Private sector and human-resource development in Georgia

IFC Financial Support to the Private Sector in Georgia

IFC's Policy. IFC's lending and investments in Georgia have been tailored to the country's special circumstances: limited foreign investments, the non-existence of large local companies, limited access to financing for a nascent SME sector, and the lack of advice for private companies on business related issues such as corporate governance and leasing. IFC would also provide support directly to the private sector through the Georgia Business Development Project, a five-year technical assistance program implemented by the Private Enterprise Partnership with the support of the Canadian International Development Agency (CIDA). The main components of the project, as already stated in the above, include development of the leasing sector and improvement of corporate governance practices. The corporate governance initiative is helping Georgian businesses improve their practices to build investor confidence and increase their access to financing. This component of the program also includes advice to the Government on improving corporate governance policies and regulations.

Assistance to SME Sector. To reach small and medium enterprises, IFC provided equity and long-term credit lines to TBC Bank and helped establish Georgia Microfinance Bank - the ProCredit Bank - the country's first bank specializing in lending to micro and small enterprises. In June 2000, IFC purchased a 10 percent stake in TBC Bank. IFC's support helped TBC to grow from a “pocket” bank into the largest and one of the best performing commercial banking institutions in Georgia. In 1999, IFC helped establish the ProCredit Bank - the first bank dedicated to lending to micro and small enterprises in the country, and now the fastest growing banking institution in Georgia. IFC has also supported other Local Companies, for example, GG&MW, a mineral water production company, where IFC's loans supported the company's acquisition of key strategic assets and strengthened control over its key brand, Borjomi mineral water. IFC's equity investment helped the company rehabilitate two mineral water bottling facilities, diversify its product mix and develop the distribution network. IFC sold its stake in the company in 2002.

Development of Mortgage Lending. In the financial sector, IFC has focused on supporting the development of the housing finance market. The introduction of mortgage financing has allowed individuals for the first time to leverage their residences to increase their standard of living. In 2000, IFC extended a $3 million credit line to the Bank of Georgia, and together with re-flows, this credit line financed over 500 projects totalling $4.5 million. In June 2003, IFC provided a second $5 million credit line to the Bank of Georgia for housing finance and for on-lending to small and medium enterprises. In August 2001, IFC provided a second $3 million loan to TBC Bank to support the development of its mortgage lending.

Facilitation of Foreign Investments: IFC invested in equity and provided loans to Ksani Glass Factory, a producer of high-quality glass bottles and packaging. IFC's The $2.5 million equity investment and $6.3 million loan supported Ksani's expansion and modernization. At project completion, the facility will be producing 40,000 tons of high quality glass bottles annually with a high level of product flexibility. In the power sector IFC provided a $30 million loan to AES Corporation to support the newly privatized Tbilisi area power distribu-tion company. The loan was pre-paid in August 2003, when the AES Corporation sold Tbilisi electricity distribution system to UES.

1.6 Legislative Basis for the Operation of the Private Companies

General. The operation of the private companies in Georgia is mainly regulated by the following two laws: a) Law on Entrepreneurs (LoE) (Corporate Law), which sets the corporate governance principles for the private companies (i.e. Limited Liability Companies and Joint Stock Companies); and b) Securities Market Law (SML), which regulates the activities of the private companies permitted to issue and trade the shares on the securities market (i.e. Joint Stock Companies). Both laws are reviewed below.

1.5.1 Law of Georgia on Entrepreneurs (LoE) (Corporate Law)

Under the Law of Georgia on Entrepreneurs the following forms of commercial entities may be established in Georgia:

i. Sole proprietorship--An enterprise operated by a physical person with unlimited liability and no minimum capital requirement. A sole proprietorship is not considered a legal entity under the commercial code of Georgia.

ii. Joint Liability Company--A legal entity with unlimited liability established on the basis of a partnership of several individuals or companies.

iii. Limited Partnership--A legal entity consisting of general and limited partners. The limited partners have limited liability and general partners bear full and direct liability for the obligations of the company.

iv. Limited Liability Company--A legal entity that is separate and distinct from its shareholders (one or more legal or physical persons). The company's liability is limited to its authorized capital. Founders and shareholders are not liable for the obligations of the company.

v. Joint Stock Company--A legal entity characterized by the limited liability of the partners. The company's liability is limited to its authorized capital.

vi. Cooperative--A legal entity characterized by the limited liability of the shareholders. In Georgia, this is a common form of organization for agricultural enterprises.

Sole proprietorships, joint liability, limited partnerships and cooperatives are rarely established by foreign investors in Georgia. Therefore, the following focuses on the legal requirements for Limited Liability Companies (LLCs) and Joint Stock Companies (JSCs), which are the most popular forms of incorporation used by foreign investors in Georgia.

The Law on Entrepreneurs does not set limitations on the domicile of partners. A partner in a legal enterprise can be a citizen or resident of any country. Foreign companies can be established as fully foreign-owned enterprises or in partnership with Georgian companies or physical persons. In accordance with the Law on the Promotion and Guarantees of Investment Activities of November 12, 1996, companies with foreign investments enjoy national treatment and the same rights as Georgian companies.

Provisions of the Law on Entrepreneurs for Limited Liability Companies (LLC):

An LLC can have a maximum of 50 shareholders. The minimum equity capital requirement is 2,000 GEL. The share of the equity capital to be covered by each of the partners may be determined freely, but it must be divisible by 10;

At least 50 percent of the equity capital must be paid up at the time of incorporation, with the remaining 50 percent due within one year;

The Law stipulates that a partners' meeting be held at least annually. Special meetings may be called at the request of partners or directors of the firm;

Partners' meetings are required to consider issues such as amendments to regulations, reorganization or liquidation of the company, appointment of directors, and so on;

Day-to-day management of the company is carried out by one or more directors who are appointed and dismissed by the general meeting or the supervisory board, when such a board is established at the discretion of the general partners meeting;

A partner may sell his shares without seeking consent of other partners, unless otherwise stated in the charter of the company;

Partners who posses 5 percent and more of the equity capital are authorized to call a general meeting.

Provisions of the Law on Entrepreneurs for Joint Stock Companies (JSC):

An entity with more than 50 partners is required to have a legal form of a Joint Stock Company (JSC);

Minimum equity capital for JSC is 15,000 GEL;

A JSC with more than 100 shareholders is required to maintain its share registry through an independent registrar (In 2003 amendments were adopted into the law requiring that a JSC with more than 50 shareholders is required to maintain its share registry through an independent registrar);

A general shareholders' meeting must be held in two months time form publishing annual financial accounts;

A general shareholders' meeting is entitled to elect the supervisory board members, make amendments into the charter of the company, approve the annual report presented by the company directors, elect auditors and so on;

Creation of a supervisory board is mandatory for a JSC. Supervisory boards must have between 3 and 21 members, but the number must be divisible by 3. The Law provides for representation of company staff on the supervisory board (up to 1/3 of the members);

Supervisory board is elected for the period of 4 years. The company directors may not be the members of the supervisory board;

Supervisory board meeting must be held al least once in a quarter;

Day-to-day management of the company is carried out by one or more directors who are appointed and dismissed by the supervisory board;

Supervisory board oversees the activities carried out by the company directors, checks the annual financial accounts, appoints and dismisses the company directors, etc.;

The consent of the supervisory board is needed to conduct the following activities: purchasing or selling more than 50% share of entities, purchasing or selling the assets of the company, setting up or liquidating the branches of the company, etc.;

The law envisages a cumulative voting for electing the members of a supervisory board to protect minority shareholders, but this is not a mandatory requirement.

Representative Offices and Branches. A foreign company may operate a branch or a representative office in Georgia. A branch is not a separate legal entity and it is allowed to engage in commercial activities that would constitute all or part of the activities of foreign head office. For purposes of registration, representative offices are treated as branches and are obliged to fulfil the same requirements.

All actions on behalf of a company can be performed by the head of the company (executive body) or by any person authorized to perform such actions by a power of attorney of the relevant body of the company. Foreign legal entities bear full liability for the activities of branches or representative offices.

Analysis - Law on Entrepreneurs (LoE). As the main company law for Georgia, the Law on Entrepreneurs provides a good basis for corporate governance for all the private companies including those with traded securities. However, based on the experience of other central and eastern European countries, there are several provisions in the Law on Entrepreneurs that could be amended to further strengthen the corporate governance provisions. They are: (1) although the LoE envisages a cumulative voting for electing the members of a supervisory board to protect minority shareholders, it should be made a mandatory requirement. As a result, there will be a mandatory cumulative voting for members of supervisory boards as a means of allowing shareholders with small shareholdings to vote at least one member of the supervisory board; (2) requirement that the shareholders' meeting approve the auditing company's contract (covering the scope of work and annual auditing fees) so that shareholders interested in a highly quality audit, requiring more time from the auditing company, can obtain such an audit, and (3) There is a need to establish a minimum quorum below which no shareholders' meeting may be considered valid; (4) although the LoE requires the financial statements of JSCs to be prepared on the basis of the International Accounting Standards (IAS), it does not specifically require that audits are conducted in accordance with the International Standards on Auditing (ISA), which needs to be amended; and (5) the LoE does not provide takeover rules to protect the interests of minority shareholders.

More specifically, the World Bank (WB) and the International Monetary Fund (IMF) conducted the Assessment of the Implementation of the Corporate Governance Principles of the Organisation of Economic Co-operation and Development (OECD) in Georgia. It is interesting to note that the assessment identified a number of the shortcomings in the corporate governance practice existing in Georgia. Namely, according to the study: (i) There are uncertainties in knowing if shareholders are sharing in company's profits; (ii) It is not uncommon practice of failing to hold the required shareholders' meetings; (iii) Markets for corporate control are limited; (iv) Court system has not yet made any decisions on the cases concerning corporate disputes; (v) Minor role is played by supervisory boards in the strategic guidance of companies; (vi) There is a less than complete disclosure by most reporting companies, particularly of financial and operating results; (vii) There are weak auditing practices;

More detailed results of the assessment are summarised in Table 1.2.1.1 below:

Table 1.2.1.1. Georgia: Assessment of the Implementation of the OECD Principles

of Corporate Governance

1.5.2 Law of Georgia on Securities Market (SML)

The Securities Market Law (SML) regulates the Joint Stock Companies whose shares are traded at Georgian Stock Exchange.

The main principles of the Securities Market Law (SML) are the following:

The purpose of the Law is to develop securities market in Georgia, to protect the investors' interests on securities market, as well as to establish fair and transparent public trading in securities and free competition;

The Georgian Securities Market is regulated by the National Securities Commission of Georgia (NSCG);

The public offering of securities is an offer to sell securities directly or indirectly on behalf of the issuer to at least 100 persons or to unspecified numbers of persons;

A company, which has a class of Publicly Held Securities, shall be deemed to be a reporting company;

All reporting companies shall prepare and submit to the National Securities Commission of Georgia (NSCG) and publish or distribute to registered owners:

I. Annual reports;
(b) Semi-annual reports; and
(c) Current reports.

II. Every person who is a member of a managing body of a reporting company shall file with the National Securities Commission of Georgia (NSCG) a report regarding the percentage of this company's securities of which he is the beneficial owner;

III. A person, acting independently or together with other persons (a "group"), shall inform the National Securities Commission of Georgia (NSCG) about the substantial acquisition of securities;

IV. Substantial acquisition of securities means beneficial ownership of securities, which provide 5% or more of the voting rights in a reporting company and also when level of beneficial ownership changes by more than 5% from that originally reported;

V. Members of the managing body of a reporting company shall exercise their rights and perform their duties: a) in good faith, b) with the care that an ordinary prudent person in a similar position would exercise under similar circumstances, and c) in a manner that they believe to be in the best interest of the company and its security holders;

VI. A Stock Exchange shall be the exclusive organizer of secondary public trading in securities;

VII. All purchases and sales of Publicly Held Securities shall be concluded through a licensed Brokerage Company;

A licensed Central Depository shall perform the following functions:
a) open, operate and close securities accounts of participants in accordance with its rules;
b) facilitate the settlement of securities transactions without physical delivery of securities certificates and, in furtherance thereof, provide facilities for comparison of data respecting the terms of settlement of securities transactions.

Licensed Stock Exchanges and a Licensed Central Depository shall be designated Self_Regulatory Organizations (SROs) under this law;

The main objective of such an organization, as an SRO, shall be to:

a) Pprepare rules for its members and supervise compliance with such rules;
Apply sanctions provided for in its inner regulations and rules or charter against members for non-compliance with its rules.

Insider means any person who, by virtue of his membership in the managing body of a reporting company, his holdings in the capital of such company, or based upon his access to such information by virtue of the exercise of his employment, profession or duties, possesses inside information. Other persons obtaining inside information that evidently originated with an insider shall be likewise considered insiders.

It shall be unlawful for any insider, and any person who knowingly receives inside information from an insider, to:

a) Acquire or dispose of, for his own account, or the account of a third party, either directly or indirectly, Publicly Held Securities of the reporting company or companies to which that inside information relates;

b) Disclose inside information to any third party unless such disclosure is made in the normal course of the exercise of his employment, profession or duties;

c) Recommend to or procure a third party, on the basis of inside information, to acquire or dispose of Publicly Held Securities.

Analysis - The Securities Market Law (SML). The SML is drawn on German model and mostly reflects the international best practice in the field described in "The Objectives and Principles of Securities Regulation" adopted by the International Organization of Securities Commissions (IOSCO), but it has the following weaknesses: (i) It does not cover collective investment schemes (CIS), such as investment funds, and therefore there is currently no legal basis for the operation of CISs in Georgia Although a draft law on Investment Funds has been prepared with assistance from USAID (IOSCO, 2001) . Meanwhile, the experience obtained from the Central and Eastern Europe indicates on crucial importance of CIS, such as investment funds, in increasing the corporate governance standards and facilitating the trust amongst investors towards stock markets; and (ii) The NSCG does not have an authority to supervise private placements.

More specifically, the World Bank (WB) and the International Monetary Fund (IMF), also conducted the Assessment of the Implementation of the Objectives and Principles of Securities Regulation of The International Organization of Securities Commissions (IOSCO) in Georgia. The assessment identified quite a lot of problems in the operation of the securities regulator, the functions of which is assumed by the National Securities Commission of Georgia (NSCG). Namely, the report lists the following problems: (i) NSCG has a seriously insufficient budget; (ii) Code of ethics for NSCG staff is awaited; (iii) No specific oversight program to supervise self-regulatory organizations (SROs) has been established; (iv) Inspection and investigation powers of the NSCG over Reporting Companies and their major shareholders are not adequate; (v) Enforcement power of the NSCG on the basis of criminal legislation is limited; (vi) International Accounting Standards (IAS) are recognized but are not fully adopted in practice; (vii) There in no legislation on Collective Investment Schemes (CIS) in Georgia; (viii) There is no market surveillance and stock watch system to detect abnormal movements and unfair trading practices.

More detailed results of the assessment are summarised in Table 1.2.2.1 below:

Table 1.2.2.1 Georgia: Assessment of the Implementation of the IOSCO Principles

for Securities Regulation

1.5.3 Employment Regulations in Georgia

Labor Code. The Labor Code of Georgia regulates labor relations between workers and employees living in Georgia and enterprise, institution and organization (regardless their ownership and organizational legal form), supports to realization of human rights and freedoms through labor fair reimbursement (legal payment), creation of safe and healthy working conditions for all employees and workers including the working conditions for minors and women. On the basis of international agreements regulating labor relationships, the state protects the labor rights of Georgian citizens abroad. Foreign citizens and stateless persons living in Georgia have the rights and obligations equal to the rights and obligations of citizens of Georgia with some exceptions envisaged by the Constitution and law.

Nondiscrimination. Under the constitution labor is free. Each person has right to choose its field of activity and profession. Discrimination in obtaining a job, or in the workplace, based on race, skin color, language, sex, religion, political and other beliefs, national, ethnic and social origin, property and title of nobility or place of residence is prohibited.

Minimum and Maximum Age of Employment. According to the legislation of Georgia minimum working age is 16 years. Maximum working age is not determined, but pension can be given to a man in the age of 65 years and a woman in the age of 60 years.

Working Hours.  According to the Labor Code of Georgia the duration of the working period is:

- 41 hours per week, with five working days;

- 36 hours per week in certain dangerous or unhealthy activities or jobs.

- The duration of a working day totals 8 hours and 15 minutes.

- Thus, the number of working days per month equals 21,1 days.

- Minimum leave is equal to a total of 24 working days.

Wages. Reimbursement of labor is carried out according to labor amount and quality. According to the legislation, minimum level of salary is determined in the amount of 20 GEL. The nominal average monthly salary of an employee in 2001 made up 91.4 GEL. Higher labor reimbursement is considered for employees working in certain dangerous or unhealthy climatic conditions. However, the wages for each professional category are usually negotiated in labor agreements.

Social Taxes. The article on Social Taxes of the Tax Code of Georgia stipulates a new system of social tax payment. According to the tax code of Georgia, social tax rates are as follows: The amount to be paid into the United State Fund of Social Security is equal to 28% of the salaries paid, out of which the employer has to contribute 27% and the employees have to contribute 1%, and the payment to the United State Fund of Employment is equal to 1% of the salaries paid, which has to be contributed by the employers.

Medical Insurance Fee. Medical Insurance Fee for legal entities is equal to 3% of the salaries paid. Medical Insurance Fee for all employed persons is equal to 1% of their income (exemptions: compensation surplus for annual leave; bonuses; awards; pensions and allowances).

Social Security System. The social security system of Georgia is based on compulsory social insurance. According to the Presidential Decree dated by June 29, 2000 (No 278), issues relating to the assignment and distribution of state pensions and aids, definition of vulnerability and other medical-social expertise are the responsibility of the Ministry of Health and Social Security. The reform in social insurance system, which was recently carried out in Georgia, encourages the improvement of the social security system and the establishment of private pension funds.

Georgian Trade Unions League. Georgian Trade Unions League is a joint national professional centre of trade unions in Georgia. The main goal of the league is to protect the labor, socio-economical, legal rights and interests of its members. The league includes 33 trade unions and 2 member organizations. Currently, there are 900 000 trade union members in the different organizations of the league. Under the Constitution of Georgia all employees (workers) have the right to join Trade Unions. Georgian Trade Unions League, together with the member organizations, co-operates productively with the General Confederation of Trade Unions, International Labor Organizations, Trade Unions of United States of America, Germany, Denmark, France, Turkey, Israel and other countries. At present, treatment of an issue on accepting the League of Trade Unions of Georgia as a member of Free Trade Unions International Confederation is in progress.

Freedom of Association and the Right to Collective Bargaining. The law prohibits discrimination by employers against union members, and employers may be prosecuted for antiunion discrimination and forced to reinstate employees and pay back wages; however, there are reports of managements warning staff not to organize trade unions. Some workers, including teachers in the Imereti region, employees of various mining, winemaking, pipeline, and port facilities, and the Tbilisi municipal government reportedly complain of being intimidated or threatened by employers for union organizing activity. Observers also claimed that employers failed to transfer compulsory union dues, deducted from wages, to union bank accounts. The Ministry of Labor has investigated some complaints, but no action has been taken against any employers to date. There are no legal prohibitions against affiliation and participation in international organizations. The Constitution and the law allow workers to organize and bargain collectively, and some workers exercise this right; however, the practice of collective bargaining is not widespread.

Forced Labour. The Constitution prohibits forced or bonded labour, including by children, and provides for sanctions against violators.

Trafficking in Persons. The law does not prohibit trafficking in persons specifically, although trafficking could be prosecuted under laws prohibiting slavery, forced labor, illegal detention, and fraud. Georgia is both a source and a transit country for trafficked persons. There have been unconfirmed reports that government customs and border officials were involved in the trafficking of persons. The Government has prosecuted some traffickers using fraud statutes, but otherwise has no active programs to address the problem of trafficking. A government program for combating violence against women included a proposal for measures to eliminate trafficking in women for the purpose of sexual exploitation; however, it has not been implemented due to budgetary constraints. Georgia itself is generally not a destination place for trafficked persons.

Effective Abolition of Child Labor. According to the law, the minimum age for employment of children is 16 years; however, in exceptional cases, the minimum age can be 14 years. The Ministry of Health, Social Service, and Labor enforces these laws and generally they are respected. The Government has not ratified the ILO Convention 182 on the worst forms of child labor.

Elimination of Discrimination in Employment. The Constitution provides for the equality of men and women. Women's access to the labor market has improved but remained primarily confined, particularly for older women, to low-paying and low-skilled positions, often without regard to high professional and academic qualifications. Salaries for women continued to lag behind those of men. Reportedly men were given preference in promotions. Of the 114,512 registered unemployed persons throughout the country, 46 percent were women. Women sometimes, but not often, filled leadership positions. According to UNDP, employers frequently withheld benefits connected to pregnancy and childbirth.

1.5.4 Regulations about Real Estate in Georgia

Acquisition of real estate in Georgia. The transfer of ownership rights on a real estate are regulated by the Civil Code of Georgia (set in force on November 25, 1997), by the Laws of Georgia on "Ownership of Agricultural Lands" (adopted on March 22, 1996), "Managing and Disposal of State-owned non-agricultural Land" (adopted on October 28, 1998), "Managing and disposal of non-agricultural land being in usage of physical persons and public legal entities"(adopted on October 28, 1998). Real estate includes land-lots with fossils (minerals), plants and real estate premises as well.

For the purchase of a real estate legally (notary) approved document and purchaser's registration in general list is required. The application for registration could be submitted by the seller or purchaser as well.

The right of ownership on agricultural and as well as non-agricultural lands is granted only to citizens of Georgia and to private legal entities registered according to Georgian legislation.

The fee for getting legal (notary) approval on real estate transactions is different in each case and depends on the value of real estate. The fee decreases with the increase of property value and fluctuates within 3-0,05%. The fee should not exceed GEL 10 000.

Transfer of real estate, except new dwelling constructions (new constructions are defined to be dwelling constructions built up within 2 years period) are free from VAT. Tax for transfer of immovable thing makes up 2% of property value.

For the registration of right on ownership on land-lot and related real estate and issue of relevant registration notice, the state registration fee makes up GEL 26.

1.7 The Business Environment in Georgia

Investors face a difficult environment in Georgia starting with the fundamental issue of geopolitical instability. In addition, several surveys of existing and potential domestic and foreign investors show that the business environment is generally perceived as bureaucratic, non-transparent and corrupt. Georgia is perceived as having significant obstacles to investment in the areas of taxes and regulations, policy instability/uncertainty and corruption. While the average official and unofficial fees for business procedures and the resources required (staff and time spent) may not be the highest in comparison to other countries, the unpredictability of costs and delays related to administrative procedures combined with uneven implementation and enforcement of regulations increases business risk and results in differential treatment among firms.

As shown in the above Figure, when scores on general constraints to business operations for enterprises in Georgia are compared to regional averages, the constraints are shown to be worse in Georgia for every category except the performance of the judiciary and anti-competitive practices. This substantiates the earlier observation that the business environment is perceived as being much more constrained in Georgia compared to competitors in the region. Further, it emphasizes the need for the Government of Georgia to address these critical constraints in order to help improve the country's attractiveness for domestic and international investors.

Time and again it has been observed that decrees and programs of reform have been adopted but weakly implemented in the absence of the strong political will necessary to effect change. For example, the State Customs Department (SCD) reform committee was established by Presidential Order to finalize a reform strategy and implement an action plan. To date, little has been done on implementation. The committee rarely meets. Reform has been impeded by competing agendas and frequent changes in SCD leadership due to absence of strong political will to reform the customs department.

Corrupt practices significantly affect the process of doing business in Georgia by increasing the cost and the risk associated with a range of administrative procedures. From the perspective of foreign investors in particular, facilitation payments or bribes do not simply increase business costs. They constitute significant risk because in Georgia they are unpredictable and uneven. Also, in all OECD countries bribery constitutes a serious legal offence that can be prosecuted in the home country. Finally, corrupt taxation administration (income tax evasion) and customs procedures (smuggling) result in unfair competition for legitimate, law-abiding enterprises.

In addition, the following fundamental issues have the impact on administrative procedures in Georgia, particularly in the areas of customs and tax administration, licensing, and inspections:

· Inconsistent implementation of legislation and lack of transparent implementing regulations and procedures. Since 1991, a number of laws have been revised and new laws have been written and promulgated. Although these laws are generally modern and well written, poor implementation and enforcement effectively undermine the intent of the laws. Throughout this report, it is clear that the legal framework and official requirements for most administrative procedures are relatively sound. However, problems and inconsistencies arise in implementation as officials often seek to maintain and exercise discretionary authority and control of administrative procedures.