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Associate, Baker McKenzie
Privatization in Ukraine
It’s been almost a year since the new rules on privatization of state and municipal property came into effect. Originally, the upgraded legal framework was aimed at speeding up the overall process of sale of state and municipal property, and it certainly reached that goal to the extent it relates to sale of small privatization assets via an e-auction system. By February 2019, the total revenue from sale of all the small privatization assets for the last half year was close to UAH 800 million. More than 40% of e-auctions are successful, with the average price increasing by almost 70%. The types of small privatization assets vary from certain abandoned real estate located on the fringes of the country to fully functioning businesses with strong customer relations.
Unfortunately, not a single sale of large privatization assets was made in 2018, whether under the umbrella of the ‘old’ rules or pursuant to the new regulations, and none of the instruments provided for by the new framework has been tested yet. The updated list of large privatization assets for coming years include such companies as Centrenergo (power generation), UMCC (mining of non-ferrous metals), Electrotyazhmash (manufacturing of power generators), Odesa Portside Plant (production of fertilizers), President Hotel, Indar (insulin products manufacturing), Ukragroleasing (leasing of agricultural machinery), several regional power distribution companies (e.g., Kharkivoblenergo, Mykolaivoblenergo) and TPPs (e.g., Odesa TPP, Kherson TPP, Dnipro TPP), and other companies.
Assets & Buyers
All privatization assets are divided into two groups — large privatization assets (LPAs) and small privatization assets (SPAs). LPAs are shares in joint-stock companies and key assets of companies, the asset value of which exceeds UAH 250 million and where the state owns 50% of shares or more. All other assets fall into the SPA category.
Privatization regulations embed a principle pursuant to which all assets that are not prohibited from privatization can be sold. From a buyer’s perspective, this means that any asset not prohibited from privatization by virtue of the law can be sold, for example, at the buyer’s initiative, regardless of whether it is listed as an LPA or SPA.
As for the qualification criteria for buyers for the purposes of privatization, the law sets out a list of persons who cannot qualify as buyers, in particular:
— buyers with non-transparent ownership structures registered in offshore zones;
— buyers registered in states included on the FATF blacklist and their 50% direct or indirect subsidiaries;
— the aggressor state and legal persons where such state holds equity interest, as well as other entities controlled by such legal entities;
— legal entities whose beneficial owners of 10% or more of shares (equity) in such legal entities are residents of the aggressor state (Russia, except for companies whose shares are traded on foreign stock exchanges other than those located in aggressor state);
— individuals (citizens or residents) of the aggressor state;
— persons under the national sanctions regime and their affiliates;
— Ukrainian legal entities whose beneficial owners have not been disclosed in breach of the applicable law; and
— persons who used to be a party to a privatization agreement, which was later terminated as a result of violations by these persons and their affiliates.
If the winner of the auction refuses to sign the sale and purchase agreement in respect of an LPA or SPA, the winner and its end beneficiary will not be allowed to participate in any future auction for the sale of such asset. This approach allows the government to cut off disreputable investors and requires buyers to think more carefully when selecting a partner for a privatization project.
Furthermore, the buyer attracting the financing to purchase the privatization asset must provide information on its creditor, who must meet the requirements of the buyers of privatization assets stipulated in the law.
Sale of Large Privatization Assets
Regarding sale of LPAs, implementation of the new rules reduces the risks associated with determining the starting price: the price shall be determined by a professional adviser engaged by the privatization authority. This should eliminate the conceptual conflict that used to be embedded in the law when the starting price was determined by valuation, which should have reflected the fair market value of the asset, while, in principle, the fair market value would be determined as a result of the auction. However, this only applies where an investment adviser is engaged, since, in the event that no adviser wishes to support the sale process, the starting price would still be determined by the privatization authority on the basis of the results of an independent valuation.
As for the actual sale process, the default option is an “English” auction with at least two bidders. However, if only one bidder is qualified, the LPA may be sold directly to that buyer at a price not less than the starting price. If the LPA is not sold by auction or direct buy-out, the sale shall be made via auction where the starting price should be determined by indicative bidding with the bid secured by an auction deposit (either in cash or as a bank guarantee).
The law expressly provides for cases where an LPA may be sold with a 25% or 50% decrease from the starting price via an “English” auction; however, it is not entirely clear when the privatization authorities shall announce the indicative bidding action. That is, immediately following the very first auction where the LPA has not been sold, or after two failed auctions when the starting price has been decreased by 25% and 50%, respectively. These tools give a certain degree of flexibility to privatization authorities, allowing them to choose the sale method appropriate to each particular asset depending on its individual characteristics.
Furthermore, the law allows the privatization agreement to be governed by the laws of England and Wales at the buyer’s request. However, this option is only available until 2021 if the Ukrainian Parliament does not extend it in the future.
The key point of the new regulations is the issue of protection of buyers’ rights. The provisions governing the content of a privatization agreement, even if governed by Ukrainian law, may include a set of warranties of the seller as to information on the LPA, and the respective liability for breaching them. Furthermore, after a privatization agreement has been signed, the target company shall not conclude any agreements that are beyond its ordinary course of business without the buyer’s prior consent, e.g., asset pledge, set-off, suretyship.
Given that many state or municipal enterprises have significant debt (typically simulated), the law prescribes an important protection mechanism: no bankruptcy proceedings shall be brought, within one year following completion of a privatization deal, against a privatized company based on grounds that relate to a period prior to the deal’s completion. On top of that, once a privatization agreement has been signed, no changes to the custody account relating to arrest or placement of other encumbrances shall be made until the title to the LPA passes to the buyer. These protection measures would allow buyers to directly control any cash-out from the target company after signing the sale and purchase agreement and to increase the overall attractiveness of an asset.
Sale of Small Privatization Assets
With regard to the privatization of SPAs, all SPAs shall be sold via an electronic auction system. The privatization authorities conclude the agreements via e-platforms that are functionally capable of holding privatization auctions. In the main, all the processes relating to submission and acceptance of bids as well as determination of the winner of the e-auction are automated and do not require the involvement of privatization authorities until the binding sale and purchase agreement is being executed.
In terms of the auction process, the default scenario is an “English” auction with at least two bidders, and if there is only one bid submitted in respect of an SPA, the asset shall be sold directly to that bidder. If the SPA is not sold, the starting price for the asset shall be decreased by 50%. If the SPA still does not sell, the starting price shall be decreased again by 50% and the asset shall be sold at a “Dutch” auction.
To some extent, the protection of buyers’ rights is also applicable in the sale of SPAs. Prohibition of bankruptcy within one year following completion of the deal, as well as placement of an encumbrance over the shares, remain topical for the sale of SPAs.