Telenor v. Alfa: the Russian game

-- 20 April 2009 --
TEXT: J. Vermin
PHOTO: Kristina Shukurova -

The duties of directors are owed to shareholders collectively, not individually. That is one of the truths few would argue about; and that is the foundation of the Siberian court's decision against Telenor, a Norwegian telecommunications giant. Still, is it a sufficient ground for the decision in the light of Russian corporate law?

Alfa, one of the Russia's largest financial groups, and Telenor, a Norwegian state owned conglomerate, jointly own JSC VimpelCom (44% - Alfa, 29,9% - Telenor) and JSC KievStar GSM (43,5% - Alfa, 56,5% - Telenor), leading communications companies in Russia and Ukraine. This union, however, created much conflict and little cooperation. Russians keep winning in Russian and Ukrainian courts, but then lost an important battle in the US, first in arbitration and then in the state courts.

The Russian side of this war has reached a climax with the decision of the Eighth Appellate Arbitrazhniy Court in Omsk ordering Telenor to pay US$1.7 billion to its Russian subsidiary, VimpelCom. The Norwegians refused to pay, their shares in VimpelCom have been arrested by a bailiff and can be sold at any time.

According to the plaintiff, Farimex Products Inc, Telenor caused damages to VimpelCom by delaying VimpelCom's acquisition of a small Ukrainian mobile operator, Ukrainian Radio Systems (URS). The deal, first suggested in November 2004, was curbed by the Telenor's nominated directors, and could only take place twelve months later when it was approved by the general meeting of shareholders. Later, Telenor tried to oppose the deal in Russian courts but lost.

The court's decision, if supported by the Supreme Arbitrazhniy Court - and its opinion on the matter seems vital - can significantly change the way we see corporate law in Russia.


Derivative suits: everyone is welcome.

One of the interesting conclusions of the case is that any person, whatever obscure and remote his interest in a company, can initiate litigation on behalf of the company.

According to article 71(5) of the Federal Law 'On Joint Stock Companies' a suit against company directors can be brought by shareholders who own at least 1% of the shares of the company. The law, however, keeps silent about any restrictions on derivative actions against third parties including, as was the case, other shareholders. Here, Farimex Products Inc owning ADRs (American Depositary Receipts) for 0.002% of the VimpelCom's shares filed a claim on behalf of the company for US$3.8 billion.

If this is a good law, then Russia deviates from international practice, which tends to restrict derivative actions. A general consideration is that in a derivative action recovery goes to the company, not to the plaintiff. A person holding only a small number of shares has little financial incentive to sue because the return to that person will be, at most, a percentage of the recovery which reflects the percentage of the shares of the company that person holds. Thus, litigation nevertheless brought by such a person runs the risk of being motivated by other concerns than those of increasing the value of the company's business.

It also follows that a plaintiff does not necessary need to be a shareholder at all, as Farimex Products Inc, strictly speaking, did not own shares in VimpelCom. Should this curious trend in Russian law stay, holders of various derivative instruments would be able to initiate legal actions on behalf of the company and then, as is already happening, use the court's decision for their own benefit.


Court shopping.

Farimex Products Inc sued not only Telenor but other shareholders. The latter, they say, they were affiliated with Farimex and, if that is true, on these directions there were mock battles. This trick, however, let the plaintiff choose the battlefield, a court in Siberia, with a history of rulings against Western companies including British Petroleum, Deutsche Bank and TeliaSonera.


Shareholders are liable for wrongdoings of directors they nominated.

Russian law does not, generally speaking, recognise agency relationship between a company and its directors or employees.

On the other hand, according to article 6(3) of the Federal law 'On Joint Stock Companies' a shareholder can be liable for damages to the company whose shares he owns, if the shareholder, knowing that a decision would cause damage to the company, procured such a decision to the company's detriment.

It was found that VimpelCom's directors, nominated by Telenor, acted in its interests and not in the interests of VimpelCom, when they opposed the purchase of a telecommunication company in Ukraine. According to the plaintiff and agreed by the court, Telenor did not want VimpelCom to compete with KievStar GSM, where it was a major shareholder. Alfa, which also had a stake in KievStar, had to call a general meeting of shareholders to approve the deal.

The court, however, did not speak on the crucial point of the matter. Namely, what set of facts must be established by a court to conclude that a director acted in the interest of a third person; and where a legitimate difference of opinion ends, and wrongdoing begins?


What is damage?

Russian law prohibits punitive damages; a plaintiff must prove actual damage and lost profit.

Ironically, Ukrainian Radio Systems, the company acquired by VimpelCom - despite investments made by VimpelCom in excess of US$600 million - continues to make losses.

Essentially, the court assumed that if URS had been acquired in 2004, and not a year later, its market share would have been 12% against 4% today, and the company would have had extra 4 mln clients. Based on this assumption the court calculated the lost profit in amount USD$160 mln, and US$1,6 billion - 'lost capitalisation of JSC VimpelCom'.

The problem with this approach is threefold. Firstly, the court preferred 'would have been' to 'is', or a speculation to a fact. Secondly, capitalisation and profit, being the function of one another, cannot both be granted. Thirdly, they are attributed to different persons; 'lost capitalisation of JSC VimpelCom' does not represent the loss of the company, but of its shareholders.





And such cases are exactly why I advise my clients not to invest in in Russia at the moment. Any obscure court can on its own interpretation of the law decide over significant interests and there is very little what one can do about that. And it doesn't matter whether Farimex acts on behalf of Alfa or on behalf of the government as a tit-for-tat related to other issues between Norway and Russia. Telenor is just f*cked.
This can well be another Khodorkovsky case.