The situation in the global economy, and in Ukraine in particular, shows that business downturns and failures are inevitable. This makes it high time for corporations to launch a comprehensive recovery process to be able to return to profitability or to salvage viable assets. With the level of globalisation reached to date, there are doubts as to whether such recovery can still be viewed as a single jurisdiction process. Mid-size and large multinational corporations no longer can afford merely restructuring distressed assets located within boundaries of one given country. In their case a solution would be a complex restructuring exercise with due regard to specifics of legal environment in each of the jurisdictions involved in a restructuring scheme.
These times seem to be even more challenging for Ukrainian businesses given that the less than two decades history of market economy in Ukraine has not yet been able to give a good lesson of coping with adverse developments in the economy similar to those we are witnessing today. Though Ukrainian corporations have already become familiar with complex restructuring processes, the principal purpose of the exercise has previously been to achieve more viable and transparent business models allowing to efficiently compete in the market-oriented economy. Such historical restructurings were mostly driven by corporations' cash-flow needs to promote efficiency, support growth, and maximise the value to shareholders or creditors. However, in the present circumstances the drivers for many financial and corporate restructurings will change. Corporations will be striving to survive the financial crisis and remain afloat, though having lost sometimes significant parts of their businesses. Obviously, the resolution of issues brought on the agenda by the global financial crisis is a time-consuming and complicated process that requires rapid action both from corporations and the government.
Optimism cut short
It is noteworthy that, on the one hand during several months before the crisis which broke out in Ukraine in October 2008, the Ukrainian banking system seemed to be sound, reporting capital adequacy ratios above the set minimum levels. Furthermore, Ukraine was growing at positive annual rate, and reports from international rating agencies and investment banks expressed an optimistic view on the health of economy and banking sector, in particular. On the other hand, in recent years, Ukrainian corporations and banks borrowed actively often with no regard to the repayment schedules, counting on easily accessible international financial markets for refinancing if need be. After the financial crisis broke out, and further following sovereign downgrades, appetite of investors for Ukrainian risk has come close to zero practically overnight, effectively cutting of Ukrainian companies from the much needed source of finance. Illiquid Ukrainian stock market could not satisfy the need for funds, and capital injections were looked at as the only solution. Now that the shareholders support is weakening as the crisis continues, financial and corporate restructuring becomes the only option for many Ukrainian businesses.
Ukrainian banks and corporates are looking at revitalising their loan portfolios, optimising the repayment schedules and refinancing troubled loans outside of bankruptcy proceedings and corporate restructurings. Financial restructuring entails restructuring of company's assets and liabilities, including its debt-to-equity structures, in line with its cash-flow needs. In this sense financial restructuring embraces various solutions, ranging from simple rearranging of loan portfolio and refinancing exercise, to a more complex combination of financings and M&A tools. For example, sales of distressed assets, recapitalizations, leveraged buyouts, sales to financial or strategic investors.
Legal environment
Ukrainian law views restructuring primarily through the prism of insolvency and bankruptcy proceedings and regulations or as a solvent corporate restructuring. Solvent restructuring is effected in connection with corporate reorganisations related to changes in profile of commercial activities, shareholding structure, and other similar issues related to the conduct of business or fine-tuning legal relationships between owners and is regulated by general rules of the Civil Code of Ukraine and the Economic Code of Ukraine adopted in 2003 and various rules on corporate governance. Under Ukrainian laws corporate restructuring along with liquidation is viewed as termination of the company's activity and can be exercised by merger, accession, division or transformation.
In the bankruptcy context restructuring is regarded as a set of organisational, financial, legal and technical measures aimed at improving the company's financial condition, solvency, production efficiency and ability to satisfy creditors' demands. Bankruptcy related provisions are contained in the Law of Ukraine 'On Bankruptcy', Code of Economic Procedure, as well as some special laws that regulate bankruptcy and insolvency proceedings of certain groups of companies (for example, banks, special regime companies, state-owned companies or companies subject to privatization). Current Ukrainian insolvency and bankruptcy regulations are significantly different from those of the European Union and the United States, and are not familiar with many concepts standard for the aforesaid jurisdictions.
Financial restructuring
Since all approaches to financial restructuring available to Ukrainian entities could hardly be covered within the scope of this article, we will focus on Ukraine specific legal issues arising in connection with certain possible options available both to Ukrainian borrowers in their relations with foreign lenders, and Ukrainian banks wishing to restructure their credit portfolio.
Buy back of LPNs by Ukrainian issuers
While this approach should seem to be the least complicated one in terms of legal and commercial structuring, Ukrainian law adds some hoops to jump before a workable structure may be implemented.
NBU licenses: In the event a Ukrainian issuer plans to acquire its LPNs, due to a structure of such notes, local law would view this transaction as an investment abroad. As a result, individual National Bank of Ukraine (NBU) licenses would be needed prior to the buyback in relation to (i) making an investment abroad and (ii) placement of foreign currency valuables on an account abroad. Application and various supporting documents are reviewed within 25 business days by the NBU and "organised crime" divisions of the Ministry for Internal Affairs of Ukraine and the Security Service of Ukraine. The licenses will only be issued in the absence of negative conclusions of such entities on the application.
Temporary prepayment restrictions: responding to the financial downturn, the NBU restricted ability of Ukrainian banks to acquire foreign currency in the local interbank market for their own needs. Currently banks are only permitted to purchase foreign currency provided that they "have liabilities in respective foreign currency, which are due". If read conservatively, this would mean that a bank may purchase foreign currency only to perform obligations that matured as per the loan terms, but not to prepay the loan. Thus, to the extent a buy-back of LPNs issued for the sole purpose of funding a loan to the bank could be viewed as prepayment of such loan, the bank would have to make payments out of its own funds in foreign currency and might not be permitted to purchase foreign currency for such prepayment. The NBU regulations remain untested in this regard and so their interpretation and application remains uncertain, however there is a risk that the NBU will seek to apply the above restriction in relation to a buy-back of LPNs by a Ukrainian bank.
To avoid the above implications, a buy-back transaction could be structured to involve a foreign affiliate of the bank to conduct the offer and buy the notes. An important aspect of the structure would be to ensure that the bank does not fund, directly or indirectly, such acquisition in order to avoid the risks of the prepayment limitations outlined above.
Prepayment of loans with foreign lenders
Early repayment of loans by Ukrainian borrowers is generally permitted, including prepayment at a discount. However, apart from taxation issues arising in connection with the tax treatment of the discount amount, certain regulatory issues remain unclear and will need to be clarified before any significant restructuring effort is made. Temporary prepayment considerations described above would also apply to banks in connection with early repayment.
Most of the loan agreements entered into by Ukrainian borrowers were registered with the NBU and as such may only be substantially amended upon registration of the relevant information with the NBU. In certain circumstances early repayment can be structured in a manner allowing avoiding registration of amendments into the previously issued registration certificate. At the same time, even when required, it is a fairly straightforward process.
The core principle of the NBU registration has until recently been limitation of the maximum interest rate (MIR) payable under the relevant loan agreement. Following the financial crisis, the NBU lifted all MIR limitations for loans with maturities over one year, however the NBU regulations continue to require that in the event of early repayment the MIR cap calculations should be adjusted to reflect a reduced maturity of the loan. It is not clear whether the NBU plans to continue monitoring and restricting amendments that could lead to the aggregate amount of payments exceeding the MIR under the loans extended prior to cancellation of the MIR cap. Current regulations fail to specify whether such loans would be subject to the MIR ratio based on the rate set at the moment of registration (close to the execution date) or based on the rate set at the moment of amendment (the prepayment). Should the NBU take a conservative approach to the MIR application, and decide that the MIR determined as at the date of registration should apply, upon prepayment amounts obtained by the lender could be restricted due to the violation of the MIR cap.
Factoring
Among various stress-induced financial solutions, acquisition of FX denominated loans extended by Ukrainian lenders to local residents seems a possible option for Ukrainian banks aimed at clearing the balance sheet and improving certain NBU ratios. Ukrainian laws generally permit assignment of monetary claims (such as claims against a borrower under a loan agreement) from a Ukrainian resident to a non-resident. However, there is ambiguity in some of the provisions of Ukrainian legislation regulating assignments by a lender and lack of precedents on such assignments as well as an absence of any publicly available guidance from the regulator. Therefore, potential investors may face certain problems, which could considerably complicate the restructuring process.
Currency control issues: under the general rule payments abroad may only be made if (a) an individual NBU license has been issued for the relevant payment; (b) payment is made under a loan agreement that has been registered with the NBU or (c) such payment falls under one of the available exemptions. Ukrainian regulations do not provide for any express exemption which could be relevant to this issue.
Taking into account that borrowings from foreign lenders is subject to special regulation by the NBU including, without limitation, registration requirement, it is not entirely without doubt whether and how the NBU will permit foreign lenders to take the place of an original Ukrainian lender, including by way of assignment.
Moreover, even in the event the NBU would find registration of an assignment to a foreign lender feasible, the loan agreement would become subject to MIR at the then applicable rate established by the NBU for loan agreements between Ukrainian borrowers and foreign lenders. MIR is currently set for the loans with maturities of less than one year.
Therefore, a Ukrainian borrower may be required after assignment of a loan to a non-resident creditor to obtain an individual licence from the NBU to authorise transfer of funds to the new lender.
Factoring issues: The Ukrainian legal system is constantly undergoing numerous changes, often leading to inconsistencies and gaps. Regulations on factoring currently leave grounds for the type of assignment discussed above to qualify as a factoring operation (a financing extended in consideration for an assignment of a monetary claim). In such circumstances, specific rules regulating factoring would apply. Due to application of such rules, assignment between banks by way of factoring of certain types of receivables could be restricted, including receivables under loans. Furthermore, due to a regulated nature of factoring operations, assignments to a non-regulated entity could potentially be an issue.
Possible restrictions
Corporate reorganisation is often inevitable for companies in or approaching financial distress, including subsidiaries and affiliates of large industrial groups and holdings that have been subsidized by the group during the better times. A well-planned corporate reorganisation could assist in eliminating or mitigating financial problems of a group by diversifying and/or concentrating its assets and liabilities and optimising its operational activities. However, in most cases any kind of corporate reorganisation is generally limited by financing arrangements (such as loan agreements) executed by group companies. This includes contractual provisions ranging from early repayment right granted to lenders in case of a change of control or corporate restructuring to events of default of similar nature leading to immediate acceleration under the respective loan.
Due to flaws in the Ukrainian corporate law and corporate governance regulations, including rules protecting minority shareholders rights, most of transactions leading to changes in ownership of Ukrainian companies and assets are structured through non-Ukrainian vehicles. As Ukrainian law generally prohibits application of foreign law to shareholders arrangements, thus exposing the agreement of foreign shareholders on the management of a Ukrainian entity to Ukrainian law risks, most of sophisticated corporate structures involved an offshore holding company being a sole owner of Ukrainian assets (where permitted by law). In such structure all decisions would be taken at the level of the foreign holding vehicle and passed down to the level of the Ukrainian companies.
In case of the above structure the only significant Ukrainian legal concern would be a prior approval of the Anti-Monopoly Commission (AMC) for concentration. In general terms this requirement is triggered when an entity or individual, directly or indirectly, (1) obtains control over a legal entity incorporated in Ukraine or (2) acquires or receives into management 25% or 50% or more of voting rights in the senior management body of such entity. For the purposes of anti-monopoly clearance, control over an entity is defined rather broadly and includes direct or indirect decisive influence over the "controlled" entity through for instance right of ownership or use over a substantial share of assets, decisive influence over the composition, voting and decisions of management bodies, contractual control, appointment of senior officers and the like, AMC concentration permit would not be required of certain economic thresholds are not exceeded.
Depending on the type of a target additional clearances could be required. For instance, direct or indirect acquisition of a substantial participation for 10%, 25%, 50% and 75% of a bank's charter capital or voting rights is only permitted after a consent of the NBU has been granted.
Recent practice shows that borrowers, lenders and potential investors tend to combine financial and corporate restructuring, allowing restructuring of financial indebtedness in exchange of access to assets or cashflows. For instance, larger Ukrainian banks often are interested in acquiring less fortunate and smaller local banks with distressed loans portfolio mainly as a method of obtaining right to foreclose against attractive collateral of the target's borrowers. Equally popular is assistance in arranging acquisitions of large borrowers by investors with the aim of repaying the borrower's indebtedness to the arranging bank. Such structure involves both corporate restructuring of the borrower's business, change in the ownership structure, repayment and/or restructuring of debt and escrow arrangement guaranteeing that the purchase price is transferred directly to the lender.
New actors
Recent restructurings in Ukraine are also driven by the current financial crisis. At the same time, the recent Ukrainian experience shows that corporations are still focusing on financial restructuring, rather than undertaking a complex restructuring covering both financial and corporate aspects of the matter.
State-owned enterprises happened to be the first swallows of the financial crisis. For obvious reasons, complex restructuring is not available for such entities, and reshuffling of their financial indebtedness may only be conducted with increased care and limited publicity. Some Ukrainian privately owned corporations have already commenced a restructuring of entire debt portfolio. As noted above, most of the Ukrainian borrowers are aiming at solvent financial restructuring of debt obligations and are not intended so far to undergo any substantial corporate reorganisations.
Certainly, the Ukrainian restructuring experience during the current crisis does not yet allow coming to any grounded conclusion as to the trends for the next year. At the same time, one should take into account that problems that Ukrainian companies experience are not exclusively resulting from the adverse effects of the economic crisis. Corporate structures of many of Ukrainian businesses are not yet transparent and do not allow access to more funds-intensive international financial market. Thus, it should be expected that future restructurings (some of which have already been launched) will not focus solely on refinancing of existing debt, but will extend to complex corporate restructurings entailing fundamental change in a company's business and financial structure with a view of increasing the company's value to shareholders and creditors.
On the other hand, the Ukrainian practice has not yet seen new actors such as hedge funds and asset management companies playing their role within restructuring schemes. In many matured economies, asset management companies (AMCs), hedge and pension funds have been employed to address the overhang of non-performing debt in the financial system. Notwithstanding that the western world have appreciated the role of such entities in helping to expedite corporate restructuring, rapidly disposing of unnecessary assets and cleaning balances, Ukraine does not seem to be prepared to establish a legal environment inducing to the funds operations.
The main obstacle to AMCs, hedge and pension funds joining the ranks of actors in Ukrainian restructuring schemes is a lack of relevant legislation. The current Ukrainian regulations applicable to the funds heavily regulate the operations of such entities, while Ukrainian law is not yet familiar with the notion of hedge funds at all. Aside from registration and reporting requirements, funds are subject to strict limitations on investments and the use of leverage. Though Ukrainian law provides for non-diversified types of investment funds, being subject to a more loose regulatory regime, which does not set forth strict requirements as to the quality of assets, lack of any relevant practice leaves doubts as to whether the said type of funds can play the role normally played by hedge funds in economically-developed jurisdictions.
Thus, the current state of restructurings in Ukraine gives grounds to believe that major restructurings (both financial and corporate) are still waiting for their hour and will be launched soon. In times of financial crisis Ukrainian corporations will further be taking efforts to optimize their financial and operational structures to properly respond to current challenges. However, Ukrainian legal framework in many aspects does not adequately address issues which are vital in terms of facilitating restructurings, and the Ukrainian legislators would have to thoroughly review the practice of their colleagues from more mature economies to be able to optimize the current legal environment.
| Author biographies |
Olga Khoroshylova, partner
Magisters
Olga Khoroshylova is a partner in charge of the capital markets, banking and finance practice, advising international banks and Ukrainian clients, Ukrainian municipalities and state bodies on all aspects of capital markets and financing operations including syndicated lending, Eurobond and other debt capital markets instruments, equity capital market deals, including initial public offerings, securitisation, commodity and structured finance, and public private partnerships.
Ms Khoroshylova also heads inter-practice Restructuring, Insolvency and Distressed Asset group.
Email: okhoroshylova@magisters.com
Tetyana Kiselyova, senior associate
Magisters
Tetyana Kiselyova concentrates her practice on banking and finance, securities and investments, corporate law and commercial law, investments and international finance, dispute settlement and arbitration.
Email: tkiselyova@magisters.com
Roman Stepanenko, Associate
Magisters
Roman Stepanenko participates in providing legal services to leading Ukrainian companies with respect to the issue and placement of Eurobonds at international capital markets, project finance initiatives and various structured deals in the international equity and capital markets.
Email: rstepanenko@magisters.com |