Legal Flaw Jeopardizes Strategic Sector Investment

Major purchases by Gazprom, Gazprom Neft, Novatek, Sistema and other companies could be ruled invalid because of a broad interpretation of the phase "a group of entities," though officials are promising to fix the legal flaw.

The law on foreign investments in strategic sectors of the economy, in effect since April 2008, applies to all foreign investors and groups of entities in which they participate that want to buy stakes in Russian companies working in one of the 42 strategic sectors, such as oil, defense and the space industry.

But the phrase "group of entities" is interpreted according to the law on protecting competition, meaning that all Russian companies that have foreign subsidiaries, including those offshore, would count as a group of entities with foreign participation, said Igor Repin, deputy director of the Association for the Protection of Investors' Rights.

Because the majority of big Russian companies would fit that bill, all of their purchases since spring 2008 would need to have been approved by the government's commission on foreign investment in strategic sectors, he said. Otherwise, they could be invalidated.

During a presentation Wednesday to a conference on problems in applying the law on investment in strategic sectors, Repin gave several examples of problematic deals. They include the purchase by Gazprom (which has foreign subsidiaries) of 20 percent of Gazprom Neft from Italy's Eni; the purchase by Novatek (the group of entities includes Swiss, Cypriot and Polish subsidiaries) of 51 percent of Yamal SPG; and the purchase by Sistema (the group of entities has several dozen foreign investors) of controlling stakes in Bashkir energy companies.

Prosperity Capital Management has sent a request to the Federal Anti-Monopoly Service asking for clarification on the matter, said Denis Spirin, the investment fund's corporate governance director.

According to the anti-monopoly service, the deals in question do require the government commission's approval. The service's deputy director, Andrei Tsyganov, conceded that there was a problem with how "group of entities" is defined.

"If you interpret it literally, then any Russian company with a foreign subsidiary that is purchasing an asset in a strategic sector should receive approval from the government commission," he said.

The companies mentioned in Repin's presentation declined to comment. But a source in a Gazprom-controlled company told Vedomosti that lawyers for the group and its subsidiaries were aware of the conflict and were studying it.

There are already instances where deals have been invalidated for this very reason, said Spirin, of Prosperity Capital Management.

Kores Invest, which is managed by Senator Leonid Lebedev’s Sintez Group, raised its stake in power generator TGK-2 to 50 percent but then refused to make a mandatory offer to minorities (including Prosperity Capital Management), citing the anti-monopoly service's ruling that the deal would lead to Kores obtaining control of a strategic asset and therefore needed approval by the government, Spirin said.

A court backed Kores in the dispute, ruling that the deal with minority shareholders was invalid, even though Kores is a Russian company, it is not managed by a foreign company, it does not have any foreign beneficiaries and the foreign entity in the group was not part of the TGK-2 deal, he said.

"We disagree with the claims, and court hearings are ongoing," a Sintez spokesperson said.

Since the anti-monopoly service required Kores to get the government's permission, all similar deals by Russian companies violate the law, meaning that they are invalid, said Spirin, adding that "not even a court ruling is needed for that."

If a deal was not approved, then under Article 15 of the law on strategic investments, it can be invalidated, Repin said, adding that it was difficult to determine the extent of the problem.

"We mentioned deals for which information is available from open sources, but there are very many unknown deals," he said.

The anti-monopoly service believes that the current requirements are excessive and is preparing amendments to the law so that approval from the commission would only be required if the purchasing entity is controlled by a foreign investor, Tsyganov said.

"A specific formulation is being developed," he said, declining to comment on the likelihood of whether deals that have already been concluded might be invalidated.

Under the current law, problems could emerge with several deals, so the anti-monopoly service's actions are logical and the amendments fit in with their general trend of liberalizing anti-monopoly law, said a lawyer at an energy company.

For example, amendments to the law on defending competition are being developed that would lift requirements that deals within a group be approved by the anti-monopoly service.

Some Russian companies are already seeking clearance from the government commission before buying assets in a strategic sector. In the commission's two years of work, more than half of all the deals it has considered were for Russian companies to buy strategic assets through offshore subsidiaries. One example was Gennady Timchenko seeking permission to raise his stake in Novatek to 23 percent.

Repin, of the investors' rights group, said the anti-monopoly service was correct to make the changes. If no challenges are made before the amendments are passed, it will be impossible to invalidate the deals, he said, adding that it was essential that the bill be approved and passed as quickly as possible.

While the amendments are being developed, the anti-monopoly service and courts should change their legal practice and not interpret the phrase "group of entities" as broadly as they do now, Spirin said.

It is unlikely that any daredevils will try to challenge a Gazprom purchase, said Igor Nikolayev, director of strategic analysis at FBK. There will be very few or no contested deals, he said, attributing the problems with the law on investment in strategic sectors to the fact that it was developed on a tight schedule.