Against the backdrop of a rapidly evolving domestic and international legal landscape in Ukraine, this OnPoint focuses on the practical steps that companies operating in Crimea may consider taking in view of the legal environment in which they are now conducting their business. For banks and companies operating in this new reality, what does the imposition of Russian law in Crimea mean? At the same time, how can foreign, Russian and Ukrainian companies in Crimea ensure ongoing international law protections for their investments in circumstances where Russia now claims sovereignty?
Russia’s Imposition of Russian Law in Crimea: What Does This Mean for Foreign Banks and Companies Operating in Crimea?
Conflicting Applicable Laws
Companies operating in Crimea are faced with the very real issue of having to comply with two different systems of law: Ukrainian and Russian.
On 18 March 2014, the Russian Federation entered into the Agreement to incorporate the Republic of Crimea and the city of Sevastopol as new subjects into the Russian Federation as of that date. The Agreement was ratified on 21 March 2014 and provides together with other implementing legislation for a transitional period of integration until 1 January 2015 during which Russian law is to apply throughout the region unless stated otherwise in other Russian laws. It also provides that normative legal acts of the Republic of Crimea shall continue to apply throughout the transition period, unless they contradict Russian law, until new legislative acts are passed either by the Russian Federation or the Republic of Crimea.
Meanwhile on 15 April 2014, the Draft Law of Ukraine No 4473-1 “On securing rights and freedoms of citizens on the Temporarily occupied Territories of Ukraine” (“Draft Law”) passed its second reading. While the Draft Law in its current form is not currently publicly available and would need to pass through additional hurdles before it becomes law, it may well contain provisions that will contradict the Russian laws that are being passed. Certainly, in its previous iteration the Draft Law contained a number of provisions affecting business operations that would have run contrary to provisions in new Russian laws applicable to Crimea, and would impose harsh penalties for non-compliance with Ukrainian laws. While it is unclear whether the Draft Law will ultimately be passed with such provisions in it, companies should have a strategy in place for their future functioning since, in any event, there will undoubtedly be conflicts between existing laws issued by Ukraine and the Autonomous Republic of Crimea with those being issued by the Russian Federation.
In parallel to the above measures, Russian legislation provides that local law, that is, legal acts of the Autonomous Republic of Crimea and the city of Sevastopol will apply in the Republic of Crimea and the federal city of Sevastopol to the extent they do not conflict with Russian law.
With which law should companies comply?
As a practical matter, for at least the foreseeable future Crimea is likely to remain under the control of Russia, governed under Russian law and its residents (personal and corporate) subject to the jurisdiction of the Russian legal system. This is evidenced by, amongst others things, the numerous laws that the Russian Federation has already passed dealing with the integration of the Republic of Crimea into the Russian Federation (which cover a spectrum of issues including pension payments, the financial sector, and army services) and control of significant infrastructure (for example, the underwater telecommunications cable linking Russia to the Crimea (and bypassing Ukraine) on which Rostelecom (Russia’s long distance telecoms provider) began construction in March is now almost complete). Indeed, on 14 April 2014, the first dispute between an American/Crimean company and its Crimean partners was heard under Russian law in the Russian language by the first Crimean arbitrator to have received his Russian law qualification at the Supreme Commercial Arbitration Court.1
In light of the practical reality on the ground, in our view, non-Ukrainian owned subsidiaries operating in Crimea would generally be advised to bring their operations into compliance with Russian law and seek Russian law advice to ensure that they are in compliance with such laws. To the extent that such laws are deemed to conflict with Ukrainian law and claims are brought against companies on the basis that they are in breach of Ukrainian law, companies may be able to avail themselves of the defence of force majeure, among other possible defences.
With regard to subsidiaries or branches of Ukrainian companies or companies where the majority of business by the company is carried out in Ukraine and little or no operations are carried out in Russia, this issue is more complex given the possibility that such companies (and their officers) may face potentially serious consequences in relation to the rest of their business in Ukraine should they comply with Russian law. Depending on their particular circumstances, such companies, subject to compliance with sanctions where they apply, may be best advised to continue to comply with Ukrainian law (and to the extent it is not inconsistent, Russian law). If such companies are ultimately sued outside Ukraine or Russia for violations of Russian law, they may argue that Russian sovereignty is not recognized under international law and therefore Ukrainian law continues to apply. If they were to follow Russian law and encounter problems, again the force majeure doctrine and other legal defences may be used to support their position.
Companies should obtain legal advice to ensure that their legal positions are properly supported, and legal defences are preserved.
Requirements for Banking Institutions
A new Russian law (the “Crimea Financial System Law”)2 gives banks and non-banking financial institutions (including currency exchange offices and non-financial institutions that provide cash wiring services without an account) operating in the Republic of Crimea and the federal city of Sevastopol (“Crimea”) the choice of whether to continue operations on the peninsula – but in compliance with Russian law – or halt all activity. Effective since 2 April 2014, the Law sets out the conditions according to which banks and non-banking financial institutions, operating on the basis of licenses/permits issued by the Ukrainian government, may continue their activity in Crimea during the transition period, which will last until 1 January 2015 (subject to certain exceptions).
In order to continue their activity during the transition period, banks operating in Crimea must:
(a) notify the RF Central Bank (the “CB”) of their decision to continue business operations;3 this notice should have been submitted to the CB’s territorial subdivision in Crimea by April 17, 2014 inclusive;
(b) provide the CB with financial reports and other information required under Russian law;
(c) provide the CB with the register of liabilities owed to creditors and customers;
(d) provide the CB by 2 May 2014 (inclusive) with copies of statutory documents, banking licenses and information with respect to management (CEO, Chief Accountant, etc.);
(e) execute CB requirements on disclosure of obligations; and
(f) provide customers with banking services on the basis of the Russian Rouble as the instrument of payment (except in cases of currency exchange).
By the end of the transition period, banks can either: (i) re-register with the CB and obtain a Russian banking license, (ii) establish 100% subsidiaries that would obtain Russian banking licenses and thereafter assume all obligations of their parent banks, or (iii) reorganize themselves by way of separating or spinning-off, such that the new entity would obtain a Russian banking license and assume the obligations of the original Crimean entity of the bank.
Requirements for Non-Banking Financial Institutions
Non-banking financial institutions registered and/or in Crimea are allowed to continue operating until 1 January 2015 without having to obtain a license from the CB, subject to compliance with conditions substantially similar to those for banks (listed above). By 1 January 2015, these non-banking financial institutions would need to obtain all permits required under Russian law if they decide to continue operating in Crimea.
Non-banking financial institutions will also be required to deposit all money and other property received by them from their clients (whether private individuals or legal entities) with Russian credit institutions and/or Russian non-credit financial institutions, or invest them in Russian securities.
How Can Investors Protect Crimean Investments?
While sovereignty over Crimea is forcefully contested, Russia’s imposition of Russian law over the Crimean Peninsula raises important considerations for investors seeking to maintain protection for their investments at international law under applicable international treaties (in particular, bilateral investment treaties or “BITs”). As a result, such investors may wish to take steps to ensure their operations in Crimea are afforded protection under one of Russia’s 50-plus BITs.
Bilateral Investment Treaties: Protections for Foreign Investors and their Investments
BITs, commonly entitled 'agreements for the encouragement and reciprocal protection of investment', are international treaties between two states which contain reciprocal promises to encourage foreign direct investment from nationals of the other state and substantive protections for investments so made. Ukraine has concluded some 60-plus BITs with other states, and is also a party to the multilateral Energy Charter Treaty (“ECT”) which protects foreign investments in Ukraine’s energy sector. Russia has concluded more than 70 BITs (of which about 50 are in force), but terminated provisional application of the Energy Charter Treaty in July 2009 (though provisional application continues until July 2029 for investments made prior to July 2009).
The substantive protections offered by a host state to investors from the other contracting state to the BIT most commonly include the host state’s promises not to expropriate (directly or indirectly) the investor’s investment without prompt payment of adequate compensation, to afford the investor “fair and equitable” treatment, to treat the investor no less favourably than the host state’s nationals (non-discrimination) and treat the investor no less favourably than the host state offers to treat investors from other states (most-favoured nation). As discussed separately below, the ability to freely transfer funds out of the host state is another guarantee routinely offered by host states to investors.
Foreign Investment in Crimea: Is Ukraine or Russia the “Host State”?
It is likely that a substantial number of foreign investors (including Russian investors) with interests in Crimea (and Ukraine more generally) are or were afforded protection by Ukraine as host state under one of Ukraine’s numerous BITs, and may well have specifically structured their investments in Ukraine to ensure BIT protection. Some investors may have contracted directly with the Ukrainian state, or state-controlled entities with respect to an investment in Crimea. Such investors may have a discrete, identifiable investment in Crimea, or an investment pertaining in part (but perhaps not in whole) to Crimea (such as nationwide concessions or licenses, including with respect to Crimea). For such investors, the current legal quagmire raises a number of serious questions under international law.
For investors who previously enjoyed the benefits and protections of a Ukrainian BIT, the critical question is whether Ukraine or Russia is now the “host state” of the investment and, in the case of Russian investors, whether they would still qualify as “investors”? The answer to this question is complex, and as far as Ukraine and Russia are concerned, a furiously debated issue. As we discuss below, in the immediate term foreign investors can take simple practical steps to avail themselves, in the event Russia was deemed to have sovereign authority over Crimea, of protection under an applicable Russian BIT. Russia’s proclamation of sovereignty over Crimea would prima facie entitle Ukrainian businesses with operations in Crimea to assert protection under the Ukraine-Russia BIT but in all likelihood (subject to restructuring in permitted circumstances) deprives Russian investors of the protections they would have had under that instrument as they will no longer be deemed “foreign” investors.
Practical Steps: Companies Operating in Crimea May Consider Taking Steps to Ensure Protection of Russia’s BITs
An investor operating in Crimea and who had the benefit of BIT protections offered by Ukraine in the past, is unlikely to have such protections in the future. Relying on Ukrainian BIT protections will not help an investor whose rights are infringed by Russian actions and, equally, Russian BIT protections are unlikely to assist investors whose rights may be infringed by currently threatened Ukrainian actions.
There are, however, practical steps which foreign (including in certain circumstances Russian) and now Ukrainian investors in Crimea can take to ensure the continued protection of their investments under international law.
The first step is to structure their investment into Crimea in a manner which ensures that such investment can now take the benefit of protections offered by a Russian BIT. In other words, investors need to ask themselves whether the holding structure through which their investment is made in Crimea has the benefit of protections offered under an applicable Russian BIT. If the structure is already compliant, then there are ways in which the investor may ensure that the act of keeping their investments in Crimea is treated to be a new investment for the purposes of the Russian treaties.
Alternatively, if the structure is not compliant, foreign investors should consider re-structuring their investments in such a way so as to take advantage of a favourable Russian BIT, while preserving the tax benefits of their existing structures. Each case is necessarily fact specific, but specialist advice will help foreign investors to ensure, so far as possible, that their ongoing investments in Crimea benefit from Russian commitments to safeguard those investments at international law. Depending on the text of potentially relevant BITs, such restructuring may also be considered by Russian investors who may have lost their immediate rights to international law protection due to no longer qualifying as foreign “investors” as defined in say, the Russia-Ukraine BIT.
Crimea-Related Contracts with Ukrainian State Parties: Has Russia Assumed Ukraine’s Obligations?
A related, but no less important, enquiry arises for investors who have contracts with Ukrainian state entities pertaining to Crimea: what is the status of such contracts? Does the Ukrainian state entity remain a party, or has Russia assumed the obligations under such contracts insofar as they relate to Crimea? These questions raise complex private law and public international law issues. The answer will in each case turn on the law applicable to and nature and circumstances of the specific contract.
For present purposes, two practical points arise. First, Russia's Federal Constitutional Law No. 6-FKZ dated 21 March 2014, on the admission of the Republic of Crimea into the Russian Federation, states that most existing permits and licenses issued by Ukrainian authorities will be deemed effective for the term of their validity. While the application of this law by Russia remains to be seen, it does indicate the Russian government’s intention to ensure business continuity in Crimea. The second practical point is that all companies who have contracted with Ukrainian state entities with respect to investments in Crimea may wish to consider the advantages and disadvantages of the Russian state formally assuming obligations under the contract in question.
In each case the position will turn on the law applicable to and nature and circumstances of the specific contract. Investors so affected should seek legal advice.
Political Risk Insurance
Companies should also check whether they have any political risk insurance in place that would cover for example, expropriation. In circumstances where the relevant state has a defence it may be that claiming on the insurance would be the most reliable way of obtaining compensation.
Dechert’s team of lawyers in our Russia and CIS Practice are keeping a close eye on events and will be issuing updates on the legal situation as appropriate. In addition, Dechert’s global arbitration practice with extensive experience in investment arbitration and matters of public international law is well placed to advise on the myriad of issues that may arise from the recent and ongoing events in Ukraine and Republic of Crimea.
1 This is a reference to the domestic arbitration court (not to the commercial state court).
2 RF Federal Law “On Certain Aspects of the Functioning of the Financial System of Crimea and Sevastopol”, effective as of April 2, 2014.
3 The form of the notice and required information is provided for in the RF Central Bank Order No. ??-562, dated April 4, 2014.