Togliattiazot Case: Lawyers against Law
In September 2019, lawyers representing the majority owners of PJSC Togliattiazot held a round table on “Protecting the rights of entrepreneurs within corporate affairs framework” at the Russian Chamber of Commerce and Industry.
The entrepreneurs in question, whose rights were discussed at the event, are majority owners of Togliattiazot chemical plant Vladimir and Sergey Makhlai, as well as Swiss national Andreas Zivy, all of whom were investigated on the charges of large-scale embezzlement committed by an organized group (Part 4 of Article 159, Criminal Code of the Russian Federation). In July, in Togliatti a local District Court convicted them in absentia, ordered them to pay over 87 billion rubles ($1.4 billion) in restitution to minority shareholders, and gave them long prison sentences.
Judging by how the round table went, the so-called domestic “legal and scientific community” in Russia is allegedly very concerned about the verdict. These “community” were represented only by Irina Shitkina, a managing partner at Shitkina and Partners legal consulting firm; Yevgeny Gubin, head of the Business Law Department at the Lomonosov Moscow State University’s law school; Alexander Sergeyev, professor with the Civil Law and Processes Department at the St. Petersburg branch of the Higher School of Economics; and Alexander Gofstein, a partner at Padva and Partners legal firm and also Sergey Makhlai’s lawyer.
Law experts, invited to the round table by the lawyers representing Togliattiazot owners, discussed the more-than-500-volume criminal case that took five years to put together and 18 months to hear in court. “The experts most likely only skimmed the surface of the criminal case while they were preparing for the round table and based their conclusions primarily on the materials provided only by the defendants’ lawyers,” says Alexander Nizov, who represents JSC Uralchem’s legal interests. “That’s why what the experts said was dominated by vague emotional statements and theoretical arguments. It makes sense. But what did come as a surprise were the numerous misinterpretations of corporate, criminal and civil law, and occasional disrespectful comments aimed at law enforcement and the legal system voiced by professors working in prestigious state universities.”
Irina Shitkina, for instance, said that the part of the verdict concerning sustaining the civil claim supposedly violates the conceptual foundations of Russian corporate law. She believes that with this case, law enforcement and the justice system “used such surprising approaches that cannot but raise concerns among experts.”
She noted that the justice system didn’t shy away from “proving” shareholder control by citing emails and even US intelligence data, whereas shareholders voting in the same way on this or that issue was interpreted as “concerted action” that allows to define the shareholders as an “organized group.”
“So, if you, being a stakeholder, just came and voted, and so did someone else, it is regarded as concerted action and as a basis for recognizing you as an organized group. Even if you haven’t seen the other stakeholder, but you share the same views, you’re in one group that acts in a concerted manner,” Shitkina said. She also found it strange that the court ruled that since “foreign legal entities <...> are controlled by the defendants, they are [therefore] de-facto part of their property.”
“Apparently, this expert is not fully familiar with the materials of the criminal case, continues Nizov. - Therefore, I would like to explain some of the circumstances of the case, which she mentions. The shareholder control, and more specifically the interdependence and affiliation between “Togliattiazot” and the distributor of its products, the Swiss company Nitrochem Distribution AG, was proved by numerous testimonies and documents, only a part of which are e-mails. By the way, e-mails received in accordance with the procedural rules are relevant and admissible evidence in any court case”.
As for the “US intelligence data”, as Shitkina put it, it was the data provided by the US Internal Revenue Service (IRS) upon request from Russian government agencies. IRS confirmed that Togliattiazot’s deals with Nitrochem Distribution featured non-market prices. According to the IRS, Nitrochem Distribution sold Togliatti-produced ammonia to Mosaic Fertilizer LLC, Nitrogen Fertilizer L.P. and Transammonia Inc. at a price 20-38 percent higher than it bought it from PJSC Togliattiazot.
“In the mineral fertilizer and chemical industry, the normal trading margin fluctuates between 0.5 and 5.5 percent, with 3 percent being the average. See the difference? A margin as high as what we’ve seen in Togliattisazot’s case is a sign of deliberate tax evasion. It would be odd to assume that a US fiscal service would be helping some Russian raiders, wouldn’t it?” Nizov pointed out.
Moreover, there have been cases when the difference between the sale price offered by Togliattiazot and the resale price of the same product by Nitrochem to third parties was even higher. For example, the tax audit for deals dated 2009-2012 determined that a Turkish company called Yildiz Entegre Agac Sanaye Ve Tigaret A.S. bought 11,500 metric tons of ammonia from Nitrochem at FOB Yuzniy 282 US dollars per ton, while Nitrochem purchased the same batch on the same terms from Togliattiazot at 171 US dollars per ton. So over 64 percent of ammonia market value remained in the Swiss offshores, Nizov explained.
Now as for the “voting” issue Shitkina mentioned, majority shareholders didn’t simply cast the same votes on issues related to Togliattiazot’s operational activities. The voting at shareholder general meetings was definitely consolidated, concerted and uniform in nature. The convicted majority shareholders informed the voting parties of the desired outcome in a centralized fashion, which was proven by the emails and witness testimonies featured in the case file, Nizov pointed out.
In his opinion, this indicates collusion between majority shareholders, who controlled all aspects of Togliattiazot’s production processes, and commercial and financial activities. In addition, a 20-year contract on ammonia supply between Togliattiazot and Nitrochem is direct evidence of collusion with criminal intent. The court ruled that the long-term agreement in question was unconscionable and made Togliattiazot dependent on Nitrochem. Nizov believes that this agreement is basically formalized criminal collusion.
Finally, Shitkina stated that the settlement of Uralchem’s civil claim is a violation of conceptual foundations of Russian corporate law. In Nizov's opinion, it should be noted that the arguments regarding the absence of a shareholder's right to such a claim are groundless and based on an incorrect interpretation of the law.
The Russian Civil Code and laws concerning joint-stock companies stipulate that shareholders and companies have certain rights and obligations to each other - that is, a certain right of a shareholder is mirrored in a certain obligation of the company. The company’s property is jointly owned by shareholders. That’s the foundation of the corporate law.
According to the guilty verdict, through their actions the defendants inflicted damages on both minority shareholders, Uralchem among them, and Togliattiazot. The Russian Civil Code states that damages include both real losses and lost profits suffered by the party whose rights were violated.
Nizov underlined that the accused violated these rights systematically. According to the Federal Law “On Joint-Stock Companies”, board members and other governing bodies should act for the benefit of the company, exercise their rights and fulfill their obligations to the company, reasonably and in good faith.
In violation of this provision, the accused sought personal gain instead of acting in the interests of the company. Revenues from export sales through Nitrochem was distributed among final beneficiaries and weren’t used in the interests of the company, Nizov reminded.
Another reason for the civil suit was that in violation of the Federal Law “On Joint-Stock Companies” the defendants covered up their affiliation with PJSC Togliattiazot, using front offshore companies. As a result of this violation of the law, the company and shareholders suffered material damage.
Thus, Uralchem as a Togliattiazot shareholder was properly recognized as the victim, as uniform case-law confirms it should be in such legal cases, Nizov said.
“In the light of this, I would go as far as to say that it was the accused who violated the Russian corporate law - the very same people that Irina Shitkina was invited to defend at the round table,” he added. “The main thing determined during the investigation was that the committed embezzlement led to the company property shrinking, the share prices going down, and the emitent’s profit share that could’ve been distributed between the shareholders whom the accused were not controlling also shrank. Thus, the JSC Uralchem’s rights were violated.”
Another round table expert Yevgeny Gubin said that “our current system, unfortunately, doesn’t allow us to differentiate between the two and recognize that in some cases complicated civil suits can’t be heard in the course of one trial combining both criminal and civil aspects.”
Alexander Sergeyev addressed the same issue, saying that “[criminal] proceedings turn to an unfamiliar area - the civil law. In some cases baseless criminal conviction of entrepreneurs is the result of conflict between the provisions of the civil and criminal law, which is why issues related to protecting the property rights of the victims should be resolved within civil legal proceedings.”
However, Alexander Nizov did have some objections. “The current legislation (Article 44 of the Russian Criminal Procedure Code) makes it possible to demand a compensation of crime-inflicted damage directly within the framework of the criminal case under consideration. This regulation allows to protect the rights and legitimate interests of the aggrieved party, as civil proceedings alone do not always suffice to get the full picture of the damage and obtain compensation. As to the criminal case in question, the investigation provided enough evidence of the damage caused to both Togliattiazot and Uralchem.”
The verdict (concerning PJSC Togliattiazot), “among other things, also upheld the civil lawsuit for property damage compensation payable to TOAZ and the Uralchem shareholder,” according to Sergeyev. “The 265-page-long verdict, incidentally, has only a six-page-long extract dedicated to the lawsuit per se. Yet even these six pages mostly deal with the judge’s reasoning on procedural issues, in particular Uralchem’s right to sue. Only one paragraph covers the amount of the damages awarded, ruling in favour of the claim in question. One is at a loss to understand what the court was guided by in the first place.”
Nizov noted that “all the materials of the criminal case also constitute evidence in a civil lawsuit, so the court did not have to describe the entire evidence separately for the civil one.” “The amount of the damage, as well as the persons who caused it, were established in the criminal case. All the court had to do was to align the amount of damage to the claims in the lawsuit - which is what it did,” he said.
Another participant in the conference, Alexander Gofstein, who is also Sergey Makhlai’s lawyer in the fraud case, stated that there is a fake necessity in Russia to protect owners from their own property. “Often, as clearly proved by legal precedents in Moscow, there is a need to protect these ultimate beneficiaries and actual owners from allegations of having stolen the property actually belonging to them,” says Gofstein.
“I would like to remind Alexander Gofstein,” commented Nizov, “that he is making the same fundamental mistake, whether intentionally or not, as his client and other persons involved in the criminal case did. They habitually see themselves as the sovereign owners of Togliattiazot property. In that, they completely disregard the rights and interests of other shareholders of the enterprise beyond control of the majority stakeholders. With minority stakeholders wielding guaranteed rights to a partition of Togliattiazot’s property and its management, the beneficiaries and actual owners of ToAZ prove to have breached property rights of other shareholders by running the property in their own interests alone.
The court found that the majority shareholders were involved in misappropriation of the company’s products by seizing them from Togliattiazot and transferring them to the Nitrochem company and its shareholders allegedly on favorable terms, with a long-term agreement signed for the purchase and sale of ammonia and urea. At the same time, the amount of damage caused by the crime is determined not by the amount of money that failed to reach the ToAZ accounts, but rather by the actual value of stolen products, which was established by the investigation based on an economic and legal evaluation. ”
Nizov recalled that “all the money transferred by Nitrochem as payment for ammonia and urea was piling up on the Togliattiazot accounts in Togliattikhimbank, wholly owned by Sergey Makhlai, a convict. Instead of being used by the enterprise, it came straight into the hands of the culprits. In other words, the perpetrators controlled all the activities of ToAZ, from manufacture to management of funds obtained from their sale.”
More about damage
Addressing the gathering, Chairman of the Board of Directors of PJSC Togliattiazot Petr Ordzhonikidze denied the charge of any damage inflicted upon Togliattiazot by selling ToAZ products at deliberately lower prices and their further resale at market prices. In his opinion, the economic and legal evaluation carried out in support of this allegation does not hold up against any criticism, since the experts used the so-called spot prices. Meanwhile, according to Togliattiazot representatives, the prices of the enterprise are essentially contractual and are consequently significantly below spot prices.
“Togliattiazot mistakenly considers the export prices at which the company sold products to Nitrochem Distribution AG to be contractual. Annual (and extended) contracts between Togliattiazot and Nitrochem Distribution AG only indicate approximate quantities of products. Delivery dates, batch volumes and product prices were outlined in monthly supplementary agreements,” says Nizov.
Both spot and contract prices are determined according to the methodology used by Argus Media and the International Fertilizer Industry Association (IFA), which has been adopted in the industry. Product batches, being sold at spot prices, must further be shipped within 30-40 days from the date of the transaction without any delay in payment. Contract prices differ from spot prices. A contract price is a specific price set by the parties for the entire period of the contract and for the entire volume of goods supplied. That spot prices were used for Togliattiazot OJSC can be seen in contracts between PJSC Togliattiazot and Nitrochem Distribution AG.
According to clause 2.1 of each of these contracts, ammonia was to be supplied in equal batches from January till December. The exact delivery time was agreed by the parties separately. According to clause 5.1, the price of ammonia and urea was adjusted as necessary and eventually agreed by the parties on a monthly basis. The total value of the contract was determined only at the time of completion of all shipments (clause 5.2).
Under clause 6.1 of each of the contracts for the supply of ammonia and urea, Nitrochem Distribution AG paid for products through documentary credit, a typical form of payment for spot transactions. Rulings by arbitration courts on additional accrual of profit taxes for Togliattiazot for 2009-2013 also recognized the fact that it is spot prices that should be used for products made by the plant.
As a consequence, the pricing procedure and timeframe for Nitrochem Distribution AG, principles used to form batches of goods, as well as the method of payment for the products make it possible to conclude that transactions between Togliattiazot and Nitrochem Distribution AG are fully in compliance with spot transactions. The court therefore recognized the absence of grounds to apply for discounts on the scope of the batches, explained Nizov.
According to Nizov, claims by the defense and representatives of Togliattiazot PJSC that there was no misappropriation are not in line with the hard facts.
“One cannot take into account arguments that arbitration courts recognized the transactions between ToAZ OJSC and Nitrochem company as non-gratuitous, with Nitrochem having paid for the ammonia and urea in full and ToAZ having received a full refund for the products. The courts proceeded from a formal assessment of the relationship between PJSC Togliattiazot and Nitrochem, without properly looking at who was managing the funds transferred to the accounts of Togliattiazot and in what way. The amount of damage caused by the crime is not based on the amount of money transferred to the accounts of ToAZ, but on the actual value of the stolen products. The latter was established by the investigating authority following an economic and legal evaluation.
All the funds transferred by Nitrochem for ammonia and urea went straight to the Togliattiazot accounts at Togliattikhimbank. In reality, however, the funds were completely taken over by the criminals, since the bank belongs to one of them, Sergey Makhlai. In other words, the perpetrators were controlling all the activities of Togliattiazot, from manufacture to sale. The criminals used the funds for various purposes, including remuneration to the board of directors under the sway of Sergey Makhlai and Vladimir Makhlai, i.a. Yevgeny Korolev; payment of dividends to shareholders - de facto to themselves; fees paid to law firms that ensured the legality of corporate procedures in Togliattiazot PJSC, TOAZ Corporation CJSC and other legal entities controlled by the culprits; payment for Korolev’s stay in London under the guise of a business trip while he was trying to hide from law enforcement; granting loans to Togliattiazot and OJSC Transammiak; and depositing the proceeds from the sale of ammonia and urea abroad in JSCB Togliattikhimbank for additional income. All these costs were associated with the personal needs of the defendants rather than the interests of Togliattiazot as such. In fact, TOAZ failed to obtain any profit from the sale of its products to Nitrochem, since all that money was controlled by the criminals, not Togliattiazot,” said Nizov.
Holding a round table discussion on a case under consideration is a rather questionable idea, observes RAPSI (Russian Legal Information Agency) lawyer Konstantin Ganderov. “In my opinion, this is unethical and even unprofessional, since the opinions of the members of the legal community voiced on it may well be used to exert pressure on the court. It is one thing when such events focus on general theoretical issues of laws and regulations, as often happens internationally, or study cases that have already been closed. This is the only way for such a discussion to facilitate legal research and raise awareness. And it’s a completely different thing when experts with a rather superficial understanding of the matter offer risky interpretations of a case still under consideration,” he said.
The only real reason for organizing a roundtable discussion on the issue may be, according to the lawyer, "the intention of one of the parties to the conflict to achieve the desired solution by all means, even if this costs respectable legal experts their reputations."
On July 5, the Komsomolsky District Court of Togliatti sentenced Vladimir Makhlai, ex-President of Togliattiazot PJSC, his son Sergey, and Andreas Zivy, owner of the Swiss company Ameropa AG, to 9 years in penal colony each. Former Togliattiazot CEO Yevgeny Korolev and CEO of the Swiss company Nitrochem Distribution AG Beat Ruprecht were sentenced to 8.5 years in prison each. The court of first instance also ruled in favor of minority shareholder Uralchem and PJSC Togliattiazot, awarding them 10.3 billion rubles ($161 million) and 77.3 billion rubles respectively. A process to consider an appeal against the sentence filed by the defendants’ lawyers started on October 8, 2018.