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#21 - JRL 2008-128 - JRL Home
Date: Mon, 7 Jul 2008 20:33:12 +0400
From: "Paul Backer" <pauljbacker@gmail.com>
Subject: Resisting corporate raiders

Survival Guide to Russia Business Law, Regulations and Compliance
Part 2: Resisting corporate raiders.
By Paul Backer (pauljbacker@gmail.com)

International corporate and securities attorney in private and public practice focused on Russia/CIS from 1994.

DISCLAIMER: This article is uncompensated. It is NOT legal advice. Everything herein is personal opinion. It does not represent anyone else’s opinion. It does not address any current or past client or employer matter.

WHY A “SURVIVAL GUIDE”? Having a client get a good result is fun. It’s good for the soul. A survival plan (assessment, tools, implementation) materially improves chances to prevail in a crisis. The goal of these articles is to suggest legal, regulatory and compliance tools (best practices) for particular situations. Historically, the Russia/CIS business, legal, regulatory and compliance environment lavishly rewards consistently applied best practices.

SYNOPSIS: A foreign investor in Russia/CIS is not a Job. He is an economic agent executing a business model competing with other business models. A raider attack on a project is not an act of god or an open invitation to join the holy martyrs. Raiding is a business model relying on the perceived advantage of its implementers, the ability to cost effectively seize and most importantly, monetize inadequately protected assets. Success of raiding largely relies on the target’s failure to implement and maintain a survival plan.

“You want the world to be one way, but it’s the other way.” HBO, The Wire.

“If you are going through hell, keep going.” W.S. Churchill

Reporting on Russia fairly screams that a raid on your business in Russia (and many other CIS countries) is a near certainty. Googling “Moscow Times” and “raiders” gives around 1000 results. Over the past 14 years in and out of the CIS, I probably read hundreds of articles on raiding. Why not? There is always a colorful tale told. The description of raiding appears somewhat muddled, but it sounds very unpleasant. The crisis is upon us. The sky is falling. Repent now. Notwithstanding the fact that having been in the region for over a dozen years, not one client had been successfully raided.

The generic raid scenario is as follows: foreigner comes to Russia, invests in something or builds up something and then is RAIDED. His stuff is seized either by virtual strangers or minority shareholders who turn out not to be the white knights hoped for. At some risk of trivializing the genuine pain of victims of raiding, but this sounds like the tale of any start-up or niche business worldwide. There are even some people in the legal and other professions who argue that hostile takeovers free companies from incompetent management and ownership, benefiting the company, its employees and customers. But, that’s not our topic here.

The idea of a survival guide is to help, “adapt and overcome” in a crisis. Life doesn’t get more “high threat” than losing all of your stuff. A viable survival plan has three elements, assessment, tools and implementation. Applying these elements can deprive the raider business model of its economic rationale. Not, convince them to hie themselves to a nunnery in shame, but to materially increase the cost and difficulty of the effort to abscond with your stuff. To make them raid someone else.

Assessment. What is raiding? Is your business at risk of a raid? Non-raiding events can happen which may involve the loss of assets. An anti-raiding survival plan is not very effective against a non-raiding attack. The punitive or inconsistent implementation of compliance and regulatory regimes leading to asset loss, while hopefully the subject of a future piece, is not raiding. TNK-BP employee visa experience is surely profoundly unpleasant to the foreign investors, but that doesn’t change the fact that Russia, as any other sovereign state has discretion to enforce its labor and visa regimes. Perhaps, it is a life lesson that laws ignored for years when relations are good, come back to bite one on the fleshy parts in time of conflict?

Street level nonproductive rent seeking by fire and health inspectors, customs officials, low ranking militia officers and other persons without a easily apparent purpose in life who wander into your place of business making mystic gestures and mumbling semi-coherent imprecations are a problem, but are not raiding. It’s an interesting separate topic, having to do with the krysha and okhrana (hmm… let’s translate those as “administrative resources utilization”) fallacies, also a subject for a future piece.

Raiding is the use of administrative and legal procedures, primarily litigation or other administrative action, sometimes including the physical seizure of assets through the use of a weapons bearing government or non-government entity to effect a long term, often permanent dislocation of an owner from his assets. The core goal of raiding is to wind up with ownership or other form of effective long term control of the assets.

Owners have found themselves suddenly locked out of their place of business, because of suits by non-existent creditors or imaginary clients. Others simply find themselves barred on the basis of a fraudulent asset transfer or real estate ownership documentation. Permutations border on the infinite. There are two key points.

First, raiding rewards the raider if he either acquires ownership or long term control of an asset enabling him to monetize it. There is little economic benefit to kicking someone out of a plant if the raider himself is kicked out a week later. Second, raiding largely relies on the target either being unprepared or implementing ineffective mechanisms.

Are you at risk? This is a complex issue, involving a great deal of emotion. A key factor is your role in the venture. Are you a passive investor, particularly a one-time investor looking to recoup through a long term revenue stream? Are you onsite every day, week, month? Is your business model based on a past unique commercial or administrative advantage? Did you get it for pennies on the dollar, b/c someone in authority in olden times provided, for whatever reasons, a signature or a stamp needed to control it? Do you provide some unique market access or management skill that the business requires to function? Generally, if you are an absentee passive investor, for a project acquired on non-market terms, and are seen as unnecessary to ongoing success, then your likelihood of being raided is exceedingly high. Or you may just “get lucky” and a raider will take a run at you, just to try their luck.

A successful raid must give the raider the opportunity to acquire durable long term control of the asset. Seizing control of a jewelry store to sell the diamonds out of the safe and disappear is burglary. Seizing control of a jewelry store to sell diamonds for years or to resell the store is raiding. Raiding requires taking control of the legal narrative, it requires documentation and control. Tools can disrupt the raid process to the point of making it nonviable.

Tool 1. Controlling documentation. There are key administrative entities that can allow access to core business documents or facilitate the creation/substitution of new enterprise documents. The tax inspectorate has the key company legal documents on file including the Articles and/or Charter, tax ID number, financial reports, etc. The real estate registry holds the documentation relevant to ownership, control, collateralization, etc. of real property. Effective raiding relies on information and documentation. Timely warning of an unauthorized (economically unjustified) effort to access documentation can serve as the first warning of a raid. Preventing the substitution of fraudulent documents into either the tax or real estate files is vital. Ensure that you know immediately if someone seeks access to your documents. Ensure that you know if anyone tries to file “amended owner lists” or re-register real estate, etc.

Tool 2. Control key employees. For legal purposes, every company in Russia/CIS has two key executives, the General and the Finance Directors. For the sake of brevity, these are the only legally meaningful executive positions in a business. I read a story about a General Director who was physically coerced to sign over key assets to a raider. If the Articles/Charter of that entity expressly barred the General Director from entering into any transaction disposing of more than X% or Y Rubles of entity assets absent signed authority by another person, this situation would have been avoided. The Finance Director (Chief Accountant) typically has the ability to “form” the company’s tax balances and access its bank accounts. Take steps to control this ability. Include provisions that any accounting statement changing the existing company balances by more than X% or Y rubles must be co-signed by another person to be valid. Rotate key executives. Conduct internal audit and security assessments.

Tool 3. Internal key documentation control. If you own an active business, there is probably good reason to keep the corporate stamp on the premises. Any reason to keep your original company documents there? Are you keeping originals of key contracts on the premises? Why? Implement a rigorous document retention policy. Do you have a policy for handling correspondence and documentation from key legal/regulatory entities? Who has the right to sign a receipt for an incoming tax document, subpoena, court document, etc.? What is the procedure to notify you or your agent immediately if documentation from a “high impact” agency such as one of the above is received?

It is not unknown for court decisions to spend weeks in someone’s “in” tray. On one occasion, a company subject to over a dozen adverse legal decisions lost the correspondence notifying it of the court hearings. A security guard signed for the envelopes, and the owners did not know that they risked losing their asset. On another occasion, the owner of a natural resource asset was notified that he had 45 days to cure a reporting deficiency, the notice waited 60 days until his next visit to Russia.

Tool 4. Legal control. Implement contractual provisions that trigger in the event that the productive asset is seized. Consider change of ownership provisions providing either for pay-outs or preferential asset purchase rights. If your asset produces widgets, consider an exclusive sale agreement for these widgets for the next decade. Examine how your assets are owned, are they held by one easy to seize entity or several? It may be worth considering splitting up your assets into several legal entities.

Tool 5. SLAPP. While not perfectly applicable, it’s a catchy abbreviation like BRIC and well… I like using it. Sorry. If your company comes under an attack, such as an effort to introduce fraudulent documentation, lawsuits by non-existent creditors, concerted employee law suits and other storm clouds presaging a raid, how ready are you to respond? How long will it take you to file counter-suits, to slow down your opponent and to either retain or gain control of the situation? Has your company established a relationship with the arbitrage (commercial) court with jurisdiction over your asset?

Tool 6. Onsite security. If you think that you are about to have real raiding issues, employ the militia as onsite security.

Finally, the issue of implementation. Is your primary defense against being raided an “A” Team lead by the Tooth Fairy, the Easter Bunny and other largely imaginary public figures invented to make the world slightly less frightening, such as your nation’s Ambassador? Unless your company is threatened by a ribbon that needs cutting, relying on your Embassy for help in a raid is a phenomenally bad idea.

I suspect that every corporate lawyer working in Russia/CIS experienced the slightly surreal situation where a disappointed foreign investor proceeded to rage about visa “black lists”, or a party’s products being banned from the European Union commodities or securities markets, etc. It’s the legal equivalent of combining “you will never eat lunch in this town” with “you won’t be able to come to the town”. They will and they can, and don’t waste your finances and emotional bandwidth on nonsense.

My favorite piece of pernicious nonsense is the dreaded… “bad PR”, and particularly, the bad PR from the (drum roll) Embassy. Many of us witnessed the disturbing spectacle of a serving U.S. Ambassador appearing to shill for an oil company involved in a criminal tax case in Russia. It did, very effectively, perform a vast disservice to America’s prestige in the region, but it didn’t seem to return any assets to the oil company in question. In the age of Internet dissemination of documents and information, the purpose and need for Embassies staffed with (in some cases) hundreds of staffers may be increasingly unclear, but whatever it is, it is not to help your business.

So, what works? As with any survival situation, assess your risks, look at the tools and the cost of their implementation. Costs in time, administrative resources and money should be proportional to the risks faced, and the project value. If your project is a small one or faces low risks, implement one time tools such as Charter and Articles amendments, reallocation of key assets, document and correspondence retention and handling policies.

If your project is a big one with a high risk, implement an ongoing program of pro-active engagement with your tax inspectorate, real estate registry and arbitrage court. The goal is to structure your project and your participation in the project so that, as the Russians say, the game is not worth the candle.

What does this sort of thing cost? It’s not my original thought, but every client should receive all the legal support he needs, not all the legal support that he can possibly afford. Very broadly, an initial assessment of risks, recommended corporate document amendment and one-time policies and drafts had run about 450,000 to 700,000 RFR (roughly, $20,000 to $25,000) and is more expensive if onsite time is required. For a high risk and/or high value asset, and particularly if on-site time for auditors and attorneys is required, the costs generally exceed 1,000,000 RFR. For situations requiring on-going monitoring, and pro-active engagement with key RF regulatory entities, costs in excess of USD $5,000 a month, I would consider somewhat suspect. As to the “white glove” and the “white shoe” transnational consultancies, multiply the costs by some factor, but it’s not the kind of work that I would task out to them. Hmm that suggests the theme for the next article, choosing a lawyer in the RF/CIS.

As always, questions and suggestions to pauljbacker@gmail.com.