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<P align="center"><font color="#660000"><b><font face="Arial, Helvetica, sans-serif" size="4" color="#990000">Frequent
Legal Issues for Contractors on <br>
Sakhalin Oil and Gas Projects<br>
</font></b></font><font size="2" face="Arial, Helvetica, sans-serif">(Appearing soon in the Russian Energy Law Journal)</font></p>
<p align="center"><font color="#990033" size="2" face="Arial, Helvetica, sans-serif"><strong>II.
Management and Control of a Russian Enterprise
</strong></font></p>
<p align="left"><font size="2" face="Arial, Helvetica, sans-serif"><em>Presented
by <a href="../subpage/attorneys.html#jjr">Jonathan Russin</a>, Managing Partner of the firm’s Russian Practice Group. </em></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">Bidders for contracts
awarded by the Sakhalin I and II operators must consider the benefits
of meeting
Russian Content requirements, that is
to bid through a company the equity of which is at least 50% held by
Russian natural or juridical persons. Meeting Russian Content requirements
is discussed in further detail below, but often entails the creation
of a 50:50 joint venture. The usual corporate form to comply with the
50% Russian ownership requirement is the formation of a Russian <font size="1">(8)</font> limited
liability company or LLC (sometimes known by its Russian initials as
an “OOO”). One of the principal issues confronted by the
non-Russian shareholders in this situation is how to deal with control
and direction of the 50:50 joint venture company. In our experience there
are three main approaches to this question.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif"><strong>Mutual Sharing of Control</strong></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">Russian law governing the formation and operation of LLCs is relatively
extensively detailed and sets out a number of requirements that cannot
be varied by the parties. One of the fundamental rules is that obligatory
requirements of Russian law cannot be avoided by an agreement between
the shareholders that attempts to override them. The type of Shareholders
Agreement often used in the United States and England, in which the shareholders
agree in advance on the division of seats on the Board of Directors,
on the selection of the Managing Director, and on the budgeting and financing
of future operations of the LLC has frequently been found by Russian
courts to be unenforceable. Russian law requires that these issues remain
open for review and decision by the shareholders at the yearly meeting
or at the times established in the company bylaws.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">The standard Russian LLC, with relations between shareholders subject
to review and decision at regular shareholder meetings, and with control
shared in proportion to equity ownership, is probably best suited for
a situation where the Russian and foreign parties are making equal contributions
to the management and operations of the joint venture company. Both parties
will look to Russian company law to regulate the mutual control features
of their joint venture.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">It should be noted, however, that Russian custom and tradition gives
substantial authority to the Managing Director of a Russian LLC. Although
the authorities of the Managing Director can be limited by the bylaws
and by narrow delegations of authority from the shareholders or the Board
of Directors, much operational discretion will still rest with the Managing
Director. The choice of this officer will be a major decision for the
joint venture partners.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif"><strong>Disproportionate Control Via Management Agreement</strong></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">One of the classic solutions used in situations where a foreign shareholder
is in fact providing a disproportionate part of the financing and expertise
of the LLC is to have the shareholders unanimously agree in the charter
of the LLC that the management functions of the company will be contracted
to a third party. A Management Contract between the LLC, usually approved
by unanimous vote of the shareholders, and the foreign shareholder, conveys
operating responsibility on the foreign party. The Management Contract
can be for an extended period and can be drafted to allow for termination
only by decision of the shareholders (where a 50:50 structure could block
any decision in which the shareholders are divided) or for breach by
the management company confirmed by a court decision. </font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">Delegation of control under a Management Contract does not remove all
aspects of participation of the Russian partner. Russian company law
requires that changes in the structure of the LLC, such as decisions
to amend the bylaws, to increase or decrease authorized capital, to reorganize
or liquidate, and to pay dividends, are in the exclusive competence of
the shareholders and cannot be delegated through a Management Contract. </font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">One additional technique used to address a situation where there is
an imbalance between the contributions of the two partners in a 50:50
joint venture is to create different attributes to the shares held by
each partner, for example, by establishing that the shares held by the
partner making the disproportionate contribution are entitled to a greater
percentage of dividends.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">In general, the solution to problems associated with disproportionate
contributions by the partners is to address the issues presented through
structures permitted by and consistent with Russian company law, rather
than to attempt solutions through the use of standard U.S. or English
style Shareholders Agreements, which run the risk of being ruled unenforceable
by Russian courts.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif"><strong>Undivided Control Through Two-Tiered Structures</strong></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">The third approach
to the issue of control, which may be useful in the context of meeting
the Sakhalin PSA Russian Content requirements discussed
below, is to create a Russian structure that avoids the participation
of a local partner. For this purpose it is necessary to incorporate two
Russian companies. For example, Company A is
established as a Russian LLC and is 100% owned by foreign shareholders.
Company A then incorporates
a Russian subsidiary, Company B, that is 100% owned by Company A<font size="1">(9)</font>.
Company B is eligible to bid on Sakhalin I and II projects because it
is a Russian
company, the shares of which are at least 50% owned by a Russian shareholder.
Although this structure meets the legal requirement for Russian Content,
it also results in the creation of two companies, both subject to the
payment of Russian taxes on their operations.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">There are obviously advantages and disadvantages to each of these three
approaches. The choice will depend on an assessment of all the circumstances
involved in each tender offered by SEIC and ENL. Relevant issues will
include: Will the services required be performed in Russia or offshore?
How much of the required work will be subcontracted? To which partner?
What will be the resultant cash flow and tax structure? The control issue
will be an important, but not the sole factor determining the structure
of the Russian LLC.<br>
</font></p>
<p align="left"> <font size="2" face="Arial, Helvetica, sans-serif"><font size="2" face="Arial, Helvetica, sans-serif"><cite><font size="1">(8)</font></cite></font></font> <font size="1" face="Arial, Helvetica, sans-serif">In
this situation Russian company law requires that one of the two Russian
companies have more than one shareholder. In this
case, the assumption is more than one foreign shareholder of Company
A. In the alternative, Company A could have one foreign shareholder and
Company B would then need two shareholders.<br>
</font><font size="2" face="Arial, Helvetica, sans-serif"><font size="2" face="Arial, Helvetica, sans-serif"><cite><font size="1">(9)</font></cite></font></font> <font size="1" face="Arial, Helvetica, sans-serif">The
use of an offshore company with 50% Russian ownership is also permitted;
however, Russian companies and individuals are restricted
in investing in companies outside Russia, making the use of an offshore
joint venture more theoretical than realistic.</font></p>
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<td width="29%"><div align="center"><strong><font size="2" face="Arial, Helvetica, sans-serif"><a href="chapter_III.html">Next</a></font></strong></div></td>
<td width="36%"><div align="center"><strong><font size="2" face="Arial, Helvetica, sans-serif"><a href="chapter_I.html">Previous</a></font></strong></div></td>
<td width="35%"><div align="center"><strong><font size="2" face="Arial, Helvetica, sans-serif"><a href="RusEnergyLaw_index.html">Table of Contents</a></font></strong></div></td>
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