it on the ground that it was intended for tax evasion. However, such attempts are gradually disappearing and the court seldom accepts such arguments.72 The following case was initiated by the tax police (now abolished): The Federal Tax Police of St.Petersburg brought an action to the Commercial Court of St.Petersburg and the Leningrad Province against a limited liability company “Euro Business Centre” and “Priborotekhnika”, asking the court to acknowledge the contract of sale between them as null and void by virtue of Articles 168 and 169 of the Civil Code. The rst instance court found the contract to be against Article

68 69 70 71 72

Sadikov ed., Kommentariik grazhdanskomu kodekusu RF, chasti pervoi, third edition, Moscow 2005, p.477. Ibid., pp.478-479. Braginskii ed., Nauchno-prakiticheskii komenntarii . . ., supra, p.289. Sadikov, supra, third edition, p.479. O.V.Gutnikov, Nedeistvitel’nye sdelki v grazhdanskom prave, Moscow 2003, p.515.

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169. This was upheld in the appellate and cassation instances. The case reached the Supreme Commercial Court. The tax police argued that the company “Pribortekhnika” was registered by using stolen identication. The Supreme Commercial Court found no ground that the sale was effected intentionally against the fundaments of the legal order. The Court also examined whether the sale was null and void on the basis of Article 168. In this case, the company was registered at the time of the conclusion of the contract, but the registration was later rescinded by the court. The Supreme Commercial Court ruled that the consequence of the rescission of registration was the liquidation of the company. The Court added that not all transactions of the company whose registration was found to be invalid are recognised as void.73

However, in the following case, Article 169 was applied: An open joint stock company, Voucher Investment Fund “Initsiativa”, extended a loan to another company. It was agreed with the borrower that the interest would be paid by privatisation vouchers which had been distributed to the general public to enable them to take part in privatisation. According to a presidential decree, privatisation vouchers were to be used solely for the privatisation of state and municipal enterprises. The contract was against this requirement. What was more, the contract “intentionally infringed the right of citizens to receive income from privatisation”. The contract was therefore regarded by the Supreme Commercial Court to have an “anti-social character” and was found to be null and void under Article 169.74

Other examples quoted in commentaries include juristic acts against the state monopoly on certain kinds of activities which restrict the legal capacity of persons or the right of ownership, or acts with the intention to create the monopolistic position of a juridical person in the market.75 The major difference between articles 168 (acts against the law) and 169 (acts against public policy and morals) is the effect of the acts. In the former, the general rule applies, and the parties are under an obligation to return those benets received in relation to the transaction. In the latter case, if both parties acted with intention, all they have received from the already performed transaction will be conscated by the state (Art.169). The outcome can be rather harsh. The Supreme Commercial Court is rather cautious in applying Article 169 liberally:

73 74 75

Decision of the Presidium of the Supreme Commercial Court, April 13, 1999, Case 2487/98. Decision of the Presidium of the Supreme Commercial Court, November 12, 1996, Case 2808/96. Sadikov ed., Kommentarii . . ., rst edition, supra, p.215.

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Mosbiznesbank brought an action at the Moscow City Commercial Court against a limited liability company “Edel’veis” for payment of 64,467,605 roubles of interest on a loan. The rst instance court acknowledged this claim, but at the appellate instance, the court rejected the claim and the amount the parties received from the loan contract was conscated and transferred to the federal budget, since the contract was “against the basis of legal order” on account of its violation of foreign exchange legislation. Upon protest by the deputy president of the Supreme Commercial Court, the court quashed the judgment of the appellate instance on the following grounds. The contract for loan was intended to nance the import of grain from Kazakhstan. The plaintiff purchased US dollars for Edel’weis and transferred this to a Kazakh bank which served an intermediary company, “Kustanai”. Edel’weis then repaid the capital to the plaintiff, but failed to pay interest. Thus, the plaintiff had duly performed its obligation under the contract of loan and was entitled to a payment of interest by the defendant. The purchase of foreign currency and its payment to the Kazakh bank was outside the scope of the contract of loan and is separate, and therefore does not affect the contract of loan. The appellate instance was found to have erred in combining the contract of loan and the currency transaction and conscating all that parties have received.76

By the same token, a contract of substitute performance has been addressed: The State Tax Inspectorate of a district in the City of Cheliabinsk initiated an action at the Commercial Court of Cheriabinsk Province claiming that the contract of substitute performance concluded by a limited liability company “Spetsstroi” and Cheriabinvestbank – a joint stock company (investment bank) was void. The rst instance court rejected the claim, but the appellate instance court found the said contract to be void on the ground that the transaction was effected with the intentional purpose against the fundaments of legal order and ethics, since it was against the procedure for settling payment by companies in arrears of tax payments. A total of 47,749,540 roubles was conscated from both parties. The Supreme Commercial Court did not accept the protest in full and found that the contract was indeed void for the violation of the presidential decree. However, the Court ruled that the contract should be declared null and void under Article 168 for the violation of law or other legal acts, and not by Article 169. Therefore, the conscation of the above amount from both parties was found to be in error.77

76 77

Decision of the Presidium of the Supreme Commercial Court, April 18, 2000, Case 9490/99. Decision of the Presidium of the Supreme Commercial Court, March 10, 1998, Case 5624/97. In fact, there were three cases initiated by the same State Tax Inspectorate which resulted in the same conclusion by the Supreme Commercial Court (December 9, 1997, October 21, 1997).

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(3)

Juristic acts against the Requirement of Form and Registration

(4)

Fictitious and sham juristic acts

95

Fictitious juristic acts (mnimaia sdelka) are those acts effected solely for appearance without the intention of creating the corresponding legal consequences. Sham juristic acts denote those acts which are effected in order to conceal another act ( pritvornaia sdelka). Both kinds of juristic acts are void. In the case of sham acts, relevant rules applicable to the act which the parties genuinely intended to effect will be applied (Art.170). An example of a ctitious act is a case where assets are sold to a related party in order to avoid enforcement.78 An example of a sham act is a contract of gratuitous lease of a vehicle instead of sale in order to avoid paying state fees ( poshlina). Although the lease contract is void, provisions on sale are still applicable. A foreign trade organisation (FTO), Tekhmashimport, brought an action against an insurance company, Mikora, claiming 306,760 US dollars, of which 200,000 dollars accounted for the return of the insurance premium. The rst instance court acknowledged the claim, whereas the appellate court dismissed it. The Supreme Commercial Court, upon protest, quashed the judgments of the lower courts. Between the FTO and the insurance company, a contract of transfer of 10 million US dollars for trust management of three months was concluded on November 26, 1993. On November 30 of the same year, the parties concluded an accident insurance contract for employees for three months. According to this contract, the FTO was under an obligation to transfer 10 million US dollars to the account of Mikora within three days. The insured amount was 100 million US dollars. In the absence of accidents, the payment was to be returned to the FTO with 1% interest added. Moreover, the insurer was under an obligation to pay an insurance bonus of 6.5% of the insured amount. The Supreme Commercial Court found that the lower courts have failed to look at the transactions from the viewpoint of Article 168 of the Civil Code. More specically, the lower courts did not examine whether or not the conclusion of a contract of trust management was compatible with the Law on Banks and Banking Activities which lists such transactions as banking activities subject to license. The insurance contract contains a clause on the payment of bonus which is not normal in such contracts.

78

Decision of the Presidium of the Supreme Commercial Court, February 6, 2002, Case 2352/01.

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In the rejoinder, the FTO explained that the insurance contract had been concluded to replace the contract on trust management at the request of Mikora, since the latter did not have a license for banking activities, and besides, with insurance contracts, there was a favourable treatment of VAT. The case was remanded to the rst instance court in order to examine the genuine intention of the parties in concluding the insurance contract and whether or not it was concluded to conceal the contract of trust management.79

This provision may also be applicable in cases involving atypical security rights. The Civil Code has a stringent provision which prohibits the enforcement of real security rights. A practice has developed in which the parties agree to transfer title to the collateral to the creditor and have it returned to the debtor once the debt is repaid. Since the parties do not really intend to transfer the title to the collateral, and the intention is to conceal the pledge transaction, there is a possibility that this will be regarded as a sham act. The same applies to the use of specic performance (ostupnoe) [see Chapter 7 Means of Securing Obligations].

5)

Primary Categories of Voidable Juristic Acts

(1)

Acts of juridical persons beyond their capacity

Acts of juridical persons in contradiction to the purposes specied in their founding documents, or acts which were effected without license when license was required are voidable (Art.173). As mentioned above, ultra vires acts of any organisation had no effect whatsoever under socialism in disregard of bona de third parties. Under the present Code, these acts are merely voidable, i.e. they can be found invalid by court procedure. The scope of those entitled to take an action is limited to the juridical person itself, its founders (members), or state supervisory agencies. Such an action is only possible when the opposite party to the transaction had known or should have known that the act was ultra vires or lacked a license. In this way, a bona de third party is protected. The tax inspectorate of the city of Cherepovets applied to the commercial court for the recognition of 38 voluntary medical insurance contracts concluded by an insurance company (a branch of Inko-Tsentr) null and void on the basis of Article 169 (acts against the fundaments of the legal order) and sought to conscate the amount received by the company. Courts of all instances denied that Article 169 was applicable since this did not amount to an anti-social act, but the court of cassa-

79

Decision of the Presidium of the Supreme Commercial Court, July 30, 1996, Case 1606/96.

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tion instance found the contracts to be invalid on the ground of articles 173 and 168 instead, since the plaintiff had claimed that the branch did not have a license. The Supreme Commercial Court agreed to the application of Article 173, but remanded the case to the rst instance court in order to have it examined whether the opposite party was aware or should have been aware of the fact that the contract was against the law in the absence of a license.80

(2)

Juristic acts in excess of the granted power

If the power of a person to effect a juristic act is limited by a contract, or in cases of organs of a juridical person, restricted by a founding document in comparison with the power of attorney, law, or what is regarded as apparent under the circumstances where the act was effected, and the person exceeded such limits, the act is voidable, i.e. can be recognised by the court as invalid in favour of the person in whose interest the restriction was set. This is possible only when it is proven that the opposite party had known or should have known that the act was in excess of power (Art.174). Thus, this provision, as well as the preceding provision, is designed to strike a balance between the interest of the person who is represented and a bona de party which entered into a transaction: An open joint stock company brought an action against a bank claiming that the contract of pledge concluded with the bank was invalid. In this case, the general director of the company presented a resolution of the shareholders’ meeting authorising the transaction and an excerpt of the share register which showed that he held 56.6% of the shares. These documents turned out to have been falsied. The Supreme Commercial Court ruled that in appearance, there was no ground for the bank to suspect the authenticity of the documents, and ruled in favour of the bank.81

The restriction on the power of the corporate body needs to be included in the founding document. In a case where a company imposed a restriction on the power of the general director in concluding contracts, the court dismissed the argument that the contract concluded by the general director was invalid on the ground that the restriction was not accommodated in the founding document, i.e. the Articles of Incorporation, and instead, was merely in the protocol of the board meeting.82

Decision of the Presidium of the Supreme Commercial Court, July 14, 1998, Case 1173/98. Decision of the Presidium of the Supreme Commercial Court, February 11, 1997, Case 5688/96. 82 Decision of the Federal Commercial Court of the North-Eastern District, March 6, 2000, Sudebnaia praktika po grazhdanskim delam, Moscow 2001, p.277. 80 81

98 (3)

BASIC PRINCIPLES AND RULES OF PRIVATE LAW

Juristic Acts effected by Mistake

Juristic acts effected by a mistake which has an essential signicance are voidable. The court may recognise it as invalid at the suit of the person who acted under the inuence of a mistake. Essential mistake in this context means errors regarding the nature of the transaction, or the identity or other qualities of the object of the transaction which signicantly reduce the possibility of its use in accordance with its purpose. A mistake concerning the motive of the act is not regarded to have essential signicance (Art.178, para.1). Mistakes concerning the law are not considered either. The party, by whose action the juristic act was recognised by the court as invalid, is entitled to compensation if it is proved that the mistake had occurred by fault on the part of the opposite party. Otherwise, the mistaken party must compensate the other for any reliance loss (ibid., para.2). (4)

Juristic Acts effected under Fraud, Duress, Threat, by a Collusion between the Agent with the Counter Party, or by Combination of Harsh Circumstances

The common thread among the acts listed here is the distortion of the genuine will of the party, i.e. the party has been deprived of the possibility of effecting a juristic act in accordance with his genuine intention.83 There is also an element of “blameworthiness (uprechnost’)” of the opposite party which is reected in the consequence of such an act. In a case decided by the commercial court at the cassation instance, a director of a company colluded with another company and concluded a contract which was grossly disadvantageous for his company. The contract of lease in question was concluded immediately after he became aware that termination of his term as a director was included on the agenda of the extraordinary shareholders’ meeting. The court found this to be an abuse of power by the director and invalid by virtue of this provision.84 These acts are voidable upon action by the “victim ( poterpevshii )” (Art.179, para.1). If such acts are found to be invalid by the court, the opposite party must return to the victim everything he has received from the victim. On the other

83 84

Sadikov ed., Kommentarii . . ., second edition, Moscow 2003, pp.432-433. Decision of the Federal Commercial Court of the Central District, March 26, 2001, A542922/00-C8.

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hand, what the victim has received from the opposite party is not returned to the latter, but is transferred to the state (ibid., para.2). Acts effected under the combination of harsh circumstances are denoted as kabal’naia sdelka – a predatory transaction. It is dened as an agreement concluded under difcult circumstances in conditions more unfavourable to one party than those available to the opposite party. There was a similar provision in the 1964 RSFSR Civil Code which was claimed to be unique to Russia, but the German BGB has a provision on Wuchergeschäft which is similar.85 M, who was a party to the contract of sale of his at, argued that he was threatened that he and his family’s life would be in danger and was forced to sell it at an extremely disadvantageous price, while the market price was much higher. Although the lower courts failed to accept his argument, the Supreme Court accepted this and remanded the case to a new hearing.86

There are three requirements for a predatory act to be acknowledged as invalid; the act was effected i) under difcult circumstances, ii) in extremely unfavourable terms, and iii) against the will of the person involved.87 It is required that the transaction was effected under very harsh circumstances and not simply under unfavourable terms and the existence of the act of the opposite party which demonstrates that this situation has been exploited.88 In commercial transactions by juridical persons, in the period of market uctuation, entrepreneurs occasionally resorted to this provision and the court had to deal with them. In an unfavourable market situation, entrepreneurs often have to conclude transactions which are obviously disadvantageous to them, fearing that the economic situation would become even worse. These transactions are not predatory. Neither are miscalculated transactions by entrepreneurs.89

6)

Representation and Power of Attorney

Juristic acts do not have to be effected personally; they can be effected through a representative (agent) in the name of the principal. The power of the agent

85 86

87 88 89

Solotych, supra, p.36. See BGB Art.138, para.2. Exploitation of a difcult situation, inexperience, lack of the capability to make decisions and signicant weakness of mind are covered. Decision of the Collegium of the Supreme Court, August 29, 1997, cited in N.N.Averchenko ed., Grazhdanskii kodeks RF s postateinym prilozheniem sudebnoi prakitiki, Moscow 2005, p.334. Braginskii ed., Nauchno-prakticheskii komenntarii . . ., supra, p.294. Sadikov, fourth edition, supra, p.492. Ibid., p.492.

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may be based upon a power of attorney, law, or decisions granting such power by state or municipal agencies (Art.182, para.1). In addition to the provisions in Part One, General Part of the Civil Code, Part Two of the Code has a chapter on agency contracts [see Chapter 8]. While the term “representation” and “representative” are used in Part One, in Part Two, the term “agency” and “agent” are used. There does not seem to be any rationale for this distinction. An agent may not represent the principal in relation to himself. Nor may an agent effect a transaction with a person whom he simultaneously represents, except in cases of commercial representation (ibid., para.3). The Code has a special provision on commercial representation. Commercial agents are those who, on a continuous basis and independently, represent entrepreneurs and conclude contracts in the name of the entrepreneur in entrepreneurial activities (Art.184, para.1). Commercial agents are allowed to represent various parties simultaneously in the same transaction, but only with the consent of all parties (ibid., para.2). Commercial representation is based upon a written contract which species the power of the agent; if such a power is not specied, the agent acts on the basis of a power of attorney (ibid., para.3). Commercial agents are under an obligation to maintain condentiality of information on commercial transactions to which they became privy even after a given assignment has been performed (ibid., para.3). As a rule, juristic acts effected by a person who is not empowered to act in the name of another person or in excess of the granted power do not have any effect in relation to the principal. Such an act is deemed to have been effected in the name and interest of the person who acted as an agent, unless the other person (principal) later directly raties this act. Ratication makes the act valid in relation to the principal from the moment of the effecting of the act (Art.183). In order to authorise another person to act in one’s name, a power of attorney is needed. Power of attorney is an authorisation issued to another person for representation before a third party. It needs to be in writing. Power of attorney for effecting juristic acts which require notarisation also requires notarisation (Art.185, paras.1 and 2). Power of attorney in the name of a juridical person is to be issued with the signature of the general director or other persons empowered to do so by the founding document and with the seal of the organisation attached to it (ibid., para.5). Power of attorney for the purpose of receiving or granting money and other proprietary valuables in the name of juridical persons founded on the basis of state or municipal ownership must also have the signature of the senior accounting ofcer of the organisation (ibid.). The term of a power of attorney may not exceed three years. If the period of validity is not specied, it is valid for one year after its execution. Notarised power of attorney for use abroad is valid until the person who issued it cancels it (Art.186).

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The person who was granted a power of attorney must personally effect the act which he was empowered to do. This person may delegate this power if he is empowered to do so by the power of attorney, or was compelled to do so due to the force of circumstances for the purpose of protecting the interests of the person who issued the power of attorney (Art.187, para.1). The delegated power of attorney must be notarised (ibid., para.3). The person who delegated the power must inform the issuer of the power of attorney regarding the fact of delegation, and give necessary information about the person who has been delegated the power. Failure to perform this obligation entails the liability of the person who delegated the power for the act of the person who was delegated the power in the same way as this person (ibid., para.2). A power of attorney expires on the following grounds (Art.188, para.1): i) expiry of the term of the power of attorney; ii) rescission of the power of attorney by the issuer; iii) refusal of the person who was issued the power of attorney; iv) termination of the juridical person in whose name the power of attorney was issued; v) termination of the juridical person to whom the power of attorney was issued; vi) death, declaration of incapacity, limited capacity, or disappearance of the issuer (physical person); vii)death, declaration of incapacity, limited capacity, or disappearance of the person to whom the power of attorney was issued (physical person). The issuer may, at any time, rescind the power of attorney or its delegation (ibid., para.2).

7

PERIODS OF TIME AND LIMITATION PERIODS

(1)

Periods of Time

Periods of time established by law and other legal acts, juristic acts, or designated by the court are determined by calendar date or by the ow of years, months, days or hours. Periods of time can also be set by an incident which will denitely happen (Art.190). The period starts owing on the next calendar day or occurrence of the incident which determines the start of the term (Art.191). Periods counted by years expire on the xed month and date of the last year. Periods counted by months expire on the xed date of the last month. If the period counted by months ends in a month in which there is no corresponding date, the period expires on the last day of that month (Art.182). If the period

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expires on a non-working day, the date of expiry is the closest working day after this day (Art.193). If the period is xed for performing a certain act, the act must be performed by the 24th hour of the day. However, if such an act is to be performed by an organisation, the period expires at the time when this organisation, in accordance with established rules, nishes its operation. Written declaration and notication given to an organisation before the 24th hour of the last day of the period are deemed to have been given within the term (Art.194).

(2)

Prescription Period for Litigation

Litigation is barred by the lapse of time. The general period of prescription is three years (Art.196). There are some provisions which establish special periods of limitation as exceptions in the Code as well as in other laws. The Civil code provides for a 10 year prescription period for a claim to apply consequences of invalidity of a juristic act (Art.181). The Merchant Shipping Code provides for a 2 year general prescription period. The claim of the person whose right was infringed will be heard by the court regardless of the expiry of the period of prescription for action. Prescription is applied only upon the petition of the party before the court renders the judgment. In such cases, the court dismisses the case (Art.199). The limitation period starts, as a rule, from the day when a person became aware of, or should have become aware of the infringement of his rights. For obligations with a xed time of performance, the limitation period starts from the time the period for performance ends. For obligations in which the time of performance is not determined, or obligations which become due on request, the period starts at the time the right of the creditor to require performance emerges (Art.200, paras.1 and 2). The ow of the period of prescription is suspended in the following circumstances (Art.202, paras.1 and 2): i)

presentation of the claim to court was hindered by extraordinary and insurmountable circumstances; ii) the plaintiff or the defendant was in military service; iii) moratorium by the Russian Government based on law; iv) suspension of the law or legal act which regulates the performance of the obligation.

These circumstances must have emerged or continued in the last six months of the period.

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The ow of the limitation period is interrupted by the initiation of litigation or performance of an act by the obligee which demonstrates the recognition of the obligation (Art.203). If the court, in exceptional cases, acknowledges that there was a justiable ground involving personal circumstances of the plaintiff for the lapse of the period for prescription (serious illness, helpless situation, illiteracy etc.), the period of prescription is “restored” and the action is not barred (Art.205). The period of prescription for an action is not applied in the following cases (Art.208): i) claim for the protection of personal non-proprietary rights (Persönlichkeitsrecht) and other things of non-material value; ii) claim of the depositors on their deposit vis à vis the bank; iii)claim for compensation of damage caused to the life or health of an individual; however, for claims made after three years of the emergence of the right to claim compensation, the compensation shall only cover three years up to the initiation of litigation; iv)claim of the owner or possessor of property concerning removal of all violations of his rights, regardless of whether he was dispossessed or not.

In the celebrated Iukos case, Iukos was sued in 2004, among other matters, for the underpayment of tax in the period between January 1, 2000 and January 1, 2001. Article 113 of the Tax Code provides for a prescription period of three years. Yukos argued that the claim of the tax agency was barred by prescription. However, the Commercial Court of the City of Moscow ruled that norms of the tax legislation which provide rights or guarantees to tax payers in good faith do not extend to taxpayers in bad faith.90

90

Cited in the decision of the Constitutional Court of January 18, 2005, Case 36-O. The Constitutional Court declined to rule on the matter.

4 COMPANY LAW

1

HISTORY OF THE RUSSIAN COMPANY LAW

It was in the late 18th century that a company akin to a joint-stock company called the Russian-American Company was founded in Russia. Some more companies followed, and in 1836, the Statute on Stock Companies (aktsionernaia kompaniia) was enacted. It was the intention of Speranskii, when compiling Svod zakonov, to combine the civil and commercial codes, but for technical reasons, some of the commercial provisions had to be separated from the civil law. In the Svod zakonov, the part on civil law in volume X part 1 contained provisions on companies (tovarishchestvo) including joint stock companies. Most of the provisions on joint stock companies came from the 1836 Statute. The Statute on Commerce (ustav torgovyi ), which was accommodated in volume XI part 2 of the Svod zakonov, also had some provisions on commercial companies such as full partnership, limited partnership, limited liability companies and joint-stock companies.1 This was obviously insufcient, and attempts were made to modernise company law. The draft Civil Code ( grazhdanskoe ulozhenie) of 1905 accommodated company law provisions in Book V – law of obligations. Some 160 provisions were allocated to joint stock companies.2 However, these attempts to enact a commercial code or a new law on joint-stock companies failed, and therefore, the 1836 Statute served as the basic law on joint-stock companies until the October Revolution.3

1 2 3

D.Nosenko ed., Ustav torgovyi, 5th edition, St.Petersburg, 1909. G.F.Shershenebich, Uchebnik torgovago prava, 7th edition, Moscow 1914, pp.20-23. Grazhdanskoe ulozhenie; proekt vysochaishche uchrezhdennoi redaktsionnaia kommisia po sostavleniiu grazdanskogo ulozheniia, St.Petersburg 1905. Shershenevich, supra, pp.128-129.

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After the Revolution, the Civil Code of the RSFSR was enacted in 1922.4 This was the beginning of the New Economic Policy, the period in which the Bolsheviks pursued a policy of mixed economy – socialist and market. The 1922 Code, which was close to the draft Civil Code prepared earlier in the century, incorporated provisions on commercial companies including limited liability companies and joint-stock companies.5 In 1927, a separate statute on joint stock companies was enacted.6 However, the government abandoned the New Economic Policy in 1928 and embarked on the course of “socialist industrialisation” which made commercial companies based upon private capital totally redundant. In fact, under a system in which the means of production was to be solely owned by the state, it was an anathema to allow the “accumulation of private capital”. Even small private entrepreneurial activities were banned under the threat of criminal penalties. It was only in 1988 that a limited scope of private entrepreneurial activity was legalised. The newly enacted Law on Co-operatives allowed individuals to form and invest in co-operatives and perform entrepreneurial activities as long as the size of business remained small and others were not employed.7 Cooperatives were allowed to operate outside the state economic plan and to determine the price of the product by themselves. It was a monumental piece of legislation allowing de facto companies to be set up by individuals. By 1990, there were around 210,000 co-operatives, but with the liberalisation of various forms of companies, they were converted into companies and the number declined. In the socialist period, there were no commercial companies; instead, there were state enterprises which were solely owned by the state.8 In place of company law, there was the Law on State Enterprises which was part of the administrative law. This Law regulated the vertical relationship between the ministries and enterprises rather than the horizontal relationship between the enterprises. Under the planned economy, state enterprises conducted business in strict conformity with the state economic plan. The autonomy of these enterprises was severely limited, although they were granted juridical personality and had a separate balance sheet. In the absence of the market, prices were determined by the state economic plan. State enterprises did not have the power to dispose of their income and make investments. They did not even have the power to conclude a contract unless so mandated by the plan. It was only towards the end of socialism that state enterprises came to be granted some autonomy.

4 5 6 7 8

SU RSFSR, 1922 No.71, item 904. An English translation can be found in Gsovski, Soviet Civil Law, vol.2, Ann Arbour 1949. SZ SSSR, 1927 No.49, item 499. VVS SSSR 1988 No.22, item 355. Some foreign trade organisations and other entities were joint-stock companies, but the state was the sole shareholder.

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107

Following the USSR Law on Ownership of March 6, 1990, which signicantly expanded the scope of private ownership, the USSR Law on Enterprises was enacted on June 4 of the same year.9 This Law referred to joint stock companies and other forms of commercial companies based upon “collective ownership” without going into much detail. The next year, on May 31, the USSR Fundamental Principles of Civil Legislation was enacted. This Law, for the rst time in the history of Soviet law, accommodated provisions on various commercial organisations, including joint-stock companies and limited liability companies.10 At the RSFSR (now the Russian Federation) level, the Law on Ownership and the Law on Enterprises and Entrepreneurial Activities were enacted on December 24 and 25, 1990 respectively.11 The former allowed ownership of “enterprises and property complexes” by individuals. The latter Law was the rst piece of legislation which can be characterised as company law. In a way similar to the 1922 Civil Code, it listed full and limited partnerships, limited liability companies and joint-stock companies as basic types of companies. However, there was some confusion; the legislature seemed to have failed to distinguish between limited liability companies and closed type joint-stock company. On the same day, the RSFSR Statute on Joint Stock Companies was enacted. As a result of these legislative developments, companies owned by private capital mushroomed in Russia. This was accelerated by the privatisation of state enterprises, in which state enterprises were converted into joint-stock companies. However, it was only by the enactment of the present Civil Code (Part One) on October 21, 1994, that a detailed regulation on companies emerged.12 As the Civil Code was based upon the unied system, i.e. civil and commercial laws were combined in the Code, it contained fairly detailed provisions on companies in the part dealing with juridical persons. Regulations contained in the Civil Code were still insufcient until the Law on Joint-Stock Companies was enacted on December 26, 1995.13 This was followed by the Law on Limited Liability Companies of February 8, 1998.14 A Russian economist pointed out that:15

9 10 11 12 13 14 15

VVS SSSR, 1990 No.25, item 460. VSND SSSR i VS SSSR, 1991 No.26, item 766. VSND RSFSR i VS RSFSR, 1990 No.30, item 418. SZ RF, 1994 No.32, item 3301. Law No.205-FZ of December 26, 1995. Law N.14-FZ of February 8, 1998. A.D.Radygin et als., The Problem of Corporate Governance in Russia and its Regions, Moscow 2002, p.52.

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the period between 1993 and 1996 became notorious for the wildest violations of corporate law caused by struggle for control: crossing out an undesirable stockholder from the register, voting at shareholder general meetings by simple rising hands rather than according to the “one share one vote” principle, solving conicts using power structures (including government ones), etc.

A commentary to the Law on Joint Stock Companies described the actual state of affairs as follows: The practice of application of the Law on Joint Stock Companies has demonstrated that in reality, in large joint stock companies which are banks, insurance companies, and investment funds. . . . and in companies established as a result of privatisation, it has become a rule to fend off a majority of shareholders from participating in the management of the respective organisation. Infringement of the proprietary rights of the shareholders of these organisations is not rare.16

Since Russian companies tend to be dominated by insiders, the management often ignored the shareholders’ rights in order to secure control over the company. A survey in Russia shows that the dominating role in the management as well as in the distribution of the prots was played by the top executives of these companies; second came the “higher management (administratsiia)”. It was pointed out that “all these things such as registrars of shares acting in bad faith, agrant breach of laws (which themselves are “super liberal” for the management), manipulation of the procedure for the general shareholders’ meeting, allow us to talk about the dominance of the top executives”.17 A judge of the commercial court explains as follows: Many corporate conicts are related to the desire of minority shareholders to take control of the company, in other words, manage the company against the will of the holder of the controlling stake. Why should the holder of the controlling stake hold the general shareholders’ meeting in breach of law, if, at the meeting, a resolution in his interest can be adopted any way? . . . . In a situation where the holder of a controlling stake is unwilling to dispose of the shares, but at the same time, is not willing to adopt a resolution needed by the minority shareholder, the latter adopts the resolution by himself. In doing so, the minority shareholder violates the procedure for convening and conducting the general shareholders’ meeting, and even resorts to criminal offences (theft of shares, falsication of documents and signets,

16 17

M.Iu.Tikhomirov ed., Kommentarii k federal’nomu zakonu ob aktsionernykh obshchestvakh, Moscow 1999, p.11. G.Klein, “Upravlenie korporativnymi predpriiatiiami v perekhodnoi ekonomike”, VE 1999 No.8, p.68.

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falsication of evidence etc.). The primary goal of this operation is to replace the general director with someone who will loyally implement the instruction of the minority shareholder. . . . By unlawfully appointing his own directors (taking over the management of the company), the minority shareholder immediately disposes of the most liquid assets of the company in the hope that the assets cannot be recovered from a bona de acquirer.18

Some organisations have conducted research on the state of corporate governance in Russia. According to those sources, typical breaches include:19 i) unlawful refusal of share registration; ii) preventing shareholders from taking part and voting in the shareholders’ meeting; iii)dilution of shares of existing shareholders by the issuing of additional shares; iv)asset-stripping by transfer pricing and other means, by holding companies; v) conict of interests and abuses of power by directors and members of the executive bodies.

OECD has been making efforts to facilitate improvements of corporate governance in Russia. A White Paper on Russian corporate governance was published in 2002. This was followed by the adoption of the Code of Corporate Governance in line with the OECD guideline. There were proposals to amend the Law on Joint-Stock Companies, particularly in order to curb abuses by the management, and a bill was submitted to the Duma in 1999. However, due to some pressure from large companies resisting introduction of “constraints” on corporate governance, the adoption has been delayed. It was only in August 2001 that a fairly substantial amendment was introduced. The changes took effect from January 2002. The 2001 amendment was a major step towards improvements in corporate governance. A foreign observer rather prematurely commented that corporate governance had receded as an issue because of changes in both legislation and management attitudes.20 However, the OECD White Paper on Corporate Governance in Russia presented a different view:21

Dobrovolskii, “Sudebnaia zashchita prav aktsionera (uchastnika) – vopros pravoprimeneniia”, VVAS 2005 No.4, p.139. 19 Institute of Corporate Law and Corporate Governance ed., Corporate Governance in Russia, Moscow 2000, pp.5-9; A.Ledeneva, Unwritten rules: How Russia really works, London 2001, pp.17-31. 20 Petroleum Review, February 2002, p.15. 21 OECD, White Paper on Corporate Governance in Russia, 2002, p.9. 18

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. . . amendments to the JSC Law adopted in 2001 provide enhanced protection of shareholder rights, attempting to close various loopholes for abuse in potential major and interested party transactions. However, during the long delay between its rst reading in April 1999 and its nal enactment in August 2001, changes were made in some instances that weakened the provisions of the initial draft.

The 2001 amendments to the Law on Joint Stock Companies have removed some loopholes in the Law. Blatant breaches of the rights of shareholders by the management may have decreased in number, but certainly, there is still more room for improvement. Abuses by the company management at the detriment of the interest of minority shareholders including foreign ones still remain.

2

PRIVATISATION OF STATE ENTERPRISES

In present day Russia, the majority of large companies are either former state enterprises which have been privatised or companies which have been spun-off by state enterprises in the process of privatisation. According to a survey data on the form of enterprises in four cities, 83.9% of the joint stock companies are privatised former state enterprises.22 Many of the co-operatives established after 1988 were later transformed into companies. In addition to those companies, there are “unitary enterprises” – Federal enterprises and enterprises of the constituent entities, which have not been privatised yet, or are not planned to be privatised.23 In a market economy, private enterprises, not state enterprises, play a major role. Naturally, a sizeable private sector cannot develop in a short time span from scratch. In a country which had almost no private sector (except the “second economy”), and where there was no “original accumulation of capital”, in order to create a market economy, the capital has to be transferred from the existing state sector to the private sector. Besides, towards the end of socialism, the enormous state sector which had developed over the decades in Russia was not sustainable any more. Furthermore, in order to alleviate the burden on the budget and to generate income, privatisation of state enterprises was inevitable. Even before the formal privatisation process began, privatisation of state enterprises in Russia had already started in a “spontaneous” manner after the enactment of the 1988 Law on Co-operatives. As a Russian author put it, “the

S.Clarke and V.Kabalina, “Employment in the New Private Sector in Russia”, Post-Communist Economies, 1999 No.4, p.430. 23 Russian Academy of Science, Institute of Economy in Transition ed., Russian Economy – 1999, Annual Report, Moscow 2000, p.158. 22

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process of “allocation” of state property got under way long before the adoption of ofcial decisions on privatisation”.24 State enterprises set up co-operatives to avoid state interference with their business activities. This was understandable, since it was much more protable to sell their products through co-operatives which were not bound by the state plan. What was more, prots could be distributed among members without surrendering them to the state. Thus, there was a large-scale erosion of state property – unofcial transfer of assets from state enterprises to cooperatives. In 1989 the USSR Fundamental Principles of Lease was enacted.25 Together with the Law on Cooperatives, this was a breakthrough against the principle of the state monopoly of means of production. The Law allowed non-gratuitous lease of various means of production by state enterprises to juridical persons as well as physical persons. Lessees were even granted the right to purchase the assets, including enterprises. Soon afterwards, the USSR Law on Enterprises allowed state enterprises to spin off part of the enterprise as a separate, non-state enterprise.26 In practice, the process was grossly abused by insiders, i.e. ofcials of sectoral ministries and the management of state enterprises as well as the employees. Government ofcials and the management colluded to transfer part of the state enterprise to newly set up companies whose founders were those ofcials and executives. These companies leased and eventually purchased the assets of the state enterprise at a low price. Such insider privatisation was dubbed “nomenklatura privatisation”.27 Russian economists reminisced ten years later: . . . . with the collapse of the state control over enterprises, on the one hand, and the absence of the legal basis for private ownership on the other hand, the seizure and maintenance of control were effected by forceful methods with the connivance of the criminal network and bribery of state and party ofcials traditionally responsible for the control of enterprises.28

The formal legal basis for privatisation was created by the RSFSR Law on Privatisation of July 1991 (replaced by a new Law in 1997 and then in 2002).29 The

24 25 26 27 28 29

A.Letenko and D.Lvov, “Problems of Ownership and Privatization in Russia”, in J.Prokopenko ed., Privatization: Lessons from Russia and China, ILO Working Paper, Geneva 1998, p.21. VVS SSSR, 1989, No.25, item 481. VVS SSSR, 1990, No.25, item 460. J.Tedstrom, “Russia; Progress Report on Industrial Privatization”, RFE/RL Research Report, 1992 No.17, pp.46-48. A.Radygin and I.Sidorov, “Rossiiskaia korporativnaia ekonomika: sto let odinochestva?”, VE, 2000, No.5, p.47. Law No.178-FZ of December 21, 2001.

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COMPANY LAW

Law provided for four methods of privatisation: tender, auction, public offer of shares, and lease buy out. This Law gave signicant privileges to employees. Then, in July 1992, a presidential decree introduced the system of voucher privatisation modelled on the Polish scheme. The nominal value of a voucher was 10,000 roubles. Vouchers distributed among citizens free of charge (for a handling charge of 25 roubles) could be used for the purchase of shares of enterprises being privatised or could be sold to others. One-third of state enterprises were exempted from this privatisation programme for various reasons. According to the State Privatisation Programme of 1992 adopted by a presidential decree, there were three alternative methods of privatisation: i) 25% free distribution of non-voting shares to employees, a further 10% sale to employees with a 30% discount and 5% sale to the management. Remaining shares to be sold by voucher auction or tender; ii) 51% of voting shares sold to employees (including managers) at nominal value. Remaining shares to be sold by voucher auction and/or tender; iii)a group of trustees (employees and managers) assume the responsibility of implementing privatisation, restructuring the enterprise and preventing bankruptcy. In exchange, they are given an option of purchasing up to 30% of the voting shares, while other employees and managers may purchase another 20% of the shares.

Naturally, the second alternative was the most popular. As many as 77% of state enterprises which took part in this scheme opted for the second variant.30 In fact, there were few incentives for state enterprises to sell their shares for vouchers, since it did not bring any income and there was a risk of losing control to outsiders. The average proportion of shares sold for vouchers was a mere 21%.31 In a well-known car company ZIL, 12% of shares were distributed free of charge to employees. A further 12.5% were sold to employees at a discount price. 50% of the shares were offered to the public, of which 30% were sold by auction in exchange for vouchers.32 Quantitavely, voucher privatisation was a success. By 1994, 16,464 large and mediuem sized state enterprises were privatised. Already by the end of 1993, 98% of the vouchers had been used, and more than 4 million people became shareholders. In terms of quality, whether or not the scheme was successful is questionable. The control exercised by the sectoral ministries over the enter-

30 31 32

P.Rutland, “Privatisation in Russia: One Step Forward: Two Steps Back?”, Europe-Asia Studies, 1994 No.7, p.1113. Ibid., p.1116. EiZh, 1993 No.11, p.10.

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prises almost disappeared, but instead, these enterprises came to be dominated by insiders, namely the incumbent managers.33 Managers often abused their power and forced the employees to hand over their shares to the management. Since the voucher auction took place at the local level, the local authorities had opportunities to exclude “undesirable outsiders”. In this way, managers purchased shares by auction as well as from the employees much more than was envisaged by the privatisation programme.34 Some of the auctions were conducted in a fraudulent manner. Thus, Gazprom allowed only individual investors to take part in the auction, while excluding foreign and professional investors. The general director of the GAZ managed to purchase a signicant number of shares by using the loan from the government. Prices of the shares at the auction were substantially undervalued.35 In 1996, state enterprises (Federal and the constituent entities) accounted for 14.3% of the companies and organisations. This percentage fell sharply towards the end of the 1990s, and in 2005, these enterprises accounted for only 3.6%. In contrast, private ownership accounted for 79.2% in 2005. While in 1992, 62.9% of employees worked for state enterprises and organisations, this fell to 44.7% in 1994, and 38.3% in 1998. In 1998, 41.8% of workers were employed by the private sector.36

Table 4 Progress of Privatisation

Number of Privatised Enterprises Federal Entities of the Federation Municipal

1993

1994

1995

1996

1997//

2002

2003

2004

42,924

21,905

10,152

4,997

2,743

2,557

434

502

7,063

5,685

1,875

928

374

86

161

121

9,521 26,340

5,112 11,108

1,317 6,960

715 3,354

548 1,621

226 2,245

152 121

246 135

Federal Statistical Service, Rossiiia v tsifrakh 2005, p.165.

33 34 35 36

V.Andreev, Rossiskaia privatizatsiia: podkhody in posledstviia’, VE, 2004, No.6, p.63. Ibid., pp.63-64. Ibid., p.64. Clarke and Kabalina, supra, p.425.

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At the Federal level, according to another source, as late as August 2001, the state had a stake in 3,949 enterprises. In 88 of them, the state had a 100% stake.37

Table 5 Major objects in Federal ownership and privatisation program of the 2000s

Total number of FSUEs Number of FSUEs privatized during one year: - Forecasts - Actual number Joint-stock companies whose blocks of shares are owned by RF Including by share in charter capital - 100% - 50-100% - 25-50% - less than 25% - “golden share” Federal blocks of shares sold during year: - Forecasts - Actual number

1999*

2000

2001

2002

2003

2004

2005

2006

13786

11200

9394

9846

9275

8820

8293

-

-

-

2

5

1652 102

970 571

1374 517

1245 741

885 -

3611

3524

4407

4222

4035

3905

3524

-

382 470 1601 863 580

61 506 1211 1746 -

90 646 1401 2270 750

99 589 1382 2152 958

124 552 1308 2051 640

273 499 1183 1950 284

413 474 1093 1544 259

-

-

87

125

1126 112

1965 630

1702 565

566

383

Institute for Economy in Transition, Russian Economy in 2005, Moscow 2006, p.333

However, even in the process of formal privatisation, abuses were rampant. “Most of the privatisation activities seemed to be of dubious legality”.38 There was an overall lack of transparency in the process. Breaches of law occurred at the stage of creation, reorganisation or liquidation of enterprises. There were instances where State Property Committee ofcials were lobbied for decisions

A.Murav’ ev, “Gosudarstvennye pakety aktsii v rossiiskikh kompaniiakh”, VE, 2003, No.5, p.107. 38 Rutland, supra, p.1113. 37

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infringing the property interest of the state or of competitors. Managers of state enterprises “parachuted” into privatised companies, often with their contribution to the share capital in the form of “intellectual property highly overvalued.39 The “loans-for-shares” scheme introduced in 1995 was another example of a shadowy privatisation process in Russia. Banks were to provide a substantial amount of loans to the government. In return, the government was to offer shares of major state enterprises yet to be privatised as security. The government picked up some attractive companies and offered them to the closed auction of the banks. In the auction, the bank which offered the largest amount of loan for each packet of shares was to win the auction. The prospects of the repayment of the loan were minimal, and in the end, the banks which won the auction, became the legitimate owners of these blue chip state enterprises. Banks which, at the same time, were the organisers of the auction made every efforts to reduce the number of participants in the auction and created conditions for themselves to win the auction.40 For example, in 1999, in the auction of 9% of the shares of a large oil company, an off-shore company based in Cyprus won the bid at a price only 5,000 US dollars higher than the starting price. Another off-shore company bid for 1,000 US dollars higher. “Self-acquisition” of the company was suspected.41 Nevertheless, there was only one case where the commercial court found an auction to be invalid.42 The result of this scheme was that a selected number of nancial groups who were close to the president managed to acquire the “jewerly” of the industry at an extremely low price.43 The scheme increased the concentration of shares in several key industries, strengthening a limited number of business groups and creating the notorious “oligarchs”.44 Foreign investors were allowed to take part in the privatisation process with some restrictions. According to the 1993 presidential decree, for privatisation of the defence industry, oil and gas companies, transport and communication companies etc., special permission of the government was required for foreign investors to acquire an interest. The 1997 Privatisation Law had a list of properties which can only be privatised with the exclusion of foreign physical and juridical persons as well as Russian resident companies with the participation of these persons. There was confusion when a law enacted in 1998 addressing the disposal of government-held shares in energy companies set a limit on the

39 40 41 42 43 44

Letenko and Lvov, supra, p.24. Andreev, supra, pp.70-71. Institute of Economy in Transition, supra, pp.154-155. Andreev, supra, p.71. Ibid., p.71. V.Volkov, “Hostile Enterprise Takeovers: Russia’s Economy in 1998-2002”, Review of Central and East European Law, 2004 No.4, p.531.

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holding of shares by foreign shareholders at 25%. In fact, in some of the companies, the holding of shares by foreign investors had already exceeded 30%, and in 1999, it further went up to 33%.45 The privatisation process understandably slowed down after 1998 in the wake of the nancial crisis, but was renewed in 2000. The number of state and municipal enterprises which were privatised remained over 2200 every year, and then fell to 434 and 502 in 2003 and 2004 respectively.46 State enterprises which were privatised in 2001 included Slavneft and Magnitogorsk Metallurgy Kombinate. However, “the absence of an effective law enforcement system and a developed market infrastructure inhibited privatisation as before”.47 Under such circumstances, it is not surprising that “genuine outsiders” and “bona de investors” are apprehensive of the opaque process of privatisation. This is compounded by potential “deprivatisation”. Since a signicant number of cases of privatisation have been conducted in breach of the law, there is always a possibility of the contract being nullied and the assets being ordered to be returned on the initiative of the Procuracy. A deputy procurator of St.Petersburg initiated an action “for the protection of state and public interest” at the Commercial Court of St.Petersburg and Leningrad Province against the Property Fund of St.Petersburg, a US company, and other entities. The deputy procurator asked the court to declare void the sale of shares of the state enterprise “Leninets” by an auction based upon privatisation vouchers of September 13, 1994 and order the shares to be returned to the Property Fund. The rst instance court and the appellate instance court dismissed the claim, but the court of the cassation instance accepted the claim of the deputy procurator. The court found that the auction was against the State Programme of Privatisation of State and Municipal Enterprises approved by a presidential decree which placed restrictions on foreign companies taking part in the privatisation process. The enterprise “Leninets” supplied more than 30% of its products to the military and therefore, foreign investors should not have been allowed to take part in its privatisation. The court ordered the US company to return the shares to the property fund, but refused reimbursement of the vouchers to the US company, since at the time of the judgment, privatisation vouchers had no value. Besides, vouchers were eventually received by the State, and the property fund was not in a position to reimburse privatisation vouchers. Thus, the US company had the shares taken away, but failed to receive any compensation.

45 46 47

Institute of Economy in Transition, supra, p.149. Federal Statistical Ofce, Rossiiav v tsifrakh 2005, Moscow 2005, pp.174-175. Andreev, supra, p.73.

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Upon protest, the Supreme Commercial Court upheld the judgment of the court of cassation instance in that the auction was void. However, the Court modied the judgment to the extent that the Property Fund was ordered to return the nominal value of the vouchers, 50 million roubles, to the US company by applying Art.167, para.2 of the Civil Code.48

In this case, the US company eventually managed to retrieve the investment. But this may not always be the case. The problem here is that there is no mechanism to protect the bona de party from the nullication of the transaction by the court.

3

STRUCTURE OF CORPORATE OWNERSHIP IN RUSSIA

A conspicuous characteristic of corporate ownership in Russia until the mid1990s, particularly in privatised companies, was the dominance of insiders. The scheme of the 1992 Privatisation Programme itself was designed to favour insiders. In the companies privatised between 1992 and1993, 48% of the shares belonged to employees, 19% to the management, and 20% to the state.49 . . . top managers had a signicant priority in realising their property rights, capturing private benets from controlling sales and nancial ows. For several years, insiders made up a closed and change-resistant group centred on the former Soviet directors – most of whom did not want or could not afford a decisive restructuring (often for fear of social instability), shielding their enterprise from market pressure and outside contenders.50

However, the situation has substantially changed since then. According to a Russian economist, two basic trends regarding corporate ownership can be identied. First is the rise of managers and the second is the growing “invasion” of outsiders.51 This is in contrast to the dominance of insiders, namely employees, in the earlier period. Perhaps one can add a third trend, which is the shift to the concentration of shares in the hands of block shareholders from dispersed share ownership created by privatisation.52

48 49 50 51 52

Decision of the Presidium of the Supreme Commercial Court, September 16, 1997, case 3212/97. Murav’ev and Savul’kin, supra, pp.86-87. Volkov, supra, p.541. Radygin, supra 2003, p.51. Ibid., p.52.

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According to a survey by the State Property Committee, by 1994, the proportion of workers’ collectives holding more than 50% of the shares of a company went down by 20%, while joint stock companies in which the management held more than 10% shares went up to 20%.53 By 1996, although insiders held 58%, of which the management held 18%, outsiders held 32%, which was an increase from 1994 when they held 21%.54 A survey of 100 joint stock companies conducted in the mid-1990s showed that 60% of companies had “outsider” shareholders. The average share of large outside shareholders was over 25%. On the other hand, managers held over 40% shares in privatised former state enterprises, while in ordinary companies, their share was around 17%.55 Since 1995, an increase of the portion of shares held by outsiders can be seen (35.2% to 42.4%), while the share of insiders fell from 54.8% to 42.4%. Among insiders, shares held by employees fell from 43.6% to 31.5%.56 The increase in the share of outsiders is attributed to the need for external nancing. This may also be attributed to the fall in the ofcially registered management stake, i.e. the management chose to hold shares not in a direct manner, but through intermediaries, and thus, technically, became outsiders.57 However, it is not clear whether there was a genuine shift of control from the management to outsiders, or whether the management still holds control via insiders. There was a further decrease of insiders and increase of outsiders since the 1998 nancial crisis. The share of insiders fell from 55-60% in 1996 to 30-35% in 2000, while the share of outsiders increased from 30-35% to 50-55% in the same period.58 This is said to have been caused by the “post-crisis concentration of ownership”.59 A mass sale of small packages of shares in the state enterprises at low prices contributed to this process, but in general, the sharp downfall in shares in the stock market enabled block shareholders to increase their stake and for outsiders to acquire a stake.60

53 54 55 56 57 58 59 60

Letenko and Lvov, supra, p.29. Andreev, supra, p.64. E.Gubin, Upravlenie i korporativnyi kontrol’ v aktsionernom obshchestve, Moscow 1999, p.102. R.Kapeliushinikov, “Krupneishie i dominiruiushchie sobstvenniki v rossiiskoi promyshlennosti”, VE, 2000, No.1, p.102. A.Radygin and S.Arkhipov, “Ownership Structure and Financial Position of Firms in Russia: Empirical Analysis”, Russian Economic Trends, 2001 Issue 2, p.20. A.Radygin, “Sobstvennost’ i integratsionnye protsessy v korporativnom sektore”, VE 2001 No.5, p.27. Ibid., p.27. Radygin et als, The Problem. . . ., supra, p.57.

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Table 6 Ownership structure of Russian industrial enterprises (1) Category of Shareholders

1995

1997

1999

Insiders Total

54.8

52.1

46.2

Managers

11.2

15.1

14.7

Employees

43.6

37.0

31.5

Outsiders Total

35.2

38.8

42.4

25.9

28.5

32.0

9.3

10.3

10.4

9.1

7.4

7.1

Non-Financial Financial State Others Total

0.9

1.7

4.3

100%

100%

100%

(R.Kapeliushinikov, “Krupneishie i dominiruiushchie sobstvenniki v rossiiskoi promyshlennosti”, VE, 2000, No.1, p.102)

The average share of the largest shareholder varies from 28% to 42%, depending on the samples.61 It should also be noted that despite privatisation, the state still has a signicant stake in some companies. According to government statistics, as of August 2001, the Federal Government had a stake in 3,949 enterprises, of which 100% in 88, more than 50% in 623 enterprises, 25-50% in 1,393 enterprises and less than 25% in 1,843 enterprises. In 542 companies, the government has a golden share.62 Concerning golden shares, since 1997, the state has the right to appoint a member of the board of directors and the audit committee, and also enjoys the same right given to shareholders with more than 2% of the shares. In the mid-1990s, large business conglomerates, which are termed nancial industrial groups, emerged. In mid-1997, there were 70 such groups which integrated more than 1,000 industrial companies and 90 nancial institutions.63 In a nancial industrial group, companies combine their resources on the basis of an agreement to create a group for economic integration, realisation of various projects and a programme for the increase of revenues, competitiveness, efciency, and expansion of market shares. Member companies are industrial

61 62 63

A.Yakovlev, “Evolution of Corporate Governance in Russia: Government Policy vs. Real Incentives of Economic Agents’, Post-Communist Economies, 2004 No.4, p.391. A.Murav’ ev, supra, p.107. E.Utkin and M.Eskindarov, Finansovo-promyshlennyie gruppy, Moscow 1998, p.7.

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COMPANY LAW

Table 7 Ownership structure of Russian industrial enterprises (2) Categories of

1995

1997

1999

2001

2003

2005

shareholders

2007 forecast*)

54

52

50

50

50

48

56

1. Managers

11

15

15

19

25

31

36

2. Enterprise employees

43

37

34

28

22

16

15

**)

**)

1

3

3

1

5

Outsiders total

37

42

42

42

45

45

40

4. Outside individuals

11

15

20

22

21

20

16

5. Other enterprises

16

16

13

12

15

18

15

Insiders, total

3. Afliated rms***)

6. Commercial banks

1

1

1

1

1

0

1

7. Investment funds

4

4

3

3

2

2

0

8. Holding companies

4

4

3

4

5

3

7

9. Foreign investors

1

2

2

0

2

2

2

10. The state

9

7

7

7

4

7

4

Grand total****)

100

100

100

100

100

100

100

Number of enterprises

136

135

156

154

102

101

65

*) Data of the 2005 survey. **) This heading was not distinguished in the survey. ***) Firms created by the respondent enterprise. ****) Column sum may not be equal to 100 due to rounding. S.Aukutsionek et als., Ownership structure of Russian industrial enterprises in 2005, Russian Economic Barometer, 2005 No.3, p.4.

companies and banks and other nancial institutions. The group has a core company, normally an “investment institution”, which is empowered to act on behalf of the member companies. This was obviously seen by the government as a positive development towards the developed-capitalism. Accordingly, the Law on Financial Industrial Groups was enacted on November 30, 1995.64 Among the rather general provisions in this Law, there was a questionable provision to the effect that member companies were jointly and severally liable for the debt of the core company. However, since the 1998 financial crisis, “the rule of the game has changed”.65 The crisis hit major bank-centred groups such as SBS-Agro and Ink-

64 65

Law No.190-FZ of November 30, 1995. H-H. Schröder, “El’tsin and the Oligarchs: The Role of Financial Groups in Russian Politics Between 1993 and July 1998”, Eurape-Asia Studies, 1999.

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ombank groups. Instead, Federal natural monopolies and “autonomous empires” that had emerged around large corporations have strengthened their positions.66 These groups were organised in the form of holding company groups. A large number of such company groups have developed in the energy and metal sectors. In the oil industry, Lukoil and Surgutneftegaz, known as “vertically integrated companies”, have expanded signicantly in the late 1990s. Such vertical integration can also be seen in the regions.67 In these holding company groups, although the subsidiaries retain some capacity for independent decision-making, nancial and commercial functions are concentrated in the holding company. Subsidiaries are often reduced to a mere production platform.68 It is not uncommon for the holding company to transfer pricing mechanisms, siphoning prots from the subsidiaries.69

4

TYPES OF COMPANIES

The Civil Code is the basic law which accommodates provisions on companies. Chapter Four, Part One of the Civil Code covers juridical persons. The Chapter begins with basic provisions on juridical persons, followed by a sub-chapter on commercial partnerships and companies, and then by sub-chapters on production cooperatives, state and municipal unitary enterprises, and non-commercial organisations. There are separate laws on joint stock companies, limited liability companies, non-prot organisations, and unitary enterprises. Commercial partnerships and companies are dened in the Code as “commercial organisations with a capital divided into participatory shares (shares) of the founders (members)”. Commercial partnerships (khoziaistvennye tovarishchestva) can be set up as full partnerships ( polnye tovarishchestva, corresponding to the German einfache Gesellschaft) or limited partnerships (tovarishchestva na vere, German Komanditgesellschaft). Commercial companies (khoziaistvennye obshchestva) can be established as joint stock companies (aktionernoe obshchestvo; AO), limited liability companies (obshchestvo s ogranichennoi otvetstvennost’iu, OOO), or companies with supplementary liability (obshchestvo s dopolnitel’noi otvetstvennost’iu). It is important to note that not only commercial companies, but also commercial partnerships have juridical personality.

Radygin et al., The Problem. . . ., supra, p.57. Institute of Economy in Transition, supra, p.147. S.Clarke, “A Very Soviet Form of Capitalism? The Management of Holding Companies in Russia”, Post-Communist Economies, 2004 No.4, p.411. 69 Yakovlev, supra, p.394. 66 67 68

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In a full partnership, partners are liable for the debts of the partnership in cases where the assets of the partnership are insufcient to cover the debts, i.e. partners bear unlimited liability. In a limited partnership, one or several partners who conduct entrepreneurial activities in the name of the partnership bear unlimited liability, while other partners are liable to the extent of their capital contribution. Since these two forms of commercial organisations involve unlimited liability, they are seldom utilised by foreign investors. Among commercial companies, the company with supplementary liability is perhaps the most unfamiliar. This exists in the Hungarian Company Act of 1988 (amended in 1997) which served as one of the models of Russian company law. It is a variation of limited liability companies. When the assets of the company are not sufcient to cover the debt, participants in this type of company are liable in a subsidiary way up to a xed amount, determined by the Articles of Incorporation in proportion to their participatory share. In reality, it is the joint stock companies and limited liability companies that are the most common forms of companies in Russia. Joint stock companies are dened in the Civil Code as companies whose capital is divided into a certain number of shares. Shareholders are not liable for the debt of the company and bear the risk of loss only within the amount of their contribution (Art.96). There are two types of joint stock companies; open and closed. Joint stock companies whose shares are freely transferable are open joint stock companies, while companies whose shares are distributed only among founders or other pre-determined persons are closed joint stock companies (Art.97, paras.1 and 2). The major difference between these two types of joint stock companies is that while in open joint stock companies, shareholders are free to transfer shares to those other than shareholders, in closed joint stock companies, other shareholders have pre-emption rights to purchase the shares on offer (JSCL Art.7). As a collolary, open joint stock companies may publicly offer and sell shares. Closed joint stock companies’ shares may not be offered to the public or to an unspecied scope of people (Art.97). Other differences are: i) The number of shareholders in closed joint stock companies may not exceed fty, while it is not limited in open joint stock companies (JSCL, Art.7, para.3); ii) Minimum capital for open joint stock companies is 1,000 times the statutory minimum wage, while it is 100 times for closed joint stock companies (JSCL Art.26); iii)Open joint stock companies are under an obligation to publicise their annual report, balance sheet, and prot and loss report to the general public (Art.97, para.1).

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The Civil Code denes a limited liability company as a company which is established by one or several persons whose capital is divided into participatory shares held by the members in accordance with the ratio (percentage or quota) determined by the Articles of Incorporation (Art.87, para.1). This is in contrast with joint stock companies in which the capital is “divided into a xed number of shares” (Art.96, para.1). Participants (holders of the participatory share) are not liable for the debt of the company and bear the risk of loss only within the amount of their contribution (Art.87). Differences between joint stock companies and limited liability companies are as follows:

Table 8 Comparison of Joint Stock Companies and Limited Liability Companies Limited Liability Companies

Joint Stock Companies

Sources of Law

The Civil Code and the Law on Limited Liability Companies

The Civil Code and the Law on Joint Stock Companies

Minimum Capital

100 times minimum wage

1,000 times minimum capital for open joint stock companies and 100 times for closed joint stock companies

Management Structure

Participants’ meeting, board of directors (optional), collective or single executive body

Shareholders’ meeting, board of directors, single executive body or single executive body plus collective executive body (companies with less than 50 shareholders can dispense with the board)

Transfer of Shares (participatory share)

Transfer to a third party subject to restrictions

In closed joint stock companies, transfer to a third party subject to restrictions

Withdrawal from the Company

Possible without the consent of other members; contribution to be paid back

Redemption of contribution not possible

Exclusion of Members

Exclusion from the company possible by an action by a 10% participant

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Table 8 (continued) Limited Liability Companies

Joint Stock Companies

Audit

Audit committee not mandatory; audit by an independent professional auditor not mandatory

Audit committee not mandatory with some exceptions; audit by an auditor

Issuing of Bonds

Possible up to the amount of the capital or of the guarantee provided by a third party

Possible; also convertible bonds can be issued

Disclosure

Public disclosure not required except when bonds are issued

Annual accounts to be published in open joint stock companies)

According to the statistics of the Federal Tax Service, in 2005, there were 168,583 joint stock companies, while there were 1,327,320 limited liability companies.70 However, according to the estimates of the State Statistical Service, 30-50% of these companies have stopped operating a long time ago.71 The proportion of open and closed joint stock companies is not accurately known. It has been assumed that there are six closed joint stock companies for one open joint stock companies.72

5

COMMON RULES ON JOINT STOCK COMPANIES AND LIMITED LIABILITY COMPANIES

1)

Liability of Shareholders (Participants)

In both types of companies, the risk of shareholders (participants) is limited to their contribution. However, the Civil Code has a couple of provisions which seem to set an exception to this principle. Thus, Article 56, para.3, after declaring that the founders (participants) of juridical persons are not liable for the debt of the juridical person “except in cases provided by the present Code or the founding documents of the juridical person”, provides as follows: If bankruptcy of a juridical person was caused by founders (members). . . ., or other persons who have the right to give binding instructions to the juridical person or in other ways, have a possibility of determining its activities, these persons shall bear

70 71 72

www.nalog.ru/html/prog/1UR_2005_01_01.xls A.Yakovlev, supra, pp.390-391. Ibid., p.391.

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subsidiary liability on its obligation in cases where the assets of the juridical person are insufcient.

The 1990 USSR Fundamental Principles of Civil Legislation had a similar provision, but it was applicable only when the act of the relevant person was unlawful. The Civil Code has dropped the requirement of unlawfulness. This provision was reproduced in the Law on Joint Stock Companies and the Law on Limited Liability Companies. However, as a result of criticisms from foreign investors, the Law on Joint Stock Companies which was enacted after the Civil Code added a paragraph to it (Art.3, para.3): Bankruptcy of a company is regarded as caused by an act (omission) of its shareholders or other persons who have the right to give binding instructions to the company, or in other ways have a possibility of determining its activities, only when they utilised such a right and/or possibility for the purpose of having the company perform a certain act, knowing that it would cause bankruptcy of the company.

On the other hand, the corresponding provision on the liability of the participants and other persons in the Law on Limited Liability Companies, which was adopted another two years after the Law on Joint Stock Companies, explicitly requires fault on the part of such persons, but does not contain the above paragraph (Art.3, para.3).

2)

Liability of the Parent Company

Another problematic provision in the Civil Code involves the liability of the parent company in relation to a subsidiary. A parent company is dened in the Civil Code as a company which, by virtue of an overwhelming ( preobladaiushchie) participation in the capital, by agreement concluded between the parties, or by other means, is capable of determining a decision which is adopted by another company (Art.105). This provision is repeated in the Law on Joint Stock Companies (Art.6) and in the Law on Limited Liability Companies (Art.6, para.2). The problem is that “overwhelming participation” does not necessarily mean a 50% or more stake. In fact, there is no xed percentage set by law. A commentary suggests that the percentage is not always decisive. Depending on the number and the spread of shareholders of the company, even a 10-15% stake may be regarded as a denitive inuence.73 Thus, even if the shareholding

73

Tikhomirov, supra, p.47.

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does not reach 50%, due to extremely dispersed share ownership structure, if a shareholder is capable of exercising certain inuence on the decision-making of the subsidiary, it can be an “overwhelming participation”.74 In contrast, afliated companies are numerically dened. The Joint Stock Company Law as well as the Law on Limited Liability Companies dene afliated companies as those companies in which another company has more than 20% voting rights (both laws, Art.6, para.4). The Civil Code provides as follows (Article 105): A parent company which has the right to give binding instructions to the subsidiary, including those by a contract, is liable jointly and severally with the subsidiary for a transaction concluded in implementation of such an instruction (para.2, section 2).

In cases of bankruptcy of the subsidiary, the parent company may be held liable. Thus, the same provision states: In cases of bankruptcy of the subsidiary by the fault of the parent company, the parent company bears supplementary liability for the debt of the subsidiary (para.2, section 3).

Furthermore: Participants of the subsidiary are entitled to demand compensation to the parent company for the loss caused to the subsidiary due to fault on the part of the parent company (para.3).

Article 105 is also reproduced in the laws on joint stock companies and limited liability companies. The Law on Joint Stock Companies limits the liability of the parent company as provided by para.2 section 3 by inserting a sentence identical to that provided in relation to the liability of shareholders; Bankruptcy of a subsidiary is regarded to have been caused by the fault of the parent company, when the parent company utilised the above right and/or possibility for the purpose of the performance of an act by the company, knowing that it would result in the bankruptcy of the company.

The liability outlined in para.2, section 3 is limited by the following sentence (Art.6, para.3):

74

O.N.Sadikov, Kommentarii k grazhdanskomu kodekusu Rossiiskoi Federatsii, chasti pervoi, 3rd edition, Moscow 2005, p.284.

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The loss shall be regarded to have been caused by the fault of the parent company only in cases where the parent company utilised its right and/or possibility for the purpose of causing the subsidiary to perform a certain act, knowingly that it would cause loss to the subsidiary.

The Law on Limited Liability Companies, which was enacted after the Law on Joint Stock Companies does not have the equivalent of such limiting provisions. It should be added that in both laws, there was no attempt to limit the liability of the parent company concerning transactions effected by the subsidiary upon the parent company’s instruction (para.2, section 2), which is in fact a sweeping provision which potentially puts burden on the parent company. There was a judgment of the commercial court at the cassation level to the effect that insofar as the loan agreement concluded by the subsidiary was actually an implementation of the instruction from the parent company, the parent company bears joint and several liability with the subsidiary.75 This virtually means that without any arrangement for a guarantee, the parent company may nd itself in a position as a guarantor of the subsidiary. Although it may be an isolated case, the following judgment of the Commercial Court of the Moscow Province acknowledged the liability of shareholders of a bank which became bankrupt: Co-owners of the RFG Bank were found to be liable for 23.5 million roubles. The Bank had its licence withdrawn, became bankrupt and was put under the control of the Deposit Insurance Agency. After the withdrawal of the license, a temporary administrator was appointed by the Central Bank. The administrator was unable to nd any documents or information on clients of the bank. Criminal prosecution of the managers was unsuccessful. The Agency then initiated an action against shareholders for the payment of the above amount, which was the difference between the registered amount of the creditors’ claim and the assets of the bank. These shareholders were pursued for liability not for any specic act, but for the failure to take any measures to prevent bankruptcy. The court cited Article 56, para.3 of the Civil Code which provides for the subsidiary liability of shareholders in cases where they had led the company to bankruptcy. According to the press, the Agency “unexpectedly” won the case.76

75

76

Decision of the Commercial Court of the North Kavkaz District, April 22, 2003, Case F08992/2003 cited in D.V.Lomakin, Sudebno-arbitrazhnaia praktika Federal’nogo zakona “ob aktionernykh obshchestvakh”, Moscow 2005, p.34. Cited in V.I.Dobrovol’skii, Problemy korporativnogo prava v arbitrazhnom prakitike, Moscow 2006, p.82.

128 3)

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Registration

Whereas in the Tsarist period, companies could be set up only with a concession of the government, now, registration is the only requirement. All juridical persons are subject to state registration and are deemed to be established on the day of registration (Civ.C Art.51). The system for registration of companies in the 1990s could be characterised at best as confusing. Local governments began setting up their own “registration chambers”, e.g. the Moscow Registration Chamber established in 1991. The Civil Code originally provided that juridical persons were to be registered by the Ministry of Justice in accordance with the Law on State Registration of Juridical Persons. However, this Law was not enacted until 2001, and therefore, until then, the “existing procedures” were applied. Registration of companies in which foreign investment did not exceed 100,000 roubles was effected by the local government, except for oil and gas production companies and rening companies as well as coal mining companies. The State Registration Chamber, which was established by government in 1994 and operated on the basis of a statute enacted by the Ministry of Economy, had jurisdiction over companies in the above-mentioned industries, and companies in which foreign investment exceeded 100,000 roubles.77 By the Decision of the Government of September 5, 1998, the Chamber was transferred to the Ministry of Justice in line with the Civil Code. The long-awaited Law on the State Registration of Juridical Persons was enacted in August 2001 and took effect in July 2002.78 Initially, it was thought that the registration would be handled by the Ministry of Justice and its territorial bodies, but in the end, it was the Federal Ministry of Tax and Levies (now the Federal Tax Service) which was entrusted with this task. The Civil Code was amended accordingly to accommodate this change. Details of registration are provided by an edict of the government.79 The Law covers not only the registration of commercial companies, but all juridical persons including non-commercial organisations. In 2003, the Law was amended to accommodate the registration of individual entrepreneurs. All these entities are entered in the Unied State Register of Juridical Persons (EGRIuL). It exists in documentary form as well as in an electronic form. The register contains, inter alia, the following information (Law Art.5, para.1):

77 78 79

A.Kramarenko, “Poriadok gosudarstvennoi registratsii kommercheskikh organizatsii s inostrannymi investitsiiami”, PiE, 1999 No.10, pp.12-17. Law No.129-FZ of August 8, 2001. Edict of the Government No.438 of June 19, 2002.

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i) full and abbreviated name of the company; ii) organisational-legal form of the company (OOO, ZAO, OAO etc.); iii) address of the permanent executive body of the company; iv) means of establishment (newly established or reorganised); v) information on the founders and the administrator of the shareholders’ list; vi) the original of the Articles of Incorporation or its certied copy; vii) share capital as indicated in the Articles of Incorporation of commercial companies; viii)name and positions of the persons who, without power of attorney, are entitled to act on behalf of the company, their passport number etc. and identication number as a tax payer if this applies; ix) information on the licence which the company holds; x) informationon the branches and representative ofces; xi) tax payer’s identication number etc.; xii) code of the economic activity in accordance with the Federal classication; xiii)date of registration and registration number with the pension fund, social security fund and medical insurance; xiv)bank account.

Naturally it is not only the establishment of companies which is subject to registration. Amendments to the Articles of Incorporation, reorganisation and liquidation of companies are also required to be entered in the Register. Information contained in the Register is open to the general public, except for the bank account numbers (Art.6, para.1). It should be noted that potentially, the Register is a major source of information on a specic company. With the payment of fees, any person can obtain not only an excerpt from the Register, but also a copy of documents led for registration including shareholders’ agreement and agreement of merger. Concerning companies which have a foreign founder, a copy of the commercial register of the founder in the home country is also available to the public. Documents required for registration are as follows (Art.12): i) application form for registration signed by the applicant; ii) resolution, or agreement to establish a company; iii)Articles of Incorporation (original, or a notarised copy); iv)excerpt from a register of foreign juridical persons of the respective country or proof of a similar nature of the status of the foreign founder of the company; v) receipt of payment of the registration fee;

In the application, it has to be conrmed that a) the submitted Articles of Incorporation are compatible with the requirements of the law, b) information contained in the documents submitted is truthful, c) in setting up the company,

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required procedure was observed including the payment of capital, and d) where necessary, consent of the relevant body has been obtained. Application for registration at the time of the establishment of a company is to be made at the tax inspectorate of the location of the company’s permanent management body (Art.13, para.1). Applicants are: the general director of the juridical person to be registered and others who are empowered to represent the juridical person without a power of attorney, founders of the juridical person, head of the juridical person which is to be a founder of the juridical person (Art.9, para.1). The rather cumbersome procedure was simplied by the 2003 amendments. While under the previous system, applicants had to go to the Registration Chamber and then to the Tax Agency to register as a tax payer and also visit the Government Statistical Agency to obtain a number, there is now a one stop shopping system. Whereas in the past, registration could take weeks, now by law, registration must be completed within 5 working days following the application (Art.8, para.1), but may still take longer. Registration can be refused only on the grounds specied by law, i.e. failure to submit the required documents, or submission of documents to the wrong registration ofce (Art.23, para.1). Refusal of registration can be contested in court. One of the problems with the Russian register was that those entities which had ceased to operate, nevertheless, seldom applied for the registration to be deleted. There were a substantial number of entities which were “dead souls”. The current arrangement is that if an entity fails to submit returns etc. required by the tax legislation and there is no operation involving the bank account for 12 months, it can be excluded from the Register (Art.21.1, para.1). The Law on Competition and Restrictions on Monopolistic Activities used to require approval by the Anti-Monopoly Agency (the Federal Anti-Monopoly Service) for the establishment of companies. The new Law on the Protection of Competition requires the advance approval of the Agency only in cases where a company is set up by very large companies.80 For the establishment of a company with foreign participation, Foreign Investment Law provides that such companies may be set up in accordance with provisions of the Civil Code and other laws (Art.20, para.1). Foreign investors are allowed to make investments in Russia in any form which is not prohibited by legislation (Art.6). As exceptions, investments which endanger the basis of the constitutional regime, ethics, health, rights and lawful interests of citizens,

80

Law No/135-FZ of July 26, 2006.

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national defence and public security can be restricted (Art.4, para.2). There are some other restrictions such as the registration found in the Aviation Code, which sets the maximum level of foreign participation at 49% in airline companies and requires that the top management be a Russian national.81 Companies with foreign investment are subject to state registration in accordance with the above-mentioned Law on the Registration of Juridical Person (Art.20, para.2).

4)

Afliates of Foreign Companies

Afliates of foreign companies are subdivisions of a company which perform all or part of the functions of the company. The concept includes both the branch ofces and representative ofces. Afliates of foreign companies are accredited by the State Registration Chamber, which is part of the Ministry of Justice.82 There is a Register of the Afliates of Foreign Companies. The procedure of accreditation is regulated by a provisional statute approved by the Ministry of Justice of December 21, 1999 and the Edict of the Council of Ministers of the USSR of November 30, 1989. For accreditation, foreign companies are required to submit: i) Application by the head of the company with the information on the business relationship with Russian partners, perspective of business cooperation in Russia, and the purpose of opening an afliate in Russia; ii) Articles of Incorporation of the company; iii)Certicate of Commercial Registration or its excerpt; iv)Decision of the foreign company to open an afliate; v) Letter of recommendation from the bank which services the company regarding the creditworthiness of the company.

Unlike in the procedure for setting up companies, a one-stop shopping system has not emerged yet. Therefore, registration with the tax inspectorate, the State Committee for Statistics, and extra-budgetary funds are required separately.

G.S.Shapkina ed., Postateinyi kommentarii k Federal’nomu zakonu “Ob aktsionernykh obshchestvakh”, second edition, Moscow 2000, p.83. 82 www.palata.ru. 81

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6

JOINT STOCK COMPANIES

1)

Procedure of Establishment

Joint stock companies may be created by setting them up anew as well as by “reorganisation”, i.e. by merger, absorption, division, spin-off, and conversion (JSCL Art.8). Division (razdelenie) means the termination of a company with the transfer of rights and obligations of that company to several new companies (Art.18), whereas in spin-off (vydelenie), the company remains, but one or several companies are created and part of the rights and obligations of the company is transferred to them (Art.19). Joint stock companies may also be founded by conversion from another type of company, such as a limited liability company. Companies are set up by the resolution of the founders adopted at the founders’ meeting. Companies can be founded by a single person, and in such cases, naturally this person can take his own decision. Physical persons as well as juridical persons can be founders of a joint-stock company. However, if there is only one founder, this person may not be another commercial organisation with a single founder. The number of founders is not limited for open joint stock companies, but for closed joint stock companies, the number may not exceed fty (Art.10, para.2). State and municipal agencies may not be a founders of a joint stock company, unless it is allowed by Federal law. On the other hand, they may take part in a company as a shareholder. On one occasion, the City of Moscow’s participation in a joint stock company was found to be lawful by the Supreme Court. However, in order to contribute state or municipal property to the capital, the procedure for privatisation needs to be followed.83 The founders conclude a shareholders’ agreement which determines, inter alia, the procedure for the joint activities regarding the establishment of the company, the amount of capital, the categories and types of shares to be issued, the amount and method of its payment, and the rights and duties of the founders in setting up the company. When approving the Articles of Incorporation and the value of contribution in kind, i.e. securities, other things as well as proprietary rights and other rights, the resolution of founders must be made by a unanimous vote. Members of the management bodies must be elected by a three-quarter majority (JSCL Art.9, paras.3 and 4).

83

Lomakin, supra, p.51.

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In principle, joint stock companies with foreign participation are set up in the same manner as other joint stock companies. There may be exceptional requirements, but these have to be provided for by Federal law. Founders bear joint and several liability for the debt related to the establishment and state registration of the company up to the moment of registration. The company is liable for the founders’ debt related to the company’s establishment, only when the company has subsequently approved the founders’ act at the shareholders’ meeting (JSCL Art.10, para.3). Joint stock companies issue ordinary shares and may also issue several types of preference shares. Issued preference shares may not exceed 25% of the capital. Shares must be nominal – no bearers’ shares are allowed (Art.25, para.2). Pre-ference shares, in general, do not have a vote, but instead, the holders enjoy preferential rights in receiving dividends and in the distribution of assets at the time of liquidation. At the time of establishment, all shares must be issued to the founders. This means that at this stage, there is no difference between open and closed joint stock companies. Public offer of shares is allowed only when the capital has been fully paid in, and within the framework of the increase of capital.84 In the process of establishment, full amount of contribution does not have to be paid in straight away, but it is sufcient if they are paid in by the founders within a period less than a year determined by the Articles of Incorporation from the time of registration. A minimum of 50% has to be paid in within three month after the registration (Art.34, para.1). This period has been extended by the 2001 amendments (before the amendments, at least 50% had to be paid in before the registration). If the shares are not paid, these shares are transferred to the company. Such shares do not have a vote. Shares (initial allotment among the founders as well as subsequent offers) can be paid in by money as well as securities, movables or immovables, or proprietary rights and other rights which have monetary value (Art.34, para.2). Although this provision seemingly allows the contribution of intellectual property rights, the decision of the Plenums of the Supreme Commercial Court and the Supreme Court of the Russian Federation denies this. “Shares cannot be paid by objects of intellectual property (patent, copyright including rights on computer programmes) and know-how”.85 Only the right to use these rights under license can be contributed. Presumably, this is intended to ensure that the contribution can be objectively valued.

84 85

V.P.Mozolin and A.P.Iudenkov, Kommentarii k Federal’nomu zakonu “ob aktsionernom obshchestve”, 2nd edition, Moscow 2003, pp.121-122. Item 17, Joint decision of the Plenums of the Supreme Commercial Court and the Supreme Court of July 1, 1996 No.6/8. See also Mozolin and Iudenkov, supra, p.177.

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In kind contribution at the time of establishment is to be valued by agreement of the founders. In such cases, an independent valuer has to be brought in (Art.34, para.3). Previously, this requirement was applicable only in cases where the payment exceeded 200 times the minimum wage, but this threshold was removed by the 2001 amendment. The valuation by the valuer does not mean that the value is determined by the valuer; it means that the company cannot set the value of contribution above the valuation. The value of in-kind contribution must be determined unanimously (Art.11). Payment in kind for additional issue of shares is to be valued by the board of directors in accordance with Art.77 of the Law.

2)

Articles of Incorporation

Joint stock companies operate on the basis of Articles of Incorporation. The Civil Code has general provisions on Articles of Incorporation for juridical persons. The Law on Joint Stock companies provides for mandatory items of the Articles of Incorporation for joint stock companies (Art.11): i) ii) iii) iv)

full and abridged name of the company; location of the company; type of company (closed or open); total amount, nominal value, category of shares (ordinary or privileged) and types of preferential shares issued by the company; v) rights of shareholders of each category of shares; vi) share capital of the company; vii) structure and competence of the company management bodies and the procedure of adopting decisions; viii)procedure of preparation and conducting of general shareholders' meeting including the list of matters which require qualied majority or unanimous vote; ix) information concerning branches and representative ofces; x) other information provided by the present Law.

In the Articles of Incorporation, the company may set a ceiling to the number of shares a single shareholder may hold and their total nominal value, as well as the maximum number of votes to be granted to a single shareholder (Art.11, para.3). This was supposedly meant to prevent concentration of excess power in a small number of shareholders.86 The ceiling can be very low. Thus, in the oil and gas

86

G.S.Shapkina ed., supra, p.53.

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upstream company Surgutneftegaz, the maximum a single shareholder can hold is set at 1% by the Articles of Incorporation. In Nizhneenergo, it is 0.5%. In this way, “undesirable outsiders” can be prevented from holding signicant block of shares.87 The Law refers to golden shares which are granted to the government of the Russian Federation, subjects of the Federation, or municipalities at the time of privatisation of unitary enterprises when the government holding falls under 75%. Information regarding the special participatory rights of these entities in the management of the company must be entered in the Articles of Incorporation on the basis of the respective decision of these entities (Art.12, para.4). This corresponds to a provision in the Law on Privatisation (Art.5). Those entities which hold golden shares are entitled to send one representative to the board of directors and the audit committee without the approval of the shareholders. These representatives must be government ofcials. Representatives of those entities take part in the general shareholders’ meeting with veto rights on matters such as the amendment of the Articles of Incorporation, reorganisation or liquidation of the company etc.88 There are more than 1,600 companies in which these entities have golden shares.89 As of 2001, the Russian Federation holds a golden share in 542 companies.90 In the light of the past history of Soviet civil codes which were strict on ultra vires, conspicuous omissions from this list as provided in the Law on Joint Stock Companies are the purpose of the company and the scope of its activities. The Civil Code provides that the name, location, procedure of administration, and other matters required by the law on the respective type of juridical person are mandatory in the Articles of Incorporation. The purposes of commercial organisations are a mandatory component of the Articles of Incorporation only when required by law (Art.52, para.2). This should be read in conjunction with the provision in the Civil Code on the legal capability of juridical persons. Commercial organisations, other than unitary enterprises and other types of organisations provided by law, have rights and bear the duties needed to perform any kind of business which is not prohibited by law (Art.49, para.1). It is possible to limit the capacity to act of a juridical person by the founding documents, which, in the case of joint stock companies, is the Articles of Incorporation. However, the excess of the scope of capability is not null and void as it used to be before. It is simply voidable by virtue of the Civil Code (Art.173).

87 88 89 90

Gubin, supra, pp.113-114. Mozolin and Iudenkov, supra, pp.8-9; Murav’ ev, supra, p.110. Radygin et als., The Problem. . . ., supra, p.50. Murav’ ev, supra, p.107.

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Changes to the Articles of Incorporation must be approved by the shareholders’ meeting. As a rule, such changes require a qualied majority vote of shareholders, i.e. three quarters of the votes present at the meeting (Art.49, para.4) and registered (Art.14, para.1).

3)

The Capital and Shares

(1)

The Capital

The share capital (ustavnyi kapital ) comprises the total amount of nominal value of shares acquired by shareholders. The capital determines the minimum amount of assets which serve as “a security of the interest of creditors” (Art.25). The minimum amount of capital for joint stock companies is set at 1,000 times the minimum monthly wage (approximately 4,000 USD) for open type joint stock companies and 100 times for closed type joint stock companies (Art.26). The Law refers to “declared shares”. The Articles of Incorporation may determine the number of such shares, their nominal value, category of shares, and the rights granted to the holders of such shares which the company is entitled to issue in addition to the already issued shares (Art.27, para.1). There is no limit to the number of shares which can be issued in this way, insofar as the number of newly issued shares is within the number of the declared shares as stated in the Articles of Incorporation (Art.28, para.3). This means that if the company intends to issue shares above the number of declared shares, it has to amend its Articles of Incorporation. However, the resolution of the shareholders to amend the Articles of Incorporation and the resolution to issue shares can be adopted on the same occasion. If the company is to issue securities convertible to shares, the number of declared shares must not be less than the number of shares needed for the conversion. The capital can be increased by increasing the nominal value of shares or issuing additional shares. Capital increase by raising the nominal value of the share requires a resolution of the shareholders’ meeting. Capital increase by issuing additional shares may require a resolution of the general shareholders’ meeting or a decision of the board of directors, depending on the provisions of the Articles of Incorporation. In the latter case, a unanimous vote is required (Art.28, paras.1 and 2). Before the 2001 amendment, although there was no explicit provision, it was understood that the company could increase capital out of the distributable

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prots, although there was an opposing view.91 The 2001 amendment introduced a provision to the effect that the increase of capital by issuing additional shares can be nanced from the company’s assets. The amount of increase cannot exceed the difference between the net assets and the capital. Increase of capital by increasing the nominal value of the shares can only be effected out of the company’s assets. If the additional issue of shares is nanced from the assets, the shares must be distributed to all existing shareholders (ibid., para.5). In issuing additional shares, while open joint stock companies are entitled to issue shares by way of public offer as well as closed offer, closed joint stock companies may not offer its shares to an unlimited scope of people (Art.39, para.2). Additional issue of shares has often been abused by the incumbent management to dilute the share of existing shareholders: Novolipetskii Metallurgical Kombinat is regarded as a leading company in the eld. Around 60% of the shares are consolidated in a company founded by the chairman of the board of directors and 34% belonged to an offshore company TWG. Then, Norilisk Nickel, which is under the holding company Interros, acquired 9% of the shares. The board of the Kombinat decided to issue additional shares which would double the capital and proposed this at the extraordinary shareholders’ meeting. Such a new share issue was ostensibly needed to repay the Kombinat’s debt to one of its shareholders. Interros claims that there was no legitimate board meeting to propose this to the shareholders’ meeting because the quorum was not met.92

In fact, as a Russian specialist pointed out, dilution of shares by additional shares has become the most popular way of changing the corporate structure and violating shareholders’ rights.93 In 1998, as a result of an additional issue of shares by Saianskii Aliuminievyi Zavod, the foreign investors’ share fell from 37,8% to 15%, and the share of the State Property Fund from 15% to 6,15%. In another case, the share of a bank was reduced to one-sixth. The Bank brought the case to the court which annulled the additional issue.94 Even in cases where the decision to issue additional shares falls under the competence of the general shareholders’ meeting, there were still many cases where the increase of capital by the additional issue of shares took place without informing shareholders:

M.Tikhomirov ed., supra, p.150. Iu.A.Meteleva, Pravovoe polozhenie aktionera v aktsionernom obshchestve, Moscow 1999, p.110. 92 Izvestiia, May 30, 2000. 93 E.Torkanovskii, “Predela aktsionernoi sobstvennosti”, KhiP, 1999 No.4, p.32. 94 Ibid. 91

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In a company called A.Liur’ka Saturn, two days before the shareholders’ meeting, there was an ofcial notice in the press regarding the additional issue of shares (9 million shares), as a result of which the capital was to be increased by 10 times. Although the agenda of the shareholders’ meeting included the additional issue of shares, in fact, shareholders were asked by the board to vote on a matter which had already been decided and publicised.95

Additional shares are often issued and offered to a closed group of people. Even if it is supposed to be a public offer, the company requires that the payment be made in kind, which most existing shareholders may not have, and thus turns the offer into a de facto closed offer. In one case, the additional issue of shares by Joint Stock Company Nost was found void because of the disproportionate distribution of newly issued shares among the shareholders.96 After the 1998 nancial crisis, it was reported that the number of closed offers of shares doubled, while the number of public offers has decreased to one-seventh. This is said to demonstrate the process of the “consolidation of shareholders’ assets”.97 If the issuing of additional shares was left to the competence of the general shareholders’ meeting, the resolution could be adopted by a simple majority. The 1999 Law on the Protection of the Rights of Shareholders introduced a requirement of a two-thirds majority vote of shareholders in cases of closed offers. The 2001 amendment to the Joint Stock Company Law has introduced signicant changes in order to prevent such abuses. First, in cases where the board of directors has the power to make a decision to issue additional shares, a unanimous vote of the board members is required. Secondly, in cases where the power to approve increase of capital belongs to the general shareholders’ meeting, a mere majority vote is still sufcient. However, there are important exceptions in that: i)

ii)

for a closed offer of shares and securities convertible to shares, approval by three-fourth of the votes of shareholders present at the shareholders’ meeting is required; for a public offer of ordinary shares and securities convertible to shares, if the number of shares to be issued exceeds 25% of the already issued shares, the same majority is required (Art.39, para.3 and 4).

However, ii) covers only ordinary shares.

95 96 97

Mateleva, supra, pp.134-135. Torkanovskii, supra, p.33. Institute of Economy in Transition, supra, p.151.

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Thirdly, existing shareholders are to be granted a right of pre-emption to purchase the newly issued shares or securities convertible to shares. Previously, only shareholders of closed joint stock companies were granted such a right; for open joint stock companies, this was not mandatory. Under the amended Law (Art.40, para.1); i)

ii)

shareholders of an open joint stock company are given a pre-emption right for the newly issued shares and convertible bonds in cases of public offer of additional shares; shareholders of a company who voted against or did not take part in the voting for the resolution of issuing shares or convertible bonds by closed offer are entitled to a pre-emption right for the newly issued shares or convertible bonds in proportion to the number of the same category of shares which belong to him.

ii) does not apply if the shares are issued only to the existing shareholders. Fourthly, when exercising the pre-emption right, even if the resolution to issue additional shares provides for payment in kind, shareholders may, by their discretion, pay by money (Art.1, para.2). Before the amendment, companies often required the payment to be made in a specic item which was possible only for a limited number of investors, thus effectively excluding the exercise of pre-emption rights. Thus, it was not an exaggeration when a Russian commentator pointed out that: For the rst time ever upon the period of incorporation and mass privatisation of the early 1990s there appeared mechanisms introduced by legal means that counteracted the most notorious way of abusing stockholders’ rights over the 1990s, that is, diluting outsiders’ shares via new issues.98

Shareholders are entitled to bring an action contesting the validity of the resolution of the general shareholders’ meeting (Art.49, para.7). This includes resolutions on the additional issue of shares; Open joint stock company Transneft brought an action against a closed joint stock company “Natsional’noe perestrakhovochnoe obshchestvo”, asking the court to declare void the decision of its board of June 10, 1998 on the additional issue of shares by a closed offer. The Commercial Court of the City of Moscow rejected the claim; this was supported at the appellate instance. At the instance of cassation, part of the original

98

Radygin et als., The Problem. . . ., supra, p.66.

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judgment which had held valid the offer of shares to a UK company, Holbrook Insurance Brokers Limited, was quashed. Upon protest, the Supreme Commercial Court revoked the decision of the cassation instance. The Court found that the board had lawfully adopted the decision, including the allocation of shares to the UK company without having an actual meeting and that the allegation of the plaintiff that there was no board decision was groundless. By the Articles of Incorporation, shareholders had been given a pre-emptive right to subscribe to newly issued shares. The plaintiff argued that the new shares were also offered to a third party, the UK company, who was not a shareholder and therefore, infringed the right of the plaintiff as a shareholder. However, the Court referred to the provision of the Law on Joint Stock Company which stated that shares of a closed joint stock company could be distributed among other persons whose scope is determined in advance. At the shareholders’ meeting of April 27, 1998, the UK company in question had been chosen as a potential investor. Furthermore, the plaintiff had been offered the opportunity to exercise its right of pre-emption, but failed to do so, and did not oppose the acquisition of shares by other shareholders and third parties. The plaintiff even offered to sell shares to the above rm. At the subsequent general shareholders’ meeting of the defendant company, a resolution was passed to the effect that the new shares be allocated to the above UK rm. The Court upheld the decision of the rst instance and appellate instance court[s] which had found that the plaintiff’s rights had not been infringed.99

As a rule, the price of shares to be issued is to be determined by the board of directors in accordance with Article 77, i.e. it is to be based upon market value. In cases where the shareholders exercise their pre-emptive rights, the price for them can be lower than for others, but not more than 10% lower (Art.36). The capital can be decreased by the reduction of the nominal value of the shares or the reduction of the number of shares. Purchasing by the company of its own shares is one of the alternative ways of effecting the latter. Decrease of capital can also be effected by redemption of shares insofar as the Articles of Incorporation provide for this. The decisions to decrease the capital and to change the Articles of Incorporation have to be adopted by the general shareholders’ meeting (Art.29). Creditors must be informed; they are entitled to terminate the obligation or accelerate the maturity of the claim within thirty days of the notice (Art.30).

99

Decision of the Presidium of the Supreme Commercial Court, March 21, 2000, Case 1539/99.

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Shares – general

Joint stock companies may issue both ordinary shares and preference shares. Preference shares may not exceed 25% of the capital. Securities convertible to shares can also be issued (Art.25, para.2). Issuing of shares and other securities is regulated by the Law on the Securities Market of 1996.100 The agency in charge of the implementation of this Law was the Federal Commission on the Securities Market, but by a major amendment to the Law in 2004, this body was reorganised into the Federal Service for Financial Markets. Issuing of shares and other securities are subject to registration with the Federal Service for Financial Markets (Art.20). There is an exhaustive list of grounds on which registration can be refused (Art.21). Issuing of shares may be found by the court to be invalid, if the issuing company gave erroneous information and report to the registration agency. A closed joint stock company Firma Link and a limited liability company Titan brought an action against an open joint stock company Ogneupory and the administration of the Sverdrovsk province, asking, inter alia, the recognition of the resolution of the general shareholders’ meeting of Ogneupory approving the issue of additional shares and the prospectus as invalid. The rst instance court dismissed the claim on the ground of lack of jurisdiction, since prospectus was not an “act” of the executive body, but was merely for information. This was supported by the appellate and cassation instances. Upon protest, the Supreme Commercial Court quashed the judgment of the lower court and remanded the case to the rst instance. The Court ruled that the action brought by the plaintiffs was in substance a request for the recognition of the part of the resolution of the general shareholders’ meeting which approved the prospectus for the issue of shares as well as the share issue to be invalid. The increase of capital and the approval of the prospectus were on the agenda. In the resolution, the shareholders agreed to the proposal of an expert on the increase of capital and entrusted the board to determine the nominal price and the number of shares to be issued. The prospectus was registered with the provincial government. In the process of registration, reference was made to the resolution of the general shareholders’ meeting of April 21. However, the resolution was awed. Although the Articles of Incorporation had made the increase of capital to be a matter which falls within the exclusive competence of the general shareholders’ meeting, the above resolution did not actually cover this decision.101

100 Law No.39-FZ of April 22, 1996. 101 Decision of the Presidium of Supreme Commercial Court, March 31, 1998, No.138/98.

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According to the Law on the Securities Market, in order to issue securities, when the decision to do so has been adopted by the issuing company, it is required to register the issue with the Federal Service for Securities Market (Art.20, para.1). If the securities are issued by public offer, or by a closed offer to a group of specied people of more than 500, a prospectus must be prepared and registered (Art.19, para.1). Russian companies are allowed to issue securities including shares, abroad. For this, the approval of the Federal Services for the Securities Market is required. Securities in such cases are required to be listed in at least one of the stock exchanges in Russia.102 In order for the shareholders to exercise their rights, it is required that the shares are registered. The company is under an obligation to ensure the compilation and keeping of the register from the time of company registration (Art.44, para.2). Companies may entrust the keeping of the register to a “professional participant of the securities market” as dened by the Law on the Securities market (Art.8). The entry into the register should be effected within three days of the presentation of the necessary documents. Refusal to register is not allowed except for circumstances provided for by law. The grounds for refusal are listed in a statute enacted by the former Federal Commission on Financial Markets in 1997. The administrator of the register is obliged to give a reasoned notication of refusal to the applicant within ve days of the ling of the application. The refusal and failure to register can be contested in court (Art.45, para.2).103 This is an area where various abuses took place in the 1990s. Legitimate shareholders were refused registration by the company or the company’s “pocket registrar”. Shareholders were also struck off from the list without any justiable reason: Irkutsk Mebel’ brought an action against a company, Primorsk, for the refusal to include the plaintiff in the shareholders’ register. A voucher investment fund, “Vozrozhdenie” acquired 2,400 shares of Primorsk at a share auction. The shares were sold to a company called “Rossiia” and then to the plaintiff, Irkutsk Mebel’. Primorsk refused the registration of shares held by the plaintiff, arguing that since Rossiia had not been registered as a shareholder, it therefore had no power to assign the shares to the plaintiff. Lower courts upheld the argument of the defendant, but the Supreme Commercial Court quashed the lower court’s decision. Primorsk was under an obligation to register the plaintiff, since documents supporting the title to the shares had been presented, and no request for further documents had been

102 M.I.Petrov, Pravovoe regulirovanie rynka tsennykh bumag, Moscow 2005, pp.156-159. 103 See also the Law on the Securities Market of April 22, 1996, Article 8.

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made, but nevertheless, Primorsk failed to register the plaintiff within three days as required by the statute.104

The Law on the Protection of Rights and Legal Interest of Investors in the Securities Market of 1999 introduced nes for breaches of regulations on the registration of shares. of up to 10,000 times the minimum wage, to the then Federal Commission on the Securities Market, but this was obviously insufcient.105 In practice, in order to manipulate the register and eliminate “undesirable” shareholders, manipulation of the register often takes place: Management company Sibirskii Variant brought an action against Kirovskii Shinnyi Zavod and the registrar of its shares, the Kirov branch of the Sberegatel’nyi Bank, asking the court to declare void the contract of sale of shares of the defendant company of March 25, 1997. The plaintiff was a shareholder of the defendant company until, under this agreement, the shares were sold to the defendant company. The plaintiff argued that this transaction was void, since the general director of the defendant company signed this agreement on behalf of the plaintiff as well as the defendant. Furthermore, the purchase of its own shares by the defendant company was effected in breach of the Law on Joint Stock Companies. The rst instance court dismissed the claim. This was supported at the appellate instance. Upon protest, the Supreme Commercial Court quashed the decision of the lower court, found the transaction to be void, and ordered the plaintiff company to be restored in the register.106

In another case, the Supreme Commercial Court found a removal from the share register by the registrar – a bank – without the entrustment and instruction of the shareholder, void.107 The independence of share registrars is said to be still problematic.108 In the past, cases of manipulation and fraud in company register were agrant, jeopardising effective ownership transfer. These included refusal to re-register ownership rights or to transfer shares, illegally striking off shares from registers,

104 Decision of the Presidium of the Supreme Commercial Court, June 18, 1996 (cited in Bushev

et al., supra, pp.135-137). 105 Law No.46-FZ of March 5, 1999. 106 Decision of the Presidium of the Supreme Commercial Court, January 27, 1998 (cited in

Gubin, supra, pp.178-179). 107 Decision of the Presidium of the Supreme Commercial Court, November 17, 1998, Case

2208/98. 108 Sprenger, supra, p.9.

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changing share registration from common to preferred and accidental loss of records. Recently, the most frequent abuses have become less blatant and more typically concern refusal to give information to shareholders on companies or their ownership structures as well as improper handling of share transactions due to negligence. These problems are still occurring, especially in the regions.

Another novelty introduced by the 2001 amendment to the Law on Joint Stock Companies was that companies which have more than 50 shareholders with voting rights must entrust the compilation and maintenance of the register to a registrar licensed by the Federal Service for Financial Markets (ibid., para.3). This arrangement is intended to prevent abuses by the companies through their “pocket registrars”. Appointment of a registrar does not relieve the responsibility of the company regarding the compilation and maintenance of the register (ibid., para. 4). While blatant refusal to register or striking off from the register has become less frequent, there are still problems. There are often cases where different registration agents administer the register; as a result, there are several registers and even general directors (the board, management council). This “leads to disorganised activities of the company by forceful takeover of company management with the participation of police, security companies, and bailiffs. When a controlling stake in a company changes hands, there may be a conict between the new and previous shareholders. New shareholders appoint their general director, while the previous management refuses to hand over the register, stamp and all corporate documents. In most such cases, the newly appointed general director chooses to regard the old register to have lost effect and starts a new register!”109 (3)

Consolidation and splitting of shares

By the resolution of the general shareholders’ meeting, companies may consolidate or split the shares (Art.74). Together with dilution of shares, consolidation of shares was also used by the incumbent management of companies to exclude shareholders. Before the 2001 amendments, companies were under an obligation to purchase the odd shares which emerged as a result of consolidation at market price. Shareholders often caused the company to consolidate shares into a small number of high value shares in order to exclude other shareholders and take control. The rate of consolidation was sometimes so high that a majority of shareholders were unable to obtain even one consolidated share. As a result,

109 Dobrovol’skii, supra, pp.117-118.

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they became holders of odd shares and eventually, those shares were purchased by the company. In one case which reached the commercial court, it was reported that as a result of consolidation of shares by the defendant company, 94% of the shareholders were deprived of their status as shareholders. The entire operation was carried out in the interest of 6% shareholders who held a large block of shares which enabled them to have such a benecial resolution for them to be adopted. In open joint stock company Sibneft’-Noiabrskneftegaz, the nominal value of the share was increased by more than 1,300,000 times. Shareholders who held even one share less than this number were forced to leave the company. The most radical course of action was taken by the holder of a controlling stake of closed joint stock company, Torgobyi dom Kuntsevo, which managed to consolidate the shares and became a sole shareholder. The remaining 426 shareholders became holders of odd shares only and left the company. The number of such cases is not small.110

The part of this provision enabling the company to purchase odd shares was dropped in 2001 and instead, a new paragraph on odd shares was inserted in Article 25. Odd shares emerge not only as a result of consolidation, but also as a result of the exercise of pre-emption rights. These shares circulate in the same manner as full shares. If a person acquires several odd shares, he can combine these shares into full shares (Art.25, para.3). (4)

Transfer of shares

Shareholders have the right to withdraw from the company by disposing of the shares they hold. While in open joint stock companies, there is no restriction on this, in closed joint stock companies, other shareholders have a pre-emptive right to purchase shares offered for sale by a shareholder in proportion to the shares they hold. The terms of sale will be the same as the terms between the seller and a third party. A shareholder who intends to sell shares must inform the company and other shareholders of his intention, together with the price and other terms of transaction. If other shareholders do not fully exercise their pre-emption rights, the shareholder, after 2 months, may sell the shares to a third party at the same price and terms (Art.7).

110 G.Shapkina, “K voprosu o zashchite prav aktsionerov”, KhiP, 2004 No.12, p.3.

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Acquisition of Shares

There are some regulations on the acquisition of substantial amounts of shares in the Law on Joint Stock Companies. This is part of the chapter on “major transactions” (Art.80):111 i) A person intending to acquire 30% or more of the issued ordinary shares by oneself or together with afliated persons must notify the company of his intention in writing not earlier than 90 days but not later than 30 days before the purchase, provided that the company has more than 1,000 holders of ordinary shares; ii)A person who has acquired 30% or more of the issued ordinary shares of a company with more than 1,000 holders of ordinary shares by oneself or together with afliated persons is under an obligation to offer to purchase the shares of the shareholders, as well as securities convertible to ordinary shares, at market price, but not lower than the average price for the last 6 months preceding the date of the acquisition of those shares, within 30 days of their acquisition.

This obligation can be waived by the company by the Articles of Incorporation or the resolution of the general shareholders’ meeting (Ibid., para.3). The resolution can be adopted by a simple majority vote of those who are present, but the person in question and his afliates are not entitled to vote. The concept of afliated persons is not dened in the Law on Joint Stock Companies, although there is a provision on the obligation of the “afliated persons” to inform the company in writing of the number and the category of shares which belong to him within 10 days (Art.93). There is a provision on this matter in the Law on the Protection of Competition. As a commentary suggests, “regrettably, no legislation, including the Law on Joint Stock Companies, provides for the procedure to acknowledge a person as afliated.”112 It should be added that the concept of afliated persons which appears in the Russian legislation is criticised for not covering all the grounds for afliation. In fact, the adoption of the Law on Afliated Persons has been proposed and a draft law has been in place for some years, but is yet to be adopted.113 By virtue of the Law on the Protection of Competition, with the exception of the founders at the time of the establishment of the company, prior consent of the Federal Anti-Monopoly Service is required for an acquisition of more than

111 In general, see A.Bushev and O.Skvortsov, Aktsionernoe pravo, Moscow 1997, pp.44-52. 112 O.M.Krapivin and V.I.Vlasov, Kommentarii k Federal’nomu zakonondatel’stvu Rossiskoi

Federatsii ob aktionernykh obshchestvakh, Moscow 2002, pp.284-287. 113 OECD, “Obzor tendentsii v oblasti korporativnogo upravleniia v Rossii; nastoiashchie prior-

itety i plany na budushchee”, 2003, pp.10-12.

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25% of the voting shares, but only when the total amount of assets of the acquirer exceeds six billion roubles and of the issuer exceeds fty million roubles (Art.28, para.1). The Law on the Central Bank provides that if a person or a group of persons acquires more than 5% of the shares of a credit institution, the Bank of Russia has to be notied, and if the amount exceeds 29%, the central bank’s prior approval is needed. Companies which have acquired more than 20% of the shares of a joint stock company are under an obligation to publicise this fact without delay as determined by the Federal Commission on the Securities Market and the AntiMonopoly Agency. (6)

Share buy-back

The acquisition by a company of its own shares is subject to restrictions. Companies may acquire their own shares in order to reduce the capital by a resolution of the shareholders’ meeting to this effect, insofar as the Articles of Incorporation provide for this (Art.72, para.1). The company may also acquire its own shares for other purposes if so provided by the Articles of Incorporation. This can be done either by the resolution of the general shareholders’ meeting or the decision of the board of directors, depending on the Articles of Incorporation (Ibid., para.2). However, this is not possible if the nominal value of the shares which are in circulation is less than 90% of the share capital. The shares acquired for the purpose of capital reduction must be cancelled once they are acquired. Shares acquired by the company on general grounds must be sold within one year of acquisition at their market price; otherwise, the general shareholders’ meeting must adopt a resolution to reduce the capital by cancelling the shares or increase the nominal value of remaining shares and thus maintain the amount of capital (ibid., para.3). The decision of the company to acquire its own shares must specify the types and the amount of shares to be acquired, the price of acquisition, the manner and date of payment, and the period during which shares will be acquired. This period must not be shorter than 30 days. Once the decision to acquire shares has been adopted, every shareholder is entitled to sell the shares to the company and the company is under obligation to purchase them. If the total amount of shares offered for sale by the shareholders exceeds the number of shares which the company may acquire, shares are purchased in proportion to the amount each shareholder has requested to be purchased (ibid., para.4). However, companies may not acquire their own shares in the following cases (Art.73):

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i) when the capital has not been fully paid in; ii) when, at the time of acquisition, there is a symptom of insolvency or where such a symptom will emerge upon acquisition; iii)when, at the time of acquisition, net assets are less than the total of the capital, the reserve fund and the difference between the liquidation value of preferential shares and the nominal value.

It is important to note that shares acquired on general grounds do not accompany voting rights (ibid., para.3). The problem is that companies are not free to acquire their own shares, but they are free to acquire shares via the subsidiaries. Those shares held by subsidiaries have a vote. Thus, the company’s management is able to control the company via the subsidiaries which hold the parent company’s shares. This led to the shareholders’ action in Surugutneftegaz. The Company’s management was claimed to control 65% of the shares via subsidiaries, while the management held only several percent of the shares.

4)

Bonds and other Securities

Joint stock companies may issue bonds and other securities by the decision of the board of directors, unless the Articles of Incorporation provide otherwise (Art.33, para.2). Bonds and other securities which are convertible to shares are issued upon either the decision of the board or the resolution of the general shareholders’ meeting, if the Articles grant such a power to either of them (ibid.). The total nominal value of the issued bonds may not exceed the capital, or the maximum amount of security provided to a third party by the company for the otation of bonds. Bonds can be secured or non-secured. Non-secured bonds can be issued by companies not earlier than their third year in existence, and on the condition that by then, two annual balance sheets were duly approved. Bonds may be either nominal or bearers’ (ibid., para.3).

5)

Dividends

Dividends are paid out from the net prot of the company. Dividends for preference shares may be paid out of a specic fund designated for this purpose (Art.42, para. 2). The decision to pay the annual dividend, including its amount and the form of payment, of each category of shares is to be adopted by the general shareholders’ meeting. The amount of an annual dividend may not exceed the amount recommended by the board of directors (ibid., para.3). Dividends must be paid within the period set by the Articles of Incorporation or the resolu-

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tion. If there is no such period determined, dividends must be paid within 60 days after the resolution of the shareholders (Art.42, para.3). Companies may not adopt a resolution to pay dividends (or payment shall not be announced) until the capital has been fully paid in, and the company has purchased all the shares from shareholders exercising their appraisal rights. Such a resolution may not be adopted also in cases where: i) there is a symptom of insolvency on the day of the adoption of the resolution; ii) as a result of the dividend payment, there will be a symptom of insolvency; or iii)on the day of the resolution, the net value of assets is less than the capital, the reserve fund, and the difference between the liquidation value and the nominal value of preferential shares combined or becomes less as a result of such a resolution.

The actual payment cannot be made either, if these circumstances exist on the day of payment (Art.43, paras 1 and 4). In reality, far from all Russian companies pay dividends, ostensibly because of low protability or emergence of loss. As the OECD White Paper puts it, “until recently, Russian companies have seldom paid dividends to their shareholders”.114 “Almost no dividends were paid in the 1990s”.115 There are companies which manipulate circumstances in order to make no prot, e.g. by transfer pricing, and therefore, pay no tax or dividend, and accumulate the prot elsewhere by using various schemes including off-shore companies. Prot from such a scheme goes only to the shareholder who has a controlling stake in the company. Others are not privy to this “extra-dividend income”.116 This represents one of the characteristics of the Russian corporate system. A Russian economist points out as follows:117 The most important and special characteristic of the Russian corporate governance system. . . . is the obtaining of revenues from stock ownership not through prots (which is characteristic of the Anglo-Saxon model) but through control exercised by the dominant owner over the enterprise’s cash ow. Using transfer pricing mechanisms, prots of the head enterprise can be systematically transferred to companies afliated with the dominant shareholder or with top managers of the head enterprise.

114 115 116 117

OECD Whitepaper, supra, p.14. Yakovlev, supra, p.394. Mateleva, supra, p.72. Yakovlev, supra, p.394.

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6)

Shareholders’ Rights

Table 9 Shareholders’ Rights 1 Share

1% Share

1% plus 1 Share

2% or more

10% or more

25% plus 1 share

receive  Pursue  Receive Proposing  Convene  Block announcement liability of information matters to extraresolutions for the GSM directors, from the be included ordinary of the (Art.52) executive register of in the shareshareholders’ participate in body etc. shareholders agenda of the holders’ meeting and vote at the vis à vis the name, general sharemeeting which GSM (Art.31) the company quantity, holders’ (Art.55, requires receive in court category meeting para.1) a qualied dividends (Art.71, and nominal (Art.53,  Demand majority, e.g. (Art.31) para.5) value of para.1) audit amendments receive assets  Obtain the shares held Proposing of the to the Articles after liquidation list of shareby each candidates nancialof Incorpora(Art.23, para.1) holders shareholder for various economic tion, reorganireceive a copy (Art.51, (7.9.1 bodies state of the sation/ of the share para.4) Polozhenie) (Art.53, company liquidation of register (Art.46) para.1) (Art.85, the company see also 7.9.1 para.3) etc. polozhenie have access to the documents listed in Article 89, para.1 (Article 91) contest the validity of the resolution of the GSM (Art.49, para.7)

(1)

The right to take part in the shareholders’ meeting

The basic provision of the Law on Joint Stock Companies on shareholders’ rights states the following (Art.31): i)

Each ordinary share of the company grants the shareholder – holder of the share – the same range of rights; ii) The shareholder-holder of ordinary shares, in accordance with the present Federal Law and the Articles of Incorporation, may take part in the general shareholders’ meeting with the right to vote on all matters within the competence of the meeting, and has the right to receive dividends and the right to receive part of the assets in case of liquidation.

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Shareholders have the right to take part in the management of the company. One of the most basic rights in this respect is the right to take part in the shareholders’ meeting and to vote. In reality, in Russia, it is not uncommon that even the right to participate in the shareholders’ meeting is restricted or denied to some shareholders. Shareholders were often denied participation in the general shareholders’ meeting out of purely technical reasons such as the failure to present their passport. In some companies, employee shareholders, who left the job, were not allowed to take part in the shareholders’ meeting.118 The Law on Joint Stock Companies provides that the list of shareholders who are entitled to take part in the general shareholders’ meeting is to be prepared on the basis of the shareholders’ register. The date of the preparation of the list must precede the date of the decision of the board to convene the general shareholders’ meeting, and must also fall 50 days before the meeting (Art.51, para.1). Naturally, shareholders must be notied of the date and place of the general shareholders’ meeting at least 20 days before the meeting (in cases where the reorganisation of the company is to be discussed, this is extended to 30 days). Extraordinary meetings require 50 days’ advance notice (Art.52, para.1). As a result of the 2001 amendments to the Law on Joint Stock Companies, the provision on the information which is to be provided to the shareholders in advance of the general shareholders’ meeting has been substantially expanded. Shareholders are informed of the procedure to access the information (materials) in order to prepare for the meeting. The materials which are required to be provided to shareholders include:119 i) nancial documents (the balance sheet, prot and loss report, proposal for the distribution of prot including the proposal for dividends, or sharing of the loss; ii) the opinion of the accountant on the result of the annual audit; iii)the opinion of the audit committee on the result of the annual nancial documents; iv)information on the candidates for the executive body, board of directors and audit committee.

In the notice of the convocation of the general shareholders’ meeting, the means of inspecting the documents which are required to be disclosed must be specied.120

118 Institute of Corporate Law and Corporate Governance ed., supra, pp.5-6. 119 Klapivin and Vlasov, supra, p.193. 120 Lomakin, supra, p.175.

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However, it is not rare for a general shareholders’ meeting to be held without the knowledge of a signicant number of shareholders: A resolution to liquidate the company was taken at the shareholders’ meeting of a closed joint stock company with foreign participation. A foreign investor, who held 49% of the shares, brought an action, asking the court to declare the resolution void, since this foreign shareholder had not been notied of the shareholders’ meeting and the resolution adopted there. The rst instance court and the court of the appellate instance dismissed the claim on the ground that a representative of the foreign company was present at the meeting, and that the power of attorney had been properly prepared. However, the court of the cassation instance quashed the judgment and reversed it to the lower court. The court found that the information on the share holders’ meeting and its agenda were not properly sent to the foreign company but instead, were sent to a company representing this foreign company in Moscow in the name of a Russian individual. On the other hand, the Articles of Incorporation of the joint venture provided that a resolution of liquidation should be made with explicit agreement of the parties and should be notarised. At the shareholders’ meeting, a Russian individual, who merely had the power to perform “commercial and representative functions”, was present. This person did not have the power to represent the foreign company in liquidating the joint venture.121

Various irregularities involving shareholders’ meetings are reported: Russia’s second largest oil company, Yukos, voted to cause a 194% share dilution of its subsidiary Yuganskneftegaz and also voted to seize oil revenues and assets belonging to this company. The largest minority shareholder of Yuganskneftegaz was barred from voting at the extraordinary shareholders’ meeting. After minority shareholders were denied entry, the shareholder’s meeting, dominated by Yukos, approved the massive additional share issue in a closed subscription to unknown companies for promissory notes which had not been independently valued.122

The most frequently quoted ground for actions by shareholders contesting the validity of the resolution are: breach of the procedure to convene and carry out the meeting; resolution without meeting the quorum; convocation of the meeting by a person who is not entitled to do so; absence of notice to shareholders. Often shareholders contend that the meeting had not taken place and the protocol had been falsied.123 Also delayed notice of the place and time of the general share-

121 Item 8, Information Letter of the Presidium of the Supreme Commercial Court No.58 of Janu-

ary 18, 2001. 122 Alexander’s Gas and Oil Companies, April 28, 1999. 123 V.I.Dobrovol’skii, “Sudebnaia zashchita prav aktsionera (uchastnika) – vopros pravoprimen-

eniia”, VVAS 2005 No.4, pp.116-117.

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holders’ meeting or the failure to send it, failure to provide the shareholders with the possibility to have access to the necessary information regarding the agenda can serve as grounds for such an action.124 The rights of shareholders to take part in the management of the company also include the right to elect and be elected to the board of directors and the audit committee. (2)

Access to information

In order to exercise their rights, shareholders need to have access to information. The general provision on disclosure simply states the following (Art.90): Information concerning the company shall be provided in accordance with the present Law and other legislative acts of the Russian Federation.

Then, there is a provision on the access to information by the shareholders (Art.91), and another provision on the mandatory disclosure of information by companies (Art.92). Documents available to the shareholders are listed in another provision (Art.89). This provision in fact lists the documents which are to be preserved by the company, and it is questionable whether or not this list should be used for disclosure purpose.

These documents include, inter alia, the following: i) shareholders’ agreement; ii) Articles of Incorporation; iii) documents which certify the right of ownership of the company over the assets on the balance sheet; iv) “internal documents” of the company; v) annual report; vi) accounting documents; vii) documents of audit reports; viii)the list of those who are entitled to take part in the general shareholders’ meeting and the list of those who are entitled to receive dividends; ix) the protocol of the general shareholders’ meeting, meetings of the board of directors, the audit committee and the collective executive body; x) list of afliated persons of the company;

124 Lomakin, supra, pp.172-173.

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xi) opinions of the audit committee and auditors as well as state and municipal nancial control agencies.

The 2001 amendment added a prospectus of the issuing of securities and the quarterly report to the above list. On the other hand, prior to the 2001 amendment, companies were under an obligation to disclose a list of persons afliated with the company along with the number and type of shares which belonged to this person. Now only the list of persons needs to be preserved and disclosed. The Law also has a questionable provision on afliated persons. While it does not give a denition of afliated persons, afliated persons are under an obligation to inform the company in writing of the number and category of shares which they hold within 10 days of their acquisition. If, due to fault on the par of an afliated person, such information is not provided, the person is liable for the loss caused to the company (Art.93). Among the documents listed above, access to accounting documents and to the protocol of the management bodies is now restricted to shareholders with 25% or more of voting shares (Art.91, para.1). In practice, companies are more than reluctant to disclose information to the shareholders, not to mention the general public. The problem is that there is no sanction against companies which fail to comply with the requirements, although this is regarded as a “serious violation of shareholder’s rights”.125 At Gazprom, representatives of minority shareholders raised the issue of the relationship of Gazprom with a company group called Itera (a group of more than 100 companies) and Stroitransgaz. The basic criticism was that the Gazprom management had transferred assets from Gazprom to companies afliated with them. However, information on the afliation of the Gazprom management with the Itera group was not made available to the shareholders.126

The extent of disclosure of information to the general public differs according to the type of companies. Open joint stock companies are under an obligation to publicise the annual report as well as the annual audit report, prospectus of the issuing of securities, and the information on the convocation of the general shareholders’ meeting. There are also reinforced disclosure requirements introduced by the amendments to the Law on the Securities Market in 2002.

125 G.S.Shapkina ed., supra, p.259. 126 Radygin, supra, p.30.

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Appraisal rights

Shareholders with votes also have the right to require the company to purchase their shares (appraisal right) in the following cases (Art.75, para.1): i)Reorganisation of the company, or effecting of large transactions which require the approval of the shareholders’ meeting, in which the shareholder voted against the reorganisation or large transaction, or did not attend the shareholders’ meeting; ii)Changes, supplements to the Articles of Incorporation, or the adoption of a new version, which the shareholder voted against, or where the shareholder did not attend the shareholders’ meeting

These grounds are exhaustive. Changes to the Articles of Incorporation must be those restricting the rights of shareholders in order to trigger an appraisal right.127 A limited liability company, Vostok Invest, brought an action vis-à-vis a joint stock company, Primorskugol’, asking the court to obligate the defendant to purchase 1,153 ordinary shares and 1,799 preference shares of the defendant company from the plaintiff. The rst instance court accepted the claim on the ground that the newly amended Articles of Incorporation of Primorskugol’ which had been approved by the general shareholders’ meeting restricted the rights of shareholders. The plaintiff had voted against the amendment, and therefore, the plaintiff was entitled to an appraisal right. The value of the shares was determined on the basis of the opinion of an independent valuer commissioned by the court. The decision was quashed by the appellate court on the ground that the company was not under an obligation to purchase the shares. The court also pointed out the fact that by another resolution of the general shareholders’ meeting afterwards, this particular provision was excluded from the Articles of Incorporation and thus, the shareholder’s right was restored. The Law on Joint Stock Companies provides that a person, on his own or in conjunction with an afliated person, purchases 30% or more of the shares of a company with shareholders of more than 1,000, this person is under an obligation to offer other shareholders to purchase their shares at market price. This requirement can be removed by the Articles of Incorporation and Primorskugol’ did remove this requirement via the resolution of the general shareholders’ meeting. Vostok-Invest was against this amendment.

127 Ibid., pp.244-245.

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The Supreme Commercial Court ruled that since the plaintiff voted against this amendment, it was entitled to require the company to purchase its shares. The conclusion of the lower courts which denied the existence of such an obligation on the part of the company was against the Law on Joint Stock Companies. The subsequent resolution of the general shareholders’ meeting does not deprive the plaintiff of the right which had emerged earlier.128

The company is under an obligation to inform shareholders of their right to have their shares purchased by the company, as well as of the price and the methods of exercising their rights. Shares are purchased at the price determined by the board of directors, but not lower than their market value which is determined by an independent valuer without taking into account the changes caused by the incidents which gave rise to the appraisal right (ibid., para.3). (4)

Remedies available to Shareholders

Shareholders have the right to take measures to rectify unlawful actions of the company and its bodies in court. Shareholders’ rights in this context include: i)the right to contest the validity of a resolution of the general shareholders’ meeting which is against the law, or other legal acts as well as the Articles of Incorporation, provided that the shareholder voted against the resolution or was absent at the meeting, and that the resolution infringes the right and lawful interest of the shareholder (Art.49, para.7); ii)the right to contest the lawfulness of a decision of the meeting of the board of directors and the executive bodies; iii)the right to a shareholder's action in the interest of the company (Art.71)

(a) Shareholders’ action to contest the validity of the resolution of the general shareholders’ meeting Shareholders often contest the validity of the resolution of the general shareholders’ meeting. In this regard, there is a conspicuous omission in the provisions on the procedure of corporate litigation. If, for instance, the validity of the resolution of the general shareholders’ meeting was denied, the effect of the decision should have an effect not only between the parties, but on everybody. Otherwise, there will be a number of actions involving the same resolution but resulting in different conclusions. The possibility of other shareholders joining in the action has to be addressed at the same time. These provisions are completely missing.

128 Decision of the Presidium of the Supreme Commercial Court, December 14, 2004, Case

4149/04.

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The same applies to the shareholder’s action (see infra). By the 2001 amendment, a requirement that the action must be initiated within 6 months after the shareholder became aware, or should have become aware of the resolution, was introduced (Art.49, para.7). The validity of the resolution of the general shareholder’s meeting is often contested in court. The most often encountered cases are those involving the breach of the procedure of convening and conducting the general shareholders’ meeting, the absence of quorum for the resolution, and the absence of appropriate notice to shareholders. The plaintiff shareholder often claims that the meeting did not take place at all, and that the minutes were simply falsied.129 The court is entitled to maintain the effect of the contested resolution by taking into account various circumstances if the vote of the shareholder/plaintiff would not have inuenced the resolution or the breach was not essential, and the resolution did not cause damage to the company (Art.49, para.7): A shareholder who held 12% of the shares of Uralstal’ konstruktsiia brought an action against the company in the commercial court, asking the court to declare void the resolution of the shareholders’ meeting which took place without his participation. The shareholder was not informed of the date or agenda of the shareholders’ meeting. These facts were ascertained by the court. However, the court found the resolution to be valid, because the procedural aw could not have inuenced the outcome.130

There are many cases where the court opted for maintaining the validity of the resolution despite some aws.131 On the other hand, there is a judgment of the Supreme Commercial Court which ruled that the breach of the right of the shareholders to participate in the general shareholders’ meeting is “essential”.132 A closed joint stock company, Andreevskii Torgovyi Dom, brought an action against another closed joint stock company LDM, in which the plaintiff is a shareholder, claiming that the resolution of the general shareholders’ meeting was adopted without its participation, and therefore, should be declared void. The defendant company argued that the plaintiff was not a shareholder, since the transfer of shares to the plaintiff which took place in 1992 was invalid. In fact, the plaintiff had taken part in the general shareholders’ meeting for several years, without any objection from the company until the general shareholders’ meeting in question. The commercial court of rst instance found the resolution to be void, since there was a breach of the

129 130 131 132

Dobrovol’skii, supra, pp.116-117. Mateleva, supra, p.159. Lomakin, supra, pp.156-159. Decision of the Presidium of the Supreme Commercial Court of April 22, 1997, Case 2525/96.

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shareholder’s rights. In the appellate instance, judgment was reversed – the court ruled that the plaintiff was not a shareholder of the company. This was supported at the cassation instance. Finally, upon a protest from the rst deputy president of the Supreme Commercial Court, the Supreme Commercial Court quashed the judgment of the appellate instance and upheld the judgement of the rst instance court. In passing, the court ruled that the failure to notify the shareholder of the general shareholders’ meeting was an essential failure.

It should be noted that the court distinguishes between voidable resolutions and null and void resolutions. The Plenum of the Supreme Commercial Court pointed out that if a party to a dispute refers to a resolution of the general shareholders’ meeting and if the court establishes that the resolution was adopted in excess of the competence of the general shareholders’ meeting without meeting the quorum, or the resolution was made on a matter which was not included in the agenda, the court shall regard such a resolution not to have any effect, regardless of whether or not the resolution is being disputed by a shareholder.133 Thus, these grounds do not require shareholders to initiate a specic action to invalidate the resolution. A shareholder of an agricultural joint stock company of an open type Razvitie and the chairman of the board of Razvitie brought an action to court against a closed joint stock company Volga-Kredit Holding for the recognition of the transfer of the company to the defendant as invalid. The Supreme Commercial Court found that this was a major transaction as provided by the Law on Joint Stock Companies, but nevertheless, an appropriate procedure, i.e. the approval of the general shareholders’ meeting, had not been followed. In addition, the person who signed the agreement on behalf of Razvitie, the general director, was not really entitled to do so. By virtue of the decision of the court of general jurisdiction, the appointment of this person as the general director had been found to be invalid, since the general shareholders’ meeting which appointed this person had not met the quorum.134

The same applies to the resolution of the general shareholders’ meeting which is in excess of its scope of competence. Thus, the court has distinguished null and void resolutions from voidable resolutions despite the absence of explicit provisions to this effect. The difference between those two is that if the resolution is voidable, it has to wait for an action by a shareholder to deny its effect, whereas if the resolution is null and

133 Item 26, of the Decision of the Plenum of the Supreme Commercial Court of November 18,

2003. 134 Decision of the Supreme Commercial Court, July 20, 2004, No.3826/04.

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void, without any action by a shareholder, the resolution does not have any effect from the beginning. There is a proposal that the Law should be amended to introduce a specic list of breaches of law which make the resolution null and void. These are to include the absence of the quorum and the adoption of the resolution without notifying the shareholder who could have inuenced the resolution. If the breach is not on the list, it should be regarded as voidable. This arrangement will enable the court, for example, to deny the effect of a transaction concluded by the general director whose power is based upon a null and void resolution of the general shareholders’ meeting without an action by a shareholder, but on the basis of an action by other interested parties. If all resolutions are simply voidable, it will mean that until the court nds the given resolution invalid based upon an action by a shareholder, transactions by the general director disposing of the assets of the company will remain valid. By the time a shareholder takes an action and the resolution is found null and void, the assets will be unrecoverable.135 A company, Bolen Commercial Limited, brought an action against Rosneft’, asking for the contract of sale concluded between Rosneft’ and Rosneft’-Purneft’gaz to be recognised as invalid. The company is a shareholder of the latter company. The rst instance court acknowledged the claim. This was upheld in the appellate and cassation instances. However, the Supreme Commercial Court quashed the decision of the lower court on the following grounds. Rosneft’ and Rosneft’-Purneft’gaz concluded a contract for the sale of oil to the amount of 9.3 million tons at the price of 1,110 rouble per ton. The plaintiff sought to invalidate this contract, since Rosneft’-Purneft’gaz, by this contract, disposed of its assets below the market price, which is against the provisions on interested party transactions in the Law. The lower courts based their opinion on the conclusion of an independent valuer who found that the price determined by the board of directors was substantially lower than the market price. In this case, according to the Supreme Commercial Court, the plaintiff had failed to indicate specically how his right as a shareholder was infringed and what negative outcome this transaction entailed. The plaintiff has not explained how, by recognising a contract which has been performed to be null and void, his rights could be restored. The plaintiff also failed to specify the amount of loss. There was no evidence which demonstrated that the procedure of the transaction was breached. In the absence of such information, there is no need for the court to examine the problem of price in the transaction. The case was remanded to the lower court.136

135 Dobrovol’skii, supra, pp.138-139. 136 Decision of the Presidium of the Supreme Commercial Court, November 12, 2002, Case

6288/02.

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(b)

Shareholders’ action contesting the validity of the decision of the board and other bodies There is no explicit provision in the Law on Joint Stock Companies (unlike in the Law on Limited Liability Companies) which entitles shareholders to contest the validity of the decisions of the board and the executive body on general grounds. However, in the light of the “numerousness and complexity of the complaints of shareholders and other interested parties which reached the court”, the Supreme Commercial Court and the Supreme Court jointly issued a plenum decision in 1997 allowing this.137 The Law on Joint Stock Companies has provisions which allows shareholders to bring an action to court on separate occasions such as the refusal by the board of directors to convene an extraordinary shareholders’ meeting. The joint decision went much further and allowed the shareholders to contest the validity of the decisions of the board of directors and executive bodies in all circumstances where the decision is against the law and infringes the rights and lawful interests of the shareholder. The Supreme Commercial Court also acknowledges that if the decisions are against the law or other normative acts and infringe the rights and lawful interests of a shareholder, these decisions can be contested in court.138 (c) Shareholders’ derivative action The company itself, or shareholders holding 1% or more of the issued ordinary shares, are entitled to bring an action against members of the board, the single executive body (director, general director), members of the collective executive body (management council, directorate) and others for compensation of loss caused to the company by their act in fault (Art.71, para.5). Presumably because the goal of this system is to ensure that the company recovers the loss from those people, there is not much incentive for shareholders to initiate this action. Such an action seems to be rare, but there have been some actions against the single executive body.139

7)

The Management Structure

(1)

General Shareholders’ Meeting

The highest body of the company is the general shareholders’ meeting (Art.47, para.1). Companies are under an obligation to hold a general shareholders’ meeting at least once a year. The annual general shareholders’ meeting must be

137 Krapivin and Vlasov, supra, pp.197-198. Item 10, Joint Decision, April 2, 1997. 138 Decision of the Plenum of the Supreme Commercial Court No.19 of November 18, 2003. 139 Lomakin, supra, p.236.

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convened more than 2 months but no later than 6 months after the end of the nancial year. At the annual meeting, members of the board of directors and the audit committee are elected, the auditor is conrmed, and the nancial reports as well as other documents are submitted by the board are discussed for approval. The competence of the general shareholders’ meeting includes (Art.48, para.1): i) ii) iii) iv) v) vi)

vii) viii)

ix)

x) xi) xii) xiii) xiv) xv) xvi) xvii)

changes and supplements to the Articles of Incorporation or adoption of new Articles of Incorporation; reorganisation of the company; liquidation of the company, appointment of the liquidation committee and approval of the interim and nal liquidation accounts; determination of the number of members of the board of directors, election of the members and the early termination of their power; determination of the number, nominal value and types of declared shares; increase of capital by raising the nominal value of shares or issuing additional shares; in the latter case, only if the matter is not entrusted to the board of directors by Articles of Incorporation; decrease of capital by decreasing the nominal value of shares, or by share buy-back, and cancellation of shares; formation of the executive body and early termination of its power, provided that this power does not belong to the board of directors by Articles of Incorporation; election of the members of the audit committee and the early termination of their power, unless the power does not belong to the board of directors under the Articles of Incorporation; approval of the auditor; approval of the annual report, balance sheet, prot and loss report, and the proposal of the distribution of prots and loss; division and consolidation of shares; approval of transactions with interested parties as provided by Article 83; approval of major transactions in cases provided by articles 79; approval of share buy-back by the company; approval of participation in a holding company group, nancial industrial group, associations etc; adoption of internal rules which regulate the activities of corporate bodies.

Matters which fall within the competence of the general shareholders’ meeting cannot be delegated to the board of directors unless there are provisions to that effect in the Law on Joint Stock Companies. If the general shareholders’ meeting adopts a resolution in excess of its competence, the court must regard this as null and void, regardless of whether a shareholder has contested its validity.140

140 Item 9, Joint Decision of the Plenums, supra, No.4/8.

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Resolutions on matters such as ii), vi), xii) to xvii) above can be adopted only when proposed by the board. While the resolution, as a rule, is adopted by a simple majority, items i) – iii), v), and xv) have to be adopted by a qualied majority – three quarters of the shares with a vote who were present (Art.49, para.4). As a rule, general shareholders’ meetings are convened upon the decision of the board. The notice of the general shareholders’ meeting should be given to the shareholders, in principle, at least 20 days before the meeting. Previously, the notice could be given either by sending shareholders a written notice by any means or by publication of such information. Sometimes, the notice was published in a regional newspaper which no one but those who lived there had access to. There was no minimum time associated with the notice. By the 2001 amendment, in principle, each shareholder has to be sent a notice by registered mail, but only insofar as the Articles of Incorporation do not provide otherwise. The notice can be delivered to the shareholders in exchange for a receipt. If the notice is to be published in the media, the medium has to be accessible to all and specied in the Articles of Incorporation (Art.52, para.1). Together with the notice of the meeting, various materials need to be sent. These include the annual report of accounting including the opinion of the audit committee and the auditor, a draft resolution of the meeting, as well as information on candidates for the board and the audit committee (ibid., para.3). An extraordinary shareholders’ meeting can be convened by the decision of the board of directors on its own initiative, by request of the audit committee, the auditor, or a shareholder with more than 10% of shares. Extraordinary meetings requested by the audit committee, the auditor, or a shareholder have to be convened via the board. The board must convene an extraordinary shareholders’ meeting within 40 days of the request. The decision to convene or not to convene the meeting must be taken within 5 days of the request (Art.55, paras.1 and 6). The board may refuse the convocation of a meeting on the following grounds (ibid., para.6): i) the procedure for submitting the request was not followed; ii) the shareholder is not entitled to the request; iii)none of the issues proposed for discussion at the meeting fell within the competence of the shareholders' meeting or they were against the law.

These grounds are exhaustive. In cases where the board has failed to convene an extraordinary shareholders’ meeting within the above period or rejected the convocation of the meeting, the body or the person who requested the convocation is entitled to convene the meeting. In such cases, the body or the person is granted the same power to

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convene and conduct the meeting as that provided by the Law (Art.55, para.8). However, the costs of convening the general shareholders’ meeting (and the impossibility of having the cost reimbursed by the company) make it difcult for shareholders to exercise this right.141 The decision of the board to refuse convocation of a shareholders’ meeting can be appealed in court (ibid., para.7). The agenda of the general shareholders’ meeting is set by the board. Shareholders with 2% or more of the voting shares are entitled to propose matters to be included in the agenda. They are also entitled to propose candidates for the board of directors, collective executive body, and the audit committee (Art.53, para.1). The board of directors is empowered to decide whether to accept or reject the proposal. The proposal can be rejected only on limited grounds on formalities (ibid., para.5). Shareholders may contest the decision of the board not to include the proposed item on the agenda, or the failure to make a decision in court (ibid., para.6). However, in practice, the board of directors often infringes upon the rights of shareholders in this respect. This not only involves the agenda of the annual meeting, but also the agenda of extraordinary meetings.142 The board of directors, by resorting to various pretexts, refuses to put the proposed matter on the agenda.143 The quorum for the general shareholders’ meeting is shareholders representing more than 50% of issued shares (Art.58, para.1). Shareholders who are on the list of shareholders are entitled to take part in the general shareholders’ meeting. The list is compiled on the basis of the shareholders’ register at the time determined by the board of directors. This date cannot be earlier than the decision of the board to convene the general shareholders’ meeting, and cannot be more than 60 days ahead of the meeting (Art.51, para.1). Although it is rather unusual compared to other jurisdictions, the resolution of the shareholders’ meeting does not have to be taken by holding an actual meeting. This is called a zaochnyi vote (Art.50). Reportedly, this has been practised since joint stock companies came into existence in the post-socialist period. By the 2001 amendments, this is not allowed for a general shareholders’ meeting which has the appointment of directors, approval of an auditor, approval of nancial statements. Shareholders may take part in the shareholders’ meeting personally, or “through a representative” (Art.57, para.1). Shareholders are free to select the representative. This right cannot be restricted by the Articles of Incorporation.

141 Krapivin and Vlasov, supra, pp.206-207. 142 Ibid., pp.197-198. 143 Ibid., p.198.

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Provisions of the Civil Code on the power of attorney (Arts.185-187) are applicable here. However, in the absence of detailed rules in the Law, shareholders’ rights in this respect are infringed. Many companies require that the power of attorney be given to the members of the board, the collective executive body, or other shareholders. This is a practice which is against the law.144 The OECD White Paper points out as follows: There have been numerous cases in Russia where procedural requirements for voting during the general meetings have not been observed and shareholders have been prevented from voting on various grounds. . . . Proxy voting is also quite rudimentary. For example, the Law provides that a proxy must contain the representative’s passport data. In practice, interpreting “passport data” arbitrarily and the requirement of cumbersome certication procedures have prevented some “unwelcome” shareholders from participating in meetings.145

The White Paper recommends the introduction of rules and procedures that would facilitate and encourage proxy voting as well as reduce abuse. The Law explicitly provides that one voting share is entitled to one vote, except in cases of cumulative voting (Art.59). Multiple voting shares are not allowed under the Law. It should be noted that under the Articles of Incorporation, it is possible to limit the maximum number of votes given to a single shareholder (Art.11, para.3). Incidentally, similar provisions can be found in German and French law. (2)

Management Bodies: Board of directors and executive bodies

(a) The structure of the management bodies Generally, the system of corporate governance in the industrialised world can be divided into two types; a single tier system and a two tier system. In a single tier system, the management of the business and the supervision of implementation are both entrusted to a single body, i.e. the board of directors. In contrast, in a two tier system, these functions are separated; there is a board of directors which manages the business, and a supervisory board, which supervises the activities of the board of directors. In Anglo-American jurisdictions, the single tier system is adopted, while the two tier system is found in the Civil Law countries. However, in reality, the system varies from country to country. US companies are supposed

144 Ibid., pp.210-211. 145 OECD White Paper, supra, p.13.

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to be in the single tier group, but in fact, boards of directors in the United States tend to perform more supervisory functions than management, whereas the management function is carried out by executive ofcers. In the Tsarist period, Russian companies were run by the management council ( pravlenie) whose members were called directors. There was no board of directors. The 1922 RSFSR Civil Code inherited this system of a management council. In contrast, the 1927 Statute on Joint Stock Companies provided for i) a pravlenie or a single director, and ii) a board (sovet), if the Articles of Incorporation provide for it. The pravlenie were to “manage all matters and assets of the company” and make transactions and operate in the name of the company and thus represent the company. The board (sovet) was set up for the “general direction of affairs and supervision over the activities of the pravlenie in accordance with the articles of incorporation”.146 In this sense, the board was closer to the supervisory board, rather than the board of directors. In the present Law on Joint Stock Companies, the system is rather confusing. There is the board of directors as well as single and collective executive bodies. In the Law, the board of directors is referred to with “supervisory board” in brackets. This is confusing, since in Anglo-American countries, while there are boards of directors, there are no supervisory boards, and in Civil Law countries, the board of directors co-exists with the supervisory board. Czech, Hungarian and Polish company laws have both, although the supervisory board is not always mandatory. In the German Aktiengesetz, it is explicitly provided that the supervisory board is to oversee the management of business (Geschäftsführung).147 There is no jurisdiction where the board of directors is at the same time, the supervisory board. However, according to a commentary to the Law on Joint Stock Companies, the terms “board of directors” and “supervisory board” have the same meaning”.148 The confusion is compounded by the fact that under Russian law, a single executive body is called a director, or general director, and in their collective form, management councils or directorates. However, they are not necessarily members of the board of directors. In fact, the term general director seems to come from the socialist period when a single ofcial ran the state enterprise on the basis of a “single responsibility (edinolichnost’)” system. In a way, the Russian system is similar in substance to the US system where the board of directors play a supervisory role rather than an executive role, while

146 SZ SSSR, 1927 No.49, item 500. 147 Art.111, para.1, Aktiengesetz. 148 Mozolin and Iudenkov, supra, p.293.

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the business is carried out by executive ofcers. A Russian commentary admits that the Russian system is closer to the US system, but for a different reason:149 In the German variation (of corporate governance), the personal composition of the supervisory board and the executive body ( pravlenie) is strictly segregated. In the US variation, the personal composition of both may overlap. The rst model is intended for a situation where shareholders are highly separated from professional managers and their function is to control the activities of the managers and receive dividends. The second model represents active participation on part of the shareholders who were appointed to the board of directors in the management of current activities of the company. The Russian model is close to the second model.

(b) Board of Directors The board of directors determines the general orientation of corporate activities, except for matters reserved for the general shareholders’ meeting (Art.64, para.1). This is contrasted to the function of the executive bodies which manages the current affairs of the company.150 The board of directors is not mandatory in companies with less than 50 shareholders with a vote. In such companies, the function of the board can be substituted by the general shareholders’ meeting (ibid.). Members of the board of directors are appointed by the general shareholders’ meeting. Shareholders who hold no less than 2% of voting shares are entitled to propose candidates for membership of the board (as well as of the collective executive body and the audit committee). The number of proposed candidates should not exceed the total number of directors (Art.53, para.1). The competence of the board of directors includes the following (Art.65, para.2): i) ii) iii) iv) v) vi) vii)

determination of the priority directions of the company’s activities; convocation of the annual and extraordinary shareholders’ meeting; approval of the agenda of the general shareholders’ meeting; determination of the date of compilation of the list of shareholders who are entitled to take part in the general shareholders’ meeting; increase of capital by additional issue of shares in cases where this power has been delegated by the Articles of Incorporation; issuing of bonds and other securities; determination of the value of assets, issuing and purchasing prices of shares and other securities in cases provided by the present Law;

149 Ibid., p.301. 150 Ibid., supra, p.294.

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viii) buy-back of shares, bonds and other securities in cases provided by the present Law; ix) formation of the executive body of the company and its early termination if the Articles of Incorporation grant this power to the board; x) recommendation as to the remuneration of audit committee members and the auditor; xi) recommendation as to the amount of dividends and the method of their payment; xii) use of the reserve fund and other funds; xiii) approval of internal documents of the company except those documents which the general shareholders’ meeting has the power to approve; xiv) establishment of branches and representative ofces; xv) endorsement of major transactions; xvi) endorsement of transactions with interested parties; xvii) approval of the share registrar and the determination of the terms of the contract, as well as the rescission of the contract.

The above matters, which fall within the exclusive competence of the board, cannot be delegated to the executive body (ibid.). An open joint stock company Surugut Gas Renery brought an action in the Moscow Commercial Court against a closed joint stock company UKBGI Bank, asking the court to declare void a contract for the acquisition of a share in the capital of the latter. The Renery had acquired a share in the Bank when the Bank was a limited liability company. The Renery argued that the contract had been signed by its general director without the consent of the board of directors, contrary to Article 65 of the Law on Joint Stock Companies [before the 2001 amendment], which provided that the decision on the participation of the company in other associations was the exclusive competence of the board. The lower courts acknowledged the claim of the plaintiff. However, upon protest, the Supreme Commercial Court reversed the judgment. The Court ruled that the provision in question covered only the “participation” in another organisation, and did not extend to “withdrawal”. Since this provision contains an exhaustive list of matters which fall within the exclusive competence of the board, it should be interpreted literally, and such a broad interpretation should not be allowed.151

As a Russian commentary points out, the Law does not give a clear denition of the board of directors. Therefore, its role can be drawn only from the list of powers and the scope of matters upon which it can decide in accordance with

151 Decision of the Presidium of the Supreme Commercial Court, January 23, 2001, Case

6282/99.

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this provision.152 Judging from the competence of the board of directors as listed above, the board of directors primarily performs supervisory functions. This is demonstrated by their power to appoint and dismiss the executive bodies and approving major transactions and interested party transactions. The number of board members for companies with more than one thousand shareholders with a vote has to be at least seven, while if the number of such shareholders is more than ten thousand, there have to be at least 9 members (Art.66, para.3). The maximum number of members is to be determined by the Articles of Incorporation. There is no statutory requirement for the qualication of a board member. It is left to the companies to determine the requirements via the Articles of Incorporation. For example, it is possible to stipulate that members can only be those shareholders who have more than 10% of the shares.153 There are some restrictions under other laws, such as the Law on the Fundamentals of Government Ofcials which prohibits government ofcials from becoming directors unless so entrusted by the government.154 Members of the board are appointed and dismissed by the general shareholders’ meeting. The term is one year, but the term can be renewed a number of times without any limit. Members of the board cannot, at the same time, be members of the audit committee. Irregularities are often seen in the process of appointing board members: A group of shareholders initiated an action at a district court in the City of Moscow asking the court to declare void a resolution of the general shareholders’ meeting of a joint stock company SELP. In the shareholders’ meeting in 1994, selection of the board members was on the agenda, but none of the candidates obtained the required minimum number of votes. Therefore, it was resolved that a second shareholders’ meeting was to be held. However, not all shareholders received the notice for the second shareholders’ meeting. Shareholders who were previously members of the workers’ collective and were later dismissed were not informed of the meeting; the total number of shares held by them exceeded 50%. The executive body of the joint stock company SELP failed to include the candidates proposed by the shareholders who were suing the company in the list of candidates for the membership of the board, despite the fact that there were no aws in the procedure by which these candidates were put forward. The company claimed that the signatures on the proposal had been forged.155

152 153 154 155

Krapivin and Vlasov, supra, pp.230-231. Shapkina, supra, p.188. Law No.154-FZ of August 28, 1995. Mateleva, supra, pp.164-165.

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Members of the board may be elected by cumulative voting. In a company with more than one thousand shareholders with a vote, cumulative voting is mandatory (ibid., para.4). In a survey conducted between 1999 and 2001, the average number of the board of directors was 7.9. Largest groups represented on the board were the management (38.1%) and the workers’ collective (20.7%) respectively. Another analysis of the composition of the board between 2002 and 2003 showed that large shareholders were represented (34% of the members) as well as the management and the employees (30%). On average, a quarter of the members were simultaneously members of the executive body.156 The chairman of the board of directors is elected by the members from among themselves by a majority vote. The chairman organises the work of the board, convenes the board and presides over it, and also presides over the general shareholders’ meeting unless otherwise provided by the Articles of Incorporation (Art.67, paras.1 and 2). The meeting of the board is convened by the chairman on his own initiative, but also upon request of the members of the board of directors, the audit committee, or the auditor, the executive body of the company and other persons designated by the Articles of Incorporation. The board meeting can be held without an actual meeting. The quorum can be set by the Articles of Incorporation, but cannot be less than 50% (Art.68, paras.1 and 2). The meeting should be held whenever it is necessary, but at least once a year.157 A 2002 survey of 400 major and medium-sized companies revealed that some of them had only 5 to 7 meetings in 2002. In the remaining companies, the frequency was 9 to 14 meetings per year.158 According to various surveys, the activities of the board of directors have a “formal nature”. One survey in 2001 suggests that members of the board of large companies spend little time discharging their duties – one to ve days a month. It is extremely rare for the board to determine the remuneration of the executives or of their own.159 The composition of the board suggests that the board of directors is in reality under the inuence of the management of the company.160 Some progress has been reported though. This progress is exemplied by the introduction of independent directors. In one survey, 28% of the respondent companies had independent directors. However, it should be noted that 61% of

156 157 158 159 160

OECD Obzor, supra, p.16. Krapivin and Vlasov, supra, p.241. OECD Obzor, supra, p.17. Ibid., p.16. Ibid.

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the respondents think that these independent directors are very likely to be “hidden interested persons”.161 (c) Executive Bodies Current activities of the company are directed by a single executive body (director or general director) or a single executive body and a collective executive body (management council ( pravlenie) or directorate (direktsiia)). Executive bodies of the company organise the implementation of resolutions of the general shareholders’ meeting and the decisions of the board of directors (Article 69, para.2). The executive bodies should not interfere with the exclusive competence of the general shareholders’ meeting or the board of directors. A single executive body is entitled to act on behalf of the company without power of attorney. More specically, the executive body is empowered to represent the interests of the company, effect transactions in the name of the company, approve the number of personnel, issue instructions and orders which are binding on all employees (ibid.). Executive bodies are appointed and dismissed by the resolution of the general shareholders’ meeting, unless this power is given to the board of directors by the Articles of Incorporation (ibid., para.3). Apart from the provision which denes the function of the executive body to be the “directing of the current activities of the company”, there is no explicit provision on the power of the executive bodies. As a commentary puts it, the Law practically determines nothing about the activities of either the director or the management council, or their competence”.162 Details of the power of the executive bodies are left to the Articles of Incorporation.163 Typical issues which fall within the portfolio of an executive body include the following: i) arrangement of an effective operational management of the current business of the company; ii) arrangement for the conducting of the general shareholders’ meeting and the meeting of the board of directors; iii) preparation and realisation of the company’s current business strategy for the purpose of increasing protability and competitiveness; iv) preparation and submission to the board of directors of the business plan of the company, nancial documents, including the balance sheet and the prot and loss report, and the proposal for the distribution of the prot and loss;

161 Ibid., p.17. 162 Krapivin and Vlasov, supra, p.248. 163 Sahpkina, supra, p.195.

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v) preparation and submission to the board of directors of draft internal rules and instructions.

If there are both single and collective executive bodies, the Articles of Incorporation must determine the scope of the power of each body. In such cases, the single executive body, i.e. the director or general director, also combines the function of the chairman of the collective executive body. By the resolution of the general shareholders’ meeting, the power of the executive body may be entrusted to a commercial management organisation or an individual entrepreneur by agreement (Art.69, para.1). The relationship between the members of the executive body and the company is governed by a contract which is categorised as an employment contract. The contract is signed on behalf of the company by the chairman of the board or a person empowered to do so by the board. The general shareholders’ meeting may terminate this contract at any time (Art.69, paras.3 and 4). However, the court practice is that since labour law is applicable here, there has to be an appropriate ground for the termination under the Labour Code.164 Members of the collective executive body may not form a majority of the board of directors. A person who is the single executive body may not simultaneously be the chairman of the board of directors (Art.66, para.2). In Gazprom, the Articles of Incorporation provide that members of the management council ( pravlenie) can be dismissed by a unanimous vote of the board of directors. However, these people are simultaneously board members, and therefore, a unanimous vote is unlikely to be achieved. This arrangement was contested in the commercial court, which ruled this clause to be against the law. Gazprom reportedly intends to change it to a majority vote, but this will not change the situation, since six management council members occupy the 11 member board of directors.165

The actual arrangement of executive bodies differs from company to company. Lukoil has a president of the company, the management committee ( pravlenie), and the board of directors. The management committee basically comprises heads of the administration. The board chairman is an outsider, but the president and the rst executive vice president are also members of the board. There are some outsiders on the board.166 In a leading steel company, Severstal’, there is a board of directors with ve independent directors out of the ten directors. The remaining directors are “executive directors”. On the other hand, the

164 Krapivin and Vlasov, supra, pp.253-254. 165 NG, June 20, 2000. 166 www.lukoil.com

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management of the company is entrusted to a management company on the basis of the resolution of shareholders, and this company acts as a collective executive body. The general director is appointed by this company.167 The Unied Energy System has a collective executive body in the form of a management council. Members of its board of directors include the president and vice president of the company and representatives of the government.168 (d) The relationship between the board and the executive body The Law is almost silent on the relationship between the board of directors and the executive body. In a book published in 2000, Russian experts raised a question – on whose behalf and against whom does the board perform a supervisory function?169 In Germany, the supervisory board oversees the board of directors. In Russia, this is not possible, since the board of directors and the supervisory board are one and the same body. Therefore, if the board is to have any supervisory function as its title in brackets suggests, it has to be supervising the executive bodies. It was only by the 2001 amendment that a provision to the effect that the executive bodies are subordinate to the board of directors and the general shareholders’ meeting was introduced (Art.69, para.1). However, this provision is not specic enough. For example, does the fact that executive bodies are accountable to the other bodies mean that the general director should attend the meetings of the other bodies and give reports from time to time?170 In reality, executive bodies, in principle, are controlled by no one, except that they are appointed and dismissed by the board of directors.171 It is pointed out in Russia that an unsupervised executive body will sooner or later start ignoring the interests of the company which it manages, increasingly subjecting their activities to their own interest which it places above the interests of the company. If appropriate measures are not taken, the nancial state of the company will start deteriorating.172 The same applies to the relationship between the single and collective executive bodies. A Russian specialist suggests that in practice, the collective executive body has failed to become an independent executive body; it continues to be a body subordinated to the single executive body – the general director.173

167 168 169 170 171 172 173

www.severstal.com www.rao-ees.ru Krapivin and Vlasov, rst edition, supra, p.163. Krapivin and Vlasov, supra, p.247. Krapivin and Vlasov, rst edition, supra, p.163. Ibid., p.164. S.Mogilevskii, supra, pp.144-145.

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Under the socialist system, state enterprises were run by the general director under the “one man management” system, assisted by some ofcers. There was no effective control over the management. After 17 years, this system seems to be continuing under a different name. (e) Liability of Directors and Executive Ofcers Members of the board of directors, a single executive body (director, general director), and members of the collegiate executive body (management council, directorate) are under a general obligation to act in the interest of the company, and to exercise their rights and full their duties in relation to the company conscientiously and reasonably (Art.71, para.1). Directors and others listed above are liable vis-à-vis the company for the loss caused by them to the company by their fault (this includes both acts and omissions). In collective bodies such as the board of directors and the collegiate executive body, those members who voted against the decision which caused the loss, or did not take part in the vote, are exempted from liability (Art.71, para.2). When determining the basis and scope of liability, the normal terms of commercial practice and other circumstances which have relevance to the case must be taken into account (ibid., para.3). If several persons are liable, they bear joint and several liability (ibid., para.4). As cited above in various cases, abuse of power by directors and members of the executive body are not rare in Russia. Here is another example: A director of a company, Zavod keramzitovogo graniia’, concluded an agreement of pledge (zalog) on behalf of the Zavod with Stroitel’nyi Bank in order to guarantee a debt of a third party, an individual entrepreneur, who had nothing to do with the company. The agreement was concluded without the consent of the management council or the general shareholders’ meeting. The Zavod brought the case to court, asking the agreement to be recognised null and void. However, courts of rst instance and the appellate instance rejected the claim. The Supreme Commercial Court quashed the decision and remanded the case to the rst instance court on the ground that “such a transaction could lead to gratuitous assignment of the company’s property without the consent of the shareholders”.174

The liability of these persons can be pursued by the company itself (Art.71, para.5). In such an action, the single executive body is to act on behalf of the company without power of attorney. If the liability of the single executive body itself is pursued, a power of attorney is issued to another person by the resolution of the general shareholders’ meeting, the board of directors, or the collegiate executive body.

174 Decision of the Presidium of the Supreme Commercial Court, March 10, 1998, No.7422/97.

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Shareholders who hold 1% or more of the shares are entitled to pursue the liability of the directors and others (ibid.). This “indirect action” has apparently been modelled on the system of derivative action in the United States. However, this provision merely outlines the general right of shareholders to pursue liability of directors and executive ofcers but fails to give details. The wording of this provision is ambiguous in the sense that the nature of this action is not clear. It is not explicitly provided that this action is not for the interest of an individual shareholder, but for the interest of the shareholders as a whole or the company and that the damages are payable to the company and not to the plaintiff shareholder. There is no procedural provision either. In order for shareholders to initiate an action, they may need the minutes of the meeting of the executive body. However, access to such documents is granted only to shareholders with 25% or more of the shares. In reality, there has been no reported case of indirect action. Presumably, the time and cost involved as weighed against the gain – even if the plaintiff wins, the damages will go to the company – discourage the shareholders.

(f ) Restraints on the Power of the Executive Bodies As mentioned above, abuse of power by the management of the company at the cost of shareholders is not uncommon in Russia. The Law accommodates two specic means of control over the activities of the management, namely the executive bodies. (i) Major Transactions Approval of the board of directors or the general shareholders’ meeting, depending on the value of transaction, is required in effecting transactions which qualify as “major transactions (krupnyie sdelki )”. Major transactions are dened by the Law as a transaction or several related transactions by the company involving direct or indirect acquisition or disposal or the possibility of acquisition or disposal of the property whose value is 25% or more of the book value of the assets (Art.78, para.1). Before the 2001 amendments, the scope of major transactions was not clear. The denition of major transactions has been criticised in Russia as having serious shortcomings since it provides ambiguous criteria.175 After the 2001 amendment, the provision has become more specic. Now, borrowing money, extending loans, and providing security and guarantees are explicitly acknowl-

175 G.S.Shapkina ed., supra, p.219.

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edged as transactions in the context of this provision. In addition, according to the Supreme Commercial Court, assignment of claims, assumption of debt, investment in another company in exchange for shares can be major transactions if the amount exceeds the limit.176 On the other hand, the previously controversial problem of issuing of shares and securities which are convertible to shares of over 25% of the already issued shares was explicitly excluded from major transactions. This is now regulated by other provisions. Still, there are some ambiguities which are abused. One of the problems is the “interrelated transactions”.177 Open joint stock company Moskovskii Avtoservis sold pieces of real estate in a series within two years to various juridical persons. The transactions were authorised by its general director. The total value of the property amounted to 48% of the assets on the balance sheet. Then the company brought an action in court vis à vis the buyers and the Moscow Registration Ofce in order to deny the validity of the sale. The rst instance court acknowledged the claim, but the appellate court overruled this decision. This was supported at the cassation instance. However, the Supreme Commercial Court found that these properties were part of the property complex and were therefore all interrelated. Furthermore, in the end, all the properties now belonged to a single person. Thus, these transactions as a whole were interrelated, and were subject to the approval of the board. In this case, the board of directors had disapproved these transactions due to the “critical nancial situation” and actually prohibited the general director from disposing of assets without the approval of either the board of the general shareholders’ meeting. The court also pointed out that the market value of the properties was three times as high as the price stipulated in the contracts, which meant that they were sold to the disadvantage of the company.

As criteria of interrelatedness, the court takes into account various circumstances including the common goal which the conclusion of these transactions aims to achieve, the intention of the parties, similarities of the obligations of the parties in different transactions, and so on. Contracts of pledge were found to be interrelated, since they were concluded to secure the same basic obligation.178 By Law, transactions effected in the course of normal economic activities, such as the sale of property which the company had purchased in the course of business, are excluded, even if the value exceeds 25% of the assets. In one case, a company took out a loan, but later claimed that this was a major transaction

176 Decision of the Plenum of the Supreme Commercial Court, November 18, 2001. 177 S.L.Budylin, “Krupnye sdelki khoziaistvennykh obshchestv”, Arbitrazhnaia praktika, 2005,

No.2, p.4. 178 Lomakin, supra, pp.257-261.

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since the amount exceeded 25% of the book value of the assets, but the general director had taken out the loan without necessity. The intention of the company was to invalidate the contract and return the money with an interest calculated by the statutory rate rather than paying the interest at the agreed rate. The court found that the company took out the loan with a view to purchasing commodities. This was part of its business activities as provided by the Articles of Incorporation. Therefore, the court concluded that the loan was taken out in relation to the performance of the company’s current economic activities.179 Another case involved a UK company:180 A British company sold pharmaceutical products to a Russian company. The Russian company was heavily in debt to the supplier – over one million dollars. In order to reschedule the debt, an agreement was reached to return the products and repay the debt. However, the Russian company never returned the products or repaid the debt. The British company took the case to court. The Russian company presented a counter-claim, arguing that the agreement had been concluded by a person in excess of his power. The court of rst instance found this agreement to be a major transaction. This was overruled by the appellate court and the court of cassation supported this decision. The Supreme Commercial Court upheld this decision on the ground that the agreement was intended for the rescheduling of debts emerging from a previously concluded contract. This meant that the agreement was concluded in the normal course of business. Besides, the products, according to the agreement, still belonged to the British company and therefore, there was no question of the disposal of the property of the company.

Major transactions must be approved either by the board of directors or by the general shareholders’ meeting (Art.79, para.1). Whether a transaction is major or not depends on its value. Major transactions with a value of between 25% and 50% of the company’s assets on the balance sheet need to be approved by the board of directors unanimously. If unanimity cannot be reached, the matter can be referred to the general shareholders’ meeting, which may approve the transaction by a simple majority (ibid., para.2). A shareholder brought an action in court for the invalidation of a major transaction by the company on the ground that one director was absent from the board meeting, and that a person with a power of attorney voted on behalf of another director who was absent. The plaintiff argued that the Law requires unanimity of all directors, not just the directors who were present at the meeting. The rst instance court dismissed the claim on the ground that unanimity meant the consent of all the directors

179 Budylin, supra, p.4. 180 Ibid., p.5.

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who were present. The appellate court quashed this decision on the ground that the Law required the unanimity of all directors. In other words, the quorum for a board meeting which approves a major transaction has to be all existing members of the board. The court also added that each and every member of the board is required to take part in the vote in person and is not allowed to delegate this duty to another person.181

By the 2001 amendments, this was accommodated in the relevant provision by inserting a clause that “all members of the board take part” in the decision (Art.79, para.2). Transactions with a value of more than 50% of assets require a qualied majority of the general shareholders’ meeting (ibid., para.3). The law provides that the value of the assets should be determined in accordance with Article 77 which, in turn, provides for the determination of the market value of the assets by the board of directors. It sets a criterion for the determination of the price of assets when the Law requires the board of directors to determine the price. A joint decision of the Plenum of the Supreme Court and the Supreme Commercial Court of the Russian Federation gave an interpretation that the value of the property which is the object of the transaction should be determined by the actual sale or purchase price of the assets as entered in the latest balance sheet, and thus gave some objectivity to the “market value”,182 but such prices may not always be available. Following the 2001 amendment, the Law now provides that the price of property which is sold or has the possibility to be sold should coincide with the value in the balance sheet, and that the value of property to be acquired is the price of its acquisition (Art.78, para.1). It is possible to have an independent valuer involved, but this is not mandatory. When the board determines the price, there is a possibility that a person who has an interest in one or several transactions is, at the same time, a member of the board. In such cases, the price is determined only by the members who do not have an interest in the transaction (Art.77, para.1). Major transactions involving a property with a book value between 25% and 50% of the assets of the company, must be approved unanimously by the board of directors, without the director proposing the transaction voting. If a unanimous approval is not obtained, the matter can be transferred by the board to the general shareholders’ meeting (Art.79, para.1). In cases where the object of the transaction has a value of more than 50% of the book value of the company’s assets, the decision is adopted by the general

181 Item 9, Information Letter of the Presidium of the Supreme Commercial Court No.62, March

13, 2001. 182 Krapivin and Vlasov, rst edition, supra, p.184.

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shareholders’ meeting by a three quarter majority of those who are present (ibid., para.2). Prior to the 2001 amendment, there was no explicit provision regarding the effect of major transactions that have been carried out without the required approval, and there was controversy as to whether such a transaction would be null and void or voidable. Some decisions of the court found such transactions to be null and void:183 A closed joint stock company, Rosinka Odin, brought an action against an open joint stock company, Russkaia Berezka, at the Moscow City Commercial Court, asking for part of an additional agreement attached to the contract to be declared void. Russkaia Berezka and a third party, Stels Plius, concluded a contract of sale of securities on May 27, 1996, according to which Russkaia Berezka sold Stels Plius shares of various companies to the total sum of 1,121,712,160 roubles (before devaluation). An additional agreement of June 14, 1996 was concluded between the above two companies, plus Rosinka Odin which provided that Rosinka Odin guarantee the performance of the obligation by Stels Plius vis-à-vis Russkaia Berezka by transferring Russkaia Berezka shares held by Rosinka Odin as pledge. Rosinka Odin’s argument was that although this transaction was a major transaction, the necessary procedural requirements were not fullled and therefore, the supplementary agreement of pledge was null and void. The rst instance court rejected the claim of the plaintiff. The appellate instance upheld this and so did the court of cassation. However, the Supreme Commercial Court overruled the judgment of the lower court. The Court found that the relevant clause of the additional agreement was null and void, since the transaction had been effected without the approval of the board of directors or the shareholders’ meeting at Rosinka Odin as required by Article 79 of the Law on Joint Stock Companies despite the fact that the value of the pledged shares had exceeded the assets of the company.

Now it is explicitly provided by the Law that such transactions are voidable, i.e. such transactions can be invalidated by the company or a shareholder (ibid., para.6). (ii) Transactions with interested parties In Russia, it is not uncommon for board members and executive ofcers to abuse their position and pursue their own interests rather than the interests of the company by effecting transactions not at arm’s length, but in favourable terms with interested parties:

183 Decision of the Presidium of the Supreme Commercial Court, February 23, 1999, Case

6115/98.

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Joint stock company Lensnabpechat’ brought an action against a limited liability company Interspekt, asking the court to invalidate a contract of sale of the production base at Shvalovo. On July 1996, Polikarpov, the general director and the chairman of the board of directors of the plaintiff company and at the same time, acting on a power of attorney issued by the defendant company, signed the contract selling this production base. Polikarpov turned out to be simultaneously one of the founders of the defendant company and in fact, held 20% of its capital. A representative of the defendant company, who held 20% of the capital of the defendant company and one of its founders, was at the same time, the deputy general director of the plaintiff company. The Federal Commercial Court of the North-West District found that the transaction was in apparent excess of power by the general director and therefore, void. The argument of the defendant company that the defendant was not aware and could not have been aware of the restrictions on the power of the general director was not accepted by the court.184

The Law on Joint Stock Companies contains provisions designed to prevent such transactions. These provisions were substantially streamlined by the 2001 amendment. Transactions (including extending of loans, borrowing money, pledge and guarantee) in which the following persons have an interest must be effected in accordance with procedure set by the Law. The Law rst denes the scope of interested parties, imposes an obligation on the interested parties to disclose information to the company and sets the procedure for the approval of such transactions. The provision covers the following persons (Art.81, para.1): i) members of the board; ii) a person who is the single executive body of the company; iii)members of the collective executive body; iv)a person or organisation which is entrusted to manage the company; v) a shareholder who, together with afliated persons, holds 20% or more of the voting shares; vi)a person who has the right to give binding instructions to the company.

These persons are regarded to have an interest in a transaction with the company, if such a person, his spouse, parent, child, sister or brother, parent or child by adoption, or an afliated person:

184 Arkhiv Federal’nogo arbitrazhnogo suda severo-zapadnogo okruga, Kassatsionnoe delo

No.1664/96 (cited in Bushev and Skvortsov, supra, pp.157-159).

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i) is a party, beneciary, intermediary, or representative in the transaction; ii) holds 20% or more of the shares in a juridical person which is a party, beneciary, intermediary, or representative in the transaction, or iii)occupies a position in the management body of a juridical person which is a party, beneciary, intermediary, or representative in the transaction, or occupies a position in the management of the organisation which is entrusted to manage the company; iv)other occasions as provided by the Articles of Incorporation.

The above persons are under an obligation to provide the board of directors and audit committee, as well as the auditor of the company, with the following information (Art.82): i) on juridical persons in which the person on his own, or jointly with an afliated person, holds 20% or more shares; ii) on juridical persons in which he holds a position in its management body; iii)on the transaction which the person has effected or intends to effect in which he may be regarded as an interested party.

However, this provision on disclosure of information is obviously insufcient. Firstly, the timing of disclosure is not clear. Ideally, these people, when they are appointed, or come to hold 20% of the shares, should disclose the information to the board and other bodies. Secondly, the list of information which is to be disclosed is insufcient. The list does not cover all circumstances where a person may become interested. Thirdly, the procedure for disclosing the information is not provided.185 Transactions are required to be approved in advance by the board of directors or the general shareholders’ meeting (Art.83, para.1). In a company with a number of shareholders with a vote up to 1,000, such transactions are required to be approved by the board of directors by a majority of directors who do not have any interest in the transaction. If the number of non-interested directors is below the quorum, the transaction can only be approved by the general shareholders’ meeting (ibid., para.2). In companies with more than 1,000 shareholders, the transaction is required to be approved by a majority vote of independent directors. If all directors are regarded as having an interest in the transaction, and/or are not independent directors, the transaction has to be approved by the general shareholders’ meeting (ibid., para.3).

185 Krapivin and Vlasov, second edition, supra, pp.291-292.

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In this context, “independent directors” denotes directors who are not, and have not been, for the past one year preceding the adoption of the decision, to approve the transaction (Art.83, para.3): i) a single executive body, or a member of the collective executive body, or held a position in the management body of the managing organisation; ii) a person whose spouse, parent, child, brother or sister, parent or child by adoption occupies a position in the above body of the company, management company, or an individual manager entrusted to manage the company, or iii)an afliated person of the company (except the member of the board).

Approval of the general shareholders’ meeting by a majority vote of the noninterested shareholders is required, in addition to the above situation where the board cannot meet the quorum, in cases such as where the object of the transaction or several interrelated transactions represents 2% or more of the assets of the company in the accounts of the last nancial period (ibid., para.4). On the other hand, these transactions do not need the approval of the general shareholders’ meeting, if the terms of the transaction do not substantially differ from the transaction between the company and the person with an interest, effected between the same parties in the course of normal commercial activities of the company before this person was recognised as a person with an interest in the transaction (ibid., para.5). If a transaction with an interested party was effected in violation of the above provisions, the transaction is voidable. As is the case with major transactions, there was controversy as to whether this was a null and void transaction or a voidable transaction, but the 2001 amendment made it clear that this is a voidable transaction, which can be invalidated by the company as well as shareholders. The person with an interest is liable to the company for the damage resulting from the transaction (Art.84). The ground for the liability is the failure of these persons to provide the information to the company as required in Article 82.186 There is a criticism that the liability of those who allowed such transactions to proceed, particularly when the disadvantage of the transaction to the company was obvious, should be pursued as well.187 There are various examples of interested party transactions. An open joint stock company “Informenergo” brought an action against a limited liability company “Gala Inform” at the Moscow City Commercial Court, asking the court to declare void the contract of sale of part of a building of 2,975.7 square

186 Mozolin and Iudenkov, supra, p.378. 187 Krapivin and Vlasov, second edition, supra, pp.297-298.

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metres on the ground that the transaction was an interested party transaction, but nevertheless, the appropriate procedure was not followed. A member of the board and at the same time, the general director, L.G.Lipnik, who gave a power of attorney to P.E.Demb for the transaction held, in conjunction with his afliated persons, more than 20% of the shares of Gala Inform. The plaintiff argued that Lipnik held 40% of a closed joint stock company which owns 50% of a limited liability companies Tovarishchestvo Flesh and Flesh Markt respectively. The latter owned 50% of the former, who is the sole founder of Gala Inform. The value of the building was 1,608,000 roubles, which was more than 2% of the assets of the plaintiff company. According to Art.83 of the Law on Joint Stock Companies, interested party transactions over 2% of the assets of the company need to be approved by the general shareholders’ meeting, but this did not take place, since Lipnik did not disclose to the board that he was interested. The lower courts dismissed the claim of the plaintiff on the ground that Lipnik was not an immediate party to the transaction and did not take part in the transaction as a representative or an intermediary. However, the Supreme Commercial Court did not uphold this view. The Court ruled that Lipnik was a board member and the general director and held 20% interest in Gala Inform. The fact that Lipnik was not a party to the transaction does not exclude the possibility that this was an interested party transaction. The conclusion of the lower courts that Lipnik did not take part in the transaction is wrong, since he, as he general director, has acted in the name of the company and Demb merely acted as his representative based upon the power of attorney.188 Open joint stock company, Samarskaia Metallurgicheskaia Kompaniia (SAMEKO), brought an action against the joint stock company, Inkombank, at the Commercial Court of the City of Moscow, for recognition of a loan agreement as void on the ground that the transaction had been effected with an interested party without following the appropriate procedure. The agreement was signed by the president of Inkombank on behalf of the Bank and by the general director, V.I.Bogocharov on behalf of the debtor, SAMEKO. At the time of conclusion of the agreement, Bogocharov was also vice president of Inkombank and a member of the top management body of the Bank. The rst instance court and the court of the cassation instance acknowledged this transaction as null and void, since the procedure as required by the Law on Joint Stock Companies had not been followed. However, upon protest, the Supreme Commercial Court quashed the judgment of the lower court and referred the case for a new hearing, since a contract of assumption of debt had been concluded between Inkombank and another company, Saianskii aliuminevyi zavod, and therefore, it was questionable whether or not SAMEKO was the appropriate plaintiff.189

188 Decision of the Presidium of the Supreme Commercial Court, June 27, 2000, Case 8342/99. 189 Decision of the Presidium of the Supreme Commercial Court, January 18, 2000, Case

6309/99.

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The general director of a company who sold shares to another company, a limited liability company, was interested, since he owned more than 20% of the quota of this limited liability company at the time it was established. There was neither a decision of the board or the resolution of the general shareholders’ meeting which endorsed this transaction. The rst instance court found the transaction invalid. However, the appellate court ruled that the general director had since then disposed of the quota in the limited liability company, and was not a member of this company at the time of the transaction, thereby quashing the decision of the lower court.190

8)

Audit – Audit Committee (revizionnaia komissia) and the External Auditor

Companies are under an obligation to carry out bookkeeping and prepare nancial reports as required by the Law. It is the duty of the executive bodies to organise bookkeeping and ensure its truthfulness as well as to provide nancial reports to the relevant bodies. They are also responsible for providing information on the activities of the company to shareholders, creditors and the mass media (Art.88, paras.1 and 2). Supervision of the “nancial and economic activities” of the company is entrusted to the audit committee (revizionnaia komissia) (Art.85, para.1). Normally, there are three members of the committee, but in smaller companies it is possible to have one member (revizor) only. Members of the audit committee are elected exclusively by the general shareholders’ meeting. Shares which belong to the members of the board of directors and other bodies of the company are not given a vote when appointing members of the audit committee. Members of the committee cannot simultaneously be a member of the board or occupy other positions in the company’s management (ibid., para.6). The audit committee supervises the accounting of the company and ensures that nancial documents are properly prepared for the shareholders’ meeting. The committee’s responsibilities include checking the correctness of the accounts, particularly the checking of the inventory of assets and debts of the company, and supervision of accounting discipline.191 This provision does not limit the scope of power of the audit committee to “nancial economic activities” of the company. By the Articles of Incorporation, the audit committee may be given power to monitor the “purpose and efciency of the operation of the company”.192

190 Item 14, Information letter No.62 of the Supreme Commercial Court, March 13, 2001. 191 Tikhomirov, supra, pp.347-348. 192 Shapkina ed., supra, p.341.

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Supervision of “nancial-economic activities” is conducted on the basis of the annual result of the activities of the company, but also on the initiative of the audit committee, by a resolution of the general shareholders’ meeting or the decision of the board of directors. Shareholders with not less than 10% shares are entitled to request an inspection by the audit committee (ibid., para.3). Upon request of the audit committee or its members, persons who occupy a position in the management body are obliged to submit documents concerning the nancial-business activities of the company. However, there is no sanction against non-compliance, and therefore, the effectiveness of this provision is doubtful. The audit committee is empowered to request the board to convene an extraordinary shareholders’ meeting (ibid., para.5). In addition to the audit committee, open joint stock companies and some closed joint stock companies are required to have an external auditor (auditor). The legislature was not content merely with the system of audit committee, since its members are elected by the shareholders who, for their judgment of the suitability of the members, have to rely on the recommendation of the board.193 According to the Law on Joint Stock Companies and the Law on Audit Activities, audit by an external auditor is required of: i) all open joint stock companies, regardless of their size, are required to have an external auditor audit the accounts; ii) closed joint stock companies, which issue bonds and other securities by public offer must have an external auditor. Annual audit has to be made during the period the securities are in circulation; iii)closed joint stock companies whose turnover of sale of goods or provision of service exceeds by 500 thousand times the statutory minimum wage in one year or the assets on the balance sheet exceeds, at the end of the nancial year, by 200 thousand times the statutory minimum wage.

In addition, audit by an auditor is mandatory upon the request of a shareholder who holds 10% of more of the capital (the Civil Code, Art.103, para.5).194 External auditors can be either an individual or a rm, but must be a person or entity with no proprietary relations with the company or its members. The external auditor checks the “nancial-economic activities” of the company based upon a contract with the company. The purpose of the audit is to prepare an opinion on the truthfulness of the nancial reports of the company and

193 Krapivin and Vlasov, supra, p.305. 194 Mozolin and Iudenkov, supra, p.384.

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on the observance of law in bookkeeping.195 The external auditor is appointed by the general shareholders’ meeting. The remuneration is determined by the board of directors (Art.86). The Law on Accounting Activities was enacted in 2001.196 Auditing is a licensed profession; there is a cabinet decision which sets out the procedure for attestation and the grant of a license. All the major global accounting rms now operate in Russia. Upon completion of the audit of the “nancial-economic activities” of the company, the audit committee and the external auditor prepare an opinion which includes: i)conrmation of the truthfulness of the information contained in the annual report and other nancial documents of the company; ii)information on the facts of breaches of laws and statutes on accounting and nancial reporting and the legislative acts of the Russian Federation in the course of conducting “nancial-economic activities” if there were any.

While the opinion of the audit committee is intended for internal purposes of the company, the auditor’s opinion is not only intended for the company, but also for third parties such as creditors and investors who need a clear representation of the state of nance of the company. Therefore, the form of the auditor’s opinion is set by the Law on Audit Activities.197 Accounting standards are provided by the Law on Accounting as well as cabinet decisions and normative acts of the Ministry of Finance.198 At present, the only methodological basis for accounting and reporting for companies (except for banks) is the Statute on the Accounting and Reporting which was enacted in 1994 in the form of an order of the Ministry of Finance.199 In 1997, the government embarked on a reform of the accounting system for approximation with the International Accounting Standards. However, the “evolutionary approach” which has been adopted seems to be taking time.200

195 196 197 198 199 200

Krapivin and Vlasov, supra, p.304. Law no.119-FZ of August 7, 2001. Mozolin and Iudenkov, supra, pp.385-386. Law No.129-FZ of November 21, 1996. Krapivin and Vlasov, supra, p.312. R.W.McGee et al., “Problems of Implementing Accounting Standards in a Transition Economy: A Case Study of Russia,” 2004, SSRN http://ssrn.com, p.9.

186 9)

COMPANY LAW

Reorganisation of Companies

The Russian concept of “reorganisation” covers merger (sliianie and prisoedinenie), division (razdelenie), spin-off (vydelenie) and conversion (JSCL Art.8). Provisions on reorganisation are surprisingly sparse. There are only two provisions on mergers, and one each for other types of reorganisations. There is almost nothing regarding the protection of shareholders on such occasions, not even the rights of the shareholders to be informed of the proposed reorganisation or to familiarise themselves with the documents. The introduction of such provisions is being proposed.201 There are two categories of merger. Sliianie is dened as an emergence of a new company with the transfer of all the rights and obligations of several existing companies to the new company and with the termination of those existing companies. Prisoedinenie is the absorption of one company by another with the transfer of all the rights and obligations to the other (Arts.16 and 17). Companies taking part in the merger are required to conclude an agreement of merger which determines the procedure and conditions of the merger as well as the procedure of converting shares of these companies into the shares of the new company. The merger needs to be approved by the general shareholders’ meeting of each company. The adoption of the Articles of Incorporation and the appointment of the board of directors of the newly established company take place at the joint general shareholders’ meeting of the companies which are parties to the merger in cases of sliianie (Art.16, para.3). In cases of prisoedinenie, the parties conclude an agreement which determines the procedure and terms of the merger, but also the procedure of the conversion of the shares of the company which is to be absorbed into the shares of the surviving company. Each company holds its own general shareholders’ meeting to approve the agreement (Art.17, para.2). In both cases, the transfer act ( peredatochnyi akt), which is a document certifying the transfer of rights and obligations, has to be approved by the shareholders. The Law on the Protection of Competition requires the advance consent of the Federal Anti-Monopoly Service for mergers with the total assets on the balance sheet exceeding 3 billion roubles or the annual turnover exceeds 6 billion roubles (Art.27, paras.1 and 2). In a division (razdelenie) of a company, the company ceases to exist, while the rights and duties of the company are transferred to several newly established companies. The board of directors of the company proposes the division to the general shareholders’ meeting and the form, procedure, terms of the division,

201 Mozolin and Iudenkov, supra, p.73.

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and other matters concerning the creation of new companies and the method of conversion of shares and securities. The general shareholders’ meeting of each newly set up company adopts a resolution on the approval of the Articles of Incorporation and the appointment of the board of directors. In a division of a company, all the rights and obligations of the company are transferred to the newly established companies in accordance with the divided balance sheet (Art.18). It should be added that the Civil Code as well as the Law on the Protection of Competition provide for the possibility of compulsory division of a company. This is possible if a company with a dominant position repeatedly effects monopolistic activities (the Civil Code, arts.10, 57, paras.1 and 2, Law on the Protection of Competition, Art.38). In a spin-off (vydelenie), a company creates one or several new companies and transfers part of its rights and duties, but the company stays in existence (Art.19). The procedure is basically the same as in division. Conversion ( preobrazovanie) means transformation of a joint stock company to another type of commercial organisation. The Law provides for conversion either to a limited liability company or production cooperative, and if all shareholders agree, to a non-commercial organisation (Art.20). All such reorganisation requires a qualied majority vote of the general shareholders’ meeting (Art.49, para.3). Those shareholders who voted against reorganisation or were not present at the shareholders’ meeting have an appraisal right (Art.75, para.1). Within 30 days of the adoption of the general shareholders’ meeting regarding reorganisation, creditors must be informed in writing and the resolution must be published in the media which publishes information on company registration. If the creditors wish to require the company to terminate or perform the obligation ahead of the due date, they are entitled to do so in writing as well as to compensation (Art.15, para.6).

7

THE RUSSIAN SECURITIES MARKET

The Russian securities market emerged as a result of the voucher privatisation which took place in 1992 and 1993. Auctions organised by the government for selling shares in privatised companies in return for vouchers contributed to the emergence of a class of private investors. The government began issuing short term government bonds in 1993 and accordingly, a market for government bonds was created. The RTS Stock Exchange which consolidated separate regional securities trading oors started operation in 1995. By the end of 2004, more than 300 securities

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were traded on the RTS Stock Exchange, including more than 40 bonds.202 The number of listed companies in Russia is rather small compared with other former socialist countries. The basic law which regulates the nancial market is the Law on the Securities Market of 1996. The Law underwent major amendments in 2002 and 2004. There is also the Law on the Protection of Rights and Legal Interests of Investors in the Securities Market of 1999 as amended. The latter sets out requirements which apply to professional participants in the market providing a service to investors who are not professionals, and also “additional requirements” concerning public offer as well as measures for the protection of investors (Art.2, para.1). It is not clear why there need to be two separate laws. The agency in charge of implementing the law in this area is the Federal Service of Financial Markets which succeeded the Federal Commission on Securities. At the time the 2002 amendments were prepared, there was a serious debate on the problem of how a civilised securities market could be established in Russia, and particularly, how and to what extent the market should be regulated. From the viewpoint of the need for the “harmonious coexistence” of the government regulatory body and the self-regulatory bodies, the Commission was criticised for its “excessive expansion of power”. This was supported by the President’s administration and in the end, the Commission was replaced by the newly established Federal Service on Financial Markets.203 According to the decision of the government, the basic functions of the Service are: i) state registration of securities and receiving reports on the result of the issuing; ii) ensurance of disclosure in the securities market; iii)supervision of the issuing companies of the securities, professional participants in the securities market, their self-regulatory body, investment funds etc.

Government regulation of the securities market operates via the following means:204 i) setting of mandatory requirements and standards for the activities of the participants in the securities market; ii) state registration of issuing of securities and prospectus and supervision of the observance of the terms;

202 www.rts.ru 203 V.A.Vaipan ed., Kommentarii k Federal’nomu zakonu o rynke tsennykh bumag, 2nd edition,

Moscow 2005, pp.50-51. 204 Ibid., pp.54-61.

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iii)licensing of the activities of the participants in the market; iv)creation of a system for the protection of the holders of securities and supervision over the observance of their rights by the issuers and the professional participants in the securities market.

The Law on Securities Market provides for the licensing regime of the “professional participants in the securities market”, which are involved in the types of businesses set out in the Law. These include brokerage, dealing, clearing, managing of share registers, depositing and trading activities. A license is also required for the handling of share registration and for the stock exchange. The 2002 amendments added a new chapter on stock exchanges to the Law. Before the amendments, only non-commercial organisations were allowed to set up a stock exchange, but now, joint stock companies may also organise it (Art.11, para.1). However, a single shareholder and afliated persons may not have more than 20% of the same category of shares. Stock exchanges may also combine their activities with those of foreign currency exchange, commodity exchange and clearing activities. Participants in the trading at the stock exchange can only be brokers, dealers and managers of the trust. Others must trade only through these intermediaries. Stock exchanges are under an obligation to constantly supervise transactions effected on the exchange in order to expose insider trading and manipulation of prices and also to supervise the observance of the law by the participants in the stock exchange and the issuers of listed securities (Art.13, para.2). The Law sets out the procedure for the issuing of securities. Issuing of securities is subject to state registration. Only after registration can the securities be issued, except for the shares which are issued at the time of establishment of a company. Breach of the procedure can be a ground for the refusal to register, the recognition of the issuing as invalid, or the suspension of the issuing by the registration body. If the issue has been completed but was found to be null and void, the issued securities must be retrieved by the issuer and the payment must be reimbursed to the investors (Art.26). Circulation (obrashchenie) of securities is prohibited until they have been paid in and the report on the result of their issue has been registered. Circulation in this context means not only on-exchange trade, but also offering of securities to an indenite scope of people, including offering through advertisements.205 The Law on Securities Market also provides for the disclosure of information. The Law denes disclosure of information as the ensurance of the availability

205 Ibid., p.39.

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of information to all interested persons regardless of the purpose of receiving it (Art.30). Once the issuer registers the prospectus, the issuer is under an obligation to disclose information in the form of: i)a quarterly report; ii)publicising of material facts involving the nancial-economic activities of the issuer.

The quarterly report is submitted to the registering body. It is signed by the single executive body of the issuer and the chief accountant. The report is provided to the holders of securities upon their request. The Law also provides for a list of material facts which include information on the facts which may result in uctuation in the value of assets or net prot/loss of more than 10% (Art.30). Such information is forwarded to the Federal Service and also publicised by the issuer within 5 days of the occurrence of the facts in the mass media which is “accessible to a majority of the holders of the issuer’s securities”. Holders of the securities are also under an obligation of disclosure. Except for holders of bonds which are not convertible to shares, the holders must report to the Federal Service when: i) the holder has come to hold 20% or more of the issued securities of the issuer; ii) each time the holder has increased the holding by 5% above 20%; iii)any changes over or below 5, 10, 15, 25, 30, 50 or 75%.

Professional participants in the market also bear obligations of disclosure with regards to their own activities. Insider trading is regulated under the heading of “the use of business information (sluzhebnaia informatsiia) in the securities market” (Arts.31-33). Business information is dened as any information regarding the issuer and the issued securities which is not generally accessible and which the person who came to possess such information through their business position, employment relations, or contract concluded with the issuer would obtain a superior position in comparison to others. The persons who are potentially in possession of such information are: i) Members of the management body of the issuer and the professional participants in the market in contractual relations with the issuer; ii) Auditors or professional participants in the market in contractual relations with the issuer;

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iii)Government employees, who, by virtue of supervisory power and other powers, have access to such information.

These persons are not allowed to use the information in possession to effect transactions, or remit the information to a third party to effect transactions (Art.33). The Law also has provisions on advertisements. Advertisements, such as those disseminating false information for the purpose of misleading or deceiving holders of securities and other participants in the market, those publicising the expected return, or guaranteeing a certain return are prohibited (Art.34). Despite the amendments in 2002, the Law, as a whole, is far from perfect. It is merely a skeleton or a patchwork of what securities laws are required to cover. The power of the regulatory body is very limited, while the reliability of the self-regulatory bodies is yet to be tested. The sanctions available for breaches do not seem to be sufcient. Most violations are covered by administrative sanctions which basically amount to a ne of 200-300 times the minimum wages. Even criminal sanctions, on rare occasions where they are available, are mostly nes, and at the most amount to 2 years of corrective labour, which is milder than imprisonment. The State Programme for the Protection of the Rights of Investors 19981999 has pointed out the following: Insider trading and manipulation of prices in the securities market are regulated in an extremely lax manner. The regulation of transactions with afliated persons is at an early stage. Regulators do not have sufcient power to ensure the implementation of the law.206

This situation has not changed much by the 2002 amendments.

8

LIMITED LIABILITY COMPANIES

The Law on Limited Liability Companies was enacted in 1998, two years after the Law on Joint Stock Companies. Learning from the experience of implementing the latter Law, the Law on Limited Liability Companies beneted from “higher level of legislative technique”.207 The Law, in comparison to the Law on

206 M.K.Treushnikov ed., Formy zashchity prav investorov v sfere rynka tsennykh bumag, Mos-

cow 2000, p.294. 207 M.Iu.Tikhomirov ed., Kommentarii k Federal’nomu zakonu ob obshechestvakh s ogranichen-

noi otvetstvennost’iu, 3rd edition, Moscow 2005, p.4.

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Joint Stock Companies, gives much discretion to the companies on matters such as the organisation of the management bodies and the formation of the capital.

1)

The Procedure of Establishment

As is the case with joint stock companies, limited liability companies can be set up by a single person. Companies set up by a single person cannot be a sole founder of another company (Art.7, para.2). The number of participants may not exceed 50 (ibid., para.3). Founding members of the company conclude a founding agreement, prepare the Articles of Incorporation, and appoint the executive body (Art.11, para.1). Unlike in joint stock companies, the founding agreement (uchrezhditel’nyi dogovor) is regarded as a founding document together with the Articles of Incorporation; its contents are listed in the Law (Art.12, paras. 1 and 2). While in joint stock companies, the shareholders’ agreement loses meaning once the company has been established, in limited liability companies, the agreement maintains its validity even after the company has come into being, since “joint activities for the funding of the company is merely one of the complex elements of the agreement”.208 If the documents do not coincide, the Articles of Incorporation prevail. The founders’ agreement determines the deadline for the payment of contribution by the founders. This may not exceed one year from the date of state registration of the company. Concerning in-kind contribution, any object which has monetary value can be contributed (Art.15, para.1). According to the Joint Decision of the Supreme Commercial Court and the Supreme Court, which is applicable to both joint stock companies and limited liability companies, “objects of intellectual property or know-how cannot be contributed”. However, the right to use such a property based on a registered licensing agreement can be contributed.209 If there is an in-kind contribution, its value needs to be approved by the founders. In-kind contribution exceeding 200 times the minimum wage has to be valued by an independent valuer. The founders and the independent valuer bear supplementary liability for the excess of the value for three years of the company registration in cases where the assets of the company cannot cover the debt. Approval of the value of the in-kind contribution requires a unanimous vote of the founders (Art.15, para.2).

208 Tikhomirov ed., supra, 3rd edition, pp.74-75. 209 Item 17, Joint Decision of the Plenums of the Supreme Commercial Court and the Supreme

Court of the Russian Federation, No.6/8, July 1, 1996.

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Founders are jointly and severally liable for the obligations incurred up to the registration of the company. The company is liable for such obligation only when the general meeting of participants subsequently endorses it (Art.11, para.2).

2)

Articles of Incorporation

In the Articles of Incorporation of limited liability companies, in addition to the matters required for joint stock companies, the following matters have to be addressed (Art.12): i) the size and nominal value of the participatory share of each member; ii) the rights and duties of the members; iii)the procedure and consequences of the withdrawal of a member from the company; iv)the procedure of transfer of a participatory share to another person.

It is possible to set the maximum participatory share a single member may hold, under the Articles of Incorporation (Art.14, para.3).

3)

The Rights and Duties of the Members

Unlike in the joint stock companies, the rights and duties of each member may differ. This is why the Articles of Incorporation provide for the rights and duties of the members. The Law lists the rights of the members to: i) participate in the management of affairs of the company; ii) receive information on the activities of the company and have access to the nancial and other documents; iii)participate in the distribution of prots; iv)at any time withdraw from the company regardless of the consent of other members; v) in case of liquidation, receive residual assets.

In addition, the Articles of Incorporation may provide for additional rights of the members (Art.8, para.2). These rights can be included in the original Articles of Incorporation, but may also be added later by a unanimous vote of the members. This possibility of supplementing the rights by subsequent resolution is a novelty added to the provisions of the Civil Code on limited liability companies. What emanates from this provision is that each member may have different additional rights. The problem is that since the amendment of the Articles of Incorporation

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is not formally required, it is difcult to nd out from the outside what rights the members have got. These additional rights given to individual members can be terminated or restricted by a two-thirds majority vote of the members, provided that the member with the additional right agrees (Art.8, para.2). Thus, it is impossible to deprive the member of additional rights without his consent. It is pointed out by a commentator that this system of giving additional rights to a member is more akin to the system of partnerships rather than companies.210

4)

The Capital and Participatory Shares

(1)

The Capital

The capital of a limited liability company comprises the nominal value of members’ participatory shares. The minimum amount of capital is set at 100 times the minimum wage. Participatory shares of members are determined by the percentage of or proportion to the capital (Art.14, para.1). The actual value of the participatory shares corresponds to the value of the part of net assets divided in accordance with the size of the participatory share. The capital can be increased from internal sources, by additional contribution by the members, or, if it is not prohibited by the Articles of Incorporation, contribution by third parties (Art.17, para.2). For increase of capital by additional contribution of the members, a two-thirds majority of the members is required. Thus, minority members may be forced to make an additional contribution. The Articles of Incorporation may provide for a higher vote. Participants are required to pay in the contribution within two months of the resolution (Art.19, para.1). The company may increase the capital on the basis of a declaration by a third party to contribute to the capital. This requires a unanimous vote of the members (ibid., para.2). The capital can be decreased by the reduction of the nominal value of the participatory share of all members or by redemption of the participatory shares. If, at the end of each nancial year after the rst, the net assets are less than the capital, the company must reduce the capital (Art.20, para.3). Within 30 days of the adoption of the resolution to reduce the capital, the company must notify creditors in writing of the decrease of capital and also publicise it in the news-

210 Tikhomirov ed., supra, 3rd edition, pp.60-62.

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paper. Creditors may accelerate the repayment and require the company to repay the debt within 30 days (Art.20, para.4). (2)

Transfer of Participatory Shares

Participants are entitled to sell or otherwise assign all or part of their participatory share to another member without the consent of the company or other members, unless the Articles of Incorporation provide otherwise (Art.21, para.1). Sale or assignment of the participatory share to a third party is allowed, unless it is prohibited by the Articles of Incorporation (ibid., para.2). It is possible to require the consent of the company or the remaining members for the sale or assignment of participatory shares to a third party by the Articles of Incorporation (ibid., para.5). If a member intends to sell or assign the participatory share to a third party, other participants have a pre-emption right to purchase the participatory share at the price offered to the third party. If the Articles of Incorporation so provide, the company itself may exercise such a right. Members who intend to sell the participatory share to a third party are under an obligation to notify in writing the remaining members and the company of the price and other terms of sale. If the remaining members and the company fail to exercise the pre-emptive right within 30 days of the receipt of notication, the sale may go ahead. Violation of the right of pre-emption enables other members and the company to resort to a court procedure for the retrieval of the participatory share (ibid., para.4). If the sale of a participatory share to a third party is prohibited and other participants decline to purchase the participatory share, or if the consent of other participants or the company required for the sale is unavailable, the company is under an obligation to purchase the participatory share at the “actual value” calculated on the basis of the balance sheet of the latest nancial period (Art.23, para.2). This is an exception to the general prohibition on the purchase of the participatory share by the company. Members are free to pledge their participatory share to other members, unless it is prohibited by the Articles of Incorporation. In order to pledge the share to a third party, a majority vote of the members excluding the member who intends to pledge the share is required (Art.22). (3)

Withdrawal from the Company

Participants may withdraw from the company regardless of whether other members agree or not. The participatory share held by this member will be transferred to the company. The company must pay the actual value of the participatory share to the withdrawing member within 6 months of the application to withdraw. The

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payment can be made in kind, but must be made from the surplus of the net assets over the capital. If no such surplus exists, the capital has to be decreased (Art.26). The valuation of the participatory share is sometimes disputed: Sportkulturtorg, which was a member of Izhkom Bank, brought an action against the Bank on the occasion of withdrawal from the Bank, requiring the Bank to reimburse 148,487 roubles which was the actual value of its participatory share in the capital. Later, the plaintiff increased the claimed amount to 429,200 roubles plus interest. The quota held by the plaintiff in the Bank was 3.2577%. The rst instance court partly accepted the claim. The court determined the actual value of the quota on the basis of the result of the activities of the defendant in 1998 as of January 1, 1999. Between the withdrawal and this date, the capital was increased. The quota was valued at 360,141 roubles, based upon the calculation that the plaintiff’s quota was 1.56% on that date. The Supreme Commercial Court ruled that the actual value of the quota coincides with the value of the net assets proportional to the percentage of the quota. In case of withdrawal of a member from the company, the quota which this member had held is transferred to the company once the member submitted his withdrawal to the company. The company is under an obligation to pay the actual value of the quota based upon the nancial report of the company for the year in which the withdrawal was submitted. Once the member has withdrawn, he ceases to be a member of the company, and the amount of the payment cannot be changed by taking into account the amount of capital which changed after his withdrawal.211

Together with the exclusion of members, this may pose a signicant threat to foreign investors who create a joint venture in the form of a limited liability company. (4)

Exclusion of members

The company may expel a member under certain circumstances. This power is not unique to Russian law. A similar system exists in the German Commercial Code regarding full partnership (offene Handelsgesellschaft), but not for limited liability companies.212 The system rst appeared in the RSFSR Law on Enterprises and Entrepreneurial Activities of 1990, but was dropped in the Civil Code, and then re-emerged in the 1998 Law on Limited Liability Companies.213

211 Decision of the Presidium of the Supreme Commercial Court, May 15, 2001, Case 2825/00. 212 HGB Art.140. 213 O.Petnikova, “Zashchita prav uchastnikov obshchestva s ogranichennoi otvetstvennost’iu”,

PiE, 2000 No.11, pp.15-16.

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A member who holds 10% or more of the capital may apply to court for exclusion of another member who was in signicant breach of his duty, or if, as a result of an act of this member, the company’s activity has become impossible or difcult to continue (Art.10). These grounds are considered to be exhaustive, and therefore, it is not possible to add other grounds under the Articles of Incorporation.214 In practice, because those grounds are broadly formulated, ultimately, it is left to the discretion of the court to decide whether a member should be expelled or not. A joint decision of the Plenum of the Supreme Commercial Court and the Supreme Court has “slightly expanded” the grounds for exclusion to include “repeated failure to take part in the general meeting which deprived the company from adopting resolutions which require a unanimous vote.”215 According to an article commenting on the explanation of the Supreme Commercial Court on company law, this provision is often used for expelling the general director cum shareholder of a limited liability company who caused loss to the company on grounds including lease of all the premise of the company at a price considerably lower than market price; providing of guarantee, while the assets of the company were pledged for intentionally unpaid debts, and unsupported bill of exchange was issued; tax declaration was not submitted and no tax paid; use of the loans extended to the company for other purposes; dismissal of staff which resulted in the termination of the operation etc.216 Iu.F.Goliusov was excluded from a limited liability company, Dal’neftetrans by the decision of the court on the ground that he had substantially breached his duties as a member of the company. Two members brought an action to court. Goliusov was appointed general director and occupied this position until February 2002. The court found a substantial breach of duties in that Goliusov initiated a transaction of sale of 50 railway tank-wagons which were under a pledge. The appellate court and the court of cassation both upheld the decision of the rst instance court. Goliusov argued that the exclusion was unlawful, since he had acted as the general director, and not a member in the transaction. The Supreme Commercial Court did not accept this argument. According to the joint decision of the Supreme Commercial Court and the Supreme Court of 1999, when determining whether the breach was substantial or not, the fault of the person as well as the emergence or the possibility of emergence of loss to the company need to be considered. In this case, Goliusov, being a member and the general director,

214 Tikomirov ed., Kommentarii k Federal’nomu zakonu ob obshchestvakh s ogranichennoi

otvetstvennost’iu . . ., supra, p.73. 215 Item 17, Joint Decision of the Plenums of the Supreme Commercial Court and the Supreme

Court of the Russian Federation No.14, December 9, 1999. 216 “Sudebnaia zashchita prav aktionera (uchastnika) – voprosy pravoprimeneniia”, VVAS, 2005

No.5, pp.142-143.

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proposed to sell a limited liability company RusOil 50 tank-wagons at their residual value plus 1%. The decision was approved by the members’ meeting. The contract of sale was signed by the new general director, since Goliusov had been relieved of his position on his own wish. The Collegium of the Supreme Commercial Court ruled that insofar as the defendant continued to perform the duties of the general director at the time of the extraordinary members’ meeting, he should be held liable. The Presidium of the Supreme Commercial Court did not agree. The Presidium ruled that since the defendant is a member of the company, obligations as a member are fully applicable to this person. In fact, the tank-wagons were pledged for a bank in order to secure a loan of 30 million roubles. Information on the pledge was not provided to the members who adopted the resolution approving the transaction. The transaction has caused a negative result to the company and the defendant was at fault. Therefore, the decision of the rst instance court approving the exclusion of Goriusov was upheld.217

The participatory share of the expelled member will be transferred to the company and the expelled member will receive the “actual value” of the participatory share in return (Art.23, para.4).

5)

Dividends

The company may pay dividends quarterly, semi-annually, or annually (Art.28). Dividends cannot be paid on the same grounds as with joint stock companies, but in addition, if the company has not paid the “actual value” of the participatory share to a participant in cases of exclusion or withdrawal, or refused to give consent on sale of participatory shares, dividends cannot be paid (Art.29).

6)

Issuing of Bonds and Securities

Limited liability companies are allowed to issue bonds and other securities. This is in contrast to most other jurisdictions where limited liability companies may not issue bonds. Russian law, however, imposes some restrictions. Firstly, bonds cannot be issued in excess of the amount of the capital. Secondly, bonds have to be secured. Thirdly, bonds can be issued only in the third nancial year of the existence of the company after the accounts for the rst two years have been approved (Art.31).

217 Decision of the Presidium of the Supreme Commercial Court, August 26, 2003, No.7325/03.

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Rights and Duties of Members

Members (participants) of limited liability companies have the following rights (Art.8): i) the right to participate in the management of the company, including the right to take part in the general meeting of the members, to elect and be elected to the executive body, and to propose items to be included in the agenda of the general meeting of the members etc; ii) the right to have access to information; iii)the right to share the prot; iv)the right to sell or otherwise assign the participatory share to other participants; v) the right to withdraw from the company at any time without the consent of other participants; vi)the right, in the case of liquidation of the company, to share the remaining assets.

The right to participate in the management of the company also includes the right to contest the resolutions and decisions of the management bodies of the company in court in cases where they were against the law or other legislative acts, the Articles of Incorporation, or infringed the rights and legal interests of the participants (Art.43, para.1). As is the case with the corresponding system in the Law on Joint Stock Companies, the court has the discretion to keep the resolution in effect, if the vote of the person who is contesting the resolution would not have affected the outcome, or the violation was not substantial and did not cause any harm to this person (ibid., para.2). It is worth noting that unlike the Law on Joint Stock Companies, it is explicitly provided not only the resolution of the general meeting, but also the decisions of the board of directors, and the single and collective executive bodies that can be contested in court by the members (ibid., para.3).

8)

Management Bodies

(1) General Meeting of the Members The highest body of the company is the members’ general meeting. Members have the right to participate and vote. The voting right is granted in proportion to the participatory share which each of them holds. However, under the Articles of Incorporation, it is possible to adopt a different means of distribution of votes, but only by a unanimous vote of members (Art.39, para.1). The following matters fall within the exclusive competence of the general meeting (Art.33, para.2):

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i) determination of the basic direction of the company; ii) amendment of the Articles of Incorporation and the founders’ agreement; iii) formation and early termination of terms of the executive body; iv) appointment and early termination of terms of the audit committee; v) approval of the annual report and balance sheet; vi) adoption of the resolution regarding the distribution of prot; vii) approval of internal rules and regulations; viii)appointment of auditor and determination of the remuneration; ix) approval of the issuing of bonds and other securities; x) adoption of the resolution on reorganisation and liquidation of the company; xi) appointment of the liquidation committee.

Extraordinary members’ meetings can be convened by the executive body on its own initiative or upon request of the board of directors, the audit committee, or the auditor. A participant who has more than a one-tenth participatory share is entitled to request the company to convene an extraordinary meeting (Art.35, para.2). The executive body must decide whether or not to convene a general meeting within ve days of receiving the request. The request can be refused only on limited grounds such as in cases where the proposed agenda does not fall within the competence of the general members’ meeting. If the general members’ meeting is to be convened, it has to be convened within ve days of receiving the request. If the executive body does not make any decision or refuses to convene a meeting, then the body or person who made the request, may convene the meeting (ibid., paras.2-4). In preparation of the general members’ meeting, any member may propose items to be included in the agenda. Members may take part in the meeting via a representative. The meeting is opened by the single executive body or the chairman of the collective executive body, who conducts the election of the chairman of the meeting (Art.37). It should be added that the members’ meeting can be held without an actual meeting (Art.38). Amendment to the Articles of Incorporation requires a two-thirds majority. Changes to the founders’ agreement and the resolution for reorganisation and liquidation must be adopted by a unanimous vote (Art.37, para.8). As a rule, these matters cannot be transferred to the competence of the board of directors, but as an exception, the formation and early termination of terms of the executive body may be left to the board of directors. (2) The Board of Directors The establishment of the board of directors (supervisory board) is not mandatory. The general members’ meeting may set up the board of directors which is granted the power to:

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i) form the executive body and terminate the terms early; ii) approve major transactions; iii)approve transactions with interested parties; iv)prepare, convene and conduct the general members’ meeting (Art.32, para.2).

(3) Executive Bodies Direction of the current activities of the company is entrusted to a single executive body (general director, president), or a single executive body and a collective executive body (management council, directorate) jointly (Arts.40 and 41). What is different from the Law on Joint Stock Companies is that there was an explicit provision that the executive body is subordinate to the general members’ meeting from the beginning. (Art.32, para.4).

9)

Restraints on the Power of the Executive Bodies

(1) Major Transactions Similar to joint stock companies, there are regulations regarding major transactions applicable to limited liability companies. The decision to effect major transactions, i.e. transactions exceeding 25% of the value of the company’s assets, lies with the general participants’ meeting (Art.46, paras.1 and 3). If there is a board of directors, major transactions whose value is over 25% but less than 50% can be authorised by the board, if the Articles of Incorporation so provide (ibid., 4). Major transactions effected without required consents are null and void (ibid., 5). A member brought an action against a limited liability company asking the court to declare void a contract of sale effected by the company. The company sold equipment and an inventory whose value exceeded 50% of the value of the assets without the resolution of the general members’ meeting. The claim was accepted by the court on the ground of Article 46 of the Law on Limited Liability Companies.218

However, it should be noted that, unlike in joint stock companies, the above requirements can be totally removed by the Articles of Incorporation (ibid., para.6).

218 Information Letter of the Presidium of the Supreme Commercial Court, March 13, 2001,

No.62.

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(2) Transactions with Interested Parties Transactions by members of the board, the single executive body, members of the collective executive body as well as participants who hold 20% or more of the capital alone or in conjunction with afliated persons, are not allowed to effect transactions with interested parties without the consent of the general meeting of members (Art.45, para.1). The general meeting may give consent to the transaction by a majority vote without the interested members voting (ibid., para.3). If there is a board of directors, this power to give consent can be entrusted to the board, except in cases where the value of the transaction exceeds 2% of the assets of the company determined on the basis of the last nancial year (ibid., para.7). Transactions are regarded as those with interested parties in cases where the above persons, spouses, parents, children, sisters and brothers as well as their afliated persons are (ibid., para.2): i) party to the transaction with the company or acting in the interest of a third party against the company; ii) holding 20% or more of the participatory share of a juridical person which is a party to the transaction with the company or which acts in the interest of a third party against the company, or iii)holding a position in the management body of a juridical person which is a party to the transaction with the company or which acts in the interest of a third party against the company.

Members of the board, the single executive body, members of the collective executive body as well as the participants mentioned above are under an obligation to disclose the information listed in the Law to the general members’ meeting (ibid., para.2). Those transactions effected in violation of this provision are voidable (ibid., para.5). A limited liability company, Mobiltelecom Sverdrovsk (hereinafter, the “Company”), brought an action vis-à-vis Proizvodstvennaia-kommercheskaia rma Mobiltelecom Sverdrovsk (hereinafter, the “Firma”), asking the court to acknowledge the transaction of transfer of property null and void and to return the property to the company. The rst instance court and the appellate court acknowledged the claim, while the court of cassation partly quashed the decision of the lower court. The Presidium of the Supreme Commercial Court supported the decision of the lower court. In this case, M.Iu.Kozin, who was the director and the single executive body of the Company, was appointed director of the Firma. Kozin gratuitously transferred signicant assets to the Firma. According to the Law on Limited Liability Companies, transactions effected by a person who holds the position of a single executive body are interested transactions and are subject to the approval of the

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members’ meeting. Kozin, who, at the time of the transaction, simultaneously held the position of a director of the Company and the Firma is an interested party. The resolution of the members’ meeting was never adopted, and therefore, the transaction was effected in breach of law. The decision of the rst instance court which found the transaction to be invalid and mandated the property to be returned should be upheld.219

10)

Liability of the Directors and Executive Ofcers

The above persons are under an obligation to act in the interests of the company in a conscientious and reasonable manner. They are liable to the company for damage caused to the company by their fault. Those who voted against the act in question or did not take part in the vote are exempted from liability (Art.44, paras.1 and 2). As is the case with joint stock companies, not only the companies, but also members may initiate an action against these persons (indirect action, derivative action) (ibid., para.5). The general director of company Liudmila, which was a successor to a limited liability company (TOO), forged a document needed to provide a non-residential building which belonged to the company as collateral and received a loan from the Saratov Bank – part of the Sberbank. Eventually, the general director defaulted and the building became the property of the Bank. The court ruled that the Bank was unaware and could not have been aware that there was no resolution of the general members’ meeting concerning the loan by offering the building as a collateral and that the general director had no power to effect the transaction. In such cases, the consequences must be borne by the juridical person, in whose name the director had acted in bad faith.220

Indirect (derivative) action is available to participants, but as is the case with the Law on Joint Stock Companies, no details are given (ibid., para.5).

11)

Audit

The company may, under the Articles of Incorporation, set up an audit committee or have an internal auditor (revizor). In a company with 15 or more participants,

219 Decision of the Presidium of the Supreme Commercial Court, April 3, 2002, Case 7611/01. 220 Decision of the Presidium of the Supreme Commercial Court, February 11, 1997, Case

8365/95.

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this is mandatory. Members of the audit committee may not be members of the board of directors, a collective executive body, or a single executive body (Art.32, para.6). The audit committee is appointed by the general participants’ meeting for checking the “nancial-economic activities” of the company (Art.47, paras.1 and 2). In order to check and authenticate the accuracy of the annual report and the balance sheet, as well as to check the state of current business, the company may involve a professional auditor unrelated to the company. By request of any participant, the audit can be conducted by a professional auditor as above, at the expense of this participant (Art.48). The requirement of publicity of their activities is less stringent in limited liability companies than in joint stock companies. Limited liability companies are under no obligation to publish their annual report. Only when they are making a public offer of bonds and other securities are they required to publish the annual report, balance sheet and other information (Art.49).

5 INSOLVENCY LAW

1

HISTORICAL BACKGROUND

In Russia, the term bankrotstvo denoted the entire procedure dealing with insolvency, while the term konkurs denotes the procedure for the sale of the debtor’s assets and the distribution of proceeds among the creditors. In the Tsarist period, the term konkurs was commonly used. The current Russian Law is entitled zakon o nesostoiatel’nosti (bankrotstve). It accommodates both the procedure aimed at the rehabilitation of the debtor as well as the procedure for liquidation. In the following, nesostoiatel’nost’ will be translated as insolvency to cover the entire procedure under the current Law, while bankruptcy will be used in a narrower sense to cover the konkurs procedure, i.e. the liquidation procedure under the 2002 Law. The history of insolvency legislation in Russia goes back to the 1800 Statute on Bankruptcy (ustav o bankrotakh). The enactment of a new law was discussed extensively in the Tsarist period and even a draft law based upon the German model was published, but it was not adopted as it was seen as an imitation of Western statutes’. After the Revolution, in the planned economy which followed, the sole owner of enterprises was the state. Despite the façade of the enterprises being separate entities from the state and operating on their own balance sheet, loss-making enterprises were supported by the state, which was actually redistributing prots made by other enterprises. There was little need to have the assets of the debtorenterprise distributed among the creditors who were also state enterprises, or rehabilitating the enterprise on the latter’s initiative. These enterprises did not have many assets which could be disposed of in the rst place. Thus, there was no system to deal with insolvent enterprises under the socialist system. In the process of transition to the market economy, the necessity for such a system as a prerequisite to the transition was acutely felt. In 1992, the Law on the Insolvency (Bankruptcy) of Enterprises was enacted. As was the case with other laws enacted in this early period, this Law, which had only 51 provisions,

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lacked consistency and internal logic. As one Russian commentator put it, it was “like a car which was difcult to start, and once it starts, inadequately responds to the attempts to manipulate it and moves in all directions”.1 In reality, between 1993 and 1997, the Law was not widely applied. In 1993, there were only 74 bankruptcy cases, although the number increased in the next several years, but only up to 2,269 in 1997. One of the problems was that the triggering mechanism for the insolvency procedure was set by the excess of debts over the value of the assets, which was too complicated to calculate in practice. This made the position of creditors difcult.2 The Law was also regarded to be too debtor-friendly. Furthermore, by the enactment of the Civil Code in 1995 which accommodated some provisions on bankruptcy in its General Part, many provisions of the 1992 Law were superseded by those of the Civil Code and some contradictions emerged. Therefore, a new Law was prepared and was enacted as the Law on Insolvency in 1998.3 In the three-year process of preparing the new Law, the “best laws of the contemporary world”, the US Bankruptcy Code, the UK Insolvency Act, the German Insolvenzordnung and the French Law were extensively studied. The end result was that, from a Russian perspective, “in terms of the conceptual parameter, the new Russian Law can be placed at the same level as the US, German, English and French laws which regulate insolvency”.4 An important novelty in the 1998 Law was the triggering mechanism for the insolvency procedure. Instead of the excess of the debt over the assets, the 1998 Law resorted to the concept of incapability to pay in order to strengthen the position of creditors. Insolvency was dened as the inability of the debtor to pay monetary debt in full and/or perform obligations for mandatory payment (taxes, levies, and other payments). For juridical persons, this was indicated by the fact that the debtor failed to satisfy a monetary claim or perform an obligation for mandatory payment for more than three months after the due date. There is a minimum requirement for the amount of debt, but it was only 500 times the minimum wage. This made the initiation of the procedure quite easy, but opened the way for abuses. Shortly after the 1998 Law took effect, a “simplied procedure” of insolvency was introduced by a government decision (Decision No.476) in the light of the looming nancial crisis. This decision introduced the debt-equity swap through auction. However, the new system was criticised for creating a water-

1 2 3 4

V.V.Stepanov, Nesosoiatel’nost’ v Rossii, Frantsii, Anglii, Germanii, Moscow 1999, p.139. Iu.Simachev, “Institut nesostoiatel’nosti v rossii: spros, osnovnye tendentsii i problemy razvitiia”, VE 2003 No.4, pp.62-63. SZ RF, 1998 No.2, item 222 [replaced by the 2002 Law]. Stepanov., supra, pp.161-162.

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shed for abuses and insider dealing. Under this system, it was pointed out, managers of the debtor-organisation, in conjunction with speculators with nancial resources, would have a major role and compromise the auction.5 There were instances where irregularities were suspected.6 This procedure was eventually abolished. Although the nancial crisis in 1998 should be taken into account, still, the increase in the number of application after the adoption of the 1998 Law was remarkable. While in 1997, only 5,687 applications reached the court, this increased to 12,781 in 1998, and in the following year, increased by 31%.7 There was a further increase to 24,874 in 2000, 55,934 in 2001, and 106,647 in 2002. However, the sharp increase in the number of application between 2000 and – 2002 is said to be partly due to the application of the simplied insolvency procedure to dormant companies, rather than to the bankruptcy of operating companies.8 However, the bankruptcy procedure under the 1998 Law, which was designed to be creditor-friendly, was open to various abuses. As a result of this creditor-friendly system, the system became a source of conicts and resulted in the collapse of many solvent companies. It was pointed out that the initiation of the procedure in fact became an inexpensive alternative to hostile takeover, provided that there was a potential alliance between the administrator, judges and other ofcials.9 Often creditors were not interested in the implementation of measures of nancial restoration of the company, but its bankruptcy and acquisition of its assets.10 In 2001, reportedly, 30% of insolvency cases were related to hostile enterprise takeovers and to the illegitimate redistribution of property.11 Takeovers under the guise of bankruptcy worked as follows. After collecting nancial information on the target company, the company which intends to carry out the takeover forges an alliance with the creditor of the target company or buys the debts through front companies. Sometimes, repayment of debt by the target company is inhibited. Then the bankruptcy procedure is initiated by a creditor, which is a front company of the raider. The key point is the appointment of the administrator who has actually been selected by the raider. The decision

Ibid., pp.163-164. A.Radygin, “Sovstvennost’ i integratsionnye protsessy v korporativnom sektore”, VE, 2001 May, pp.31-32. 7 Rabota arbitrazhnogo suda RF v 1998 godu, 1999 godu, edited by AKDI, Ekonomika i zhizn’, www.akdi.ru. 8 Simachev, supra, pp.68-69. 9 Ibid., p.33. 10 S.A.Karelina, Pravovoe regulirovanie nesostoiatel’nosti, bankrotstva, Moscow 2006, p.9. 11 V.Volkov, “Hostile Enterprise Takeover: Russia’s Economy in 1998-2002”, Review of Central and East European Law, 2004, No.4, p.532. 5 6

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of the court, which is often obtained through a substantial bribe, will be duly enforced by this administrator.12 This proved to be true in the celebrated Sidanco case where a major oil production company was taken over by a rival company through manipulation of the insolvency law. At government level, the perceived shortcomings of the bankruptcy system included:13 i) Breach of the rights of the debtor and their shareholders; ii) Violation of the right of the State as a creditor in tax claims; iii)Exit of assets of the debtor in the interest of a specic group of creditors in the course of external administration and bankruptcy (konkurs); iv)Wide use of ctitious bankruptcy as an instrument of uncivilised takeover of property; v) “Lack of transparency”, lax regulation of the insolvency procedure which allows the bankruptcy administrator and other participants in the procedure to abuse loopholes and the absence of an effective mechanism of pursuing the responsibility of unfaithful and inefcient administrators;

Because the 1998 Law led to widespread abuses, it was felt that the system needed a complete review, and in 2002, a new Law on Insolvency was adopted.

2

THE LAW ON INSOLVENCY

The basic law which covers insolvency is the Law on Insolvency (bankruptcy) of 2002. The Civil Code also has some provisions on the insolvency of juridical persons. The problem is that the Civil Code and the Law on Insolvency do not always coincide. An important provision such as Article 64, para.1 of the Civil Code, which provides for the rank of creditors in the distribution of proceeds from the sale of assets, differs from the equivalent provision in the Law on Insolvency. In addition to the Law on Insolvency, there are two separate laws. One is the Law on the Insolvency of Credit Organisations of 1999 and the other is the Law on the Special Measures on the Insolvency of the Subjects of Natural Monopolies in the Fuel-Energy Complex enacted in the same year. The Law on Insolvency has adopted a “one stop shopping” system, instead of having a separate law for each type of procedure. Once the application for the recognition of the debtor as bankrupt has been accepted, after the observation procedure, different measures and proceedings can be applied.

12 13

Ibid., p.533. Simachev, supra, p.63.

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These are: i) Financial restoration (sanatsiia; Sanierung); ii) External administration; iii)Bankruptcy proceedings; iv)Amicable settlement.

The Law is applicable to the insolvency of juridical persons as well as that of individuals. There is a separate chapter for the insolvency procedure involving individuals, including individual entrepreneurs. Concerning juridical persons, the Law extends to “all juridical persons, except for treasury enterprises, agencies (uchrezhdenie), political parties and religious organisations (Art.1, para.2). This does not exactly correspond to the provision of the Civil Code which excludes only treasury enterprises from bankruptcy (Art.65, para.1). It should be added that as agencies are excluded from the scope of the bankruptcy law, constituent entities of the Russian Federation as well as municipalities are not covered by this Law. The Budget Code partly deals with the insolvency of such entities. The “symptom of bankruptcy” which triggers off the insolvency procedure is the incapability of the debtor to pay debts. Juridical persons are deemed to be incapable of performing monetary obligations and/or the obligation to make mandatory payments (e.g. taxes) if the performance is overdue by three months (Art.3). In a separate provision, the minimum amount of debt is set at 100 thousand roubles (Art.6, para.2). An additional requirement for creditors is that in order to le an application for the recognition of the debtor as bankrupt, a judgment of the court of general jurisdiction, commercial court, or an award of an arbitration tribunal which has taken effect and evidence that the enforcement document has been sent to the bailiff has to be attached (Art.39, para.2). Such arrangements are intended to prevent abusive applications which were common under the 1998 Law. In 1999, insolvency proceedings were initiated against Sidanco, the then fth largest oil company, by an unknown company. The amount of claim this company held was actually 0.1% of the total debt of the company. Proceedings were initiated against Sidanco’s production subsidiaries too. In relation to one of the subsidiaries, the creditor who led for recognition of insolvency had been offered payment, but reportedly, the court ignored it and went ahead with the proceedings.14

Reportedly a paradoxical situation was observed where enterprises which have sufcient assets were dragged into the insolvency procedure because there was a

14

East European Energy, 1999 September issue, pp.11-13.

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fair chance of their competitors taking control of these enterprises, while hopeless enterprises escaped the procedure because no one wanted to take control of such enterprises. Therefore, it was proposed to require the initiator of the procedure to prove that there is no other way of recovering the debt than insolvency procedure.15 However, the new arrangement under the 2002 Law has actually gone to the other extreme and made applications extremely difcult for creditors. This is demonstrated by a sharp fall in the number of application. In 2002, there were 106,647 applications for the commencement of the procedure. The Law came into force on December 2, 2002. In 2003, the number of application fell to 14,277. Although the fact that there was a “last minute rush” of applications in 2002 has to be taken into account, this is still a signicant decrease.

Table 10 Insolvency cases handled by the commercial court: 2003-2006 2003

2004

2005

2006

9,695

10,093

25,643

83,068

10

29

32

39

2,081

1,369

1,013

947

17,081

9,390

13,963

76,447

Refusal of recognition as bankrupt

688

163

308

737

Settlement

170

150

84

106

3,213

2,162

1,506

2,625

56,440

20,116

18,812

60,848

Accepted Cases Financial restoration External administration Recognition as bankrupt

Application for the dismissal of the administrator Insolvency procedure Completed (www.arbitr.ru)

15

Radygin, supra, pp.32-33.

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3

THE PROCEDURE

1)

Initiation of the Procedure

211

The insolvency procedure is initiated by an application for the recognition of the debtor by the court as bankrupt. The commercial court has exclusive jurisdiction in bankruptcy cases, regardless of whether the debtor is a juridical person or an individual (Art.6, para.1). It should be noted that the Law explicitly provides that insolvency cases may not be handled by arbitration (Art.33, para.3). The debtor, creditor, and “empowered bodies” are entitled to apply to court for the recognition of the debtor as bankrupt. “Empowered bodies” primarily means tax and pension agencies. A large portion of insolvency cases are initiated by the tax agency. In 2000, 43.7% of the cases were initiated by the tax agency, while 20% were initiated by creditors. The share of cases initiated by the tax agency actually was close to 70% in 2001.16 Obviously, the tax agency uses the insolvency procedure as an effective device for collecting unpaid taxes.17 Not only creditors, but debtors are entitled to apply for bankruptcy. The debtor is entitled to apply, if there are circumstances which clearly demonstrate that the debtor is not in a state to perform the obligation in time (Art.8, para.1). This means that even when the “indications of bankruptcy” as provided in Article 6 have not emerged, the debtor, foreseeing such a situation, is entitled to apply for bankruptcy. The executive (the single executive body or the head of the collective executive body) of the debtor which is a juridical person is under an obligation to apply in cases where repayment to a creditor(s) results in the debtor’s impossibility to fully satisfy the other creditors’ claim. This also applies in cases where a body of the debtor/juridical person which is empowered to adopt the decision of liquidation decided to apply to court, and when the seizure of properties by a creditor makes the economic activities of the debtor signicantly difcult, or impossible. The grounds for the mandatory application for the initiation of the procedure by the debtor have been expanded by the 2002 Law. Although it is not clear from the Law, the application of the executive body has to be preceded by the decision of the body, i.e. the board or the shareholders’ meeting, to do so.18 The commercial court of the place of location of the debtor has jurisdiction over the insolvency case (Art.33, para.1).

16 Simachev, supra, p.74. 17 Supreme Commercial Court, “Rassmotrenie del o bankrotstve v 2000 godu’, www.akdi.ru. Information on the number of application by the tax agency is no longer available. 18 Karelina, supra, p.51.

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A copy of the application is sent to the debtor (if the creditor or empowered body has made the application) and to the self-regulatory body of insolvency administrators for the preparation of the list of candidates as a provisional administrator. The application is accepted by a single judge, and within 15 days to 30 days of the decision of the judge conrming the acceptance of the application, the judge examines at the hearing whether or not the application is with grounds. Once the application for the recognition of the debtor as bankrupt is found to be with a ground, the judge introduces the observation procedure (Art.49, para.1). The hearing preceding the observation procedure is a novelty of the 2002 Law following a decision of the Constitutional Court which found the arrangement under the 1998 Law to be unconstitutional since it did not give an opportunity to the debtor to contest the decision of the court to proceed with the application.19 The creditor is entitled to apply for a security measure when applying for the recognition of the debtor as bankrupt and the commencement of the insolvency procedure. This application is considered by the judge within the next day without informing the debtor (Art.42, para.7).

2)

Administrators

The Law set common rules for administrators appointed separately for observation, nancial restoration, external administration, and bankruptcy procedures. Under the 1998 Law, the creditor who les the application for the initiation of the procedure often exercised considerable inuence over the choice of the temporary administrator, and as a consequence, gains control over the entire procedure.20 In the light of such an experience the 2002 Law introduced a system aimed at improving the quality of administrators and ensuring their impartiality. Administrators are required to: i) Have higher education; ii) Have an experience of an executive position of a juridical person for at least two years in total; iii)Have passed a written examination for administrators;

19 20

Decision of the Constitutional Court, March 12, 2001, Case No.4-P. A.S.Alexandrovich, “Bankruptcy Law, and Economic Medicine: How Russia’s New Bankruptcy Legislation Facilitated Recovery from the Nationwide Financial Crisis of August 17, 1998’, Cornell International Law Journal, vol.34, 2001, p.114.

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iv)Have worked as a trainee administrator for a minimum of six months; v) To have no record of conviction for economic crimes, or for crimes of medium level seriousness or more; vi)Be a member of one of the self-regulatory bodies. (Art.20, para.1)

The court may not appoint a person as an administrator, if this person is: i) an interested party in relation to either a creditor or the debtor; ii) had an insolvency procedure initiated against himself; iii)has not paid compensation for the loss caused to creditors, the debtor, or a third party while he served as an administrator; iv)has been disqualied or deprived of the right to hold an executive position etc.; v) has not concluded an insurance contract for the potential loss resulting from the liability as an administrator. (Art.20, para.6)

Creditors are entitled to require additional qualications such as higher education in law, economics, or other relevant discipline, experience as an executive in a particular area of economy etc. Self-regulatory organisations of administrators are set up throughout Russia. They are non-commercial organisations. Administrators must belong to a selfregulatory organisation. One of the signicant roles of the organisation is to prepare a list of candidates for the role of administrator in each case for the court. In the past, administrators were appointed by the court upon proposal of the creditors. This has led to the appointment of biased administrators. Therefore, under the 2002 Law, the procedure for appointing administrators went through a major change. The judge who conducts the initial procedure after receiving the application for the recognition of the debtor as bankrupt consults the self-regulatory organisation which prepares a list of three candidates. The debtor and the creditor who applied for bankruptcy are both entitled to strike off one candidate (Art.45, paras.1, 3 and 4). This procedure of selection of the administrator is applicable to provisional administrator who is in charge of the initial observation procedure as well as other administrators such as external and bankruptcy administrators. Despite the tightening of control over administrators, corruption still takes place: In the city court of Bashkirstan, an assistant to the administrator and the accounting ofcer of the company who set aside assets of the company were convicted for abuse of ofcial power. The external administrator who was approved by the commercial

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court lived in Moscow and had left the matter to an assistant. The assistant colluded with the accounting ofcer and disposed of the factory and materials at a very low price. In the end, the company had to be liquidated.21

3)

Observation (nabliudenie)

Observation is a procedure intended for the preservation of the debtor’s assets, analysis of the nancial state of the debtor, preparation of the list of creditors, and holding of the rst creditors’ meeting. A provisional administrator is appointed at this stage. In the decision to commence the observation procedure, the judge conrms the provisional administrator selected via the procedure explained above in 2). The provisional administrator can be dismissed by the court upon the petition by a participant in the insolvency procedure for the non-performance or inadequate performance of duties which violates the rights or lawful interests of the petitioner, or would result in harming the debtor or a creditor (Art.65, para.3). The commencement of the observation procedure has the following effects: i) creditors may present their claims vis à vis the debtor only through the insolvency procedure; ii) upon the petition by creditors, the court procedure vis à vis the debtor to collect the debt is suspended; iii)enforcement procedure vis à vis the debtor is suspended; iv)return of investment, buy-back of shares, payment of dividends, or payment of the value of shares is prohibited; v) sett-off is prohibited, if it is against the priority of creditors set out by the Law. (Art.63)

The incumbent management does not lose its power to manage the debtor-company by the commencement of the observation procedure. However, their power is subject to restrictions. Transactions involving the acquisition, disposal of, or the possibility of disposing of the property of the debtor which is over 5% of the assets in the balance sheet (this used to be set at 10% in the 1998 Law), as well as receiving and extending loans, providing of guarantee, assignment of claims and assumption of debts requires the consent of the provisional administrator. It is prohibited to take a decision on:

21

Obzor deiatel’nosti arbitrazhnykh sudov v SMI, September 25, 2005, www.arbitr.ru.

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i) reorganisation (merger, split, conversion etc.); ii) creation of a juridical person or participation in another juridical person; iii)creation of an afliate or a representative ofce; iv)issuing of securities except for shares; v) withdrawal of a member from the company or share buy-back; vi)participation in an association, a holding company group, etc. (Art.64, paras.2 and 3).

It should be noted that increase of capital by issuing shares and allocating them to the founders (members) or a third party is allowed at this stage (Art.64, para.5). The court, however, may remove the executives of the debtor company upon the request of the provisional administrator in cases of breach of law by the executives (Art.69, para.1). Duties of the provisional administrator are: i) adopt measures to ensure the preservation of the debtor’s assets; ii) analyse the nancial state of the debtor; iii)identify the creditors of the debtor; iv)prepare a register of claims; v) inform the creditors of the introduction of observation procedure; vi)convene and conduct the rst creditors’ meeting. (Art.67, para.1)

In order to take part in the rst creditors’ meeting, creditors are to present their claims to the debtor within 30 days of the notice of the court’s acceptance of the application for the recognition of the debtor as bankrupt. Claims should be forwarded to the court, the debtor and the provisional administrator together with the court judgment, contract, or other documents which certify the claim (Art.71, para.1). Objection to the claims can be made to court by the debtor, creditors, provisional administrator, and a representative of the founders (ibid., para.2). Claims found to be with grounds are entered into a register by the court. This stage is crucial to creditors, since if their claim is not acknowledged, they will not be able to take part in the creditors’ meeting and would fail to inuence the procedure. Under the 1998 Law, it was the provisional administrator, not the court who made the decision to register claims: In a case involving Sidanco’s subsidiary, Kondpetroleum, the provisional administrator refused to acknowledge the existence of a claim by the parent company Sidanco, and the court upheld this decision. Sidanco argued that this was an abuse of power by the administrator who was close to Sidanco’s competitor, but the court rejected this argument.

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The provisional administrator convenes the rst creditors’ meeting. Known creditors as well as the representative of the employees are notied. The meeting takes place at least 10 days before the end of the observation procedure (Art.72, para.1). At the rst creditors’ meeting, the executive of the debtor, representative of the founders (members) and employees take part without a vote. The rst creditors’ meeting may: i) adopt a resolution and apply to the court for the introduction of nancial sanitisations; ii) adopt a resolution and apply to the court for the introduction of external administration; iii)apply to court for the recognition of the debtor as bankrupt and the commencement of the bankruptcy procedure; iv)conclude an amicable settlement. (Arts.73, para.1, 74, para.4)

Creditors hold the number of votes proportional to the amount of their claim in relation to the total amount of the registered claim. The meeting stands if more than half the votes is represented (Art.12, paras.3 and 4). As a rule, decisions of the meeting are adopted by a majority of the votes represented at the meeting. However, decisions such as those listed above require a majority of total number of the votes of all creditors, regardless of their presence at the meeting (Art.15, paras.1 and 2). Based upon the decision of the creditors’ meeting, the court renders a decision either to introduce nancial sanitisations or external administration, a decision to recognise the debtor as bankrupt and to commence the bankruptcy procedure, or conrms the amicable settlement and terminates the insolvency procedure (Art.75, para.1).

4)

Financial Restoration ( nansovoe ozdrovlenie)

Financial restoration is a new procedure introduced by the 2002 Law. The term was known before, but at that time denoted measures taken by the founders, creditors or others before the application to the court for the recognition of the debtor as bankrupt. Now, it is an alternative procedure to external administration, bankruptcy, and amicable settlement. However, resorting to this procedure does not exclude the possibility of shifting to another procedure afterwards. In the course of the nancial restoration procedure, the debtor repays the claims in accordance with the agreed schedule of repayment. During the observation procedure, the debtor, founders (members) of the debtor, or a third party

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217

may propose to the rst creditors’ meeting the introduction of a nancial restoration procedure. A copy of the proposal must be sent to the court as well as the provisional administrator (Art.76, para.1). Financial restoration is characterised as a procedure to provide guarantee for the repayment of debt.22 The debt can be repaid not only by the debtor, but also by those who guarantee its repayment. Founders (members) of the debtor company who agree to the nancial restoration are entitled to provide guarantee for the debtor’s repayment of the debt in accordance with the schedule of repayment (Art.77, para.3). A third party may, with the consent of the debtor, propose the introduction of nancial restoration. If the proposal comes from a third party, the intended guarantee by the third party(ies) needs to be indicated (Art.78, para.1). Guarantee may take the form of hypothec, bank guarantee, suretyship, or state or municipal guarantee (Art.79, para.1). The plan for nancial restoration as well as the schedule of repayment prepared by the debtor must be attached to the proposal (Art.77, para.5). The plan for nancial restoration must contain the means by which the debtor is to receive nance for repayment of debts in accordance with the schedule such as borrowing or increase of capital.23 The court commences the nancial restoration procedure based upon the decision of the creditors’ meeting. In its decision to commence the procedure, the court conrms the administrator, endorses the repayment schedule and at the same time, determines the length of the procedure (Art.80, paras.2 and 3). The length of this procedure is maximum two years (Art.80, para.6). This is criticised as being too short for the implementation of large scale measures.24 The incumbent management is not deprived of its power by the commencement of nancial restoration procedure. However, upon the request of the creditors’ committee, the administrator, or the person who provided guarantee, the court may remove the executives of the debtor company in cases of inadequate implementation of the restoration plan or acts which infringe upon the rights and lawful interests of creditors and the provider of the guarantee (Art.82, paras.1 and 2). The debtor is not allowed to effect transactions involving the acquisition or disposal of the assets, extending loans and providing pledges etc. without the consent of the creditors’ meeting (ibid., para.3). Neither may the debtor effect transactions which increase the amount of debt by more than 5% or take out a loan without the consent of the administrator (ibid., para.4).

22 23 24

V.V.Vitrianskii ed., Nauchno-prakticheskii kommentarii: Fderal’nyi zakon o nesostoiatel’nosti, Moscow 2004, p.323. Ibid., p.371. Karelina, supra, p.144.

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INSOLVENCY LAW

At least one month before the end of nancial restoration procedure, the debtor must submit a report on the result of nancial restoration. The administrator reviews the report and prepares an opinion which is sent to creditors and to the court. In cases where the claims of the creditors were not fully repaid, the court either adopts a decision to commence external administration or to recognise the debtor as bankrupt and commence the bankruptcy procedure. If the claims have been fully repaid, the procedure is terminated (Art.88). In reality, nancial restoration procedure is not commonly utilised. In 2004, there were only 29 cases of nancial restoration, followed by 32 in 2005.

5)

External Administration

External administration is a procedure for the restoration of the debtor’s solvency (Art.2). This is contrasted to the bankruptcy procedure (konkurs), which is aimed at liquidation and the subsequent distribution of proceeds from the sale of assets. The procedure is commenced by the court upon the decision of the creditors’ meeting. The period of external administration is limited to 18 months, but can be extended for another 6 months (Art.93, para.2). Unlike in the nancial restoration procedure, upon the introduction of external administration, the power of the executives of the debtor company is terminated by the commencement of this procedure. The external administrator takes over the power to manage the debtor company. The external administrator is empowered to dismiss the executives, or to transfer him to another position in accordance with Labour law. The power of the management bodies of the debtor company is also terminated and the management power is transferred to the external administrator, except for, inter alia, the following: i) ii) iii) iv)

Amendments to the articles of incorporation for the increase of the capital; Determination of the amounts and nominal value of declared shares; Increase of capital by issuing supplementary ordinary shares; Submission of a proposal to the creditors’ meeting to include in the agenda the possible supplementary issue of shares to the external administration plan; v) Determination of the procedure of the general shareholders’ meeting; vi) Submission of a proposal to dispose of an enterprise of the debtor; vii) Substitution (zameshchenie) of the debtor’s assets by setting up one or several joint stock companies on the basis of the assets of the debtor; viii)Appointment of the representative of the founders (members).

In contrast to the 1998 Law, it is now clear that the issuing of shares in order to restore solvency of the debtor is allowed only when the management body of the debtor company proposes it to the creditors’ meeting and when it is included

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in the external administration plan.25 Another novelty is the right of the management body of the debtor company to make a decision on the disposal of its enterprise and to set the minimum price of sale (Art.94, para.2). An important outcome of the decision of the court to commence external administration is the moratorium on the payment of the debt, including taxes and other mandatory payments (Art.94, para.1). The constitutionality of the moratorium in the 1998 Law was contested in the Constitutional Court. The court found this to be constitutional.26 There are exceptions to the moratorium such as current payments, arrears of wages, royalty for copyrights, compensation for the harm to life or health, and compensation of moral damages. When commencing the external administration procedure, the court conrms the external administrator. The procedure is set in the general part of the Law (Art.45). The external administrator is selected from the list in accordance with the general rule. The administrator can be dismissed by the court: i) On the basis of the decision of the creditors’ meeting in cases of non-performance or inappropriate performance of the duties by the administrator, or failure to implement the external administration plan; ii) Upon petition by a participant in the procedure regarding the non-performance or inappropriate performance of the duties by the administrator which violates the rights and lawful interests of this party, or has brought, or is likely to result in harming the debtor or creditors; iii)Cases where circumstances that prevent the person to be conrmed as an external administrator have emerged, or if after their conrmation, such circumstances were revealed. (Art.98, para.1).

The external administrator has the power to: i) dispose of the assets of the debtor in accordance with the external administration plan under the restrictions set out in the Law; ii) conclude amicable settlement in the name of the debtor; iii)refuse the performance of contracts concluded by the debtor; iv)apply to court for invalidation of transactions and decisions.

The external administrator adopts the assets of the debtor for his management, prepares an inventory, and prepares the external administration plan to be submitted to the creditors’ meeting. He also express objection to the claims

25 26

Vitrianskii, supra, p.416. Decision of the Constitutional Court, March 12, 2001, supra.

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presented by creditors if necessary and collects the debts owed. After the plan is approved by the creditors’ meeting, the administrator is responsible for its implementation (Art.99). As compared to the 1998 Law, under which external administrators tend to abuse their power, the 2002 Law has signicantly curtailed their power. “Practically, all powers of the external administrator for disposal of the assets of the debtor must not go beyond the external administration plan, and also is under the control of the creditors meeting”.27 Certain transactions effected by the debtor, including those effected before the commencement of external administration, can be invalidated by the court: i) Transactions by the debtor with interested parties, the performance of which harmed or may harm the interests of creditors or the debtor, upon application of the external administrator; ii) Transactions by the debtor with a specic creditor or others concluded or performed after the application for the recognition of the debtor as bankrupt was accepted by court, or within six months before the application was led, provided that such transactions result in satisfaction of a claim of a creditor in preference to other creditors, upon the application of the external administrator or creditors; iii)Transactions effected by the debtor within six months prior to the application for the recognition of the debtor as bankrupt was led involving pay-back of the contribution made by the founders (members) of a juridical person in relation to this person’s withdrawal from the organisation, if such a transaction violates the rights and lawful interests of creditors, upon application of the external administrator or creditors.

In addition, pay-back of contribution to the founders (members) of a juridical person in relation to this person’s withdrawal from the organisation after the application for the recognition of the debtor as bankrupt was accepted by court is null and void (Art.103, paras.1-5). The external administrator prepares a plan of external administration within one month of his conrmation by the court and submits it to the creditors’ meeting for approval. This plan must contain a proposed measure for the restoration of the solvency of the debtor, the terms and procedure for realising it, and the costs (Art.106, para.1). Measures for the restoration of solvency include (Art.109):

27

Vitrianskii, supra, pp.435-436.

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i) changing the prole of production; ii) closing of loss-making production; iii) collection of debts; iv) sale of part of the debtor-organisation; v) assignment of claims of the debtor; vi) performance of the debt by a third party; vii) increase of capital by contribution from the members or a third party; viii)issuing of supplementary common shares; ix) substitution of the assets of the debtor; x) sale of enterprise(s) of the debtor.

It should be noted that the sale of enterprises of the debtor was often abused under the 1998 Law. The 2002 Law introduced major changes to the system. First of all, the sale of enterprises can only be included in the plan on the basis of the proposal of the management body of the debtor. Second, a public auction is mandatory, and the minimum price is set by the debtor.28 Substitution of the assets of the debtor was introduced in Russia after the nancial crisis under the procedure led by ARKO. On the basis of the assets of the debtor, an open joint stock company is founded. The debtor is the 100% owner of this company. Other than the shares of this company, there are no assets left with the debtor. In due course, the shares of the company will be sold and the debts will be repaid from the proceeds.29 The creditors’ meeting is convened by the external administrator within two months of his conrmation by the court. The creditors’ meeting may: i) endorse the external administration plan; ii) reject the plan and apply to court for the recognition of the debtor as bankrupt and the commencement of the bankruptcy procedure; iii)reject the plan of the external administrator and have another meeting convened in order to examine another plan; iv)reject the plan and remove the external administrator.  (Art.107, para.3)

The court is empowered to recognise the plan as invalid as a whole or in part upon the request of a person whose rights or lawful interests were infringed. Once the plan is adopted by the creditors’ meeting and approved by the court, the external administrator is responsible for the realisation of the plan under the

28 29

Ibid., p.482. V.F.Popondopulo, Kommentarii k federal’nomu zakonu “o nesostoiatel’nosti”, Moscow 2003, pp.248-250.

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supervision of creditors. The administrator is under an obligation to keep the creditors’ committee informed. When required by the creditors’ meeting or committee, the administrator must report to creditors of the progress of the realisation of the plan (Art.106, para.4). The administrator must report to the creditors when external administration has been completed, when there is a ground for early termination of the procedure or upon the request of a person who is entitled to convene creditors’ meeting (Art.107). The creditors’ meeting, after hearing the report of the external administrator, is to adopt a decision either to apply to court for the termination of external administration due to the restoration of the solvency of the debtor, due to the fullment of all the claims of creditors in accordance with the register of the claim, or to apply for the recognition of the debtor as bankrupt and to commence the bankruptcy procedure (Art.118, para.3). Compared to the overall number of insolvency cases, the number of cases where external administration is effected is rather small. In 2000, external administration was introduced in 1,069 companies. In 907 cases, the company was recognised as bankrupt and the bankruptcy procedure started. 296 cases ended in amicable settlement (composition) between the creditors and debtors. Only in 50 cases, the debtor became solvent.30 In 2005, there were 1,013 cases of external administration. In only 21 cases was the solvency of the debtor restored. Thus, the effectiveness of the present system of external administration is questionable.31 The primary problem with external administration under the 1998 Law was the quality of external administrators. According to the report of the commercial court, no corpus of qualied administrators has been formed. “In fact, the incompetent and unprofessional external administrators and the absence of an effective means of controlling them often results in the liquidation of companies”. Some administrators who are qualied totally lack experience. On the other hand, many administrators handle the procedure of 8-10 large companies simultaneously.32 External administrators are in practice, free from control and the result is the “theft of basic assets of the enterprises, violation of the rules of auction for the sale of assets etc”.33 What is more, the neutrality of the administrators was questionable:

30 31 32 33

Supreme Commercial Court, “Rabota arbitrazhnykh sudov Rossiiskoi Federatsii v 2000 godu’, www.arbitr.ru VVAS 2001 No.5, pp.11-12. Spravka o rassmotrenii arbitrazhnyni sudami RF del o besostoiatel’nosti v 2002-2005 gg., www.arbitr.ru. “Rabota . . .’, supra. Ibid.

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In a case involving Chernogorneft, which was the largest production subsidiary of Sidanco, the then fth largest oil company, a competitor of Sidanco had been collecting claims vis à vis this subsidiary. The competitor oated a massive amount of bonds to nance this operation. Eventually, this competitor came to hold a substantial claim to the subsidiary indirectly. At the beginning of the procedure, EBRD, US Export-Import Bank and other creditors were not allowed to vote for the candidates for the post of external administrator, but eventually, a new creditors’ committee chaired by EBRD was formed and worked for the restoration of the company. However, the competitor applied to court for the removal of the external administrator. The commercial court, on appeal, accepted this and replaced the administrator who was said to be close to the competitor. The Supreme Commercial Court quashed this decision, but soon afterwards, reinstated the same administrator. In the creditors’ meeting which followed, since the amount of registered claims of the EBRD was reduced by the court and the claim of the US Exim Bank had been repaid shortly before, the competitor’s side had a majority, and another administrator close to the competitor was appointed. In the end, the creditors’ meeting later resolved that Chernogorneft be sold by auction. Despite objections from Sidanco and foreign creditors, the auction went ahead, and a company related to the competitor successfully acquired Chernogorneft at a low price. Similar questionable incidents took place in relation to other subsidiaries and Sidanco itself. In 2000, a compromise was reached, but was not fully implemented. Finally, in July 2001, a deal was announced to the effect that a holding which owns the competitor will acquire a 44% stake in Sidanco, and the same competitor returns Chernogorneft to Sidanco. The competitor’s group will come to hold 84% of Sidanco, while a foreign investor – BP-Amoco – will maintain 10% as was the case before the incident.34

Whether the quality of administrators has really improved under the 2002 Law is probably too early to judge.

6)

Bankruptcy (konkurs)

Bankruptcy in a narrow sense denotes the procedure of liquidation of the debtor company, sale of assets and distribution of the proceeds among the creditors. It is a “procedure applied to a debtor who was recognised as bankrupt for the purpose of proportional fullment of creditors’ claims” (Art.2).

34

Project Finance International, June 16, 1999, p.47, October 6, 1999, p.52; The Moscow Times, November 24, 26, 1999, August 3, 2001; Kommersant, March 2, May 16, 2000.

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When the court recognises the debtor as bankrupt, the bankruptcy procedure begins. With the commencement of the bankruptcy procedure, all monetary claims become due. As a rule, transactions related to the disposal of the property of the debtor are not allowed. The arrest of the debtor’s assets and other restrictions on them in place are terminated and further measures are forbidden. Most importantly, the power of the executive as well as the management bodies of the debtor company is terminated (Art.126, paras.1 and 2). The recognition of the debtor as bankrupt is published. The bankruptcy administrator is conrmed by the court in the same manner as administrators in other procedures. The administrator performs the function of the executive or management bodies of the debtor company during the bankruptcy procedure. The bankruptcy administrator is under an obligation to: i) manage the assets of the debtor and conduct inventory checks; ii) involve an independent valuer for the valuation of the assets of the debtor; iii) notify employees of their dismissal within a month of the commencement of the bankruptcy procedure; iv) adopt measures to preserve the assets of the debtor; v) analyse the nancial state of the debtor; vi) collect debts owed to the debtor; vii) prepare a register of claims; viii)adopt measures for the search, discovery and retrieval of the assets of the debtor.

The bankruptcy administrator is empowered to dispose of the assets of the debtor, to refuse the performance of contracts and other transactions, and to initiate an action in court to invalidate certain transactions having been effected by the debtor (Art.129). Limited liability company Kamgesstroibeton and an open joint stock company Kamgesenergostroi owed debts against each other. On April 30, 2003, both parties signed a protocol to the set-off mutual claims. On this very day, an application for the recognition of Kamgesstroibeton as bankrupt was submitted to the commercial court. On May 22, 2003, the observation procedure started. Subsequently, Kamgesstroibeton was recognised as bankrupt and the bankruptcy procedure was commenced. The bankruptcy administrator applied to the court for the above set-off agreement with Kamgesenergostroi to be invalidated. The rst instance court dismissed the claim on the ground that the transaction was effected in the normal course of economic activities and other creditors were not affected and that preferential repayment has not been proved. This was supported by the court of cassation. The case eventually reached the Supreme Commercial Court.

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The Supreme Commercial Court ruled that the Law on Insolvency did not acknowledge such a transaction to be valid merely because it was effected in the normal course of economic activities. Furthermore, according to the Court, the Law does not acknowledge such a transaction to be valid simply because the creditor, at the time of the transaction, was not aware, or could not have been aware that the debtor was on at the verge of bankruptcy. The rst instance court should have veried whether the transaction had been effected within six months of the application for the recognition of the debtor as bankrupt, and whether or not it had resulted in the preferential repayment of the claim ahead of other creditors. On the rst point, the set-off was effected on the day of the application in this case. On the second point, there are creditors of the rst and second rank. The judgment of the lower court was quashed.35

The bankruptcy estate comprises all properties of the debtor existing at the time of the commencement of the bankruptcy procedure and properties found in the course of the procedure. Properties which are excluded from circulation, e.g. items of cultural or historical signicance, proprietary rights which are related to the personality of the debtor, including licences for carrying out specic types of activities etc. are excluded from the estate (Art.131, paras.1 and 2). Within a month after the preparation of the inventory and valuation of the assets, the bankruptcy administrator must submit a proposal to the creditors’ meeting the manner, the timing and the terms of the sale of the debtors’ assets. The bankruptcy administrator is to sell the assets by public auction, unless otherwise provided by the Law (Art.139, paras.1 & 4). The order of fullment of claims from the proceeds is as follows (Art.134): i) Claims outside the rank (a)Court costs; (b)Fees of the administrator, holder of the register; (c)Current communal and other payments; (d)Claims which emerged after the application for the recognition of the debtor as bankrupt was accepted by court until the recognition of the debtor as bankrupt; (e)Arrears in wages which emerged after the application for the recognition of the debtor as bankrupt was accepted by court, and wages during the bankruptcy procedure; (f )Claims which emerged during the bankruptcy procedure.

35

Decision of the Presidium of the Supreme Commercial Court, January 18, 2005, Case 11119/04.

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ii) Claims of the rst rank: Claims of individuals based upon the liability of the debtor for causing damage to life and health iii)Claims of the second rank: Payment of retirement money and wages, and royalty for author’s rights (copyright) iv)Claims of the third rank: Other claims.

The order of distribution of the proceeds of sale has been different in the past. The difference primarily involves the tax claims and secured claims. Under the 1998 Law, tax claims were ranked after the secured claims as the fourth in rank, but ahead of the general claims which were fth in rank. Now the tax claims are in the same rank as the general claims, which is in the third rank. The problem with the 2002 Law is that the order of distribution is different from the provision in the Civil Code which sets out the order of fullment of the claims. By virtue of Article 3, para.2 of the Civil Code, the Code has priority over the Bankruptcy Law. According to the Civil Code, tax and other mandatory payment claims come third, and general claims follow as the fourth rank (Art.64). In fact, this is one of the most controversial issues in Insolvency Law.36 The view of the Supreme Commercial Court is that the Civil Code is applicable to liquidation without bankruptcy and is not applicable to insolvency per se.37 However, this approach is not without criticisms.38 The treatment of secured claims has changed over the years too. In the 1992 Law, secured properties were excluded from the bankruptcy estate. The 1998 Law included them in the estate, but secured claims were in the third rank, ahead of tax and mandatory payment claims as well as general claims. This is said to be because the Civil Code, which was enacted after the 1992 Law, has a provision to this effect (Art.64, para.1), and the Law on Insolvency could not provide otherwise. Another reason was that the security rights are regarded as rights in personam, and not real rights in Russia.

36 37 38

Karelina, supra, p.202. Vitrianskii, supra, p.52; Decision of the Plenum of the Supreme Commercial Court No.4, April 8, 2003, item 8. M.V.Teliukina, Kommentarii k federal’nomu zakonu o “nesostoiatel’nosti (bankrotstve)”, second edition, Moscow 2004, pp.349-350.

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This was criticised since secured creditors now had to wait for a long time for the whole insolvency procedure to be competed and also because their claim may not be fully satised.39 The 2002 Law does not distinguish between secured and unsecured claims insofar as the rank is concerned – both are in the third rank. However, secured claims are satised from the proceeds of sale of the collateral ahead of other claims, except for the claims of the rst and second rank which emerged before the conclusion of the contract of pledge (Art.138, paras.1 and 2). In 2005, in 13,963 cases, the debtor was recognised as bankrupt by the court and the bankruptcy procedure was initiated. This was an increase of 48.7% from 2004. Whether or not the creditors can have their claim satised by this procedure is questionable, though. The Commercial Court of Moscow completed the bankruptcy procedure in relation to an open joint stock company, Legprombank. The Central Bank withdrew the banking license on February 9, 2004 for the failure to comply with law and regulations and to pay creditors. Since then, a provisional administrator was operational. On April 1, a bankruptcy administrator was appointed. On April 7, 2005, the court extended the bankruptcy procedure by six months in April 2005. Claims of creditors of the rst and second rank were fully repaid. Creditors of the third rank only had around 1% of the claim repaid. The value of the bankruptcy estate was 79.8 million roubles. The cost of the procedure amounted to 39.5 million roubles.40

The Government Accounting Ofce, after inspecting the Federal Tax Agency, pointed out that the basic reasons for the insufcient effectiveness of the bankruptcy system are the sale of the assets of the debtor by the administrator at a low price and the unjustiable increase in the cost of the procedure which leads to the decrease of the bankruptcy estate. For instance, the value of the assets of the open joint stock company, Nosta, decreased by 75% of the balance sheet value between October 2003 and January 2004.41

7)

Amicable Settlement

An amicable settlement can be made between the debtor and the creditors including the empowered bodies (for tax and mandatory payments) at any stage of the

39 40 41

Teliukina, Konkursnoe pravo, Moscow 2002, p.338. Obzor deiatel’nosti arbitrazhnykh sudov v SMI, October 6, 2005 www.arbitr.ru. Ibid., November 12, 2005.

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procedure. The decision on the creditors’ side is taken at the creditors’ meeting with a majority of the total vote of creditors and the empowered bodies. All secured creditors need to give their consent (Art.150, para.1). The settlement also has to be approved by the court (ibid., para.4). 150 cases were settled in 2004, followed by 84 cases in 2005.

8)

Subsidiary Liability

The Law provides for subsidiary liability of founders (members) and executives of the debtor organisation, who, by their fault, caused the bankruptcy of the organisation (Art.10, para.4). An identical provision exists in the Civil Code. Agency for Insurance of Deposits is contemplating to pursue subsidiary liability of those who were responsible for the bankruptcy of the Olympic Bank. The Agency is acting as a bankruptcy administrator. Criminal procedure has been initiated against the former executive of the Bank. The president of the Bank was arrested together with the head of the securities division. The Agency is also considering action for subsidiary liability of several other banks. It is also planning to take an action in court to invalidate ten contracts of assignment of claims concluded before bankruptcy.42

42

Ibid., October 28, 2005.

6 GENERAL RULES OF THE LAW OF OBLIGATIONS

1

GENERAL

Book Three of the Civil Code is divided into two sections: general rules of the law of obligations and general rules of contract law. The rst section is divided into six chapters: concepts of and parties to an obligation, performance of obl igation, securing of performance of obligation, change of parties, liability for the breach of an obligation, and the termination of an obligation. Individual types of obligation are provided in Book Four, which is in Part Two of the Code enacted one year after Part One in 1996. Book Four not only contains obligations arising from various types of contracts, but also obligations arising out of tort and unjust enrichment. This structure is in line with the tradition of Russian civil law under the inuence of the Pandekten system. The draft Civil Code of the Russian Empire of 1905 was arranged in this way.

2

PERFORMANCE OF OBLIGATION

1)

Manner of Performance

The general rule is that an obligation should be performed in an adequate manner in accordance with the terms of the obligation and the requirements of the law and other legal acts, and in their absence, in accordance with the business custom (obychai delovogo oborota) or other normally applicable requirements (Art.309). Inadequate performance is not acknowledged as performance: The Allied Colleges of Advocates of St.Petersburg brought an action in court against an open joint stock company Stroimashin for the payment of 42,500,000 roubles for legal services provided to the latter. The rst instance court acknowledged the claim of the plaintiff. The Supreme Commercial Court, upon protest, quashed the judgment and remanded the case for a new hearing.

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According to Article 309 of the Civil Code, an obligation must be performed in an adequate manner. The defendant argued that the plaintiff had performed its contractual obligations in an inadequate manner. The advocates were acting on behalf of Stroimashin against a limited liability company Medlamo. Documents prepared and submitted to the court on behalf of Stroimashin were rejected several times by the court, due to their poor formulation. Even the iskovoe zaiavlenie was returned four times. The proceedings were delayed because of this, and in the end, although the court acknowledged the claim of the Stroimashin, because Medlamo had become bankrupt in the meantime, Stroimashin was unable to receive payment.1

Commercial custom means “accumulated and widely applied rules of conduct in a particular area of entrepreneurial activity” (Art.5). Some other laws, such as the Law on International Commercial Arbitration, use the term commercial custom (torgovyi obychai). There are three requirements for business custom to be applied; it has to be accumulated, i.e. continuous and sufciently dened in its content, it has to be widely applied and not against the law.2

2)

Time of Performance

If the obligation presupposes a xed date or period of performance, it has to be performed on that day or within the period. If no date or period is determined, the obligation must be performed within a reasonable period after the obligation emerged. With an obligation which was not performed within a reasonable period, or an obligation by presentation, the debtor must perform the obligation within seven days of the creditor requiring the performance, unless otherwise provided by law, legal acts, business custom or emanates from the content of the obligation (Art.314). Performance of obligation ahead of the agreed time is allowed in principle. However, in obligations involving entrepreneurial activities, performance ahead of time is allowed only when it is provided by law, legal acts, business practice or emanates from the content of the obligation (Art.315).

1 2

Decision of the Presidum of the Supreme Commercial Court, February 23, 1999, Case 2732/98. O.N.Sadikov ed., Komentarii k grazhdanskomu kodeksu Rossiiskoi Federatsi, Chasti Pervoi, third edition, Moscow 2005, pp.19-20.

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231

Place of Performance

If the place of performance of the obligation is not provided by law, legal acts, or contract, or is not apparent from business practice or the content of the obligation, the place of performance is determined by the following rules: i) obligation to transfer land, building, installation and other immovables – the place of the location of the property; ii) obligation to transfer goods and other property which presupposes transportation – place of the location of the rst carrier for the delivery to the creditor; iii)other obligation of entrepreneurs to transfer goods and other property – place of production or storage if these places were know to the creditor at the time of the emergence of obligation; iv)monetary obligation – place (location) of the creditor at the time of the emergence of the obligation; v) all other obligations – place (location) of the debtor.

4)

Currency of Performance

Monetary obligations must be denominated in roubles. They can also be determined as a rouble equivalent of foreign currency or units of payment. In such cases, the exchange rate is determined by the ofcial rate at the time of payment (Art.317, paras.1 and 2). The basic law which regulates currency transactions is the Law on Foreign Currency Regulation and Control of 2003.3 A closed joint stock company Ekoglin brought an action against an agricultural cooperative, Posevskiia, for the payment of 5,624 and 24,889.86 US dollar at the exchange rate of the Central Bank – the price for chemical fertiliser. The rst instance court partly acknowledged the claim of the plaintiff, but the payment was calculated on the basis of the exchange rate on September 30, 1998 which was the contractual date of payment. The appellate court calculated the amount on the basis of the exchange rate of July 31, 2002, which was the date of actual payment. The cassation court totally quashed this decision and rejected the claim of the plaintiff on the basis that the plaintiff had abused its right. The product had been purchased by the plaintiff from a Swiss rm, but, according to the court, there was no evidence that the plaintiff had current debt in relation to the Swiss rm and therefore, the payment was against the Law on Foreign Currency Regulation.

3

Law No.173-FZ of December 10, 2003.

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The Supreme Commercial Court, quoting Article 317, para.2 of the Civil Code, found that the terms of the contract regarding payment were not against the law. The fact that the plaintiff is not currently indebted to the foreign supplier was not a ground to exempt the defendant from payment. The decision of the appellate court was upheld.4

5)

Performance by Deposit

Depositing money or securities is deemed to be performance of obligation (Art.327). Debtors are entitled to place money or securities in deposit with the notary public or, in cases provided for by law, with the court if the obligation is impossible to perform for the following reasons: i) absence of the creditor or the person empowered by the creditor to accept performance at the place of performance of obligation; ii) absence of legal capacity of the creditor and the absence of a legal representative iii)apparent difculty in determining who the creditor is, especially when there is a dispute in this regard between the creditor and a third party; iv)failure on the part of the creditor to accept performance or other delay on his part.

The procedure for depositing money and securities is provided by the Basic Law on Notary Public.5

6)

Counter-Performance

When the performance of an obligation presupposes counter-performance by the opposite party vis à vis the other party, if the opposite party does not offer performance or there are circumstances which demonstrate that the obligation will not be performed within the agreed period, the other party is entitled to suspend the performance of his obligation, or refuse performance and demand compensation (Art.328, paras.1 and 2). Limited liability company Ritsa-Intorg, brought an action against the Sberegatel’nyi Bank for payment of penalties of 453,914,625 roubles for the failure to provide a

4 5

Decision of the Presidium of the Supreme Commercial Court, May 27, 2003, Case 1199/03. Law No.4462-I of February 11, 1993.

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loan, 58,187,357 roubles of unpaid interest for the deposit, and 155,387,289 roubles for the interest for the use of other person’s money. The rst instance court partly acknowledged the claim. The appellate court and the cassation court upheld this decision. The Supreme Commercial Court, however, quashed the decision on the following grounds. An agreement for a loan of 880,000 US dollars with 30% interest was concluded between the parties on November 17, 1995. According to the contract, the bank was to provide the loan within three days of the receipt by the plaintiff of certicates of deposit. In order to secure the repayment of the loan, the right emanating from the certicates of deposit was to be pledged. The list of certicates was attached to the loan contract, and the certicates were to be held in possession of the bank. If the bank failed to provide the loan, it was under an obligation to pay a penalty. The Supreme Commercial Court ruled that the provision of the loan by the bank was made conditional on the performance of the obligation by the borrower to obtain certicates of deposit. The same parties concluded two contracts of bank deposit of 500,000,000 and 1,200,000,000 roubles. However, the deposit was not made, and there is no evidence that the borrower received the certicates and handed them over to the bank as a pledge. The list of certicates of deposit was not attached to the loan agreement. Thus, the borrower had failed to perform his obligation. By virtue of Article 328, para.2 of the Civil Code, if the counter party has failed to perform his part of the obligation, the other party is entitled to refuse performance. The defendant therefore has a ground to refuse providing the loan to the plaintiff.6

3

OBLIGATION WITH MULTIPLE DEBTORS/CREDITORS

As a rule, if there are several debtors and/or creditors, each creditor has the right to demand performance and each debtor has a duty to perform obligation in the same proportion as the others (Art.321). The Code also provides for joint and several obligations and claims. In [a] joint and several obligation ( joint and several obligation with multiple debtors), the creditor is entitled to demand from all debtors simultaneously, or separately, performance in full or in part. Each debtor continues to be liable until the obligation is performed in full (Art.323). A debtor is not entitled to set up an objection to the creditor based upon the relationship between his co-debtors and the creditor to which he is not a party (Art.324). For example, even if one of the debtors has a counter claim against the creditor, other debtors are not entitled to rely on this counter claim.

6

Decision of the Presidium of the Supreme Commercial Court, April 1, 1997, Case 4684/96.

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Obligations related to entrepreneurial activities with several debtors or creditors are joint and several, unless the law, legal acts, or terms of obligation provide otherwise (Art.322).

4

CHANGE OF THE PARTIES

1)

Assignment of Claims

The right (claim) which belongs to the creditor can be assigned by a juristic act (contract) or shift to another person by law (Art.382, para.1). As an exception, rights which are inseparable from the personality of the creditor cannot be assigned. These include the right to alimony and the right to compensation for damage on the life and health of an individual (Art.383). Also assignment is not allowed if it is against the law, legal acts, or contract (Art.388). Thus, it is possible to restrict the right to assign the claim by means of a contract. For assignment of claims, the consent of the debtor is generally not needed, unless otherwise provided by law or contract. However, notication is necessary. If the debtor was not notied in writing of the assignment of the claim, the new creditor bears the risk of disadvantageous consequences; performance of obligation to the original creditor is regarded as an appropriate performance in such cases (Art.382, para.3). Consent of the debtor is needed, however, if the identity of the creditor has an essential meaning to the debtor (Art.388, para.2). The rights of the original creditor are transferred to the new creditor in the same scope and with conditions which existed at the time of the assignment. What is particularly important is that the rights which secure the performance of the obligation, e.g. pledge, as well as other rights related to the obligation, such as the right to unpaid interest, shift to the new creditor (Art.384). Whether the agreement concerning the place of dispute settlement would be transferred together with the claim was disputed at the former Foreign Trade Arbitration Commission in Moscow in 1984. The Commission concluded that the agreement was independent from the main contract and could not be transferred.7 The issue in the following case was whether or not this conclusion can be maintained under this provision in the Civil Code: By an agreement concluded in 1996, a Belgian company assigned to a US company a claim against a Russian joint stock company in lieu of the repayment of a loan. The US company, which opened an ofce in Russia, brought an action against the

7

Sadikov ed., Komentarii k grazhdanskomu kodeksu Rossiiskoi Federatsii, Chasti Pervoi, rst edition, Moscow 1996, p.379.

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Russian company for the enforcement of the claim in the Russian commercial court. The original loan agreement had an arbitration clause, referring the dispute to the Stockholm Arbitration Institute. The US company, in bringing the case to a Russian court, was of the view that the arbitration clause was independent of the loan agreement, had a procedural nature, and therefore, had not been transferred together with the claim to the assignee of the claim. The Russian commercial court ruled that the right to bring the case to court was one of the component parts of the claim and should be recognised to have been assigned to the new creditor together with the claim by virtue of Article 384 of the Civil Code.8

The debtor is entitled to refuse performance until the new creditor presents evidence that the claim has been transferred to this person. The assignor of the claim is under an obligation to provide documents which certify the claim and any relevant information to the new creditor (Art.385). The debtor may set up the objection he had against the original creditor also against the new creditor up to the moment of notice of assignment (Art.386). The creditor who assigned the claim is liable to the assignee for the invalidity of the claim which has been assigned, but is not liable for the non-performance of the claim unless the assignor guaranteed performance by the debtor to the assignee (Art.390).

2)

Assumption of Debt

Transfer of debt by the debtor is allowed only with the consent of the creditor (Art.391). The new debtor is entitled to set up objections against the claim based upon the relationship between the creditor and the original debtor (Art.392).

5

TERMINATION OF OBLIGATION

1)

General

Obligations are terminated on the following grounds (arts.407-419): i) performance; ii) substitute performance (otstupnoe); iii) set-off;

8

Item 15, Decision of the Plenum of the Supreme Commercial Court, February 16, 1998 No.29.

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iv) merger of the status of the creditor and the debtor; v) novation; vi) discharge; vii) impossibility of performance; viii)act of government; ix) death of a physical person or liquidation of a juridical person.

2)

Substitute Performance

Performance of an obligation can be substituted by another kind of action subject to agreement of the parties (Art.409). Substitute performance has been practised for many years, but the present Civil Code has, for the rst time since 1922, accommodated a provision on it.9 The Code refers to payment of money and transfer of property as substitute performance, but it can be in other forms, such as provision of service. Substitute performance is widely practised in Russia due to the “ineffectiveness of pledge as a means of securing performance”.10 A contract of substitute performance by transferring property (collateral) from the debtor to the creditor is concluded simultaneously with the basic loan contract. This is a contract with condition precedent and comes into effect by the debtor defaulting in the basic loan contract. The basic loan contract is terminated by substitute performance. The court practice seems to acknowledge this as “substitute performance of obligations secured by pledge”. In principle, all agreements of pledge which provide for the transfer of the collateral to the creditor in case of default are null and void, but as an exception, if the agreement qualies as substitute performance or novation, it is valid.11

3)

Set-off

Set-off is possible between countering claims of the same nature which are due, have no xed time of performance, or become due on presentation. It is effected by an act of one of the parties (Art.410). The requirement of the same nature means that the object of the claim should be of the same kind, e.g. pecuriary. Setoff is not allowed when the counter claim is extinct by prescription, is a claim on

9 10 11

O.Iu.Shilokhvost, Otstupnoe v grazhdanskom prave, Moscow 1999, pp.60-132. Ibid., pp.213-216. Decision of the Plenums of the Supreme Court and the Supreme Commercial Court, No.6/8 of July 1, 1996.

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compensation for damage caused on health and life of an individual, is a claim on alimony, or life annuity (Art.411). If a claim has been assigned, the debtor is entitled to set-off his counter-claim against the original creditor and also against the new creditor. This is possible when the counter claim against the original creditor existed before the debtor was notied of the assignment and the claim was due, the time of performance was not determined, or was to become due on presentation (Art.412).

4)

Novation

Obligation can be terminated by novation, i.e. agreement of the parties to replace the original obligation by another obligation with a different object or manner of performance. The basic difference between novation and substitute performance is that in novation, a new obligation emerges. Novation is not allowed with obligations on compensation of damage caused on health and life of an individual, or payment of alimony (Art.414, paras.1 and 2). It should be noted that novation terminates “supplementary obligations” related to the original obligation unless otherwise provided by the agreement between the parties. “Supplementary obligations” in this context includes means of securing the performance of obligation, e.g. agreement of pledge or guarantee (except for bank guarantee).12

5)

Impossibility of Performance

Impossibility of performance also terminates obligations, i.e. an obligation is terminated if performance became impossible due to circumstances in which neither party is responsible. Normally, impossibility of performance is excluded in monetary obligations. If impossibility of performance was caused by an intentional or negligent act of the creditor, the creditor is not entitled to demand return of the performed part of the obligation (Art.416). On the other hand, if impossibility of performance was caused by fault on the part of the debtor, the obligation is not terminated, but is changed; the debtor is liable for non-performance of obligation.13 There are a number of decisions of the court which ruled that the unavailability of government nance is an “impossibility of performance”.

12 13

Sadikov ed., Kommentarii . . . third edition, Moscow 2005, p.927. Ibid., rst edition, p.405.

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A company which manufactures aircrafts in Kazan, KAPO, brought an action against a state transportation company, Rossiia, for the rescission of a contract and payment of damages for its non-performance. The court of rst instance acknowledged the claim, which was upheld by the appellate court and the court of cassation. The Supreme Commercial Court quashed the judgment of the lower court on the following grounds. According to the contract of May 25, 1994, the plaintiff was under an obligation to produce an aircraft – IL-62M – and the defendant was under the obligation to take it. 80% of the price was to be paid in advance by June 1994 in order to nance the purchase of the engine and other components. However, the government decided that the production of this type of aircraft was not appropriate, and the budget did not provide nance for the advance payment. KAPO was informed on August 31, 1994. Article 416 of the Civil Code provides that an obligation is terminated by impossibility of performance, provided that it has been caused by reasons for which the debtor is not liable. The Supreme Commercial Court found that the non-allocation of the budget to the debtor qualies as such a ground. Therefore, the obligation shall be deemed to have been terminated on August 31, 1994.14

6

LIABILITY FOR THE BREACH OF OBLIGATIONS

Debtors are liable for compensation for the loss caused to the creditor by nonperformance or inadequate performance of an obligation (Art.393, para.1). As a rule, this is a liability based upon fault (intent or negligence). The present Code has introduced a denition of fault for the rst time. A person is found to have not been at fault, if this person has taken all measures to ensure the adequate performance of the obligation with the standard of care and foreseeability which are required of this person in accordance with the nature of the obligation and the terms of business (Art.401, para.1).15 The absence of fault has to be proved by the person who is in breach of obligation (ibid., para.2). In most jurisdictions, the absence of fault is not a defence in monetary obligations. However, in Russia, there have been cases where fault was required in pursuing the liability for the delay of performance in monetary obligations of government institutions:

14 15

Decision of the Presidium of the Supreme Commercial Court of March 11, 1997, Case 7522/95. M.I.Braginskii ed., Nauchno-prakticheskii kommentarii k chasti pervoi grazhdanskogo kodeksa Rossiiskoi Federatsii, second edition, Moscow 1999, p.521.

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A government institution was sued for the delay in payment for the service provided by a joint stock company. The Supreme Commercial Court rejected the argument of the defendant that the penalties were unreasonable, but found that the delay of payment was due to the delay in the allocation of funds to the government institution from the federal budget and that this could mean that the institution was not at fault.16

For those involved in entrepreneurial activities, the Code provides for stricter liability. A person who failed to perform an obligation or performed an obligation in an inadequate manner while performing entrepreneurial activities is liable for compensation, unless it is proved that adequate performance was impossible due to force majeure (insurmountable force, nepreodolimaia sila), i.e. circumstances which are extraordinary and impossible to prevent (ibid., para.3). This applies when a law or a contract does not provide otherwise. Force majeure includes natural disasters like earthquakes, oods, severe changes of temperature, military activities, epidemics, and large scale strikes as well as acts of government. Acts of government in this context include declaration of quarantine, prohibition of transport, and international trade sanctions.17 The Code explicitly provides that the breach of an obligation by a third party in relation to the debtor, absence of the goods in the market, or absence of money with the debtor are not force majeure (ibid.). A foreign trading company with a representative ofce in Russia brought an action against a Russian foreign trade organisation for payment of the price for the sugar supplied to this Russian organisation. The defendant claimed that the money was transferred to a foreign bank in accordance with the term of the contract with the trading company, but was stolen from the bank, and argued that it could not be held liable for the fault of a third party. The commercial court, by referring to the Vienna Convention on the Sale of Goods, ruled that the defendant had failed to prove that the act of a third party in this case was a “hindrance out of control”.18 Bank “Kodeks, Vektris i kompaniia” brought an action against another bank, Rosbank, claiming the return of 3,700,000 roubles which was paid out from the plaintiff’s account. The rst instance court acknowledged the claim in full. This decision was quashed by the court of cassation. The Supreme Commercial Court ruled upon the protest as follows.

D.V.Murzin ed., Grazhdanskii kodeks RF s postateinymi materialami iz praktiki VAS RF, Moscow 1999, pp.402-403. See also S.V.Sarbash, Arbitrazhnaia praktika po grazhdanskim delam, Moscow 2000, pp.379-384. 17 Sadikov ed., supra, third edition, pp.901-902. 18 Item 4, Decision of the Plenum of the Supreme Commercial Court, No.29 of February 16, 1998. 16

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The contested amount was transferred from the plaintiff’s account to the account of a limited liability company Terentina upon the instruction of the plaintiff. However, the plaintiff had never given such an instruction. In fact, the instruction was forged by an accountant of one of the group companies of the plaintiff. The accountant was convicted of theft by the ordinary court and the judgment had taken effect. Thus, the payment by Rosbank was effected without proper instruction by the holder of the account. According to the decision of the Plenum of the Supreme Commercial Court regarding transactions involving bank accounts of April 19, 1999, the power of the person who is given the right to dispose of the money in the account is to be veried by the bank in a manner set out by the bank’s regulations and in the contract with the client. Unless otherwise stipulated in the law or the contract, the defendant bank is liable for the consequences of the execution of an instruction given by an unauthorised person even in cases where the bank, by resorting to the procedure set out by the bank’s regulations and the contract with the client, was unable to establish that the instruction was given by an unauthorised person.19

In a similar case, a company opened a foreign currency account with a bank. After receiving a payment instruction from the company signed by the head of the company and the senior accounting ofcer, the bank paid 1,570,275 US dollars to another company as a payment for a transaction on shares. Later it was found that these signatures as well as the share purchase contract were forged. The Supreme Commercial Court found that by transferring money without authorisation, the bank had failed to perform its obligation in an adequate manner, and thus, was in breach of law and the contract.20 If non-performance or inadequate performance of the obligation was caused by the fault of both parties, the court must accordingly reduce the amount of liability of the debtor. The court is entitled to do the same if the creditor by intention or negligence contributed to the increase of damage caused by non-performance or inadequate performance, or failed to take reasonable measures towards the reduction of damage (Art.404). An act of employees of the debtor in performance of obligation is regarded as an act of the debtor. The debtor is liable for the acts of employees in relation to non-performance or inadequate performance (Art.402). If the debtor entrusted the performance of an obligation to a third party, the debtor is liable for nonperformance or inadequate performance by this person unless the law provides that the third party is liable (Art.403).

Decision of the Presidium of the Supreme Commercial Court of September 10, 2002, Case 3468/02. 20 Decision of the Presidium of the Supreme Commercial Court of June 30, 1998, Case 2310/98. 19

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The debtor is liable for the damage caused by non-performance or inadequate performance of obligation (Art.393, para.1). A basic provision on compensation is located in the General Part of the Code. The principle of full compensation is applicable (Art.15, para.1). Damages cover both real loss and lost prots. Thus, the cost which the person had incurred and will incur in order to restore his rights and the loss and damage to property as well as the lost prot are compensated (ibid., para.2). Although The Code provides for the compensation of moral damage in the General Part (Art.15), this is understood not to apply in cases of breach of contractual obligations. Full compensation means that as a result of compensation, the assets of the creditor should be the same as they would have been had the obligation been performed in an adequate manner. In some jurisdictions which adopt this principle, the scope of damage which is to be compensated is limited by the concept of “adequate compensation”. The same idea seems to apply in Russia – the compensation has to be “adequate”. “The creditor should not receive anything more than necessary to have his rights restored”.21 One commentator suggests that a creditor who claims lost income beyond reasonable scope may be found to be abusing the rights (Art.10).22 The Civil Code does not contain detailed provisions in this respect. The only relevant provision merely concerns the price. As a rule, when determining the amount of compensation, the price of goods and services in question on the day of performance by the debtor at the place where the obligation was to be performed is to be taken into account; if the obligation was not voluntarily performed, the price on the date of action to bring the case to court should be taken into account (Art.393, para.3). In cases of ination, if the creditor proves that he had taken all measures to prevent the damage or to reduce the damage, the price which is a result of ination may have to be taken into account, since it is the damage at the time of the court action that is to be compensated.23 Based upon the principle of full compensation, not only real loss, but lost prots (upushchennaia vygoda) are also to be compensated. By virtue of the general provision on compensation of loss in the General Part of the Civil Code, this is explicitly acknowledged. Lost prots are dened as an income which a person would have received under normal terms of business transactions, if his rights had not been infringed (Art.15, para.2). When determining the amount of lost prots, measures taken by the creditor to earn prots and the preparation for them are to be taken into account (Art.393, para.4).

21 22 23

Braginskii ed., supra, p.490. Ibid., p.491. D.V.Murzin, supra, pp.31-32. Also VVAS RF, 1993 No.11, p.185.

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GENERAL RULES OF THE LAW OF OBLIGATIONS

State enterprise, Prodintorg (seller) and a joint stock company, Nakhodtorg (buyer), concluded a contract of sale of imported citrus fruits on November 4, 1994. In order to perform its part of the obligation, Prodintorg concluded a contract with Landesman Trans Trade on the import of fruits on November 16, 1994. However, Nakhodtorg, in a telegramme dated November 22, refused to buy these fruits from Prodintorg, since it failed to secure a space in a refrigerated warehouse. Prodintorg was forced to nd another buyer, and eventually sold the products to another company at a considerably lower price. Prodintorg brought an action to court in order to recover the lost prot, i.e. the difference between the contractual price and the price agreed in the subsequent contract. The court of rst instance acknowledged the claim of the plaintiff, which was upheld by the appellate court. However, the Supreme Commercial Court found that between the refusal to perform the obligation by the buyer and the loss caused to the seller by selling the products to another buyer, a causal link was lacking. According to an expert report, a substantial part of the products which reached Russia were either rotten or did not meet the state standards. The difference of the value was therefore not 814,687,198 roubles as the plaintiff claimed, but 69.635 roubles. Besides, the products were insured and the plaintiff had been paid by the insurance company. Furthermore, by virtue of Article 393, para.4 of the Civil Code, measures taken by the seller to sell the products at the price agreed with Nakhodtorg to an alternative buyer and the fact that these measures were unsuccessful were not proven by the plaintiff. Therefore, the claim had to be dismissed.24

The right to full compensation for the breach of performance can be limited by law or contract. Sometimes, the amount of compensation is limited to penalties, to the value of goods or service, or to the real damage and not the expected income, i.e. the loss sustained but not the income foregone. In some cases, a ceiling is set for the amount of compensation. However, limitation on the amount of compensation by standard form contracts or contracts in which the creditor is an individual as a consumer, is void, if the amount of compensation for such instances or such kinds of violations is determined by law, and the contract had been concluded before the incident occurred (Art.400, para.2). In order to claim compensation, the plaintiff must prove 1) the breach of obligation by the defendant, 2) existence of a causal link between the non-performance or inadequate performance and the damage, and 3) the scope of damage caused by the breach on the part of the defendant. Contracts often provide for penalties (neustoika – sometimes called peni or shtraf ) for non-performance or inadequate performance. The relationship between penalties and compensation for damage varies. The general rule is that compensation covers the damage which is not covered by penalties (Art.394,

24

Decision of the Presidium of the Supreme Commercial Court of April 23, 1996, Case 508/96.

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para.1). However, there are variations. In some cases, penalties are all that the creditor is to receive (liquidated damages), such as in the transport industry. In other cases, penalties are charged in addition to compensation of damage. There are also instances where either penalties or compensation is available (ibid.). For non-performance of monetary obligations, including the use of another person’s money as a result of its unlawful retention, refusal to return the money, and other delays in payment or unjustied receipt or holding of another person’s money, interest must be paid on the amount of the money. The rate of interest is determined by the bank interest rate applicable at the place of residence of the creditor on the day of performance (Art.395, para.1). If the damage incurred by the creditor through illegitimate use of money by another person is more than the interest payable, the creditor may claim the difference as well (ibid., para.2). Penalties can be reduced by discretion of the court if they are apparently disproportional to the result of the breach (Art.333). This power of the court is said to be widely utilised due to the “extremely low standards of contract” which often provides for 5-10% penalties a day!25 In order to be reduced, the penalty must be apparently disproportionate to the consequence of non-performance or inadequate performance. A closed joint stock company “Visit” brought an action against Torgovyi Dom, Parnas-Agro, for the payment of 1,001,940 roubles plus interest of 51,003 roubles. The rst instance court acknowledged the basic claim in full, but regarding the interest, it reduced the interest rate to 8% per annum by virtue of Article 333 of the Civil Code. The plaintiff argued that the interest rate stipulated in the contract, calculated on the basis of the renance rate of the Central Bank, could not be reduced below that level, since the renance rate was a statutory minimum liability. The Supreme Commercial Court, quoting the joint decision of the Plenum of the Supreme Commercial Court and the Plenum of the Supreme Court, ruled that the court is empowered to reduce the interest only when the penalty is apparently disproportional to the consequence of the inadequate performance of the obligation. The criteria for “apparent disproportionality” include an interest rate which is considerably higher than the renance rate of the Central Bank. In this case, the renance rate during the period in question was between 16-18%. Therefore, the court concluded that the interest rate as stipulated in the contract did not need to be reduced.26

In one case, an interest rate which was 6-10 times higher than the renance rate of the Central Bank was found to be apparently disproportional.27

Braginskii ed., supra, p.498. Decision of the Presidium of the Supreme Commercial Court of August 10, 2004, Case 2613/04. 27 Decision of the Presidium of the Supreme Commercial Court of April 11, 2000, Case 1048/99. 25 26

7 MEANS OF SECURING OBLIGATIONS

1

GENERAL

The Russian Civil Code has a separate chapter on securing the performance of obligations. The starting provision in this chapter states as follows: Performance of an obligation can be secured by a penalty (neustoika), a pledge, the withholding of the object, a suretyship, a bank guarantee, earnest money, and other means provided by law or contract (Art.329, para.1).

Penalties, pledges, withholding of the object, suretyship, and bank guarantees are covered in subchapters in this part. In addition, there is a provision which refers to the retention of title in the part on contract of sale. Bank guarantee is a novelty of the Code, while other means already existed in the socialist code. The Code has another provision which refers to the retention of title in a different part. If it is agreed in the contract that the title to the product is to be retained by the seller until payment or fullment of other conditions, the seller is under an obligation not to alienate or otherwise dispose of the product (Art.491). It also allows the parties to agree on other means of securing obligations under a contract. The list of means of securing performance of obligation is by not exhaustive. The above-mentioned provision refers to “other means provided by law or contract”. This means that the Code does not exclude atypical security rights (see infra). Furthermore, the Law on Banking and Banking Activities provides that repayment of credit can be secured by a pledge on movables and immovables, including state and other securities, bank guarantees and other means provided by Federal law or contracts (Art.33).

246

MEANS OF SECURING OBLIGATIONS

2

REAL SECURITY RIGHTS (PLEDGE)

1)

The Concept

The Russian term zalog is usually translated into English as “pledge”. The Civil Code provides that by virtue of zalog, the creditor has a right to have the claim satised from the assets of the debtor in priority to other creditors in case of the debtor’s default. Thus, in this context, zalog refers to security rights in general. The Code divides zalog into two categories; pledges with or without transfer of the collateral to the creditor. Zalog over immovables is known as hypothec (ipoteka), while pledges on other properties do not seem to have a specic name under the Code. The 1992 Law on Pledge (zalog) called it zaklad. The 1998 Law on Hypothec reconrmed that zalog on immovables was hypothec. This arrangement was the reverse in the Tsarist law. There was no specic term for the zalog on immovables, while zalog on movables was called zaklad.1 Pledge is regarded as a right in personam rather than a right in rem under the Code. Provisions on pledges are part of the law of obligations and not the law of property. This is different from German, French and English law, but it is similar to the Dutch Civil Code on which the Russians had modelled the Code. Those who took part in the preparation of the Code pointed out that this is indeed a Russian tradition from before the Revolution. Indeed, the Svod zakonov had provisions on security rights in the part dealing with contracts. Volume X (Civil Law) of the Svod zakonov was composed of four books. It started with the rights and duties of the family, followed by the procedure of obtaining and consolidating property rights in general. This part basically covered property rights. It was followed by the procedure of obtaining and consolidating property rights in specics. This latter part contained provisions on, inter alia, the obtaining of property by gift, sale, and inheritance. Book Four contained provisions on contracts. There was a chapter here which was devoted to the means of securing the performance of obligations. This included suretyship, pledges, and penalties for delay.2 Pledge was dened as a right to receive payment from the proceeds of sale of the collateral in case of default.3 Thus, a pledge was not regarded as a right over the collateral, but rather, a right to demand that the collateral be sold and to have the claim satised from the proceeds. Presumably, this was why it was not made part of property law, but part of the law of obligations. On the other hand, some

1 2 3

D.I.Meier, Russkoe grazhdanskoe pravo, St.Petersburg 1902, pp.434-435. Ibid., pp.43-48. Ibid., p.432.

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lawyers in the Tsarist period maintained that zalog was a real right. According to Verblovskii, “an essential feature of pledge is its nature as a real right (veshchnoe pravo, dingliches Recht)”.4 The present Code seems to have followed the model of Svod zakonov. Russian commentators stress that a pledge is not a right in rem, but a right in personam by referring to a number of grounds. First, the object of a pledge extends to rights (claims) as well as things. Second, a pledge can be placed on property or claim which the debtor is to acquire in the future. Third, a third party, whose right over the property of the debtor is endangered by the enforcement of a pledge, may discharge it by paying the creditor without the consent of the debtor. Fourth, in case of loss of the collateral, the person who provided the object of the pledge may replace it with another property of the same value. Fifth, secured creditors may assign the right to another person by following the procedure for the assignment of claims.5 However, there are some provisions which seem to contradict the nature of the pledge as a right in personam. The major difference between a right in rem and a right in personam is that rst, the former is valid against everybody, but the latter is valid only against those who are bound by contractual relations. Under the current Russian Code, these rights are valid not only against the contractual party, but against everybody, if the necessary requirements, such as registration, are met. In this respect, the Law on Registration of Immovables and Transactions Involving Them cautiously provides that real rights are subject to registration, and in addition, encumbrances such as servitude, hypothec, trust, and lease are also subject to registration.6 Second, if a pledge is a right in personam, it will not necessarily follow the fate of the collateral. For example, if the collateral changes hands, the pledge on it may not always be transferred at the same time. However, the Code provides that the pledge follows the collateral in such cases. Third, if there are encumbrances on the property such as servitude, rights in personam are normally subordinate to these rights. This is not the case in the Code. Some problematic effects can be deduced if is viewed as a right in personam. An example is the Insolvency Law. Under the Insolvency Law, secured claims are not excluded from the bankruptcy estate as they used to be under the previous law. This is explained as being a result of the fact that a pledge is a right in personam; only objects of real rights are qualied for exclusion from the bankruptcy estate.

4 5 6

F.A.Brokgaus et al. eds., Entsiklopedicheskii slovar’ brokhaus, St.Petersburg, vol.23, p.189. M.I.Braginskii and V.V.Vitrianskii, Dogovornoe pravo, Vol.1, second edition, Moscow 2005, pp.501-502. Law on Registration of Immovables and Transactions Involving Them, Law No.122-FZ of July 21, 1997, Art.4, para.1.

248 2)

MEANS OF SECURING OBLIGATIONS

The Laws

At present, there are two statutes other than the Civil Code which provide for pledge. In 1998, a new Law on Hypothec was enacted. This Law has claried some matters which were left ambiguous by other laws. In addition, the Law on Pledge of 1992 is still valid, insofar as it does not contradict the Civil Code and the 1998 Law. There are some other laws which are relevant and supplement the system of security. Firstly, there is the Law on Registration of Immovables and Transactions Involving Them which was enacted in 1997. Although the system of registration is still in the process of development, it is hoped that this Law will bring order into the present chaotic registration system where local authorities set up their own rules. Secondly, there is the Law on Civil Enforcement which was enacted in 1997.7 Thirdly, a new Law on Insolvency was enacted in 2002 to replace the 1998 Law.8 According to the Civil Code, a new law which deals with the security of “goods in circulation”, e.g. inventories, is to be enacted, but has not been adopted so far.

3)

Objects of Pledge

The Code provides that any property can be the object of a pledge, including proprietary rights (claims), but excludes property which is withdrawn from circulation and claims which are inseparably linked with the personality of the creditor (Art.336, para.1). A commentary to the Code suggests that the basic requirement for an object of pledge is its nature as a commodity.9 The Code, in the General Part, refers to the capability of circulation (oborotosposobnost’) of objects of civil law rights (Art.129). Objects of rights under the Code are freely disposable and can be transferred to another party unless it is withdrawn from circulation or the circulation is restricted. What specically is meant by the term “withdrawn from circulation” is not necessarily clear. A commentary on the Civil Code refers to natural resources on the continental shelf and exclusive economic zones, and cites forests as well as assets related to national defence as examples. Gold or silver which is not processed into ornaments cannot be traded

7 8 9

Law No.119-FZ of July 21, 1997. Law No.127-FZ of October 26, 2002. M.I.Braginskii and V.V.Vitrianski, supra, p.513.

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freely either.10 On the other hand, in stark contrast to the socialist system, while mineral resources belong to the state, once they are extracted, they can belong to private entities and can be pledged. The 1998 Law on Hypothec lists the following objects of hypothec (Art.5, para.1): i) ii)

pieces of land; enterprises, as well as buildings, installations and other immovables used for entrepreneurial purposes; iii) residential houses, ats and parts of them which comprise one or several separate rooms; iv) dacha, garden houses, garage and other structures of a consumerist nature; v) aircraft, ships and satellites.

These are immovables as provided for in the Civil Code. The Code lists land, subsoil reserves, demarcated water objects, and other property which is rmly attached to the land, i.e. cannot be removed without unreasonable harm to its purpose of use, as immovables. These also include forests, perennial plants, buildings and installations, aircraft, ships, and satellites. Under a separate provision, an enterprise as a whole is considered an immovable (Art.130, para.1). On the other hand, this Law has a provision which sets out exceptions. Thus, land which belongs to the state or municipality and agricultural land cannot be hypothecated (Art.63, para.1). Goods in circulation can also be the object of a pledge. The goods remain in possession of the titleholder, but the “composition and the identity” of the goods may change, provided that the total value does not fall below the agreed amount. Goods which are disposed of by the pledger cease to be the object of the pledge, while goods which newly come into the possession of the pledger become an object of the pledge. Rights are pledgeable. However, the Code does not have specic provisions on the pledge on rights. The only reference to rights as objects of a pledge is a provision which requires that rights embodied in securities be transferred to the pledgee or deposited with a notary public unless otherwise agreed in the contract (Art.338, para.4). Therefore, at this moment, the 1992 Law on Pledge is applicable here. It provides that the right to possess and use a property, including leases as well as other rights, and claims emanating from obligations and other proprietary rights qualify as objects of a pledge.

10

O.N.Sadikov ed., Kommentarii k grazhdanskomu kodekusu Rossiiskoi Federatsii, chasti pervoi, third edition, Moscow 2005, pp.365-368.

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MEANS OF SECURING OBLIGATIONS

Furthermore, the 1998 Law on Hypothec accommodates a provision on leases (arenda) of immovables (Art.5, para.5). A lease cannot be hypothecated without the consent of the owner. Furthermore, in the case of default by the debtor, the creditor is not entitled to take over the lease; the lease has to be realised, i.e. sold by auction.11 Securities can be pledged. In fact, the pledge of securities is widely utilised and is one of the few means through which juridical persons and individuals can receive a loan from a bank. Furthermore, it is, in many instances, the only collateral the creditor accepts. When the Bank of Russia (the Central Bank) extends loans to banks, treasury bonds are the only security accepted.12 Whether money in an account can be the object of a pledge or not is being discussed. The problem is whether the money in the account can be seized by a secured creditor in preference to others in the case of default by the debtor. Sverbank initiated an action against Pakamar Bank claiming that the contract of pledge concluded between them was null and void. The pledged object was the “money in the correspondence account”. The Supreme Commercial Court found this contract to be null and void by virtue of Article 168 of the Civil Code, since money in a correspondence account was not transferable, while the Civil Code presupposes that the collateral should be transferable.13

The Supreme Commercial Court summarised this case as demonstrating that “the object of a pledge cannot be specied as money in the bank account”.14 However, this decision is being criticised.15 Perhaps the pledge should have been arranged as a pledge on the claim of the debtor to the money in the bank account. But even then, there is a problem with the realisation of the collateral (see infra).16 In contrast to a pledge on roubles in the account, using foreign currency as the object of a pledge is said to entail no problem.17

11 12 13 14 15 16 17

V.Smirnov and Z.Lukina, Kommentarii k federal’nomu zakonu ob ipoteke, Moscow 1999, pp.30-31. A.A.Makovskaia, Zalog denezhnykh sredstv i tsennykh bumag, Moscow 1999, pp.25-26. Decision of the Presidium of the Supreme Commercial Court, July 2, 1996, Case 7695/95. Item 3, Information Letter of the Supreme Commercial Court No.26, January 15, 1998. A.Lisov, “Mogut li byt” predmetom zaloga nalichnye denezhnye sredstva?”, RIu 2002 No.7, pp.29-30. Sadikov ed., supra, p.827. Braginskii and Vitrianski, supra, pp.516-517. Lisov, supra.

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4)

251

Form of Contracts and Registration

The Code requires that a contract of pledge be in written form. A pledge on movables or rights on property which secures a claim based upon a contract which is subject to notarisation, must be notarised (Art.339, para.2). In a contract of pledge, the object of the pledge, its value, the nature, and the amount and time of performance of the secured obligation must be specied (ibid., para.1): A bank brought an action against a joint stock company for the repayment of a debt and at the same time, the seizure of two automobiles which had been pledged. In the contract, the object of the pledge was specied as “automobiles and other means of transport which belong to the debtor”. During the hearing, it was found that the debtor had several automobiles in its possession. The court found this contract had not been concluded, since the object of the pledge was insufciently identied. In addition to the type of the property (“automobile”), individual characters of the object which allow the object to be distinguished from similar objects must be specied.18

The Law on Hypothec lists essential elements to be specied in the contract (Art.9). Security rights over a property presuppose an appropriate system of publicity, particularly when the collateral remains in the possession of the debtor. The Code distinguishes two types of pledge; pledges with and without the transfer of the collateral to the creditor. Pledges on immovables (hypothec) and on “goods in circulation” belong to the latter. The Code provides that a hypothec must be registered; otherwise, the contract is null and void (Art.339, para.3). The system of registration of immovables was almost absent in Russia under socialism. After the collapse of socialism, until 1997, it was the task of the committees on land resources and land reallocation attached to the local government to register rights on land. However, since it was not clear whether a hypothec was a right which could be registered with the committee, there were cases where the committee simply refused to register such rights. After all, it was only in the early 1990s that the committee started to develop a register of rights over land. In one case, a commercial bank applied for the registration of a hypothec over a piece of land, which was refused by the committee. The bank appealed to the commercial court, which eventually ordered the committee to register the hypothec.

18

Item 2, Information Letter, supra.

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MEANS OF SECURING OBLIGATIONS

In this respect, the enactment of the Law on the Registration of Immovables and Transactions Involving Them in 1998 was a major step forward. Under this Law, a unied state register of immovables and related transactions is to be developed. Rights to immovables covered by this Law include ownership rights, as well as “encumbrances” such as servitude, leases, hypothecs and trust rights. Instead of the land committee, it is the Ministry of Justice and its local agencies which are to have jurisdiction over registration. The registration of immovables should be distinguished from the registration of other properties. Some other types of property are subject to registration; e.g. aircraft are registered at the Ministry of Civil Aviation, automobiles are registered by the Ministry of Internal Affairs, and construction machinery by the State Technological Inspectorate. The registration procedure for these properties has improved in the past several years. Now, not only ownership, but also a pledge can be registered. This applies to share registers as well. What is different is that for these properties, registration is not a prerequisite to the rights taking effect. In one case, a creditor tried to foreclose a car which had been pledged. The debtor argued that since the pledge had not been registered, it had no effect. The commercial court of rst instance accepted this argument. On appeal, the court ruled that registration was not a prerequisite for a pledge on cars.19 In contrast, registration is a prerequisite for a hypothec, i.e. pledge on immovables, to take effect. For a hypothec, registration is the only means by which the rightholder can prove the existence of the right. The validity of registration can only be contested by court procedure. A bank in Moscow initiated an action against a closed joint stock company at the Commercial Court of Moscow Province for mandating the defendant company to register the contract of pledge of September 30, 1997. As a third party, the Registration Chamber of the Province was brought into the procedure. A loan agreement between the bank and the defendant was concluded on August 1, 1997, and in order to secure this loan, the defendant was to transfer the assets including movables and immovables located in the town of Pushkino to the bank by the contract of pledge dated September 30, 1997. At the time of conclusion of the contract, the land on which the immovable property was located had been provided by the administration of the Pushkin District. The contract was notarised and accounted for by the Bureau of Inventory of the District. However, according to the Civil Code (Art.117) and the law of Moscow Province, property rights and transactions involving them were required to be registered by the Registration Chamber of Moscow Province. The defendant failed to do this, so the bank initiated an action.

19

Ibid., item 1.

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The rst instance court acknowledged the claim and ordered the Registration Chamber to register the contract on May 25, 1998. The contract was eventually registered on September 21, 1998. Upon protest, the Presidium of the Supreme Commercial Court reviewed the case. The problem was that according to the Civil Code (Art.433, para.3), contracts which are subject to registration are deemed to be concluded by registration. Therefore, the contract in question was deemed to be concluded not on September 30, 1997, but on September 21, 1998. However, the Register of the Registration Chamber of Moscow Province indicated that as late as December 1, 1997, the title to the pledged assets was held not by the plaintiff, but by two other closed joint stock companies. There was no entry as to the encumbrance on the property. The Presidium ruled that the rst instance court, when ordering the contract to be registered, failed to ascertain whether the property actually belonged to the defendant or not, and therefore, the case should be remanded to the original instance.20

The Law on the Registration of Immovables and Transactions Involving Them requires that in addition to the real rights, hypothecs, trusts, and leases be registered (Art.4, para.1). Registration is the only means of proving the existence of such rights. If one looks into the register, even without disclosure by the pledger, the existence of immovables rights and other rights in effect should be evident. Thus, theoretically, those who enter into a transaction on immovables are protected from unknown encumbrances on the property. It is important to note that the Law on Registration of Immovables and Transactions Involving Them expressly declares that the register is open to the public. In the past, it was difcult for the interested party to have access to the register. Under the new Law, the agency which manages the register is under an obligation to provide information on the registered Immovables. The Law on Hypothec has a similar provision.

5)

Multiple Pledges

It is possible to create security for different claims on the same property. In such cases, the creditor who has security with priority receives payment from the proceeds of the sale of the collateral ahead of the others, and the creditor with security of an inferior rank receives payment only after that. The 1992 Law provided that creating security on the same property which has already been made an object of security was possible, but only when there is no agreement against

20

Decision of the Presidium of the Supreme Commercial Court, May 30, 2000, Case 5210/99.

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MEANS OF SECURING OBLIGATIONS

it. The pledger was obliged to notify all the subsequent pledgees of the existing pledges. For non-compliance with this requirement, the pledger was to be held liable. The Civil Code has a similar arrangement (Art.342), but whether this has any practical meaning is questionable. Subsequent creditors are protected only if there is a proper system of registration which the person who intends to create security can refer to for information on prior security. A Japanese company EIP initiated an action against a limited liability company MBT and a regional bank asking the court to acknowledge the contract of pledge of immovables concluded between the MBT and the bank on September 13, 1996 to be invalid. As a result of a tri-partite contract, concluded between 1993 and 1995, EIP provided a loan to the company Greenline Express for constructing a hotel in Khabarovsk. MBT, as the possessor of the hotel, was to transfer the right to possess and use the hotel to EIP in the case of default by Greenline Express. On May 1, 1996 and February 18, 1997, MBT which had assumed the debt of Greenline Express, concluded a contract with EIP to the effect that MBT transfer the title to the hotel in the case of default. However, MBT had concluded a loan agreement with the bank on September 4, 1996 and a contract of pledge on the hotel with the bank on September 13, the same year. EIP sued MBT and the bank to have this agreement recognised as null and void. The ground for this action was the failure on the part of the MBT to indicate the possessor of the assets, and to disclose the EIP debt owed by MBT. Both the appellate instance and the cassation instance judges rejected the claim, but acknowledged that EIP had pledge on the hotel. The Supreme Commercial Court found that the lower courts recognised the right of pledge of EIP on the hotel and concluded that the pledge by the bank was inferior to the pledge by EIP without sufcient grounds. In this case, Russian Law is applicable, since the status of immovables should be determined by the law of the location of the property. Russian law sets certain requirements as to the content of the pledge agreement. The contract takes effect only by registration. The Court reversed the case to examine whether these requirements were met by the parties.21

The 1998 Law on Hypothec has some provisions on subsequent hypothecs. The creation of a subsequent hypothec is allowed only when it is not prohibited by prior hypothec agreements. If, despite the prohibition, a subsequent hypothec is created, the court may declare subsequent hypothecs null and void. This applies regardless of whether the subsequent pledgee was aware of the prior hypothec

21

Decision of the Presidium of the Supreme Commercial Court, December 14, 1999, Case 5534/98.

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or not (Art.43, para.3). Most signicantly, it provides that subsequent hypothecs can be registered and that the priority of hypothec is determined by the order of registration (ibid., para.1). However, for other properties such as motorcars, or construction machinery, there is no protection as in the case with a hypothec, since registration is not a prerequisite for the effect of a pledge. If a subsequent hypothecary creditor applies for enforcement, then, prior creditors may also apply, regardless of whether the claim is due or not.

6)

Transfer of Collaterals

The Civil Code provides that the pledger may assign the collateral, offer it for lease, for gratuitous use, and by other means dispose of it, as long as it is not against the law or contract, or does not emanate from the nature of the pledge, but only with the consent of the pledgee. Agreements which restrict this right of the pledger are null and void (Art.346, para.2). There is a different arrangement regarding an encumbrance on the collateral in the Law on Hypothec as below. In cases where the title to the collateral is transferred to a third party, the pledge remains with the property. The person who obtained the title replaces the pledger and becomes liable for the debt (Art.353, para.1). While the Civil Code is silent on the effect of disposal of the collateral without the consent of the pledgee, the Law on Hypothec has a provisions on this matter. Thus, if the collateral was assigned without the consent of the pledgee, the pledgee has a choice of: i) avoiding the transaction between the pledger and the third party, or ii) accelerating the performance of the claim and seizing the collateral regardless of whom the collateral belongs to.

If the third party who obtained the collateral had known, or should have known that the assignment was effected without the consent of the pledger, the third party is liable to the pledgee jointly with the pledger for the non-performance of the obligation, but within the value of the collateral (Art.39). The Civil Code allows the pledger to offer the collateral for lease, or gratuitous use of a third party in principle, but only with the consent of the pledgee. The Law on Hypothec differs from the Code in this respect. Under this Law, unless otherwise provided by a Federal law or contract, the pledger may lease the collateral, offer it for temporary use with compensation and create servitude without the consent of the pledgee. The period of such encumbrance should not exceed the period of the claim secured by the pledge (Art.40, para.1). These

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encumbrances can be created in excess of the period of the claim only with the consent of the pledgee. In the case of the enforcement of a pledge, those encumbrances created after the conclusion of the pledge agreement without the consent of the pledgee can be discharged by a court judgement (Art.40, paras.1 and 2). In this way, the Law on Hypothecs has attempted to adjust the interests of the pledgee and the users of the property by slightly deviating from the Civil Code. The Law on Hypothec explicitly makes it an obligation of the pledger to disclose the existence of all the encumbrances on the collateral to the pledgee. These include pledges, leases, life-long use, and servitude. Non-compliance with this requirement gives a right to the pledgee to accelerate the claim or to modify the terms of the agreement (Art.12).

7)

Transfer of the Right of the Pledgee

The right of the pledgee can be assigned to a third party in the manner provided for in the Civil Code. The assignment is valid only when the claim which is secured by the pledge is assigned to the same person (Arts.355, 382-390). The same rule is set out in the Law on Hypothec. Under this Law, the assignment of the rights of pledge is presumed to accompany the assignment of the claim (Art.47). The Law on Hypothec has introduced a novelty – the hypothecary certicate (zakladnaia). This is a type of nominal security which embodies the claim secured by the hypothec as well as the hypothecary right over the collateral. It is issued by the agency which handles the registration of hypothecs upon request of the rst pledgee. The rights embodied in the certicate are assigned by way of endorsement on the certicate. It is also possible to pledge the certicate (Arts.13-18).

8)

Enforcement of Real Security Rights

This is the most controversial area in the Russian law on pledges. Even the latest law, the Law on Hypothec, is not without inconsistencies in this respect. In fact, according to one commentator, this is the part which contains serious contradictions.22

22

B.D.Zavidov, Kommentarii k federal’nomu zakonu Rossiiskoi Federatsii ob ipoteke, Moscow 1999, p.73.

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Firstly, a real security right is not always enforceable when the debtor has defaulted. The Code provides for a moratorium for the pledger. Upon the request of the pledger, the court may postpone the public sale for up to one year (Art.350, para.2). According to a commentary, this applies in cases where, for example, the pledger had pledged his only property, such as accommodation. The pledger is to be given a chance to repay the debt before his property is foreclosed.23 Naturally, this is a great disadvantage to creditors. Secondly, the Law on Hypothec provides that with regards to obligations which require periodic payments, the collateral can be seized only in cases where there was a systematic breach of terms in repayment by the debtor, i.e. where the repayment was not made in compliance with the date of repayment three times in 12 months unless otherwise provided in the contract (Art.50, para.2). Finally, there is the mandatory requirement of recourse to court procedure and public sale. The Civil Code distinguishes between the enforcement of immovables and movables. In the case of movables which have already been transferred to the pledgee, unless the law provides otherwise, the parties may agree not to use court proceedings for seizure. Concerning immovables, the Civil Code provides that satisfaction of the claim without recourse to the court is allowed only on the basis of a notarised contract concluded after the default (Art.349, para.1). Otherwise, the creditor has to go through court procedure. Furthermore, the Code also provides that such an arrangement to bypass the court can be invalidated by the court upon the petition of an interested party, whose right was affected by such an agreement. Interested parties in this context means secured lenders of a senior rank, or the owner of the collateral. An example is when the price of the collateral was incorrectly determined.24 According to the resolution of the Plenum of the Supreme Court and the Supreme Commercial Court, a clause in the contract of pledge which provides for the right of the creditor to take possession of the collateral immediately and directly is null and void.25 Such arrangements used to be common.26 The preference for court procedure is clearly based upon social policy considerations. Proponents of this approach maintain that with notarised agreements concluded in advance, at the time the document is formulated, the existence and validity of the secured claim as well as the possibility of recovering the claim by other means are not ascertained, and therefore, it entails a risk for the debtors.

Braginskii and Vitrianskii, supra, p.431. Ibid., pp.429-430. Sadikov ed., supra, p.841. Item 46, Joint Decision of the Plenums of the Supreme Court and the Supreme Commercial Court No.6/8, July 1, 1996. 26 A.A.Vishnevskii, Zalogovoe pravo, Moscow 1995, p.87. 23 24 25

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Particularly at a time when the consumer credit industry is ourishing and citizens are pledging their ats which are their sole property, it is “unethical” to let creditors foreclose the property without recourse to court.27 This antipathy against enforcement without recourse to the court is also evident in the 1997 Law on Civil Enforcement. Previously, under the Code of Civil Procedure, along with court judgements and arbitral awards, notarised agreements of enforcement were listed as one of the grounds for enforcement. However, the 1997 Law on Civil Enforcement considerably limited the use of the notarised agreement, only allowing it to be used in alimony cases. In fact, this approach had already been clear in the 1992 Provisional Statute on Pledge, which was prepared by the Institute of Private Law in Moscow. Later, this Institute played a major role in preparing the Civil Code. A further problem for the creditor is that the realisation of the collateral has to go through a public sale ( publichnyi torg). The Civil Code provides that the pledged property is to be realised by public sale as provided by the procedural law (Art.350, para.1). The possibility of sale on a commission basis is excluded.28 The reason why public sale was made mandatory in the Civil Code is presumably because this way, instances such as pledgees taking advantage of commissioned sale, and acquiring the property at an unfairly low price, can be avoided. There has to be an element of competition in order to keep the sales price higher. The arrangement seems to be primarily based upon the policy to protect the debtor/pledger. As one commentator pointed out, “under no circumstances can the pledgee automatically become the owner of the pledged property”.29 Another commentator stated that “this rule protects the interest of the weaker party, since it ensures that the collateral is sold at market price”.30 The 1998 Law on Hypothec has a similar provision (Art.56, para.1). While the Code is silent as to the agency which handles public sale, the Law provides that it is the agency which is entrusted with the enforcement of court judgments that is to handle public sale (Art.57, para.1). According to the Law on Hypothec, the procedure starts with the announcement of a public sale, at least one month before the sale. The starting price is declared at this stage. Those who intend to take part are obliged to place a deposit of up to 5% of the value of the property on sale. At the sale, only those who take part in the sale and those who are entitled to use the property or have a real

27 28 29 30

Braginskii and Vitrianskii, supra, p.532. O.N.Braginskii ed., Nauchno-prakticheskii komentarii k chasti pervoi Grazhdanskogo Kodeksa, second edition, Moscow 1996, p.303. Ibid., p.304. Sadikov ed., supra, p.843.

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right to the property may be present. The bidder who bid the highest price is the winner. This person must pay the price within ve days of the sale. Within ve days of the payment, the successful bidder concludes a sales contract with the organiser (Art.57). There is some confusion regarding the concept of public sale. In addition to publichnyi torg, the Code refers to torg. Torg takes two forms; auction (auktsion) and tender bid (konkurs) (Art.447, para.4). The distinction between them is that in an auction, the highest bidder in price wins, while in a tender, “the most suitable person to solve the task” or the bidder “who made the best offer” wins.31 In other words, the price is not decisive in a tender bid. Presumably, as can be seen from the fact that the tender bid is utilised in the privatisation process for the sale of state enterprises, the tender bid may be intended to be used in the realisation of collaterals such as enterprises. The Law on Hypothec juxtaposes public sale with auction. It has a separate provision on auction in addition to public sale. It provides that by agreement of the pledge and the pledger, a specialised organisation can be selected. This organisation is in a contractual relationship with the pledgee and acts in the name of the pledgee. The auction is, as a rule, conducted in public (Art.59, para.1).32 Thus, the Law on Hypothec, which is the latest law in this eld, has maintained the principle of mandatory public sale of the pledged property, but expanded the concept to include auctions by specialised organisations. It should be remembered that at the time of the preparation of the Civil Code, the possibility of commercial organisations being involved in auctions was already acknowledged.33 On the other hand, it has been made clear that the hypothecated property is to be realised within the framework of the civil enforcement procedure regulated by the Law on Civil Enforcement.34 This requirement of mandatory court involvement and public sale is inevitably time consuming and costly, and is therefore being criticised in Russia as “a completely inconvenient arrangement which apparently does not meet the needs of contemporary times”.35 Another problem with the mandatory public sale is that it is obviously not suited to pledges on claims. The 1992 Law on Pledge devoted a chapter to pledges on rights. It provided that objects of a pledge could be the right to

31 32 33 34 35

Ibid., supra, p.998. B.A.Zavidov, Analiza zaloga v grazhdanskom prave. Moscow 1999, p.73. L.A.Novoselova, Publichnye torgi v ramkakh ispolnitel’nogo proizvodstva, Moscow 2006, pp. 18-19. Braginskii ed., supra, p.303. Novoseleva, supra, p.19. Sviridenko, supra, p.74.

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possess and use property including the right to lease, and other rights (claims) emanating from obligations, as well as other proprietary rights (Art.54). This means that claims can be pledged in the same manner as proprietary rights, such as intellectual property rights. If a public sale is mandatory, problems arise with the realisation of a pledge on rights. There is no problem in realising them by public sale or auction, if the given right is embodied in securities, for example, if company shares or bonds were pledged. However, if it is a simple money claim, such a claim is normally unsuitable for auction. Let us assume that A has a claim against B. B, in turn, has a claim against C. B pledges his claim against C as a security for his debt to A. According to the present Russian Law, A cannot realise the claim other than by public sale or auction. It is unrealistic to think of a “market” for such claims unless debtor C is a major company. A possible solution is to let A exercise the right of B vis à vis C, i.e. let A replace B as a creditor within the scope of A’s claim by court order. However, under the current law, even a claim against an individual has to be sold at auction or public sale, which does not seem to be rational. The requirement of a mandatory public sale is justied by the fact that it ensures that the collateral will be realised at a fair price. However, the pledgee substituting the pledger in a claim by court procedure will not harm the pledger, since the pledgee substitutes the pledger only to the extent of his claim against the pledger, and the amount of this claim is already xed. There is no more possibility of unfairness to the pledger here than in a public sale.

9)

Real Security Rights and Insolvency Procedure

Russian commentators agree that the nature of a pledge lies in the right to have a claim satised out of the proceeds from the pledged property in priority to other creditors. However, this is not necessarily the case under Russian Law. The rst Insolvency law in the Russian Federation was enacted in 1992. This Law excluded secured property from the bankruptcy estate. The 1992 Law was replaced by a new Insolvency Law in 1998. In contrast with the 1992 Law, the 1998 Law as well as the current 2002 Law do not exclude the pledged property from the bankruptcy estate. Secured claims do have priority to unsecured claims, but are inferior to two other categories of claims. One is the claim for compensation arising from damage caused to the life and health of people, and the other is the claim for wages and retirement payments. These claims, particularly the rst category, can be substantial if there was e.g. environmental damage caused by the pledger. The justication for not excluding secured claims from the bankruptcy estate is primarily that a pledge is not a real right, but a right in personam.

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What is more, the Civil Code provides in a chapter on bank accounts that in cases where the amount in the bank account is not sufcient to satisfy all the claims, tort claims are of the rst rank, followed by wages and retirement payments, and then, by tax and other mandatory payments. Money claims come after tax payments, and moreover, there is no distinction here between secured and unsecured claims (Art.855).

3

ATYPICAL SECURITY RIGHTS

As mentioned above, the procedure for the enforcement of a pledge is rigid because of mandatory public sale requirements and does not meet the need of creditors who prefer quick, inexpensive and less complicated enforcement. As one commentator put it, “because of restrictions imposed by the laws, a pledge does not give creditors in most cases condence of speedy and full satisfaction of the claim through seizure of the pledged property”.36 Another commentator found “essential shortcomings of the pledge system” in that: . . . the system, in a majority of cases, does not give creditors condence in full and prompt satisfaction of the claim, since court procedure, which requires cost and time, is mandatory for enforcement.37

This author suggested that because of these shortcomings, in order to avoid risk, banks should conclude an agreement to have the title to the property combined with an agreement of reverse sale. In some jurisdictions where speedy, uncostly, and uncomplicated enforcement of security rights is not available, eventually, alternative methods of security have developed. This is also the case with Russia. In practice, varieties of transactions are being used as alternative means of securing obligations. Parties often resort to novation, or substitute performance (otstupnoe). They agree in advance to terminate the contract and conclude another agreement, which, in effect, is an agreement to transfer the title of the property to the pledgee. However, novation is accompanied by a risk of litigation by interested parties such as other creditors, since as the original transaction has been terminated and replaced by a new agreement, whatever priority they had

G.Adamovich, “O nekotorykh sposobakh obespecheniia kreditnykh obiazatel’stv, KhiP, 1996 No.9, p.41. 37 M.Chirkova, “Otsenka zaloga kak sposoba obespecheniia vozvratnosti kredita”, VVAS RF, 1998 No.8, p.38. 36

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is gone.38 This is particularly true when the debtor had been declared bankrupt. It is most likely that the effect of such an agreement would be denied by the bankruptcy administrator. Substitute performance became an issue in the following case: An open joint stock company, Company for the Assistance of Regional Development, brought an action at the Commercial Court of Primorskii Region against the Russian Tikhookeanskii Bank, claiming compensation of 1,595,417,775 roubles for the damage caused by an unlawful act by the Bank in taking away and disposing of the property of the company. The plaintiff also claimed that the contract of sale (substitute performance) of July 7, 1995 was null and void. The court of rst instance acknowledged the claim. At the appellate and cassation instances, the judgment was upheld. The Supreme Commercial Court quashed the judgment and referred the case to a new hearing on the following grounds. The plaintiff was a debtor of the bank in the loan agreement of October 14, 1994. The plaintiff defaulted, and the Bank received two notarised documents on which basis, a bailiff seized the property in question. The property was valued by an expert to be worth 857,765 thousand roubles. By the enforcement judgment of the Lenin District Court of Vladivostok of July 7, 1995, the property was transferred to the Bank as repayment of the debt. On the same day the Bank sold the property to a third party at the price of 857,759,445 roubles. However, this was before the judgment had taken effect and therefore, the Bank had acted unlawfully in selling the property. On the other hand, the Court noted that the lower courts failed to take into account that as a result of the sale, the debt of the plaintiff was reduced by 857,765 thousand roubles, and therefore, it was wrong to claim this amount as damages. The Court referred the case to a new hearing in order to examine the lawfulness of the contact of substitute performance and other arrangements which served as a basis of the plaintiff’s claim.39

One way of securing a claim is by selling the property to the creditor at the outset. This is called a “REPO” – sale and repurchase operation. The creditor purchases a property from the debtor with an obligation to sell it back to the debtor. The payment for the rst sale is equivalent to the amount of debt, while the resale price, which is agreed in advance, is repayment of the debt, and therefore, interest is added. In case the debtor (the seller) failed to tender payment for resale, the second agreement is simply rescinded and the rst buyer (the creditor) will

38 39

K.Sklovskii, “Zalog, arest imushchestva, isk kak sposoby obespecheniia prav kreditora”, RIu, 1997 No.2, p.26. Decision of the Presidium of the Supreme Commercial Court, March 31, 1998, Case 5624/97.

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retain the title. Thus, theoretically, there are two different contracts of sale, but they are usually combined into a single agreement. A variation of this arrangement is a preliminary agreement of sale with a condition precedent of the debtor’s repayment. If the debtor defaults, the condition is not fullled, and therefore, the agreement of repurchase does not come into effect. Another variation is the use of a trust agreement. The debtor grants the title to the creditor by trust agreement and the creditor becomes a trustee. However, there may be some problems concerning these arrangements, since these alternative means are designed to circumvent the cumbersome requirements of a statutory pledge. The Civil Code provides that sham transactions, i.e. transactions which conceal another transaction, are null and void. In such cases, provisions for the transaction which the parties genuinely desired (the concealed transaction) are to be applied (Art.170). There is a likelihood that an unfaithful pledger, after defaulting, may claim that such an arrangement is a sham and therefore, null and void. If the above-mentioned alternative transactions are found to be sham, then provisions on statutory pledges, instead of sale, will be applicable and various restrictions which the parties intended to avoid will have to be applied. There is also a problem concerning publicity. If the title over immovables shifts to the creditor, even provisionally, this has to be registered. Then, technically, the creditor is free to dispose of the property to a third party. There may be a dispute between the debtor seeking to retrieve the property once he has repaid the debt, and the third party who acted on the belief that the registered owner was the genuine holder of the right. The Commercial Court used to be fairly cautious in dealing with the problem of validity of atypical security rights, but in the following case, the court found the sale to be a sham. A closed joint stock company, “Evroresursy” (“the Company”), brought an action to court vis à vis a bank, “Diamant” (“the Bank”), demanding the return of shares which the latter held allegedly without grounds. The rst instance court dismissed the claim on the ground that the shares had been acquired on the basis of a contract of sale. The appellate instance upheld this, followed by the cassation instance. The Supreme Commercial Court, however, quashed the judgment and remanded the case to the lower instance. The view of the Court was that the claim of the plaintiff should be acknowledged. By virtue of the contract of sale of March 4, 1996, the Company sold 977,641 shares of another company to the Bank for 500 million roubles. The contract was performed, shares were registered, and the amount was paid. At the same time with the contract of sale, the parties concluded a contract of repurchase to the effect that the same number of the shares of the same company were to be repurchased by the Company at the price of 700 million roubles after

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May 6, 1996. This contract was rescinded by the Bank on the ground that the Company failed to pay this amount within the agreed period. These two contracts were inseparable from the contract of loan in which the Bank extended a credit line of up to 30 million USD valid until April 29, 1996. In order to secure the loan, the Company was obliged to transfer the title to the above shares to the Bank. The contract stipulated that the Company would lose the title to the shares in case of default.

The Company received the credit line, used 500 thousand USD out of it, and repaid this amount on May 16, 1996. The above, according to the Court, indicates that all three contracts were interrelated. The lower courts, without sufcient grounds, had treated these three separately. They ruled that the Bank had acquired shares on the basis of the contract of sale, whose validity they had failed to examine. The Company had asserted that the intention of the parties was to create a pledge. The fact that the parties had no intention to transfer the title can be demonstrated by the following circumstances: reference in the contract on the credit line the nature of the sale of shares as security with the right of repurchase, setting of the sales price lower than the market value, the right of repurchase after the repayment etc. Thus, the Court ruled that the contract of sale concealed the pledge of shares. According to Article 170 of the Civil Code, a sham transaction (pritvornaia sdelka) is null and void. Since the contract of sale of shares of March 4, 1996 is null and void, it does not generate any right on the part of the Bank to the shares. Since the parties had pledge in view, the contract of sale is null and void, and the provisions on pledge are applicable. The Court declared the sale contract to be null and void as a sham contract and applied the provision of a pledge to this transaction. Since the Bank had no grounds to hold the shares, the court ordered the Bank to return the shares to the Company. In exchange, the Company was ordered to return ve million roubles to the Bank.40 There was a sequel to this case: The above shares were disposed of by the Bank before the judgment took effect. The Company claimed 104,828,615 USD, which is the value of the shares held by the Bank without grounds and the damages, from the Bank. The amount of claim was later raised to 160,866,015 USD.

40

Decision of the Presidium of the Supreme Commercial Court, October 6, 1998, Case 6202/97.

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By the judgment of December 16, 1998, the Bank was ordered to pay 20,210,691 roubles as the value of shares and 155,919,152 USD as damages. Upon protest, the Supreme Commercial Court ruled as follows: The shares in question were not returned to the Company, and therefore, this dispute has arisen. The lower court was right in applying Article 1105 of the Civil Code (unjust enrichment). The Company claimed compensation for the lost income which allegedly resulted from the failure of the Bank to return the shares; namely the contract for the supply of oil of January 15, 1996 and the contract for the sale of shares of December 2, 1997. The latter was possible only if the shares were in the hands of the Company. However, the rst contract was concluded before the shares were offered to the Bank as a security, and the second contract was concluded while the dispute involving the share was still pending.41

There is another example of such an approach: An open joint stock company initiated an action against the Moscow Interregional Commercial Bank, asking the court to acknowledge a loan agreement and an agreement of pledge as null and void. The Bank had extended a loan of 100 billion roubles (before denomination) at 25% annual interest. In the accompanying contract of pledge, the company transferred to the Bank its own bills of exchange of the amount of 125 billion roubles. The court, with the perspective of applying Art.170 (sham transactions), reversed the case to the lower court for further examination of the intention of the parties.42

Thus, at least, this type of atypical security right failed to be endorsed by the court. However, Article 329 of the Civil Code which is a general provision on the means of securing the enforcement of obligations, lists suretyship, bank guarantees, pledges, and in addition, other means provided by law or contract. The Law on Banks and Banking Activities has a similar provision. The Civil Code guarantees freedom of contract. There seems to be room for atypical security rights. In the light of these open-ended provisions on the list of the means of securing obligations, it may be possible to argue that contracts involving atypical security rights are contracts which are not specically referred to in the Civil Code, but which are perfectly legitimate under the principle of the freedom of contract. The requirement of court procedure and public sale can be construed as being applicable only to statutory pledges.

41 42

Decision of the Presidium of the Supreme Commercial Court, October 6, 1998, May 22, 2001, Case 7598/00. Decision of the Presidium of the Supreme Commercial Court, January 23, 2001, Case 8/97.

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SURETYSHIP AND BANK GUARANTEE

Under Russian Law, suretyship has been one of the traditional means of securing the performance of an obligation. However, under socialism, the use of suretyship was very much limited. The 1964 Civil Code provided for suretyship and guarantee. The latter was in fact a variation of suretyship, the basic difference being the latter having the governing body of the state enterprise as a guarantor. Even this institution was limited in scope. Guarantee was nally abolished by the 1991 USSR Fundamental Principles of Civil Legislation as something unique to the planned economy.43 In suretyship, the surety and the debtor are jointly and severally liable to the creditor in the case of non performance or inappropriate performance of an obligation by the debtor, unless the law or contract provides for the liability of the surety as supplementary (Art.363, para.1). In contrast to the 1964 Code, the present Code allows suretyship which guarantees an obligation which is to emerge in the future (ibid., para.2). Sureties that jointly secured a claim are jointly and severally liable to the creditor (ibid., para.3). A contract of suretyship requires written form. Terms of suretyship can be agreed in a separate contract, or in the contract of the obligation which is secured by suretyship. The Supreme Commercial Court held a valid suretyship to be one in which the undertaking of the surety was entered in writing in the contract of loan.44 In any case, the acceptance of a surety by the creditor is required.45 In banking practice in Russia, the surety sends a letter to the bank-creditor, guaranteeing the repayment of the debt by the debtor. This practice is said to be valid under the current Code, since the subsequent act of the bank-creditor in extending the loan signies the acceptance of suretyship by the creditor.46 The surety is entitled to a defence vis a vis the creditor which the primary debtor can raise. The surety does not lose this right even if the debtor waived the defence or acknowledged the claim (Art.364). The right of the creditor is transferred to the surety once the latter performs the obligation. Upon performance by the surety, the creditor must provide the surety with documents certifying the claim and transfer the claim secured by suretyship to the surety (Art.365, paras.1 and 2).

S.N.Bratus and O.N.Sadikov eds., Kommentarii k grazhdanskomu kodeksu RSFSR, Moscow 1982, p.257. Braginskii ed., supra, pp.448-449. 44 Braginskii ed., ibid., p.452. 45 Sadikov ed., supra, p.615. 46 Braginskii ed., supra, p.452. 43

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Suretyship is terminated if: i) ii)

the obligation secured by suretyship is terminated; there was a change to the secured obligation which resulted in the increase of liability on the part of the surety or other unfavourable consequences without the consent of the surety; iii) the secured obligation is assigned to a third party in the absence of the surety giving consent to the creditor in guarantee for the new debtor; iv) the creditor refused to accept adequate performance offered by the debtor or surety; v) the term of suretyship expires; if there is no such term, it expires if the creditor, within a year from the time the secured obligation became due, failed to initiate an action against the debtor (Art.367). A creditor brought an action against a surety, after failing to have his claim satised by the debtor. The surety and the debtor bore joint and several liability vis à vis the creditor. It was agreed between the creditor and the debtor that the creditor could unilaterally change the rate of interest. In accordance with this agreement, the creditor had informed the debtor and the surety of the increase in the rate of interest. However, the argument of the creditor that the surety consented to the change by concluding the suretyship contract containing such terms was rejected by the court. The court ruled that an express consent of the surety to accept liability in accordance with the changed secured obligation was lacking.47

There is no requirement as to the qualication of the surety in the Civil Code. However, in cases where entities related to the state are involved, care should be taken. The court found a suretyship contract null and void on the ground that the state unitary enterprise which acted as a surety exceeded its power in becoming a surety for an obligation of a debtor, with whom the enterprise had no production relations. Furthermore, state treasury enterprises or institutions may not be a surety, since it may result in the liability of the owner – the state – without its consent, since, by law, the owner bears supplementary liability for the debt of those entities.48 In the following case, the provincial administration guaranteed the debt of a company as a surety: Bank Globeks brought an action in court against the administration of the Orenburg province claiming payment of 14,336,246 roubles. The Bank had extended a loan

47 48

Item 6 of the Information Letter of the Supreme Commercial Court, January 20, 1998, No.28. Sadikov ed., supra, p.858.

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to a joint stock company, Buguruslanskii Kombinat Khleboproduktov. In order to secure this loan, a suretyship contract was concluded between the administration of the Orenburg Province and the creditor. The debtor defaulted, and as a result, the creditor terminated the loan agreement and demanded the return of the loan within three days. The borrower was unable to pay, so the Bank brought an action against the surety – the provincial administration. The Bank withdrew the action against the borrower at the rst instance and only pursued the surety. The rst instance court acknowledged the claim, but the court of cassation quashed the judgment and rejected the claim of the Bank. Upon protest, the Supreme Commercial Court ruled as follows. The rst instance court has failed to take into account various circumstances. The contract of suretyship was signed by the rst deputy head of the administration. The deputy was empowered to sign such a contract only when the head of the administration was away from ofce, whereas on the day the contract was signed, the head was actually in the ofce. The rst instance court also failed to verify the lawfulness of the procedure of guaranteeing the debt. Furthermore, the law of the Province sets a ceiling to the total amount of guarantee which the Province may provide. However, the contract in question in this case did not specify the amount the Province is to guarantee. Besides, at the time of the conclusion of the contract, the Province had already provided a guarantee in excess of the ceiling set by the law. The Supreme Commercial Court also pointed out that the early termination of the loan agreement by the bank, its withdrawal of action against the debtor and the sole pursuit of the provincial administration should be examined in the light of the doctrine of abuse of rights.49

Bank guarantees did exist in a limited scope under socialist law as part of suretyship, but the present Civil Code accommodated it in a separate chapter. In a bank guarantee, the bank or other credit institution, upon request of another person (principal), assumes an obligation vis à vis the creditor of the principal (beneciary) and pays the guaranteed amount upon presentation of the claim by the beneciary (Art.368). In exchange for the bank guarantee, the principal pays remuneration to the guarantor – the bank. The obligation assumed by the guarantor, in relation to the beneciary, does not depend on the basic obligation which is secured by the guarantee (Art.370). A bank guarantee is, as a rule, irrevocable (Art.371). The guarantor may refuse payment if the demand or documents attached to it does not coincide with the terms of the guarantee, or the period of the guarantee had expired (Art.376, para.1).

49

Decision of the Presidium of the Supreme Commercial Court, July 6, 1999, Case 8190/98.

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OTHER MEANS OF SECURING PERFORMANCE OF OBLIGATION

1)

Penalty

269

A penalty (forfeiture or ne) is an amount of money set by law or contract which the debtor is under an obligation to pay in cases of non-performance or inappropriate performance of an obligation, but in particular, in cases of delay of performance (Art.330, para.1). What is important is that the creditor does not have to prove damage. This is an obligation based upon fault, and therefore, if the debtor is not liable for non-performance, inappropriate performance or delay, he does not have to pay the penalty (ibid., para.2). It should be noted that agreement on a penalty has to be in writing. Noncompliance will result in its invalidity (Art.331). A peculiarity of the Russian Law on penalties is that the agreed amount of a penalty can be reduced by the court, if the amount is “apparently disproportionate to the consequence of the breach of the obligation” (Art.333). There was a case where the creditor was to receive penalty of three times as high as the renance rate of the Central Bank. There was another case in which a penalty was set at 300 thousand roubles for a a contract of a value of 652 roubles. In both cases, the amount of penalty was reduced by the court.50 In cases of delay, a penalty is not to be imposed in addition to interest for delay. According to the commercial court, “two different means of liability cannot be applied to one and the same breach”.51

2)

Withholding of the Object

Withholding of an object means that the creditor, who is in possession of an object which is to be transferred to the debtor, may retain it in cases where the debtor has failed to perform an obligation, to reimburse the cost related to the object, or to pay other damages on time. If both parties are entrepreneurs, then the requirement of a relationship between the obligation and the object is dropped (Art.359). This is not merely a right of retention; the creditor has the right to have his claim satised from the proceeds of the sale of the object which has been withheld (Art.360).

50 51

Sadikov ed., supra, p.820. Decision of the Presidium of the Supreme Commercial Court, May 26, 1998, Case 6162/97.

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3)

Earnest Money

Earnest money is dened as the money paid to the opposite party from the amount which is due to this party to prove the conclusion of the contract and to secure its performance (Art.380,para.1). The agreement for payment of earnest money has to be in writing (ibid., para.2). The effect of earnest money is: i)

if the obligation was terminated by the agreement of the parties or by the impossibility of performance before the performance has started, the earnest money is returned; ii) if the obligation was not performed by the fault of the party which paid the earnest money, the money stays with the opposite party; iii) if the obligation was not performed by the fault of the opposite party, this party is under an obligation to return twice the amount of the earnest money.

In addition, the party which is responsible for the non-performance is liable for damages minus the amount of earnest money (Art.381).

8 CONTRACT LAW

1

GENERAL

A contract is dened in the Civil Code as an agreement of two or more persons on the establishment, change or termination of civil law rights and obligations (Art.420, para.1). This is identical to the concept of the juristic act as determined in the Civil Code (Art.153). Contracts are juristic acts. As is the case with the German BGB and the Dutch Civil Code, provisions relevant to contracts can be found in several different places in the Civil Code. First of all, rules on juristic acts (sdelka-transactions) which are contained in Book One of the Code (General Part) are applicable. These include the public order provision and abuse of rights provision. Secondly, provisions in Book Three, general rules of obligation, such as provisions on performance and termination of obligations, are applicable unless the part on contracts has different provisions (Art.420). Thirdly, general rules of contracts, such as those on offer and acceptance, and rescission, also accommodated in Book Three, are also applied. Finally, provisions on individual contracts can be found in Book Four.1 Within the Civil Code, the rule that a special norm has priority to a general norm applies.

2

FREEDOM OF CONTRACT

A signicant novelty in the current Civil Code is that the principle of the freedom of contract has been enshrined there. Article 421 provides as follows:

1

M.I.Braginskii and V.V.Vitrianskii, Dogovornoe pravo, Second edition, Moscow 2005, pp.2023.

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1. Individuals and juridical persons are free to conclude a contract. Compulsory conclusion of a contract is not allowed except in cases where it is provided by the present Code or law, or by a voluntarily assumed obligation. 2. Parties may conclude a contract which is provided or not provided by law or other legal acts. 3. Terms of the contract are determined by the discretion of the parties except in cases where the content of the terms are determined by law or legal acts.

Freedom of contract in the Russian Civil Code, as in other jurisdictions, encompasses i) freedom of concluding a contract, ii) freedom of choosing the counter party, and iii) freedom of determining the terms of the contract. In the socialist period, freedom of contract did not exist. Contracts between enterprises (they were called plan-contracts) were subordinated to the state economic plan. Under the dominance of the state economic plan, enterprises had no choice but to conclude contracts with a specic party dictated by the plan. The parties were not free to negotiate the terms of the contracts, nor even the price. In fact, there was a procedure at the then State Arbitration Commission (gosarbitrazh) to compel the parties to conclude a contract. Naturally, freedom of contract has its limits even under the present Civil Code, as is the case in other industrialised countries. In Russia, freedom of contract exists with the following exceptions: Firstly, the Code has a concept of “public contracts”. This is a new concept which was rst introduced by the Law on the Protection of the Rights of Consumers of 1992 and now accommodated in the Civil Code.2 Public contracts are contracts concluded by commercial organisations which establish the duty of the organisation to sell goods, provide service or work. The organisation, by nature of its activities, must perform for everybody who turns to it for such goods, work or service. Examples of these activities include retail trade, public transportation, communication, energy, medical services and hotels (Art.426, para.1). The uniqueness of public contracts lies in that i) commercial organisations are not entitled to refuse the sale of goods, the provision of work or services other than in instances provided by law (ibid., para.3), ii) the price of goods, work, or services and the terms of contract should be the same for all, unless the law allows preferential terms to be applied to a specic category of consumers (ibid., para.2), and iii) in case of refusal on the part of the commercial organisation to conclude a contract, the organisation may be forced by law to conclude it. In addition to the public contracts, government supply contracts can put selected Russian

2

Law 2300-1 of February 7, 1992.

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companies under an obligation to conclude a contract with the government and supply goods or provide services. Secondly, there are standard form contracts which also substantially limit freedom of contract. Standard form contracts are those contracts whose terms are determined by one of the parties in a standard form and can be accepted by the opposite party only as an “attachment/adhesion” to the entire contract (Art.428, para.1). The Civil Code provides some protection for consumers from standard form contracts. The counter party in a standard form contract may demand rescission or alteration of the contract if the it deprives this party of the rights normally provided in this type of contract, excludes or limits the liability of the other party for the breach of an obligation, or includes other disadvantageous terms which this party, based upon his reasonably understood interest, would not have accepted had he been given an opportunity (ibid., paras.1 and 2). This applies even when the contract is not against the law or legal acts. Since this provision aims to protect individuals (consumers), it is not applicable if the contract involved entrepreneurial activities by the opposite party and this party had known or should have known under what terms the contract was concluded (ibid., para.3). Thirdly, contracts must conform to the mandatory provisions of the law and other legal acts valid at the time of the conclusion of the contract (Art.422, para.1). Other legal acts in this context are presidential decrees and government edicts as well as subordinate acts enacted by ministries and agencies. A similar provision concerning juridical acts exists in the General Part (Art.168). However, this provision in the contract law part is slightly different in that it refers to the law and legal acts valid at the time of the conclusion of the contract. This means that if a law which was adopted after the conclusion of the contract has a mandatory provision different from the law existing at the time of the conclusion of the contract, terms of the contract retain the effect insofar as the new law does not provide for retrospective effect (Art.422, para.2). A similar “grandfathering clause” concerning tax and other mandatory payments exists in the amended Foreign Investment Law in relation to major projects (Art.9). It is not clear why contracts are treated differently from juristic acts in general.

3

CONCLUSION OF A CONTRACT

A contract takes effect and becomes binding on the parties from the time of its conclusion (Art.425, para.1). A contract is deemed to have been concluded if an agreement with all the essential terms of the contract has been reached in the required form between the parties. Essential terms in this context are the terms of the object (subject matter) of the contract, terms which are determined as

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essential by law or legal acts, terms necessary for the given type of a contract, as well as other terms, to which agreement is required by one of the parties (ibid.). A contract is concluded by the offer of one party and the acceptance by the other (ibid., para.2). An offer is a presentation to one or several persons which is sufciently denite and reects the intention of the offeror to regard a contract to be concluded upon acceptance by the opposite party. The offer must contain the essential terms of the contract (Art.435, para.1). The offer binds the offeror from the time it was received by the offeree (ibid., para.2). An offer which has been received by the offeree cannot be withdrawn by the offeror for the period established in the offer for its acceptance, unless otherwise reserved in the offer, or unless the withdrawal emanating from the nature of the offer or the circumstance in which the offer has been made (Art.436). Acceptance is a response by the offeree to accept the offer. The acceptance has to be in its entirety and without reservation. As a rule, silence is not an acceptance. Acts on the part of the offeree which execute the terms of the contract, such as accepting the goods, providing services etc., within the period of acceptance is regarded as acceptance unless otherwise provided by law, a legal act or the offer itself. Acceptance can be withdrawn until it has reached the offeror (Art.438). If the period of acceptance is xed in the offer, the contract is concluded when the offeror receives the acceptance from the offeree within this period (Art.440). If a period of acceptance is not xed in written form, the contract is concluded if the offeror received the acceptance within the period established by law or a legal act, and if such a period does not exist, within the period normally needed for the acceptance (Art.441, para.1). If the offer has been made orally without indicating the period for acceptance, the contract is considered to be concluded if the offeree immediately expresses its acceptance (ibid., para.2).

4

INTERPRETATION OF CONTRACTS

Following the model of the 1990 Fundamental Principles of Civil Legislation of the USSR, the Civil Code has a provision on the interpretation of contracts. The Code provides that rst, the literal meaning of the words and expressions in the contract should be considered. If this fails, the meaning of the term should be established from other terms and conditions of the contract and the meaning of the contract as a whole (Art.431).3

3

For details, see Braginskii and Vitrianskii, supra, pp.266-274.

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An open joint stock company, Krap (lessor), brought an action against a closed joint stock company, Konfort-servis (lessee). The parties concluded a contract of lease. The contract provided that the rent was to be indexed to the rise in the tariff for electricity. Whether this meant that the rise in the tariff was linked merely to the part of the rent covering the electricity, or the rent as a whole was unclear. The commercial court found the latter to be the case, since this clause was accommodated in the part of the contract entitled “the amount of rent and the procedure of payment” and because the “words and expressions contained in this part gave a basis for the conclusion that this part provided for the mechanism of the increase of rent, and not merely the increase of the electricity payment”.4

If this method is not sufcient to ascertain the content of the contract, then, the actual common intention of parties should be claried by taking into consideration the purpose of the contract. In such cases, all appropriate circumstances, including the negotiations which preceded the conclusion of the contract, and communications as well as the practice established between the parties, trade custom and subsequent conduct of the parties are to be taken into account (ibid.). A military procurator brought an action against an investment-construction company, Khabarovskinveststroiservis, on behalf of the Housing Administration of the Far East Military Division. The Administration and the company concluded a contract of joint participation in the construction of an apartment block. The company was under an obligation to pay 551.4 million roubles and to provide 10 ats (3 two bedroom ats, 5 three bedroom ats, and 2 four bedroom ats) of a total of 919 square metres to the administration, but in reality, 10 ats of only total 685 square metres were provided. The administration brought an action to have the remaining space transferred, or compensation to be paid. The rst instance court ordered the defendant to provide another 234 square metres of space. The appellate court quashed this decision on the ground that the contract had been fully performed. The court of cassation upheld this. The Supreme Commercial Court upheld this decision on the following grounds. The contract provided that the administration was to provide nance to build ve ats each in two buildings. These buildings contained no at the total size which amounted to 919 square metres, which was contrary to what was stipulated in the contract. The court of cassation had rightly concluded that there was a contradiction concerning the object in the contract. By virtue of Article 431 of the Civil Code, as the meaning of the contract was unclear, the meaning needed to be established by

4

Decision of the Presidium of the Supreme Commercial Court, February 18, 1997, Case 1852/96.

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other terms of the contract and the contract as a whole by taking into account various documents. The conclusion of the court of cassation was that the obligation under the contract was to transfer 10 ats. The court found that the contract merely obliged the owner to transfer 10 ats (3 two bedroom ats, 5 three bedroom ats, and 2 four bedroom ats) in the two buildings located in the given addresses. This obligation had been performed by the defendant. The decision of the court of cassation was upheld.5

5

REVISION AND RESCISSION OF A CONTRACT

As a rule, revision and rescission of a contract is possible by agreement of the parties, unless law or the contract itself provides otherwise. The Code provides that a contract can be revised by the judgment of the court upon application of one of the parties only when there was a substantial breach of contract by the opposite party and on other occasions as provided by the Civil Code, law or the contract. “Substantial breach” means a breach “which causes the other party to suffer a loss which signicantly reduces what this party may legitimately expect by concluding a contract” (Art.450, para.2). Another provision of the Civil Code prohibits the unilateral refusal of performance or the unilateral change of obligations (Art.310). On this matter, the Supreme Commercial Court has published a “Review of the Court Practice of Settling Disputes involving Conclusion, Revision, and Rescission of Contracts”.6 Thus, for example, the failure of the buyer to pay for real property as provided in the contract of sale is a substantial breach of a contract. Similarly, a failure to pay for a privatised object is a ground for a unilateral rescission of the contract of privatisation. Failure on the part of the contractor to complete the construction work within the agreed time limit and exceeding the projected cost were found to be grounds for rescission of the contract. On the other hand, in a case where the lessee repeatedly failed to pay the rent, make repairs, and even subleased the property without the consent of the lessor, the defendant submitted evidence that the breach had been rectied within a reasonable period. The court dismissed the claim of the lessor to rescind the contract. Commission for the Administration of State Assets of Tatarstan brought an action against a closed joint stock company, Tatintreid, for the rescission of the contract of sale of the shares of a kombinat and the return of the shares. Shares of the kombinat were sold to the defendant as a result of an investment tender. The shares were

5 6

Decision of the Presidium of the Supreme Commercial Court, June 17, 1997, Case 1063/97. Information letter of the Presidium of the Supreme Commercial Court, May 5, 1997, No.14.

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sold to the defendant upon the order of the Commission. One of the terms of the tender was for the successful bidder to nance the modernisation of the Kombinat at the cost of 5.3 billion roubles. It was provided in clause 1.3 of Part 1 of the sales contract. Since the buyer failed to full this obligation, the Commission brought an action in court. The rst instance court as well as the court of cassation found that the term of the contract regarding the investment for modernisation should be regarded as essential, and the breach of this term by the defendant is a sufcient ground for the rescission of the contract in accordance with Art.450 of the Civil Code.7

If a creditor fails to accept the performance of an obligation without justiable reason, this serves as a ground for rescission by the counter party: A joint stock company brought an action against a limited liability company in order to rescind the contract of sale of a non-residential property for the failure of the defendant to pay the price. The court dismissed the claim, since it was ascertained that the plaintiff/seller had failed to accept the payment by the buyer and the buyer had deposited the amount. By virtue of Article 327, para.1 of the Civil Code, if an obligation cannot be performed due to failure on the part of the creditor to accept performance, the amount in question can be deposited with a public notary.8

A contract can be revised or rescinded on the ground of the change of circumstances. The relevant provision (Art.451, para.1) states as follows: A substantial change of circumstances on which one of the parties relied at the time of the conclusion of the contract is a ground for the revision or rescission of the contract, unless otherwise determined by the contract or unless this emanates from the nature of the contract.

A change of circumstances is substantial if the circumstances changed to the extent that if the parties were reasonably able to foresee it, they would not have concluded the contract or they would have concluded the contract under substantially different terms. There are four basic requirements for the application of this provision: i)

7 8

at the time of the conclusion of the contract, the parties relied on the fact that no such change of circumstances would occur;

Decision of the Presidium of the Supreme Commercial Court, April 13, 1999, Case 6685/98. D.V.Muzin ed., Grazhdanskii kodeks Rossiisokoi Federatsii s postateinymi materialami iz praktiki VAS RF, Moscow 1999, p.469.

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ii)

the change of circumstances was the result of a phenomenon which, after it had happened, was insurmountable by the interested party despite the care and alertness which are required of this party by the nature of the contract or the terms of business; iii) the performance of the contract without revision of its terms harms the relationship of the proprietary interest of the parties and results in a loss on the part of the interested party to such an extent that this party would be deprived of what he had legitimately expected on concluding the contract; iv) it cannot be derived from trade custom or the substance of the contract that the risk should be borne by the interested party.

This provision is a novelty which was introduced for the rst time by the present Civil Code. Since the concept of change of circumstances is not common in the Anglo-American jurisdiction, when this was introduced, some US lawyers were apprehensive, since it was suspected to be an attempt to reduce the binding effect of contracts. However, this concept is familiar to lawyers in Civil Law countries. In fact, the Swiss Civil Code has long had this concept, and so has the Dutch Civil Code which served as a model for the Russian Civil Code. A Russian expert points out that this has been recognised as “one of the most important principles of contemporary contract law”, which is demonstrated by the fact that it is incorporated in the “Principles of International Commercial Contracts” prepared by UNIDROIT.9 The effect of the change of circumstances is that the parties are able to renegotiate the contract in order to bring it in line with the changed circumstances or to rescind the contract if they fail to reach an agreement. If one of the parties brings the case to the court for rescission of the contract, in principle, the court must allow the rescission of the contract.10 On the other hand, the contract can be revised by the court in exceptional circumstances where rescission of the contract is against the interests of society or where it results in a loss to the parties that signicantly exceeds the cost necessary for performing the contract under changed circumstances (Art.452, para.4). The commercial court has been cautious in acknowledging that a change of circumstances has occurred. In several cases, the court denied the application of this provision to a lease agreement, where the revision of the rent due to the increase of the cost was at issue.11 In another case, the court denied that the bankruptcy of the creditor was a change of circumstances.

A.S.Komarov, “Izmenenie obstoiatel’stv i dogovornoe otnoshenie”, in A.L.Makovskii ed., Grazhdanskii kodeks Rossii, Moscow 1998, pp.337-348. 10 Ibid., p.350. 11 Decision of the Presidium of the Supreme Commercial Court, January 12, 1999, Case 6548/98. 9

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The bankruptcy administrator of Tserta Bank, brought an action against a limited liability company, Firma BAK, in order to have the loan agreement of February 9, 1998 rescinded and the amount of the loan, 300,000 roubles, and the interest, 33,750 roubles, retrieved from the defendant (borrower). In this case, the Bank had provided a loan over ve years with 5% interest to Firma BAK. The rst instance court acknowledged the claim and the appellate instance as well as the cassation instance court upheld the judgment. Upon the protest of the deputy president of the Supreme Commercial Court, the Supreme Commercial Court reversed the judgment. Tserta Bank was declared bankrupt after the conclusion of the loan agreement. The Bank applied for rescission of the loan agreement on the ground that the bankruptcy of the Bank was a substantial change of circumstances. However, in the view of the Supreme Commercial Court, the lower courts failed to take into account the fact that the payer of the promissory note was not the Bank. Furthermore, the contract can be rescinded only when the four requirements set out in Article 451 are met. Bankruptcy of the creditor which occurred as a result of a risky credit policy does not qualify as a change of circumstances resulting from a cause which the interested party, in this case, the Bank, could not have overcome with due care. Therefore, Article 451 is not applicable in this case.12

In yet another case, the Supreme Commercial Court rejected the claim of the party for the revision of a construction contract due to the increase in the price of materials. The Court ruled that in order to revise the terms of the contract, all four requirements of Article 451, para.2 should be met, and in addition, pointed out that revision of the contract was possible, in accordance with para.4, only in exceptional cases where rescission of the contract is against the interests of society or where it results in a loss to the parties that signicantly exceeds the cost necessary for performing the contract under changed circumstances.13 In order to claim revision or rescission of a contract, the interested party must rst propose such a revision or rescission to the opposite party. Only when the interested party receives a refusal to revise or rescind the contract from the counter party, or fails to receive a reply within the period determined by law or a contract, or in the absence of such a period, within 30 days, can he apply to court for revision or rescission (Art.452). Revision or rescission of a contract takes effect from the time of the agreement by the parties, or, in cases where the revision or rescission is made by court procedure, from the time the judgment enters force. As a rule, the parties are not entitled to demand the return of that which has been transferred to the opposite party as performance of obligations up to the time of the revision or rescission

12 13

Decision of the Presidium of the Supreme Commercial Court, June 15, 1999, Case 1020/99. Decision of the Presidium of the Supreme Commercial Court, October 6, 1998, Case 249/98.

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of the contract (Art.453, para.4). However, if a substantial breach of contract by one of the parties has served as a ground for revision or rescission of a contract, the opposite party is entitled to claim damages for revision or rescission of the contract (para.5).

6

INDIVIDUAL CONTRACTS

1)

General

Part Two of the Civil Code covers individual contracts, tort and unjust enrichment. There are 28 types of contracts in total provided in the Code ranging from sale, exchange to public tender and even betting. These include contracts which are normally concluded between individuals and also commercial contracts which have entrepreneurs involved. In fact many of the commercial contracts, i.e. contracts in which at least one of the parties is an entreprenuer such as factoring, nancial lease, franchising and management of assets (trast) have been newly incorporated in the Code. The problem is that provisions on some of those contracts such as nancial lease are not necessarily well thought through. The list of contracts is not exclusive. Based upon the principle of freedom of contracts, parties are free to conclude a contract which is not directly provided by law (anonymous contracts), unless it is against the law. Parties may also conclude a contract which encompass different types of contracts as provided by law and other legal acts (mixed contracts). Many provisions of the part of the Code on contracts are of an optional nature, i.e. it is possible to provide otherwise by agreement of the parties.

2)

Contract of Sale

(1)

Types of Sales Contracts

A contract of sale is dened as a contract in which the seller is obliged to transfer the ownership of a thing (goods) to the buyer, while the buyer is under an obligation to accept it and pay the price (Art.454, para.1). The contracts of sale part of the Civil Code starts with a general part which sets out rules which are applicable to all kinds of contracts of sale. This is followed by specic types of sales contracts such as i) retail contracts, ii) supply contracts, iii) government procurement, iv) supply of agriculture products (kontrataktsiia), v) energy supply contracts, vi) sale of immovables, and vii) sale of enterprises.

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A retail contract is a contract in which an entrepreneur in retail sales, sells goods for personal, family, domestic, and other use not related to entrepreneurial activities. It is a “public” contract, i.e. the seller is not allowed to refuse entering into a contract if someone makes an offer. Supply contracts are those on which the supplier/entrepreneur supplies goods to another person for entrepreneurial activities or other purposes not related to personal, family, domestic purposes. Government procurement (supply of goods for government needs) covers both contracts with the Federal government and the constituent entities of the Russian Federation. Government procurement is effected in two forms: agreement (kontract) with the state for the needs of the state, and the state supply contract (dogovor) concluded in accordance with the former (Art.525, para.1). The former can be compulsory on the counter party, i.e. the counter party may not be entitled to refuse to supply. This is allowed only when provided by law, and on a compensation basis (Art.526, Art.527, para.2). (2)

General Rules on Contract of Sale

(1) Object of Sale The object of sale can be anything which is regarded as an object of civil law rights in the Code, except for those excluded from circulation or whose circulation is restricted (Art.129, para.1). It should be noted that land and other natural resources can also be objects of sale to the extent it is allowed by laws regarding land and other natural resources (ibid., para.3). A contract of sale can be concluded regarding the goods of which the seller is in possession at the time of the conclusion of the contract as well as the goods which are to be acquired by the seller in the future (Art.455, para.2). (2) Performance and Acceptance The obligation on the part of the seller is regarded to be performed at the time of either (i) delivery of the goods to the buyer or to the person designated by the buyer, if the buyer is under obligation to deliver the goods by the contract, or (ii) providing of the goods for the disposal of the buyer, if the goods, by contract, are to be transferred to the buyer or a person designated by the buyer at the location of the goods. In the latter case, goods are regarded to be provided for the disposal of the buyer when the goods are ready at the time and place determined by the contract and the buyer is notied of the readiness of the goods in accordance with the terms of the contract (Art.458, para.1). If the seller fails to transfer the goods to the buyer, the buyer is entitled to refuse performance of the contract on his part. If the seller refuses to transfer an individually specied thing, the buyer may claim damages (arts.463 and 398).

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The buyer is under obligation to accept the goods except in cases where he is entitled to a replacement or to refuse performance. The buyer also has a duty to cooperate with the seller: he is obliged to perform acts which, in the light of normally presented requirements, are necessary for ensuring the transfer and acceptance of the goods, unless otherwise provided by law or other legal acts (Art.484, paras.1 and 2). (3) Transfer of Risk As a rule, the risk for accidental loss or damage on goods is transferred to the buyer when, by law or contract, the seller is regarded to have performed his obligation to transfer the goods to the buyer. The risk of goods in transity is transferred to the buyer from the moment of conclusion of the contract of sale, unless the contract provides otherwise or there is a different commercial custom (Art.459, para.2). (4) Third Parties The seller is under an obligation to transfer the goods to the buyer without any encumbrance by rights of a third party, unless the buyer agreed otherwise. A breach of this obligation will result in the right of the buyer to demand a reduction in price or rescission of the contract, if it is not proved that the buyer had known or should have known of the existence of the third party’s right on the goods. The same applies when there was a claim on the goods which the seller was aware of, and this claim was subsequently found by an established procedure to be with grounds (Art.460). If the object of sale was taken away from the buyer by a third party on the ground which had existed before the performance of the contract, the seller is liable for the damage unless the seller proves that the buyer had known or should have known of the existence of such a ground. An agreement to exempt or limit the liability of the seller in such cases is null and void (Art.461). Exemption of the liability of the seller if he proves that the buyer should have known of the existence of the third party’s right is rather questionable in that it gives too much protection to the seller who was aware of the existence of such a right. If a third party initiates litigation vis à vis the buyer for taking away the object of sale on the ground which had emerged before the performance of the contract, the buyer may cause the seller to take part in the proceedings and the seller is under an obligation to take part on the side of the buyer. If the seller was not involved in the proceedings, the seller is exempted from liability, if he successfully proves that had he participated, he could have prevented the third party from taking away the property (Art.462).

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(5) Quality of Goods The seller has a duty to transfer to the buyer the goods which in terms of their qual-ity correspond to the requirements set out in the contract. If there are no requirements in the contract, the seller is under an obligation to provide goods which are produced for the purpose for which such goods are normally used for. If the buyer had informed the seller of the specic purpose or use for the goods, the seller must provide goods for that particular purpose (Art.469, paras.1 and 2). If, there is a mandatory requirement as to the quality of the goods, the seller, who is engaged in entrepreneurial activities, is under an obligation to provide the goods which correspond to such mandatory requirements (ibid., para.4). The buyer who receives goods of inappropriate quality may, by his choice, require the seller the following (Art.475, para.1): i) commensurate reduction in price; ii) free removal of defects within a reasonable period; iii) reimbursement of the cost of the removal of the defect incurred by the buyer.

If there was a substantial breach of the requirement of quality, dened by the Code as an irreparable defect, defect which cannot be removed without disproportional cost or time, or repeatedly appearing defects, the buyer may choose from the following alternatives (ibid., para.2): i) ii)

refuse the performance of the contract of sale and require the reimbursement of the money paid for the goods require the replacement of the defective goods with those which meet the quality requirements

In retail sale, the buyer is entitled to require replacement even if there is no substantial breach regarding the quality of goods (Art.503, para.1). As a rule, the seller is liable for the defect of the goods if the buyer has successfully proved that the defect of goods or the cause of the defect had emerged before the transfer of the goods to the buyer. Only when the seller has guaranteed the quality of the goods, does the burden of proof shift to the seller; the seller must then prove that the defect of goods or the cause of the defect emerged after the transfer of the goods to the buyer and as a result of the breach of the rules of use or storage by the buyer, an act of a third party, or by force majeure (Art.476). In contrast with laws in other jurisdictions as well as the EU directive on product liability, where the burden of proof usually lies with the seller, this seems to be rather disadvantageous to the buyer. The procedure of inspecting the quality of goods is established by law and other legal acts, mandatory requirements of the state standards, or by contract.

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In the absence of such procedure, the inspection is carried out in accordance with commercial custom or other normally applicable requirements to the given goods (Art.474, paras.1 and 2): Limited liability company, Firma SDM-Servis, brought an action in the Commercial Court of Krasnodarsk Region against the joint stock company Agrokompleks claiming compensation for supplying substandard bricks. The rst instance court dismissed the claim on the ground that the plaintiff had failed to prove that the bricks were substandard. This was upheld by the appellate instance. Upon protest, the Supreme Commercial Court quashed the original judgment. In this case, the plaintiff supplied the defendant with an excavator and machinery for cutting bricks, which were to be supplied by the defendant. The inspection of the brickwork on the 7th oor on May 13, 1996 revealed that the bricks were cracking and collapsing. The bricks were sent to the laboratory for technical examination. The plaintiff had submitted the report of this test as well as a report prepared with the participation of a director of a construction material plant. The director had agreed that the bricks were substandard. The rst instance court dismissed the claim because the plaintiff had failed to follow the procedure set by an instruction of the former USSR gosarbitrazh on the acceptance of products. The Supreme Commercial Court found this reasoning to be unjustiable, since the contract between the parties of March 5, 1996 was governed by Book Two of the Civil Code and the above instructions were not applicable any more. According to Article 513, para.2 of the Code, the buyer is under an obligation to inspect the quantity and quality of the accepted goods in accordance with the procedure set by law and other legal acts, contract or business custom. The contract was silent on this matter. The Court also noted that the lower court failed to examine the result of a random test referred to in the report. The Court concluded that the plaintiff’s claim should be satised.14

As a rule, the buyer must inform the seller of the breach of the terms of the contract regarding quantity, quality, packaging etc. within the period determined by law, and other legal acts or by the contract itself. If such a period is not determined, the claim has to be presented within a reasonable period by taking into account the nature and purpose of the goods (Art.483, para.1). There is a separate provision for discovering defects. If there was no guarantee period or period of use specied, the defect should be found within a reasonable period, but less than 2 years from the transfer of goods to the buyer unless law or contract provides

14

VVAS 1998 No.5, pp.46-47.

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for a longer period. If a period of guarantee or usage is established, the claim has to be presented within this period (Art.477). For sale of goods to consumers, there is a special law – the Law on the Protection of Consumers of 1996.15 “Consumers” in this Law means individuals who order, acquire or use the goods exclusively for personal needs not related to gaining of prots. Consumers are guaranteed the right to information on manufacturer and seller of the goods as well as the goods themselves (Arts.812). Manufacturers and sellers are liable for inappropriate information. There are detailed provisions on the consequence of sale of goods with inadequate quality (Art.18). (3)

Sale of Immovables

The denition of immovables is given in the General Part of the Civil Code (Art.130). The sale of immovable requires a written form – a single document signed by the parties (Art.550). Previously, some transactions involving immovables, e.g. sale of accommodation, required notarisation, but with the introduction of the system of state registration of immovables, this ceased to be mandatory except for transactions on hypothecs securing obligations subject to notarisation. An important requirement for the sale of immovables is that in the contract information that allows the demarcation of the immovable to be transferred must be specied. This is an “essential term” of the contract as provided in the general part of the contract law (Art.432). If there is no such information, the parties are deemed to have failed to agree on the terms, and therefore, the contract is null and void (Art.554). This may be rather difcult in a sale of land where, in many areas, with the insufcient development of the Land Register, the demarcation of the land is not clear. The transfer of immovables by the seller and acceptance by the buyer are effected by a “transfer document” or other documents signed by both parties. The seller’s duty to transfer the object is considered to be fullled by handing over of the object to the buyer and signing of the transfer document (Art.556, para.1). The transfer of title to immovables is subject to state registration. The contract itself takes effect between the parties at the time of conclusion. The signicance of state registration is that only after the registration, may the buyer become a titleholder in relation to a third party. Performance of the contract of sale of immovables before state registration is not a ground for a change of relations vis à vis a third party (Art.551, paras. 1 and 2). In cases where one of the

15

Originally enacted in 1992, Law 2300-1 of February 7, 1992.

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parties fails to register the transaction, the court, upon the petition of the other party, may render a decision to register the transaction. The party that failed to register without justiable grounds is liable for damages to the other party. True to the tradition of Russian law, the Civil Code provides that if a building, installation, or other immovable is sold, the right over the piece of land which the immovable occupies and which is needed for its use is transferred to the buyer together with the title to the immovable (Art.552, para.1). The right over the land which the buyer obtains depends on the right which the seller had held. If the seller had a title-ownership right over the land, then the buyer may acquire either an ownership right, the right of lease, or other rights over the land as provided by the contract of sale (ibid., para.2). If the seller did not have the title over the land, nevertheless, he is entitled to sell the building, installation etc., without the consent of the owner of the land, provided that it is not against the terms of use of the land determined by law or contract. In such cases, the buyer obtains the right to use the land on the same terms as the seller (ibid., para.3). Conversely, if a piece of land on which a building, installation, or other immovable belonging to the seller is located is sold, the seller retains his right to use the land which is occupied by the building etc., and the land which is needed for its use. The terms of use are to be determined by the contract of sale. In the absence of contractual provisions, the seller retains the right of servitude over the land (Art.553). The above arrangement contradicts the arrangement in the Land Code [see Chapter 9]. Since most of the immovables – land, buildings, and enterprises – used to be state-owned, the title of the current seller emanates from state or municipal property. However, the process of the transfer of title to the private sector was at the best, murky. Therefore, the title of the seller is often contested in court: A deputy procurator of the Perm Province brought an action in the Commercial Court of the Perm Province “for the interest of the state” to declare void the decision of the city government of the Solikamsk on the sale of a non-residential building and the contract of sale between the municipal enterprise of retail trade, Sosenka, and an open joint stock company Sosenka. The claim was based on the ground that property which belonged to the municipality had been transferred to the company in breach of the privatisation law. The retail enterprise Sosenka was set up by the city committee for the administration of municipal assets in 1992. The shop was used on the basis of a lease agreement between the enterprise and the committee which was renewed every year. In 1998, the premises were transferred for the right of economic management of the enterprise by the decision of the city government, and Sosenka was granted permission for its sale to the newly established joint stock company on the condition that the latter fully assume the debt of the enterprise.

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The rst instance court and the appellate instance dismissed the claim of the procurator on the ground that the sale of the premise was effected in accordance with articles 215, 295 and other provisions of the Civil Code. However, the Supreme Commercial Court pointed out that the lower courts failed to take into account that enterprises are prohibited from alienating assets directly needed for production purposes which belong to its economic management. Such transfer is void on the basis of Art.168, regardless of the existence of the owner’s (city government) consent. The case was referred for a new hearing.16

Thus, the buyer can never be certain of whether the seller’s title to the immovable is free from any claims. (4)

Sale of Enterprises

There are separate provisions for the sale of enterprises in addition to the provisions on the sale of immovables, although, according to the Civil Code, enterprises are immovables. If the object of sale is state or municipal property, the Law on Privatisation also applies. Under a contract of sale, an enterprise as a whole – a “proprietary complex” – is transferred to the buyer. This includes the trade name, trademark, service mark and other means of identication. The contract has to be in writing, and subject to registration. Unlike the contract of sale of other immovables, not only the title, but the contract itself has to be registered. The contract takes effect only with registration (Art.560, para.3). Before the signing of the contract, act of inventory, balance sheet, opinion of an independent auditor on the composition and the value of the enterprise, list of all the debts with the indication of the name of the creditor, nature, amount and the time of payment must be prepared and inspected by the parties (Art.561). There are protections for creditors. Creditors must be notied of the sale in writing by one of the parties before the transfer of the enterprise to the seller. Creditors who did not give consent to the transfer of debt to either the seller or the buyer are entitled to require, within three month of the receipt of the notice, the termination of the claim or accelerated payment and compensation of loss by the seller. Creditors may also require the contract of sale to be recognised as null and void in its entirety or its part. They may initiate litigation within a year from the time of becoming aware of the transfer, or should have become aware of the transfer. After the transaction, the seller and the buyer bear joint and

16

Decision of the Presidium of the Supreme Commercial Court, October 19, 1999, Case 5733/99.

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several liability for the debt for which the creditor’s consent was not obtained (Art.562). An enterprise is deemed to have been transferred to the buyer from the date of the signing of the transfer act by both parties. From this moment, the risk of accidental loss or damage shifts to the buyer (Art.563). The consequence of the transfer of enterprise with defects, including the quality of the assets, is determined by the provisions on the seller’s liability in the general part of the contract of sale. Particularly important is that the buyer is entitled to a reduction in price if a debt which was not indicated in the contract of sale or the transfer act was transferred to the buyer, unless the seller proves that the buyer was aware of such a debt at the time of the conclusion of the contract and the transfer of the enterprise (Art.565, para.3). The buyer is entitled to rescind the contract or require revision of the contract, if the enterprise is not t for the purpose indicated in the contract due to a defect for which the seller is liable, provided that the defect has not been removed in accordance with the terms, procedure, and time as set by law and other legal acts or contract, or that removal of the defect is impossible (ibid., para.5).

3)

Contract of Lease

(1)

The Concept and Types of Lease

There are two Russian terms for lease: arenda and naem. The term arenda, according to a Tsarist Russian source, originates from the Latin reditta. It denotes a lease of immovables, i.e. a contract by which a person provides immovable property to another for a xed period for a rent.17 The concept of imushchestvennyi naem also existed at that time, but there was a clear distinction between arenda and naem. The object of arenda was of “productive nature”, while naem was for objects of an “instrumental character”.18 Thus, arenda was historically used in relation to lease of means of production. There was no wonder the term arenda did not appear in the civil codes of the socialist period when means of production was monopolised by the state. Instead, the term “proprietary lease (imushchestvennyi naem)” was used for a limited scope of properties. Lease of land and enterprises existed in the NEP period, but disappeared in the late 1920s. Under socialism, not only was the

17 18

F.A.Brokgaus et al. eds., Entsiklopediicheskii slovar’, vol.II, St.Petersburg, 1890, pp.54-55. Ibid., vol.XX, p.450.

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object of “imushchestvennyi naem” limited, but its length was also limited to the maximum term of 10 years.19 A signicant change was introduced by the Fundamental Principles of the Law on Lease of the USSR in 1989. It was not only that the term arenda was ofcially restored. This Law dened a lease as a contract of possession and use (not disposal) of land and other natural resources, enterprises and proprietary complexes as well as all other properties needed by the lessee for economic and other activities. These objects which were hitherto unavailable for lease could now be leased by entities such as state enterprises and local governments. Juridical persons and individuals including foreign ones were allowed to be lessees. While this Law remained in force only until 1992, it marked a radical turn towards market economy in that it enabled individuals and private entities to establish business on the basis of leased assets. In fact, by leasing state enterprises and eventually purchasing them, which was allowed by this Law, “spontaneous privatisation” of state enterprises in the form of management and/or employees buy-out spread rapidly. In this sense, together with the Law on Cooperatives, it accelerated the transition to the market economy. The current Civil Code has a chapter on lease (arenda) and another chapter on lease (naem) of residential premises. The chapter on lease (arenda) is further divided into different types of lease. After the general part applicable to all kinds of lease (arenda), there are provisions on hire ( prokat), lease of means of transportation, lease of buildings and installations, lease of enterprise, and nancial lease (lizing). Hire denotes a contract in which the lessor leases movables as a permanent entrepreneurial activity. (Art.626, para.1). Financial lease is dened as a contract in which the lessor is under obligation to acquire a property designated by the lessee from the seller and provide it to the lessee for the possession and use for entrepreneurial purposes of a xed period in exchange for payment (Art.665). (2)

General Rules

The object of a lease includes all durable property, from land and other “natural objects”, enterprises and other proprietary complexes, buildings, installations, equipment, means of transportation and other things which do not lose their natural attributes with their use. It is possible to determine by law types of property in respect of which lease is prohibited or restricted (Art.607, para.1). At present,

19

Art.277, 1964 Civil Code of RSFSR.

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there is no such law.20 Information which enables the object of lease to be identied has to be indicated in the contract; otherwise, the contract is regarded not to have been agreed and concluded (ibid., para.3). A contract of lease for more than a year, or in cases where at least one of the parties is a juridical person, regardless of the term, must be concluded in writing. A contract of lease of immovable is subject to state registration (Art.609, paras.1 and 2). The length of lease is determined by the contract. If there is no such term, the lease is regarded to be for an indeterminate period. This means that either party may terminate the lease with one month’s notice (in the case of immovables, three months’ notice). As a rule, it is the owner of the property who may be a lessor. In addition, those who are empowered to do so by law or by the owner may lease the property under his control. Thus, state enterprises may lease state property only with the consent of the owner. The lessor is liable for the defects of the property provided to the lessee which inhibits its use wholly or partly, even if he was not aware of such a defect at the time of the conclusion of the contract. The lessor is not liable if the defect could have been discovered by the lessee at the time of inspection or check at the time of the conclusion of the contract or transfer of the property (Art.612, paras.1 and 2). If a defect is found, the lessee has the following alternatives: i)

require gratuitous removal of the defect, reduction of the price, or reimbursement of the cost of removing the defect; ii) withhold part of the rent corresponding to the cost incurred for the removal of the defect with advance notice; iii) require early termination of the contract.

If neither of the above measures covers the loss incurred by the lessee, the lessee is entitled to compensation (ibid., para.1). Provision of the property for lease is not a ground for termination or modication of the right of a third party on this property, e.g. servitude or pledge. When concluding a contract of lease, the lessor is under an obligation to disclose to the lessee all the rights of the third party on the object of lease. Failure of the lessor to full this duty results in the right of the lessee to demand reduction of rent, or rescission of the contract and payment of damages (Art.613).

20

M.N.Braginskii et al., Kommentari k chasti vtoroi Grazhdanskogo kodeksa Rossiiskoi Federatsii, rst edition, Moscow 1996, p.73.

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The lessee may, with the consent of the lessor, sublet the property, assign the rights and duties of the lessee to another person, provide the leased property for gratuitous use of another person, pledge the right of lease, and contribute it to the capital of a company. In these cases, except for the assignment of the rights and duties of the lessee to another person, the lessee remains liable to the lessor (Art.615, para.2). Lease can be rescinded only via court procedure. Upon the action of the lessor, the contract can be rescinded by the court if the lessee (Art.619): i)

uses the property with a substantial breach of the terms of the contract or the purpose of the property, or repeatedly breached the terms; ii) substantially worsened the property; iii) more than twice failed to pay the rent in time; iv) in cases where a capital repair is the responsibility of the lessee, failed to carry out such a repair.

The lessee may take an action in court to rescind the contract in the following instances (Art.620): i)

the lessor has failed to provide the property for the use of the lessee, or has created obstacles for its use in accordance with the term of the contract or the purpose of the property; ii) the property has a defect which inhibits its use and this defect was not known to the lessee before, and could not have been detected by the lessee on inspection; iii) the lessor has failed to carry out a capital repair which he is under obligation to carry out; iv) the property, due to a cause not attributable to the lessee, has turned out to be unsuitable for use.

The lessee who has appropriately performed his obligation, has a pre-emptive right ahead of others to conclude a contract for a new period, if the terms offered by the others are the same as the lessee’s, unless otherwise provided by law or contract. The lessee must inform the intention to renew the contract within a reasonable period in advance. If the lessor refused to conclude a contract with the lessee, but within one year of the expiry of the contract, has concluded a contract of lease with another person, the previous lessee has the following choices (Art.621, para.1): i)

ii)

bring an action to court requiring the rights and duties of the lessee in the new contract to be transferred to him and claim compensation for not renewing the contract; claim compensation for not renewing the contract only.

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If the lessee continues to use the property after the expiry of the term and the lessor does not object, the contract is deemed to have been renewed on the same terms for an undetermined period (ibid., para.2). The Code provides for the right of the lessee to purchase the object of lease. Thus, by law or contract, it is possible to provide that the title to the leased property is to be transferred to the lessee on expiry of lease, or that even before the expiry, the lessee may purchase the property by paying the full purchase price as determined by the contract (Art.624, para.1). This right of the lessee to purchase the leased property was rst introduced by the above-mentioned Fundamental Principles on Lease of 1989. In the case of a lease of a state enterprise, the lessee was entitled to purchase the enterprise by deferred payment and convert it to a joint stock company or other forms of business entities. In the formal privatisation process which started in 1992, commercial companies which the workers’ collectives set up were allowed by law to have the ofces, buildings and structures leased to them on a long term basis and were given a preferential right eventually to purchase them.21 (3)

Lease of Buildings and Installations

The lease of buildings and installations has to be effected in written form. Breach of this requirement makes the contract null and void. Contracts of lease of buildings and installations with a term of one year or more are subject to state registration and are regarded as concluded at the time of registration (Art.651). With the lease of a building or installation, the right to use the land which it occupies and needed for its use is transferred to the lessee. If the lessor is the owner of the land, the lessee obtains the right to lease or other rights as provided by the contract (Art.652, paras.1 and 2). Even if the lessor is not an owner of the land, the lessor may still lease the building or installation standing on it without the consent of the owner of the land, if providing the property for lease is not against the conditions of use of land as provided by the law or contract (ibid., para.3). If the land on which the building or installation is located changes hands, the lessee of the building or installation maintains the right to use the land which it occupies and which is needed for the use of the building or installation on the same terms that existed prior to the sale of the land (Art.653).

21

Fundamentals of the Legislation on Lease, Vedomosti SSSR, 1989 No.25, item 481.

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Lease of Enterprises

Contracts of lease of enterprises must be concluded in writing and are subject to state registration. It is considered to be concluded from the time of registration. The breach of form makes the contract null and void (Art.658). In the lease of enterprise, creditors of the enterprise are given the same right as in the case of sale of enterprises. Lease of enterprises has been means of privatisation and thus, very close to sale. Creditors must be notied of the lease of the enterprise in writing. Creditors who did not give written consent to the lease are entitled, within three months of the notice, to require termination of the debt or accelerated repayment of debt with compensation of loss. Creditors who failed to be notied are entitled to the same claim within one year of the day when they became aware, or should have become aware of the lease. After providing the enterprise for lease, the lessor and lessee are jointly and severally liable for the debt which was transferred to the lessee without the consent of the creditor (Art.657).

4)

Commission, Agency, and Mandate Contracts

(1)

The Concepts

In a commission contract (kommissiia), a party (commission agent) undertakes an obligation to effect one or several transactions entrusted by another party (commission principal) for remuneration in his own name, but at the expense of the commission principal (Art.990, para.1). In a transaction with a third party, the commission agent obtains rights and assumes duties even if the name of the commission principal was indicated in the transaction or the principal directly dealt with the third party in the performance of the obligation (ibid.). In a contract of mandate ( poruchenie), one party is under an obligation to effect a certain legal act (iuridicheskie deistviia) in the name of, and at the expense of, the other party (Art.971, para.1). Remuneration is not an essential component of mandate, although remuneration can be provided by law, other legal acts or contract. An agency contract (agentirovanie) is defined as a contract in which one party (agent) undertakes an obligation to effect juristic acts or other acts entrusted by the other party (principal) for remuneration in his own name, but at the expense of the principal, or in the name of the principal and at the expense of the principal (Art.1005, para.1). In Russian Law, an agent may either act in his own name or in the name of the principal. If the agent has acted in his own name vis à vis a third party for

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the benet of the principal, the agent obtains rights and assumes duties even if the principal was referred to in the transaction or if the principal had directly performed the obligation in relation to the third party. In this “commission type model”, the agent is under obligation to transfer the rights and duties to the principal. When the agent acts in the name of the principal, the principal obtains rights and assumes duties directly (Art.1005, para.1).22 There seems to be signicant overlap between these three types of contracts. In fact, if a person is to effect a juristic act in the name of another person, it can be either mandate or agency. If a juristic act is to be effected in the name of the person himself, it can be either commission or agency. Acts performed by the commission agent, agent, and the person with a mandate are juristic acts (including “transactions”), but in the case of agents, they can effect non-juristic – factual acts as well. Provisions on mandate and commission contracts are applicable to agency contracts insofar as they are not against the provisions of agency contracts, depending on whether the agent has acted in the name of the principal or in his name (Art.1011). This confusing state of legislation has a historical background. Commission contracts and contracts of mandate had been accommodated in the socialist civil codes, while the agency contract, which came from Anglo-American Law, is new to Russian Law. The agency contract was added as a new category of contract in the light of the transition to the market economy to cope with situations e.g. where an agent not only undertakes the task of selling products, but also advertises and markets the products. This is a combination of juristic acts (e.g. sale) and factual acts (e.g. advertisement) which cannot be fully covered by either mandate or commission contracts, so a new type of contract in the form of agency had to be introduced.23 It should be added that in the General Part of the Civil Code, there is a provision on “commercial representation (kommercheskoe predstavitel’stvo)”. A commercial representative is a person who, constantly and independently represents an entrepreneur in the name of this entrepreneur in concluding contracts in the area of business activities (Art.184). Although this resembles agency, reference is made to commercial representation in the chapter on contracts of mandate (Art.973, para.3).

22 23

O.N.Sadikov ed., Kommentarii k grazhdanskomu kodeksu Rosiiskoi Federatsii chasti vtoroi, Moscow 1999, p.592. Braginskii, supra, pp.306-307.

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295

Commission Contracts

In a commission contract, the commission principal retains the title to those properties which he has transferred to the commission agent or those which the commission agent has acquired at the expense of the commissioner (Art.996, para.1). The commission principal has a duty to remunerate the commission agent. The commission principal must also reimburse the cost incurred by the commission agent for performing his duty, except for the storage (Art.1001). If the commission contract was not performed due to a cause which is attributable to the commission principal, the commission agent retains the right to remuneration (Art.991). The commission agent is under an obligation to perform his duty in the most advantageous manner for the commission principal, bound by the latter’s instruction. If there is no instruction, he must perform his duty in accordance with commercial custom or normally applicable requirements. If the commission agent effected a transaction in a better term than the term instructed by the commission principal, the additional prot is to be divided between the parties, unless the parties had agreed otherwise (Art.992). The commission agent is liable for the loss, shortage, and damage of the property of the commission principal in his possession (Art.998, para.1). Commission contracts can be terminated on the following grounds (Art.1002): i) ii)

refusal on the part of the commission principal to perform the contract; refusal on the part of the commission agent to perform the contract in cases provided by law or contract; iii) death, declaration of incapacity, limited capacity, or disapperance of the commission agent; iv) recognition of an individual entrepreneur insolvent (bankrupt).

The commission principal may, at any time, revoke the commission contract. In such cases, the commission agent is entitled to compensation (Art.1003, para.1). The commission agent is not entitled to refuse performance of the commission contract unilaterally unless otherwise provided by the contract, except in cases where the contract was concluded for an indenite period. In the latter case, the commission agent may refuse performance with 30 days’ notice (Art.1004, para.1).

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(3)

Agency Contracts

In agency contracts, if the principal grants to the agent a general power to act in the name of the principal, the principal may not refer to the absence of power on the part of the agent vis à vis a third party, unless he proves that the third party had known or should have known the restriction of power on the agent (Art.1005, para.2). In the contract, it is possible to provide for an obligation of the principal not to conclude a similar contract with another agent who is active in the same territory determined by the contract, or to refrain from conducting activities by himself analogous to those which are the object of the agency contract. By the same token, the agent may be placed under an obligation not to conclude an analogous agency contract with another principal in the territory which in all or part, overlaps with the territory covered by the agency contract (Art.1007, paras.1 and 2). On the other hand, the terms of an agency contract by which the agent is allowed to sell products, execute works, or provide service exclusively for a specic category of buyers, or only to those who are located or resident in the territory, are null and void (Art.1007, para.3). This is explained to be because by these terms, a specic category of people will be excluded in advance from among potential consumers (buyers, customers).24 In the process of performance of an agency contract, the agent is under an obligation to submit a report to the principal as provided by the contract. If there is no such provision in the contract, the agent has a duty to report to the principal in the course of the performance or at the end of the performance of the contract. If the principal has objections to the report, he has to inform the agent within three days of the receipt of the report; otherwise, he is considered to have accepted the report (Art.1008). Unless otherwise provided by the contract, the agent is entitled to contract a subagent for the purpose of performing the agency contract, but has to remain responsible vis à vis the principal for the act of the subagent (Art.1009, para.1). Agency contracts are terminated on the following grounds: i)

refusal of performance by either party of a contract concluded without a xed period of validity; ii) death, declaration of incapacity, limited capacity, and disappearance of the agent; iii) recognition of an individual entrepreneur as insolvent (bankrupt).

24

Ibid., p.309.

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297

Contracts of Mandate

The person under mandate must perform his duties in accordance with the instructions of the principal. The instructions must be “lawful, enforceable, and specic”. The person under mandate may deviate from the instruction if it is in the interest of the principal and there was no time to inquire with the principal or if the person had failed to receive a reply to the inquiry. The person under mandate must inform the principal of such deviation without delay, once the communication has become possible (Art.973, paras.1 and 2). A person under mandate acting as a “commercial representative”, i.e. a person who perpetually and independently represents an entrepreneur in concluding contracts in the area of entrepreneurial activities (Art.184, para.1), may be granted a right to deviate from the instructions without advance consultation with the principal (Art.973, para.3).

5)

Contracts related to Banking

(1)

Contracts of Credit and Loan

The current Civil Code has a chapter on contract of credit and loan. This chapter is subdivided into credit and loan, and “commodity and commercial credit”. In the RSFSR Civil Code of 1964, provisions on credit and loan contracts were accommodated in separate chapters and were scarce. In contracts of credit, with the absence of commercial banks, creditors were invariably state banks. There was only one provision on extending credit to “organisations” including state enterprises to the effect that the loans to various entities were to be granted in accordance with the plan by state banks and in accordance with the procedure established by legislation. Loans between enterprises were allowed only in cases provided by legislation.25 The current Civil Code distinguishes between loan (zaem) and credit (kredit). The RSFSR Civil Codes of 1923 only provided for zaem. Credit was referred to in the USSR Fundamental Principles of Civil Legislation of 1990, but not as a separate type of a contract. Zaem and kredit were regarded as one and the same contract (Art.113). In contrast, the current Civil Code, zaem and kredit are provided as different types of a contract. In zaem, the lender transfers money or other things determined by their generic nature to the ownership of the borrower, and the borrower is obliged

25

Art.392, Civil Code of the RFSFR of 1964.

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to return the same amount of money or things of the same generic nature to the lender within the agreed period. Contract of zaem is a contrat réel, i.e. it is deemed to be concluded at the time of the transfer of money or other things (Art.807, para.1). Contract of zaem concluded between juridical persons must take a written form; the same applies to contracts between individuals for the amount of 10 times or more of the minimum wage (Art.808). The lender is entitled to receive interest out of the money or other things transferred to the borrower (Art.809). Although interest is not a constituent element of zaem, unless otherwise provided by law or contract, the lender is entitled to an interest as provided by the contract. If the terms regarding the amount of interest are not provided in the contract in which the lender is a juridical person, the rate of interest is determined by the bank renancing rate at the place of the lender on the day of repayment by the borrower. Unless otherwise agreed between the parties, the interest is payable every month until repayment (Art.809, paras.1 and 2). There is no restriction on the level of interest charged in zaem or kredit contracts. Variations of zaem are promissory notes (veksel’), corporate bonds (obligatsiia) and government bonds. If the borrower issued a promissory note which certies an unconditional assumption of debt by the issuer (simple promissory note) or by another person indicated on the note as a payer (bill of exchange), the relationship between the parties is regulated by the law on promissory notes and bills of exchange. If there is a contradiction between the Civil Code and this law, provision of the latter prevails (Art.815). At the moment, the Statute on Bills of Exchange and Promissory Notes, which was attached to the Federal Law of March 11, 1997, is applicable. In fact, this was a “reconrmation” of the 1937 Law which was enacted following the ratication of the 1930 Geneva Convention by the USSR in the same year. Although after the “reform of the credit system” in the early 1930s, there was no need for bills of exchange or promissory notes within the country, they were thought to be necessary for foreign trade, and therefore, the USSR ratied the Geneva Convention. Basic rules of the Convention are said to have been incorporated in the statute. The Civil Code presupposes the enactment of a new law on this matter. It is expected that the new law will take into account the 1988 UN Convention on International Bills of Exchange and International Promissory Notes which was signed, but not ratied by the former USSR.26 There is a joint decision of the Plenums of the Supreme Commercial Court and the Supreme Court on bills of exchange and promissory notes.27

26 27

Braginskii, supra, p.213. Joint decision No.33/14 of December 4, 2000.

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The Civil Code also provides that a contract of zaem can be concluded by issuing and offering of bonds. Bonds are securities which certify the right of the possessor to receive its nominal value or its proprietary equivalent plus interest from the issuer (Art.816). In a contract of state zaem, the borrower is the Russian Federation, and the lenders are individuals or juridical persons. Contract of state zaem is concluded by acquisition of state bonds and other securities by the lenders. Terms of state bonds may not be altered (Art.817, paras.1 and 3). In contrast with zaem, in kredit, lenders (creditors) are banks or other credit organisations. It is not a contrat réel; signing of a contract is sufcient. The creditor is obliged to offer the agreed amount under agreed terms to the debtor, and the debtor is under an obligation to repay the money and the interest (Art.819, para.1). Kredit contracts must be concluded in a written form. As a rule, provisions on zaem are applicable to kredit contracts. In kredit, creditors are entitled to refuse the granting of credit provided by a contract wholly or partly, if there are circumstances which demonstrate that the money will not be returned on time (Art.821, para.1). The borrower naturally is under an obligation to return the borrowed sum to the lender. If the period of return is not determined or if the credit is to be returned on demand by the lender, the borrowed sum should be returned to the lender within 30 days of the demand. While loans without interest can be returned before maturity, a loan which bears interest can be returned prematurely only by agreement of the parties (Art.810, paras.1 and 2). If the borrower fails to return the loan (zaem and kredit) in time, the borrower must pay interest for delay as provided in the general part of the Law of Obligations of the Civil Code, i.e. at the bank discount rate on the day the performance was due (Art.395). If the borrower fails to provide security as provided by the contract, and also in cases where the means of security was lost or worsened due to a cause not attributable to the lender, the lender is entitled to require premature return of the loan and payment of interest (Art.813). (2)

Bank Deposit (bankovskii deposit) Contracts

In a contract of bank deposit, the bank accepts the money paid in by the depositor or for the benet of depositor and is under an obligation to return the amount to the depositor with interest as provided by the contract (Art.834, para.1). The deposit account serves only a depositary purpose, i.e. the account cannot be used for payment; juridical persons may not transfer the deposited money to another person (ibid., para.3). If the depositor is an individual, this type of a contract is a public contract and the bank cannot refuse to conclude it. Bank deposit can take the form of payment on demand, or xed term (Art.837, para.1).

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Interest is paid on the deposit. The interest rate is to be determined by the contract, but in the absence of an explicit provision, the rate is determined by the bank renancing rate at the place of business of the creditor – juridical person (Art.838, para.1). (3)

Bank Settlement (bankovskii schet) Contracts

In bank settlement contracts, the bank is under an obligation to accept and credit the money to the account opened by the client, execute the instructions of the client on transfer of the money, payment and other operations (Art.845, para.1). The bank is entitled to use the money in the account, provided that it guarantees free disposal of the money in the account by the client (ibid., para.2). It is possible to open a credit account from which a payment can be made regardless of the absence of money in the account (Art.850, para.1). Bank settlement contracts are public contracts, i.e. the bank is obliged to conclude a contract when requested to do so by a customer. The bank is liable for ungrounded refusal to open an account (Art.846, para.2). There is no question that the client is entitled to withdraw money by instructing the bank. However, the Code also provides for withdrawal of money without the instruction of the client. Grounds for such withdrawal are court judgments, and “instances provided by laws or contracts between the bank and the client” (Art.854, para.2). At present, the Federal Tax Service is empowered to withdraw unpaid tax and penalties from the account of juridical persons without recourse to court. The same applies to unpaid customs duty, pension, social security contributions and medical insurance payments by employers.28 (4)

Payment (raschet) Contracts

This is a new section introduced by the present Civil Code. Previously, there was only one provision concerning payment in the 1964 Civil Code. It was primarily regulated by subordinate legal acts, namely by normative acts of the Central Bank. With the enactment of the new Civil Code, payment is regulated by banking regulations only when so provided by the Code and other laws (namely the Banking Law). Payment in Russia is not entirely free from restrictions. The Civil Code provides that payment with at least one party being an individual who is not engaged in entrepreneurial activities can be effected by cash without restriction. However, payments between juridical persons, and between juridical persons and

28

Sadikov, fth edition, supra, pp.525-526.

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individuals involving performance of entrepreneurial activities are to be effected in a non-cash form. As a rule, payment in a non-cash form is effected through banks and other credit organisations where an account is opened (Art.861). The Civil Code lists various methods of payment by taking into account international rules and practices. The list is not exhaustive. i) ii) iii) iv)

payment by order payment by letter of credit incasso payment payment by cheque

Provisions on the letter of credit in the Civil Code were prepared with the ICC Uniform Customs and Practice for Documentary Credits taken into consideration. As for cheques, the Geneva Convention on Cheques was ratied by the USSR. There was a Statute on Cheques which was revived in 1993 which followed the line of the Geneva Convention. However, this Statute was repealed by the enactment of the Civil Code. The current Civil Code has made efforts to toe the line with the 1932 Geneva Convention on the Unication of Cheques.29 (5)

Contract of Entrustment of Property

Auxiliary business of credit organisations as listed in the Law on Banks and Banking Activities includes “trast operations”, i.e. attract and invest assets and manage securities as entrusted by customers. In the property law part of the Civil Code, there is a provision which refers to the management of entrusted property (doveritel’noe upravlenie), but does not use the term trast (Art.209). The special part of contract law contains a chapter on the same matter, but does not use the term trast either (Chapter 53). In the management of entrusted property, a party transfers property to another person for a xed period, and the latter manages the property for the interest of the former or a person designated by the former (Art.1012, para.1). Important differences between this arrangement and the trust under the Anglo-American system are that the title to the property does not shift to the entrusted party (ibid., para.2), and that it is not necessarily a tri-partite arrangement between the parties and the beneciary.30

29 30

Ibid., p.595. E.Reid, “The Law of Trust in Russia”, Review of Central and Eastern European Law, 1998 No.1, pp.50-51.

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Contract on the management of entrusted property is used in mutual funds and pension funds as well as in the process of privatisation.31

6)

Concession Contracts

In a contract of commercial concession as provided in the Civil Code, a party (rightholder) is obliged to provide the other party (concessionaire) for a xed period, or without determination of the period, with the right to use the entirety of exclusive rights which belong to the rightholder, including the right to the name of the company and/or commercial identication, the right to protected commercial information, trade marks and service marks (Art.1027, para.1). Parties to this contract are commercial organisations and individuals registered as entrepreneurs (ibid., para.3). Commercial concession contracts are subject to registration. Registration is effected by the agency which registers juridical persons and individual entrepreneurs (Art.1028, para.2). Contracts whose object is protected by patent need to be registered by the Patent Agency as well (ibid.). This type of contract should not be confused with the concession contracts involving natural resources and the construction and operation of infrastructure. For such contracts, a new Law was enacted in 2005.32 The rst draft of this Law had been submitted to the Duma in the early 1990s. At that time, concession was regarded as one of the potential schemes for natural resources exploration and development. However, in the end, the Production Sharing Law was adopted in 1995, and the draft concession law became redundant. Concession law then re-emerged as a legal framework for infrastructure projects in 2004. There was a difference of opinion regarding the scope of this Law, and as a result of a compromise, upstream natural resources projects were excluded from the remit of this Law. The declared goals of the Law are the induction of investment into the Russian economy, ensuring the effective use of state and municipal property, and the improvement of the quality of goods and services provided to the general public. In other words, effective utilisation of public property by introduction of private capital in a form similar to UK Public Private Partnership (PPP) is intended. In fact, PPP has been under discussion in Russia in the last couple of years. For

31 32

Ibid., pp.52-55. Law No.115-FZ of July 21, 2005.

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example, the draft concept of the reform of road transportation prepared by a working group of the Ministry of Transport pointed out that “based upon international experience regarding the development of automobile roads, priority is given to the continuing nancing of projects by the government, but with a broad application of government-private partnership”. A concession agreement is dened by the Law as an agreement in which a party (concessionaire) is under an obligation to build or re-build an object (immovable) agreed upon in the concession agreement at its own cost and carry out business by using this object, while the counter party, the granting authority, is under an obligation to grant the right to possess and use the object to the concessionaire for an agreed period. The title to the object belongs, or is to belong to, the granting authority. According to the Law, concession contracts are “hybrid” contracts. The problem is that the nature of a concession agreement – whether it is a public law contract or a private law contract – is not clear. This means that the Civil Code is not automatically applicable to concession agreements. The Law provides that the legislation on concession comprises the present Law, other Federal laws and normative acts of the Russian Federation. The Civil Code is not explicitly referred to here, although in the Law itself, some provisions of the Code are cited. Parties to the concession agreement are the granting (public) authority on one hand and the concessionaire on the other. The granting authority can be the Russian Federation, constituent entities of the Russian Federation, and municipalities. Russian as well as foreign juridical persons or consortia of juridical persons can be a concessionaire. Change of the concessionaire by means of assignment or assumption of obligation is allowed only with the consent of the granting authority and after the object is put into operation. The Law lists various projects which fall within its scope. These include: i)

Highways and engineering installations of transport infrastructure, including bridges, tunnels, tool gates etc. ii) Railways; iii) Pipelines; iv) Sea and river ports; v) Airport terminals; vi) Hydropower plants; vii) Power and thermal generation, transport and distribution installations; viii) Communal infrastructure including water, heating, gas and energy supply, sewage system etc; ix) Installations destined for the health system and objects of tourism; x) Sports, education, and cultural installations.

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The length of concession is to be determined by agreement, by taking into account the object of concession, the amount of investment, the period needed for the recovery of the investment, and other obligations of the concessionaire. Payment for the concession is made by the concessionaire during the period of concession. Payment can take the form of a xed amount which is paid periodically, or in a lump sum, a portion of the income received by the concessionaire, or as a transfer of property from the concessionaire to the granting authority. These means of payment can be combined. Rights of the concessionaire as provided by the Law are rather sparse. Concessionaires have the right to: i) ii)

use the object of concession in accordance with the agreement; perform the concession agreement on their own or by sub-contracting to others; iii) utilise exclusive rights over the products of intellectual activities.

On the other hand, concessionaires are under an obligation to: i) ii)

build the object and start operation within the agreed period; use the object in accordance with the purpose and the procedure set out in the agreement; iii) carry out the activities as provided in the agreement and not to terminate the activities without the consent of the granting authority; iv) ensure that the consumers receive the products, work or service; v) provide the consumer privileges as provided by the Federal law and the law of the constituent entities and municipalities insofar as stipulated in the agreement; vi) maintain the object in an appropriate state and carry out repairs etc., unless otherwise agreed.

Particularly problematic is the obligation to provide privileges to consumers. In Russia, prices of public service such as electricity, water, heating etc. are heavily subsidised. The concessionaire needs to ensure that the subsidised price is backed up by the granting authority in one way or another. Another problem is that the Law explicitly provides that the object of the concession agreement cannot be pledged, or disposed of, by the concessionaire. The concessionaire is not allowed to pledge his rights – income stream – emerging from the concession agreement. This naturally makes nancing difcult for investors. The concessionaire is liable for any breach of the requirements of the agreement as well as technical regulations and project documents, and other mandatory requirements concerning the quality of the object in the course of

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construction of the object. If the breach is serious, the concessionaire must pay compensation. The parties are liable for the non-performance or inadequate performance of any obligation provided for by the Law and other Federal laws, or by the agreement. The concessionaire is also liable for the quality of the object throughout the period of the concession agreement. The procedure by which the granting authority is to supervise the observance of the terms of the agreement by the concessionaire shall be established by the agreement. In addition to the essential terms of the concession agreement, the following matters can be provided for by the agreement: i) procedure and conditions of the setting and changing of the tariff; ii) the scope of investment for the project; iii) the date of the commencement of the operation of the object in accordance with the technical-economic parameters set out in the agreement; iv) obligation of the concessionaire to provide privileges to consumers; v) obligation of the granting authority to nance part of the cost of building the object and/or its maintenance.

Concession agreements are concluded through a tender procedure for the right to conclude the agreement. Unlike the draft Sub-soil Law which was submitted to the Duma last year, there is no explicit restriction on foreign participation. A model concession contract for each type of objects listed in the Law is expected to be published in due course. The agreement must be concluded in accordance with the model agreement. Concession agreements can be revised upon request of either party by the decision of the court on the grounds as provided for in the Civil Code. This seems to refer to the substantial change of circumstances. Concession agreements are terminated on the following grounds: i) expiration of the concession agreement; ii) mutual agreement of the parties; iii) termination of the concession agreement by the decision of the court.

There are no problems regarding the rst two grounds. The third point, however, is problematic. The court can revoke the contract in the following cases: i) material breach of the terms of the agreement; ii) substantial change of circumstance; iii) other grounds as provided by Federal law or the concession agreement.

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Material breach of contract terms are: i) ii)

breach of the date of completion of construction; use of the object for purposes other than those provided by the agreement, or breach of the procedure for using it; iii) failure to carry out activities as provided by the concession agreement; iv) suspension or termination of activities without the consent of the granting authority; v) non-performance or inadequate performance of the obligation to supply products or provide work or services to citizens and consumers.

If, after a reorganisation of the concessionaire, its successor is incompatible with the requirements set out by the decision to conclude a concession agreement, this also constitutes a ground for termination. Investors’ rights are protected in accordance with the provisions of the Constitution, international treaties, and Federal laws. Concessionaires, including foreign concessionaires, are guaranteed equal rights, the legal regime against discriminatory treatment and other measures which prevent the concessionaire from freely disposing of investment and receiving products and income. Investors are also protected from unfavourable changes in the law. If, during the effective period of the concession agreement, legislation of the Russian Federation, the constituent entities of the Federation, or municipalities changes and as a result, the status of the concessionaire worsens to the extent that he is deprived in a signicant manner of what he was entitled to expect at the time of the conclusion of the contract, the parties may revise the agreement. The Law merely provides that the procedure for the revision of the agreement shall be accommodated in the agreement. It is not clear whether there is any need to go to court for the revision. Furthermore, it should be noted that this does not apply to changes in technical regulations which cover the protection of sub-soil, environment, or public health. If the “regulated” price of the product, work, or service changes in such a way as to worsen the position of the concessionaire in a substantial manner, the contract must be revised upon request of the concessionaire. The tariff and the subsidy for public services are now regulated by the Law on the Fundamentals of the Regulation of Tariffs for the Organisations of Communal Services of December 30, 2004. The Law covers the tariff and the level of surcharges of electricity, heating, water, sewage and waste disposal services. In addition to the substantial change of circumstances, the Law on Tariffs for Communal Services provides for mid-term review of tariffs and surcharges. The grounds for this early review include an “objective change of conditions of activities of the business entity which affects the value of the product or service”.

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Instructions of the Federal administrative agencies and regulatory bodies of the constituent entities are also a ground for changes. “Objective changes” include changes to the Federal legislation, ination above the level foreseen at the time of setting the tariff, rise of energy prices beyond the scope provided by the Russian Federation, and change of other conditions as determined by the Federal government.

7)

Joint Venture Contracts

Joint venture contracts are denoted as a contract of simple partnership (prostoe tovarishchestvo) in the Civil Code. In this kind of a contract, two or more parties are under obligation to invest in a joint scheme and join force with the goal of making prots or achieving other goals without forming a juridical person (Art.1041, para.1). As is the case with other typical contracts provided by the Civil Code, most of the provisions are optional and as such, can be modied by contracts. The contribution is presumed to be equal among the parties, but the parties may agree otherwise (Art.1042, para.2). The property which the joint venture obtained or produced belongs to the co-ownership with shares of the participants, unless otherwise agreed by the parties (Art.1043, para.1). It should be noted that creditors of the participants are entitled to require the split of the share of the debtor-participant from the common property of the joint venture (Art.1049). Participants are liable for the debt of the joint venture jointly and severally, if the joint venture is involved in entrepreneurial activities (Art.1047, para.2). The contract of joint venture is terminated on the grounds including the following (Art.1050): i) ii) iii) iv)

bankruptcy of the participant; rescission of the contract with a xed period by the participant; withdrawal of the participant from a contract without a xed period; splitting of a share of the participant by a creditor.

However, this does not apply, if the contract provides that the contract would continue to be valid among the remaining participants (Art.1050, para.1). Another important ground of the termination of a joint venture contract is the change of circumstances. In addition to the general provision on the change of circumstances in the general part of the contract law (Art.450, para.2), there is a special provision in the Chapter on Joint Venture Contracts to this effect. Thus, in a contract of joint venture with a xed period, or a xed purpose as a condition pending, participants are entitled to rescind the contract between

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themselves or with the remaining participants given with a justiable ground and on the condition that the real damage caused to the remaining participants is compensated (Art.1052). No denition of a “justiable ground” is given. According to a commentary, “the effect of the contract can be preserved by the agreement of the remaining parties”, but this provision remains a potential risk to the joint venture.33

33

Sadikov eds., Kommentarii . . . chasti vtoroi, enlarged edition, Moscow 1999, p.645.

9 PROPERTY AND LAND LAW

1

OWNERSHIP RIGHT AND OTHER REAL RIGHTS

Part One, Book Two of the Civil Code is entitled “the Right of Ownership and other Real Rights”. This part, which begins with a provision on the “content of the right of ownership”, covers property law. It comprises eight chapters, including chapters on the acquisition of ownership, the termination of ownership, joint ownership, and the protection of ownership and other real rights. Chapter 17, which covered the rights over land, nally took effect when the long-awaited Land Code was adopted and came into force in November 2001. The concept of real rights (veshchnoe pravo) was known in Tsarist Russia. The draft Civil Code of the Tsarist period had its Book Two devoted to real rights. However, in the socialist period, this concept totally disappeared, since land and other “means of production” were nationalised and became subject to administrative law. A separate Code – the Land Code – was enacted in 1922. Thus “Land Law” came into being as a new area of law. Property relations covered by civil law were very much limited in scope. The civil law concept of real rights had little use in such circumstances. It was revived only by the 1990 Law on Ownership and the Fundamental Principles of Civil Legislation of the USSR. In the area of Land Law, there exists a dual system consisting of the Civil Code (Chapter 17) and the Land Code. The Land Code is a product of the socialist time, based upon the concept of state monopoly over the means of production. The rst Land Code after the collapse of socialism was enacted in 1991. It was substantially curtailed in 1993, and then replaced by the current Land Code in 2001. The Land Code is part of the administrative law aimed at regulating ownership and use of land, while the Civil Code presupposes freedom of ownership of land as well as freedom of its circulation. For this reason, whether this dual system is still justiable in the era of the market economy is questionable. There has been some overlap as well as some contradictions between the two codes. The 1991 Land Code did not give precise denition of “land relations”

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which the Code was supposed to cover. The demarcation of the Civil Code and the Land Code was therefore not clear. This was more or less a theoretical problem in the 1990s, since Chapter 17 of the Civil Code was to take effect only with the enactment of the new Land Code. This was a result of a compromise between those who favour the free circulation of land and those who were against it.1 The Land Code was nally enacted in 2001 and Chapter 17 of the Civil Code came into force at the same time. The 2001 Land Code introduced a provision according to which the Land Code is to regulate relations concerning the “use and protection” of land, whereas the “proprietary relations concerning the possession, use and disposal of land, and effecting of transactions with land” are to be regulated by the Civil Code (Land Code, Art.3, paras.2 and 3). There have been advocates of the “expanded concept of Land Law”, but with the enactment of the new Land Code, such an interpretation is said to have been nally dropped.2 However, the new Land Code still “often exceeds the regulation of the use and protection of land and unjustiably interferes with the area of civil law regulations”.3 There are some signicant contradictions between the Civil Code and the Land Code. For example, both codes contain a provision on the right of perpetual (indenite) use of land. The Civil Code provides that land which falls within the category of the state or municipal property may be offered to individuals or juridical persons for perpetual use (Art.268). On the other hand, the Land Code provides that such land can only be provided to state or municipal agencies, Federal treasury enterprises etc., but not to individuals (Art.20). Real rights, in contrast to rights in personam, are absolute rights, i.e. they can be set up against an unlimited scope of people, while rights in personam can be claimed only vis à vis the opposite party. Thus, real rights are created by law only; a new type of right cannot be created by individuals through contracts. Real rights maintain effect even with the transfer of the title to the property. In contrast, traditionally, it was understood that a right in personam e.g. a lease, could not be set up against the change of ownership over the leased property; the lease lost effect through the sale of property by the lessor. However, this distinction has become blurred in many jurisdictions. The lease of immovables has come to be protected in a way similar to real rights.4 The same applies in Russian law.

1 2 3 4

V.V.Chubarov, “Nesootvetstvie grazhdanskogo i zemel’nogo zakonodatel’stva i puti ikh resheniia”, ZRP 2005 No.9, p.57. G.V.Chubukov et al. eds., Kommentarii k zemel’nomu kodeksu Rossiiskoi Federatsii, Moscow 2006, pp.37-38. Ibid., p.8. See BGB Art.571.

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There is a provision in the Part Two of the Civil Code to the effect that the transfer of title of the land does not affect the lease (Art.617). A real right being an absolute right, the holder of the right retains it even when he loses possession of the property. The owner of a property has the right to require the return of the property from the illegitimate possessor of the property in question (Art.301). This action of vindikatsiia (lat. vindicare) is widely utilised: On the basis of a capital construction contract, a joint stock company sent a crane and ve bulldozers to a kombinat. After the completion of construction work, the company could not retrieve its machinery since the kombinat had refused to return it. In fact, the crane was there, but the bulldozers had disappeared altogether. The company sued the kombinat and demanded the return of the machinery on the basis of Article 301. The Supreme Commercial Court ruled that the object of this action could only be the property in the possession of the defendant. The kombinat was ordered to return the crane, but since the bulldozers were no longer in its possession, the claim was dismissed on this part. It was suggested that the plaintiff sue for compensation or sue the current possessor.5

This action is an action by the owner who lost possession of the property against the illegitimate possessor. “Illegitimate” in this context means that the possession does not have a legal basis, or that the legal basis is defective. The ownerplaintiff is required to prove that he is the lawful owner of the property.6 On the other hand, if a property was transferred to the counter party based upon an invalid juristic act, the property should be claimed from the opposite party not on the basis of this provision, but as a result of the “effect of an invalid juristic act”.7 An owner is entitled to a claim for the elimination of an infringement upon his right to ownership. He may require the removal of any kind of infringement on the possession, use and disposal of the property, even if the infringement does not involve deprivation of possession (Art.304):8 In a dispute concerning an ofce building, the plaintiff, a company with limited liability which owned the building, brought an action against a joint stock company

5 6 7 8

Information Letter of the Presidium of the Supreme Commercial Court No.13 of April 28, 1997. Sadikov ed., Kommentarii k grazhdanskomu kodekusu Rossiiskoi Federatsii Cahsti Pervoi, third edition, Moscow 2005, p.776. Decision of the Presidium of the Supreme Commercial Court, July 1, 2003, Case 11224/02. A.N.Guev eds., Postateinyi kommentarii k chasti pervoi grazhdanskogo kodeksa Rossiskoi Federatsii, second edition, Moscow 1999, p.375.

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which leased an adjacent building. This company closed the plaintiff’s only access to the premises. Based on Article 304, the commercial court ordered the defendant to cease the obstruction of the use of the ofce premises by the plaintiff.9

This right is also extended to possessors of properties who are not owners, e.g. state and municipal unitary enterprises which have the right to economic management or operational administration (Art.305).

2

THE RIGHT OF OWNERSHIP

1)

The Content of the Right of Ownership

The right to ownership is the most fundamental real right. In relation to other real rights, the right to ownership is the basic right, while other real rights are “restrictive rights” on ownership.10 Ownership has been dened in Russia during the Tsarist period as the right to possess, use and dispose of an object. The same applied in the socialist period, the only difference being that these rights were limited in one way or another. Under socialism, there were various restrictions on property rights (e.g. there was a limit to the number and size of the accommodation one could own). The term “private ownership” was an anathema and had been replaced by the term “individual ownership”. In contrast, the present Constitution declares that the right of private ownership is protected by law (Art.35, para.1). Every person is entitled to have property under his ownership, and possess, use, and dispose of it by himself or jointly with others (ibid., para.2). This provision is understood to include foreign nationals. Furthermore, individuals and their associations may also privately own land (Art.36, para.1). This part, however, is not applicable to foreign nationals. The Civil Code provides that owners of property are attributed the right of possession, use, and disposal of that property (Art.209, para.1). Disposal means the freedom to decide the legal fate of the property and includes sale, gift, lease, and pledge.11 The Civil Code declares that the owner may, at his discretion, transfer the title of his property to another person, transfer the right to possess, use and dispose of the property while remaining an owner, pledge or encumber it, or dispose of it in other ways, insofar as it is not against the law or legal acts,

D.V.Murzin eds., Grazhdanskii kodeks Rossiiskoi Federatsii s postateinymi materialami iz praktiki VAS RF, Moscow 1999, p.300. 10 Sadikov, supra, p.549. 11 Ibid., p.550. 9

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and does not infringe the rights and lawfully protected interests of others (ibid., para.2). On the other hand, the owner bears the risk of loss and destruction of the property (Art.211). The owner’s property may be taken to satisfy his obligations elsewhere (Art.24). The right of ownership can be limited by law, but as is the case with civil law rights in general, it can be limited by Federal law only, and to the extent necessary for the defence of the constitutional system, morals, health, rights and the legally protected interests of other persons as well as for the defence and national security of the state (Art.1, para.2). In addition to the Civil Code (Chapter 17), provisions on ownership and other rights on land are found in the Land Code.

2)

Owners

The Constitution acknowledges private, state, municipal and other forms of ownership and provides that they are protected in an equal manner (Art.8). The Civil Code reproduces this provision (Art.212, para.1). This is in contrast with the socialist period, when the “primacy of state ownership” was the rule and the state monopolised the ownership of “means of production”, including land and other natural resources and state enterprises. Property may be owned by individuals and juridical persons as well as the Russian Federation, constituent entities of the Russian Federation, and municipalities (ibid., para.2). (1)

Ownership by Individuals and Juridical Persons

Property which belongs to individuals or to any juridical person, except for unitary enterprises, state and municipal agencies (ucherezhdenie), is private property. Individuals and juridical persons may own any property except for those properties which, by law, they are not allowed to own. Thus, they can own various immovable properties including “enterprises as proprietary complexes”, ats and houses (Art.213, para.1). Furthermore, the Constitution guarantees private ownership of land and natural resources (Art.9, para.2, Art.36, para.1). However, despite the constitutional guarantee, private ownership over land has not fully developed. Also private ownership of other natural resources is signicantly restricted by various laws such as the Subsoil Law and the Forestry Code. The quantity and the value of the property which is owned by physical persons or juridical persons are not restricted except for restrictions established by

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law for the purpose of protecting the constitutional system, morals, health, rights and the legally protected interests of others, the defence of the state and national security (Art.213, para.2). (2)

State and Municipal Ownership

The Civil Code provides for state and municipal ownership as separate types of ownership. Some lawyers use the concept of public ownership to cover both state and municipal ownership; the common denominator is the “public-law characteristics” of the state and the municipality.12 Under socialism, the state monopolised the “means of production”. All land, natural resources, and state enterprises were owned by a single entity, the Soviet State. The current system is different in that i) state ownership not only means ownership by the Federal state, but also by constituent entities of the Russian Federation (state ownership), ii) municipalities (local self-governments) have also come to own properties (municipal ownership) separately, and iii) privatisation of the property owned by the state has taken place. It should be noted that while the Constitution uses the term “local self-government”, the Civil Code uses the term “municipalities (munitsipal’noe obrazovanie)” (e.g. Art.215). Objects of state ownership are those properties owned by the Russian Federation (Federal property) and constituent entities of the Russian Federation (property of constituent entities) (Art.214, para.1). Unitary enterprises (state or municipal enterprises) do not own the property, e.g. land, factories, buildings etc. which are entrusted to them, but merely have a right of economic management or operational administration; their assets are owned by the state or municipality. The same applies to agencies (Art.214, para.4). Assets of the state which are not entrusted to unitary enterprises and establishments comprise the Federal treasury (kazna) and the treasury of the constituent entities of the Russian Federation (ibid., para.4). The Land Code also contains provisions on state and municipal ownership of land as well as ownership of land by individuals and juridical persons. Land which does not belong to individuals, juridical persons or municipality, is deemed to be state property (Land Code Art.16, para.1). Individuals and juridical persons enjoy “equal access” to the acquisition of land. As a corollary, in principle, land under state and municipal ownership can be offered to individuals and juridical persons for their ownership (Ibid., Art.15, para.2).

12

Braginskii ed., Nauchno-prakticheskii komenntarii k chasti pervoi Grazhdanskogo kodeksa Rossiiskoi Federatsi, second edition, Moscow 1999, p.338.

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A continuing problem with state ownership is the demarcation of ownership over assets between the Russian Federation and constituent entities. The issue emerged immediately after the collapse of the USSR, but so far, has not been solved.13 The procedure for the allocation of assets between the Russian Federation and constituent entities was supposed to be regulated by law, but no such law existed, and therefore, the 1991 decision of the RSFSR Supreme Soviet, which transferred a signicant part of state property including state enterprises to constituent entities and municipalities, remained in force. In 1999, the Federal legislature nally managed to enact a law which sets out the basic principles of demarcating ownership, and in 2001, the Law on Demarcation of State Ownership on Land was enacted.14 However, this Law is applicable only to the relations which emerged after the Law has taken effect and does not really solve the problem. Properties which are under the right of ownership of the city, village settlement, and other municipalities are municipal property. Agencies of municipalities exercise the ownership rights (Art.215, paras.1 and 2). As is the case with state property, assets of municipalities comprise assets consolidated with municipal enterprises and institutions, as well as assets which directly belong to the treasury. This concept of municipal ownership did not exist under socialism; local entities did not have their own title over any assets. The process of devolution which started after the collapse of the USSR found its reection in the management of property. By virtue of the above-mentioned decision of the RSFSR Supreme Soviet of 1991, a large part of state assets including land, enterprises, accommodations, ofce buildings and other buildings were transferred to the municipality. State and municipal property can be transferred by its owner to the ownership of physical persons or juridical persons by way of privatisation (Art.217). Privatisation is not limited to state enterprises, but to other kinds of assets such as land, accommodation, buildings, and other properties. There is a separate Law on Privatisation of 2001.15 Provisions of the Civil Code on the manner of acquisition and termination of ownership are applied only insofar as the Law on Privatisation does not provide otherwise (Art.217). Concerning land, the procedure for providing land to individuals and juridical persons is accommodated in the Land Code (Land Code, Art.30).

G.E.Bystrov, “Zemel’naia reforma v Rossii: pravovaia teoriia i praktika”, GiP, 2000 No.4, pp.52-53. 14 Law No.101-FZ of July 17, 2001. 15 Law No.178-FZ of December 21, 2001. 13

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It should be noted that attachment of the land and other natural resources under state or municipal ownership is allowed only when provided for by law (Art.126, para.1).

3)

Acquisition and Termination of the Right of Ownership

The right of ownership over things (property) is acquired on various grounds such as the following (Art.218): i) ii)

iii)

iv) v) vi)

vii)

acquisition of ownership over a thing newly created by the person who created it; acquisition of ownership over fruits, products, and income received as a result of the use of property in accordance with the rules set out in the General Part of the Civil Code; acquisition of ownership over property which already has an owner by another person on the basis of a contract of sale, exchange, gift and other juristic acts; acquisition by inheritance, either by statute or will; acquisition of property by the successor to the reorganised juridical person in case of the reorganisation of a juridical person which owns property; acquisition of ownership over property which has no owner, property whose owner is not known, or property whose owner waived the right to ownership or lost the right of ownership on grounds provided by law (arts.225-228); acquisition of ownership by acquisitive prescription.

In acquisitive prescription, a person (physical or juridical) acquires ownership of immovables if this person, in good faith, openly and without interruption possessed the property in question as his own property for 15 years. For property other than immovables, this period is 5 years (Art.234, para.1). A person who acquired for value a property from a person who does not have the right to assign it may nevertheless acquire the right of ownership if he acted in good faith, i.e. the purchaser was not aware and could not have known that this person had no right to assign it (a purchaser in good faith). This applies to cash and securities as well. Exceptions arise where the owner had lost the property, the property had been stolen or otherwise alienated against the will of the owner from the owner himself or from the person to whom the owner had given possession of the property (Art.302, para.1): The State Property Fund brought an action vis à vis a joint stock company and a limited liability company, asking the court to recognise the contract of sale of 1,500 shares by the limited liability company to the joint stock company and apply

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the consequences of null and void transactions. The State Property Fund had sold shares of a company created on the basis of a privatised state enterprise to the limited liability company, but later, this transaction was recognised by court as void, since the shares should have been distributed through a closed offer. The limited liability company was ordered by the court to return the shares to the Fund, but by the time the judgment was rendered, the company had sold part of the shares to the joint stock company. The Fund argued that the sales contract between the companies was void, since the seller – the limited liability company – did not have the title to these shares and could not have effectively sold the shares. The lower court rejected this argument, and the Supreme Commercial Court upheld this on the ground that a claim of the owner (or an agency entrusted by the owner) to retrieve property in possession of a person who acquired it by contract as a third party should be examined under Article 302. The court ruled that this provision is applicable to securities, including shares.16

There is a problem with who qualies as an acquirer in good faith. The Constitutional Court ruled that “acquisition in good faith is possible only when the property has been acquired not directly from the owner, but from a person who was not entitled to dispose of this property”.17 Normally, in other jurisdictions, this action is available only in respect of movables, and is not applicable to immovables which can be registered.18 However, in Russia, there is no statutory restriction to this effect: An individual entrepreneurial entity brought an action against a company with limited liability for the return of the building of a shop. The plaintiff argued that the disputed property had been sold by the plaintiff to a joint stock company (the buyer) under duress. The defendant company which purchased the property from the buyer (the third party) claimed protection under Article 302. The contract of sale between the plaintiff and the buyer had been found null and void by the commercial court on the ground that there had been a threat of force on the plaintiff by the buyer. However, during the period of the possession of the building, the buyer pledged the building for various loan agreements with the bank. Since the buyer defaulted, the building was sold at an auction organised by the district court and the defendant in this case successfully bid for the building. The Supreme Commercial Court dismissed the claim on the ground that the defendant had purchased the property

16

17 18

Information letter of the Presidium of the Supreme Commercial Court No.33 of April 21, 1998. Zhurakovskii and Kalinin, Kommentarii i primenenie zakonodatel’stva arbitrazhnymi sudami Rossiiskoi Federatsii, Moscow 2000, p.235. Decision of the Constitutional Court No.6-P of April 21, 2003. E.g. BGB Art.932.

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through an auction legitimately organised by a court bailiff and that the plaintiff had no right under Article 302.19

However, the fact that the property was registered would probably lead to the conclusion that the person who obtained the property should have been aware that the seller was not the legitimate owner. Limited liability company “ART” brought an action to the Commercial Court of St.Petersburg and the Leningrad Province vis à vis state enterprise Luzhskii zavod belkovoi kolbasnoi obolochki (hereinafter, “the Zavod”), claiming the release of a non-residential building unlawfully occupied by the latter. ART argued that it was a bona de acquirer of the property. Although the rst instance court satised the claim of the plaintiff, it was quashed by a higher court. The disputed property was purchased by ART from a limited liability company “Mirazh” on November 10, 1993. Mirazh had purchased the property from another limited liability company, Stroikom, which, in turn, purchased it from the defendant on March 22, 1993. However, this contract of sale dated March 22, 1993 had been found to be null and void for the breach of law in the privatisation process by the court in a separate procedure. The Supreme Commercial Court ruled that because of the invalidity of the rst sale, subsequent transactions were all invalid. What the lower courts failed to agree was whether or not the plaintiff was a bona de acquirer and was entitled to the transfer of the property. The Court ruled that according to Article 302 of the Civil Code, a bona de acquirer is a person who, at the time of the transaction, was not aware and could not have been aware that the counter party was not entitled to dispose of the property in question. In order to reach the right conclusion, the lower courts should have examined whether an unnished building is an immovable or not, and whether it was subject to registration. The building in question was not nished and none of the buyers of this property had it registered. On the other hand, it is obvious that the property is an immovable in the light of Article 130. According to Article 223, para.2, the title to an immovable emerges by registration. Article 551, para.1 provides that the transfer of the title to the buyer requires registration. Therefore, before registration of the title, the buyer is not entitled to dispose of the property, since the title remains with the seller until registration. The plaintiff did not deny that when purchasing the disputed building from Mirazh, it inspected all legal documents including the contracts dated March 22, 1993 and May 4, 1996, and was aware that none of the previous buyers had registered the property, but nevertheless, proceeded to enter into a contract with Mirazh. Therefore, the plaintiff should have known that Mirazh was not an adequate seller and was not entitled to sell the property. Thus, the plaintiff is not a bona de acquirer.

19

Murzin eds., supra, pp.298-299.

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Since the plaintiff is not the owner of the property or a bona de acquirer, or is occupying or using the property, the plaintiff is not entitled to claim the property.20

The right of ownership can be terminated on the following grounds (Art.235, para.2): i) ii) iii) iv)

assignment of the property to another person; waiver of the right of ownership by the owner; the loss or destruction of the property; other instances provided by law.

The Land Code provides that the right of ownership of land terminates by disposal or waiver of property by the owner, and compulsory taking away in accordance with the procedure set out by civil legislation (Art.44). According to the Civil Code, property can be taken away in cases where it is attached as in the course of enforcement of obligations (Art.237), and also in cases of requisition (Art.242) and conscation (Art.243). Conscation takes place only when a criminal offence has been committed and on the basis of a court judgment. Furthermore, land destined for agriculture, housing and other construction can be taken away from the owner in cases where the owner has failed to use it for these purposes within three years (Art.284), has used it in violation of law (Art.285), or in cases of compulsory purchase for the needs of the state or the municipality (Art.279). The Civil Code also leaves room for a law which terminates ownership rights (Art.306). The Land Code has similar provisions involving land. The provision for compulsory purchase of land for the needs of the state or municipality is found in the Land Code (Art.49). This takes place in exceptional circumstances when certain objects of state or municipal signicance, e.g. installations of the Federal energy system, defence and national security, highways, as well as “lineal objects of Federal and regional signicance which ensure the activities of the entities of natural monopoly” can have no alternative locations (Art.49, para.1). The Civil Code explicitly provides that nationalisation may be effected on the basis of law with compensation for the value of the property and any other damage caused (Art.235, para.2). Nationalisation means the transfer of the property to the Russian Federation or its constituent entities; transfer to municipal ownership is not allowed.21 It should be added that the Foreign Investment Law

Decision of the Presidium of the Supreme Commercial Court, December 18, 2001, Case 1125/00. 21 Guev eds., supra, pp.404-405. 20

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of 1999 guarantees that nationalisation or requisition of the assets of foreign investors is not to take place unless based upon a Federal law or an international treaty (Art.8, para.1). At the moment, there is no law on nationalisation.

4)

Joint Ownership

Property which is owned by two or more persons is deemed to be under joint ownership (obshchaia sobstvennost’). Joint ownership is divided into two categories: share ownership – a form of common ownership with the share of each joint owner determined (dolevaia sobstvennost’) and common ownership – without such shares being determined (sovmestnaia sosbtvennost’) (Art.244, paras.1 and 2). Joint ownership is presumed to be share ownership unless the law provides that the property in question be under common ownership (ibid., para.3). Examples of common ownership include matrimonial property and the property of a farming household ( fermer skoe khoziaistvo).22 The property under share ownership is disposed of by the unanimous consent of joint owners. Joint owners are entitled to sell, give away as a gift or by will, pledge or otherwise dispose of the share. If the share is to be sold to a person other than a joint owner, other joint owners have a pre-emptive right to purchase the share at the price and other conditions at which it has been offered to the other. For this purpose, the joint owner who intends to sell the share to an outsider is under an obligation to inform the other owners of the intention to sell and the price and other conditions of sale (Arts.246 and 250). In share ownership, the property can be divided by agreement of the joint owners. A joint owner may demand the split of his share from the common ownership. If no agreement is reached among the joint owners on the manners and terms of the division, the joint owner who demanded the division of his share may apply to court for the withdrawal of his share in kind. If this is not possible without unreasonable damage to the property, the joint owner who intends to withdraw is entitled to reimbursement in cash (Art.252, paras.1-3). In common ownership, owners jointly possess and use the property. For the disposal of the property, unanimous consent is needed (Art.253, paras.1 and 2). Division of the property or the withdrawal of a joint owner is possible. In such cases, the share of each joint owner has to be determined; the shares are to be equal, unless otherwise provided by law or agreed by the joint owners (Art.254, paras.1 and 2).

22

Sadikov ed., supra, p.475.

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Creditors of the joint owner in both share ownership or common ownership may request the division of the shares in cases where other assets of the joint owner is insufcient to cover the debt. If, in such cases, division of the property is impossible without damaging it, the creditor may require the debtor to sell the share to the remaining joint owners (Art.255).

3

THE RIGHT OF ECONOMIC MANAGEMENT AND OPERATIONAL ADMINISTRATION

Under the socialist system, state enterprises and institutions were allocated state property. Since the property was owned by the state, these enterprises and institutions themselves could not be regarded as owners of the property. A new concept which is close to ownership, but not exactly that had to be invented to explain the right of these entities over the property they administered. This is the right of operational administration ( pravo operativnogo upravleniia) which was conceived in the 1940s by A.V.Venediktov, a renowned specialist of economic law, in order to explain the rights of state enterprises under the system of state monopoly over means of production.23 After the collapse of socialism, the state has been distancing itself from being directly involved in production and commercial activities. The right of economic management ( pravo khoziaistvennogo vedeniia) was introduced later as a “transitional form from state monopoly to private entrepreneurship”.24 These concepts are used in relation to unitary enterprises and state agencies. The number of enterprises with the right of operational management is in decrease. The right of economic management is a right to possess, use, and dispose of assets and properties in accordance with the terms and purposes set by the owner. The owner is either the state (the Russian Federation and its constituent entities) or the municipalities and the unitary enterprises merely manage the property on behalf of the owner. Therefore, entities such as unitary enterprises are not entitled to dispose of immovables entrusted to it by sale, placement as a security, or contribution to the capital of a commercial company without the consent of the owner (Art. 295, para.2). The right of operational administration is exercised by some unitary enterprises and institutions, including government agencies. It is stricter than the right of economic management in that not only immovables, but properties in general

23 24

A.V.Venediktov, Gosudarstvennaia sotialisticheskaia sobstvennost’, Moscow 1948. V.P.Pavlov, “Pravo khoziaistvennogo vedeniia”, in A.Ia.Sukarev ed., Rossiiskaia iuridicheskaia entsiklopediia, Moscow 1999, pp.2251-2252.

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cannot be disposed of without the consent of the owner. The state, on the other hand, is entitled to take away “excessive” property, or property which is not used in accordance with the purpose of the enterprise or institution (Art.296). Unitary enterprises which are based on this right over the assets are called treasury enterprises (kazennoe predpriiatie).

4

LAND LAW

1)

The Abolition of the State Ownership of Land

The modern history of land ownership in Russia goes back to the mid-19th century. By the Emancipation in 1861, peasants were allocated agricultural land in return for the payment of redemption. However, the title to the land was given not to individual peasants, but to village communes. It was only after 1906 that through a reform initiated by P.A.Stolypin, the prime minister, individual ownership of land by peasants emerged. However, the reform failed in 1914, and the village communes remained the predominant owners of land until the October Revolution. One of the rst decrees which the Bolshevik government issued after the October Revolution was the renowned Decree on Land. Private ownership of land was abolished altogether without any compensation; land was placed under the control of the local land committees together with the buildings, implements, livestock and everything pertaining thereto. It was prohibited to sell, buy, pledge, or otherwise dispose of land. The right to use land was acknowledged to all citizens, but the use of paid labour was not allowed.25 This was conrmed by another decree of February 19, 1918. While these decrees were primarily aimed at rural land, yet another decree issued on August 20, 1918 totally abolished the private ownership of land by individuals as well as enterprises in the urban area.26 In fact, the peasants interpreted these decrees as authorising the seizure and redistribution of large estates. The bulk of the agricultural land in European Russia was actually taken over by the peasants and used in a traditional manner. An astute observer pointed out that the Bolsheviks did not achieve socialisation, but instead, individualisation of land.27 The 1922 Civil Code excluded rights over land, and instead, these rights came to be regulated by the Land Code, which was part of administrative law.28

25 26 27 28

SU RSFSR 1917 No.10, item 150. SU RSFSR 1918 No.62, item 674. V.Gsovski, Soviet Civil Law, vol.1, Ann Arbor 1948, pp.693-694. SU RSFSR 1922 No.68, item 901.

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The Land Code, which was enacted in the same year, was rather different from the decrees which had been issued after the October Revolution. Although it repeated the phrases of the preceding decrees on the abolition of private ownership of land, subsoil, water and forests and its replacement by state ownership, the village commune and the individual household were entitled to select any type of land tenure, including individual enclosure similar to that introduced by the Stolypin reform. Individual peasants and their communes were granted the right of “immediate toil tenure of land without time limit”.29 It is no wonder that the Land Code was dubbed the Magna Carta of landowners. It was inevitable that the Land Code went into oblivion in the late 1920s when these individual peasants were labelled kulaks (“rich peasants”) and “liquidated as a class”. Land, together with all sorts of natural resources, came to be solely owned by the state. After the collapse of socialism, this system radically changed. A substantial part of the land has been “de-étatised” since then. The process started primarily with agricultural land. Already towards the end of socialism, in February 1990, members of collective and state farms were given the right to the land which belonged to those farms, if they desired to set up a farmer’s business by the Fundamental Principles of Land Legislation.30 Such a transfer of land to private ownership was effected in a gratuitous manner. The RSFSR Law on Land Reform of December 27, 1990 declared that land and other natural resources were the “property of the people” and that the state monopoly of land was to be abolished. Various forms of ownership over land, including private ownership, were acknowledged. In the process of reform, land was to be distributed to citizens, enterprises, institutions, associations and companies and regarding distribution to citizens, land was to be transferred to their ownership for individual gardening as well as farming and other agricultural purposes. No payment was required for the land up to a certain limit. On the other hand, unlike in the Central and Eastern European countries, land was not to be returned to those who were its owners before the Revolution.31 This was followed by a similar provision in the Land Code of 1991. In 1992, the scope of private ownership was extended in that the subject of ownership came to include juridical persons, and the available land extended to non-agricultural land. Since the early 1990s, collective and state farms were reorganised into agricultural enterprises based upon private ownership, and private farmer’s households were created. There are currently around 270,200 farmer’s households

29 30 31

Gsovski, supra, pp.698-703. I.A.Ikonitskaia, Zemel’noe pravo Rossiiskoi Federatsii, Moscow 1999, pp.21-26. VVS RSFSR 1990 No.26, item 327.

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which collectively own 6.2% of all agricultural land. A further 63% of agricultural land is under the joint ownership (share and common ownership) of members of the agricultural commercial organisations.32 108 million hectares of agricultural land was eventually transferred to farmers and 12 million rural inhabitants became landowners and were issued a “certicate of the right of ownership”.33 In the urban areas, the 1991 Land Code provided that urban land would be made available for individual ownership for a limited range of purposes such as gardening. The 1997 decree of the president decreed that land is either sold or leased in the urban area by the state or municipal government by auction in which “any person may take part”.34 However, there is strong scepticism towards the fully-edged private ownership of land. A commentator stated as follows: Rules of city and town planning are mandatory for companies, state agencies as well as individuals. Local administrative agencies are empowered to give instructions to the subjects of rights over the land in order to ensure the compatibility of economical development and the optimal use of the natural environment. However, if private ownership of land is to be introduced, it would be difcult for administrative agencies to interfere with the use of land, even when it is necessary. In the urban area, there is a necessity for limiting private ownership of land and making the lease the basic form of land use.35

In major cities such as Moscow, following the above idea, the lease is the basic form of land use. The circulation of land is also severely limited. The amendment to the 1978 RSFSR Constitution in 1991, while acknowledging private ownership of land, introduced a 10 year moratorium on the sale of land. This moratorium was gradually lifted, rst in relation to subsidiary farming plots and dacha businesses, gardening, and individual housing construction. A presidential decree of 1993 allowed individuals and juridical persons who are owners of land to transfer land by inheritance, gift, lease, exchange, and investment in companies, including those with foreign investment. The 1993 Constitution granted the owners the right to freely possess, use, and dispose of land insofar as they do not cause any damage to the environment or infringe the rights and interests of other persons (Art.36). The Civil Code repeats this and allows circulation within the limit established by law, but is vague on the actual scope of permissible circula-

32 33 34 35

Bystrov, supra, p.47. Ikonitskaia, supra, p.67. RG, January 12, 1997. This decree is not in force any more. S.A.Bogoliubov, Zemliia i pravo, Moscow 1998, pp.100-101.

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tion (Art.209, para.3). Furthermore, it provides that persons who own land are entitled to sell it, give it as a gift, pledge it, lease it, and dispose of it in other ways insofar as the piece of land in question is not excluded from circulation or restricted of circulation on the basis of law (Art.260, para.1). Land for subsidiary farming, dachas, and possibly housing in the rural areas can be sold. There is also “no restriction on the sale of agricultural land”. But in reality, as far as agricultural land and land for housing as well as land for entrepreneurial use are concerned, circulation of land is very much limited. The new Land Code of 2001 does not seem to set excessive restrictions on the circulation of land either [see infra].

2)

Legal Framework of the Land Law

Despite the above developments towards de-étatisation of land, a systematic legal basis for these developments had been absent until 2001, when the new Land Code was nally adopted and took effect. The 1991 Land Code was amended in 1993 after the adoption of the Constitution and a majority of the provisions were deleted. Since then, several drafts of the Land Code have been submitted to the Duma, but failed to become law. The primary points of disagreement were reported to be the permissible scope of private ownership and of the circulation of land. There was more or less a common understanding that the reemergence of large scale land ownership should be prevented. Some people were apprehensive of the possible growth of speculative transactions which may lead to an accumulation of land in the hands of a small number of people, once free circulation of land is allowed. On the other hand, there was a view that unless free circulation of land is allowed, private ownership is incomplete. While the new Land Code was not in place, primary sources of regulations concerning land were presidential decrees, edicts of the government, orders and instructions of the State Committee for the Management of State Property as well as the laws of the constituent entities of the Russian Federation. The Constitution provides that the conditions and procedure for the use of land are determined on the basis of Federal law (Art.36, para.3). However, various constituent entities of the Russian Federation have adopted laws which seemingly contradict the provision of the Federal Constitution. For example, the constitution and Land Law of Dagestan deny private ownership of land. The Constitution of the Sakha Republic does not recognise private ownership of agricultural land.36 There was no clear demarcation between the land which belongs to the Russian Federation,

36

Kostiuk, supra, p.30.

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constituent entities, and municipalities. Some entities have enacted their own constitution and laws and claim ownership over land and natural resources in the Republic. The Land Code of Kareliia did not recognise Federal ownership over land. Confusion in this respect was widespread. The number of disputes involving land has been increasing; in 1999, the commercial court handled 2,507 cases of disputes involving the use of land; the number has more than doubled since 1996.37 A Russian specialist characterises the state of land law by its “insufciency, lack of system, contradiction, ambiguity, and instability”.38 In the absence of comprehensive and clear legislation, the market for land has reportedly become subject to corrupt and ambiguous deals.39 There was even a view that the new Land Code was delayed by some people who do not want it, since with the absence of the Code they can operate without being penalised.40 According to another Russian specialist, the existing system of disposal, possession and use of land in fact restricts access to land resources and does not allow for the redistribution and transfer of land to entities who can effectively manage it. The system of guaranteeing the right to land is lacking.41 The absence of the market made secured nancing by land impossible. The new Land Code was adopted in October 2001 and took effect on the day of its publication. Accordingly, Chapter 17 of the Civil Code also took effect. The taking of effect of the new Land Code and Chapter 17 is certainly a major step forward. For example, there is now an explicit provision to the effect that the laws of the constituent entities should coincide with the Federal law. This will contribute to putting an end to the arbitrary creation of regional law. On the other hand, although the new Code is advanced than the previous Code in terms of legislative technique, it cannot be denied that it is an outcome of various compromises, e.g. in relation to the right of ownership of foreign individuals and juridical persons. The latest commentary on the Code points out that there are defects many of which are essential.42

37 38 39 40 41 42

“Sudebno-arbitrazhnaia statistika”, VVAS RF 2000, No.3, p.8. Bystrov, supra, p.49. Ibid., p.51. Ibid. Kostiuk, supra, p.29. Chubukov, supra, pp.7-8.

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327

The Land Code

The new Land Code of 2001 provides that Land Law regulates the use and protection of land in the Russian Federation, while the proprietary relationship concerning the possession, use, and disposal of land as well as transactions with land is to be regulated by civil legislation, unless otherwise provided by the land, forestry, water and sub-soil legislation, environmental and other special Federal laws (Art.3). This is another afrmation of the fact that land relations are basically civil law relationships, not administrative law relationships. Whether foreign nationals can own land was hitherto not clear. In 1992, as part of the privatisation of state and municipal enterprises, those who became owners of a privatised enterprise including foreign nationals and juridical persons were allowed to acquire the land of these enterprises as well.43 However, this part of the decree concerning the right of foreign nationals was deleted in 1997. The 1993 Constitution does not specically refer to the right of foreign nationals to own land. The Foreign Investment Law of 1999 merely provides that acquisition of land, natural resources, buildings, installations and other immovable is to be effected in accordance with the law of the Russian Federation and constituent entities (Art.15). The draft Land Code did not give foreign individuals and juridical persons the right to ownership of land; they were merely entitled to a lease.44 The new Land Code does not explicitly prohibit land ownership by foreign nationals, nor does it declare such a right of foreign nationals in a straightforward manner. It merely provides that the right of foreign individuals and juridical persons to own land is to be determined by the Land Code and Federal laws (Art.5, para.2). However, the Land Code itself is silent on this matter, except that foreign individuals and juridical persons are prohibited from owning land in the border areas. The list of areas where these people are not allowed to own land is to be set by the president (ibid., para.3). The only other Federal law which refers to the right of foreign nationals with regards to land is the above-mentioned Foreign Investment Law. The arrangement of this provision is said to be an outcome of a compromise between those who support the idea of granting ownership to foreign nationals and those who are against. Because of the wording, it is still not clear whether land ownership by foreign nationals is allowed in areas other than the border areas or whether only a lease is available to them as the Foreign Investment Law

43 44

VVS i SN RSFSR, 1992 No.25, item 1427. Ikonitskaia, supra, p.70.

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provides. It should be noted that the Land Code has a provision that rules on land accommodated in other Federal laws must comply with the provisions of the Land Code (Art.2, para.1). There was an interesting case in this regard which was brought to the Constitutional Court in 2004. The provincial duma of Murmansk applied to the Constitutional Court to rule on the constitutionality of various provisions of the new Land Code, including Article 15, para.3. The argument against it was that this provision, by allowing ownership of land by foreign nationals, contradicts the Constitution, since “it reduces (restricts) the territorial basis of the life and activities of the people of the Russian Federation, creates possibilities for the cessation of land to foreign states by way of transactions or by presentation of territorial claims to the Russian Federation, and may lead to the violation of its sovereignty”. The Constitutional Court, however, ruled that this provision was not unconstitutional. This may imply that the Constitutional Court had presupposed that the given provision actually allows foreigners to own land.45 Owners of land are under an obligation to use the land in accordance with the purpose of the land (e.g. if it is purported to be for housing, it should not be used for industrial purposes), the owner must not cause damage to the environment and the soil, he must pay in a timely manner the payment for land, and observe planning, construction, ecological, sanitary, re and other regulations (Art.42). The ownership of land is terminated by assignment of land to another person by the owner, waiver of the right of ownership by the owner, and compulsory withdrawal of land by the procedure established by civil legislation (Art.44). Land can be withdrawn in a compulsory manner (including compulsory purchase) from the owner for the needs of the state or municipality in exceptional cases as follows (Art.49): i) ii)

implementation of international obligations of the Russian Federation; allocation of objects of state or municipal signicance, if there is no alternative site; iii) other cases provided by Federal law or law of constituent entities.

Compulsory withdrawal of land for the need of the state or municipality can be made only with advance compensation equal to the value of the land, and on the basis of court judgment (Art.55, para.2). If the owner so wishes, alternative land of an equal value is provided (Art.63, para.1). Chapter 17 of the Civil Code has similar provisions on those matters.

45

Chubukov, supra, p.121.

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While the permissibility of free circulation of land was a much debated issue before the enactment, there is no reference to the free circulation of land in the new Code. As a rule, land which is excluded from circulation cannot be an object of private ownership, or an object of transactions provided by the Civil Code. There is a list of such land which is excluded from circulation, which includes natural reserves and national parks as well as land occupied by military and nuclear energy installations. The list is not particularly extensive or unreasonable and is regarded as exhaustive. Land is to be circulated in accordance with the Civil Code and the Land Code (Art.27). Then, the problem is whether the land which is not withdrawn from circulation is really allowed to be an object of sale and other transactions. As mentioned above, Article 260 of the Civil Code which came into effect with the enactment of the Land Code allows for the sale and other transactions involving land. However, to what extent free circulation of land is allowed in practice is still open to questions. Concerning agricultural land, the Law on the Circulation of Land for Agricultural Purposes was enacted in 2002.46 The Law provides for the preferential right of the constituent entities to purchase land, except in cases of auction. Foreign individuals and nationals as well as Russian juridical persons with more than 50% foreign capital are not allowed to purchase agricultural land. Instead they may only take out lease. There is a specic provision on the sale of land in the Land Code. First of all, only the land which is accounted for in the land cadastre (kadastr) can be an object of sale. The seller is under an obligation to provide information on all encumbrances on the land to the buyer (Art.37, para.1). The following terms of sale are void (ibid., para.2): i) ii)

sale with the seller’s repurchase option; sale with terms restricting the creation of hypothec, lease, and the effecting of other transactions; iii) sale with terms limiting the liability of the seller when a third party asserts his right over the land.

Sale with the seller’s repurchase option was a common instrument for securing claims, but has now been made void by the Land Code insofar as land is concerned.

46

Law No.101-FZ of July 24, 2002.

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4)

Rights on Land other than Ownership

Chapter 17 of the Civil Code accommodates provisions on the right of ownership and other real rights over land. The Civil Code lists the following rights on land in addition to the right to ownership: i) ii) iii) iv) v)

the right of life-long, inheritable possession; the right of permanent (indenite) use of land; servitude lease gratuitous use

The right of life-long, inheritable possession is a right very similar to ownership which emerged towards the end of socialism, when “it was still terrifying to talk publicly about private ownership of land”.47 This is a right to possess and use land, and it is inheritable. The power to dispose of land is very much limited. In the past, this right has been granted in rural areas by local administrative agencies.48 Although it was a concept of the transitional period and was abolished in the early 1990s, it was restored in the Civil Code (Art.265). The new Land Code still retains this, but only insofar as the person has obtained this right before the new Land Code took effect (Art.21, para.1). The right to permanent (indenite) use of land, according to the Land Code, is the right to possess and use land which is under state or municipal ownership. This is a gratuitous right; no rent is payable. This right is not available to individuals; it is only for government and municipal institutions, Federal treasury enterprises, and state and municipal representative bodies (Art.20, para.1). The new Land Code also provides for free use of land, but this is for a xed period (Art.24). Servitude is a right of limited use of land by neighbours. Servitude may be established for passing through the land, the passage of livestock, laying of cables etc. Servitude retains its effect even when the title to the land is transferred. Servitude can be created by contract, or by law. The new Land Code leaves “private servitude”, i.e. servitude created by agreement, to the Civil Code and provides only for “public servitude” (Art.23, para.1). Public servitude can be created by federal law and normative acts and by the law and normative acts of the constituent entities (ibid., para.2). These include servitude for crossing a

47 48

S.A.Bogoliubov, Zemlia i pravo, Moscow 1998, p.300. Ikonitskaia, supra, p.85.

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piece of land, for the use of land to repair cables and transportation infrastructure, for drainage etc. (ibid., para.3). The lease of land is provided for by the Civil Code as a typical contract in the part on the Law of Obligation.

5)

Land and Buildings

The Civil Code provides that if there is a building or installation on a piece of land, these objects can be owned separately. If the ownership of the building is transferred to another person, the right to use the land also shifts from the seller to the buyer. If the seller of the building is simultaneously the owner of that land, then the buyer of the building acquires the lease or any other rights to use the land (Art.552, paras.1 and 2). If the land and the building belonged to the same person and the land is sold to another person without the building, the seller retains the right to use the land (Art.553).

5

REGISTRATION OF THE RIGHT OF OWNERSHIP AND OTHER REAL RIGHTS

The right of ownership and other real rights on immovables, the encumbrance on these rights, as well as creation, transfer, and termination of these rights are all subject to state registration (Art.131, para.1). Although they are not real rights, lease and rights based upon trust are also subject to registration. Registration is not merely for authentication of these rights. It has a “creative effect”, i.e. it is a prerequisite of those rights having effect. State registration is the sole evidence for the existence of registered rights. These registered rights can only be contested through court procedure. Concerning land, there was no unied system of registration under socialism. Since land and other immovables were not in circulation, there was no real need for it. There was a system of land survey and accounting (uchet), but this was merely a record keeping system for the state. Besides, the means and the agency of recording differed, depending on the type of land and the region. The move for land registration began in 1992 by the Federal Special Purpose Programme for the creation of the automatised system of state land cadastre. In 1993 a presidential decree on land registration was issued. Registration was to be handled by the land commission and its local entities – local committees on land resources and redistribution. After 1994, in some regions, land registration was introduced, but it was only in 1997, when the new Law on the Registration

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of Immovables and Transactions involving Them was enacted, that a uniform system of registration was introduced throughout the country.49 According to this Law, the Ministry of Justice was to administer the Register, but now, the Federal Registration Service administers the system. For certain kinds of immovables, e.g. ships and aircrafts, a special register is administered by other agencies. As late as 2001, the Ministry of Justice reported that the development of local land registries has been completed; there are 1,400 local registries and their outlets with 2,000 registry ofcials.50 The Register is not always accurate: The administration of a district issued a certicate of consolidation of land of 6.12 hectares for an indenite term of use to a joint-stock company, instead of the original certicate for 5 hectares. As a result, 1.12 hectares of land were taken away from the user of the adjacent land. No measures of acquisition or redistribution as provided in the 1990 Land Code were taken. In fact, there had been a dispute over these 1.12 hectares. The commercial court found the decision of the district administration to be null and void.51

In cases where the entry in the register and the factual state of affairs contradict, in some jurisdictions such as Germany, the entry in the register prevails. However, this is not the case in Russia. This is understandable in a country where the register has just begun to develop and does not necessarily reect the true state of rights. On the other hand, the registry is responsible for the accuracy and authenticity of the information contained in the register and is liable for errors by fault. Immovables subject to registration include pieces of land, acreage of subsoil, forest, buildings, houses, ats, installations, engineering and transport infrastructures etc. Rights on immovables which are subject to registration are: i) i) iii) iv) v) vi) vii)

49 50 51

right of ownership; right of economic management; right of operational administration; life-long, inheritable right of possession; indenite right of use; hypothec; servitude.

SZ RF, 1997 No.30, item 3594. “Novost’ Ministerstva Iustitsii RF”, www.scli.ru/news V.Kostiuk, “Pravovye problemy regulirovaniia zemel’nykh otnoshenii i sudebnaia praktika v usloviiakh formirovaniia zemel’nogo zakonodatel’stva” KhiP, 2000, No.3, p.31.

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The objects of registration are “immovables and relevant transactions ( juristic acts)”. Transactions involving immovables which are subject to registration include: i) ii) iii) iv) v)

contract of hypothec; contract of sale or exchange of residential premises contract of sale or lease of an enterprise as a proprietary complex; gift of immovable or part of it; contract of lease of a building or installation exceeding one year (if the party is a juridical person, regardless of the length of the term, it must be registered); vi) contract of lease of other kinds of immovable, regardless of the length of the term.52

The above real rights and the transactions involving them are registered in the Unied State Register of Immovables and Transactions involving them (ediny gosudarstvennyi reestr prav na nedvizhimoe imushchestvo i sdelok s nim). The Register is divided into sections allocated to specic properties. Each section is composed of three parts: Part One – description of the object property Part Two – entry of the title and other real rights, transactions on the disposal of the property Part Three – entry of encumbrances and other real rights

Each section has a “cadastre number” of the land. According to a commentary, the registration of real rights and the registration of transactions involving real rights do not overlap.53 For example, a contract for sale of land does not require registration, but the title which results from the sale requires registration. The legislature may have intended to enable the lease of immovables (not a real right) to be able to be registered by requiring registration of juristic acts. However, it is not clear why registration of the contract and the resulting right both have to be registered in transactions involving residences and ats, while registration of the right alone is sufcient in land transactions. The commentary explains that when the situation is complex and state supervision is needed not only for the transfer of rights, but also for the juristic acts themselves, registration is required for both.54

52 53 54

S.A.Stepanov ed., Kommentarii k grazhdanskomu kodekusu Rossiiskoi Federatsii, Moscow 2006, p.214. P.V.Krashninnikova ed., Postateinyi kommentarii k federal’nomu zakonu o gosudarstvennoi registratsii prav na nedvizhennoe imushchestvo i sdelok s nim, Moscow 2000, pp.42-43. Ibid.

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As a general rule, the acquisition of the right of ownership by means of contract takes effect by transfer of the object, unless otherwise provided by law or contract. However, if state registration is required for the disposal of property, the title is acquired only by registration, unless the law provides otherwise (Art.223, para.2). A provision in the contract law part provides that the performance (ispolnenie) of a contract of sale of immovables by the parties before state registration of the transfer of title does not serve as a basis for changes in relation to a third party (Art.551, para.2). Thus, the buyer of an immovable has no power to act as the owner of this property before registration. A contract transferring the property to another person by the buyer before registration of his title is considered to be void: A joint stock company sold a building to an individual entrepreneur. The buyer did not pay the price to the seller nor did he register the building in his name. The entrepreneur then sold the building to a third party, and disappeared with the money which he received from the third party. The joint stock company brought an action asking for the contract between the individual entrepreneur and the third party to be declared void. The court found that since the individual entrepreneur did not acquire the ownership right due to the failure to register (Art.223, para.2), he had no power to dispose of the property, and therefore, the sale between the him and the third party was void. The court also pointed out that the third party had failed to check the title of the entrepreneur to the building, particularly in the Register, and therefore, acted “on his pain and risk”.55

Thus, when purchasing immovables, the buyer is expected to check the register and ensure that the seller really has got the title, and if necessary, the registered transaction.56 On the other hand, it is not clear from the Civil Code what would happen if the seller sold the immovable to another person after the sale to the rst buyer, but before registration by the rst buyer. In such cases, the second buyer would have relied on the register which showed that the seller was still the title holder. A commentary suggests that the seller loses the right to dispose of the property once the contract has been performed and thus, the rst buyer retains the title.57 On the other hand, Article 551, para.2 of the Code can be interpreted as stating that the seller retains the title until registration and is entitled to dispose of the property. However, this interpretation is criticised as allowing abuse of rights by

Item 2, Information Letter of the Supreme Commercial Court No.21 of November 13, 1997. S.F.Savkin, “Sudebno-arbitrazhnaia praktika po sporom, sviazannym s zashchitoi prava sobstvennosti i drugikh beshchnykh prav”, VVAS RF, 1998 No.10, pp.67-68. 57 Sadikov ed., supra, p.139. 55 56

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one of the parties to the transaction.58 According to the Decision of the Plenum of the Supreme Commercial Court on the application of the Civil Code, until registration, neither the seller nor the buyer is entitled to dispose of the property.59 The Commercial Court has always maintained that until registration of the transfer, the title remains with the original owner. State enterprise “Pishchepromsyr’e” brought an action to the Moscow City Commercial Court vis à vis the Department of State and Municipal Property of the City of Moscow for the recognition of the certicate of ownership of a building located in Moscow as valid. As third parties, an open joint stock company “Chaiservis” and “Moskovskaia chaerazvesochnaia fabrika (hereinafter, “the Fabrika”)” took part. This was before the present Law on the Registration of Immovables and Transactions with them came into force. In the course of enforcement of a judgment, the court bailiff seized the disputed premise which, according to the certicate of April 15, 1998, belonged to the Fabrika. Despite the seizure, on December 17, 1998, the Moscow City Department issued another certicate which acknowledged the title of Chaiservis to the property. This case was, in substance, a claim by the plaintiff to invalidate the registration of the properuy by Chaiservis. The rst instance court ruled that at the time of the seizure, the property belonged not to the Fabrika, but to Chaiservis, which was set up by the resolution of the shareholders of the Fabrika. The lower court found that the Fabrika had lost its title by contributing the property to the capital of Chaiservis on July 8, 1998. The Supreme Commercial Court quashed this decision on the ground that this was against Article 223 of the Civil Code which provides that the right of ownership emerges by registration. Since, at the time of the seizure, the title of Chaiservis was not registered, the owner was still the Fabrika.60

After the performance of the contract, if a party fails to cooperate in the registration, the other party may initiate an action against this party. The court, in such cases, examines the existence of a valid contract between the parties and the fact of the transfer of the property, and may render a judgment on state registration of the property. The party which failed, without justiable reason, to cooperate may be obliged to pay damages for the delay in registration (Art.165, para.3).

58 59 60

Savkin, supra, pp.67-68. Item 14, Decision of the Plenum of the Supreme Commercial Court of February 25, 1998, No.8. Decision of the Presidium of the Supreme Commercial Court, June 19, 2001, Case 193/01.

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It is not clear how the court is to effect registration. The information letter of the Supreme Commercial Court suggests that the judgment of the court serves as the basis for the obligation of the registering agency to register the transaction.61 In a case where a bank brought an action against a company for its failure to register the contract of pledge (pledge of a complex of movable and immovable property), the lower court did not involve the registration chamber as a party, but merely invited it as a third party joining in the side of the defendant. This was found to be wrong by the Supreme Commercial Court, which suggests that in such cases, the agency of registration should be brought in as a defendant as well.62 The Unied State Register of Immovables and Transactions involving them is open to the public. The agency which administers the register is under an obligation to provide any person with information on the fact of registration and the rights which have been registered (Art.131, para.4). A system which is closely related to the registration of immovable is the State Land Cadastre (kadastra). The Land Code provides that the State Land Cadastre is a systematised compilation of information concerning land, including the location, value, size of the pieces of land and the objects rmly attached to them, and the entities which have rights over them (Art.70, para.1). The system is governed by the Law on the State Land Cadastre of 2000.63 This should not be confused with the Unied State Register of Immovables and Transactions Involving Them. Through this system, each piece of land is “individualised” and valued. Each piece of land is assigned a registration number. The information contained in the register includes: i) ii) iii) iv) v) vi) vii) viii) viv)

61 62 63

cadastre number (kadastrovye nomera); address; size; category of land and use; description of the border; registered real rights and restraints (encumbrance); economic characteristics, including the amount of payment for the land; quality of the land; existence of objects rmly attached to the land.

Item 1, Information letter of the Presidium of the Supreme Commercial Court of November 13, 1997, No.21. Decision of the Presidium of the Supreme Commercial Court, May 30, 2000, Case 5210/99. Law No.28-FZ of January 2, 2000.

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What is important is that this Register contains the plan of each piece of land. Information on the rights and restraints (encumbrance) on the land entered in the State Land Cadastre is based upon the information contained in the Unied State Register on the Rights on Immovable and the Transactions involving them.64 Since the administrative reform in 2004, the State Land Register is administered by the Federal Agency of the Survey of Land.

64

Chubukov, supra, p.459.

10 TORT (OBLIGATIONS ARISING FROM CAUSING OF HARM) AND UNJUST ENRICHMENT

1

GENERAL RULES OF TORT

Obligations arising from the causing of harm (deliktnoe obiazatel’stvo – tort) are covered in Part Two of the Civil Code as obligations arising from non-contractual grounds. This arrangement, which is in line with the Pandekten system, was adopted by the draft Civil Code in the late Tsarist period and has been inherited by the 1922 and 1964 RSFSR civil codes. Tort law under socialism was, in principle, no different from tort law in the West. Instead of the “grand scheme of state compensation from public funds” as envisaged by some Marxists, the system still continued to be that of private law tort.1 The structure of the part on tort in the current Civil Code is basically the same as that in the previous civil codes. First, there is a general provision on tort liability based upon fault, combined with a provision on a non-fault principle for “activities involving increased danger”. Various forms of government tort liability are covered in the Civil Code. In addition to the general rules on tort, there are further provisions on the liability of minors, employers, persons without capacity to act etc. Liability for causing damage to the health or the life of a person is covered in a separate subsection. What is new in the current Civil Code is that there are subsections on the liability arising from defective goods, services and work and on moral damage. The general provision on tort states the following (Art.1064): 1. Damage caused to a physical person or his property and also damage caused to the property of a juridical person is subject to full compensation by the person who caused the damage.

1

W.Gray, “Soviet Tort Law: New Principles Annotated”, in W.Lafave ed., Law in the Soviet Society, Urbana 1965, p.181.

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TORT (OBLIGATIONS ARISING FROM CAUSING OF HARM) AND UNJUST ENRICHMENT

The obligation to compensate can be imposed by law on a person who is not the person who caused the damage. It is possible to impose, by law or contract, an obligation on the person who caused the damage to pay compensation to the victim at a level above that of the actual damage. 2. The person who caused the damage can be exempted from liability if he proves that the damage was not caused by his fault (vina). By law, it is possible to provide for compensation despite the absence of fault on the part of the person who caused the damage. 3. Damage caused by a lawful act is subject to compensation in cases provided by law. Compensation of damage may be denied, if the damage was caused by the request or with the consent of the victim, and the act which caused the harm is not against the ethical principles of society.

Thus, the general rule is that the tortfeasor is liable for full compensation of the damage based upon the principle of fault. The burden of proof of fault lies with the tortfeasor. For liability to emerge, there has to be (i) an occurrence of loss, (ii) unlawfulness of the act of the tortfeasor, (iii) causal links between (i) and (ii), and (iv) fault on the part of the tortfeasor.2 (ii) is not explicitly provided by law, but is “presupposed”.3 Loss caused by necessary defence does not have to be compensated, insofar as it was within the permissible scope of actions undertaken in necessary defence (Art.1066). In cases of extreme necessity, the act of the person who caused the damage is understood to have been lawful under Russian Law, but nevertheless, this person is liable for damages (Art.1067). Loss is understood as a material harm in the form of a decrease in the value of the property of the victim and/or a worsening of non-material welfare (life, health etc.). The General Part of the Civil Code has a provision which denes the concept of loss (ubytka) (Art.15, para.2): Loss is understood as the cost, which the person whose right has been infringed, spent or has to spend in order to recover his rights, loss or damage to his property (real damage) and also loss of future income which this person would have received

2

3

O.N.Sadikov ed., Kommentarii k grazhdanskomu kodeksu Rossiiskoi Federatsii, chasti vtoroi, fourth edition, Moscow 2004, p.789. See e.g. the decision of the Presidium of the Supreme Commercial Court, April 18, 2000, Case 8051/99. Ibid., p.791.

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in normal conditions of civil transactions had this right not been infringed (loss of future income). If the person who infringed the right has received an income as a result of the infringement, the person who had his rights infringed may require compensation, in addition to the compensation for other losses, for the loss of future income of an amount not less than this income. An independent gas company, Neftegazpostavka, brought an action against Gazprom, Tomsktransgaz and Gazsibkontrakt claiming compensation on unrealised prot from the sale of gas. The plaintiff contended that the defendants prevented the plaintiff from transporting gas to the counter party. The Anti-Monopoly Agency had held Gazprom liable for restricting competition by abusing its dominant position and blocking access to the market by restricting the use of truck pipelines. The Agency also ruled that Gazsibkontrakt sent letters containing compromising information concerning the plaintiff to the counter party of the plaintiff which was found to be in breach of the Anti-Monopoly Law. The lower courts ruled in favour of the plaintiff and ordered the defendant to pay compensation including the unrealised income from the sale of gas. The Supreme Commercial Court, upon protest, quashed the judgment of the lower court, but only the part regarding the amount of unrealised prot. According to the Supreme Commercial Court, the amount determined by the lower courts was incorrect, since it included the amount of value added tax.4

As a rule, tort liability is based upon fault on the part of the tortfeasor. This includes both intentional and negligent acts. An intentional act is dened in a commentary as an unlawful act which the tortfeasor not only has foreseen, but has also desired, or at least, he has allowed the harmful result to happen. Negligence is dened as the “lack of caution, foresight, care etc., required under the given circumstances”.5 In contrast, there is a provision which sets out non-fault liability as follows (Art.1079): Juridical and physical persons whose activities are related to increased danger to the surroundings (use of means of transportation, mechanisms, high-voltage electrical energy, atomic energy, explosive substances, strongly-acting poisons etc.; carrying out of construction works and other activities connected to such works) are under an obligation to compensate for damage caused by the sources of increased danger, unless it is proved that the damage has occurred as the result of an insurmountable force or an intentional act of the victim.

4 5

Decision of the Presidium of the Supreme Commercial Court, April 24, 2002, Case 6695/01. Sadikov, supra, pp.791-792.

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The effect of this provision is that the juridical persons and physical persons whose activities involve increased danger to the surroundings are liable, unless they prove that the damage has occurred as the result of an insurmountable force or an intentional act of the victim. Insurmountable force is understood as “extraordinary and unpreventable circumstances under the given conditions” (Art.401, para.3). This provision is an exception to the general rule of tort liability based upon fault but it has been fairly extensively applied since the time of socialism. A similar provision had existed in the socialist civil codes whereby the listed activities included those of industrial enterprises and installations, transport organisations, and car possessors. There have been cases where the provision was applied to the keeping of animals in a zoo and a circus, as well as the dumping of toxic waste above the permissible level in the environment.6 Damage caused by trafc accidents was covered by this provision, not by the general tort provision. Thus, in cases of trafc accidents, the tortfeasor bore non-fault liability. This is still the case in the current Code. The above provision in the current Code merely lists examples of activities associated with an increased danger to the surroundings. Whether the activity involves increased danger depends on the “large scale of destructive power which cannot be controlled in the light of the given state of safety technology”. The resolution of the Plenum of the Supreme Court of the Russian Federation of 1994, which was published before the enactment of the Civil Code, but is still applicable, suggests that such activities are those whose implementation creates an increased probability of the occurrence of damage caused by the impossibility of people fully controlling them, as well as activities involving the use, transportation, and storage of objects, substances etc. of a production and commercial nature which have the same characteristics as above.7 In a recent case, the owner of a tanker was held liable for the environmental damage resulting from the spillage of oil.8 The person ( juridical or physical) who is in possession of the sources of increased danger on the basis of ownership, right of economic management, right of operational administration, lease, trust (trast) etc. is liable for damages in such cases. This person is exempted from liability, if he proves that the source of increased danger left his possession by an unlawful act. It is important to note

6 7 8

S.N.Bratus and O.N.Sadikov eds., Kommentarii k grazhdanskomu kodekusu RSFSR, Moscow 1982, p.533. Item 17, Decision No.3 of the Plenum of the Supreme Court, April 28, 1994. Decision of the Presidium of the Supreme Commercial Court of July 20, 1999, Case 7431/98.

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that it is the “possessor (vladelets)” of the source of increased danger, who is liable. “Possessor” in this context is broader than the concept of an owner, since it includes the right of economic administration and operational management. Those who jointly caused damage are liable jointly and severally for damages (Art.1080). In cases where the damage was caused by joint acts involving increased danger to a third party, the possessors of the source of increased danger are jointly and severally liable (Art.1079, para.3): Spouses G initiated an action against joint stock company Sergievskavtotrans and an individual L for the compensation of for the material and moral damage caused by the death of their son A who died in a collision of two cars. One of the cars was owned by this company and driven by Iu, and another car was driven by L. L and the passenger of the latter car, A, died in the accident. The collision was caused when a pedestrian suddenly came running, against trafc rules, in front of the car driven by Iu, and in order to avoid hitting the pedestrian, the car steered into the opposite lane in which the other car was driving. The rst instance court, the district court, acknowledged the claim in full. In the second instance, the court reduced the moral damages by 80% as well as the compensation for the material loss. The case eventually reached the Supreme Court by protest. The Court rejected the protest and upheld the original judgment. The Supreme Court ruled that this was a case where the provision of the Civil Code involving sources of increased danger (Art.1079) was applicable. In this case, Iu was found to have had no technical possibility of avoiding hitting the pedestrian by applying the emergency brake. The pedestrian was later prosecuted, but was discharged by an amnesty. The Supreme Court acknowledged that Iu as well as L had not acted unlawfully, and they were never pursued for administrative or criminal responsibility, but nevertheless, the company who employed Iu, and the driver L were found to be liable for the death of A. The Court ruled that the occurrence of the collision is in itself a ground for the liability of possessors of the sources of increased danger. The counter argument for driver L, that the diversion of the other car into his lane should be regarded as an “insurmountable force” was not accepted by the Court.9

In addition to activities involving increased danger, Article 1096 of the Code (product liability) and the Law on Atomic Energy and the Merchant Shipping Code provide for non-fault liability.10 Fault on the part of the victim is also taken into account when determining the level of compensation. The rule is that if the victim was grossly negligent

9 10

BVS RF 2001, No.5, pp.1-2. Law No.213-FZ of December 27, 1995; Law No.81-FZ of April 30, 1999.

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in a manner which contributed to the occurrence or increase of damage, the amount of compensation is to be reduced accordingly. If the victim was grossly negligent and the liability of the tortfeasor was on a non-fault basis, the amount of compensation may be reduced or the compensation may be denied altogether. On the other hand, in cases of the death of the breadwinner, the fault of the victim is not counted (Art.1083, para.2). An airline company, Vnukovskie avialinii, brought an action against an open joint stock company, Aeroport Vnukovo claiming 93,541,500 roubles in compensation for the damage caused on a container as a result of the collision with an aircraftpushing vehicle. The judgment of the rst instance acknowledged the claim, but ordered the defendant to pay half of the claimed amount on the ground that gross negligence on the part of the plaintiff had contributed to the damage. The appellate court ruled that the liability rested with the possessor of the source of increased danger but the level of compensation depended on the level of fault of both parties and upheld this judgment. The court of cassation also upheld this judgment. Upon protest, the Supreme Commercial Court ruled that there was gross negligence on the part of the plaintiff in that the container was not located in the right place and that there was no control by the company of the driver of the container carrier. Therefore, the lower court judgment was right in reducing the amount of compensation to half.11

One of the unique features of Soviet/Russian Law is that the court is entitled to reduce the amount of compensation by considering the nancial state of the individual, unless the act was intentional (Art.1083, para.3). E, who was driving a car, collided with another car driven by K. E was convicted of a breach of trafc rules and of causing bodily harm to K and was also ordered to pay 3 million roubles (before denomination) as compensation for moral damage by the district court. The presidium of the provincial court quashed this judgment on the ground that the district court failed to take into account the actual nancial state of E, who was a pensioner, married and with two children (minors). The amount was reduced to 500 thousand roubles.12

Injunctions are available under the current Civil Code. The Code provides that the danger of causing damage in the future is a ground for an action to prevent activities which create such a danger (Art.1065, para.1). In addition, if the dam-

Decision of the Presidium of the Supreme Commercial Court, September 10, 1996, Case 471/96. 12 BVS RF, 1995 No.4, p.15. 11

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age which has already occurred was a result of the utilisation of enterprises, installations, or production activities which continue to cause damage and threaten further damage, the court may oblige the defendant to suspend or terminate such activities. However, the court may dismiss the claim for suspension or termination, if it considers this to be against social interests (ibid., para.2).

2

SPECIAL RULES

There are some provisions which cover specic rules of tort liability.

1)

Liability for Damage Caused by a Minor Below 14 Years of Age

In such cases, the parents are liable, unless they prove that the damage was not caused by their fault (Art.1073).

2)

Liability for Damage Caused by a Minor between 14 and 18 Years of Age

As a rule, these minors are liable for damage caused by them under the general rules of tort, but if they do not have income or assets, the parents are liable, unless they prove that the damage was not caused by their fault (Art.1074).

3)

Liability for Damage Caused by Persons who are Declared Incapable to Act

The guardian or the organisation which is under an obligation to supervise this person is liable, unless they prove that the damage was not caused by their fault (Art.1076).

4)

Liability for Damage Caused by a Person Declared Partly Incapable to Act (Limited Capability)

This denotes those who have alcoholic or narcotic dependency. They are liable for the damage caused (Art.1077).

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5)

Liability for Damage Caused by a Person who is not Capable of Understanding the Meaning of His Act

This covers the acts of those people who are perfectly capable to act, but have temporarily lost the capability to understand the meaning of their acts, or are unable to be guided by such an understanding by e.g. a serious mental disease, a deceived state, or loss of consciousness. In such cases, the court may, by taking into account the nancial state of the victim and the tortfeasor and other circumstances, make the tortfeasor fully or partly liable (Art.1078).

6)

Liability of a Juridical Person or a Physical Person for the Damage Caused by an Employee in the Course of Discharging his Employment Duties

The employer is liable in such cases. In this context, the term “employees” does not only mean those people employed on the basis of an employment contract governed by labour law, but also those who work under a civil law contract, provided that the person acts or is supposed to act on instruction and is under the control of the employer for the safe conduct of work. Furthermore, commercial organisations and production cooperatives can be held liable for the activities of their members in implementing entrepreneurial, production and other activities of the commercial organisations and production cooperatives (Art.1068). For this liability to emerge, the basic prerequisites of tort must exist in relation to the employee, i.e. the employee has to be at fault, his act has to be unlawful, and the causal links should exist.13 In court procedure under such circumstances, the employer is the defendant, and the actual tortfeasor – the employee is a third party participant.14

3

LIABILITY FOR CAUSING DAMAGE TO THE LIFE OR HEALTH OF AN INDIVIDUAL

The Code has a separate chapter on compensation for damage caused to the life or health of an individual. The rule is that for causing disability or another harm to the health of a person, the loss of wages (income) which he had or could have denitely had,

13 14

Sadikov ed., supra, p.796. Ibid.

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the cost which became necessary as a result of the harm including medical care, supplementary diet, medicine, articial limbs, treatment in sanatoriums, acquisition of special means of transportation, training for another profession etc., is recoverable, provided that they are needed and cannot be obtained without payment (Art.1085, para.1). In determining the lost income, pensions and other payments the person is entitled to receive are not deducted (ibid., para.2). This is a marked difference from the socialist civil codes which deducted pensions and other payments and as a result made the amount of damages meagre. In cases of a death of the bread-winner, the following persons are entitled to compensation (Art.1088, para.1): i) dependants who are not capable of working; ii) children of the deceased who were born after his death; iii) either parent or spouse or other members of the family who did not work and were dependent on the deceased such as children, grandchildren, brothers and sisters below 14 years of age, or those above 14, but who need care for health reasons; iv) a person who was dependent on the deceased and who lost his working capability within ve years of his death.

A person who has the right to claim compensation for the death of the breadwinner is entitled to the portion of the wages (income) of the deceased which this person had been receiving or had the right to receive for his subsistence (Art.1089, para.1). The period of compensation for damage depends on the category of these people. For example, minors are paid damages up to the age of 14, while the disabled are paid during the period of disability (ibid., para.2). As a rule, compensation for the loss of life or health is paid as a monthly payment. The court may order a lump sum payment if there is a reasonable ground to do so, but this cannot exceed three years’ payment (Art.1092, para.1). If the working capability of the victim subsequently decreased, the victim may require an increase in the monthly payment, while in the opposite case, the tortfeasor may require a decrease of the payment (Art.1090). Furthermore, if the price of subsistence increases, the payment must be indexed with the prices. The increase of the minimum wage also affects the payment (Art.1091).

4

MORAL DAMAGE

One of the novelties in the post-socialist period is the introduction of compensation for moral damage. The Fundamental Principles of the Civil Legislation of the USSR of 1990 introduced this system for the rst time in the history of

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Russian Law. There were discussions on this matter in the early 20th century and the draft Civil Code in the Tsarist period accommodated a provision on compensation for moral damage, but the Code was never enacted.15 Under the socialist system, compensation for moral damage was denied, since it might result in an unfair windfall prot for the victim. Compensation was limited to real damage. However, there were proposals to introduce this system, particularly after some Eastern European countries introduced it. The current Civil Code has a provision on moral damage in the General Part, since it is intended to cover not only tort, but contractual liabilities as well (Art.151). This provision is part of a chapter on “non-material welfare and its protection”. Compensation for moral damage is indeed a novelty in the postsocialist period. It was introduced by the 1990 Fundamental Principles of Civil Legislation of the USSR and inherited by the current Civil Code. The decision of the Plenum of the Supreme Court of 1994 denes moral damage as follows: moral or physical suffering caused by an act (or omission) which harms an immaterial benet that belongs to an individual by birth or by law (life, health, personal integrity, business reputation, privacy, personal and family secrets etc.), or infringes his personal non-proprietary rights (right to use the name, copyright and other rights in accordance with the laws protecting the rights on the results of intellectual activities) or which infringes the proprietary rights of individuals.16

This includes “psychological experience related to the death of the next of kin, the impossibility of continuing active social life, and the loss of work”. As a corollary, it is only individuals, not juridical persons, who are entitled to claim compensation for moral damage. “Since juridical persons cannot feel physical or moral pain, it is impossible to cause them moral damage”.17 The Civil Code provides that moral damage is subject to compensation in monetary terms. However, there are no precise criteria as to the determination of the amount of compensation.18 The Code provides that the court should take into account the level of fault of the person who has caused the harm (if fault is required) and other contributing factors. The court must also consider the moral and physical suffering of the victim (Art.151). There is a requirement of reasonableness and fairness as well (Art.1101, para.1).

15 16 17 18

R.A.Beliatskii, Vozmeshchenie moral’nogo vreda, St.Petersburg, 1913, p.52. Decision of the Plenum of the Supreme Court, December 20, 1994, No.10. Judgment of the Supreme Commercial Court, December 1, 1998, Case 813/98. B.D.Zavidov and O.B.Gusev, Grazhdansko-pravovaia otvetstvennost’, Moscow 2000, pp.485486.

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The rule is that moral damage to non-proprietary rights is subject to compensation without restriction, while moral damage to proprietary rights is subject to compensation only in cases that are specically provided by law (Art.1099, para.2). In principle, fault is a prerequisite of compensation for moral damage. However, fault is not required in cases where the damage was caused to the life or health of an individual by activities involving increased danger, or was caused to an individual as a result of unlawful conviction, arrest, detention etc. Furthermore, it is not necessary to demonstrate fault where damage was caused by the dissemination of information which has harmed honour, dignity, or business reputation (Art.1100). Concerning defamation, under the socialist civil codes, the publication of a rebuttal was the only remedy. The 1990 Fundamental Principles of Civil Legislation introduced compensation of moral damage for defamation. The present Code inherited this provision. A senior doctor of a hospital, Shorokhov, brought an action against the editor of the newspaper Tribuna and the senior assistant procurator of the City of Syktyvkar for compensation for moral damage caused by the publication of an article in the newspaper. Y was the author of the article which, according to the plaintiff, was untrue and harmed his honour and dignity. The City Court ruled in favour of the plaintiff and ordered the newspaper to pay ve million roubles and Y to pay one million roubles. The judgment was upheld by higher courts. The protest brought to the Presidium of the Supreme Court of the Russian Federation was also dismissed. The newspaper published an article which claimed that the re-registration of a small enterprise Sana into a joint stock company was effected for the purpose of separating Shorokhov from other founders, and that the commercial activity of this enterprise was aimed at reselling bandages at a high price to the hospital where Shorokhov worked. The City Court had earlier ruled in favour of Shorokhov and ordered the newspaper to publish a rebuttal by Shorokhov in another procedure. The Supreme Court ruled that under such circumstances, the City Court had acted lawfully in nding that due to the publication of an article which was untrue and which harmed the honour and dignity of the plaintiff, moral damage, which requires compensation by the editor of the newspaper and the author, had occurred. The City Court was right in determining the amount of compensation for the moral damage by taking into account the nature and the content of the publication, the level of dissemination of the information which harmed his honour and dignity as well as his reputation, and other contributing factors.19

19

Decision of the Presidium of the Supreme Court, July 10, 1996, in Spory o zashchite chesti, dostoinstva i delovoi reputatsii; sbornik dokumentov, Moscow 2000, pp.24-27.

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5

PRODUCT LIABILITY

There are some provisions on product liability in the chapter on tort. Thus, damage caused to the life, health or property of individuals, or the property of juridical persons as a result of design, formula, or other defects of goods, work, or services as well as a result of inaccurate or insufcient information on goods, work, or services is to be compensated by the seller, or the manufacturer of the goods, those who performed the work or provided the service, regardless of whether this person was at fault or not, and whether there was this person was in a contractual relation with the victim or not (Art.1095). There are not so many judgments on product liability. The following is a rare case where the victim claimed a substantial amount of compensation: The plaintiff brought an action against the manufacturer of a television which caused a re in his at. The plaintiff claimed compensation for material damage of 4,167,568 roubles for the ruined at and furniture, and for moral damage of 2,500,000 roubles. The court took into account that the suffering of the victim had been compounded by the delay in responding to the claim, and also that the plaintiff, who was an aged person, had been deprived of the opportunity of enjoying watching television. The court granted compensation for moral damage, awarding the claimant 1,000,000 roubles.20

The victim may choose whether to sue the seller or the manufacturer. Sellers, manufacturers, or providers of work or services are exempted from liability if they prove that the damage occurred as a result of an insurmountable force, or as a result of a breach on the part of the consumer of the rules of use or storage of the goods or the results of the works or services (Art.1098). The burden of proof lies with the seller, manufacturer, or the provider of work or service. The Law on the Protection of the Rights of Consumers of 1992 has more detailed provisions on this matter.21 However, if there is an overlap, the provisions of the Code take priority.

6

GOVERNMENT TORT LIABILITY

It has been a tradition since the socialist times to accommodate government tort liability in the Civil Code.

20 21

Cited in Kompensatsiia za moral’nyi vred, Moscow 1998, p.69. Law No.2300-1 of February 7, 1992.

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It is a constitutional right of the people to claim damages for unlawful acts of the government or government ofcials. The Civil Code provides as follows (Art.1069): damage caused to individuals or juridical persons as a result of unlawful acts (or omissions), including the enactment of acts against the law or other legal acts, by a state agency, agencies of local self-government or their ofcials is subject to compensation.

The 1999 Foreign Investment Law also has a provision on the liability of state agencies (Art.5, para.2). They are to be liable in accordance with the Civil Code. Not only are acts or omissions of these agencies or ofcials covered in this provision, but so is the enactment of unlawful normative or non-normative acts. “Ofcials” in this context means only the key personnel who perform the function of a representative of power or “organisational-dispositionary, administrative-economic” power, i.e. prerogative power.22 The act should have been effected in the course of duty. Otherwise, the liability is covered by general tort rules. The above provision does not explicitly require fault on the part of the government or municipal agencies or ofcials. However, the Supreme Commercial Court is of the view that when applying this provision, the general requirements of tort, including the existence of fault, should be met:23 An individual entrepreneur P brought an action against the Federal Financial Administration of the Puskov Province for the damage caused by the unlawful conscation and the destruction of goods. The judgment of the district court which had served as a basis for the conscation was quashed by a higher court. The Court ruled that the act of destroying conscated goods was unlawful and acknowledged the causal links between this unlawful act of the government agency and the damage caused to P. This was upheld by higher courts.24 Judge M, who was a deputy president of the City Court of Magadan, was convicted of neglect of duty and of intentionally rendering an unjust judgment. The act of judge M seriously harmed the rights and lawful interests of P. Judge M was

22 23 24

Sadikov ed., supra, p.673. Decision of the Presidium of the Supreme Commercial Court, December 8, 1998, Case 5656/98. Decision of the Federal Commercial Court of the North-Western District, April 10, 2000, in A.N.Dolzjenko et al eds., Sudebnaia praktika po grazhdaskim delam, Moscow 2001, pp.922924.

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ordered in the criminal procedure to pay 100,000 roubles in moral damages to P. P had claimed compensation of 385,000 roubles for material damage and 42,640,012 roubles for moral damage. Upon protest, the Supreme Court ruled that the lower court had failed to take into account the physical suffering of the victim and other circumstances referred to by the victim. Also the lower court had failed to apply Article 1069 which provides that in cases there the fault of a judge was established by a judgment which entered into force, the victim will be compensated from the Federal budget.25

The Law on the Protection of Environment of 2001 also provides for compensation for environmental damage: The State Far-Eastern Marine Environmental Protection Agency brought an action against the Pacic Naval Fleet for compensation of 37,531,482,500 roubles (before denomination) for polluting the environment by arbitrarily dumping waste in the sea. The rst instance court acknowledged the claim for compensation of up to 12,749,482,500 roubles. The court of the appellate instance upheld this. The Supreme Commercial Court, however, reversed the judgment on the ground that compensation of damage in such cases should be calculated on the basis of the actual cost of restoring the polluted state of environment.26

7

UNJUST ENRICHMENT

A person who, without a ground established by law, or other legal acts or juristic acts, has obtained or kept property at the expense of another person must return this property to the latter (Art.1102, also see exceptions in Art.1109). The same applies to a person who assigned his right to another person on the ground of a non-existing or invalid obligation (Art.1106). As a rule, property which represents unjust enrichment has to be returned in kind (Art.1104). If this is impossible, the actual value of the property at the time of the acquisition shall be returned, together with the damage resulting from the subsequent change of its value if the person has failed to return the property without delay when he became aware of the fact of unjust enrichment (Art.1105, para.1). Furthermore, all income which this person has received or would have received from the property, if this person was aware, or should have been aware of the fact of unjust enrichment should be returned with the property (Art.1107, para.1):

25 26

Decision of the Presidium of the Supreme Court, May 7, 2003, Case No.27pv03. Decision of the Presidium of the Supreme Commercial Court, February 18, 2000, Dolzjenko, supra, pp.915-916.

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A small enterprise Meditsina-Tekhnologiia-Servis brought an action against the city administration of Shlissel’burg at the Commercial Court of the City of St.Petersburg and Leningrad Province claiming 1,571,983 roubles as compensation for unjust enrichment in relation to the defendant occupying a building of 860 square metres which the plaintiff owned. The rst, appellate and cassation instances all rejected the claim of the plaintiff. However, the Supreme Commercial Court, upon protest, acknowledged the claim. In this case, the owner of the disputed property was established as the plaintiff in another case. However, the defendant continued to occupy the building, and failed to maintain it properly. The Supreme Commercial Court found this to be an unjust enrichment and reversed the case to the rst instance court.27

27

Judgment of the Presidium of the Supreme Commercial Court, April 4, 2000, Case 4843/99.

11 BANKING LAW

1

HISTORICAL BACKGROUND

The origin of the modern banking system in Russia goes back to the nancial reform of 1859. The State Bank of Russia was founded in 1860, followed by some private credit institutions. At the beginning of the 20th century, the Russian banking system comprised the State Bank, the State Savings Bank and some other government banks plus various social and private credit institutions including around 50 commercial banks which were formed as joint stock companies and in addition, 300 city credit societies and banks.1 Immediately after the October Revolution, these banking institutions were nationalised by the Decree on Nationalisation of Banks. Banking business was declared to be under state monopoly. Activities of foreign banks in Russia were prohibited by 1918. At the beginning of the New Economic Policy in 1921, the State Bank of the RSFSR which was later transformed into the USSR State Bank was founded. Some specialised state banks such as the Foreign Trade Bank and the Agricultural Bank were set up around this time. During the period of the New Economic Policy, the state monopoly of banking was temporarily forgotten and some private credit organisations in the form of mutual credit societies were allowed to be set up.2 However, these institutions were phased out by the end of the 1920s. The socialist system of banking could be characterised as a mono-bank system in contrast with a two-tier banking system of state banks and commercial banks. The State Bank (gosbank) of the USSR, being the issuer of money, together with a selected number of specialised banks such as the Foreign Trade Bank and the Workers’ Savings Bank, was the sole credit institution. The State

1 2

O.Kuschpeta, The Banking and Credit System of the USSR, Leiden 1978, pp.17-21. G.A.Tosunian et al., Bankovskoe pravo Rossiiskoi Federatsii, obshchaia chast’, Moscow 1999, pp.272-303.

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Bank acted as a cashier or a settlement house for the government. All State enterprises and organisations had an account with a local branch of the State Bank and were under an obligation to pay all the money into this account and effect payments through the Bank, which enabled nancial resources to be pooled in the State Bank and be reallocated. After all, this system was designed for the state to closely monitor state enterprises for the ultimate goal of fullling the state economic plan. On the other hand, individuals could use only cash for payments and maintain saving accounts only.3

2

THE EMERGENCE AND DEVELOPMENT OF COMMERCIAL BANKS

The system started to change in 1987, when the last economic reform under socialism was attempted. In the proposed new system, the State Bank was to be transformed into a genuine central bank, leaving other functions to newly created specialised state banks such as the Industrial Construction Bank (Promtsroibank) and the Agricultural Development Bank (Agrostroibank). In addition, the Foreign Trade Bank (Vneshekonombank) and the Savings Bank (Sberbank) were reorganised and given more independence from the State Bank.4 In 1988, the Law on Cooperatives was enacted. This Law was a watershed for private entrepreneurship which had previously been banned by law. According to a Russian specialist, “for the rst time since the New Economic Policy (in the 1920s), individual freedom in the area of labour activities was signicantly expanded”.5 The Law allowed associations of cooperatives to set up cooperative banks. Cooperative banks were not only a clearing house, but were also expected to ensure the development of cooperatives by nancing their activities from resources which primarily comprised deposits from cooperatives as well as other organisations (including ministries) and individuals. In the light of the increased autonomy of state enterprises by the economic reform in the 1980s, namely the expansion of their right to retain part of the profits, and the newly introduced freedom of entrepreneurial activities for individuals, non-government banks rapidly developed in Russia on the basis of this Law. In 1988 and 1989, 150 commercial banks and cooperative banks were founded

3 4 5

M.Lavigne, The Economic of Transition, 2nd edition, New York 1999, pp.13-14. J.E.Johnson, “The Russian Banking System: Institutional Responses to the Market Transition”, Europe-Asia Studies, 1994 No.6, pp.977-978. Tosunian, supra, p.324.

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out of the money accumulated in particular branches of industry.6 By the end of 1990, the number of “commercial banks” exceeded one thousand.7 The question was where the initial capital for these “commercial banks” came from. “Ministries, state committees, large state enterprises, government organs, state nancial institutions, the Communist Party afliates” – these were the entities which were already doing business on their own account. In reality, banks which mushroomed after 1988 were mainly “wildcat” banks formed by state enterprises and local governments. Approximately four-fths of all Russian commercial banks were set up by one or more state enterprises. For example, Gazprom created the Gazprom Bank. Toko Bank, which went bankrupt in 1998, but until then was the 6th largest commercial bank, was founded by Gossnab, the state supply and distribution system. Oneksim Bank was created by large foreign trade organisations. Banks primarily accepted deposits from the shareholders and borrowed on the cheap inter-bank credit market to nance their own enterprises. Those banks applied for credits at subsidised rates from the State Bank and used this money to extend loans to the state enterprises.8 Major source of the banks’ capital was free credit resources held in the accounts of the clients, who were, at the same time, the shareholders of the bank. Banking and industrial capitals were integrated in the way that major energy and export enterprises and conglomerates became the founders (shareholders) of many banks and at the same time, their partners. For instance, in 1993, Promstroibank’s 30 largest shareholders were all clients.9 Many of them operated as “pocket banks” of the state enterprises which created them. Also there is little doubt that the capital accumulated in the “second economy” under socialism poured into these banks.10 These banks helped their clients convert their stateowned assets into cash, circumvent foreign exchange regulations and transfer prots to offshore accounts.11 As one observer later put it rightly, “Russian banks were distorted from the beginning”.12 The reform of state banks belatedly followed. With the collapse of the Soviet Union, the Central Bank of the Russian Federation (Bank of Russia) was founded in 1990 on the basis of the RSFSR Bank which was founded as part of the USSR

N.D.Eliashibili, Bankovskoe pravo, Moscow 1999, p.6. Tosunian, supra, pp.323-329. Johnson, supra, p.979. W.Tomspon, “Old Habits Die Hard: Fiscal Imperatives, State Regulation and the Role of Russia’s Banks”, Europe-Asia Studies, 1997 No.7, p.1170. 10 T.Gustafson, Capitalism Russian Style, Cambridge 1999, p.81. 11 Ibid., p.83. 12 Ibid. 6 7 8 9

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State Bank earlier that year. The USSR State Bank was formally abolished and its assets and debts within the territory of the RSFSR were transferred to the Bank of Russia in 1991. At the RSFSR level, on December 2, 1990, the Law on the Central Bank of the RSFSR, and the Law on Banks and Banking Activities were enacted. The latter is still in force with subsequent amendments.13 In the rst half of the 1990s, “commercial banks” continued to increase in number. From 1993 to 1996, the number of registered credit organisations increased from 1,700 to 2,600.14 In the period of high ination, these credit organisations became accustomed to a fast-and-loose style closer to loan-sharking, currency speculation, and arbitrage than conventional banking.15 Ensuring access to soft credit for the state enterprises which founded them was the banks’ major task. Their managers were more concerned with the interests of the enterprises which controlled them, rather than with the soundness of their banks.16 On the other hand, banks did not pay interest for around 70% of the total liabilities. This included budgetary organisations’ accounts, which, since 1993, the state had allowed commercial banks to handle.17 In a word, Russian banks did remarkably little to attract funds, subsisting largely on the basis of resources made available to them at little or no cost, and did relatively little lending except to the state.18 In 1996, of the 2,600 registered banks, 2,213 were operating. There were two distinctive characteristics of the system. Firstly, there was an increasing concentration of assets in a small number of large banks. Of the registered banks, there were 64 banks which had a capital of 30 million roubles or more. On the other hand, a great majority of banks were undercapitalised. Secondly, the “integration of banking and industrial capital continued to grow.19 The number of withdrawals of licences had been strikingly high in Russia even before the nancial crisis, reecting the dubious nature of some of the banks. In 1995, 45 banks had their license revoked.20 In 1998, Russia fell into a serious nancial crisis which led to the default on government securities and subsequent devaluation of the rouble. In 1993, the government started issuing government bonds (GKO), which was followed by

Law No.395-1 of December 2, 1990. “Vankovskii krizis: tuman rasseibaetsia?”, Voprosy ekonomiki, 1999 No.5, p.5. Gustafson, supra, p.87. Tompson, supra, p.1171. Ibid., p.1165. Ibid., p.1176. S.V.Bazhanov et al., Possiskie banki: proshloe i nastoiashchee, St.Petersburg 2004, pp.214215. 20 K.T.Tifomirov, Postateinyi kommentarii k Federal’nomu zakonu “O nesostoiatel’nosti’ kreditnykh organizatsii”, Moscow 2001, p.IX. 13 14 15 16 17 18 19

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Federal loan bonds (OFZ)s. The government heavily relied on these instruments to keep the economy aoat. In 1996, the government allowed non-residents to participate in the government bond market. In 1997, non-residents held around 30% of the GKO-OFZs, which exceeded the amount of gold reserve of the Russian Federation. Difculties in controlling public nances, the increasing reliance on the government on short-term debt issuance, falling commodity prices and the appreciation of the exchange rate cast doubts on Russia’s debt servicing capabilities in late 1997 and the rst half of 1998.21 Foreign investors lost condence in the GKO-OFZs and the rouble fell sharply in 1998. Various causes of the nancial crisis in Russia have been pointed out. These include the general deterioration of the economy, the growing government decit (the government decit averaged 7.5% of GDP, while fair and efcient tax collection has yet to emerge), the increase in foreign debt, and the weak banking sector which was unable to play the role of nancial intermediation.22 The interest rate reached 150% by May 1998. In July 1998, the exchange rate fell further, and capital freight started. The government suspended the issuing of GKO-OFZs. On August 17, the government announced that the 1) the devaluation of roubles, 2) the suspension of trading in GKO-OFZs and a mandatory rescheduling of government debts, i.e. de facto default on the bonds, and 3) a 3 months’ moratorium on the repayment of corporate and bank debt to foreign creditors. The overall nancial crisis hit the banking sector hard. The Russian banking system had been in a critical state as early as autumn 1997. The fall of the rouble seriously affected their capability of repaying debts in foreign currency, the amount of which had been steadily increasing. In many banks, GKO-OFZ formed a large portion of the assets. Banks often used these government bonds as collateral for foreign currency loans, but with the fall in the market, creditors demanded additional security. Many banks simply could not afford it. In May 1998, Toko Bank, which was one of the larger banks, got into crisis and eventually had its licence withdrawn. Top ranking banks such as the Imperial Bank and the SBS Agro Bank defaulted in August. By then, there were 511 loss making banks. In this month alone, 140 credit organisations collapsed. There was a “run on the bank”.23 However, the government default and devaluation of roubles, merely triggered the failure of the banks. The systemic crisis of the banking system had

Bank for International Settlments, 69th Annual Report, 1999, p.50. In general, see T.Malleret et al., “What Loaded and Triggered the Russian Crisis”, Post-Soviet Affairs, 1999 No.2, p. 107ff. Tosuniain, supra, pp.330-338. 23 “Russia’s Banking Crisis”, Russian Economic Trends, 1998 No.3, p.39.

21 22

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been prepared by “economic-, social- and political-legal developments of the country” since 1991.24 The BIS Report pointed out as follows: Banks have relied on returns from nancial arbitrage created by either the continuous devaluation of the rouble or the large acquisitions of high-yielding government paper. Often, these securities were nanced by borrowing in foreign currency, leaving banks with large open foreign currency standing. By contrast, credit outstanding to the private sector has remained very modest at about 15% of GDP so that a credit culture has not evolved.25

A survey of 18 banks (15 of which are among the 30 largest banks) conducted by the Bank Review Unit of the World Bank in autumn 1998 suggests that the massive failure of the banks was primarily the result of mismanagement of funds by the banks. Connected lending and excessive risk taking in the forex market were the most destructive factors. The main sources of banks’ capital decit were bad loans (45%), followed by forex and transaction losses (37%). The failure of the government to redeem GKOs and OFZs accounted for less than 18%. The survey also revealed that 14 of the 18 banks had negative capital in September – October 1998, and all of Russia’s top ve banks were among them.26 In 1999, the Chairman of the Central Bank stated as follows: The roots of such a serious crisis denitely go much deeper. The causes of the crisis are: insufciently qualied management of banking risks, particularly foreign currency risk and credit risk, undercapitalisation of many banks, extreme increase of operations in the nancial market, including pure speculations instead of more labour-consuming and often less protable operations with the real sectors of the economy. We should also be reminded that the low level of nancial discipline of many borrowers substantially increased the credit risk of the banks.27

In early 1999, the Central Bank reported that a quarter of the existing banks were not sustainable, and 149 of them were “apparently bankrupt”.28 The government was rather slow in responding to the situation. Individual banks were rescued by the Central Bank via cash injection and “repo” loans in a highly opaque manner. It was only in July 1999, almost one year after the crisis, that the Central Bank found the courage to withdraw licences from some of the bigger violators of

24 25 26 27 28

Tosunian, supra, p.330. BIS, supra, p.53. “Banking Sector”, Russian Economic Trends, 1999 No.2, p.85. V.V.Gerashchenko, “Akutual’nye problemy bankovskoi sistemy v 1999 godu”, www.cbr.ru. VE, 1999 No.5, p.31.

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banking regulations and credit rights.29 The Central Bank came under signicant political pressure in the process. In the case involving the Imperial Bank, which held Gazprom and Lukoil accounts, but had made headlines for theft and asset stripping, the Bank had its licence revoked in August 1998. In June 1999, however, the licence was reinstated as a result of the appeal of the Minister of Fuel and Energy and major creditors to the Central Bank.30 In September, the government introduced measures to restore the banking system. The Central Bank provided “stabilisation loans” to banks which could be expected to recover, and banks which had high economic and social signicance, particularly for the regions. According to the Central Bank, 70% of the operating banks survived the crisis. On the other hand, around 400 banks experienced serious shortfall in capital, could not pay the customers, and were unable to come out of the crisis on their own. Many of them disappeared as a result of merger or bankruptcy.31 In February 1999, the long-awaited Law on the Insolvency of Credit Organisations was enacted. A new agency – Agency for Restructuring of Credit Organisations (ARKO) – was founded in March.32 The board of ARKO included representatives of the government, the Central Bank, and the Association of Russian Banks. The Law on the Restructuring of Credit Organisations, which sets out the procedure for restructuring credit organisations by ARKO, was enacted in July 1999.33 ARKO started the process of restructuring 20 banks in 12 regions such as SBS Agro and AvtoVAZ Bank by taking control of these banks and injecting funds into their capital. In the aftermath of the crisis, bank owners and managers had been given plenty of time to strip assets from the banks by transferring them into “bridge banks”.34 This happened, for example, with Bank MENATEP, which was the fth largest bank in Russia. By the time the Law on the Insolvency of Credit Organisations was adopted, the Bank was reduced to a mere shell whose assets had been transferred to an independent “sister bank” which continues to operate. Some of the assets had been hidden abroad.35

29 30

31 32 33 34 35

“Banking sector”, Russian Economic Trends, 1999.2, p.87. A.S.Alexandrovich, “Bankruptcy Law, An Economic Medicine: How Russia’s New Bankruptcy Legislation Facilitated Recovery From the Nationwide Financial Crisis of August 17, 1998”, Cornell International Law Journal, 2001, vol.34, pp.110-112. Bazhanov, supra, p.229. Law No.144-FZ of July 8, 1999. Law No.40-FZ of February 25, 1999. K.Eggenberger, “Bank Restructuring: Developments in 1999”, Russian Economic Trends, 1999 No.4, p.27. Alexandrovich, supra, p.108.

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As a representative of the IMF seconded to the Central Bank pointed out in his report, the fundamental problem which stands in front of the banking sector and the Central Bank is the task of reinforcing the condence of the Russian society in banks, since at present, in order to cause a panic or massive withdrawal of deposits, a simple rumour is sufcient, and it does not matter whether it is true or false.36 In 2004, the government introduced a deposit insurance scheme. Under this scheme, only deposits of individuals are covered and to the limit of 100,000 roubles, excluding deposits with exceptionally high interest rates. The potential coverage of this scheme is around 40% of all deposits. Participating banks are required to pay each quarter a premium of up to 0.15% of the average value of their insured deposits in the preceding quarter. If the fund is not able to meet its obligations, it may apply to the government for budgetary support.37 At present, deposits in the Sber Bank made before 2004 are fully guaranteed by the state. In addition to promoting the condence of the general public in the banking sector, the new scheme is expected to create a level playing eld for the state and private banks. The Central Bank reviews the soundness of the banks which applied to join the scheme. 1,140 banks applied for the scheme, but as of January 1, 2006, only 930 banks were allowed to participate.

3

SOURCES OF BANKING LAW

Banks are regulated by Federal law and subordinate acts. On the regulatory side, two Federal laws are relevant. One is the Law on the Central Bank (Bank of Russia) and the other is the Law on Banks and Banking Activities. The latter provides that banking activities in Russia are regulated by the Federal Constitution, Federal laws and normative acts of the Central Bank (Art.2). However, this list is incomplete in that decrees of the President and decisions of the government which regulate banking activities in reality, were “omitted by mistake” in the legislative process.38 Both laws were enacted in 1990 at the incept of the banking reform, but the former was replaced by a new Law enacted in 2002.39

A.de Vil’pua, Kommentarii po tekushchim problemam rossiiskogo bankovskogo sektora, www.cbr.ru. p.6. 37 IMF Country Report No.5/379, Russian Federation:Selected Issues, October 2005, p.99. 38 V.A.Belov, Bankovskoe pravo Rossii; teoriia, zakonodatel’stvo, praktika, Moscow 2000, p.21. 39 Law No.86-FZ of July 10, 2002. 36

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The Law on Banks and Banking Activities provides, inter alia, for the procedure of registration and licensing of banks, mandatory reserves, bank accounting, bank condentiality, arrest of accounts etc. Mandatory requirements to the banks are covered not by this Law, but by the Law on the Central Bank. There are also the Law on Insolvency of Credit Organisations and the Law on the Restructuring of Credit Organisations which were enacted in the aftermath of the 1998 banking crisis.40 In 2001, the Law against Laundering of Income Received by Criminal Acts and Financing of Terrorism was enacted.41 On the banking transaction side, the Civil Code is the major source of law. The Code covers contracts of bank guarantee, loan and credits, factoring, bank deposit, payment etc. The Central Bank has a power to enact subordinate legislative acts which are binding on the agencies of state power of the Russian Federation, constituent entities of the Russian Federation, municipalities, as well as juridical persons and individuals. Subordinate acts include normative acts of the Central Bank, decrees of the President, and decisions of the government. Normative acts of the Central Bank take the form of rules (ukazaniia), statutes ( polozheniia), instructions (instruktsiia), as well as letters and telegrams. In fact, it is these normative acts which provide for matters relevant to the operation of banks. Thus, the procedure for credit organisations to prepare annual accounts is regulated by the ukazanie of the Central Bank No.1530 of October 17, 2004. The preparation and submission of reports to the Central Bank by credit organisations are covered by ukazanie No.1375 of January 16, 2004. Organisation of internal control system of credit organisations and banking groups is regulated by a polozhenie No.242 of December 16, 2003. Preparation and submission of consolidated accounts are covered by polozhenie No.191 of July 30, 2002. A particularly important document is the instruktsiia of the Central Bank No.110 of January 16, 2004 on “Mandatory Normatives of Banks”, which incorporated prudential requirements in line with the BIS rules. The Constitution also provides that “the universally accepted principles and norms of international law and international treaties of the Russian Federation” are an integral part of the legal system of the Russian Federation (Art.15, para.4). What specically constitutes “universally accepted principles and norms of international law” in the area of banking law is not clear in court practice, and academic views vary. The Geneva Convention of Unied Rules on Cheques, Unied Rules on Transferable and Simple Bills of Exchange, the UNIDROIT

40 41

Supra, footnotes 32 and 33. Law FZ 115 of August 7, 2001.

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Convention on International Factoring, and the UNIDROIT Convention on Financial Lease, inter alia, are understood to incorporate these principles and rules.42 The prudentiality requirements of the BIS, which the Central Bank is a member, certainly is one example of those rules. In addition, commercial custom serves as a source of law insofar as it is not against mandatory statutes or binding contracts (Civil Code, Art.5, para.2). Commercial custom is referred to in the Civil Code in the part covering banking transactions (e.g. Art.836 and 848) as well. International commercial custom applied in banking practice includes ICC Uniform Rules on Incasso Transactions, Rules for Demand Guarantees, Contract Guarantees, as well as the Uniform Customs and Practice on Documentary Credits.

4

THE CENTRAL BANK (BANK OF RUSSIA)

The Constitution provides that the defence and ensurance of the stability of the rouble are the basic function of the Central Bank. The Bank is to carry out this duty independently of agencies of state power (Art.75, para.2). The goals of the Bank as provided by the Law on the Central Bank are (Art.3): i) protection and ensurance of the stability of the rouble; ii) development and strengthening of the banking system; iii) ensurance of the effective and incessant functioning of the payment system.

The Central Bank is a juridical person. It reports to the State Duma, which appoints and dismisses the Chairman of the Bank upon recommendation of the President (Art.5). Members of the Board of directors of the Bank are appointed by the Duma upon recommendation of the Chairman of the Bank with the consent of the President. The National Committee of the Bank, a powerful body within the Bank which has the power to review the annual report of the Bank and to approve the expenditure of the Bank, has 12 members, of which three are representatives of the President, and another three are representatives of the government. In addition, there are three representatives of the Duma and two of the Federal Council.43 Despite the fact that the Board of Directors is the highest body of the Bank, the new Law on the Central Bank has signicantly strengthened the

42 43

Tosunian, supra, p.132. A.S.Tosunian and A.Iu.Vikulin, Postateinyi kommentarii k federal’nomu zakonu o tsentral’nom banke RF, Moscow 2003, pp.38-39.

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power of this collective body of the Central Bank. This seems to cast doubt on the independence of the Central Bank. The Central Bank performs the following functions: i)

preparation and implementation of the monetary-credit policy of the state in conjunction with the government; ii) emission of the currency and organisation of its circulation; iii) acting as a creditor of the last resort for credit organisations by organising the system of renancing; iv) establishment of rules for payment in Russia; v) establishment of rules for banking operations, bookkeeping and auditing for the banking system; vi) registration of credit organisations and granting licenses; vii) supervision of credit organisations; viii) registration of emission of securities by credit organisations; ix) regulation of foreign currencies and sale and purchase of foreign currencies; x) determination of the procedure for payments with foreign states; xi) control of foreign currency transactions; xii) organisation of the balance of payment for the Russian Federation.

In its regulatory and supervisory capacity, the Central Bank i) ii) iii) vi) v) vi)

sets the numerical norms in order to ensure the prudentiality of credit organisations; forms the fund of minimum mandatory reserve for credit organisations; nances credit organisations; ensures the liquidity of the banking system by buying and selling government securities (open market operation); establishes the rules for the banking operations, accounting and reporting, organisation of internal control etc. and; supervises the observance of banking laws and the normative acts of the Central Bank and inspects the activities of credit organisations.

In order to carry out the regulatory and supervisory functions, the Bank is empowered to inspect credit organisations and their branches, give them binding instructions for the removal of violations, and to impose sanctions. Inspections are carried out by representatives (ofcials) of the Bank, or by accounting rms retained by the Bank (Art.73). In cases of violation of the law, normative acts or orders of the Central Bank, or where there has been a failure to provide information or false information has been provided to the Bank, the Bank is empowered to impose a ne of up to 0.1% of the minimum capital or suspend a specic operation of the credit organisation for up to 10 Months. If the credit organisation fails to rectify the violation within a xed period, the Bank may impose a

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ne of up to 1% of the paid-in capital, but not more than 1% of the minimum capital (Art.75). The Central Bank is, in the end, empowered to withdraw the license of credit organisations on grounds provided by the Law on Banks and Banking Activities (Art.18). Withdrawal of licence is not limited to cases where banks were in breach of the law. Failure to meet the capital requirement or insolvency is a ground for withdrawal.

5

CREDIT ORGANISATIONS (BANKS AND NON-BANKS)

The Law on Banks and Banking Activities was originally enacted in 1990, but underwent various amendments since then. Initially, the key concept was “banks”, but by the 1996 amendment, the concept of “credit organisations” was introduced. Credit organisations are dened as juridical persons which, for prot, based upon the licence granted by the Central Bank, are entitled to conduct banking operations listed in the Law (Art.1). Credit organisations are divided into banks and non-banks. Banks are dened as credit organisations which have an exclusive right to carry out all of the following banking operations; soliciting deposits from individuals as well as juridical persons, lend the deposited money in the name and at the cost of the bank and, open and manage accounts of individuals and juridical persons. In contrast, non-bank credit organisations are those which have the right to carry out specic banking transactions (Art.1). The Law lists the following banking operations (Art.5): i) ii)

taking of deposits from individuals and juridical persons; lending of the money deposited in the bank’s own name and account on the condition of return, prot basis, and limited term; iii) opening and managing of accounts of individuals and juridical persons; iv) arranging payments upon instruction by customers; v) service of customers by incasso transactions, bills of exchange transactions, payment and settlement by documents; vi) purchase and sale of foreign currencies in cash and non-cash form; vii) solicitation for deposit and investment of precious metals; viii) issuing of bank guarantees; ix) transfer of money upon instruction of individuals without opening an account.

There is a list of auxiliary businesses including trust business, storage, leasing and consulting service. On the other hand, credit organisations are prohibited from being engaged in production, trading and insurance business (Art.5).

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It should be noted that in Russia, there is no segregation of the banking and securities businesses. Credit organisations are allowed to carry out professional activities in the securities market. Based upon the general banking licence, banks may issue, purchase, sell, register, and possess in deposit securities. They can also hold securities on trust on behalf of individuals and juridical persons (Art.6). Table 11 Registration of Credit Organisations as of January 1, 2006 Registered Credit Organisations in Total Banks Non-Bank Credit Organisations Credit Organisations entitled to Carry Out Banking Activities Banks Non-Bank Credit Organisations Credit Organisations with a License to Solicit Deposits of Individuals Credit Organisations with a General Banking License Credit Organisations with a License for Foreign Currency Operation Credit Organisations with Foreign Participation 100% Foreign Capital Over 50% Foreign Capital

1,409 1,356 53 1,253 1,205 48 1,045 301 827 136 41 11

Credit Organisations with the Licence Withdrawn, but not yet Liquidated Credit Organisations for which a Resolution to Liquidate was adopted Credit Organisations whose Liquidation has been Registered

154 146 1,687

Registered Capital (million roubles)

444,377

(Biulleten’ bankovskoi statistiki, 2006, No.4, pp.86-88)

Credit organisations can be founded as “commercial organisations on any form of ownership”. This means that credit organisations can be either joint stock companies or, limited liability companies. Credit organisations must have the word “bank” or “non-bank credit organisation” as well as the organisational form of the company attached to their name. The minimum capital of newly founded credit organisations is set by the Central Bank (Art.11, para.2). Credit organisations are subject to registration with the Central Bank. Credit organisations receive the right to perform banking transactions on the basis of a licence granted by the Central Bank. Registration and the issuing of licences can be refused on the following grounds (Law on Banks and Banking Activities, Art.16):

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i)

ii) iii)

incompatibility of the candidates for senior management positions of the bank with the requirements of the Federal law and the normative acts of the Central Bank; unsatisfactory nancial state of the founders or their non-performance of tax payment and other mandatory payments to the state; non-compliance of the submitted documents with the requirements of the law or the normative acts of the Central Bank.

Grounds for the withdrawal of licence include: i) ii)

information on which the licence was based turned out to be untrue; delay in starting banking operation for more than a year from the issuing of licence; iii) essential inaccuracy of reported data; iv) delay in the submission of a monthly report for more than 15 days; v) carrying out of banking operations which are not included in the licence; vi) non-compliance with federal laws regulating banking activities and normative acts of the Central Bank, repeated within a year (includes breaches of anti-money laundering law); vii) repeated failure to enforce court judgments to seize money in the account within a year; viii) existence of a temporary administrator (on the basis of the Law on Insolvency).

Licence must be withdrawn on the following grounds: i) ii) iii) iv)

6

the capital adequacy rate fell below 2%; the capital of the credit organisation fell below the minimum capital set by the Central Bank at the time of registration. the credit organisation failed to increase the capital in accordance with the requirements within the period set by the Central Bank; the credit organisation is unable to satisfy the claim of the creditors or the state for 14 days (the total claim must be 1,000 times or more of the minimum capital).

CURRENT STATE OF THE RUSSIAN BANKING SYSTEM

In early 2001, it was reported that the Russian banking system has not really recovered from the 1998 crisis. By January 2001, aggregate capital was restored only to 60% of the pre-crisis level.44 The ratio of non-performing loans to total

44

“Banking Sector”, Russian Economic Trends, 2001, p.63.

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loans declined from 17% in 1998 to 4% in 2004. Return on assets is around 2.5 to 2.9% between 2001 and 2005.45 Lack of transparency in nancial reporting and the absence of reliable information about the condition of banks, particularly about their loan portfolios, are among the serious obstacles to recovery.46 The ultimate problem is the lack of condence of the general public in the banking system. In 2004, there was a “run on the bank” following the suspension of business by Guta Bank. There was another such incident soon afterwards when several of the ATMs of the Alpha Bank, which is the largest bank, ran out of funds. The number of banks in Russia is stunningly high as compared to the size of the banking sector in the economy (Banking sector assets of Russia was 42.2% of the GDP, while in the Czech Republic, it was 93%, and in Poland, 67%. The total capital is 6% of the GDP). As of January 1, 2006, there are 1,253 banks registered, of which 1,205 are banks and the remaining are non-bank institutions.47 In the peak year of 1994, the number was 2,457, but the strengthening of enforcement of prudential and supervisory requirements and the introduction of anti-money-laundering measures resulted in the decline in the number of banks. In 2004, 33 licenses were withdrawn. In the last quarter of 2005 only, 16 banks were liquidated and registered as such.48 The total number of banks with the licence withdrawn and liquidated since the beginning of the banking system amounted to 1,498. The ratio of regulatory Tier 1 capital to risk-weighed assets, the capital adequacy ratio, was 13.8% in the rst quarter of 2004. Nonperforming loans accounted for 5.0% of the total gross loans. This ratio has been constantly declining from 17.3% in 1998.49 “Integration” of industry and the banks is another feature of the Russian banking system. Major private banks are part of large nancial groups:50 Alfa – Alfa Bank Interros – Rosbank Lukoil – Sobin Bank, Petro Commerce, Ural-Sib MDM – MDM Bank Menatep – Trust & Investment, KB Menatep Rosprom – DII Bank

45 46 47 48 49 50

IMF Country Report: Russian Federation, October 2005, pp.89, 92. “Banking Sector”, Russian Economic Trends, 2001 March, pp.62-63. Vestnik Rossiislokgo Banka, 2006 No.3 (electronic version). Ibid. IMF, Russian Federation, Selected Issues, August 10, 2004, p.44. IMF Country Report, No.05/379, October 2005, p.90.

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The state controlled Gazprom has Gazprom Bank in the group. Of the 13 private banks among the top 20 banks, 12 are related to nancial-industrial groups in the resource-extracting sector, and the remaining one is related to a group in IT/Telecommunication sector.51 Despite the large number of banks, the system is fragmented. Only 19.4% of them have a registered capital of 300 million roubles or more.52 Top 30 banks held 66% of the assets of the banks at the end of 2004. As of December 1, 2005, the top ve banks held 43.1% of all assets of the banks. Top 6 to 20 banks held another 19.4%. The total amount held by the top 50 was 74.2%.53 On the other hand, there are around 800 banks which have capital below 5 million euro.54 It is primarily banks of this size which had the licence withdrawn. It should be noted that, according to the Central Bank, of 638 banks surveyed in 2004, 20% of them reported over-inated capital.55 A study of 30 banks in the early 2000s showed that several had signicantly overstated capital and some had negative net worth.56 As a whole, the Russian banking sector is characterised by its undercapitalisation. The ratio of the capital to the GDP was 5.7% in 2005, which had increased from 2.9% in 1999.57 Another unique characteristic of the Russian banking system is the dominance of state-owned banks. There are six fully state-owned banks and some state-controlled-banks which total 21. The top two banks are state owned banks – Sber Bank and Vneshtorg Bank. In addition, even though not directly owned by the state, many banks are owned by state-owned enterprises. In 2004, Guta Bank, which was one of the medium-sized banks, was acquired by Vneshtorgbank which is a state bank with the support of the Central Bank deposit of 700 million USD. This should be regarded as a nationalisation.58 Sber Bank which is the former savings bank, with its 1,009 branches all over Russia, holds over 60% of the deposits of individuals. In total, 21 state-owned or state-controlled banks hold around 38% of the total bank assets, 42% of the credits and 66% of household deposits.59

51 52 53 54 55 56 57 58 59

IMF Selected Issues, supra, p.49. Central Bank, Grouping of operating credit organisations by the amount of registered capital, 2006. Obzor bankovskogo sektora RF, electronic version, p.7. Ibid., p.72. Vilpu, supra, p.4. IMF Selected issues, supra, p.49. IMF, Financial System Stability Assessment, Russian Federation, April 11, p.19. Obzor, supra, table.1. Vil’pua, supra, p.7. IMF, Country Report 05/379, supra, p.97.

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Foreign banks are allowed to be set up. There are currently 41 banks with 100% foreign capital operating in Russia. There are 11 banks with more than 50% foreign participation.60 There is a quota for foreign investment in the banking sector.

7

SUPERVISION OVER CREDIT ORGANISATIONS

The Central Bank is the regulating and supervisory agency over credit organisations. It exercises permanent supervision over the observance of banking legislation and normative acts of the Central Bank, namely the mandatory numerical requirements established by them (Art.55, Law on the Central Bank). Between 1992 and 1995, the Central Bank gradually created a system of supervision and inspection over credit organisations. However, supervision by the Bank can hardly be regarded as effective as has been demonstrated by the 1998 banking crisis. The Central Bank conducted a survey of 18 large banks, based upon Western accounting standards. Most banks were found to have negative capital due to insufcient loan loss provisioning, excessive lending to related parties, inaccurate and incomplete reporting, reliance on speculative income, and over-exposure to foreign currency risk.61 As part of the monetary policy, the Law on the Central Bank requires a mandatory reserve be deposited by credit organisations with the Central Bank (the Law on the Central Bank, Art.38). Territorial agencies of the Central Bank conduct a quarterly inspection over the accuracy of the calculation of the mandatory reserve by credit organisations. On banking supervision, the Basel Committee was set up in 1974 and provides an international forum for regular cooperation on banking supervisory matters. It has developed increasingly into a standard-setting body on all aspects of banking supervision, including the Basel II regulatory capital framework. In 1997, the Committee prepared the Core Principles for Effective Banking Supervision. Although Russia is not a member of this Committee (the Central Bank is a member of the Bank of International Settlement), numerical requirements accommodated in this document are reected on the Russian banking legislation. The Law on the Central Bank provides that in order to ensure stability of credit organizations, the following mandatory numerical requirements are set out (Art.62):

60 61

Vestnik, supra. IMF, Financial System Stability Assessment, supra, p.22.

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i) ii) iii) iv) v) vi) vii) viii) ix) x)

minimum capital; proportion of proprietary contribution to the capital; maximum risk to a single borrower or group of interrelated borrowers; maximum amount of major credit risk; liquidity of the credit organisation; capital adequacy; foreign currency, interest rate and other nancial risks; minimum amount of reserve; use of the capital for the acquisition of shares in other juridical persons; maximum amount of loans and guarantees extended to its shareholders.

Details of these numerical requirements are given in the Instruction No.114-I of the Central Bank of January 11, 2004. Most of these requirements had already been in place before the 1998 crisis. However, it turned out that many banks, including the top 15 banks, had actually failed to meet these requirements. This is presumably due to the lack of transparency in the banks’ accounting system and lax supervision by the Central Bank. The report of the Central Bank on the inspection of banks in the rst half of 1998 (i.e. the period immediately leading to the banking crisis) revealed various violations and non-fullments of the prudential requirements. “In many credit organisations, the capital was articially inated by an inaccurate reection of the nancial activities on the balance sheet”. “In almost all credit organisations, the true nancial state of the borrower was not evaluated”. Arranging of security for lending was also reportedly inappropriate.62 The failure of the Central Bank in supervising credit organisations was duly acknowledged by the Bank in the “Basic Directions of Unied State MonetaryCredit Policies for 2001”. The Bank declared that: Measures to improve the requirements for the licensing of credit organisations should be taken. Special care should be taken in analysing the nancial state of the founders of the institution and examining the possible inuence of interrelationship between the founders. The Bank intends to analyse more carefully the structure of the real owners of credit organisations and the capability of the institutions to implement prudential regulations after the reorganisation procedure, and more strictly assess the quality of bank management . . . . . . The Bank intends to strengthen supervision so that the real state of affairs of credit organisations is reected on the accounts and reports . . . Efforts should be continued to oust those banks from the market which do not have the capability to survive and whose existence in the mar-

62

Informatsionnoe soobshchenie of the Central Bank, August 20, 1998.

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ket negatively affects the condence of creditors and investors. Efforts to liquidate banks whose licence has been withdrawn should be strengthened.63

However, the situation has not changed much. As late as 2004, an IMF report pointed out as follows: Circumvention of prudential requirements is common. Lending through nominee companies is used to formally comply with prudential norms on large exposures and can overinate capital . . . Triangles of indirect lending to nal borrowers through other banks are used to formally meet exposure limits to single borrowers, as well as liquidity requirements.64

Poor accounting practice is a serious problem. The Russian Accounting Standard which tends to overestimate capital and assets and less stringent denition for capital ownership and interested-party transactions is still commonly used. Around 200 banks publish nancial statements in accordance with the International Financial Reporting Standards, but usually with a signicant lag.65 In 2004, the government launched a programme to address the various weaknesses of the banking sector. Bank supervision has shifted towards risk-based supervision and strengthened through increased use of qualitative judgment by supervisors, expanded supervision on a consolidated basis, and tightened procedure for connected lending, and enforcement of denitions of bank capital.66 The new system of supervision on the one hand, substantially reduced the sheer volume of reporting, but on the other hand, it requires that the banks meet prudential norms daily, rather than on specic reporting dates. They may be required to provide information on their compliance at any time.67 “Fit-and-proper” requirements for bank ofcers and owners were tightened. The Central Bank is empowered to inspect credit organisations and issue binding orders. In cases where credit organisations acted in breach of laws or normative acts, the Bank may demand these institutions to rectify the violation, impose nes up to 0,1% of the minimum capital, or restrict a specic activity of the institution for up to 6 months.

63 64 65 66 67

The Central Bank, Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politili na 2001 god., 2001. IMF, supra, August 10, p.49. Ibid., p.49. Ibid., p.51. W.Tompson, “What Kind of “Financial Safety Net” for Russia? Russian Banking Reform in Comparative Context”, Post Communist Economies, 2004 No.2, p.123.

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If the credit organisation in question fails to comply with the order of the Bank to remove violations, and also in cases where the violation or the operation by the institution created a real threat to the interest of the depositors, the Bank is empowered to: i)

impose nes up to 1% of the paid-in capital (but less than 1% of the minimum capital); ii) demand the credit institution to implement measures for nancial rehabilitation, including restructuring of the assets, and/or replacement of the management; iii) change the mandatory numerical requirements for the institution for the period of up to 6 months; iv) prohibit the credit institution from performing banking operations included in the licence for up to 1 year or prohibit opening of a branch for the same period; v) initiate temporary administration for up to 18 months; vi) withdraw licence.

(Art.75, the Law on the Central Bank) Table 12 Measures applied to Credit Organisations in 2004 Preventive Measures Sending the senior management information re: insufciency of their activities and recommendation for rectication Meeting with the senior management Other measures Compulsory measures Fines For the non-compliance with the reserve requirement Breach of other mandatory norms of activities Restrictions on banking operation Inducing deposits by individuals Payment of tax and other mandatory duties on behalf of juridical persons Prohibition of banking operation Inducing deposits by individuals Others Demands To comply with the mandatory numerical requirements To replace the senior management Others Prohibition of opening an afliate ofce Introduction of temporary administrator Withdrawal of licence (Central Bank, 2004 godovoi otchet, p.232)

1,175 373 174 460 224 300 81 59 32 57 34 52 764 71 6 753 50 1 33

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BANK CONFIDENTIALITY

8

The Law on Banks and Banking Activities protects condentiality of banking information (bankovskaia taina). However, as exceptions, banks and other credit organisations are obliged to provide information on the banking operations and account details of juridical persons and individuals engaged in entrepreneurial activities to the following institutions (Art.26): i) ii) iii) iv) v)

9

ordinary courts; commercial courts; Accounting Ofce of the Russian Federation; Ministry of Tax and Levies and the tax police; investigating agencies with the approval of the procurator on an ongoing case.

RESTRUCTURING AND LIQUIDATION OF CREDIT ORGANISATIONS

In the aftermath of the banking crisis of 1998, the Law on the Insolvency of Credit Organisations was enacted in February 1999 as a special law to the Law on Insolvency. The Law provides for 1) measures for the prevention of insolvency of credit organisations, and 2) special rules (in relation to the general insolvency procedure) on bankruptcy and liquidation procedure for credit organisations. Measures for the prevention of insolvency are (Art.3): (a) nancial restoration; (b) interim administration; (c) reorganisation.

Those measures for the prevention of bankruptcy are to be applied if the credit organisation has: i)

failed to satisfy a monetary claim of a client more than once in the past 6 months, and/or failed to make mandatory payments for up to three days, due to absence or insufciency of funds in the corresponding account, ii) failed to satisfy a monetary claim of a client and failed to make mandatory payments for more than three days, due to absence or insufciency of funds in the corresponding account, iii) allowed absolute decrease of its own capital by 20% as compared to the highest amount in the last 12 months and at the same time, failed to satisfy one of the numerical requirements of the Central Bank, iv) failed to full the capital adequacy requirement, or

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v)

failed to full the liquidity requirement for more than 10% in the past 10 months (Art.4).

These preventive measures are applicable when “defects of the activities of the credit organisations do not directly threaten the interest of creditors and depositors”.68 If the grounds for preventive measures emerge, the management of the credit organisation is under an obligation (under the threat of criminal penalty) to take these measures. The Central Bank is empowered to demand that the credit organisation in question takes those measures if any of the above grounds emerge, and also to initiate interim administration (Art.3, para.2).

1)

Financial Restoration

Financial restoration can take the following forms (arts.7 and 8): i)

granting of nancial assistance to the credit organisation by the founders and other persons; ii) changing of the structure of assets and debts; iii) changing of the organisational structure.

The changing of the structure of assets and debts includes the improvement of loan portfolio, curtailing of costs and expenses of management, and sale of assets (Art.9). The changing of organisational structure includes shedding personnel and abolition of subdivisions and branches (Art.10).

2)

Interim Administration

Interim administration is a procedure initiated by the Central Bank which is introduced when credit organisations have: i)

ii)

68

failed to satisfy a monetary claim of a client and failed to make mandatory payments for more than seven days, due to absence or insufciency of funds in the corresponding account, allowed absolute decrease of its own capital by 30% as compared to the highest amount in the last 12 months and at the same time, failed to satisfy one of the numerical requirements of the Central Bank,

Tromov, supra, p.11.

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iii) failed to full the capital adequacy requirement, iv) failed to full the liquidity requirement for more than 20% in the past month, v) failed to comply with the order of the Central Bank to replace the management, or measures of nancial restoration or reorganisation within the established period, or vi) there is a ground for withdrawal of the licence in accordance with the Law on Banks and Banking Activities (Art.17).

During the period the body of interim administration is in operation, the incumbent management’s power can be restricted or suspended (Art.16). In cases where the power of the incumbent management is restricted, the interim administrator takes part in working out the measures for nancial restoration and supervises its implementation (Art.21). If the power of the incumbent management is suspended, the administrator replaces the management and basically performs the function of the interim administrator under the general Insolvency Law (Art.22).

3)

Reorganisation

The Central Bank may demand that credit organisations reorganise themselves. Reorganisation takes the form of mergers (Art.32). The other law in this area is the Law on the Restructuring of Credit Organisations also enacted in 1999. In fact, the Agency for the Restructuring of Credit Organisations was founded earlier in 1999, but its power was dened later by this Law. ARKO is a non-prot organisation – a “state corporation” – nanced by the state (Art.28). The Law denes “restructuring” as “complex measures adopted by credit organisations for overcoming their nancial instability and restoring capability of payment or measures for implementing the procedure for liquidation of credit organisations’ (Art.2, para.1). For the purpose of implementing these measures, ARKO was created. Credit organisations can be transferred to the management of ARKO if the shortfall of the capital adequacy is less than 2%, but has failed to satisfy a monetary claim of a client and/or failed to make mandatory payments for more than 7 days, due to the absence or insufciency of funds in the corresponding account (Art.3). The Law provides for the investigation of credit organisations and their restructuring. Investigation is conducted by ARKO in order to determine the possibility of taking the given credit organisation under its management after receiving a proposal from the Central Bank (arts.6 and 7). Once ARKO accepts the proposal, it may adopt the decision to decrease the capital of the credit

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organisations to the level to meet the capital adequacy requirement or increase the capital (Art.10). ARKO has the power to: i) ii) iii) iv)

take measures for nancial restoration of credit organisations; increase and decrease the capital of credit organisations; take decisions of the reorganisation of credit organisations; sell or otherwise dispose of the shares of credit organisations which belong to ARKO; v) initiate an action in court for recognising transactions effected by credit organisations within the last three years as null and void; vi) extend loans, place deposits, provide security, and other nancial assistance to credit organisations; vii) implement other measures to restore the nancial status of credit organisations; viii) implement procedure for liquidation of credit organisations. (Art.14, para.1)

However, it is reported that ARKO lacks the necessary resources to complete its task, and the power struggle with the Central Bank continually impairs ARKO’s work.69

69

Alexandrovich, supra, p.104.

12 NATURAL RESOURCES LAW

1

THE OWNERSHIP OF SUB-SOIL RESOURCES

The present Constitution of the Russian Federation has two relevant provisions on natural resources. One involves the ownership of natural resources and the other relates to their possession, use and disposal. In the socialist period, natural resources were exclusively owned by the state. In contrast, the Constitution of the Russian Federation of 1993 provides that land and other natural resources are used and protected in the Russian Federation as the basis for the life and activities of the people who live in the territory. They may belong to private, state, municipal, or other forms of ownership (Art.9). Natural resources in this context include land, sub-soil, water resources, forest and other plant resources etc.1 However, the provisions of the Civil Code and other laws are slightly different from the Constitution. The Civil Code provides that land and other natural resources which do not belong to individuals, juridical persons, or municipalities, are state property (Art.214, para.2). Thus, there is a “presumption of natural resources as state property”. Furthermore, while land can be owned by individuals and juridical persons by virtue of the Land Code, the Sub-soil Law provides that sub-soil including the underground space as well as useful minerals (iskopaemoe), energy and other resources are state property. The Civil Code provides that land and other natural resources can be assigned or transferred to another person in so far as it is permitted by law (Art.129, para.3). However, the Sub-soil law declares that sub-soil blocks may not be an object of purchase and sale, gift, inheritance, contribution, pledge, or be assigned in any other manner. The right to use sub-soil, on the other hand, can be assigned to the extent permitted by Federal law (Arts.1-2, para.2). In contrast with unextracted resources, resources which have been extracted may remain

1

V.V.Lazarev, Nauchno-prakticheskii kommentarii k Konstitutsii RF, Moscow 2001, p.63.

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under the ownership of the state, constituent entities, and the municipality as well as to private entities. Another provision in the Constitution which concerns natural resources is the provision on the demarcation of the power of the Russian Federation and the constituent entities. There are matters which fall within the exclusive jurisdiction of the Federal State and which fall within the joint jurisdiction of the Federal State and constituent entities. “Possession, use and disposal of land, sub-soil, water and other natural resources” the joint jurisdiction of the Federal State and constituent entities (Art.72, para.1). In the period of separatism of constituent entities in the 1990s, there was a controversy between the Federal government and constituent entities over the control of natural resources. The provision of the Constitution on the joint jurisdiction over their possession, use and disposal, is an outcome of compromise between the Federal government and the regional powers. The assertion of power by the regions on natural resources can be seen in the laws of various constituent entities which contradict the Federal Constitution and law. The Sub-soil law of the Komi Republic of 1992 has many original provisions which directly contradict the Federal law.2 The Constitution of the Republic of Altai which declared that land, sub-soil and other natural resources were the property of the Republic which was found to be unconstitutional by the Federal Constitutional Court in 2000.3 This system of joint jurisdiction over natural resources was reected in the 1995 Production Sharing Law which adopted the “dual key system” in which both the Russian Federation and the relevant constituent entities were given power to sign the agreements. However, under the Putin administration, the Law was amended in 2004 and now, only the Russian Federation is the party to the production sharing agreement. The same applies to Sub-soil Law which was amended in 2005 to abolish the dual key system.

2

THE SUB-SOIL LAW

The basic law in the area of natural resources is the Sub-soil Law (zakon o nedrakh). Since the Tsarist period, this area of law had been called “mining” law, e.g. the Mining Statute (Gornyi ustav) of the Russian Empire and the USSR Mining Statute (Gornoe polozhenie) of 1927. The term “subsoil (nedra)” came to be used widely since the Principles of Legislation on Sub-soil of the USSR

2 3

A.I.Perchik, Gornoe pravo, second edition, Moscow 2002, pp.44-61. Decision of the Constitutional Court, June 7, 2000, No.10-P.

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and Constituent Republics of 1976, followed by the RSFSR Sub-soil Code. However, “Russian jurisprudence was not ready for the development of indigenous mining legislation and the utilisation of foreign experience was needed” at the time of the collapse of the socialist system. Nevertheless, according to a Russian specialist, a sufcient body of laws regulating the use of sub-soil has developed in 5-6 years.4 The Sub-soil Law which was enacted in 1992 was the rst piece of such legislation in the post-socialist period. Although this Law was not dissimilar to the 1976 Law, there was a major novelty, i.e. the introduction of the licensing system for the use of sub-soil. The use of sub-soil has always been subject to permission since the Tsarist period. The same applied to the 1927 Statute, although it was based upon a contractual system whereby the terms of use were agreed in a contract with the government. However, with the end of the New Economic Policy, sub-soil was provided to enterprises simply through administrative procedure. The 1992 Law did not return to the contractual model, but formalised the administrative procedure of providing sub-soil by introducing a single licensing system. Since the 1992 Law was fairly general and actually a rework on the 1976 Law, a major reform soon became necessary. In 1995, a new version of the 1992 Law was enacted. Although it took the form of the amendment of the 1992 Law, practically all the provisions were amended, and some new provisions were introduced.5 The Sub-soil law provides for the use of sub-soil based upon the licensing system, but also refers to production sharing which is regulated by the Production Sharing Law. Sub-soil block is provided to investors on the basis of a license or a production sharing agreement (Art.7). The use of a specic block can be restricted or prohibited on the ground of national security and protection of the environment (Art.8). An example is the restriction based upon the Law on the State Border which requires that commercial activities in the border area which involve border crossing or other interests of the state not to harm the health of the inhabitants, the ecological and other security of the RF as well as of the neighbouring countries, or obstruct the maintenance of the state border or the activities of the border control. Those who are entitled to use sub-soil are “entities of entrepreneurial activities” including simple partnership ( prostoe tovarishchestvo), foreign individuals and juridical persons” (Art.9). Simple partnership is dened in the Civil Code

4 5

A.I.Perchik, Gornoe pravo, second edition, Moscow 2002, pp.11-12. Ibid., p.101.

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as a group of persons who contribute and participate in joint activities without forming a juridical person. A consortium of companies is an example of simple partnership. This provision leaves room for the restriction of the scope of people who are entitled to use subsoil on the basis of Federal law. The use of sub-soil is on a payment basis. The sub-soil Law provides for the following payments for the use of sub-soil resources (Art.39): i) ii) iii) iv) v)

lump-sum payment for the use of sub-soil; regular payments for the use of sub-soil; payment for the geological information on sub-soil; fee for the participation in the auction or tender; fee for the issuing of license.

Sub-soil Law provides for the State licensing system. A license is a document which certies the right of its possessor to use the sub-soil of a certain area in accordance with its purpose for a certain period and in compliance with the agreed terms (Art.11). Granting of a license presupposes the preliminary consent of the body which administers the relevant land or its owner on the use of land. The granting of the license can be a decision of the Federal government, or a joint decision of the Federal and regional administrative agencies (Art.10-1). In principle, licenses are granted on the basis of a tender or an auction for the right to use sub-soil. In a tender, the criteria for the selection of the licensee is the scientic-technical level of the programme, completeness of the extraction of minerals, contribution to the socio-economic development of the region, the necessary time for the realisation of the programme, effectiveness of the measures for the protection of sub-soil and environment as well as the consideration of national security of the Russian Federation. The primary criterion for the winner of an auction is the amount of payment (Art.13-1). Until 2004, a tender or auction was organised jointly by the Federal Ministry and the relevant regional authority. However, reecting the move towards centralisation, since 2005, tenders and auctions are conducted by the Federal Agency for Sub-soil Use.6 Sub-soil can be provided for an indenite term or for a xed period. Before the 2000 amendment to the Sub-soil Law, licenses were granted for exploration for ve years, and for production, 20 years. A combined license for 25 years was also available. The current Law does not explicitly provide for a combined license, but such licenses are still granted.

6

“Dec 14, 2005: Oil and Gas Exploration and Production: Russian Legislation”, in American Chamber of Commerce in Russia, Doing Business in Russia, online version.

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The right to use sub-soil can be transferred to another person in cases where the company merged with, or absorbed another company. In cases where the company with a license was absorbed by another company and ceased to exist, the remaining company may retain the license provided that the company fulls all the requirements as a user of sub-soil and has qualied experts, as well as nancial and technical resources for safely carrying out the work. The same applies where a business company acquired a bankrupt company which had a license. In cases where the license holder sets up a new juridical person in order to continue activities in compliance with the license, the new entity may continue the use of sub-soil, provided that assets needed for the activities were transferred to the new entity, the new entity has a license, and the share of the previous license holder in the new entity is no less than 50% (Art.17-1). In cases of transfer of the right to use sub-soil, the license needs to be reissued. The right to use sub-soil is terminated by the expiry of the license period, surrender of license by the licensee, or the breach of terms at the time of reissuing of the license. In addition, the right to use subsoil can be either terminated early, suspended, or restricted by the licensing agency in the following cases (Art.20): i)

emergence of a direct threat to the life or health of the people who work or live in the area; ii) breach on the part of the licensee of essential terms of the licence; iii) repeated violations by the licensee of rules for the use of sub-soil; iv) Occurrence of an emergency situation such as an epidemic and military action; v) failure on the part of the licensee to commence the use of sub-soil on a preagreed scale within the agreed time; vi) liquidation of the licensee; v) failure of the licensee to submit reports required by Russian law.

The decision to terminate, suspend or restrict the use of sub-soil can be contested in court. Termination of the production sharing agreements is governed by the Production Sharing Law, and not the Sub-soil Law. The Sub-soil Law also provides for means of dispute settlement. Disputes are settled by administrative agencies, courts, and commercial courts. This provision previously did not refer to commercial arbitration. By a subsequent amendment, commercial arbitration was added as an alternative in disputes. However, this provision limits the dispute to be arbitrated to “nancial disputes” only (Art.50).

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Earlier, the Ministry of Natural Resources was the sole agency in charge of the implementation of the Sub-soil Law. The Ministry of Economic Development and Trade was responsible for the production sharing projects. However, as a result of the “Administrative Reform” by President Putin in 2004, another ministry – the Ministry of Industry and Energy was granted power to prepare government policy and normative acts in the area of all “fuel and energy complexes”. The previous PSA Commission, which was a coordinating body of ministries and regional entities, was abolished. Instead, this Ministry was made the “authorised body” concerning production sharing. The Ministry of Natural Resources was made an agency which carries out the function of preparing government policy and normative acts in the area of sub-soil use, protects the environment and ensures ecological safety. There are two relevant bodies under this Ministry – the Federal Agency for Sub-soil Use, and the Federal Service for the Supervision of the Use of Nature. The former is in charge of sub-soil licensing. Concerning production sharing, the latter is responsible for supervising and controlling the rational use and protection of sub-soil.7 The latter has been active investigating the alleged breach of environmental law by Sakhalin 2 production sharing project.

3

LICENSING SYSTEM V. PRODUCTION SHARING SYSTEM

After the collapse of socialism, it was felt that foreign investment and technology were needed for the development of natural resources in Russia. The problem was the legal form that foreign investment was to take. A new model of legal regulation of exploration, development and production of natural resources was sought. The system available under the Sub-soil Law of 1992 was the licensing system, whereby the government granted entrepreneurs the right to explore and develop sub-soil block. The relationship between the host government and the investor falls within the realm of public law. It is the prerogative power of the state to grant such sub-soil rights to investors. As a collolary, the state is entitled to revoke the license in a unilateral manner. The terms of the license are susceptible to changes by legislation. Foreign investors were apprehensive of the licensing system, since it seemed to provide little stability for investment. In a country like Russia at that time where legislative change was frequent, tax law was underdeveloped, and bureau-

7

N.V.Frolova, “Gosudarstvennoe upravlenie neftegazodobyvaiushchim kompleksom Rossii”, Neft’, Gaz, i pravo, 2006 No.1, pp.15-17.

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crats were wielding broad discretionary power, this system was thought to be unacceptable for foreign investors. There were two alternatives: concession and production sharing. A draft concession law was prepared and discussed in at parliament, but was superseded by the Production Sharing Law. In a concession contract, the state, unlike in production sharing, acts as a subject of prerogative power and grants private entities rights to perform certain activities reserved to the state, such as the right to explore, develop and produce natural resources for a xed period. The contract is governed by administrative law, not by private law.8 Concession was referred to in the 1991 Foreign Investment Law of the RFSFR as one of the possible forms of foreign investment. After an abortive attempt to enact a concession law to cover natural resources projects in the 1990s,9 concession law re-emerged after more than a decade as the Concession Contract Law covering infrastructure projects in 2005. As the name of the Law indicates, it has shifted from the arena of public law to private law. However, it now explicitly excludes natural resources projects from its coverage. Production sharing was rst introduced in Indonesia in the 1960s. Since then, it had spread to over 65 countries in the world.10 The Russian Federation was the rst among the CIS countries to enact the Production Sharing Law. Among the CIS countries, other than Russia, Ukraine and Kazakhstan have a Production Sharing Law. In 1993, a presidential decree on production sharing was adopted in Russia. However, due to the political divide on the desirability of this system, it took another two years until the Law on Production Sharing was adopted. In the meantime, several oil and gas projects based upon the production sharing scheme took place. These are Sakhalin 1 and 2, and Khariaga projects. Contracts were signed before the adoption of the Production Sharing Law in 1995, but they are “grandfathered”, i.e. agreements concluded before the Law took effect are implemented in accordance with the agreed terms there. Provisions of the Law are applicable only to the extent that it does not contradict the terms of the agreement and does not restrict the right of the investor based upon the agreement (Art.2, para.7). It should be noted that since the adoption of the Law, there has not been any new production sharing project which is operational. The Law on Production Sharing denes production sharing as follows (Art.2, para.1):

I.A.Drozdov, Dogovory na peredachu v pol’zovanie prirodnykh resursov, Moscow 2001, pp.98-102. 9 J.Zvorykina, “Building an Efcient Concession System for Russia”, Capital Perspective, November-December 2001, pp.33-35. 10 Y.Shchukin, “Update on PSA Legislation: A Russian Perspective”, BISNIS Bulletin, April 2001, p.5. 8

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NATURAL RESOURCES LAW

Production sharing is an agreement by which the Russian Federation provides the investor on a payment basis and for a xed period, an exclusive right to explore, develop and produce natural resources in the block indicated in the agreement, and the investor is under an obligation to carry out the work at the investor’s expense and risk. The agreement determines all the necessary terms concerning the use of sub-soil, including the terms and procedure of production sharing between the parties in accordance with the present Law.

This arrangement is different from the traditional scheme based upon licensing in the following ways. Firstly, a production sharing agreement is a civil law contract between the host country and the investor(s). The present Civil Code explicitly provides for the possibility of the state entering into a contract with a private entity. The Russian Federation, constituent entities of the Russian Federation, and local self governments (municipalities) are entitled to be a party to civil law contracts (Art.124, para.1). These entities are liable under their obligation for the assets they own (Art.126, para.1). The Production sharing law provides as follows: Rights and duties of the parties to a production sharing agreement which have civil law characteristics shall be determined by the present Law and the civil legislation of the Russian Federation.

This is in contrast with the licensing system in which the relationship between the host government and the investor is governed by public law. A relationship governed by civil law is preferred by investors to a public law relationship, because in the former, the host country and the investor are on an equal footing and bilaterally bound by an agreement, whereas in the latter, there is no guarantee that the host country will not unilaterally change the arrangement, e.g. withdraw the licence. The withdrawal of a licence may be subject to court appeal, but investors have doubts about the neutrality of Russian courts. It is thought that in the production sharing regime, the position of the investor would be more stable than in the licensing regime. Furthermore, under the licensing system, the right of the licensee is not transferable, whereas under the production sharing system, rights of the investor may be transferable. As the above denition in the Law makes it clear, parties to the production sharing agreement can negotiate and agree to share the output of the project. Particularly important is that a “special tax regime” is applicable to such projects. Instead of paying various taxes and duties whose rates may change during the life time of the project, the investor may simply share the products with the host government in a predetermined ratio. In this way, taxes and other payments are

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“replaced by a share in the product”.11 This effectively shields the investor from frequent changes to tax laws. On the other hand, this may cause antagonism in Russia, since the scheme may be seen to give favourable tax treatment to foreign investors. Thus, the attraction of the production sharing system is that it provides the investor with a relatively stable regime in a complex and rapidly changing legal and political environment.12 The Production Sharing Law was enacted in 1995 after a erce and prolonged struggle at the Duma. Opponents of the Law argued that the system would result in a loss of revenue to the state, based upon a misunderstanding that investors were to be granted tax exemptions and privileges. The power struggle between the Federal government and the regions also affected the legislative process. While supporters of the production sharing system intended to replace the licensing system with it, opponents of the production sharing system endeavoured to maintain the licensing system based on the Sub-soil Law. The Law which was eventually adopted was a product of political compromise, and as such, was confusing and contradictory. What was more, the Law lacked consistency with the existing laws such as the Sub-soil Law. The production sharing system represents an autonomous regime, shaped by the agreement of the parties. This means that it involves a special regime, different from the general rules accommodated in the laws such as the Sub-soil Law, the Law on the Continental Shelf, the Law on Exclusive Economic Zones, the Water Code as well as various tax laws. However, few changes were brought to the relevant laws. Thus, the Production Sharing Law was not really workable.13 It was not surprising that a major amendment was contemplated shortly after its adoption. Draft amendments to the Production Sharing Law and related laws had been submitted to the Parliament in 1996, but they remained there for three years. The delay in amending the imperfect Production Sharing Law and in removing contradictions with related laws affected existing investors heavily, and discouraged prospective investors. Some companies withdrew from the planned projects.

S.Sosna, Kommentarii k federal’nomu zakonu o soglasheniiakh o razdele produktsii, Moscow 1997, p.10. 12 D.Slade and E.Chung, Production Sharing Legislation in the Russian Federation: A Current Assessment’, OGLTR, 1998 issue 4, p.123. 13 N.L.Platonova, Nauchno-prakticheskii kommentariii k Federal’nomu zekonu “O soglasheniiakh o razdele produltsii”, Moscow 2002, predislovie, in the on-line version. 11

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Finally, a compromise was reached against the backdrop of the nancial crisis in Russia, and in early 1999, a major amendment to the Production Sharing Law was adopted. Shortly afterwards, the long-awaited amendments to the related laws were enacted. However, although there were some positive changes such as an increase in the autonomy of the production sharing regime, onerous requirements to foreign investors such as the local contents requirement were introduced. Another problem was the delay in the adoption of normative acts which enable production sharing to become operational. Acts such as the rules on cost recovery, liquidation funds, and customs matters were seriously delayed.

4

THE PRODUCTION SHARING LAW

1)

Autonomy of the Production Sharing Agreement

One of the major advantages of the production sharing system is that it constitutes an independent and autonomous regime based upon an agreement, which is free from arbitrary interference by the host government. Terms of production sharing should be negotiated by the parties solely within the framework of the Production Sharing Law, and not that of the Sub-soil Law. However, this was not fully achieved in Russia. The original Production Sharing Law (as enacted in 1995) had provided that terms of the use of sub-soil, provided by the production sharing agreement should not contradict the requirements of the Sub-soil Law (Art.3, para.2). The Production Sharing Law provides that relations which are not regulated by the Law, including relations emerging from the use of land and other natural resources, should be governed by the Sub-soil Law and other legal acts of the Russian Federation. On the other hand, relations which emerge from exploration, development, and production of mineral resources, the sharing of productions, as well as transportation, renement, storage, use, sale and other means of disposal, are to be regulated by the production sharing agreement (Production Sharing Law, Art.2, para.2). Another problem is that the Production Sharing Law required the investor to obtain a licence under the Sub-soil Law. This is not consistent with the nature of production sharing, since production sharing is supposed to be based upon a contract (a production sharing agreement) and not on a licence. The Production Sharing Law provides that the use of sub-soil under a production sharing system is based upon a contract (Art.4, para.1). However, it also provides that a licence which “certies” the right to use sub-soil is to be granted by the government within 30 days of the signing of the contract (ibid., para.2). According to the

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Sub-soil Law, the licence is a document which certies the right to use sub-soil. This requirement of a licence in a production sharing project is regarded as a major inconsistency.14 Investors prefer to avoid having the licence revoked unilaterally by the government. In this respect, the original Production Sharing Law had provided that the licence to use sub-soil was to be terminated on the grounds provided by the Production Sharing Law and the Sub-soil Law. The 1999 amendment to the Production Sharing Law strengthened the autonomy of the production sharing regime to a certain extent. Firstly, the amended Law provided that the terms of the use of sub-soil established by the agreement should coincide with Russian Legislation. Specic reference to the Sub-soil Law was dropped. Secondly, concerning termination, it is now provided that the right to use sub-soil blocks can be restricted, suspended, or terminated in accordance with the terms of the agreement concluded in accordance with Russian legislation (Art.3, para.2). Again, there is no specic reference to Sub-soil Law. There was no change to the Production Sharing Law concerning the assignment of a licence, but the Sub-Soil Law was amended to the effect that the assignment of the right to use the block to entities involved in entrepreneurial activities on the basis of production sharing and the rewriting of the licence for the use of the block are to be effected in accordance with the Production Sharing Law (Art.17-1, para.3).

2)

Parties to the Production Sharing Agreement

Parties to the production sharing agreement are the Russian Federation on the one hand and investors on the other. The Russian Federation is represented by the Federal Government. Investors can be juridical persons, as well as a consortium of juridical persons without juridical personality who invest in the exploration and development of mineral resources and are users of sub-soil under the production sharing agreement (Art.3, para.1). The original Law referred to foreign juridical persons, but this has been dropped in the 1999 amendment. In cases where investors form a consortium, the Production Sharing Law provides that in such cases, the participants are jointly and severally liable vis à vis the Russian Federation (ibid., para.2). The original Law required that both central and the local government should represent the host government – the “dual key” system – emanates from the Constitution which provides that the Federation and the constituent entities jointly

14

Sosna, supra, p. 47.

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decide on the issues of possession, use and disposal of sub-soil. The Sakhalin 1 and 2 agreements were signed by the President of the Russian Federation and the Governor of Sakhalin Province. This system of dual representation was dropped by the 2004 amendment, and now, the Federal government alone represents the host country. For the coordination of activities related to production sharing, a managing committee must be set up (Art.7, para.7). Both parties are entitled to be represented by an equal number of members. The Russian side was to be represented by an equal number of representatives from the Federal and the regional levels, but by the 2004 amendment, the requirement of equal representation of both levels was abolished. While the original Law left the determination of the composition and power as well as the procedure of the committee to the production sharing agreement, but this was also amended in 2004. It is now the power of the Federal Government to determine these matters.

3)

Blocks available for production sharing

The list of blocks which are offered for production sharing, as a rule, must be established by law. In November 2001, 27 blocks were approved by Parliament to be offered for production sharing. These included 21 oil elds, 2 gas elds, 3 gold elds, and 1 iron ore elds. By 2003, 17 laws which enable certain blocks to be offered for production sharing have been passed. However, by virtue of the 2003 amendment, the scope of blocks available for production sharing has been signicantly narrowed. The current version of the Law provides as follows (Art.2, para.4): The basis for the inclusion of the list of blocks in which the right to use subsoil may be provided in terms of production sharing is the absence of the possibility of exploration and production of useful minerals by way of other terms of the use of sub-soil as provided by Russian legislation, other than production sharing.

Thus, a block can be offered for production sharing only when there is no other alternative for the use of sub-soil. In order to conrm the absence of alternatives, an auction for the use of sub-soil in terms other than production sharing needs to be held on the basis of the Sub-soil Law. In cases where the absence of alternatives was conrmed, the block can be included in the list of blocks available for production sharing if the: i)

development of the given block secures employment for a large enterprise and the termination of the work involving the block results in a negative social consequences;

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ii)

development of the given block is needed to put the useful mineral in the continental shelf, extreme north and other equivalent areas and located in places where there is no settlement of inhabitants, transportation and other infrastructure in economic circulation; iii) development of the given block requires especially costly technology for the extraction of signicant amount of useful minerals located in difcult mininggeological conditions.

Another important change in the direction of limiting production sharing was introduced by the 1999 amendment. There is a “cap” on the total amount of reserves to be offered for production sharing. The current law provides that the reserves offered for production sharing shall not exceed 30% of the reserves of minerals prospected and accounted for by the state (Art.2, para.3). This 30% gure has been criticised as arbitrary. When the amendments were discussed, a 10% limit for strategic resources and 20% limit for other resources had been proposed; there was no economic rationale for such gures. Besides, the denominator – the total reserve accounted for by the government, is not available to the public. The register of reserves itself is based upon the Sub-soil Law. For each type of mineral in each eld, a register which contains information of the size of the reserve, its quality, the extent of development etc., is prepared. At the time of the 1999 amendment, there were around 25 blocks to be offered, the 30% limit would be almost exhausted. In the discussion for further amendments to the Law, there is a proposal to increase this percentage to 40% or to exclude the existing projects from it.15 It was suggested by government ofcials that there will be only around ve blocks available for production sharing, including the three ongoing projects.

4)

Procedure for the Conclusion of a Production Sharing Agreement

Originally, production sharing agreements were to be concluded on the basis of tender or auction. There were several exceptions to this rule. For instance, if the investor was already a user of sub-soil under other terms, tender or auction was not needed. Thus, if an investor had a licence under the Sub-soil law and has been involved in the exploration and development of sub-soil in the block, this investor was entitled to negotiate a production sharing agreement without tender or auction. In such cases, the agreement can be concluded with this particular

15

M.Subbotin, “Aktual’nye problemy sovershenstvovaniia zakonodatel’stva o soglasheniiakh o razdele produktsii’, paper submitted to the conference “Oil, Gas and Law” on November 14-15, Moscow.

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investor, or other juridical persons or a consortium of juridical persons established with the participation of this investor. However, by the 2004 amendment, this rule has changed. Production sharing agreements can be concluded only with the successful bidder in an auction. A successful bidder is the person who offered the highest amount for the right to conclude a production sharing agreement (Art.6, para.1). What is important is that since 2004, there is a requirement that the terms of the auction provide for mandatory participation of a Russian entity in the production sharing project. The share of the Russian entity in the project is to be determined by the Federal Government (ibid.). In the three ongoing production sharing projects, only Sakhalin I had signicant Russian participation. However, this has changed by Gazprom forcefully joining Sakhalin 2. In order to work out the terms of the use of sub-soil, prepare the draft agreement and to negotiate with the investor regarding each block, a special interagency commission is to be set up.

5)

Terms of the Production Sharing Agreement

The Production Sharing Law has a provision which basically covers the duties and obligations of the investor. These include: i)

implementation of the work in accordance with the programme, projects and plans, budgets approved in the way provided in the agreement; ii) implementation of the work in compliance with Russian law, standards concerning the safety of work, protection of sub-soil, environment and the health of inhabitants; iii) implementation of measures for the prevention of any harmful inuence on the environment and elimination of the outcome of such an inuence; iv) taking out of insurance for the compensation payable for the potential damage to the environment; v) liquidation of all installations, structures and other assets after completion of the work based upon the agreement and clean up the environment.

Some onerous obligations on the investor have been introduced by subsequent amendments (Art.7, para.2). Firstly, for the participation in the project as subcontractors, suppliers, and transporters, Russian juridical persons are to be given preferential rights. This provision had already been in the Law before the 1999 amendment, but there, the preferential right was limited to instances where “other terms were the same”. Russian companies were to be preferred only when the terms offered by them were the same as those offered by foreign companies. This part of the provision

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was dropped by the 1999 amendment. Now, even when Russian companies offer less advantageous terms, they will be preferred to foreign companies. Secondly, a minimum of 80% of the workers in the project must be Russian nationals. The recruitment of foreign workers and specialists is allowed only at an early stage of the project by agreement, or in cases where there are no workers and specialists who are Russian nationals. Thirdly, there is a local content requirement. 70% of the total value of the orders for equipment and materials for geological exploration, production, transportation and renement of useful minerals must be of a Russian origin. These items are regarded as those of a Russian origin only if they are produced by Russian juridical persons and/or individuals from parts and components, 50% of more of which have been produced in Russia by Russian juridical persons and/or individuals. Fourthly, when carrying out a project in the territory where ethnic minorities lead their traditional life and conduct economic activities, measures [required] provided by Federal law for the protection of their lifestyle must be taken by investors, and furthermore, compensation must be paid.

6)

Production Sharing and Taxes

The produced natural resources are shared between the state and the investors. Normally, in production sharing agreements, the products are divided into several portions. The rst portion is allocated to the host country as a “royalty production”. This varies between 10 to 15%. The second portion is the cost recovery production, which the investor is entitled to. This part is designed to cover the cost incurred by the investor. The third portion is the prot production which is to be shared by the parties.16 The Russian Production Sharing Law has a provision on prot production and compensation (cost) production. There is no royalty production; royalty is payable separately at the time of the conclusion of the contract. The Law provides that prot production is shared between the state and the investor in accordance with the production sharing agreement (Art.8). The agreement provides for the terms and procedure for determining, inter alia, the total amount of production and its value, the cost production portion, and the sharing of prot production. In such cases, the amount of cost production which is to be compensated to the investor should not exceed 75% of the total volume,

16

B.Taverne, “Production Sharing Agreements in Principle and in Practice”, M.R.David ed., Upstream Oil and Gas Agreements, London 1996, p.81.

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or in cases of projects in the continental shelf, 90%. The determination of the ratio of prot production is also to be agreed. The amount of prot production is the total product deducted by the equivalent of tax payment for the extraction of mineral resources and the cost payment for the given accounting year. It is also possible to agree on different methods of production sharing – e.g., direct sharing which was introduced to the Law by the 2001 amendment (Art.8, para.2). In this scheme, the total amount or value of the product is shared. However, the share of the investor may not exceed 68%. The investor has the title to the share of the production which has been attributed to it. Mineral resources which have been transferred to the investor can be used as collateral. In a production sharing scheme, the payment of taxes and other mandatory payments is replaced by the sharing of the production. In this regard, the original Production Sharing Law provided that with the exception of prot tax and unied social tax, the investor was exempted from taxes and duties for the period of the agreement. With the exception of the prot tax and the payment for the use of sub-soil, the investor for the period of the agreement shall be exempted from taxes and levies established by the legislation of the Russian Federation.

By the 2003 amendment, this part was deleted, and the Law now provides that in implementing production sharing, the manner of calculating and paying taxes and levies are to be determined by the Tax Code. In 2001, Chapter 26 of the Tax Code Part Two, which covers the “tax on the exploitation of mineral resources” was enacted. A chapter on the “System of Taxation in Implementation of Agreements on Production Sharing”, which provides for a special tax regime for production sharing was nally introduced as Chapter 26-4 in 2003. The Code has a lengthy list of taxes and levies which investors in a production sharing project are required to pay: i) ii) iii) iv) v) vii) viii) ix) x) xi) xii)

value added tax; corporate prot tax; unied social tax; tax on the extraction of useful minerals; levy for the use of natural resources; levy for the negative effect on the environment; levy for the use of water resources; state duties; customs tariff; land tax; excise.

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This is a long list, which makes the production sharing arrangement almost meaningless. On the other hand, the amount of value added tax, unied social tax, levy for the use of natural resources, levy for the use of water resources, state duties, customs tariff, land tax, excise, and payment for the negative effect on the environment are to be reimbursed (Art.346-35 of the Tax Code). Investors are exempted from regional and municipal taxes by the decision of the relevant regional and municipal bodies. In production sharing, investors are subject to the following payments: i) ii) iii) iv) v) vi) vii)

lump sum payment (bonuses) for the use of sub-soil at the time when incidents determined by the agreement or license take place; payment for geological information; fees for the participation in auction; fees for issuing of license; regular payment for the use of sub-soil (rentals); compensation of the cost of the government for exploration and development of mineral resources; compensation of damage caused to indigenous minority people.

Furthermore, if the project involves the use of the continental shelf, payment for the use of the continental shelf is required (Law on the Continental Shelf, Art.40).

7)

Stability of the Production Sharing Agreement – Grandfather Clause

One of the important reasons for investors preferring production sharing to conventional licensing schemes lies in its relative stability achieved by eliminating the possible changes in law and unilateral action by the host government. The Law provides that: Terms of the agreement maintain their effect for the entire period of the validity of the agreement. Changes to the agreement are allowed only by the consent of both parties except by the request of one of the parties in cases of signicant change of circumstances in accordance with the Civil Code (Art.17, para.1).

Furthermore, the Law has a “grandfather clause” which provides as follows (ibid., para.2): If, within the period of validity of the production sharing agreement, a norm which worsens the commercial outcome of the activities within the framework of production sharing is established by the legislation of the Russian Federation, its constituent entities, or legal acts of the local self-governments, the agreement shall

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be revised as if the commercial outcome which the investor could have received had the legislation of the Russian Federation, its constituent entities or legal acts of the local self-governments valid at the time of the conclusion of the agreement had been applicable. Manners of introducing such changes shall be determined by the agreement.

It should be noted that this provision is not applicable if the changes involve requirements for the safety of work, the protection of sub-soil, the environment and the health of the inhabitants. Afterwards, a similar provision was introduced in the Foreign Investment Law by the amendment of 1999. The amended Law defers for seven years the application of subsequent laws in cases of: i) changes in taxes, customs duties, or extra-budgetary contributions; ii) increase in the total tax burden of a foreign investment project; iii) introduction of a more restrictive investment regime.

8)

Dispute Resolution

The Production Sharing Law provides that disputes between the State and the investor concerning the implementation, termination and validity of the production sharing agreement shall be resolved by the ordinary court, the commercial court and arbitration institutions (treteiskii sud ). The latter includes foreign commercial arbitration institutions (Art.22). The above production sharing agreements provide for arbitration in Stockholm. In the Khariaga Project, there was a dispute involving the cost which was arbitrated in Stockholm. The parties reached a settlement in 2005.

5

PIPELINE TRANSPORTATION AND EXPORT

There is no comprehensive law which regulates oil and gas pipelines. A draft Pipeline Law was submitted to the Duma in 1999, but there has been no movement since then. The Law on Concession Contracts of 2005 lists pipeline construction as one of the kinds of projects covered by this Law. The Production Sharing Law has a provision on transportation of the products. The share of the production to which the investor is entitled can be exported in accordance with the terms and manner determined by the production sharing agreement without being subject to quotas (Art.9, para.2). This provision seemingly benets investors, but it should be noted that this is subject to the Funda-

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mentals of the State Regulation of Foreign Economic Activities which allows the introduction of export quotas under certain circumstances. This Law which was enacted in 2003 empowers the government to temporary prohibit or restrict export in order to prevent critical shortage of important goods in the internal market (Art.21, para.2, subpara.1). It also allows the introduction of necessary measures to prevent exhaustion of irreplaceable natural resources on the ground of national interest (Art.32, para.1, subpara.5). This Law has replaced its predecessor – the 1997 Law of the same title – with the accession to the WTO in view. Under the current system in Russia, trunk oil pipelines are owned and managed by a single company – Joint Stock Company Transneft’, while gas pipelines are owned by Gazprom and its subsidiaries. Transneft is a state-owned company which manages, services and is responsible for developing the trunk pipeline system. The company is charged with ensuring the transport of crude oil in appropriate volumes and by routes specied in the transportation (export) schedule prepared by the Government Inter-Ministerial Committee. The schedule is based upon annual transport contracts which producing companies negotiate with Transneft. The contracts specify the amount and quality of crude oil to be transported, the starting and nal points of shipping, routes, and the terms and schedule of payment. Quarterly and monthly allotments are calculated using the oil companies’ certicates of their own annual production. The Production Sharing Law guarantees the access of the investor to the oil and gas pipeline on a contractual basis. In reality, access to the pipelines was not always easy for foreign operators due to the pressure on Transneft by Russian oil companies. The problem is that the system of allocating pipeline capacity in this way is not transparent, due to its bias towards the government-backed programmes and all sorts of side deals. It should also be noted that the transportation of oil and gas through trunk pipelines is also regulated by the Law on Natural Monopolies. According to this Law, the right to access to trunk pipelines and terminals is granted to companies extracting oil and their parent companies.

6

THE DEMISE OF THE PRODUCTION SHARING SYSTEM

The procedure for realising production sharing projects has been poorly regulated and is complicated. Various permissions are required before concluding the production sharing agreement. For example, if the project involves the use of the continental shelf, separate permissions are required for building articial islands, installations and facilities (The Law on the Continental Shelf,

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arts.16-20). For the use of public land, which is inevitable, the Land Code provides for a procedure to obtain permission and have the land allocated. What is worse, as seen above, amendments to the Production Sharing Law since 1999 have endeavoured to “defend the rights of the Russian Federation” at the cost of foreign investors. The enactment of the Law in 1995 was not without serious obstacles in the rst place, but even after the adoption of the Law, opposition against production sharing steadily increased over the years. By the 2003 amendment, production sharing, which was once a progressive means of developing natural resources with the participation of foreign investors, was reduced to an exceptional means of utilising natural resources, which is allowed only when other terms of investment failed. The tax regime which was introduced by the amendment to the Tax Code in the same year deprived production sharing of various tax advantages. Before the 2003 amendment, there were close to 30 blocks which Parliament allowed to be offered for production sharing. However, in 2003, the government decided to reduce the scope of production sharing. It is now assumed that in addition to the three operational production sharing projects, there will be only a few projects which will be left to production sharing. Companies which have already established themselves in the blocks offered for production sharing may have to develop these blocks on ordinary terms. For example, in Sakhalin 3, the Kirinsky Block was approved by parliament to be developed by production sharing in 1999. Exxon Mobile and Texaco had been given a preferential right of negotiation in 1993, but even after 1999, there was no development in the negotiation. The US companies gave up the idea of developing the block by production sharing and opted for the licensing system. However, the Russian government announced in 2004 that there would be a tender for the license regarding this block. There are various arguments against production sharing. Firstly, many Russian people think that production sharing favours foreign investors at the cost of the Russian state. It was criticised that the existing production sharing projects failed to produce revenue to the state, while the cost was running uncontrollably high. An expert referred to the three ongoing projects based upon production sharing and reminded the readers that in these projects, the Russian state owed 60 million US dollars to foreign investors for the obligation to reimburse value added tax. In addition to many items of the cost are recoverable from the production as compensation share.17 The Government Audit Chamber published a report in conjunction with the regional tax agency on production sharing projects on the Sakhalin Island comparing these projects with the use of sub-soil under

17

Platonova, supra, Predislovie . . .

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a conventional scheme. It pointed out that the two projects had reduced the revenue at the Federal level by 50 billion US dollars. Cost overrun has been a problem in Sakhalin 2 and Khariaga projects. In July 2006, the Minister of Natural Resources criticised delays in starting production and cost overruns and pointed out as follows:18 This is harming the interest of the Russian Federation, because it defers to a later date the sharing of oil prots between the state and investors and causes the costs of the project to rise.

In 2005, the Audit Chamber, as a result of the review of Sakhalin 2’s activities in 2003/2004 accused the project operator of increasing the cost of the project by buying overly expensive equipment and failing to hire from the local workforce and companies. Thus the protability of the project was lowered and the Russian budget suffered losses of at least 2.6 billion US dollars. The Audit Chamber proposed to reconsider the terms of the agreement in order to reect the “real expenses and the effectiveness of the deposit’s development.19 In 2006, an institute which is part of the Russian Academy of Natural Sciences submitted a report to the Ministry of Natural Resources regarding the existing production sharing projects. According to this report, because of the delay of the work which is attributable to the operator in the Khariaga Project, the sharing of production and the receiving of the prot share by the Russian Federation was delayed by 3-5 years. In the meantime, the cost has signicantly increased. The reasons for this state of affairs included the neglect of the interest of the Russian Federation by the operator, insignicant share of Russian companies in the consortium (only in Sakhalin 1, Russian companies have sizeable interest in the project), the incompatibility of the standard of sharing the income with the world standard etc.20 Secondly, the production sharing system allegedly lacks transparency. While the tax system is clear-cut and objective, production sharing is based upon the agreement of the parties and can be arbitrary. According to the Russian authorities, the argument that the Russian tax system is instable and therefore, production sharing bests suits investment in Russia is not applicable any more, since the tax system has become stabilised with the adoption of the Tax Code.

18 19 20

Moscow Times, July 21, 2006. Ibid., October 31, 2005. Novosti, May 25, 2006, www.mnr.gov.ru.

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PROSPECTIVE REFORM OF THE SUB-SOIL LAW

The history of sub-soil legislation in Russia can be seen as a struggle between two camps: those who support the use of sub-soil to be regulated by public or administrative law (the licensing system) and those who support this to be regulated by private law contracts. In an article entitled “the Development of contractual basis of the right to use sub-soil” published in 2004, the author pointed out that the proponents of the administrative law system start from the premise that the state, as a sovereign, is entitled not to assume obligations and not to be liable for the breach vis à vis the user of sub-soil by completely ignoring the interest of the latter. This is unsuitable in sub-soil use which involves high level of risk, an enormous amount of capital investment and a long period of recovering the cost.21 Obviously, the author is one of those experts who were behind the production sharing system, and then the concession law. However, the Concession Contract Law which was eventually enacted in 2005 expressly omitted upstream natural resources projects [for the Law on Concession Contracts, see Chapter 8]. As discussed above, the production sharing system has become marginalised in Russia. In the meantime, the replacement of the current Sub-soil Law by a completely new law came on the agenda. A government draft of the new Law was submitted to the Duma in May 2005. In November of the same year, the government withdrew this draft, ostensibly to revise the part involving strategic blocks, but this draft was never returned to the Duma. The draft Sub-soil Law was a strange mixture of liberal and conservative ideas which seems to be the outcome of a political compromise. On the one hand, it introduced a new system of sub-soil use based upon contracts. A contractual system of sub-soil use was to replace the existing licensing system. As is the case with production sharing, the contract for the use of sub-soil is, in principle, a civil law contract. This contract is to be concluded between the Russian Federation (in small blocks, with constituent entities) and the investor. Investors are to bid for the status to conclude a contract with the State. The right to use sub-soil is in principle, transferable and pledgeable. On the other hand, the draft law had some provisions on the increase of state control over sub-soil use. Parties to the contract of sub-soil use are, in principle, juridical persons established in accordance with Russian Law. Even those Russian juridical persons may be restricted to be a party, if they belong to a “group of foreign juridical persons”. The government is entitled to restrict the participation

21

B.D.Kliukin, “O razvitii dogovornoi osnovy prava pol’zovaniia nedrami”, GiP 2004 No.9, p.47.

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of foreign investors in projects involving “strategic blocks”. Foreign investors may be mandated to sell part of the products to the Russian government. Disputes arising from sub-soil projects were to be handled by Russian court. Submission of the draft Law coincided with the policy of the Russian government to impose restriction on foreign investment in some strategically signicant projects, not limited to sub-soil use. There are to be restrictions on the acquisition of “strategic assets” by foreign entities. “Foreign companies” in this context means not only non-residents, but Russian companies with foreign participation of more than 50%, or if there is a ground to believe that the given company is “acting in the interest of foreigners”.22

22

Kommersant, March 2, 2006.

13 ENVIRONMENTAL LAW

1

THE BACKGROUND TO THE 2002 LAW ON THE PROTECTION OF ENVIRONMENT

One of the basic requirements towards the users of natural resources is the protection of the environment. The Sub-soil Law lists the “prevention of pollution of the sub-soil, particularly by storing oil and gas and other toxic substances underground, or abandoning harmful substances and waste of production as well as waste water” as an obligation of the licensee (Art.23, para.1, subpara.8). Prevention of harmful effects on the environment and the removal of the result of such effects are also obligations of the investor under the Production Sharing Law (Art.7, para.2). The Russian Federation ratied the Kyoto Protocol to the UN Convention on Climate Change in 2004 and was thus instrumental in bringing the Protocol into effect. However, if one looks at the state of the environment in Russia, the picture is rather gloomy. It has been generally acknowledged in Russia that the country has been in a state of “environmental crisis” for some years.1 Concerning atmospheric pollution alone, according to the National Report on the State of the Natural Environment of 2004 prepared by the Ministry of Natural Resources, “in 203 cities, concentration of a certain substance exceeded the permissible level”. The average concentration of formaldehyde and benzin perinoyd were 2.6 and 2.8 times higher than the permissible level.2 30% of the tested water resources failed to meet the chemicalhygenical standards.3 The State Sanitary Inspectorate reports that almost half of the inhabitants in Russian are forced to drink water which is not compatible

1 2 3

M.M.Brinchuk, Ekologicheskoe pravo, institutions, second edition, Moscow 2005, pp.25-31. Gosudarstvennyi doklad o sostoianii okruzhaiushei prirodnoi sredy v RF v 2004 godu, p.9 www.mnr.gov.ru. Doklad, supra, p.96.

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with the hygienical standards. This crisis is attributed to various causes including the absence or decit of the will to implement consistent and the lack of effective measures for the protection of environment on the part of the government, underdeveloped legislation and rights in this area, defective organisation of administration, “an extremely low level of legal consciousness, ecological knowledge and culture”.4 On the other hand, facing economic and budgetary difculties, Putin administration is reported to have reduced the funding allocated for environmental protection.5 The Constitution of the Russian Federation has a provision which guarantees the right of the people to a favourable environment (Art.42): Everyone has the right to a favourable environment, to truthful information on the state of the environment, and to compensation for damage caused to his health or property by violations of an ecological nature.

The Constitution also makes it a duty of the people to preserve nature and the environment, and to deal with natural wealth with care (Art.58). The right to a favourable environment of the people presupposes an obligation of the state to take necessary legislative and administrative measures to ensure that these rights of individuals are realised.6 The rights covered by Article 42 are realised via Federal laws and subordinate acts. The rst comprehensive law in the area of the protection of the environment was the RSFSR Law on the Protection of the Natural Environment of 1991 (hereinafter, “the 1991 Law”).7 The 1991 Law was enacted at the very end of the socialist period, based upon the abortive USSR Law on the Protection of the Environment. Despite the fact that it was prepared at the nal stage of socialism, the 1991 Law marked a new stage of the development of Russian ecological legislation. It is regarded in Russia as having laid the basis of the progressive development in this area by taking into consideration the changing political, economic, ecological, and social conditions of the development of the society and the state in the modern period.8 Indeed, it contained some new ideas such as the economic mechanism for the protection of the environment, ecological review and environmental monitoring, as well as environmental agreements between the entrepreneurs and

4 5 6 7 8

Brinchuk, supra, pp.35-37. US Environmental Information Agency, “Russia: Environmental Issues”, www.wia.doc.gov. V.V.Lazarev ed., Nauchno-prakticheskii komenntarii k Konstitutsii Rossiiskoi Federatsii, Moscow 2001, p.42. Law No.2060-1 of December 19, 1991. M.M.Brinchuk, “O golovnom akte ekologichskogo zakonodatel’stva”, GiP 2001, No.11, p.65.

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the local government. Furthermore, for the rst time in Russian environmental law, the ecological rights of individuals were given appropriate coverage. This was not surprising, since Russian had been facing serious environmental problems towards the end of the 1980s such as the diminution of the Aral Sea and the Chernobyl disaster. A need for environmental protection had been acutely felt even by the Socialist regime.9 Nevertheless, it was evident that the 1991 Law in its original form was not sufcient to deal with environmental issues in the rapidly changing circumstances. Many of its provisions were intended to have direct effect, but in fact, they did not fully have such an effect. Therefore, the implementation of the Law had to wait until other laws and subordinate legislation were enacted. This process was slow, and in the meantime, many provisions of the Law remained “declaratory”. There were “vacuums”, for example, the concept of environmental impact assessment, which had been introduced in the late 1980s by subordinate legislation, was not accommodated in the 1991 Law. There were ambiguities as to the demarcation of the competence of Federal and regional agencies, and an unclear denition of the rights and duties of the entrepreneurs carrying out activities which may affect the environment.10 Changes to the 1991 Law were also required because of the legislative developments after the enactment of this Law. Many laws relevant to the environment, including the Law on Ecological Review of 1995, the Sub-soil Law of 1995 etc. have been adopted since then. The 1991 Law had to be brought into line with these laws. Naturally, the Constitution, which was enacted after the 1991 Law, had to be taken into consideration too. The major directions of the proposed changes included the following: i)

strengthening of the ecological rights of individuals with the broadening of the possibility of them inuencing the state of the environment and the activities of the state agencies as well as ofcials; ii) expansion of the scope of environmental information; iii) creation of a well-proportioned system of state administration of the quality of the environment with a coordinating agency at the top; iv) strengthening the economic mechanism for preventing pollution; v) introduction of the concept of environmental impact assessment (OVOS) in the Law; vi) expansion of the ecological function of municipalities.11

M.M.Brinchuk and O.L.Dubovik, “Federal’nyi zakon “ob okhrane okruzhaiushchei sredy”: teoriia i praktika”, GiP, 2004 No.3, p.31. 10 S.A.Bogoliubov, Kommentarii . . . supra, p.viii. Brinchuk, supra, p.65. 11 Bogoliubov, Ekologicheskoe pravo, Moscow 2000, p.70. 9

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In October 2000, the draft Law was approved in the rst reading of the Duma. It was unclear whether there would be a completely new Law or merely amendments and supplements to the 1991 Law until quite late. At the rst reading, there was a proposal to enact a new law instead of changes and supplements to the 1991 Law, which was welcomed by the government.12 In addition, there were those who supported a comprehensive “Environmental Code” such as the Tax Code which incorporates all the laws covering the environment.13 However, even as late as 2001, the National Report published by the Ministry of Natural Resources referred to the forthcoming law as the “Law on the Introduction of Changes and Supplements to the 1991 Law”.14 It took more than a year for the draft to go through the second and third readings. On December 20, 2001, the new Law on the Protection of the Environment was adopted by the Duma. It came into force on January 16, 2002 (hereinafter, “the 2002 Law”).15 Although the 2002 Law was a completely new law and was not merely amendments and supplements to the 1991 Law in its appearance, if one looks at the substance, there does not seem to be much progress since 1991. Some new concepts which had existed in practice, but were not covered by the 1991 Law, such as environmental insurance, environmental certicates etc. were incorporated in the 2002 Law, and some inconsistencies of the 1991 Law with the later legislation were removed. However, as will be seen below, the 2002 Law is far from sufcient or perfect. Russian experts pointed out in 2003 that the 2002 Law was a step backwards in ecological legislation. It is worse than the 1991 Law.16 The shortcomings of the Law include various provisions of a declarative nature only, ambiguity of concepts as well as the failure to regulate the procedure involving environmental standards, ecological review etc.17 In addition to the Law, according to the Annual Report on Environment, there are 70 Federal laws and 4,000 subordinate acts involving the use of nature and the protection of environment.18 The relevant laws include the Law on the Protection of Air and the Water Code.19 The multiplicity of laws and subordinate act causes confusion, and a new Ecological Code is now being prepared.

12 13 14 15 16 17 18 19

Kanal Dumy, www.akdi.ru. Brinchuk, “O golovnom akte . . .”, supra, p.75. Gosudarstvennyo doklad 2000 . . ., supra, www.mnr.gov.ru., p.299. Law No.7-FZ of January 10, 2002. Brinchuk and Dubovik, supra, p.40. Ibid., pp.34-39. Doklad 2004, supra, p.358. Law No.96-FZ of May 4, 1999; Law No.74-FZ od June 3, 2006.

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OUTLINE OF THE 2002 LAW

2

The 2002 Law sets out some basic principles at the beginning. To be sure, these are not the principles on which the Law is based, but the principles which the government as well as private entities should observe when they are carrying out economic and other activities which affect the environment. The 2002 list itself is much more extensive than the 1991 Law. It includes the following (Art.3): i) ii)

observance of the right of the people to a favourable environment; scientically based combination of the ecological, economic and social interests of the people, society and the state for the purpose of ensuring consistent development and a favourable environment; iii) protection, reproduction and rational use of natural resources; iv) independence of control in the area of environmental protection; v) presumption of ecological risk of the planned economic and other activities; vi) mandatory environmental impact assessment for taking decisions on economic and other activities; vii) mandatory ecological review of the plans and other documents which serve as a basis for economic and other activities which may have a negative impact on the environment, create risks to the life, health, or property of individuals; viii) mandatory participation of social and other non-commercial organisations in the activities of state agencies in the area of environmental protection; ix) observance of the right of individuals to receive truthful information on the state of the environment and to participate in decision-making involving their right to a favourable environment.

Most of the above principles had already been there in the 1991 Law, but in a more general manner. A conspicuous omission in the 2002 Law is the “priority of the protection of the life and health of individuals and the ensurance of a favourable environment for the life, labour and leisure of individuals”, which was on top of the list in the 1991 Law. This may symbolise a retreat from the rather idealistic approach of the 1991 Law. The list is also of signicance to the problem of ecological review. One of the shortcomings of the 1991 Law was the ambiguity of some of the concepts accommodated there. A typical case was the concept of ecological review (ekologicheskaia ekspertiza), particularly how this differed from the environmental impact assessment. Both concepts were new to Russia when the 1991 Law was enacted. The former was covered by the 1991 Law, but the latter was not. It was not clear whether the two institutions were one and the same, or different. A novelty of the 2002 Law in this respect is that both are mentioned in the above list in the Law, and thus it is made clear that they are different. Environmental

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impact assessment was made mandatory (ecological review was already mandatory under the 1991 Law) by the 2002 Law.20 Another novelty in the list of principles is the “presumption of risk” in economic and other activities. This provision was already accommodated in the 1995 Law on Ecological Review (Art.3), but has been incorporated in the 2002 Law. Whether this principle has any real meaning, e.g. the shift of the burden of proof in environmental litigation or increasing the burden of the entrepreneur in the environmental review, is not clear in the laws. The above list emphasises the participation of individuals as well as social organisations in the protection of environment more than the 1991 Law. The 1991 Law merely referred to “glasnost’ (transparency)” in a general manner. Furthermore, reecting the Constitutional provision, the observance of the right to receive truthful information on the state of environment is also provided. In terms of the underlying idea of the law, the absence of the concept of “sustainable growth” from the 2002 Law is conspicuous. In the area of environmental protection, there is always a conict between economic development and the protection of the environment. Following the UN Environmental Conference in Rio de Janeiro in 1992, the El’tsin administration endorsed the concept of “sustainable development (ustoichivoe razvitie)” in a presidential decree in 1996.21 This is about striking a balance between the interests of economic and social developments and the protection of the environment, but 6 years later, the balance may have shifted. V.A.Grachev, the Chairman of the Duma’s Committee on Ecology, which prepared the draft of the 2002 Law, referred to sustained development when presenting the bill for the rst reading, but the Law itself does not seem to have any imprint of this idea. The 2002 Law provides for specic rights of individuals after reiterating Article 42 of the Constitution (Art.11). These include: i)

the right to create social organisations, funds and other non-commercial organisations in the area of environmental protection; ii) the right to send a petition to state or local agencies for timely, full and truthful information concerning the state of the environment in the place of the individual’s residence and measures for its protection; iii) the right to take part in meetings, processions, demonstrations, picketing, petitions etc. concerning the protection of environment, which are not against Russian legislation;

20

21

There is still some confusion between ecological review and environmental impact assessment. In a paper presented at an international conference in 2005, an ofcial of the Rosstekhnadzor referred to “environmental impact assessment (ecological review)”. Ekologicheskoe pravo: sbornik dokumentov, Moscow 1998, pp.368-373.

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iv) v) vi)

vii)

409

the right to propose a social environmental review and to take part in it; the right to assist the state and local agencies in solving problems regarding the protection of the environment; the right to lodge appeals, or to present petitions and proposals to the state and local agencies regarding the protection of the environment from negative impact and to receive a timely and reasoned reply; the right to bring an action in court for compensation for environmental damage.

Whether the 2002 Law marks any signicant progress in this respect is questionable. A conspicuous omission in the 2002 Law is the following provision which had existed in the 1991 Law: [the right to] require via administrative or court procedure the revocation of a decision concerning the siting, projecting, construction, reconstruction and exploitation of ecologically harmful objects, and also to require restrictions, suspension, or termination of activities of enterprises and other objects which have negative effects on the environment and the health of the people (Art.12 of the 1991 Law).

It may be the case that since this right is vested with individuals anyway in the Land Code and the general law concerning judicial review of administrative decisions, it was not necessary to cover it in the 2002 Law. But then, the same should apply to other rights in the list which are also based upon other laws, and there is no reason why only this right has to be excluded from the list. Another important change regarding the right of individuals is the right to an injunction. In the 1991 Law, there was an explicit provision which allowed individuals to seek an injunction against ecological harmful activities which cause damage to the health or property of individuals, the economy, or the natural environment, although its actual scope of application was less clear (Art.91, para.1). There have been such actions by environmental groups. The latest action involved an injunction against the Sakhalin I project for the protection of a rare specie of whales.22 This provision was omitted from the 2002 Law, which merely refers the matter to the Civil Code. This seems to suggest that the government is rather apprehensive of the possible ood of litigation against major national projects by groups of individuals. The 2002 Law provides that in cases where the siting of buildings, installations and other objects affects the lawful interests of individuals, the decision is adopted by taking into consideration the result of the referendum held in the

22

Moscow Times, February 23, 2002.

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respective area (Art.35, para.3). The 1991 Law provided for “discussions or referendum”, but the 2002 Law refers to referendum only. Concerning the right to petition for information, the current list limits the information to the state of the environment in the place of the individual’s place of residence. This was not the case in the 1991 Law.

3

ENVIRONMENTAL STANDARDS AND THEIR ENFORCEMENT

Chapter 5 of the Law provides for environmental standards. There are three types of such standards: i) ii)

qualitative standard of the environment; maximum permissible standard of negative impact on the state of environment; iii) standard for maximum permissible extraction of natural resources.

Concerning the qualitative standards of environment, the Law provides that there are three kinds of such standards, i.e. chemical, physical and biological (Art.21). The standards are called “maximum permissible concentration (PDK)” or “maximum permissible level (PDU)”. At the moment, there are numerous such standards, e.g. for atmosphere alone, 500.23 There are six types of maximum permissible standards of negative impact on environment, including the standards for disposal of toxic substances, permissible level of noise and vibration, permissible level of using fertilisers etc. (Art.22). Standards for negative impact on the state of environment serve as a basis for regulating the compliance with the qualitative standards of environment.24 However, there is no detail of the mechanism of setting such standards or actual numerical standards in the Law. According to the Law, the standards are set by the procedure established by the government (Art.19, para.3). There are a number of government decrees which provide for such standards. There is a general requirement of compliance with environmental standards in siting, planning, constructing, reconstruction, introducing into operation, operating, conserving and liquidation of buildings, installations and other objects. Failure to full such requirements may result in the suspension of these activities by an administrative order. Total termination of such activities is available by a court decision (Art.34).

23 24

Brinchuk, Ekologicheskoe pravo, second edition, supra, p.220. Ibid., p.221.

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For the breach of environmental law, Chapter 14 of the Law provides for nancial, disciplinary, administrative, and criminal sanctions. Administrative sanctions primarily take the form of administrative nes which are not substantial. The maximum amount of ne which can be imposed on juridical persons is merely 3,000 times the minimum wage. The Federal Service for the Supervision of Ecology, Technology and Nuclear Activities exposed 4,909 breaches of the law in the last three months of 2004, of which 2,111 involved disposal of dangerous wastes. Administrative sanctions (nes) were imposed in 1,340 cases, and an action was brought to court for the recovery of damages in 9 cases.25 Concerning criminal sanctions, the Criminal Code contains a chapter on “ecological offences”. However, provisions of the Criminal Code are applied to offences such as unlawful hunting, shing, or felling of trees, ad are seldom applied to pollution of water and atmosphere, and thus regarded by experts to be ineffective. In fact, these minor offences constituted 98.3% of “ecological offences” in 2000.26 Those who caused harm to the environment by pollution etc. are under an obligation to compensate the full amount of damage. The Federal Service of the Supervision of the Use of Nature inspected the compliance of environmental regulations of Zapadno-Sibirskii Metallurgicheskii Kombinat. The result showed that the Kombinat had substantially exceeded the maximum permissible limits of disposing of polluting substances such as aluminium, magnecium, etc. into the rivers which are the source of water supply of the City of Novokuznetsk. The Agency was ordered to pay 121 million roubles for the negative effect caused to the environment. The Kombinat was also ordered to install purication devices at its own cost at the pain of suspension of activities.27

Under the Civil Code, persons who are engaged in activities involving increased danger to the environment bear the burden to prove that they had not acted by intention or negligence. Industrial enterprises which emit toxic substances into the environment are qualied as a source of increased danger.28 Whether or not the given enterprise or company is involved in “activities with increased danger” is a matter to be determined by the court “on each specic case independently”.

25 26 27 28

Doklad 2004, supra, pp.375-377. Brinchuk, Ekologicheskoe pravo, second edition, supra, p.369. Novosti, March 30, 2006. www.mnr.gov.ru. Abanina et als., supra, p.453.

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Enterprises which emit toxic and other harmful substance into the environment are regarded to be involved in activities with increased danger.29 Specialised Marine Inspectorate of Kamchatka region brought an action vis à vis a limited liability company “Partner” and a closed joint stock company “Vostoktransservis” for compensation of 1,152,545,625 roubles for polluting water with oil products. “Vostokotransservis” owns a tanker “Siluet”. “Partner” concluded a contract with “Vostokotransservis” to transfer 1,500 ton of diesel oil to the shore from the tanker. There was an accident in this process and diesel oil was spilt into the water. The oil spread for 500 metres in diameter and 10-12 centimetres in thickness and thus polluted the water of the Channel of Korf. The court found only “Vostoktransservis” liable for compensation, since the tanker proceeded with the transfer of diesel oil without conrmation of readiness from the “Partner”. The liability of “Vostoktransservis” is based upon its status as the owner of the source of increased danger.30

In a project which had a positive conclusion of state ecological review, the damage is to be compensated by the owner of the project. If the tortfeasor is an entrepreneur, compensation is paid in accordance with a xed rate and methods. In their absence, the compensation is calculated on the basis of the actual cost of restoring the environment (Art.77). For instance, concerning the spillage of oil from a trunk pipeline, there is a method of determining the damage caused to the environment, established by the then Ministry of Fuel and Energy in 1995.31 Those who caused negative effects on the health or property of individuals as a result of economic and other activities are liable for full compensation. Details are left to the tort law, which is part of the Civil Code [see Chapter 10]. In reality, 20-30% of the illness of the Russians are directly caused by pollution. However, compensation to the people for the damage to their health usually takes the form of subsidy for their temporary loss of capability to work.32 Apart from imposing administrative sanction on those who are in breach of environmental law, authorities occasionally bring the case to court for the suspension of operation:33 Closed Joint Stock Company Tsepruss, Limited Liability Company Nemanskii TsBK and Open Joint Stock Company Sovetskii TsBZ were found to be the primary pollutors of a region in the Baltic Sea. They were dumping waste water which con-

29 30 31 32 33

Decision of the Plenum of the Supreme Commercial Court, October 21, 1993. Decision of the Presidium of the Supreme Commercial Court, July 20, 1999, Case 7431/98. Abanina et als., supra, p.444. Brinchuk, Ekologicheskoe pravo, second edition, supra, p.381. Novosti, July 31, 2006. www.mnr.gov.ru.

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tained various substances very much above the permissible range of concentration. The Federal Service of the Supervision of the Use of Nature repeatedly inspected these companies and initiated the procedure for imposing nes. Furthermore, the senior management of these companies were given orders to eliminate the breach of the law and to install purication devices. In the end, the Federal Agency instructed its territorial agency to initiate an action in court to suspend the operation of these companies.

4

STATE ECOLOGICAL REVIEW

Economic development and the protection of the environment come into conict particularly when economic activities such as natural resources projects or infrastructure projects which may have a signicant impact on environment are carried out. The problem is not only where the balance should be struck, but whether there is a functional system to mediate between such different and conicting interests. One of the key institutions in this respect is the system of ecological review (ekologichekaia ekspertiza), which is designed to check the compatibility of economic activities with the environmental requirements before allowing the planned activities to go ahead. Ecological review is intended to screen such activities and prevent excessive harm to the environment. An embryonic form of state ecological review had existed under socialism. It was introduced as a “preventive measure” against negative impacts on the environment. It was only in the late 1980s that a positive conclusion of the state environmental review was made a prerequisite to the nancing of projects.34 The 1991 Law accommodated some provisions on ecological review, including one which made it a mandatory prerequisite to the adoption of “economic decisions”, the implementation of which may have harmful effects on the natural environment. The nancing and implementation of all projects and programmes were prohibited without a positive conclusion of the ecological review. However, the Law failed to give any details of ecological review and merely provided that the purpose of the state ecological review was to verify the compatibility of economic and other activities with environmental safety. Details emerged only in 1995, when a separate Law on Ecological Review was enacted.35 This Law dened ecological review as a system of ascertaining the compatibility of the planned economic and other activities with the ecological requirements, and the determination of the permissibility of the realisation

34 35

A.K.Golichenkov, Ekologicheskii kontorl’: teoriia, praktika, pravovogo regulirovaniia, Moscow 1992, pp.58-66. Law No.174-FZ of Novermber 23, 1995.

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of the object which is under the review with the goal of preventing possible unfavourable impacts on the environment or unfavourable social, economic and other consequences (Art.3). However, the concept was still not necessarily clear, particularly in that there was confusion between environmental impact assessment and ecological review.36 Whether they were the same, or different institutions was not clear in the law. In fact, preceding the 1995 Law on Ecological Review, the Statute on the Environmental Impact Assessment was endorsed by an edict of the government in 1994. This was an outcome of the ratication of the International Convention on the Assessment of the Impact on the Environment in a Trans-border Context by Russia in 1991. The preamble of this Statute refers to Article 41 of the 1991 Law which provides for ecological review, and not environmental impact assessment. There was no legal basis to it, since no reference had been made to environmental impact assessment in the 1991 Law. Even in the 1995 Law on Ecological Review, there was only an indirect reference to it. Details were given by the 1994 Statute, approved by a ministerial order (prikaz) which was replaced by the new Statute on the Environmental Impact Assessment of 2000.37 Even in legal literature, the coverage of ecological review was brief, and reference to the environmental impact assessment was seldom found.38 It was only in a book published in 2002 that a chapter on the “environmental impact assessment and ecological review” appeared.39 The 2000 Statute denes environmental impact assessment as the process of facilitating the administrative decisions regarding the realisation of the planned economic and other activities by means of determining the potential negative inuence on the environment, assessment of the ecological consequences, consideration of public opinion, and working out measures to reduce or prevent negative effects on the environment (1.1). Although the law was ambiguous and confusing, ecological review and environmental impact assessment were in practice two different institutions in Russia. Ecological review is conducted by an expert committee which is set up on a project by project basis by the “empowered agency” for environmental protection.

Iu.R.Khramova, “K voprosu o pravovykh problemakh osushchestvleniia ekologishcskoi ekepertizy”, GiP, 2000, No.8, p.13. 37 Order of the State Committee on Ecology, May 16, 2000. 38 E.g. N.N.Vedenin, Ekologicheskoe pravo, Moscow 2000, pp.76-82; Iu.V.Truntsevskii and N.E.Savvich, Ekologicheskoe pravo, Moscow 2002, pp.83-88. 39 O.I.Krassov, Ekologicheskoe pravo, Moscow 2002, pp.204-240. 36

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In the ecological review of the draft agreement for the development of Komsomol’sk oil eld on a production sharing basis, the expert committee examined the possible impact of the project on the environment. It was pointed out that the production and transportation of hydrocarbon fall within the category of high environmental risks with the probability of accidents. The project failed to take into account Russian legislation in the area of environmental protection. The contract lacks a clause which provides for the obligations of the investors to take measures for the prevention of harmful effects on the environment and the removal of such effects. After examining the technical and economic justication for the project, the expert committee found the operator to be unsuitable. In conclusion, the basic goal and concepts of the project were positively appraised by the committee, but a revision of the draft agreement was recommended.40 A project to extract gips was found by an expert committee to be impermissible, since the extraction of gypsum from below the level of underground water may affect one of the world’s largest salt lakes. The conclusion of the committee was that the proposed project was not sufciently prepared – the assessment of the impact on the lake was insufcient and the technology was not yet proven. The company was advised to rework the project.41

Entrepreneurs who intend to start economic activities such as the exploitation of natural resources, construction of buildings and installations, or infrastructures, must prepare materials for the review. These materials include “documents which contain information on the assessment of the impact on the environment of the economic and other activities under ecological review” (Art.14, Law on Ecological Review). Environmental impact assessment is conducted by the entrepreneur and submitted to the expert committee which carries out an ecological review. The outcome of the environmental impact assessment is one of the objects which is examined in the process of ecological review. The ecological review is not immune from outside pressure: In the ecological review of the project for a high speed train link between Moscow and St.Petersburg in the 1990s, there was allegedly “psychological pressure” from those specialists who prepared the technical and economic basis (TEO) of the project and the head of the train company on members of the expert committee. The conclusion of the committee was appealed to the Federal Procuracy which made some recommendations to the Ministry.42

40 41 42

Order of State Commission on Ecology, No.24, January 28, 1997. Novosti, June 21, 2006. www.mnr.gov.ru. M.M.Brinchuk, Ekologicheskoe pravo, rst edition, Moscow 1998, p.329.

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The Ministry of Natural Resources reported that in a meeting of the territorial agency of the Federal Service for the Supervision of the Use of Nature and the deputy head of this Agency, it was agreed that the Agency would provide assistance to the companies involved in the construction of the North European gas pipeline. The conduct of the ecological review will be regarded as the priority task and the review will be carried out in the rst place. The last review did not nd anything against the environmental law.43

Concerning environmental impact assessment, according to the 2002 Law, it is conducted in relation to the planned economic or other activities which may directly or indirectly have inuence on the environment (Art.32). Environmental impact assessment is mandatory for adopting decisions concerning the implementation of economic and other activities (Art.3). Details of the system are again left to the subordinate legislation. It is not clear from the Law, for example, who is to conduct the environmental impact assessment and at what stage it should be conducted. The same applies to ecological review. There is only a very brief provision on ecological review (Art.33). Even in comparison to the 1991 Law, the coverage of ecological review is scarce. As a Russian expert pointed out, the Law lacks details as well as procedural rules.44

5

PROCEDURAL ASPECTS OF ECONOMIC ACTIVITIES

In Russia, the process of carrying out economic activities which potentially affect the environment is complicated for various reasons. As explained above, basic institutions such as environmental impact assessment and ecological review are not properly regulated by law. The 2002 Law does not seem to have brought about much improvement here. Furthermore, the procedure is governed by many different laws relevant to the protection of environment, such as the Land Code and the Water Code, the Law on the Exclusive Economic Zones or the Law on the Continental Shelf, which are often contradictory and/or overlapping. There is no coordination among them. Deciphering the system requires a careful reading of laws and subordinate acts. This is indeed an unfriendly system both for citizens and entrepreneurs. When an entrepreneur embarks on the process of carrying out economic activities such as the exploration and exploitation of natural resources or the construction of infra-structures, enterprises and other installations (hereinafter, “the

43 44

Novosti, April 12, 2006. www.mnr.gov.ru. Brinchuk, Ekologicheskoe pravo, second edition, supra, p.93.

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project”), before reaching the ecological review stage, there is a procedure for the allocation of land for the project. It is the Land Code which covers the allocation of land, while there is a whole range of laws including technical standard laws, and sanitary and hygiene laws, which are involved. If the project involves the continental shelf, the Law on the Continental Shelf is applicable. The entrepreneur is to apply to the state agency or the municipal agency for the selection of the land for this purpose and the preliminary allocation of land for the project. This only applies when the land involved is state or municipal property, but normally, the project cannot be carried out solely by private property, and will involve state or municipal property (Land Code, Art.31, para.1). There is some confusion regarding the sequence of the procedure. The 1991 Law added some further requirements: the site for the construction of the buildings, structures, installations etc. should be selected on the basis of positive conclusions of the “empowered agencies” in the area of environmental protection and the sanitary-hygiene inspectorate (Art.41, para.2). The 2002 Law provides that the site should be selected when there is a positive conclusion of the state ecological review (Art.35, para.2). However, according to the Land Code, the site is selected before the ecological review. The Land Code was enacted only in late 2001, shortly before the 2002 Law! After the site is selected and the preliminary allocation is made, the entrepreneur must prepare the “technical-economic justication (TEO)” of the project. This is the equivalent of a feasibility study. It is regulated by a 1995 instruction approved by the Ministry of Construction.45 The TEO presupposes the acquisition of licenses and permissions from the various agencies involved. These include the agencies in charge of internal affairs, defence, nance, transportation, labour, and health. They are not limited to the federal agencies: local agencies are involved too. This is where the environmental impact assessment comes into play. The TEO includes the environmental impact assessment as an independent component.46 Preparation of the TEO is usually entrusted to a subcontractor. Although it is not clearly stated in the law, environmental impact assessment is part of the TEO. In the process of preparing the environmental impact assessment report, the public is widely consulted. The next stage is the state ecological review. The review is conducted by an expert committee. The members are selected by the agency in charge of ecological review specically for each project. External experts who have academic

45 46

SNiP, 1995 No.11, item 101. M.I.Vasil’eva, “Problemy zashchity obshchestvennogo interesa v ekologicheskom prave”, GiP 1999 No.8, p.60.

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knowledge or practical expertise are invited.47 In the review, the TEO containing the environmental impact assessment and the plans for the given economic activities are examined. All the licenses and permissions required should be obtained and submitted for the review (Law on Ecological review, Art.14). The committee prepares the conclusion of the review and submits it to the agency. Only when it is approved by the agency, does it become the formal conclusion of the ecological review. A formal conclusion of the ecological review is mandatory for all projects. The absence of the law which clearly sets out the above procedure is an impediment to the implementation of projects. The procedure needs streamlining and proper coverage by law.

6

RIGHTS OF INDIVIDUALS AND SOCIAL ORGANISATIONS IN THE PROCEDURE

Individuals and social organisations are given a fairly broad opportunity to take part in the process and inuence the decision, although they do not have a decisive say.48 In the rst stage of the project, i.e. the selection of the site and the allocation of land, the Land Code provides that the municipal agency is under an obligation to inform the inhabitants of the possible or impending allocation of land to the entrepreneur. Individuals and social organisations are entitled to participate in the decision-making on matters which affect the interests of the inhabitants and are related to the taking away of land for social and state needs (Art.31, para.3). The latter part of the provision is ambiguous as to whether inhabitants are entitled to take part in the decision-making which affects the interests of the inhabitants, or the decision has to involve the taking away of land at the same time. In cases where the land is allocated in the area where native minorities live and work, a traditional meeting (skhod) or a referendum can be held. The result of such a meeting or referendum must be taken into account in the decision-making process. In the process of preparing the TEO, the entrepreneur, together with the subcontractor commissioned to prepare the TEO, conducts a public hearing or a discussion in the media for the purpose of informing the inhabitants of

47

48

See, for example, the list of experts for the construction of a test well in the Caspian Sea for the Shirotnaia eld, order of the then State Committee for the Protection of Environment of November 23, 1999. S.A.Bogoliubov ed., Kommentarii k zemel’nomu zakonodatel’stvu Rossiiskoi Federatsii, Moscow 1998, pp.188-197.

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the planned project, ascertaining all the possible negative consequences, and searching for possible alternatives. As explained earlier, environmental impact assessment is part of the TEO process. The 2000 Statute on Environmental Impact Assessment provides for a broad scope of the participation of the public. The entrepreneur is under an obligation to provide information which is to be contained in the TEO report to the public and get them involved in the discussion regarding the proposed project at all stages. The preliminary result of the report is made available to the public for comments and proposals. Public hearings are to be organised, and the outcome is to be documented and attached to the nal assessment report (the Statute, 4.8). In the 2002 Law, the participation of individuals is made mandatory not only in the general process of ecological review, but also in environmental impact assessment. However, this has been the case since the 1994 Statute. At the stage of ecological review, materials of the discussions with the inhabitants and social organisations are considered (Law on Ecological Review, Art.14). Ecological review is, as mentioned above, conducted by the “empowered agency”. However, in addition to this state ecological review, there can be a parallel social ecological review. While state ecological review is mandatory, social ecological review is voluntary, i.e. it is initiated and paid by social organisations. A separate expert committee is set up for this. What is important is that the social organisation which is conducting the social ecological review is entitled to receive the same scope of materials which are submitted by the entrepreneur for state ecological review (arts.22 and 23). Also, such social organisations can participate in the sessions of the expert committee for the state ecological review as an observer and can take part in the discussion concerning the conclusion of the social ecological review there (Art.22, para.3). The conclusion of the social ecological review is not binding, i.e. it is forwarded to the state agency in charge of environmental protection and is also published in the media, but its negative conclusion does not hinder the project (Art.25). Those are the provisions of the Land Code, the Law on Ecological Review and some subordinate acts. What do the 1991 Law and 2002 Law, as the basic law on environmental protection provide? The 1991 Law provided that in the process of the siting of buildings, structures, installations etc., if necessary, the decision is to be adopted “as a result of discussions or a referendum” (Art.41, para.3). The 2002 Law provides that in cases where the siting of buildings, structure, installations etc. affects the lawful interests of citizens, the decision is to be adopted with the result of the referendum taken into consideration (Art.35, para.3). This is better than the 1991 Law in that the non-binding nature of the referendum has been made clear. On the other hand, the provision is not specic in what comprises the lawful interests of the citizens, nor does it dene the scope of citizens whose interests are affected. There is no clue as to whether the holding

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of the referendum is obligatory, nor are there any specics concerning the timing and the organiser of the referendum. Referenda on environmental matters, which are governed by the general Law on referendum of 1995, are not uncommon. It is reported that in Kostroma in 1996, and in Moscow in 1998, referenda were successfully held. In Krasnoiarsk, a referendum for the proposed nuclear waste disposal plant was proposed, but was rejected by the local government. The case reached the court, but the court dismissed the claim.49 The problem with citizens’ participation in the current system is that rst, participation is allowed in many different stages, and seems to be overlapping. For example, participation is required in each and every stage of environmental impact assessment and then, at the stage of ecological review. In addition to participating in the state ecological review, social organisations are entitled to conduct their own social ecological review and have the outcome considered in the state ecological review. As a Russian expert pointed out, the institution of social participation in Russia is still in the process of formation. This involves norm creation as well as social practice. In Russia, the “historical tradition of social participation has been practically absent”.50 In addition, the overlap is primarily the result of the fact that these institutions were introduced by different laws and statutes at different stages and there is little coordination among them. The system lacks consistency and makes it difcult to work.51 The 2002 Law could have rectied the situation, but failed to do so. These layers of citizens’ participation certainly delay the decision-making process in a considerable way. Instead of, or in addition to the excessive permissions and approvals which are required for projects, there is excessive participation of the public. Second, although there are various opportunities for citizens’ participation in general, specics are missing. For example, on what occasions and under what conditions does citizens’ participation becomes mandatory is not clear. At what stage a hearing should be held, and by whom (is it the entrepreneur or the municipality, or the “empowered agency”?) is not specied either.52 The right of individuals and social organisations is not limited to participation in the decision-making process. They are entitled to contest the decision in court. There has been a fairly signicant number of cases where various decisions such as the allocation of land or the approval of the project were contested in

49 50 51 52

S.A.Bogoliubov, “Referendumy po ekologichskim proektam”, GiP, 1999 No.11, p.35. Vasil’eva, supra, 57. Ibid., p.60. Bogolibov, “Referendumy. . . .”, supra, p.32.

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court. A celebrated case involved the planned St.Petersburg-Moscow High Speed Train project. Some inhabitants of Novgorod and a regional social organisation initiated an action against the Administration of Novgorod and the High Speed Train company, asking the court to recognise the decision of the administration to allocate land to be void. The grounds for the action were that 1) a positive conclusion of the ecological review was absent, 2) the allocation of land was against the law, and 3) the right of the inhabitant to a favourable environment was infringed. The City Court dismissed the claim on the ground that 1) there was no violation of the Land Code, and 2) the infringement of the right of the inhabitants to a favourable environment was not proved. The court did not address the problem of the absence of a positive conclusion of the ecological review. The case eventually reached the Supreme Court, which acknowledged the absence of the ecological review and ruled in favour of the plaintiff.53

7

AGENCIES IN CHARGE OF ENVIRONMENTAL PROTECTION

Neither the 1991 Law nor the 2002 Law species the state agency which is in charge of environmental protection. It is in fact common in Russian legislation not to specify the agency which is in charge of implementing a specic law. The agency in charge is simply referred to in an abstract way such as the “Federal executive body” or “especially empowered agency”. Presumably this arrangement is intended to avoid the amending the law every time the agency in charge changes. In the area of environment, the agency in charge at the Federal level is the Ministry of Natural Resources. The agency in charge of environmental protection has changed from time to time in and after the Soviet period. The problem has been whether the utilisation of natural resources and the protection of the environment should fall within the portfolio of the sane agency or not. In 1988, the USSR State Committee on the Protection of the Environment was founded as a separate agency. After the collapse of the Soviet Union, both functions merged into the Ministry of the Use of Natural Resources and the Protection of the Environment. In the early 1990s, this became the Ministry of the Protection of the Environment and Natural Resources. In 1996, this Ministry was abolished, and its functions were divided into two agencies: the Ministry of Natural Resources and the State Committee on the Protection of the Environment (goskomekologii). However, in 2000, the State Committee for the Protection of Environment was abolished by a presidential decree, and its power was transferred to the

53

Vasil’eva, supra, p.52.

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Ministry of Natural Resources, which is the “basic user of natural resources”. The Ministry was not renamed. The protection of the environment does not appear in the name of the Ministry as it did before 1996.54 The move has been criticised by some, who regard this as a result of pressure from the powerful companies in the industry which maintain that environmental regulations are hampering economic development. Environmentalists argue that this is tantamount to “putting an alcoholic in charge of a vodka shop”.55 At the time the draft 2002 Law was being discussed, the deputy Minister of the Ministry of Natural Resources addressed such apprehensions and assured that there was a separate administration for the protection of the environment within the Ministry. However, this may not be sufcient. Ecological review, which is a mandatory prerequisite to economic activities which may negatively affect the environment, used to be approved by the Goskomekologii until it was abolished in 2000. After 2000, it was approved not by the head of the State Environmental Protection Administration, but by the Minister of Natural Resources. Organisation of the administrative apparatus in charge of environmental protection took another twist in 2004 as part of the “administrative reform” under the Putin administration. Since the reform, the agency generally in charge of supervision of the compliance with environmental requirements is the Federal Service of Supervision for Ecology, Technology and Nuclear Power (Rosstekhnadzor). This is an agency which is directly subordinate to the government ( pravitel’stvo) and is separate from any ministry. On the other hand, within the Ministry of Natural Resources, there are four agencies involved in the protection of the environment. These are the Federal Service for the Supervision of the Use of Nature (Rosprirodonadzor), the Federal Agency for Forestry, the Federal Agency for the Use of Sub-Soil, and the Federal Agency for Water Resources. Rosprirdonadzor has jurisdiction covering certain natural resources, such as water pollution including the sea, continental shelf and exclusive economic zones as well as the use of sub-soil.56 However, the demarcation of power of these agencies is not clear. According to the 2004 Annual Report, the Federal Service for the Supervision of the Use of Nature completed and approved 27 cases of ecological review in 2004, in which one contained a negative conclusion.57 It also carried out the review of the TEO of a neutron observatory near the Lake Baikal and project of sewage plant in the City of Baikalsk.58

54 55 56 57 58

V.V.Guchkov ed., Ekologicheskoe pravo, Moscow 2000, p.67. www.ecoterra.org.ru Doklad 2004, supra, pp.375, 379. Ibid., p.395. Ibid., p.395.

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On the other hand, the Federal Service for the Supervision of Ecology, Technology and Nuclear Power also conducts the state ecological review. At the Federal level, 100 cases of ecological review reached the Agency, of which 12 have been completed. There was no negative conclusion. The most signicant case was the project for the construction of Eastern Siberia – Pacic Ocean Oil Pipeline.59 Concerning the state ecological review, the 2004 State Report pointed out the absence of a clear demarcation between the objects which are to be reviewed by both agencies and reports that in many instances, this ambiguity has led to the duplication of functions and emergence of disputing situation.60 In 2006, the Federal Service for the Supervision of the Use of Nature reviewed the Sakhalin 2 Project and studied a recommendation by a certain institute which pointed out that since “the oil/gas pipeline along the shore may be damaged by a quick ocean stream at any time”, the construction of the pipeline should be suspended.61 It even proceeded to take an action against the Ministry of Natural Resources for revoking the positive conclusion of state ecological review of the Ministry of 2003. It should be added that the revocation of the subsoil license falls within the power of the Federal Agency for the Use of Sub-Soil, and the Federal Service for the Supervision of the Use of Nature merely has the power to propose it to the committee attached to the former.

59 60 61

Ibid., 2004, p.397. Ibid., p.396. Novosti, August 3, 2006. www.mnr.gov.ru.

14 TAXATION

1

HISTORICAL BACKGROUND

The system of taxation in Russia was abolished after the October Revolution, but was restored in the 1920s in the period of the New Economic policy. After the completion of the “socialist industrialisation” in the 1930s, tax was gradually replaced by “income from the socialist economy”. With the overall “étatisation” of the economy, “direct administrative methods” were used for siphoning off the prots of state enterprises and redistributing them through the budget. In addition, indirect tax in the form of circulation tax (nalog s oborota) occupied a signicant part of the income of the state. It was only towards the end of socialism when individuals were ofcially allowed to be involved in entrepreneurial activities as individual entrepreneurs or members of a cooperative that direct tax on individuals was introduced in a large scale.1 At the end of 1991, Russia embarked on the path of scal reform. New taxes were introduced in succession. These included the tax on the prot of enterprises and organisations, value added tax, and individual income tax. In the same year, a brief law on the Basis of the Taxation System was enacted.2 The tax system in Russia has been notorious for its failings which include: i) ii) iii) iv) v)

1

2

excessively large number of Federal and local taxes; frequent changes in the law and its interpretation; broad taxable basis and narrow scope of deductible expenses; vague and contradictory provisions of tax laws; poor and often unfair enforcement.

D.G.Chernik, Nalogi, Moscow 1994, p.31; A.Ia.Sukharev ed., Iuridicheskii entsiklopedicheskii slovar’, Moscow 1984, p.183; I.I.Kucherov, Nalogovoe pravo Rossii, Moscow 2001, pp.1721. VS NDRF i VS RF, 1992 No.12, item 604.

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An OECD report pointed out as follows: Russia’s tax system has performed very poorly since its creation in 1991 for a number of reasons. To start with, it is a cumbersome system. The nominal tax rates are very high. There are numerous exemptions for a wide range of favourably treated taxpayers. Emergency tax commonly involves draconian penalties, but these penalties are applied at the discretion of the ofcials. The entire system is open to abuse and corruption. Regional authorities routinely issue guidelines that contradict centrally issued instructions, where the latter exist. In the absence of clear legislation and procedure, tax inspectors have tended to act autonomously, leading to a very uneven treatment of taxpayers . . . . . . Not surprisingly, the outcome is a tax system which fails to produce adequate revenue to government. Furthermore, it impedes growth, puts off foreign and domestic capital and drives investment under ground.3

Indeed, at the initial stage, government policy was to make the taxable basis as broad as possible. Various kinds of Federal taxes were introduced; the number reached fty at one stage.4 Between 1994 and 1997, agencies of constituent entities and municipalities introduced more than 100 taxes and levies which were not provided by the then Basic Law on the Taxation System.5 The quality of the tax laws introduced in the early 1990s was far from perfect. They were prepared only within several months and amendments had to be contemplated immediately after their enactment and before their taking of effect. Shortage of time, absence of knowledge of international experience in shaping the tax system, and uncertainty of the future course of structural reform of the economy were the primary cause of such defective legislation.6 Various changes which, between 1992 and 1999, were introduced every year in the tax legislation merely succeeded in solving some partial problems, but failed to address fundamental issues. The system was simply characterised as “unstable and unpredictable” and gave rise to severe criticism from Russian companies as well as foreign investors.7 For most of the time since 1991, the system was regulated not only by laws, but by over one thousand subordinate acts, i.e. decisions of the government, instructions, letters, explanations of the tax authorities. Due to the sheer number of these acts, it was difcult to be guided by them in a specic case. In some cases, interested parties contested the validity of such subordinate acts in the

3 4 5 6 7

OECD Observer, No.215, January 1999. Kucherov, supra, pp.22-23. R.F.Zakharov et al. eds., Kommentarii k nalogovomu kodeksu RF, Moscow 2005, p.88. S.D.Shatalov, Razvitie nalogovoi sistemy Rossii, Moscow 2000, p.10. Ibid., p.11.

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Constitutional Court and the Supreme Court; in some cases, the courts acknowledged their incompatibility with the law, and even with the Constitution. The lack of stability in the tax regime has affected foreign investors. In one of the rst oil projects in Russian with foreign investment – Polar Lights – the original three taxes increased to 22 with the Russian government’s take quadrupling. Moreover, there was even an attempt by the local government to take the foreign investor to court for not paying a mineral reproduction tax from which it was exempted in the original licence.8 Another celebrated case involved a tobacco company, JT International. The company was faced with a 85 million US dollars bill of value added tax from 2000. After several years of a costly struggle in the commercial court, the Company managed to reduce the amount of payment but not substantially. The need for a comprehensive tax reform had been acknowledged in Russia for some time. As the market economy developed in Russia, it became obvious that the inadequate tax system was an obstacle to the economic development of the country. Since 1996, several versions of the draft Tax Code were submitted to Parliament by the government. However, since the government proposals affected the interest of powerful lobbying groups, Parliament, under various pretexts, delayed the discussion and the adoption of these drafts.9 In the end, the government split the Code in two parts. The draft Tax Code (parts One and Two) went through its rst reading in April 1998, but only Part One was adopted in July 1998 and came into force in January 1999. Part One of the Code covers the basic system of taxation, rights and duties of tax payers and other parties such as tax agents, and the power of the tax authorities and the procedure of discharging the duties by them. The enactment of Part Two, which covers specic taxes, took more time. Four chapters of Part Two (individual income tax, unied social tax, value added tax and excise) were adopted in July 2000. In July 2001, the Chapter on prot tax was adopted. Other chapters of Part Two, including chapters on tax on mineral resources and sales tax followed. In the meantime, Part One of the Code has been amended many times.10 Despite the fact that the draft Tax Code had been “watered down” by Parliament, some important provisions and novelties were lost and doubtful provisions added in the process, the Code clearly dened the rights and duties of the “partcipants” in tax relations, and introduced provisions on the process of tax payment and control.11

8 9 10 11

The Russia Journal, June 5, 2000. Shatarov, supra, p.14. A good overview of the system is given in A.Taferner, “Tax Reform – Act II”, European Taxation, February 2001, pp.48-60. Shatarov, supra, p.15.

428 2

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THE TAX CODE

The Code provides that tax legislation in Russia comprises the Tax Code and other Federal laws enacted in accordance with the Code and furthermore, laws and normative acts of the constituent entities of the Federation as well as the normative acts of the local self-governments. Constituent entities of the Russian Federation may enact tax laws in accordance with the Federal Tax Code (Art.1). On the other hand, the Constitutional Court has ruled that since taxation restricts the right to private ownership of individuals which is guaranteed by the Constitution, taxation has to be based upon Federal law.12 Concerning the relationship between laws and normative acts enacted by administrative agencies, the Code empowers the Federal administrative agencies and administrative agencies of the constituent entities of the Russian Federation and the local self-governments to enact normative acts on taxation. In addition, the Federal Tax Service, Ministry of Finance and State Customs Committee may issue binding orders, instructions and methodical guidance. The Code expressly provides that these acts may not modify or supplement the law (Art.4). In practice, these agencies often amended or supplemented the laws by way of “explanations” and other instruments, particularly in relation to the objects of taxation. Although this was against the law even before the enactment of the Code, it is hoped that the new provision would be an effective means of combating such practice.13 However, the actual remit of various level of the power in enacting these acts is not clear. This may signicantly reduce the effects of this provision. The Code lists examples of contradictions between the law and subordinate normative acts. These include acts adopted by an entity which does not have such a power under the Code, revocation or limitation of rights of tax payers provided by the Code as well as acts which contradict the general principles of the Code. These acts are to be acknowledged as against the Code by court procedure, but the Federal government and the agencies which adopted such an act, as well as their superior agencies may withdraw these acts before the case reaches the court (Art.6).

12 13

Decision of the Constitutional Court, April 4, 1996, No.9-P. A.M.Zrdelevskii, Kommentarii k chasti pervoi nalogovogo kodeksa RF, Moscow 2000, pp.3334.

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429

TAXES AND LEVIES

The Tax Code covers “taxes and levies (sbor)”. Tax is dened in the Code as a “mandatory, individual and non-gratuitous payment collected from organisations and individuals in the form of alienating the money which belongs to them for the purpose of nancing the activities of the state and/or municipal governments”. Levies are dened as “mandatory payments collected from organisations and physical persons which is one of the conditions of the state agencies, local government agencies and other entities as well as ofcials for performing legally signicant acts, including the granting of rights or licences” (Art.8). In order to create a tax, the scope of tax payers as well as the essential elements of the given tax has to be determined. This includes the object of tax (e.g. prot, assets, income etc.) taxable basis, taxable period, tax rate, methods of calculating tax, methods and terms of tax payment (Art.17). There are three layers of taxation in Russia: Federal, regional and municipal. In addition to the Federal tax, constituent entities of the Russian Federation as well as local self governments (municipalities) are empowered to create taxes (Constitution Art.132). Taxes and levies at the level of constituent entities of the Russian Federation are called “regional”, while those at the level of local self governments are called “municipal” by the Tax Code. The Tax Code was amended in 2004 in respect of regional and municipal taxes. There was a provision to the effect that regional and municipal taxes and levies were created, modied and abolished by the laws of the constituent entities on taxes and levies and normative legal acts of the local self-governments respectively (former Art.3, para.5), but this provision was replaced by the following paragraph: No one shall be imposed of an obligation to pay tax, levies or other payments which have the characteristics of taxes and levies as provided in the present Code, which are not provided in the present Code or established by the procedure different from the provisions of the present Code.

Already in the original version of the Tax Code, regional and municipal taxes which were not listed in the Tax Code could not be created. The 2004 amendment has made it clearer that entities other than the Russian Federation may not create taxes and levies, unless they are created within the framework of the Code. This is an important step towards certainty and stability in the system. As of August 2006, there are nine Federal taxes, three regional taxes, and two municipal taxes. Part One of the Code lists the following taxes at various levels:

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(a)

Federal Taxes (Art.13) i) ii) iii) iv) v) vi) vii) viii) ix)

(b)

Regional Taxes (Art.14) i) ii) iii)

(c)

tax on the assets of organisations; tax on gambling business; transport tax.

Municipal Taxes (Art.15) i) ii)

4

value added tax; excise; individual income tax; unied social tax; tax on prot of organisations; tax on the extraction of useful minerals; water tax; payment for the use of objects of the animal world and biological resources of water; state fees.

Land tax; Tax on the assets of individuals.

BASIC PRINCIPLES AND RULES OF TAXATION

The Code sets out basic principles of taxation which include the following (Art.4): i) ii)

universality and equality of taxation; non-discriminatory nature of taxation (prohibition of applying different rate of tax, providing of privileges based upon the form of ownership, citizenship, or place of location); iii) prohibition of taxation which inhibits the realisation by individuals of their constitutional rights; iv) prohibition of arbitrary taxation – requirement of “economic rationale” for taxation; v) requirement of accuracy and specicity of tax laws; vi) interpretation of laws in favour of tax payers in case of irremovable doubt in interpretation, contradiction, or ambiguity of the tax law.

Russian tax law has not always been fair and non-discriminatory. In the early 1990s, by presidential decrees, some favoured organisations such as the Russian

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Sports Foundation were exclusively granted tax privileges which amounted to full exemption from taxes, excises, and customs tariff. The result was that these organisations quickly established a monopoly over the importation of alcohol products, cigarettes and cars from abroad and reinforced their inuence over the other sectors of the economy. The government lost a signicant amount of income until these privileges were nally taken away.14 The principle of non-discrimination does not, however, exclude tax privileges or a “special regime”. Concerning privileges, the Code denes privilege as a preferential treatment of a specic category of tax payers, including full exemption from tax payment. Privileges are available under the Code, but should not have an “individual character” such as in the case of the above-mentioned Sports Foundation (Art.56). In fact, the Code in its original 1998 version had allowed individual privileges in “exceptional circumstances”, but this paragraph was deleted by the amendment of July 1999. Privileges concerning Federal taxes and levies are to be set and revised by the Tax Code. The Code also provides for special tax regimes. A special tax regime is dened by the Code as a “special method of calculation and payment of taxes and levies for a specic period of time”. Special regimes are applicable in cases provided by the Code and other Federal laws. Special regimes available under the Code include the simplied taxation procedure and the regime for production sharing (Art.18). A simplied tax procedure is primarily for small entrepreneurs. Concerning the interpretation of tax law in favour of the taxpayer in cases of ambiguity, judgments of the Provincial Commercial Court of Rostov and the Commercial Court of St.Petersburg and the Leningrad Province, both of which applied this rule in their interpretation of businesses subject to sales tax, are reported.15 Concerning the stability of the tax regime, the Code provides that legislative acts on taxation which establish a new tax or levy raising the tax rate, increasing the amount of levies, establishing liability or increasing liability for violations of tax law, or by other means worsening the position of tax payers and payers of levies, do not have retrospective effect (Art.5, para.2). Legislative acts on tax take effect only after one month of their ofcial publication and after the end of the rst tax period of the tax in question. Federal laws, laws of the constituent entities of the Federation and acts of the representative bodies of the local self government which amend or supplement the Tax Code by establishing a new tax or levy may not enter into force before the January 1st of the following year, and not before one month after its adoption (Art.5, para.1).

14 15

Shatarov, supra, p.7. A53-4826/99-C5-28; A56-6440/99.

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In the court review of cases, the following case was reported without names: A procurator initiated an action in the interest of the state and the society vis à vis the government of a constituent entity, arguing that the latter’s decision to grant privilege to a joint venture was invalid, since it was against the interest of the region. The joint venture was formed between a foreign company with 40% participation in the capital and two Russian companies for the purpose of developing an oil eld in an autonomous region. The royalty was set at 10% and the prot tax was set at 32%. The foreign company contributed 40 million US dollars. After the rst year of operation of the joint venture, there was a change to the land legislation and the tax rate went up. Export tax was also increased. The foreign company asked the government of the autonomous region to reduce the tax burden in accordance with the parameters in the Technical Economical Basis of the project. The government of the autonomous region exempted the joint venture company from export tax for three years and reduced the royalty by 5%. The defendant – the government of the autonomous region – defended its position in court by reference to the grandfather clause in the 1991 RSFSR Law on Foreign Investment and Article 9 of the 1999 Foreign Investment Law of the Russian Federation. The commercial court found the defence of the defendant to be with grounds and dismissed the claim of the procurator.16

5

TAX AGENCY

The agency which is in charge of collecting taxes and levies in Russia used to be the Ministry of Taxes and Levies. The system was changed by the “Administrative Reform” in 2004, and the Ministry was replaced by the Federal Tax Service (Federal’naia nalogovaia sluzhba Rossii, “FSN”) and its territorial agencies.17 The Federal Tax Service is subordinate to the Ministry of Finance which, inter alia, gives written explanations on the application of the Federal tax law. The Federal Tax Service represents a “single centralised system” (Art.30). This wording is also a novelty introduced by the 2004 amendments. The power of the Federal Tax Service includes the right to: i)

demand taxpayers to submit tax declarations, to provide documents and explanation which support the accuracy and timeliness of the calculation;

Item 8, Information Letter No.58 of the Plenum of the Supreme Commercial Court, January 18, 2001. 17 Edict of the RF Government, September 30, 2004. 16

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conduct tax inspections ( proverka); seize documents in the course of inspections which demonstrates a violation of tax law, provided that there are sufcient grounds to assume that these documents would be destroyed, concealed, modied or replaced; iv) summon taxpayers for questioning concerning payment of tax or tax inspection; v) suspend bank transactions of tax payers and attach their assets in accordance with the procedure set by the Code; vi) search the business premises of taxpayers and prepare an inventory of their assets; vii) determine the amount of taxes payable by the taxpayer; viii) demand taxpayers to rectify the violation of tax law and supervise the process of rectication; ix) collect unpaid taxes and the interest for the delay ( pen’) and nes; x) monitor the compatibility of large expenditure with the income of individuals; xi) request from banks documents supporting the instruction for tax payment by taxpayers; xii) involve specialists and experts and summon witnesses; xiii) present petitions for the revocation or suspension of license for performing certain kinds of activities by taxpayers; xiv) bring an action to the ordinary court or commercial court for:

ii) iii)

(a) collecting tax sanctions for the violation of tax law; (b) recognising registration of juridical persons and registration of individual entrepreneurs as null and void; (c) liquidation of organisations regardless of the type of ownership; (d) collection of unpaid taxes and corresponding interests and nes of more than three months from subsidiaries in cases where the proceeds from the realisation of products of the subsidiary have been paid into the bank account of the parent company or the other way around; (e) accelerated termination of agreements on tax credits.

Monitoring of the large expenditure by individuals had existed under socialism, but the original 1998 Tax Code did not accommodate this system. On the other hand, the original Code had empowered the tax agency to apply to court for acknowledging a particular transaction of the taxpayer to be void and for permission to conscate the proceeds of the transaction for the benet of the state budget. The tax agency was also empowered to conscate income arising from unlawful activities. By the July 1999 amendments, this new system of monitoring was introduced and the latter two provisions were deleted. It was thought that such measures would be better left to law enforcement agencies. However, under the general provision of the Civil Code, the agency is still entitled to

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initiate an action in court in order to nullify a transaction on the basis of legal order and good morals (Civil Code Art.169).18 A unique system under Russian law is the seizure of tax arrears and penalties from subsidiaries if the proceeds of the products of the company were paid into the subsidiary’s account, or in case the subsidiary is in arrear and the subsidiary’s proceeds were paid into the parent company’s account. In addition to the former Ministry of Taxes and Levies, there was another agency by the name of Federal Tax Police. It was set up in 1992 as part of the then Federal Tax Service. Its task was to prevent, detect, and investigate violations of tax law which entailed criminal or administrative sanctions. The tax police was not subordinate to the tax agency, but rather, was an independent agency subordinate to the President and was expected to cooperate with the tax agency. The tax police, which was notorious for its ruthlessness, was abolished in 2003. The Tax Code now provides that agencies of the Ministry of Internal Affairs participate in the tax inspection upon the request of the Federal Tax Service (Art.36). The enforcement function of the Tax Police was inherited by the Ministry of Internal Affairs. A commentary suggested that the strength of enforcement has not been affected by this change. The role of the Ministry of Internal Affairs in the area of tax enforcement is no less than that of the former tax police.19

6

THE PROCEDURE

1)

Tax Inspection

The tax agency is in charge of “tax control”, which is a procedural act to ensure compliance with the tax legislation, accurate accounting of taxes, and timely and full payment of taxes. It includes inspections, obtaining of documents and explanations, review of such documents and explanations, and the search of the premise and territory used for the pursuit of prot.20 There are in-house inspections and on site inspections. The former are conducted in the ofce of the tax agency, while the latter take place on the tax payer’s premise. On site inspection is conducted upon a decision of the head of the tax agency. The maximum length of the inspection is two months (Art.89,

18 19 20

Zrdelecskii, Kommentarii . . ., supra, p.97. Zakharov et al. eds., supra, pp.140-141. A.N.Kozyrin ed., Kommentarii k nalogovomu kodekusu RF, chast’ pervaia, Moscow 2005, pp.406-407.

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para.1). Companies are often troubled by the frequency of the on site inspections. According to a survey of taxation issues conducted by an international accounting rm operating in Russia, 40% of the respondents answered that they had inspections more than once a year. 17% responded that they had it once a year.21 In cases where there is a sufcient basis to assume that documents which indicate breaches of law may be destroyed or concealed, the tax agency may seize these documents. Ofcials of the tax agency are granted access to the territories and premises of the tax payer by simply showing their ofcial ID and the decision of the head of the tax agency. If access is inhibited, the tax agency may determine the amount of tax without further information (Art.91). Ofcials may also require submission of documents. Submission is mandatory, and the failure to cooperate is a breach of tax law (Art.93). The result of the inspection is formulated into a document (akt), which is handed to the tax payer. If the tax payer disagrees with the facts or the conclusion of the akt, it is possible to submit a reasoned refusal to sign this document in writing (Art.100, paras.4 and 5).

2)

Compulsory Collection of Taxes and Sanctions

In cases where a taxpayer fails to pay tax within the established period, the tax agency is empowered to resort to the compulsory collection procedure. The procedure differs between “organisations” (including companies) and individuals. The tax agency is to collect the amount by seizing the money held in the bank account of the taxpayer (organisations and individual entrepreneurs). Insofar as the taxpayer is an organisation or an individual entrepreneur, this can be done solely by the decision of the tax agency, while if the taxpayer is an individual, this has to go through court procedure (Art.45, para.1, 46, para.2, and 48, para.1). The decision to seize the money held in the account is to be made within the period set by the tax agency for the payment, but this cannot exceed 60 days after the tax became due. The actual enforcement takes the form of the tax agency instructing the bank to transfer the money from the rouble and/or foreign currency account of the tax payer to the government account. It should be noted that the Federal Tax Service is the agency which handles company registration. The bank account of the company is included in the information which is to be provided to the Agency at the time of registration. Banks may open an account for an organisation only when a certicate for the registration of this organisation for tax purposes is presented. Banks are under an obligation to provide the tax

21

Ernst & Young, 2005 Survey of Taxation Issues in Russia, 2006, p.4.

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agency with the relevant information regarding the opening and closing of the accounts by organisations (Art.86, para.1). In cases where the amount in the account is insufcient or where information on the accounts was unavailable to the tax agency, taxes can be collected from other assets of the taxpayer (Art.46, para.7). If the taxpayer is an organisation, the head of the tax agency adopts the decision and forwards it to the bailiff for enforcement. In contrast, for enforcement vis à vis individuals, the above procedure via the bailiff is not available, and the tax agency has to resort to court procedure (Art.48). For a delay in payment of tax, interest for the delayed period is also collected. This is set at the renancing rate of the Central Bank and can be collected by the tax agency together with the unpaid tax by the procedure provided in the Tax Code (Art.75). The Tax Code also provides for the procedure of imposing penalties – “tax sanctions” – for the breach of tax law. Taxpayers’ responsibility is pursued for intentional or negligent acts explicitly provided in the Tax Code. Breaches of tax law include: i)

delay in or failure to register with the tax agency as a taxpayer (Arts.116 and 117); ii) delay in reporting the opening and closing of bank accounts (Art.118); iii) failure to present tax declarations (Art.119); iv) serious violations of rules on accounting the income, expenditure or the objects of taxation (Art.120); v) non-payment or underpayment of tax by way of understating the taxable basis, other inaccurate calculation of tax or unlawful means (Art.122); vi) failure to provide the tax agency with information needed for tax control (Art.126).

Banks are held responsible for failures to implement the decisions of the tax agency to suspend banking transactions (Art.134) and to collect taxes (Art.135) as well as for the failure to provide information on the nancial activities and operation of the taxpayer to the tax agency despite the legitimate inquiry by the latter (Art.135-1). Violations of tax law entail sanctions in the form of nes (shtraf ). Failure to pay tax as a result of understatement of the taxable basis, for example, entails a ne of 20% of the unpaid tax. The same act committed on intent entails a ne of 40% of the unpaid tax (Art.122). Tax sanctions used to be imposed by court procedure, and not by the decision of the tax agency. However, this imposed a heavy burden on the commercial court. It was proposed to change the system and alleviate the burden of the court,

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e.g. by introducing a requirement to rst go through the administrative procedure.22 In 2004, the commercial court handled 297,213 cases of such application from the tax agency, of which 71.3% were endorsed. Almost 30% of the cases of these cases involved an amount of less than 100 roubles.23 In 2005, the Code was amended and for a ne below a certain threshold, court procedure was no longer needed. For organisations and individual entrepreneurs, nes which do not exceed 50 thousand roubles can be imposed by the tax agency (Art.103.1, para.1). If the amount exceeds this limit, after adopting a decision to impose tax sanctions, the tax agency is to apply to the court for the imposition of tax sanctions (Art.104, para.1). In addition to these sanctions, the Criminal Code provides for penalties for tax evasion. Maximum 6 years deprivation of freedom is available for “especially large scale” evasion of tax payable by organisations (Art.199). The harshness of the sanctions under the 1991 Law on the Basic System of Taxation led some taxpayers to take the case to the Constitutional Court: As a result of the tax inspection, joint stock company Bolshevik, Svet and other companies as well as individual entrepreneurs were found liable for violations of the Law on the Basic System of Taxation of 1991 by the head of the tax inspectorate and the tax police. The plaintiffs claimed that the sanctions provided by the law were unjustiably excessive, and that they were applied to the plaintiffs without due observance of procedure, and without establishing fault, which considerably harmed their constitutional rights to the free use of property for entrepreneurial activities. The plaintiffs had been held responsible for violations of tax law and 1) had the entire amount of under-declared taxable income conscated and were imposed of ne of the same amount, 2) on repeated violations, had a ne of double the amount of the initial ne imposed (the amount could be multiplied by ve times, if the act was found to be intentional), 3) had nes for the failure to declare taxable incomes at 10% of the undeclared income imposed, and 4) had a penalty for the delay in paying tax imposed. The Constitutional Court found that the law provided for responsibility for different types of violations without properly demarcating them. Sanctions provided by the law had failed to take into account the nature or the level of harm to society. The law contained ambiguous and often mutually indistinguishable concepts. Also, in the majority of provisions on violations, there was no direct requirement of fault as a prerequisite to the sanctions. Furthermore, the construction of the provisions allowed an overlapping application of various measures, penalising the taxpayer twice for one and the same act.

22 23

EiZh, May 19, 2001. V.F.Iakovlev, “Itogi raboty arbitrazhnykh sudov v 2004 godu i zadachi po dal’neishei realizatsii sudebnoi reformy”, VVAS 2005 No.2, p.25.

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TAXATION

The Court concluded that the relevant provisions of the Law on the Basic System of Taxation were against the Constitution.24

With the amendments by Part One of the Tax Code, sanctions and penalties have been more or less rationalised and streamlined. Tax sanctions are subject to the period of prescription of three years from the day the breach was committed or from the next day of the end of the tax period during which the breach was committed (Art.113). In June 2004, the Commercial Court of Moscow rendered a judgment imposing tax sanctions on Iukos for the tax period of 2000. Iukos argued that the period of prescription had already passed. The Court ruled that the period of prescription was applicable to taxpayers in good faith only. The appellate court, however, found this argument to be with grounds and reduced the amount of nes. The court of cassation, upon the request of the tax agency, asked the Constitutional Court to give an opinion on this matter, since the tax agency argued that this provision was against Articles 19 and 57 of the Constitution. The Constitutional Court did not nd the provision on prescription to be unconstitutional.25

In 2006, the Tax Code was amended and this provision of 3 year prescription was deleted from the Code.

3)

Procedure for Contesting Decisions of the Tax Agency

Taxpayers are entitled to appeal against non-normative acts (decisions) of the tax agency as well as against the act or failure to act on the part of ofcials of the agency, if they consider that their interests have been infringed. Appeal can be made to the higher echelons of the tax agency, or to the court. Resort to the former does not exclude the possibility of the latter (arts.137 and 138). Normative acts of the tax agency can also be appealed in court. Ordinary courts have jurisdiction in such cases. Appeals by organisations and individual entrepreneurs fall within the jurisdiction of the commercial court, while appeals by individuals other than entrepreneurs are handled by the ordinary court.

Decision of the Constitutional Court, July 15, 1999, Case No.11-P. Nalogovye spory: svornik dokumentov, second edition, Moscow 2001, pp.228-235. 25 “Obzor deiatel’nosti arbitrazhnykh sudov v SMI, April 20, 2005”, in www.akdi.ru. Decision of the Constitutional Court, July 14, 2005, No.9-P. 24

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There is no requirement that the appeal should be lodged with the superior body rst. In fact, more than 90% of appeals go directly to the court. In 2005, there were 48,414 cases where the validity of the decision of the tax agency was contested by taxpayers. Surprisingly, in 72.6% of these cases, the taxpayers’ claim was accepted by the court.26 This was attributed to the low quality of the decisions of the tax agency by the president of the Supreme Commercial Court. On the other hand, the Federal Tax Service released a chart which shows the amount of claim which was accepted by the court against the total amount of claim brought to the court by the tax agency. In 2002, it was over 80%, while in 2005, it was around 30%.27 Some companies with foreign investment have successfully contested decisions of the tax agency in the commercial court. A closed joint stock company, Koka-Kola Bottlera Orel, initiated an action at the commercial court of Orlov province vis à vis the tax agency of the district. The tax agency had ordered the company to pay 3,890,893 roubles in VAT and a 35,241 roubles penalty for the delay. The decision of the rst instance court found part of the order of the tax agency to be void. In the cassation instance, the decision was reversed. The issue was whether the company was allowed to enter in the tax declaration the amount of VAT paid by the company in the fourth quarter of 1995 as capital contribution when the foreign investor imported materials (sugar), packing cases, and xed assets. The tax agency did not allow this, and therefore, the declaration by the company was found to be lower than the actual VAT to be paid and the company was ordered to pay the difference plus the penalty. The Supreme Commercial Court ruled that the amount of VAT paid at the border to the customs ofce could be deducted when calculating the tax payable to the budget at the time of the realisation of the product, insofar as the materials imported were used for the production and distribution of the product in Russia. This depends on the composition of the imported materials, so the case was referred back to the lower court in order to determine the composition of the imported items.28 Skanska Construction Company Ltd. brought an action for the recognition of the tax agency’s decision to be invalid. The rst instance court dismissed the claim, but the appellate court acknowledged it. At the cassation instance, this decision was upheld.

www.arbitr.ru/news/totals/2004/4.htm. “Analiz rassmotreniia nalogovykh sporov v sudebnom poriadke za 2000-2005 goda”, www. nalog.ru. 28 Decision of the Presidium of the Supreme Commercial Court, January 18, 2000, Case 4653/99. 26 27

440

TAXATION

In this case, as a result of on site inspection, the tax agency, despite the objection of the plaintiff, determined that corporate prot tax and the tax for the use of the automobile road were not fully paid. The prot tax was for the construction work carried out by the plaintiff. The tax agency was of the view that with the transfer of the completed work on a non-gratuitous basis, the plaintiff has made a prot. However, the court of cassation found that the transfer of the construction site was not the same as the transfer of the completed work. In fact, this case involved a transfer of the construction site which resulted from a settlement of dispute between the plaintiff and a Russian company “VSM” after the termination of a subcontract agreement. The plaintiff had suspended the work and the agreement was terminated because of the breach on the part of the Russian party. The Treaty against Double Taxation between the Russian Federation and the United Kingdom and Northern Ireland was found to be applicable in this case. According to the Treaty, prots of companies are taxed in the host country only when there is a permanent establishment. The Treaty provides that a construction site qualies as a permanent establishment only when the work continues for more than 12 months. The court of cassation found that the period of work did not exceed 12 months. Besides, the payment the plaintiff received was a compensation of the loss caused by the Russian company for the breach of contract and was not a prot. Therefore, the court upheld the judgment of the appellate court.29

According to the survey by an accounting rm cited earlier, 80% of the respondents indicted that they had had disputes with the tax agency in the past three years. 92% of those disputes were brought to court. Of the 101 cases in which the respondents were involved, VAT and prot taxes were by far the main areas of disputes. In 58% of the cases, the contested amount was over one million US dollars. 90% of the reported court cases ended in favour of the tax payer. It should be added that while the respondents’ perception of the tax agency is below average, the perception of the court system is above average.30

7

MAJOR KINDS OF TAXES

1)

Corporate Prot Tax

Prot tax was introduced in 1991. There was some confusion at the inception when an “enterprise income tax” was introduced soon afterwards, coexisting

Decision of the Federal Commercial Court of North-West District of February 20, 2004, A5617837/03. 30 Ernst & Young, 2005 Survey of Taxation Issues in Russia, on line version, pp.6-8. 29

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with corporate income tax, but before long, the tax on prots of enterprises and organisations became the main direct tax imposed on companies. However, there was some confusion again when Part One of the Tax Code referred to “income tax on organisations”. Eventually, in July 2001, Chapter 25 on Tax on the Prot of Organisations was added to Part Two of the Tax Code and replaced the “income tax on organisations”. (1)

Taxpayers

Payers of prot tax are Russian organisations as well as “foreign organisations which perform their activities in the Russian Federation through a permanent establishment and/or receive income from sources in the Russian Federation” (Art.246). Regardless of whether or not foreign corporations are liable for prot tax or not, they are required to register as tax payers at the place of their representative ofce. (2)

Object of Taxation

The object of taxation is the prot of the organisation. For Russian organisations, prot is the received income that remains after the cost had been deducted as determined by the Code, while for foreign organisations with a permanent establishment, it is the income received by the permanent establishment minus the cost incurred by this establishment (Art.247). It should be noted that costs incurred overseas are not deductible. Not all expenditures deductible in other countries can be deducted in Russia. For example, loan nancing costs and insurance costs are deductible only in a limited manner. It is suggested that the taxable base should be made much closer to the actual income earned in the tax year and that all expenditures needed for the production, marketing and sale of goods should be deducted. Full deduction of advertising, insurance, payment of interests and the cost for the and the cost of training of personnel has been proposed.31 The Tax Code now has a detailed list of non-deductible costs, which is shorter than before (Art.270). Depreciation was also a problem. Depreciation was on a straight line basis. In general, it took much longer for xed assets to be depreciated in Russia than in other countries.32 The Tax Code provides for straight line as well as non-straight line method of depreciation (Art.259, para.1).

31 32

Shatarin, supra, p.34. Ibid., p.34.

442

TAXATION

Losses can be carried forward for 10 years. The amount of loss carried forward may no not exceed 30% of the taxable base in any tax year (Art.283, paras.1 and 2). (3)

Tax Rate

The maximum prot tax rate used to be 35%, of which 11% went to the Federal budget, 19% to the budget of the constituent entities of the Russian Federation, and 5% to the local self governments. In 2001, the rate was signicantly reduced. At present, the maximum rate of prot tax is 24%, of which 6.5% goes to the Federal budget, and 17.5% to the budget of the constituent entities.

2)

Value-Added Tax (VAT)

Value-Added Tax is said to be the “most fundamental and stable” revenue in Russia. In fact, even in the socialist period, there was a similar indirect tax called “circulation tax”, which was also a source of stable revenue for the state. VAT was introduced by the 1991 Law on VAT. This Law was incorporated in Part Two of the Tax Code. The basic structure of VAT is the same, but the provisions have become clearer. (1)

Taxpayers

Taxpayers are organisations and individual entrepreneurs. Those with a turnover of less than two million roubles for the preceding three months are exempted from VAT (Art.145). Other entities may be acknowledged as a taxpayer in relation to the crossing of the customs border of the Russian Federation (Art.143). Foreign companies carrying out entrepreneurial activities in Russia are also regarded as taxpayers. Imported goods are subject to import VAT at the border. (2)

The Object of Taxation

The object of VAT is the realisation of goods, services and work in the Russian Federation. Importation of goods into the customs territory of Russia is also covered (Art.146). The place of realisation is regarded to have been Russia, if the goods were actually in Russia and do not involve dispatching or transportation, or the goods were dispatched or transported from Russia. In cases of work or service, if the work or service is directly related to immovables in Russia, e.g.

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design and construction of a piece of architecture in Russia, the place of realisation is Russia. If the recipient of the work/services is engaged in entrepreneurial activities in Russia, Russian VAT is imposed (Art.148). These include legal and accounting services as well as engineering service. The taxable base of VAT is the value of the product, work, or service including excise, but without taxes (Art.154, para.1). (3)

Tax Rates

The standard rate of VAT is 18%. Reduced rate of 10% is applied to food products and children’s goods. (4)

Exemptions

There is a list of exemptions from VAT including the sale of medical products and the provision of medical services (Art.149). Concerning import VAT, technological equipment which is to be contributed to the capital of Russian entities are exempted. This exemption has been considerably narrowed from the previous VAT Law.

3)

Unied Social Tax

Unied social tax is a novelty introduced by Part Two of the Tax Code. It combines the payment to extra budgetary funds, i.e. the Pension Fund, Social Insurance Fund, and Mandatory Medical Insurance Fund. Contributions to the mandatory work accident insurance are not included and therefore, are still payable separately. (1)

Taxpayers

Taxpayers are employers including organisations, individual entrepreneurs as well as individuals. (2)

The Object of taxation

Object of taxation is determined as “payments and other remuneration paid by the employer to the employee on all grounds” (Art.236, para.1).

444 (3)

TAXATION

Tax Rate

Tax rate starts from a total 26.0% of the contribution. For payment of over 600,000 roubles, the amount is 104,800 roubles plus 2% of the amount over 600,000 roubles (Art.241).

4)

Tax on Assets of Organisations

(1)

Taxpayers

Taxpayers are Russian organisations as well as foreign organisations which carry out business through a permanent establishment and/or have immovable property in the territory of the Russian Federation, continental shelf, or exclusive economic zone (Art.373, para.1). (2)

The Object of Taxation

For Russian organisations, the taxable basis is the movable and immovable property which is on their balance sheet. For foreign organisations which carry out business through a permanent establishment, the taxable basis is the movable and immovable property which is capital assets (Art.374, para.1). (3)

Tax Rate

This tax is a regional tax, and therefore, the tax rate is set by the law of the constituent entities. However, the rate may not exceed 2.2% (Art.380, para.1).

5)

Individual Income Tax

Individual income tax was introduced in 1991. It is now covered in Part Two of the Tax Code. The system has undergone signicant changes in 2000. (1)

Taxpayers

Taxpayers are residents of the Russian Federation and non-residents who receive income from Russian sources. Residents are those who spend more than 183 days a year in Russia. In most cases, individual income taxes are withheld at the source. Those taxpayers who are entitled to “professional deductions” (indi-

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vidual entrepreneurs, notaries and other professionals) are required to submit a tax declaration by April 30 every year. (2)

The Object of Taxation

The object of taxation is the world-wide income for residents and Russian sourced income for non-residents (Art.209). The taxable base is all of the income of the tax payer, i.e. not only monetary income, but also income received in kind as well as rights of disposal and material benets (Art.210, para.1). Pensions, payments of compensation, alimony, income of farmers (5 years) and state subsidies, among other payments, are exempted from the taxable base (Art.217). There are some allowances available. These include 3,000 roubles per month standard allowance and 300 roubles per month per child. The minimum taxable annual income has been reduced from 50,000 to 20,000 roubles. The current minimum wage is 83.49 roubles per month. Deduction of expenses is not generally available for individual income tax, but there are standard deductions, social policy deductions, property deductions and professional deductions. Standard deductions are applicable to those who suffered from the Chernobyl accident and other major accidents, “heroes of the USSR and RF”, and “participants of the Second World War and other military operations for the defence of the USSR” (Art.218). Social policy deductions include donation to a charity, expenses for the taxpayer’s own education and medical expenses (Art. 219). Property deduction covers income received from the sale of a residential house, at, dacha etc. which has been in the ownership of the taxpayer for less than 5 years and expenditure for the construction or purchase of a house or a at (Art.220). As for “professional deduction”, people who are registered as individual entrepreneurs are allowed to deduct the actual costs directly related to the earning of the income provided that these are supported by documents. Those who receive an income from providing a service or work based upon civil law contracts are entitled to a deduction of the cost directly related to the carrying out of the service or work. Those who receive royalty payments are also entitled to a deduction of expenses (Art.221). (3)

Tax Rates

By the latest amendments to the tax law, individual income tax rate was set at 13% at, instead of the progressive rate which existed earlier. There is a 35% tax rate set for bank interest exceeding three-quarters of the Central Bank renancing rate. Non-resident individuals are taxed at the rate of 30% (Art.224, paras. 1-3).

446

TAXATION

8

TAXATION OF FOREIGN COMPANIES

1)

Foreign Companies with a Permanent Establishment in Russia

The Chapter on Prot Tax in Part Two of the Tax Code has some provisions on taxation of foreign organisations. Foreign organisations (companies) which perform entrepreneurial activities in the Russian Federation are taxed on the income received as a result of their activities carried out via a permanent establishment (permanent representation – postoiannoe predstavitel’stvo) as well as income from the possession, use, or disposal of the property of the permanent establishment. Costs are deducted. “Permanent establishment” in this context includes representative ofces, divisions, ofces, agencies, and other places through which the organisations conduct entrepreneurial activities. Permanent establishments are assumed to have been set up as a division of a foreign organisation to conduct entrepreneurial activities such as the following on a regular basis: i) ii) iii) iv)

the use of sub-soil and/or other natural resources; construction, assembling, repairing etc., service and operation of equipment; sale of products in the Russian Federation; providing of other works, services, and other activities in the Russian Federation.

However, the establishment of a division does not in itself create a permanent establishment (Art.306, para.2). The conclusion of a contract by a foreign company of simple partnership (consortium) or a joint venture to be implemented in Russia does not necessary mean that this company is doing business in Russia through a permanent establishment (ibid., para.6). As a rule, foreign companies with a permanent establishment are taxed at the same rate applicable to Russian organisations (Art.307, para.6).

2)

Foreign Companies without a Permanent Establishment in Russia

Foreign organisations without a permanent establishment in Russia are liable for prot tax on income from Russian sources (Art.309, para.1): i) ii)

dividends paid by Russian companies; distribution of prots or assets of organisations, including distribution of the assets at the time of liquidation; iii) interests;

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iv) v)

royalties for the use of intellectual properties in the Russian Federation; income from the sale of shares of a Russian organisation, more than half of whose assets are immovables located in the Russian Federation; vi) income from the sale of immovables in the Russian Federation; vii) rent including income from a leasing operation; viii) income from international transportation.

The tax rate for the above is set at 20%, except for dividends received from Russian companies which are taxed by 15% (Art.284, paras.2 and 3).

3)

Transfer Pricing

According to a Russian commentator, transfer pricing has been actively used for a long time by Russian as well as foreign companies. The Tax Code has introduced regulations on transfer pricing for the rst time. Reportedly, transfer pricing in Russia does not only have international character, but also “national” character, since even within the country, an “off-shore zone” often emerges which enables taxpayers to use different schemes.33 A provision on the “principles of determining the price of goods, work or service for the purpose of taxation”, which was introduced in 1999, provides that the tax agency may examine the appropriateness of the price applied in transactions only in the following cases (Art.40, para.2): i) ii) iii) iv)

transactions between mutually related persons; barter transactions; foreign trade transactions; in cases of deviation of more than 20% from the level of the price applied by the taxpayer in identical products (work, services) within a short period.

The basic criterion for mutually related persons is the capability to exercise inuence on the terms or economic results of the activities of the other party.34 More specically, the Code lists the following cases (Art.20, para.1): i) ii) iii)

33 34

an organisation directly or indirectly has a participating interest exceeding 20% in another organisation; an individual is subordinate to another person holding an ofcial position; individuals have family relations.

Ibid., pp.80-81. Zrdelevskii, supra, p.73.

448

TAXATION

“Market price” is determined as the price in a market of an identical product in compatible economic conditions when the demand and supply coincide. It is reported that the main problem in applying the transfer pricing rules is the calculation of the market price. The tax agency tends to determine the market price in a very simplistic way and fails to take into account all the necessary conditions relating to pricing, and as a result, the case collapses in court. “The tax agency simply does not have the experience, resources, or economic data to prove that the prices they support is at market level.”35 In a case involving a Russian licensee’s payment of trade mark royalties to a Swiss licensor, the Swiss licensor licensed a beer trade mark to a Russian entity, which, in turn, sublicensed it to a Russian brewery. The royalty rate under the sublicense agreement uctuated substantially during the period of 2001-2002, between 24/27% and 1.6/1.8% of the turnover. The royalty was subject to value added tax which was claimed by the brewery for recovery from the state. The court ruled in favour of the tax agency supporting its argument that the applied royalty rate exceeded the arms-length royalty rate signicantly. The arms-length rate in the beverage industry was determined by an independent appraiser on the basis of a discounted cash ow method and was estimated at 2-5% of the turnover.36

35 36

Ernst & Young, Russian Tax Brief, July 2004, p.5. Decision of the Federal Commercial Court of the North-Western District, October 6, 2005, A66-5524/2004, cited PricewaterhouseCoopers, “Russia: Courts extend application of Russian Transfer Pricing Rules”, International Tax Review, March 2006, p.1.

15 THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

1

JURISDICTION

In the commercial court system, the commercial court of the constituent republics, regions, provinces, cities of Federal signicance, autonomous provinces and regions handles cases as the rst instance court. The basic rule is that the claim has to be presented to the court of the location of the defendant juridical person or the place of residence of the individual. As an exception, claims against a juridical person which arise from the activities of its subdivision such as a branch or a representative ofce are to be presented to the court where this subdivision is located (Code of Commercial Court Procedure, hereafter, “the Code” Art.35). A claim vis à vis a defendant located or resident in a foreign country can be brought to the commercial court of the place where the assets of the defendant are located (Art.36, para.3). In addition to the above general jurisdiction, a claim arising from an agreement which has a clause regarding the place of performance can be brought to the court of the place of performance (ibid., para.4). Parties may agree to a different venue in the above cases (Art.37). There are cases where jurisdiction of a specic venue is mandatory. These include (Art.38): i) actions involving real property – the court of the location of the property; ii) actions involving ships and airplanes – the court of their place of registration; iii) actions involving the carriage of goods and passengers – the court of the location of the carrier; iv) actions for the recognition of the debtor as a bankrupt – the court of the location of the debtor; v) actions for setting aside or enforcement of arbitral awards – the court of the location of the arbitration institution which rendered the award; vi) actions for the recognition and enforcement of foreign judgments and foreign arbitral awards – the court of the location or place of residence of the defendant, or if it is unknown, of the location of the assets.

450

THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

The commercial court is empowered to handle cases with foreign and international organisations as well as foreign individuals who are performing entrepreneurial activities as a party in cases including the following (Art.247): i)

the defendant juridical person is located or the individual has residence in the Russian Federation or assets of the defendant are located in the Russian Federation; ii) the management body, branch, or a representative ofce of the defendant is located in the Russian Federation; iii) the dispute has emerged from a contract the place of performance of which is the Russian Federation, or which was performed in the Russian Federation; iv) the claim to property arose by an act or other circumstances which took place in the Russian Federation, or the loss occurred in the Russian Federation.

There is another provision which provides for the exclusive jurisdiction of Russian commercial courts (Art.248 – See Chapter 2).

2

COMPOSITION OF THE COURT

At the rst instance, in the commercial court, cases are heard by a single judge. As an exception, insolvency cases are heard by three judges. The same applies to cases where the validity of an act of government or local government agencies is contested (Art.17, paras.1 and 2). Whereas in the socialist period, the gosarbitrazh heard cases with one arbitrator and the representatives of both parties as a panel as in international commercial arbitration process, this is no longer the case. In civil procedure, the system of people’s assessors used to be one of the fundamental principles under socialism. This system was introduced after the October Revolution in lieu of the jury system. It was thought to be inconvenient to have an independent body of laymen to determine the outcome of the case – in contrast to juries, assessors could be kept under the control of the judge. While the previous Code did not have the system of assessors, the 2002 Code has reintroduced the system of assessors. Upon application of the parties, the case can be heard with the participation of arbitrazh assessors. Arbitrazh assessors exercise the same rights and bear the same duties as judges. A law on arbitrazh assessors was enacted in 2001. These assessors are invited to take part only when “specialised knowledge in the area of entrepreneurial and other economic activities is needed for the solution of a specic case”. This is different from the system of lay assessors in the civil procedure where assessors are

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not required to have any specialist knowledge. In 2005, arbitrazh assessors took part in 1,115 cases.1 In practice, in the ordinary court where the system of lay assessors existed, a majority of civil cases in the rst instance were heard by a single judge without people’s assessors. The primary reason was nancial. Many companies were reluctant to release employees to perform the duty of a lay assessor. Enormous delay in the civil procedure due to the shortage of lay assessors “spread like an epidemic in the courts of many regions in Russia”.2

3

PARTIES AND OTHER PARTICIPANTS IN THE PROCEDURE

The Code provides that all interested persons are entitled to have recourse to court action in order to defend their infringed or disputed rights or lawful interests (Art.4, para.1). Russian procedural law contains the concept of “participants in the procedure”. These include the following (Art.40): i) ii) iii) iv)

parties; petitioners and interested parties in the bankruptcy procedure; third parties; procurator and government agencies.

One of the unique characteristics of the traditional Russian civil procedure was that procurators had a role to play in it. Under socialism, procurators, who were regarded as the guardians of legality, took part not only in criminal procedure, but also in civil procedure as a party in order to protect public interest. Procurators also exercised the power of “judicial supervision”. The latter term was abolished after the collapse of socialism, but the role of the procurator taking an action out of public interest remained. However, the 2002 Code has signicantly reduced the scope of the participation of procurators in the procedure in order to “align the Code with international standards”.3 Now procurators are only entitled to initiate an action in the following instances (Art.52, para.1):

1 2 3

VVAS, 2006 No.5, p.7. V.Taranenko ed., Grazhdanskoe protsessual’noe pravo Rossii, Moscow 1999, pp.36-37. V.F.Iakovlev and M.K.Iukov eds., Kommentarii k arbitrazhnomu protsessual’nomu kodeksu RF, Moscow 2005, p.5.

452

THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

i)

petition for contesting normative and non-normative acts of Federal, regional, and municipal agencies when the rights and lawful interests of organisations and individuals in the area of entrepreneurial and other economic activities are involved; ii) action for requesting the court to recognise transactions which were effected by Federal, regional, and local agencies, state and municipal enterprises, institutions as well as juridical persons who have Federal, regional, and municipal participation in their capital; iii) action for requesting the court to apply the consequences of invalidity of transactions which were effected by Federal, regional, and local agencies, state and municipal enterprises, institutions as well as juridical persons which have Federal, regional, and municipal participation in their capital.

Thus, procurators may now intervene with the transactions of companies only when the companies involved have Federal, regional, or municipal participation in the capital. The Code provides for the participation of third parties. A third party with an independent claim regarding the contested matter is entitled to join at any time before the court renders the judgment. Such a third party is entitled to exercise all the rights of a party, but also bears all the duties attributed to a party (Art.50, paras.1 and 2). A third party without an independent claim may join on the side of either party, provided that the outcome of the case would affect its rights or duties in relation to one of the parties. A third party of this kind may also be brought into the procedure upon request of either party or upon the initiative of the court. Such a third party is entitled to exercise the rights of the parties except for major decisions such as the change of the subject matter of the case, change in the amount of claim, withdrawal, acknowledgement of claim, or settlement (Art.51, paras.1 and 2). There is no provision in the Code which enables a group of individuals which does not form a juridical person to sue in the name of the group, as in the US class action or German Verbandsklage. In principle, in such cases, these individuals must sue jointly. However, according to certain laws, a group of individuals can nevertheless sue as a group. For example, the Law on the Protection of Environment provides that a group of individuals may present a claim in order to prevent ecologically harmful activities which cause damage to the health and property of individuals, the economy, and the environment, either to the ordinary court or the commercial court (Art.91).4 Similarly the Law on the Protection of the Rights of Consumers allows consumer organisations which are not juridical

4

Law No.7-FZ of January 10, 2002.

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persons to sue on behalf of specic individuals as well as unspecied number of consumers (Art.17, para.3).

4

THE ADVERSARIAL PRINCIPLE AND THE ROLE OF THE COURT

The adversarial system of court procedure is guaranteed by the Constitution. This system is in contrast with the inquisitorial system adhered to under socialism where the court played an active role in the procedure. An authoritative commentary denes the adversarial system as follows:5 As a result of the adversarial system, the parties, insofar as they intend to achieve the most favourable decision for themselves . . . . are under an obligation to inform the court of all legal facts which are materially signicant to the case, indicate or submit evidence which supports or refutes these facts, and also to perform other procedural acts permitted by law for the purpose of convincing the court of their truthfulness.

Instead of the court playing an active role in nding the “objective truth”, now each party is under an obligation to prove the circumstances which it refers to as the basis of its claim or response (Art.65, para.1). In the past, because of the active role played by the court, the way the burden of proof was to be distributed had not necessarily been clearly determined in Russia.6 In any case, under the adversarial system, the court does not have an obligation or power to collect evidence on its own initiative, as was the case under socialism. There are provisions in the substantive law which allow presumptions. For example, in a dispute involving the performance obligation, the debtor-entrepreneur is liable, unless he proves that an adequate performance was impossible due to insurmountable circumstances (Civil Code Art.401). Another example is tort liability, in which the fault of the possessor of sources of increased danger to the surroundings is presumed (ibid., Art.1079, para.1). On the other hand, the Russian adversarial system is not completely adversarial. The Code provides that the court is entitled to ask the parties and other participants in the procedure to produce supplementary evidence needed for the correct examination of the case and rendering of a lawful and well-grounded decision (Art.66, para.2). A similar provision had existed in the previous Code. Exercise of this power of the court to “take all measures for the full clarication of circumstances which have relevance to the case” is regarded more or less

5 6

Iakovlev and Iukov, supra, p.41. Kommentarii . . ., supra, p.118.

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THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

as a duty of the court.7 Although the system is understood to have changed to the adversarial system where the judge is to play a passive role, “an element of activeness has been preserved”.8 The right of the parties to dispose of the subject matter of the litigation was not without restriction in the past. The predecessor to the present commercial court, the gosarbitrazh, had operated under the principle of “active intervention”, since the fullment of the state economic plan had precedence over the interest of the parties. In the civil procedure, the court was allowed to exceed the scope of the claim and render a judgment in pursuit of the objective truth if it was necessary for the protection of the rights and lawful interests of state enterprises, other entities as well as individuals.9 Even under socialism, this provision had been criticised. Under the adversarial principle, the court is not granted authority to interfere with the power of disposition of the parties, to take initiative in favour of either of the parties, or to exceed the scope of the claim etc.10 Still, in the 1992 Code, the court was allowed to change the grounds or subject matter of the claim on its own initiative, but this was dropped in the 1998 Code. The current Code provides that the plaintiff may change the basis or subject matter of the claim, change the amount of the claim, or withdraw the claim in full or part until the judgment is rendered. The defendant may accept the claim (Art.49, paras.1–3). The court is empowered not to accept the withdrawal, reduction of the amount of claim, or acceptance by the defendant if it is against the law or infringes the right of the others (ibid., para.5). Thus, the scope of interference by the court on these issues has been signicantly narrowed.

5

PRESENTATION OF THE APPLICATION FOR AN ACTION

The application for an action (iskovoe zaiavlenie) must be presented to the court of appropriate jurisdiction. Together with the written application, documents such as the certicate of payment of state duty should be submitted (Art.125). A single judge makes the decision whether or not to accept the application within ve days. The application can be rejected on procedural grounds only. If the problem is rectiable, the application is returned to the applicant.

Ibid., p.121; Anokhin, supra, p.192. Iakovlev and Iukov, supra, p.230. Art.195 before the 1995 amendment. M.Gurvich ed., Sovetskii grazhdanskii protsess, second edition, Moscow 1975, p.196. 10 Anokhin, supra, p.158. 7 8 9

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After the application is accepted, preparation for the court hearing begins. The purposes of the preparation are (Art.133, para.3): i)

the identication of the nature of the disputed legal relations and the applicable legislation; ii) the identication of circumstances which have relevance to the correct examination of the case; iii) sorting out the problem of who is to take part in the procedure; iv) assisting the parties in presenting the necessary evidence; v) assisting the parties in settling the dispute.

For these purposes, the judge handling this procedure takes the following actions (Art.135, para.1): i)

invite the parties and/or representatives and have a meeting to clarify circumstances, propose disclosure of evidence and if necessary, ask for the submission of supplementary evidence; ii) provide assistance to the parties to receive necessary evidence, either upon the request of the parties or on its own initiative; iii) decide with regards to the summoning of witnesses, appointment of experts; iv) upon the application of the parties, decide on the issue of preservatory measures.

The preparation must be completed within two months of the application (Art. 134). After the preparatory stage, there is a preliminary hearing. This is a novelty introduced by the 2002 Code. The preliminary hearing is a formal procedure, based on the adversarial system, in which the parties and other participants take part. It is mandatory in all cases. At the preliminary hearing, a single judge, among other matters, decides on the petition of the parties and also determines whether the submitted evidence is sufcient or not. At the preliminary hearing, the parties may submit evidence, make a petition and explain the grounds for all the issues arising in court (Art.136, paras.2 and 3). Under the previous Code, the judge was to examine the relevance of the evidence at this stage. There was therefore a possibility for the judge to pre-empt the formal hearing. The new Code has eliminated this possibility. If the judge acknowledges that the case is ready, the decision to refer the case to the court hearing is rendered. The court is under an obligation to suspend the procedure in cases e.g. where the case cannot be heard until the Federal Constitutional Court, the ordinary court, or the commercial court decides on another case (Art.143, para.1).

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THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

The court leaves the case without further action on grounds including the following (Art.148, para.1): i)

a dispute between the same parties on the same matter and on the same grounds is pending at the commercial court, ordinary court, or arbitration tribunal; ii) there is an agreement between the parties to have the dispute settled by arbitration, provided that either party raises this point, except in cases where the agreement is invalid, extinguished, or unenforceable; iii) the parties agreed to have the dispute settled by arbitration in the course of the proceedings before the rendering of the nal judicial act.

The procedure is terminated on grounds including the following (Art.150, para.1): i) ii)

the case does not fall within the jurisdiction of the commercial court; there is a judgment of the ordinary court, commercial court, or a competent foreign court on a dispute between the same parties on the same matter and on the same grounds which has taken force; iii) there is an arbitral award in force between the same parties on the same matter and on the same grounds, except in cases where the commercial court refused enforcement of the award.

In instances where the case has been terminated, the plaintiff may not present a claim to court again regarding the dispute between the same parties, with the same subject matter and grounds (Art.151, para.3).

6

SETTLEMENT

Under the previous Code, settlement could be encouraged at an early stage, but this seldom happened. The new Code of Commercial Court Procedure has introduced a new chapter on settlement. The court is to take measures for settlement and assist the parties to settle the case (Art.138, para.1). At the preparation stage, the judge explains to the parties their right to settle. According to a commentary, settlement is benecial since it saves time and cost, and preserves business relations of the parties.11 Obviously, another consideration is the alleviation of the case load which is enormous in Russia. Parties may settle the case at any stage of the procedure, including the enforcement procedure. Settlement may not infringe the rights and lawful inter-

11

Iakovlev and Iukov, supra, p.451.

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est of others, or be against the law (Art.139, paras.1 and 3). Settlement needs to be approved by the court (Art.141, para.1). In 2005, in total, 25,536 cases – 1.7% of all cases at the rst instance and 7% of cases involving civil law relations – were settled.

7

SECURITY MEASURES

The court may take “prompt interim measures” (security measures) in order to secure the action or to ensure the property interest of the applicant (Art.90, para.1). Security measures are available at any stage of the procedure, if the failure to adopt such measures would make the enforcement of the judgment difcult or impossible. Such measures can be used for the prevention of signicant loss to the applicant (ibid., para.2). It should be noted that upon application of either party in commercial arbitration, security measures are available at the place of the arbitral tribunal, or the place of location or residence of the debtor (ibid., para.3). The following security measures are available (Art.91, para.1): i)

attachment of the defendant’s money or other assets in possession of the defendant or a third party; ii) prohibition on the defendant from effecting certain actions concerning the object of the dispute; iii) imposition of a duty on the debtor to take certain acts to prevent the loss or deterioration of the state of the disputed property; iv) transfer of the disputed property to the entrustment of the plaintiff, or a third party; v) suspension of enforcement by ex-parte procedure; vi) suspension of sale of property in cases where an action to release the property from arrest has been initiated.

Application for the security measures can be submitted together with the application to initiate the procedure or at any stage before the nal judicial act is rendered. The application is considered at the latest on the next day of the application. Parties are not invited to attend the consideration of security applications.12 The application is considered by a single judge who will render a decision on the availability of such measures. The application cannot be rejected if the applicant offered a counter security (Art.93, paras.1, 4 and 5). The

12

Ibid., p.320.

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THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

positive decision of the court is enforced without delay (Art.96, para.1). There were 48,702 applications for security measures in 2005.13 Preliminary security measures are also available. The commercial court is empowered to adopt preliminary security measures upon application of either party for the protection of property interests of the applicant before bringing the case to court (Art.99, para.1). The previous Code only provided for the security measures only after the procedure had commenced but not before. The 2002 Code has newly introduced this system. The application for preliminary security measures is to be submitted to the court of the location of the applicant, or the location of assets with regards to which the applicant is applying for security measures. When applying for such measures, the applicant is under an obligation to provide a counter security of the same amount (ibid., para.4). When the court grants preliminary security measures, the period within which the applicant is to bring an action to court on the same matter is indicated in the decision. This period cannot not exceed 15 days (ibid., para.5).

8

THE HEARING

The hearing is the central stage of commercial court procedure. Various principles, including those guaranteed by the Constitution, apply here. Firstly, there is the principle of openness (glasnost’). A closed hearing is only possible in cases where an open hearing will result in the divulgence of state secrets and also in cases where the court accepts the petition of a participant referring to the necessity of protecting commercial and other secrets (Art.11). Secondly, the principle of directness applies. Thus, the Code provides that the court must examine all evidence directly (Art.10). As a corollary, the case must be heard by the same court from the beginning. In cases where the composition of the court has changed, the case has to be re-heard from the beginning.14 Thirdly, there is the principle of continuous hearing. Cases are heard without interruption except for a recess, unless the procedure is suspended. An interval of a maximum of three days is allowed (Art.163). Finally, the Constitution provides that the proceedings shall be conducted on the basis of the adversarial system, and with equal rights of the parties (Art.123).

13 14

VVAS 2006 No.5, p.27. G.A.Zhilin ed., Kommentarii k arbitraznomu protsessual’nomu kodeksu RF, second edition, Moscow 2005, p.651.

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This is in contrast to the system under socialism, in which the court played a paternalistic role in pursuit of absolute truth. There is a time limit for the procedure. The case must be considered by the court within one month of the day of the referral of the case to the hearing (Art.152). According to the 2005 statistics, only in 3.6% of the cases was this time limit unobserved.15 The Code does not contain detailed provisions on the manner of the hearing. There is only one provision on the “oral session”. In civil procedure, a judge reports at the hearing the substance of the claim, the response of the defendant, circumstances which support the claim and the available evidence. Thus, it is not the parties which present the case at the hearing. Although there is no corresponding provision in the Code, reportedly, the same procedure is adopted in the commercial court procedure “by way of analogy”. The court examines evidence, hears the statements of participants in the procedure, the testimony of the witnesses, and the opinions of experts. Witnesses must be present at the beginning of the hearing, but are not allowed to be present at the hearing before their testimony and therefore, are instructed to leave the room, and then return separately to the court room to give testimony. There is only one provision regarding the testimony of witnesses. Witnesses are summoned upon petition of the parties. The court may, upon its initiative, summon witnesses, but this is now limited to cases where the witness was involved in pre-paring documents examined by the court, or producing tangible evidence (Art.88, paras.1 and 2). Testimony of the witness is not regarded as evidence, if the witness failed to disclose the source of information (ibid., para.4). Unlike Anglo-American law, the parties do not have a constitutional right to question witnesses.

9

EVIDENCE

Evidential rules are sparse. This is more in line with the Franco-German system. The Constitution has an explicit provision which prohibits the use of evidence that has been unlawfully obtained (Art.50, para.2). This is reproduced in the Code (Art.64, para.3). The court determines the relevance, permissibility, truthfulness and the mutual relation of the evidence in its totality. The judge is to evaluate the evidence by their “internal conviction”, based upon its all-sided, complete, objective and direct examination (Art.71, para.1).

15

VVAS 2006 No.5, p.27.

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THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

While in the civil procedure, the representative of a person in a civil or criminal procedure cannot be summoned to give testimony on matters which came to his knowledge in the course of the duty (Art.61), the Code does not limit the scope of persons who can be summoned as witnesses. However, it is understood that in the commercial court procedure, the same applies.16 In addition to the codes, there are separate laws which provide for the immunity of members of parliament, plenipotentiary for the protection of human rights, and clergy.17 There is no explicit provision against hearsay evidence. However, the witness is required to orally convey the information he holds. According to a commentary, this provision is in principle meaningless without the summoning and questioning of the witness. In one case the decision cited an explanatory note of a bank employee which stated that there was an oral agreement of transfer of 14 million roubles between two individuals, but this was not supported by any other evidence. Under the Code, this should not happen, since an explanatory note is not a testimony or a document. The witness should have been summoned and questioned.18 Parties and other participants in the procedure may apply to court for obtaining evidence which others are in possession of, if it is not possible to obtain such evidence directly. The evidence needs to be identied in the application, as well as the circumstances which are to be proved by this evidence and the reason why the evidence cannot be obtained. The court, upon acceptance of the application, requires the evidence from the possessor (Art.66, para.4). The possessor of the evidence will be ned for failure to comply with the request of the court for reasons which the court nds to be unjustiable, or for the failure to inform the court of the impossibility to submit evidence (ibid., para.9). Parties who have reason to be concerned that the submission of necessary evidence will become impossible or difcult may apply to court for measures to preserve evidence. Provisions on security measures are applicable to this procedure (Art.72, paras.1 and 3). In the previous Code, these measures were available only after the action was brought to court. The new Code has expanded this. However, the procedure is not provided in details but left to the provisions involving security measures. A commentary points out that in substance, this arrangement is questionable, and may lead to difculties and uncertainties in practice.19 Preservation of evidence before an action has been brought to court can be effected by the notary public.

16 17 18 19

Kommentarii . . ., p.98. Postateinyi kommentarii . . ., p.148. Iakovlev and Iukov, supra, p.308. Ibid., p.262.

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There is a nascent system of disclosure. Parties and other participants in the procedure must disclose the evidence which they quote as the basis of his claim or response before the beginning of the hearing session. Only such evidence which other participants in the procedure had studied in due time can be quoted in court (Art.65, paras.3 and 4). This is based upon the idea of adversary system and is one of the novelties in the new Code. The problem is that the concept of disclosure is not claried in the Code. Copies of documents can be exchanged, but how corporal evidence, testimony of witnesses, and expert opinions can be disclosed is not clear and has to be developed in practice.20

10

JUDGMENTS AND DECISIONS

The proceeding of the rst instance ends with either a judgment or a decision of the court. When the case has been heard on its merit, the court renders a judgment. At the end of the hearing, after the nal words by the parties, the judge(s) retire(s) to the anteroom and prepares the judgment. The judges, after deliberation, may decide to reopen the hearing if there is a need to examine further evidence, or to continue clarifying the circumstances relevant to the case. In such cases, the procedure is renewed (Art.168). Otherwise, judges prepare the judgment, return to the courtroom and the presiding judge announces the judgement (Art.176). The court does not need to declare the entire judgment at this stage – it may choose to delay the announcement of the entire judgment up to ve days (Art.176, para.2). The judgment of the commercial court takes effect after one month of its adoption unless it is appealed, except for judgments of the Supreme Commercial Court and the judgments of the commercial court on the legality of normative acts, which take effect immediately (Art.180, paras.1 and 2).

11

APPEAL AND OTHER PROCEDURES

Russia has a rather peculiar system of appeal in civil and commercial procedure. There is an extensive possibility of reviewing judgments which have taken force. In the commercial court, the parties have a right to one appeal against judgments which have not taken effect. The appeal is lodged via the court of rst instance which rendered the judgment in question (Art.257, paras.1 and 2).

20

Ibid., p.226.

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THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

Under the previous Code, it was the court of rst instance which considered the appeal. This did not mean that the commercial court of the rst level has a special division on hearing appeals. Appeals were heard by three judges of the rst instance court who are members of the relevant court division. As a result of the latest reform, appellate commercial courts are being set up.21 Appeals can be lodged within a month of the judgment of the rst instance court (Art.259, para.1). There are no limits as to the grounds for appeal. The appellant merely has to specify the reason why he thinks the judgment was wrong and to cite laws, facts and evidence in support of the case. The right to appeal is not limited to the parties – third parties who took part in the procedure are also granted the right to appeal. The appeal is heard by a panel of judges. New evidence can be examined, but the party has to justify the fact that this evidence could not be produced at the rst instance for reasons that are not of the party’s making and the court must acknowledge the reason to be justiable. Parties may apply for new witnesses, experts etc. the petition for which had been rejected by the rst instance court (Art.268, paras.1 and 2). The duty of the appellate court is to review the legality (compatibility with law) and the well-groundedness of the judgment of the rst instance court. Review of well-groundedness means that the appellate court examines the completeness and correctness of the facts established by the rst instance court.22 This is in fact a repeated examination of the case on legal as well as factual points.23 Until the previous Code, the court was not bound by the scope of appeal and was entitled to examine the entire judgment regardless of the ground of appeal by the party. The new Code, as part of the enhancement of the adversarial system, limited the scope of this power of the appellate court. The appellate court may now only review the procedural aspect of the judgment of the rst instance court outside the scope of appeal by the parties (Art.268, para.6). The judgment of the rst instance court can be quashed or revised on the following grounds (Art.270, para.1): i) ii) iii) iv)

21 22 23

insufcient clarication of the relevant facts; relevant facts which the court found were not properly proved; incompatibility of the conclusion of the court and the facts of the case; breach or erroneous application of substantive and procedural law.

VVAS 2006 No.5, p.17. Iakovlev and Iukov, supra, p.822. Zhilin, supra, p.24.

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In order to contest the validity of judgments and decisions which have entered into force, cassation procedure is available. As the name demonstrates, the system was introduced in Russia from France in 1864. However, the system appears to be different from its original institution. The Russian commercial court procedure grants the participants in the rst instance the right to lodge a cassation appeal against judgments of the commercial court and the appellate instance which have entered into force (Art.273). In fact, the system was different under the 1992 Code in which cassation appeal was for judgments which have not taken effect. In contrast, under the previous Code, it was a means of reviewing judgments and decisions which have taken effect together with the supervisory procedure and the procedure for reopening the case upon discovery of new facts. The new Code has inherited this system. According to a commentator, “the new system, by taking into account foreign experience, provides for a supplementary guarantee of the rights of those who took part in the procedure”.24 Cassation appeal is submitted via the commercial court which rendered the contested judgment. The case is heard by the commercial courts of cassation instance. There are 10 such courts. The appeal must be led within two months of the contested judgment taking effect (Art.276, para.1). Upon the petition of the participant who led the appeal, the court may suspend the enforcement of the contested judgment on certain grounds (Art.283, para.1). In principle, cassation appeal covers only matters of law. The court reviews the legality of the judgments and decisions of the rst instance and/or appellate court, i.e. from the viewpoint of whether substantive or procedural law has been observed or not (Art.286, para.1). Another provision of the Code lists the ground for revising or quashing judgments and decisions of the rst and/or appellate instance court as follows: i)

incompatibility of the conclusion of the court of rst and/or appellate instances and the facts of the case established by those courts or the evidence; ii) breach or erroneous application of substantive or procedural law.

In 2005, 8% of the judgments and decisions of the rst instance commercial court (125,882 cases) were appealed, of which 20% were quashed or revised. 94,511 cases were appealed by way of cassation, of which 20,748 cases were quashed or revised. It should be noted that 36.2% of the cases handled by the court of cassation instance were appealed directly to the court of cassation without recourse to the appellate court.25

24 25

Ibid., p.376. VVAS RF, 2006, No.5, p.27, p.11.

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THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

Finally, supervisory review by the Supreme Commercial Court is available for all judgments and decisions of the commercial court which have taken effect. The supervisory instance is a system that existed in the Tsarist period, inherited by the Bolsheviks and remained in the post-Soviet procedural codes. The differences with the cassation appeal were that only a limited scope of ofcials were allowed to initiate these proceedings and also that the grounds for the supervisory review were unlimited. Ofcials who were entitled to present “protests” which triggered the procedure were: the President of the Supreme Commercial Court and the Procurator General on the decisions of all commercial courts except those of the Presidium of the Supreme Commercial Court, and the deputies of the above ofcials on the decisions of all commercial courts except those of the Supreme Commercial Court. Parties did not have a right to initiate the proceeding, but were merely allowed to le a petition with these ofcials to lodge protest. What was peculiar was that the grounds for supervisory review were almost unlimited, and there was no time limit for lodging protests by the above-mentioned ofcials. Actually, the time gap between the rendering of the contested judgment and the supervisory review was not that long. The ground for altering or quashing the original judgment or decision was either unlawfulness or absence of appropriate grounds of the judgment or decision. Thus it represented a serious threat to legal stability. The only restraint on this institution was that the scope of ofcials who are empowered to lodge protest is very much limited. The 2002 Code has substantially revised this system. Firstly, parties and other participants in the procedure themselves are now entitled to le a supervisory appeal, rather than leaving the decision to the discretion of senior ofcials such as the president of the Supreme Commercial Court or the Procurator General. This is because the previous arrangement was though to inhibit access to justice by the people and did not match international standards. Secondly, the term “protest” which was inherited from the Soviet time is not used any more. It is a review of judgments and decisions which have taken effect upon application of the participants in the procedure. Procurators are still entitled to initiate the procedure, but this is not a “protest” any more. Their applications are treated in the same way as the applications by others. Thirdly, the ground for the application for supervisory review has been narrowed. As before, the supervisory instance is designed to review the legality of judgments and decisions of the court and does not concern facts. Breaches of substantive or procedural law were the grounds for the review. However, the new Code provides that parties and other participants in the procedure are entitled to le an application for a supervisory review, if this person nds that a judgment

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or decision of the commercial court has substantially infringed upon his rights and lawful interests in the area of entrepreneurial and other economic activities (Art.292, para.2). Examples of substantial infringement include infringement of rights and freedoms guaranteed by the Constitution, generally accepted principles and norms of international law, as well as the breach of international treaties to which the Russian Federation is a party.26 Fourthly, a time limit for the ling of an application was introduced. This is set at three months after the contested judgment or decision has taken effect (Art.292, para.3). The application for the supervisory review is submitted to the Supreme Commercial Court. The application is rst screened by the judges of the Supreme Commercial Court. They determine whether or not the case should be referred to the Presidium of the Supreme Commercial Court. It is the Presidium which actually reviews the case in the supervisory instance. Once the case has been referred to the Presidium, parties and other participants in the procedure are informed of the time and place of the court hearing and are entitled to take part in the procedure (Art.303, para.4). The court may revise or quash judgments and decisions if they are: i)

against the uniform interpretation and application of legal norms employed by the commercial court; ii) inhibits the adoption of lawful decisions in another case; iii) infringes upon the rights and lawful interests of an unspecied range of people or other public interests (Art.304).

It should be noted that under the current system, supervisory instance is the only way by which a case can be heard by the Supreme Commercial Court. Normally, the Federal territorial courts are the highest instance the parties can reach. Above this level, remedy is very much limited. According to the 2005 statistics, 15,233 applications were led for supervisory review, i.e.18.2% of the judgments and decision of the cassation instance. Of these applications, only 317 cases were referred to the Presidium. In 271 cases, the Presidium quashed the judgment.27

26 27

Yakovlev and Iukov, supra, p.884. VVAS RF, 2006, No.5, pp.11-12.

466 12

THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

COSTS

Court costs comprise state duty and costs related to the hearing of the case, e.g. cost and remuneration of witnesses, experts and interpreters, costs of enforcement. In the judgment, the court also rules on the allocation of the cost (Art.127). The Code provides for different rates of state duty for the commercial court and the ordinary court. The amount of state duty depends on the disputed amount. In the commercial court, the highest rate is for disputes the contested amount of which is over one million roubles – 16,500 roubles plus 0.5% of the contested amount over one million roubles, but not exceeding 100 thousand roubles. Attorneys’ fees were not an issue in the socialist period when the fees were negligible or non-existent. The previous Code of Civil Procedure contained a provision which required the court to order the losing party to bear the cost for the assistance of a representative “within a reasonable scope and by considering specic circumstances”. However, the Code of Commercial Court Procedure was silent on this matter. With the rapid increase of commercial lawyers involved in the procedure at the commercial court, this issue needed to be addressed by the legislature. The new Code provides that “payment for the service of advocates and other persons providing legal assistant (representatives)” are included in the cost (Art.106), but does not elaborate on its amount.

13

ENFORCEMENT OF JUDGMENTS

1)

General

Under the planned economy, the enforcement of decisions did not pose a problem. In disputes between state enterprises, voluntary enforcement by the losing party was the norm. The procedural code at that time accommodated provisions on enforcement, implemented by court bailiffs. The procedure was divided between enforcement with regards to individuals and state enterprises. The assets of the latter were heavily protected against creditors. On the other hand, since there were virtually no private businesses, no reference was made to enforcement vis à vis companies. In 1997, the new Law on Enforcement Procedure was enacted.28 This law covers the enforcement of decisions of both the ordinary court and the com-

28

Law No.119-FZ of July 21, 1997.

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mercial court and is the basic law on enforcement of civil and commercial judgments. There is also the Law on Bailiffs enacted in 1997.29 The Law on Enforcement Procedure has set out the procedure of enforcement vis à vis companies for the rst time. Another novelty is that the actual enforcement procedure was transferred from the court to bailiffs, who form an ofce – Federal Service of Court Baillifs (Federal’naia sluzhba sudebnykh pristavov) which is part of the Ministry of Justice. Actual enforcement is conducted through the bailiffs who work in the agency’s 2,500 territorial ofces. The underlying idea was that enforcement was not an exercise of judicial power, but of executive power. On the other hand, the Code also has provisions on enforcement, namely on the granting of the enforcement note, deferring of enforcement, imposing of sanctions for non-enforcement or inappropriate enforcement of judgments etc. by the debtor, banks and other institutions, and the supervision of the enforcement procedure, i.e. contesting the decision of the bailiff. Thus, the court does not enforce judgments and decisions, but it supervises the process.

2)

Enforcement Documents

Enforcement documents denote documents in which the requirement by the court to pay is manifested. The Law lists documents including the following which serve as a basis for enforcement (Art.7, para.1): (a) enforcement notes issued by the court on the following grounds; i) ii)

judgments and decisions of the court awards of International Commercial Arbitration Court (MKAS) and other arbitration institutions iii) judgments of foreign courts and awards of foreign arbitration institutions; iv) decisions of international organisations concerning the protection of rights and freedom of people (b) decisions of government agencies and ofcials imposing administrative ne; (c) decisions of the bailiff.

29

Law No.118-FZ of July 21, 1997.

468

THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

The party that wins the case is entitled to apply for an enforcement note to the court or arbitration institution. If the original judgment was rendered by the commercial court, the application is led with the commercial court. For the enforcement of foreign arbitral awards, the application must be led with the commercial court.

3)

Enforcement Procedure

The actual enforcement procedure is handled by bailiffs on the basis of the enforcement documents listed above. Bailiffs used to belong to the court, but by virtue of the 1997 Law on Bailiffs, bailiffs were separated from the court. The bailiff, upon receiving the enforcement documents from the court or the party, within three days, renders a decision to initiate the enforcement proceedings (Art.9, para.1). This decision should not change the judgment of the court, but sometimes, the bailiffs use discretion in interpreting the court’s decision, the reason being that these decisions are unclear. In principle, enforcement documents should be presented for enforcement within a certain period. Thus, judgments and orders of the ordinary court have to be presented within three years, while judgments of the commercial court have to be presented within six months. The same applies to the awards of international arbitration institutions and other arbitral institutions (Art.14). A copy of the decision to initiate the procedure is sent to the creditor, debtor and the court. In order to ensure the effectiveness of the enforcement, upon application of the creditor, while at the same time rendering the decision to initiate the proceedings, the bailiff may arrest the assets of the debtor (Art.9). The entire proceeding of enforcement must be completed within two months of receiving of the enforcement document (Art.13). There is a short period (within a maximum of ve days from the decision of the bailiff to initiate the enforcement procedure) during which the debtor is expected to enforce the judgment voluntarily. Expiration of this period is a prerequisite of compulsory enforcement (Art.44). The Law lists ve measures of compulsory enforcement (Art.45): i) arrest of the property of the debtor and its sale; ii) seizure of wages, pension, stipend, and other income of the debtor; iii) seizure of money and other property of the debtor in possession of a third party; iv) retrieval of property indicated in the enforcement document from the debtor and its transfer to the creditor.

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469

Seizure of the debtor's property is conducted in three stages – attachment, taking of possession, and mandatory realisation (sale). The Law provides for a certain order in taking possession of the debtor’s property. First, currency in roubles, foreign currency and other valuables, including those in the possession of banks and other nancial institutions, will be seized. Cash found in possession of the debtor will also be seized. Foreign currency is seized only when there is not a sufcient amount of currency in roubles with the debtor. If there is information that the debtor has money or other valuables in bank accounts or custody, those are also frozen. According to the Law on Bailiffs, the bailiff is empowered to make inquiries and receive information (Art.12, para.2). Banks and other credit institutions can be approached. However, the Law on Banks and Banking Activities provides for bank condentiality. This Law lists government agencies to which these institutions are allowed to provide information, but the ofce of court bailiffs is not one of them.30 Bailiffs may also make an inquiry with the tax agency, which is obliged to supply information within three days. Such information is also supplied to the creditor upon application to the Ministry of Finance by presenting the enforcement note (Art.46, paras.2 and 3). It should be noted that creditors are entitled to present the enforcement document directly to banks and other nancial institutions that are under an obligation to implement the enforcement document, i.e. to freeze the account, or, in cases of absence of sufcient money in the account, make an entry in the document to that effect within three days of receiving the enforcement document from either the bailiff or creditor (Art.6). Non-compliance on the part of banks and nancial institutions may entail a ne imposed by the court of 50% of the amount to be seized (Art.86). In cases where the amount of money found is insufcient to full the claim, other properties of the debtor can be attached (Art.51). Attachment of the debtor’s property comprises the taking of inventory, declaration of prohibition of disposal of the property, and if necessary, imposition of restriction on the use of property and taking possession of the property. The value of the property is determined by market value. If the evaluation of a specic property is difcult or the debtor objects to the evaluation, the bailiff may involve an expert (Art.52, paras.1 and 2).

30

A.Vlasov and A.Maksulov, Grazdanskoe ispolnitel’noe pravo, Moscow 2003, pp.137-140.

470

THE SYSTEM OF SETTLING DISPUTES – PROCEDURE

Depending on circumstances of the cases, the bailiff may attach the entire assets of the debtor. The creditor does not have to present the list of assets of the debtor to the bailiff. The debtor, upon the request of the bailiff, must submit it. However, locating the debtor’s assets is often difcult. One way is apply to the bailiff’s ofce for the search of the debtor’s property.31 Property which is pledged may also be attached, provided that other properties are insufcient to fully cover the unsecured claims (Art.49, para.1). Thus, in such cases, unsecured creditors may attach secured assets. Presumably, the provision of the Civil Code applies here and the secured lender has priority over unsecured creditors. As a rule, properties are sold within two months of the attachment. Except for immovables, properties are sold by specialised organisations on the basis of a commission agreement or other arrangements. Immovable property is sold by specialised organisations which are licensed for real property business by public sale (torg). If the property is not sold within two months, the creditor is entitled to this property (Art.54). From the proceeds of sale, creditors have their claim satised in the following order (Art.78, para.2): First rank – claims for the payment of alimony and compensation of loss caused to the health of others and loss from the death of the breadwinner Second rank – claims of the employees, advocate’s fees, royalties etc. Third rank – claims by pension funds and social security funds Fourth rank – tax claims and other claims which do not fall within the third rank.

The Law also has provisions on the enforcement of non-monetary claims. Particularly important is the enforcement of judgment mandating the debtor to do something or to refrain from doing something. In cases where the debtor does not comply without justiable grounds, the bailiff may impose nes (maximum 200 times the minimum wage) and apply other measures including administrative sanctions and criminal sanctions to be imposed by relevant bodies (Art.85). If the debtor’s involvement is not needed for enforcement, the bailiff may arrange it to be enforced by a third party at the expense of the debtor. In such cases, the debtor will be charged three times as much as the cost of enforcement (Art.73). In the eight months in 2005, 556 criminal cases were initiated by the bailiffs’ ofce for failure to enforce judgments and decisions of the court.

31

Ibid., pp.136-137.

CHAPTER 15

4)

471

The Actual State of Enforcement

As of 2005, there are 2,468 territorial subdivisions of the Federal Service of Court Bailiffs. There are 20,422 bailiffs in these ofces. The caseload of the bailiffs is substantial. On average, each bailiff handled 979 proceedings in 2004. Only 49.6% of the cases were completed in 2004. Less than 20% (in 2003, 10.3%, in 2004, 14.8%, and in 2005, 18.7%) of the claimed amount is recovered through enforcement.32 Enforcement often encounters active and passive resistance. In the 8 months period in 2005, 2,347 cases of criminal procedure were initiated in relation to enforcement. These included three cases of obstruction of justice, 77 cases of disrespect of court, and 543 cases of unlawful acts involving the attached property. Eventually, 562 cases were referred to court.33 The report of the Commercial Court of 2000 referred to the “low level of qualication on the part of the bailiffs”. This is said to be reected in the number of appeals against the decisions and acts of the bailiffs submitted to the court on the basis of the Law on Enforcement Procedure (Art.90). It is not uncommon for bailiffs to return the enforcement list without grounds, on grounds not provided by law, or on formal grounds.34 In the rst half of 2006, there were 4,942 such appeals, of which 22.7% were found to be with grounds.35

32 33 34 35

www.fssprus.ru Ibid. “Rabota arbitrazhnykh sudov. . . .”, supra. www.arbitr.ru

16 PRIVATE INTERNATIONAL LAW

1

SOURCES OF PRIVATE INTERNATIONAL LAW

Russia does not have a separate law on private international law equivalent to those found in some jurisdictions such as the UK and Switzerland. Rules on private international law are found in various laws such as the Law on the Status of Foreign Nationals, the Family Code, the Merchant Shipping Code, and the Code of Civil Procedure. Traditionally, a set of substantive rules on private international law has been accommodated in the Civil Code in Russia. The 1964 Civil Code had a part on the “legal capacity of foreign nationals and persons without nationality, the application of civil law of foreign nations and international treaties”. The turning point of Russian private international law was the enactment of the Fundamental Principles of Civil Legislation of the USSR in 1990. It marked a complete departure from the socialist civil law, brought Russian private international law closer to internationally accepted rules. Rules contained in this Law “were characterised by more exibility and were brought closer to the needs of contemporary international relations as compared with the previous rules”, although they were not comprehensive.1 Part VII of this Law, which accommodated rules on private international law, remained in force even after the collapse of the USSR until 2002 when Part Three of the Civil Code of the Russian Federation came into effect. Part Three of the current Civil Code which covers inheritance and private international law was enacted in November 2001. It should be added that the Russian Federation joined the Hague Conference on International Private Law in December 2002.

1

M.M.Boguslavskii, Mezhdunarodnoe chastnoe pravo, third edition, Moscow 1999, p.85.

474 2

PRIVATE INTERNATIONAL LAW

GENERAL RULES

The Code sets out the general rule on the applicable law as follows (Art.1186): Laws, which are applicable to civil law relationships with the participation of foreign individuals, juridical persons, or with foreign law elements, including instances where the object of civil law is located abroad, are determined on the basis of international treaties to which the Russian Federation is a party, the present Code, and other laws and customs recognised by the Russian Federation. If it is impossible to determine the applicable law in accordance with paragraph 1, the law of the country with which the civil law relationship with foreign elements is most closely connected shall be applied.

In determining the applicable law, legal concepts are to be interpreted in accordance with Russian law (Art.1187, para.1). The content of the foreign law is determined in accordance with its ofcial interpretation, practice of application, and the doctrine of the given foreign state. In order to ascertain the content of foreign law, the court may seek the assistance of the Ministry of Justice of the Russian Federation. If the content of the foreign law cannot be ascertained within a reasonable period, Russian law is applied. Even in the period of socialism, in international commercial arbitration, foreign law was applied in Russia by the predecessor to the present International Commercial Arbitration Court. Now it is not rare for the Russian commercial court to apply foreign law in transnational cases: A Russian joint stock company initiated an action in the Russian commercial court against a German company regarding a contract of lease of a ship. Originally, the German company sold the Russian party a ship, which was to be operated by a joint venture of both parties. However, this joint venture failed to materialise, and the Russian party, which intended to pay for the ship out of the prots from this operation, defaulted. Both parties eventually concluded a lease agreement, the German company being the lessor and the Russian company, the lessee of the ship. However, this scheme did not work. In the claim submitted to the court, the Russian party argued, inter alia, that the terms of the lease agreement were extremely disadvantageous, and that it was void as a predatory transaction under Russian law. The court ruled that since the parties had failed to agree on the governing law, the law of the country of the lessor, in this case, German law, was applicable by virtue of the Fundamental Principles of Civil Legislation of 1990, and denied the application of the provision of the Russian Civil Code on predatory transactions as argued by the Russian party.2

2

Item 12, Information Letter No.29 of the Presidium of the Supreme Commercial Court, February 16, 1998.

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475

Company Abdeil Limited, registered in the Isle of Mann, brought an action against a limited liability company, Merkurii Plus, in the Moscow Commercial Court for invalidation of the contract of sale of the participatory share of 3.1% in the Merkurii Plus. The ground for the claim was that the contract was signed by a single director instead of two, as required by the Company Act of the Isle of Mann and the plaintiff’s Articles of Incorporation. The rst instance court rejected the claim of the plaintiff. The court applied Russian law on the ground of Article 1205 of the Russian Civil Code, i.e. because “the property (participatory share) was located in Russia at the time of the transaction”. The appellate court found the contract to be null and void by applying the law of the country of the seller, i.e. the law of the Isle of Mann. After analysing the Company Act of the Isle of Mann, the court concluded that a special decision of the directors was needed for the transaction. The cassation court ruled as follows on the applicable law. The rst instance court applied Russian law on the ground that the ownership right and other rights in rem are governed by the law of the country where the property is located. The appellate court applied the law of the country of the seller. However, these courts had failed to take into account that this dispute did not emerge from obligational relations emanating from a transaction. What is at issue is the validity of a juristic act in which one of the parties did not have the power to effect (excess of power). They failed to take into consideration Article 1210 which lists the matters to be governed by contract law, namely interpretation of the contract, rights and duties of the parties, performance of the contract and the consequences of non-performance. The consequence of an act of a juridical person effected by a person to do so, or in excess of the power granted to him is a matter to be decided by the personal law of the party, i.e. the Law of the Isle of Mann (Art.1202, para.2, subpara.6).3

The above provision, however, do not affect the mandatory provisions of Russian legislation which, by virtue of the requirement of such a provision itself, or because of its special signicance, regulate the given relation regardless of the applicable law (Art.1192, para.1). Two types of mandatory norms are identied: mandatory norms of the domestic civil law and super-mandatory norms. The rst category of mandatory norms sets the limit of party autonomy and reects the interests which are more signicant to the given country than the party autonomy. The application of this type of mandatory norms can be excluded by rules of conict of laws which require application of foreign law. “Elimination of the effect of not only optional norms but also mandatory norms of lex fori as a result of the subordination of the given legal relation to foreign law is an established principle of conict of laws”.

3

Decision of the Commercial Court of the Moscow District of August 2, 2006, Case KG-A40/ 6788-06.

476

PRIVATE INTERNATIONAL LAW

Norms which fall within the second category are applicable regardless of what law governs the given relations. The application of the conict rules does not exclude their application. In other words, the government policy reected in such a norm is so important that the state cannot allow such relations to be subject to foreign law. The problem is how to distinguish mandatory norms of the second category from the rst. The decision of the Supreme Commercial Court in the Pressindustria case [see Chapter 2] demonstrates the risk of a broad application of such “super mandatory norms”. A commentary, referring to an earlier draft of this part of the Code, lists the following as “supermandatory”:4 i) ii) iii) iv) v)

norms of basic principles of civil law scope of the exercise of civil law rights invalidity of acts against public policy freedom of contract requirement of a written form for foreign trade contracts

There are some cases decided by the predecessor to the International Commercial Arbitration Court (MKAS) on this matter. In one case, the provision of the Russian Civil Code which prohibits changes to the length of the limitation period for an action and to the manner of its calculation by mutual consent of the parties was applied, and the agreement was found void.5 This does not mean, however, that Russian law should always be applied to the limitation period. There was a case where a provision on the limitation period of a foreign law, in this case, Japanese law, which was the law of the country of the seller, was applied under the 1990 Fundamental Principle of Civil Legislation.6 In addition to the mandatory provisions of Russian law, the court may consider mandatory norms of another country which has a close connection with the relationship in question (Art.1192, para.2). Another exception to the general rule of applicability of foreign law is public policy. The applicable law determined in accordance with the Code, “in an exceptional instance”, is not applied, if its application apparently contradicts the basis of the legal order (public order) of the Russian Federation. In such cases, if necessary, Russian law is applied (Art.1193).

4 5 6

A.L.Makovskii ed., Kommentarii k chasti tret’ei grazhdanskogo kodeksa Rossiiskoi Federatsii, Moscow 2002, 346-351. Bogusulavskii, supra, fth edition, Moscow 2006, pp.113-114. Cases No.139 and No.180, 1988, cited in Bogusulavskii, supra, p.96. International Commercial Arbitration Court ed., Arbitrazhnaia praktika za 1998 g., Moscow 1999, pp.138-140.

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477

Restriction of the application of foreign law based upon public policy is common in most jurisdictions. The 1964 Russian Civil Code simply provided that foreign law was not applicable if its application was against the basis of the Soviet system.7 However, even under the Soviet system, the “exceptional” nature of this provision was stressed. An example cited in a commentary at that time involved a case where a foreign law allowed racial and gender discrimination in the people’s capacity to leave a will.8 At the doctrinal level, the exceptional nature of the application of public policy continues to be stressed. A leading specialist of private international law refers to the “extremely cautious approach to the problem of applying this concept in practice”.9 Reecting this approach, the current provision contains the following paragraph: Refusal to apply norms of foreign law may not be justied merely by the difference in the legal, political, or economic systems of the given foreign country with those of the Russian Federation.

Public policy is often quoted by Russian parties in order to prevent the enforcement of foreign judgement against them [see Chapter 2]. A Latvian shipping company applied to the Moscow City Court for the enforcement of the judgment of the Latvian Economic Court against the Russian foreign trade organisation, “Soiuzplodimport”, for the payment of 4,825,727.25 US dollars for the carriage of goods by sea. The City Court acknowledged the claim of the plaintiff. This was upheld by the Civil Law Division of the Supreme Court. However, the Procurator General lodged a protest. The Presidium of the Supreme Court ruled, rst, that the Latvian Economic Court was not an arbitration court as the Procurator General had erroneously thought, but a state court. Therefore, the enforcement of the judgment in Russian was not governed by the 1993 Law on the International Commercial Arbitration. In the light of the consonants, it was clear that the Latvian court had competence over this dispute. Concerning enforcement, there was a treaty between Latvia and the USSR which provided for the mutual recognition and enforcement of court judgments between both countries. The Procurator General argued that the enforcement of this judgment was against the public order of the Russian Federation. The legal act applicable in such

7 8 9

Art.568 of the 1964 Civil Code. S.N.Bratus and O.N.Sadikov ed., Kommentarii k grazhdanskome kodekusu RSFSR, Moscow 1982, pp.674-675. Bogusulavskii, supra, fth edition, pp.108-111.

478

PRIVATE INTERNATIONAL LAW

a situation at that time was the Decree of the Presidium of the Supreme Soviet of the USSR of June 21, 1988 on the recognition and enforcement of foreign judgments. This decree referred to public order as one of the grounds to block enforcement. The Procurator General referred to a declaration of the Russian government of September 27, 1994 which set out various requirements for repayment of commercial debts by Russian “empowered entities”. Repayment by Soiuzplodimport did not meet these requirements and therefore, was against the public order. However, the Supreme Court ruled that “empowered entities” in this context meant entities which were acting under the entrustment of the government. In the present case, the defendant was acting as an independent juridical person, and not under any entrustment by the government. The above government declaration does not deprive the plaintiff of the right to receive payment, does not exempt the liability of the defendant, and cannot serve as a ground for rejecting the enforcement of a foreign judgment in Russia.10

3

RENVOI

A novelty in the Civil Code is the provision on renvoi. In Russia, there always has been a negative attitude towards renvoi. An example is the case decided in the 1960s by the International Arbitration Commission of the USSR Chamber of Commerce: An English company Romlus Films ltd initiated an action at the then Foreign Trade Arbitration Commisison against a Soviet foreign trade organisation. The case involved a right in a lm “Sleeping Beauty”. According to Soviet law, since the contract was concluded in London, English law was applicable. However, the English rules of conict of laws referred to Soviet law, and therefore, the respondent argued that Soviet law was applicable in this case. The arbitration tribunal rejected this argument and ruled that regardless of the English rules, the application of renvoi was a matter of Soviet law, and that Soviet doctrine and practice, as a rule, did not acknowledge renvoi in foreign trade contracts.11

Under the new Civil Code, as a rule, any reference to foreign law is to be regarded as a reference to the substantive law, and not the conict of law rules of that country, except in cases related to the status of individuals (Art.1190, para.1). The same provision is contained in the Law on International Commercial Arbitration.

10 11

Decision of the Federal Commercial Court of the Moscow District of June 25, 2001, Case KG-A40/3057-01. Bogusulavskii, supra, fth edition, p.102.

CHAPTER 16

479

PERSONAL LAW

4

Part Three of the Civil Code has newly introduced the concept of personal law of individuals and juridical persons. The personal law of individuals is determined by their nationality, not by their domicile. However, if a foreign national resides in Russia, his personal law is Russian law. If this person has dual nationality, one of which is Russian, Russian law is the personal law. Concerning juridical persons, the personal law is the law of the country where the given juridical person was established (Art.1195). Legal capacity and the capacity to effect juristic acts are determined by the personal law of the given individual (arts.1197 and 1198). On the basis of the personal law, the following matters concerning juridical persons are determined in accordance with the law of the place of the establishment: i) ii) iii) iv)

status of the organisation as a juridical person; organisational-legal form of the juridical person; requirements to the name of the juridical person; establishment, reorganisation and liquidation of juridical persons, including succession; v) content of the legal capacity of the juridical person; vi) manner in which the juridical person obtains rights and assumes obligations; vii) internal relations, including relations with the members; viii) capability of the juridical person to respond to its obligations.

It should be added that juridical persons are not allowed to refer to the restrictions of power imposed on its bodies or representatives in effecting juristic acts, which are not known in the country where the juristic act is effected. This does not apply when it is proved that the opposite party had known or should have known of such restrictions (Art.1202).

5

APPLICABLE LAW ON THE SPECIFIC ISSUES

1)

Ownership Rights and other Real Rights

The general rule is that the content of ownership rights and other real rights on immovables and movables, and the manner of exercising and defending these rights are determined by the law of the country where the property is located (Art.1205, para.1). The emergence and termination of ownership rights and other real rights are determined by the law of the country where the given property was located at the time at which the incident which serves as the ground for the

480

PRIVATE INTERNATIONAL LAW

emergence or termination of the rights occurred. Regarding these rights that arise from transactions on properties in transit, the law of the consignor’s country applies (Art.1296, paras.1 and 2). Ships and satellites are regarded as immovables; regarding ships and satellites which are subject to registration, the law of the country where they are registered is applicable (Art.1207).

2)

The Form of Juristic Acts

As a general rule, the form of a juristic act is subject to the law of the country where the given juristic act is effected (Art.1209, para.1). On the other hand, the Code provides that insofar as the form required by Russian law is observed, the given juristic act will not be found void for non-compliance with the form. However, there is an exception. With foreign trade contracts in which one of the parties is a Russian juridical person, the form is determined by Russian law, regardless of the place of the contract. This also applies when one of the parties is an individual entrepreneur registered in Russia (ibid., para.2). Under socialism, there used to be a requirement that foreign trade contracts must be signed by two designated persons on the Russian side, this requirement being set out in a 1978 edict of the USSR Council of Ministers. Failure to comply with this requirement made the contract void. After the collapse of socialism, it was not clear whether this requirement still existed. There was a serious debate on this issue among the specialists.12 The current view is that this requirement of two signatures no longer exists; the 1978 Edict is no longer in force.13 However, several authors point out that nevertheless, such a requirement is still valid if it is stipulated in the statute of the given Russian organisation. An example of a treasury enterprise which has a statute with such a requirement is cited.14 Thus, the only requirement to the form of foreign trade contracts now is that such contracts must be made in writing. The Civil Code provides that the failure to comply with this requirement makes a foreign trade contract void (Art.162, para.3). It is unusual for foreign trade contracts themselves to be concluded orally, but in the past, what was at issue was not the validity of the contract per se, but the subsequent amendments to the contract which have not been effected in a written form. In the practice of international commercial arbitration in Moscow, such agreements were found void.15

12 13 14 15

V.P.Zvekov, Mezhdunarodnoe chastnoe pravo, Moscow 1999, p.281. O.N.Sadikov, Kommentarii k Grazhdanskomu Kodeksu Rossiiskoi Federatsii, chasti pervoi, enlarged edition, Moscow 1999, p.351. Boguslavskii, supra, p.204; Zvekov, supra, p.282. Zvekov, supra, p.283.

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481

The denition of foreign trade activities is given in the Fundamentals of the State Regulation of Foreign Trade of 2003.16 It should be noted that the scope of foreign trade activities extends beyond the trade and covers “entrepreneurial activities in the area of the exchange of goods, work, services, information, and products of intellectual activities”.

3)

Contracts

(1)

Choice of Applicable Law by the Parties

As a rule, parties are free to choose the governing law of the contract (Art.1210, para.1): Parties to a contract may, at the time of the conclusion of the contract, or subsequently, choose by mutual consent, the law which is to be applied to the rights and obligations concerning this contract.

The choice of law by the parties must be either expressly stated, or can be denitely derived from the terms of the contract or the entire circumstances of the case (ibid., para.2). Agreement of the parties on the choice of law after the conclusion of the contract has a retrospective effect, but must not affect the rights of third parties (ibid., para.3). Parties are allowed to choose the law for the entire contract as well as for part of it (ibid., para.4). Unlike in many other jurisdictions, in Russia, in the absence of an explicit clause, the governing law cannot be assumed from the parties’ choice of the venue of dispute settlement. This has been the practice of international commercial arbitration in Russia.17 The commercial court also takes this approach: A Belgian company concluded a contract for the supply of equipment to a Russian company. The parties agreed in the contract that all disputes arising from the contract should be subject to the jurisdiction of the Russian commercial court. However, there was no explicit agreement on the governing law. The Russian party defaulted, and the Belgian company brought an action in the Russian commercial court for payment. The defendant acknowledged that the company was at default, but argued that the calculation of the payment should be made under Russian law, since the venue of the court was Russia. The court ruled that the choice of Russia as the venue of dispute settlement did not automatically mean that

16 17

Law No.164-FZ of December 8, 2003. Boguslavskii, second edition, supra, p.205.

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PRIVATE INTERNATIONAL LAW

the relationship between the parties should be subject to Russian law. Absence of the expression of will of the parties means that the choice of the applicable law was left to the court. In such cases, the court is guided by the conict of law rules of its own law – Russian law. Thus, the court applied the Fundamental Principles of Civil Legislation which was in force at that time and applied Belgian law, which was the law of the seller’s country.18

(2)

Applicable Law in the Absence of the Agreement of the Parties

In the absence of agreement on the governing law between the parties, the law of the country with which the contract is most closely connected is applied. This means the law of the country where “the party which performs the act with the decisive meaning for the contract” is domiciled, or has the basis of business, unless otherwise provided by law, or unless another conclusion emerges from the terms or the content of the contract, or the entire circumstances of the case (Art.1211, paras.1 and 2). “The party which performs the contract, and has the decisive meaning for the contract” varies. The Code has a list of such parties for basic types of contracts (ibid., para.3): i) ii) iii) iv) v) vi) vii) viii) ix) x) xi) xii) xiii) xiv) xv) xvi) xvii) xviii) xix)

18

contracts of sale – the seller; contracts of gift – the donor; contracts of lease – the lessor; contracts of gratuitous use – the lender; work contracts – the owner; contracts of carriage – the carrier; contracts of freight forwarding – the freight forwarder; contracts of credit – the creditor; contracts of nancing under assignment of claims – the nancial agent; contracts of bank deposit – the bank; contracts of storage – the bailee; insurance contracts – the insurer; contracts of mandate – the agent; commission contracts – the commissionaire; agency contracts – the agent; contracts of commercial concession (franchising) – the franchisee; contracts of pledge – the pledgor; contracts of suretyship – the surety; licensing contracts – the licensor.

Item 5, Information Letter, supra.

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483

As for “the law of the country with which the contract is most closely connected”, the following rules apply (ibid., para.4): i)

design and construction contracts – the law of the country where the object of the work is located: ii) contracts of simple partnership (joint venture contracts) – the law of the country where the basic activities are performed; iii) contracts concluded on the basis of tender, auction, or in the exchange – the law of the country where the tender or auction took place, or where the exchange is located.

(3)

Consumer Contracts

In cases where a party to a contract is an individual who uses, obtains, or orders movables, or has such an intention for personal, family, or domestic purposes unrelated to entrepreneurial activities, the mandatory norms of the law of the country where the consumer is domiciled are applied, if e.g. i) the conclusion of the contract was preceded by an offer made to the consumer or an advertisement in that country and the consumer performed acts needed for the conclusion of the contract in this country, or ii) the opposite party or the agent of the opposite party received the order of the consumer in this country (Art.1212, para.1). (4)

Contracts regarding Immovables

In the absence of an agreement on the governing law between the parties, the law of the country which is most closely connected to the contract is applied. Unless otherwise provided by law, or unless another conclusion emerges from the terms or the content of the contract, or the entire circumstances of the case, such a law is deemed to be the law where the given immovable is located (Art.1213, para.1). Contracts concerning pieces of land, acreage of sub-soil resources, divided water resources and other immovables are governed by Russian law. (5)

Assignment of Claims

The law applicable to the agreement between the previous and the new creditors is determined in accordance with the above general rules of the choice of law (Art.1216, para.1 and Art.1211, paras.1 and 2). Problems of the permissibility of assignment, the relationship between the new creditor and the debtor, the presentation of the claim to the debtor, and the appropriate performance by the debtor are governed by the law which is applicable to the claim that is the object of assignment (Art.1216, para.2).

484

PRIVATE INTERNATIONAL LAW

(6)

Interests

Grounds for charging interest, the manner of calculation and the amount of interest for monetary obligations are determined by the law of the country which is applicable to the obligation (Art.1218). (7)

Matters to be Determined by the Chosen Law

When the law of a particular country has been chosen or determined to be applied to a contract, this law specically covers the following matters (Art.1215): i) ii) iii) iv) v) vi)

4)

interpretation of the contract; rights and obligations of the parties; performance of the contract; outcome of non-performance or inappropriate performance of the contract; termination of the contract; outcome of the voidness of the contract.

Obligations arising from the Causing of Harm (Tort)

To obligations arising from tort, the law of the country in which the tortious act was carried out, or the circumstances which gave rise to the claim for compensation took place, is applied. If, as a result of such an act or such circumstances, the damage emerged in another country, the law of that country may be applied, provided that the tortfeasor has foreseen or should have foreseen that the damage would emerge in another country (Art.1219, para.1). Concerning product liability, in claims for compensation based upon defective products, works and services, the victim may choose from the law of the country where the producer or the seller resides or has the basic place of business, the country where the victim resides, or the country where the work was performed, the service was provided or the product was obtained (Art.1221, para.1).

5)

Unjust Enrichment

The law of the country in which unjust enrichment took place is applicable to obligations based upon unjust enrichment. However, parties may agree to have the lex fori applied.

CHAPTER 16

6)

485

Competition Law

Whether this is a problem of private international law or not is questionable, but there is a provision to the effect that the law of the country whose market was penetrated by unjust competition is applicable, as a rule, to obligations arising from such relations (Art.1222).

INDEX

A Abuse of Rights 73, 74, 268, 271, 334 Accounting Standards 185, 381 Advocates and Lawyers 11, 57-61, 229, 230, 310, 466 Applicable Law 42, 474-476, 479, 481, 482 Arbitration, International Commercial 20, 26-28, 30, 40-53, 74, 81, 90, 209, 211, 230, 234, 235, 272, 383, 396, 449, 456, 457, 467, 468, 474, 476, 477, 478, 480, 482 ARKO 361, 377, 378 Auction 112, 113, 115-117, 142, 206, 207, 221-223, 225, 250, 259, 260, 317, 318, 324, 329, 382, 390-393, 483 Audit 119, 124, 135, 150, 151, 153, 154, 161-163, 166-169, 180, 183-185, 200 Audit chamber 411, 412 B Bank Guarantee 73, 217, 237, 243, 266, 268, 363 Banking Supervision 371-373 C Central Bank 127, 227, 231, 243, 250, 269, 300, 356-358, 360-368, 370-378, 436, 445 Civil Code, General 63-71 Commercial Banks 73, 251, 265, 297, 355-358 Commercial Courts 24, 26-31, 33-37, 45, 47-52, 56, 375, 383, 450, 462-464 Commercial Organisations 39, 72, 76, 80, 83, 107, 121, 122, 135, 259, 272, 302, 324, 346, 367 Competition/Competition Law 46, 73, 74, 130, 146, 186, 187, 258, 341, 485

Constitution 1-13, 16, 18, 21, 25, 28, 38, 39, 56, 72, 74, 75, 306, 312-314, 324-328, 362-364, 379, 380, 389, 404, 405, 408, 427-429, 438, 453, 458, 459, 465 Constitutional Court 2, 3, 5, 7-9, 13, 14, 19, 25, 29, 39, 56, 103, 212, 219, 317, 328, 380, 427, 428, 437, 438, 455 Contracts Conclusion of 273-274 Freedom of 48, 265, 271-273, 476 Interpretation of 274-276 - of Agency/Agent 99-101, 293, 294, 296 - of Bank Deposit 299-300 - of Commission 293, 295 - of Concession 70, 302-307, 396, 400, 482 - of Credit and Loan 297-299 - of Entrustment 301, 302 - of Joint Venture 49, 50, 54, 55, 152, 196, 307, 308, 432, 446, 474, 483 - of Lease 78, 95, 98, 111, 112, 197, 247, 250, 255, 260, 275, 276, (280), 286, 288-293, 310-312, 324, 325, 327, 329-331, 333, 342, (364), 474, 482 - of Mandate 293, 294, 297, 482 - of Payment 300, 301 - of Sale 82, 92, 99, 143, 159, 178, 179, 181, 198, 201, 242, 245, 262-264, 276, 277, 280-288, 316-318, 333, 334, 475 Court of General Jurisdiction (Ordinary Courts) 22, 27, 31-36, 45-47, 158, 209, 375, 438 Cross-Border Disputes 36, 37 Custom 20, 229, 230, 275, 278, 282, 284, 295, 364

488

INDEX

E Economic Management, Right of 76, 78, 79, 286, 287, 312, 314, 321, 332, 342 Environmental Law 30, 384, 403-423 Federal Agency for the Supervision of the Use of Nature (Russprirodnadzor) 384, 411, 413, 416, 422, 423 State Ecological Review 404-408, 412-423 Environmental Impact Assessment 405, 407, 408, 414-420 F Federal Constitutional Law 7-9, 13, 36 Federal Law 3, 4-8, 9-11, 14, 22, 35, 36, 44, 72-74, 132, 133, 150, 245, 255, 298, 304, 305, 313, 320, 326-328, 330, 362, 368, 379, 380, 393, 428 Foreign Investment Law 53, 55, 130, 273, 319, 327, 351, 385, 396, 432 Foreign Law 22, 47, 49, 53, 65, 73, 474-478 G Government Edicts 6, 12, 13, 273, 325 Grandfather Clause 55, 395, 432 H Hypothec 333

70, 90, 217, 246-259, 329, 332,

I Independence of the Courts/Judges 2, 19, 23, 24, 37-40, 54 Insider Trading 189-191, 207 Insolvency Law Administrator 40, 127, 132, 207, 208, 210, 212-220, 223-225, 227, 228, 262, 279, 368, 374, 377 Application for Bankruptcy 211, 212 Bankruptcy (konkurs) Procedure 223-227 Cases of 29, 450 External Administration Procedure 218-223 Financial Restoration 209, 216-218, 374-378 Insolvency of Credit Organisations 361, 363, 366, 368, 375-378 Law of 30, 39, 205-228 Observation Procedure 214-216

Symptoms of Bankruptcy 148, 149, 209 Inviolability of Property 48, 71, 72 J Joint Stock Companies General 43, 35, 68, 70, 71, 76, 84, 90, 91, 105-110, 114, 118, 121-127, 132-187, 189, 191-193, 198, 199, 201, 203, 204, 218, 253, 355, 367 Appraisal Rights 149, 155, 156 Articles of Incorporaiton 80, 82, 97, 122, 123, 129, 131-136, 140, 141, 146-148, 150, 152, 153, 155, 156, 161-163, 166-171, 176, 180, 183, 186, 187, 218, 475 Audit Committee 124, 125, 151, 153, 154, 161-164, 167, 169, 180, 183, 194, 185 Board of Directors 90, 91, 119, 123, 134-138, 140, 147, 148, 151, 153, 156, 159-180, 183-187 Capital 136-140 Closed 122-124, 132, 133, 139, 145, 184, 253 Establishment of 132-134 Executive Bodies 109, 156, 160, 164-166, 168, 170-173, 183 General Shareholders’ Meeting 108, 134-141, 144, 146-160, 163, 166-177, 180-187, 218 Golden Shares 119, 135 Independent Directors 169-171, 180, 181 Interested Party Transactions 161, 167, 178-183, 220 Liability of Directors and Ofcers 150, 173, 174, 181, 228 Liability of Shareholders 124, 125, 228 Liability of the Parent Company 125-127, 228 Major Transactions 146, 161, 167, 168, 174-178, 181 Mergers/Reorganisation 30, 35, 77, 80, 114, 129, 132, 135, 151, 155, 186, 187, 215, 236, 306, 361, 372, 373, 377, 378, 479 Open 90,122-124, 132, 137, 139, 145, 154, 185 Share Buy-Back 147-148

489

INDEX

Shareholders’ Rights 108, 137, 150, 156, 164 Jurisdiction of the Court 19, 25, 28, 30, 33-37, 42, 43, 45, 47, 51, 52, 82, 91, 141, 211, 428, 449, 450, 454, 456, 481 Juristic Acts 80, 85-100, 271, 273, 293, 294, 316, 333, 352, 479, 480 Void and Voidable 87-99 Sham/Fictitious 89, 95, 96, 263-265 L Limited Liability Companies General 70, 71, 75, 105-107, 121-127, 160, 182, 191-204, 367 Articles of Incorporation 192-195, 197, 199, 200, 201, 203 Audit Committee 200, 203, 204 Establishment of 192, 193 Exclusion of Members 196-198 Interested Parties Transaction 202-203 Liability of Directors and Executive Ofcers 203 Major Transactions 201-202 Management Bodies 199-201 Members of 193, 194, 199, Participatory Shares 121, 123, 194, 195, 198 M Money Laundering

368, 369

N Non-Commercial Organisations 70, 76, 77, 81, 121, 128, 189, 213, 407, 408 Notary Public 61-62, 232, 249, 460 O Obligations Delay of Performance 74, 238, 239, 246, 269, 299 Impossibility of Performance 236-239, 270, 283 Inadequate Performance 30, 229, 238, 240-243, 305, 306 Liability for Breach of Obligations 238-243 Operational Administration, Right of 76, 78, 79, 81, 312-314, 321, 322, 332, 342 Ownership Private 107, 111, 113, 312, 313, 323-325, 329, 330, 428

Right of 69, 93, 153, 309, 312-321, 324, 326, 328, 330-335 State (Federal and Municipal) 10, 313-315, 322, 323 - Foreign, of Land 326-328 - of Land 10, 313-315, 322-324 P Parent Company 125-127, 215, 397, 433 Partnerships 31, 76, 107, 121, 194 Pipe Line 396, 397, 412, 416, 423 Pledge 70, 73, 78, 96, 106, 107, 173, 175, 178, 179, 195, 197, 198, 227, 233, 234, 236, 237, 245-261, 263-265, 290, 291, 304, 312, 320, 322, 325, 336, 379, 482 Precedents 14-19, 45 Prescription Period 40, 89, 102, 103, 236, 316, 438 Presidential Decrees 12-13, 74, 85, 89, 90, 93, 94, 112, 115, 116, 324, 331, 335, 408, 421 Privatisation 32, 37, 46, 84, 88-91, 93, 107, 108, 110-117, 119, 132, 133, 139, 187, 259, 276, 286, 287, 289, 292, 293, 302, 314, 315, 318, 327 Procedure Adversarial Principle/System 453, 454, 458, 462 Enforcement of Foreign Arbitral Awards 17, 42-53, 468 Enforcement of Foreign Judgments 17, 29, 35, 43, 45-47, 449, 478 Security Measures 457, 458 Procuracy/Procurators 29, 31, 38, 54-55, 57, 58, 116, 275, 286, 287, 349, 375, 415, 432, 451, 464, 477, 478 Product Liability 283, 343, 350, 484 Production Sharing 312, 380, 381, 383-400, 403, 415, 431 Public Policy 44, 46-48, 51, 92, 93, 476, 477 R Real Security Rights (see Pledge) Registration of Immovables 83, 247, 248, 253-256, 285, 287, 290, 292, 293, 318, 331-337, 480 Registration of Juridical Persons 37, 52, 75, 76, 80, 88, 89, 93, 128-131, 133, 187-189, 192, 193, 368, 433, 435, 480 Registration of Shares 109, 141-144, 365

490 Rights on Land other than Ownership 330-331 S Securities 30, 37, 51, 61, 83, 84, 132, 133, 136, 138, 139, 141, 142, 146, 148, 154, 166, 167, 175, 178, 184, 187-191, 198, 200, 204, 215, 232, 243, 249, 250, 260, 299, 301, 316, 317, 358, 360, 365, 367 Sovereign Immunity 81, 82 Securities Market 70, 142, 143, 147, 148, 154, 187-191, 367 Sub-soil Law 305, 379-384, 387-391, 400, 403, 405 Suretyship 217, 245, 246, 265-268, 482 T Tax Code 398, 399, 406, 427-429, 431, 433, 434, 436, 438, 441-444, 446, 447 Value Added Tax 341, 394, 395, 398, 425, 427, 430, 442-443, 448 Corporate Prot Tax 440-442

INDEX

Taxation of Foreign Companies 446-448 Transfer Pricing 109, 121, 149, 447, 448 Tort Liability Activities involving Increased danger (Non-Fault Liability) 339, 341-344, 411, 412, 453 General 339-345 Government Tort Liability 350-352 Moral Damage 74, 75, 339, 343, 344, 347-350, 352 Special Rules 345-346 Treasury Enterprises 76, 79, 209, 267, 310, 322, 480 U Ultra Vires 79, 80, 96, 135 Unitary Enterprises 70, 76, 78, 79, 81, 83, 110, 121, 135, 312-314, 321, 322 Unjust Enrichment 37, 50, 68, 229, 265, 280, 352-353, 484