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Overview (May 2007) - International Law Office

International Law Office

Corporate Finance/M&A - Ukraine

Overview (May 2007)

May 09 2007

Limitations for Acquirers
Special Sector Requirements
Share Deals
Asset Deals
Transfer of Legal Title and Obligations
Labour Relations
Takeover Bids and Squeeze-Outs


Ukraine's mergers and acquisitions market is still in development. An inadequate legal framework means that investors may easily be deprived of their property as a result of hostile takeovers. Nevertheless, the first decade of the new millennium is showing certain positive trends as foreign capital starts to enter the market, bringing with it Western European standards of corporate development.

Although the market was born out of the wave of privatizations in the 1990s, its real development can be traced to 2005, which was remarkable for the famous Krivorozhstal sale for approximately $4.79 billion. This deal alone caused the market to grow by 200%. Although the second half of 2005 brought an expected slight downturn, it established a trend for foreign investments in Ukraine in the banking, telecommunications, construction, retail, wholesale and media sectors.

The first half of 2006 saw around $3.5 billion of officially declared deals. This figure almost doubled in the second half of the year, mostly as a result of acquisitions of control over leading Ukrainian banks and financial services providers.


The market is characterized by:

  • an absence of clear procedural rules or established practice;

  • the incomplete privatization of state property;

  • the highly political nature of state intervention in the operation of enterprises and the economy as a whole, partly because of the state's authority and considerable shareholdings and partly because of the prevalence of white-collar corruption; and

  • the inadequacy and inexperience of the judicial system in M&A matters.

Ukrainian legislation almost entirely ignores M&A transactions. There is no unified legal act on the subject and no systematized framework for such deals exists in an array of civil and commercial legislation. The Civil Code and the Commercial Code barely touch on the issue and subordinate provisions are scattered throughout national legislation. This results in a large range of practical schemes for conducting corporate operations on an ad hoc basis on one hand, and numerous problems arising from the absence of adequate legislation on the other. The interpretation of poorly worded legal provisions makes it difficult to undertake the required sequence of actions, which in turn gives rise to abuses.

Recently approved amendments refer all disputes arising from corporate relations, including privatizations, to the jurisdiction of the economic courts. This change is intended to reduce corruption in decisions on corporate matters and improve standards of judicial proficiency in such cases - local courts have frequently been used in hostile takeovers in order to obtain a particular decision, and the problem of multiple decisions and determinations passed by courts of different jurisdictions all over Ukraine has been widespread.

Limitations for Acquirers

In general, Ukrainian legislation imposes few limitations on non-resident participation in M&A procedures, including the acquisition of sole participation in Ukrainian companies. The most significant limitations on foreign investments relate to registration, restrictions on foreign participation in certain sectors of the economy and significant limitations on the right of non-nationals to own land.

The Law on Treatment of Foreign Investments provides that registration of foreign investments is not compulsory. However, if a foreign investor does not register its investment, it loses certain safeguards under the law, including rights in respect of economic stability and against nationalization. In addition, foreign investors may not repatriate their profits or recover their initial investments without a registration certificate allowing them to export investments abroad. Registration is relatively easy and does not involve an assessment of the desirability of a particular investment in a given sector of the economy; in general, the process is an administrative formality, not a limitation.

However, in late 2005 the National Bank of Ukraine introduced a new limitation for non-resident investors: such investors must open investment accounts which are subject to registration and must carry out investment activities (including the repatriation of investments) through such accounts. The requirements gave rise to a debate about whether such accounts must be used in share deals between non-residents regarding the corporate rights of a Ukrainian legal entity - the answer remains in doubt.

The Land Code, which came into effect in 2002, prohibits foreign investors from purchasing agricultural land or strategically important state-owned land. Under Paragraph 6 of the Transitional Provisions, agricultural land may be owned only by Ukrainian natural or legal entities. The sale or other alienation of such land, except by exchange or demise, will be allowed from 2008. Agricultural land inherited by foreign individuals and legal entities is subject to alienation within a year of inheritance. Except for these limitations on the ownership of agricultural land, rights of title to land do not differ substantially for Ukrainian and foreign persons or entities. The code allows foreign subjects to own non-agricultural land within and outside city limits if real estate stands on it. Although the wording of the code applies this restriction only to wholly foreign-owned entities, in practice joint ventures and legal entities with even minimal foreign participations are subject to the same limitations.

Foreign individuals and legal entities also enjoy the right to participate in land privatization. Notwithstanding the provisions of the code which give such individuals unlimited rights to own non-agricultural land within the city limits, in practice they are required to own real property on such land, regardless of the location of the land.

Special Sector Requirements

Certain legislative limitations apply in areas of business which are particularly attractive to would-be acquirers. For example, the Law on Banks and Banking Activities provides that the National Bank of Ukraine is entitled to grant or withhold approval for M&A transactions involving banks. Amendments to the charters of commercial banks should also be registered with the National Bank of Ukraine. The registration process can be longer if non-residents are involved, as the process for amendment generally involves submitting all of the documents that would be required for an initial registration, in particular documents confirming the new participant's solvency and ability to comply with obligations to pay for the corporate rights of the bank. Banks should have a minimum chartered capital of €10 million. The National Bank of Ukraine has proposed to the Cabinet of Ministers that it set a restrictive quota on overall foreign participation in the banking sector, but the proposal is unlikely to be approved.

The Law on Telecasting and Broadcasting sets general requirements for legal entities in this area, in particular a number of limitations on the right to own television channels and radio stations. No person may exercise control over more than 35% of a specified local, regional or national market. Foreign subjects are prohibited from establishing television and broadcasting companies, and foreign investments in domestic television and broadcasting companies may not exceed 10% of the chartered capital.

Share Deals

The acquisition procedure depends on the form of the company. Corporate legislation does not directly prescribe the form in which the transfer of corporate rights must be agreed. However, the Law on State Registration of Legal Entities and Individual Entrepreneurs requires that the document confirming the transfer be drafted and certified by a notary. If a joint stock company is party to a contract for the sale of stock, the deal must be conducted through an agent which carries out professional purchase and sale activities on an equity market (ie, a dealer operating under a licence issued by the State Commission for Securities and the Stock Exchange).

An assignment of corporate rights is not included in the taxable base for value added tax (VAT). However, foreign entities must pay profit tax on profits obtained as a result of alienating corporate rights in favour of a Ukrainian company. Where the seller is a foreign entity, payment on the part of a Ukrainian buyer may be subject to 15% withholding tax on profits received from the sale of corporate rights and on gross income from the sale of real estate, unless bilateral or multilateral double taxation treaties provide otherwise. The payable tax can be reduced or eliminated by party-to-party agreement. If both parties to the transaction are non-residents, it will be theoretically possible to apply Ukrainian tax legislation and levy tax but, in practice, such operations are not subject to taxation. On the other hand, profits obtained in the Ukrainian territory are subject to tax depending on the type of beneficiary, source of profits and other factors.

Certification by a notary is required for a bilateral agreement to transfer corporate rights, as are documents confirming the consent of the spouses of the natural persons acting as sellers (in accordance with the Family Code, which sets out the legal regime for common property held by spouses). Further documents - usually in standard form - must confirm the seller's withdrawal from membership of the company and the absence of claims against him or her in connection with the withdrawal. Certain other documents, such as minutes of the general meeting that decided to transfer the corporate rights and/or conduct the corporate transaction, can also be certified by a notary if members of the company so wish. Such certification is not mandatory; however, for the purpose of a lawful transfer of corporate rights, the document confirming the transfer, including the minutes, must be certified by a notary.

Share deals and asset deals must be approved by the general meeting. Moreover, the draft Law on Joint Stock Companies states that, in the event of a direct acquisition of one company by another, a joint meeting must be conducted by the companies. The place of the general meeting must be the company's official location in Ukraine, unless the company is wholly owned by a non-resident. A long and complicated procedure for summoning the meeting and informing its participants is prescribed by law and is mandatory, regardless of the number of shareholders in the company.

In transactions involving the transfer of rights to shares in a joint stock company, the SEC must be informed and the information disclosed if shares exceeding 10% of the chartered capital are affected or acquired as a result. Moreover, changes must be made to the company's shareholder register (if the shares are in material form) - which must be kept by an independent registrar (except in the case of a company with fewer than 500 shareholders, which may keep its own register) - or to the custody account (if the shares are in dematerialized form).

Separate requirements apply to the acquisition of corporate rights in certain areas of business. For example, a party that buys 20% of the shares of a joint stock company is required to publish information relating to the transaction. Although such publication is not required by law and no requirement to this effect can be enforced, the publication of information (in one of the official journals of the central authorities) might be desirable if the substance of the transaction requires that all formalities be respected.

The specific features of the Ukrainian market mean that target companies may have hidden risks. Therefore, thorough due diligence is required before embarking on a share or asset deal.

Asset Deals

The purchase of a company's assets implies the paid transfer - pursuant to an agreement - of an integrated property structure or any part thereof to a buyer that is unconnected to the company concerned. The seller continues to exist as a legal entity and its corporate rights are not transferred to the buyer. A key distinction between such a deal and an acquisition of corporate rights is that the target company as seller participates in the transaction directly, rather than through its members. The sale of property located in Ukraine is subject to VAT at 20% (unless the buyer is the legal successor of a seller); this applies equally to transactions with enterprises that are exempt from VAT or those in which the consideration exceeds the annual registration threshold. Enterprises that are liable for VAT may claim tax credits.

This form of acquisition has the advantage of allowing for an assessment of the property; the buyer can choose the property which best fits its needs. However, there is not always a right to choose, as the seller's interests are usually opposed to this.

The Commercial Code considers an 'enterprise' to be an entity, but the Civil Code also regards an enterprise as an amalgamation of property that serves as the basis of the company's business activity and consists of the property itself and the rights and obligations related to the company's operation. However, there is no clear definition in legislation. Moreover, the Law on Value Added Tax introduces the concept of 'aggregate gross assets', again without a clear explanation. No other regulatory act clarifies the issue (with the exception - in very particular circumstances - of the Law on Re-establishing a Debtor's Solvency or Declaring Bankruptcy).

The question of the definition of such terms must be decided urgently at legislative level; pending such a decision, it would be useful to have clarification in court decisions if disputes arise about whether a transfer of certain property is considered to be a sale of an integrated (single) property or of aggregate gross assets. A collection of properties that can be sold by a company may be understood as a separate structural subdivision of a company. Such a sale may be associated with the transfer to the buyer of the trade name of the property being sold. Insofar as a sale of property implies the transfer of movable and immovable objects, as well as rights and obligations (which are subject to a different legal regime), executing such a transfer is usually complex. In addition to the principal agreement under which the collection of properties is transferred, other agreements should be concluded as annexes which are executed in accordance with requirements for the alienation of particular types of property. In most cases the agreement is subject to certification by notary. If a transfer includes properties which are subject to specific state registration (eg, real estate and cars), such objects must be transferred under separate agreements.

However, experience shows that the conclusion of a general agreement has not always been the most suitable course of action because it can involve problems (eg, during certification by a notary) and high certification costs (ie, 1% of the price of the real estate being sold). The problem of high costs is an integral feature of such transactions and parties should anticipate the need for substantial resources in such a transaction.

Where the transfer of property requires special registration, the availability of the whole package of documents for each object is the key requirement for completion of the transaction. However, as foreign investors cannot own certain forms of property, particularly certain forms of land, some types of property which make up part of the enterprise may not be transferred simultaneously with the other elements.

The transfer of the enterprise almost always results in the assignment of rights arising out of agreements that were previously concluded with the company to which the enterprise belongs and which relate to the property being sold. Such assignment is executed in the form of annexes to agreements which, in the future, will give rise to rights and obligations in respect of the enterprise purchased by the buyer. Such annexes should be concluded in the same form as the corresponding agreements. However, certain documents - notably permits provided to the legal entity, such as construction permits - cannot be assigned as a part of the enterprise; such documents may be acquired only in the context of a share deal.

Transfer of Legal Title and Obligations

Shares in joint stock companies should be not only registered by the commission on issuance (and given an international identification number), but also recorded in the accounting system as prescribed by law.

Unlike most European countries, Ukraine has no single central registry or other centralized entity that is authorized to keep records of share rights. Pursuant to changes introduced to the system for recording rights to securities after the adoption of the Law on Securities and the Stock Exchange, Ukraine abolished the issuance and circulation of bearer shares from May 2006. A three-year transitional period was established during which all shares issued in material form must be dematerialized.

A shareholder is supposed to have either a personal account or a personal entry in the registry system where all details of the shares owned by a particular owner must be indicated. Only in the case of the immobilization of shares issued in material form - through their dematerialization and the recording of such shares by the custodian - may rights to securities be recorded without the identity of the owner being indicated; the location of the shares is determined by the custodian as nominal holder. In such cases rights to shares are recorded in the system and by the custodian simultaneously. The identification of the nominee is designed to enable the circulation of shares issued in material form on regulated markets (ie, on the Stock Exchange or in trade information systems that are licensed by the SEC to carry out professional activities on securities markets) where transactions may be conducted in respect of securities recorded at securities accounts.

Shares issued by joint stock companies should be registered in the share accounting system; this is crucial for share transactions, as rights to shares are transferred by cession (ie, assignment under agreement). However, the actual transfer of shares (eg, on notarization of the relevant agreement) does not coincide with their legal transfer, which takes place when the appropriate changes are made to the system for recording rights in the register or securities account. In practice, this discrepancy frequently results in disagreements between parties about ownership of shares at a given moment. Moreover, discrepancies may occur in the systems for recording securities rights because of the time lag, which gives rise to 'dual' share ownership. As rights are not transferred instantly, there is nothing to prevent parties from dragging out a transfer in respect of shares which have already been sold in order to prevent other subjects from realizing their rights in such shares. (Such a scheme is possible only with the involvement of the subject responsible for maintaining the system for recording ownership.)

However, this system does not apply to transfers of corporate rights which are not formalized as securities (ie, shares in the chartered capital of a limited/added liability company), in which case the transfer of rights takes place in accordance with the agreement concluded between the parties. The moment of transfer is determined by the need to obtain consent from other members of the company for the transfer of corporate rights to the third party specified in the agreement; such an agreement is not legally binding until consent is obtained. This applies equally to joint stock companies, but does not generally apply in practice to transfers between members of the same company.

In the case of closed joint stock companies and limited/added liability companies, a separate condition requires the implementation of pre-emption rights (on conditions which are analogous to those proposed to the other party in the transaction) where a participation in the company is offered to an entity outside it. Consent must be entered in the minutes of the general meeting that takes the decision to transfer corporate rights and admit a new member to the company, although such consent may be formulated in a letter from the member to the general meeting.

When transferring corporate rights, the chartered capital - or at least the seller's share - must be paid up in full. The consent of the seller's spouse may be necessary (in the form of an entry in the agreement to the assignment of corporate rights or a notarized application). Therefore, it is advisable to obtain notarization of the whole package of documents related to the transfer.

Theoretically, it is possible to specify another procedure for the alienation of corporate rights and the obtaining of consent in the company's charter. However, this is rare - most such conditions are in the charters of large companies - and involves nothing very different from the procedure described above. Nevertheless, particular attention must be paid to ensure the transfer of corporate rights to the buyer as an honest acquirer in order to protect it from potential claims against its rights.

Changes in company membership as a result of a transfer of corporate rights must be registered by amending the relevant company documents - companies may either file a reformulated charter or draft the alterations as a separate document.

If the transfer of corporate rights leaves only one member in the company, the executive body must review its situation (and joint stock companies should inform the SEC), as important limitations apply to such companies - for example, neither the company nor its member may be a sole member of another company.

Ukrainian legislation limits the right of a company to provide loans to its members or a third party to facilitate the acquisition of a participation in the company. A contribution to the charter capital may not be made using such assets and the company may not guarantee or otherwise provide security for a loan obtained from another lender for this purpose. However, despite the clear formulation of this requirement, it has not always been applied in practice.

Legal title is transferred according to the applicable legislation; the way in which such a transaction is undertaken depends largely on the type of property to be transferred. If the property in question has been or must be registered, the seller is required to guarantee that entries have been or will be made in the relevant registers before completing the transaction. In addition, if any property which forms part of the object of the transfer has encumbrances that have been publicly registered (eg, mortgages or prohibitions against alienation), such records must be taken into account when drafting the principal agreement, as changes relating to the ownership of the property may be need to be added. From the buyer's perspective, it is usually recommended that the principal agreement prescribe time limits for such registration and that the burden of payment for the registration be shared proportionately by the parties. As a result, there is generally a gap between the signing and formal certification of the principal agreement and the date of its execution to allow for re-registration and similar procedures.

Pursuant to the Civil Code, a creditor's rights may be assigned without the debtor's consent, unless the agreement provides otherwise. However, the debtor cannot be changed without the creditor's consent. Thus, the transfer of contractual obligations as part of a transaction in most cases requires the consent of the parties to which the transferred entity owes a debt. Even if participants in subsidiaries are not in a position to prevent the transfer of enterprises, the buyer is supposed to inform debtors and obtain creditors' consent for changing a party to such obligations without delay. In practice, it is recommended that parties to the transaction notify all parties which will be affected by the transaction in this way. Such notification may take the form of public notification and personal communication, which is generally sufficient to maintain contractual relations. If this is not done, parties run the risk that debtors will fulfil their obligations to the wrong party (ie, the seller, not the buyer).

Insofar as licences, permits and authorizations do not pass to the new controlling entity even in cases of direct succession, it may be necessary to reapply for them once the transaction is completed. The time limits for obtaining such permits vary, which is why this process should be conducted in parallel with the acquisition process. Furthermore, as long as qualifying requirements are established for most licences, permits and authorizations - where such requirements relate to some types of right or asset or to the availability of personnel holding certain levels of qualifications, security clearance, licence or certificate - the issue of personnel transfer with the enterprise and of the preservation and timely transfer of property may be crucial to the avoidance of a 'grey period' between concluding the principal agreement and putting the enterprise into operation. The transaction must be structured in such a way that the key property and personnel are transferred as soon as possible and as close to the completion date of the transaction as possible. An alternative solution involves leasing rather than purchasing, although a permit from the Anti-monopoly Committee may be required in order to lease real property.

Attention should be paid to the joint responsibility of seller and buyer in respect of obligations related to property. In international practice a time limit is prescribed for joint responsibility after the completion of the transaction (usually, this is linked to the statute of limitations). Appropriate provisions should be included in the principal agreement, but even if they are not, the principle applies. Nevertheless, the division of spheres of responsibility both during and after the completion of the agreement is obligatory for parties to the transaction (eg, by including a non-exhaustive list of responsibilities in the agreement).

These requirements partly explain why asset deals are regarded as less attractive than share deals. The former involve a more complicated process, particularly when an operating enterprise is involved, and higher risk as a result of the considerable property and high costs involved; international practice has consistently shown the risks of undertaking such transactions without extensive due diligence, and expenses can exceed the value of the property acquired. Moreover, a non-resident buyer is generally ineligible for reimbursement of the VAT paid during the transaction. The key argument in favour of acquiring property in this way is that the mechanism allows the buyer to complete a prompt purchase of the operating entity or assets of interest to it without also acquiring the history and problems of the previous entity and the risks attached to them.

Labour Relations

Ukrainian legislation covers a certain group of risks relating to M&A deals, most notably the issue of senior managers. Although there are no legislative provisions for the particular problems involved (eg, termination safeguards, such as golden parachutes), they are generally covered in employment contracts. A dismissed manager may therefore turn to the company for obligations concerning indemnity and other financial privileges. However, the protection for companies in the event of a breach of confidentiality obligations by a manager is inadequate and the consequences of such a breach for the manager are relatively unclear.

A permit must be obtained from the Anti-monopoly Committee for the appointment of senior managers if such appointment falls within the definition of 'establishing control over the company'. The procedure for acquiring a permit and the possible penalties for failing to do so are the same as for the merger control permit.

Another concern arises if the asset deal results in a restructuring of production facilities and a reduction in workforce. M&A deals aimed at obtaining specialists are relatively uncommon in Ukraine; thus, the assignment of assets or corporate rights often results in major workforce changes. Social guarantees must be observed (including those relating to future employment), but new staff must be employed and made part of the operating structure as quickly as possible. This will involve significant expenditure, which should be taken into account by a prospective acquirer.

Takeover Bids and Squeeze-Outs

International practice has established two mechanisms whereby a majority shareholder which has obtained a package of corporate rights (usually shares representing over 80% of the chartered capital) that ensures near-complete control of a company can squeeze out other participants to become the sole owner of the company.

The first mechanism consists of buying out corporate rights at the majority shareholder's initiative and officially offering to buy out the remaining shares in the company at the market price. Shareholders may refuse such an offer, but may not name their own alternative price. A limited buy-out (ie, a two-tier offer) is a particular form of this mechanism: the offer includes the condition that only an identified package of corporate rights is subject to the buy-out at the price indicated, whereas other corporate rights are either sought at a lower purchase price or excluded from the bid.

The second mechanism is essentially a reversal of this procedure and is triggered by participants that wish a majority shareholder to buy out their interests in the chartered capital. The conditions of such a buy-out are established at the shareholders' meeting if at least a specified majority (usually between 80% and 95% of participants) vote in favour. Buy-out conditions defined in this way are binding on the majority shareholder - even if the price is considerably greater than the market price - and the majority shareholder is required to buy out corporate rights from other shareholders within an established time limit.

Both procedures are intended to protect the rights of minority shareholders and allow them to sell their interests in the chartered capital at a fair price. In both cases the company does not necessarily become a one-member company. As a rule, such procedures are conducted within two months (taking into account all of the formalities, including convening the general meeting and preliminary publication of the notice).

Ukrainian legislation takes no account of either mechanism, which makes them almost impossible to apply in practice, particularly from the point of view of protecting the rights of minority shareholders, and the corresponding practice is remarkable for its informal and non-systematic character. The main legislative instrument regarding buy-outs is the Law on the State Privatization Programme, which provides a buy-out option for shareholders of a joint stock company which is partly state-owned if such shareholders vote against certain operations regarding the assets of the company or its reorganization. Analogous provisions are included in the implementing regulations of the SEC with regard to the reorganization of a company in certain circumstances. Current legislation provides for nothing comparable to a takeover bid during the acquisition of shares in the company. Both forms of buy-out are included in the Draft Law on Joint Stock Companies, but this is unlikely to be adopted in the near future.

For further information on this topic please contact Timur Bondaryev at Arzinger & Partners by telephone (+380 44 494 2350) or by fax (+380 44 490 9698) or by email (timur.bondaryev@arzinger.com.ua).

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