With the global financial crisis approaching its end, the mergers and acquisitions (M&A) activity is picking up in Ukraine. Foreign buyers are again looking at the Ukrainian market as sellers have adjusted their pricing expectations to reasonable levels. With this trend in mind, it could be useful to reiterate a few basic aspects of investing in Ukraine.
1. Any Serious Deal In Ukraine Is Done Under English Law. Why So?
While Ukrainian contract law is fairly developed by standards of continental Europe, our corporate law and judicial system leave much to be desired. The adoption of the new Law on Joint Stock Companies is just the first step in the chain of many reforms, which need to be undertaken to bring Ukrainian corporate law framework up to European standards. In the meantime, any acquisition of the size above USD10 million in Ukraine is structured under English law. In addition, it is often structured offshore to optimize taxation and completely eliminate impact of Ukrainian judiciary.
English common law gives a choice of legal instruments currently unavailable in Ukraine. Warranties and indemnities serve as a good example. Option agreements and other instruments common in Western shareholders' agreements also prove difficult to structure and enforce in Ukraine. English law also boasts a few centuries of precedents which encompass virtually every business situation.
Having said this, a foreign buyer should be aware that Ukrainian mandatory rules will apply when buying Ukrainian shares. For instance, a Ukrainian securities broker may be required for the acquisition of shares and the settlement will have to be structured via investment bank accounts in Ukraine.
2. Legal Due Diligence: What To Expect?
It goes without saying that legal due diligence is necessary before signing the deal. In our practice, we have come across a few problems, which are common to almost any business group.
Corporate law violations – you will certainly find them in any transaction. This is due to the past history of group's growth by way of acquiring new companies. It is very rare for assets to be purchased in Ukraine, because of taxes and loss of permits and licenses. Share acquisitions would often breach preemptive rights of other shareholders or lack spousal consents. Sometimes unpaid shares are sold, which is prohibited under Ukrainian law.
Public registers are not fully reliable, especially registers of court judgments, and most such remain inaccessible via the internet, meaning it is necessary to visit a notary or state authorities to obtain this information. For some registers, it takes more than 10 days to get an official response.
Past real estate acquisitions are rarely free of procedural violations. First of all, it is worth noting that Ukrainian law treats land and buildings as separate objects. Thus, title to land and buildings located on it may belong to different owners, while registration of their title is reflected in different public registers. Ukrainian land law was actively changing in the last few years, while the construction legislation has undergone at least 3 major reviews in the last 10 years. These legislative changes contributed greatly to varying practice and numerous inconsistencies in the procedure for the sale of land and construction permitting.
Pensions and the environment are not yet hot topics in Ukraine. Thus, the buyer should not expect extensive discussions on these matters with the sellers. The pension system is still run by the State and no issues of private pension plans will arise in the near future.
The majority of commercial contracts in Ukraine are short-term. A contract for one year is considered quite long, while a 3-year contract is definitely long-term. Apart from sophisticated office leases, a commercial contract would rarely contain notice periods for termination of more than one month.
Regulatory issues are quite common among manufacturing and FMCG companies, but so far the level of fines and penalties imposed for regulatory violations is relatively low and the enforcement of ordinances of regulatory authorities is of limited efficiency.
3. Seller's Lawyers – Insist On Having Ones From The Start
Many Ukrainian sellers are not used to engaging a professional legal advisor when buying or selling business. They tend to rely heavily on their in-house legal advisor, who often has limited practical experience in sophisticated M&A. However, there is some danger in allowing a seller to negotiate with a Western buyer without professional seller's advisors at the table. The buyer and its legal counsel may spend days explaining the mechanics of an English common law agreement and giving up some valuable commercial points in exchange for progress with the documentation. What often happens next is the Ukrainian seller will realize that it desperately needs professional legal advice. Eventually, the Ukrainian seller will realise the need for professional legal advice and hire a law firm to advise him on an agreement already negotiated! The seller's counsel will often bring up a lot of legal points, which the buyer thought had been already settled earlier. Hence, our strong advice – insist on having seller's lawyers at the table right from the start!
4. Arranties And Indemnities – Strange Animals For Ukrainian Sellers
Ukrainian sellers are unfamiliar with the notion of warranties and indemnities, which do not exist under Ukrainian law. This means, a regular seller will often resist giving extensive warranties and will refuse to give any indemnities at all. In the view of a Ukrainian seller, once the deal is closed, it will not refund any money to the buyer. It requires great effort and professional legal help on both sides to explain to the Ukrainian seller how warranties and indemnities operate and what mechanisms are available to the seller to protect him against excessive claims from the buyer.
5. Disclosure Letter – Warn The Seller That You Want One At The Start
It may sound counterintuitive to a sophisticated foreign buyer to insist on the disclosure letter, if the seller does not want to provide it. However, we strongly recommend requesting one early in the negotiations, even if the seller is reluctant to bother with preparing the disclosure letter. The simple reason for this is that the disclosure letter could flush out any "skeletons in the closet", not previously disclosed the buyer in the course of the legal due diligence. While this fact is true in many Western jurisdictions, it is especially true in Ukraine.
6. Who Gives The Warranties? Get Proper Guarantors!
It is important to bear in mind that the warranties and indemnities are worth as much as the party giving them. If the seller is dealing through its off-shore holding company, it is likely that such a company has few assets and may not be around if the buyer raises a warranty claim. Thus, we always recommend either (a) to withhold a sufficient portion of the purchase price keeping it in escrow to cover potential losses, or (b) to have a financially strong company acting as guarantor of the seller's obligations under the share purchase agreement. Personal guarantees seem to re-appear in practice, but one should remember of their limited enforceability in Ukraine.
7. Buying "As Is" – Risk And Understanding
Ukrainian sellers will often treat the sale of business as a sale "as is" and push the buyer to accept this approach. There is great inherent danger in accepting such approach, because the buyer will expose itself to the following risks: (a) the seller may not always be co-operative in providing all requested information, (b) the financial and legal due diligence could not be sufficient to uncover all "skeletons in the closet", and (c) as discussed above, unless limited warranties on title to shares are backed by a financially viable seller or guarantor, the value of even title warranties may be very limited.
8. Deal Structuring And Group Restructuring – Discuss As Early As Possible
It is always a good idea to discuss early whether an on-shore or an off-shore structure will be used in your acquisition. Ukrainian sellers will often have tax minimization or reputational concerns and insist on selling a foreign holding company (Cyprus is a common domicile) with Ukrainian assets underneath it. If agreed, insist on starting the restructuring as soon as possible and monitor it closely. It normally takes around three months to properly complete a corporate restructuring for the off-shore structure.
Internal group restructuring is often required, too. Many business groups historically tend to use "nominal" shareholders, in order to avoid transfer pricing restrictions and reputational concerns. In the course of a sale to a new buyer, all independent subsidiaries will need to be brought under one roof, which also takes from 2 weeks to 2 months, depending on various factors.
9. Escrow Arrangements – Some Work And Some Don't In Ukraine
A popular and handy mechanism in the West, escrow arrangements do not formally exist in Ukraine. Some commercial banks offer a similar alternative, which works perfectly with the sale of shares of a Ukrainian joint-stock company. A sale of participatory interests in a limited liability company requires a very sophisticated structuring. As a rule of thumb, documentary escrows are generally possible in Ukraine, while cash escrows are not.
10. Signing And Closing – Warn The Sellers That You Expect Proper Authorizations In Place
As in any M&A transaction, it is worth raising the issue of proper authorizations and corporate approvals well in advance. Involvement of off-shore holding companies adds some complication to language of resolutions and powers of attorney due to the additional local law element (e.g., Cypriot law), while the on-shore sale in Ukraine may require approvals of shareholders' meetings of the sellers and could impact the timing of the transaction.
11. Non-Compete And Non-Solicitation Clauses Are Not Easily Enforceable In Ukraine
Common clauses in Western share purchase agreements, non-compete and non-solicitation clauses are not easily enforceable in Ukraine. Non-compete will formally require a prior approval of the antitrust authorities of Ukraine. Non-solicitation obligations will be limited by mandatory rules of Ukrainian labor law.
12. Antitrust Approvals – Materiality Thresholds In Ukraine Are Extremely Low!
Virtually all good acquisitions in Ukraine are likely to require the prior approval of Ukrainian antitrust authorities against concentration. This is due to the fact that financial thresholds under Ukrainian competition law remain very low, with EUR12 million as the minimum turnover or total assets requirement and only EUR1 million for at least two of the participants in the acquisition (provided that one of the participants has EUR1 million in Ukraine in assets or turnover).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
