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Managing Partner, Baker McKenzie – Kyiv
Senior Associate, Baker McKenzie – Kyiv
Privatization in Ukraine
It’s been almost two years since the new rules for the privatization of state and municipal property came into effect. Originally, the upgraded legal framework was aimed at speeding up the overall process of selling state and municipal property, and it certainly reached that goal to the extent that it relates to the sale of small privatization assets via an e-auction system. 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 relationships. As of the end of 2019, total revenue from the sale of all small privatization assets amounted to UAH 2.03 billion, where 40% of e-auctions were successful, with an average price increase by more than 63%. It is also expected that alienation of small and large privatization objects in 2020 will ensure revenues to the state budget of UAH 12 billion.
Unfortunately, there was not a single sale of any large privatization asset in 2019 and none of the instruments provided by the new framework have been tested yet. The updated list of large privatization assets for coming years includes companies such as Centrenergo (power generation), UMCC (mining of non-ferrous metals), Electrotyazhmash (manufacturing of power generators), Odesa Portside Plant (production of fertilizers), Indar (insulin product manufacturing), Ukragroleasing (leasing of agricultural machinery), several regional power distribution companies (e.g., Kharkivoblenergo and Mykolaivoblenergo), TPPs (e.g., Odesa TPP, Kherson TPP and Dnipro TPP), the President Hotel and other companies.
Assets and Buyers
All of the 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% or more of the shares. 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 (Russia) and legal entities 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 the shares (equity) in such legal entities are residents of the aggressor state (except for companies whose shares are traded on foreign stock exchanges other than those located in such 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;
– Persons who used to be a party to a privatization agreement that was later terminated as a result of violations by these persons and by 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 financing to purchase a privatization asset must provide information on its creditor, who must meet the requirements put on buyers of privatization assets, as stipulated in the law.
Sale of LPAs
Regarding the sale of LPAs, the implementation of the new rules reduces the risks associated with determining the starting price; the price will 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 fact, a fair market value would be determined as a result of an auction. However, this only applies where an investment adviser is engaged, because if 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 buyout, the sale will be made via an auction where the starting price should be determined by indicative bidding with the bid secured by the auction deposit (either in cash or as a bank guarantee).
The law expressly provides for cases when an LPA may be sold with a reduction of 25% or 50% from the starting price via an “English” auction; however, it is not entirely clear when the privatization authorities will announce the indicative bidding auction. 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 reduced by 25% and 50%, respectively. These tools give a certain degree of flexibility to the 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.
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 will not conclude any agreements that are beyond its ordinary course of business without the buyer’s prior consent, e.g., asset pledge, set-off or suretyship.
Given that many state or municipal enterprises have a significant amount of (typically simulated) indebtedness, the law prescribes an important protection mechanism: no bankruptcy proceedings will 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 the arrest or placement of other encumbrances will 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 the signing of the sale and purchase agreement and to increase an asset’s overall attractiveness.
Sale of SPAs
In relation to the privatization of SPAs, all SPAs will 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 of the processes relating to the submission and acceptance of bids as well as determination of the winner of an e-auction are automated, and they do not require the involvement of privatization authorities until the binding sale and purchase agreement is 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 will be sold directly to that bidder. If the SPA is not sold, the starting price for the asset will be decreased by 50%. If the SPA still does not sell, the starting price will be reduced again, this time by 50%, and the asset will be sold at a “Dutch” auction.
To some extent, the protection of buyers’ rights is also applicable to the sale of SPAs. The prohibition of bankruptcy within one year following completion of the deal, as well as placement of an encumbrance over shares, remain current for the sale of SPAs.