On 6 November 2012, Law of Ukraine No. 5406-VI “On Amendment of Relevant Ukrainian Legislative Acts in Respect of Performance of Product Sharing Agreements” (the “Law”) came into force.

The Law introduces long awaited improvements to the procedures of conclusion and performance of production sharing agreements (the “PSAs”) and adjacent mechanisms, removing certain contradictory provisions of existing regulations and making investments in Ukraine’s subsoil sphere generally more attractive and flexible.  The Law introduced a wide range of amendments to the Law of Ukraine “On Production Sharing Agreements” as well as to a number of related laws and regulations, the most significant of which are summarized below:

I.         Additional option for entering into a PSA without a tender

The Law expanded options for concluding PSAs on a non-tender basis, permitting the execution of a PSA (with participation of one or more investors) based on several special permits for subsurface use and/or in respect of multiple subsurface areas, regardless of whether the latter are adjacent or separately located.  As a result, a holder (holders) of a permit (several permits) can now develop multiple subsurface areas within the framework of a single PSA, which, potentially, should make such a mechanism more attractive for sophisticated strategic investors and financial institutions willing to finance subsurface projects.

Additionally, the Law stipulated that in the case of and upon execution of a multi-lateral PSA (with participation of several investors) under the above mechanism, a special single permit for subsurface use has to be re-issued in the name of all investors/participants of the PSA.

II.       Detailing the procedure for executing non-tender PSAs

Although more detail has been added to regulating the procedure to approve and execute PSAs on a non-tender basis, the Cabinet of Ministers of Ukraine (the “CMU”) subjected its approval to conclusions of a special commission within the CMU, having wide discretion in determining what documents and materials the PSA applicant must provide in order to obtain the CMU’s approval.

At the same time, the Law established clear deadlines for entering into a PSA on a non-tender basis. Namely, the CMU must grant its prior approval for execution of a PSA within three months from the date of registration of the relevant application, and the PSA itself is to be executed no later than twelve months from the date of the CMU’s approval.

The introduction of such limitations and formalization of the non-tender procedure shows lawmakers' willingness to make PSAs an attractive legal instrument for potential investors and a less cumbersome procedure for current Ukrainian subsurface users.

III.     Further regulation of multi-lateral PSAs and rights of investors in general

The Law elaborated in more detail on various aspects of so-called “multi-lateral PSAs”, implying the possible participation of several investors in PSAs along with the original permit holder and the state, expanding their rights and obligations to the project. 

Apart from the participation of several investors in the non-tender PSAs mentioned above, the Law specified that a special permit for subsoil use shall be issued in the name of each investor/participant of the project for the duration of and under the terms of the PSA.  The Law also requires the state to issue other regulatory approvals (including mining allotment acts, approvals related to the use of land, regulatory approvals required for operation a project, etc.) to such investor(s), or even their subcontractors.

The Law also provides investors in multi-lateral PSAs with the following rights:

-          to define in the PSA changes in the scope of their rights and obligations regarding the project, including (in certain circumstances) the re-allocation of their shares in the production;

-          where a foreign investor is involved, to define the currency for expression of production value under the PSA (i.e., permitting value expression in a foreign currency rather than Hryvnia);

-          to choose accounting and financial reporting rules and reporting currency for the project;

-          to pass its right to profit or compensate production shares or their monetary equivalent (provided this is permitted under the PSA) to another multi-lateral PSA investor;

-          to share geological and other information received by the investor in the course of performing a PSA with an investor’s subcontractors, consultants and affiliated entities involved in the operation of a PSA;

-          and more importantly, to establish conditions for the sale of production extracted under a PSA (including the right to choose a buyer) as well as to sell such production at free (non-regulated) prices in Ukraine and abroad (i.e., in the case of natural gas, avoiding formerly existing minimum and maximum thresholds).

IV.     Operational agreement concept is introduced

The law introduces the concept of an “operational agreement” and defines more clearly the role of the operator in a PSA project.  In particular, the Law requires the execution of an operational agreement in order to regulate relations between the operator and other investors in a multi-lateral PSA. 

The operator’s obligations under a PSA are now clearly stipulated as a result of changes introduced by the Law and can be additionally expanded under the terms of the PSA.  The Law also requires that PSAs clearly provide the operator with the right to take independent decisions with respect to daily operational management issues. 

The Law also clearly stipulates that an operational agreement is not a joint activity agreement (the “JAA”), unless otherwise provided in the PSA. However, it still remains unclear whether, as a result of such change, those investors who have already concluded JAAs in Ukraine would be in a position to enter into a PSA without further being forced to conclude an operational agreement and to terminate the JAA.

V.       Compensation of investor’s PSA costs

The Law stipulates that the investor shall be compensated for those costs, which it incurred in connection with the execution of works under a PSA after official publication of tender results or relevant approval of the CMU, unless otherwise provided in the PSA.  This carve-out implies that costs incurred by the investor in connection with preparation for the PSA’s execution may be recovered, if so explicitly provided in the PSA.  Such interpretation, however, would need to be further promulgated by supporting regulations or practice.

Additionally, the Law clearly provides that a foreign investor or its representative office should be compensated for its expenses in connection with a PSA, which are to be accounted for by the PSA’s operator in a manner envisaged in the PSA.

VI.     Early termination of a PSA by the CMU and sovereign immunity waiver

The CMU is now obliged to apply to a court (or other competent dispute resolution forums) to request early termination of a PSA in cases of material violation of the terms envisaged by the PSA with or without suspension of operations.  Until these changes were made, the CMU had the right to terminate a PSA unilaterally if such right was provided for under the PSA.

Finally, at the request of a foreign investor, the state can now waive its sovereign immunity under the PSA.  This is a positive development which will definitely be welcomed by foreign investors eyeing subsurface projects in Ukraine.

VII.   Significant exemptions from currency control rules

The Law has also exempted the operations of investors (and representative offices of foreign investors in Ukraine) in PSA projects from various stringent currency control rules and regulations, establishing a more flexible regime for the use of foreign currency by PSA participants in Ukraine.  In particular, investors operating PSAs are now exempt from, inter alia, the following currency control restrictions:

-          restrictions on settlements under export and import contracts (the 180 days rule);

-          registration of loan agreements with the National Bank of Ukraine (the “NBU”) and maximum interest rate limitations;

-          transfer of foreign currency to the account of other investors in Ukraine and receipt of the relevant NBU license to this effect;

-          purchase of foreign currency to settle with non-residents and repay loans abroad; and

-          placement of foreign currency in foreign bank accounts and receipt of the relevant NBU license for this purpose.

VIII. Employment issues

The Law also simplified the procedure for issuing work permits to foreign employees engaged in activities related to the operation of PSAs, pursuant to which such permits shall be issued only subject to an investors request and list of foreign employees which need the respective permits prepared by the investor. Moreover, the Law envisages that the requirements for submission of any other documents required by the applicable labor legislation to obtain such permits shall not apply.

IX.     Other important changes

Additionally, numerous amendments to the Laws of Ukraine “On Fundamentals of Functioning of Natural Gas Market” and “On Pipeline Transport”, were introduced pursuant to which the investors/participants of a PSA can conduct commercial activities on the natural gas market of Ukraine without obtaining licenses in respect of any gas activity and may now freely access the Unified Gas Transport System of Ukraine.

However, it should be noted that the practical approach, which will be taken by NJSC Naftogas Ukrainy and its subsidiaries as well the National Commission on State Regulation of Energy Sphere, towards such liberalization of the licensing regime as well as free access to gas grids still remains unclear.

And finally, the Law explicitly provided that provisions of the Laws of Ukraine “On Public-Private Partnerships” and “On State Procurement” shall not apply to PSAs.   

Conclusion

The changes introduced by the Law are crucial in terms of promoting an effective and more transparent PSA regime in Ukraine and making PSA mechanisms less contradictory and more attractive and reliable for foreign investors.

The innovations introduced by this Law are important from a practical point of view as they will stimulate the exchange of technologies and experience between subsurface users and other investors willing to enter into PSAs. What is more, such innovations will also make it easier for parties to a PSA to attract international funding for their projects in Ukraine.

Despite the remaining gaps and legal conflicts in the interpretation of certain new rules, the Ukrainian parliament took a steady step toward improving legislation on production sharing agreements, providing a more beneficial investment environment under PSAs both for current Ukrainian subsurface users and for foreign investors.

Additional notes

This LEGAL ALERT is issued to inform Baker & McKenzie clients and other interested parties of legal developments that may affect or otherwise be of interest to them. The comments above do not constitute legal or other advice and should not be regarded as a substitute for specific advice in individual cases.