Quo Vadis?

With the ongoing economic turmoil in our country transactional activity is very poor. Many deals were aborted or kept on hold for better market conditions. Russian investors, who came or planned to settle in Ukraine, had to review their strategies. And the annexation of Crimea provoked an unprecedented situation for lawyers and clients on all sides. Oleh Malskyy, partner and head of corporate and M&A of AstapovLawyers International Law Group, says that internal regulation should be ultimately simple. Quo vadis? This simple question does not have a definite answer at the moment.

UJBL: The Ukrainian crisis provoked a slowdown in M&A deals. However, this is a favorable time for purchasing distressed assets. Which economic actors are vivid at the moment?

Oleh Malskyy: It’s true to say that a crisis indeed does provoke a slowdown in M&A deals. This, I would say is a general rule. If we talk about more specific rule, which is rather an exception to the general rule, indeed the crisis provoked several opportunistic buyers to look for assets, that are highly distressed or depreciated. This would be called a typical behavior of a trader, which looks for an opportunity whenever the market is down, with hope and inspiration that this market will grow in time as the markets are always cyclical. Therefore, the value of money has risen substantially and lots of clients are looking for distressed assets. However, it is also true that lots of potential buyers are not willing to go on another step below the value they think is already distressed one. It is a very usual situation when a seller wants to sell distressed assets and the buyer wants to buy them, however the buyer takes the position that despite quite a low price already he wants another 50% discount. This is the situation there is no zone of possible agreement between the two.

We have several clients who are looking for the assets to be sold really below their value. That level of pricing is hard to determine. One of my clients refers to that level as basically cost of construction, for instance, of the real estate object, minus 30%. Therefore, there are several potential buyers that do buy assets in Ukraine.

We see also quite a huge movement in life science area, biological and medical research fields where the buyers are actually looking for global buys, and those global targets have subsidiaries in Ukraine. So, irrespective of the situation, global deals that continue and those global companies that do have their assets in Ukraine, subsidiaries in Ukraine, sells in Ukraine are dragged into M&A transactions.

Another vivid client list is comprised of high-net worth individuals who are of Ukrainian background.

UJBL: Do you see any changes in the structuring of M&A deals in Ukraine? Which risks do you usually face when assisting your clients?

O.M.: When structuring M&A deals in current time, the main risk is, of course, a political one. The other risk is the uncertainty of regulatory environment, however, there is new team in place and there is a hope that regulatory environment will be more civilized and will not get more complicated. Tax structuring is also a concern because of changes to the taxation system. More and more clients pay attention to possibility of withdrawal of dividends, as well as other mechanisms of cash outflow from existing business. If we have an international buyer he would expect that, of course, once he bought the asset he would have the right after payment of all taxes due, to distribute dividends and expects that those dividends will be in a free float and he will have no hardships taking those out of the country. Despite that, the National Bank recently basically banned the payout of dividends and the clients are stacked with the local currency, which depreciates with no possibility to exchange. So, several of our clients decided to buy physical gold in banks just to hedge the currency risks. Such a situation substantially influences the assessment of risks of foreign investors, which believe that dividends are part of their property rights, especially after all taxes have been paid to the government.

UJBL: How does the choice of governing law affect legal advice given?

O.M.: The choice of law basically stays the same. Most of the deals, which are more complicated will be governed by English law. This is still a tradition from old times, as English law allows many niceties and is rather flexible to accommodate several needs of the clients, especially with regard to the shareholders agreement while it provides for warranties and disclosure. Smaller deals are governed by Ukrainian law on a local level. The difference in this case is of course that UK law firms are rarely attracted for the whole process and very often the deals are negotiated basically on the local level with local counsels, who have by this time pretty good understanding of English law and only the final document is submitted to a UK counsel for review, opinion and approval. This enables clients to save quite a lot of funds. Theoretically, the quality may suffer, however, I believe that by this time there are quite a lot of M&A lawyers in Ukraine who are sufficiently familiar with UK law and with the help of final review from the counsel they can do a pretty good job in this regard.

UJBL: How did the situation with the annexation of Crimea affect deals structuring in the peninsula? How does your firm solve sensitive issues of such transactions?

O.M.: The situation with Crimea of course effected debt restructuring and deals in the peninsula. One of the typical questions will be — under which law will the deal be structured: under Ukrainian or Russian or English? Another one will be the corporate clones that came into existence after the annexation. So Crimean companies will be registered as Russian companies, but they will not be struck off from the Ukrainian register of companies. So, basically this company will be counted twice in two countries, this causes quite a lot of issues. Specifically, if that company holds for instance trademarks or IP rights registered in Ukraine, so basically in Ukraine this would be a Ukrainian holder, in Russia it would be a Russian holder of Ukrainian trademarks, but, in fact, it will be the same company. There are also many tax issues with regard to that, etc. In a way, it is much easier to deal with the said problem on a foreign holding level and do transactions one level up. The same implies to real estate re-registration of rights, etc.

UJBL: You have an office in Moscow and usually support Russian business expanding to Ukraine. What is the situation from the Russian investors’ perspective?

O.M.: From the Russian investors perspective, I would say that most of our Russian clients are very much worried about the sanctions. However, it is true that Ukraine itself right now having introduced the law has not provided any sanctions so far and has not really worked out the mechanism to apply any of those sanctions to Russian companies.

In practice, lots of Russian clients do face problems on a local level, which usually are related, for instance, issues of work permit for Russian managers, governmental approvals of transactions, when they are needed, because in fact, there is an unofficial ban to issue such permitsfor Russian originated investors. So, in case a Russian investor would like to buy something right now in Ukraine there is a very real likelihood he will not be able to do so by way of blocking the approval that investor should get. On the other hand, we have a huge rise in Russian clients who demand representation in Ukraine in many aspects. Having a Moscow office helps in that regard, because it proves the firm is professional and apolitical as the ethics basically requires attorneys to be.

UJBL: How have the legislative novelties of M&A practice in law firms been affected of late? Do they change clients’ needs?

OM: The latest legislative changes are quite new to the market and I think that they will be more coming right now as a novelty. It is news to all the clients and it will take time for the market to get accustomed to them. I believe that soon we will see much more changes. I have recently talked to the newly appointed Head of Securities Commission and we discussed many potential issues that will be implemented and changed. I would say that joint stock companies are up for quite a big change as well and this change is very much needed. I believe that the so-called closed joint stock companies should be transformed into LLCs not to overburden the Securities Commission. This also goes to a number of big joint stock companies with lots of physical persons as shareholders; most of those physical persons are unreachable or unavailable either because of natural causes (like death) or they have immigrated quite some time ago and it creates a huge problem for corporate governance.

In any case, the initiative to enhance corporate governance is highly welcomed and I believe that it enhances the possibility to invest to the minorities shares of the joint stock companies. Now it is very problematic because of the lack of minority protection like squeeze out of rights, inspection rights, etc. Due to change and independent directors will enhance with governance. I think there will be more investors willing to invest. It also helps development of a better stock market, the idea is to have one or two stock exchanges and not ten or twelve that we have right now and to put more liquidity into stock exchanges. This will help joint stock companies to be able to do national or public offerings, not just to look for the capital internationally.

UJBL: How does the recent tax reform effect M&A activity? In what sectors do you still see activity? Which of them will be pioneers for recovery?

O.M.: Recent tax reforms will affect M&A activity. I believe that there are still much more questions than answers. The general trend is uncertain to be truthful, I believe that many of the tax reforms and initiatives that were called for and were announced at the very beginning, somehow failed to some extent, and were abandoned. I believe that right now, tax reforms should really focus on the future and not on past violations. So-called tax compromise is not really working for a number of clients. The main reason is that even if the client agrees to a “tax compromise” and tax evasion charges are dropped, there is a risk that other criminal charges will stay in place and that kills the incentive for a compromise (for instance, if charges are dropped under Article 212, 222 of the Criminal Code that does not automatically lead to charges dropped under Articles 358, 366 of the Criminal Code). Another idea will be that tax reforms should lead to very simple taxation, which may be turnover based (e.g. 10%), maybe abolishing of the VAT as such (some countries don’t have it all). And the rules are very simple.

Sectors where I see perspectives are definitely sectors that everybody thinking of. There is more talk about small, medium enterprises in the agrisector, most people do not believe after the “Mriya” story agri companies are a way forward. There is need for land reform in order to allow medium and small enterprises to grow into those markets, as well as a need of export reform to allow those enterprises to export directly not just through traders, which take much of the profit. This also goes to VAT refund during the export. But lots of people are thinking of investing in small or medium agrisector enterprises. Another interesting and potential area is, of course, pharmaceuticals, medical research, diagnostics centers, etc. Healthcare is an issue in such a country as Ukraine. Once the purchasing capacity increases there will be demand for high quality medical services, etc. Oil and gas was interesting, however the recent increasing in gas taxes and rent charges and JKX claim against the state killed interest in this area.

UJBL: Please, name key urgent improvements to Ukrainian legislation which you would recommend for introduction.

O.M.: As to urgent improvements in Ukrainian legislation I’d recommend to introduce ideas that are quite simple. I think tax reform is indeed a key one, I believe such a complicated system should be eased to the very maximum and should be very easy to follow. This, unfortunately, will lead to huge reduction in tax officials, which can do nothing else but being an official. I believe that’s why that idea is not so popular. However, I think it is time for quality not quantity. The number of taxpayers will increase as a whole, definitely making the business environment quite easier. Another important reform should be private entrepreneurship reform and incentive reform. There are quite a lot of incentives in the EU, which lead people to try to do their small business because if they do small business they will hire quite a lot employees for the time and take the burden of social payment from the state. So, I believe that incentives for start-ups and business incentives are very important. One such idea is so called “industrials parks”, draft law I’m commenting and helping to draft right now deals with the idea of creating an industrial park like Silicon Valley, which allows small and medium entrepreneurs to benefit from several aspects of such industrial parks but create efficiencies later on. And, of course, the key element to entrepreneurship is security with property. If the businessman is secured with the property of his business, or the profit of his business and may transfer that profit to the place he would like to and can exchange that profit for any well tradable currency that feeling of freedom and feeling of property will drive many more people into business. I believe that the more limitations put the more is the will to brake and overcome them. When those limitations are away there are actually less people willing to squeeze out funds out of the country and invest elsewhere.

On a macro level I believe that reforms should be focused on “earning money for the state”. Since, there is a risk of sovereign default, I would focus on “income” as a priority. I believe that if we start reforming everything at once (judicial system, education, etc) we will not be able to achieve the most important targets. Therefore, I believe reforms should be prioritized and not simultaneously run in all directions. To achieve that income I would focus on Top-5 money earning strategies: 1) Export promotion; 2) Collection (Tax & Tariff); 3) Saving (cost-cutting); 4) Assets sale (privatization); 5) Borrowings (this however is not earning).

---

AstapovLawyers

Key facts:

• Year of establishment 2002
• Number of lawyers/partners 76/7
• Core practice areas
  • International Arbitration
  • Litigation
  • Corporate and M&A
  • Competition & Compliance
  • Intellectual Property
  • Energy and Natural Resources
  • International Tax Planning
  • Agribusiness