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

1. 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

2. 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

3. 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;

4. How to Structure the Business or Deal(cont’d) • 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.

5. How to Structure the Business or Deal(cont’d) • 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.

6. How to Structure the Business or Deal(cont’d) • 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.

7. How to Structure the Business or Deal(cont’d) • 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.

8. How to Structure the Business or Deal(cont’d) No permanent establishment. Examples include • A foreign company involved in importinggoods 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.

9. How to Structure the Business or Deal(cont’d) • 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.

10. 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 licensee’s rights to the development site. Also, the terms of the license may establish special rules on using contractors for the licensee.

11. B. How to Operate Legally (cont’d) • 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.

12. B. How to Operate Legally (cont’d) 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.

13. B. How to Operate Legally (cont’d) • 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.

14. B. How to Operate Legally (cont’d) 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.

15. B. How to Operate Legally (cont’d) • 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.

16. B. How to Operate Legally (cont’d) • 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.

17. B. How to Operate Legally (cont’d) • 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.

18. B. How to Operate Legally (cont’d) • 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

19. B. How to Operate Legally (cont’d) • 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.

20. B. How to Operate Legally (cont’d) • Make timely payments of levies and taxes for subsoil use • Provide geological information to the relevant agencies • Meet other reporting requirements

21. B. How to Operate Legally (cont’d) • 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 Operator’s 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

22. B. How to Operate Legally (cont’d) • 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)

23. B. How to Operate Legally (cont’d) • 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.

24. B. How to Operate Legally (cont’d) • 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,

25. B. How to Operate Legally (cont’d) • 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.

26. B. How to Operate Legally (cont’d) 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. 

27. 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.

28. C. What to Do if Disputes Occur (cont’d) • 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.

29. C. What to Do if Disputes Occur (cont’d) • 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.

30. Thank you! Shane R. DeBeer Chadbourne & Parke LLP