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Exchange control considerations

Creating and enforcing Ukrainian collateral can be problematic

There are a number of principal problems associated with the creation and enforcement of collateral provided as security to non-residents in Ukraine. To begin with, there are special problems with taking pledges over funds in bank accounts in Ukraine. Prior to January 1 2004, when the Ukrainian law on the securing of creditor claims and the registration of encumbrances No.1255-IV, dated November 18 2003 (the Encumbrances Law) took effect, a charge over a bank account was possible only as a pledge over the property rights of the account owner to demand payment from such account, and not over the funds themselves.

The Encumbrances Law made charges directly over the funds in a bank account possible. Thereafter, in practice, pledges of bank accounts in Ukraine have usually covered (in separate clauses) both a pledge over the funds on deposit and a pledge over the property rights attached to them. This distinction remains especially relevant for pledges of foreign currency because, as explained in the National Bank of Ukraine (NBU) letter No.18-211/1697-3597, dated June 2 2000, a pledge of the property rights to currency should not be subject to the NBU's licensing requirement for pledges of foreign currency funds, referred to below.

Transfers abroad

Under Ukrainian exchange control rules, any transfer of currency from Ukraine abroad may only be made after obtaining an individual NBU licence, unless an exemption from such requirement is provided by law. The most common exemptions apply to transfers that constitute payments by a Ukrainian resident to a non-resident abroad (1) for property, services or certain rights based on an agreement between them, or (2) under a loan agreement registered by the NBU.

Ukrainian exchange control rules do not provide any express exemptions from this NBU licensing requirement for the transfer abroad of proceeds from the enforcement of a pledge or mortgage. This is an issue when a Ukrainian resident gives a pledge or mortgage to secure its obligations to a non-resident to pay for property, rights or services under a foreign commercial agreement or a registered loan agreement,. The transfer of the proceeds from the enforcement of this collateral, arguably, should be possible without a special NBU licence on the basis that the transfer is made in respect of the resident's outstanding contractual obligations for payments that should be able to be made without a special NBU licence. This conclusion seems stronger because of the NBU position on suretyships, as discussed below.

It should be noted that if collections under mortgages and pledges used to secure a non-resident borrower's obligations to a non-resident lender result in Ukrainian currency proceeds, it appears doubtful under Ukrainian exchange control rules that a Ukrainian bank would have any legal basis to convert them into foreign currency in order to pay them abroad.

Similar exchange control issues exist for payments abroad under sureties and guarantees. In particular, such an issue on whether a licence is required arises where a Ukrainian resident, acting as a surety (ie like a guarantor, but under Ukrainian law only licensed banks can act as financial guarantors), secures the obligations of a non-resident obligor to a non-resident obligee, for example where a Ukrainian subsidiary company's plant expansion is being financed by loans to its foreign parent.

To respond to this issue, on June 8 2007, and July 6 2007 the NBU issued two letters (the NBU Letters) confirming that no individual NBU exchange control licence is required to effect payments abroad in foreign currency under such a suretyship. These private NBU Letters, although not having any force as legal acts, are widely known and relied upon in Ukraine. However, there are serious problems in the legal rationale they express, and it is therefore unclear whether the NBU will continue to hold this view.

Under applicable Ukrainian regulations, a Ukrainian resident may only pay its obligations under such a suretyship, as described above, from its own funds held in foreign currency if the funds were not borrowed or purchased in the interbank exchange market.

It could be argued that the principles of the NBU Letters similarly apply for the making of payments abroad in respect of the enforcement of mortgages and pledges in Ukraine.

Bank account pledges

Under bank account pledges, enforcement can in principle be accomplished extra-judicially by the direct debiting of funds from the pledgor's bank account at the pledgee's request. However, if the Ukrainian bank refuses for some reason (such as its interpretation of Ukrainian exchange control rules) to transfer the funds to enforce the pledge, then a court decision would have to be obtained to authorise the transfer.

There will always be a risk that the NBU licensing issue could be raised in such a Ukrainian court proceeding by the Ukrainian borrower, and that, in the particular litigation context, the Ukrainian court might rule that the funds may not be transferred from Ukraine where the transfer abroad is not specially licensed by the NBU. Ukrainian courts have a reputation for favouring Ukrainian parties over foreigners. Therefore, it should be expressly agreed, when a pledge over a bank account in Ukraine is created, that the account holding bank will actually transfer funds from the account in response to the non-judicial enforcement of the pledge by the secured party.

One weakness in the Ukrainian pledge system for bank accounts is that account holders can freely withdraw funds irrespective of any pledge or other contractual commitments up until enforcement occurs. There is the possibility, however, that they will incur some contractual liability for doing so.

The use of foreign currency for pledges in Ukraine falls within the licensing requirement of the NBU. It should be possible for a Ukrainian pledgor to instead pledge the foreign currency it holds in a bank account outside of Ukraine without having to obtain an NBU licence. However, the crediting of funds to such an account abroad is itself subject to obtaining an NBU licence, and the funds should be repatriated upon the expiration of the term of this licence.

By Bate C Toms and Svitlana Petrenko of

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