Oda Russian Commercial Law 2007

Law provided for four methods of privatisation: tender, auction, public offer of shares, and lease buy out. This Law gave signi cant privileges to employees. Then, in July 1992, a presidential decree introduced the system of voucher privatisation modelled on the Polish scheme. The nominal value of a voucher was 10,000 roubles. Vouchers distributed among citizens free of charge (for a handling charge of 25 roubles) could be used for the purchase of shares of enterprises being privatised or could be sold to others. One-third of state enterprises were exempted from this privatisation programme for various reasons.

According to the State Privatisation Programme of 1992 adopted by a presidential decree, there were three alternative methods of privatisation:

i) 25% free distribution of non-voting shares to employees, a further 10% sale to employees with a 30% discount and 5% sale to the management. Remaining shares to be sold by voucher auction or tender;

ii) 51% of voting shares sold to employees (including managers) at nominal value. Remaining shares to be sold by voucher auction and/or tender;

iii) a group of trustees (employees and managers) assume the responsibility of implementing privatisation, restructuring the enterprise and preventing bankruptcy. In exchange, they are given an option of purchasing up to 30% of the voting shares, while other employees and managers may purchase another 20% of the shares.

Naturally, the second alternative was the most popular.As many as 77% of state enterprises which took part in this scheme opted for the second variant.30 In fact, there were few incentives for state enterprises to sell their shares for vouchers, since it did not bring any income and there was a risk of losing control to outsiders. The average proportion of shares sold for vouchers was a mere 21%.31 In a well-known car company ZIL, 12% of shares were distributed free of charge to employees. A further 12.5% were sold to employees at a discount price. 50% of the shares were offered to the public, of which 30% were sold by auction in exchange for vouchers.32

Quantitavely, voucher privatisation was a success. By 1994, 16,464 large and mediuem sized state enterprises were privatised.Already by the end of 1993, 98% of the vouchers had been used, and more than 4 million people became shareholders. In terms of quality, whether or not the scheme was successful is questionable. The control exercised by the sectoral ministries over the enter-

30P.Rutland, “Privatisation in Russia: One Step Forward: Two Steps Back?”, Europe-Asia Studies, 1994 No.7, p.1113.

31Ibid., p.1116.

32EiZh, 1993 No.11, p.10.

prises almost disappeared, but instead, these enterprises came to be dominated by insiders, namely the incumbent managers.33 Managers often abused their power and forced the employees to hand over their shares to the management. Since the voucher auction took place at the local level, the local authorities had opportunities to exclude “undesirable outsiders”. In this way, managers purchased shares by auction as well as from the employees much more than was envisaged by the privatisation programme.34 Some of the auctions were conducted in a fraudulent manner. Thus, Gazprom allowed only individual investors to take part in the auction, while excluding foreign and professional investors. The general director of the GAZ managed to purchase a signi cant number of shares by using the loan from the government. Prices of the shares at the auction were substantially undervalued.35

In 1996, state enterprises (Federal and the constituent entities) accounted for 14.3% of the companies and organisations. This percentage fell sharply towards the end of the 1990s, and in 2005, these enterprises accounted for only 3.6%. In contrast, private ownership accounted for 79.2% in 2005. While in 1992, 62.9% of employees worked for state enterprises and organisations, this fell to 44.7% in 1994, and 38.3% in 1998. In 1998, 41.8% of workers were employed by the private sector.36

Table 4 Progress of Privatisation

Federal Statistical Service, Rossiiia v tsifrakh 2005, p.165.

33V.Andreev, Rossiskaia privatizatsiia: podkhody in posledstviia’, VE, 2004, No.6, p.63.

34Ibid., pp.63-64.

35Ibid., p.64.

36Clarke and Kabalina, supra, p.425.

At the Federal level, according to another source, as late asAugust 2001, the state had a stake in 3,949 enterprises. In 88 of them, the state had a 100% stake.37

Table 5 Major objects in Federal ownership and privatisation program of the 2000s

Institute for Economy in Transition, Russian Economy in 2005, Moscow 2006, p.333

However, even in the process of formal privatisation, abuses were rampant. “Most of the privatisation activities seemed to be of dubious legality”.38 There was an overall lack of transparency in the process. Breaches of law occurred at the stage of creation, reorganisation or liquidation of enterprises. There were instances where State Property Committee of cials were lobbied for decisions

37A.Murav’ ev, “Gosudarstvennye pakety aktsii v rossiiskikh kompaniiakh”, VE, 2003, No.5, p.107.

38Rutland, supra, p.1113.

infringing the property interest of the state or of competitors. Managers of state enterprises “parachuted” into privatised companies, often with their contribution to the share capital in the form of “intellectual property highly overvalued.39

The “loans-for-shares” scheme introduced in 1995 was another example of a shadowy privatisation process in Russia. Banks were to provide a substantial amount of loans to the government. In return, the government was to offer shares of major state enterprises yet to be privatised as security. The government picked up some attractive companies and offered them to the closed auction of the banks. In the auction, the bank which offered the largest amount of loan for each packet of shares was to win the auction. The prospects of the repayment of the loan were minimal, and in the end, the banks which won the auction, became the legitimate owners of these blue chip state enterprises. Banks which, at the same time, were the organisers of the auction made every efforts to reduce the number of participants in the auction and created conditions for themselves to win the auction.40 For example, in 1999, in the auction of 9% of the shares of a large oil company, an off-shore company based in Cyprus won the bid at a price only 5,000 US dollars higher than the starting price. Another off-shore company bid for 1,000 US dollars higher. “Self-acquisition” of the company was suspected.41 Nevertheless, there was only one case where the commercial court found an auction to be invalid.42

The result of this scheme was that a selected number of nancial groups who were close to the president managed to acquire the “jewerly” of the industry at an extremely low price.43 The scheme increased the concentration of shares in several key industries, strengthening a limited number of business groups and creating the notorious “oligarchs”.44

Foreign investors were allowed to take part in the privatisation process with some restrictions. According to the 1993 presidential decree, for privatisation of the defence industry, oil and gas companies, transport and communication companies etc., special permission of the government was required for foreign investors to acquire an interest. The 1997 Privatisation Law had a list of properties which can only be privatised with the exclusion of foreign physical and juridical persons as well as Russian resident companies with the participation of these persons. There was confusion when a law enacted in 1998 addressing the disposal of government-held shares in energy companies set a limit on the

39Letenko and Lvov, supra, p.24.

40Andreev, supra, pp.70-71.

41Institute of Economy in Transition, supra, pp.154-155.

42Andreev, supra, p.71.

43Ibid., p.71.

44V.Volkov, “Hostile Enterprise Takeovers: Russia’s Economy in 1998-2002”, Review of Central and East European Law, 2004 No.4, p.531.

holding of shares by foreign shareholders at 25%. In fact, in some of the companies, the holding of shares by foreign investors had already exceeded 30%, and in 1999, it further went up to 33%.45

The privatisation process understandably slowed down after 1998 in the wake of the nancial crisis, but was renewed in 2000. The number of state and municipal enterprises which were privatised remained over 2200 every year, and then fell to 434 and 502 in 2003 and 2004 respectively.46 State enterprises which were privatised in 2001 included Slavneft and Magnitogorsk Metallurgy Kombinate. However, “the absence of an effective law enforcement system and a developed market infrastructure inhibited privatisation as before”.47

Under such circumstances, it is not surprising that “genuine outsiders” and “bona de investors” are apprehensive of the opaque process of privatisation. This is compounded by potential “deprivatisation”. Since a signi cant number of cases of privatisation have been conducted in breach of the law, there is always a possibility of the contract being nulli ed and the assets being ordered to be returned on the initiative of the Procuracy.

A deputy procurator of St.Petersburg initiated an action “for the protection of state and public interest” at the Commercial Court of St.Petersburg and Leningrad Province against the Property Fund of St.Petersburg, a US company, and other entities. The deputy procurator asked the court to declare void the sale of shares of the state enterprise “Leninets” by an auction based upon privatisation vouchers of September 13, 1994 and order the shares to be returned to the Property Fund.

The rst instance court and the appellate instance court dismissed the claim, but the court of the cassation instance accepted the claim of the deputy procurator. The court found that the auction was against the State Programme of Privatisation of State and Municipal Enterprises approved by a presidential decree which placed restrictions on foreign companies taking part in the privatisation process. The enterprise “Leninets” supplied more than 30% of its products to the military and therefore, foreign investors should not have been allowed to take part in its privatisation. The court ordered the US company to return the shares to the property fund, but refused reimbursement of the vouchers to the US company, since at the time of the judgment, privatisation vouchers had no value. Besides, vouchers were eventually received by the State, and the property fund was not in a position to reimburse privatisation vouchers. Thus, the US company had the shares taken away, but failed to receive any compensation.

45Institute of Economy in Transition, supra, p.149.

46Federal Statistical Of ce, Rossiiav v tsifrakh 2005, Moscow 2005, pp.174-175.

47Andreev, supra, p.73.

Upon protest, the Supreme Commercial Court upheld the judgment of the court of cassation instance in that the auction was void. However, the Court modi ed the judgment to the extent that the Property Fund was ordered to return the nominal value of the vouchers, 50 million roubles, to the US company by applying Art.167, para.2 of the Civil Code.48

In this case, the US company eventually managed to retrieve the investment. But this may not always be the case. The problem here is that there is no mechanism to protect the bona de party from the nulli cation of the transaction by the court.

3STRUCTURE OF CORPORATE OWNERSHIP IN RUSSIA

A conspicuous characteristic of corporate ownership in Russia until the mid1990s, particularly in privatised companies, was the dominance of insiders. The scheme of the 1992 Privatisation Programme itself was designed to favour insiders. In the companies privatised between 1992 and1993, 48% of the shares belonged to employees, 19% to the management, and 20% to the state.49

...top managers had a signi cant priority in realising their property rights, capturing private bene ts from controlling sales and nancial ows. For several years, insiders made up a closed and change-resistant group centred on the former Soviet directors – most of whom did not want or could not afford a decisive restructuring (often for fear of social instability), shielding their enterprise from market pressure and outside contenders.50

However, the situation has substantially changed since then.According to a Russian economist, two basic trends regarding corporate ownership can be identi-ed. First is the rise of managers and the second is the growing “invasion” of outsiders.51 This is in contrast to the dominance of insiders, namely employees, in the earlier period. Perhaps one can add a third trend, which is the shift to the concentration of shares in the hands of block shareholders from dispersed share ownership created by privatisation.52

48Decision of the Presidium of the Supreme Commercial Court, September 16, 1997, case 3212/97.

49Murav’ev and Savul’kin, supra, pp.86-87.

50Volkov, supra, p.541.

51Radygin, supra 2003, p.51.

52Ibid., p.52.

According to a survey by the State Property Committee, by 1994, the proportion of workers’ collectives holding more than 50% of the shares of a company went down by 20%, while joint stock companies in which the management held more than 10% shares went up to 20%.53 By 1996, although insiders held 58%, of which the management held 18%, outsiders held 32%, which was an increase from 1994 when they held 21%.54 A survey of 100 joint stock companies conducted in the mid-1990s showed that 60% of companies had “outsider” shareholders. The average share of large outside shareholders was over 25%. On the other hand, managers held over 40% shares in privatised former state enterprises, while in ordinary companies, their share was around 17%.55

Since 1995, an increase of the portion of shares held by outsiders can be seen (35.2% to 42.4%), while the share of insiders fell from 54.8% to 42.4%.Among insiders, shares held by employees fell from 43.6% to 31.5%.56 The increase in the share of outsiders is attributed to the need for external nancing. This may also be attributed to the fall in the of cially registered management stake, i.e. the management chose to hold shares not in a direct manner, but through intermediaries, and thus, technically, became outsiders.57 However, it is not clear whether there was a genuine shift of control from the management to outsiders, or whether the management still holds control via insiders.

There was a further decrease of insiders and increase of outsiders since the 1998 nancial crisis. The share of insiders fell from 55-60% in 1996 to 30-35% in 2000, while the share of outsiders increased from 30-35% to 50-55% in the same period.58 This is said to have been caused by the “post-crisis concentration of ownership”.59 A mass sale of small packages of shares in the state enterprises at low prices contributed to this process, but in general, the sharp downfall in shares in the stock market enabled block shareholders to increase their stake and for outsiders to acquire a stake.60

53Letenko and Lvov, supra, p.29.

54Andreev, supra, p.64.

55E.Gubin, Upravlenie i korporativnyi kontrol’ v aktsionernom obshchestve, Moscow 1999, p.102.

56R.Kapeliushinikov, “Krupneishie i dominiruiushchie sobstvenniki v rossiiskoi promyshlennosti”, VE, 2000, No.1, p.102.

57A.Radygin and S.Arkhipov, “Ownership Structure and Financial Position of Firms in Russia: Empirical Analysis”, Russian Economic Trends, 2001 Issue 2, p.20.

58A.Radygin, “Sobstvennost’ i integratsionnye protsessy v korporativnom sektore”, VE 2001 No.5, p.27.

59Ibid., p.27.

60Radygin et als, The Problem...., supra, p.57.

Table 6 Ownership structure of Russian industrial enterprises (1)

(R.Kapeliushinikov, “Krupneishie i dominiruiushchie sobstvenniki v rossiiskoi promyshlennosti”, VE, 2000, No.1, p.102)

The average share of the largest shareholder varies from 28% to 42%, depending on the samples.61

It should also be noted that despite privatisation, the state still has a signi - cant stake in some companies. According to government statistics, as of August 2001, the Federal Government had a stake in 3,949 enterprises, of which 100% in 88, more than 50% in 623 enterprises, 25-50% in 1,393 enterprises and less than 25% in 1,843 enterprises. In 542 companies, the government has a golden share.62 Concerning golden shares, since 1997, the state has the right to appoint a member of the board of directors and the audit committee, and also enjoys the same right given to shareholders with more than 2% of the shares.

In the mid-1990s, large business conglomerates, which are termed nancial industrial groups, emerged. In mid-1997, there were 70 such groups which integrated more than 1,000 industrial companies and 90 nancial institutions.63 In a nancial industrial group, companies combine their resources on the basis of an agreement to create a group for economic integration, realisation of various projects and a programme for the increase of revenues, competitiveness, ef ciency, and expansion of market shares. Member companies are industrial

61A.Yakovlev, “Evolution of Corporate Governance in Russia: Government Policy vs. Real Incentives of Economic Agents’, Post-Communist Economies, 2004 No.4, p.391.

62A.Murav’ ev, supra, p.107.

63E.Utkin and M.Eskindarov, Finansovo-promyshlennyie gruppy, Moscow 1998, p.7.

Table 7 Ownership structure of Russian industrial enterprises (2)

*) Data of the 2005 survey.

**) This heading was not distinguished in the survey.

***) Firms created by the respondent enterprise.

****) Column sum may not be equal to 100 due to rounding.

S.Aukutsionek et als., Ownership structure of Russian industrial enterprises in 2005,

Russian Economic Barometer, 2005 No.3, p.4.

companies and banks and other nancial institutions. The group has a core company, normally an “investment institution”, which is empowered to act on behalf of the member companies. This was obviously seen by the government as a positive development towards the developed-capitalism.Accordingly, the Law on Financial Industrial Groups was enacted on November 30, 1995.64 Among the rather general provisions in this Law, there was a questionable provision to the effect that member companies were jointly and severally liable for the debt of the core company.

However, since the 1998 financial crisis, “the rule of the game has changed”.65 The crisis hit major bank-centred groups such as SBS-Agro and Ink-

64Law No.190-FZ of November 30, 1995.

65H-H. Schröder, “El’tsin and the Oligarchs: The Role of Financial Groups in Russian Politics Between 1993 and July 1998”, Eurape-Asia Studies, 1999.

ombank groups. Instead, Federal natural monopolies and “autonomous empires” that had emerged around large corporations have strengthened their positions.66 These groups were organised in the form of holding company groups. A large number of such company groups have developed in the energy and metal sectors. In the oil industry, Lukoil and Surgutneftegaz, known as “vertically integrated companies”, have expanded signi cantly in the late 1990s. Such vertical integration can also be seen in the regions.67 In these holding company groups, although the subsidiaries retain some capacity for independent decision-making, nancial and commercial functions are concentrated in the holding company. Subsidiaries are often reduced to a mere production platform.68 It is not uncommon for the holding company to transfer pricing mechanisms, siphoning pro ts from the subsidiaries.69

4TYPES OF COMPANIES

The Civil Code is the basic law which accommodates provisions on companies. Chapter Four, Part One of the Civil Code covers juridical persons. The Chapter begins with basic provisions on juridical persons, followed by a sub-chapter on commercial partnerships and companies, and then by sub-chapters on production cooperatives, state and municipal unitary enterprises, and non-commercial organisations. There are separate laws on joint stock companies, limited liability companies, non-pro t organisations, and unitary enterprises.

Commercial partnerships and companies are de ned in the Code as “commercial organisations with a capital divided into participatory shares (shares) of the founders (members)”. Commercial partnerships (khoziaistvennye tovarishchestva) can be set up as full partnerships (polnye tovarishchestva, corresponding to the German einfache Gesellschaft) or limited partnerships (tovarishchestva na vere, German Komanditgesellschaft). Commercial companies (khoziaistvennye obshchestva) can be established as joint stock companies (aktionernoe obshchestvo; AO), limited liability companies (obshchestvo s ogranichennoi otvetstvennost’iu, OOO), or companies with supplementary liability (obshchestvo s dopolnitel’noi otvetstvennost’iu). It is important to note that not only commercial companies, but also commercial partnerships have juridical personality.

66Radygin et al., The Problem...., supra, p.57.

67Institute of Economy in Transition, supra, p.147.

68S.Clarke, “A Very Soviet Form of Capitalism? The Management of Holding Companies in Russia”, Post-Communist Economies, 2004 No.4, p.411.

69Yakovlev, supra, p.394.