Ukrainian M&A transactions after more than four years of war

The unprovoked full-scale Russian aggression against Ukraine is now in its fifth year and continues to have profound impact on mergers and acquisitions in Ukraine. M&A activity has adapted to the war situation and is continuing, at a lower level, during the conflict. While uncertainty and significant security risks persist and local players continue consolidating and restructuring local businesses’ existing assets, recent technological developments have brought Ukraine back on the radar of certain foreign strategic investors. A massive inflow of foreign state money attracts entrepreneurial and opportunistic actors looking for suitable deals in the defense, energy, IT, and related sectors. However, ongoing migration of millions of Ukrainians to abroad has worn thin the workforce of more than a few businesses, triggering discussions on whether to relax restrictions on immigration of third world migrants.

Currently, most promising and attractive to opportunistic foreign investment are the Ukrainian defense and energy sector, followed by agriculture and consumer goods.

In the Ukrainian defense industry, groundbreaking developments are occurring at a fast pace regarding state-of-the-art military technology solutions. These include UAVs, drone interceptors, electronic warfare, ground robotic systems, cruise missiles, air defense, and others. While foreign investment remains under tight state control due to national security considerations, Ukrainian state and private sector players continue to actively pursue military cooperation with numerous partner nations. The ongoing conflict around Iran has brought new opportunities for in-bound as well as out-bound investment involving the Ukrainian defense sector.

The Ukrainian energy sector, which has greatly suffered as a primary target of Russian air strikes, has recently seen an uptick of investment as energy production, storage, and distribution structures are transforming into smaller-scaled, decentralized and more flexible segments with sizeable foreign state aid flowing in.

Careful consideration is needed how to address the war situation during each stage of an M&A transaction. War can become a serious deterrent and even render a transaction unfeasible due to considerable associated risks, such as when the target company or its assets are located in an occupied territory or close to the frontline or are (as in the case with energy facilities) potential targets of air strikes. In many cases, the conflict will trigger specific obligations of the parties to a transaction agreement.

Term Sheets

In the context of the war in Ukraine, both buyers and sellers will often seek to postpone the signing of a term sheet, letter of intent, heads of agreement or a memorandum of understanding until the buyer has completed due diligence and the extent of the war impact on the target’s business has been fully estimated.

Furthermore, the content of a negotiated term sheet will be somewhat different from what is normally included in such a document and also reflect specific pre-closing and closing conditions, especially long-stop dates and material adverse effect clauses.

Due Diligence

The war has altered the professional practice of conducting the legal due diligence of a target. Due to physical safety issues, primarily in areas close to the frontline and active battlegrounds, as well as the constantly present risk of air strikes by Russia, many enterprises still practice a remote work regime (where that is feasible considering the nature of a particular business, for example, IT, consultancy services, etc.) or have relocated the workforce to” safer” western regions of Ukraine or even abroad. Therefore, virtual data rooms are standard in almost all transactions. In-person management representations and interviews are typically substituted by video conferences. The parties should also adjust their timetables and take into account possible delays in the collection of additional documents.

Furthermore, the conflict has considerably changed the scope of due diligence. In particular, buyers need to investigate specifically how the war situation impacts the target’s business, including such aspects as (i) the existing or potential physical damage to, and destruction of, the target’s assets; (ii) employment, in particular, how mobilization and migration is affecting the target’s workforce; (iii) supply chain risks; (iv) legal obligations under key business contracts; (v) forex restrictions, financial and tax liabilities; (vi) contingency arrangements and business continuity plans; (vii) insurance policies and their coverage, (viii) any presence of Russian elements in the shareholding structure as well as connections to sanctioned persons, and properly evaluate all related legal risks.

Finally, the conduct of legal due diligence is complicated by the fact that access to the (otherwise publicly accessible) Ukrainian public registers containing material corporate data on legal entities (such as the Unified State Register of Legal Entities, Private Entrepreneurs, and Public Organizations) and information on real estate assets (such as the State Register of Rights to Real Property) can be restricted during war time. As of the date of this article, such restrictions exist with respect to the temporarily-occupied territories as well as territories where active combat operations take place. Otherwise, proper identification (e.g., through a qualified electronic signature) may be required to access data in the online versions of those public registers.

Deal structure and Russian element

Ukraine has prohibited transactions with shares of a target that is incorporated and registered under Ukrainian law as well as with such assets as real estate, securities, road vehicles, water – and aircraft if the seller or purchaser is: (i) Russia; (ii) a Russian citizen; (iii) a legal entity incorporated and registered under Russian law; (iv) a legal entity incorporated and registered under Ukrainian law whose ultimate beneficiary owner (UBO), participant (shareholder) holding a share of 10% and more is one of the subjects mentioned under items (i)-(iii); or (v) a legal entity incorporated and registered under foreign law whose UBO, participant (shareholder) holding a share of 10% and more is one of the subjects mentioned under items (i)-(iii). Under certain conditions, the Cabinet of Ministers of Ukraine may, as an exception, approve the above-mentioned share deals. Notarization, state registration and otherwise recognition (endorsement) by Ukraine of any respective share and/or asset deals are prohibited.

Many assets, including shares (corporate rights) in Ukrainian companies, located in the territory of Ukraine and formerly belonging to Russia as a state, its residents and other persons supporting the war of aggression have been forcible expropriated since the begin of the war. Respective regulations apply to Ukrainian legal entities (their branches, representative offices), whose founder, participant, shareholder, and/or UBO is directly or indirectly (through other legal entities) Russia or any other persons (individuals and legal entities, both residents and non-residents, regardless of formal affiliation and control) who support Russian aggression against Ukraine. Any movable and immovable property of the mentioned entities and persons, including funds, bank deposits, securities, corporate rights, and other property (assets) can be seized (expropriated) without any compensation (reimbursement) of its value. Meanwhile, numerous expropriated assets (including, for example, shares in a bank and a company operating a large shopping mall in Kyiv) have been restructured by the Ukrainian state and are in the process of re-privatization through auctions.

Due to the above, from the very beginning of a transaction special attention should be paid to existing or former “Russian elements” in the target’s or buyer`s shareholding structure. A prospective acquirer should apply a careful approach to selecting a local target, analyzing its shareholding structure and structuring the deal to avoid any involvement of a Russian element. It should be noted that cleaning of corporate structures of Ukrainian companies from Russian elements (on grandparent and higher levels) has in many cases been already completed.

Sanctions

Besides the shareholding structure, other potential deal breakers in the present context could be the target’s, seller’s, or buyer’s being subject to, or having connections, to persons and entities currently under sanctions imposed by Ukraine, the EU and other countries and organizations in response to Russian aggression. Such connections could be maintained through the shareholding structure, UBOs, as well as the supply chain and customers. For example, a prospective buyer should consider declining a deal if the target’s major suppliers or customers are sanctioned entities, including those located in Russia or Belarus. And part of the target’s legal due diligence should be reviewing the most recent sanctions lists in order to clarify potential deal breakers. It is worth noting that after the start of the Trump II administration, alterations made to US sanctions have become more likely an element of the increasingly disruptive, deal-oriented US foreign policy.

Forex restrictions

Ukrainian law prohibits (with some exceptions) outbound Ukrainian bank account transactions involving payers who are: (i) Russian or Belarusian residents, including individuals resident there as well as legal entities incorporated and registered under Russian/Belarusian law; and (ii) legal entities (except banks) whose UBOs are Russian or Belarusian residents. Furthermore, prohibited (with some exceptions) are payment transactions whose beneficiaries are: (i) Russia; (ii) a Russian citizen; (iii) a legal entity incorporated and registered under Russian law; (iv) a legal entity incorporated and registered under Ukrainian law whose ultimate beneficiary owner (UBO), participant (shareholder) holding a share of 10% or more is one of the subjects mentioned under items (i)-(iii). Thus, under a contemplated M&A deal, payments should be structured in a way that excludes any of the above-mentioned subjects/entities/persons as payers or beneficiaries.

Also, the National Bank of Ukraine periodically reviews and amends its existing outbound forex restrictions, such as regarding payments under cross-border contracts, loan and interest repayments, and dividend disbursements. The regulator keeps some possibilities for repatriation open because institutional and other Western creditors continue funding Ukraine’s deficits, as well as in order not to damage the trust of existing investors, who are, among other things, interested in repatriating their accrued dividends. Local businesses adapt quickly to changes in forex regulations.

Signing the Agreement

The execution of a transaction in person is complicated and, therefore, rather an exception to the rule at the moment. Notarization sometimes poses practical problems due to travel restrictions and tight controls for Ukrainian male citizens applicable under martial law. Thus, the parties should, ahead of time, envisage specific arrangements for the signing, exchange of counterparts and coming into force of their agreement. Well-prepared, comprehensive notarized powers of attorney are useful in this regard.

Signing of documents in electronic (instead of standard paper) form by using qualified electronic signatures is common these days in Ukrainian legal practice. However, electronic form is generally not suitable for transactions that are subject to notarization and state registration. Furthermore, its use is complicated in cross-border transactions because of the lack of mutual legal acceptance of Qualified Electronic Signatures between Ukraine and, for example, EU countries.

Notarizations and Registrations

Under martial law, only state registrars and notaries whose office is located outside of temporarily-occupied territories and territories where active combat operations take place may perform registration/notarization actions (including those related to share deals/M&A) regarding legal entities and real estate rights.

Furthermore, notarization of most legal transactions (including share transfers and real estate transactions) at the request of a person related to Russia is prohibited. That is, a Ukrainian notary will refuse to notarize a deal (transaction) whose party (signatory) is: (i) Russia; (ii) a Russian citizen; (iii) a legal entity incorporated and existing under Russian law; (iv) a Ukrainian legal entity whose UBO, participant (shareholder) holding a share of 10% and more is Russia, a Russian citizen, or a legal entity incorporated and registered under Russian law; or (iv) a legal entity incorporated and registered under foreign law whose UBO, participant (shareholder) holding a share of 10% and more is one of the subjects mentioned under items (i)-(iii). Thus, most of the actions needed to change the composition of the target`s direct shareholders and UBOs related to Russia cannot be currently completed.

Regulatory Approvals

The ongoing war and restrictive measures imposed by the Government of Ukraine to address the existing situation still have an impact on the working routines of regulatory bodies. Originally, the government had suspended the statutory deadlines for the provision of certain public services, which increased the time required to procure regulatory approvals for an M&A deal, such as antitrust clearance from the Anti-monopoly Committee or approvals issued by the National Bank of Ukraine. Although most normal processing times and deadlines are restored in the meantime, the possibility of re-introducing such measures remains open (depending on the overall war-related situation in the country) and, thus, should be duly taken into account as a factor affecting the completion of a transaction.

Specific Deal Terms

Obviously, war-related issues need to be sufficiently addressed in transaction documents in order to minimize associated risks.

In particular, the parties should consider including in the agreement adequate provisions on how the target’s business will function in conditions of war and how the parties intend to coordinate their actions during the period between signing and completion. It is essential that the seller and target be able to make crucial decisions to address crisis situations in a timely and effective manner whenever the buyer’s consent is required. Also, representations and warranties provided in the agreement should adequately cover all potential implications of the war related to the target’s operation and the obligations of the parties.

The parties should also thoroughly take into consideration whether the war and the resulting restrictive measures on the general public will (still) qualify as a material adverse change. As war has somehow become the new normal in Ukraine, it is questionable that every war-related event gives rise to a party’s right to file a lawsuit requesting unilateral termination of the agreement pursuant to the respective provisions of the Civil Code of Ukraine.

Notably, parties are increasingly integrating insurance of war-related risks in their agreement. Various insurance policies have become available on the Ukrainian market and in certain Western jurisdictions, while the insured risks and coverage have been gradually expanding. Government programs offer partial compensation of insurance premiums for some businesses, such as those located close to the frontline. Thus, insurance can also become a stimulating factor for inbound foreign investment.

Force Majeure

Force majeure is generally understood as extraordinary circumstances outside of a party’s control that, in contrast to a material adverse change, only relieve the affected party from liability for breach of contract attributable to such circumstance.

In Ukrainian legal practice, force majeure has never had the same relevance as in developed Western jurisdictions because of the difficulties involved in proving its existence and actual impact. Preferably, a force majeure event needs an express confirmation from the Ukrainian Chamber of Industry and Commerce to be legally relevant.

Consequently, Ukrainian transactional practice has developed other tools for amending or dissolving contractual obligations in the event of unexpected outside events.

Transaction Financing

Unsurprisingly, the war situation has resulted in a fall in commercial bank lending for transactions in Ukraine. In most sectors, third-party financing implies funding by Ukrainian, multilateral or foreign state-owned banks, international financial organizations and institutions, or by private financial entities backed by them. Nevertheless, financing options have been gradually expanding to support reconstruction and recovery and provide funds for priority projects of businesses operating in strategic branches of the national economy, such as defense, energy, and infrastructure.

Financing conditions are different in the defense technology sector: As the rapid development of genuinely Ukrainian UAV technology has attracted global attention and is in high demand these days, financing has become widely available and even abundant for certain Ukrainian targets that reach increasingly aggressive valuations.

Where public funding is required, application paperwork should be prepared as early as possible, typically in the early stage of negotiations, taking into account lengthy processing and budgetary regulations in relevant jurisdictions.

Conclusion

In overall terms, Russian aggression against Ukraine, which has so far gone for over four years, continues to have a serious adverse impact on M&A. In these circumstances, parties are advised to carefully consider all war-related aspects when planning and implementing a transaction in order to adequately address, limit or allocate any relevant risks.

Unfortunately, the recent, rather inconsequential, attempts by the Trump II administration and other state actors from the EU to bring the war to an end, have so far not resulted in any positive outcome. There are currently no visible signs that the conflict can be resolved quickly, with the hope for a return to some normality in the not-too-distant future gradually waning. Thus, resumption of active cross-border M&A processes is not to be expected.

Nevertheless, depending on the results of any peaceful settlement, the impending post-war reconstruction of Ukraine may open up immense investment opportunities for existing and potential foreign investors, which will undoubtedly provide positive prospects for future M&A deals.