April 23, 2012 |Alex Frishberg, Esq.
Ukraine has long been called "the bread-basket of Europe," and for one excellent reason: its fertile, black soil. The estimated value of this treasure is anywhere between 40 and 80 billion dollars. The only problem with investing in such an obviously profitable business was an artificial bureaucratic/legislative barrier commonly known as the "moratorium on alienation of farm land" (the "Moratorium").
As a background, the Moratorium prohibits not only alienation of any land that is designated (zoned) as "farm land," but it specifically bars all foreign citizens and foreign-owned companies from owning such land. Consequently, foreign investors had no choice but to gain a foothold in agricultural land by leasing it directly from farmers that could legally own their small parcels. The lease term was usually either medium (up to 25 years) or long-term (up to 99 years), with an option to buyout such land whenever the Moratorium was lifted.
Using this set up, foreign investors registered wholly-owned Ukrainian companies, which would sign literally hundreds or even thousands of lease agreements with private farmers, allowing them to accumulate fairly large parcels of farmland. In one way or another, all of these foreign investors planned to cash in whenever the Ukrainian government lifted the moratorium. Some hoped to sell their Ukrainian companies, with valid lease agreements, to the highest bidder(s). Others invested into the infrastructure (buildings, tractors) and planned to purchase their leased land so that they could continue running their farming operations long-term.
At long last it appears that the Moratorium will be lifted in 2013. Will these foreign investors finally be able to buy the farmland they have been leasing all these years? Highly doubtful. After all, this is Ukraine, where doing business has never been easy or predictable. Once again, an unfortunate legislative tendency of creating unnecessary problems will probably repeat itself for the following reasons.
The Land Cadastre Law is a very ambitious piece of legislation, which regulates the main principles of forming and maintaining the land cadastre (the unified land register of all landholders in Ukraine). A major portion of this law has come into force on January 1, 2012, while the remaining provisions will come into effect only in 2013. Unfortunately, all too many if its provisions refer to specific procedures necessary to register farm land in the cadastre that are yet to be determined by sub-legislative acts of the Cabinet of Ministers of Ukraine.
The Land Cadastre Law has introduced a number of changes to the Law "On Land Lease" and other laws, requiring lessees (in many cases, foreign investors) to re-enter into their lease agreements with farmers. Pursuant to the amendments to the Law "On Land Lease", one of the material provisions of a lease agreement is the cadastre number of a land plot. If a lease agreement fails to reflect one of the required material provisions, then it may be deemed to be invalid (i.e., terminated). Also, prior land valuation will have to be reconsidered in line with the indicative price of land leases. These two factors will also need to be reflected in the land lease agreements with farmers.
Presently, only the Land Cadastre Law has been passed, and the last barrier to lifting the moratorium remains the passing of the law on the land market. In fact, the Ukrainian Parliament has already adopted a draft law "On the Land Market" No. 9001-1 in July, 2011, and even published it on its website. On its face, this document permits the sale of agricultural land plots starting on January 1, 2012, although the absence of other necessary legislation (and accompanying instructions) made that deadline seem irrelevant.
The initial draft law "On the Land Market" provided that the acquisition of agricultural land by foreign citizens and companies with non-resident shareholders holding over 10% of the authorized capital is prohibited. Only Ukrainian citizens and farming businesses will be able to purchase agricultural land; however, they will NOT be allowed to change the purposeful designation (zoning) of such land plots for the duration of ten years (i.e., once labeled "farmland," one cannot re-zone into, for example, "residential development" for ten years).
Other significant limitations existed, including: (a) the re-sale of agricultural land in this period will be possible only upon payment of 30-100% of its normative value; (b) agricultural land plots may be purchased directly from the seller or at auctions; (c) a Ukrainian citizen may not purchase more than 2,100 hectares in the steppes (temperate grassland/prairie), 1,500 hectares in forest areas or 900-1,100 hectares in mountain regions.
On December 9, 2011, the Ukrainian Parliament passed a yet another draft of law No. 9001-d "On the Land Market," which also contains significant barriers to land ownership by foreign companies. First, this law strictly prohibits all non-residents (foreign companies) from buying Ukrainian farm land. Second, the law excludes all legal entities from the list of potential landowners, allowing only various government agencies and Ukrainian citizens to own such land (even then, Ukrainian natural persons cannot own more than 100 hectares of land).
Another problem in the draft law is a rather strange tax on the potential farm land buyers: if purchased during the first year permitted by the law, the buyer has to pay one hundred percent (100%) of the land plot price. This number drops by 10% for the second year (90% tax), with similar reductions in each following year. This provision assures that any interested buyer will have to pay about twice the value of any land.
Last, but not least, the looming threat of eminent domain (government take-over of land) is ever-present. Under the current draft law, any lease agreement may be terminated if the lessee fails to comply with the land designation (purpose) or somehow damages the quality of the leased land. Such cancellation of lease agreements frightens many investors, existing and potential.
Importantly, none of the above barriers apply to "non-agricultural land." Obviously, one loophole that many foreign lessees will seek to employ involves having the farmers (lessors) change the so-called "purposeful designation" (zoning) of the land thereby selling to buyers land with another purposeful designation (private, commercial, etc.). How is that done? GosZemAgency gave its consent in several regions for scientific research institutes in the fields of land use and land improvement to issue conclusions regarding the nature of certain lands and their unsuitability for use in agricultural business. Any land judged to be "impoverished or bare" is by definition considered to be poorly adapted for agricultural use/business, thereby allowing the local authorities (Regional Councils) to change the "purposeful designation" due to their unsuitability for agricultural use. After this change, the owners (farmers) may sell such land without any limitations set on the sale-purchase of agricultural land.
For those who elect to change the "purposeful designation" of their land, time is of the essence. They must do so before any information in the land cadastre will be transferred from paper to electronic form and published on the website of GosZemAgency and other internet sources. While the information from the land cadastre has not yet been published on the Internet, there is still an opportunity to change purposeful designation (zoning).
In conclusion, it appears that the long-awaited lifting of the moratorium on sale of farmland will take place in 2013. Nobody can predict the final rules that will eventually emerge. Although the necessary laws and instructions, which will regulate this complex process, are yet to be passed, one thing is certain: the initial transfer of land will be problematic for numerous legal and bureaucratic (administrative) reasons, some of which were outlined above. At that point, the assistance of experienced lawyers will become indispensible.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.