Cover Story (#07-08 July-August 2017)

Cornerstones of Law

Ukrainian agriculture is one of the core drivers of the economy. This sector demonstrates growth even in times of unfavorable market conditions and numerous constraints and restrictions to its development.

The moratorium on the sale of agricultural land produces a great deal of emotive debate and is widely quoted by populists to earn political points. From the business perspective, the situation has resulted in the spreading of an alternative to sale mechanisms and determined a certain market landscape that is rather suitable for big players. It revealed that too many stakeholders follow their own interests and fail to consolidate around cornerstones of law.

We arranged a very insightful conversation with the Real Estate and Land Law Practice at the Spenser & Kauffmann law firm, contributed to by its head Aleksandra Fedotova, partner, PhD, co-head Maksim Maksimenko, counsel, PhD, and Dmitriy Nikolov, associate.

The moratorium on sale of agricultural land in Ukraine has been justified by many different objectives. How would you comment on its consequences?

Aleksandra Fedotova: First of all it should be mentioned that most attempts to justify the moratorium are either political or could be regarded as a desire to maintain the status quo, and such attempts have nothing in common with the market economy or transparent performance by local authorities of their functions.

A few words should be said about the history of the moratorium. Firstly, the Law of Ukraine On Agreements Concerning the Alienation of Land Shares No.2242-III, adopted on 18 January 2001, established that until the procedure for the implementation of the rights of citizens and legal entities to a land share (pai) is regulated, they cannot enter into sale and purchase agreements, gift a land share or otherwise alienate these shares, with the exception of their transfer by inheritance and buying out of land plots for the needs of the state and the general public. However, the Land Code of Ukraine adopted in 2001 not only determined the term for this prohibition of alienation until 1 January 2005 but also extended it both to land shares and land plots for farming as well as for commercial agricultural production regardless of the form of ownership. This became known as the moratorium on the purchase and sale of agricultural land.

Introduced originally in 2001 as a temporary measure, the moratorium has been extended 8 times.

Some of the negative consequences of the moratorium are excessive land parceling (as a result the impossibility of conducting economically viable agricultural business on such small land plots in the majority of cases); high operating costs for the formation and retention of such a distracted land bank; ecological problems, especially related to erosion of land (including the impossibility to introduce mechanisms of soil protection on such a large number of land plots owned by different owners). Moreover, the statistics show that about a million deceased people failed to realize their land ownership through the disposal of such land plots. The moratorium preserves all these issues.

It should be noted separately that farmers try to support the infrastructure of their communities by any means, including social payments which are not provided for by current legislation (so-called social packages) and villagers are afraid that such social packages will be cancelled in the event of the moratorium being lifted.

Adoption of laws on agricultural land turnover is expected by the end of 2017 and is one of the requirements set by the IMF. How do you assess the prospects for its adoption? What are the commitments if Parliament fails to adopt appropriate legislation?

Maksim Maksimenko: In our opinion, at the moment the complete lifting of the moratorium possesses an illusory prospect. The main reason is that large agro-holdings are not interested in this as the current situation whereby rents are low satisfies them completely.

We partially agree with the opinion that over the short term there may also be negative political effects. Given the current military situation with Russia and reduced living standards, a good portion of the population may become over-excited by the possibility that Ukraines land may fall into the wrong hands. Populists may take advantage of these concerns.

As we know the updated program of cooperation between Ukraine and the IMF provides that Ukraine is obliged to launch the market of agricultural land turnover. Parliament was obliged to develop a draft law on the land market by the end of May (but this draft law has not been adopted to this very day).

Since the main reason for cooperation between Ukraine and the IMF is receipt of new tranches for investment in the Ukrainian economic system, the only commitmentof Parliaments failure to adopt appropriate legislation is that Ukraine may not receive the next IMF tranche (for example, Ukraine expected to receive the fifth IMF tranche this summer to the tune of USD1.9 billion).

At the beginning of July 2017 two mutually exclusive pieces of news were shared on the Internet that the reason for postponing the above IMF tranche till winter is that Ukraines obligations regarding land reform are not being carried out, and that President of Ukraine agreed with the Head of the IMF that the moratoriums cancellation is not a precondition of the tranche.

There are two main draft laws on agricultural land turnover, No. 5535 and No. 5535-1. What changes do you expect to these documents? How can the legal community affect the draft laws?

Dmitriy Nikolov: In the context of both draft laws we want to note that we do not support the establishment of restrictions on the size of land plots which may be owned by an individual, since such restrictions are economically and organizationally inappropriate and impose significant barriers to cost-effective economic activity, restricting the right to ownership as established in Article 41 of the Constitution of Ukraine. We also do not support the lifting of the moratorium for legal entities only from 2020.

The legal community can affect the draft laws through various NGOs (UBA, EBA, etc.). Moreover, current legislation provides for procedures on public discussion of draft laws, including parliamentary hearings (in particular, such provisions are established by the Law On the Principles of State Regulatory Policy in the Economic Activity Sphere).

How could you comment on the position held by the state authorities and officials regarding the moratorium?

D. N.: The approach of the State Service of Ukraine for Geodesy, Cartography and Cadastre is contained in the Draft Law On Agricultural Land Turnover. The Draft Law provides for the lifting of the moratorium and the land markets introduction from 1 January 2018. The subjective composition of landowners includes only citizens of Ukraine, local self-government and executive bodies.

If we are talking about senior officials of Ukraine such as the President of Ukraine, Prime Minister, Finance Minister and Head of the National Bank, then they signed the updated Memorandum on Ukraines cooperation with the IMF which provides for the cancellation of the moratorium by 2018.

Some MPs oppose the lifting of the moratorium referring mostly to populist statements, that foreigners will acquire agricultural land and as a consequence this will destroy Ukrainian villages. Nevertheless, in our opinion, the key problem is to reach agreement on the cornerstones of the future law: subjective composition of landowners, restrictions on size, stages of implementation of agricultural land turnover, etc. Unfortunately, these issues are now more political in their nature.

A total of 55 MPs addressed the Constitutional Court with a request on cancellation of the current moratorium on the sale of agricultural land. What legal consequences do you predict after the consideration of this appeal?

A. F.: It should be noted that we do not believe in the prospect of the moratorium being lifted through the Constitutional Court of Ukraine (hereinafter — CCU). There are several reasons for this:

1) at the moment the CCU has postponed consideration of the moratorium case as one that is not of paramount importance;

2) unfortunately, in recent years the CCU has become a political authority, and therefore in many respects the decision depends on the balance of power within Parliament itself;

3)moreover, case consideration may be delayed for many months (such a situation arose in the case of the law on lustration’s constitutionality).

 

M. M.: In our opinion, at least several legal issues could arise after the consideration of this appeal in the CCU:

1) the moment of the moratorium’s unconstitutionality and the “fate” of transactions concluded prior to its recognition as unconstitutional; as a consequence we could face massive revision of judicial decisions on newly-discovered facts (the reason is recognition of the law as unconstitutional);

2) the alienation of agriculture land will only be regulated by the Civil and Land Codes. Nevertheless, in our opinion, such regulations will be sufficient and will satisfy the needs of turnover at the beginning.

In the final analysis, nothing forbids the adoption of a new moratorium after the CCU’s adoption of a decision.

What are the alternative mechanisms to selling land?

D. N.: At the moment the alternative mechanisms to selling land are land lease, the emphyteusis (emphyteusis rights), and the acquisition of corporate rights of legal entities.

According to current legislation, land lease is a contract based on limited time paid possession and use of the land plot needed by a lessee for conducting entrepreneurship and other types of activity. There are no restrictions regarding persons that can be land lessees. The term of a land lease agreement cannot exceed 50 years and cannot be less than 7 years. The leasing of land is currently the most popular and common form of use of land plots.

In the context of land lease rights circulation, it should be mentioned that in general, with regard to an up-to-date land lease rights market in its common understanding, which provides sale and purchase of such rights, does not exist in a straightforward way. Due to legislative provisions, only the owner of the land plot can alienate the right to lease out such a plot.

According to legislation an emphyteusis right is a right to use the land plot owned by another person for agricultural purposes. The main advantage of the emphyteusis right (to private land plots) is its free circulation: the emphyteusis right is a right in rem so thats why this right can be alienated (sold, inherited, contributed to the charter capital of a legal entity) and transferred into pledge, and the land owners consent on the abovementioned deeds is obtained at the moment of execution of the emphyteusis agreement. The term of an emphyteusis agreement is unlimited for private land plots and cannot exceed 50 years when the object of emphyteusis is a state or municipal land plot.

In order to circumvent the moratorium it is often convenient to acquire the corporate rights of a legal entity which is the owner of the agriculture land plot, the lessee under the lease agreement or emphyteuta.

How do you evaluate the prospects of the land lease and emphyteusis markets?

D. N.: As Ive mentioned above land lease is the most popular form of use of land plots in Ukraine. For example, as of 1 July 2015 in Ukraine:

-4.7 M. private agricultural land lease agreements were executed related to lands with a total area of 16.6 M. ha (the average size of the leased out land plot was 3.6 ha), i.e. 54% of all private agricultural lands;

-56 K. state agricultural land lease agreements were executed in relation to land with a total area of 2.5 M. ha.

The land lease institution is one of the most regulated institutions in Ukrainian legislation and could be regarded as a convenient form for conducting agribusiness. Taking into account that the average term of a land lease agreement in Ukraine is currently about 7-10 years (many of them have been renegotiated on the same term) the land lease market can be considered as an essential alternative to land purchase.

It should be stated that such a legal instrument as emphyteusis is insufficiently used by enterprises in Ukraine. Nevertheless, in our opinion, the opportunities for this institution are undervalued. Firstly, emphyteusis is regarded in Ukrainian legislation as a right in rem, which is why the main feature of this institution is full turnover (as opposed to lease rights, emphyteusis can be alienated under any agreement). Secondly, in comparison with a lease agreement, the institution of emphyteusis includes fewer grounds for termination. It indicates better protection and risk avoidance for the pledgee regarding the termination of the emphyteusis.

Nevertheless, the main obstacle is that almost all private agricultural land is leased and re-registration of lease agreements into emphyteusis agreements requires a lot of time and financial resources. Considering that the average term of land lease agreement in Ukraine is about 7-10 years and many of them have been renegotiated in the last few years, large-scale implementation of the institution of emphyteusis into the agricultural land market may take about 10-15 years in the medium term.

Regarding the current economic situation in Ukraine (in particular, financial and lending markets), we should note another prospective direction of the agrarian sectors development implementation of land lease and emphyteusis rights as collateral. But today there are no existing practices of land lease mortgages and current statistics in this sphere are absent.

What problems do your clients face when using these mechanisms? What legislative changes should be introduced to simplify their use?

A. F.: In the case of land leases, most of the problems are purely of a legal nature. First of all this refers to the invalidity of such agreements. The legislation, which was valid until 20 February 2015, contained 11 essential terms and 5 integral supplements to a land lease agreement, and the absence of at least one of them in the agreement was a formal ground to recognize the agreement invalid. Another problem is the lack of permanent judicial practice on lease agreement termination issues (especially on the grounds related to non-payment of rent), the commencement of the term of agreements (from the moment of its signing or registration). Moreover, the legal procedure for renewing a land lease agreement remains ambiguous, which results in permanent court disputes between lessors and lessees.

When we talk about the emphyteusis market it should be mentioned that this tool is not widely used in Ukraine. In our opinion, the explanation for such statistics is the fear held by landowners in working with the institution of emphyteusis, which is unknown for them. In all other respects we believe that this institution does not have any significant problems (except for the impossibility of land plot transfer in use to other persons via emphyteuta).

In order to simplify the use of land lease we should resolve the following issues:

to determine the legal nature of the lease (as right in rem or obligatory right);

to clarify the contract renewal procedure;

to establish the possibility to use land lease rights as a form of collateral.

Are Ukrainian banks ready to provide finance upon security of land lease rights?

M. M.: First of all it should be noted that current Ukrainian legislation contains provisions which establish that pledgees of agricultural land and rights thereto (lease rights, rights of emphyteusis) can only be banks (with no exceptions).

Nevertheless, despite such a monopoly position, Ukrainian banks are quite skeptical about the possibility of providing loans to agricultural enterprises using lease rights as collateral under these loans. The main reasons are the low liquidity of lease rights as collateral and lack of practice and methods of lease rights evaluation. The National Bank of Ukraine does not consider lease rights as acceptable collateral that could provide an effective guarantee for the bank under a loan and does not determine a liquidity ratio for such a form of collateral.

Ukrainian banks also believe that the use of lease rights as collateral in the long term is unlikely due to the fact that the evaluation of lease rights is depreciated in proportion to the reduction of the term of a lease contract.

Banks now prefer to lend under corporate rights as collateral since they consider this asset more valuable and liquid.

Taking into account the above, Ukrainian banks are not ready to provide finance upon the security of land lease rights.

What changes do you anticipate in the development of Ukrainian agribusiness?

A. F.: First of all we should mention tax problems in connection with subsidies in agribusiness. We can identify the following problems that have to be resolved:

blocking of special accounts;

impossibility to register tax invoices / settlements of adjustments which were made up till 1 January 2017;

absence of a registry under which an entrepreneur could see the amount of subsidy he/she could receive;

absence of time limits during which the State Treasury Service of Ukraine has to pay a subsidy.

M. M.: In other spheres of agribusiness we could also highlight problems like:

shadow rent (without entering into a contract and registering rights);

lack of reforms in the sector of state enterprises land usage (a huge land bank which is not used effectively)

lack of proper infrastructure (including wholesale markets for agricultural production);

lack of support for small and medium-sized agribusiness;

necessity for legislative regulation of land consolidation in order to resolve the parcel problem, as well as

necessity for harmonization of Ukrainian standards with European equivalents.

We believe that solving the above-mentioned problems can help to develop Ukrainian agribusiness.

Spenser & Kauffmannkey facts:


  • Year of establishment:
  • 2006

  • Number of lawyers/partners/tax consultants:
  • 34/5/2

  • Core practice areas
  • Accounting Services, Antitrust and Competition, Banking and Finance, Capital Markets, Corporate and M&A, Energy and Natural Resources, Enforcement Proceedings, Insurance, Intellectual Property & IT Law, Labor & Employment, Litigation & Dispute Resolution, Private Client, Real Estate and Land, Tax Litigation, Tax Consulting

    Subscribe
    The Ukrainian Journal of Business Law

    Subscribe to The Ukrainian Journal of Business Law right now and enjoy the most relevant issues on doing business in Ukraine on your device or in print.

    All this for just USD 9.99 a month.

     

    Subscribe now

    .