English Law in Russian M&A - What to Expect
- By Elizabeth Walters
- Sep. 30 2008 00:00
For the foreseeable future the common practice of using English law to govern Russian M&A transactions is likely to continue. This is because English concepts have long been established and interpreted by the judicial system and give investors confidence as to the effectiveness, predictability and enforceability of documents. However, the Russian environment is quite different from the UK and there are some issues that investors should consider.
Heads of terms are regularly entered into on commencing a transaction. In the UK, they are usually expressed to be non-binding (other than any confidentiality or exclusivity obligations). Binding documents are only signed once the due diligence process has been completed and any purchaser concerns have been resolved by renegotiating the price or seeking specific indemnities.
In Russia, due diligence may take longer to complete and the list of conditions precedent to closing may be more extensive, for example if the target group is in need of restructuring. Purchasers are therefore keen to sign binding documents, closing to be conditional upon due diligence being completed to their satisfaction and restructuring of the target group. This may reduce the certainty that the deal will complete and a purchaser may need to renegotiate certain terms after it is bound when its negotiating position may be weaker. A seller should ensure that any condition precedent is objective to avoid any dispute as to whether the purchaser is being unreasonable in claiming the condition is not satisfied, particularly if the seller must indemnify the purchaser against its costs on termination. It should be noted that a provision in the sale agreement that the parties will agree to negotiate and agree a reduced price if any issue arises out of due diligence or restructuring will not be enforceable under English law.
In Russia, conditions precedent, especially the requirement to obtain Russian antimonopoly clearance or other regulatory consents, can take a long time to be satisfied. During this period, the business may change for better or worse and a seller may seek to sell it at a higher price to another. Alternatively, a purchaser may wish to reduce the price. Thought should be given as to the inclusion of provisions to compensate the seller for any increase in value between exchange and closing and to payment by a purchaser of a non-refundable deposit at signing. However, it is important that any deposit or payment is not a penalty which, under English law, would be unenforceable.
The concept of warranties, representations and disclosure, are well established in the UK (with the possible exception of what is "fair" disclosure, for which the standards have been evolving). Nevertheless, much time is often spent negotiating these matters. Limitations on the seller's liability in Russian agreements are usual. The threshold for bringing claims is generally between 1% and 5% of the purchase price, with the cap on the seller's liability being anywhere from 10% to 100% of the purchase price.
In the UK, it is usual for a purchaser to seek to protect the goodwill for which it is paying by requiring the seller to give restrictive covenants. Unfortunately, such restrictive covenants have little prospect of being enforced successfully by a purchaser of a Russian business. Restrictive covenants which would otherwise be valid under English law, may be void for illegality in Russia on public policy grounds. They will, therefore, be unenforceable in the very territory where they need to be operated (namely, where the seller or its assets are located).
Notwithstanding the choice of English law, it is usual to provide for disputes to be referred to arbitration rather than the English courts. This is because there is no agreement between the Russian and English courts for the reciprocal enforcement of judgments. There is therefore no guarantee that the Russian courts will enforce English judgments. However, Russia is a signatory to the New York Convention on Arbitration and foreign arbitral awards are usually enforceable.
Care needs to be taken to comply with all the necessary execution formalities. Execution formalities should comply not only with the governing law of the agreement but also the laws of the place of execution of the contract and of the country where the relevant company is incorporated which may often be a jurisdiction other than Russia, such as Cyprus.
DLA Piper's experience suggests that the volume of deals transacted under English law has allowed market practice to develop amongst Russian M&A practitioners. However, it will be interesting to see whether, with time, there is a move towards using Russian law to govern documentation.