Evading Sanctions With Russian MK Companies
Sanctions work, but targets adapt. Sanctions adaptation moves at the speed of modern business, which is often fast given the billions of dollars or euros involved. The new Russian “International Companies”—denoted by the Russian acronym MK—are one such adaptation. They are an entirely new type of corporate entity—Russian lawfare against sanctions. They allow the Russian elite to enjoy benefits similar to those of offshore companies in Cyprus or Jersey or Panama—such as anonymity and easy access to foreign currency flows—but with a reduced risk from sanctions or other law-and-order meddling. They show a way forward for Russian sanctions evasion that current U.S. and European Union sanctions do not address, and they might already be a major means for the Kremlin-connected to avoid consequences and continue something close to business-as-usual, especially when it comes to banking.
Russian elites often store their wealth and property in offshore companies located in places with strong property rights and respected courts, usually under English or EU law. These offshore companies allow Russians to mask their wealth to avoid trouble from Western regulators or Russian predators. Until recently, the main place for Russia’s elite to store their offshore cash and their property, and to make contracts and do banking, was Cyprus. But Cyprus is in the EU and therefore is subject to EU regulators and sanctions. In April 2018, the U.S. Treasury moved decisively against Putin’s business interests and sanctioned six key oligarchs (including Putin’s son-in-law) and 12 companies they owned or controlled. The two most prominent oligarchs (and their respective companies) sanctioned were Viktor Vekselberg and his Renova Group management company, and Oleg Deripaska and his EN+/Rusal cluster of companies—the world’s second largest aluminum company. According to a statement from then-Under Secretary of the Treasury Sigal Mandelker, the April 2018 sanctions resulted in the freezing of Vekselberg’s assets and an estimated $3 billion reduction in his net worth. The sanctions also caused Deripaska’s cumulative wealth to be reduced by half. In May 2018, the Russian press reported that a delegation from the U.S. Treasury’s Office of Foreign Assets Control (OFAC) had recently visited Cyprus and demanded that the country’s banks “get rid” of Russian accounts.
The Russian legal counteroffensive came quickly: A package of new laws—quickly passed through the Russian Duma and then confirmed by the Federation Council in a lightning-fast 10 days—established the MKs as well as new “Russian offshore” zones to house them. There are three kinds of MK companies: the international company limited liability company (Russian acronym MKOOO), the international company joint stock company (MKAO), and the international company public joint stock company (MKPAO).
As their names suggest, by law every one of these companies must be “international.” In other words, they cannot be Russian companies registering in Russia—they must be “foreign” companies applying for special domiciliation. To receive MK status, companies must be based in one of two special economic zones in Kaliningrad or on Russky island (the Russian offshore zones) and pledge to invest at least 50 million rubles there (in U.S. currency, approximately $650,000). Once a company gets MK status and “redomiciles” to Russia, it receives some special tax breaks and also enjoys a few special advantages for Russian companies:
- Exemption from Russian currency controls.
- Internal corporate regulation can be governed under foreign laws based on where the company “came from.” (For example, a company that came from Cyprus or Jersey would be permitted to operate under English corporate law.)
- The company can apply to have its ownership be secret, so that only Russian courts and government agencies can get access to the identities and equity amounts of shareholders.
Above all, Russian law indicates that these companies are officially under Russian jurisdiction, which means foreign powers can’t seize them or exercise effective oversight. A Russian MK company can enjoy many of the benefits of residents in an offshore zone, including in corporate governance, anonymity, not having to respect Russian laws and regulations about currency transfers—all without the risk that Western officials will seize securities, or freeze accounts, among other threats. As one Russian lawyer put it:
The “tenacious claws” of foreign government agencies no longer have power over such a company, its activities are regulated by Russian law. At the same time, the charter of an international company may provide for the application of the rules of foreign law governing the relations of its participants, as well as the rules of foreign [currency] exchanges. It turns out that the company will be in Russia, its litigations will be considered in Russia, and the corporate rules for the relations of participants will remain the same as they were in the country of origin[.]
This is not to imply that everyone who registered an MK is engaged in sanctions evasion or otherwise up to no good. Putin has been campaigning to “deoffshore” the Russian economy for years, and we suspect that some Russian owners of offshore companies have shifted to MKs to avoid Kremlin punishment. Even so, MKs certainly enabled some rapid movement that looks an awful lot like sanctions evasion. For example, the laws that govern these new kinds of corporate entities went into force on Aug. 3, 2018. Not long after, on Aug. 17, the board of United Co. Rusal PLC approved a move to Russia, transforming into an MKPAO. Today, there are just under 150 of these MK companies, all of them originally foreign-registered companies (mostly from Cyprus) that “returned home” to Russia.
Since their creation, the MKOOO has been the most widely used form of MK company. At Exovera, we have been keeping tabs on the MKOOO companies since we started to come across them last year. By our count, there are currently a little over 100 in existence, with new ones appearing every now and again. MKOOOs include holdings from well-known Western sanctioned oligarchs such as Vekselberg and Deripaska and entities like Gazprom, as well as other prominent Russian businessmen, real estate interests, and agribusinesses. Many of these MKOOO companies are anonymous holding companies that don’t reveal their beneficial owners. There is, however, a curious pattern among those that do: Many of these MK companies are ultimately or partly owned by anonymous offshore companies still outside of Russia. Most of these are Cypriot, but there are also a few that have corporate owners from other places including Hong Kong, Kazakhstan, and Lichtenstein. Upon investigation of some of the MK companies, we discovered that the inverse is also true—some MKs own offshore companies. Rather than showing a trend of a pure redomiciliation of important parts of the Russian economy, the MKs allow Russian companies to act like the oligarchs that control many of them—to act with flexibility abroad and with impunity at home under the protection of the Kremlin. Like Russian oligarchs and officials, MKs are elite companies that must be foreign companies first. In other words, only Russians who already have the wealth, access, and freedom to establish offshore companies are eligible to receive the special privileges and tax breaks of MKs.
Deripaska and EN+/Rusal’s use of MKs is a case in point. There are approximately 30 MKAOs, six of which are reportedly associated with Oleg Deripaska. There are only four MKPAOs. One is the MKPAO for EN+, and another is MKPAO Rusal International, which was also redomiciled from Jersey to Kaliningrad in September 2020, just over a year after its parent company EN+ made the move. EN+/Rusal has also redomiciled three of its holding companies as MKOOOs: EN+ Holding, Gershvin, and Aktivium. Though EN+ redomiciled to Russia, it still has at least eight offshores in Cyprus, some of which officially control important parts of the Russian aluminum empire. For example, two of Rusal’s major assets in Sverdlovsk Oblast—a plant producing aluminum foil and a plant producing important silicon precursors for aluminum production—are both managed by a Moscow-based office but owned by the Cyprus company Rusal Silicon Limited. There is also an active Cyprus company named Rusal China Limited, which suggests that despite chatter about Russia’s shift to Asia, at least some of Rusal’s China business is conducted in Europe under English law. According to its 2021 annual report, Rusal also maintains a trading company in Jersey called RTI Limited and another trading company in the British Virgin Islands called Alumina & Bauxite Company Limited. It also has three companies based in Switzerland: RUSAL Marketing GmbH, Rusal Products Gmbh, and RS International GmbH.
EN+/Rusal’s rapid move to Russia took place during negotiations with the U.S. Treasury that resulted in a deal to drop sanctions against EN+/Rusal on the condition that Deripaska reduce his share in EN+ to below 50 percent and relinquish his control over the company. However, given that EN+ is now in Russian jurisdiction under the oversight of Russian regulators, with essential documents under the control of Russian leaders, is it possible to trust that Deripaska has actually distanced himself from controlling the company? Now, if there is a dispute about ownership, it will be tried in Russian courts rather than English or Cypriot courts—which are much more likely to enforce the conditions of the deal. At last resort, Deripaska’s ownership or control of EN+ could be established by some kind of government decree or “authentic” documents produced by a Russian court or government officials. Deripaska may have transformed several of his holding companies into Kaliningrad MKs, and he still makes use of Cyprus shell companies.
According to a recent Justice Department indictment, Deripaska allegedly recruited the retired senior FBI official Charles McGonigal to use his status, connections, and access to classified information to investigate a rival oligarch in exchange for payments. In August 2021, Deripaska used an unnamed Cyprus corporation to write a contract with a New Jersey firm owned by McGonigal’s friend for “business intelligence services” costing $41,790 a month. Though the contract was with a company based in Cyprus, the money to pay McGonigal’s friend was wired from a bank based in Russia. There is no indication in the indictment that this was facilitated through an MK. However, this relationship points to one possible use case for MKs as long as Russian banks are still connected to the global financial system: Since MKs can conduct transactions in foreign currency without the normal taxes and limitations, Deripaska and others like him can use an MK in cooperation with a Cyprus shell company to keep conducting business in the West. The contracts can be made in Cyprus; the hard currency can flow freely from Russia. If the shell company is identified and sanctioned, as long as not too much cash is held in its Cyprus bank, then it is no great loss—another offshore company can be quickly opened and start banking again with hard currency flowing freely from Russian banks.
The speed with which EN+ transformed into an MK and moved to Russia may have been an exceptionally fast move under pressure of further sanctions and the attention of regulators. But since then, laws governing the MKs have been changed to enable the extremely fast transformations. In March 2022, the Russian law on international companies was amended to include:
In connection with the unfriendly actions of foreign states and international organizations related to the introduction of restrictive measures against the Russian Federation, Russian legal entities and citizens of the Russian Federation, the Government of the Russian Federation in 2022 and 2023 may establish the specifics of implementation and (or) recognition as fulfilled, and also exempt foreign legal entities from the requirements regarding the submission documents during the state registration of an international company in the procedure of redomiciliation[.]
In other words, while the original legislation exhaustively specified the particular documents and requirements for becoming an MK, after March 2022 (and for the rest of 2023) the Russian government can simply declare that a company is in compliance and redomiciled. The new “simplified procedure” for becoming an MK does not require the company to produce a document on the state registration of a foreign legal entity, a copy of its charter, a copy of annual financial statements, and so on. This leaves open the possibility of rapid transformation in the face of impending sanctions or legal battles, or even simple ownership disputes. Thanks to the amended law, if there is a business dispute with a company with Russian assets or if Kremlin-connected owners of a foreign company are worried about possible sanctions, they can quickly redomicile to Russia. This creates a big challenge for regulators, banks, and other businesses performing Know Your Customer checks and due diligence, and for anyone investing in Russia or who could be potentially involved in a legal dispute with an entity that does business in Russia, because a foreign company could “teleport” to Russia at any time, or an MK company might be “legally” controlling Russian assets or accounts that have been, effectively, hijacked.
This may have already happened. Deripaska was recently sued unsuccessfully in a London court by a former business partner who claimed that by rapidly moving EN+ to Kaliningrad, Deripaska had violated a court order to keep some of the shares of EN+ he controlled indirectly in Jersey pending the resolution of a business dispute. According to the plaintiff—Russia’s former Deputy Finance Minister Vladimir Chernukhin—by transforming the company into an MK, Deripaska placed these shares beyond the “tenacious claws” of British law. Deripaska testified recently that he had nothing to do with the move, had not consulted anyone about it, and that transforming EN+ into an MK was an obvious move for the company to make in order to avoid bankruptcy.
There will be a huge political/legal risk to any foreign company trying to invest in Russia as long as MK companies exist. In 2007, a Russian “tax-fraud investigation raid” on Bill Browder’s asset management company Hermitage Capital made off with the corporate seals and stamps that were then used by criminals to re-register the company under new owners to ultimately receive a fraudulent $230 million tax refund. Using the amended MK law, a well-connected Russian could conceivably masquerade as the owner of any foreign company, have his application waved through, and then become the “legal owner” of any assets in Russia, disguised with the corporate identity of the “cloned” company. While this was likely not the purpose of the legislation, the MKs may have gutted the ability of any foreign company to invest in Russia with any kind of confidence. The fear here is not that the Russian government could nationalize assets, but that well-connected Russians could “legally” seize companies and assets via an MK.
Even companies that redomicile to Russia properly might be running the risk of default. Lenders or clients of non-Russian companies controlled by Russians may not have banked on the possibility that their customer, client, or debtor could suddenly become a Russian entity, but many contracts contain provisions that may define this kind of redomiciliation as a default. A 2018 blog post from Moscow-based lawyers working for the international law firm Debevoise & Plimpton pointed this out:
Particular attention should be paid to continuing contractual obligations that are governed by foreign law, since the applicability of the above provisions to such obligations may not be indisputable. Moreover, loans, options, joint venture agreements and other contracts entered into, for example, under English law may contain fairly broad language concerning events of default, material adverse change, reorganization or liquidation, the scope of which may also extend to re-domiciliation. Some agreements may even expressly restrict re-domiciliation or give rise to additional rights or obligations in the event of re-domiciliation, such as the right to sell or buy out shares.
The Russian legislation answered this charge directly when it was first formulated in 2018 in Article 4, Section 2:
The state registration of an international company is not: a. The basis for the emergence of obligations of a foreign legal entity and an international company for early fulfillment of obligations; b. a circumstance that worsens the financial position of a foreign legal entity and an international company; c. a significant change in the circumstances from which the relevant parties proceed when concluding a contract; d) grounds for payment of a penalty or losses, transfer of property to creditors or participants of a foreign legal entity, redemption of shares (stakes) from its shareholders (participants), occurrence of other obligations that may arise from a foreign legal entity as a result of its liquidation, reorganization, insolvency (bankruptcy)[.]
The legislation protests too much.
The utility of MKs to sanctions evasion does not stop with rapid redomiciling. The secrecy, the flexibility, and the Russian legal cover that MKs provide opens a potential route for Kremlin-connected companies to perform all kinds of creative end-runs around sanctions. A potential example of something happening with a Gazprom MK might be a case, though further information is necessary: Over a decade ago, the oil-producing Gazprom subsidiary Gazprom Neft set up the Dutch company Gazprom Neft Badra B.V. to develop the Badra oil field in Western Iraq. Gazprom Neft reportedly operates the Badra project and owns 30 percent of the project alongside state-owned energy companies from Iraq, Turkey, Korea, and Malaysia.
In March 2022, in the wake of the Russian invasion of Ukraine, the EU imposed a transaction ban on Gazprom Neft, which would presumably include Gazprom Neft’s Dutch subsidiary developing the Badra oil field. The Dutch entity Gazprom Neft Badra B.V. is still an active company, but in October 2022 Gazprom Neft moved a Russian power-transmission company it owns named GPN-Energo from Moscow to the special economic zone in Kaliningrad and changed its name to Badra Petroleum for 111 days. In late January, the name changed again: to Veleta. Not long before this second name change, on Jan. 18, 2023, an anonymously owned Kaliningrad-based MKOOO named Zvezda was renamed Badra Petroleum. Under normal circumstances, these curious shifts in naming might be chalked up to a clerical error, but given the sanctions imposed on the Russian energy sector, the ability of MKs to transact in foreign currency without barriers, and Gazprom’s reputation for skullduggery, one suspects this MK may also be a vehicle for sanctions evasion involving a major Iraqi oil project.
Given the timing of their creation, the content of the laws, and the kinds of entities involved in them, the MKs are evidently designed primarily to blunt the effects of Western sanctions and allow the Russian elite to still use the global financial system and do business in the West without risking legal trouble or their Russian assets or cash. As long as Russian financial institutions are still connected to the global system, the corrupt Russian elite will use MKs, or something like them, to be in the modern world, but not of it. Sanctions formulators should take note, particularly with regard to EN+ and Gazprom Neft.