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Practice Areas Review: Banking & Finance

Implementation of Foreign Law Governed Risk Sharing Arrangements in Ukraine



Partner, Vasil Kisil & Partners



Associate, Vasil Kisil & Partners


Vasil Kisil & Partners

Leonardo Business Centre, 17/52A Bogdana Khmelnitskogo Street,
Kiev, 01030, Ukraine
+ 380 44 581 7777
+ 380 44 581 7770

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The history of the Ukrainian facility market demonstrates that the dominant number of progressive tendencies, concepts and instruments have been inspired and introduced by the West. Over the years of intensive utilization in UK and US financial markets large commercial loans gained quite standardized forms in these jurisdictions. Thus, foreign lenders are often reluctant to deviate from the typical facility transfer instruments and types of documentation, necessary to implement the risks sharing arrangements. This article is supposed to shed some light on possible challenges foreign lenders may face in the course of implementation of the risks sharing instruments in Ukraine.

Prior to the global financial crisis and economic downturn, syndicated facilities started to rev up in the UK and the US as efficient mechanism for hedging of economic risks. Over the years key players in the leading financial markets have been using five major forms of transferring the lender’s rights under the loan agreements: (i) novation; (ii) legal assignment; (iii) equitable assignment; (iv) funded participation; (v) risk participation. The choice among available methods is to be made depending on the lender’s preferences and goals in each particular case.

Made in Ukraine

Modern Ukrainian facility market is also familiar with novation and legal assignment instruments, being implemented according to the local laws.

In the UK interpretation — novation is the only way for a creditor to transfer all of its rights and obligations under the facility agreement. The process of transfer effectively cancels the existing rights and obligations under the loan agreement, while the new lender assumes identical new ones in their place. The Civil Code of Ukraine has also embedded such instrument under the auspices of the debtor’s replacement concept.

The major difference between the approaches in the above jurisdictions is concentrated in the degree of borrower’s involvement in the process. Notably, Ukrainian law exempts creditors from the burden of obtaining the borrower’s consent (unless otherwise is explicitly agreed by the parties in the respective loan agreement), which may be considered quite favorable by overseas lenders, who are usually compelled to “coordinate” novation process with the debtors.

Foreign lenders, willing to retain their creditors’ commitments but to assign corresponding rights through legal assignment, stipulating the transfer of rights but not obligations, will be able to find an analogous instrument in the Ukrainian law as well. In our jurisdiction assignment may be effectuated through either of the following instruments: (i) straightforward assignment agreement, not requiring any specific status of the assignee, or (ii) factoring agreement, stipulating the transfer of the creditor’s rights of claim towards the debtor at a certain discount and to the assignee enjoying a status of a bank or non-banking financial institution.

Over the last years’ legal practice in implementing assignment as the instrument to transfer lender’s rights under the loan agreement has developed significantly. Undoubtedly assignment has become one of the most commonly used facility transfer methods in Ukraine.

In view of the above, the route for implementation of such common UK law instruments as novation and legal assignment in our jurisdiction appears to be rather straightforward, given that Ukraine is able to offer its own legal options for their implementation.

Invisible Lenders

In certain cases the primary reason for transfer of the lender’s rights under the facility agreement is releasing the capital and risk/portfolio management via removal of the risks associated with any such facility from the lender’s balance sheet. However, under a variety of circumstances, it is not always practically possible to replace the lender through novation or legal assignment described above. In this regard, equitable assignment, funded participation and risk participation appear to be unique transfer methods when the initial creditor retains existing contractual relationship with the borrower, while the underlying obligations go off the balance.

In equitable assignment, in contrast to legal assignment, the new lender, as equitable assignee, must join the existing lender, as assignor, in any action on the debt. In such a case the existing lender remains in direct contractual relationship with the borrower.

Under a funded participation agreement, the existing lender and the participant enter into a contract, providing that in return for the participant paying the existing lender an amount equal to all or part of the principal amount of the loan, granted by the existing lender to the borrower, the existing lender agrees to pay to the participant all of the relevant share of principal and interest collected by the existing lender from the borrower in respect of that amount. In such a case the existing lender remains in direct contractual relationship with the borrower.

Risk participation is a form of participation serving as a guarantee. The risk participant will not immediately place any funds with the existing lender, but will agree, for a fee, to reimburse the existing lender against losses upon the borrower’s default.

Given that Ukrainian laws have not yet offered any analogous instruments at local level, foreign creditors often remain puzzled on how to implement such foreign law governed instruments in our jurisdiction.

In our experience, many global financial institutions favor involving their parent or subsidiaries in lending process creating cross-border duplex creditor-debtor contractual relationship: first — with the borrower and second — with the risk or funded participant.

Both risk and funded participation under UK law are practical methods to implement certain sharing of economic risks. In both cases the existing creditor and the participant enter into the respective participation agreement on the same terms as have already been agreed in the underlying facility agreement. No borrower consent is required for either funded participation or risk participation, so the process remains confidential. Hence, debtors experience no changes when a Ukrainian bank becomes entitled to write the indebtedness off its balance sheet according to the International Accounting Standards. Instead, the existing creditor is turning into a “technical debtor” towards the participant with a remaining obligation to transfer to the latter all funds received from the borrower.

Voice of Regulators

According to the civil laws of Ukraine, implementation of foreign law governed transfer instruments is not prohibited in transactions with non-residents of  Ukraine and is not expected to face any bans from the Ukrainian authorities unless transaction documentation violates the effective legislation.

However, the lack of sufficient practice in this type of transactions, blurs the official position of Ukrainian regulators, especially in so important areas as FX control, arising within the course of cross-border funds transfer and taxation.

According to the On Investment Regime Act of Ukraine, foreign investments may be effectuated in forms, which are not prohibited in Ukraine, under respective commercial agreements and with no need to create a separate legal entity. Considering such a legislative permit, any “classy” form of participation agreement executed under the foreign law may serve as a valid legal ground for investments. Yet, based on our experience of dealing with the National Bank of Ukraine (NBU) in such matters, participation is not recognized as a sufficient legal ground for license-free transfer of proceeds collected from Ukrainian borrowers to the non-resident participant. Hence, a Ukrainian bank, being the creditor, shall file the documents with the NBU for obtaining the individual license to be able to purchase foreign currency and to transfer it abroad.

Another vital question, arising out of the participation process, shall be tax treatment. In the UK and the US it is crucial to ensure recognition of the participant as a “qualifying lender” in order to implement the tax gross up approach. In Ukraine, the Tax Code restricts the parties from including into agreements contractual provisions, which enable the beneficial owner of proceeds to experience tax-free terms. Thus, the tax treatment concern of the participation parties shall be concentrated around the respective double tax treaty provisions (if any).

However, since the approach of Ukrainian tax authorities is sometimes inconsistent and variable, it is advisable to turn to the competent tax authority for the individual clarifications depending on the transaction peculiarities.

Balance it off!

Returning to the main benefit of participation instruments, it is always essential to make sure beforehand that a Ukrainian bank, being the creditor, will achieve off-balance sheet accounting treatment after participation arrangements have been implemented. Today, Ukrainian banks are obliged to comply with International Accounting Standards (IAS), meaning that the participation agreement shall be drafted in compliance with IAS 39 (Financial Instruments: Recognition and Measurement) to enable the bank-lender to write the indebtedness off the balance sheet in favor of the foreign participants.

Moreover, it is important to note that parties to the participation agreement shall agree on three major conditions to follow:

(i) no undertaking to transfer funds to the participant until the equivalent amount has been received from the borrower;

(ii) no sale or pledge of the proceeds; and

(iii) prompt transfer of funds received from the borrower to the participant.

Considering the quite unstable lending market in Ukraine and high level of insolvency among borrowers, financial assistance from the creditor’s group may appear vital. Thus, the foreign nature of certain risk sharing instruments for the Ukrainian banking market, including participation arrangements, is not a reason to disregard them. Although the process is currently subject to the NBU licensing requirements, utilization of properly drafted transaction documents is still likely to achieve off-balance accounting treatment in Ukraine and to clear-off the bank's balance sheet from certain credit risks.

* In August 2014 she left Vasil Kisil & Partners with four other partners and established Aequo law firm.