A Few Tips for M&A in Agricultural Sector

Статья посвящена вопросам, связанным со сделками M&A в сельскохозяйственном секторе экономики Украины. Автор рассматривает типы аграрных компаний, сезонные тенденции в деловой активности аграрных компаний в зависимости от их специализации и района деятельности, детально исследует специфику организации предприятий в аграрной сфере хозяйственной деятельности, а также раскрывает важность института добрососедства и ключевые аспекты состояния сельскохозяйственных предприятий, которые учитываются при проведении подготовки сделки в отношении аграрной компании.

Особый интерес публикация вызывает анализом практических рисков, существующих при заключении M&A сделок в сельскохозяйственном секторе.

Agricultural business continues to be one of the most attrac­tive businesses in Ukraine. Indeed, the agricultural sector is the second most important sector for the Ukrainian economy, which has a vital impact on the country in general.

Notwithstanding the fact that agricultural companies dif­fer from one another and con­duct their business in different sectors, certain aspects remain to be common for all of them. This article is aimed at outlining certain common tips for M&A trans­actions in the agricultural sector.

Types of agricultural companies

Agricultural sector is rather diversified and can be classified by types of activities, location, size and other criteria.

For the sake of easy pres­entation and classification we may identify the following three groups of agricultural compa­nies:

a)   Farms cultivating grains and other plants (cultivating farms);

b)   Farms breeding cattle and other animals (breeding farms); and

c)   Other agricultural compa­nies. This group usually includes companies combining cultivation of crops with cattle breading, companies producing so-called “sub-agricultural” products and processing companies.

Please be informed that farm­ing companies exist in different legal forms. Historically, the ma­jority of farming companies were created in the form of an enter­prise (private, collective, farming, leases and others). Today, most of such forms are outdated and poorly regulated, which how­ever, does not prevent farming companies from continuing to exist in such forms. At the same time, the vast majority of new farming companies are created in the form of a limited liabil­ity company, which is the most common form of doing business in Ukraine as it is comparatively easy to create and manage.

Seasonal nature

It is obvious that activities of all farming companies peak in certain seasons regardless of their location and specialty.

Cultivating farms usually start their season in February — March and end in August — Octo­ber, while breeding farms usually start their season in March — April and ends in October — No­vember.

It is important to consider this seasonal nature when struc­turing an acquisition of a farm­ing company. In rare cases, it is possible to perform the whole acquisition within this short period of time, whereas in most cases due diligence, negotiations, merger clearance take much more time.

It is common when a buyer of a cultivating farm wants to take control over planting works after the deal is reached and be­fore completion of all formalities. In order to achieve this goal, in many European countries it is possible to conclude a so-called planting or cultivation agree­ment which allows the buyer to cultivate the land and to collect the future harvest.

Although possible in Ukraine, this scheme is rather rare because of the tax consequences. Indeed, most farms have the status of a special VAT payer as producers of agricultural products. This sta­tus allows farms not to pay VAT but to use these funds for expan­sion of their business. In order to maintain such status, the farm should receive 75% of its income from agricultural activity.

It is important to note that the harvest collected under such cultivation agreement becomes the ownership of the buyer only in case the buyer has either a right to lease (easement) or the ownership over the cultivated lands. In most cases, the land is owned by numerous physical per­sons and leased to the farm. As a matter of practice, certain lease agreements do not even fore­see a right to grant a sub-lease. In addition, the sub-lease should be notarized and, therefore, en­tails additional costs.

Apart from this, according to the Tax Code of Ukraine, the farm does not benefit from its special VAT status for income received from joint venture activity.

Therefore, in order to be fea­sible, the cultivation agreement should not constitute any joint activity relating to the cultiva­tion of land, as well as any share of the collected harvest. More­over, the cultivation agreement should be accompanied with notarized sub-lease agreements over the cultivated land. All this makes the cultivation and other similar agreements not very pop­ular in Ukraine.

It is worth noting that Ukrain­ian practice invented several other solutions that allow achiev­ing the results of the cultivation agreement. One of the most pop­ular is conclusion of the services agreement between the farming company and the buyer, accord­ing to which the buyer provides cultivation services to the farm­ing company. As a result, the buy­er can ensure a desirable quality of planted crops and cultivated land. At the same time, the buyer and the seller specify in the sale and purchase agreement that all collected harvest should remain with the farming company until the closing of the deal.

Although rather deviated, this scheme allows the buyer to con­trol the planting, cultivation and harvesting works on the farming company and to become an ulti­mate owner of the harvest.

Local people

Historically, many farming companies were created based on former collective enterprises owned by individuals. It is a com­mon case when the farming com­pany is owned by one family or even one individual person.

Naturally, such an owner of the farming company is well known in a village or a city where the farm is located, whereas his authority defines the attitude of employees and local government authorities to the farming com­pany.

Practically, it is important to note two possible risks linked to this situation:

1)  Possible negative impact on the farming company due to leaving the former owner, who has a good local image. This risk can be mitigated by engaging this owner into further business of the farming company.

The most common solution would be to keep the owner at the position of a Director of the farm­ing with additional limitations of powers or to appoint him to a quasi-managerial position such as a Chairman or a President of the farming company; and

2)  Possible risk that the former owner with good local relations will create a new competing farming company. In this case, there is a risk of loosing cli-
ents, employees and even land.

This risk exists due to the fact that widely spread in Europe non­compete clauses in practice are hardly enforceable in Ukraine. In­deed, it is not possible to impose on the seller an obligation not to create any farming company or not to work in the same field of ac­tivity for a certain period of time. However, it is possible to specify a fine to be paid by the seller in case he decides to continue the agro business in any form.

Also, in practice, this risk can be mitigated by keeping the former owner within the compa­ny either on a management posi­tion or in the role of a minority shareholder.

Know your neighborhood

Another important issue is the neighborhood of a farming company regardless of its size. The importance of this issue is caused by the fact that the main asset of each farming company is land, whereas in many cases this land is leased from individu­als under a short-term land lease agreements.

Knowing that every 3-5 years the farming company should re­new a part of its lease agreements, it is important to know neighbor­ing companies which potentially may compete for the lease of the land. It is apparent that a risk of a potential local competition for the lease of the land from a small privately-owned farming compa­ny substantially differs from the one which can be created by a big agro holding.

Potential pitfalls

It is very common when a legal due diligence is conducted before an acquisition of a compa­ny. While auditing the farms in Ukraine there are certain issues which require special attention:

1) Land

Land constitutes the main as­set for the cultivation farms and important asset for the breed­ing farms. As it was mentioned before, in most cases the farm leases the land from numerous individuals or from a local municipality. Of course, these land lease agreements usually contain a number of mistakes and omis­sions, however, when the farm has lease agreements for all land being cultivated, it is considered that the farm works under a so-called white flag.

It is worth noting that the farm can also cultivate the land under grey and black flags. This is a pure practical flag legend for identification of a legal ground of the farm for using the land. Ac­cording to this legend, the grey flag means that the farm has in­complete or improper documents to the land. For example, there is a decision of the local municipal­ity to grant the land into lease to the farm, however, the lease agreement has not yet been con­cluded.

The black flag means that the farm has no documents to the land at all. This, for example, could be reserved lands which are not actively used by the state or a municipality.

2)   Real Estate

Real estate very often consti­tutes an important asset for both cultivating and breeding farms. Usually there are two main problems relating to real estate, namely, absence of legal grounds for use of the land underlying the buildings and improper docu­ments relating to reconstruction of these buildings.

3)   Compliance

It is worth keeping in mind that the vast majority of farms require certain permits and au­thorizations. This could be breed­ing certifications, permits for water usage, permits for usage of mineral resources, permits for pollutions and waste allocation, etc.

It is very common when a farming company either has no certain permits or breaches rules for their exploitation.

4) Corporate restructur­ings

One of the issues which are often identified during a due dili­gence is non-careful and some­times even unnecessary corpo­rate restructurings. Sometimes the shares of a farming company are transferred several times within the same group or even the same family. Quite often such transfers are not properly accompanied with necessary spousal consents and waivers of the pre-emption rights. Another common situation is merger of different farming companies within the same group, which due to the friendly nature of the restructuring are not always properly formalized.

In principle, each violation which creates or may create a risk should be either remediated or covered by a guarantee. Need­less to say that the best option would be to remove such viola­tion before the signing of the sale and purchase agreement, how­ever, in most cases due to a tight time schedule of the transaction there is no room for their reme­diation. Considering this, it is common practice when all such violations are implemented into transaction documents as pre-closing conditions, conditions precedent or even post-closing conditions.

***

Therefore, the agricultural sector in Ukraine has its own pe­culiarities, which should be con­sidered while planning an M&A transaction. The most important issues to be kept in mind are the season-oriented nature of agro business and importance of the local practice. At the same time, careful due diligence of the farm­ing company and proper mitiga­tion of the revealed risk into trans­action documents are key factors for a successful acquisition.

Автор:

Illya O. TKACHUK

Источник:

The Ukrainian Journal of Business Law. – 2013. – № 7-8. – Р. 24 – 26.

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