Tips for Successful Acquisitions in Ukraine
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Avellum Partners is a leading full-service law firm in Ukraine with key strength in finance, M&A and dispute resolution. The firm covers capital markets, competition, corporate/M&A, disputes, employment, finance, projects, energy and infrastructure, real estate, restructuring and insolvency, and tax.
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Despite the current turmoil, we expect mergers and acquisitions (M&A) activity to pick up again in Ukraine in the second half of 2015 or early 2016. With this expected trend in mind, it could be useful to reiterate a few basic aspects of investing in Ukraine.
Legal Due Diligence: What to Expect?
It goes without saying that legal due diligence is necessary before signing any serious deal in Ukraine. 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 the group’s growth through acquisition of 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 the preemptive rights of other shareholders or lack spousal consent. Sometimes, unpaid shares are sold, which is prohibited under Ukrainian law.
Public registers are not fully complete, but they are certainly improving year by year and many have become accessible via the Internet.
Past real estate acquisitions are rarely without any procedural violations. First of all, 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 changed in the last few years, while 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 issue of construction permits.
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.
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 a business. They tend to rely heavily on their in-house legal advisor, who often has limited practical experience of sophisticated M&A. However, there is some danger in allowing a seller to negotiate with a Western buyer without a professional advisor from the seller at the table. The buyer and its legal counsel will spend days explaining the mechanics of an English law agreement and giving up some valuable commercial points in exchange for progress with the documentation. What often happens next is that the Ukrainian seller will realize that it desperately needs professional legal advice. The seller will, eventually, hire a law firm to advise on the agreement, i.e., on the already negotiated one! The seller’s counsel will often bring up a lot of legal points, which the buyer thought had already been settled earlier. Hence, our strong advice — insist on having the seller’s lawyers at the table right from the start!
Deal Structuring and Group Restructuring — Discuss as Early as Possible
It is always a good idea to discuss early on 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 will insist on selling a foreign (Cyprus is common choice) holding company with Ukrainian assets underneath it. If agreed, insist on starting the restructuring as soon as possible and monitor it closely. It normally takes around 3-4 months to complete a corporate restructuring for the off-shore structure properly.
Internal group restructuring is also often required. Many business groups historically tend to use “nominal” shareholders so as 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 up to 2 months, depending on various factors.
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. Thus, any acquisition above USD 10 million in Ukraine is structured under English law. In addition, it is often structured offshore to optimize taxation and completely eliminate the impact of the Ukrainian judiciary.
English law gives a choice of legal instruments, which are unavailable or undeveloped in Ukraine. Warranties and indemnities serve as a good example. Option agreements and other instruments common in Western shareholders’ agreements are also very difficult to structure and enforce under Ukrainian law. English law can also boast a few centuries of precedents, which have come to address literally any potential business situation.
Having said this, a foreign buyer should be aware that mandatory Ukrainian rules will apply when buying Ukrainian shares. For instance, a Ukrainian securities broker may be required for the acquisition of shares and the settlement may have to be structured via investment bank accounts in Ukraine.
Warranties and Indemnities — Strange Animals for Ukrainian Sellers
Ukrainian sellers are not used to the notion of warranties and indemnities. They do not exist under Ukrainian law. Thus, 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 pay 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.
Who Gives the Warranties? Get Proper Guarantors!
It is important to bear in mind that 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 when 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 for 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 their limited enforceability in Ukraine.
Disclosure Letter — Warn the Seller that You Want one at the Start
It may sound counterintuitive to a sophisticated foreign buyer to insist on a 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 reason for this is simple — the disclosure letter could flush out any “skeletons in the closet”, which were not disclosed to the buyer in the course of legal due diligence. While this fact is true in many Western jurisdictions, it is especially true in Ukraine.
Buying “AS IS” — Risk and Understanding
Ukrainian sellers will often treat the sale of business as an “as is” sale and push the buyer to accept this approach. There is great inherent danger in accepting such an 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 the “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.
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. Sale of participatory interests in a limited liability company requires very sophisticated structuring.
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 prior approval from the antitrust authorities of Ukraine. Non-solicitation obligations will be limited by mandatory rules of Ukrainian labor law.
Antitrust Approvals — Materiality Thresholds in Ukraine are Extremely Low!
Literally any decent acquisition in Ukraine is likely to require prior approval of Ukrainian antitrust authorities for concentration. This is because financial thresholds under Ukrainian competition law are very low, with EUR12 million as the minimum turnover or total assets requirement and only EUR 1 million for at least two of the participants in the acquisition (provided that one of the participants has EUR 1 million in Ukraine in assets or turnover).