Oda Russian Commercial Law 2007-1

as a group of persons who contribute and participate in joint activities without forming a juridical person. A consortium of companies is an example of simple partnership. This provision leaves room for the restriction of the scope of people who are entitled to use subsoil on the basis of Federal law.

The use of sub-soil is on a payment basis. The sub-soil Law provides for the following payments for the use of sub-soil resources (Art.39):

i)lump-sum payment for the use of sub-soil;

ii)regular payments for the use of sub-soil;

iii)payment for the geological information on sub-soil;

iv)fee for the participation in the auction or tender;

v)fee for the issuing of license.

Sub-soil Law provides for the State licensing system. A license is a document which certi es the right of its possessor to use the sub-soil of a certain area in accordance with its purpose for a certain period and in compliance with the agreed terms (Art.11). Granting of a license presupposes the preliminary consent of the body which administers the relevant land or its owner on the use of land. The granting of the license can be a decision of the Federal government, or a joint decision of the Federal and regional administrative agencies (Art.10-1).

In principle, licenses are granted on the basis of a tender or an auction for the right to use sub-soil. In a tender, the criteria for the selection of the licensee is the scienti c-technical level of the programme, completeness of the extraction of minerals, contribution to the socio-economic development of the region, the necessary time for the realisation of the programme, effectiveness of the measures for the protection of sub-soil and environment as well as the consideration of national security of the Russian Federation. The primary criterion for the winner of an auction is the amount of payment (Art.13-1).

Until 2004, a tender or auction was organised jointly by the Federal Ministry and the relevant regional authority. However, re ecting the move towards centralisation, since 2005, tenders and auctions are conducted by the Federal Agency for Sub-soil Use.6

Sub-soil can be provided for an inde nite term or for a xed period. Before the 2000 amendment to the Sub-soil Law, licenses were granted for exploration for ve years, and for production, 20 years. A combined license for 25 years was also available. The current Law does not explicitly provide for a combined license, but such licenses are still granted.

6“Dec 14, 2005: Oil and Gas Exploration and Production: Russian Legislation”, in American Chamber of Commerce in Russia, Doing Business in Russia, online version.

The right to use sub-soil can be transferred to another person in cases where the company merged with, or absorbed another company. In cases where the company with a license was absorbed by another company and ceased to exist, the remaining company may retain the license provided that the company ful ls all the requirements as a user of sub-soil and has quali ed experts, as well asnancial and technical resources for safely carrying out the work. The same applies where a business company acquired a bankrupt company which had a license. In cases where the license holder sets up a new juridical person in order to continue activities in compliance with the license, the new entity may continue the use of sub-soil, provided that assets needed for the activities were transferred to the new entity, the new entity has a license, and the share of the previous license holder in the new entity is no less than 50% (Art.17-1).

In cases of transfer of the right to use sub-soil, the license needs to be reissued.

The right to use sub-soil is terminated by the expiry of the license period, surrender of license by the licensee, or the breach of terms at the time of reissuing of the license. In addition, the right to use subsoil can be either terminated early, suspended, or restricted by the licensing agency in the following cases (Art.20):

i)emergence of a direct threat to the life or health of the people who work or live in the area;

ii)breach on the part of the licensee of essential terms of the licence;

iii)repeated violations by the licensee of rules for the use of sub-soil;

iv)Occurrence of an emergency situation such as an epidemic and military action;

v)failure on the part of the licensee to commence the use of sub-soil on a preagreed scale within the agreed time;

vi)liquidation of the licensee;

v)failure of the licensee to submit reports required by Russian law.

The decision to terminate, suspend or restrict the use of sub-soil can be contested in court.

Termination of the production sharing agreements is governed by the Production Sharing Law, and not the Sub-soil Law.

The Sub-soil Law also provides for means of dispute settlement. Disputes are settled by administrative agencies, courts, and commercial courts. This provision previously did not refer to commercial arbitration. By a subsequent amendment, commercial arbitration was added as an alternative in disputes. However, this provision limits the dispute to be arbitrated to “ nancial disputes” only (Art.50).

crats were wielding broad discretionary power, this system was thought to be unacceptable for foreign investors.

There were two alternatives: concession and production sharing. A draft concession law was prepared and discussed in at parliament, but was superseded by the Production Sharing Law. In a concession contract, the state, unlike in production sharing, acts as a subject of prerogative power and grants private entities rights to perform certain activities reserved to the state, such as the right to explore, develop and produce natural resources for a xed period. The contract is governed by administrative law, not by private law.8 Concession was referred to in the 1991 Foreign Investment Law of the RFSFR as one of the possible forms of foreign investment. After an abortive attempt to enact a concession law to cover natural resources projects in the 1990s,9 concession law re-emerged after more than a decade as the Concession Contract Law covering infrastructure projects in 2005. As the name of the Law indicates, it has shifted from the arena of public law to private law. However, it now explicitly excludes natural resources projects from its coverage.

Production sharing was rst introduced in Indonesia in the 1960s. Since then, it had spread to over 65 countries in the world.10 The Russian Federation was therst among the CIS countries to enact the Production Sharing Law. Among the CIS countries, other than Russia, Ukraine and Kazakhstan have a Production Sharing Law. In 1993, a presidential decree on production sharing was adopted in Russia. However, due to the political divide on the desirability of this system, it took another two years until the Law on Production Sharing was adopted.

In the meantime, several oil and gas projects based upon the production sharing scheme took place. These are Sakhalin 1 and 2, and Khariaga projects. Contracts were signed before the adoption of the Production Sharing Law in 1995, but they are “grandfathered”, i.e. agreements concluded before the Law took effect are implemented in accordance with the agreed terms there. Provisions of the Law are applicable only to the extent that it does not contradict the terms of the agreement and does not restrict the right of the investor based upon the agreement (Art.2, para.7). It should be noted that since the adoption of the Law, there has not been any new production sharing project which is operational.

The Law on Production Sharing de nes production sharing as follows (Art.2, para.1):

8I.A.Drozdov, Dogovory na peredachu v pol’zovanie prirodnykh resursov, Moscow 2001,

pp.98-102.

9J.Zvorykina, “Building an Ef cient Concession System for Russia”, Capital Perspective,

November-December 2001, pp.33-35.

10Y.Shchukin, “Update on PSA Legislation: A Russian Perspective”, BISNIS Bulletin, April 2001, p.5.

Production sharing is an agreement by which the Russian Federation provides the investor on a payment basis and for a xed period, an exclusive right to explore, develop and produce natural resources in the block indicated in the agreement, and the investor is under an obligation to carry out the work at the investor’s expense and risk. The agreement determines all the necessary terms concerning the use of sub-soil, including the terms and procedure of production sharing between the parties in accordance with the present Law.

This arrangement is different from the traditional scheme based upon licensing in the following ways.

Firstly, a production sharing agreement is a civil law contract between the host country and the investor(s). The present Civil Code explicitly provides for the possibility of the state entering into a contract with a private entity. The Russian Federation, constituent entities of the Russian Federation, and local self governments (municipalities) are entitled to be a party to civil law contracts (Art.124, para.1). These entities are liable under their obligation for the assets they own (Art.126, para.1).

The Production sharing law provides as follows:

Rights and duties of the parties to a production sharing agreement which have civil law characteristics shall be determined by the present Law and the civil legislation of the Russian Federation.

This is in contrast with the licensing system in which the relationship between the host government and the investor is governed by public law.

Arelationship governed by civil law is preferred by investors to a public law relationship, because in the former, the host country and the investor are on an equal footing and bilaterally bound by an agreement, whereas in the latter, there is no guarantee that the host country will not unilaterally change the arrangement, e.g. withdraw the licence. The withdrawal of a licence may be subject to court appeal, but investors have doubts about the neutrality of Russian courts. It is thought that in the production sharing regime, the position of the investor would be more stable than in the licensing regime. Furthermore, under the licensing system, the right of the licensee is not transferable, whereas under the production sharing system, rights of the investor may be transferable.

As the above de nition in the Law makes it clear, parties to the production sharing agreement can negotiate and agree to share the output of the project. Particularly important is that a “special tax regime” is applicable to such projects. Instead of paying various taxes and duties whose rates may change during the life time of the project, the investor may simply share the products with the host government in a predetermined ratio. In this way, taxes and other payments are

“replaced by a share in the product”.11 This effectively shields the investor from frequent changes to tax laws. On the other hand, this may cause antagonism in Russia, since the scheme may be seen to give favourable tax treatment to foreign investors.

Thus, the attraction of the production sharing system is that it provides the investor with a relatively stable regime in a complex and rapidly changing legal and political environment.12

The Production Sharing Law was enacted in 1995 after a erce and prolonged struggle at the Duma. Opponents of the Law argued that the system would result in a loss of revenue to the state, based upon a misunderstanding that investors were to be granted tax exemptions and privileges. The power struggle between the Federal government and the regions also affected the legislative process. While supporters of the production sharing system intended to replace the licensing system with it, opponents of the production sharing system endeavoured to maintain the licensing system based on the Sub-soil Law. The Law which was eventually adopted was a product of political compromise, and as such, was confusing and contradictory.

What was more, the Law lacked consistency with the existing laws such as the Sub-soil Law. The production sharing system represents an autonomous regime, shaped by the agreement of the parties. This means that it involves a special regime, different from the general rules accommodated in the laws such as the Sub-soil Law, the Law on the Continental Shelf, the Law on Exclusive Economic Zones, the Water Code as well as various tax laws. However, few changes were brought to the relevant laws.

Thus, the Production Sharing Law was not really workable.13 It was not surprising that a major amendment was contemplated shortly after its adoption. Draft amendments to the Production Sharing Law and related laws had been submitted to the Parliament in 1996, but they remained there for three years. The delay in amending the imperfect Production Sharing Law and in removing contradictions with related laws affected existing investors heavily, and discouraged prospective investors. Some companies withdrew from the planned projects.

11S.Sosna, Kommentarii k federal’nomu zakonu o soglasheniiakh o razdele produktsii, Moscow 1997, p.10.

12D.Slade and E.Chung, Production Sharing Legislation in the Russian Federation: A Current Assessment’, OGLTR, 1998 issue 4, p.123.

13N.L.Platonova, Nauchno-prakticheskii kommentariii k Federal’nomu zekonu “O soglasheniiakh o razdele produltsii”, Moscow 2002, predislovie, in the on-line version.

ii)development of the given block is needed to put the useful mineral in the continental shelf, extreme north and other equivalent areas and located in places where there is no settlement of inhabitants, transportation and other infrastructure in economic circulation;

iii)development of the given block requires especially costly technology for the extraction of signi cant amount of useful minerals located in dif cult mininggeological conditions.

Another important change in the direction of limiting production sharing was introduced by the 1999 amendment. There is a “cap” on the total amount of reserves to be offered for production sharing. The current law provides that the reserves offered for production sharing shall not exceed 30% of the reserves of minerals prospected and accounted for by the state (Art.2, para.3).

This 30% gure has been criticised as arbitrary. When the amendments were discussed, a 10% limit for strategic resources and 20% limit for other resources had been proposed; there was no economic rationale for such gures. Besides, the denominator – the total reserve accounted for by the government, is not available tothepublic.TheregisterofreservesitselfisbasedupontheSub-soilLaw.Foreach type of mineral in each eld, a register which contains information of the size of the reserve, its quality, the extent of development etc., is prepared.At the time of the 1999 amendment, there were around 25 blocks to be offered, the 30% limit would be almost exhausted. In the discussion for further amendments to the Law, there is a proposal to increase this percentage to 40% or to exclude the existing projects from it.15

It was suggested by government of cials that there will be only around ve blocks available for production sharing, including the three ongoing projects.

4)Procedure for the Conclusion of a Production Sharing Agreement

Originally, production sharing agreements were to be concluded on the basis of tender or auction. There were several exceptions to this rule. For instance, if the investor was already a user of sub-soil under other terms, tender or auction was not needed. Thus, if an investor had a licence under the Sub-soil law and has been involved in the exploration and development of sub-soil in the block, this investor was entitled to negotiate a production sharing agreement without tender or auction. In such cases, the agreement can be concluded with this particular

15M.Subbotin, “Aktual’nye problemy sovershenstvovaniia zakonodatel’stva o soglasheniiakh o razdele produktsii’, paper submitted to the conference “Oil, Gas and Law” on November 14-15, Moscow.