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23 December 2006

Some Legal Aspects of Mergers and Acquisitions in Ukraine


Author: Vadym Samoilenko
Source: AmCham Membership Directory, Country Profile Ukraine - December 2006 - p. 188

1. THE NOTIONS OF MERGERS AND ACQUISITIONS

From the legal perspective, the mergers and acquisitions (sliyaniya i pogloscheniya) transactions (hereinafter "M&A", the "Transaction", or the "Transactions") pursued in Ukraine may be examined within a narrow (formally legal) or wide (economic-and-legal) contexts.

From the formally legal point of view (Articles 104-107 of the Civil Code of Ukraine (hereinafter "CCU")), M&A appears to be a form of reorganization (termination) of legal entities (hereinafter "LE"). At a 'merger' (sliyanie) of two LEs, such LEs terminate as subjects of law and instead of them there appears a new LE. Such new LE stands as a full (universal) legal successor of all rights and obliga­tions of LEs merged, i.e., its legal predecessors.

At an 'acquisition' (pogloschenie) of a LE by another LE, the former LE terminates, and all of its assets and liabilities transfer to the raider. The latter LE becomes a full (universal) legal successor of LE thus acquired.

At the same time, Ukrainian business practice has also adopted the "mergers and acquisitions" term in a wider, primarily economic, sense as used in the West. In the wide sense the term purports that corpo­rate control (hereinafter "CC") is established over the undertaking.

In the context of this research, the M&A is understood by the author as acquisition by a person or a group of persons acting in concert (here­inafter the "Raider") of CC over an enterprise (hereinafter the "Target") in the form of a block of shares or an equity interest representing a part of the Target's authorized capital, securing such control.

2. TYPES OF CORPORATE CONTROL OVER JOINT STOCK COMPANY

Obviously, the final objective of each M&A is an indirect right to man­age the Target's assets for the benefit of the Raider, while an interim objective as well as an instrument for achieving the Raider's plans to manage the Target's assets is to obtaine CC over the Target.

The author discerns between a few types of CC over a Target, be­ing a joint stock company (hereinafter "JSC"), such as:

1. Relative;

2. Operating;

3. Strategic.

Relative CC over the Target JSC is usually achieved through a trans­fer to the Raider of a block of shares constituting less than 50% + 1 share of the total number of the shares (hereinafter "TNS") in the Target JSC, which vote at the general shareholders' meeting (here­inafter "GSM") of the Target. However, therewith there exist certain circumstances, which allow the Raider to soundly consider that:

1. It will be able to convene a valid GSM; and

2. Such GSM will, by a simple majority vote (hereinafter "SMV") of the participating shareholders (owning at least 50% + 1 voting shares), elect the management board of the Target JSC (here­inafter the "Management Board") nominated by the Raider.

Generally, such result can be achieved through:

1. An agreement between the Raider and a number of independ­ent shareholders to tender a consolidated vote on a given item of GSM agenda (hereinafter the "Agenda");

2. Obtaining by the Raider appropriate proxies for participat­ing and voting at GSM, issued by a number of independent shareholders;

3. Inertness of independent shareholders (particularly, the State Property Fund of Ukraine (hereinafter the "SPF") or other governmental authority authorized to manage a government-owned block of shares in the Target JSC, if any) revealing itself in a regularly low attendance of GSM (however, securing a quorum) and/or their passivity in voting at GSM (however, allowing to achieve SMV at voting during GMS).

Operating CC over the Target JSC is achieved through a transfer to the Raider of a block of the Target JSC's shares equal to, or ex­ceeding 50% + 1 share of TNS, however lesser than 60% + 1 share of TNS. Provided it can convene a valid GSM, the Raider is guar­anteed to achieve SMV in the election of the Management Board nominated by the Raider.

Strategic CC (hereinafter "SCC") over the Target JSC may be con­ventionally divided into:

1. Relative;

2. Full;

3. Absolute.

Relative SCC is, as a rule, achieved when a block of the Target JSC's shares equal to, or exceeding 60% + 1 share, however lesser than 75% of TNS, is transferred to the Raider. Therewith, the Raider can implement the following scenarios of corporate management of the Target JSC:

1. Despite of the other shareholders' will, convene a valid GSM and adopt any decisions that require SMV;

2. Block any GSM for an indefinite period of time and thus "freeze" such Target JSC management structure as evolved or was cre­ated by the Raider at previous GSMs.

Full SCC is established when a block of the Target JSC's shares equal to, or exceeding 75%, however lesser than 90% + 1 share of TNS, is transferred to the Raider. Such equity interest in the Target provides the Raider with an infallible opportunity, despite of the oth­er shareholders' will, to convene a valid GSM and adopt any deci­sions that require SMV or a qualified majority vote, i.e., not less than 75% of the votes present at the valid GSM (hereinafter "QMV").

Please note that pursuant to part 4 of Article 159 of CCU, QMV is required for the GSM to resolve the following matters:

1. Amendment of the company charter;

2. Liquidation of the company.

Absolute SCC is achieved when a block of the Target JSC's shares equal to, or exceeding 90% of the TNS, is transferred to the Raider. In such case:

1. No one except the Raider (which, naturally, controls the Management Board as well as the Target JSC's supervisory council and the auditing commission, and also benefits from the Target's charter convenient for it) can convene the GSM. (Please note that part 4 of Article 45 of the Law of Ukraine "On Business Associations" No.1576-XII of September 19, 1991 as further amended (hereinafter the "Business Associations Law") vests such right, particularly, with the shareholders that own the aggregate over 10% of the votes);

2. Shareholders cannot request a mandatory audit of the Target JSC's operations (pursuant to part 2 of Article 162 of the CCU, such right is vested with the shareholders, which own the aggregate of at least 10% of JSC shares);

3. Shareholders cannot request from the auditing commission of the Target JSC the audit of financial and business operations of the Management Board (part 4 of Article 49 of the Business Associations Law vests such right with the shareholders, which own the aggregate over 10% of the votes).

3. TYPES OF CORPORATE CONTROL OVER LIMITED LIABILITY COMPANY

Other most common legal form of organization of large- and me­dium-sized businesses in Ukraine, which usually stands as an M&A target, is a limited liability company (hereinafter "LLC").

The author discerns between the following types of CC over a Target LLC:

1. Relative;

2. Operating;

3. Strategic.

Relative CC over the Target LLC is usually achieved through a trans­fer to the Raider of an equity interest representing a part of the au­thorized capital (hereinafter "AC") and securing less than 50% + 1 vote of the total number of the votes (hereinafter "TNV") at the gen­eral participants' meeting (hereinafter "GPM") of the Target LLC. However, therewith there exist certain circumstances that allow the Raider to soundly consider that:

1. It will be able to convene a valid GPM; and

2. Such GPM will, by a simple majority vote (hereinafter "SMV") of the participants in attendance (owning at least 50% + 1 voting shares), elect the director or a directorate of the Target LLC (hereinafter the "Directorate") nominated by the Raider.

Generally, such result can be achieved through:

1. An agreement between the Raider and a number of independ­ent participants to tender a consolidated vote on a given item of the GPM Agenda;

2. Obtaining by the Raider appropriate proxies for participating and voting at the GPM, issued by a number of independent participants;

3. Inertness of independent participants (particularly, the SPF or other governmental authority authorized to manage a govern­ment-owned equity interest in the Target LLC, if any) revealing itself in a regularly low attendance of the GPM (however, secur­ing a quorum) and/or their passivity in voting at the GPM (however, allowing to achieve SMV).

Operating CC over the Target LLC is achieved through transfer to the Raider of an equity interest representing a part of AC of the Target LLC and securing 50% + 1 vote of TNV or more. Provided it can convene a valid GPM, the Raider is guaranteed to achieve SMV in the election of the Directorate nominated by the Raider.

SCC over the Target LLC may be conventionally divided into:

1. Relative;

2. Full;

3. Absolute.

Relative SCC is, as a rule, achieved when an equity interest repre­senting a part of AC securing 50% + 1 vote of the total number of the votes set forth in the Target LLC's charter (hereinafter "TNVC") (please notice that this is not TNC!) or more, however at least 60% + 1 vote of TNVC, is transferred to the Raider. Provided it can con­vene a valid GPM, the Raider is guaranteed to achieve SMV (which pursuant to Article 59 of the Business Associations Law consti­tutes 50% + 1 vote of TNVC or more, but not of the total number of votes of the participants attending the validly convened GPM (as in the case with JSC!)), when resolving the following issues (part 4 of Article 145 of the CCU; part 2 of Article 59 of the Business Associations Law):

1. Determining the company major lines of activities; approving its plans and status/completion reports;

2. Amending the company charter; changing the amount of its capital fund;

3. Excluding a participant from the company.

Full SCC is established when an equity interest representing a part of AC that secures 60% + 1 vote of TNVC or more, is transferred to the Raider.

Therewith, the Raider can implement the following scenarios of corporate management of the Target LLC:

1. Despite of the other participants' will, convene a valid GPM and adopt any decisions that require SMV or QMV;

2. Block any GPM for an indefinite period of time and thus "freeze" such Target LLC management structure as evolved or was cre­ated by the Raider at previous GPMs.

Absolute SCC is achieved when an equity interest representing a part of AC that secures 80% of TNVC or more, is transferred to the Raider. In this case no one except the Raider (which, naturally, controls the Directorate as well as the Target LLC's auditing com­mission (auditor), and also benefits from the Target LLC's charter convenient for it) can convene GPM (part 4 of Article 45 of the Business Associations Law vests such right, particularly, with the shareholders, which own the aggregate over 20% of the votes).

4. LEGAL REPRESENTATION WITH RESPECT TO MERGERS AND ACQUISITIONS

After the management of the Raider and, in the event of a friendly Transaction, the Target principally adopt a decision favoring the Transaction and defines its major economic benchmarks and timeframe, lawyers become the "think tank" of this sophisticated process. Usually, the implementation of the Transaction is as­signed to one law firm or, where the Transaction is of international (trans-border) nature and requires legal expertise from different jurisdictions, then even to several law firms. This is prompted by the scope, which requires a large number of lawyers, as well as by the multipronged nature of the Transaction, which calls for engag­ing in the group high-skilled lawyers specializing in different areas of law, viz: corporate, antitrust, finance, and other.

As practiced in Ukraine, the M&A representation goes, as a rule, through the following major phases:

1. Legal due diligence of the Target;

2. Structuring (developing a system of transactions) M&A;

3. Drafting and execution of the Transaction documents;

4. Implementation of the M&A transactions, which usually includes:

a) AMCU filing for the Transaction authorization;

b) Transfer of the Target's corporate rights to the Raider;

c) Delivery of shares and payments under the M&A transac­tions.

4.1. Legal Due Diligence of the Target

Usually, the legal due diligence phase (hereinafter "LDD") is aimed at:

1. Supplying the Raider's top manager with impartial information on the economic and legal status of the Target, facilitating the decision on continuing, modifying, or even terminating the Transaction;

2. Supplying the top manager of the Raider and, perhaps, of the Target, with information and, possibly, recommendations on cor­recting legal defects in the documents and/or the business of the Target prior to, in the course of the Transaction, and thereupon;

3. Obtaining information and documents, necessary for subse­quent phases of the Transaction, particularly, structuring of the Transaction.

Depending on:

1. Transaction complexity;

2. Transaction value;

3. Transaction timeframe;

4. Specifics of the Target business;

5. Sophistication of the parties to the Transaction, etc.;

LDD may be:

a) Full-blown; or

b) Quick-scan.

Full-blown LDD normally addresses the following issues and the respective LDD report (hereinafter the "LDD Report") generally in­cludes the following sections:

a) Full-blown LDD:

1. Corporate Records of Documents;

2. Governmental Regulations, Filings and Authorizations;

3. Finance;

4. Property;

5. Operational Matters;

6. Management and Employees;

7. Material Agreements;

8. Accounting and Audit Reports;

9. Disputes and Litigation;

10. Tax Matters;

11. Environmental Matters;

12. Miscellaneous;

13. Conclusions and Recommendations;

b) Quick-scan LDD:

1. Corporate Records of Documents;

2. Governmental Regulations, Filings and Authorizations;

3. Material Agreements;

4. Conclusions and Recommendations.

Further, one may discern between two major methods used in com­piling LDD Reports, viz:

1. Descriptive and problem focused;

2. Problem focused.

The former contains a detailed description of the issues and docu­ments examined, laid down as a narrative, following which is a description of problem issues pertaining to the operations and/ or documents of the Target, while the latter focuses solely on the Target's legal issues.

Normally, LDD extends for a term of 3 weeks to 2 months and more (in the event of a large-scale Transaction).

4.2. Transaction Structuring

This phase includes, as a rule, the following major efforts:

1. Identifying ways and timeframes for correcting material legal defects in the establishing and operations of the Target, which bar implementation of the Transaction (inaccuracies and contradictions in the constituent and other corporate documents of the Target, the Target's representatives that execute the Transaction documents lacking due powers, the Target lacking relevant licenses, etc.);

2. Identifying ways and timeframes for removing encumbrances over the Target's assets, its corporate rights, with liabilities (tax lien over the Target's assets, pledge of the Target's shares of stock being acquired by the Raider, in favor of independent third parties, etc.);

3. Identifying quantities, type (purchase-and-sale, pledge, exchange, etc.), material terms and conditions of the contracts, under which the Raider is acquiring the Target, particularly:

a) Parties;

b) Terms and manner, in which the parties will perform their ob­ligations;

c) Governing law;

d) Arbitration;

e) Penalties for breach of obligations;

4. Identifying quantities, type (pledge, surety, guarantee, etc.), material terms and conditions of the contracts securing due performance by the Target sellers and/or (which is less common) by the Raider of the obligations under the contracts set forth in Item 3 of this Section 4.2;

5. Opinion on the necessity to obtain from the AMCU its prior authorization of the Transaction treated as 'economic concentration';

6. Developing a model general Transaction implementation schedule;

7. Assigning duties with respect to the development of the Transaction documents and performance of other acts required for its implementation to the parties and their counsels.

4.3. Drafting and Executing Transaction Documents

Normally, this Transaction phase includes the following major ef­forts:

1. Developing first draft contracts, minutes of the meetings, and resolutions issued by the Raider's and Target's governing bodies, amendments to the Target's constituent documents, various filings, authorizations, waivers, and other docu­ments mediating the agreements between the parties to the Transaction and legal requirements;

2. First comments and coordination of the draft documents with the parties to the Transaction and their counsels;

3. First negotiations between the parties to the Transaction, based on the first drafts of the documents, coordination and adjust­ment of material terms and conditions of the Transaction;

4. Finalizing the drafts of the Transaction documents by the coun­sels to its parties;

5. Final negotiations between the parties to the Transaction, based on the finalized drafts of the Transaction documents, immate­rial adjustment of the terms and conditions of the Transaction and the draft documents;

6. Preparing execution copies of the Transaction documents;

7. Official execution of the Transaction documents by authorized representatives of the parties, and where necessary, certifica­tion and/or registration of such documents by authorized officers and governmental authorities.

4.4. Transaction Implementation

At this phase, the parties to the Transaction and their counsels undertake efforts and follow procedures, the mandatory nature of which is established by law and the Transaction documents execut­ed. Below, the author provides a description of the most common and important efforts and procedures.

4.4.1. Filing with the AMCU for Transaction Authorization

According to part 2 of Article 22 of the Law of Ukraine "On Protection of Economic Competition" of January 11, 2001, No.2210-III, as further amended (hereinafter the "Competition Law"), the economic concen­tration the implementation of which may require a prior AMCU authori­zation (hereinafter the "Authorization") is, particularly, as follows:

"1) merger of undertakings or accession of one undertaking to another;

...3) direct or indirect purchase or other acquisition of a title to, or management of, equity interests (stocks, shares), which se­cures 25 or 50 percent of the votes or more in the governing body of a respective undertaking."

In reality, these are most typical M&As, however, other kinds of M&A, which according to the Competition Law provisions, require the Authorization, are also possible.

According to part 1 of Article 24 of the Competition Law, the fore­going requires the Authorization where the aggregate value of the assets or the aggregate revenues from sales of the partici­pants in the concentration, also considering control relationship, for the most recent financial year, including abroad, exceeds an equivalent of €12,000,000 as calculated using the National Bank of Ukraine (hereinafter "NBU") exchange rate effective on the last day of that financial year (hereinafter "Criterion 1"), and there­with:

1. the value (aggregate value) of the assets or the revenues (aggregate revenues) from sales of the goods, including abroad, of at least two participants in the concentration, also considering control relationship, exceeds an equivalent of € 1,000,000 as calculated using NBU exchange rate effective on the last day of that financial year (hereinafter "Criterion 2"); and

2. the value (aggregate value) of the assets or the revenues (aggregate revenues) from sales of the goods in Ukraine of at least one participant in the concentration, also con­sidering control relationship, exceeds an equivalent of €1,000,000 as calculated using the NBU exchange rate effective on the last day of that financial year (hereinafter "Criterion 3" and together with Criterion 2 and Criterion 1, "Criteria").

Where M&A Authorizations are sought, typical problems thus en­countered are of the following nature:

1. Low threshold values of the Criteria. This particularly con­cerns Criterion 3 and Criterion 2. In the author's estimates, from 80% to 85 % of large- and medium-sized M&As fall under these Criteria and, consequently, require Authorization. Approximately same percentages of the M&As, which require Authorization, do not in fact proceed with the AMCU filings that seek the Authorization. This occurs following a deliber­ate business decision (in fact, in a majority of cases!) to take the risk and avoid the AMCU filing that seek the Authorization (e.g., to structure the Transaction involving a number of "non-transparent" offshore companies), as well as by virtue of a lack of information regarding the Authorization, and sometimes, by virtue of legal illiteracy of the parties to the Transaction.

Obviously, the lawmaker ought to correct the situation and increase the threshold values of the Criteria. Otherwise, the Criteria will con­tinue "driving the market in the shadow".

2. The Authorization requirement for non-resident entities where M&As occur solely abroad. Such obligation arises where a foreign Raider, or a foreign Target, owns a Ukrainian subsidiary or a sales office, the revenues from sales effected in Ukraine from abroad or any other asset in Ukraine, which falls under Criterion 3.

3. The Target and its seller are considered as one undertaking. This requirement that arises from the Competition Law is par­ticularly burdensome where the Target is rather small while the seller is a large undertaking.

4. The requirement to provide detailed information of economic nature on the foreign Raider. This Ukrainian antimonopoly law requirement is rather burdensome in a situation where the non-resident Raider owns a large number of foreign subsidiaries.

5. The excessive scope of economic information that has to be filed with the AMCU. The following information requirements are next to impossible to meet at large M&As, particularly, where non-resident entities are involved:

1) Market shares controlled by each entity being part of the undertaking that is a party to the concentration;

2) Major competitors of such entities;

3) Full details of such entities, including telephone numbers and top management;

4) Information covering 2 to 2.5 most recent years of the enti­ty's operations.

6. The lack of a legalization procedure for the M&As completed in breach of the antimonopoly laws. Currently, such legaliza­tion is feasible, however, under the threat of heavy penalties assessed by the AMCU and adjudication of the Transaction null and void for the reasons of breach of the antimonopoly laws by the parties.

4.4.2. Transfer of Target's Corporate Rights to the Raider

When implementing the given phase of the Transaction, it is impor­tant to consider that, according to law, the Raider acquires:

a) Title to the following Target's shares:

• Bearer shares, from the moment of their endorsement by the seller;

• Immobilized bearer shares, from the moment when the shares are credited to the Raider's account with the custodian;

• Registered shares issued in the documentary form, from the moment when their seller issues respective written transfer instructions to the registrar of the holders of the Target's securi­ties to the effect of registration of those securities in the Target's shareholders' register in the Raider's name;

• Immobilized registered shares issued in the documentary form, from the moment when they are credited to the Raider's account with the custodian;

• Registered shares issued in the non-documentary form, from the moment when they are credited to the Raider's account with the custodian;

b) An equity interest that represents a part of the LLC's AC (cor­porate rights), from the moment of the state registration of the LLC's restated charter naming the Raider as a participant in the LLC, holding the equity interest that represents such part

of AC.

4.4.3.Delivery of Shares and Payment under the Transaction

The established practice of executing agreements that provide for the blocking of shares in the Target seller's securities account with the seller's custodian (hereinafter the "Blocking Agreement") pro­vides a useful mechanism for minimizing the risk of failure by the par­ties to the Transaction to perform their obligations to deliver the JSC Target's shares and pay for them. In order to follow this pattern:

1. The shares ought to be issued in the non-documentary form, or the shares already issued in the documentary form ought to be immobilized in advance;

2. Both the Raider and the seller of shares ought to have securi­ties accounts opened with one and the same custodian;

3. The shares purchase agreement ought to provide for the delivery of the shares to the Raider, using a separate Blocking Agreement.

The Blocking Agreement is executed by and between the Raider, the seller of the shares, and the custodian. Under such an agree­ment, the seller issues to the custodian instructions to block (re­strict the mobility of) the shares in the seller's securities account until the moment when the custodian receives the documents evi­dencing the payment made by the Raider in favor of the seller for the Target's shares being acquired by the former. Upon receipt of such documents, the custodian automatically debits the shares from the seller's securities account and credits them to the securi­ties account of the Raider.



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