This is the second alert in a series relating to the recently adopted Law of Ukraine “On Amendments to Certain Legal Acts to Attract Investments and to Introduce New Financial Instruments” (the “Law”). The Law became effective on 16 August 2020 and launched a wide range of reforms in the capital markets area (the previous alert covered derivatives and netting reform).
This alert covers the bondholders’ collective rights reform which was supported by EBRD, with Sayenko Kharenko acting as its legal counsel. The reform introduced by the Law will become operative on 1 July 2021 and will establish a framework for collective action by bondholders and enable them to benefit from an increased level of information and control over the bonds and the issuer.
By creating a framework for collective action by bondholders through bondholder meetings and bondholder representative, as well as by introducing a detailed regulation of a default on bonds, the Law provides investors with an instrument to enforce the covenants included in the prospectus. Local borrowers will also benefit from the new regulation due to a simpler and more feasible procedure for obtaining waivers and approvals for bond restructuring stipulated in the Law.
The below summary describes:
Scope of legislation on bondholders’ collective rights
Framework for the collective rights of bondholders in Ukraine
The reform introduces a mechanism for exercising collective rights by holders of bonds issued under Ukrainian law for the first time.
Bondholder meeting concept enables bondholders to make decisions on bond-related matters collectively and by the binding majority vote.
The concept of bondholder representatives (referred to in the text of the Law as the “bond issue administrators”) is somewhat similar to that of bondholder trustee in common law countries. The role of bondholder representative is to act in the interests of the bondholders, in particular where a centralised action is necessary (such as monitoring issuer’s compliance with its obligations, participation in legal proceedings etc.).
Types of bonds covered by the reform
The provisions on bondholder meetings and bondholder representatives apply to all corporate bonds (other than housing corporate bonds (tsiliovi oblihatsii)) and to the local municipal bonds issued after 1 July 2021.
International financial institutions may choose to apply the new rules to their local UAH-denominated bonds issued after 1 July 2021 by expressly specifying this in the prospectus.
Ukrainian Government’s local bonds will be fully exempted from the collective arrangement rules.
Bondholder meetings have the power to decide on all matters affecting the interests of the bondholders, such as approving amendments to the prospectus and the security documents, authorising the entry into certain transactions by the issuer and the security providers, waiving the breach of certain obligations by the issuer or a security provider, approving restructuring plans, appointing, suspending and granting special powers to the bondholder representative and deciding on any other issues referred to the competence of bondholder meetings by law or by the prospectus of the respective issue.
This flexible approach where the competence of bondholder meetings can be detailed in the prospectus allows the parties to adjust the level of control as they see fit for each individual transaction.
Generally, bondholder meetings are convened at the request of the issuer or of the holders of at least 10% of the outstanding bonds.
The Law also provides for the possibility to convene a joint bondholders meeting in respect of several bond issues of the same issuer. This can be used to facilitate debt restructuring across several debt instruments.
The Law introduces a two-tier quorum approach. The bondholder meeting is quorate if the owners of 75 per cent of the outstanding bonds are present. However, if a quorum is not met for the first meeting, then a second meeting may be held which would require the presence of the holders of only 25 per cent of the outstanding bonds. This approach encourages timely action by the bondholders and helps to tackle holdout risks, while at the same time aiming at maximum participation in decision-making process.
Meetings are held without physical presence and voting takes place in electronic form via depository system.
All bondholders have the right to vote at a bondholder meeting, except for the issuer, the security provider, their affiliated persons, UBOs and trusts or other entities acting in the interest of any of them. This restriction aims to ensure that all decisions taken at bondholder meetings reflect the will and are in the best interest of the actual investors, including when the incentives of creditors and of the borrower are not aligned.
The number of votes of each bondholder is equal to the par value of the outstanding bonds held by them (where one Ukrainian hryvnia of the par value constitutes one vote). A bondholder can split its vote and vote differently by parts of its holding on the same item of agenda. This allows a nominee securities holder to participate in voting on behalf of more than one client.
The Law provides for multiple voting thresholds depending on the matter to be decided.
Most matters can be decided by a simple majority of votes of the bondholders participating in a bondholders meeting.
A 75 per cent majority vote by participating bondholders is required to approve changes to the financial terms and conditions of the issue, restructuring plans and waivers of default related to the breach of financial terms and conditions, as well as to appoint or suspend a bondholder representative. Coupled with the provisions on quorum described above, it means that these crucial decisions can be taken by the vote of the holders of 56.25 per cent of outstanding bonds (if the quorate bondholder meeting is convened at first request) or even by the holders of only 18.75 per cent of the outstanding bonds (if the bondholder meeting is convened at second request).
Allowing changes in financial terms and conditions and restructuring plans and waivers to be adopted by 75 per cent of the bondholders participating in the vote is a compromise solution. On one hand, it seeks to protect the interests of most of the bondholders, while at the same time shielding the issuer from the minority investors who could lead him into bankruptcy by withholding their consent to the necessary changes in the terms and conditions of the bonds if a unanimous consent of the bondholders was required. However, given how these voting thresholds apply in combination with the rules on quorum, it is essential for the bondholders to participate in the meeting convened at the second request to ensure that the decisions are in line with the interests of the majority.
Binding nature of majority vote
Resolutions of bondholder meetings are binding for all holders of the respective bonds, including those who did not participate in the meeting, had no right to vote or voted against such resolution, provided however, that such resolutions must not discriminate against any particular bondholder nor impose any additional financial liabilities on any bondholders (other than with their express consent).
Eligibility to act as a bondholder representative
Financial institutions with sufficient capital or other legal entities that meet the requirements to be established by the Ukrainian Securities Commission will be eligible to act as bondholder representatives. This may also include foreign entities, if the Securities Commission’s regulations will allow that.
The issuer, the security provider, their affiliated persons and UBOs, a bondholder who directly or indirectly holds more than 5 per cent of bonds of the respective issue or other persons whose interests conflict with those of bondholders generally may not act as a bondholder representative on the relevant bond issue.
Appointment of a bondholder representative
Bondholder representative is appointed by the issuer. If the issuer fails to appoint a bondholder representative where this is required in the prospectus or in case of an event of default (even where the appointment of bondholder representative was not contemplated in the prospectus), bondholder representative may be appointed through a bondholders’ meeting or by consent of all bondholders.
Authority of a bondholder representative
A bondholder representative must act in good faith in the interest of all bondholders.
Bondholder representative is authorised to monitor issuer’s and security provider’s compliance with their obligations, to participate in court, enforcement and bankruptcy proceedings (against the issuer and the security provider), to act as claimant in civil or criminal proceedings on behalf of the bondholders – and to take any other action on behalf of the bondholders if duly authorised thereto by the resolution of the bondholder meeting.
As a result, appointment of a bondholder representative allows bondholders to have their interests protected, including in all types of legal proceedings, without each individual bondholder having to bring a court action of their own. In addition to saving the time and resources, this can also result in better protection of the bondholders rights as a representative may be better equipped to assess their collective position and to determine the actions which would serve their interests.
While appointment of a bondholder representative may facilitate a collective action, it may not prevent an individual action by a bondholder. Under Ukrainian law, a waiver of right to seek protection in court is void. As a result, cases brought by individual bondholders will still be heard by Ukrainian courts.
Fees of bondholder representatives
Fees and expenses of a bondholder representative are payable by the issuer in accordance with the agreement on such bondholder representative appointment. An alternative arrangement may be established by the appointment agreement and the prospectus.
Liability of bondholder representatives
Liability of the bondholder representative for failure to perform their obligations shall be limited to the amount of their tenfold annual remuneration, except in cases of willful misconduct or gross negligence.
Definition and consequences of default
The prospectus shall specify the events constituting a default, being a breach of the issuer’s or security provider’s obligations or other events detrimental to the bondholders. Absent such specification, a default would occur in case of:
Upon occurrence of an event of default, holders of 25 per cent of the amount of outstanding bonds may demand early redemption by notice to the bondholder representative, the issuer or the security provider, as applicable, and without convening the bondholder meeting. The early redemption demand may be waived by a resolution of a bondholder meeting adopted by a 75 per cent majority of bondholders participating in such meeting.