Russia Sanctions: Forced administration of subsidiaries of Western groups in Russia

Over the course of the last months, the Russian government has ramped up its “countermeasures” intended to counteract the effect of sanctions imposed by Western governments. Among these countermeasures is an arsenal of rules targeting Russian subsidiaries of Western corporate groups. For example, a new forced administration regime was introduced earlier this year which allows the Russian government to remove such subsidiaries from the control of their parent companies and instead appoint a Russian administrator to manage their business. The Russian subsidiaries of several European corporate groups have already been put under forced administration over the last few months.

This blog post examines the impact on, and the sanctions risks for Western (and in particular European) parent companies, other group companies and business partners as well as steps to consider in case a Russian group company or business partner becomes subject to forced administration.

The forced administration regime in Russia

There appear to be several possible “triggers” for the imposition of forced administration, which are outside the control of Western investors: Forced administration appears to have been imposed in particular in relation to subsidiaries that Western investors are in the process of selling in order to exit Russia. While exits of Western investors from Russia already attract unfavourable conditions – including significant discounts to the sale price alongside a “voluntary” contribution to the Russian state budget – the forced administration regime may be used as a further measure to pressure Western investors to agree to unfavourable exit terms imposed by the Russian authorities. If an exiting company chooses a purchaser for its Russian subsidiaries that does not meet with the Russian authorities’ approval, forced administration may also be used as a means of ensuring the subsidiaries are removed from their former corporate owner without being handed over to a purchaser perceived to be unsuitable.

In addition, placing companies under forced administration allows the Russian government to appoint an administrator who exercises control over these companies’ business for the foreseeable future, and who may in practice derive financial benefit from their role. This opens up opportunities for “rewarding” senior Russian businessmen and politicians for their continued loyalty.

Risks for parent companies and business partners

For Western parent companies, other group companies and business partners, the forced administration of Russian subsidiaries poses risks from multiple sides. While steps can be taken to mitigate these risks, such measures should be carefully reviewed before being implemented.

Sanctions risks

The change in control of Russian subsidiaries may expose Western companies, groups companies of the subsidiary in question and business partners alike, to potential sanctions risks.

Most notably, forced administration removes the parent company’s control over its subsidiary and hands it over to a person or entity appointed by the Russian government. As such, there is a risk that the subsidiary could be considered a sanctioned entity if the appointed administrator is designated under applicable sanctions or de facto acts on the instructions of a sanctioned person. As a result, it would be prohibited to provide any funds (loans, payment of a purchase price, etc.) or economic resources (such as the sale of goods and the provision of services, including intra-group services) to the subsidiary.

Furthermore, even if the administrator is not sanctioned, the change in the subsidiary’s control could, in certain circumstances, cause other new sanctions prohibitions to apply to the subsidiary, as many provisions in Western sanctions regimes apply only to companies owned or controlled by the Russian government, or contain express exemptions for subsidiaries of non-Russian companies. If a Russian subsidiary is placed under forced administration by the Russian government, there is a risk that regulators may regard the subsidiary as controlled by the Russian government (leading to additional sanctions applying to the company) and/or may regard it as no longer being controlled by a non-Russian parent company (leading to certain exceptions from sanctions prohibitions no longer applying to it).

For group (and in particular parent) companies, increased risk exposure may result from intra-group loans, internal governance structures and approval mechanisms and indirectly due to ownership/control the Russian subsidiaries have over non-Russian companies in the group and high level of reliance on Russian subsidiaries in the wider group’s supply and delivery chains.

Practical issues

Many Western corporate groups have reduced the business activities of their Russian subsidiaries to a minimum. They may nevertheless have ongoing intra-group dealings with their Russian subsidiaries (e.g. intra-group loans; shared IT systems). Even if there are no sanctions concerns, a situation where control over those subsidiaries is removed from their parent companies and handed to an administrator will inevitably raise questions about to what extent such dealings can be maintained (e.g. whether maintaining an intra-group loan made on favourable terms is still appropriate after a subsidiary has in effect ceased being part of the group) and how they can be discontinued (e.g. severing access to group-wide platforms and IT systems) without giving these subsidiaries the right to claim for breach of intra-group agreements.

These issues will likely be considerably greater in situations where Russian subsidiaries of Western corporates are still actively operating their business and form part of the wider corporate group’s supply and/or delivery chains. In such cases, forced administration of the Russian subsidiaries is likely to cause significant disruption to the business of the entire group.

A particular risk arises in corporate groups where Russian subsidiaries themselves own further subsidiaries outside Russia. In those circumstances, if the Russian subsidiaries are placed under forced administration, there is a risk that the non-Russian subsidiaries controlled by them are also removed from the parent company’s control.

Further, should the Russian subsidiary be considered a sanctioned entity as a result of the forced administration, business partners may experience disruptions when it comes to the receipt of payments for products sold or services provided: Banks are generally required to freeze incoming payments from sanctioned persons or entities.

Impact on divestment transactions

If, as noted above, forced administration is imposed on a subsidiary which is in the process of being sold, this is likely to create particular problems for the parties involved. If a binding agreement for the sale of the subsidiary has already been reached at this point, questions will undoubtedly arise as to how to allocate the loss between the parties or terminate/amend the agreement, and whether it is possible to approach the Russian authorities to reverse the forced administration so that the sale may proceed.

Steps to consider in the event of forced administration being imposed

If a Western corporate group’s Russian subsidiaries are put under forced administration, the parent company, other group companies and Western business partners should consider, in the first instance, pausing all ongoing interactions with the subsidiary and investigating the situation. Such investigations could include:

• Requesting confirmation from the Russian government regarding the reasons for forced administration and the administrator appointed.
• Searching corporate databases and Russian official announcements to determine the identity of the administrator.
• Conducting sanctions screenings and further sanctions due diligence on the administrator to determine whether it is a sanctioned person.
• Obtaining legal advice to determine the risk of ongoing interactions with the subsidiary, and options for ceasing such interactions.

In addition, the parent company will likely wish to consider issuing a statement to the press to explain the situation and to note that it does not consent to the measures imposed. In the case of companies listed on a stock exchange, there may also be a legal requirement to update the public on these developments.

Conclusion

Forced administration – especially if it becomes more prevalent as relations with Russia further deteriorate – is likely to present a significant problem for corporate groups affected. Determining the impact of forced administration requires careful analysis of the fact patterns in the individual case from a sanctions and contract law perspective. Nevertheless, if corporate groups affected and business partners of the relevant subsidiary react quickly (and possibly put mitigating measures in place in advance) they may be able to minimise the negative impact on their global operations.