Is "due diligence" required for contracts with Russia?

22.06.2010 — Analysis

- Anna, there is the opinion that the Russian and Western approaches to entering into and execution of contracts are different. Do you agree with it?

- Yes, it is really so. We have different legal culture, which naturally has its impact. Unfortunately, in some cases transactions fall through, sometimes because a European entrepreneur does not understand the requirements put forward by the Russian colleague. 

- Just recently we have received a letter from a British businessman who is perplexed: in European practice, a written contract between the parties to a transaction in many cases is not required at all. In Russia, he is required to sign the contract...

- Yes, the Russian legislation specifies explicitly: transactions that are made between legal entities and with individuals must be executed as a written contract (Article 161 of the Civil Code of the Russian Federation). This applies directly to international (foreign economic) contracts made with foreign partners. Only in this case, the written contract, which sets forth the subject matter of the arrangements, rights, obligations and liability of the parties, is not only a legal guarantee, but also an "authorization" document for completing formalities related to the performance of a foreign economic contract. For example, the bank acting as an agent of currency control requires submission of a written contract to perform currency transactions, which include, in particular, cash settlements between the Russian (the resident) and foreign (the non-resident) parties. The foreign economic contract is also required for the customs clearance of the goods crossing the Russian border. 

- By the way, Russian corporate lawyers are sometimes especially concerned about a due diligence investigation of the other party to the contract requesting heaps of documents from it: the Articles of Association, extract from the register of legal entities, etc. Do they have the same practice in the West?

- In European countries such investigation is referred to as due diligence ("due circumspection"). It is generally performed for making a decision on acquisition of a new business. The similar investigation of the future contracting party is performed quite rarely. The reason for this is that contractual relationships in the West tend to be built on trust to the partner. It is assumed that the contracting party acts honestly, as it is known well that "reputation comes first". Nevertheless, when choosing a potential partner in business we would recommend such due diligence.

- That's OK, but how should a Western business person perform inspection of his or her Russian partner?

- Let me point out that the do-it-yourself inspection is unlikely to have the required effect. The reason for this is that the legislation in another country is different (sometimes quite substantially); it is important to know certain procedural aspects and to understand the practices. Due to this, we would recommend a foreign business person to entrust a law firm located in Russia with due diligence inspection of the Russian contracting party. Then the customer will be able to receive explicit answers to important questions: whether this company is legally incorporated; whether it goes through bankruptcy or liquidation; who its owners and managers are; how long this legal entity has been on the market, etc. You can't but agree that such information can be essential for making a decision whether it is feasible to enter into a million-euro contract with the subject entrepreneur. 

- Another quite important nuance - who must sign a contract? Is inspection of this person is required in terms of his or her authority to act as a signatory?

- The foreign practice shows that contracts are often signed by top-managers rather than by the CEO of the company. In Russia typically the signatory is the director (president, general director) of the company. Foreign business people should give serious consideration if the contract is signed by another person acting, for instance, by virtue of the power of attorney. We would advise that this person should be checked for his authority to enter into this transaction. If the required authority is not given, the transaction will not have any legal implications to the Russian company; however, the foreign contracting party may incur sizeable losses. 

Furthermore, it is advisable to check whether the company's executive does not overstep his or her authority when entering into the subject contract. The fact is that owners may often restrict the right of the company's directors, not allowing them to enter into major or individual types of transactions. It is highly important to have such information prior to making a decision. 

- Is the corporate seal a mandatory or optional attribute of the foreign economic contract?

- In Russia, the seal on a contract (if a legal entity is the party) is established practice, rather than a legal requirement. In other words, in Russia it is common practice to secure the signature in the contract with the seal, thus, giving a feeling of certain assurance to the contracting party. On the other hand, many western companies do not put the seal in their contracts; some of the companies even do not have it. Furthermore, the experience of Hedman Partners Attorneys-at-Law shows that Russian supervisory agencies understand the cases when the contract is not stamped by the foreign contracting party. 

- What is the usual procedure for discussion of terms and conditions of a foreign economic contract and is this discussion required?

- From the perspective of western lawyers, their Russian colleagues work in an odd manner: they agonize over each or every other provision of the contract, offering their version; prepare long memorandums of disagreements and agreements, etc. Here is advice to a Russian business person: such way of doing business can scare away a foreign partner! There is one recommendation: too much water drowned the miller. Any provision of the contract is worth discussing if it is impossible, violates materially the rights of the party to the contract, is required by the Russian practice, etc.

- Anna, taking into consideration that the Customer (Buyer) and the Contractor (Seller) are located in different countries, we are talking, first of all, about the exchange of signed and scanned copies of the contract. Is it a problem that the Russian party does not have the original document and how serious is it?

- We strongly recommend doing a thorough job and receive the original document of the foreign economic contract signed by both parties. The copy is invalid as a document. It can become a "stumbling block" if a tax or any other audit is initiated; besides, accountants and auditors generally work only with original documents. If, God forbid, you decide to litigate with the foreign contracting party, there is no sense going to court without original documents. 

- Are electronic digital signatures allowed when signing a contract? What does the Russian legislation say in this respect?

- Undoubtedly, in the age of information technology, remote execution of contracts and signing of documents are becoming more and more popular with parties. In many cases, people do not have to see each other in order to enter into and finalize a transaction with the electronic digital signature. This practice is especially popular in transactions with securities and banking operations. The Russian legislation has a special regulation of relations in this respect in the form of the Law "On electronic digital signature". The signature is deemed equivalent to the handwritten signature provided that the key certificate is valid, the signature authenticity is confirmed and the signature conforms to the data indicated in the certificate. 

- Many European companies use the so-called engagement letters in transactions with their contracting parties. Do such letters have the binding force of a contract from the perspective of the Russian legislation?

- In our business, we often encounter the situations when entering into an international transaction, one of the parties signs and delivers the other party the documents that constitute, in fact, its unilateral declaration of intent - letters of commitment (to pay or to fulfill specific obligations), or the aforesaid engagement letters (the letter where one party acknowledges its obligation to the other party in terms of performing certain actions - the obligation to render services, to deliver goods, to be its representative, etc.). Such documents have the right of existence, but legally they are not contracts, because the contract must constitute the intention of two or more persons to perform specific actions. The problems related to such documents can arise both during the performance of a transaction and in attempting to compel the contracting party to perform its obligations through court action. Yet we recommend the "standard" contract signed by both parties and, if required, applying such letters to individual obligations. 

Fact Sheet:

Hedman Partners Attorneys-at-law - an international law firm founded in 1975. The head office is in Helsinki. The firm has its offices in Ekaterinburg, St. Petersburg and Tallinn; the partner companies of the Hedman Group are located in Riga and Vilnius.