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English & Welsh Law prevails over Russian Law for M&A Transactions

18 Nov 2011

Russian businesses often prefer to structure big deals using English and Welsh law because it is more flexible than Russian law and can provide autonomy of will of the parties to an agreement. Parties of such agreement can be more confident that their dispute will be decided by an authoritative, competent and independent court. Taxand Russia discusses the impact of a recent case and how this will benefit M&A transactions going forward.

In the past, M&A players had to protect their risks and therefore, M&A contractors have therefore included terms regarding compensation of damage and loss in the M&A agreement.

If the M&A deal had been successful and following the deal, the new firm is required to undertake a tax audit, the new owner would carry all the risks of extra payments, interest and penalties, incurred by the previous owner. Russian courts have not protected the rights of the new owner. The previous owner, therefore, escaped from paying the taxes that should had been paid earlier. Russian legislation has stipulated, until recently, that this type of tax is an individual payment and should therefore not be treated as damage or loss.

In these circumstances, the parties would have been forced to make a claim to the foreign courts or follow commercial arbitration procedures if the previous legal entity's owner has assets abroad. If not, the M&A parties would not have the opportunity to recover the exact taxes charged as damage from the previous owner in Russia.

However, this situation has recently changed. On 19 June 2011, the Supreme Court of Russia (the SC) ruled that taxes charged after an M&A should be treated as damages for the legal entity's buyer and should be exacted.

The Case
The subsidiary of Russian aluminium company "UC Rusal SA Ltd.", Cyprus (buyer) bought shares of Belise Ltd., Russia (M&A Company) from Mangista Ltd., Belize (seller).

The contract was agreed under British law. After the deal was successful, the Russian tax authorities carried out an audit of the M&A Company which resulted in an additional tax charge, interest and penalty. The M&A Company appealed against these additional charges and was unsuccessful. The international commercial arbitration decided to exact from the seller an amount of charged taxes to the M&A Company.

The International commercial arbitration's decision wasn't served. The main issue was a conflict between English and Russian law, because Russian legislation does not treat taxes as damage. This time, the Russian courts decided that in accordance with English law, the main instrument of defence for a share buyer is a demand of compensation to be paid to a value that will restore his / her initial financial position.

Taxand's Take

In the past, when contractors have chosen foreign law for their agreements, Russian courts have not respected it it, particularly if some of the terms of the agreement were not in line with the Russian law. However, the situation would be different due to the ruling of the SC. This ruling is the first of its kind where the court has considered the foreign law even though it was not in line with the Russian law.

This case is of great importance for Russian and foreign businesses involving Russian assets. It gives confidence to M&A parties in a transaction that the courts can defend Russian investors, even if will of sides conflicts with domestic law rules.

This latest ruling will also impact the seller in a merger and acquisition. Sellers should consider paying greater attention to tax risks and be more circumspect when conducting tax due diligence before a sale, to ensure all the tax risks connected with previous periods stay with the seller.

Your Taxand contacts for further queries are:
Andrey Tereschenko
T. +7 495 967 00 07

Ivan Zelenin
T. +7 495 967 00 07

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