2017 Project Finance Report: Russia

The financial sanctions imposed on certain Russian individuals and companies following the Ukrainian crisis in 2014 restrict some Russian borrowers from accessing long-term debt financing in the western markets. As a result, the Russian market is currently dominated by Russian and Asian (particularly Chinese) banks, whilst most western banks have reduced their Russian focus significantly.

The decline in the oil price and in the Russian ruble has also had an adverse effect, particularly on dollar-denominated project financings.

However, project finance, specifically for toll roads, bridges, airports and power facilities remains a hot topic given the government's commitment to modernise Russia's infrastructure. Furthermore, the Russian legal framework for project financings has improved significantly over the past few years and, as a result, the arsenal of instruments and structures available to project finance lenders has expanded significantly. Accordingly, notwithstanding the numerous headwinds, project finance activity in Russia remains moderately high.

Export credit agencies, multilateral agencies and international financial institutions play a significant role in the Russian market by providing debt finance, guarantees and insurances. The main Russian institutions include the principal development bank Vnesheconombank (Bank for Development and Foreign Economic Affairs – VEB) and the Russian Agency for Export Credit and Investment Insurance (Exiar), which provides insurance support and issues guarantees to counterparties of Russian export-oriented companies. In 2006, Russia and Kazakhstan established the Eurasian Development Bank (EDB), which has subsequently been joined by certain other former CIS countries as shareholders and which has financed a number of projects in Russia. In addition, the New Development Bank BRICs, founded by Brazil, Russia, India, China and South Africa, is expected to be an important player in the Russian project finance market. The European Bank for Reconstruction and Development (EBRD) and International Finance Corporation (IFC) have also historically been amongst the largest market players in Russian project finance. However, following the adoption of the Ukraine-related sanctions, they have either decreased their Russian operations or ceased them altogether.

A number of laws relating to public-private partnerships (PPPs) are effective in Russia, including the recently adopted federal law on PPP. Only a Russian legal entity may be a private partner. The law does not impose any restriction on foreign shareholding of a private partner and, therefore, a foreign investor may participate in PPP projects through a Russian subsidiary.

Both greenfield and brownfield projects are permitted. The PPP law contains an exhaustive list of facilities that may be the subject of a PPP agreement. Certain facilities (which may not be owned by the private sector under Russian law) may only be subject to concession agreements, and natural resources may be subject to production sharing agreements.

A concessionaire may not pledge the subject of a concession agreement.

A concessionaire may only pledge its rights under the concession agreement to the extent permitted by the concession agreement itself (including, if applicable, the consent of the relevant government or contracting authority) and provided that such pledge is in favour of the banks financing the concession. A person, which becomes the assignee as a result of the pledge enforcement, shall satisfy the criteria set out by the relevant concession agreement.

Foreign investors are generally entitled to make investments in the form of debt or equity. The general taxation regime applies to foreign investors in terms of payment of taxes and other fees (subject to the provisions of international tax treaties).

Pursuant to the Russian law on strategic investments, any direct or indirect acquisition by a foreign investor of control over a Russian company engaged in certain strategic activities requires prior governmental approval.

Control over a strategic enterprise may be triggered by:

• a direct or indirect acquisition of a certain percentage of shares or participatory interests;

• an acquisition of a certain percentage of fixed assets; or

• the appointment of a certain percentage of the overall members of the relevant management bodies.

The applicable thresholds depend on the type of strategic enterprise and the type of investor (foreign, state-owned or private) and range from 5% to 50%.

In addition, anti-trust clearance procedures may apply under Russian competition protection law in connection with investments.

If all the necessary anti-trust and strategic approvals have been duly received, Russian governmental authorities cannot block or unwind a transaction. If a clearance should have but has not been obtained, the authorities may challenge (unwind) the transaction in court.

Russian law provides for the nationalisation or (in case of an emergency) the requisition of assets (subject to compensation in favour of the injured party).

Russia is a party to a number of international treaties on protection of foreign investment, which give additional comfort to foreign investors from certain jurisdictions.

Income received by a foreign legal entity may be subject to withholding taxes in Russia at the following rates:

• 15% on dividends from shareholdings Russian entities; and

• 20% on income received from sources in Russia.

Double tax treaties may reduce these tax rates or exempt foreign legal entities from taxes in Russia subject to confirmation of their tax residency.

Russia also has a set of thin capitalisation rules and rules which oblige entities controlled by Russian tax residents to pay taxes in Russia.

Russian currency residents are allowed to open:

• onshore foreign currency accounts with authorised banks which have a license for currency operations;

• offshore foreign currency accounts with branches of authorised banks; and

• offshore foreign currency accounts with foreign banks provided that Russian currency residents:

• notify the Russian authorities of opening the account and all movements of funds on such accounts; and

• may only receive funds on their offshore accounts as a result of a limited number of operations, such as receipt of loans from foreign banks residents in Financial Action Task Force (FATF) or Organisation for Economic Co-operation and Development (OECD) member states for a term exceeding two years to accounts in banks which are residents in FATF or OECD member states.

Russian currency residents shall repatriate the proceeds they receive from foreign trade. The exceptions to this rule include use of such proceeds for the repayment of the loans referred to item c (2) above or set-off of such proceeds for reinsurance purposes.

Insurance in Russia is subject to licensing and licences are only issued to Russian legal entities. Russian subsidiaries of foreign insurers may only provide certain types of insurance in Russia. Foreign insurers are not allowed to engage in any insurance business (subject to exceptions, such as merchant shipping insurance). Insurance proceeds paid by the project lenders can be subject to withholding tax under the Tax Code.

Reinsurance may be provided by foreign reinsurers which have a licence abroad without a local licence. Reinsurance is a common instrument and Russian insurance companies often seek reinsurance from foreign reinsurers, which is typically provided under English law and may include cut-through clauses.

The submission to foreign state courts is not prohibited. However, Russian courts may refuse to recognise or enforce a judgment of a foreign court unless there is an international treaty between Russia and relevant foreign state or there is reciprocity in relation to judgments of Russian courts in the relevant foreign jurisdiction. Russia has a number of international treaties with CIS countries, however, notably, no such agreements have been concluded between Russia and the UK or Russia and the US.

Russian law is based on the principle of immunity of foreign states. However, a foreign state is considered to have waived its immunity where such foreign state has filed a claim or a counterclaim with a Russian court for a particular case. Some international treaties concluded by Russia (for example, with the US) provide for limited immunity of foreign states which implies that immunity of a foreign state does not apply in a purely commercial matter.

Russian law allows waivers of immunity by international organisations, provided that such waiver is granted in accordance with the rules and procedures of the relevant organisation.

Russian courts generally recognise and give effect to the choice of English or New York law as the governing law.

However, as a general rule, foreign law is only permitted in circumstances where there is a foreign element (for example, where one of the parties is a foreign person).

The application of a foreign law to a legal relationship involving a Russian counterparty may not contradict:

• Russian public policy;

• mandatory provisions of Russian law or a foreign law if the relevant jurisdiction has a close connection with the legal relationship; or

• a statute which makes the application of foreign law subject to reciprocity.

If the choice of foreign law is upheld by the Russian court in a particular case, the party seeking to rely on the foreign law provisions shall demonstrate their contents and meaning. As regards foreign law, a Russian court would only rely on the advice and the interpretation by foreign law experts.

The Russian Federation is a party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958 and, subject to its conditions and applicable Russian law rules and procedures, a Russian court would recognise and enforce a foreign arbitral award. Arbitration is commonly used as a dispute resolution mechanism in cross-border transactions involving Russian entities, including project finance transactions.

The following types of security are available in Russia:

• Mortgages (including over real estate objects, land plots and lease rights); and

• Pledges over:

1) shares (in joint stock companies) and participatory interests (in limited liability companies);

2) movable property (including equipment, goods in circulation, all assets pledge and other property);

3) intellectual property rights; and

4) contractual rights (including receivables, bank accounts etc.).

A construction-in-progress may be subject to a mortgage, if such construction-in-progress is registered with the Russian real property registry. However, it is possible to mortgage all future real estate objects under construction by way of mortgage of the underlying land plot.

Security assignments under Russian law are not expressly recognised as security interest for the purposes of the Russian bankruptcy legislation. Therefore, it is advisable to obtain pledges of contractual rights instead.

A pledge over rights to bank accounts is a new concept under Russian law which remains, to some extent, untested. Therefore, lenders still prefer to obtain direct debit rights with respect to the borrower's bank account.

Suretyships (accessory to the secured obligations), independent guarantees (by corporate entities) and bank guarantees (by credit institutions and insurance companies) are also available in Russia.

Security cannot be established over rights under subsoil licences, other licenses and permits issued by governmental authorities and a limited number of other assets (such as concession objects).

The concept of contractual subordination or similar intercreditor arrangements is not recognised under the Russian bankruptcy legislation. Accordingly, Russian courts or bankruptcy officials would not give effect to a subordination agreement entered into by a Russian debtor.

Onshore indebtedness is commonly subordinated either structurally (for instance at different corporate levels) or by way of pledge in favour of the lender of promissory notes issued by an onshore debtor as payor to group companies (whereby such group companies are prohibited from demanding payment under such promissory notes until the pledge is released).

The Civil Code amendments introduced the concept of an intercreditor agreement, which may:

• be concluded between different creditors of one borrower;

• restrict the ability of some or all creditors to enforce claims or security on an individual basis;

• set out rules on priority and subordination of claims; and/or

• provide for non-proportional allocation of proceeds.

As mentioned above, no such concept has been introduced into the bankruptcy legislation and in insolvency each lender would have a separate and independent claim against the borrower, regardless of the provisions of any intercreditor agreement.

However, the (senior) lenders would have a contractual claim for damages against a (junior) creditor which files a claim against a project company in breach of the relevant intercreditor agreement and receives proceeds therefrom.

• Mortgages are perfected by registration with the Russian real property registry;

• Pledges of shares are perfected by registration with the relevant depositary or registrar;

• Pledges of participatory interests are subject to mandatory notarisation and are perfected by registration with the Russian company's registrar;

• Pledges over rights to bank accounts are effective following their due execution;

• The perfection requirements applicable to pledges over intellectual property rights depend on the type of pledged right; and

• Pledges of other movables (including movable property, receivables and contract rights) are effective following their execution but should be recorded with the Russian pledge notification register maintained by the Russian notaries.

The pledge priority can be set out in the underlying pledge agreement (first ranking, second ranking etc.) and, in relation to mortgages and pledge of shares, must also be recorded in the relevant public register.

As regards pledges of movables (in circumstances where the priority is not set out in the pledge agreement itself), priority is determined in accordance with the Russian pledge notification register on the basis of the date of registration.

Other than in respect of pledges over participatory interests (see the paragraph below), no state duty or registration or similar tax or duty is mandatory in Russia in connection with perfection of security over movable assets.

Registration of a pledge over participatory interests or a mortgage over immovable assets will be subject to the Russian state duty tax and registration fees.

Notarisation of pledge agreements (including a pledge over participatory interests) is subject to a notary fee. The amount of the notary fee depends on whether the notarisation is mandatory or voluntary and the amount of the secured obligations. The notary fees are determined by law (in respect of mandatory notarisation) or by notaries in accordance with general guidelines adopted by the notarial community (in respect of voluntary notarisation). Although voluntary notarisation is not required at law to ensure the validity of the underlying document, lenders often choose to voluntarily notarise security documents to facilitate out-of-court enforcement or ensure the correct priority.

Neither state duties nor notary fees can typically be reduced or deferred.

Russian law does not recognise trusts. However, the recent amendments to the Civil Code introduced the concept of a pledge manager. A pledge manager is a person that can be appointed for the purposes of executing and exercising the pledgee's rights under the security documents on behalf of the lenders. The lenders can appoint a bank (either a lender or a third party), a commercial entity or a sole proprietor to act as pledge manager.

The concept of a pledge manager has a number of disadvantages compared with traditional project finance security structures (such as trustee, joint and several creditor or parallel debt). For example, notwithstanding the appointment of a pledge manager, each lender should still be registered as pledgee in the relevant public registers.

Historically, two structures have been used to enable one of the parties to an English law governed facility agreement to act as a pledgee under Russian law security documents. These structures are joint and several creditorship and parallel debt. Both of them are extra-statutory. Accordingly, these could now be deemed by a Russian court not to comply with the pledge manager provisions of the Civil Code. That said, in English law documentation, it remains common in the market to employ these structures.

Under bankruptcy law, following the commencement of bankruptcy proceedings, there is a general moratorium on acceleration and enforcement over the assets of the company, meaning that the claims of all creditors shall be satisfied in accordance with the order of priority established at law.

Claims, which have arisen after the bankruptcy proceedings commenced (including certain mandatory claims, such as taxes, salaries or fees), have super-priority.

Other claims are divided into three groups. First-priority claims include those arising from the debtor's liabilities to individuals for harm to life or health. Second-priority claims arise out of the debtor's obligation to pay wages and similar amounts in the ordinary course of business, or pay fees or royalties. Other claims included into the ranking list constitute third-priority claims.

Claims secured by pledge or mortgage over the debtor's assets are settled out of the proceeds from the sale of such collateral ahead of all other claims. 70% to 80% of such proceeds are allocated to the relevant secured lenders, with the remaining 20% to 30% being divided between creditors of claims of higher priority.

Specialised project finance organisations:

The Russian securities law features the concept of a specialised project finance special purpose vehicle (SPV), which is bankruptcy remote. The bankruptcy remoteness is achieved by limiting the ability of the creditors of the SPV to file a bankruptcy claim against the company (if so provided under the relevant contract). This type of SPV can solely be used for the purposes of being a project finance investment vehicle. An additional (non-bankruptcy remote) company with a broader capacity would need to be the owner of the relevant assets and the counterparty to the relevant project-related contracts.

A secured creditor may enforce its security in the event of the debtor's failure to duly perform the secured obligations. Unless the security documents provide for out-of-court enforcement, the secured creditor needs to file a claim to court to enforce the security.

Russian law sets out detailed procedures for out-of-court enforcement by way of notary endorsement. In order to be eligible for out-of-court enforcement by way of notary endorsement, the underlying pledge agreement must be notarised. Enforcement by the pledgee (but not a mortgagee) without a notary is also possible but is not regulated in detail.

In certain cases, in order to exercise its rights the secured creditor needs to obtain prior anti-trust or strategic clearance approvals or comply with mandatory tender offer requirements.

Under Russian law, contractual enforcement is possible only in relation to assets that are pledged under a pledge or mortgage agreement.

To enable out-of-court enforcement, the secured creditor and the security provider need to expressly agree not only that such approach shall apply but also which specific method shall apply.

Out-of-court enforcement is generally allowed by way of one of such pre-agreed permitted enforcement methods, which may include public or private auction, retention (for example, by way of transfer of title to a secured property to a secured creditor) or private sale without an auction (the latter is not possible in case of enforcement of mortgage).

About the author
		Mikhail Turetsky Partner, Latham & Watkins Moscow, Russia T: +7 495 644 1910 E: mikhail.turetsky@lw.com W: www.lw.com Mikhail Turetsky is the office managing partner of the Moscow office of Latham & Watkins. His practice focuses on finance and capital markets and he has extensive experience advising banks and corporate clients on all aspects of transactions in Russia and the CIS. Turetsky’s primary areas of expertise include debt and equity capital markets as well as a broad range of finance transactions, including project finance, structured finance and financial restructuring.

About the author
		Ragnar Johannesen Counsel, Latham & Watkins Moscow, Russia T: +7 495 644 1831 E: ragnar.johannesen@lw.com W: www.lw.com Ragnar Johannesen is an English law qualified, Moscow-based counsel specialising in banking and corporate finance, with a particular focus on event-driven transactions, restructurings, and structured and limited recourse financings (including structured trade and export financings). Johannesen has experience in transactions involving multilateral financial institutions, development banks and export credit agencies. His sector experience covers oil and gas, mining and commodities, financial services, real estate, retail, transport and TMT.

About the author
		Ksenia Koroleva Associate, Latham & Watkins Moscow, Russia T: +7 495 644 1943 E: ksenia.koroleva@lw.com W: www.lw.com Ksenia Koroleva is a Russian law qualified associate in Latham & Watkins’ Moscow office. Koroleva has experience advising large Russian and international banks and corporate clients on all aspects of transactions in Russia and the CIS. Her practice primarily focuses on banking and corporate finance across multiple industries on the Russian market, including real estate, oil and gas, financial services and TMT.