Russian countersanctions restricting exit from the country: Is there room for investment treaty claims?
Nearly two years into the Russian Federation’s internationally condemned invasion of Ukraine, the war shows no signs of ending soon. The same holds true for the economic sanctions imposed by many Western countries against Russian parties, and the countersanctions Russia has in turn adopted targeting companies and individuals associated with ‘unfriendly’ states.
Russia introduced its first countersanctions in early 2022 to respond to the threatening exodus of Western businesses. Among other things, Russia published a draft law on the nationalisation of foreign companies. The nationalisation law would have enabled the Russian government to nationalise the operations of nearly all foreign companies associated with unfriendly states looking to cease their operations and leave Russia, unless such foreign investors sell their shares in a way that preserves the related business activity and jobs.
The nationalisation law was not ultimately enacted, but Russian countersanctions have grown stricter over time. In April 2023, Russia introduced legislation establishing a basis for placing certain Russian assets controlled by foreign investors associated with unfriendly states under ‘temporary’ government administration. Shortly thereafter, Russia brought the local subsidiaries of two energy companies – Uniper and Fortum – under state control. Later in July, Russia similarly took control of the Russian subsidiaries of food-products company Danone and brewing company Carlsberg.
At the same time, Russia has also imposed very strict rules for exiting the country. These exit restrictions have caused significant harm to many foreign businesses seeking to exit Russia. Indeed, while we have seen many Western companies follow through with their decision to exit Russia during the past two years and have had the privilege to advise several companies – such as Valio, Fazer, Huhtamäki, and Ramirent and Cramo – in doing so, most if not all exits have been affected by the exit restrictions.
Therefore, even after a successful exit from the country, it continues to be paramount for foreign investors to evaluate whether they suffered damages because of the Russian countersanctions and to assess the remedies they may have available against Russia for interfering with their investments. As we blogged already in March 2022, one form of legal protection may stem from international investment treaties. This blog post gives its readers an overview of the Russian countersanctions restricting divestment of Russian assets and the key features of the bilateral investment treaty between Finland and Russia (Finland-Russia BIT).
Countersanctions restricting exits from Russia
In 2022, Russia introduced countersanctions making a variety of transactions between Russian entities and companies from or associated with unfriendly states subject to a prior approval of the Government Commission on Monitoring Foreign Investments in Russia (GovCom). Currently, all unfriendly foreign investors must obtain the GovCom’s permission for the direct or indirect transfer of shares in Russian entities.
From late 2022 onwards, the Russian countersanctions regime has required unfriendly foreign investors to sell their shares for less than the market value and to either defer the payment of the sale price or to make a ‘voluntary contribution’ to the Russian state budget. In March 2023, the option of deferring payment of the sale price was abolished, and all sales under the regime will now incur a contribution to the Russian state budget.
To summarise, the conditions for obtaining a permit from the GovCom under the regime currently in place are the following:
- The investor must submit an audited asset valuation report prepared by a GovCom certified appraiser.
- The sale price cannot exceed 50% of the appraised market value.
- The investor must make a ‘voluntary contribution’ to the Russian state budget of 15% of the appraised market value of the assets.
- As a part of the permit process, the GovCom sets KPIs for the investor and/or the Russian target company to ensure the continuation of the overall business activities, employment as well as fulfilment of contractual and other obligations of the target company following the contemplated sale.
- When selling a public company, up to 20% of the shares must be placed at auction.
It is also noteworthy that the GovCom is not subject to any statutory processing time for the applications for exit permits. In practice, the processing times vary considerably and are also getting longer and longer.
Protection for foreign investments under investment treaties
Russia has entered into bilateral investment treaties (BITs) with over 60 states, including Finland, many of which it has now designated as ‘unfriendly’. The Finland-Russia BIT, like other Russian BITs, contains several standards of protection for foreign investors and their investments, such as:
- Fair and equitable treatment (FET): Russia must not take arbitrary, unfair or discriminatory measures against investors or their investments that would violate the investors’ legitimate expectations and opportunities to benefit from their investment.
- Prohibition of unlawful and uncompensated expropriation: Russia must not adopt compulsory measures of nationalisation, requisition, or other measures to expropriate investments, unless certain conditions are met, such as non-discrimination and payment of adequate compensation.
- Most favoured nation (MFN) treatment: Russia must not treat foreign investors or their investments less favourably than it treats investors and investments from other states. This also means that investors may benefit from more favourable provisions of other investment treaties entered into by Russia.
- Free transfer of investments and returns: Russia must guarantee the right of foreign investors to freely transfer payments related to their investments out of Russia, without undue delay or restriction, and in a freely convertible currency.
All of these protections are relevant in the context of Russia’s exit restrictions, which may adversely affect the value, profitability and viability of foreign investments in Russia. For example:
- Russia may breach its FET obligation by restricting the ability of foreign shareholders to sell their shares in Russian companies, and thereby significantly reducing the value of these shares. Depending on the formulation of the expropriation standard in the applicable treaty, this could also potentially constitute unlawful and uncompensated expropriation by Russia.
- Russia may infringe its non-discrimination and FET obligations by imposing exit restrictions on investors or their investments in Russia based on investors’ ‘unfriendly’ nationality.
- Russia may violate its free transfer obligation by restricting the free transfers of funds outside of Russia by individuals and companies from ‘unfriendly’ states, especially if the restriction is prolonged or becomes permanent.
It is important to note that the specific language of different treaty standards varies from one BIT to another. Accordingly, the scope of protection offered by one treaty under the different treaty standards may be limited in comparison to the protection offered by another treaty.
Though such limitations may potentially be overcome through use of MFN provisions in the relevant treaties, it is important for Finnish investors to also recognise that their investments in Russia may enjoy direct treaty protection under a BIT between a third state and Russia, if their investment into Russia has been structured through a subsidiary located in such a third state. In the field of energy, a foreign investment in Russia may also be protected under the provisions of the multilateral Energy Charter Treaty (ECT).
Arbitration as a mechanism for resolving disputes
Investment treaties contain legal mechanisms that allow foreign investors to seek compensation for damages caused by the host state’s actions. Investment treaties typically lay down that disputes between investors and the host state relating to the investment or the protection offered by the investment treaty may be settled by arbitration. Through arbitral proceedings, an investor may be awarded compensation for any losses it may have incurred because of Russia’s actions violating the provisions of the investment treaty.
Bringing an investment treaty claim against the Russian Federation is not without its challenges. The Russian Federation has a track record of disregarding international law and failing to comply with the awards issued by international tribunals. As such, successful investors would likely need to seek enforcement of the award through national courts to recover any compensation awarded. The feasibility of recovering any compensation from the Russian Federation through Russian courts is currently highly unlikely. Rather, enforcement would likely need to be sought in other countries where assets belonging to the Russian Federation are located. This is possible under the provisions of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), which allows investors to seek enforcement of arbitral awards in any contracting state where Russia has assets. Investors may, however, expect Russia to challenge the enforcement also before the national courts of such enforcement states.
Additionally, if enforcement is sought against Russian assets that have been frozen under the applicable sanctions regime, attention would also have to be paid to the particulars of that regime. Enforcement against frozen assets is in many instances possible only by way of obtaining an authorisation to release the assets from the relevant authorities.
What is next for foreign investors in Russia?
Despite the challenges associated with holding Russia accountable for the potential violations of the protections it has guaranteed to foreign investors under international law, many investors are still considering investment treaty claims against the Russian Federation. It has been publicly reported that at least two Nordic companies have served Russia with notices of dispute concerning potential investment treaty claims.
If you are a foreign investor whose investments in Russia have been impacted by the Russian Federation’s countersanctions, we recommend evaluating the potential financial harm you have suffered and the possibilities of raising an investment treaty claim.