Practical guidance for avoiding disputes arising from commercial and investment activity
Irina Paliashvili and Ethan S. Burger
Russian–Ukrainian Legal Group, Washington, D.C.
At first glance the current economic, legal and political situation in both Russia and Ukraine seems to preclude the establishment of profitable long-term business relations. But with proper pre-transaction planning, successful business deals are possible. Foreign businesses operating in such an environment are likely to encounter frequent and often intense disputes with their joint venture partners, agents, customers, suppliers, providers of land, buildings and regulatory approvals.
Types of dispute
The types of dispute that are likely to be faced fall into four broad categories:
(1) Good faith disputes
The first category involves good faith disputes arising from imperfectly crafted documents, the failure of documents to address necessary issues or unanticipated situations. It is exceedingly difficult for businessmen and their lawyers to anticipate properly the myriad of contingencies that may have to be addressed in a contract. As transactions get more complex, there is a greater likelihood that written documentation will prove inadequate. Consequently, except with respect to straightforward purchase-sale agreements, contracts must be compared to constitutions, establishing mutually acceptable procedures for addressing changing circumstances.
(2) Disputes arising from inability to perform
The second category are disputes arising from a party’s inability to perform their obligations under a contract or pay for goods or services received (whenever feasible, doing business by means of letters of credit and bank guaranties is advisable). Many Russian and Ukrainian enterprises are unable to meet their financial and other obligations. Often this is because they themselves are creditors of debtor-organisations that lack the financial resources to pay their bills. Much of the Russian and Ukrainian economy is demonetarised with settlements between local enterprises occurring through barter and the issue of promissory notes. For political and sociological reasons, the authorities and the courts are unwilling to force debtor-enterprises into bankruptcy. Consequently, western businesses need to exercise great caution before entering into contractual relations with such enterprises.
(3) Bad faith disputes
The third category of disputes is bad faith disputes where the local party may or may not have the ability to perform its obligations, but irrespective of its financial position has no intention of performing them. Such enterprises are often tied to organised crime and frequently have protectors within the federal and local government structures. (See Ethan S. Burger, New Legislation on Enforcement of Judicial and Arbitral Decisions in Russia, Russia Business Watch, Summer/Fall, 1997).
(4) Disputes arising due to corruption
The final category involves disputes arising because government officials may feel that other parties may do more for the region (or for the individual government officials themselves), such as offering (implicitly) a future economic stake in an ongoing business relationship, including future employment for such officials or their families. In practice, small companies tend to encounter more problems from corrupt officials since they are less likely to offer potential benefits to a region. (With the anticipated entry into effect of OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, signed on 17 December 1997, US companies will be less likely to operate under a competitive disadvantage.)
In general, litigation and arbitration often do not yield satisfactory outcomes with respect to the types of dispute listed in items (2)–(4). The time and cost of prevailing by legal means are likely to be high, and at the end of the day one may find that, even if successful, one will not be satisfactorily recompensed. It is useful to note that one's own embassy may be able to intervene in cases of intransigence on the part of local authorities. In the light of such problems, businessmen should focus their efforts on avoiding entering into transactions where the parties have divergent expectations of the benefits and risks involved.
Measures to be taken at outset
The absence of reliable mechanisms for enforcing one’s rights in Russia and Ukraine means that businesses need:
(1) to perform at the outset of business relations a thorough due diligence on potential joint venture partners, customers, suppliers and government officials with whom they will be working; and
(2) to have in place a management system to monitor the evolution of such relationships – such a system reduces the risk of good money being invested after bad.
It is also worth noting that with regard to disputes arising from corruption, it is often said that `corruption only survives in the shadows'. For this reason, it is advisable for foreign businesses to initiate and maintain regular contacts with state officials at all levels throughout the course of a project, since such officials are likely to be less tolerant of improper conduct than certain officials involved in a particular project. A single corrupt official might be tolerated by his immediate superior, but not by members of other regulatory or oversight bodies.
Where a project or contract involves funding from foreign banks, foreign countries or international financial organisations, there is a greater chance of avoiding the consequences of corruption since other officials at the national level who benefit from the existence of such programmes do not want to see them jeopardised.
Means of dispute resolution
With regard to good faith disputes, mediation may offer a viable means for achieving a satisfactory solution. It may be advisable to include appropriate mechanisms (including mediation clauses) in relevant contracts to prevent disagreements from developing into full-blown disputes.
Mediation differs from adjudication and arbitration in that the mediator has no authority to impose a solution on the parties. Advocates of mediation believe not only that it is more cost effective, but also that its solutions are superior since they are crafted by the disputing parties themselves. It might appear that the business environment for mediation in Russia and Ukraine is not suitable, given that their legal systems are not well developed, but this may in fact be the very reason why it could be more appropriate: the parties do not have to refer to changing legislation and adjudicators of varying quality to resolve their disputes.
If a dispute is not resolvable by mediation, it is most likely to be settled through the court system or arbitration (although costs are likely to be high and the outcome not received in a timely manner).
Both the Russian and Ukrainian court systems are divided into courts of general jurisdiction and commercial (arbitrazh) courts. (There is also the option of resolving disputes through so-called treteiskie sudy (third courts), which are either ad hoc arbitral tribunals, which may involve the use of UNCITRAL Rules, or existing arbitral tribunals, including international tribunals.) In recent years, there has been a considerable improvement in Russian and Ukrainian legislation governing the court system. However, both countries’ courts remain plagued by a lack of resources, judges of uneven quality (who are often vulnerable to outside influence and susceptible to bribery) and a lack of reliable mechanisms for the enforcement of judicial decisions and arbitral awards.
In 1997 Russia enacted Laws `On the Executory Procedure' and `On Judicial Marshals' to address the situation where, according to Ministry of Justice data, less than 50 per cent of the country’s judicial decisions were enforced. As yet Russia’s judicial marshal system is not fully operational, in part due to budgetary constraints. Similarly, Ukraine has enacted its own Law `On the State Enforcement Service', but whether implementing this legislation will be feasible and adequate funding available remains to be seen.
Both Russia and Ukraine have in force Laws `On International Commercial Arbitration', dated 7 July 1993 and 24 February 1994, respectively, which are based on the UNCITRAL model and which authorise the use of international commercial arbitration to resolve:
(1) disputes arising from contractual and other civil legal relationships involving foreign trade and other types of international economic relations (if one of the parties is located abroad); and
(2) disputes of enterprises with foreign investors and among their participants (art. 1, Point 2).
Even though both Russia and Ukraine adhere to the 1958 UN Convention on the Recognition and Enforcement of International Arbitral Awards, some western parties have encountered considerable frustration in getting local courts to recognise the validity of such foreign arbitral decisions, which sometimes are not enforced since the party against whom the decision was issued has powerful protectors. Another problem with opting for dispute resolution pursuant to international commercial arbitration is that interim remedies may not be available unless contained in a decision of the arbitral body. This means that a respondent may have time to dispose of assets once the arbitration process has been initiated.
Despite the language in art. 9 of both Russia’s and Ukraine’s Laws on International Commercial Arbitration that `an application of a party to a court before or during an arbitral proceeding with a request for the adoption of conservatory measures and the issuance by such court a determination on the application of such measures are not incompatible with an arbitration agreement', neither country’s Arbitrazh Procedural Codes explicitly authorise the adoption of conservatory measures (the equivalent of a preliminary injunction) where the parties to a contract have agreed to international commercial arbitration. It is thus doubtful that a Russian or Ukrainian judge would feel able to order conservatory measures when not having jurisdiction irrespective of the language contained in the relevant contract’s dispute resolution provision.
Nonetheless, if the value of a transaction is substantial, it is usually advisable to provide for dispute resolution by international commercial arbitration rather than to avail oneself of the local courts. In certain circumstances, it may be preferable to provide in the contract that a party has the option of seeking resolution of a dispute either by international commercial arbitration or by a local court. This may be particularly important if one fears that the local entity might dispose of its assets prior to the resolution of the dispute.
It is also desirable when possible to provide that one’s contractual relations be governed by the foreign law of a developed industrial country rather than local law, since the law of such foreign countries is more likely to be stable. This is generally permissible under both Russian and Ukrainian legislation – however, it is not possible to opt out of either Russia’s or Ukraine’s regulatory schemes and corporate norms. (See with respect to Russia, Fundamental Principles of Civil Legislation of the USSR and Republics, art. 166, dated 31 May 1991, and for Ukraine, the Law `On Foreign Economic Activity', dated 19 September 1991, art. 6.)
Resolution stipulated in contract
It is often advisable before entering into a contractual relationship with a Russian or Ukrainian party to prepare a `transaction framework document' (sometimes titled `protocol of intent', although these are generally not as detailed) detailing the range of issues that must be addressed and setting forth concepts for the transaction to be successfully completed. Ideally, this document will prompt dialogue concerning issues that will have to be addressed in any formal contractual relations. It will give the parties an opportunity to learn how the other does business and help establish personal relations that may be critical in overcoming unforeseen problems.
At the present time, there are only fairly limited sources of information that can offer useful management intelligence and financial information on most enterprises, but this situation is improving. Consequently, to reduce the risk of a non-performance, non-payment or a delayed payment situation from arising, the following documents, at a minimum, should be obtained from potential joint venture partners, customers, and clients (hereinafter `the Partners') prior to entering into any agreements:
¨ A recently issued notarised copy of the Partner’s Certificate of Registration (since Russia has not yet adopted legislation on the state registration of legal entities, Presidential Edict 1482, dated 8 July 1994, establishes the relevant norms). This document in Russia will have been issued by the relevant registration chamber or body of the Ministry of Justice, and in Ukraine by the relevant Administration.
¨ One notarised copy of the latest complete version of the Partner’s corporate charter (with all relevant amendments). If possible, the authenticity of this document should be checked with the body that registered the Partner as a legal entity. This document should be carefully reviewed to determine which official or officials of the Partner has authority to sign the proposed agreement. It is also possible that a separate corporate document authorises the relevant persons to sign contracts on behalf of the Partner. Typically, the General Director has the authority to sign the agreement, but above certain monetary thresholds other approvals may be necessary, such as by the board of directors (sovet direktorov) or management board (pravlenie). If the Partner’s corporate charter is not the relevant document authorising the person to sign a contract on behalf of the Partner or if approvals are required, the foreign party should insist on receiving a notarised copy of the relevant document(s).
¨ Documents establishing the other parties’ rights to relevant property (buildings, land, equipment, etc.) In particular, if one is seeking to acquire securities in a Russian or Ukrainian entity, one must confirm that such securities were issued and registered in accordance with applicable legislation and properly reflected in the issuer’s security register.
¨ Notarised copies of relevant licences and permits.
¨ For some transactions, reviewing annual financial reports and balance sheets for the last two fiscal years will be essential. These documents will give you some idea of the financial health of the company. One should interview the Partner’s Chief Bookkeeper to confirm that its budget has allocated enough money to pay for anticipated financial obligations. In addition, one should ask to be able to contact the enterprise’s independent auditor and, if feasible, obtain the Partner’s consent to review its tax status with the local tax inspectorate.
¨ A notarised copy of the enterprise’s pledge register.
¨ A reference letter from the Partner’s local bank stating that the Partner has been a reliable customer for a number of years. One should also obtain permission from the Partner to contact the Bank directly to confirm the information in the letter.
¨ Depending on the nature of the relationship, it is worth contacting local government officials to learn more about one’s potential partner. In the case where a governmental body is guaranteeing obligations, a request should be made for a copy of the document setting out the legal basis for the issue of such guaranty by the relevant state body, as well as the document authorising the guaranteeing of the relevant transactions.
Where relevant, one should explore the possibility of including in the relevant contract documents bank guarantees, pledges of property and property rights (especially property located off-shore), the keeping of deposits in off-shore bank accounts, etc.
The best advice for handling vexing business disputes in Russia and Ukraine is to exercise caution before getting started, develop good planning documents outlining what business objectives are sought, hire the best people you can find to implement such planning documents and try to settle business disputes amicably whenever possible.