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The Future of Ukrainian Ports: Concession vs Privatization?

12.11.2019

Sergey Nedelko, Attorney at Law, Head of Odesa Office

Source: Yurydychna gazeta

Ukrainian ports are the country’s sea gate and an important sector of the economy that can generate billions of dollars of GDP and create thousands of workplaces. Not only domestic and foreign investors, but also reputable international financial organizations speak about investment attractiveness of the maritime industry, as evidenced by the real boom in the construction of handling terminals in ports, including those financed by loans granted by the EBRD, IFC and other organizations.

At the moment 13 Ukrainian seaports fit in 103 private port operators, each of which is developing its business not thanks to but in spite of the public administration policies. With the adoption of the Law on Seaports in 2012, the pending discussion of how to reform and develop domestic ports (concession or privatization) has significantly intensified. Recently, however, certain events have been taking place, allowing us to form an opinion on the probability of industry development and speak with cautious optimism about possible positive changes.

Port privatization

The foundations for privatization of port infrastructure facilities were laid down in the Law of Ukraine On Seaports of Ukraine, which came into force on 13 June 2013 and divided port infrastructure facilities into strategic (not subject to privatization) and non-strategic (subject to privatization). However, due to the imperfection of legislative regulation and the inclusion of all ports into the List of State Property Objects Not Subject to Privatization, approved by the Law of Ukraine No. 847 XIV dated 7 July 1999, the privatization actually never got round to work.

The Law of Ukraine On Privatization of State and Communal Property adopted in 2018 improved and systematized the legislation, in particular, provided for the possibility of privatization of separate individually defined property, which is the most acceptable scenario for most ports, given the existence of lease relations. However, no global changes in the system occurred and the issue of port privatization remained unresolved.

On 2 October 2019 an important event took place in the privatization system reform — the Parliament adopted the Law of Ukraine On Declaring Invalid the Law of Ukraine ‘On the List of State Property Objects Not Subject to Privatization’, which came into force on 20 October 2019. The explanatory note to the Law states that the List contains information that has lost its relevance as regards the names of state bodies and enterprises, and also does not provides for the grounds for their inclusion into the List. Thus, there are currently no formal obstacles to the privatization of port infrastructure facilities, and the further development of the process depends primarily on the political will of the Government.

The position of the Minister for Economics is that strategically important state-owned enterprises shall not be privatized. Given this criterion, seaports are not subject to privatization, since they are included in the list of state-owned objects of strategic importance for the state economy and security (Resolution of the Cabinet of Ministers No. 83 dated 3 March 2015). Recent public speeches delivered by the Minister of Infrastructure pertaining to the development of the port sector also indicate that the concession was given the edge over privatization. In any case, a more substantive assessment of the prospects for port privatization will be possible after 1 December 2019, when the Government will fulfill the President’s order to form the list of enterprises for small privatization and to include the State Property Fund of Ukraine (SPFU) therein.

Global and domestic concession experience

Concession is considered one of the most widespread, effective and progressive forms of public-private partnership (PPP) worldwide. For the state, the concession is always an instrument of economic growth and market competition increase, attraction of managerial resources and latest engineering and technologies, as well as up-to-date organization of production in the context of a decrease in budget costs. The investors are also interested in the concession, taking into account the possibility of sharing risks, guaranteeing the protection of concessionaire’s rights, and the state’s obligations to facilitate the implementation of projects.

The largest-scale concession projects in recent history are the Channel Tunnel (agreement concluded in 1986, investment volume — GBP 9 bln, concession period — 99 years), Kai Tak International Airport, Hong Kong (1994, USD 20 bln), and 407 Express Toll Route, Canada (1999, USD 3.1 bln, concession period — 99 years).
At present, about 83% of PPP projects in ports have been implemented in the form of concession. Successful examples include the construction of a new container terminal in the port of Samsun, Turkey (2008, USD 125.2 mln, concession period — 36 years), modernization of three terminals in the port of Burgas, Bulgaria (2013, USD 127 mln, concession period — 35 years), construction of a container terminal in the port of Constanta, Romania (2003, USD 100 mln, concession period — 46 years). Back in 1993, four state ports in Colombia were transferred into concession to a private partner, which increased competition, as well as the quality of services and working conditions of the dockers. The concession of Mexican ports in the mid-1990s helped to adequately compete with the southern ports of the USA, taking from them a significant part of the cargo flow thanks to economically attractive handling tariffs.

According to the State Property Fund, a total of 144 concession agreements were concluded in Ukraine: 136 for communal property and only 8 for the state property objects in the field of automobile roads, energy and coal industry, yet, however, both contracts for the construction of roads were terminated shortly after their signing at the beginning of 2000s. Such disappointing data from the Fund clearly indicate that, unlike the international experience, the concession mechanism in Ukraine did not actually work, since not a single large-scale infrastructure project has been implemented yet. The reasons behind were the obsolescence and inconsistency of the concession legislation, the lack of clear and understandable rules, as well as an excessive bureaucracy.

Concession Law and its innovations

Finally, on 3 October 2019, the Parliament adopted the long-awaited and hard-fought Law On Concession No. 155 ІХ, which came into force on 20 October 2019. The Law provides for a number of innovations and amendments to the legislation, which should revive the concession mechanism, creating favorable conditions for investments, primarily those into the sea and river ports, highways, and airports.

Concession envisages the concessor’s granting to the concessionaire of the right to create, build, manage the concession object, provide socially significant services in the manner and on the conditions determined by the concession agreement. The Law defines, in particular, a unified procedure for initiating and deciding on the implementation of PPP in the form of a concession; introduction of a transparent procedure for the selection of a concessionaire (concession tender, competitive dialogue); possibility of attracting advisers and independent experts; replacement of one concessionaire with another; simplification of land allocation procedures for concession projects; procedure for converting leases into concessions; possibility of submitting disputes for resolution by international commercial or investment arbitration; possibility of initiating a concession by a potential concessionaire; clear mechanism for monitoring and control over performance of concession agreements; regulation of the ownership right to concession object, etc. Certain key innovations of the Law should be considered in more detail.

Transition from lease to concession without tender

At present, a vast majority of PPP projects in Ukrainian ports are carried out on the basis of lease of state-owned real estate, but this form is outdated and implies a passive use of leased objects with rather limited rights and capabilities of the lessee to improve and modernize such real estate. The significant deterioration of fixed assets in Ukrainian ports does not allow the lessees to effectively use the leased property, and the procedure for obtaining the consent of the State Property Fund for their integral improvements is usually delayed for many years. In addition, the lack of ownership rights to the land plots does not allow the lessees to carry out reconstruction and new construction of facilities. Under such conditions, the issue of transferring to concession through direct negotiations is quite relevant for many port workers.

The Law establishes the conditions under which a concession agreement can be concluded through direct negotiations with the lessee of state property without tender. In particular, the conclusion of a lease agreement before the entry into force of the Law; the lessee’s intention to implement a concession project using the leased property, which requires additional investment; proper fulfillment by the lessee of the terms and conditions of the lease agreement and the absence of significant violations of obligations on its part, which is established by the State Property Fund on the results of a special audit; the term of the concession agreement shall not exceed the term of the lease and shall be at least 5 and not more than 50 years.

The Law clearly outlines the actions to be taken by all interested parties to implement the mechanism for transforming leases into concessions. It is only the lessee which can initiate the procedure, and the final decision on the transfer to concession is made at a Government meeting, subject to the preliminary approval by the Ministry of Economy of the conclusion on the PPP’s expediency. However, a major drawback of the Law is the lack of time limits for consideration of materials by the Ministry of Economy and the Cabinet of Ministers of Ukraine, which carries the risk of delaying the procedure for an indefinite period.
An important stage in the transformation is an inventory of assets constituting the leased property. The permanent improvements, regardless of the presence or absence of the consent of the Fund, are considered to be the state property, subject to the transfer of such improvements, new things and objects into the concession. The cost of these improvements is not taken into account when determining the size of concession payment. In the case of a concession agreement, the permanent improvements made with the consent of the Fund are not compensated for.

The lease agreement is considered terminated from the moment the concession agreement is concluded. If the object of concession is a part of the leased property, the agreement is terminated in the relevant part. Moreover, the Law does not provide for the need to return property to the lessor under the certificate, which is a good decision, given the possible delay in the process on the part of the Fund.

Legal regime of concession objects

The objects of concession may be the integral property complexes and individually defined property that are not leased. The transfer to the concessionaire of the existing concession object, including its further reconstruction, restoration, overhaul, technical re-equipment by the concessionaire, does not entail the transfer of ownership right to the concessionaire. Real estate built by the concessionaire under the agreement also remains in state/communal ownership. The concessionaire is granted the right to lease part of the concession object, which may be required having due regard to the peculiarities of the production process. The list of such property and the conditions for its transfer should be established directly in the concession agreement.

An important provision of the Law is the directly established possibility of pledging property rights under the concession agreement, yet only the entire complex of such rights by agreement with the concessor. In addition, the foreclosure on the subject of pledge is carried out by replacing the concessionaire and is executed by signing an additional agreement between the concessor and the new concessionaire.

Comparing the pledge of property rights under the concession and lease agreements, we can note that the international financial organizations are ready to accept as a security for credit obligations the pledge of property rights of stevedore companies under the lease agreements for real estate in ports, since the aforementioned rights are, of course, a valuable asset for which the company can attract additional funding. Yet, however, unlike the concession, the pledge of property rights under the lease agreement is not directly provided for by the law, and therefore should be regulated by the general provisions of the law on the procedure for replacing a debtor in an obligation (Article 520 of the Civil Code of Ukraine), which provides for the permission of the creditor, being the lessor, represented by the regional branch of the SPFU. However, in our practice, the SPFU has never granted such permission, without which it is impossible to enforce the lessee’s property rights and effectively protect the interests of the pledge holder.

Regulation of land relations

The Law provides for leasing to the concessionaire of the state-owned or communal land plots of for the duration of the agreement, as required for the implementation of the concession project. The authorized executive authorities and local self-government bodies are obliged to transfer to the concessionaire for use the land plot(s) determined by the concession agreement. The corresponding amendments were introduced into the Land Code. The Law determines the procedure for providing land plots for the implementation of project and their detailed list as the essential terms and conditions of the concession agreement.

Dispute resolution

The Law provides for the right of the parties to freely choose a dispute resolution mechanism, including mediation, non-binding expert opinion, national or international commercial or investment arbitration, including arbitration abroad.

Given the judiciary reform and certain instability in legal proceedings, this step is absolutely justified, since the guarantee of a fair trial is one of the first requirements of any investor. Although the concession agreement is governed by the law of Ukraine, the construction of the norm allows a different law to be applied, probably, to regulate its individual provisions.

Summing up, it can be argued that the Law contains a number of positive and progressive provisions consistent with the world practice of regulating concession relations. In addition to the adoption of the progressive Law, the priority of the concession scenario for the development of ports is also evidenced by the provisions of the Ukraine’s Seaports Development Strategy by 2038, as well as the recent announcement by the Ministry of Infrastructure of concession tenders in respect to the state stevedores Olvia and the Kherson Sea Port, which gained the attention of the entire port community. According to preliminary estimates, as much as USD 250-280 mln will be attracted within a framework of the project. The successful holding of concession tenders and the successful start of pilot projects will be a litmus test for investors and will demonstrate the state’s readiness for systemic changes in the port sector.

 
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