Russian Exposure: Guidance for Tech Companies

This guidance does not constitute legal advice. To the extent that you have any questions arising out of the guidance, please speak to a member of the Orrick team who will be happy to assist.

The invasion of Ukraine by Russia has had a profound impact across the globe. One of the results of the invasion has been the swift and severe imposition of sanctions by various nations on Russian individuals and entities, in particular those with close ties to the Russian state. The Russian government has also established special procedures for shares in non-Russian companies held by Russian residents.

Many technology companies have some level of exposure to Russia – whether as a result of receiving investment which is connected with Russia (e.g., by venture capital funds backed or affiliated with Russian linked general or limited partners^[1]), having counterparties (including Russian banks)^[2] established in Russia (or which are owned by Russian interests) or because they have Russian employees and/or option holders. Exposure to Russia can also be in the form of businesses with operations in Russia or which export to Russia. Accordingly, the imposition of sanctions is causing VC-backed companies both legal and practical headaches. With the sanctions against Russia unlikely to be removed anytime soon – the following is a guide for VC-backed companies to help navigate the sanctions imposed in the U.S., UK and EU.

The sanctions regimes impose significant consequences if they are breached. Therefore, it is important to understand such regimes even in high-level terms. This guidance focuses on:

• what you should do if your company has received equity or debt investment and/or other financing linked to or from Russia ("Russian Investment" or "Russian Investor") or relies on funds flowing through Russia or a Russian bank;
• what to do if your company is doing business with Russian counterparties;
• what to do in relation to Russian employees and/or option holders; and/or
• what to do if your company has operations in Russia

What should you do if your company has received Russian Investment?

If your company has already received Russian Investment, the funds are already within your company.^[3] Whilst the exact approach which should be taken by your company will differ depending on the specific facts and relevant jurisdiction in which you are located, below are some suggestions about how to approach such a scenario.

Will a sanctions regime apply?

The scope of application for the UK, EU and U.S. sanctions regimes is set out below. If your company is incorporated in:

• England and Wales, Scotland or Northern Ireland, then the UK sanctions regime will apply;
• an EU member state or doing business within the EU, then the EU sanctions regime will apply to you; and
• the United States, then the U.S. sanctions regime will apply to you.

Sanctions requirements can also apply due to a role by a third party who is a citizen or resident of one of these jurisdictions or that is incorporated in one of these jurisdictions. For example, engagement by a U.S. bank can result in the investment implicating U.S. sanctions.

What prohibitions may apply?

If your company has Russian Investment, then:

1. Is your Russian Investor a Designated Person, a Sanctioned Entity or a Designated Blocked Person (see BOX #B)?

   1. If yes, then the Russian Investor will be subject to (amongst other restrictions) the prohibition on making funds or economic resources available, and the asset freeze or, in the U.S., similarly broad “blocking” of their property and interests. Therefore, their ownership of shares in your company will be frozen and dividends / return of capital etc. will be forbidden or, in the U.S., may have to be placed in a blocked interest-bearing account. In addition, a U.S. company would need to file reports of blocked property with the U.S. government.
   2. If no, and (i) there is no attempt to circumvent the sanctions restrictions and (ii) you have no reason to believe that any funds paid to your Russian Investor will be paid to Designated Persons, Sanctioned Entities or Designated Blocked Persons, it is permissible to deal with the Russian Investor both in the present and going forwards.^[4]

2. If your Russian Investor is a Designated Person, a Sanctioned Entity or a Designated Blocked Person, then as noted above, their ownership of shares in your company will be frozen. The implications of this will include:

   1. The Russian Investor cannot deal with the shares in your company (including buying, selling or mortgaging such shares – note this may also impact drag and tag options, call and put options, as well as RoFR and RoFO clauses); and
   2. You cannot pay any amounts, such as dividends or loan repayments, owed to the Russian Investor. In the U.S., payments may have to be placed in a blocked interest-bearing account.
   3. If you are a U.S. company, you would also have to file reports of blocked property with the U.S. government.

3. If your Russian Investor is not a Designated Person, a Sanctioned Entity or a Designated Blocked Person, but is, under UK or EU sanctions, ultimately owned, held or controlled directly or indirectly by a Designated Person or a Sanctioned Entity (i.e., holding 50% or more of the shares, voting rights or right to appoint or remove a majority of the board of directors) or, under U.S. sanctions, 50%-or-more owned by one or more Designated Blocked Persons, then the restrictions set out in point 2 (above) will apply.

   1. In such a scenario, the Russian Investor (as a result of being ultimately owned, held or controlled by a Designated Person or Sanctioned Entity or 50%-or-more owned by a Designated Blocked Person) would have all its funds and assets subject to an asset freeze. A U.S. company would also need to file reports of blocked property with the U.S. government.

What practical steps should you take?

In the event that your Russian Investor is a Designated Person, a Sanctioned Entity or a Designated Blocked Person (or deemed to be such due to its ultimate ownership), then your company should consider the following steps:

• Do not pay any amounts, such as dividends, owed to such person. Such payments would be a breach of the sanctions regimes – by providing economic resources to a sanctioned entity.
• Do not allow such investor to deal with the shares they hold in your company. Again, such an action would be a breach of the sanctions regimes – by dealing with frozen assets and providing economic resources to a sanctioned entity.
• A U.S. company would need to file reports of blocked property with the U.S. government.
• Write to the Russian Investor to explain your company’s position.
• If you are unsure of the ultimate ownership of your Russian Investor, you may wish to write to them to confirm the ultimate owner / controller, so as to confirm whether your Russian Investor is deemed to be sanctioned.

Looking forwards, when dealing with Russian Investors in the future, to the extent this is not already in place, you will likely wish to conduct enhanced “Know Your Client” checks, including confirming the ultimate ownership.

What should you do if your company is doing business with Russian entities?

If your company is already doing business with Russian entities – or a U.S., UK or EU entity which is owned or controlled by a Russian entity – the contracts between your company and the Russian entities are already in place.^[5] Whilst the exact approach which should be taken by your company will differ depending on the specific facts and relevant jurisdiction in which you are located, below are some suggestions about how to approach such a scenario.

Will a sanctions regime apply?

As above, to the extent that there is a jurisdictional link to either the U.S., UK or EU, then the relevant sanctions regime shall apply.

What prohibitions may apply?

If your company is doing business with Russian entities:

1. Is your Russian counterparty a Designated Person, a Sanctioned Entity or a Designated Blocked Person?

   1. If yes, then they will be subject to (amongst other restrictions) the prohibition on making funds or economic resources available, and the asset freeze or, in the U.S., similarly broad “blocking” of their property and interests. Therefore, the Russian counterparty will not be permitted to provide you with goods/services as such products will be frozen. Equally, you will not be permitted to make payment for such goods/services. In addition, in the U.S., you may be subject to requirements to file reports of blocked property with the U.S. government.
   2. If no, then so long as (i) there is no attempt to circumvent the sanctions restrictions and (ii) you have no reason to believe that any funds paid to your Russian counterparty will be paid to Designated Persons, Sanctioned Entities or Designated Blocked Persons, it is permissible to deal with the Russian counterparty both in the present and going forwards.

2. If your Russian counterparty is a Designated Person, a Sanctioned Entity or a Designated Blocked Person, then their assets and economic resources will be frozen. The implications of this will include:

   1. The Russian counterparty cannot provide you with goods/services. Such an action would be a breach of the sanctions regimes – by receiving such goods/services, you would be receiving frozen assets of a sanctioned entity/individual. It would also be a breach in that it would create an obligation to pay a sanctioned entity/individual.
   2. You cannot pay any amounts owed to the Russian counterparty. Such payments would be a breach of the sanctions regimes – by providing economic resources to a sanctioned entity/individual.
   3. In addition, in the U.S., you may be subject to requirements to file reports of blocked property with the U.S. government.

3. If your Russian counterparty is not a Designated Person, a Sanctioned Entity or a Designated Blocked Person, but is, under UK or EU rules, ultimately owned, held or controlled directly or indirectly (more than 50%) by a Designated Person or a Sanctioned Entity or, under U.S. rules, 50%-or-more owned directly or indirectly by one or more Designated Blocked Persons, then the restrictions set out in point 2 (above) will apply.

   1. In such a scenario, the Russian counterparty (as a result of being ultimately owned, held or controlled by a Designated Person or Sanctioned Entity) would have all its funds and assets subject to an asset freeze. Therefore, it will not be permitted to provide you with the goods/services for which you contracted.
   2. In return, you will not be permitted to make payment to the Russian counterparty, as a result of sanctions, as such payment would be rendered illegal. This in itself could raise legal issues with regard to breach of contract (for which we suggest you seek discrete legal advice).
   3. In addition, in the U.S., you may be subject to requirements to file reports of blocked property with the U.S. government.

What practical steps should you take?

In the event that your Russian counterparty is a Designated Person, a Sanctioned Entity or a Designated Blocked Person (or deemed to be such due to its ultimate ownership), then your company should consider the following steps:

• Do not pay any amounts owed to such counterparty. Such payments would be a breach of the sanctions regimes – by providing economic resources to a sanctioned entity/individual.
• In the U.S., you may be subject to requirements to file reports of blocked property with the U.S. government.
• Obtain legal advice to consider the contract in place with your Russian counterparty, and whether there are any clauses which permit termination of the contract on grounds of illegality, material adverse change or similar. If you are subject to U.S. requirements, you would likely also need to seek a license to terminate any such contract. You may also wish to write to your Russian counterparty once such analysis has taken place.
• If you are unsure of the ultimate ownership of your Russian Investor, you may wish to write to them to confirm the ultimate owner/controller, so as to confirm whether your Russian Investor is deemed to be sanctioned.

Looking forwards, when dealing with Russian Investors in the future, to the extent this is not already in place, you will likely wish to conduct enhanced “Know Your Client” checks, including confirming the ultimate ownership.

What should you do in relation to Russian employees and/or option holders?

The Russian president issued two decrees that impose certain restrictions on Russian residents, and which are relevant to companies with Russian employees and/or option holders.

Who is a “Russian resident”?

For purposes of the exchange control laws and regulations, a “Russian resident” covers any Russian national even if they are living outside of Russia and are not a tax resident in Russia. While these Decrees impose restrictions on Russian residents, they do not impose restrictions on the foreign companies for whom they work.

What do these two decrees prohibit?

These two decrees impose:

• A prohibition on Russian residents, among other things, receiving (i) proceeds from the sale of their shares or (ii) cash dividends into non-Russian bank accounts. Subsequently the Russian Government changed the legislation to make it permissible to receive cash dividends into non-Russian bank accounts.
• A prohibition on Russian residents, among other things, from entering into any transaction concerning the transfer of title to shares involving a resident of an unfriendly country, i.e., Russian residents cannot purchase or receive shares from companies of unfriendly countries.

It has since been clarified by the Russian Central Bank that the above-mentioned restrictions imposed from entering into any transaction concerning the transfer of title to shares involving a resident of an unfriendly country do not apply, as long as: (i) the shares are held by a foreign entity outside of Russia; (ii) the money used to acquire those shares was already in a foreign bank account; and (iii) such funds and accounts have been previously disclosed to the Russian tax authorities in accordance with Russian law.

The Russian Central Bank has also issued communications to Russian banks urging them to pay special attention to any transactions aiming to circumvent the restrictions imposed by the Decrees, including moving assets out of Russia.

What should a company with Russian employees and/or option holders do?

The above decrees impose restrictions on Russian residents, but do not impose restrictions on the foreign companies for whom they work. That said, it is strongly advisable to formally suspend any outstanding stock awards for Russian residents for the time being, at a minimum with those who are currently residing in Russia.

1. This would include the vesting of RSUs and vesting/exercise of stock options. This is the safest solution, as it should avoid putting your employees or contractors at risk of breaching these new orders upon the receipt of shares.
2. Alternatively, companies can consider cancelling outstanding stock awards and making a one-time bonus payment through local payroll. This would require a waiver of outstanding equity.

To the extent that you have Russian citizens that have permanently relocated to another country, while these restrictions apply to them, the likelihood of enforcement is low, particularly if they no longer have any ties to, or assets in, Russia. Therefore, while you do not have an obligation to determine who is a Russian resident and who is not for purposes of these rules, they should seek their own legal advice.

Similarly, the payment of employees based in Russia raises particular challenges, most directly in terms of ensuring that payment flows will work without passing through a restricted bank.  Consideration may have to be given to making payment offshore, or via a foreign bank with a presence in Russia.