INTRODUCTION
The successful transition to a market economy in Ukraine will depend to a great extent on the development of an adequate legal infrastructure to support an attractive and enabling investment environment. Traditionally, international financial institutions and other multilateral aid organizations have focused on the adoption of macro-economic structural reform measures consisting of the elimination of exchange controls, price liberalization, restrictive fiscal and credit policies and privatization to facilitate the transition from command economies to market systems in the post-communist societies of Central and Eastern Europe.
Within the past three years Ukraine has adopted several important legislative measures which could serve as the foundation for the development of the legal infrastructure necessary to support the transition to a market economy. Nonetheless, a market oriented legal infrastructure is still at an early stage of development in Ukraine. Essential regulatory mechanisms required to support the institutional structures of a market economy in the areas of banking, corporations, securities regulation and property rights must be further developed in order to facilitate capital accumulation and financing techniques - two essential elements for the development of a robust private sector.
| Property Rights | Land Ownershipand Use | Quality of Legislation | Enforcement Mechanisms |
Certain existing impediments to private sector development and foreign investment in Ukraine may be attributed to the vestiges of the communist system which replaced a civil code tradition of property rights in Ukraine. Those attributes of the legal framework are somewhat incompatible with the concept of a market economy and will require a fundamental reorientation. To this end, the Government is introducing a number of changes in the legal framework to respond more positively to an emerging market economy.
Property Rights
One of the most significant legal issues affecting the restructuring of Ukraine's economy relates to property rights. The Law of the Ukrainian SSR On Ownership , which was one of the first major parliamentary measures adopted after sovereignty, but before the declaration of independence, represented a significant step forward in the conceptual reorientation of Ukraine's legal system of ownership toward more liberal principles. In contrast to the rigid regime of state and collective ownership, the Law on Ownership specifically recognizes private ownership and includes Ukrainian residents, foreign individuals and foreign legal entities among those entitled to own property in Ukraine. Moreover, the Law on Ownership specifically permits owners of property, including foreign investors and joint ventures, to use such property for commercial purposes, to lease property and to keep the revenues, profits and production derived from its use.
Notwithstanding the explicit recognition of private ownership, the Law on Ownership does not establish a comprehensive regime regulating the rights of ownership and the mechanisms for their transfer. Under the Soviet model of ownership sophisticated mechanisms for transferring ownership were unnecessary. Virtually all of the productive assets within the territory of Ukraine were restricted to collective or state ownership, and most alienation of property involved transfers for nominal value or no consideration between state enterprises or between workers' collectives and various state agencies or instrumentalities. Accordingly, both practice and theory required only the most rudimentary mechanisms for the transfer of property or property rights.
New measures must be enacted to redefine property rights and to develop coherent mechanisms for the regulation, protection and transfer of ownership rights and other property interests. The conceptual problems surrounding the issue of property rights in Ukraine's current legal infrastructure are best illustrated in the context of the ownership of land. Additional problems stemming from an underdeveloped legal system of property rights are explored in the Section XII below on Secured Transactions.
Land Ownership and Use
Issues relating to the ownership, use and disposal of rights and interests in land are regulated by the Land Code of Ukraine, adopted in 1992. The Land Code formally recognizes three forms of ownership of land: state, collective and private and provides that all three forms are equal in force and effect before the law. On the other hand, the Land Code also provides that all land in Ukraine is in the ownership of the state, except for land granted in collective or private ownership, and sets forth in considerable detail the various purposes for which the right to the use of land may be granted by the local councils of people's deputies to joint ventures, wholly foreign owned enterprises, foreign legal entities and foreign individuals.
As with the Law on Ownership, the Land Code contains a restrictive view of what constitutes private ownership. Under the Land Code the right to private ownership of land may be granted only to physical persons who are citizens of Ukraine and generally for the limited purposes of the construction of private residences and for agricultural subsistence. The Land Code specifically prohibits the ownership of land by foreign persons, providing only for the right to the "use" of land in such cases.
By definition, legal entities, whether resident Ukrainian companies or foreign legal entities, cannot own land in Ukraine. Neither the right of private ownership nor the right of collective ownership extends to such entities. Under the Land Code such entities may possess land on the basis of either lease rights or rights to the use of land.
While the concept of leasing is essentially consistent with the Western understanding and includes rights incident to leasing, such as the right to make improvements, the notion of a right to use a parcel of land is an odd construct which has no analogy in western models. As with the "collective" ownership of land, rights to the use of land are remnants of the socialist legal framework which are fundamentally incompatible with a commercially based regime of rights in real property.
Like the Law on Ownership, the Land Code is primarily concerned with proprietary relationships between various levels of state administration and collectives, especially with respect to agricultural and industrial land. Generally, the disposal of land is carried out by state bodies (usually the local council of people's deputies) either at the municipal, oblast (regional) or republican level, who grant uses to land primarily to other levels of government administration, to state enterprises or to collective associations or enterprises. Predictably, such practice has led to the development of only the most simplistic mechanisms for the transfer of interests in land.
Within the past year two narrow exceptions to the prohibition on the private ownership of land have emerged in the form of Presidential Decrees. The first Decree relates to the privatization of parcels of land accompanying incomplete construction sites and the second Decree relates to the transfer into private ownership of land surrounding privatized gasoline service stations.
Recently, the President of Ukraine has taken a progressive position on the question of land ownership in a major policy statement and in the form of additional Presidential Decrees. This position faces fierce opposition, however, from a conservative Parliament, whose communist/socialist/agrarian majority block is staunchly opposed to any redefinition of ownership rights to land.
On August 8, 1995, the President signed a decree (the "Land Decree") principally aimed at the devolution of the so-called "collective" form of ownership in the area of agriculture and at the facilitation of the transition from socialist-era organizational forms of agriculture to private farming in Ukraine. The Land Decree establishes a mechanism whereby each member of the so-called "collective" agricultural enterprises will secure his or her interest in a share of agricultural land owned by the enterprise. Each member would be eligible to convert a land share into a private parcel of land in the event that he wished to withdraw from the enterprise.
Quality of Legislation
From a practical point of view, Ukrainian legislation often suffers from a relative poor quality of the laws passed since Ukraine's proclamation of sovereignty early in 1991.
In many respects the unsatisfactory condition of the laws is an understandable result of the convergence of many factors affecting Ukraine since independence. Independent Ukraine inherited a bureaucratic structure that was essentially incapable of governing a modern state. Under the Soviet system Ukraine's parliament had the limited function of implementing all-Union legislation and its Ministry of Foreign Economic Relations consisted of a skeletal staff which was directly responsible to central authorities in Moscow. The expertise for developing policies and drafting coherent, sophisticated legislation conforming to the standards of the industrialized world for the most part was non-existent.
Moreover, after the collapse of the Soviet system Ukraine was suddenly confronted with the overwhelming task not only of rebuilding its economy, but of creating the institutions of a modern viable state. In addition, the new Ukrainian leadership was preoccupied with the task of nation building; the rush to pass laws became a symbolic exercise of sovereignty and the development of a coherent body of commercial legislation to support market reforms simply was not a priority.
For these reasons, a coherent legislative framework that can support the influx of capital and the growth of a vibrant private sector has still to be developed in Ukraine.
Enforcement Mechanisms
Shortly after independence, the courts in Ukraine were, for the most part, ill-suited to address complex commercial disputes. Foreign investors are well advised to include carefully crafted dispute resolution provisions in their joint venture agreements that provide for arbitration outside Ukraine. Recent developments, however, provide ample reasons for the expectation of improvement in this area.
As a general matter, the Law of Ukraine On Foreign Economic Activity allows the parties to a commercial dispute to select a forum for the resolution of their disputes. In addition to the guaranteed right to seek relief before an ordinary civil court of law, the parties may appoint a permanent or an ad hoc court of arbitration as the dispute resolution body. The arbitration may be conducted within or beyond the territory of Ukraine.
On April 20, 1994, the Parliament enacted the Law of Ukraine On International Commercial Arbitration ("LICA"). The LICA clarifies certain issues that were not addressed in prior law and as a result places foreign businesses in a much better position with respect to commercial disputes which may arise in connection with their operations in Ukraine.
In particular, the LICA supports the principle of the exclusivity of the arbitration jurisdiction designated by the parties in the event of a commercial dispute. In addition, the LICA provides that a Ukrainian civil court of law reviewing a dispute which is subject to a valid arbitration agreement between the parties shall, if requested by any one of the parties, terminate the proceedings and transfer the dispute to the organ appointed in the arbitration agreement. In addition, the LICA guarantees that a valid arbitral award shall be recognized in Ukraine irrespective of the country in which the arbitration proceedings were conducted.
In spite of the progressive developments outlined above, Ukrainian legislation governing international commercial arbitration still lacks clarity with respect to a number of important issues.
In particular, the precise mechanism for enforcing a foreign arbitral award is unclear. While the Civil Procedural Code of Ukraine contains provisions which govern the enforcement of judgments of civil courts and the awards of Ukrainian arbitration courts, it is unclear whether these provisions are applicable to awards of foreign arbitration bodies. In fact, the Civil Procedural Code provides that the procedure for enforcing foreign arbitral awards shall be governed by international treaties. As a result, the exact legal procedure that should be followed to enforce a foreign arbitral award in Ukraine is unclear. Notwithstanding the foregoing, recent examples in which foreign arbitral awards have been enforced in Ukraine for the benefit of foreign investors suggest that Ukrainian domestic courts are prepared to abide by Ukraine's treaty obligations, notwithstanding the absence of clear implementing regulations.
FOREIGN INVESTMENT REGIME
The new Law of Ukraine "On the Regime of Foreign Investment" (the "FIL") was officially published on April 25, 1996 after having been adopted by the Parliament of Ukraine and signed by the President on March 19, 1996. The FIL replaces Decree No. 55-93 of the Cabinet of Ministers of Ukraine "On the Regime of Foreign Investment" (the "Decree") which was in effect since June 1993.
As originally adopted, the Decree provided for a five (5) year tax holiday on profits for enterprises with qualifying foreign investments. Effective January 1, 1995, the Law "On the Taxation of the Profits of Enterprises", adopted on December 28, 1994 (the "Corporate Tax Law"), repealed the five year tax holiday previously available to Ukrainian enterprises capitalized with a qualified foreign investment in accordance with the Decree. However, enterprises with qualified foreign investments that were registered on or prior to January 1, 1995 may still qualify for the five year tax holiday under the Decree. In addition, certain residual benefits still apply to enterprises with foreign investments registered after January 1, 1995.
The FIL does not change the rights and obligations previously extended to foreign investors under the Decree in any significant way. The FIL also does not reinstate the tax holiday once available to enterprises with qualifying foreign investment under the Decree.
The FIL provides for a range of vehicles for carrying out a foreign investment in Ukraine, including: establishing a new company with a Ukrainian partner or purchase of an interest in an already existing Ukrainian company; establishing a wholly-owned subsidiary or a branch or any other separate structural unit of a foreign legal entity, or acquisition of an existing Ukrainian company; direct acquisition of any kind of real or other property which is not directly prohibited by applicable Ukrainian legislation, or acquisition of shares of stock, bonds and/or other securities; acquisition of land use rights or concessions for the development of natural resources (whether independently or together with a Ukrainian partner); acquisition of other property rights; and any other vehicle which is not directly prohibited by applicable Ukrainian legislation, including investments in a joint cooperation agreement with a Ukrainian partner.
The FIL's remaining key provisions may be summarized as follows:
An enterprise with foreign investment ("EFI") is defined as any type of organizational form created in accordance with Ukrainian legislation where the foreign investment in the charter fund is at least 10%.
Types of foreign investment permitted under the FIL include:
(i) foreign currency; (ii) reinvested Ukrainian currency; (iii) any type of movable or immovable property, together with any rights associated therewith; (iv) shares, bonds, other securities or corporate rights; (v) monetary or contractual receivables guaranteed by a first class bank; (vi) intellectual property rights; and (vii) rights to carry out economic activities, including rights to natural resources.
The exchange rate for converting foreign investments into Ukrainian currency shall be the rate established by the National Bank of Ukraine. The Decree allowed the parties to an EFI to agree upon the exchange rate, provided that the exchange rate for the Ukrainian currency was not higher than the rate established by the National Bank of Ukraine.
The foreign investor is guaranteed the protection provided by the FIL for 10 years in the event Ukrainian foreign investment legislation is changed. A foreign investor's investment may not be nationalized. A foreign investor is guaranteed the right to remit its revenues and a right to withdraw investments from Ukraine within six months upon the termination of the investment activity.
The Cabinet of Ministers of Ukraine shall establish procedures for the registration of foreign investments.
A foreign investor may import property into Ukraine for the charter fund of an EFI without paying custom duties. (While a VAT exemption was considered in the first draft of the FIL, the adopted draft of the FIL does not include a VAT exemption.)
When importing property for its charter fund, an EFI shall issue a promissory note in the amount equivalent to the duty owed and with a maximum term of 15 days. Such promissory note shall be extinguished once the property is transferred to the account (balance) of the EFI and the local tax inspectorate where the EFI is located notes such transfer on the promissory note.
The Cabinet of Ministers of Ukraine shall establish procedures for issuing, recording and extinguishing promissory notes.
An EFI shall be required to pay import duties on the declared value of foreign investment if, within three years of importation, the foreign investment is alienated.
An EFI shall pay taxes in accordance with Ukrainian legislation.
Foreign investors may be granted rights to develop natural resources and engage in economic activity with state owned objects based on concession agreements. Concession agreements shall be between a foreign investor and either the Cabinet of Ministers of Ukraine or some other state organ which has appropriate authority under Ukrainian legislation. Concession agreements shall not exceed 99 years. The Verhovna Rada must approve any concession agreement which includes terms and conditions not foreseen by Ukrainian legislation.
Foreign investors may carry out investment activities based on contracts/agreements ("Joint Activity Agreements") rather than through a legal entity. However, such joint activities must have a separate accounting and separate bank accounts for such operations. Joint Activity Agreements must be registered in the manner established by the Cabinet of Ministers of Ukraine.
In addition to replacing the Decree, the FIL cancels the 1992 Law of Ukraine "On Foreign Investment" and the Law "On the State Program for the Promotion of Foreign Investment in Ukraine", dated December 1993.
Currently, legal entities can be created under two parallel bodies of law: the Law of Ukraine On Enterprises and the Law of Ukraine On Business Associations. The most common vehicles for business activity and the preferred vehicles for foreign investors are the joint stock company and the limited liability company, both of which incorporate the concepts of limited liability for investors. BUSINESS ENTERPRISES
However, under Ukrainian law each of these vehicles is treated as a separately taxable entity. As a result, neither foreign investors nor private domestic investors have the option of engaging in business activities through a Ukrainian legal entity that would afford the benefits of the pass through or conduit method of taxation which is the principal advantage of the partnership and smaller business ("S") corporation forms of doing business in the United States.
Sole Proprietorship
In order to carry out business activities as a sole proprietorship, an individual is required to register as an "entrepreneur' with the local authorities. This is the only form of doing business in Ukraine which provides for a single tier of taxation. There is no requirement with regard to the minimum capitalization of a sole proprietorship. Registration of a sole proprietorship is subject to payment of a small official fee ranging from $0.6 to $2.1 U.S. dollars depending on the principal area of activity of the registered entrepreneur.
Partnership
Ukrainian legislation does not provide for the creation of legal entities or partnerships which act as "flow through" entities for tax purposes. Although the corporate legislation permits the creation of "full liability companies" ("FLC"), they are subject to two levels of taxation: at the corporate level and at the shareholder level. The creation of a "differentiated liability company" ("DLC") (similar to a US limited partnership) is also possible; however, it too is subject to two levels of taxation.
There is no requirement with regard to the minimum capitalization of a FLC or DLC, although certain inimum investment thresholds have to be met in order to obtain the benefits accorded EFIs under the FIL.
Corporations
The Ukrainian Law on Business Associations (the "Companies Law") provides for five corporate forms of legal entities: joint-stock companies (both open and closed) ("JSC"), limited liability companies ("LLC"), additional liability companies, FLCs and DLCs. As a practical matter, most business entities in Ukraine are established as JSCs or LLCs.
Joint Stock Company.
A JSC is very similar in form and operation to a U.S. corporation. It is a limited liability company in which the shareholders are only liable for the obligations of the entity to the extent of their capital contributions. There are two levels of taxation: the JSC is taxed on its profits; the shareholders are then taxed when dividends are distributed.
There are two types of JSCs: open and closed. An open JSC is established through a public offering and subscription of shares; a closed JSC's shares are distributed privately among the founding shareholders. At least two founding shareholders are necessary to create a JSC. Minimum capitalization for registration of a JSC is currently approximately $600 U.S. dollars. Under the prior foreign investment Decree, a capital contribution of either $50,000 in kind or $500,000 in cash is required in order for the JSC to obtain the various benefits provided enterprises with foreign investments. This requirement appears to have been eliminated in the FIL.
Limited Liability Company
A LLC is a cross between a U.S. corporation and a U.S. partnership. It is similar to a corporation in that it is a limited liability company in which the interest holders are only liable to the extent of their capital contributions. However, it is similar to a partnership in that ownership interests are expressed in terms of contractual rights that arise out of the foundation documents. Thus, transfer of ownership rights is carried out through an assignment of contractual rights.
There are two levels of taxation: the LLC is taxed on its profits; the interest holders are then taxed when dividends are distributed. At least two founding interest holders are necessary to create a LLC. Minimum capitalization for registration of a LLC is currently approximately $300 U.S. dollars. Again, under the prior foreign investment Decree, a capital contribution of either $50,000 in kind or $500,000 in cash is required in order for the JSC to obtain the various benefits provided enterprises with foreign investments. This requirement appears to have been eliminated in the FIL
Representative Offices
Foreign legal entities are permitted to establish representative offices in Ukraine. A representative office is permitted to carry out marketing, promotional and other auxiliary functions on behalf of the foreign legal entity. It is less clear whether a foreign company can also carry out a trade or business through a representative office, although in practice many have been permitted to engage in activities that go well beyond the scope of traditional representative offices. A registration fee of $2,500 is to be paid in connection with the registration of a representative office.
Branches
Although branches of foreign companies are permitted by the FIL, they have yet to take root in Ukraine. The procedure for their registration remains unclear and untried.
Joint Ventures; Joint Production Agreements
Joint ventures in Ukraine are generally created in the form of a JSC or LLC. Ukrainian legislation also permits a foreign investor to invest in Ukraine without creating a legal entity by entering into a joint production or joint cooperation agreement with a Ukrainian legal entity.
TAXATION
On January 1, 1995, a new corporate tax law governing the taxation of entities in Ukraine, the Law "On the Taxation of the Profits of Enterprises" (the "Corporate Tax Law") took effect. The Corporate Tax Law provides new tax rates for entities in Ukraine and additionally has modified the basis on which entities are taxed so as to bring Ukrainian taxation principles more in line with Western practice. Significantly for the foreign investor, the Corporate Tax Law repealed the five year tax holiday available to Ukrainian enterprises capitalized with a qualified foreign investment in accordance with Decree No. 55-93 of the Cabinet of Ministers of Ukraine "On the Regime of Foreign Investment", dated June 5, 1993 (the "Decree"). However, enterprises with qualified foreign investments that were registered on or prior to January 1, 1995 may still qualify for the five year tax holiday under the Decree.
The Corporate Tax Law abolished the concept of taxing "dokhod", which was defined as the difference between the value of products (works, services) sold and their cost of production (not including employee's salaries and most interest paid on borrowed funds). Commencing on January 1, 1995, the concept of taxing "dokhod" was replaced with a tax on profits.
The Corporate Tax Law established a basic corporate tax rate of 30%. However, the rate of taxation for profits gained from intermediary activities or from the carrying out of auctions (except for auctions involving securities, ownership interests in legal entities, currency values and other financial instruments) is 45%. Profits from lotteries, casinos and other types of gambling activity are taxed at a rate of 60%. In certain cases, reduced tax rates or tax exemptions are available to enterprises which carry out activities in the agricultural field or which are engaged in the construction of homes and other facilities in rural areas.
The corporate tax is levied on the gross profits of an enterprise. Gross profits are defined as revenues obtained by an enterprise from all of its activities carried out in Ukraine and abroad during the reporting period, including revenues: (i) from the sale of products (works, services), fixed assets, intangible assets, securities, currency values and other types of financial instruments and other material items; (ii) from leasing operations; (iii) from royalties; and (iv) from non-sales transactions, less the cost of production and other permitted expenses and deductions.
Unlike previous Ukrainian tax legislation, the Corporate Tax Law provides for clearer definitions of permitted costs and expenses. For example, interest payments for loans incurred for working capital needs and for the acquisition of fixed and intangible assets required for current production needs may now be included in the cost of production, as well as payments for investment management and depository services, expenses connected with the payment of dividends and expenditures for printing and issuing shares and other securities.
Depreciation is calculated on the basis of book value (as re-valued) in accordance with the rates of depreciation established under regulations issued by the Council of Ministers of former USSR.
Prior to the adoption of the Corporate Tax Law, depreciation rates were very conservative. Rates for most types of equipment were normally from 8 to 10 years; accelerated depreciation was permitted only for enterprises with qualifying foreign investment, enterprises engaged in military conversion and enterprises operating in priority branches of the Ukrainian economy. The Corporate Tax Law permits enterprises to determine independently their own accelerated rates of depreciation. However, such rates may not be more than twice that established by the applicable regulations and they may not lead to an increase in the prices of products produced by the enterprise. Depreciation of intangible assets is calculated based on their initial cost of acquisition and period of effective use (but not more than 10 years). Intangible assets whose value does not decrease as a result of their use in the production process (e.g. goodwill) are not subject to depreciation. The Corporate Tax Law does not contain any specific provisions governing the taxation of capital gains. As a result, capital gains are taxed at the basic rate of 30%. Capital gains are taxed at the moment securities are actually sold.
The Corporate Tax Law provides that a foreign legal entity carrying out business activities on the territory of Ukraine through a "permanent establishment" is subject to tax on all profits generated by the activities of such permanent establishment. A permanent establishment is defined under the Corporate Tax Law as (i) any structure in Ukraine which is not a legal entity through which a foreign legal entity either partially or fully carries out business activities in Ukraine or (ii) an individual who represents and is employed by a foreign legal entity in Ukraine. However, the determination of whether a "permanent establishment" exists would be subject to the provisions of any applicable tax treaties.
Profits generated by a permanent establishment are now subject to a 30% tax. Profits for purposes of this tax are deemed to be those profits which a permanent establishment would have obtained if it (i) were a separate independent enterprise involved in similar activities on the same conditions as the foreign legal entity and (ii) had acted independently with respect to the foreign legal entity.
In the event it is not possible to determine such profit, an alternative method may be negotiated with the Ukrainian tax inspectorate. In practice, the most common method is for a permanent establishment to pay a 30% tax on a deemed profit equal to 30% of the expenses attributable to such permanent establishment.
Passive Ukrainian source income received by a non-resident who does not carry out business activities in Ukraine through a permanent establishment (e.g. dividend, interest, lease and royalty payments and payments for insurance premiums), as well as Ukrainian source income obtained from technical engineering services is subject to a 15% withholding tax upon repatriation from Ukraine. Such withholding tax rate would be subject to the provisions of any applicable tax treaty. Ukraine has indicated that it will adhere to the USSR tax treaties until such time as Ukraine has entered into new treaties with such countries. Ukraine has signed its own treaties with Poland, Canada, the United States, Great Britain and others. Many others are currently under negotiation.
Income obtained by non-residents from freight charges paid by Ukrainian enterprises are subject to a 6% withholding tax. Interest payments received in connection with loans granted to the National Bank of Ukraine or to the Cabinet of Ministers are not subject to withholding tax upon repatriation.
VAT of 20% is currently levied on the sale of goods and services on the territory of Ukraine, although exports, sales of certain essential goods and sales in foreign currency are not subject to VAT. In addition, early in 1994 an "import VAT" was introduced on all imported goods other than contributions to charter funds of enterprises with foreign investment ("EFIs"), equipment and raw materials needed for the production purposes of enterprises and fuel, energy and agricultural materials which will be utilized on the territory of Ukraine.
Excise taxes are levied on certain goods. A tax of 0.2% is currently levied on all transactions involving securities.
Most Ukrainian legal entities are required to pay as of December 1, 1994 a total of 51% in payroll taxes in connection with their employees. These include 37% to the pension and social security funds, 12% to the Chernobyl fund and 2% to the employment fund.
Ukrainian accounting practices do not yet conform to internationally accepted accounting principles. All taxes with the exception of withholding taxes on dividends, interest, freight and engineering services are paid in local currency.
CURRENCY REGULATION
In 1992, Ukraine introduced as its temporary currency the karbovanets (commonly referred to as the "coupon"), which resulted in Ukraine effectively ceasing to be a member of the ruble zone of the former Soviet Union. It is anticipated that after several announcements a new currency, the "hryvnia" will finally be introduced in 1997.
In March 1993, the Cabinet of Ministers of Ukraine published three decrees concerning currency regulation in Ukraine:
(i) Decree No. 1593, "On the System of Currency Regulations and Currency Control";
(ii) Decree No. 1693, "On Provisional Procedures for the Use of Foreign Currency Earnings"; and
(iii) Decree No. 1793, "On the Procedure for Settling Accounts in Foreign Currency" (together the "Currency Decrees"). Decree No. 1793 has since been replaced by the Law of Ukraine "On the Procedure for Settling Accounts in Foreign Currency", adopted in November 1994.
In addition, the National Bank of Ukraine ("NBU") has issued several instructions and regulations which address a number of the issues covered in the Currency Decrees. A new draft law on currency regulation is currently being debated by Parliament and is expected to be adopted with the introduction of the new national currency, the hryvnia.
The Currency Decrees are structured around the general principle that Ukrainian currency is the only lawful form of payment on the territory of Ukraine which may be accepted without limitation for the settlement of debts and obligations. Accordingly, Article 5 (4)(d) of the Decree provides that an individual license must be obtained from the National Bank of Ukraine in order to use foreign currency on the territory of Ukraine as a means of payment.
As a general exception to the foregoing principle, Article 7 of the Decree No. 15-93 provides that all commercial transactions between a resident and non-resident in the sphere of `trade turnover' (torhovelniy oborot) must be carried out in foreign convertible currency and only through authorized Ukrainian banking institutions. As such, a non-resident wishing to carry out commercial transactions within the scope of `trade turnover' in local currency on the territory of Ukraine would need to apply for an individual license from the National Bank of Ukraine.
The Currency Decrees provide that individual licenses have to be obtained from the NBU for the carrying out, inter alia, of the following operations:
(i) hard currency transactions on the territory of Ukraine between residents (as of August 1, 1995 such licenses are no longer available for cash transactions);
(ii) use of hard currency on the territory of Ukraine as a form of security;
(iii) opening by a resident of bank accounts abroad;
(iv) making of investments abroad by a resident or, except in the event of inheritance, the acquisition of shares or an ownership interest by a resident in a non-Ukrainian legal entity;
(v) obtaining or granting of loans in hard currency by a resident if the amount of the loan is in excess of minimum levels established by the NBU;
(vi) making hard currency payments from Ukraine abroad (with the exception of instances listed in the following paragraph).
Individual licenses are not required, inter alia, for the following transactions:
(i) payments abroad in hard currency which are carried out by residents in order to fulfill obligations in such currency before nonresidents in connection with payment for goods, services, works, intellectual property rights and other property rights;
(ii) payments abroad in hard currency made in the form of interest payments on loans and profits from foreign investments;
(iii) transfer, upon the termination of investment activities, of hard currency from Ukraine which had been previously invested in Ukraine.
According to a Resolution of the Board of National Bank of Ukraine dated May 16, 1995, the use of foreign currency for cash payments on the territory of Ukraine was prohibited as of August 1, 1995. Unless otherwise provided in the individual license, the obtaining of an individual license by one of the parties to a currency operation means that permission for the execution of such operation has also been granted to the other party to the transaction.
The Currency Decrees provide as a basic principle that all resident legal entities are required to sell 100% of their hard currency revenues for coupons to a Ukrainian commercial bank at the interbank currency auction rate. However, as a temporary measure until the Ukrainian currency stabilizes, the Currency Decrees provide (i) that enterprises with foreign investments (e.g. joint ventures and wholly-owned foreign subsidiaries) will be permitted to keep 100% of hard currency revenues generated through the export of goods or services which qualify as their "own production" and (ii) that all other Ukrainian legal entities would be required to sell 50% of their hard currency revenues for coupons to a Ukrainian commercial bank.
Commencing in 1993, the system of forced conversion of 50% of all foreign currency revenues was instituted. Given the sharp decline of the karbovanets against the dollar, in the summer of 1993 an official exchange rate fixed by the Cabinet of Ministers was introduced and applied to all mandatory conversion of foreign currency under applicable law; in November 1993, the government ordered the Ukrainian Interbank Currency Exchange (UICEX) to suspend operations and a currency tender committee under the government was formed to allocate foreign currency reserves. In addition, in early 1994, the NBU commenced controlled auctions for foreign currencies. These measures created tremendous distortions in the Ukrainian currency market and resulted in a significant spread between the official and "black market" rate for the Ukrainian currency.
Presidential decrees and NBU decisions in late 1994 resulted in the reopening of the
UICEX, the abolishment of the currency tender committee and the NBU auctions and the establishment of an official exchange rate which is determined on the basis of the rate fixed at the previous UICEX auction. As a result, the official and "black market" rates have moved closely together. At the present time, forced conversion of foreign currency revenues is carried out at the rate established at the UICEX.
CONVERTIBILITY AND REPATRIATION OF PROFITS
The Ukrainian currency is at present not fully convertible, although significant measures have been undertaken recently in order to progress towards that goal. Currencies are traded at auctions held by the UICEX. In addition currencies may now be traded at the informal interbank currency market. Currently, the U.S. dollar and the Russian ruble trade on the UICEX daily, the German DM trades twice weekly and the Italian lira and the French franc trade once per week each.
Figures released for the months of July and August 1995 indicate that the volume of US dollar trading on the UICEX exceeded an average of US $325 million per month.
Prior to November 1994, foreign currency could be obtained only for the purpose of importing certain essential goods. At present, the rules have been substantially relaxed and a Ukrainian legal entity may convert local currency into a foreign currency in the event it has entered into a foreign economic contract or provides other justification for the foreign currency. (Repatriation of foreign currency dividends or invested capital to a foreign investor would serve as a valid justification for obtaining foreign currency). The entity would be required to carry out the conversion through its commercial bank: the commercial bank receives a conversion request from its client, reviews the basis on which the entity is requesting foreign currency and participates in the UICEX auction to purchase the currency on behalf of its client.
Foreign investors are guaranteed the right of repatriation abroad, in foreign currency, of their revenues, profits and other sums obtained legally in connection with their investment. A foreign investor may currently convert local currency into a foreign currency through the UICEX. Such an investor would request its commercial bank to participate in the auction and convert local currency into foreign currency. Foreign investors are permitted to convert local currency into foreign currency for the purpose of repatriating legally obtained profits or investments abroad.
BANKS AND BANKING REGULATION
Ukraine has a banking system in the process of developing. It is two-tiered, with the NBU and approximately 250 commercial banks. Of the commercial banks, five are the former specialized state banks: one is a savings bank (Oschadbank), three are specialized lending banks (industrial investment, agricultural and social development) and one is the Export-Import Bank of Ukraine. The three specialized lending banks receive concessionary treatment from the NBU and are responsible for the vast majority of enterprise lending. There are reports that a three-tiered banking system comprised of the NBU, specialized banks and commercial banks may be introduced in the near future.
The NBU regulates and supervises commercial banks. However, the NBU's resources are often insufficient to provide for thorough supervision and regulation. It is anticipated that there will be significant amendments to the current legislation governing banking activities.
The fact that most of the commercial banks are lending to financially strapped state enterprises has resulted in tremendous instability in the Ukrainian banking system. In addition, bank clients face considerable problems with the disclosure of confidential information by banks and their employees to unauthorized third parties; state authorities such as the tax inspectorate have wide-ranging powers to freeze bank accounts or to withdraw funds for payment of taxes or fines without the need to obtain a court order or authorization.
Notwithstanding the foregoing difficulties in the banking sector the mechanism for settlements, particularly relating to domestic transfers, has proven to be extremely efficient and has won praise from many observers. Although the situation is rapidly improving foreign investors are confronted with delays in converting currency and repatriating profits in foreign currency.
One foreign bank, Credit Lyonnais, has opened a wholly-owned subsidiary commercial bank. Société Générale has also obtained a commercial banking license from the NBU and is expected to open a full service branch in Kiev in the near future. Other foreign banks are attempting to obtain a banking license, although there appears to be considerable opposition within the NBU for the granting of further banking licenses to subsidiaries of foreign banks.
Numerous Ukrainian commercial banks have joined the international Society for Worldwide Interbank Financial Telecommunications (SWIFT). SWIFT provides financial data communication and processing services to support the business activities of banks around the world. Through SWIFT, the participating Ukrainian banks may complete instantaneous transactions with other U.S. banks on line with SWIFT. Western Union has also recently begun a money transfer service between Ukraine and the outside world.
IMPORT AND EXPORT REGIME
The regulation of foreign trade over the last three years has moved in cyclical patterns, from little control to significant barriers and restrictions. In the beginning of 1993, the Cabinet of Ministers adopted a Decree which established quotas and required licenses for the export of a large number of export products. In May of 1993 a decree on the liberalization of foreign economic activities was enacted and decreased the number of export products requiring quotas and licenses. At the end of 1993, the Cabinet of Ministers reversed course and reinstated a restrictive license and quota system.
In the spring of 1994, quota and license requirements were again relaxed and in October 1994, the Cabinet of Ministers as part of Ukraine's agreement with the IMF embarked on a course of radical trade liberalization, eliminating almost entirely all license and quota requirements. Unfortunately, the positive effects of such measures have been significantly undercut by a recent Presidential Decree requiring the registration of a significant portion of foreign trade contracts with the Ministry of Foreign Economic Relations and Trade.
At present, a limited number of goods must be licensed by the Ministry of Foreign Economic Relations in order to be imported into Ukraine. A Presidential Decree was issued in September 1994 which may create additional trade barriers for imported goods in an attempt to protect domestic producers and decrease the country's trade deficit.
In 1994 and again in 1995 there were no export taxes or duties levied in Ukraine. None are expected for 1996. Import duties exist with respect to certain products. There are three levels of import duty rates which are applied; the exact rate depends on the imported item's country of origin.
The Cabinet of ministers of Ukraine has published figures indicating that during the first quarter of 1995 Ukrainian exports equaled 1.99 billion dollars and imports 2.78 billion dollars. More recent information reported in the financial press indicates that for the period January - July 1995, for the first time since independence Ukraine achieved a positive balance of payments structure with exports valued at 5.77 billion dollars and imports for the same period valued at 5.73 billion dollars.
In accordance with the Law of Ukraine On the State Budget for 1994, as of January 1, 1994, all imported goods are subject to VAT at their full import value which consists of the declared customs value, plus import duty, custom's fees and excise taxes, if any. The new VAT regime also extends to goods imported to Ukraine on a temporary basis. VAT is generally payable at the moment of customs clearance by the importer. The current VAT rate on imported goods in 20%. Notwithstanding the foregoing, however, based on the June 30, 1995 Presidential Decree On the Application of Value Added Taxes to Imported Goods (the "Import VAT Decree"), a limited number of goods, including raw materials, component parts, equipment, machinery and other goods and materials, including energy supplies (oil and gas) imported by commercial enterprises for "production purposes and their own needs" (excluding goods imported for sale or other disposition) are exempt from value added taxes.
Significant changes have been introduced to the import regime of goods that are subject to excise taxes as recently as December 12, 1995, with the implementation of the Law of Ukraine On Certain Questions Concerning the Taxation of Excise Goods, dated November 16, 1995 (the "Excise Tax Law"). Based on the provisions of the Excise Tax Law and subsequently adopted implementing regulations a serious risk exists that, at least under current interpretation of the Excise Tax Law, to the extent any of the imported goods are subject to excise taxes, such goods will also be subject to all other import duties, import VAT and other import related charges, regardless of the intended use of the goods, including goods imported as capital contributions to enterprises with qualifying foreign investments.
ANTI-MONOPOLY AND UNFAIR COMPETITION LAWS
During the period from 1992 to 1994, the Parliament, the Cabinet of Ministers and the Anti-Monopoly Committee ("AMC") of Ukraine adopted a series of laws, decrees and regulations which form the basis for the Ukrainian anti-monopoly legislation including:
(i) The Law of Ukraine On Restriction of Monopolism and Prevention of Unfair Competition in Entrepreneurial Activity, effective March 15, 1992 (the "Law");
(ii) Regulations on the Methods for Determining the Monopolistic Position of Enterprises in the Market, approved by Order No. 1-R of the AMC, dated March 10, 1994 (the "Regulations"); and
(iii) The Cabinet of Ministers of Ukraine Decree No. 765 "On the Introduction of the Mechanism for Preventing the Monopolization of Product Markets" adopted November 11, 1994 (the "Anti-Monopoly Decree").
Under the Anti-Monopoly Decree, the approval of the AMC is required for the creation, merger, and acquisition of enterprises which may result in the formation of a new monopoly enterprise; and in certain instances, the acquisition of the assets of, or the ownership interests in, enterprises.
AMC Approval for the Creation of an Enterprise
A legal entity may be established in Ukraine only upon the AMC's approval if:
the entity is to be formed by two or more founders and (i) the total value of the assets of all of the founders (the "Asset Value") or the total sales volume of all of the founders' goods or services in the last financial year (the "Sales Volume") is in excess of an amount which is equal to $2 million U.S. dollars in local currency (calculated at the official exchange rate in effect at the end of the previous financial year) and (ii) the Asset Value or the Sales Volume of at least two of the founders is in excess of $100,000 U.S. dollars; or
the entity is to be formed by two or more founders which operate in a given product market and the total share of such founders of such product market exceeds 35 per cent; or
the share of a given product market of the entity which is to be formed will exceed 35 per cent.
AMC Approval for the Merger or Acquisition of Enterprises
The Anti-Monopoly Decree provides that a merger of enterprises or the acquisition by one enterprise of another enterprise must be approved by the AMC if:
any of the participating enterprises enjoys a monopolistic position in a given product market; or
although none of the participating enterprises enjoys a monopolistic position in a given product market, the Asset Value or Sales Volume of all of the participating enterprises in local currency is equal to $1 million U.S. dollars and the Asset Value or the Sales Volume in local currency of at least two of the participating enterprises exceeds $100,000 U.S. dollars.
AMC Approval for the Purchase of Ownership Interest in an Enterprise
The AMC must approve any direct or indirect purchase of ownership interest in an enterprise which results in the buyer acquiring 10, 25, 33 or 50 per cent of voting rights in the enterprise if the total value of the ownership interest which is to be bought exceeds the local currency equivalent of $100,000 U.S. dollars calculated at the official exchange rate which is in effect on the date when the purchase of the ownership interest is made. The AMC's approval is also required to acquire an ownership interest in an enterprise which enjoys a monopolistic position regardless of the value of the ownership interest which is to be acquired.
AMC Approval for the Purchase of Assets of an Enterprise
The AMC must approve the direct or indirect purchase of assets of an enterprise if the assets which are to be acquired are "substantially all" of the assets of the enterprise. Such a requirement would apply if the value of the assets exceeds the local currency equivalent of $100,000 U.S. dollars.
PRIVATIZATION
Ukraine enacted three major pieces of legislation on privatization in March of 1992, covering large scale privatization, the privatization of small-scale enterprises and privatization through privatization certificates. These measures were supplemented by the State Privatization Program for 1992, the State Privatization Program for 1994 (the "1994 Program"), and more recently the March 19, 1996 Presidential Decree "On the Goals and Specifics of the Privatization of State Assets in 1996" (the "1996 Presidential Decree"). In addition, a law on the lease of the property of state enterprises and organizations was originally adopted in April of 1992 which provided workers with rights to lease (and subsequently to buy out) the assets of state enterprises on favorable terms. The Lease Law was amended and restated in March 1995.
The Law on Privatization Certificates contemplates the exchange of state property for privatization certificates distributed by the state to all citizens of Ukraine. According to the 1994 Program, approximately 70% of the value of all state property to be privatized is to be distributed at no cost to Ukrainian citizens through privatization certificates.
Privatization certificates were introduced into circulation in Ukraine in January 1995. Since the inception of the privatization certificate program in November 1992, privatization "certificates" have existed only in the form of amounts credited to special privatization deposit accounts opened by the government for each citizen of Ukraine at branches of the State Savings Bank, the "Oschadbank".
In accordance with Resolution No. 34 of the Cabinet of Ministers of Ukraine "On the Indexation of Fixed Assets and the Designation of Amortization Rates for their Full Depreciation in 1995", dated January 17, 1995, the nominal value of privatization certificates was increased from the original nominal value of 1,050,000 Ukrainian karbovanets to 50,000,000 Ukrainian karbovanets. At current commercial exchange rates, the value of the privatization certificate is approximately $280 U.S. dollars; this compares with the substantially lower value of approximately $8 U.S. dollars attributable to the privatization certificates prior to their revaluation. Unlike in Russia, privatization certificates are not issued as bearer instruments and therefore not freely transferable. In addition, amounts credited to a privatization deposit account in Oschadbank are also not freely transferable.
In view of the erosion in the face value of privatization certificates as a result of inflation and currency devaluation, in accordance with a Presidential Decree, issued on November 26, 1994, Ukrainian citizens will benefit from a significant indexation of monies held in savings accounts. Such indexed amounts may be converted into "savings certificates" which can be used by Ukrainian citizens as a supplement to their privatization certificates in order to purchase shares in privatized enterprises. Unlike privatization certificates, these "savings certificates" will be freely transferable. According to the November 26, 1994 Presidential Decree, shares of open joint stock companies held by the state after the sale of shares to workers and management on preferential terms and the issuance of shares to Ukrainian citizens in exchange for their privatization certificates at privatization certificate auctions, will be transferred to Ukrainian citizens in exchange for their savings certificates as compensation for their losses from the devaluation of their savings on accounts at Oschadbank, the State Savings Bank of Ukraine.
The 1994 Program projected an ambitious schedule for privatizing over 20,000 small-scale enterprises, 1,400 incomplete construction projects and 8,000 large and medium-scale enterprises (including the state's share in joint ventures and enterprises that enjoy a monopoly market position), with a view to reducing the state's ownership in productive assets from 98% to approximately 74% by the year end. By 1996, the state share in enterprises was projected to be reduced to 44%.
The ambitious privatization agenda set forth in the 1994 Program was confirmed in 1995 by the Presidential Decree "On Measures for the Implementation of Privatization in 1995" (the "Privatization Decree"), issued on June 23, 1995. This Privatization Decree was introduced by the President in the face of the failure of Parliament to adopt a State Privatization Program for 1995.
The implementation of the President's privatization agenda progressed further with the adoption of the 1996 Privatization Decree in which the President put forward his ambitious plan to privatize during 1996 a total of: 4,085 medium and large-scale state owned enterprises and open joint-stock companies;
8,682 small-scale state-owned enterprises (of which 957 are agricultural companies);
4,043 incomplete construction sites; and
the state-owned shares of 654 open joint-stock companies, whose privatized has begun but has yet to be completed.
The 1996 Privatization Decree provides that the privatization of small-scale state-owned enterprises should be completed by July 1, 1996 and that Ukrainian citizens will have until December 31, 1996 to invest their privatization certificates. To date, according to reports issued by the SPF, approximately 32 million citizens, or 62% of the population have redeemed their privatization certificates. In addition, the 1996 Privatization Decree provides for the implementation in 1996 of a regime in which foreign investors may participate in the privatization process on equal terms with Ukrainian residents.
Notwithstanding the foregoing measures, however, until recently, an effective program for the systematic large-scale transfer of state-owned assets to private entities or individuals has not been implemented in Ukraine. Although the government has begun to transform state enterprises into joint stock companies in the "corporatization" process, and to sell them through auctions and competitive tenders, most enterprises privatized to date have been small businesses involved in the spheres of retail trade, food service and other service-related activities. A significant portion of those enterprises which have been privatized have done so through a buy-out of the enterprise by the workers' collective. Based on a report prepared by the SPF, during 1993 62% of those state assets which were privatized had been privatized through a buy-out by workers' collectives on the basis of lease agreements with buy-out options.
Compared to the relative stagnation of the privatization process in past years, however, the pace of privatization has increased dramatically in the last quarter of 1995 and during the first quarter of 1996, especially after the adoption of the 1996 Presidential Decree. According to announcements made recently by the SPF, the first quarter targets for privatization of small and medium-scale enterprises were exceeded. In January and February, 3,070 small businesses were privatized, equivalent to 25% of the total planned for 1996, while 583 medium- and large-scale enterprises were privatized, representing 15% of the targets for the year.
SECURED TRANSACTIONS
The Law of Ukraine On Pledges, represents an important step forward in addressing the absence of mechanisms to facilitate secured transactions in Ukraine. Significantly, the Law on Pledges allows for the pledge of tangible as well as intangible property and recognizes the concept of the floating lien. In addition, the secured lender is endowed with extensive rights of seizure and sale in the event of a default.
At the same time, the Law on Pledges is insufficiently detailed and underdeveloped to facilitate major financings, including project financings. In this respect, two principal deficiencies should be mentioned.
The Law on Pledges fails to provide for a uniform, easily accessible and reliable mechanism for registering a pledge in collateral in order to give adequate notice to third party creditors. In accordance with existing mechanisms for effecting pledges in assets the pledge agreement should be registered with a notary public, but only with respect to certain categories of property, including inventory, vehicles and immovable property. With respect to all other forms of collateral, the only mechanism available for "perfecting" a security interest is to make a notation of the fact of the pledge in the borrower's register of pledged assets. The absence of a registration and recording procedure becomes particularly problematic where there is more than one creditor.
In the current legal framework it will be virtually impossible for a creditor to determine with any level of certainty whether property has been pledged. Accordingly, a prospective creditor would have to rely on the records (if any) kept at the appropriate office of notary public and/or notations which may be found in the pledgor's book of pledged assets. This is further complicated by the fact that apart from the defects of the pledge mechanism it is generally difficult to confirm the validity of title or other interests in property in Ukraine.
Second, at least initially, a burdensome state fees structure accompanied the process of notarization of pledge agreements. For certain types of property the state fee payable when registering a pledge agreement with the notary public were equivalent to five percent (5%) of the "value of the agreement". The state fee for the registration of a pledge agreement was reduced in 1995 from 5% to 0.1% of the value of the pledged property.
PROTECTION OF INTELLECTUAL PROPERTY RIGHTS
Ukraine has already established a comprehensive legislative system for the protection of the intellectual property rights. Since 1993 Ukraine has enacted legislation relating to patents on inventions, models, industrial designs, plant varieties, seeds, and cattle breeding, as well as laws on trademarks, copyrights and related rights, and laws on the protection of information in automated systems. Special amendments have been made to the Criminal and Administrative Codes of Ukraine to provide criminal and administrative sanctions for disclosure of trade secrets and unfair competition.
Ukraine is a member of the Paris and Madrid Unions, and a party to the Patent Co-operation Treaty and Universal Copyright Convention. In addition, on May 31, 1995, the Parliament passed a law whereby it acceded to the Berne Convention for the Protection of Literary and Artistic Works (the Paris Text of July 24, 1991, as amended). The accession by Ukraine to the Berne Convention represents further positive developments in the area of the protection of intellectual property rights. Application of the Berne Convention is limited to literary and artistic works which have not yet become a part of the public domain in Ukraine. According to the Law of Ukraine On International Treaties of Ukraine all international agreements to which Ukraine is a party constitute integral parts of its domestic legislation. Accordingly, the provisions of the foregoing conventions form part of Ukraine's legislative regime on intellectual property.
The weak point in Ukrainian intellectual property law is the issue of remedies and their enforceability. As a matter of practice, ordinarily only civil remedies (injunctive relief, compensation for damages including punitive damages, specific performance, etc.) may be sought by the injured party in courts. Ukrainian legislation does not provide for any criminal sanctions, except for violations of trade secrets. Administrative liability in the form of fines, confiscation of products, equipment and raw materials may be sought in the event that an infringement of intellectual property rights is accompanies by unfair competition on the part of the infringer.
The notion of unfair competition under Ukrainian legislation is formulated very broadly to include, any unlawful use of patents, trademarks, brand names or markings, unlawful copying of the product's form, packaging, trade dress, imitations, direct counterfeiting, violation of trade secrets and confidential information, public defamation, etc. On the other hand, the amounts of administrative fines provided for in the Code of Administrative Offenses are symbolic at best when compared to the profits which could be generated by infringers.