Disputable Provisions of Privatization Law

By Pavlo Yelnyk
Legal Advisers

There is no doubt that the privatization of state property is one of the most attractive spheres for investors. It would seem that potential participants of the privatization process should enjoy a certain degree of confidence in the legitimacy of a privatization tender and, therefore, have sufficient guarantees as to protection of their property rights, since such property is offered for sale by state authorities. Nevertheless, the existing practice demonstrates that the mere fact that a privatization competition is announced by the state cannot itself be considered a self-sufficient guarantee for legitimate acquisition of ownership rights. Every asset of state property is far from being sold on irreproachable legal grounds. Thus, a potential investor should be aware of the peculiarities of Ukrainian legislation and relevant judicial practice regarding privatization disputes.

According to the 1992 State Property Privatization Act, state policy on privatization issues is carried out by the State Property Fund of Ukraine (SPFU) and its regional divisions.

One of the most widespread methods of privatization is tendering of state-owned property, i.e. assignment of state-owned assets to a tender participant, which outbid its competitors and undertook to comply with the terms of the tender. As for privatization facilities, there are highly publicized judicial cases which concern the sale of state-owned share stakes. Thus, the attention of investors should be concentrated on substantive law and the latest judicial cases regarding well known share stakes sold via privatization tenders.

Exercising their powers, as provided by the 1992 State Property Privatization Act, the State Property Fund of Ukraine, Antimonopoly Committee of Ukraine and the State Commission for Securities and Stock Market approved the Regulations on the Procedure of Holding Tenders on Sale of Blocks of Shares of Joint Stock Companies (the Regulations).

The 1992 State Property Privatization Act and the Regulations confer considerable powers on the State Property Fund of Ukraine in such issues as the admission of potential buyers to participation in a tender, approval of tender terms and conditions, choosing the winner of the tender, etc. For example, the so-called fixed tender conditions, qualification requirements for industrial investors and additional conditions of participation in a tender are to be approved by a tender commission – a collective body, appointed by SPFU.

As practice testifies, approval of tender terms and admission conditions cause disputable issues which, in their turn, eventually bring the parties to court. For example, potential buyers may challenge qualification requirements for industrial investors or additional conditions of participation in a tender, that make admission to the tender of certain investors impossible but which, at the same time, favor others. For example, in 2004 when a 93.2% stake of shares in the JSC Krivorozhstal was put up for privatization, certain admission requirements for potential participants were specified by SPFU: 3-year experience in production of steel with output of at least 2 million tons per annum and a minimum of 2-years profitability; 3-years of experience in production of Ukrainian origin coke with output of at least 1 million tons per year and a minimum of 2-years profitability; 3-year experience in manufacturing products containing steel with output of at least 200,000 tons per year and a minimum of 2-years profitability. It was considered obvious that such requirements favored a certain applicant company that was admitted to the tender and finally purchased the 93.2% stake.

As is well known, the tender was later disputed in courts and was finally found not to comply with legislation. Afterwards, when the block of shares in JSC Krivorozhstal was returned to the state following court decisions, it was tendered again in 2005 during which the Government and SPFU adopted the most general conditions regarding the admission requirements. According to the new requirements, the potential buyers needed to prove the mere fact of their business activity in the iron and steel industry for a minimum of 3 years. Thus, the possibility to take part in the tender was open practically for all investors who were interested in buying the state property.

It should be noted that during a lawsuit on the privatization of JSC Krivorozhstal, the state authorities claimed the tender to be illegal and demanded the privatization agreement to be declared null and void. State authorities announced a similar stance in 2005 during another lawsuit regarding the Nikopol Ferroalloy Plant privatization tender. In this case the Prosecutor-General’s Office of Ukraine, Government and SPFU inter alia claimed that unfair tender admission requirements resulted in distortion of the competition. As in the case with conditions in the tender to sell JSC Krivorozhstal, the admission terms in the privatization of the Nikopol Ferroalloy Plant favored only those potential buyers which complied with requirements like 3-year experience in producing electroferroalloys of at least 350,000 tons per year; profitability; allocation of dividends on the basis of the results of business activity for a minimum of 2-years as well as other conditions, which were interpreted by investors as aiming to admit to the tender a specific potential buyer. In this respect it should be mentioned that Ukrainian legislature does not contain any restrictions as to the plaintiff in privatization disputes. Thus, the legitimacy of the tender procedure can be appealed by anyone who considers his rights to have been breached, including the state authorities, disregarding the fact that state authorities themselves adopted tender conditions. As mentioned above, in the well known cases regarding the privatization of the JSC Krivorozhstal and Nikopol Ferroalloy Plant, it was the state authorities which initiated suits regarding the legality of privatization tenders.

Reviewing the case regarding privatization of the Nikopol Ferroalloy Plant, the Supreme Court of Ukraine pointed out in 2007 that the tender participants did not have the possibility to examine the accuracy of decisions by the state authorities concerning the terms and conditions of the tender. The only task of the tender participants was to match the terms and conditions defined by SPFU. The Supreme Court pointed out that the violation of law if any, committed by state authorities while defining tender conditions, could not be considered as sufficient grounds to declare privatization agreements invalid and expropriate the privatized assets.

The Supreme Court’s ruling was based on the provisions of European Convention for the Protection of Human Rights and Fundamental Freedoms and relevant practice of application of the Convention’s provisions by the European Court of Human Rights in such cases as “Stretch v. The United Kingdom” and “Fedorenko v. Ukraine”. In these cases the European Court of Human Rights came to the conclusion of infringement of Article 1 of Protocol 1 to the Convention by the responding states. This was because in both cases when states concluded debatable agreements with private individuals, relevant state authorities considered themselves to be competent to do so. Moreover, national legislation did not contain a clear prohibition on concluding such agreements, which were common practice and, therefore, private individuals had all the grounds to believe that the state authorities were not acting ultra vires.

Judicial cases regarding privatization tenders give sufficient grounds to conclude that Ukrainian privatization law and relevant domestic court practice are testimony of many problems that may constitute substantial risks for investors who decide to acquire state-owned property.

One of these risks is the right of the SPFU to define at its own discretion terms of admission to tender, which may be considered as discriminatory to one group of potential buyers and favorable to another. As practice shows, disputable terms of admission usually lead to lawsuits and a case can be heard in courts for a long time, thereby creating an uncertain situation with the property rights of the tender winner. Furthermore, legislation does not contain provisions on an exclusive circle of plaintiffs who may lodge a complaint concerning tender conditions and the privatization agreement. Thus, the state itself may initiate court proceedings on the basis of unlawful tender conditions adopted by state authorities.

Finally, legislation contains neither a provision on reduced terms of legal proceedings in privatization cases nor guarantees that appeals cannot be brought against final court decisions, which may also create an uncertain situation with an investor’s property rights for several years.

In this context the case regarding privatization of JSC Odessaobl energo should be recalled. In 2007 the Supreme Court of Ukraine reversed a court ruling adopted by the Supreme Arbitration Court of Ukraine in 2000, which for 7 years had been considered to be final.

Summing up the abovementioned, investors who intend to take part in privatization proceedings should foresee risks which may question the legality of their property rights and the mere fact that a privatization tender is initiated and assets are sold by state authorities cannot be considered to be a sufficient guarantee of lawful acquisition of state-owned property.