Cover Story (#10 October 2020)

A Huge Step Forward

Broad-based reforms in the strategic sectors of the Ukrainian economy are facing new issues, and demonstrated vital needs for transparent privatization and efficient investment protection. The announcement made by the countrys new leadership on the new course on preparing large state assets for privatization has been interfered with recently by the global pandemic. Its certainly time to move from declared priorities to real, concrete steps forward, as Ukraine has already shown a number of successful privatization cases. Serhiy Piontkovsky, managing partner of Baker McKenzie Kyiv, head of the energy, chemicals, mining and infrastructure and real estate practice groups, who advised almost all sound privatizations in our country, explained their importance in the pursuit of new success stories.

UJBL.: The task of privatization is pending for decades. It presently moves forward with the new governmental course. Is it reasonable, in your opinion?

Serhiy Piontkovsky: Privatization of state-owned assets has been a priority of Ukraine for many years. Most of the state-owned enterprises (SOEs) are managed extremely inefficiently and, as a result, have been consistently loss making. Many SOEs, instead of making money, often require additional financial support from the state budget. On top of this, SOEs are the primary source of corruption in Ukraine. For the above reasons, the new Government of Ukraine pushed for the sale of numerous SOEs on an expedited basis. In conformity with the above goal, the State Property Fund of Ukraine (SPF) launched a process of small-scale privatization as well as preparing large state assets for privatization tenders.

UJBL.: How has the situation around COVID-19 affected the countrys privatization program?

S.P.: COVID-19 has affected every area of business activity in Ukraine and privatization is not an exception. At the end of March 2020, the Parliament of Ukraine suspended the privatization of large-scale objects for the period of the COVID-19 lockdown. As a result, the SPF has not yet sold any large-scale privatization assets in Ukraine. The rationale for such a privatization ban is that asset valuations significantly decreased and the COVID-19 pandemic, as it is not the time to sell an asset.

UJBL.: The most resonant privatization project in 2020 was the sale of the Dnipro Hotel in the very center of the Ukrainian capital, where you acted as a legal counsel. How would you comment on work on this project? What did you find challenging from the legal perspective?

S.P.: At the same time, so-called "small" privatization has not been suspended, and the sale of small state-owned assets continues as usual and even better than it was before COVID-19. The best example of small privatization is the successful sale of the Dnipro Hotel in July 2020. That auction attracted 29 bidders and the competition was exceptionally fierce. As a result, the initial asking price increased by more than tenfold. It is a landmark privatization transaction in Ukraine since the sale of Kryvorizhstal in 2005. The Baker McKenzie team provided legal support to the State Property Fund in preparing the Dnipro Hotel for privatization. In particular, we carried out comprehensive legal due diligence and prepared the respective audit report for potential bidders to disclose all legal issues and likely challenges. In the course of the due diligence, our team of experienced lawyers verified the title documents to the hotel building, its material fixed assets and the land use rights with respect to the underlying land plots. We checked all court cases involving the Dnipro Hotel and its contractors or employees. We did our best to review and authenticate all major legal documents related to it, as well as to find all potential skeletons and poisoned pills related to the asset. One of our findings was that the Dnipro was offered for sale along with all existing long-term leases on several floors of the hotel. This was important information that any potential bidder had to know before the privatization auction.

This successful privatization of the Dnipro Hotel took place as a result of an open, transparent and highly competitive bidding process, a selection of international advisers by the SPF for preparing due diligence and audit reports regarding the Dnipro, the solid preparatory work done before the auction and, lastly, due to an electronic data room containing all the necessary financial, technical and legal information regarding the asset was available to all investors.

UJBL.: The Ukrainian Parliament recently imposed parliamentary control over privatization and prohibited the sale of big objects until the end of quarantine. What outcome would you predict?

S.P.: Yes, on 2 September 2020, the Parliament of Ukraine passed Bill No. 3552 On Amendments to the Law of Ukraine On Privatization of State and Communal Property (concerning parliamentary control over privatization of state property). The bill provides for parliamentary control over the privatization of state property exercised by an authorized Committee of the Verkhovna Rada of Ukraine. We recently observed certain criticism of the current management of the SPF by various members of parliament. It appears that the members of parliament intend to be closely involved in and closely monitor the privatization activity of the SPF. It is hoped that such involvement of members of parliament will not make the whole privatization process unproductive, bureaucratic and politically motivated.

According to this bill, auctions for the sale of large-scale privatization objects are still not allowed. Privatization auctions are not being held for the period of quarantine and restrictive measures established by the Cabinet of Ministers of Ukraine to prevent the occurrence and spread of the coronavirus (COVID-19).

At the same time, the bill does not prohibit the SPF to resume the preparation for the privatization of large-scale state-owned assets. In other words, the SPF may now proceed with arranging the sale of such large SOEs as Odesa Portside Plant (OPZ), Krasnolimanskaya Mine, Ukrainian Mining and Chemical Company, the President Hotel, Electrotiazhmash, Bolshevik Plant and others. A while ago, the SPF appointed investment advisers for each of the above-mentioned assets. Now such investment advisers may resume their efforts to prepare the respective large state-owned assets for privatization. It should be mentioned that once such large assets are ready for privatization, the Parliament of Ukraine will give its green light for holding privatization auctions (tenders). Currently, the SPF may not hold a privatization auction with respect to a large SOE without Parliament first amending the bill.

On 9 September, the Cabinet of Ministers of Ukraine decided that one of the large-scale state-owned companies Ukrainian Mining and Chemical Company will be privatized at the end of 2020. This decision is stated in the Priority Actions Plan for 2020 approved by the Cabinet of Ministers of Ukraine. The Priority Actions Plan also provides that 21 assets in the defense industry will be transferred to the SPF for privatization.

On 15 September 2020, the State Property Fund of Ukraine announced the privatization of the property of the Nemyrivske spirit production and storage site of SE Ukrspyrt (Property), the first of 41 objects of SE Ukrspyrt. The plant in Nemyriv is one of the top producers of spirit and spirit-containing products in Ukraine. The property will be sold as part of the small-scale privatization program. In order to preserve the continuation of production of rectified spirit, the purchaser of the property will be required to obtain a license for carrying out the respective activities. The auction will be held on 15 October.

UJBL.: What is the role of investment advisers in the privatization process?

S.P.: The current Privatization Law requires that large privatization assets must be prepared for privatization by investment advisers selected by the SPF. An investment adviser is chosen by the SPF via a tender based on its respective skills, experience, deals list, proposed sale strategy and timeline. As of today, the SPF has selected a number of investment advisers, such as EY, KPMG, BDO, Pericles and Concord Capital. The SPF advisers will, among other things, determine the starting price of the asset before the privatization tender. In the past, a local appraiser determined the starting price, which was often above the fair market value. As a result, many assets were overpriced and did not attract potential investors.

UJBL.: Could you single out the key provisions of the Privatization Law?

S.P.: The Privatization Law allows the privatization agreement to be governed by the laws of England and Wales at the buyers request. However, this option is only available until 2021, if the Parliament of Ukraine does not extend it in the future. At the same time, there are no time limitations as to referring potential disputes between the investor and the SPF to a foreign dispute resolution forum.

To be admitted to an auction for a large state asset a bidder must pay a security deposit in the amount of 5% (decreased from 20% in the old law) of the starting price or provide a respective bank guarantee.A bidder must also disclose the information about its ultimate beneficial owner (UBO) and provide its most recent annual/quarterly report.

The key point of the Privatization Law is the protection of investors rights. The provisions governing the content of a privatization agreement, even if governed by Ukrainian law, may include a set of warranties by the seller as to the information on the asset, and the respective liability for breaching them. Further, 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 buyers prior consent, e.g., asset pledge, set-off, suretyship.

Given that many state or municipal enterprises have a significant amount of (often moot) 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 deals completion. On top of that, once a privatization agreement has been signed, no changes to the custody account relating to arrest or placement of other encumbrances will be made until the title to the asset passes to the buyer. These protection measures would allow buyers to control directly any cash-out from the target company after signing the sale and purchase agreement, as well as increase the overall attractiveness of the asset.

The Privatization Law does not exempt a privatization acquisition from merger clearance requirements, which means that an investor must obtain approval from the Antimonopoly Committee of Ukraine before the privatization deal is closed.

UJBL.: What are the most successful privatization cases in Ukraine, in your opinion? Why?

S.P.: In my view, the most successful privatization cases in the history of Ukraine are: (i) the sale of the majority shareholdings in several power distribution companies, including Kyivoblenergo and Rivnenergo in 2000; (ii) the sale of 95% of the shares in Kryvorizhstal; and (iii) the sale of the 100% shareholding in the Dnipro Hotel. In all three examples, the primary reason for the success was the same: an open, transparent and highly competitive privatization process. The Baker McKenzie team provided its legal support in all the above privatization transactions.

UJBL.: What are the main risks that make foreign investors refrain from privatization?

S.P.: The main risks that disincentivize foreign investors from making investments in Ukraine are the lack of stability and certainty in Ukraine, frequent changes in Ukrainian legislation, unpredictable court rulings, corruption and the lack of rule of law.

UJBL.: The government adopted the updated principles of strategic reform in state-owned banks that foresee reduction in state-held stakes in the banking sector from 60% to 25% in 2025. Thus, there are government plans to completely or partly privatize all four state-owned banks. How would you comment on this initiative? What are the specifics of banking privatization?

S.P.: The privatization of these state-owned banks is governed by the Law of Ukraine On the Peculiarities of Sale of State-owned Shares in the Charter Capital of Banks, Capitalized by the State, dated 15 March 2012 (Banking Law). Under the Banking Law, privatization of banks is carried out through a tender for the sale of state-owned shares in the charter capital of the respective bank. The state, being the seller, is to be represented by the Ministry of Finance of Ukraine. Only strategic investors are allowed to participate in such a tender. Strategic investors include banking institutions and banking groups, and international financial organizations that comply with the requirements of the National Bank of Ukraine (NBU) with respect to flawless reputation and satisfactory financial standing. Those who owned significant shareholding in the banks at the time of its capitalization by the state, as well as certain other persons, do not qualify as strategic investors.

Another option for a state to reduce its share in the banks is to increase the charter capital of the bank (capitalization procedure). According to Article 3 of the Law of Ukraine On Simplification of Procedures of Reorganization and Capitalization of the Banks, dated 23 March 2017 (Capitalization Law), capitalization can be financed by, among others, investors, including international financial organizations. After the successful completion of the capitalization procedure, the investor receives the respective amount of shareholdings in the charter capital of the bank, and the state presence in the bank is reduced.

In order for a bank to commence the capitalization procedure, the banks general meeting of participants must adopt the respective decision and receive the NBUs prior approval. If state shareholdings exceed 75% of the total amount of shares, and international financial organizations are to participate in the capitalization of the bank, prior approval from the NBU is not required.

For the time being, there are four major state-owned banks in Ukraine:

JSC CB Privatbank (100% state-owned bank)

PJSC JSC Bank Ukrgazbank (94.9410% state-owned bank)

JSC Oschadbank (100% state-owned bank)

JSC Ukreximbank (100% state-owned bank)

According to the recently updated Principles of Strategic Reforming of State Banking Sector (Strategic Principles), Ukraine aims to reduce its presence in these banks from 55% (at the end of 2019) to 25% by 2025. The state is expecting state-owned banks to commence consultations with financial advisers in order to develop a roadmap and a sale strategy to start the reduction of state presence in state banks by December 2021.

UJBL.: What should we expect in banking privatization in the near future?

S.P.: As provided in the Principles, the progress of state reduction of shareholdings is as follows:

PJSC JSC Bank Ukrgazbank: The state is expecting the conversion of a loan from the International Financial Corporation into an additional issuance of shares in PJSC JSC Bank Ukrgazbank of up to 20% by October 2020.

JSC Oschadbank: The state is working on certain tasks prior to allowing international financial organizations to become shareholders in JSC Oschadbank, which is expected by the end of 2020. The main task is for JSC Oschadbank to join the Natural Persons Deposit Insurance Fund (to be accomplished through the adoption of a law by the Parliament of Ukraine in November 2020). The state expects major or full privatization to occur by the end of 2025.

JSC Ukreximbank: The state is looking for an investor that will become a minority shareholder within the following five-year term.

According to the Principles, the state is considering selling shareholdings in these state banks to international commercial banks or carrying out IPOs of state banks.

Note that a full-scale preparation for privatization of the states shareholdings in a state bank is to commence only after the recovery of the Ukrainian economy from the crisis caused by COVID-19 (Ukrainian GDP must grow for two quarters in a row).

UJBL.: What are the prospects for privatization in 3-5 years?

S.P.: I believe that in the next few years the State Property Fund, using the ProZorro sale platform, will sell a significant number of "small" privatization objects, which it did not sell for many years. This will be a huge step forward. As for large-scale privatization, it should be possible to sell major state-owned assets that were transferred to the SPF for privatization, including but not limited to the Ukrainian Mining and Chemical Company, CenterEnergo, Krasnolimanskaya Mine, President Hotel, Electrotiazhmaz, Bolshevik Plant and certain large power distribution companies (oblenergos). It is also plausible that in three to five years one or two large state-owned banks might be placed for sale as well.

Baker McKenzie Kyiv

Year of establishment: 1992

Location:Kyiv, Ukraine

Number of partners/lawyers: 9/60

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