SPIC & Offset Contracts in Russian Healthcare and Pharma

March 18, 2022

BRACE Law Firm ©

Investment projects in the healthcare sphere have been and remain one of the attractive areas for investment of entrepreneurs' funds, driven by competition for budget financing. Attracting private capital to the healthcare sphere allows for modernization and infrastructure development, as well as the implementation of drug supply and provision of high-quality high-tech medical services to the population. This applies both directly to medical services and to accompanying spheres — the production of medicinal products and medical devices.

With the introduction of investment projects, legislation has incorporated mechanisms for interaction between private capital and the public sector, such as public-private partnerships, concessions, special investment contracts, and offset contracts.

PPP in Healthcare

Public-private partnership and municipal-private partnership (the "PPP") is a legally formalized cooperation for a specified term, based on the pooling of resources and distribution of risks, between a public partner on one side and a private partner on the other side, which is carried out based on a public-private partnership agreement or a municipal-private partnership agreement concluded to attract private investments into the economy, ensure the availability of goods, works, and services by state authorities and local self-government bodies, and improve their quality [1].

To attract investments into the economy of the Russian Federation, ensure the effective use of property owned by the state or municipality, and improve the quality of goods, works, and services provided to consumers, investments are also attracted under the terms of concession agreements [2]. In accordance with Part 1 of Article 3 of Federal Law No. 115-FZ dated July 21, 2005, On Concession Agreements, the reconstruction of a concession agreement object includes measures for its reconfiguration based on the introduction of new technologies, mechanization and automation of production, modernization and replacement of obsolete and physically worn-out equipment with new, more productive equipment, changing the technological or functional purpose of the concession agreement object or its individual parts, and other measures to improve the characteristics and operational properties of the concession agreement object.

In the medical sphere, the subjects of concession agreements [3] and public-private partnership agreements [4] are healthcare facilities, including objects intended for sanatorium-resort treatment. As a rule, either unfinished objects belonging to the state ownership of either the Russian Federation or a constituent entity of the Federation are used, or the repair and (or) reconstruction of an existing healthcare institution as a complete complex.

Mandatory elements of investment agreements are construction and (or) reconstruction, financing, operation and (or) maintenance, and the emergence of the private partner's ownership right to the object of the agreement, subject to the encumbrance of the agreement object in accordance with the legislation. Also, an important condition is that changing the designated purpose of the reconstructed object of the concession agreement is not permitted. Thus, having received a medical facility at their disposal, a private investor cannot change the direction of the medical organization's activity at their own will and discretion.

One of the first examples of a concession agreement for the production of medical devices in the field of traumatology, orthopedics, and neurosurgery was the agreement between JSC "Innovative Medico-Technological Center (Medical Technopark)" and the FSBI "Novosibirsk Research Institute of Traumatology and Orthopedics named after Ya.L. Tsivyan" of the Ministry of Health of Russia (NIITO). When forming the draft of this agreement, unfinished federal property areas were involved, the maintenance of which was estimated at about 400,000 rubles. In December 2015, a concession agreement was concluded between the Ministry of Health and JSC Innovative Medico-Technological Center (Medical Technopark), under which the investor was to reconstruct the vacant building and launch the production of medical devices there — endoprostheses and their components, construction systems and their components for traumatology, orthopedics, and neurosurgery, exoprostheses and their components, as well as hardware-software complexes for the rehabilitation of patients with musculoskeletal and nervous system pathologies.

Entering into this type of agreement obliges the investor to carry out their activities in good faith; investment risks may arise at any stage of project implementation. Despite the state's interest in implementing such projects, liability for improper performance of the concession agreement arises for the investor regardless. The Arbitration Court of the Novosibirsk Region considered a case on the claim of the Ministry of Health of the Russian Federation for the recovery of penalties under a concession agreement against the Joint Stock Company "Innovative Medico-Technological Center (Medical Technopark)" [5]. Penalties under the concession agreement were recovered by the court decision.

Russian legislation has been supplemented over the last 15–20 years with regulatory documents allowing for the implementation of investment projects and interaction between the state and business for the benefit of consumers and, regarding medicine, patients. The rule of law allowing for the conclusion of special investment contracts was provided by Federal Law No. 488-FZ dated December 31, 2014, On Industrial Policy in the Russian Federation. This is a tool allowing for the stimulation of investments in industrial production in Russia.

Another investment mechanism is offset contracts, which allow the investor to build long-term relationships by creating new production facilities and jobs in the region of their conclusion and ensuring a sales market for the manufactured products in the long term.

Such a number of types of implementation of various forms of interaction between investors and the state allows making such interaction beneficial for both the state and business.

SPIC (Special Investment Contracts) in Healthcare and Pharmaceuticals

In accordance with Clause 1 of Article 16 of Federal Law No. 488-FZ dated December 31, 2014, On Industrial Policy in the Russian Federation, under a special investment contract (the "SPIC"), one party (the investor) undertakes, within the period provided for by this contract, to create or modernize and (or) master the production of industrial products in the territory of the Russian Federation, on the continental shelf of the Russian Federation, or in the exclusive economic zone of the Russian Federation independently or with the involvement of other persons, and the other party (the Russian Federation or a constituent entity of the Russian Federation) undertakes, during such period, to implement measures to stimulate activity in the sphere of industry provided for by the legislation of the Russian Federation or the legislation of the constituent entity of the Russian Federation at the time of concluding the special investment contract.

One of the important priorities of healthcare development is improving the quality of medical care provision. The state cannot always cope with the request of the modern consumer (the patient) regarding the quality and quantity of necessary medical services. Private capital investments come to the aid in this sphere. Despite the large number of investment projects being implemented in healthcare, a significant part of them relates to the sphere of laboratory diagnostics and outpatient care.

Federal Law No. 44-FZ dated April 5, 2013, On the Contract System in the Sphere of Procurement of Goods, Works, and Services for Provision of State and Municipal Needs, was supplemented in 2016 with Article 111.3, "Specifics of procurement of goods, the production of which is created or modernized and (or) mastered in the territory of the Russian Federation in accordance with a special investment contract", according to which the Government has the right to determine a party (an investor) of a special investment contract carrying out the creation or modernization and (or) mastering of the production of goods in the territory of the Russian Federation. A special investment contract in this case is concluded based on Federal Law No. 488-FZ dated December 31, 2014, On Industrial Policy in the Russian Federation. The rules for concluding, amending, and terminating special investment contracts are approved by the relevant Decree of the Government of the RF [6]. At the same time, control over the execution of the SPIC by the investor is carried out based on Decree of the Government of the RF No. 1049 dated July 16, 2020, On Approval of the Rules for Control over the Fulfillment by Investors of Obligations under Special Investment Contracts and Forms of Reports on the Fulfillment of Said Obligations. In accordance with this decree, the investor submits a report in the approved form to the authorized executive body.

Most medical services are provided at the expense of the Compulsory Medical Insurance Fund, the tariff of which does not include funds for the construction of new and reconstruction of old industry facilities, or the purchase of expensive equipment exceeding 100,000 rubles per unit of product. As a rule, the federal budget, as well as the budgets of constituent entities of the federation, allocate small financial opportunities for capital construction of facilities and equipment in the healthcare sphere. Considering that a large part of expenses in investment projects consists of construction and equipment costs, investment projects are a reasonable solution for the development of medicine.

The conclusion of SPICs at the federal level is carried out in accordance with Decree of the Government of the RF No. 708 dated July 16, 2015, On Special Investment Contracts for Certain Industries (the "Decree No. 708"). The investor thereby receives the possibility of favorable economic conditions for organizing new production or expanding existing production. As a rule, such conditions include the stability of the tax burden during the term of the contract and protection from regulatory risks arising as a result of changes in legislation. The investor gains stability due to the fact that legal acts that entered into force after the conclusion of the investment contract do not apply to them. For the investor, the "grandfather clause" is one of the attractive conditions for concluding a SPIC. In accordance with Clause 4 of the rules approved by Decree No. 708, the parties to a special investment contract, along with the Russian Federation, may be a constituent entity of the Russian Federation and (or) a municipality. The term for which a SPIC is concluded is limited to 10 years; a standard form of the contract is also provided by Decree No. 708. Furthermore, the goals of concluding a SPIC are the achievement of target indicators within the framework of state programs of the Russian Federation. The decision to conclude a special investment contract is made by an interdepartmental commission on special investment contracts acting based on the Regulation on the interdepartmental commission on special investment contracts.

A special investment contract is concluded, including signed, as well as amended and terminated on behalf of the Russian Federation by the Ministry of Industry and Trade of the Russian Federation [7].

In the field of medicine, the first Russian special investment contract concluded by the Ministry of Industry and Trade in 2017 was the contract concluded with the pharmaceutical company GEROPHARM. GEROPHARM is a national manufacturer of biotechnological preparations and is engaged in the full-cycle production of medicinal products, investing in technological development and the creation of modern pharmaceutical infrastructure. The subject of the concluded SPIC was the creation in Russia of a full cycle of production of vital and essential medicinal products, including insulin preparations and its analogues.

However, the production of safe disposable syringes with engineering protection against reuse became possible in the Nizhny Novgorod Region after the signing in 2019 of a special investment contract with. The project envisages investment of at least 3 billion rubles by the investor until 2027, as well as the creation of more than 500 new jobs.

The production of medicinal products cannot be carried out without pharmaceutical substances, which, in accordance with Federal Law No. 61-FZ dated April 12, 2010, On Circulation of Medicinal Products, is a medicinal product in the form of one or several active substances possessing pharmacological activity, regardless of the nature of origin, intended for the production and manufacture of medicinal products, and determines their efficacy. The organization of production of pharmaceutical substances of more than 70 items will become possible after the implementation of the special investment contract signed in October 2020 with JSC "Active Component". The amount of planned investments should amount to more than 2.7 billion rubles. The SPIC is aimed at expanding the range of pharmaceutical substances for the production of medicinal products and, accordingly, reducing dependence on supplies of substances from China and India.

However, concluded special investment contracts are not always implemented in full; sometimes situations arise where a pharmaceutical company moves to terminate the SPIC, which is often associated with an unstable economic situation. For example, in 2018, the Russian pharmaceutical company NovaMedica, the Ministry of Industry and Trade, and the Kaluga Region concluded a special investment contract. The implementation of the investment project was intended to increase the availability of modern, effective, and safe medicinal products for Russian patients. According to the concluded contract, the production of 24 sterile injectable preparations classified as vital and essential was to begin under the license of Pfizer. However, NovaMedica decided to suspend the construction of the plant in the Kaluga Region and terminate the special investment contract. As a result, the SPIC was terminated, and since NovaMedica did not take advantage of preferences and benefits, the Ministry of Industry and Trade had no financial claims.

Offset Contracts in Healthcare and Pharmaceuticals

An offset contract represents a form of public-private partnership where an investor organizes production in a specific constituent entity of the Russian Federation and establishes the supply of the produced goods. The main element of an offset contract is the reciprocal nature of the obligations of the contracting parties.

In 2016, Federal Law No. 44-FZ dated April 5, 2013, On the Contract System in the Sphere of Procurement of Goods, Works, and Services for Provision of State and Municipal Needs (the "Law No. 44-FZ"), was supplemented with Article 111.4, "Specifics of concluding a state contract providing for reciprocal investment obligations for the provision of state needs of a constituent entity of the Russian Federation", according to which the conclusion of a state contract for the supply of goods provides for reciprocal investment obligations of the supplier-investor to create or modernize and (or) master the production of such goods in the territory of the constituent entity of the Russian Federation. The executive authority of the constituent entity of the Federation has the right to conclude an offset contract.

In accordance with Part 1 of Article 111.4 of Law No. 44-FZ, an offset contract is a contract under which the supply of goods is carried out and reciprocal investment obligations of the supplier-investor are provided for regarding the creation or modernization and (or) mastering of the production of such goods in the territory of the constituent entity of the Russian Federation. Requirements for determining the maximum price per unit of goods, the production of which is created or modernized and (or) mastered in the territory of the constituent entity of the Russian Federation in accordance with an offset contract, are defined by the relevant Decree of the Government of the RF [8].

As a rule, the conclusion of an offset contract is carried out for a long period of time; this is associated with increasing import substitution opportunities and a sufficiently long payback period for investments.

Within the meaning of this rule of law, the reciprocal obligations of the parties will include:

• obligation on the part of the supplier-investor to create or modernize and (or) master the production of a certain good in the territory of the constituent entity of the RF at its own expense and supply it to the customer;
• obligation on the part of the customer to carry out the purchase of the produced good during the term established in the contract, as well as to include the supplier-investor in a special register of sole suppliers.

It should be noted that assigning the status of a sole supplier to the investor company and including it by an act of the Government of the Russian Federation in the register of sole suppliers does not generate an obligation for state and municipal customers to purchase the products produced by it outside of competitive procedures.

The term of an offset contract cannot exceed 10 years, and the minimum investments cannot be less than 1 billion rubles. Only Russian legal entities can be participants in the tender for the conclusion of such a contract.

In accordance with Clause 5 of Article 111.4 of Law No. 44-FZ, a contract with a sole supplier for the supply of goods is concluded taking into account the following specifics:

• the conclusion of such a contract is carried out during the period specified in Clause 7 Part 4 Article 111.4 of Law No. 44-FZ;
• the term for which such a contract is concluded cannot exceed the term of the corresponding state contract providing for reciprocal investment obligations of the supplier-investor;
• the price per unit of goods, the supply of which is the subject of such a contract, cannot exceed the maximum price determined in the manner established in accordance with Law No. 44-FZ;
• the subject of such a contract is the supply of goods produced in accordance with a state contract concluded in accordance with the requirements of this article;
• the supplied goods must be recognized as goods of Russian origin in accordance with the legislation of the Russian Federation.

For the budget of a constituent entity of the Russian Federation, the conclusion of an offset contract represents real investments that increase production safety through high-tech equipment, new jobs appear, and more taxes flow into the budget. In turn, for the investor, the conclusion of such a contract is a clear advantage because they gain a stable and long-term sales market. In addition, after fulfilling investment obligations, the investor company is included in the regional register of sole suppliers, which is also a clear advantage in a competitive market.

The goal of concluding offset contracts is to stimulate capital investment by investors in the creation of new enterprises, re-equipment of existing ones, introduction of more modern technologies, as well as the development of import substitution.

The main element of concluding such contracts is the good-faith performance by the parties of the concluded offset contract; in case of non-performance by the investor company of its obligations, the customer has the right not to carry out the purchase of goods produced under this contract and not to include the investor company in the special register of sole suppliers.

In the sphere of production of medicinal products and medical devices, investors are successfully attracted and offset contracts are concluded. The first offset contracts in Moscow were concluded in the pharmaceutical industry with the company CJSC "Biocad" and the company "R-Opra".

Within the framework of the offset contract concluded with the Government of Moscow in 2017, CJSC "Biocad" built a pharmaceutical production facility in Zelenograd. Under the terms of the deal, it was planned that the enterprise would produce 40 oncological medicinal products. At the same time, the Government of Moscow undertook to purchase products manufactured at the new production facilities for the city's medical institutions from 2021 to 2027 for an amount of about 2 billion rubles.

Offset contracts allow for saving budget funds; this is due to the fact that as a result of competitive procedures, the price of the purchased goods often decreases. For example, when concluding a contract with the company "R-Opra", the initial contract price during the competitive procedure was 22.6 billion rubles and was reduced to 18.4 billion rubles.

Another investment offset contract was concluded with the company Moscow Endocrine Plant, which undertook to organize the production of 20 items of medicinal products. As a result of the competitive procedure, only one application was submitted by the Moscow Endocrine Plant, and an offset contract was concluded with it for a term of 10 years. Under the terms of the competitive procedure, the investor must invest one billion rubles; in turn, over 8 years, the Government of Moscow is obliged to purchase medicinal products from the manufacturer for a total amount of 1.1 billion rubles. As a result of the implementation of this contract, the production of betaxolol (used for arterial hypertension), the anti-inflammatory drug diclofenac, the antibiotic levofloxacin in the form of eye drops, the anticoagulant nadroparin calcium, as well as the neuroleptic clozapine, the antidepressant paroxetine, the antiepileptic drug pregabalin, the opioid analgesic tramadol, and rivastigmine for the therapy of Alzheimer's disease should be established.

An enterprise for the production of medical devices for ostomy patients will be implemented within the framework of the third offset contract concluded in 2019 by the Government of Moscow with the company "Gemamed"; investments in creation in the territory of the special economic zone "Technopolis Moscow" under this project should amount to 1 billion rubles. The contract was concluded with the company "Gemamed", which, like the Moscow Endocrine Plant, was the company that submitted the only application for participation in the competitive procedure for concluding an offset agreement. Medical devices from the implementation of this project have already begun to be supplied to patients.

In 2019, summarizing the results of an open tender for the right to conclude a state contract for the supply of medicines providing for reciprocal investment obligations, an offset contract was concluded with "PSK Pharma". The investor was to invest at least 1 billion rubles in 2 years and begin supplying 26 items of medicinal products for the treatment of bronchial and oncological diseases for 7 years.

An important element in this type of interaction is not only mutually beneficial cooperation between the state and business but also obtaining additional jobs and tax revenues to the budget. For business, signing an offset contract means a sufficiently long-term guarantee of sales of manufactured medical devices or medicinal products.

As a rule, investment interest arises in the field of the most popular and necessary products. Often, products produced under an offset contract are sold and realized not only in the region where the contract was concluded but are also supplied throughout the country and may be exported.

The price of the final product after the implementation of an offset contract becomes affordable for consumers; this is achieved, among other things, by eliminating chains of trade intermediaries. Also, an important effect in the implementation of an offset contract is the ability to control the quality and storage conditions of the produced medical goods.

All investment contracts concluded within the framework of the production of medicinal products and medical devices are aimed at implementing important economic components: import substitution, new jobs, replenishing the budget through tax payments, etc. At the same time, a positive effect from the interaction of the state and business in this sphere can be achieved only by combining the efforts and capabilities of each of the parties.

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References

[1] Clause 1 Article 3 of Federal Law No. 224-FZ dated July 13, 2015, On Public-Private Partnership, Municipal-Private Partnership in the Russian Federation and Amendments to Certain Legislative Acts of the Russian Federation.

[2] Federal Law No. 115-FZ dated July 21, 2005, On Concession Agreements.

[3] Subclause 13 Clause 1 Article 4 of Federal Law No. 115-FZ dated July 21, 2005, On Concession Agreements.

[4] Subclause 11 Clause 1 Article 7 of Federal Law No. 224-FZ dated July 13, 2015, On Public-Private Partnership, Municipal-Private Partnership in the Russian Federation and Amendments to Certain Legislative Acts of the Russian Federation.

[5] Decision of the Arbitration Court of the Novosibirsk Region dated August 25, 2021, in case No. A45-14812/2020.

[6] Decree of the Government of the RF No. 1048 dated July 16, 2020, On Approval of the Rules for Concluding, Amending and Terminating Special Investment Contracts.

[7] Clause 2 of the Rules approved by Decree of the Government of the RF No. 708 dated July 16, 2015, On Special Investment Contracts for Certain Industries.

[8] Decree of the Government of the RF No. 1441 dated December 22, 2016, On Establishing Requirements for the Procedure for Determining the Maximum Price per Unit of Goods, Production of Which is Created or Modernized and (or) Mastered in the Territory of a Constituent Entity of the Russian Federation in Accordance with a State Contract Concluded with a Sole Supplier of Goods – a Legal Entity in Accordance with Article 111.4 of the Specified Federal Law, to be Established by the Executive Authority of the Constituent Entity of the Russian Federation for the Purposes of Procurement in Accordance with Clause 48 Part 1 Article 93 of the Federal Law "On the Contract System in the Sphere of Procurement of Goods, Works, Services for Provision of State and Municipal Needs", as well as for the Procedure for Determining the Price of Such Contract.