The Technology M&A Review: Russia
Following the implementation of the US and EU sanctions against Russia in 2014, the Russian M&A market has been generally struggling.2 Although in the past few years there have been some signs of recovery, the ongoing covid-19 pandemic is currently putting serious pressure on the Russian economy in general and on the Russian M&A market in particular. However, the technology market seems to be relatively resistant to the external economic factors due to an increasing level of digitalisation of the economy and sustained growth in the technology sector.
Regulation of the technology sector in Russia has been tightening over the past several years, as illustrated by the adoption of the Yarovaya Law (named so after one of its authors, Irina Yarovaya, a member of the Russian parliament), the Data Localisation Law and new limitations on foreign investments (see below). The increasing regulatory pressure presents many challenges for market participants (especially for foreign investors), while also creating lucrative niche submarkets that are quickly occupied by Russian players.
While the Russian technology market is dominated by large state-owned companies, private investors have also been quite active. And although most transactions are purely domestic, foreign investments are still an important part of the technology M&A market in Russia. Despite the growing regulatory burden and negative economic consequences of the covid-19 pandemic, we hope to see further development of the technology M&A market in the near future.
Year in review
In the past year, the main players in the technology M&A market were prominent state-owned Russian companies, including Sberbank of Russia and VTB Bank (PJSC), the two largest Russian banks, which were actively investing into various sectors of the Russian economy. Another important player was Rostelecom PJSC, Russia's largest integrated provider of digital services and solutions, which was expanding its presence in the technology sector.
In particular, Sberbank completed the following notable deals:
- its acquisition of a 46.5 per cent stake in Rambler Group, a Russian internet and media holding, from Alexander Mamut for approximately 11 billion roubles;3
- its acquisition of a 51 per cent stake in Speech Technology Center, a leading Russian developer of biometric technology, from Gazprombank; and
- its acquisition of a 25 per cent stake in PayZakat, a startup platform that collects charity for Muslims in need.
Among VTB's notable deals there were:
- its acquisition of a 25.1 per cent stake in Citadel, the largest provider of systems for compliance with the Yarovaya Law (see below), from Anton Cherepennikov (for the purposes of the deal, the whole company was estimated at approximately 60 billion roubles);
- its acquisition of ESK, a Russian fiscal data operator, from Grigory Berezkin for approximately 1 to 2 billion roubles;
- its acquisition of a controlling stake in Domyland, a real estate management service; and
- its acquisition of a 63 per cent stake in Medialogia, a developer of media monitoring and analysis systems, from Anatoly Karachinsky and Sergey Matsotsky.
Rostelecom's notable deals included:
- its acquisition of DataLine, the second-largest data centre provider in Russia, from Inline Technologies Group for approximately 17.5 billion roubles;
- its acquisition of a 49 per cent stake in National Technologies, a provider of digital services and solutions, including systems for compliance with the Yarovaya Law (see below), from Anton Cherepennikov; and
- its acquisition of a 51 per cent stake in CorClass, a smart city platform developer, from Anton Cherepennikov.
Privately owned companies were also quite active in the technology M&A market, having completed, among other things, the following deals:
- the acquisition of a controlling stake in BelkaCar, a Russian car sharing services provider, by Dmitry Zimin's Coneplace, from Winterberg Group;
- the acquisition of Worki, an online recruiting service, by Mail.ru Group, a Russia-based internet company;
- the acquisition of a 29.5 per cent stake in New Cloud Technologies, the developer of MyOffice data storage and document processing software, by Kaspersky Lab, a Russian cyber security firm, from Andrey Cheglakov; and
- the acquisition of a 25 per cent stake in Skillaz, a privately owned staff selection platform, by HeadHunter, a leading Russian online recruitment company.
In addition to domestic transactions, foreign investments were also made into the Russian technology sector, for example:
- OLX Group, Naspers' classifieds business, acquired a further 29.1 per cent stake in Avito, a leading online general classifieds and property platform in Russia, for approximately US$1.16 billion, bringing its shareholding in the target to 99.6 per cent;
- Seller Labs, a Georgia-based provider of software for Amazon sellers, acquired Russia-based X-Cart, a software and services company that provides e-commerce solutions to major online retailers;
- the UK-headquartered BeMyEye acquired Streetbee, a Russian crowdsourcing and image recognition provider; and
- EPAM Systems, Inc, a leading global provider of digital platform engineering and software development services, acquired Competentum, a full-stack educational content services company, and its learning platform, ShareKnowledge.
Legal and regulatory framework
From the deal structuring perspective, the key laws regulating M&A transactions are:
- the Civil Code of the Russian Federation (Civil Code), including:
- Part I, which, among other things, regulates contracts and obligations in general as well as shareholders' agreements in particular;
- Part II, which, among other things, regulates sale and purchase agreements, including share purchase agreements; and
- Part III, which, among other things, regulates conflict of laws issues;
Procedures for Russian regulatory clearance of M&A transactions are principally set out in the Federal Law on Competition Protection (the Competition Law), which, among other things, regulates merger control review by the Federal Antimonopoly Service (FAS). Under the Competition Law, a prior FAS clearance is required for, among other things:
- the acquisition by a person (or its group) of more than 25 per cent of shares in a JSC or a one-third participation interest in an LLC;
- a subsequent increase of the stake to more than 50 per cent and more than 75 per cent of shares in a JSC, or a one-half and two-thirds participation interest in an LLC, respectively;
- obtaining rights to determine the business activities of a Russian company or to exercise the powers of its executive body by a person (or its group); and
- the acquisition by a person (or its group) of more than 50 per cent of shares (participation interests) in a foreign company supplying goods (services) to Russia in the aggregate amount of more than 1 billion roubles as of the preceding year; or obtaining rights to determine the business activities of such company or to exercise the powers of its executive body.
In each of the cases above, FAS clearance is required provided that either:
- the aggregate asset value of the acquirer (and its group) and the target (and its group) exceeds 7 billion roubles; or
- the aggregate annual revenues of the acquirer (and its group) and the target (and its group) for the preceding calendar year exceed 10 billion roubles, and at the same time the total asset value of the target (and its group) exceeds 400 million roubles.
When granting clearance, the FAS has the discretion to impose various conditions to mitigate potential negative impacts on competition. For example, in April 2018, the FAS cleared the merger of Bayer, a German chemical company, and Monsanto Company, an American producer of genetically modified seeds and herbicides. Pursuant to the clearance decision, among other things, Bayer was required to transfer certain technologies relating to seed selection to Russian players on the market.4 Localisation of critical technology is an important agenda item for the FAS today, and it drives many of its decisions in the technology sector.
The Federal Law on the Procedure for Investing into Business Entities Having Strategic Significance for National Defence and Security of the State regulates foreign investments into strategic Russian companies (see below) (FSIL), and the Federal Law on Foreign Investments in the Russian Federation (the Foreign Investments Law), among other things, imposes additional limitations on sovereign foreign investments into Russian companies (see below).
Regarding technology M&A-specific legislation, the following laws are particularly important:
- Part IV of the Civil Code, which is the core of Russia's intellectual property (IP) law;
- the Federal Law on Mass Media, which, among other things, prohibits direct foreign ownership of Russian mass media or broadcasting companies, and also limits direct and indirect foreign ownership, managing and controlling rights with respect to shares in Russian entities holding, in their turn, shares in such mass media or broadcasting companies, to a maximum of 20 per cent; and
- the Federal Law on Information, Information Technologies and Data Protection (the Information Law), which, among other things:
- since 2017, has prohibited direct foreign ownership of a news aggregator (such as Yandex.News, a Russian equivalent of Google News), which is any programme, website or webpage that is used for processing and distributing news via the internet in Russian or a local language spoken within Russia; can distribute commercials targeted at customers in Russia; and is accessed on a daily basis by more than 1 million users from Russia;
- since 2017, has limited foreign investments into an audiovisual service (such as an online movie theatre), which is any website, webpage, information system or software that is used for collecting or distributing audiovisual works; is accessed for a fee or subject to watching commercials; is targeted at customers in Russia; or is accessed on a daily basis by more than 100,000 users from Russia. The Information Law prohibits direct foreign ownership of audiovisual services. Moreover, owners of a foreign audiovisual service with less than 50 per cent of its users located in Russia are required to obtain the clearance of a special governmental commission to acquire direct or indirect ownership, managing or controlling rights with respect to more than 20 per cent shares in any entity owning an audiovisual service; and
- sets out the obligations of online services (such as messengers, email services and social networks) to store users' communications and provide them to the state authorities in certain cases, in particular, since 2018, to store text messages, voice data (including phone call recordings), images, sounds, video and other communications for up to six months; and since 2016, to store information on the receipt, transmittal, delivery or processing of such communications for one year (the Yarovaya Law).
Moreover, pursuant to the Yarovaya Law, online services are required to provide any such data to Russian investigation authorities and the Federal Security Service of the Russian Federation (FSB), and, upon their request, shall install special systems to be used for investigation purposes as well as to provide the FSB with decryption keys if the stored data is encrypted. Non-compliance with the new requirements may result in fines or blocking of the relevant service.
For example, in April 2018, a Russian court decided to block the Telegram app in Russia after Pavel Durov, its founder, had refused to provide the decryption keys to the FSB upon their request. However, the blocking subsequently implemented by the Federal Service for Supervision of Communications, Information Technology, and Mass Media (Roskomnadzor) was largely ineffective, and Telegram remained popular in Russia. Eventually, in 2020, Roskomnadzor, upon consultation with Russia's general prosecutor's office, lifted the blocking due to Telegram's founder's 'willingness to combat terrorism and extremism', although it is still not clear whether Telegram has shared its decryption keys with the Russian authorities.
The Federal Law on Communications, among other things, regulates the telecommunications industry, including the obligations of telecommunications operators to store users' communications and provide them to the state authorities in certain cases (under the Yarovaya Law, broadly, the same data storage requirements apply to telecommunications operators as to online services, save that telecommunications operators are required to store information on the receipt, transmittal, delivery or processing of communications for three years rather than one year); and
Finally, the Federal Law on Personal Data (the Personal Data Law) sets out the fundamental principles of personal data protection (see below).
Key transactional issues
i Company structures
Although Russian corporate legislation offers various forms of legal entities, the overwhelming majority of Russian companies are organised either as LLCs or JSCs. Depending on whether their shares are publicly traded, JSCs may be either public or non-public.
The principal laws regulating internal company matters in Russian companies, including relations between shareholders, are the Civil Code, the JSC Law and the LLC Law. Such matters may also be governed by a company's charter and other internal documents. While, in public JSCs, such documents may derogate from the default statutory provisions to a very limited extent, LLCs and non-public JSCs and their shareholders have much more flexibility and can easily tailor the charter and other internal company documents to their specific needs and arrangements. However, in general, Russian company law still has multiple mandatory provisions, which may not be changed by agreement and thus should be carefully considered, especially when structuring a joint venture.
In addition, shareholders can enter into a shareholders' agreement, which may regulate, among other things, voting rights, share options, share transfer restrictions (e.g., rights of first offer and rights of first refusal), profit distributions, deadlock resolution mechanics and other matters. A shareholders' agreement may be governed by foreign law, and parties sometimes choose this, but this may lead to a number of uncertainties as mandatory provisions of Russian company law would still apply.
The multi-level corporate ownership structure is quite common in Russia. For instance, a Russian company may have a Cyprus holding company as its sole direct shareholder, with ultimate beneficial owners holding shares in such Cyprus company (or another holding company). Such structure enables making use of a more flexible Cyprus company law, which, in particular, expressly allows shareholders to enter into English law-governed shareholders' agreements and benefit from the longstanding solid practice of Cyprus courts in settling disputes under such agreements. Up until recently, a Cyprus domicile also allowed one to obtain substantial tax savings based on the double taxation treaty between Russia and Cyprus, but recent changes in Russian taxation policy are expected to result in the significant reduction of such tax benefits.
Another consideration to be taken into account in M&A deals is the Russian doll (or Matryoshka) rule, which precludes a company that is the sole shareholder of a JSC or an LLC from being, in its turn, owned by a sole shareholder. Thus, for example, a company owned by a sole shareholder cannot directly acquire 100 per cent of shares in a JSC or an LLC, but instead it can acquire 100 per cent minus one share while this remaining share can be acquired by its subsidiary, sibling or parent company.
ii Deal structures
The overwhelming majority of technology M&A deals are structured as share purchases. The popularity of this structure is mainly explained by its relative simplicity and clarity of the tax treatment, while other potential deal structures are usually viewed as less preferable due to complex tax treatment and other structural issues. Thus, the formalities relating to transfers of shares (in the case of JSCs) or participation interests (in the case of LLCs) are quite straightforward and can be easily completed. A share-purchase deal with respect to a Russian business may be structured either as a direct purchase of the target's shares (participation interests) or as a purchase of shares in its holding company, including a foreign one.
On the opposite side, asset deals are quite rare on the Russian M&A market, including in the technology sector, due to grey areas in tax treatment and numerous risks regarding the transfer of various types of assets. In particular, there is significant uncertainty if an asset-transfer deal involves a transfer of employees, assignment of contracts (leases or any other types of contracts) or a transfer of rights to registrable IP. In addition, a transfer of assets does not allow for automatic transfer or assignment of any governmental licences and permits that may be critical for a business, such as telecom licences and permits, cryptography licences, and licences issued to banks and other financial organisations that could be critical in fintech deals.
Parties are generally allowed to subject the transaction documents to any foreign law, provided that there is a foreign element in the transaction (for example, one of the parties is a foreign company or individual). M&A deals on the Russian market, including in the technology sector, are often governed by English law, which is generally more flexible compared to Russian law. However, following the amendments to the Civil Code, including the introduction of certain legal constructions traditionally used in English law-governed transactions (such as representations and warranties (R&W), indemnity and options) in 2015, Russian law as the governing law for M&A deals has been gaining popularity.
Given the sophisticated nature of the technology business and the relevant legal landscape, it is sensible to engage relevant advisers. For example, as part of the due diligence process, a purchaser might want to have external IT specialists review the target company's software to correctly evaluate the business and reveal any potential issues. Investment banks are often involved if a sale is structured as an auction.
iii Acquisition agreement terms
The form of consideration used most often in Russian technology M&A deals is cash, although other forms may be used (e.g., shares in publicly traded companies, a combination of stock and cash: the acquisition of Streetbee by BeMyEye, mentioned above, was structured as a share swap; in return for their stake in Streetbee, its owners received a 20 per cent stake in BeMyEye). It is important to carefully consider if the use of non-cash consideration may lead to negative tax consequences.
As in other M&A deals, purchase price adjustment mechanisms are sometimes used in technology M&A deals. However, in technology startups the potential and uniqueness of the product and market growth perspectives, as well as the input of founders and key employees, may have much more weight in the assessment of a deal's value than historic financial performance. Pre and post-completion covenants, including regarding the reorganisation of an existing business, are entering into various software and other IP licensing and strategic cooperation agreements, and are often used to ensure that a business lives up to its valuation and the price paid.
It is customary to agree upon various risk allocation mechanisms, including R&W and indemnities. Apart from customary R&W, in technology M&A deals, specific detailed R&W are often provided with respect to a company's IP (particularly, title to IP, validity and enforceability of licences, and no infringement and no third-party claims), cybersecurity and compliance with industry-specific regulatory requirements, such as personal data protection.
In Russian M&A deals, indemnities are usually given by the seller solely with respect to fundamental risks (such as the title to the shares and tax liabilities) or to address certain specific issues identified in due diligence, which would not otherwise be sufficiently covered by R&W. For instance, indemnities may be given in relation to ongoing litigations and outstanding third-party claims with respect to IP.
The parties may also seek additional comfort through other mechanisms, which may include, among other things, withholding of a part of the purchase price by the purchaser to allow for a purchase price reduction if any indemnity payment is triggered or the issuance of a performance guarantee by the seller's beneficial owners.
Once the transaction documents are agreed and signed, the parties typically focus on the satisfaction of various conditions preceding the closing. Industry-specific pre-closing conditions may include, for example, registration of title to certain IP.
Upon satisfaction of the pre-closing conditions, the parties proceed with the closing, which typically includes registration of the share transfer and payment of the purchase price. If an interest in an LLC is transferred, the process involves a Russian notary public who certifies the transfer agreement and ensures the submission of the documentation to the registering authority.
Following the closing, the parties may still be obliged to comply with certain covenants. Among customary post-closing covenants, there might be non-compete, non-solicitation and similar undertakings (see below) as well as the seller's obligation to provide necessary technical support to the target or purchaser. In particular, if the target company is deeply integrated into the seller's ecosystem, the purchaser might want to set out provisions in a transition services agreement, ensuring that the seller will continue to provide the necessary services during a transition period post-closing.
Finally, another aspect of many technology M&A deals is a compensation and incentives package to be granted to the company's founders, who may retain minority stakes, and key employees. Such package may include equity options or cash bonuses paid depending on the company's performance in the future. However, structuring equity options directly for shares in a Russian JSC (and even more so for participation interests in a Russian LLC) is quite cumbersome, if not unfeasible in certain cases, due to Russian corporate and securities law limitations that should be carefully analysed by the parties and their counsel in advance.
Technology M&A deals are typically completed by purchasers using their own funds, although various acquisition finance mechanisms may be used, depending on the availability of liquidity. Given, among other things, the restraints on access to international financial markets pursuant to the US and EU sanctions, many acquirers may want to seek funding on the Russian internal market, including via issuing Russian bonds or borrowing from a bank or a syndicate of banks.
Covenants in bank financing are usually more burdensome and typically involve a whole package of undertakings to be assumed by the borrower (in particular, upon closing, the target shares are likely to be pledged to secure the repayment of the loan).
Leveraged buyouts are made from time to time but remain relatively unpopular on the Russian M&A market.
v Tax and accounting
Parties should take into account tax considerations while structuring a deal to minimise the tax burden. It is even more important for non-Russian parties, who need to be mindful of the international taxation angle and carefully review tax legislation of the relevant jurisdictions as well as applicable bilateral tax treaties. To date, Russia has entered into such agreements with approximately 80 countries.
It is also important to conduct tax due diligence with respect to the target business. Common industry-specific tax risks include the following:
- IP may be used by companies within the target group without formal contractual arrangements and consideration;
- a single business may be divided into a number of legal entities, resulting in, among other things, transfer pricing risks; and
- IP may be incorrectly evaluated or not listed on the balance sheet as intangible assets at all, which may lead to a tax reassessment or other disputes with the tax authorities.
It is also necessary to make sure that the target's accounting is organised properly. All Russian companies are required to prepare standalone (separate) financial statements in accordance with the Russian Accounting Standards (RAS). In addition to standalone RAS statements, consolidated financial statements of certain entities, for example, public companies, shall be prepared under the International Financial Reporting Standards.
vi Cross-border issues
Foreign acquirers may face additional challenges while completing M&A transactions in Russia.
In particular, under the FSIL, prior to acquiring ownership of certain percentages of shares, certain rights to shares or certain management rights with respect to Russian strategic companies, including in the technology sector, foreign investors are required to receive a prior clearance from the special governmental commission chaired by the Prime Minister of Russia (PM).
A company is considered strategic if, among other things, it conducts or has a licence to conduct any of the following activities:
- space-related activities;
- nuclear energy-related activities;
- television and radio broadcasting (depending on the coverage);
- activities of a telecommunications operator with a dominant position on the market; and
A foreign investor who is acquiring, directly or indirectly, more than 50 per cent of shares in a strategic company or the right to appoint its CEO or more than half of its board of directors or its management board should obtain FSIL clearance. The requirements are stricter for foreign states and foreign investors that have not disclosed their beneficiaries to the FAS; they and their controlled entities are prohibited from making such acquisitions at all, and they must obtain FSIL clearance in the case of the acquisition, direct or indirect, of more than 25 per cent of shares in a strategic company or rights to block the decisions of its corporate bodies (potentially including veto rights customarily given to minority shareholders).
Moreover, since 2017, the PM has discretionary powers to decide whether any transaction by a foreign investor with respect to any Russian company – which is not necessarily strategic under the FSIL – is subject to prior governmental control under the FSIL.
The FSIL review procedure is rather cumbersome and time-consuming, as the governmental commission usually holds its meetings only a few times per year.
In addition to the FSIL, under the Foreign Investments Law, foreign states and entities controlled by them acquiring, directly or indirectly, more than 25 per cent of shares in any non-strategic Russian company or rights to block the decisions of its corporate bodies shall obtain clearance in accordance with the procedure set out in the FSIL (although in this case, if the target is not strategic under the FSIL and the PM has not decided the transaction is otherwise subject to prior governmental control under the FSIL, the clearance is granted by the FAS rather that the governmental commission, and so the process is much easier).
Among other things, Part IV of the Civil Code distinguishes between such types of IP as software, databases, inventions, utility models, industrial designs, breeding achievements, integrated circuit layout-designs (topography), know-how, company names, trademarks, service marks and commercial names, all of which are legally protected.
Depending on their transferability, all rights to IP fall into two major categories:
- non-transferrable non-proprietary personal rights (such as the right to be recognised as the creator of IP) as well as some other specific rights (such as right to a re-sale royalty or right of access); and
- transferrable proprietary exclusive rights, which are basically rights to make use and dispose of IP, for example, by way of granting a licence to use IP or a sale (assignment) of IP.
In addition to domestic legislation, Russia is a party to a number of international conventions regulating IP, including:
- the Convention Establishing the World Intellectual Property Organization (1967);
- the Agreement on Trade-Related Aspects of Intellectual Property Rights (1994);
- the Universal Copyright Convention (1952);
- the Berne Convention for the Protection of Literary and Artistic Works (1887);
- the Paris Convention for the Protection of Industrial Property (1883);
- the Patent Cooperation Treaty (1970);
- the Eurasian Patent Convention (1994);
- the Madrid Agreement on the International Registration of Marks (1891) and the Protocol Relating to the Madrid Agreement (1989);
- the Singapore Treaty on the Law of Trademarks (2006); and
- the Nice Agreement on the International Classification of Goods and Services for the Purposes of Registration of Trademarks (1957).
Since IP is often of great value for technology companies, the distinctive features of technology M&A transactions include:
- due diligence with an emphasis on IP (see below);
- specific protection sought by the purchaser in the transaction documents with respect to IP, mostly through R&W and indemnities (see above);
- additional steps related to the transfer of IP, if applicable. Generally, the transfer of any registered IP shall be registered. Thus, the transfer of patentable IP (inventions, utility models and designs) and means of individualisation (such as trademarks and service marks), which need to be registered with the Federal Service for IP (Rospatent) or under the relevant convention in the first place to have protection in Russia, is also subject to registration with Rospatent. With respect to copyrightable works, including software and databases, there are no requirements for registration or depositing such works and they enjoy legal protection from the time of their creation. However, software and databases may be registered with Rospatent, mainly for additional public evidence of title to them, and, once registered, any further transfer of such software and databases is also subject to registration.
Russian courts are rather conservative when it comes to non-competition, non-solicitation and similar restrictive undertakings, either in M&A transaction documents or employment contracts. In most cases, such clauses are considered unenforceable as breaching labour law and employees' constitutional rights to labour,5 but are nevertheless commonly included in transaction documents in practice. As an alternative to enforcing these contractual provisions, an employer may instead try to file a complaint with the FAS against the breaching employees for violation of the Competition Law, although in practice it may be difficult to prove breach by an employee, especially in the case of use of commercial secrets. For example, we are aware of a case where competing activities of a company's former employees with the use of its commercial secrets were considered unfair competition by the FAS.6
Another important aspect of employer–employee relations is employment works, which are IP objects created by employees within their employment duties. Employees always retain personal non-proprietary rights with respect to their employment works while, unless agreed otherwise in the employment contract, the employer acquires exclusive proprietary rights by operation of law. However, if within three years after the creation of the employment work the employer does not commence using the employment work, or license or assign it, and does not notify the author of the intention to protect the work as a commercial secret, the exclusive proprietary rights are automatically transferred to the employee.
The concept of employment works gives rise to a number of practical issues. For example, it is not always clear whether work falls within an employee's duties, and the burden is on the employer to prove so. Thus, in 2019, Russian IT company Rambler claimed that its IP rights were infringed by Igor Sysoev and Maxim Konovalov, ex-workers of the company, who developed web server technology and then, with the use of this technology, founded their own company, Nginx. According to Rambler's allegations, the technology was developed when both worked at Rambler and hence all exclusive rights to the technology should belong to Rambler. After an attempt to initiate a criminal investigation, Rambler decided not to press criminal charges and instead transferred its claimed rights to the technology to Lynwood Investment, a holding company reported to be related to Alexander Mamut, Rambler's shareholder, which brought a civil suit with an American court against Nginx, its founders and related companies claiming compensation for the used technology. As of September 2020, the case is pending.
In addition, an employee is entitled to compensation for the employment work even if it is not used by the employer, and issues may arise in assessing the amount of such compensation, particularly if the employment contract is silent in this regard.
Thus, as part of due diligence, a purchaser and its legal counsel should carefully investigate how employment works are treated in the employment contracts and whether there is any evidence of use or protection of such work as a commercial secret to identify any risks.
Under the Personal Data Law, personal data is broadly defined and includes any information referring, directly or indirectly, to a particular individual. The personal data protection regime extends to any processing of personal data, including collection, recording, systematisation, accumulation, storage, clarification, updating, changing, extraction, use, transfer, distribution, provision, accessing, depersonalisation, blocking, deletion and destruction of personal data.
Any individual, company or authority that processes in any way any personal data is considered a personal data operator. Unless any of the carveouts set out in the Personal Data Law applies, to process personal data of an individual, a personal data operator must obtain his or her consent. As a general rule, such consent may be provided in any form, but it is always advisable for the personal data operator to obtain written consent. Moreover, in certain cases only written consent is valid, for example, when certain sensitive personal data, such as data relating to an individual's race, nationality, political, religious or philosophical views, or health and private life, is to be processed. Such consent may be given either as a separate document or incorporated into another document (such as the employment agreement) and shall be signed by the person by a handwritten or electronic signature.
With respect to cross-border transfers (from Russia to abroad) some additional limitations apply. Thus, the Personal Data Law allows only:
- the transfer of personal data to countries that are signatories to the Convention for the Protection of Individuals with regard to Automatic Processing of Personal Data (1981);
- the transfer of personal data to countries that are included into the list of additional countries with 'adequate protection of the rights of personal data subjects' maintained by Roskomnadzor (such as Australia, Canada, Singapore, Japan); or
- the transfer of personal data to any other countries (such as the US), provided that there is the express written consent of individuals to such transfer.
Any personal data operator is under an obligation to keep the processed personal data confidential, unless required otherwise by law. For example, an operator must provide personal data to the investigation authorities in connection with an ongoing criminal investigation.
The parties shall comply with personal data protection requirements when working on an M&A deal. For example, to provide documents containing employees' personal data (for example, their employment contracts) to the purchaser and its legal counsel as part of due diligence process, the company needs to obtain such employees' consent or, alternatively, depersonalise the provided documents.
In recent years, the Russian data protection regime has become significantly stricter. In particular, in 2014, amendments to the Personal Data Law were adopted that require personal data operators to store and process Russian citizens' personal data using databases physically located in Russia (the Data Localisation Law). While the Data Localisation Law created new opportunities for Russian data centres and stimulated the technological development in this area, it was highly criticised by business in general since data storage infrastructure had to be redesigned at high costs. Certain international companies refused to comply with the new requirements: for example, for that reason, in 2016 LinkedIn was officially blocked in Russia, and in 2019 and 2020 Twitter and Facebook were both fined.
IT companies can benefit from a number of tax incentives. For example, IT companies that have accreditation with the Ministry of Digital Development, Communications and Mass Media that receive 90 per cent or more of their revenues from IT products and have seven or more employees can pay social security contributions at the aggregate rate of 14 per cent (while the general aggregate rate is 30 per cent).
Moreover, certain IT companies that are residents of the Skolkovo Innovation Center, a special scientific and technological innovation area near Moscow, which status is granted to a company for up to 10 years, are also exempt from profit tax, provided that the annual revenues of the company do not exceed 1 billion roubles; and VAT and property tax, provided that, if the annual revenues of the company exceed 1 billion roubles, its annual profit does not exceed 300 million roubles.
Further, pursuant to the amendment to the Tax Code of the Russian Federation adopted in July 2020 (also referred to as the law on tax manoeuvres in the IT sector) with effect from 1 January 2021, for IT companies meeting the above criteria, the rate of profit tax will be reduced to 3 per cent (while the general rate is 20 per cent) and the aggregate rate of social security contributions to 7.6 per cent (from 14 per cent, as described above).
Since under Russian law tax incentives pertain to companies themselves, they are not affected upon acquisition and no specific steps from the parties are usually required. However, before entering into a transaction, a purchaser might want to estimate if the company will be able to retain the applicable tax incentives, if any, in the future.
Due diligence with respect to a technology company is not significantly different from that in any other sector. Typically, the purchaser's counsel reviews the target's corporate and financial documents, major commercial contracts, documents relating to the target's regulatory compliance, employment contracts, taxation, litigation and other documentation, and then flags the identified risks and suggests mitigation options in a due diligence report.
However, given the fundamental role of IP for the business of a technology company, it is crucial to identify the IP used in its business and confirm the target's rights to it, including by checking the chain of title transfers with respect to IP and a history of claims, if any. For these purposes, an emphasis shall be placed on licence agreements, assignment agreements and employment work clauses in employment contracts as well as publicly available information, such as commercial courts databases. With respect to IP that is subject to registration (see above), the purchaser's counsel shall also check such registration in the relevant public registers administered by Rospatent or, as the case may be, certain international organisations, such as the World Intellectual Property Organization and the Eurasian Patent Organization.
If a target's activities are subject to licensing, purchaser's counsel shall also confirm that all the necessary licences are in place and remain valid. For example, developing and servicing encrypted software requires a special licence granted by the FSB.
Another important work stream of due diligence is to check how the target complies with the applicable regulatory rules, such as data protection requirements (see above).
Although Russian courts occasionally resolve disputes arising from technology M&A deals, parties usually tend to refer their potential disputes to arbitration, mainly because they consider this forum more qualified and independent.
Certain types of disputes that are purely contractual in their nature (such as disputes relating to the calculation or payment of a share purchase price) can be submitted to a foreign court or ad hoc international arbitration, or both.
On the contrary, disputes that are considered to be corporate can be settled by arbitration only subject to certain conditions. Thus, pursuant to the Arbitration Procedural Code of the Russian Federation, such corporate disputes fall into the following categories, depending on their arbitrability:
- arbitrable corporate disputes: such disputes must be settled by a permanent arbitration institution (PAI – see below) (e.g., disputes in relation to the ownership of shares, the creation of an encumbrance over shares and the exercise of ownership rights, and disputes in relation to enforcement against shares);
- corporate disputes arbitrable under a special procedure (e.g., disputes in relation to the incorporation, reorganisation or liquidation of a company, shareholders' claims for losses caused to the company or for challenging company decisions, disputes relating to management of the company, including disputes arising out of shareholders' agreements, and disputes in relation to the issue of new shares): such disputes may be referred to arbitration subject to the following conditions:
- the arbitration must be administered by a PAI;
- the seat of arbitration must be Russia;
- the arbitration must be conducted under a special set of rules adopted by the PAI for the arbitration of corporate disputes and deposited with the Ministry of Justice of the Russian Federation; and
- all shareholders of the company and the company itself must be parties to the arbitration agreement; and
The status of a PAI is granted to an arbitration institution, whether Russian or foreign, by the Ministry of Justice of the Russian Federation subject to certain conditions and following a formal procedure. To date, only seven arbitration institutions have obtained PAI status and hence may settle arbitrable corporate disputes:
- five Russian arbitration institutions:
- the International Commercial Arbitration Court at the Chamber of Commerce and Industry of the Russian Federation;
- the Arbitration Centre at the Russian Union of Industrialists and Entrepreneurs;
- Russian Arbitration Center at the Russian Institute of Modern Arbitration;
- the National Center for Sports Arbitration at the Sports Arbitration Chamber; and
- the Maritime Arbitration Commission at the Chamber of Commerce and Industry of the Russian Federation;
However, as mentioned above, to be eligible to settle corporate disputes arbitrable under a special procedure, a PAI must also adopt a special set of rules for arbitration of corporate disputes and deposit them with the Ministry of Justice of the Russian Federation. To date, of the seven PAIs listed above, only the first four have done so and therefore can settle corporate disputes arbitrable under a special procedure.
In addition, foreign judgments are generally recognised and enforced by Russian courts pursuant to a federal law or an international treaty. For example, Russia is a party to more than 40 bilateral treaties on legal assistance in civil and related matters, which set out the rules of enforcement of foreign judgments in Russia. However, no such treaty exists between Russia and certain jurisdictions (including the US and the UK), and no relevant federal law on enforcement of foreign judgments has been adopted. Even in this case, a final judgment may still be recognised and enforced by a Russian court on the basis of reciprocity (i.e., if courts of the country where the foreign judgment has been rendered have previously enforced judgments issued by Russian courts). Even if there are legal grounds for recognition and enforcement of a foreign judgment, whether pursuant to an international treaty, a federal law or on the basis of reciprocity, such recognition and enforcement will still be subject to certain Russian law qualifications. For example, a Russian court may refuse to recognise and enforce a foreign judgment if it would contradict Russian public policy.
Foreign arbitral awards may also be enforced by Russian courts pursuant to an international treaty or a federal law, or on the basis of reciprocity. Among other things, Russia is a party to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (New York Convention). Therefore, Russian courts generally enforce arbitral awards rendered in countries that are parties to the New York Convention, subject to certain qualifications provided for in Russian law and the New York Convention itself, which largely overlap.
Given the increasing role of technologies and the further digitalisation of the Russian economy, the technology sector stands a good chance of remaining attractive for investments in the near future.
Certain recent regulatory amendments may even further contribute to the development of Russian technology business. For instance, in November 2019, the Federal Law on Protection of Consumers' Rights was amended so that, with effect from 1 January 2021, certain Russian software shall be preinstalled on computers, laptops, gaming consoles, smartphones, smart TVs and similar devices sold in Russia, including those that have been imported. However, the new Law has been heavily criticised since in many cases local Russian software falls short of international standards and sometimes there is simply no alternative Russian software.
In addition, in March 2019, the concepts of digital rights and smart contracts were introduced into the Civil Code, and further, in July 2020, a law was passed that, among other things, regulates the issuing, recording and circulation of digital financial assets and the circulation of digital currencies. These new laws, which basically create a legal framework for cryptocurrencies, tokens and related technologies, may also boost the growth of the technology sector and the relevant M&A market.
However, probably the main driver influencing the technology M&A market in the near future in Russia, as in most countries, will be the long-term economic fallout of the coronavirus pandemic. The Russian M&A market in general is likely to show relatively limited activity throughout 2020 due to the economic slowdown. On the other hand, the technology sector appears to have suffered much less from the lockdown than the economy in general, and we may even see a boost in M&A transactions in telecommunications, online trade, online learning and some other areas.
The pandemic is also likely to affect the structuring of M&A transactions. For instance:
- material adverse change and effect clauses may be reconsidered and given more importance;
- purchase price adjustment mechanisms will be an even more important subject for negotiations as the parties will try to achieve a more balanced distribution of economic risks;
- the timing for merger control and other regulatory approvals may be considerably delayed; and
- the way M&A transactions are planned, signed and closed will also likely be affected – for example, virtual meetings may become much more common.
1 Yulia Solomakhina is a partner, Andrey Lipin and Ilya Nekrasov are associates and Nikita Klepalov and Dmitriy Sokolov are paralegals at Cleary Gottlieb Steen & Hamilton LLC.
2 See the Russian M&A Review 2019 by KPMG: https://assets.kpmg/content/dam/kpmg/ru/pdf/2020/02/ru-en-ma-survey-2019.pdf.
3 Here and below, information about deals, including deal sizes, is set out as reported in the media.
4 See the FAS press release of 23 April 2018: https://en.fas.gov.ru/press-center/news/detail.html?id=52952.
5 See Resolution of the Federal Arbitration Court of the Moscow district dated 24 June 2014 N F05-5818/2014 in case N A40-80777/13-40-742; Resolution of the 13th Arbitration Appellate Court dated 17 March 2014 in case N A56-51527/2013.
6 See Resolution of the Federal Arbitration Court of the Moscow district dated 16 September 2013 in case