The lure of Russia

The lure of Russia
Bernie O’Rourke knows the dark side of doing business in Russia.
As the senior vice president and longtime general counsel of I.M.P. Group International Inc., a Halifax-based hotel and aerospace company, O’Rourke has twice fought legendary legal battles to protect his company’s interests in Russia.

I.M.P. was a pioneering, western investor in the twilight years of the Soviet Union, spending $50 million to refurbish and operate the now-infamous Aerostar Hotel Moscow. In 1994, five years after the hotel’s re-opening, O’Rourke fended off an attempt by I.M.P.’s partner, Aeroflot, to wrestle I.M.P. out of the venture. He and his legal team won their case at the International Court of Arbitration in Stockholm, and then forced Aeroflot to obey the court’s decision by seizing the airline’s most liquid asset available in Canada — the fuel in the wings of an Aeroflot plane parked at the airport in Montreal.

A decade later the partners had patched up their differences and the Aerostar Hotel was going strong. But in 2004, during the crazy, gangland economy that emerged after the collapse of the Soviet Union, I.M.P. had its hotel simply taken away from it, effectively at gunpoint, by what O’Rourke obliquely calls a “Russian business organization.” Years of legal and diplomatic lobbying ensued, at the highest levels of the Canadian and Russian governments, until a negotiated settlement was finally agreed on by all sides. I.M.P. withdrew from Russia, and, stung by its experience there, has never returned.

The Aerostar affair became a cautionary tale — a symbol for many business people across North America of the high risks of doing business in Russia.
How surprising then to learn that O’Rourke, for all the sleepless nights he and other I.M.P. executives endured over Russia, says he would happily go back there today if the right opportunity presented itself. He doesn’t buy into what he calls the many myths that have grown up about the difficulties and pitfalls of investing there.

“I’m bullish on Russia,” he says. “If an opportunity came up there again that we found attractive, and it would have to have the right rate of return to justify the risk, we’d look at it again, I think we would.
“Our senior management team — we all kind of miss the whole Russian scene.”

O’Rourke also endorses a recent call-to-arms by the Canadian Eurasia Russia Business Association — whose members include a handful of Canadian law firms with offices in Moscow — that Canadian business must overcome its squeamishness about Russia and start to invest in what is now the 10th largest economy in the world.

One of CERBA’s directors, Lou Naumovski, vice president and general director (who oversees Russian gold mining operations) for Toronto-based Kinross Gold Corp., harshly criticized Canada’s business community in The Globe and Mail last year for what he called its “timid” and “chickenshit” attitude towards Russia. He said overblown fears of expropriation and other risk factors mean Canadians are missing out on major money-making opportunities there.

“I agree 100 per cent,” says O’Rourke. “Russia’s had some problems. There’s been some bad experiences there. But there’s also a long-standing history there of a very sophisticated economy. They’re a highly educated workforce with a lot of inherent capability. There aren’t too many countries on the planet that have the capability to put human beings into space. I’m still in touch with our Russian lawyers, and I think Russia is gradually coming out of that period of legal chaos in the 1990s that followed the collapse of the Russian state. They recognize the importance of the rule of law — that you’ve got to be able to buy a piece of property, or borrow money and take normal business risks, and know somebody’s not going to take it away from you unilaterally. I think they’re becoming much more a part of the world community.”

In fact, Russia will enter the World Trade Organization this year, further opening access to a rapidly growing economy powered by vast natural resource wealth, and hungry for consumer goods, technological know-how, and foreign partners to build and expand Russia’s sprawling transportation, communications, and industrial infrastructure.

So what do Canadian companies, and particularly their in-house counsel, need to know about doing business in Russia before taking the plunge?

The first thing, says Paul Drager, one of Canada’s most experienced legal minds on Russia, is to approach the country with an open mind, remembering that Russia today is not the chaotic, “Wild West” environment it was 10 or 15 years ago. “The difference is enormous,” says Drager, who once served as a trade official at the Canadian embassy in Moscow, and is now a Calgary-based partner at Norton Rose Canada LLP, which merged this year with Canada’s Macleod Dixon LLP. (In 1990, Drager helped Macleod Dixon become one of the first western law firms to open an office in Moscow. The firm now employs 40 lawyers there, under the Norton Rose banner.)

“Since then, not only has the political system changed, the currency is now very convertible, the banking system is relatively solid, and you have a much better understanding by the Russians themselves of what international business is. In the past when you started working there, in the final years of the Soviet Union, it was all state-controlled entities. Now you have a private sector, which is extremely vibrant. In that way it’s normalized to a substantial degree.”

Is working in Russia now roughly the same as operating in western Europe? “Regrettably, that’s going too far,” says Kinross’s Naumovski. “Whether you’re buying legal services there or mining gold, you need to remember that Russia is still an emerging economy. The key is to be prepared,” he said in an interview.

The most critical piece of due diligence for any foreign company entering Russia is to find out who, exactly, your partners are there. Russia’s economy may have come a long way since 1990, but the country remains one of the most stubbornly corrupt jurisdictions on the planet.
On the Corruption Perceptions Index maintained by Transparency International, Russia ranks only 143 out of 182 countries. Canada is ranked 10th. Russia receives only 2.4 points on the Index scale between zero (very corrupt) and 10 (very clean). That puts Russia well below the other BRIC nations of China, India, and Brazil, and only slightly higher than Zimbabwe, which has 2.2 points.

For all the bullishness of Paul Drager and his colleagues at CERBA, Russia is still rife with stories of businesses, foreign and domestic, having their assets pilfered by corrupt tax collectors, police officers, security officers, and bureaucrats, some of whom operate together much like organized crime families.

Doing business in Russia is “a moving target, there are no real rights,” said a Moscow restaurant entrepreneur in an interview last September with Time magazine. “If you could put your $100 million in any market, why would you put it here?”

Along with such business insecurity is Russia’s ongoing political volatility. In February, hundreds of thousands of Russians rallied in the streets of Moscow and other cities, demanding an end to then Prime Minister Vladimir Putin’s rule, and challenging his campaign to reclaim the presidency in March. He was victorious but many protested that the election was skewed in his favour.

All of this underlines the importance of a comprehensive due diligence and anti-corruption program for foreign companies entering Russia.
Kristine Robidoux, a partner with Gowling Lafleur Henderson LLP in Calgary, who helps foreign investors with anti-bribery compliance programs, says Russian corruption is more sophisticated than in other emerging markets such as Mexico, for example. It’s therefore more insidious and harder to avoid. Investors in Russia, she says, won’t be asked for a bribe directly by the government agency or private partner they’re dealing with. Instead they’ll be directed to make purchases or sub-contract services through a specific party, which in turn will use that money to pass kickbacks up the chain. “Invariably the biggest pitfall for clients I work for in Russia is that they often don’t entirely know who they’re contracting with,” Robidoux says. “They deal with state-owned or state-controlled entities. Those entities require business be done in a particular way — that transport be contracted to specific firms, that purchases of commodities occur through specific channels, that there be legal representatives for that company in Russia that are named by the state entity.

“Any time the organization is being that directive in how you contract for other services, that is a significant red flag.”

Corruption matters not only because it’s unethical, says Robidoux, but also because the United States and more recently Canada have started aggressively enforcing anti-corruption laws against homegrown companies. “Canada has been under significant international pressure to ramp up its enforcement of the Corruption of Foreign Public Officials Act. That law has been on the books since 1998, but Canada has not taken steps to vigorously enforce it until recently, and they’ve come flying out of the gate in an effort to rid themselves of the reputation of being easy on this.”

Robidoux says Russia offers an easy trap for Canadian businesses. “Corruption is vertically integrated there,” she says. “You’ve got a state-owned entity at the top, which is going to contract with a Canadian company to do something, but in order for the company to carry out its work, it needs gasoline or trucks or whatever. And because corruption runs throughout the whole supply chain, the money being paid by the Canadians to the trucking company is getting kicked back to someone at the state-owned entity.
“Perhaps the tide is starting to turn in Russia, but sadly our experience is that corruption remains sophisticated and it remains prevalent.”

Lou Naumovski says it pays to invest not only in anti-corruption forensic and legal expertise, but also in public relations and government affairs experts familiar with Russia’s business scene. “You probably wouldn’t spend $30,000 finding out about the background of your potential partner if you were going to Nebraska,” he says. “But in Russia you need to do that. You also need to understand how the business in that sector has evolved, and who are the big players. You have to hire dedicated people to figure this out. And a lot of companies don’t do this because the upfront costs can be huge. But what they fail to analyze is the cost benefit. Yes it costs you $100,000 more than what you would normally spend, but you’re looking at the biggest consumer market in Europe. The profitability is greater.”

Naumovski says that over a 29-year-career of working in Russia for various companies, he has been solicited for bribes but has never paid. He says companies don’t need envelopes of money to succeed there, just patience and perseverance. “What I say to my employees and colleagues is, ‘We’re here, we’re working in Russia, we’ll speak Russian to each other, but we’ll behave like Canadians,” he says. “That’s something I’ve personally done over all this time frame.”

Refusing to pay bribes hasn’t hurt Kinross in the eyes of Russia’s national leadership. The company and its CEO have for the past several years occupied a prized seat, along with 40 other international firms, on the country’s Foreign Investment Advisory Council, chaired by the now President Vladimir Putin.

Naumovski says Kinross’s success is due in part to its careful nurturing of government and political relationships — at the highest levels in Moscow, and also with local authorities in the regions where it operates.

This underscores another important truth about the Motherland: For all the free market changes that have taken place since Soviet times, Russia remains, perhaps more than any other major economy, a predominantly government culture. Good partnerships with bureaucrats, provincial governors, and with the myriad state agencies they control are essential to success for foreign investors. “The importance of government in Russia cannot be overstated,” says Naumovski. “It’s key to everything that happens. Whether you’re operating in a small, remote district of the country or whether you’re in Moscow, you really have to accept and be able to relate to government in its particular role.”
One of the most important decisions any in-house Canadian lawyer will make for a company investing in Russia is hiring a team of good Russian lawyers who can help navigate not only the country’s burgeoning civil law codes, but also the thickets of government relations. In Moscow there is now a competitive field of domestic law firms to choose from, as well as numerous large-scale, global firms with offices there employing teams of Russian lawyers familiar with the local landscape.

“It’s important to track down very good international legal advice,” says O’Rourke. “Find a firm that has experience conducting east-west transactions out of Russia. They in turn will either have on staff, or be able to guide you to the acquisition of good, capable local counsel, which you will also need.”

Adds Paul Drager: “It is no longer good enough to just have a passing knowledge of Russian law. Russian commercial law has developed to the extent that you can no longer be up to speed on it by reading a few of the texts. You need legal advice directly from Russian lawyers.”

One quirk of Russian law is that commercial shareholder agreements aren’t enforceable there. Therefore it’s vital for foreign investors to register their joint ventures with Russian partners not in Moscow, but in another jurisdiction where independent courts can be relied on to fairly adjudicate shareholder disputes. It’s for this reason that Montreal-based Bombardier Inc. — which sells trains and aircraft to Russian state-owned agencies — has structured its joint Russian ventures out of Holland, says Daniel Desjardins, Bombardier’s chief legal officer. “You create a joint venture in the Netherlands, sign your partnership agreement in the Netherlands, and then the Netherlands company invests in Russia as a single entity. This way, all the votes and governance decisions take place at the holding company level in the Netherlands — where the courts uphold and enforce shareholder agreements.”

Desjardins also says that Russia’s cultural proclivity for government and bureaucracy infuses business relations in both the public and private sectors. “Part of the culture over there is that decisions are only taken at the highest levels of any organization. People don’t want to be accountable for decisions, therefore you let higher levels make them. So in middle management, you won’t see much initiative taken to resolve issues, it has to come from the top.”

There’s also a Soviet-like fondness for official paperwork. Everything is done contractually — managers don’t pick up the phone to order a piece of equipment or hire a consultant’s services, they fill out detailed purchase orders and other documentation.
“It can be very cumbersome and difficult to get things done,” says Hans Gjerdrum, vice president of international business development with Kudu Industries Inc., a Calgary company that sells pumps and other equipment into the Russian oilfields. “We hire local people who have been born and raised and educated in that bureaucracy, and they don’t mind dealing with it.”

On the other hand, sometimes it’s the Canadians who appear slow and bureaucratic by comparison. People like Gjerdrum have been frustrated in recent years when trying to host their Russian partners on trips to Canada. He and others say slow visa processing times at the Canadian embassy in Moscow have forced some Russian business people to cancel Canadian visits.
The visa problems may be embarrassing, but they serve as a useful reminder of the folly of national hubris when engaging in global business — of thinking that one country’s business culture, or its business practitioners, may be superior to those elsewhere, particularly those in emerging markets.

“Russians are savvy businessmen,” says Desjardins. “Just look at the oil-oligarchs and the way they’ve structured their very powerful companies. Just because you have to spend a lot of time in Russia doing your due diligence, do not assume your Russian counterparts are not as savvy as you. They are. They know how to do business.”

Russians also know how to live in a cold northern climate. They understand the challenges and tricks of tying a vast swath of ice-bound geography together with roads, remote airports, and continental communications links. They chainsaw, mine, and pump the same natural resources from their land as Canada does, and they share Canada’s love of hockey. Despite all the political differences and cultural obstacles of history and language, there are also stark similarities that tend to ease business arrangements with Canadians in Russia.

“Canada has not and continues not right now to focus on the opportunities we have and the similarities we have, for our companies to work in Russia,” says Drager. “I’m talking about everything from aviation to cold-weather technologies to agriculture — not to mention the Arctic. There’s so many areas where there could be so much more co-operation.”

Drager remembers working in Russia, trying to break a difficult negotiation deadlock between a Canadian client and a group of Russian executives discussing a possible deal, when he noticed a table hockey game sitting in a corner of the room. “I found this table hockey game and put it between the two heads of each delegation,” he recalls. “By golly, they both started to play, and both the negotiating teams starting cheering their sides. That really broke the ice between the two sides and got things moving.”

O’Rourke says Russia seemed an “alien” place when he first began working there as a foreign lawyer in the 1980s, but he quickly became fond of Russia and the uniquely interesting challenges it presented in his career. “I enjoyed Russia,” he says. “It was intimidating at first. We had our difficulties there — but you can have problems all around the world — and at the end of the day I met some very good people there, and it made being a lawyer for me much more interesting.”

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