Jurisdictions with Corporate Paradise
Focus: Advantages to Use Foreign Companies in Cross-Border Transactions
M&A cross-border transactions have for long become customary in the Ukrainian business and law practices. Plenty of both big and small foreign investors acquire assets in various Ukrainian industries, including construction and service sectors.
Lots of lawyers have already gained grounds in advising in such deals on the sell-side as well as on the buy-side. At the same time, the deal structuring to optimize tax burden and corporate structure is still the issue of concern in the legal community.
One of the most relevant issues in course of cross-border transactions is the use of foreign jurisdictions to ease tax burden or circumvent restrictions imposed by the Ukrainian corporate legislation. The most frequently used for those purposes are the companies registered within the jurisdictions of Cyprus, the British Virgin Islands, the United Kingdom, Switzerland, and the Netherlands etc.
Cypriot companies have gained the most popularity among Ukrainian businessmen and lawyers. The key advantage of this jurisdiction lies in the Double Tax Treaty signed between the USSR and Republic of Cyprus, taking effect from August 26, 1983 and remaining effective for Ukraine so far. As such, in most cases Cypriot companies pay taxes in Cyprus where the current laws and regulations highly favour the companies if they are solely involved in overseas business operations with the income earned in other countries. All the while, Cyprus is a EU member and not referred to an offshore zone as interpreted in Decree of the Cabinet of Ministers of Ukraine (the CMU) No. 77-р “On the list of offshore zones” of February 24, 2003.
The CMU’s bills on the foregoing Treaty denunciation repeatedly initiated by different Premiers were each time declined by the Verkhovna Rada of Ukraine (Parliament) for reasons well understood by the readership. Although the 2010—2014 Economic Reforms Program, enacted by the Committee for Economic Reforms under the President of Ukraine, sets forth “the amendment of the current treaties on avoidance of double taxation to minimize fiscal evasion practices”, but a newly elected CMU has taken no appropriate actions with this regard and a new bill has not even been introduced in the Parliament. Thus, Cyprus may further be deemed a tax paradise for Ukrainian entrepreneurs.
Furthermore, the use of Swiss companies is a matter of particular interest. Each canton in Switzerland has its own specific tax laws and some jurisdictions provides for so-called negotiated taxation. According to such system, a company enters with tax authorities into the agreement specifying the procedure for tax liabilities discharge in the given canton.
Viewing “evasion” of the Ukrainian corporate legislation, the jurisdictions with an effective Anglo-Saxon (common) law are most commonly used. Corporate legislation of such countries often closely resembles the English law and allows company’s shareholders to anticipate in charters and shareholders’ agreements the regulation of some aspects that is impossible within Ukrainian legal framework.
It is worth saying here that the law of England and Wales gives a free hand (especially to private business) in regulation of certain aspects at the discretion of contractual parties. Therefore, the parties may adjust the issues of corporate governance, stock turnover, shareholders’ disputes settlements, and arbitration issues more effectively and beneficially for them than within the applicable Ukrainian legal framework.
In case when less than 100% company’s shares are acquired and some business partners stay in business, the parties often choose to enter into a shareholders’ agreement. Such agreement usually contemplates the representation of a minority shareholder in the board of directors and ensures this right by a special procedure purposed to elect board members. Such procedure may set out an obligatory advance approvals by partners of candidates nominated to the board of directors.
Moreover, a crucial point is that the shareholders’ agreement should outline the peculiarities of stock turnover that are out of the Ukrainian corporate framework. A tag-along right — the right of joint sale of the stake – is among the said peculiarities. This right allows the minority holders or partners to sell their stake at the same terms and conditions that would be offered for the majority shareholders in any sale of their stakes.
Also the parties may allow for a drag-along right — the right of the majority shareholder selling its stake to force the minority holder to join the deal at the same terms and conditions.
Such shareholders’ agreements include more detailed procedures for the issue of stock options for the company’s management, which may be used to motivate top executives.
Shareholders may also cover the non-dilution clause as regards the minority stake. Such clause is a fair instrument of minority shareholders protection.
In addition, the mechanism of shareholders’ dispute settlement often proves to be one of the most interesting aspects for Ukrainian businessmen. A deadlock provision – a clause or a set of clauses defining the key procedures for dispute settlement within the corporate governance framework – is used in order to prevent a wide-scale conflict. Such procedures usually concern the most significant issues the owners may quarrel on.
In case such disputes arise during several successive meetings of the board of directors or another management body, both parties must prepare in writing their concepts for their top executives to reach amicable settlement of the conflict at the meeting where a mediator may also participate. Shall the parties fail to mediate out, a so-called termination clause is to take effect. The main principle in such case is to avoid disruption of effective business solely due to failure to reach consensus between the two partners.
The mechanisms which are typically used to terminate an agreement are as follows:
- Russian roulette. This mechanism may appear to the parties as the most drastic. It provides that one party to dispute notifies the other. Then, the notified Party must indicate price of its share in business. The initiating Party has two choices: either to buyout the share of the other party or to sell it at the nominated price;
- Texas shoot-out. This rule provides that each of the shareholders submits to the arbitrator sealed offer to buy out a share of the other shareholder at a certain price. Sealed bids shall be opened simultaneously and the shareholder, who offered the higher price, undertakes to buy its partner’s stock out (the other shareholder, in its turn, must sell its share in business);
- Dutch auction. This way of disputes resolution is slightly different from the traditional Dutch auction, and requires the parties to submit sealed bids indicating the minimum price for which they would be prepared to sell their shares in business. Whichever sealed bid is the higher ‘wins’ and that bidder then buys the ‘loser's’ share at the price indicated in the ‘loser's’ sealed bid;
- multi-choice procedure. Usually the parties use this softer option of the termination clause when they do not wish to commit themselves to the above rules. The benefit of this method is that, when faced with the implications of the further disagreement, the parties are thought to be better able to compromise. At the same time, if the parties cannot agree, most likely, they will involve an arbitrator, who may provide them with a series of options;
- cooling-off and mediation. Although this alternative is not strictly a termination clause, many agreements provide that mediation, of all others, can serve as a definitive way to resolve a conflict (sometimes providing that if the parties cannot mediate out, the mediator will, in his/her discretion, make the most reasonable decision to resolve the conflict; and this decision will have a crucial impact on both the agreement and the parties). This method, though seemingly flexible, in practice often can lead to the decision on winding up business itself, if the parties are not able to reach a consensus through mediation;
- deterrence approach. Rather often a termination clause entails punitive measures directed at the party initiating appropriate procedure. For instance, ‘deadlocks’ usually considered as occurred upon the notice thereof from one party to the other (but not when it is impossible to resolve significant matter in the course of certain number of meetings). In this case, an expert or auditor (or both specialists) will determine a fair market price for a stake of each shareholder. Immediately after evaluation, the party that has initiated the procedure undertakes to buyout the stock of the other party in the company at the rate of 125 per cent of the fair value or to sell its share for 75 percent of the fair price. The drawback of this approach is that conflicts may remain unresolved, thus paralyzing the company’s activity due to impossibility to take managerial decisions.
All the above peculiarities of corporate management and shareholders’ relations are the elements of the complex system that ensures balance of interests between different shareholders or groups of shareholders within the companies, which ensure foreign companies’ attractiveness in cross-border deals.
Parties in the transaction always get the last word with regard to the jurisdiction choice, which depends on peculiarities of the requirements related to the specifics of each particular transaction and its structuring.
Roman Drozhanskyi is a Partner in Volkov and Partners Law Firm