15 July 2011
The European Lawyer publishes commentary by Mikhail Kazantsev

Slumbering bear

Russian business lawyers are cautiously optimistic, but concerns over corruption and the reliability of the country's commercial courts still beset legal practice in a country striving to take its place on the global stage. Jonathan Ames reports

It's better to be a BRIC than one of the PIGS, but questions still get asked when you are pulling up the rear.

Russia is well above the bottom rung of the European economic ladder, populated by Portugal, Ireland, Greece and Spain, and is very much still part of the emerging market elite. But its growth forecast of 4.4 per cent for this year and next places it at the back of that pack, trailing its BRIC counterpart Brazil, which is predicted to grow by 5.2 per cent, and well behind India on 8.8 per cent and China at 9.8 per cent.

Figures emerging from the recently concluded St Petersburg International Economic Forum - which followed the inaugural legal gathering in the same city a few weeks before - showed that forecast Russian growth was even trailing that of sub-Saharan Africa, which includes South Africa and is on a trajectory for 5.5 per cent over the next two years.

Tragic relationship

Russians are worried that they are falling off the pace. And while Leo Tolstoy was renowned for disparaging the value of the English bard from Stratford, he would surely have enjoyed the Shakespearean tragic elements of the relationship between two Russian leading men: current Prime Minister Vladimir Putin and the man who was the country's wealthiest oligarch, Mikhail Khodorkovsky. It can be argued that the former has done his utmost to silence the latter, but like a spectre at the feast, Mr Khodorkovsky continues to haunt much of Russian political and economic life.

Of course, the former billionaire chief executive of energy oil company Yukos Oil is far from dead - he is in fact imprisoned in a remote jail on the Finnish border, serving a 13-year-sentence for fraud and tax evasion, handed down in 2005 and which Mr Khodorkovsky has consistently maintained was politically motivated. Despite his remote incarceration, he manages to pester Mr Putin and the man many see as his puppet in the president's office, Dimitry Medvedev.

As the St Petersburg conference opened, Mr Khodorkovsky fired a broadside at the Russian leadership. In written answers delivered by his lawyers to questions from US news agency Bloomberg, he stated that because corruption was endemic in the country's economy, oil prices would have to reach the stratospheric level of $200 a barrel if Russia were to match the growth rates of India and China.

Indeed, Russian business lawyers point out that oil prices have so far played a crucial role in buffering the country from the ravages of the global financial crisis and its aftermath. After Saudi Arabia, Russia is the world's largest producer of oil, the price of which is hovering around $95-$ 100 per barrel.

'Russia hasn't been as badly affected by the global financial crisis as others, thanks in most part to our oil and gas reserves,' comments Mikhail Kazantsev, a partner at leading Russian business law firm Egorov Puginsky Afanasiev & Partners. 'Once the oil prices went back up, the country recovered fairly quickly.'

Mr Kazantsev also points out that the Russian government reacted to the financial crisis by pumping considerable sums into the country's financial system. 'So 2010 was a restructuring year and 2011 will see the return of mergers and acquisitions work,' he forecasts, although warning that 'real estate is still slow - it is coming back but not as fast as we had hoped.'

Property bubble

Indeed, the Moscow property price bubble that had expanded in the run-up to the crisis has burst with a bang. Commentators point out that of the big seven developers in the Russian capital prior to the crisis, only two are still in independent business, as the others have been rescued by the government.

But outside the property sector, there are signs of life for business law practices in Russia. Vassily Rudomino, the founding and senior partner at Moscow-based Alrud, points out that his firm has recently been involved in a couple of large technology deals: Mail.ru - the Russian equivalent of Gmail, had an initial public offering valued at around $5.5 billion on the London Stock Exchange last September; and only last month, Yandex, the Russian version of Internet search engine Google, also had a $1.3 billion IPO on the New York market. 'This shows that independent Russian firms can compete with the offices of the global firms and that we are starting to take back our market,' comments Mr Rudomino.

In general, he remains buoyant, saying that his and other top business law firms in the jurisdiction 'were busy through the crisis completing deals that we had started before. And litigation and arbitration has grown considerably, as has insolvency and restructuring work'.

Indeed, restructuring has been a bit of a boon to Russian firms as companies strove to align their corporate governance regimes with western European and US standards. Litigation also spiked, not least because one of Russia's biggest financial institutions, Alfa Bank, was reportedly particularly hard on debtors, and, says one leading Russian lawyer, 'was filing law suits all over the place, in Russia as well as abroad'. However, Mr Kazantsev points out that Alfa's stance was the exception, with the rule being that Russian banks in general were reluctant to go to court and instead aimed to restructure debt, meaning that few Russian companies went to the wall during the financial crisis.

But the leaders of independent law firms are effectively unanimous in their view that the local offices of UK and US global practices were seriously damaged by the crisis. 'International law firms continue to lose segments of their markets and there have been decreases in personnel as well as a drop in fee rates,' maintains Vladislav Zabrodin, the managing partner of law firm Capital Legal Services. He reports that the local offices of global firms are increasingly willing to work on fixed fee arrangements and are slashing rates drastically to drive fresh instructions.

Mr Kazantsev agrees, claiming that the international law firm offices in Russia 'fired a lot of people'. He maintains that M&A and real estate practices were dispensed with wholesale by the globals, although as the market begins to recover, those firms are scrambling to recruit again. Local firms were not immune from redundancies and some practices split creating spin-offs. Mr Kazantsev maintains his firm was an exception - 'we didn't fire anybody. At that time, we made a decision not to raise salaries for at least a year'.

Overall, this heightened competition has also impacted on the fees of local independent law firms. Hourly rates may not have dropped, but the fixed fees that they are offering at the beginning of projects are significantly lower.

There are several key factors affecting the Russian legal sector: first remain the bugbears of corruption and the validity of the local commercial courts; second are the moves by the authorities to reform the country's civil code and to encourage businesses to use Russian instead of English law to govern their deals; and lastly is the comprehensive proposals from the Ministry of Justice to reform regulation of the country's legal profession.

It is impossible to have a conversation with a Russian business lawyer without the issue of corruption arising quickly. While Capital Legal Service's Vladislav Zabrodin maintains that the Russian government at the highest level is committed to cracking down on fraud and bribery, corruption is still prevalent on the ground, and indeed it increased during the financial crisis.

In addition, he takes the view that the state 'is using the wrong methods to crack down on corruption. We need more than pure legislation -we need a wholesale review of the way in which the country is managed. There is an old saying - the severity of Russian laws is negated by the equal seriousness with which the population declines to comply with them. The Russian business environment is not transparent and clear. One of the most efficient control mechanisms to ensure that transparency is a free press. Unfortunately, the authorities and the establishment in Russia consider the press to be unfair critics.'

The reliability of court judgments is also a major concern of international investors in Russia, and is an issue that is integrally linked to problems over corruption. Mr Zabrodin maintains that independence is not an issue, as unless there is a specific high-profile political angle to a hearing, then judges are just as likely to rule in favour of business interests over those of the authorities.

However, poorly remunerated judges - specifically those sitting in the lower courts -can be highly susceptible to inducements. 'There is a general problem with business ethics in Russia and the ability of judges to resist the temptation of bribes,' explains Mr Zabrodin. The biggest problem is at the lower, first level courts. You stand a much better chance of getting a fair hearing -unaffected by bribery - at the appeal levels. The problem is that doing so involves additional costs and some businesses might take a commercial view that it is not worth that expense. But it is possible for a business to protect its interests - it just has to be persistent.'

Ethical problems

A lack of faith in the predictability and reliability of the Russian commercial courts has promoted the use of English law in major local and international deals in the country. But there are moves afoot to restore confidence in the local system.

President Medvedev has launched a working group to study prospective reforms of the civil code, but there are concerns that business lawyers have been carved out of the early stages of that analysis. 'That working group consisted mostly of scholars who are sophisticated and knowledgeable - but out of the Soviet school,' explains Mr Zabrodin. 'As soon as the first drafts were released, there were significant efforts by commercial lawyers to comment on the process. And by no means were all the proposed changes negative, from our point of view, a lot of them were positive. However, on balance the position of Russian commercial lawyers was undermined.'

But an informal group of local commercial law firms has been organised to comment on the process, and they are hoping that eventually the reforms will allow Russian law to become more attractive to international players.

'Therefore we will see Russian law being used more and more in both international and national deals,' says Mr Zabrodin.

Quality gap

Wider concerns about the overall quality of Russian lawyers are also troubling the top end of the profession and officials at the Ministry of Justice. According to Egorov's Mr Kazantsev, 'standards can be so low that international clients are often forced to use international or major domestic law firms because of that'. He continues: 'When the Soviet Union fell apart, there was a huge army of unqualified legal advisors with no experience of business law. And when the international law firms came in with their 200 years' experience they initially occupied the whole legal market. After several years, independent Russian law firms started to build expertise, the result, in part, owed to the fact that some Russian lawyers did LLMs abroad'.

Alrud's Vassily Rudomino agrees that ministry moves to impose greater regulation are to be welcomed. 'Our firm definitely supports that initiative,' he says. 'A self-regulated profession will provide better protection. But there are concerns that such a body would be dominated by those who are not business lawyers, but those who are, say, criminal lawyers from the older generation who won't understand the needs and interests of the commercial sector.'

However, there are lawyers who are sceptical, fearing that a single regulator would fall into the Russian trap of becoming too politically coloured and ultimately would be used by the government to influence the work of law firms and even specific practitioners.

But Mr Rudomino maintains those concerns are unfounded. 'The Ministry of Justice is determined to bring our regulatory regime up to international standards - it is keen to understand the international experience. The current minister is very much a modemiser and keen to engage with international practitioners. And they are very concerned about the current quality levels of some of the Russian lawyers, as well as corruption issues. They are probably right to fear that some in the legal community are clearly involved in corruption.'