Trade successfully with Russia

Trade Successfully With

  • Russia
  • Agriculture,
  • Automotive/Transport,
  • Chemicals/Pharma,
  • Construction,
  • Consumer Durables,
  • Electronics/ICT,
  • Financial Services,
  • Food,
  • Machines/Engineering,
  • Metals,
  • Paper,
  • Services,
  • Steel,
  • Textiles

16th May 2011

Russia remains an important market in the global economy. The ten easy to follow principles of the report are meant to help businesses mitigate risks when exporting to Russia.

10 Principles that can help make your supply relationship to Russia successful

Supplies do not normally require  any more preparation and legal review  than supplies to any other country, which  is generally good news. The legal basics  that should be observed in relation to  Russian customers are largely the same as  those that apply in your home jurisdiction  and in supply relationships with other  customers. Having said that, there exist  certain peculiarities in Russian law as well as  practical specifics which a supplier should  take into account when planning sales to  customers located in Russia. The below  overview lists 10 principles which we believe  are easy to comply with and can help make  your supply relationship a lasting and  successful one.  

1. Choose the law you  feel comfortable with  

In cross-border relationships between  Russian and foreign companies, the parties  are entitled to choose the law that should  govern their supply relationship. Certain mandatory provisions of Russian law may  apply to the supply agreement even if it is governed by a foreign law. The vast majority  of contractual terms can, however, be agreed without limitation as there are very  few mandatory rules applicable to supply arrangements.

It is common for a foreign supplier  to make supplies to Russia based on  agreements governed by the law of its  home jurisdiction. In practice, there are a  number of laws that are most frequently  used, including in particular, German,  English, French and Swiss law. Russian law  is also used, although in a cross-border  relationship the parties would typically  tend to choose a foreign law. Agreements  governed by the Vienna Convention on  the Sale of Goods are rarely used.  

As a rule of thumb, it is advisable for  the parties to choose a law they both feel comfortable with and that can be easily  applied by arbitrators in case of a dispute.  In other words, it should be a law with  settled court practice and for which both  parties would be able to nominate  experienced arbitrators.

2. Get the basics right

In cross-border sales, it is common practice  for foreign and Russian partners to enter into written supply agreements regulating  all details of their relationship before  starting any supplies. Nonetheless, it does  regularly happen that supply agreements  are concluded that are unlikely to be  enforceable against the contracting  party due to very basic insufficiencies.  For example, it is not unusual in Russia  to find more than one legal entity using  the same corporate name. It is therefore  essential to state the full corporate name, legal form and address in order  to clearly identify the parties entering  into the agreement. In addition, any  supply agreement must contain sufficient  information about specification, quantity  and quality of the products, the purchase  price and payment provisions as well as  the specific terms and time of the supply,  e.g. by using INCOTERMS or otherwise.   

3. Keep it simple 

Over the last two decades, there was a  tendency to structure supplies to Russia  through complex import schemes, which  often involved the use of one or more  offshore entities, typically located in  Cyprus, deliveries to non-Russian  warehouses, imports via Russian special  purpose vehicles and settlement of  invoices by other offshore entities. In some sectors such schemes were only found  occasionally, e.g. in the pharmaceuticals  and construction equipment sectors. In  other sectors, such as consumer electronics  and various food products, such schemes  were widespread. While valid reasons may  exist for structuring supplies indirectly via  non-Russian entities, one should generally  act with caution whenever complex schemes  are proposed by a potential counterparty.  In the past, imports via offshore structures  were often used to decrease or avoid  Russian customs duties and evade import  tax. Complex import schemes have therefore  recently been under increasing scrutiny by  the Russian authorities.

There have been numerous investigations  initiated by the Russian customs and prosecution authorities, which often lead  to the confiscation of the imported goods,  for which the importing entity then refuses  to pay. There have also been cases (even if  not many) where investigations were  initiated not only against the importing  entity, but also against the foreign seller  suspected of aiding and abetting tax  evasion by the importer.  

Generally speaking, it is therefore advisable  to use simple and transparent supply arrangements, namely in the form of direct  deliveries from the foreign supplier to  the Russian customer and, in turn, direct  payment from the Russian partner’s account  to the account of the supplier. Where  supply arrangements involve third parties,  offshore entities and indirect deliveries,  it should be ensured that there is a valid  economic rational that can be referred to as  justification in the event of an investigation.

4. Make sure you get paid 

As a starting point, there is no reason  to be concerned about the risk of non- payment merely due to the fact that  supplies are made into Russia. The majority  of supply relationships between foreign  suppliers and Russian customers have  been working successfully for many years  and in accordance with the agreed supply  arrangements. Having said this, a supplier  should seek the same level of protection it  requires when selling in its home country or  to other parts of the world. Generally, this  means that supplies should only be made  to a creditworthy entity that has sufficient  assets for payment claims to be enforceable.  Where this cannot be guaranteed, a supplier  should require additional security from a  sufficiently solvent affiliated company  or from a third party guarantor. In this  context, the following types of security  are generally available:

 • The most commonly used security  instrument is a guarantee or surety  granted by another group member,  typically the (ultimate) parent company  of the customer. It is a peculiarity of  Russian law that a guarantee can only  be issued by a bank, and not by other  corporate entities. Corporate entities  are limited to issuing a surety, which is, however, accessory in nature. In other  words, the validity of the surety depends  on the validity of the underlying supply  agreement. As mentioned above, it is not  uncommon that supplies are structured  through complex offshore schemes  and with the participation of third  parties. It must then be borne in mind  that any risk relating to the underlying  supply agreement may also affect the  enforceability of the surety. This is, hence, a further reason to make sure  that the underlying supply relationship  is transparent and fully legally compliant.  

As an alternative to a Russian-law surety,  the parties may use a guarantee issued  under foreign, e.g. German or English,  law, which is generally accepted by  Russian courts and constitutes a non- accessory security instrument. In practice,  both instruments – a Russian-law surety  and a foreign-law guarantee – have  certain disadvantages and weaknesses.  The final decision in favour of one or the  other must, therefore, be made on the  basis of a risk assessment in the light  of the specific circumstances and  preferences of the parties.  

• As mentioned above, the customer  may arrange for a bank guarantee to be  issued by its Russian bank. In practice,  the provision of a bank guarantee in  connection with a supply agreement  is rare. The reason for this is that the  costs associated with obtaining a bank  guarantee are often considerable and may  make the supply relationship unattractive.  Bank guarantees can, however, be an  option in situations where other security  instruments are not available or where  the value of the supplied goods is high.  

• Depending on the circumstances of the  particular case, the parties may consider  the use of a pledge. A pledge over the  supplied products or other movable  property owned by the customer will,  however, involve a certain amount of  administrative work and can be difficult  to enforce, e.g. in cases where the  pledged property has been sold to a third party. A pledge can nonetheless be an  option where products are sold that  can be easily traced, such as heavy  machinery or large equipment.  

Depending on the specific circumstances,  a parent company of the customer may  offer to pledge a certain number of shares  in the customer entity rather than having  to provide other security.

• A mortgage over immovable property  owned by the customer or a third- party can likewise be very attractive  and valuable security. The creation  of a mortgage is, however, subject to  the conclusion of a detailed mortgage  agreement that is to be registered with the Russian property register. In addition,  a mortgagee will typically wish to carry  out a due diligence review of the property  prior to accepting a mortgage. As a  consequence, it is often not practical to  negotiate a mortgage in connection with a  supply relationship. Moreover, customers  are often not ready to mortgage property  for the purpose of purchasing goods. In  practice, therefore, the use of a mortgage  is rare in such cases unless exceptional  circumstances exist. This may be the case  if the value of the goods to be supplied  is exceptionally high, if deferred payment  arrangements are accepted by the supplier,  or if large equipment is to be supplied and  installed in a building or on land which can  be mortgaged.

Whatever type of security the parties  eventually agree to, it is, in any event, essential to clearly define the payment  obligations in the underlying supply  agreement to make sure that the secured  obligations are defined in sufficiently  specific terms. This is particularly important where the supply agreement  takes the form of a framework agreement  and deliveries and payments are made on  the basis of separate orders. As a general  rule, Russian as well as foreign courts  apply very strict standards in this regard.  The provision of collateral security only  makes sense if it is ensured that any  right to realize such security is  enforceable by court action.  

Last, but not least, it should be noted  that enforcement proceedings in Russia  can be lengthy and burdensome. Where  the Russian customer belongs to an  international group or owns assets outside  of Russia, it may often be preferable to  obtain security outside Russia in order to  avoid the procedure of getting an arbitral  award recognised and enforced in Russia.

5. Beware of corporate approval requirements   

Supply agreements are usually signed  by the general director of the Russian  company. General directors of Russian  companies are entitled by law to enter  into agreements with third parties and to  bind the company. To verify his authority,  however, it is common practice to request  submission of the company charter and of  the shareholders’ resolution on the basis of  which the general director was appointed.

In addition, under specific circumstances,  corporate approvals may be required on  the Russian side. Essentially, there are two  situations that should be borne in mind.  Firstly, if the value of the supplied products  is high, it may have to be checked if the  supply agreement qualifies as a “major  transaction” for the Russian customer and  therefore required approval at the board  or shareholders’ level. Secondly, if security  is provided by an affiliate of the customer,  the Russian regime on so called “interested  party transactions” may be applicable.  The issuing entity may then require a  corporate approval to be adopted under  a special procedure. Without going into  details of this approval procedure, from  the supplier’s perspective it is important to  determine whether a surety or guarantee  could fall within the “interested party  regime”. It is therefore critical to obtain any  relevant information on the relationship  and any affiliation between the customer  and the entity providing the security. 

6. Comply with competition laws 

Irrespective of the governing law chosen  by the parties, any supply agreement  relating to supplies into the Russian  territory is subject to mandatory Russian  competition rules. The Russian rules  applicable to vertical supply relationships  are similar to those existing in the European  Union. In brief, Russian competition law  prohibits contractual provisions concerning  vertical supply relationships that (i) interfere  with the setting of the resale price, (ii)  restrict the customer’s capability to sell  goods of a competitor, or (iii) otherwise  restrict competition in the relevant market.

There exists a safe harbour exemption  for vertical agreements between parties  that do not hold a market share of 20%  in any of their markets. Unfortunately,  such exemption is often not available as  the 20% market share threshold extends  to any markets in which the parties are  active in Russia, whether related to the  supplied goods or not.  

Where one of the parties holds a market  dominating position, which normally means that it has a market share of above 35%  (or less in cases of collective dominance),  special rules may apply, prohibiting, among  other things, discrimination of customers, unjustified refusal to supply, any bundling  and tying of products, etc.   

7. Just a supply, or is there anything in addition? 

As a rule, the conclusion of a supply  agreement is not subject to Russian  licensing, registration or other  administrative approval requirements.  Something else may however apply if an  agreement contains elements of other  types of agreements for which Russian  law provides mandatory requirements.  It is therefore necessary to verify that  none of the following applies:

•  If a supply agreement contains  features of a franchise relationship,  this may mean that the mandatory  provisions concerning franchise  agreements apply. In particular,  franchise agreements are subject  to state registration with Rospatent,  Russia’s Federal Service for Intellectual  Property, Patents and Trademarks,  which includes the obligatory  registration of the agreement, any  amendments to the agreement or its  termination. Without such registration  a franchise agreement is deemed void.

• If a supply agreement also relates  to intellectual property rights (e.g.  trademarks and/or patents) that are  to be transferred to the customer,  such transfer may constitute a licensing  agreement. In this case, the agreement  must be registered with Rospatent in order to be valid and protected  by Russian law.  

8. Observe tax and customs regimes   

As mentioned above, tax and customs  issues often arise where supplies are made through complex offshore schemes and  not directly from the supplier to the actual customer. As a general rule, the supply  relationship should therefore be kept simple  and transparent. It is also important to  keep on file all documentation relating  to the supply relationship, including  agreements, order documents, price  lists and payment documentation.  

In addition, supply arrangements for the  import of goods into Russia from abroad  often require an analysis from a Russian  permanent establishment and VAT  perspective, in particular, where supplies  are made via an agent and/or via a  warehouse located in Russia.  

Finally, applicable customs legislation,  including the application of customs duties  and import VAT, will have to be reviewed  prior to entering into the supply agreement.  

9. Don’t go to court

Russia is a party to only a very limited  number of treaties on the mutual  enforcement of court judgments. These  treaties extend to CIS countries and  various other countries, but not to most  Western countries. As a result, decisions  of a foreign court cannot normally be  enforced in Russia. Vice-versa,  Russian court decisions cannot normally  be enforced against a foreign supplier.  

The situation is much different in relation  to arbitral awards, even if rendered by a foreign arbitration tribunal. For any  cross-border supply agreement, it is,  therefore, a ‘must’ for the parties to  include an arbitration clause into their  agreement. Russian and foreign arbitral  awards are generally recognised by  Russian courts, provided that certain procedural requirements applicable to  the presentation of such awards are  complied with.  

10. Be insured

As holds true for any supplies to other  countries, there remain certain risks  relating to supplies in Russia that  cannot be fully excluded, even if all  legal aspects are assessed and complied  with. It is therefore common for  suppliers to consider export insurance  of their supplies to a Russian customer.

In case of cross-border supplies to  Russia, it is common for suppliers to  seek insurance outside Russia in their  home country. Where supplies are made  within Russia from a Russian supplier to  a Russian customer, such supplies are  typically insured by a Russian insurer.  This is due to the fact that insurance  activities on the Russian market are  subject to mandatory licensing, which  can only be obtained by Russian entities,  but not by foreign insurers acting from  abroad. Various international insurance  groups have, however, entered into  cooperation agreements with Russian  insurance companies, enabling such  local insurance companies to sell certain  insurance policies on the Russian  market with re-insurance backing by  the foreign insurance group.  

To obtain insurance for export supplies  to Russia, a company will typically  have to provide the underlying supply  agreement and proof that sufficient  security has been sought from the  Russian customer, e.g. by obtaining a  guarantee or surety from the customer’s  ultimate parent. Insurance policies will  normally exclude coverage for risks arising  out of circumstances that are under the  supplier’s control. Such circumstances  may include the legal validity of the  underlying supply agreement, validity of  the security obtained by the insured and  compliance with any corporate approval  and regulatory requirements. In other  words, observing the 10 rules listed in  this overview is not only essential for  the supply relationship with the Russian  customer, but also forms the basis  enabling the supplier to obtain and  rely on its insurance coverage.

Clifford Chance 

Legal support in relation to the preparation of the 10 principles recommended  by Atradius was provided by Torsten Syrbe, Partner, Clifford Chance CIS. This overview is intended to provide general guidance on the legal framework applicable to supply  relationships with Russian customers. It is not intended to provide legal advice and cannot replace  a thorough analysis of a respective supply arrangement. 

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