The mere fact of successive Russian judicial reform drives has been misunderstood as evidence of the judiciary’s “un-reformability”. On the contrary, each campaign has left considerable positive residue: more definitional legislation, better pay and conditions for judges and staff as well as advances in transparency. The Medvedev administration convincingly promises to intensify the judicial reform efforts that are essential to Russia’s democratic and economic progress.
The most important point about this latest reform drive is its systematic approach to the root problems of judicial incompetence, corruption and vulnerability to external pressure. This matters for the investment climate more than positive outcomes to topical cases such as those involving Ingosstrakh and Vimpelcom. The present economic crisis is casting a fresh and powerful spotlight on the rule of law. Even more than usual, individual rulings and evidence of fundamental reform progress will be an important driver of capital flows as Russia negotiates the crisis.
Investment risks decrease as the rule of law improves. The development of an independent and competent judiciary is the single most important factor in strengthening the rule of law. For any emerging market, those two statements would be commonplace and perennially relevant. But there are three good reasons for considering the progress of judicial reform specifically in Russia and specifically against the background of the present financial and economic crisis.
The first reason is that such crises expose risks and weaknesses more clearly than in normal times. So the performance of the courts in present conditions will throw up solid evidence on the effectiveness of the various judicial reform measures introduced in recent years.
Second, the crisis is generating concrete tests that are highly relevant to the investment climate. The last financial market crash, in 1998, led to corporate governance abuses by cash-strapped oligarchs; but abused investors found scant remedy in the domestic courts. In one notorious ruling, NDF contracts were adjudged to be akin to a gambling bet, hence unenforceable. Will this new crisis reveal an improvement? The answer – or at least the perceived answer (which, as far as the investment climate is concerned, amounts to almost the same thing) – will largely hinge on the outcome of litigation already begun or likely to follow fresh corporate governance scandals. These include unauthorised and allegedly unfavourable cash purchases of unrelated assets from controlling shareholders (OGK-3 and Sibir Energy) and reneging on contractual share buy-back obligations (TGK-4). Meanwhile, some very significant litigation between oligarchs and foreign investors (Alfa-Telenor and Basic Element-PFF) dating back before the crisis is fast nearing the moment of truth.
Returns on Russian assets in 2009 – or, put another way, the question of whether Russian markets will be worth paying attention to next year – will be determined, above all, by the outcome of the currency crisis and other macro factors. But evidence from the courts on the state of the rule of law will also play a role in attracting (or repelling) all types of investment flow – especially portfolio equity investment and FDI – against the background of a widely perceived deterioration in the country risk pre-dating the escalation of the global financial crisis in September 2008.
The third reason for taking time to reconsider the Russian judiciary and court system at this moment is that improving the rule of law is the stated priority of Dmitry Medvedev’s presidency – together with the related challenge of fighting corruption. Medvedev has said that this is the agenda on which he would like to be judged at the end of his term (in 2012). By now, the new Medvedev administration has had time to lay out the details of its policy agenda in these priority areas, providing some basis for judging the quality and likely effectiveness of their plans.
Making that judgement requires setting the new plans in the perspective of what has gone before. After a decade and a half of foundational work on the Russian judicial system, enormous progress has been made in establishing a functioning, relatively accessible and relatively efficient court system.
The Yeltsin-era reforms took on the enormous task of creating a judicial branch of government out of the Party instrument of Soviet courts and personnel, with their perverse incentives and habits of mind. This challenge of basic institution building was undertaken against a backdrop of profound popular distrust and cynicism towards the court system, which pre-dates the Soviet period. The post-2000 reforms of Vladimir Putin involved finishing much of the incomplete work on foundational legislation as well as finally ensuring serious funding for the judiciary and court system. During Putin’s presidency, average judicial salaries went from being barely more than the national average wage to a multiple of 6.5 – that is, in present nominal terms, about Rb100,000 per month.
From an investment point of view, the commercial (or arbitrazh) courts have the greatest impact on risks (we focused on those courts in a research note published in January 2007). But a proper perspective requires seeing the development of the court system in the round. To this end we start with a summary of the “story so far”.
Some important milestones of judicial reform (in roughly chronological order):
These efforts amount to a serious achievement – one that is wrongly disparaged by those who toe the standard line that “there is no rule of law in Russia”. A November 2008 survey on Russia in The Economist asserted the non-existence of the rule of law with a simple reference to the Yukos affair without further elaboration or argument. That case is, indeed, unanswerable: no investor with the slightest familiarity with Russia will be unaware of this fundamental aspect of country risk. The risk boils down to the lack of judicial independence, which is owing to the corruptibility and/or manipulability of individual judges by powerful state or private interests.
At the heart of this problem is a dilemma that no reform to date has been able to solve. On the one hand, it makes sense to do everything possible to strengthen the (constitutionally-enshrined) independence of the judiciary. On the other hand, shielding the judicial corporation from outside interference leaves the rule of law vulnerable to the failings of the judges themselves – not only those inclined to solicit bribes but also the many more who are professionally incompetent. As an inward-looking corporation, the judiciary has a collective interest in concealing professional shortcomings. This problem appears to call for more administrative oversight and accountability – which, however, might once again undermine judicial independence.
The tension between independence and accountability was strongly in evidence during the Putin presidency. Part of the Putin administration’s wider campaign to re-centralise power and roll back state capture by oligarchs and regional barons took the form of a counter-attack against the commercialisation of the court system. The most typical form of this abuse is the suborning of judges by corporate raiders. As the Yeltsin-era Chief Prosecutor Yury Skuratov put it: “A significant portion of cases arises from requests of competitors, telephoned in and designed to knock someone out of a given market”.
The counter-attack was led by Viktor Ivanov, a senior Kremlin staffer from the so-called siloviki (or FSB) faction, who had overall responsibility for appointments. Besides the usual informal channels of influence, some direct leverage has always been available through what is, in effect, the Kremlin appointment of most senior judges (formally, they are nominated by the President and appointed by the Federation Council). In his first address to a body of judicial specialists in 2004, Ivanov flagged the government’s concern about the low level of public esteem for the judiciary. New rules were put in place to make judicial applicants ineligible for judge’s positions if they had ties to businesses, let alone criminal structures, or if their family members had private law practices.
So far, so reasonable. But in practice, this turned out to be a case of “out of the frying pan, into the fire”. For corporate raiders can just as easily be affiliated to the state – in particular, the police and security agencies – as to private sector mafias. In May 2008 the veil was lifted on this well-known but hitherto opaque reality by none other than the second-ranking judge in the SAC, Yelena Valyavina. The occasion was a libel suit pressed by one Valery Boyev (an Ivanov staffer) against a journalist who had broadcast his objections to Ivanov’s influence on legal practice. Called as a defence witness, Valyavina testified in court that Boyev had pressed her to deliver pre-ordained judgements with the threat that her “inadequate understanding of state interests” might prevent her from being reappointed at the end of her term. After Valyavina’s spectacular testimony, Boyev quietly dropped the case.
It is worth noting the substance of the litigation that those Kremlin staffers were trying to influence. It concerned Togliattiazot (Russia’s largest ammonia producer and a major fertiliser exporter). The well-connected raiders were supported by officials (obviously suborned) in the Federal Property Agency, which filed legal actions to reverse a 1996 privatisation and share swap, and in the Interior Ministry, which had brought charges of criminal tax evasion against the Togliattiazot CEO. These parallel attacks, which date back to 2004, succeeded in some lower courts before being repeatedly thrown out (most recently in November 2007) in the higher courts. The chronology is significant: those enlightened rulings came soon after the Yukos affair – in which the integrity of the courts was patently compromised by political pressure. The evidence of this case – in which corporate raiders, despite their strong links to the bureaucracy, were foiled in the higher arbitrazh courts – points to the uniqueness of the Yukos affair.
President Medvedev came to office in 2008 on a platform of fighting what he calls the historically entrenched “legal nihilism” that pervades state and society. He brings a strong ideological commitment to this issue thank to his legal background and new-generation modernising outlook (click here for our in-depth analysis of Medvedev). Until being raised to the presidency, Medvedev’s influence on judicial reform was for the most part exercised indirectly through the appointment and actions of his university classmate Anton Ivanov as head of the SAC (see above). Now Medvedev and his team have had a few months directly on the case, backed by all the power and influence of the presidency. In the informal division of labour between Medvedev and Putin that has emerged in this period, judicial reform – together with the wider anti-corruption agenda – has been allocated to Medvedev.
As might be expected, Medvedev has used every opportunity to speak publicly about problems such as “telephone justice” in blunt, news-making language and to advertise the seriousness of his intentions on judicial reform. Notable recent instances are his first annual state-of-the-nation address on 5 November and an important statement to the Seventh All-Russian Judges Convention on 2 December. The following quotes from the latter session capture the general flavour:
The quality of our judges and courts is a determining factor in the democratic development of our country ... On paper, the legal and material foundation exists to ensure judicial independence, so why is it that our judges, though de jure independent, often prove de facto to be far from independent?... New methods of putting pressure on judges are emerging. These days, there may be fewer phone calls to judges by or on behalf of officials suggesting or requesting certain decisions. Instead, information campaigns, sometimes in the guise of anti-corruption initiatives, in effect influence rulings without any phone calls being made or money changing hands.
Turning from words to deeds, initial actions have been organisational, led by the establishment of a working group on judicial reform chaired by Sergey Naryshkin, the Kremlin chief of staff. Judging from the amount of new legislation that has been drawn up judicial reform has taken second place to the anti-corruption agenda during the early phase of the Medvedev presidency. But the outlines of his substantive policies on the judiciary are already clear.
The single most important feature is a stress on organic solutions to the problem of balancing judicial independence with accountability. Instead of ad hoc administrative oversight – with all its potential for abuse – Medvedev aims to reform the system itself.
The headline measure concerns transparency. The above-mentioned initiative by Anton Ivanov to publish all arbitrazh court rulings on the internet will now be generalised to the entire court system and will open up to public scrutiny not only judicial decisions but also information about the career histories and appointment of judges. Above all, the basis for these new transparency rules would no longer be administrative orders within, say, the arbitrazh court system but rather a new federal law.
Medvedev is also pressing for a more systematic approach to quality control. He noted in his 2 December speech that a much higher proportion of judges are suspended for disciplinary reasons in Russia than in other countries, implying that the candidate screening process is inadequate. This points to a further increase in the number of members of the Qualifications Collegia who are not themselves judges (despite the failure of the Federation Council initiative – see above) and – something that Medvedev has explicitly called for – freshening up the judiciary by a broader search throughout all parts of the legal profession for candidates who might be suitable for appointment to the judiciary.
In the same vein, Medvedev is pressing for a single and distinct disciplinary body. This is clearly designed to limit the arbitrary power of individual court chairmen while submitting judges to a system of accountability at arm’s length from the state bureaucracy. Medvedev’s other proposals in this area include compensation for judicial error and negligence, abolishing the existing three-year probation period for newly appointed judges in exchange for easier procedures for disciplining negligent and corrupt judges and legislating to ensure consistency and rigour in judges’ qualification examinations (to include tests of ability to draft rulings).
Directly related to the subject of competence is what from an investment point of view may prove Medvedev’s most important new proposal. This is to broaden the exclusive competence, and hence the specialisation, of the arbitrazh courts from bankruptcy cases and litigation between companies to all litigation related to tax and customs duties, competition regulation, financial markets and investments. The general business climate would benefit from an increase in the number of judges versed in commercial and financial practicalities and technicalities. At the same time, this would address the most obvious weakness of the arbitrazh courts – alongside, of course, the general problem of corruption in the arbitrazh system driven by large sums at stake in much of the litigation.
The flipside of this planned deepening of arbitrazh court competence is the frozen status of long-discussed plans to create a new category of specialised “administrative” courts, which would deal with complaints against the government and regulatory bodies in areas such as taxation, sub-soil licensing, zoning, technology and patent law. The SAC, with apparent support from the legal team on the Kremlin staff, has lobbied against this proposal on grounds of duplication with the expanding competence of the arbitrazh courts. Medvedev has demanded that this turf battle be settled one way or another. As things stand now, the arbitrazh courts look like winning.
While pollsters find average Russians happy to criticise the court system, another, possibly more objective measure of public confidence is the increasing volume of litigation: 1.65 million cases were heard in 1990, rising to 3.04 million in 1996 and more than 7.5 million in 2006. As for efficiency, data for 2006 show that civil, criminal and commercial courts were meeting their target of settling cases within three months nearly 95 per cent of the time (with some regional variation).
In qualitative terms, decisions in run-of-the-mill cases are showing an open-minded rather than pro-government tendency. University of Toronto academic Peter Solomon, Jr. wrote in 2008 that “various courts, including military tribunals and arbitrazh courts, have satisfied citizen complaints against officials at well above the fifty per cent level. Even complaints against the legality of normative acts of ministries come out in favour of the complainant (and against the government) around 30 per cent of the time. Most of the complaints have involved social benefits or the conduct of police.”
The October 2008 installment of Ernst & Young’s annual study on tax cases found that among the companies (Russian and foreign) surveyed, the percentage of disputes going to court had dropped from 82 per cent in 2007 to 65 per cent in 2008. However, companies litigating against the tax authorities won 89 per cent of the time both in 2007 and 2008, while taxpayers nationwide win about 70 per of tax cases that go to court. The increasing proportion of disputes being settled out of court appears to reflect pressure from the Finance Ministry on the Federal Tax Service to refrain from unwinnable litigation, which ends up costing public money.
Even after courts have handed down their verdicts, enforcement of decisions is poor. Separate surveys carried out in 2008 for the Russian human rights ombudsman, Vladimir Lukin, and the UN Special Rapporteur Leander Despouy, concurred that enforcement remains a weak link in the judicial system. Medvedev has referred to data showing that one half of all rulings are not enforced. The most topical difficulty is enforcing judgements against delinquent retail borrowers. New draft amendments to the Law on the Bailiff Service are concentrated in this area.
As for international decisions, while Russia is a signatory to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, the enforcement of international arbitral awards still ultimately requires action from Russian courts and follow-up by bailiffs, who, as indicated above, have yet to become a consistently effective enforcer of court judgments generally.
We have already referred to two ongoing cases whose outcome will affect investor perceptions on the state of the rule of law. Each illustrates important risk factors connected with the Russian court system.
Ingosstrakh
The litigation between the Czech financial services group PFF and Oleg Deripaska’s Basic Element has been encouraging so far. The dispute originates in PFF’s 2007 acquisition of a 30 per cent stake in the major Russian insurance company Ingosstrakh from a third party in the absence of prior consultation with Deripaska, who controls the rest of the stock. Basic Element proceeded to call an EGM without informing PFF and thus had the necessary votes to authorise and issue to itself new shares, diluting PFF’s shareholding to around 2 per cent. The PFF side has since won two judgements (in April and September 2008) in Russian courts against Ingosstrakh and Basic Element. The next relevant court hearing is set for 18 December 2008.
This success (so far) of a foreign investor in the Russian courts against a powerful oligarch is noteworthy in itself. More important is the reason for that success. A key problem with Russian judges noticed by foreign litigants, especially those used to Anglo-Saxon common law jurisdictions, is the tendency to apply the letter of the law not only without regard to precedent (which, formally speaking, is unavoidable in a Roman law jurisdiction like Russia) but without even making an effort to probe into the litigants’ positions and to get to the heart of the matter. In the Ingosstrakh case, however, the relevant law – On Joint Stock Companies (in its comprehensively amended version of 2001) – is relatively watertight.
The provisions of the revised JSC Law violated by Basic Element include not only procedures for shareholder meetings and for approving new share issues but also the principle of automatic pro rata pre-emptive rights for existing shareholders in any new share issues. Given this lack of legal wiggle room, which similar corporate governance abusers (like Yukos and Sibneft) exploited to dilute minority shareholders in the 1990s, it is less surprising to see the courts handing down investor-friendly rulings.
Vimpelcom and Kievstar
The battle between Telenor and Alfa Group, the major shareholders of GSM operators Vimpelcom and Kievstar, dates back to 2004, when Telenor blocked Alfa’s initiative for Vimpelcom to acquire a Ukrainian operator competing with Telenor-controlled Kievstar. In 2008 a tiny BVI-based Vimpelcom shareholder, Farimex Products, sued Telenor for denying Vimpelcom business opportunities in Ukraine. Telenor’s vigorous PR campaign surrounding this litigation has highlighted the fact that the sole director of Farimex is one Dmitry Fridman – a cousin of the head of Alfa, Mikhail Fridman.
The case was heard in the arbitrazh court of Khanty-Mansiysk (western Siberia) on the grounds that Farimex’s complaint cited a range of companies besides the obvious main target (Telenor), including a small Alfa affiliate that has its registered office in Khanty-Mansiysk – but which has nothing to do with Vimpelcom. In August 2008, the judge awarded Farimex US$2.8 billion (of US$3.8 billion requested) in damages, after an irregular process that involved a suspiciously long delay in deliberations by the judge, who emerged from his chambers to deliver his ruling at the unconventional hour of 1.30 a.m.
The manipulations here are so obvious (not to mention typical) as to make this an important test case. Telenor has appealed the Khanty-Mansiysk ruling in the Eighth Arbitrazh Appellate Court in Omsk – meaning that the test also includes the quality of the separate arbitrazh appeals circuit mentioned above. Showing a realistic awareness of the judges’ preference for literal application of the letter of the law rather than getting to the heart of the matter, Telenor have based their appeal on procedural and technical points, such as Farimex being a holder of depositary receipts in Vimpelcom rather than actual shares. At the time of writing, the Omsk hearing has been postponed to 18 December.
Ekaterina Mishina, Deputy Director of the Institute for Legal Studies, expert at the INDEM foundation, former chief adviser to the Chairman of the Constitutional Court
The three main problems of the judiciary are:
Regarding the judicial reform working group set up by President Medvedev, I am not particularly optimistic. Working groups are unlikely to be able to solve the fundamental problem that a large number of judges can still be called homo sovieticus – essentially passive and guided by the Soviet notion that their job is just an extension of an omnipotent executive power. Mentality and practice have to change. The new generation has somehow to avoid falling under the spell of those old concepts, which is difficult insofar as teaching positions are often held by former judges who pass along misconceptions.
There are serious legislative gaps to be filled. A federal law is needed to establish administrative courts, although draft legislation was, in fact, submitted seven years ago. The Duma may be examining draft proposals, but we will count this as progress only when bills emerge as law.
As for problems in the workplace, the worst are crippling workloads and (related) delays in enforcing judicial decisions. On the other hand, the first of two rather positive points is the progress made in publicising court rulings on the internet. This reform has been implemented without any serious delays – a bright spot in judicial reform. The second positive trend is that while there is a shortage of judges, it is no longer the case that there is a shortage of qualified legal personnel, nor of court administrators who want to work for judges and aspire to the bench themselves.
As with so much fundamental reform in the post-Soviet transition, any progress report on the judicial system is likely to conclude that this is a case of the cup being half-empty and half-full. There are strong arguments for emphasizing both the “emptiness” and the “fullness”, and this is a debate that is almost the same as it would have been several years ago – or, indeed, as what it is likely to be during the next decade.
The best way to take this analysis beyond such unremarkable conclusions and into more interesting territory is to ask the following three questions.
First: Does the ruling establishment really understand the importance of an independent and competent judiciary? The answer, not least given Putin’s decision to hand the presidency to a leading young lawyer with experience in private legal practice, is “yes”.
This leads to the second question: Even if the authorities “get it” in principle, is there not an element of humbug here? To dissipate the risk perception created by the Yukos affair, many years will need to pass in which top officials refrain from compromising the integrity of the courts. The possibility of a relapse can never be ruled out, even under a champion of legal reform like Medvedev. Time is the only cure.
The final question focuses on the inherent limits of even the most enlightened and determined reform. Are some of the problems simply too intractable? As our trusted source argues, no reform can substitute for generational change. At the same time, she highlights the real importance and benefits of some recent developments – especially as regards transparency of judicial decisions. Moreover, the key problems she highlights – on the quality of the human resources in the court system and on judicial independence – are exactly the ones that the Medvedev programme is addressing.
Here lies the heart of the matter. The only reforms worthy of the name are those that address the system itself. Of course, investor-friendly court rulings will always provide a welcome boost to sentiment. The year 2008 has brought a string of nice surprises, such as the SAC throwing out, once and for all, a long-running attempt by officials to reverse the privatisation of Domodedovo airport. But in the mirror image of the situation left by the Yukos affair, years will be needed to dispel the suspicion that all such enlightened verdicts – including a positive outcome to the cases concerning Ingosstrakh and Vimpelcom – might be politically directed rather than true reflections of the rule of law.
The crucial feature of Medvedev’s approach is that it targets the foundations of the court system and the judiciary, as opposed to merely providing investor-friendly promptings in specific disputes. If the Yukos affair and other such scandals prevent the cup appearing full for the foreseeable future, the present reform drive – which builds on an often under-estimated foundation – is the way in which the cup can continue to be filled.
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