Peter B. Maggs, Clifford M. and Bette A. Carney Chair in Law, UI

In the early 1990s, I talked to the head librarian at one of Russia’s leading law schools. She said, “Nobody’s interested in Soviet law any more, but everybody wants to read the pre-revolutionary textbooks on commercial law.” By then it was clear that Russia was going to restore and modernize the commercial law system that had been destroyed by the Communist revolution. Today, 15 years later, Russia has largely completed its process of reforming commercial legislation. The legislation on the books today generally meets international standards (though it is somewhat weak in corporate governance and intellectual property enforcement) and the legal climate is attractive for foreign companies seeking to do business in Russia, with one huge exception.

As a recent article in the leading Russian Internet newspaper pointed out, in key areas, such as energy, the legal regulation of the private economy is manipulated by Kremlin insiders, not to further government interests, but for their own private benefit. This makes competition in these areas a very dangerous game for others. In other areas, the newspaper suggested, there was a normally functioning private economy. In particular, Russian legislation, Russian government actions, and Russian court decisions have in some cases banned, in some cases discouraged, and in some cases seized foreign investments in the areas of oil and gas. Russia’s huge natural resource reserves, weak environmental law enforcement, and relatively stable government, along with the rapidly increasing prices of oil and gas, would seem to make it an ideal target for investors. However, Russia has increasingly restricted the issuance of permits for the exploration and exploitation of new oil and gas fields to Russian companies; it has placed increasingly burdensome demands on foreign companies in the energy business in Russia; and has effectively confiscated billions of dollars of the value of foreign-owned stock in the Yukos Oil Company. At present, the most attractive investment vehicle remaining open is investment in stock of Russian companies in which a majority of the stock is government-owned and a minority is owned by super-rich Russians influential in the Kremlin. An example was the recent Rosneft IPO, which attracted billions from foreign investors. However, much of the money came from foreign companies already heavily committed to investment in the Russian energy sector, who undoubtedly felt pressure to appease the Russian authorities by buying Rosneft stock. Rosneft’s own prospectus warned:

“There are weaknesses in legal protections for minority shareholders and in corporate governance standards under Russian law.
The Russian government, whose interests may not coincide with those of other shareholders, controls Rosneft and may cause Rosneft to engage in business practices that do not maximise shareholder value. “

This disclosure is not complete. It does not indicate the key point that company insiders are also Kremlin insiders and so may act not for the benefit of the Russian government, but for their own personal benefit.

Government intervention in key areas has eroded the confidence of the Russian business community. As the Council on Foreign Relations noted in a recent report:

“ In last year’s rankings of 117 countries by the World Economic Forum, Russia fell from 85 place to 106 in “favoritism in decisions of government officials,” from 84 to 102 in ‘judicial independence,’ and from 88 to 108 in ‘protection of property rights.’”

My own opinion is that these views are far too pessimistic because they lump together two different systems of legal regulation, that of large businesses controlled by Kremlin favorites and that of ordinary businesses beneath the Kremlin's radar. It is important to be aware at all times of the political and legal environment and to take precautions accordingly. Adequate legal advice in structuring investments and other transactions can protect foreign parties from difficulties both with the Russian government and with their Russian business partners. The more conservative investor can use offshore corporate structures to avoid corporate governance problems and use international arbitration to avoid the Russian courts. The more daring investor can profit from the fact that the very shortcomings of the Russian system means that the market capitalization of Russian companies often reflects a huge discount from their actual asset value, a discount reflecting overreaction by the investment community to weaknesses in the legal system.