Manufacturers Turn to Leasing

Many Western manufacturers are beginning to investigate the possibility of producing their goods in Russia. The reasons are varied, ranging from a consumer demand that may outstrip the ability to import to the effects of customs duties on a product's competitiveness.


Alternatives can include leasing part or all of an existing manufacturing facility or taking a 49-year lease on open land outside the city and building a plant. But whichever route a company follows, its managers will face a series of steps which could make or break the profitability of producing goods domestically.


With Russia's transition to a market economy, an increasing number of privatized factories and other enterprises are looking to supplement their income and make better use of excess space by leasing out premises for manufacturing. Often well-served by road and rail networks, such facilities pose an interesting option for Western manufacturers looking to produce their goods without constructing a new plant.


In conducting negotiations, however, prospective lessees should clarify certain issues at an early stage. As with all property ownership, rights should be confirmed ahead of time. It is also worth carrying out a review of the privatization plan for the lessor enterprise. Many have restrictions upon the disposition of assets and the use of property.


Western manufacturers of consumer products, such as the growing number of food and beverage companies, should cooperate closely with the local sanitary inspectorate. The Russian Government Standardization Documents, known as Gosstandard, give detailed requirements for the production standards of all types of consumer products.


In addition, the Guide to Important Official Materials on Sanitary and Anti-Epidemic Questions lays down requirements for production techniques. In granting a permission, the local sanitary inspectorate will look not only at the production process, but also at the other products being manufactured in a building or its vicinity.


Because the nearby production of incompatible products can cause permit problems, it is worthwhile early on to ask the local sanitary inspectorate to make an initial survey of the property to be leased. Such a survey can, at an early stage, reveal potentially insurmountable problems and highlight any corrective work that needs to be done.


A third area of concern, which is more difficult to investigate, involves the classified status of many enterprises. For example, those previously connected with the defense industry can be subject to unpublished regulations which, if invoked, could lead to restricted access.


If getting involved with leasing sounds too complicated, an alternative could be development of a greenfield site. The Moscow oblast and various local authorities in the region have encouraged Western manufacturers to invest in the construction of new factories based on 49-year leases. In some cases, these have included the option to buy outright ownership once Russian law permits such a transaction.


However, foreign manufacturers should bear in mind that the current draft of the new Land Code -- which has passed only its first reading in the State Duma -- contains significant restrictions on land ownership by both foreign enterprises and Russian enterprises with foreign investment.


Finally, an important consideration for any site is the environmental state of the land and the possible liability attached to the planned production process. This factor may be overlooked by manufacturers given Russia's other serious and obvious environmental problems. Environmental due diligence today, however, should be a consideration for all those investing in Russia's manufacturing base.





Adrian Moore is an attorney with Baker & McKenzie.