The Ukrainian economy is currently growing, despite the conflict in the eastern part of the country and internal issues such as corruption. Ukrainian businesses looking to expand are increasingly looking to debt financing. However, given the extremely high interest rates offered by the Ukrainian banks, more and more Ukrainian companies are looking for cheaper finance from foreign financial institutions or private investors.

However, the efficiency of Ukrainian courts and law enforcement authorities is far from perfect, and many foreign creditors ask a legitimate question – what would be sufficient security to mitigate the risks? Which collateral should be sought from the Ukrainian borrowers? Although Ukrainian law allows a broad range of assets to be pledged as a security, effective enforcement is not the same in respect of different asset types.

Pledge of right of claim under a contract with a third party or pledge of goods in circulation, though practically applied by the local Ukrainian banks, are efficient only if the business of the pledgor is well-known to the pledgee and the collateral is properly monitored on a day-to-day basis. Such a type of pledge does not appear to be an efficient tool to secure substantial long-term financing.

Pledge of shares in joint stock companies is enforceable. At the same time, pledge of so called equity shares of a Ukrainian limited liability company (LLC), the most common type of company in Ukraine, can be difficult to enforce in practice due to a lack of efficient mechanisms of registration of the title to the equity shares to the pledgee. The efficiency of enforcement will be improved when the new LLC law enters into force (June 2018), although it is still not clear how enforcement practices will develop.

The most common and effective security is mortgage of real estate. Mortgage over non-residential buildings and premises and land plots can be effectively enforced. In addition to standard enforcement via court, so called out-of-court enforcement is available in regard of the real estate. Under out-of-court enforcement, the real estate can be collected from the borrower in case of default and subject to 30 day notice. On the other hand, the downside of such enforcement is termination of any further claims under the loan. In other words, if a piece of real estate, for example a building or a number of buildings, is enforced under the out-of-court procedure, claims under the respective loan agreement are terminated from the moment of the enforcement (where several pieces of real estate are mortgaged – from the moment when the first of them is foreclosed), irrespective of the fact that the value of the foreclosed asset may be substantially lower than the outstanding debt. It is also worth mentioning that such enforcement does not apply automatically. For the out-of-out enforcement to be applicable, the respective clause should be properly worded and incorporated in the mortgage agreement. Last but not least, some enforcement formalities, such a proper notification of the debtor, shall be complied with for the out-of-court enforcement to be effective and legitimate (not exposed to the risk of being successfully challenged in the future).

Another effective form of collateral is the pledge of crops or other agriculture products. Such tools are quite commonly applied for financing (especially short-term) of Ukrainian agriculture companies. The key point here that the agriproducts provided into pledge should be stored at a licensed warehouse of a reliable third party. Such storage is formalised by double warehouse receipt, which ensures that no goods could be taken from the warehouse without the pledgee’s consent.

Needless to say, the collateral documentation should be properly elaborated, and a number of the respective formalities (such as inclusion of the records regarding the collateral to the respective state registеrs) should be performed to ensure that the pledge is enforceable. In Ukraine even minor formal deficiencies may be applied by unfair debtor to invalidate the collateral or to suspend the enforcement. However, if the collateral is properly structured from the beginning, the level of certainty and comfort in respect of the future enforcement is quite high.

Sergiy Benedysiuk, Head of Corporate and M&A, exclusively for Emerging Europe