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Managing Partner, Baker McKenzie – Kyiv
Senior Associate, Baker McKenzie – Kyiv
Privatization in Ukraine
It has been three years since the new rules for the privatization of state and municipal property took effect. Originally, the aim of the upgraded legal framework was to speed up the overall process of selling state and municipal property, and it certainly reached that goal regarding 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 2020, total revenue from the sale of all small privatization assets amounted to UAH 3.89 billion. Among the small privatization assets sold in 2020 was the Dnipro Hotel with a winning bid of UAH 1,111,111,222 (approximately USD 41 million) while the starting price was UAH 80,923,400. The privatization of the Dnipro Hotel was provided in a fair, transparent and open way and demonstrated that Ukraine provides equal opportunities to all investors (except those related to the aggressor state of Russia).
Unfortunately, there was not a single sale of any large privatization assets in 2019 and 2020, and, therefore, none of the instruments provided for 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), Electrovazhmash (manufacturing of power generators), Krasnolymanska Coal Company (coal mining), 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), 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 a stake of 50% or more. All other assets fall into the SPA category.
The 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, particularly the following:
- buyers with non-transparent ownership structures registered in offshore zones;
- buyers registered in states included in the FATF blacklist and their 50% direct or indirect subsidiaries;
- the aggressor state of Russia and legal entities where such state holds an equity interest, as well as other entities controlled by such legal entities;
- legal entities whose beneficial owners holding 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 the aggressor state);
- individuals (citizens or residents) of the aggressor state;
- persons coming under the national sanctions regime and their affiliates;
- Ukrainian legal entities whose beneficial owners have not been disclosed in breach of 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 the financing to purchase the privatization asset must provide information on its creditor, who must meet the requirements of buyers of privatization assets stipulated in the law.
Sale of LPAs
Following the advent of the COVID-19 pandemic, at the end of March 2020 the Ukrainian Parliament introduced a temporary prohibition on the privatization of LPAs. Yet, in September 2020 it limited this to a ban on carrying out auctions for the sale of LPAs, thereby allowing the preparation of LPAs for sale. However, starting from 1 May 2021, the ban on the sale of LPAs was partially lifted, which allows for the privatization of large-scale assets until the end of government-imposed pandemic restrictions via the following means:
- through a Dutch auction or an auction with a preliminary examination of potential bids;
- by way of a buyout to a single bidder
Regarding the sale of LPAs, implementation of the new rules reduces the risks associated with determining the starting price; the price is 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, if no adviser wishes to support the sale process, the starting price would still be determined by the privatization authority based on 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 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 when 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 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 method of sale appropriate to each particular asset depending on its individual characteristics.
The law allowed the privatization agreement to be governed by the laws of England and Wales at the buyer’s request. This option was available before 1 January 2021. Parliament has not, for the time being, expressed an intention to extend this option.
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 mechanism of protection: 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 completion of the deal. 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 has passed to the buyer. These protection measures would allow buyers to directly control any cash-out from the target company after signing of the sale and purchase agreement, and would also increase the overall attractiveness of the asset.
Sale of SPAs
In relation to the privatization of SPAs, all SPAs are sold via an electronic auction system. The privatization authorities conclude agreements via e-platforms that are functionally capable of holding privatization auctions. All of the processes relating to the submission and acceptance of bids as well as the determination of the winner of the e-auction are largely automated and do not require the involvement of the privatization authorities until the binding sale and purchase agreement is actually 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 will be sold directly to that bidder. If the SPA is not sold, the starting price for the asset will be reduced by 50%. If the SPA still does not sell, the starting price will be decreased again by 50% and the asset will be sold at a Dutch auction.
The protection of buyers’ rights is also applicable, to some extent, to the sale of SPAs. The prohibition of bankruptcy within one year following completion of the deal, as well as the placement of an encumbrance over the shares, remain in place for the sale of SPAs.