Ukrainian Government has pledged to bring economic opportunities for foreign investors by digitalising the country and liberalising business laws. A big part of this promise comes with a new law “On Stimulating Development of Digital Economy in Ukraine” (“Law”). Most provisions of the Law came into force on 14 August 2021, but the Law will be operative in 2022 once all regulations are in place.
The cornerstone of the Law is a special legal and operational regime for IT companies incorporated in Ukraine (whether or not such companies have their principal place of business in Ukraine). This regime, called Diia City (“diia” stands for “action” in Ukrainian), guarantees certain legal, labour, and economic benefits for Diia City residents (“Resident”) and will remain in place for at least 25 years. Additionally, Ukrainian Parliament is considering tax legislation providing for certain tax benefits to the Residents.
Who can qualify as Resident?
To be become a Resident, an IT company incorporated in Ukraine will need to file an application with the Ministry of Digital Transformation of Ukraine and comply with the following criteria:
- do business in one or more IT industries specified in the Law (g. programming, software design, information technology, data processing, cryptocurrency, etc.);
- employ at least nine employees and/or contractors engaged under special gig-contracts (with average monthly remuneration of EUR1,200); and
- make at least 90% of its net income in a designated IT industry (industries).
The benefits of Diia City regime are not available for companies with a state-owned stake of at least 25%, Russian companies and Russian-owned companies, companies having tax debts in Ukraine, and companies under sanctions.
Benefits for Residents
Unlike other Ukrainian companies, the Residents can regulate relations with their employees in a more discretionary way. They will have a right to engage IT specialists and other contractors under civil-law gig-contracts that are not subject to the requirements of Ukrainian labour law. Meanwhile, such IT specialists and other contractors will be eligible for certain social benefits provided by the Law (for example, vacation and social security). Mostly, existing labour norms did not offer adequate protection to IT specialists. Nor did they give sufficient options for employers to enter into a tailored contract.
Non-compete and non-disclosure agreements
The Residents may enter into non-compete and non-disclosure agreements (“NDAs”) with their employees and contractors. The NDAs are exempt from general labour law and mean to give sufficient comfort to the Residents to protect their commercial secrets. The NDAs are exempt from mutual consideration requirement and may specify contractual fines for their violations. The non-competes are geographically restrictive, limited to 12 months after the termination of employment, need to be very specific, and require consideration to be valid.
Previously, a Ukrainian court would refuse to enforce non-competes and non-solicitation agreements citing constitutional and antitrust grounds. NDAs were generally enforceable; however, it was hard to prove the fact of a bad faith disclosure.
On the legal side, the Residents (limited or additional liability companies – “LLCs” and “ALCs”) can engage a legal entity as their external manager. Third parties (i.e. creditors or future investors) can become parties to shareholders’ agreements (“SHAs”). The SHAs are expressly permitted to be governed by foreign law if at least one shareholder of the company is a foreigner. This is particularly important considering that many Ukrainian businesses prefer to choose English law, but remained cautious, given the long-standing position of Ukrainian courts to invalidate such choice of law.
New English law instruments
The Law introduces a couple of helpful legal instruments into Ukrainian law that will be of particular use for IT businesses. We will briefly go through the novelties here.
Representations & warranties
A Ukrainian law governed contract can include representations and warranties, i.e. statements as to the validity of facts on which the parties rely when contracting. Such statements can cover issues of corporate approvals, debts, litigations, financial soundness of the company, etc. The Law permits to specify contractual amounts that the defaulting party will have to pay in case of a breach of such representations and warranties.
The parties can contractually agree on liability for breach of their obligations, e.g. as mentioned before a breach of an NDA can result in contractually set damages. Such contractual damages are not civil law fines or sanctions, meaning that the parties will not need to recourse to court remedies, prove causation or detrimental consequences as required by Ukrainian civil code. Under the Law, the court may limit the amount of damages if both parties share liability.
Liquidation preference is a tool to ensure that in case of liquidation some investors of a company get their money back prior to other creditors, stockholders, and employees. Liquidation preference clauses are a market standard for venture capital firms who invest in IT start-ups. The Law permits the parties to negotiate liquidation preferences for creditors in case of the borrower’s bankruptcy making sure investors are properly protected.
Option agreements grant option holders the right to purchase part of company’s stock at a pre-determined price in the future. Option agreements have already been quite popular in Ukraine. However, the Law introduces formal requirements that option agreements should include certain mandatory clauses, like price, term, and option trigger events. The application of some of these requirements is yet to be clarified by Ukrainian courts. What’s more, option agreements pave the way for stock option plans for senior management – a lucrative tool of corporate governance.
Convertible loan agreement
The Law introduced convertible loan agreements (“CLAs”) into Ukrainian law. A CLA permits investors to convert the amount of the loan extended to a company into company’s shares rather than to require the company to pay back the money. Conversion option is usually exercised if the company is successful, which allows creditors not just to receive back their money, but to become shareholders of a successful venture and have the right to claim future dividends. A CLA is also a standard tool for IT companies and start-ups.
The Law is an important signal to investors as well as a big step forward in Ukrainian business law. Without any doubt, it brings a number of important changes and will likely open up new opportunities for lawyers and businesses. However, only time will show the quality of those changes in practice.
By Andriy Kornuta and Yaroslav Pavliuk, Associates, Avellum