Crux (#09 September 2011)

What are the main trends on the Ukrainian M&A market that lawyers come across in everyday practice?

Mykola Stetsenko, managing partner, Avellum Partners

Mykola Stetsenko, managing partner, Avellum Partners

While the financial crisis is not over for Ukraine, there has been a lot of positive M&A activity in the last twelve months. Since August 2010 M&A activity picked-up in many sectors, including agriculture, FMCG, real estate, and financial services.

The agricultural sector experienced a lot of consolidation, especially in the sugar industry, where major sugar producers (Dakor, Rise, and UkrRos) changed owners in early 2011.

This consolidation was driven by Ukrainian groups, which expand their production capacities by purchasing smaller or debt-burdened producers. Kernel also expanded its presence in CIS by acquiring the Russkie Masla sunflower oil producer in Russia. We also saw several private equity investors in the market, but only Horizon Capital successfully invested in AgroSoyuz.

M&A in the financial sector has not yet recovered, since most investments are small and do not represent a clear trend

The financial institutions sector has seen the sale of VAB Bank, Renaissance Credit and investment by Horizon Capital into UkrFinance Group, one of the largest debt purchase and collection businesses in Ukraine. Insurance companies have also been for sale in a few cases. However, M&A in the financial sector has not yet recovered, since most investments are small and do not represent a clear trend. Banks with a focus on consumer lending are definitely one of the favorites in this market segment.

We also saw some moderate activity in the retail property segment of real estate.

Finally, FMCG saw a lot of interest both from Ukrainian and foreign investors. A few notable investments include investment by Horizon Capital into Inkerman Wine Group, the investment by Europe Virgin Fund (sponsored by Dragon Capital) into the Ruta Group, the hygiene products producer, and the most recent acquisition by the private equity group Oasis of the Radomyshl Beer Plant.

Oleksiy Demyanenko, associate, Asters law firm

Oleksiy Demyanenko, associate, Asters law firm

The purpose of a due diligence exercise in the context of the M&A project is to assist a potential buyer in assessing the level and nature of legal risk related to an acquisition target. Being interested in the most cost-effective approach, the purchasers normally ask their legal advisers to prepare a red flag due diligence report highlighting only identified legal risks. In some M&A projects clients ask for limited due diligence reports covering only specific and most crucial parts of the target’s business, e.g. corporate history, title to core industrial assets and financial covenants.

The recent increase in the number of acquisitions by private equity funds, which are reluctant to undertake their own due diligence until they have some exclusivity in a competitive bid process, has made increasingly common preparation of vendors’ due diligence reports. Moreover, preparation of a vendor’s due diligence report helps the vendor to identify and resolve in a timely manner any legal issues in the target’s business before potential buyer commences its own due diligence.

One of the most popular mechanisms of an obstacle to executing the judgment of an arbitration court is initiation of legal proceedings in Ukraine

Prior to launching a due diligence process, the client and the legal advisor have to establish a materiality threshold allowing the scope to be determined for the due diligence review, which excludes from the analysis documents regarding insignificant matters. One recent trend is to determine a materiality threshold not as a specified dollar or Euro amount, but rather as a fixed percentage of the group’s turnover for the previous financial year. This percentage varies depending on the value of the transaction.

Oleh Malskyy, partner, AstapovLawyers International Law Group

Oleh Malskyy, partner, AstapovLawyers International Law Group

Assessing the risks in M&A transaction in Ukraine may turn out to be difficult as there may be a vast number of country inherent risks as well as hidden commercial/political risks.

The role of a good lawyer will be to provide the client with sufficient background to make an educated assessment of such risks. Country inherent risks would include lots of minor irregularities and violations that may lead to imposition of fines. If viewed in a very conservative way — any such risk may be seen as substantial and theoretically may lead to a bigger trouble. However, in practice, this is not always so and such risks may turn to be immaterial. One should not overlegalize such risks but look into their practical implication and history of application. Latest state policy is to deregulate the business and shorten the list of required licenses and permits.

More serious risks are those of commercial and even political nature.

Post acquisition measures should be applied to avoid any potential historical risks that may be hidden and acquired together with the target or asset

To unveil such aspects an in-depth commercial intelligence is usually required. Many businesses are in one way or another related to politically exposed persons or silent partners which may turn to be an issue post-acquisition. Understanding the reality and rules of the game are important. Representations and warranties under English law transactional documents may turn to be of no use in practice.

Unfortunately, when assessing the risks, it should be taken into account that many things which are contary to logic may be possible and general 3-year statutory limitation period may not always work as the best security blanket. Rumor has it that a case was reopened recently relating to 10-year old acquisition of a land plot, on which the commercial building is currently in operation.

Usually, post acquisition measures should be applied to avoid any potential historical risks that may be hidden and acquired together with the target or asset. Despite any additional cost that may arise in such respect, such post acquisition restructurings always turned to be a helpful tool in defense strategy if the need arises.

Due care, broader view and creative thinking must be applied by attorneys when assessing the risks for the client.

Alexander Tretiakov, lawyer, Antika law firm

Alexander Tretiakov, lawyer, Antika law firm

While the number of M&A transactions has been gradually rising in Ukraine, their quantity is still below the pre-crisis level.

It is worth mentioning the large number of transactions on transfer of companies into ownership of a bank during settlement of loan debts.

The large number of such transactions is rather connected with the complex procedure of recovery of a mortgaged property and existing tax burden, and not with a bank’s desire to acquire a company. Actually, banks purchase the corporate rights of debtor companies explicitly with the purpose of further sale of liquid assets and the company’s dissolution, because such procedure is much faster and profitable from the taxation point of view, than just recovery of a mortgaged property.

There is a relatively new trend for clients to use complex and multistage schemes, which supersede simple schemes on purchase and sale of shares.

Expiry of the three year deadline may be used as grounds for refusal to recognise and enforce a foreign arbitral award in Ukraine

For example, acquisition by transfer of actual assets of an object to a newly-founded company becomes rather common.

Such an approach allows a client to receive a pure object without additional bonuses, such as prolonged and not always successful history of a company, its debts and credits, and other potential problems. Of course, it also saves money during legal due diligence, which is not necessary during application of such scheme.

Also, there is an increase in the number of transactions during which a seller provides additional guarantees and assumes new obligations, which weren’t usual for mergers and acquisition, particularly, obligation of non-competition for a certain period. Thus, the western M&A experience is becoming more popular in Ukraine.

At the same time it should be mentioned, that application of a complex transaction scheme and existence of additional obligations usually require obtaining permits from the Antimonopoly Committee of Ukraine not only for concentration, but for concerted actions as well, and that must be considered during application of non-standard transaction schemes.

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