International Conference on Services and Equipment for the Russian Oil and Gas Industry

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Nuts and Bolts Legal Aspects of Oilfield
Services in Russia
by Shane R. DeBeer, Partner Chadbourne Parke
LLP

• International Conference on Services and
  Equipment for the Russian Oil and Gas Industry
• December 2, 2003Moscow

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• As we have heard earlier today, Russia is one of
  the largest markets in the world for oilfield
  equipment and services, and still growing. But
  sponsors and contractors alike face legal
  challenges on any project in Russia.
• What do Sponsors and Contractors need to know
  about the legal environment in Russia?
• How to Structure the Business or Deal
• How to Operate Legally
• What to Do if Disputes Occur

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A. How to Structure the Business or Deal

• Does a foreign contractor need to form a Russian
  legal entity or a Representative Office?
• If a foreign company plans on bringing a
  significant amount of equipment or cash into
  Russia to pursue its business, it should consider
  setting up a legal entity.
• The foreign company can set up a Russian company
• Equipment or cash can be contributed as charter
  capital to the newly formed Russian company free
  of VAT
• If cash is contributed, it can be used to
  purchase or manufacture equipment in Russia

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How to Structure the Business or Deal(contd)

• But the rules on contributions to charter capital
  are complicated and restrictive
• The Russian company can be set up by the foreign
  company alone or together with a Russian partner
• A Russian partner may be necessary for a foreign
  company that seeks business in Russian content
  restricted work, such as certain PSAs.
• A Russian legal entity provides another layer of
  limitation of liability.
• If a foreign company is largely in the business
  of selling equipment (or in a few situations
  services) outside Russia (to Russian buyers), a
  Representative Office is a better option.
• A Representative Office is not a separate legal
  entity. Instead, it is the face (including
  eyes and ears) of a foreign company in Russia.

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How to Structure the Business or Deal(contd)

• Where a foreign company sells equipment, (or
  certain services) outside Russia, the
  Representative Office merely provides information
  and support.
• The Representative Office cannot sign contracts
  in its own name it is the foreign company
  itself that has the capacity to enter into
  contracts.
• This method is advantageous to a foreign seller
  because sales can be made in convertible
  currency, and the Russian buyer must deal with
  customs and other import formalities.
• But even information and support can lead to a
  permanent establishment (as I shall discuss
  shortly), and a Representative Office must
  register with the Tax Inspectorate even if it is
  not liable (or thinks it is not liable) for
  Russian taxes.

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How to Structure the Business or Deal(contd)

• What is a Permanent Establishment?
• A permanent establishment of a foreign company
  for tax purposes is a branch office,
  representative office, department, office,
  bureau, agency, or any other separate division or
  any other place of activity, through which the
  foreign company conducts, on a regular basis,
  activity within Russia, relating to
• use of subsoil and/or other natural resources
• carrying out construction, installation,
  maintenance and exploitation of equipment
• sale of goods from warehouses located in Russia
  and owned or leased by the foreign company
• rendering services in Russia, and certain other
  activity.

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How to Structure the Business or Deal(contd)

• Under Russian tax law, a separate division is any
  division, territorially separated from the head
  office, with stationary work places. The
  authority or competence of this division, or the
  mention of or silence on such division in the
  foundation documents of the foreign company, is
  irrelevant for tax purposes. Work places are
  deemed stationary when they are created for a
  period of more than one month.
• The activity of other persons (natural persons or
  legal entities), acting in the name and on behalf
  of the foreign company, authorized to enter into
  agreements in the name of the foreign company or
  negotiate the substantive provisions of such
  agreements, where those persons exercise that
  authority on a regular basis, may be grounds for
  permanent tax establishment.

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How to Structure the Business or Deal(contd)

• No permanent establishment. Examples include
• A foreign company involved in importing goods
  into Russia would not in itself be grounds for a
  permanent establishment. However, a permanent
  establishment would nevertheless be found if the
  activity has any features of the "catch-all"
  definition above.
• Pure secondment agreements, which do not provide
  for any other services except for the secondment
  services (and with some other conditions), are
  not grounds for permanent tax establishment.

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How to Structure the Business or Deal(contd)

• Leasing
• Equipment can also be supplied to Russian oil
  and gas projects via a cross-border
  (international) lease or a domestic lease.
• An international lease would be covered by the
  UNIDROIT Convention.
• Domestic leasing under the Russian Law on
  Leasing.
• International leasing is not widespread, largely
  because of enforcement/repossession issues.
• Domestic leasing is now simpler and more
  flexible, and most important for the lessor it
  expressly permits the seizure of leased assets.
• Domestic leasing provides certain tax benefits,
  but it is still subject to VAT.

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B. How to Operate Legally

• Counterparty to the Contract
• Even if a company other than the licensee in an
  oilfield is financing operations, the contractor
  will often need to enter into the service/supply
  contract with the licensee, due to the licensees
  rights to the development site. Also, the terms
  of the license may establish special rules on
  using contractors for the licensee.

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B. How to Operate Legally (contd)

• Licensing Issues
• Licensing Requirements for Service and
  Engineering Companies
• Russian law imposes licensing requirements for a
  variety of activities relating to oilfield
  services.
• The Law "On Underground Resources" (the
  "Underground Resources Law"), imposes licensing
  requirements for certain types of activity,
  including
• regional geological studies, including regional
  geological and geophysical work
• geological surveys and site surveys
• geological studies, including exploration and
  estimates of mineral deposits
• construction and operation of underground
  facilities other than for the extraction of
  mineral resources.

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B. How to Operate Legally (contd)

• Also, Article 24 of the Underground Resources
  Law provides that all work involving dangerous
  conditions in the course of using underground
  resources must be carried out on the basis of a
  separate license for the particular dangerous
  activity.
• The Law "On Licensing of Certain Types of
  Activities" mandates a license for a variety of
  other activities including
• mine surveys
• geodesic (land-surveying) activity
• map-making
• the use oil and gas production equipment,
  including servicing of oil and gas drilling
  holes
• the use of flammable, hazardous or explosive
  industrial equipment and the use or storage of
  explosive industrial materials.

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B. How to Operate Legally (contd)

• Status of Geological Information
• Under Russian law, geological information is
  accorded a special status.
• Underground Resources Law
• Article 27 of the Underground Resources Law
  mandates that information on the geological
  structure of a subsurface deposit, its reserves,
  its development conditions, as well as other
  characteristics of the deposit included in
  geological reports and other materials may only
  be owned either by the state or by the licensed
  user of underground resources.
• Geological information is presumed to be owned
  by the state. However, if geological and other
  information on the deposit was obtained by the
  licensed user of underground resources and paid
  for with the licensed user's own funds, it is
  treated as the property of the licensed user.

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B. How to Operate Legally (contd)

• Such information must be reported to the
  appropriate government agencies, including the
  federal and territorial geological information
  funds. Commercial and other use of such
  information must be coordinated with the
  appropriate governmental agencies.
• Law on State Secrets
• Under the RF Law "On State Secrets", certain
  geological information is considered a state
  secret and is subject to a confidentiality
  regime.
• Additionally, according to Article 8 of the
  Russian Law "On Participation in International
  Informational Exchanges", the export of
  confidential information is allowed only in cases
  expressly provided by the Russia Government. The
  owner of such confidential information (e.g., the
  operator) or its users (e.g., the shareholders of
  the operator) may have access to the documents
  containing geological confidential information
  only within Russia.

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B. How to Operate Legally (contd)

• PSA Law
• Under the Law On Production Sharing Agreements
  (the PSA Law), there are similar provisions on
  confidentiality. The PSA Law designates all raw
  geological, geophysical, geochemical and other
  data, data on its interpretation and derived data
  as well as rock samples, including core and
  reservoir fluids obtained by the investor as a
  result of PSA operations as State property.

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B. How to Operate Legally (contd)

• An investor has the right to freely and
  gratuitously use the information, data, and
  samples for the purposes of operations under the
  PSA, but subject to the confidentiality
  provisions of the PSA. The procedure for the use
  of such information, data and samples as well as
  the procedure for the export of such information,
  etc., outside Russia is spelled out in the PSA,
  in accordance with Russian law.
• Also, the underground resources license itself
  may limit the ability to use geological
  information.

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B. How to Operate Legally (contd)

• Oilfield Activities License
• Any services related to the operation of
  hydrocarbon production facilities require a
  special license Oilfield Activities License
  which is issued by Gosgortechnadzor.
• Gosgortechnadzor issues Oilfield Activities
  Licenses for a term of 5 years, and they are
  generally renewable.
• Gosgortechnadzor must issue a license within 60
  days of receiving a complete and accurate
  application with all supporting documentation.

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B. How to Operate Legally (contd)

• Other Licenses and Permits
• Depending on the Services provided, other
  licenses and permits may be needed
• Licenses for exploitation of hazardous objects
  (pipelines, refining equipment, etc.)
• Licenses for the exploitation of oil gas
  production facilities
• Licenses for processing, storage and
  transportation through trunk pipelines of oil,
  gas and related products
• Approval of design and feasibility studies, pilot
  projects and development plans. Approvals for
  construction of any facilities on site

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B. How to Operate Legally (contd)

• Licensing Rules and Related Issues
• Liability for Failure to Comply with Licensing
  Requirements
• Fines and restrictions may be imposed and/or
  licenses may be suspended, amended, or terminated
  if a licensee fails to
• Comply with license requirements (such as
  stipulated levels of oil gas extraction in the
  case of production licenses). Oilfield
  Activities Licenses can also be suspended or
  terminated for non-compliance.

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B. How to Operate Legally (contd)

• Make timely payments of levies and taxes for
  subsoil use
• Provide geological information to the relevant
  agencies
• Meet other reporting requirements

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B. How to Operate Legally (contd)

• Environmental, and health and safety issues
• Environmental impact assessment must be made
  prior to implementation of a project related to
  the use of natural resources this is generally
  the Operators responsibility.
• Obtaining operational licenses and permits
  usually authorize the discharge of pollutants
  into the air, water and soil under a
  "pay-to-pollute" regime. If such discharge
  exceeds permissible levels, the company is
  subject to fines calculated as a multiple of the
  original "fee" set for the discharge of
  pollutants

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B. How to Operate Legally (contd)

• Russian environmental legislation consists of
  numerous federal and regional regulations which
  quite often contradict one another and cannot be
  consistently interpreted. As a result, full
  environmental compliance may not always be
  ensured
• Nothing like CERCLA or Superfund in Russia
• Often only small penalties applied
• It is a good idea to check for any existing court
  cases or documents concerning administrative
  proceedings. Contractors should pay special
  attention to the use of any hazardous substances
  (e.g., asbestos)

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B. How to Operate Legally (contd)

• Work Permits
• Who needs to obtain a work permit?
• All foreign citizens who satisfy the following
  criteria
• are employed in Russia, or
• have contractual obligations to perform work in
  Russia, or
• are seconded to perform work in Russia.
• Who does not need a work permit?
• In particular, the following individuals
• permanent or a temporary resident of Russia, or
• employees of foreign companies (producers or
  suppliers) installing or servicing technical
  equipment imported into Russia.

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B. How to Operate Legally (contd)

• What is the procedure for obtaining work permits?
• The following procedure is set forth by the
  Russian Law "On the Legal Status of Foreign
  Citizens in the Russian Federation"
• an employer must obtain approval from the local
  State Employment Service Office,
• an employer must obtain the recruitment permit
  applicable to all foreign citizens to be employed
  in Russia, issued by the local department of the
  Ministry of Internal Affairs,
• an employer must obtain an entry invitation for
  each foreign citizen, issued by the local
  department of the Ministry of Internal Affairs,

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B. How to Operate Legally (contd)

• an employer must obtain a work permit for each
  foreign citizen, issued by the local department
  of the Ministry of Internal Affairs, the whole
  procedure usually takes 6-12 weeks,
• the total State duty to be paid
• 3,000 Rubles (approximately US 94.50) for the
  recruitment permit,
• 200 Rubles (approximately US 6.50) for each
  entry invitation, and
• 1,000 Rubles (approximately US 31.50) for each
  work permit.
• costs for services of third parties to facilitate
  the process generally vary from US 1,500 to US
  2,000.

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B. How to Operate Legally (contd)

• Practical Note "Unofficial Guidelines"
• A non-resident who spends more than 30 days in
  total within a period of one year in Russia on
  business trips must obtain a work permit, if the
  relationship between a foreigner and a Russian
  legal entity could be qualified
  as employment-related or contractual (including
  secondment) in nature. 

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C. What to Do if Disputes Occur

• Courts versus Arbitration
• Russia is a signatory to the New York Convention
  on the Recognition and Enforcement of Foreign
  Arbitral Awards (1958), but not a signatory to
  the Hague Convention on the Recognition and
  Enforcement of Foreign Judgments in Civil and
  Commercial Matters (1971).
• Russia does have bilateral treaties on the
  enforcement of judicial decisions with a limited
  number of countries (mostly former socialist
  countries).
• As a result, a judgment from a foreign arbitral
  tribunal (UNCITRAL, LCIA in London, AAA in New
  York) can be enforced against a Russian party in
  Russia, but a Russian court is not required to
  enforce a decision of a foreign court against a
  Russian party in Russia.

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C. What to Do if Disputes Occur (contd)

• What about Russian courts? A foreign company
  doing business in Russia can certainly bring a
  lawsuit against a Russian party in a Russian
  court (unless a contract between the parties
  provides otherwise).
• Note the arbitrage (misnomer they are judicial)
  courts specialized to deal with commercial
  disputes.
• What about corruption in Russian courts? Of
  course it exists (indeed President Putin recently
  formed a new federal agency to deal with it), but
  it is incorrect to automatically assume it in
  every case.

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C. What to Do if Disputes Occur (contd)

• Chadbourne Parke has a litigation practice in
  Russia, and we have won many cases even where the
  other party may be suspected of corruption.
• If the corruption takes the form of a judicial
  error (as it often must for a clearly breaching
  party to win), these errors can be appealed and
  overruled in appeals or cassation courts.

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• Thank you!
• Shane R. DeBeer
• Chadbourne Parke LLP