By Oleksander Plotnikov
Ukraine is actively involved in the international capital market, and the Ukrainian government and private companies are active in attracting debt financing from abroad. It is no secret that international banking and financial groups which provide financing to companies globally, work in well-established patterns which do not significantly differ from a country to another. However, from my own experience I can say that standard schemes do not always work in a way they should and in each case,individual national peculiarities should be taken into account.
In this article I will try to summarize the peculiarities of Ukrainian legislation and legal practice, which affect foreign lenders that provide financing to Ukrainian companies.
Since the financing of public companies is subject to specific rules, this article focuses on lending to the private sector.
Ukraine is quite correctly considered as a high risk country and consequently, much attention is paid by lenders to securing their loans. However, often some relevant peculiarities concerning Ukrainian legislation and its judicial system are not considered leading to serious mistakes on the part of a lender.
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Before providing a loan to a Ukrainian company, the lender should know that foreign lending in Ukraine is strictly regulated by the National Bank of Ukraine (NBU). In particular, all loans to Ukrainian companies from foreign lenders are subject to mandatory registration with the NBU (aside from a few exceptions). According to Ukrainian legislation, a loan agreement becomes effective only after its registration with the NBU. Although the registration procedure is fairly straightforward and in principal should take no longer than 7 working days, in practice the NBU often denies the registration based on minute technicalities. Such a refusal does not prevent a re-filing of documents for registration after the elimination of the identified violations, but significantly delays the moment when the funds become available.
In order to prevent uncontrolled cash flow out of Ukraine, the NBU has limited amounts that may be paid by Ukrainian borrowers to foreign lenders under loan agreements. Namely, according to a resolution of the NBU, the maximum amount of payments under a loan agreement containing a fixed interest rate with a term less than one year, shall not exceed 9.8per cent of the principal, per annum. For loans with a term from 1 year to 3 years,the cap is 10 per cent per annum, and for loans with a term exceeding 3 years, it shall not be higher than 11 per cent per annum. In the case of a loan with a floating interest rate the amount of payments is limited to the three-month LIBOR rate + 750 basis points, regardless of the term of the loan. These restrictions apply to any payments under a loan agreement, including but not limited to, interest, default interest, fees, penalties, etc. As a result of the application of the aforesaid limitations, foreign lenders in the drawing up of loan agreements are severely restricted in their ability to insert penalty clauses and indemnities towards the borrower. For example, if a loan agreement with a term of more than 3 years, provides for an interest rate amounting to 11 per cent per annum, a lender may not include into the agreement any indemnities, penalties or default interest payments,as this will lead to an excess of the permitted cap. Prior to registration of a loan agreement, the NBU checks whether provisions of such a loan agreement comply with the NBU’s established payment caps.
In order to bypass this restriction parties to a loan agreement often use a scheme in which a foreign company associated with a Ukrainian borrower undertakes to pay to a lender an amount of penalty or other payments that the borrower would have to pay in the absence of said payment cap. In this context it should be noted that most of large Ukrainian companies have associated companies abroad, which can be used for this purpose.
As a rule, to secure a loan provided to a Ukrainian company, foreign creditors intend to receive a standard package of security instruments, which includes:
- mortgage over real estate;
- pledge of borrower’s movable property;
- pledge of shares in the borrower;
- pledge of all borrower’s bank accounts;
- pledge/assignment of all rights to revenues arising from existing and future lease contracts, bank/corporate guarantees, deposits, etc. (pledge of receivables);
- pledge/assignment of insurance policy related to the pledged/mortgaged property;
- suretyship of third person.
Although all of these instruments can be used from the legal standpoint, not all of them effectively protect a foreign lender in Ukraine.
Generally speaking, lenders can rely only on the mortgage of real estate and pledge of shares in a joint stock company. The effectiveness of other security agreements is significantly limited due to undeveloped Ukrainian civil and commercial legislation and restrictions imposed by the currency legislation.
For example, current Ukrainian legislation does not provide for efficient mechanism of enforcement of a bank account pledge agreement due to absence of the statutory procedure for funds freezing on a bank account in case the borrower’s default and the transfer of these funds to the lender. The parties may establish the respective procedures in the pledge agreement, but the lender will much depend on the position of a Ukrainian bank which holds account of a borrower. Thus, the bank should be involved as a party of the pledge agreement, and the foreclosure mechanism should be as much detailed as possible. In addition it is necessary to make relevant amendments to a bank account agreement between the bank and the borrower, and to include the lender as a party to such agreement. However, irrespective of all detailed foreclosure procedures, if a Ukrainian bank is on the borrower’s side, which is quite common, the freezing of funds on the account before they are transferred to another borrower’s account is almost impossible. In addition the bank may refuse to freeze the funds without a court order, alleging that it will lead to violation of the law (the Civil Code of Ukraine contains a rule prohibiting banks to limit the client’s rights to use funds on the current account, which isin practice interpreted by banks quite differently, depending on the situation). The obtaining of a court decision in such case may take several days even under the most favorable scenario. Obviously, if a borrower is informed of the lender’s claims, it will transfer funds to an account with another bank.
In addition, if a foreign lender has managed to obtain judicial arrest over the funds on the account andto obtain a court decision on the foreclosure on such funds, the foreign lender will be able to transfer funds abroad only in foreign currency. If the borrower’s funds are in Ukrainian national currency (UAH) it is impossible to transfer them abroad, since the legislation does not provide for a legal mechanism for the purchase of a foreign currency and its transfer abroad in this case.
This obstacle may be eliminated only by way of assignment of a debt to a Ukrainian bank or a financial institution,which can obtain UAH from the borrower in Ukraine.
The second part of the article will be devoted to other security documents used to secure cross-border loans in Ukraine.
Oleksandr Plotnikovis a counsel at Arzinger, a Ukraine-based independent law firm