Category: Ukraine

Olexander Martinenko, Partner at CMS in Kyiv, starts his summary of The Buzz in Ukraine by addressing the ongoing judicial reform in the country, noting that the system has been returned to its traditional 3-tiered structure (courts of first instance, appellate courts, and Supreme Court) from the 4-tiered system that was installed by previous President Yanukovych shortly after his rise to power in 2010.

Martinenko explains that “the country is experiencing its first-ever public competition to fill vacant Supreme Court slots.” The Ukrainian Supreme Court is required by law to review all Cassation complaints, Martinenko reports, and itself consists of a two-tiered structure, with separate chambers for separate matters (i.e., a Civil Cassation Court, Commercial Cassation Court, Criminal Cassation Court, Administrative Cassation Court, etc.) and a Grand Chamber for “ground-breaking decisions” to interpret legislation and create precedent (“although nobody refers to it as precedent”). Any and all who satisfy the necessary requirements have been invited to apply to the Judicial Commission, which is examining and evaluating candidates. This procedure is expected to result in 160 of the approximately 220 Supreme Court slots being filled, with the rest to come from “a second wave” in two years or so, after the effectiveness of this first stage has been reviewed and evaluated

A number of positions have already been filled, Martinenko says, and “we believe [the first process] will be completed by summer, and fully functional.” Even in the interim, he says, the Court is “not inactive,” and almost all the Cassation divisions are “working at full speed to the extent possible.”

Otherwise, Martinenko’s provision of the Buzz focuses on significant legislative initiatives, referring to “several new laws that either have already been adopted or are being debated by the Ukrainian Parliament that will provide a more liberal regime for corporate activity in Ukraine.”

He starts with a new law affecting companies with majority ownership in the hands of one shareholder. “Normally, in more developed jurisdictions,” Martinenko says, “there are so-called ‘squeeze-out’ provisions. In Ukraine such provisions have been absent from the legislation. But a ‘squeeze-out’ law has been adopted by the Ukrainian Parliament in its initial reading.” According to Martinenko, “they’re still debating what the relevant threshold should be – whether it should be 95%, or 92% or 90% – but once they settle on that, they’ll allow a majority shareholder who meets that threshold to squeeze out the minority shareholders, providing they pay fair market value for their shares.”

The second significant piece of legislation, he says, is the establishment of shareholders’ agreements, which he describes as “a very controversial issue in Ukraine.” Martinenko notes that the Supreme Court had, in the past, ruled that Shareholders Agreements should be completely banned, as “in their minds all of the issues related to corporate activity should be regulated by Corporate legislation only.” As a result, he explains, “people were using off-shore facilities for those purposes, like entering into shareholders’ agreements at the level of their holding companies somewhere in Cyprus, in the UK, in the Netherlands, or elsewhere, in order to regulate their relations.” Martinenko describes this as “a completely wrong approach,” and he reports that “Parliament is now debating a new law on shareholders’ agreements that will be specifically permitted and will become as regular a corporate instrument as in the United States or elsewhere.”

In what Martinenko describes as “yet another ground-breaking move,” the Ukrainian parliament has “gotten around to regulating debt-to-equity swaps.” The previous rules, he explains, were a “very significant stumbling point, because they prevented to some extent normal business mechanisms being applied in the financing part of corporate activity. In the West, for example, if I am a creditor and either because the debtor is unable to repay my loan and it is willing to proceed with a restructuring, or if I am interested in receiving the debt in that company for a whole variety of other reasons, I can convert my debt into equity of the company.” These exchanges have not been possible in Ukraine for “a whole variety of reasons, including tax reasons and regulatory reasons,” Martinenko reports, but “this snag is being removed right now, so this essentially will become a normal marketing instrument going forward.”

“One more interesting thing on the Corporate side,” Martinenko says: “The government has decided to do something about state controlled companies, in which the assets are owned by the companies, but the shares are owned by the state. The government has now moved in the direction of opening them up, and in an initial step towards their privatization, they introduced the system of so-called ‘supervisory boards,’ which as a matter of law will be composed of state appointed and independently appointed directors so that they can control the activity of those state-owned or state-controlled companies to the fullest extent possible.”

Finally, Martinenko turns to a significant development in the labor/employment area. “The Parliament of Ukraine has significantly increased the national minimum wage,” he reports, ‘bringing it into line with the minimum essential standard of living. And employers will be fined if they bypass that requirement without labor contracts or by paying people in brown envelopes.” Martinenko describes this as “a positive move, because it means our labor market will become more transparent and more civilized. It may have some repercussions because some people may be laid off because their employers will not be able to pay them their official salaries. However, for the ones that will be employed, they’ll be employed on the basis of a normal, regular, civilized contracts and terms.” 

Although the economic crisis has significantly slowed down the financial sector’s M&A activity in Ukraine with nearly 90 (of the 180 existing before 2014) commercial banks becoming insolvent or being taken over by the state, several banking cross-border equity transactions closed in recent years are paving the way towards the market’s gradual recovery.

Investors with a risk appetite for geopolitical risks and an unstable banking system recovering from the hryvnia’s significant devaluation are destined to get substantial rewards based on the current distressed pricing of these assets in Ukraine.  

The peak of the financial meltdown was arguably reached at the end of 2016, when the largest Ukrainian commercial bank, PrivatBank, was nationalised. The share of the state-owned banks in the banking sector has now exceeded 50% and, in some sectors of the banking market (deposits, domestic payment services, domestic money transfers and a number of others), PrivatBank’s dominant positions have now become state-controlled. The regulators should be concerned that the banking market could be quickly monopolised by state-owned banks, which have previously shown a notable lack of cutting-edge innovation and agility in developing banking services.  

From a transaction mechanics standpoint, there has been a variety of transaction types over the last two years, from classic M&A deals to share swaps and debt-to-equity conversions or their combinations. No matter which form the deal takes, the buyers and sellers need to consider some essential rules of thumb to avoid problems during implementation of the equity deals in the financial sector and achieve a smooth and timely completion.

(1) Timely tend to the possible need of bank re-capitalisation 

In the market’s currently difficult position, parties to banking M&A deals often face the requirement for the bank’s regulatory capital to be improved during preparation for the deal or after the parties have entered into binding transaction documentation. 

The local laws allow a bank to be re-capitalised in many different ways. In particular, the parties need to analyse whether re-capitalisation is possible by means of a regular full-fledged or a fast-track share capital increase procedure. The latter, with its various exemptions from the regular complex process, is only available to those banks which, based on qualified auditors’ stress tests, required being re-capitalised to meet the capital adequacy requirements. 

If the private share issue route is chosen, it needs to be fully aligned with the deal timeline. Additionally, before the capital increase kicks off, both the seller and the buyer have to pre-agree who will subscribe for the new shares. Not attending to this matter in advance may frustrate both the deal and the re-capitalisation plan. 

The central bank has also recently been allowing the regulatory capital to be replenished using historical cash infusions by means of a shareholder’s forgiveness of bank’s debt based on an ad hoc approval. The terms of this forgiveness need to be structured appropriately so that they satisfy the regulator’s requirements. 

(2) Accurately define the terms of the buyer’s pre-acquisition involvement

No buyer wishes to buy “a pig in a poke” or an asset that has lost its value since due diligence. Thus, it is not uncommon for the Ukrainian M&A market to enable the buyer to have a certain degree of involvement in the bank’s affairs prior to the actual sale. 

The crucial point here is to preclude such involvement from becoming troublesome in respect of merger control or the banking secrecy regulations. The seller often agrees to allow a buyer’s nominated person to have some degree of oversight, veto and information rights. The scope of these rights should be crafted with extreme care to avoid problems with the regulators, who will see the terms of these arrangements when pre-approving the deal. 

When structuring the pre-closing oversight arrangements, we recommend that the parties also thoroughly think about until what point in time they keep the deal undisclosed from the bank’s employees, as this is a very sensitive point that may sometimes lead to staff outflow. This will directly affect the terms of the oversight arrangements.

(3) Motivate incumbent management 

Where the deals would result in a change of the controlling shareholder and replacement of management, the parties need to think about how to properly motivate the key personnel, as the cooperation of the target’s personnel during the sale process is vital for the sale to be closed successfully.

Management often becomes the connector between the buyer and the seller in communicating information about the bank and taking various regulatory actions to honour the regulatory requirements. 

The seller is interested in keeping both management and the buyer happy with the process, which is not always an easy task to achieve. For example, resigning managers may be concerned with getting new job offers from the outside or with any potential damage to their professional reputation in the event the regulator finds out that their bank is in trouble within one to three years (depending on the violation) after closing the deal. It may be difficult for resigning managers to argue that they should not be held liable for the trouble. 

The sellers often use ‘golden parachute’ structures to give incentives to the people steering the bank to stay and cooperate up until its sale. In Ukraine’s volatile market, the sellers tend to opt for variable amounts of bonuses to be tied to the transaction value. Regardless of whether the seller chose fixed or variable bonuses, careful structuring of arrangements should be made to avoid situations where expats’ bonuses would be caught up by the local currency control regulations in Ukraine. 

(4) Make a decision as to new management beforehand 

Recent amendments to the central bank’s regulations now allow a buyer’s management to be pre-approved in advance of completing the deal. 

Previously, the buyer had to retain the incumbent head of the management board and the chief accountant for reporting purposes until the regulator approved the new management appointed at transaction closing. During this transition period, the new head was only given the status of acting chairperson, having a rather nominal role which could not provide enough comfort to the buyer. Now, the pre-approval is issued within one month after such request and remains valid for six months. 

Therefore, the parties may want to factor this step into their transaction timeline. Importantly, the filing process requires the full cooperation of the bank’s incumbent management, which may prove to be tricky given that the incumbent management essentially works towards its own replacement. 

(5) Carefully plan closing mechanics 

Closing in banking M&As is usually tied to the general assembly of the shareholders convoked more than a month in advance to accept resignations from the incumbent supervisory board, appoint the buyer’s supervisory board members, adopt the new articles to match the buyers’ needs and pass other relevant resolutions. 

Recent legislative developments, in certain cases, now allow changing certain board members without the general assembly. This route may be particularly attractive in cases where parties, for some reason, need to close urgently while the other matters constituting the exclusive competence of the general meeting are not so urgent to be resolved at closing. 

At completion, the selling shareholder can replace the supervisory board members it previously appointed as its representatives by a simple notice to the bank having immediate effect. This option, however, cannot be used to replace the independent members of the bank’s board or to appoint new ones to fill in the positions that are already vacant. When going into the deal, the buyer needs to figure out whether the board will be quorate post-closing, as well as if it has comfort around the issue of independent members.

To conclude, although Ukrainian law is slowly but steadily improving the banking M&A environment, the market continues to remain weak and unstable. Investors should be mindful of the plethora of structuring options, both for those who intend to enter and those who intend to leave the market, which need to be used with great care and with the assistance of experienced consultants.

By Ihor Olekhov, Partner, and Andrii Moskalyk, Senior Associate, Baker McKenzie Kyiv

On December 19, 2016, Resolution of the Cabinet of Ministers of Ukraine No. 921 “On Approval of the Procedure on Organization and Maintaining Military Records of Conscripts and Reservists”, dated December 7, 2016, came into effect (the “Procedure”).  

The Procedure, among other things, establishes: (i) the main obligations of employers with regard to maintaining military records (the “Records”) of conscripts and reservists (“Employees on Record”); (ii) the forms of documents for the Records; and (iii) a list of the issues that can be checked during relevant audits.

Persons responsible for the Records

According to the Procedure, a person responsible for the Records should be appointed (the “Responsible Person”) by every employer depending on the number of Employees on Record.  In particular:

• if the number of Employees on Record is less than 500, the responsibility for maintenance of the Records should be placed on an officer from the HR department (with additional compensation);
• if there are more than 500 Employees on Record, a separate Responsible Person should be appointed (which requires establishment of the relevant position); and
• if there are more than 2,000 Employees on Record, several Responsible Persons should be appointed.

The employer must notify the relevant military commissariat about the appointment, transfer or termination of any Responsible Person(s) within seven days.

Obligations of employers

Employers must: (i) at the time of hiring, verify whether the new hire has valid military registration documents; (ii) verify whether the information in the personal cards of the employees matches the records of the military commissariats with which such employees are registered; and (iii) update the personal cards of the employees if there are changes concerning their marital status, place of residence, education, job title, etc.

Also, if the employer is ordered by the military commissariat to notify the Employees on Record that they must come to the military commissariat (for instance, for military service or training), the employer must also notify the military commissariat in writing which individuals have disregarded the order and failed to arrive to the military commissariat.

Audits of maintenance of the Records

In the course of an audit, the following can be verified:

• accuracy and completeness of the Records; and
• timeliness of updating the personal cards of the employees and of notifying the military commissariat regarding relevant changes, etc.

In addition, certain HR documents may be examined, particularly the documents on the appointment of Responsible Persons and their remuneration, as well as on the hiring and termination of Employees on Record, the number of personnel protected from mobilization, etc.

* * *

By way of a reminder, Records must be maintained by all employers, regardless of the industry and whether private or state owned.

By Lina Nemchenko, Partner, and Mariana Marchuk, Counsel, Baker McKenzie