Investing in Ukraine: How to Make a Successful M&A Deal
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Avellum is a leading Ukrainian full service law firm with a special focus on finance, M&A, and dispute resolution.
The firm covers capital markets, competition, corporate/M&A, dispute resolution, employment, banking and finance, energy and infrastructure, real estate, restructuring and insolvency, and tax.
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Although the topic of this article may seem to go against the current trend, sooner or later it will again become popular to invest in Ukraine. Like any other investment instrument, an M&A deal in Ukraine has its own specifics.
One of the main features of a successful M&A deal is when the parties are able to identify and bridge gaps between them, which is often a difficult task. In case of a Ukrainian M&A deal, this task becomes even more difficult when the buyer is a foreign entity dealing with a local seller.
As evidenced by various international ratings, the investment climate in Ukraine has improved in the past few years. Moreover, Ukrainian businessmen are not as ignorant on how to carry out M&A deals as they were several years ago.
Therefore, a foreign buyer does not have to come to Ukraine wearing a bulletproof vest any more (figuratively speaking, of course). However, there are still a number of specific points of a local nature that they should be aware of before starting the deal.
As a response to Russia’s illegal annexation of Crimea and its support of separatists in Eastern Ukraine, both Ukraine and its Western partners (mainly, the EU and US) have introduced various economic sanctions against Russia. Some of these sanctions are sectoral, while others are personal.
Thus, a diligent foreign buyer should check this matter in advance to make sure that these sanctions affect neither the seller nor the target in question.
Any Serious Deal in Ukraine is Done under English Law
Although Ukrainian law is gradually evolving, it is still unable to provide parties to an M&A deal with the sufficient range of legal instruments comparable with those provided by English law. Warranties and indemnities serve as a good example. Option agreements and other instruments common in Western shareholder 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.
In addition, corruption in the Ukrainian judicial system, which still remains at a high level, is another factor that forces the parties to an M&A deal to govern their relations by non-Ukrainian law and subject their disputes to non-Ukrainian judicial authorities (often to an arbitration under the rules of the London Court of International Arbitration).
Legal Due Diligence
When conducting legal due diligence in Ukraine, you should expect various violations of corporate law due to the historical growth of companies. Past real estate acquisitions are rarely free of procedural violations. Pensions and the environment are not yet hot topics in Ukraine, while regulatory issues are quite common among manufacturing and FMCG companies.
The good news is that, due to the recent deregulation in Ukraine, as well as tax and antitrust “amnesties”, the exposure of local companies to various regulatory risks has been reduced, which may often result in “cleaner” due diligence reports than before.
Another piece of good news is that, as a result of recent reforms, Ukrainian public registers have been substantially improved and now most of the registers are both reliable and accessible via the internet. By way of example, now, knowing just basic information about a Ukrainian company, you can quite easily find corporate information on it, information on its real estate, litigations it participates in, licences it holds and whether or not it is in insolvency proceedings.
Some Ukrainian sellers are still not used to engaging a professional legal advisor in M&A transactions. They tend to rely on their in-house counsel, who often has limited practical experience in sophisticated M&A. The buyer and its legal counsel may spend days explaining the mechanics of an English law agreement. Eventually, the Ukrainian seller is likely to realise the need for professional legal advice and will hire a law firm to advise him on the agreement already negotiated!
We strongly recommend that the foreign buyer insist on the seller engaging qualified lawyers from the outset.
Warranties and Indemnities
Some Ukrainian sellers are unfamiliar with the notion of warranties and indemnities. This means that many sellers will resist giving extensive warranties and will refuse to give any indemnities whatsoever. In the view of such a seller, once the deal is closed it will not refund any money to the buyer. One of the reasons for this is that, at some stage, M&A deals “as is” were widespread in Ukraine.
However counterintuitive this may sound, we strongly recommend requesting a disclosure letter from the Ukrainian seller early in the negotiations, even if the seller is reluctant to prepare one. The simple reason is that the disclosure letter could flush out any “skeletons in the closet” not previously disclosed to the buyer in the course of legal due diligence. While this is true in other jurisdictions as well, it is particularly so in Ukraine.
Indeed, some unpleasant surprises are possible, because some sellers are naturally less inclined to disclose their problems at the stage of due diligence. They fear that this might affect the valuation of the target and prefer to disclose this at the stage of the disclosure letter, when they finally realise that the more problems they disclose the less liability for breach of warranties they will bear.
Who Gives Warranties and Indemnities?
It is important to bear in mind that warranties and indemnities are worth as much as the party giving them is. If the seller is dealing through its offshore holding company or a special purpose vehicle (SPV), it is likely that such a company has few assets and may not be around when the buyer raises a warranty claim.
Thus, it is always better either to withhold a portion of the purchase price or to have a financially strong guarantor to cover potential losses. For example, a public company with listing on a major stock exchange or a bank. Personal guarantees by ultimate beneficial owners seem to remain popular, but their practical value is often limited.
A foreign buyer should also be aware that such a security instrument as warranty and indemnity insurance, while popular in more developed jurisdictions, is still broadly unavailable in Ukraine.
Therefore, it is critical to discuss the issue of security in detail and we encourage you to do so as soon as possible in the negotiations (and, for instance, to clearly include this in a term sheet or a letter of intent). Some sellers are not prepared to provide any security if this was not agreed from the outset.
Discuss early on whether an onshore or an offshore structure will be used in your acquisition. Ukrainian sellers will often have tax optimisation or reputational concerns and will insist on selling a foreign holding company (Cyprus is a common domicile) with Ukrainian assets underneath it. At the same time, it might well be that no such foreign structure exists at the moment the negotiations commence.
Therefore, if an offshore structure for the deal is agreed, insist on starting the restructuring as soon as possible and monitor it closely. It normally takes several months to properly complete a corporate restructuring for an offshore structure. The timing will largely depend on whether the target group was historically formed in accordance with antitrust rules. If yes, the corporate restructuring will be regarded as an intra-group and, as such, will not require any antitrust approvals. Otherwise, such approval will be required which will prolong the process (see section on regulatory approvals below for more details on antitrust approvals).
Escrow arrangements, a popular and handy mechanism in the West, do not formally exist in Ukraine. This is one of the reasons why many M&A deals in Ukraine are done offshore.
Some commercial banks offer solutions which, in effect, work as escrow mechanisms in support of simultaneous completion. However, these solutions work well only with the sale of shares in a Ukrainian joint stock company. In the case of sale of shares in a limited liability company, more complicated structuring is required to achieve something similar to escrow.
While certain positive legislative changes allowing escrow arrangements may occur in the short-term perspective, Ukraine is still not there.
As a rule of thumb, documentary escrows are generally possible in Ukraine, while cash escrows are not.
Virtually all good acquisitions in Ukraine are likely to require the prior approval of Ukrainian antitrust authorities for concentration. This is because the financial thresholds under Ukrainian competition law remain very low.
Long-awaited legislative changes in this area were adopted in January 2016 and will come into force in May 2016. These changes increase the financial thresholds triggers to more reasonable levels and simplify the merger filing procedure.
If the target is doing business in a certain regulated area (e.g., banking, insurance or securities trading), in addition to the antitrust approval, in order to close the M&A deal the buyer will have to obtain separate approval from the relevant regulator.
Furthermore, depending on the legal form of the target and the area of its business, the M&A deal may trigger certain notification requirements.
Non-Compete and Non-Solicitation Clauses
Common clauses in Western share purchase agreements, non-compete and non-solicitation clauses are not easily enforceable in Ukraine. In particular, the enforceability of non-solicitation clauses will be limited by the applicable labour legislation of Ukraine, which is quite pro-employee now.
Finally, a non-compete arrangement requires prior approval from the antitrust authorities of Ukraine. Unlike in more developed jurisdictions, a non-compete arrangement will not be covered by an antitrust approval for the transaction mentioned above (concentration approval), but requires separate approval (concerted actions approval).