UKRAINE COMMERCIAL DISPUTE RESOLUTION STUDY

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized UKRAINE COMMERCIAL DISPUTE RESOLUTION STUDY Researching commercial disputes among Ukrainian companies

The contents of this report are protected by copyright. Neither this report nor its parts may be reproduced, copied or distributed in any form without reference to the International Finance Corporation report Ukraine Commercial Dispute Resolution Study. Researching Commercial Disputes among Ukrainian Companies. This report is to be distributed under the condition that it will not (as the result of sale or otherwise) be loaned or resold, rented or distributed on any kind of commercial basis without prior consent from the International Finance Corporation (IFC). The materials contained in this report are presented as an overview of the results of a study that was conducted in May-June 2006 among Ukrainian companies by size small, medium and large and by region Kyiv, Lviv and Dnipropetrovsk. The study was funded jointly by IFC and the Swedish International Development Agency (SIDA). The information in this report is presented in good faith for general information purposes, and the Swedish International Development Agency (SIDA), the International Finance Corporation (IFC), the World Bank Group or PricewaterhouseCoopers (PwC) shall not be held liable for any of the information contained herein. This report does not claim to serve as an exhaustive presentation of the issues discussed herein. Although the Ukraine Commercial Dispute Resolution Study experts took a very thorough approach in preparing this report, it should not be used as a basis for making commercial decisions. Please approach independent legal experts for their expert recommendations on any legal issues. All information and materials used in preparing this report are the property of and archived by the International Finance Corporation (IFC). 2007 International Finance Corporation This report was peer reviewed and edited by PwC

UKRAINE COMMERCIAL DISPUTE RESOLUTION STUDY Researching commercial disputes among Ukrainian companies 2006

CONTENTS 1. INTRODUCTION... 4 2. KEY TERMS DEFINED... 5 3. EXECUTIVE SUMMARY... 6 4. THE RESULTS... 9 4.1 Introduction...9 4.2 Frequency of Disputes...9 4.3 Nature of Disputes...10 5. IMPACT OF DISPUTES...12 5.1 Effect on Current Business...12 5.2 Termination of Business Relationships...13 5.3 Employees and Time Involved in Resolving the Dispute...14 5.4 Financial Costs of the Dispute...15 6. CURRENT USE OF DISPUTE RESOLUTION METHODS...18 6.1 Use of Dispute Resolution Methods in General...18 6.2 Negotiation...19 6.3 Court Proceedings...21 6.4 Arbitration...22 6.5 Mediation...24 7. AWARENESS OF ALTERNATIVE DISPUTE RESOLUTION...25 8. CONCLUSION...27 ANNEX 1. Survey Methodology... 28 ANNEX 2. Survey Results by Company Size... 34 3

1. Introduction 1. INTRODUCTION The International Finance Corporation (IFC), the private-sector arm of the World Bank Group, conducted a comprehensive survey of commercial disputes of businesses in Ukraine in 2006. This study, which was funded by SIDA, the Swedish International Development Cooperation Agency, is part of IFC s work to improve business opportunities and the private sector environment in Ukraine. Consistent with these aims, IFC is interested in ensuring that business disputes can be efficiently resolved so that enterprises can devote their resources to doing business. IFC conducted the survey to gain an understanding of how business disputes are currently managed and resolved, the resources businesses devote to such disputes, the effectiveness of and satisfaction with current dispute resolution methods, the needs and priorities of businesses when resolving disputes, and the demand for alternative methods, particularly focusing on the potential for developing commercial mediation in Ukraine. The survey required executive level people to take time out of their busy schedules to share potentially sensitive information about company matters. IFC wants to thank all respondents for their time and efforts and also leading business organisations for their cooperation in order to help promote an interest in the survey. IFC also wants to thank Dr. Patricia Shaughnessy, University of Stockholm, Sweden, lead consultant to this survey for her professional guidance and analysis of the survey results and also Dr. Michael Hammes, PricewaterhouseCoopers, Frankfurt, Germany, for editing and providing a peer review of the survey report. 4

2. Key terms defined 2. KEY TERMS DEFINED Alternative dispute resolution (ADR) refers to any process by which parties, either individuals or legal entities, can resolve disputes without entering the formal court system. The two main types of ADR are arbitration and mediation. Arbitration is a process whereby two parties come together before a neutral third party who is a trained arbitrator, who listens to both sides and then issues a decision which may be binding or non-binding, depending on what the parties have agreed to in advance (usually in a contract). In effect, arbitration creates a private court system. If one of the parties does not want to adhere to the terms of the decision, it might need to be enforced through the public courts. International arbitration is used when the parties or the subject of the dispute are based in different jurisdictions. Usually the parties have entered into an agreement which indicates to which international arbitration court the case should be referred. This type of arbitration is also used by governments to resolve international disputes. Domestic arbitration is used when the parties reside in or have a business registered in the same country and refer the dispute to an arbitration court in that country. Mediation is a process whereby two or more parties sit down with a neutral third party, usually a trained mediator, who facilitates a mutually acceptable agreement to resolve the dispute in question by focusing on interests rather than legal positions and contractual rights. Unlike litigation and arbitration, in mediation the parties come to an agreement themselves the mediator does not make any decisions for them. 5

3. Executive summary 3. EXECUTIVE SUMMARY In business, disputes are inevitable. Resolving them quickly while preserving important business relationships is a key priority in a modern commercial environment. In Ukraine today the main formal methods available to businesses for resolving disputes are the court system and arbitration. Informal methods include negotiations, out of court settlements and using the mass media to put pressure on other parties involved in the dispute. The survey gathered comprehensive information from businesses about their disputes, how disputes affect their business, and how they attempt to resolve them. The survey sought to gain insight into business disputes across Ukraine by looking at different regions and sizes of businesses. A commercial dispute was defined for the respondents as any disagreement between companies that required intervention by any method, including negotiation, some form of alternative dispute resolution, or initiating judicial proceedings. Disputes involving consumers or government bodies, such as tax disputes or other regulatory types of disputes, were excluded from consideration. The survey was conducted in the city of Kyiv which, as the capital, has the largest concentration of businesses, and in the oblasts of Lviv and Dnipropetrovsk, reflecting significant business activities in diverse geographic locations. A total of 1,210 companies were included in the survey. For further information on the survey methodology please see Annex 1. The following key survey results should be highlighted: On average businesses have 4 disputes per year mainly concerning goods and services contracts with clients and suppliers Disputes often trigger an end to business relationships and medium-sized businesses suffer more from disputes while large businesses use courts more frequently and win more often Businesses are dissatisfied with the court system, particularly with the enforcement of court judgments and a majority of businesses are interested in trying Alternative Dispute Resolution (ADR) Many businesses lack knowledge about arbitration and mediation, but those businesses who have experience in arbitration are satisfied with this procedure 6

3. Executive summary The survey found that businesses in Ukraine had approximately four disputes per business in the 12-month period preceding the survey. There was a direct correlation between the size of the business and the number of disputes: most small businesses had two disputes, medium-sized businesses four, and large companies ten. Most disputes concern conflicts with clients and suppliers regarding goods and services contracts, but also include financial matters (debts and loans). Many survey respondents reported that their most recent dispute involved a significant contractual relationship with another party. Unfortunately, the survey also indicated that disputes often result in terminating business relationships, with 26 percent of small companies reporting they had terminated a business relationship as a result of their most recent dispute and 17 percent of medium and 7 percent of large companies reporting the same. Such a result is not helpful to business growth and development, particularly if the business relationship was an important one. Generally, in their most recent dispute, larger companies were less affected and more successful in using the court system to resolve disputes. er companies suffered a greater impact on their current activities and were less successful in using the court system as a dispute resolution method. er companies stated they used the courts less frequently, and, when in court, they lost the dispute more often than not. companies report greater use of the courts and greater success, most likely because they frequently have in-house lawyers or legal departments, can afford to hire the best trial lawyers, can exert more influence, have greater access to the media, and are better able to manage the cost of the dispute. er companies tend to try to resolve their disputes through negotiations rather than resort to the courts. Businesses are generally dissatisfied with the court system as a mechanism for resolving disputes. Thirty-two percent of all businesses surveyed reported they were very dissatisfied with the lack of enforcement of court judgments and this may dissuade companies, especially smaller ones, from undertaking the effort and expense to pursue a dispute in court. Fifty percent of large businesses are able to effectively use the courts to obtain a decision in their favor, but even these users had problems enforcing decisions. Although new legislation has recently improved the legal framework supporting arbitration in Ukraine, this form of dispute resolution is currently only used by approximately three percent of all companies regarding domestic arbitration and four percent of companies regarding international arbitration. It is noteworthy that 65 percent of respondents who have experience with arbitration are either completely or very satisfied with the effectiveness of this instrument as a means of dispute resolution. 7

3. Executive summary Mediation is essentially non-existent in Ukraine today. Seventy-seven percent of businesses currently solve their disputes through negotiation without third party involvement. When third parties are engaged to assist in negotiations, parties often feel they ve been brought in to exert influence rather than to help the parties conciliate or find ways to compromise. Despite this impression of the role of third parties in dispute resolution, 56 percent of businesses indicated they would likely try mediation to resolve disputes if it were available. The low awareness among Ukrainian businesses of alternative dispute resolution procedures is accompanied by a great interest in obtaining more information about ADR and participating in training and seminars. There is a need to develop more effective dispute resolution in Ukraine, and it is hoped that the judicial system and business organisations will work to accommodate these needs. Increased awareness should lead to a wider inclusion of ADR in contractual dispute clauses and increase the application of ADR in commercial disputes. In particular, mediation as an interest-based consensual solution will increase the rate of compliance with such solutions and therefore, will also decrease the burden of enforcement of judicial decisions. One of the challenges in drafting the questions was determining the level of interest in and demand for mediation when few business people had any knowledge about or experience with mediation. Difficulties with terminology exacerbated this problem as there is no generally accepted equivalent term for mediation in Ukrainian and the word mediatsiya (mediation in Ukrainian) is not commonly used or understood. Therefore, it was very important to provide a clear definition of mediation when conducting the survey. 8

4. The results 4. THE RESULTS 4.1 INTRODUCTION The results of the study provide unique insights into the nature of current commercial disputes in Ukraine and how businesses deal with and are affected by these disputes. While the survey found no statistically significant variation in the data between the three regions surveyed, there was a correlation, in many cases, between the size of the company and the responses to questions. The discussion of the results is presented in the following order: information about the frequency of disputes, the nature and impact of disputes, current methods for resolving disputes, awareness of and interest in the development of alternative dispute resolution mechanisms. 4.2 FREQUENCY OF DISPUTES The survey found that businesses in Ukraine had approximately four disputes per business in the 12-month period preceding the survey. There was a direct correlation between the size of the business and the number of disputes: most small businesses had two disputes, medium-sized businesses four, and large companies 10. At the time of the survey twenty-eight percent of the respondents were involved in an ongoing business dispute. Less than 10 percent of all businesses surveyed had no disputes in the 12 months preceding the survey and nearly 30 percent of large businesses had more than 10 disputes. 1 8% 6% 4% 1 4% 4% Chart 1: Average Number of Disputes for Ukrainian Businesses Per Year 2% 2% All companies 9

4. The results 4.3 NATURE OF DISPUTES While there is some variance in the nature of business disputes in Ukraine, nearly all disputes have arisen regarding a contract with an important business partner. The majority of respondents indicated that they most often have disputes with companies they will have to do business with in the future. When asked to describe their most recent dispute 87 percent of all respondents, regardless of company size, reported that they had a signed contract with the opposing party, a figure which was slightly lower for smaller companies (84% for small companies, 89% for medium-sized and 9 for large companies). This is significant because it indicates that the parties have an established business relationship presumably intended to have long-term value and provide commercial benefit to both parties. Fifty percent of all respondents noted that their most recent dispute was with clients and suppliers about goods or services. This is consistent with general international trends where these types of disputes are often the most commonly occurring in terms of the number of disputes registered at courts and arbitration institutes. Disputes concerning financial matters, particularly loans and debts, are also quite common in Ukraine: 36 percent of all most recent disputes were reported in this category. Less common were disputes involving property (8%), intellectual property rights (3%), and corporate relations (3%) 1. However, it can also be noted that, internationally, disputes regarding the latter categories are on the rise and this trend is eventually likely to affect disputes in Ukraine as well. er companies tend to have more disputes involving goods and services, while larger companies have slightly higher figures for financial disputes. However, there is not a substantial difference between the type of dispute and the size of the company as Chart 2 illustrates. Chart 2: GOODS AND SERVICES DISPUTES FINANCIAL DISPUTES Nature of Disputes 6 5 4 5 55% 49% 47% 4 3 36% 32% 38% 37% 3 2 2 1 1 All companies All companies 1 Disputes on corporate relations include disputes regarding ownership of the company (e.g. transaction disputes, shareholder related disputes) and other governance issues. 10

4. The results Parties based their legal positions in their most recent disputes on interpreting and applying legislation (82%), rather than on industry practices (18%), common sense (16%) or customary practices accepted in a specific business relationship (9%). This is significant because the respondents indicated that they consider one of the most important factors in selecting a dispute resolution method to be obtaining the implementation of the letter of the law despite the fact that respondents frequently indicated that they find Ukrainian legislation related to business relationships to be inadequate, ambiguous, or in conflict with other legal provisions. This apparent contradiction is not unusual for a country in transition such as Ukraine where the ambiguous nature of the letter of the law is often used by businesses to their advantage, where possible. However, when unclear legislation is the basis of a dispute, it can be difficult to predict the outcome, which may increase legal costs and can lead to appeals. The time and expenses associated with such procedures are typically beyond the means of small businesses in Ukraine. This is borne out by the survey results which indicated that while all companies tended to rely upon legislation as their key argument in a dispute, small companies more often relied on common sense, customary practice with the business partner, and generally accepted industry practices than large companies did. Many respondents reported they were critical of Ukrainian legislation and this opinion was also supported by anecdotal evidence. 11

5. Impact of disputes 5. IMPACT OF DISPUTES 5.1 EFFECT ON CURRENT BUSINESS Although all companies suffer negative consequences from their disputes to some degree, it comes as no surprise that smaller companies suffer greater impact from their disputes than larger ones. The actual impact of disputes can be difficult to measure as many companies appear to underestimate the impact and costs of their disputes by only focusing on legal fees and the amount of the dispute, and not quantifying the costs associated with employee time or opportunity costs. The survey sought to identify some of the factors that could indicate how disputes may affect Ukrainian businesses, but did not attempt to exhaustively explore this area and did not quantify the impact. The survey focused on the factors which were of particular relevance for determining the suitability of introducing ADR methods. These factors included: incidence of terminating business relationships because of a dispute; the cost of the dispute in relation to the value of the matters in dispute; the number of employees involved in dealing with the dispute; the number of days needed to resolve the dispute; and the degree of satisfaction with the outcome of the dispute. The survey did not measure the level of businesses actual recovery from a dispute and also did not quantify the impact of negative media coverage, increased costs for doing business, or the loss of business opportunities, good-will or reputation, all of which can often be significant factors in the actual costs of a dispute. The degree of satisfaction with the outcome is discussed in connection with the assessment of particular dispute resolution procedures in section 6. companies reported more frequently that their most recent dispute did not have a significant effect on their current activities; about 55 percent of large companies reported the dispute had no effect on the company s on-going activities, while 36 percent indicated that the dispute had some but not significant effect on such activities; only 9 percent reported that the dispute completely or substantially adversely affected the company s activities. About 59 percent of small companies reported that the most recent dispute had affected the current activities of the business. 12

5. Impact of disputes 11% 39% 48% Chart 3: 13% 43% 11% 39% 41% 49% Impact of Most Recent Dispute on Current Business Activities 9% 36% 55% Completely suspended current activities Slowed down current activities, but not substantially Substantially slowed down current activities Did not affect at all -sized companies fell between these figures, thus indicating that the perceived impact of a dispute on the activities of a company is related to the size of the company. Therefore, it can be concluded that the larger the company the less likely the company s on-going activities will be affected by a dispute. This may be explained by the fact that larger companies may have more diversified activities and greater resources to withstand and compensate for the negative consequences of disputes. 5.2 TERMINATION OF BUSINESS RELATIONSHIPS Relationships between business partners, suppliers and clients often play a key role in the success of a business, therefore ending a business relationship can be a decision with far-reaching ramifications. As reflected in Chart 4, more small and medium sized companies (47% each) than larger companies (35%) reported that they had used breach of business relationship as a dispute resolution method in their most recent dispute. When reporting the outcome of their company s most recent dispute, 26 percent of small companies said the dispute resulted in the termination of the business relationship with the disputing party, compared to 17 percent of medium and 7 percent of large companies. Despite this relatively high rate of business relationship termination, approximately 34 percent of the responding companies indicated the disputing party was either a rather important or the most important business partner for the company. There were only marginal differences according to the size of the company on this last response. 5 4 3 2 44% 47% 47% 35% Chart 4: Incidence of Use of Terminating Business Relationship as a Dispute Resolution Method 1 All companies 13

5. Impact of disputes In cases where the business relationship was terminated 59 percent of companies suffered a financial loss. In 30 percent of these cases, the loss of the relationship was valued at more than half of the amount in dispute. There were only slight differences in responses according to company size when reporting the length of time over which the parties had cooperated before their dispute arose. In about 75 percent of the responses, the disputing parties had cooperated for more than a year, and in over 40 percent of the disputes this cooperation existed for more than three years. Despite the relatively long-term nature of the business relationships which formed a basis for the disputes, preservation of business relationships was ranked only fourth on the list of factors companies consider when selecting a method of resolving a dispute (see Chart 12). These responses would seem to indicate that many Ukrainian businesses either do not place significant value on preserving business relationships and may underestimate the cost of establishing new business partners, or can easily establish new partnerships. Other business dispute surveys have shown that companies that value longterm business relationships tend to have fewer disputes, use the courts less frequently, are more likely to resolve their disputes through negotiations, and more frequently base their position in a dispute on common sense rather than on legislation 2. The results of the Ukraine ADR survey may be an indication that businesses, particularly small businesses, need more non-court dispute resolution methods and information about the negative impact ineffective dispute resolution can have on their companies. 5.3 EMPLOYEES AND TIME INVOLVED IN RESOLVING THE DISPUTE One of the important indicators of the impact of disputes is the amount of employee time which is devoted to dealing with a dispute. Human capital is a valuable resource for a company and dedicating employee time and attention to handling disputes does not usually contribute to the productivity 2 A survey Dispute-Wise Business Management, Improving Economic and Non-Economic Outcomes in Managing Business Conflicts, New York, 2003, conducted by the American Arbitration Association in the USA determined that so called most dispute-wise companies place a higher value on their business relationships with clients, suppliers and partners and thus being economically more successful than least dispute-wise companies. Another study Commercial Dispute Resolution Konfliktbearbeitungsverfahren im Vergleich (A Comparative Study of Dispute Resolution Procedures), Frankfurt am Main, 2005, conducted by PricewaterhouseCoopers in cooperation with the European University Viadrina, Frankfurt/Oder also revealed that German companies regard the preservation of business relationships as one of the most important qualities of a dispute resolution mechanism. 14

5. Impact of disputes of the business or generally promote business development. It was not possible to actually measure the total amount of employee time dedicated to handling disputes, but respondents were asked to report the number of people within the company who were involved in handling the company s most recent dispute. -sized and large companies indicated their most recent disputes required the involvement of approximately 3 employees, while small companies reported a slightly lower figure of about 2. As mentioned above, many companies fail to fully measure the financial impact of a business dispute because they do not quantify employee time devoted to resolving disputes, or the opportunity costs of employees involved in dispute resolution rather than their regular responsibilities. Taking these issues into account, it becomes obvious that the longer it takes to resolve a dispute the greater the costs may be for the company, therefore efficient dispute resolution capacity is a skill businesses may want to cultivate. Surprisingly, medium-sized companies reported the shortest number of days to resolve issues in dispute with a mean of about 225 days for settled issues and 318 for unresolved issues or cases ongoing as of the date of the interview. In contrast, large companies reported a mean of 240 days for resolved issues and 367 days for unresolved ones; and small companies reported 254 days and 437 days, respectively. These figures are in line with a 2008 World Bank and IFC study which found that resolving a collection dispute in Ukraine required an average of 30 procedures over the course of 354 days 3. 5.4 FINANCIAL COSTS OF THE DISPUTE One of the more obvious costs of a dispute is that of procuring legal services to handle the dispute. The frequency with which businesses referred their most recent dispute to outside legal counsel varied according to the size of the business. er companies tended to refer their disputes to outside counsel more frequently, which is likely due to the fact that large and medium-sized companies often have in-house counsel. 3 World Bank publication: http://www.doingbusiness.org/exploretopics/enforcingcontracts/ 15

5. Impact of disputes Chart 5: Use of Lawyers in Business Disputes Use of External Lawyer 5 4 36% 3 26% 29% 2 1 11% All companies Use of In-house Lawyer 6 IN-HOUSE LAWYER 59% 6 LEGAL DEPARTMENT 5 4 3 2 1 42% 22% 48% 5 4 3 2 1 17% 9% 13% 33% All companies All companies As seen in Chart 5, over 90 percent of large companies have a legal department or at least an in-house lawyer, about 60 percent of mediumsized companies report having in-house legal services, and only about 30 percent of small companies have such services. Interestingly, regardless of the size of the company, those with legal departments have on average three lawyers employed in the legal department. 16

5. Impact of disputes During their most recent dispute only 11 percent of large companies turned to outside counsel, while 28 percent of medium-sized companies and 36 percent of small companies sought help from an external lawyer. Given the fact that twice as many medium-sized companies have in-house lawyers or legal departments as small companies, it might appear surprising that small companies do not refer more disputes to outside lawyers. This can probably be explained by the cost factor; small companies may have fewer resources available to devote to outside legal services. The disputes of the smaller companies may also involve lesser amounts, thus not justifying incurring legal expenses, and as discussed in this report, smaller companies report less success in court proceedings that may inhibit their willingness to pursue their disputes in court. companies report that the cost of resolving disputes is less than five percent of the value of the dispute, while small companies estimate 10 percent, and medium-sized companies estimates fall between these figures. Companies may underestimate the impact and total actual cost of their disputes on the company s resources because they often do not consider the lost opportunity costs, non-legal personnel costs and resources devoted to dealing with the dispute, tied-up capital, insurance and other measures to avoid or minimize disputes, using legal services to deal with disputes, and most importantly, the cost of ending business relationships. These costs can particularly affect small and medium-sized businesses which typically have fewer resources to spare. Apart from the costs to individual companies, there are also significant costs to society both in terms of providing judicial and enforcement services, businesses transferring the costs of disputes through higher costs for goods and services, and reduced investment and capital flow as a result of the losses connected with the risks of disputes. 17

6. Current use of dispute resolution methods 6. CURRENT USE OF DISPUTE RESOLUTION METHODS 6.1 USE OF DISPUTE RESOLUTION METHODS IN GENERAL The most commonly used method for resolving disputes in Ukraine today is to try to negotiate a settlement with the opposing party. The survey indicated that negotiation without third party involvement was used by 77 percent of all businesses in their most recent dispute, 73 percent of all companies formally settled their dispute prior to filing a claim, and 67 percent filed a claim with the commercial court. Less than seven percent of all disputes are resolved by arbitration, either international or domestic. Commercial mediation was not indicated as a dispute mechanism by any of the respondents and is essentially non-existent in Ukraine today 4. This general determination is also reflected in Chart 6 which indicates the respondents preferences of dispute resolution procedures for their most recent disputes. It is possible, and indeed likely, that parties use more than one type of dispute resolution method to attempt to resolve a dispute. For example, a party may seek to negotiate and, if not successful, may file a claim with the court. A party may continue to negotiate after a claim is filed and may also seek to use the media or exert influence through other channels. Some parties report termination of the relationship as a final dispute resolution method. Interestingly, when asked to describe their most recent dispute, most companies reported that they were the party initiating the dispute (76%). Chart 6: Dispute Resolution Methods Used Today Negotiations without third party involvement Formal settlement prior to filing a claim Claim/response at the commercial court of Ukraine Breach of relationship with the disputing company Negotiations through the third party, unrelated to either company 13% 44% 67% 73% 77% Acted via mass media Claim/response in domestic arbitration Claim/response in international arbitration 3% 2% 1% 18 4 This pattern can also be observed in other countries which a much longer tradition of civil law, e.g. Germany or Austria. The survey Commercial Dispute Resolution A Comparative Study of Dispute Resolution Procedures in Germany conducted by PricewaterhouseCoopers in 2005 also shows this ranking in a similar extent.

6. Current use of dispute resolution methods 6.2 NEGOTIATION Although negotiations are frequently used by Ukrainian businesses to resolve disputes the survey indicates that many businesses may not be employing the most effective negotiation methods. Almost 60 percent of all businesses say they strive to find common interests and solutions that satisfy both parties in a dispute. However, the survey also shows that the main reason parties believe business dispute negotiations fail is the dishonesty of the other party, followed by incomplete information, reluctance to make concessions, lack of negotiating skills, and lastly, emotions. This contradiction between businesses intentions and their perceptions about the other party and the negotiation process is surely a barrier to effective dispute resolution. Negotiations can take a variety of forms in Ukraine, but most often occur without any third-party involvement. Only 13 percent of all companies relied upon a third party to assist them in negotiations to settle their most recent dispute. When small and medium-sized companies did engage a third party, the majority of them (as reflected in Chart 7) relied on external lawyers, while large companies reported that they most frequently engaged a government official as their third party which likely reflects the political clout of larger companies in Ukraine. In fact, large companies reported using government officials as the third party in 43 percent of cases and lawyers in only 21 percent of cases. and medium-sized companies reported quite the opposite, using government officials in only 18 percent and 22 percent of their cases respectively, and external lawyers in 60 percent and 57 percent. Law firm, external lawyers Other professional or industry associations 7% 5% 6% 21% 21% 55% 6 57% Chart 7: Third-Parties Assisting with Negotiating Disputes Professional mediator 2% 3% 7% Government officials (excl. court officials) 22% 18% 22% 43% Representatives of other companies A person, who has personal relations with the other party of the dispute Other 2% 2% 2% 5% 6% 6% 8% 8% 8% 14% 19

6. Current use of dispute resolution methods The survey results indicate that these third parties are almost never a trained mediator and often (37% of all cases) their main role was to exert influence on the other party. However, large companies reported that they most often used the third party to provide legal advice (38%) or reveal the interests of the other party (38%), as compared to small companies which reported that the third party was mostly used to exert influence (4), and to help establish proper communication (35%). Based on this information, it appears that third parties currently assisting in negotiating disputes are not used in the most effective manner. These figures are illustrated in Chart 8. Chart 8: Role of the Third Party Assisting in Negotiations Influencing the parties Establishing proper communication 15% 23% 3 29% 35% 37% 4 38% Revealing the interests of the parties 18% 23% 26% 38% Other (mainly legal advice) 17% 22% 22% 22% Chart 9: Use of Third Party Negotiations and Formal Settlement prior to Filing a Claim NEGOTIATIONS THROUGH A THIRD PARTY 2 18% 15% 13% 12% 1 8% 10 8 6 4 FORMAL SETTLEMENT PRIOR TO FILING A CLAIM 73% 66% 75% 8 5% 2 All companies All companies 20

6. Current use of dispute resolution methods Though current negotiation methods may not be completely effective, the survey does indicate that negotiation is more effective than other methods in terms of compliance with the outcome. When a dispute is settled through negotiation, the rate of compliance with the agreement is higher than the rate of adherence to court decisions: reportedly about 68 percent full compliance with a negotiated settlement versus about 45 percent complete adherence to a court decision. Parties also frequently use claim settlement to attempt to resolve disputes, which is a more formal type of negotiated settlement. There is also a significant difference in the usage of extrajudicial claim settlement procedures by companies according to their size: nearly 80 percent of large companies have used this method in their most recent dispute in comparison to 66 percent of small companies. 6.3 COURT PROCEEDINGS companies litigate disputes in commercial courts much more often than medium or small-sized companies: 86 percent of large companies have resolved disputes in court as compared to 72 percent of medium-sized companies, and only 46 percent of small companies. The rate of success in court proceedings also varied greatly, correlating to the size of the company. companies frequently prevailed in court, while small companies usually lost. The rate for having the case decided in the company s favor was: 58 percent for large companies, 40 percent for medium-sized companies, and 24 percent for small companies 5. Given the statistics, it is not surprising that small companies use the court system less often. Around 79 percent of the companies that prevailed in court reported that the court has completely restored their rights. When asked to rank the most important attributes of an effective court system, companies stated that the most important factors were the competence of judges, fairness of the decision, and independence of judges, while efficiency and enforcement were rated low, and surprisingly, cost was the least important. It might appear contradictory that enforcement was rated low, but this is likely because enforcement in Ukraine is beyond the power of the courts. When selecting dispute resolution methods respondents indicated ability to enforce the agreed to resolution as the most important factor (see Chart 12). The survey results confirmed anecdotal evidence that court decision enforcement mechanisms are inefficient and ineffective. In relation to their last dispute companies reported that the court decision was completely enforced in only about 45 percent of the cases, with about 37 percent not being enforced and the remaining cases partially enforced. Thus, while the respondents may have reported that their rights had been restored, it did not mean that their actual losses were fully compensated. The rate of adherence to a settled agreement is significantly higher when there is a negotiated settlement. 5 These figures also include arbitration proceedings. Since arbitration is virtually not used by Ukrainian companies the above statement can be attributed to court proceedings without restriction. 21

6. Current use of dispute resolution methods 6.4 ARBITRATION Although relatively new, arbitration legislation has encouraged a growing interest in this method of dispute resolution. Arbitration remains underdeveloped and is rarely used to resolve commercial disputes between Ukrainian companies, accounting for only about seven percent of total dispute resolution in Ukraine. Of the companies surveyed, only 24 percent had ever been a party to domestic arbitration. The survey made a distinction between domestic arbitration and international commercial arbitration as these are subject to differing legal frameworks and different court jurisdiction. Some companies, primarily large ones, resolve international disputes at either the International Arbitration Court at the Ukrainian Chamber of Commerce and Industry, or through an arbitration proceeding abroad; five percent of medium-sized and nine percent of large companies surveyed indicated they have been a party to an international arbitration, while only two percent and four percent respectively have been involved in domestic arbitration. This can be compared to small companies, which are even less experienced with international (2%) and domestic (1%) arbitration. Chart 10: Use of Arbitration and Arbitration Clauses Use of Arbitration Clauses in Contracts DOMESTIC ARBITRATION 1 8% INTERNATIONAL COMMERCIAL ARBITRATION 1 9% 8% 6% 4% 4% 6% 4% 5% 4% 2% 2% 1% 2% 2% 2% All companies All companies Use of Arbitration DOMESTIC ARBITRATION INTERNATIONAL COMMERCIAL ARBITRATION 3 5 25% 23% 4 4 2 15% 1 19% 16% 17% 3 2 28% 21% 26% 5% 1 All companies All companies 22

6. Current use of dispute resolution methods Currently, large companies use clauses providing for international commercial arbitration in nearly 40 percent of their contracts and domestic arbitration clauses in approximately 17 percent of their contracts. sized companies and small companies report significantly less use of such clauses. However, arbitration may become more common as companies and courts become more familiar with the idea and increasingly use arbitration clauses in contracts. Domestic arbitration Chart 11: Lack of information Deficiencies in arbitration law Difficulty in enforcing decisions 27% 38% 46% Factors Hindering the Use of Arbitration for Dispute Resolution in Ukraine High costs Partiality of arbitrator 18% 18% Unprofessional arbitrators 12% Too time consuming Other 8% 8% International arbitration Difficulty in enforcing decisions 46% High costs 41% Lack of information 29% Too time consuming 24% Other Partiality of arbitrator Unprofessional arbitrators Nothing 7% 6% 5% 3% Users of both international and domestic arbitration tend to be satisfied with this dispute resolution method, with 40 percent completely satisfied and 36 percent rather satisfied with international arbitration. This can be compared with domestic arbitration where 50 percent reported being completely satisfied and 15 percent reported being rather satisfied. Only a relatively small percentage was rather dissatisfied or completely dissatisfied (2% and 4% for international and 8% and 12% for domestic arbitration). 23

6. Current use of dispute resolution methods 6.5 MEDIATION Mediation is a process where a neutral third party assists the parties in amicably resolving their dispute without judicial involvement by helping them to identify their interests and find a consensual solution. It is based upon the agreement of the parties to refer their dispute to an alternative form of resolution. Unlike litigation and arbitration, mediation is not a determination based on legal and contractual rights and obligations. Increasingly businesses worldwide are relying upon mediation as a means for resolving disputes. However this methodology, and knowledge of it, is essentially non-existent in Ukraine today. The survey reflects the extremely low levels of mediation use in Ukraine as none of the respondents indicated they had ever used mediation as a dispute resolution mechanism. 24

7. Awareness of alternative dispute resolution 7. AWARENESS OF ALTERNATIVE DISPUTE RESOLUTION One of the primary objectives of the survey was to determine the interests and needs of Ukrainian businesses in developing alternative methods for resolving commercial disputes. As noted above, there is currently little use of arbitration or mediation in Ukraine, yet there is a need for developing more effective and efficient methods for resolving disputes. Through the survey companies assessed their level of knowledge about mediation as very low with 66 percent of companies indicating they know nothing about mediation and 29 percent indicating they know very little. Only around four percent of respondents reported that they are fully aware of mediation. The survey sought to evaluate the potential demand for mediation services among companies. While it is difficult to accurately determine whether companies will use a dispute resolution process that they know nothing or very little about, a majority of companies indicated that they would certainly (16%) or most likely (4) use meditation if it were available, while approximately 25 percent indicated that they would probably not use it. Surprisingly, many companies thought that mediation was most suited for large and medium-sized companies, when in fact the results of the survey seem to indicate that small and medium companies may benefit most from using mediation as they suffer the greatest impact from their disputes and are less successful in bringing claims to a successful conclusion in court. Companies believe that mediation may be most appropriate for disputes involving customers and suppliers (5), financial issues (49%), corporate relationships (41%), intellectual property (39%) and company property (31%). It is noteworthy that 73 percent of the surveyed companies are interested in obtaining information or participating in trainings and seminars on ADR. It is somewhat surprising that large companies show a much higher interest (82%) in this regard than small companies (65%). To assess the needs and demands of businesses for dispute resolution services, the survey requested respondents to record the factors that were most important to them in resolving disputes. The respondents were given a number of factors to select from and Chart 12 indicates the responses and demonstrates that the most important factor was obtaining an outcome that could be enforced, followed by an outcome that conformed to the applicable law. Obtaining complete recovery (satisfaction of interests) was 25

7. Awareness of alternative dispute resolution ranked third and preservation of the business relationship was ranked fourth followed by the possibilities to affect and control the process. This ranking of factors can be contrasted with the factors which were deemed important when considering dispute resolution in courts as presented in Chart 13. Chart 12: Ranking of Factors Considered Important When Selecting Dispute Resolution Methods Guaranteed decision enforcement Execution of the letter of the law Satisfaction of interests Preservation of business relationships Possibility to affect the result Possibility to control the process Preservation of confidentiality Possibility to appeal the decision Saving money Saving time Neutrality and independence of the third party Informality of the process 58% 55% 5 46% 45% 44% 41% 41% 4 38% 37% 35% Chart 13: Competence of judges 29% Important Factors for Assessing Court Proceedings Fairness of decision Independence of judges Time from filing a claim to court decision 12% 2 24% Decision enforcement 9% Cost of proceedings 6% It is also noteworthy that businesses in Ukraine appear to be less concerned with the cost of proceedings or the time involved in obtaining a final, enforceable outcome than with other factors including adherence to the letter of the law 6. This may be in part due to a desire for predictability in the legal system and a response to the perception that legislation is often unclear and conflicting. Ukraine has undergone significant legislative reform in recent years and there may be a wish to ensure the rule of law. Businesses need to be able to resolve their disputes not only in a predictable manner but also efficiently in order to use their resources to do businesses rather than to battle over legal positions. 26 6 The 2005 PricewaterhouseCoopers study for Germany (refer to footnote 4) also determined that time and cost are not considered as decisive factors by the surveyed companies when assessing dispute resolution procedures. Time and cost issues as the main driver of ADR are primarily referred to in surveys conducted in Common Law countries, particularly the USA, where the legal system is much more adversarial and includes instruments of discovery.

8. Conclusion 8. CONCLUSION The findings of the survey indicate that Ukrainian businesses are regularly involved in disputes, often with companies with which they have a contractual relationship. As a result, dispute resolution is an important issue for the Ukrainian private sector. Dissatisfaction with the court system and the inability to effectively enforce court judgments related to business disputes mean that many companies currently engage in negotiation to solve their disputes but mediation is not widely used in Ukraine. The survey shows that companies in Ukraine would benefit from and are interested in having access to alternative methods for efficiently resolving their disputes. Particularly small and medium-sized businesses have a need for dispute resolution methods which would allow them to promptly and effectively resolve disputes at a reasonable cost in order to preserve important business relationships. 27

Annex 1. Survey methodology ANNEX 1. SURVEY METHODOLOGY 1. INTRODUCTION The business survey was a key component of the overall CDR study. Therefore, the methodology of the survey was designed to best achieve the aims of assessing the needs and interests of the Ukrainian business community for developing alternative methods of dispute resolution. Importantly, the survey needed to be designed and implemented in a manner that ensured that the resulting data were statistically reliable and accurately represented the views of the full range of business entities in Ukraine. It was essential that the data could be collected with a low risk for error. Achieving these aims required careful preparation and implementation of the survey. In order to help promote an interest in the survey and to obtain cooperation, leading business organisations were contacted and provided with information about the survey and its aims. Some of these organisations kindly contacted their member companies and encouraged them to cooperate with the survey. Some business organisations included a notice about the survey in their member s newsletters and magazine, encouraging cooperation with the IFC study. This cooperation was key to the success of the survey. 2. SELECTING A PROFESSIONAL RESEARCH COMPANY In order to select an appropriate professional research company, a shortlist of three leading international firms with wide experience in conducting customised market research in the Ukrainian business community was prepared. These three firms were provided with information about the assignment and were invited to meet with the IFC consultant team ( the team ) to further discuss the assignment. Following meetings with representatives from the three firms, each was invited to submit written proposals for the assignment based upon developed guidelines. These guidelines included the budget for the work, the number of interviews to conduct, the time period when the work should be carried out, and other relevant information and instructions. Two of the firms submitted written bids for the assignment. Following a review of the proposals, GfK, Kyiv, was selected to perform the survey. 28