Oleksander Plotnikov of Arzinger in Ukraine explores the country's exciting economic environment and analyses the risks for foreign investors

Ukraine has great investment capacity. Rich and fertile soils and the comparatively affordable cost of labour have long made it one of the favourite investment destinations in the agriculture sector. The real estate sector also makes an attractive investment opportunity: the demand in the market still fails to meet the supply. Wealthy foreign individuals also choose to deposit their money in Ukrainian banks, which offer on average 10% a year on foreign currency deposits, outperforming by far most of US and European banks.

Over the last year, the main driver for both foreign and domestic investors was the Euro 2012 football finals. This encompassed not only the construction of stadium arenas, but also the repair or building of infrastructure assets, such as airports, hotels and roads. Alternative sources of energy (including solar, wind and biomass) have attracted investors and caused this sector of the economy to grow. Despite the unfavourable weather conditions – there was a long, cold winter – the agricultural business also provided a market opportunity over the last year.

There are no restrictions on the involvement of international counsel in investment transactions, apart from the necessity for a resident to provide the servicing bank with copies of the relevant agreements with foreign companies if payments are to be made abroad. Also, according to currency control rules, if the aggregate amount of payments to be made by a resident of Ukraine in discharge of contractual obligations in foreign currency towards a non-resident of Ukraine exceeds €100,000 ($128,000) or its equivalent in one year, the resident is required to obtain a price evaluation act from the State Information and Analytical Centre for Monitoring of the External Goods Markets, confirming that such payment does not exceed the fair market price for such work or services.

Regulating inbound investment

The main legislation regulating foreign investment in Ukraine is the Law of Ukraine on the Regime of Foreign Investment, adopted on 19 March 1996 and amended many times since. Under this Law, the term "foreign investment" refers to assets invested by foreign investors in investment properties pursuant to effective legislation of Ukraine for the purpose of gaining profit or achieving social effect. Capital contributions can be in cash or in kind (either tangible or intangible assets). Virtually no restrictions are set for the form of the contemplated investment in Ukraine.

Other notable regulations in this sphere include the Civil Code of Ukraine (2003), Commercial Code of Ukraine (2003), Law of Ukraine on Investment Activity (1991), Law of Ukraine on Protection of Foreign Investments in Ukraine (1991), Cabinet of Ministers' Resolution on the Procedure for State Registration of Foreign Investments (1996), and National Bank of Ukraine Resolution on Regulation of Procedure of Foreign Investing in Ukraine (2005).

The Law of Ukraine on the Regime of Foreign Investment contains a number of guarantees which are granted to a foreign investor upon registration of investments in the country.

The first is protection against changes in legislation (a 10-year grandfathering clause permitting the investor to enjoy favourable treatment and guarantees contained in the Law in the event of a subsequent change in legislation).

A second is protection against nationalisation excluding emergency measures, such as national disasters, accidents or epidemics, and only on the basis of decisions authorised by the Cabinet of Ministers of Ukraine.

There is also a guarantee for the compensation and reimbursement of losses whereby foreign investors may seek damages (lost profit and moral damages) resulting from negligent acts by, or failure to perform on the part of, state bodies of Ukraine or their officials; a guarantee in the event of termination of investment activity (the right of foreign investors to remit their revenues and to withdraw their investments from Ukraine free from export duties within six months from termination of their investment activity); and a guarantee of repatriation of profits (after payment of taxes, duties, and other mandatory payments, foreign investors are guaranteed the right to unimpeded and immediate transfer abroad of all profits and other proceeds in foreign currency legally earned as a result of their investment activity).

In addition to these guarantees, the government offers incentives to promote the general investment image of Ukraine outside of the country. The success of such incentives is rather dubious, however.

Ups and downs

There are, of course, risks for investors too. Ukraine still remains extremely vulnerable to external economic fluctuations; this has been the case since the onset of the financial crisis. Cooperation with the IMF has been on hold over the past year. Ukraine has received no further tranches under the stand-by programme and was forced to borrow money on the international markets and from the Russian banks. In addition, the reserves of the National Bank of Ukraine (NBU) have decreased significantly. On top of that, the parliamentary elections triggered fears of a possible devaluation of the Ukrainian currency (the hryvna). Altogether this has made foreign and local investors rather reluctant to invest actively.

Investors should be aware that the Ukrainian currency is artificially pegged to the US dollar. During politically unstable times in particular, this does not add attractiveness to the investment image of the country and keeps certain investors on hold. Currency risk is quite significant today.

Ukraine has plans both to join the EU and to seek closer cooperation with Russia and the CIS countries. This has led, and most likely will continue to lead, to certain political ambiguity.

Certain steps need to be taken to stabilise the country's economic situation and to ensure constant growth. This will take several more years.

International investors doing business in Ukraine should also be conscious of the existing high level of corruption in the country. This has been a problem for many years and is something that the government has been trying lately to counteract more actively. It not only concerns the various state bodies, but also the court system.

There is also a certain risk of raiders' attacks: attacks on businesses aimed at forced change of control. This, as well as the constantly changing legal environment, requires secure protection of assets at all stages of business activity in the country. In addition, there are many formalistic requirements, such as the requirement to seal all official documents, or sometimes to bind official documents together. These may appear rather archaic to a foreign investor, but failure to comply with them implies a certain risk.

In addition, when acquiring assets in Ukraine, a foreign investor should structure the transaction in compliance with Ukrainian legislation. The investor may otherwise experience significant problems at the stage of transfer of the profit from Ukraine abroad. For example, if a non-resident of Ukraine acquires shares in a Ukrainian company from another non-resident of Ukraine, it is highly advisable to make payment through investment accounts of both parties opened with Ukrainian banks, as is prescribed by the effective legislation of Ukraine. If the settlements are performed abroad, which is not prohibited, the purchaser, in order to transfer abroad his profit generated by such assets in Ukraine, will have to provide a Ukrainian bank with documents confirming that a foreign investment in relation to these assets was previously made (in other words, that the previous owner has transferred funds in Ukraine in payment for these assets). Sometimes, it can appear impossible to provide sufficient proof and the only legitimate way remaining is to obtain an individual licence from the NBU.

It should also be noted that Ukraine has one of the strictest currency control regimes in Europe. Under the effective currency control rules (NBU Regulation on Procedure of Foreign Investing in Ukraine), foreign direct investments in cash can be made only in hryvna and a certain number of other currencies (most freely-convertible currencies). But the main barriers are aimed at prevention of the outflow of foreign currency outside the country. The NBU, as the main body for exchange control, has established a precise list of transactions which allow transfer of a foreign currency from Ukraine and an exhaustive list of documents to be provided to a respective bank for the performance of the transfer.

Laws under development

There are a number of areas of corporate law which are still under-developed. Among these are corporate governance issues, protection of the rights of shareholders (especially minority shareholders) and disclosure of information. While some of the issues are related to the fact that provisions of various laws and other regulations are either outdated or overlapping, and there is sometimes a lack of coordination between them, certain issues are not governed at all. It will require quite some time before relevant regulation is enacted.

When comparing the rules regulating the activity of limited liability companies (LLCs) and joint-stock companies – the most popular forms of company incorporated in Ukraine – it is clear that the latter enjoys a far higher level of statutory regulation. The rules related to LLCs have not changed significantly since 1991 and are long overdue modernisation.

The basic legislative act regulating competition in Ukraine is the Law of Ukraine on Protection of Economic Competition, adopted on January 11 2001. The law provides the main principles, concepts and procedures for merger control and regulation of concerted actions and dominance.

The Antimonopoly Committee of Ukraine (AMCU) provides state protection of competition, and its status is determined by the Law of Ukraine on the AMCU, adopted on November 26 1993. One of the main targets of the AMCU is to make decisions concerning abatement of competition legislation breaches, which are obligatory for enterprises and state authorities; to allow or prohibit concerted actions in the market; and to impose fines or apply other sanctions with respect to those who breach the rules of fair competition.

For a number of reasons certain commercial contracts in Ukraine are typically governed by foreign laws. This is especially true for shareholders' agreements, which due to loose domestic protection of the rights of minority shareholders, are typically concluded under English, Cyprus or other foreign laws. In foreign economic contracts, parties also prefer to opt for foreign laws: this typically gives more comfort to the parties as to unbiased dispute resolution. Although sometimes parties do choose Ukrainian law, the general trend is unlikely to change in the next several years.

Recent trends show increasing activity and improving professionalism in the AMCU's departments with regard to fighting monopolisation, cartelisation, deceptive advertising and other unfair business practices of all sorts. The trend has been naturally accompanied by a growing number of inspections (frequently in the form of so-called dawn raids) and businesses being under investigation, with fines of unprecedented size imposed.

These trends, and the excessive influence of the political environment on Ukrainian antitrust regulations, have resulted in a great demand for immediate and competent legal representation in complex antitrust cases – both in the AMCU and in the courts.

Recipe for success

Despite the risks, the investment opportunities and possibilities in Ukraine will continue to attract foreign investors. The potential profit is much higher than in countries with more mature economies.

Counsel should, however, familiarise themselves with the current hot topics in Ukraine: the anti-moneylaundering rules, currency control issues (important for every company doing business with foreign legal entities) and protection of personal data.

Being a member of a lobby group can also be helpful for foreign investors. Domestic large business groups have their own lobbies in the Ukrainian parliament and other state authorities. While there are regional chambers of commerce and industry in each region of Ukraine, they appear not to be very effective in defending and promoting the interests of the business community, especially those of the foreign investors doing business in Ukraine.

Among the most effective lobbies of foreign businesses operating in Ukraine are the American Chamber of Commerce and the European Business Association. While the American Chamber is located in Kiev, it regularly holds events in various regions of the country. The EBA, on the other hand, has regional offices operating in a number of the largest cities throughout Ukraine. Both of these organisations have various committees, hold regular meetings with different state bodies and organise a range of social events for their members. It is very common that a foreign business is a member of one or even both of these organisations.

There is no single piece of advice on how to succeed in the country, but it is relatively simple to mitigate the risks: choose your business partners in Ukraine carefully (do the necessary due diligence checks), never forget to have all documents in order and always seek qualified legal advice. If you overlook certain risks now, they may be turned against you later.

Originally published in ILFR.com - 1 December 2013.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.