Most often, when buying a business in Ukraine, transactions are concluded either with reference to English law (according to the laws of England, Cyprus and other countries that use the Anglo-Saxon system of law), or – to national Ukrainian legislation.
This article will discuss the acquisition of a business by local rules. It should be noted that the number of transactions based on Ukrainian legislation will increase. And this should contribute to two positive changes in the legislation that have occurred over the last year in Ukraine, in particular, the introduction of a legal mechanism for securing obligations through escrow-accounts and the liberal reform of currency legislation.
So, we usually divide the process of acquiring business assets in Ukraine into five conditional stages.
Basic conditions of asset purchase procedure in Ukraine. Signing non-disclosure agreements(NDA)
As a rule, at the initial stage of negotiations between the seller of the business and the buyer, the latter only in general terms represents the real composition of the seller’s assets, the literacy of their legal clearance, financial performance indicators, the state of payables and receivables, and, in general, the entire “internal kitchen” of the business of interest .
Yes, and the seller on the part of the cost also, often, only gives an approximate guideline of the desired compensation for their business.
Therefore, at this stage it is important for the parties to agree on a “roadmap” – the basic conditions for the future procedure for the sale and purchase of business assets. In particular, a mutual agreement should be reached on the following aspects:
- estimated value of assets, their composition, quantitative and other significant parameters of a business or assets;
- the planned structure of the main transaction for the sale of assets, the approximate timing of the conclusion and closure of such a transaction;
- inform (documents) about the business (corporate entities, assets and liabilities, and other important information for the buyer) will be provided to the buyer, to what extent and at what time frame;
- coordinate contact persons from both parties responsible for preparing the transaction, providing information (documents) for conducting legal, accounting and tax audits.
Such an agreement of the parties on the results of negotiations may be executed in writing, for example, a protocol of intent.
Then, as usual, the parties and the external consultants involved by them sign agreements on non-disclosure of the information provided regarding the business and assets (NDA).
Carrying out due diligence when buying assets in Ukraine
In order to avoid leakage of confidential information about a business and its assets, often the seller organizes for the buyer and his consultants, who will conduct due diligence, the places for reviewing the documents, the so-called data rooms. In such rooms, the latter have the opportunity to familiarize themselves with all the necessary documents, but without the possibility of copying, photographing, sending and carrying them to the outside world.
Legal due diligence of assets
This is one of the key elements in the procedure for acquiring assets, since it depends on the results of such a check whether the purchase decision will be made by the buyer, at what price and under what conditions.
volume of legal due diligence depends on many factors, in particular: the corporate structure of the business (the number of legal entities and their legal form; the presence of structural units – branches, divisions, representative offices);
specifics of the activity (availability of licenses and other permits);
composition of assets and their number (land; real estate; manufacturing equipment; goods; raw materials; transport; securities; trademarks; intellectual property rights; lease rights and other assets);
state of financial and economic activity (size of assets and liabilities; net assets; accounts receivable and payable; availability of loans; guarantees; mortgages; debt obligations (issued promissory notes, bonds and others);
current (non-executed) a) contracts, including export or import contracts concluded for an amount determined by the buyer as significant);
number of staff; as well as the volume of claim work (the number of ongoing legal disputes, open enforcement proceedings).
Usually, the period of such verification covers the last three years (within the limits of the limitation period), but sometimes the examination and evaluation of documents for a longer period is required.
When checking the corporate structure of a business, the analysis for compliance with the requirements of the law and the assessment of the presence (absence) of avoidable (unremovable) legal defects for each business entity, as a rule, are subject to:
- order of creation and state registration, registration in the bodies of the state fiscal service, the pension fund and other mandatory bodies;
- constituent documents (charters, constituent agreements), corporate agreements, internal regulations on supreme bodies, supervisory boards, executive bodies, and auditing commissions;
- decisions of higher bodies, supervisory boards and executive bodies (including the procedure for convening, holding meetings, as well as decision-making);
- documents on the procedure and completeness of the formation and increase (decrease) of the authorized capital, and for joint-stock companies also documents relating to the procedure for issuing shares (including, additional issues of shares);
- turnover of shares in the authorized capital (shares), including an analysis of the grounds for the transfer of ownership, respect for the preemptive rights of participants (shareholders) and settlements between participants (shareholders), from the moment of creation of the legal entity to the last owner.
Also, for each legal entity, information on all available state registries is checked and evaluated for the presence of registered prohibitions (restrictions, encumbrances), including tax liens or the seizure of assets, open executive and judicial proceedings.
Depending on the specifics of the business, legal checks are usually subject to:
- availability of licenses (permits) for the right to carry out certain types of economic activity;
- compliance of a business entity with licensing conditions established by regulations;
- compliance with financial monitoring requirements, the presence of responsible persons and properly approved internal regulations (if such requirements are statutory established);
- availability of permits and other mandatory documentation depending on the specifics of the activity (documents on commissioning facilities, certification of production, product certification, permits for harmful emissions, stationary emission sources, contracts for the export of hazardous waste, mining allotments, permits for construction and others) .
In the legal verification of assets, as a rule, the following are evaluated: documents (title documents) on the acquisition of assets in ownership and full payment for them, the presence (absence) of state registration of ownership or other real rights (if state registration is provided), state registration of vehicles , registration of copyright or property rights to objects of intellectual property rights, trademarks, etc.
In any case, during such an inspection, the legality of acquiring assets (or obtaining other real rights) of assets and the absence of legal obstacles to such acquisitions and the rights of third parties to such objects, as well as presence of state registration (if state registration is envisaged).
Information on all available state registries is also checked and evaluated for the presence of registered prohibitions (restrictions, encumbrances) on movable and immovable property.
With legal due diligence of the state of financial and economic activity for each legal entity within the corporate structure, the following to be usually checked:
- the balance sheet for the last reporting year with explanations on certain items of the balance sheet (receivables and payables, availability of assets and their description) in order to calculate the size of net assets;
- contracts and documents confirming the conduct of business transactions and payment (transfer and acceptance acts, bank registries of payments and receipt of funds, and other documents), on the basis of which accounts receivable and payable are reflected in the balance sheet;
- current (unfulfilled) contracts, including export or import contracts for which there is no violation of obligations concluded in the amount determined by the buyer as significant (for example, over 100,000 hryvnia);
- loan agreements (issued and received) and bank account statements on the movement of funds for such transactions;
- contract of guarantee (property guarantee), guarantees (provided and received) and bank account statements on the movement of funds for such transactions;
- mortgage (pledge) agreement, extracts from the register of state registration of property encumbrance for such operations, existing correspondence with counterparties regarding the performance or violation of obligations under such agreements;
- register of debt obligations (issued and received promissory notes, etc.) and contracts, acts (other documents), on the basis of which debt obligations were acquired or transferred to third parties.
Labor relations with staff and the correctness of the personnel work during due diligence, usually checked in this volume:
- the correctness of the personnel documentation: hiring and dismissal;
- the correctness of the imposition of disciplinary actions;
- the availability of internal documents: labor regulations, job descriptions, and labor compliance documents: policies, codes of conduct, and others.
Claim block of questions, on the basis of the data provided by the seller’s party, as well as information from the relevant judicial register and the register of open enforcement proceedings, is subject to legal verification for the presence of:
- current (including those for which court decisions have entered into force, but the time for appeal has not expired) litigation, determining the legal position on each of them and the prospects for their consideration;
- judicial decisions that have entered into force in cases of exceptional importance, in order to determine the legal position and assess risks for their review;
- open enforcement proceedings against the seller or its counterparties.
Legal check may also include other blocks of issues that are relevant to the business being acquired. For example, in the intellectual sphere: the correctness of registration of labor relations with personnel, labor functions, which include the development of intellectual property objects, or registration of the transfer of exclusive property rights to intellectual property objects made on an order, the legality of using objects of intellectual property rights belonging to third parties etc.
Accounting and tax due diligence
The scope of the audit of accounting and compliance with discipline in matters of taxation and timeliness of tax reporting, primarily depends on the specifics of commercial activity, sales of goods (services, works), volumes of transactions subject to VAT, export-import transactions, cash operations, the number of hired personnel, the number and frequency of travel, including abroad.
As with legal due diligence, often, the period of accounting and tax audit covers the last three years (within the statute of limitations established by tax legislation), but sometimes it is necessary to examine and evaluate documents for a longer period.
In any case, the following sets of questions for each legal entity within the corporate structure will be subject to accounting and tax audits:
On general issues of organization and maintenance of accounting and tax accounting:
- established accounting policy;
- determination of the tax system, the status of the VAT payer;
- determination of the content of business transactions (production, trade, provision of services or performance of work) and the annual volume of their implementation;
- tax liabilities, uncoordinated tax liabilities, tax lien or tax arrest of assets, loans.
Regarding the correctness of tax accounting for separate taxes:
- assessment of the correctness of tax accounting for income tax, the formation of income and expenses, their documentary confirmation;
- assessment of the correctness of tax accounting of VAT transactions, documentary confirmation of them, the availability of operations that are not subject to VAT taxation or exempted from VAT, timeliness of registration of tax invoices and the correctness of their registration;
- determining the timeliness of the accrual and payment of other taxes (excise duties, land charges, property taxes, and others).
On separate sections of accounting and tax accounting:
- assessment of the correctness of the formation of production costs and production costs (if you have your own production);
- assessment of the correctness of the reflection of the results of export-import operations;
- assessment of the formation of administrative and other costs;
- correctness assessment of mapping in the accounting of loans and borrowings from residents and non-residents, as well as interest associated with loans and credits;
- analysis of the main suppliers of raw materials (products) and the main buyers of finished products, goods (services, works);
- analysis of receivables and payables, including bad debts;
- payment discipline, banking, cash discipline and compliance with regulatory requirements for working with cash.
On payment, the wage bill:
- determining the system of remuneration, staffing, number of employees, working hours (labor schedule), the procedure for calculating and timely payment of wages, related personal income tax, military duty, a single social contribution, as well as hospital, vacation and other mandatory payments;
- the procedure for calculating, paying and documenting travel allowances (if any);
- assessment of the correctness of payroll, hospital and other payments to staff;
- assessment of the correctness of the reporting related to payroll;
- the availability of benefits, people with disabilities and other persons who have additional guarantees in employment.
Regarding the timeliness of filing and completeness of mandatory tax reporting.
Also, acts of inspection of state fiscal service bodies and a pension fund for a period of at least three years are usually analyzed.
If a legal, accounting and tax assessment of a business has confirmed the absence of critical legal defects that may impede a future transaction, as well as unavoidable legal risks that may arise in the future after acquiring a business asset, then you can proceed to the next stage.
Terms of asset acquisition and transaction structuring
(Term Sheet/Memorandum of understanding)
At this stage, taking into account the findings on legal verification, accounting and tax audit, the parties can agree on the final structure of operations related to the acquisition of assets and the timing of their implementation.
As a rule, at this stage, a preliminary agreement (Term Sheet or Memorandum of understanding) is signed between the seller and the buyer, which, unfortunately, is still unparalleled in Ukrainian legislation, therefore its implementation by the parties is still based on their own will and not get legal protection. To give such an agreement the force of a preliminary contract in accordance with national legislation is unlikely to succeed because of the complexity of its content, the diversity of obligations of the parties, which may be beyond the scope of a single legal entity, as well as the requirements for the form of such an agreement.
However, in most cases, the lack of legal regulation for this kind of contractual relationship does not stop the parties from intending to sign such agreements.
What provisions should be included in the preliminary agreement (Term Sheet Agreement или Memorandum of understanding)?
First, now the parties can accurately determine the subject of a future transaction or transactions. That is, this agreement specifies how the buyer acquires the business from the seller: whether by buying shares in the authorized capital (shares), buying individual objects of real estate, re-registering lease rights, and so on. Moreover, often, such agreements provide for the creation by the seller of new legal entities to which shares in the authorized capital (shares) or any other assets should be transferred, as well as the timing of such operations.
Secondly, the parties can accurately determine the future cost of selling the business, taking into account the identified deficiencies or legal defects.
They can also determine and record in the agreement what shortcomings are recognized by the parties, how and at what time they should be eliminated by the seller, and how the cost will change if the seller does not eliminate such shortcomings at the reporting date.
Thirdly, it is desirable for the parties to agree and fix in the agreement a complete list:
- composition of assets and their quantities, which must be duly executed on the date of the main transaction for legal entities, the rights to which will be transferred to the buyer;
- licenses and other permits that should be valid on the date of the main transaction;
- indicators of the state of financial and economic activity, which should be valid on the date of the main transaction;
- requirements for the number of personnel, payroll, acceptable conditions of employment contracts, etc., which must be established on the date of the main transaction;
- legal disputes or enforcement proceedings that may be in production (or vice versa – must be terminated) on the date of the main transaction;
- other essential requirements of the buyer related to the business that must be eliminated by the seller on the date of the main transaction, for example, the elimination of any burdens of property or the conclusion of any commercial contracts.
It is also important for parties to determine what the consequences would be if, at the balance sheet date, the seller fails to fulfill the above conditions, whether this will affect the total cost of the business or give the buyer the right to refuse to buy it.
Fourthly, the parties can fix the settlement procedure for the main transaction with the possibility of using a mechanism ensuring compliance with the principle of “delivery versus payment”.
We summarize that all operations by the parties will be carried out only legally – using bank transfers, and cash payments will not be carried out.
All banking operations using payment instruments in Ukraine are carried out in local currency (hryvnia).
Exceptions at the regulatory level are provided only for individual transactions of non-residents who are entitled to make payments in euros or US dollars. It is a question of non-resident investors. In particular, the acquisition of corporate rights or real estate in Ukraine is an investment transaction, and persons carrying out such operations acquire the status of non-resident investors (regardless of whether they are individuals or legal non-resident entities).
Therefore, it makes sense for non-residents to carry out the purchase of a business in Ukraine in foreign currency.
At present, the best way to guarantee the fulfillment of delivery obligations against payment is operations using escrow accounts. The essence of these operations is that the bank itself controls the sufficiency of the documents provided by the seller to the bank for payment. To do this, the bank provides the buyer in advance with an escrow account (an account that has statutory limits for withdrawing funds from it), and the buyer transfers funds to it (as usual, in the amount equal to the sale price of assets). Funds from this account can only be received by the seller, and only if the appropriate assets are transferred to the buyer. Such a legal construction will also be applicable if the parties agree on payment step by step.
Thus, there is reason to believe that such operations are reliable and safe for both parties.
In accordance with the regulatory regulation, an escrow account in a local bank in Ukraine can be opened both by a resident (a business entity or an individual) in hryvnia and by a non-resident investor in foreign currency for investment purposes.
Fifth, the parties must agree and fix the procedure in the agreement:
- changes in the members of the supervisory boards (if any) and members of the executive bodies, possibly providing the seller with the dismissal of individual employees on the date of the main transaction;
- transfer all documents related to the business and assets.
Sixth, the parties must agree and state in the agreement a list of formal conditions that must be fulfilled on the date of the main transaction:
- receipt by the buyer of the prior consent of the Antimonopoly Committee of Ukraine on the concentration of assets (if required);
- confirmation of the market price of the assets according to the rules established at the local level (if required);
- making appropriate decisions in accordance with the law and corporate documents (holding meetings of the highest bodies of business entities in accordance with the established procedure);
- if the assets are created or acquired in a marriage with the funds of the spouses, then obtaining the consent of the second of them to the alienation, should be notarized.
Seventh, the parties may also determine the guarantees and assurances of the seller regarding the business and assets, the legal purity of the acquisition transactions and the absence of third-party rights to such assets, including the seller’s liability for violations of the guarantees and assurances given to them.
This is probably the most “slippery” part in the agreements of the parties, since the absence in Ukrainian legislation of certain legal structures inherent in English law makes it very difficult to protect investors’ rights associated with the violation of guarantees and assurances of the seller. However, if it is a question of acquiring a small or medium-sized business, and the buyer has thoroughly carried out its preliminary comprehensive check, then the general legal instruments that are contained in local legislation may also be sufficient to protect the interests of the buyer.
And so, if all issues have been resolved, and the parties have signed Term Sheet or Memorandum of understanding, you can proceed to the fourth stage of the procedure.
Performing preliminary agreement conditions
(Term Sheet/Memorandum of understanding)
This is a preparatory stage where the seller, and sometimes the buyer, often takes actions and measures stipulated by the mandatory conditions of the preliminary agreement to fulfill the conditions for concluding the main transaction, including the elimination of legal deficiencies identified during the legal due diligence, accounting and tax audit of the business. .
Also at this stage it is desirable for the parties to carry out additional actions prior to the conclusion of the main transaction.
At first, agree on a notary who will conduct all registration activities related to the implementation of the main transaction.
The complexity of transactions with escrow accounts requires careful planning of the sequence of all registration activities and proper preparation of documents. Therefore, it is important to agree with the notary in advance all the procedures and documents to be signed by the parties in the future.
Secondly, determine the bank to support operations on the implementation of the main transaction.
Not all banks in Ukraine provide services with such accounts, so you should jointly find a bank in advance to support the main transaction.
We summarize that, most likely, the actual corporate rights of a legal entity (or several legal entities), for which assets of interest to the buyer are issued, will be the subject of the main transaction. Therefore, in negotiations with the bank, it is necessary to agree on all the essential conditions for their inclusion in the main contract and the contract for opening a special account (escrow), namely: the contract price, terms for finding funds for the escrow, the scope of rights during the verification of documents, terms of disclosure of escrow and other conditions .
The coordination of correct documents, the provision of which to the bank will allow the seller to unblock the buyer’s funds in the account, is of key importance for the security of the buyer. Banks, as a rule, are reluctant to perform control functions in such operations, therefore, the parties only need to agree on such documents to debit funds from the account in favor of the seller, which are subject only to formal analysis regarding the content of certain data. In planned operations, this can be achieved by correctly formulating the conditions for transferring ownership to the subject matter of the transaction in the main contract, as well as the conditions for disclosing an escrow in the relevant agreement with the bank.
Thirdly, to prepare drafts of the main contract for the acquisition of assets and the contract for opening a special account (escrow).
For a contract with a bank, the standard draft of the contract used by such a bank should be taken as a basis so that the draft prepared by you fully complies with its document flow.
And so, if all the preliminary conditions of Term Sheet or Memorandum of understanding are fulfilled by the parties, all legal shortcomings are eliminated, necessary approvals, powers of attorney and solutions for the main transaction are obtained, then we proceed to the final procedure.
Main transaction for the purchase of assets in Ukraine (SPA) and its closure
According to the sequence stipulated in the preliminary agreement (Term Sheet or Memorandum of understanding), the parties can sign the main agreement on the acquisition of assets and the agreement on opening a special account (escrow).
The agreement for opening a special account (escrow) can be signed in a bilateral format or trilateral (with the involvement of the seller). After signing such an agreement, the special account to make a bank transfer according to the amount plan for the main transaction will be opened for the buyer.
Once escrow currency enrolled, all documents related to the transfer of ownership of corporate assets to the buyer, and other documents in accordance with the plan set out in the Term Sheet and Memorandum of understanding must be signed. Having received the documents signed by the seller, the buyer has the opportunity to submit them to the notary to take the necessary registration actions to change the owner and manager.
If the transfer of ownership of the share in the authorized capital (shares) to the buyer took place and the relevant information was entered into the state register, and the assets acquired by the buyer are unencumbered assets to third parties, the seller himself or the notary at the request of the latter, generates corresponding extracts from state registers on the day of ownership transfer of corporate assets to the buyer.
After that, the seller submits to the bank the sample agreed by the parties and a statement obtained by extraction from public registries.
Verification of documents from the seller, as a rule, does not take a lot of time from the bank – the transfer to the seller’s own account must be carried out within a few banking days (unless the parties have agreed on other dates).
This is approximately the general procedure for acquiring a business asset in Ukraine. Some external details can be explained to you by an external consultant to whom you are forced to address if you plan to acquire a business in Ukraine, since it will be difficult to implement this procedure yourself without errors and losses.
Artur NONKO, Ph.D., managing partner of «Legal Consulting Center»