The recent legislative development in the area of regulation of natural monopolies constitutes a new trend in Russian law. Not only is the concept of natural monopoly novel for it, but the system of regulation which this new legislation purports to implement differs significantly from the theretofore predominant system of government management of state economy. The system of government regulation contemplated in the Law "On Natural Monopolies" enacted last August as well as in a number of other laws dealing with specific instances of natural monopolies is conceived not as an alternative to the market regulation, but rather as a supplement to it in those areas where market is not deemed an adequate mechanism of self-regulation.
As Article 1 of the Law "On Natural Monopolies" states, this law is aimed at the "achievement of a balance of interests between the consumers and holders of natural monopolies, ensuring the accessibility of the commodities produced by the latter for consumers and an efficient functioning of the holders of natural monopolies." In other words, the purpose of this legislation is not only to regulate natural monopolies for the public benefit, but to mediate between the competing interests of all the parties involved, including those of the holders of natural monopolies themselves which are not conceived of as substantively different from, or less important than, the interests of any other private parties. Accordingly, the implementation of this legislation should make possible in principle the achievement of its object without necessarily preserving a direct governmental control over the ownership and operation of the entities occupying the position of natural monopolies. Even where such control is retained (as in most of the areas enumerated in the law as instances of natural monopolies), the law treats state entities not as mere vehicles of public interests but as independent and self-interested players in the market. Indeed, the Law "On Natural Monopolies" as well as other legislation in regard to natural monopolies imposes significant restrictions on the operation of holders of natural monopolies, both private and state-owned entities.
Definition of Natural Monopolies
Natural monopolies are defined in two ways:
- by a general conceptual definition and
- by the provision of the list of specific areas of its application.
The general definition is set forth in Art. 3 of the Law which states as follows: "natural monopoly is the condition of a commodity market under which the satisfaction of the demand in this market is more efficient in the absence of competition by virtue of the technological peculiarities of the production process (because of a significant reduction of the cost per commodity item as the output increases), and the commodities produced by the holders of natural monopolies cannot be substituted for in consumption by other commodities, so that the demand in this market for the commodities produced by the holders of natural monopolies is less dependent on the variations in the price of this commodity than in that of other commodities." Apart from the heavy-handedness of this definition, its very nature calls for a rather complex evaluation of the specific circumstances in order to identify instances of natural monopolies. For that reason the provision of the list of specific instances of natural monopolies in Art. 4 is helpful as it appears to create a presumption that any activity in the indicated areas falls under the definition of natural monopolies and is subject to the regulatory regime set up by this Law. Such areas include:
- transportation of oil and products of oil refining via trunk pipelines;
- transportation of gas via pipelines;
- transmission of electric and heat energy;
- railroad transportation;
- services of transportation terminals, ports and airports;
- services in the areas of electric and postal communications.
Despite the substantial specificity of this list the question still remains whether the regulatory regime established under the Law "On Natural Monopolies" applies automatically to any activity undertaken in those areas or a specific determination is necessary in order to extend such regime to a concrete entity or operator. This question is particularly important in view of the fact that this Law imposes on the holders of natural monopolies very stringent pre-approval requirements for a broad range of business transactions.
The answer to this question may be found in some provisions scattered throughout the Law. Thus, articles 10 and 11 setting forth the powers and responsibilities of the regulatory agencies in the sphere of natural monopolies provide among other things that these agencies must set up and keep the register of the holders of natural monopolies and take decision with respect to the inclusion into, or exclusion from, such register. This appears to indicate that the definition of natural monopolies provided in articles 3 and 4 is not self-applying, but is designed to serve as a guidance for the regulatory agencies in deciding whether to apply the regulatory regime set forth in the Law to specific entities identified as holders of natural monopolies. Until such entities have been duly determined to hold natural monopoly and entered on the register, they should bear no duties or liabilities under this law.
Forms of Regulation and Control
The regulatory regime contemplated by the Law "On Natural Monopolies" includes two major elements:
- regulation per se, and
- supervision and control in the form of pre-approval of certain acts intended to be engaged into by the holders of natural monopolies.
(1) Forms of Regulation. The regulatory agencies can apply to the holders of natural monopolies the following forms of regulation: price-setting (or setting the price limits) and determination of the categories of consumers entitled to the provision of goods and services by the holders of natural monopolies (Art. 6.) The general criteria for price-setting are set forth in Art. 12 and are designed to stimulate the improvement in quality of the goods and the satisfaction of the demand for them in the market. In particular, the regulatory agencies are instructed to take into account the following factors: cost of production; taxes; capital expenses and need for capital investment; anticipated profits; location of consumers; adequacy of the quality of goods and availability of state subsidies. Such economic analysis is designed to ensure a proper balance between the business interests of the entities involved and the interests of consumers as well as the public interest in the overall competitive development of the market. For example, the law "On the Federal Railroads" provides in Art. 11.6 that rail tickets should be sold at their "full value" and any fare privileges granted to specific categories of passengers by federal legislation should be compensated from the federal or other state budgets.
Within the scope of their regulatory powers stipulated in the law, the regulatory agencies may issue orders addressed to the specific holders of natural monopolies, as well as to the executive and local authorities, prescribing the action to be taken (e.g. to enter into contracts with the indicated customers, to change the provisions of the existing contracts, to rescind a regulatory act deemed inconsistent with the Law etc.) as well imposing administrative penalties for non-compliance (see below).
(2) Forms of Control. Holders of natural monopolies are required to obtain approval from the regulatory agencies for certain types of business transactions, in particular, of any acquisition of, or investment in, unrelated business involving more than 10% of their own capital, as well as a sale, lease or other disposition of the assets by a holder of natural monopoly the book value of which exceeds 10% of its own capital (Art. 7.2.) For the approval of such transactions, the holder of natural monopoly must apply to the appropriate regulatory agency and provide the latter with the necessary information (as determined by the agency) about the contemplated transaction. The regulatory agency may deny its approval if it deems that the transaction will have an adverse effect on the interests of consumers or on a competitive development of the market, in which case the applicant can appeal to the court.
Similarly, a notification of the regulatory agency is required for any acquisition by third parties of a stake in a holder of natural monopoly giving them more than 10% of the votes on the shares of such a holder. However, such notification can be performed subsequent to the acquisition and the regulatory agency has apparently no authority to approve or enjoin such an acquisition.
The holders of natural monopolies are also required to submit to the appropriate regulatory agency periodic reports on their current business activities and plans of capital investment (Art. 8.2). The officials of the regulatory agencies have the right of an unimpeded access to the data and information held by the executive and local authorities as well as by the holders of natural monopolies themselves, and all of the latter are obligated to provide such information to the regulatory agencies (Art.13).
Regulatory Agencies
The Law "On Natural Monopolies" and other related legislation (see in particular Art. 7 of the law "On the Federal Railroads") provide that the government regulation of natural monopolies should be carried out by the special agencies created for that purpose. The assignment of regulatory functions to such agencies, specifically designed for that purpose and endowed with a significant degree of autonomy from a direct governmental or political interference, is apparently expected to ensure that such regulation not yield to political pressure but be exercised professionally, according to the objectives and principles laid down in this legislation. This role of the regulatory agencies is reinforced by the power given them by the Law to direct the executive and local authorities to rescind or amend their acts deemed by the agencies to be inconsistent with the Law (Art. 11).
The Law provides for the creation of regulatory agencies in each of the areas enumerated in Art. 4 with the chief officer to be appointed by the President of Russia (Art. 9). The agency is to be governed by a board of members selected by the Government of Russia among the reputable experts in the respective area and must enjoy a significant degree of independence from a governmental interference (thus, the board members' term of office should be no less than 4 years.)
Other laws and decrees provide for the creation of specific regulatory agencies in various areas designated as natural monopolies. Thus, the Law "On the State Regulation of Tariffs on Electric and Heat Energy in the Russian Federation" of April 14, 1995 provides for the creation of the Federal Energy Commission as well as regional energy commissions to discharge the regulatory functions envisaged in this law (Art. 6). The Law "On the Federal Railroads" designates the Ministry of Railroads as the federal regulatory agency in the area of railroad transportation (Art. 2). The Government Decree 1446 of December 31, 1994 provided for the creation of the "Interdepartmental Commission for the Regulation of Matters Related to the Use of the System of Trunk Oil and Oil Products Pipelines and Sea Terminals for the Export of Oil and Oil Products from the Customs Territory of the Russian Federation" the status of which was determined by the Government Decree 94 of January 30, 1995. This Commission was charged primarily with the control over the allocation of the access quotas to the trunk pipelines for the export of oil and oil products.
The regulatory agencies contemplated by the Law "On Natural Monopolies" can act on their own initiative or at the instance of other interested parties such as consumers' associations, business entities, executive authorities, local authorities and prosecutor's offices (Arts. 21 and 22). At the same time, the entity-holder of natural monopoly with respect to which regulatory action is to be taken is allowed to attend the deliberations at the regulatory agency on that subject. Thus, to some extent regulatory agencies are designed to serve as a mechanism of mediation between conflicting interests of different parties involved, including the holders of natural monopolies, even if such parties do not participate in the deliberative or decision-making process. This role of the regulatory agency as a mechanism of mediation is particularly well-pronounced in the law "On the State Regulation of Tariffs on Electric and Heat Energy in the Russian Federation" where the Federal Energy Commission is designated as an institutional mediator between consumers and providers to which they can apply prior to, or instead of, applying to an arbitration court (Art. 13.)
Forms of Liability
To the regulatory powers of the agencies correlates a broad range of liabilities provided by the Law for the holders of natural monopolies, as well as for the executive and local authorities. Thus, they are obligated under this law to undertake the action prescribed by the agency or to discontinue the practice enjoined by it, to enter into a contract with a consumer or to change the existing contract, to pay the fines imposed by the agency, to remit to the government the profit received as a result of the violation of this Law or to compensate the damage caused to other parties. The rates of the fines for specific violations are set forth in Art. 16 (for legal entities) and 18 (for individuals, including officers of the entities-holders of natural monopolies and government officials.)
Most of the liabilities envisaged by the Law are of the administrative nature and can be imposed directly by the regulatory agencies. However, recovery of damages caused by unlawful acts of the holders of natural monopolies is subject to civil laws and can be effected only through a court of law. Similarly, any damages caused to the holders of natural monopolies by the action or decision of the regulatory agency taken in derogation from the Law, including setting the prices "without sufficient economic justification," can be recovered by the former in a civil court (Art. 20.) The latter provision may have potentially far-reaching implications: on the one hand, it purports to limit the arbitrary discretion of the regulatory agencies in the exercise of their powers by inducing them to provide a well-substantiated economic justification of their regulatory measures; on the other hand, given the lack of clearly defined standards of "economic justification" it may significantly limit the ability of the regulatory agency to discharge its regulatory functions while facing the threat of a litigation with an uncertain and possibly costly outcome. Presumably, the phrase "without sufficient economic justification" will be interpreted as meaning procedural deficiencies in the decision-making process, rather than any objective criteria of economic efficiency of the regulatory acts of the agency.
The punitive powers of the regulatory agencies are restrained by the lack of their own enforcement mechanism. Even though the affected parties are required by law to comply with the orders issued and penalties imposed by the agencies, their failure to do so leaves the agencies without any other remedy than an action in court. Certain regulatory and fiscal agencies in Russia have the power to collect fines and other punitive payments in the so-called "non-contestable" manner, i.e. without going through formal legal proceedings which give the other party an opportunity to raise objections as to the validity and cause of the collection. Such powers are given the tax authorities and certain other agencies which can normally exercise them through the tax authorities (e.g. agencies of building and architectural control, price-control agencies, agencies of currency control). The regulatory agencies created pursuant to the Law "On Natural Monopolies" clearly are not accorded such powers under this law. Accordingly, if the penalties imposed by them on a holder of natural monopoly are not paid voluntarily, they need to go through formal legal proceedings in the arbitration court to collect the payment. The same rule applies to the enforcement of other orders of the regulatory agencies such as orders of specific performance.
Remedies of Private Parties.
This enforcement mechanism provided for in the Law "On Natural Monopolies" also sets the procedural framework for the protection of interests and rights of private parties affected by the activities of the holders of natural monopolies. The Law does not provide directly for any enforceable substantive rights of such parties, except for the general right to seek damages, as this Law is designed as an instrument of mediation between the conflicting interests of various parties involved, rather than as a direct source of substantive rights (the Law almost never refers to the "rights" of consumers but only to their "interests"). While it establishes certain duties for the holders of natural monopolies, the parties for whose benefit such duties can be deemed to exist are not expressly endowed with directly enforceable rights: their normal legal recourse should be through the appropriate regulatory agency.
If the regulatory agencies have to resort to the court for the enforcement of their orders, the Law does not expressly provide for the right of private parties to resort independently to the court, for example, in order to compel a holder of natural monopoly to provide services to them when they are unlawfully withheld or denied. In such a case, a private party may need an action of the regulatory agency which can obtain a court order (Art. 24.3). This distinguishes the legal regime set up by this Law (as well as by the law "On Competition and Restriction of the Monopolistic Activity in the Commodity Markets" of March 22, 1991) from the regime of protection of individual rights set up under the law "On Consumers' Protection" which accords individual consumers directly enforceable rights. This does not mean, however, that private parties are deprived under the Law "On Natural Monopolies" of their right based on civil law to seek in court damages inflicted on them by unlawful acts of the holders of natural monopolies: this right is explicitly reiterated in Art. 17.
One should also note that, while the Law does not generally provide for directly enforceable rights of private parties, it does not expressly rule out a recourse in the court for them. In fact, other laws dealing with specific types of natural monopolies expressly provide for the availability of judicial remedies in cases of disputes between the holders of natural monopolies and consumers (See, e.g. Art. 13 of the law "On the State Regulation of Tariffs on Electric and Heat Energy in the Russian Federation" or Art. 22 of the law "On the Federal Railroads.") Thus, one should not in my view interpret Art. 24 of the Law as giving the regulatory agencies the exclusive access to judicial remedies in cases of violation of this law. Rather, one should refer to the general principle of Russian law that everyone has the right of recourse to the courts for the protection of one's rights (See e.g. Art. 3 of the Code of Civil Procedure, Art. 4.1 of the Code of the Arbitration Procedure of May 5, 1995). Only where the law expressly provides that the parties must resort to non-judicial remedies before applying for relief to the court, will this general right be limited by such condition. For example, some provisions in other laws (such as Art. 22 of the law "On the Federal Railroads") set a clear procedural framework for the protection of the rights of private parties in which the recourse to judicial remedies is possible only after the exhaustion of special non-judicial remedies provided for under this law.
The foregoing commentary was based mainly on the legal analysis of the laws adopted. However, the nature of the legal regime contemplated by the legislation on natural monopolies is such that it can be adequately understood and evaluated only in the light of the actual practice of it implementation. The inefficiency and corruption of the Russian bureaucratic machine are notorious and the laws in question offer no guarantee that the regulatory mechanism contemplated by them will be insulated from the prevailing environment; the opposite may be expected given that regulatory agencies are largely made up of the existing bureaucratic structures. This reservation does not, however, preclude me from assessing the new legislation on natural monopolies as a significant step in the right direction, namely in creating in Russia a system of regulation of the economy consistent with the realities of free market and with the rule of law, rather than the rule of governmental directives. The ultimate success of this system depends on a lot of factors that it is beyond the scope of this article to analyze.
*article courtesy of Igor V. Pashensky of Coudert Brothers.