How to Make Russia Pay its Debts: An Interview with Franz Sedelmayer

In this exclusive interview, German businessman Franz J. Sedelmayer discusses his decades-long dispute with the Russian government, challenging Russia’s sovereign immunity, and the link between state corruption and the current environment of civil unrest in Russia.

Q: Looking at the very long history of your dispute with the Kremlin, no one could say that you lack resilience in seeking recovery of your stolen property. So where did this all begin?

A: As the Eastern Block began to break down in 1989, we saw an opportunity to set up a company supplying law enforcement equipment to Russian executive organs of state helping with their modernization and training their personnel. Later on I also founded a security service to assist new foreign investors in navigating in a rather risky economy. We set up our joint venture, JSC Kamenny Ostrov, together with the Leningrad (St. Petersburg) Police Department, which offered the use of facilities on Stone Island for a 25-year lease. We ended up bringing in cash, equipment and renovating our company facilities, investing upwards of $4,000,000.

We began having political problems right away as the law changed, banning the police from participation in commercial activities, and creating a heated competition for the other 50% of our company between organs of the new federal government and the old property fund ran by the Supreme Soviet.

It was at this point that I developed a close working relationship with Vladimir Putin, who at the time was the head of the foreign relations department of the Mayor of Leningrad (St. Petersburg), Anatoly Sobchak. He came up with a solution to our problem – that the city government, through an executive order by Anatoly Chubais, could take the share in the joint venture, but what would they get out of it?

We agreed that if the city would take the share, then our company would form, fund, equip and train a FSB counter-terrorist team free of charge as St. Petersburg had to host the Goodwill Games, but the City’s law enforcement agencies lacked any counter-terrorism capability.

Q: At what point did your good relationship with Putin break down?

A: Well, trouble started in 1994, when President Boris Yeltsin had decided to confiscate our facilities, where we had more than 150 employees working at the time. We were in an awkward situation because we had invested a lot of money in the facilities and we had no alternative replacement. On behalf of the city, Vladimir Putin wanted to provide us with new facilities owned by the City, but had no money to compensate for our leasehold improvements. So instead, what Putin and I decided to do was to write a letter to Pavel Borodin, who at the time was the head of the Managing Department of the President of the Russian Federation, asking him to compensate us for our leasehold improvements for around US$800,000.

To our surprise, Borodin wrote back to us stating that the company had been established illegally, and thereby the Russian state had no duty to pay us any compensation, and that they would simply expropriate everything we had without any payment. Putin was unable to do anything about this raid, and that’s where our legal dispute begins. We had our last conversation in early 1996.

Q: So what has been your strategy to recover the investment taken in the expropriation?

A: Well, our strategy is very simple – we are trying to make the Russian Federation pay its debt, and this is a government that never wants to pay anyone. With all the domestic courts being absolutely useless in arbitrating a dispute for foreign investors, the only thing that we can do is search for assets wherever we can find them and attach them to our case.

Russia’s obstinacy on paying debts is not unique to my case, but rather it is a widespread practice of state policy. In principle, it is like fighting with a schoolyard bully who refuses to give in, and all you can do is hit them where it hurts. In our fight against Russia’s abuses of sovereign immunity, in some cases we were not very fortunate, while in others we were able to create case law.

Q: What are some of the issues that come up when you go after Russian assets in the West?

A: Well, when it comes to sovereign immunity, the fine line is always about whether or not the assets in question are being used for a sovereign purpose or for a commercial purpose. The worst case scenario, which always comes up in our case, is when the asset is claimed to be used for both.

The problem is that no one, since we’ve been around, has been trying to execute against a foreign sovereign in the Western world, so we are the first ones to develop real precedent and case law. There are instances in which the courts disagree. For example, the Supreme Court of Sweden decided last July that as soon as a government is using a facility for a mixed purpose, “sovereign and commercial purposes,” it can no longer be protected under immunity. This case concerned the former USSR trade mission in Stockholm.

But Germany, with the most recent decision in December, decided exactly the other way around. The court concluded that if an asset is used for even a partial sovereign purpose, it cannot be attached.

Q: What was the reasoning for the German court’s ruling?

A: Well, first of all, the court did not examine the merit of the case, but rather issued a decision on the grounds of whether or not to accept the case. That means that the case subject will continue coming back to that German court until that question has been handled and is finally ruled upon! Basically, they have now concluded that it was OK for a foreign government to use commercial activities to fund sovereign activities in the same building– which is, quite simply, ridiculous. In practically any other country, a commercial activity is considered a commercial activity, full stop. It doesn’t matter what a government claims is going to be done with the money it earns from this business.

In our case, this concerned the Berlin-based House of Russian Science and Culture. Actually 90% of the building there is leased to companies and to retailers, and the Russians have claimed that this is not a commercial activity, as they use the profits from these leases to fund the representation of Russia in Germany.

But bullied into the corner, the Germans have been excessively lenient with Russia on this ruling, requiring us to take the case to the final point before the European Court of Human Rights. It reminds me of the Yukos case before the ECHR, when the Tribunal seriously decided the persecution and expropriation conducted against Mikhail Khodorkovsky and his partners was not politically motivated. Frankly, I really fail to see what we as Europeans stand to gain, if our courts permanently give in to Russian pressure. This practice must stop! Why would we even want Russia to remain a member in the Council of Europe, if today’s Russian administration willfully ignores the very human rights it once had promised to observe and to protect? Should we Europeans lower our standards?

Q: How much have you been able to recover so far?

A: So far we have recovered about 1.2 million euros, and we are owed about 4.5 million euros more, including all the legal fees – Russia has a very bad habit of refusing to pay legal fees when they lose. For example, we are engaged in at least 60 ongoing lawsuits as we speak, most of them connected with the execution of Russian assets.

What is interesting is that instead of just paying us the relatively small amount to make the problem go away, they instead allowed the case law to develop in court, and this is going to help anybody else in the future who has money to collect from Russia. And quite frankly, now they are standing there with these results, and they look actually pretty foolish, as what they have done was not at all necessary, and was not helpful to their image.

Q: So why have the Russians been so foolish when it would have been so much less damaging just to settle your case?

A: Well, back when I was working in Russia, we had this term we called “nachalnik syndrome”: if an official has reached a certain level in his career, he cannot ever be wrong again, so whatever decision he makes, it is like an edict from the pope. It cannot be reversed or reconsidered in light of new evidence.

And this is how they are pursuing their legal affairs – and I don’t see any way that they will change their attitudes, because at the moment they are surviving. Even though 50% of the country’s income coming from oil and gas and rare metals, and only 1 million people actually benefit from that by being employed in those sectors, I don’t think that they actually think they absolutely need the foreign investments.

Russia has a very short-term attitude, Putin himself included. They know that the system as it stands now cannot last more than 3-5 years, but they think, “who cares what happens after I am gone.”

Q: Do you think your experience represents a horror story for foreign investors in Russia, or a more unique experience?

A: Look, the truth is that Russia’s image as a destination for foreign investment is terrible, and I don’t care about all the positive things that any Western government, including the United States, has to say about how great the country is, how it is moving in the right direction, etc. And the American “reset policy” in particular has failed miserably in bringing any progress to Russia that continues to fail to protect people’s property and freedom.

A normal businessperson today would not invest a dime in Russia. The only companies that are able to invest are multinational corporations of the size that they don’t care if they lose their investment. On the one hand, the investment is either relatively small in the terms of the company’s overall portfolio, and on the other, they don’t care if they lose the money because it is not their money but rather that of the shareholders. These guys can go out there and take all the risks, and then worry about handling the disputes among shareholders and auctioneers in the event that they lose the investment, but in no case are they making any investment that would cause the end of company. It seems strange some shareholders have not woken up to that reality, yet! But when you talk about small and mid-sized companies, there is no way they would take the risk to invest in Russia when there is no way to recover debts.

Q: So given that you worked so closely with Putin in the past, what are your impressions of him now?

A: Well there is a nice phrase that describes what happened to Putin: “power corrupts, and absolute power corrupts absolutely.”

When I worked with Putin, he was known for two things: being honest and being loyal to his boss, who at that time was Mayor Sobchak. Putin would do absolutely anything for Sobchak, including covering up his corruption – and it was incredible, he did a very good job at it. It was this type of display of loyalty that eventually landed him his first top job in Moscow, and I think essentially that was the role he was originally expected to play by Yeltsin and his family.

If Putin would really be reelected as president in March 2012 he will, in order to stay in control for the whole duration of his term, restrict the freedom of the Russian people even more harsh; possibly to rival the situation as it has existed under the communists in the 1970’s. The Russian people are fully aware of that danger!

Q: But if Putin were to exit the political scene, would foreign investors find an improved environment?

A: No, not right away. The crisis in Russia is not just limited to Putin the person, but the people who work around him. By nature, a dominant and charismatic personality like Putin is not going to surround himself with very capable people. That actually describes the whole situation in Russia today, whether you are talking about the FSB, the bureaucracy, or the nachalniki that control the cities and regions. These are not exactly the brain surgeons and rocket scientists of Russia – these are people who jumped on the bandwagon of Putin’s party, just like the same type of people who jumped on the bandwagon of the Communist Party for decades.

Q: Do you see a connection between the hostile environment for foreign investment in Russia and the current wave of protests seizing Moscow?

A: Well the motivations of the protesters are complex – I think that if you interviewed ten different people demonstrating, you would get ten different answers. But it is precisely this diversity that indicates all the makings of a genuine popular movement, and that’s particularly dangerous for Russia’s current administration.

What started everything, I believe, were two core features of the current system in Russia: 1) the lack of fair distribution of wealth, and 2) the display of absolute power. You have this immense wealth generated from the oil, gas, and minerals sector going to a very select few, along with the immense wealth generated by corruption going to members of the bureaucracy, judiciary, and the executive organ of the state. Take this along with the brazen display of power during the last Duma election, when it was clear that nobody even took the vote seriously enough to even bother concealing the rigging of the elections, and you have a recipe for trouble. The lack of opportunities combined with the open gestures of power, and many Russian people finally understood that they were being treated as though they didn’t exist by their leaders.

Q: Putin’s main campaign slogan this year appeals to stability, arguing that without his guiding hand, Russia will fall into chaos. Do you buy it?

A: It’s a complete myth that Putin’s Russia is stable. The lack of control over the country is the same as back in the Czar’s days – “the heavens are high and Moscow is far.” It is sheer logistics that do not allow a vertical line of power from the Kremlin to all the cities and the villages in the faraway regions, requiring Moscow to relinquish wide ranging discretion to locals.

What Putin has done essentially is to strike a deal with anybody in the regions that doesn’t step on his feet and or on the feet of the federal government, and then this or that governor or mayor is allowed to fill his own pockets without any oversight from the federal government. But the moment that they mount an opposition to the center, no matter how small it might be, Putin and his people will do anything possible to break it up.

Back in the 1990s, one of my business activities was to help Western investors to deal with the local mobs who tried to take away their business or a chunk of the business. And one thing we learned is that mobsters don’t fight each other. They distribute their market share, making an agreement and they stick by it. And that’s exactly how Putin and his cronies have organized their arrangement with other people in the country that serve in public and bureaucratic functions.

Putin is not the reason for the corruption, but under Putin, corruption became an accepted structure, and if you don’t have ways to break up this structure, such as a fiercely independent judiciary, then nothing will change.

Q: If you were a Russian protester, what approach would you take?

A: Well, my advice, welcome or unwelcome, coming from a foreigner with some experience dealing with Putin, is that his biggest weak spot is that he hates comedy. If anybody wanted to destabilize Putin, comedy is the best weapon they have. You cannot insult the man, you cannot pressure the man, but you can ridicule the man.

Have you ever heard Putin tell a joke? The very first thing he did as Prime Minister was to cancel the most popular political satire show. I would describe these as delusions of grandeur, but he cannot live with the idea that people out there are not taking him seriously. Putin does not break out into rage unless it is issues like that – it’s his Achilles heel.

Q: Last time we spoke, you said that you saw Grigory Yavlinsky as the only candidate independent from Putin. Now he is not being allowed to run.

A: Well, it’s a great pity, because now all that leaves us with is Prokhorov and the Communists, who are both of course connected to Putin.

The banning of Yavlinsky’s candidacy illustrates Putin’s general fear of him and fear of risk, as no matter low the popularity of a competitor, his party is not going to be able to pull the same level of electoral fraud as last time, so almost anybody not under his control represents a risk in his eyes.

And we shouldn’t overestimate the appearance of people like Mironov and Kudrin at the protest rallies, because as far as Putin is concerned, the more the merrier. All that matters is that the only people actually allowed to run in the election pose no threat and are under control. So now, the problem is that the Russian opposition needs to decide whom to support – and that will be a choice of the lesser evil.

Q: So you believe Putin will become the next president and remain in power for many years to come?

A: Well, never forget that Russia can also surprise you, and no one can absolutely be sure of what happens from today to Election Day. But as I have said before, it is not a wise move for Putin to run for President, as he will be poison for the country. The people are disgruntled, and he knows that they are disgruntled, requiring an even heavier level of control over sources of influence. When Putin comes back as president, I believe we will see the flight of more people, more brains, and more money leaving the country without a return ticket.

But it is interesting: out of all the people that I continue to speak with, Russians both inside and outside the country, even the most pessimistic, all of them have plans. They are all planning for a future, a future without Putin.