Ukraine: ban on foreign law and arbitration clauses in shareholder agreements

At the end of 2007 recommendations with potentially damaging consequences for foreign investors have been issued to all commercial courts by the Presidium of the High Commercial Court of Ukraine.

The recommendations affect shareholder relations in Ukrainian companies. In chapter 6, they state that all shareholder agreements governed by foreign law should be null and void on public policy grounds. They also state that agreements to use international arbitration to resolve shareholder disputes, particularly regarding corporate governance issues, are to be prohibited.

It has become increasingly common for agreements involving Ukrainian companies and foreign investors or between foreign shareholders in Ukrainian companies to apply a foreign governing law and/or agree to resolve disputes by arbitration. Both measures offer the advantages of familiarity and convenience.

If the recommendations are followed by the courts, they may harm the investment climate in Ukraine and damage Ukraine’s reputation as an investor-friendly country. They may also increase the number of cases taken to the European Court of Human Rights and cause foreign investors to institute proceedings against Ukraine in the International Centre for Settlement of Investment Disputes. Further, any failure by the Ukrainian courts to recognise the validity of arbitral awards in other countries may lead to reciprocal non-recognition of arbitral awards issued by Ukrainian tribunals.

Considering that the World Trade Organisation has approved accession terms for Ukraine, it can ill afford to damage its reputation and credibility with the international investment community. Both the European Business Association and American Chamber of Commerce have already set up working groups to lobby for the recommendations to be changed or withdrawn as soon as possible. Lawyers of CMS Cameron McKenna in Kyiv are involved in the activity of both working groups.

The recommendations do not explain why it is contrary to public policy to use a foreign law as the governing law of an agreement. According to the Supreme Court of Ukraine, public policy means fundamental principles forming the basis of order in the state, such as independence, integrity and liberty.

Similarly, current legislation prohibits the use of arbitration to resolve certain types of dispute but does not do so for corporate disputes. Corporate disputes fall under the jurisdiction of the commercial court whose procedural code allows disputes to be referred to arbitration.

Moreover, Ukrainian laws on international commercial arbitration expressly allow the use of arbitration within Ukraine for disputes involving Ukrainian companies with foreign investments or their participants. Laws on foreign investments also allow parties to agree to resolve disputes using arbitration.

The recommendations are not legally binding nor it is mandatory for the commercial courts to follow them; but, even so, they are regularly referred to by the courts and used as guidance. The fact that these recommendations are expressed in the imperative is particularly surprising, given that freedom of contract is a fundamental principle of international law and is also proclaimed by the Civil Code of Ukraine.

The initial adverse consequences of such recommendations have already started to appear. According to information provided by a leading Ukrainian investment bank, as a result of these recommendations being adopted, foreign investors started insisting on including reservations to contracts on the purchase of Ukrainian companies. The purpose of such reservations is to mitigate various risks (express and implied) caused by the controversial recommendations.