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					                              Survey of the Legal and Regulatory Environment
                          for Microfinance Institutions in the Republic of Armenia



                                                  By:
                                    Kate Lauer and Timothy R. Lyman




                                                                            December 18, 2001




August 21, 2011 8:45 AM
                                                       Table of Contents
                                                                                                                                  Page

I. Introduction .................................................................................................................... 1

II. Summary Conclusions................................................................................................... 1

III. Legal Forms ................................................................................................................. 3

A. Nonprofit Legal Forms ................................................................................................. 3
   1.     General ...................................................................................................................... 3
   2.     Ownership ................................................................................................................. 4
   3.     Permitted Purposes and Activities ............................................................................ 4
   4.     Access to Capital....................................................................................................... 4
   5.     Management and Administration; Reporting............................................................ 4
   6.     Prudential Regulation and Supervision ..................................................................... 5
   7.     Tax Treatment ........................................................................................................... 5
   8.     Legal Feasibility of Transformation ......................................................................... 6
B. Commercial Companies ............................................................................................... 6
   1.     General ...................................................................................................................... 6
   2.     Ownership ................................................................................................................. 6
   3.     Permitted Purposes and Activities ............................................................................ 8
   4.     Access to Capital....................................................................................................... 8
   5.     Management .............................................................................................................. 8
   6.     Reporting................................................................................................................... 9
   7.     Prudential Regulation and Supervision ..................................................................... 9
   8.     Tax Treatment ........................................................................................................... 9
   9.     Legal Feasibility of Transformation ....................................................................... 10
   10.    Other ....................................................................................................................... 10
C. Cooperatives ............................................................................................................... 10
   1.     General .................................................................................................................... 10
   2.     Ownership ............................................................................................................... 11
   3.     Permitted Purposes and Activities .......................................................................... 11
   4.     Access to Capital..................................................................................................... 11
   5.     Management and Administration ............................................................................ 12
   6.     Prudential Regulation and Supervision ................................................................... 12
   7.     Tax Treatment ......................................................................................................... 12
   8.     Legal Feasibility of Transformation ....................................................................... 13
D. Banks .......................................................................................................................... 13
   1. General .................................................................................................................... 13
   2. Ownership ............................................................................................................... 13
   3. Permitted Purposes and Activities .......................................................................... 14

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   4.     Access to Capital..................................................................................................... 15
   5.     Management and Administration ............................................................................ 15
   6.     Records, Audits, Reports; Disclosure ..................................................................... 16
   7.     Prudential Regulation and Supervision ................................................................... 17
   8.     Tax Treatment ......................................................................................................... 17
   9.     Other ....................................................................................................................... 18
IV. Financial Sector Laws and Regulations ..................................................................... 18

A. General ....................................................................................................................... 18

B. Law on Banks and Banking ....................................................................................... 18
   1. Scope of Application............................................................................................... 18
   2. Licensing ................................................................................................................. 18
   3. Regulation and Supervision .................................................................................... 19
C. Law on The Central Bank of Armenia ....................................................................... 19

V. Lending Activities and Collateral ............................................................................... 20

A. Lending Activities ...................................................................................................... 20
   1.     Who May Lend ....................................................................................................... 20
   2.     Sources of Funds for Lending ................................................................................. 20
   3.     Loan Agreement...................................................................................................... 21
   4.     "Credit" vs. "Loan" ................................................................................................. 21
B. Interest Rates .............................................................................................................. 21

C. Collateral .................................................................................................................... 21

VI. Taxation ..................................................................................................................... 22

A. VAT............................................................................................................................ 22

B. Profits Tax and Deductions ........................................................................................ 22

C. Property Taxes............................................................................................................ 24


Appendix A – Assessment and Recommendations ........................................................... A-1
Appendix B – Comparison Matrix of Legal Forms ............................................................B-1
Appendix C – Legal Sources Consulted .............................................................................C-1
Appendix D – Persons Consulted ...................................................................................... D-1
Appendix E – Existing Draft Legislation............................................................................ E-1
Appendix F – Comments on the Credit Forum Draft Law ................................................. F-1




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                                                                          - ii -
                                                       List of Abbreviated Terms



CBA – Central Bank of Armenia

ACC –Civil Code of Armenia

JSC – Joint stock company

LoCB – Law on the Central Bank of Armenia

LLC – Limited liability company

LoB – Law on Banks and Banking

Law on JSCs – Law on Joint Stock Companies

LLC Law – Law on Limited Liability Companies

MFC – Microfinance Centre for Central and Eastern Europe and the Newly Independent
States

MFI – Microfinance institution

MoF – Ministry of Finance and Economy

MoJ – Ministry of Justice

NA – National Assembly

NGO – Nongovernmental organization

VAT – Value Added Tax




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I. Introduction

         This Survey outlines the legal and regulatory environment for microfinance
institutions (MFIs) in the Republic of Armenia. The Survey, together with the
Assessment and Recommendations (attached as Appendix A) and the Comparison Matrix
of Legal Forms (attached as Appendix B), was commissioned by Save the Children/US
(with financial support from USAID) and the Microfinance Centre for Central and
Eastern Europe and the Newly Independent States (MFC).1 These documents are based
on (i) a review of English translations of relevant Armenian legislation (listed in
Appendix C),2 (ii) interviews with officials of the Armenian Ministry of Justice (MoJ),
the Armenian Ministry of Finance (MoF), Armenian Ministry of State Income (MoSI),
the Central Bank of Armenia (CBA), the Law Department of the Government of
Armenia, staff and members of the Armenian Parliament, foreign advisors, donors and
microfinance practitioners (names are listed in Appendix D)3 and (iii) extensive legal
advice and assistance from a member of the Armenian bar, Mr. David Sargsian.

II. Summary Conclusions

         Currently, microfinance in Armenia consists primarily of lending activities,
although there are a few banking institutions that offer depository and other financial
services to microentrepreneurs and other microfinance customers. Microfinance
activities in Armenia are conducted in the following ways:

      (i) project-based lending – either directly or through partner banks – conducted by
            representative offices of both foreign NGOs (using funds lent or granted by
            donors and by their respective "parent" organizations) and international
            organizations (similarly using funds lent or granted by the parent organization or
            by donors),
      (ii) lending by local Armenian foundations4 using funds borrowed or granted by their
            parent organizations and by donors,
      (iii) direct lending by an LLC5 using funds granted and lent by its parent organization
            and by donors, and


1
  The MFC has embarked on a multi-year, multi-country Microfinance Legal and Regulatory Policy
Program, under the auspices of which diagnostic assessments (referred to as "Phase I Diagnostic
Assessments") are to be conducted in countries throughout the region. This Survey constitutes the Phase I
Diagnostic Assessment for the Republic of Armenia. It is planned that recommendations for legal and
regulatory reform contained in the Phase I Diagnostic Assessment will be implemented in a Phase II
initiative, depending upon the availability of funding and demand from the microfinance sector.
2
  With the permission of Save the Children, the authors have relied on the accuracy and completeness of the
documents supplied to them and the information imparted in interviews with the persons consulted. Please
note that all references to Articles refer to the numbering of the English translation, which may differ from
the numbering in the Armenian original. This is due to the fact that the English translation renumbers the
articles when there are deletions; the Armenian does not.
3
  The authors express their gratitude to the persons consulted.
4
  The Armenian legal organizational form of "foundation" is also referred to as a "fund." To avoid possible
confusion arising from the different meanings of the use of the term "fund," the authors have used the term
"foundation" throughout the Survey.
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      (iv) lending and deposit-taking by banks (including the one existing cooperative
           bank, Agricultural Cooperative Bank of Armenia) using funds made available by
           donor organizations.6

        The operational microfinance programs and institutions are functioning within the
existing legal and regulatory framework, although most fall under bilateral agreements
and therefore are shielded from excessive or intrusive government interference.7
However, it is likely that the current framework will shift in the near future given the
many parties – governmental and non-governmental, including lenders and donors – that
are interested in either (i) clarifying the "situation" for microfinance or for agricultural
lending or (ii) addressing the looming issue of the existing banks that are expected not to
be able to meet the new minimum capital requirements that are to be complied with as of
January 1, 2005.

         In fact, the impetus for this Survey stems in large part from the recent legislative
drafting activity of various parties (governmental, parliamentary and others). There exist
at least five draft laws (described in brief in Appendix E) which will affect or could
potentially affect the microfinance sector in Armenia. Many involved with the
microfinance sector are concerned that more than one of the draft laws could either make
it difficult for certain existing MFIs to continue operating under their current legal
structure or cause non-deposit-taking MFIs to become subject to an inappropriate
regulatory and supervisory system. At least two of the drafts would require certain non-
depository institutions to be regulated by a governmental body, thus leaving non-
depository MFIs exposed to criticism (by some in the Armenian financial sector) that
they are being treated too "lightly" compared to other lending organizations.8

       While the authors have only reviewed and commented on one draft law (the draft
prepared by a consortium of microfinance practitioners and advisors known as the Credit
Forum),9 two of the other drafts – the MoF draft and the Berberian draft – have been
described in detail by their authors as well as by Mr. Sargsian. Not surprisingly, the
5
  There is one such organization currently operating through this legal form. It is wholly-owned by a
foreign NGO.
6
  Donor lending through banks is currently conducted by the Eurasia Foundation, the German-Armenian
Fund (which provides technical assistance through Internationale Projekt Consult GmbH) and the World
Bank (although its funds have been fully disbursed and are now used on a revolving basis).
7
  In fact, the authors were advised by Terry Murdoch, Chief of Party of the USAID Tax, Fiscal & Customs
Project, that although the bilateral agreement with the U.S. government was signed on December 15, 1992,
it has not yet been ratified by the Armenian government. Instead, in July 2000, the MoJ introduced a law to
effectuate the terms of the treaty. According to Mr. Murdoch, the law sets forth some, but not all, of the
provisions contained in the treaty.
8
  Mr. Stepan Gishyan, General Manager of the Agriculture Cooperative Bank of Armenia, which engages
in microlending through the German-Armenian Fund program (among others) expressed to the authors
strong disapproval of the unequal treatment of banks and MFIs. In the opinion of Mr. Gishyan, MFIs,
which are not subject to regulation, have an "unfair advantage" over banks, which are regulated and subject
to the strict scrutiny of the CBA.
9
  The authors’ commentary on the Credit Forum draft is set forth in Appendix F. NB: The Scope of Work
for this Survey called for review and comments only on the Credit Forum law. Funding is currently being
sought to cover the review of at least three of the other draft laws, as part of the planned Phase II activities
described in note 1, above.
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subject matter of these various proposals overlaps substantially. If the microfinance
sector is to preserve the benign legal and regulatory situation in which it currently
operates – and at the same time prepare for its anticipated longer-term need of accessing
to new sources of capital – it will be important for the sector to become actively engaged
in harmonizing the various proposals and making sure they integrate clearly and
unambiguously with the surrounding legal and regulatory environment described in this
Survey. A detailed assessment and recommendations aimed at these objectives are
attached as Appendix A.

III. Legal Forms

 A. Nonprofit Legal Forms

        1. General

        A foundation is the only legal form available under current Armenian law that is
appropriate for organizing as an NGO MFI.10 In addition, a foreign NGO may engage in
microfinance activities in Armenia through a branch or representative office (i.e., not a
separate legal entity) 11 recorded at the central office of the State Registrar.12 Foundations,
as well as branches and representative offices, are governed by provisions of the
Armenian Civil Code (ACC or Civil Code), which provides that branches and
representative offices of foreign organizations are to be treated on the same terms as
Armenian organizations (with respect to civil matters), unless different treatment is
specifically provided for.

        A foundation is a legal entity formed for the purpose of pursuing "social,
charitable, cultural, educational and other socially-useful purposes." A foundation is
formed by a founder or founders on the basis of voluntary contributions of property. The
founders, who may be either foreign or domestic individuals or legal entities, adopt the
foundation's charter, which must then be registered with the State Registrar. Following
the receipt of the certificate on state registration, the foundation must present a copy of its
charter and its certificate of registration to the tax and social pension authorities for the
receipt of the relevant operational codes.13


10
   The other available NGO legal forms – unions, societal amalgamations and public organizations – are
not suitable. A union is formed to coordinate the activity of its members and to represent and protect the
members' common interests. A societal amalgamation is a voluntary association of persons united on the
basis of common interests for the purpose of satisfying spiritual or other non-material needs. Similar to
societal amalgamations, a public organization is a voluntary association of persons and other public
organizations united on the basis of common interests for the purpose of satisfying spiritual or other non-
material needs.
11
   Under Armenian law, both a branch and a representative office are separate subdivisions of a legal entity
located outside the place where the legal entity is located. A representative office represents the interests of
the legal entity; a branch conducts all (or a part) of the functions of the head office, including the function
of representation.
12
   The State Registrar is housed in the Ministry of Justice; the Head of the State Registrar is the Deputy
Minister of Justice.
13
   This requirement applies equally to a foreign organization's branch or representative office.
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        Upon liquidation of a foundation, its property is to be put to the purposes
indicated in its charter and, if this is not possible, paid over to the State Treasury.

        2. Ownership

        A foundation does not have "owners" in the sense of parties with an economic
interest in the outcome of the activities of the organization or rights to receive
distributions of net revenue.

        3. Permitted Purposes and Activities

        A foundation must specify its purpose in its charter. As stated above, a
foundation's charter must identify a "socially useful" purpose. Although there are no
specific barriers to forming a foundation for the explicit purpose of engaging in
microlending and related activities such as business development services,14 the Civil
Code stipulates that "non-commercial organizations may conduct entrepreneurial activity
only to the extent that this serves the attainment of the purposes for which they are
founded and corresponds to these purposes."15 The Civil Code also provides that, in
conducting entrepreneurial activity, a non-commercial organization may form
commercial companies or invest in them.

        The Law on Licensing states that, with respect to any activity which requires a
license (e.g., foreign currency trading), a non-commercial organization may only engage
in such activity if its charter explicitly permits it.

       Beyond these seemingly non-problematic restrictions, the Civil Code leaves
foundations wide latitude to choose the purposes and activities they wish to pursue and
contains no barriers to a foundation engaging in microlending activities.16

        4. Access to Capital

       Foundations may receive contributions from their founders. In addition,
foundations are entitled to receive charitable gifts. The Civil Code also permits
foundations to borrow funds.17

        5. Management and Administration; Reporting


14
   However, with respect "banking transactions," a banking license from the CBA is required. See Section
IV B, below.
15
   ACC, Art. 51.4. As far as the authors are aware, neither the tax authorities nor the MoJ has thus far taken
the position that any of the microfinance activities currently being carried out by Armenian foundations
constitutes entrepreneurial activities.
16
   The Civil Code does not impose any restrictions on the types of individuals or legal entities that may be
parties to a loan contract. See Section V.A below.
17
   Although the Civil Code imposes no restrictions on a foundation borrowing funds and then onlending
the borrowed funds, there is some disagreement among public officials about whether this kind of financial
intermediation should be permitted without a banking license. See Section V.A.2 for further discussion.
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        The Civil Code does not provide any specifics regarding the management of a
foundation. A foundation is required to publish reports annually on the use of its
property. Foundations must also keep the information filed with the State Registrar up-
to-date.18

        6. Prudential Regulation and Supervision

        As discussed in Section IV below, the relevant financial sector laws in Armenia
currently subject only banks (i.e., depository financial institutions) to prudential
regulation. Microlending by an NGO – whether a foundation or branch or representative
office of a foreign non-profit organization – is not currently subject to any form of
prudential regulation or supervision,19 although various suggestions for self-regulation
and regulation by a governmental body (CBA or MoF) are being discussed.

        7. Tax Treatment

       The Law on Profits Tax provides that foundations, as non-commercial
organizations, need not file profit tax forms, provided that none of their revenues are
considered to be taxable income under Article 8 of that Law. The Armenian text appears
to make it possible to interpret the relevant provision as exempting all revenues of a non-
commercial organization (such as a foundation) that are used to carry out its charter
purposes, including revenue derived from the provision of services.20 This is also
apparently the interpretation currently given to this provision by the Legal Department of
the Ministry of State Revenue.

       Foundations pay property taxes 21 and land taxes.22 Tax treatment accorded
microlending activity generally is discussed in Section VI below.




18
   This requirement applies equally to foreign non-commercial organizations' branches and representative
offices.
19
   As noted above, there is some disagreement among public officials about whether an institution that
borrows funds for the purpose of onlending should be subjected to the regulation and supervision
applicable to banks. See Section V.A.2 for further discussion.
20
   Under the English translation supplied to authors, income of non-commercial organizations excludes all
revenues (including membership fees) received gratuitously, but appears not to exclude income earned on
the provision of services.
21
   Property tax is paid on real estate, automobiles and boats.
22
   Land tax is payable by land owners and users of state-owned land. Tax for leased lands is collected from
the lessor. As only Armenian citizens and Armenian organizations (i.e., those formed and registered under
Armenian law) may own land in Armenia, branches and representative offices of foreign organizations
would only pay land taxes if they were "users of state-owned land." According to D. Sargsian, there is no
Armenian citizen ownership requirement with respect to Armenian organizations that own land.
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        8. Legal Feasibility of Transformation

        The Civil Code permits a legal entity to reorganize or transform into another form
or legal entity, given the proper authorization (i.e., decision of its founders or by a body
authorized by the charter of the organization). However, the specific mechanism for the
reorganization or transformation of a foundation is not set forth either in the Civil Code
or elsewhere.

        Despite the absence of any explicit mechanism for transformation of a foundation
into another legal form, it appears that it would be legally feasible for a NGO MFI
formed as a foundation to exchange its loan assets for an interest in a commercial
company (whether a new or existing company) such as a JSC or LLC. The foundation
would have to make a convincing case that this exchange would not violate the legal
requirement that it use its assets solely to fulfill its charter purposes.23 Clearly, the case
would be more difficult if the foundation transferred all of its assets and then held only an
equity interest in a for-profit company. In any event, the tax ramifications of such an
approach to transformation are not clearly defined in the tax code.

 B. Commercial Companies

        1. General

         As general partnerships, limited partnerships and companies with supplementary
liability24 do not provide convenient vehicles for microfinance, the authors have limited
the discussion of commercial companies in this Survey to JSCs and LLCs.25 A company,
whether a JSC or an LLC, may conduct business only after receiving a state registration
certificate. Registration is conducted by a local division of the State Registrar. The local
division sends a completed registration card to the central state registration body, which
assigns a state registration code and a registration number and issues a certificate.
Following the receipt of its registration certificate, the company must present a copy of
its charter and its registration certificate to the tax and social pension authorities for the
receipt of the relevant operational codes.26

        2. Ownership


23
   The authors are not aware of any Armenian foundation fulfilling its charter purposes in this fashion.
However, this structure is quite similar to that of one MFI presently active in Armenia, SEF, which is
formed as an LLC that is wholly owned by a foreign NGO.
24
   The participants in a company with "supplementary liability" jointly and severally bear subsidiary
liability for the company's obligations in accordance with a multiple of the value of their contributions. In
the case of bankruptcy of one of the company's participants, its liability is distributed among the remaining
participants.
25
   As with non-commercial companies (see Section III.A.1 above), foreign commercial companies may
operate in Armenia through a branch or representative office that is recorded at the relevant regional office
(or "local division") of the State Registrar. Any such branch or representative office is entitled to the same
civil treatment as an Armenian commercial company. Treatment of such branches and representatives
regarding non-civil matters (e.g., tax) may differ from the treatment accorded to Armenian companies.
26
   This requirement applies equally to a foreign company's branch or representative office.
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            (a)          Joint Stock Companies

        A JSC is an organization owned by shareholders, who may be individuals or legal
entities, foreign or Armenian. A JSC may be founded and owned by one individual or
legal entity. A JSC may be formed as an open or a closed company. If shareholders have
the right to sell their shares without the consent of the other shareholders, the company is
deemed an open JSC. A shareholder of a closed JSC has the right of first refusal with
respect to shares being sold by another shareholder in the company.

       If a JSC has more than 49 owners, it must be established in the form of an open
JSC. If the number of participants in a closed JSC exceeds 49, then the company will be
required to transform into an open JSC within one year.

        The authorized capital of an open JSC must be at least 1,000 times the minimum
monthly wage applicable at the time of registration. The authorized capital of a closed
JSC must be at least 100 times the minimum monthly wage applicable at the time of
registration. The shares of a JSC must be fully paid-in prior to registration. Both money
and non-monetary property may be used to capitalize a JSC. Each common share has one
vote. A JSC may also issue non-voting preference shares; however, the total nominal
value of preferred shares shall not exceed 25% of the company's equity.

            (b)          Limited Liability Companies27

        An LLC may be established by one or more persons (both individuals and legal
entities); however, an LLC may not be established by only one LLC. The founders of an
LLC must fully pay in the charter capital before registration.28 Both money and non-
monetary property may be used to capitalize an LLC.

        If there are more participants than permitted under the relevant law,29 the
company will be required to transform into a JSC within one year (or be liquidated if the
number of its participants is not reduced to the maximum permitted number). The risk of
loss of a participant in an LLC is limited to the equity invested in the company by the
participant.

       A participant in an LLC may transfer its interest to one or more participants in the
LLC. The transfer or sale to a non-participant is permitted unless the charter provides
otherwise. A participant has the right of first refusal with respect to interests being sold
by another participant in the company. If a participant wishes to sell its interest (or part

27
    Although the LLC Law was signed by the President on November 21, 2001, as of the date of this
Survey, no English translation exists. Thus, the authors have relied on David Sargsian's review of the LLC
law to ensure that this Survey incorporates the relevant new provisions and accurately reflects the state of
affairs.
28
   While the Civil Code requires the charter capital of an LLC to be fully paid in by registration, the LLC
Law provides that the founders may pay in 50% of the capital on registration and the balance within one
year after registration. While the Civil Code overrides the LLC Law, David Sargsian has advised that this
legal collision will be addressed by the Armenian legislature.
29
   Currently there is no maximum.
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of it) and no other participant is interested (and sale to a non-participant is forbidden by
the company charter), the company shall purchase such interest.

        3. Permitted Purposes and Activities

       As provided in the Civil Code, a legal entity may engage in any activity not
prohibited by law.30 This may include lending and borrowing, as discussed in Section
V.A below.

        4. Access to Capital

        Companies may raise capital through capital contributions,31 the issuance of debt
securities as well as through general borrowings. 32

        5. Management

            (a)          Joint Stock Companies

        A JSC with 50 or more shareholders is managed by (i) its board of directors,33
which is responsible for general management (other than those matters in the exclusive
purview of the shareholders) and (ii) an executive body comprised of either a chief
executive officer (a general director) or a chief executive officer together with an
executive (or management) board. The executive body – which consists of the director
(or general director), his/her deputies, the chief accountant and other company officials –
is responsible for the day-to-day operations of the company. Representatives of the
executive body may not comprise a majority in the board.

        The term of the members of the board of directors is not limited. Shareholders
decide an the annual general meeting of shareholders whether to terminate the service of
any member. Among the exclusive rights of the board of director are the rights to: (i)
increase the company equity; (ii) acquire outstanding shares, bonds and other securities
of the company; (iii) form the executive body and determine the remuneration of the
general director, the executive board and the management officials (if the charter so
specifies); and (iv) make recommendations to the shareholders regarding dividends.



30
   The entity must obtain a license or licenses prior to commencing certain activities (such as banking
activities). See Section III.D of this Survey.
31
   As mentioned, capital contributions may be made in monetary or non-monetary form (securities,
commercial paper as well as other property and rights having a monetary value).
32
   Although there is no explicit legal restrictions on a JSC or an LLC borrowing funds and then onlending
such borrowed funds, there is some disagreement among public officials about whether this kind of
financial intermediation should be permitted without a banking license. See Section V.A.2 for further
discussion.
33
   A company with fewer than 50 shareholders is not required to establish a board of directors. If it does
not do so, then the rights of the board of directors (other than a few specified rights, including those listed
in clauses (i), (ii) and (iv) below, which shall become the rights of the company's executive body) are to be
exercised by the shareholders at their annual general meeting.
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         The shareholders also elect a "control" or "audit" committee consisting of at least
three members. Members of the committee, who are elected at the annual meeting of
shareholders, serve for three-year terms and may not concurrently serve in management.
The committee monitors the implementation of the decisions of management and checks
the compliance of internal company documents with its charter as well as with applicable
laws and regulations. In addition, the committee inspects the financial activities of the
company (at the committee's own initiative or at the request of the board or the owners of
at least 10% of the voting shares of the company) and reviews the annual financial
reports.

            (b)          Limited Liability Companies

        An LLC is managed by an executive body – either a group or one individual –
elected by the participants. In addition, an executive director may also be elected,
provided that the person in question is not a participant in the company.

        6. Reporting

        JSCs must submit their annual reports as well as statistical and financial reports to
the public administration body stipulated by law.34 An open JSC must annually publish
its annual report and balance sheet. Closed JSCs are not required to publish their annual
reports and balance sheets.

       An LLC is not required to publish its annual report and balance sheet. Both LLCs
and JSCs must keep the information filed with the State Registrar up-to-date. 35

        7. Prudential Regulation and Supervision

        As discussed in Section IV below, the relevant financial sector laws in Armenia
currently subject only banks (i.e., depository financial institutions) to prudential
regulation. Microlending by either an LLC or a JSC is not currently subject to any form
of prudential regulation or supervision,36 although various suggestions for self-regulation
and regulation by a governmental body (CBA or MoF) are being discussed.

        8. Tax Treatment

       In general, Armenian JSCs and LLCs pay profits tax.37 In addition to a profits tax,
Armenian companies pay property taxes38 and land taxes.39 The tax treatment accorded
microlending activity generally is discussed in Section VI below.

34
   The JSC Law does not stipulate the public administration body that will collect such reports.
35
   The same requirement applies to foreign companies' branches and representative offices.
36
   As previously observed, there is some disagreement among public officials about whether an institution
that borrows funds for the purpose of onlending should be subjected to the regulation and supervision
applicable to banks. See Section V.A.2 for further discussion.
37
   However, for small companies (other than what are referred to in the relevant tax law as "loan
companies") which, during the prior reporting year, had AMD 30 million or less in total sales and payment
for services rendered (exclusive of VAT), a simplified tax may be paid in substitution of VAT and profit
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                                                         -9-
        9. Legal Feasibility of Transformation


        A company may, given the necessary approval required by its charter, transform
into a company of another type (i.e., LLC or a commercial cooperative). In addition, an
operating JSC may file an application for a banking license (in accordance with the
procedure set forth in the Law on Banks and Banking).

        10. Other

       A company may establish representative offices and branches (which are not
separate legal entities). Such offices and branches must be indicated in the charter.40

 C. Cooperatives

        1. General

        The Civil Code defines a cooperative as "a voluntary amalgamation of citizens
and legal [entities] … formed by the combining of …share contributions by its members"
for the purpose of satisfying the material and other needs of the members. Cooperatives
may be commercial or non-commercial organizations41 and may operate as a licensed
bank.42 However, there is no law specifically providing for the creation (or the
regulation) of typical non-bank savings and credit cooperatives or any similar form of
member-owned and governed non-bank financial institution. While there are no MFIs
currently organized as non-commercial cooperatives in Armenia, the authors were
informed that some informal savings clubs have been formed under the provisions of the
Civil Code governing cooperatives. However, there was no information regarding how
the savings clubs had structured their activities to avoid the requirement of a banking
license for deposit-taking activities.




tax. Although some companies may pay a so-called "presumptive tax" instead of a profits tax, the
presumptive tax does not apply to microfinance activities.
38
   Property tax is paid on real estate, automobiles and boats.
39
   Land tax is payable by land owners and users of state-owned land. Tax for leased lands is collected from
the lessor. As only Armenian citizens and Armenian organizations (i.e., those formed and registered under
Armenian law) may own land in Armenia, branches and representative offices of foreign organizations
would only pay land taxes if they were "users of state-owned land." According to D. Sargsian, there is no
Armenian citizen ownership requirement with respect to Armenian organizations that own land.
40
   As noted above, a foreign company may operate in Armenia without establishing a new entity. They are
required only to record their representative office or branch with the State Registrar.
41
   The distinction between "commercial" and "non-commercial" cooperatives, which is elaborated in the
Civil Code, is principally relevant in determining the profits tax treatment of the entity in question. See
Section III.C.7, below.
42
   A cooperative must obtain a license or licenses prior to commencing certain activities (such as banking
activities). See Section III.D of this Survey.
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       Cooperatives become legal entities upon court registration in the Court Registrar.
Under the Civil Code, there are no reporting or audit requirements applicable to
cooperatives.

        2. Ownership

       A cooperative is owned by its members. The Civil Code permits both individuals
and legal entities, foreign and domestic, to be members of a cooperative. There are no
other qualifications required to be a member-owner of a cooperative. Unless otherwise
provided in the charter of the cooperative, each member must pay his, her or its share
contribution in full before registration of the cooperative.

         Members are required, within two months after the approval of the annual balance
sheet, to cover any losses through contribution of additional capital. If members fail to
cover such losses, the cooperative may be liquidated by judicial procedure upon the
demand of creditors. The members of a cooperative jointly and severally bear subsidiary
liability for the cooperative's obligations up to the amount of the uncontributed part of
any supplementary contribution required of each of the members.

        3. Permitted Purposes and Activities

        In the event a cooperative is formed as a non-commercial organization, it may
conduct entrepreneurial activity only to the extent that such activity serves the attainment
of the purposes for which it was founded. To conduct entrepreneurial activity, as stated
above, non-commercial organizations may create commercial subsidiaries or invest in
commercial companies.

       If formed as a commercial organization, it may engage in any activity not
prohibited by law.43 This may include lending and borrowing, as discussed in Section
V.A below.

        Regarding liquidation of a cooperative, the Civil Code's general provision
regarding liquidation states that property of a legal entity remaining after the satisfaction
of the claims of creditors shall be transferred to its founders (or participants), unless
otherwise provided by law or the charter of the legal entity in question. As no separate
law has been adopted thus far on cooperatives, it would appear that this provision should
prevail.

        4. Access to Capital

        Cooperatives have access to capital from their members in the form of both
membership shares and member deposits. However, as there is no separate law
governing savings and credit cooperatives, a cooperative would have to obtain a banking
license to attract member deposits legally. Unless otherwise provided by the

43
  The entity must obtain a license or licenses prior to commencing certain activities (such as banking
activities).
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cooperative's charter, a member of a cooperative is required to pay his, her or its
contribution in full before registration of the cooperative. In addition, non-commercial
cooperatives may receive charitable gifts and grants.

        5. Management and Administration

       The highest body of management of a cooperative is the general meeting of its
members. Each member has one vote. A member of the cooperative may be excluded
from the cooperative by decision of the general meeting (i) in case of nonfulfillment or
improper fulfillment of its obligations as specified in the charter or (ii) in other cases
provided by in the charter or by law (there currently is no law on cooperatives).

        The executive bodies of a cooperative are the administration and/or the chairman.
If a cooperative has more than 50 members, then a supervisory board may be formed.
Only members of the cooperative may be members of the supervisory board, the
administration or the chairman.

       The supervisory board supervises the activities of the executive bodies; however,
members of the supervisory board do not have the right to act in the name of the
cooperative. A member of the supervisory board may not be simultaneously either a
member of the administration or the chairman. In addition, a member of a supervisory
board or an executive body of one cooperative may not be a member of another
cooperative conducting the same activities.

        6. Prudential Regulation and Supervision

        As discussed in Section IV below, the relevant financial sector laws in Armenia
currently subject only banks (i.e., depository financial institutions) to prudential
regulation. Cooperatives licensed as banks (such as the Agricultural Cooperative Bank of
Armenia) are subject to the same regulation as banks formed as JSCs or LLCs.
Microlending by a non-bank cooperative (whether operating as a commercial or non-
commercial organization) is not currently subject to any form of prudential regulation or
supervision,44 although various suggestions for self-regulation and regulation by a
governmental body (CBA or MoF) are being discussed.

        7. Tax Treatment

       A cooperative functioning as a non-commercial organization is subject to the
same tax regime as other non-commercial organizations (including foundations).45
Grants, membership fees and donations received by a cooperative are exempt from



44
   As previously observed, there is some disagreement among public officials about whether an institution
that borrows funds for the purpose of onlending should be subjected to the regulation and supervision
applicable to banks. See Section V.A.2 for further discussion.
45
   See Section III.A.7.
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profits tax.46 If a cooperative is functioning as a commercial organization, then it is
subject to the same tax regime as other commercial companies.47

       As previously noted, the tax treatment accorded microlending activity generally is
discussed in Section VI below.

        8. Legal Feasibility of Transformation

        Under the Civil Code, both a commercial or a non-commercial cooperative may,
given the necessary approval required by its charter, transform into an organization of
another type. However, the Civil Code does not specify a transformation mechanism.
Unlike with a foundation, there is no explicit statement that a non-commercial
cooperative may not distribute its assets to its owners nor is there an explicit requirement
that the cooperative must use its property for the purposes indicated in its charter.48 Thus
there appears to be no prohibition on a cooperative either converting into a commercial
entity or contributing its assets in return for shares in a company (whether a new
company or an existing one). In any event, the tax ramifications of either approach to
transformation are not clearly defined in the tax code.

 D. Banks

        1. General

      The Armenian banking system includes "banks registered in Armenia (including
affiliated companies), subsidiary branches, representative offices, operation agencies, and
branches and representative offices of foreign banks." All banks and branches and
representative offices of foreign banks must, prior to applying for a license, register with
the State Registrar (as JSCs, LLCs or cooperative banks).

        2. Ownership

        All banks are formed as JSCs, LLCs or cooperative banks.49 (See Sections III.B
and III.C above for a more detailed discussion of the issues generally to JSCs, LLCs and
cooperatives that are not licensed banks.) With respect to cooperative banks, there must
be at least three members.

       As with JSCs, LLCs and cooperatives, any individual or legal entity may acquire
an equity interest in an Armenian bank. However, the Civil Code provides that with

46
   Regarding the informal savings clubs described above, the authors were not informed whether any of
these organizations had successfully defended a claim that their activities were non-commercial, and
therefore not subject to profits tax.
47
   See Section III.B.8.
48
   It is possible that the relevant provisions of the Civil Code would be interpreted to require that a
cooperative use its property in a manner consistent with the best interests of its members, which might
extend to a decision by the members to transform into another legal form.
49
   The LoB states that "a bank shall be considered a cooperative if a participant has the power of only one
vote, regardless of his equity share in the statutory [capital]."
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respect to legal entities established in offshore tax havens (to-be-adopted regulations will
specify which countries are "offshore tax havens" for purposes of being a shareholder in a
bank), the acquisition of an interest in an Armenian bank will require the prior consent of
the CBA.

        Any individual, legal entity or any affiliated group50 may acquire a significant
interest51 in a bank only with the prior approval of the CBA. The CBA may reject the
application if, among other reasons, the applicant has been: convicted of a crime; denied
the right to work in the financial industry by a court decision; recognized bankrupt and
has overdue liabilities. The prior approval requirement does not apply to acquisitions that
are effected through the stock exchange and result in the ownership of not more than 20%
of the voting stock of the bank.52 With respect to acquisitions made on the stock
exchange, CBA approval is required only if the total interest acquired by the individual,
legal entity or affiliated group in question would exceed 20%.

        3. Permitted Purposes and Activities

            As specified in the LoB, a bank may engage in the following activities:53

                  Taking deposits (demand, term, savings or other interest or non-interest-
                   bearing deposits);
                  Extending credits;
                  Issuing guarantees and letters of credit;
                  Opening accounts;
                  Providing payment and accounting services;
                  Issuing, buying, selling and servicing securities, payment instruments,
                   travelers checks, cards and other instruments;
                  Making investments and subscribing for shares;

50
   Legal entities are affiliated under any of several circumstances: (i) if one party is vested with the right of
acquiring, or does acquire, more than 20% of the voting shares of another or otherwise influences or may
influence the decisions of the other; (ii) if one or more shareholders owning more than 20% of the voting
shares one legal entity either own more than 20% of the voting shares of another entity or can control the
decisions of the other entity in a manner not prohibited by law; or (iii) if one-third of the administration of
one entity (including family members) is the same as for another. Individuals are affiliated if they are
members of the same family or run a joint business or joint venture activities or have otherwise acted in
agreement based on common economic interests. Individuals and legal entities are considered affiliated if
an individual or any member of his or her family: (i) owns more than 20% of the voting shares of a given
legal entity; (ii) has the ability to influence the decisions of the entity; or (iii) is a member of the
administration of the entity.
51
   A significant interest in a legal entity means: (i) owning 10% or more of the voting stock of the entity; or
(ii) owning less than 10% of the voting or non-voting stock of the company but, in the opinion of the CBA,
having the ability to determine or exercise a significant influence over the decisions of management.
52
   The CBA may reject the application if, among other reasons, the applicant has been: convicted of a
crime; denied the right to work in the financial industry by a court decision; or recognized bankrupt and has
overdue liabilities.
53
   To the extent that the activities listed below may, under the Civil Code, be performed without a banking
license (e.g., making investments), the listing of such activity as a "banking activity" under the LoB does
not prohibit non-banks from conducting such activity.
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                  Performing financial dealing, managing securities and investments of another
                   individual or legal entity;
                  Buying, selling and managing precious metals and coins;
                  Buying and selling foreign exchange;
                  Financial leasing;
                  Holding clients' precious metals, stones, jewelry, securities, or documents;
                  Providing financial advice and investment consulting services;
                  Establishing and maintaining a credit rating agency and providing debt
                   collection services.

        In addition, a bank may carry out other operations not directly envisaged by the
LoB but which either (i) are closely correlated with banking activities or (ii) do not
contradict the objectives of the law and do not endanger the interests of depositors or
creditors of the bank.

         A bank may hold equity interests in other legal entities, provided that CBA
approval shall be required prior to (i) the acquisition of an interest of 4.99% or more in
any non-bank entity; (ii) the acquisition of an equity interest in any non-bank entity in
excess of 15% of the bank's total capital; and (iii) the acquisition of an equity interest in
any bank or non-bank entity if the acquisition would result in the total equity investment
in all such entities (banks and non-banks) exceeding 35% of the bank's total capital.54
The CBA's prior consent is required with respect to any further action that would cause a
bank's interest in a legal entity to exceed 9%, 15%, 35%, 50% or 70% or to equal 100%.

        4. Access to Capital

        Banks have access to capital through (i) share and bond issuances, (ii) deposits
and (iii) loans. In addition, banks have access to short-term loans from the CBA,
provided that the loans are secured by certain permitted assets.

        5. Management and Administration

            (a)          General

        A bank is managed by (i) its board of directors, which (as with the board of
directors of a JSC) is responsible for general management (other than those matters in the
exclusive purview of the shareholders) and (ii) an executive director. Both are appointed
by the shareholders at the annual general meeting. If provided for by its charter, a bank
shall also have an executive (or management) board, which works together with the
executive director in the day-to-day management of the bank.

            (b)          Audit Committee

54
   Prior approval shall not be required if the equity interest in any other legal entity was acquired (i) against
its outstanding liabilities (provided that such interests shall be sold within six months unless an extension is
granted by the CBA) or (ii) on behalf of a customer of the bank.
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       A bank must have an audit committee that consists of not fewer than three persons
appointed by the shareholders. A person may not simultaneously be a member of the
board of directors and a member of the audit committee.

            (c)          Internal Supervision Unit

        A bank must also establish an internal supervision unit. Board members, members
of the audit committee and other bank management may not be appointed to the internal
supervision unit.

            (d)          Standards for Governors

        Governors of a bank include, among others, the chairman of the board, members
of the board, the executive director and his or her deputies, the chief accountant and his
or her deputy, the chair and members of the control (or audit) committee and heads of
departments and branches.

        No person may serve as governor who, among other things: (i) has been convicted
of a crime; (ii) has been denied the right (by a court) to work in the financial, banking or
other specified sectors; (iii) has been adjudged bankrupt and has outstanding liabilities; or
(iv) does not meet the criteria set by the CBA.

        6. Records, Audits, Reports; Disclosure

            (a)          Records

        Banks and branches of foreign banks are required to submit to the CBA annual
and quarterly financial statements prepared in accordance with international standards
prescribed by the CBA. Pursuant to the LoB, the CBA may (but does not currently)
require additional reports.

            (b)          Audit

        In addition to the supervisory committee, a bank shall be audited by an authorized
independent auditing company appointed by the bank in accordance with the procedure
set by the CBA.

            (c)          Reports

        Banks are required to publish in the newspapers a summary of the balance sheet
and auditing statement and the annual report within six months after the end of the
financial year. In addition, banks shall publish quarterly reports no later than 15 days
after the end of the last month of the quarter.

            (d)          Disclosure


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        Banks are required to disclose (in the manner specified by the CBA) on a regular
basis (no less than quarterly) information regarding their performance as well as the
terms and conditions for accepting deposits and providing loans. The CBA may also
require banks to disclose additional non-confidential information through the press and
media.

        7. Prudential Regulation and Supervision

            All banks are licensed and supervised by the CBA.

        All banks are subject to CBA regulations on the customary matters including (i)
minimum capital;55 (ii) capital adequacy requirements; (iii) liquidity requirements; (iv)
credit exposure limits that apply generally, to insiders and to the top borrowers; (v)
provisioning; and (vi) foreign reserves management. While the norms are to apply
equally to all banks (other than the exception regarding the minimum capital
requirement), the CBA is authorized to set stricter economic norms for a bank if (a) the
CAMEL rating of such bank is below the level set by the CBA, (b) the financial
indicators of the bank have deteriorated, or (c) the bank functions in highly risky sectors.

        Banks may not engage in money laundering. The CBA may require information
from a bank, its customers or shareholders relating to the legitimacy of the origin of funds
circulating in the bank.

        All banks are subject to inspection by CBA inspectors or by auditors appointed by
the CBA. These inspectors or auditors may examine the accounts, books, documents and
other records of the bank and its subsidiaries, and require administrators, employees and
agents to provide information upon the CBA's request.

        8. Tax Treatment

         As a commercial organization (whether a JSC, LLC or cooperative), a bank pays
profits tax. In addition to profits tax, banks pay property taxes 56 and land taxes.57

       The tax treatment accorded microlending activity generally is discussed in Section
VI below.


55
   The CBA raised the minimum capital requirement on May 31, 2001 from $1.5 million to $5 million.
Existing banks have until January 1, 2005 to meet the new requirement. The LoB authorizes the CBA to
set a different minimum capital requirement that would apply only to newly established banks. The CBA
may revise the minimum capital requirement for newly established banks, but not more than once a year.
56
  Property tax is paid on real estate, automobiles and boats.
57
  Land tax is payable by land owners and users of state-owned land. Tax for leased lands is collected from
the lessor. As only Armenian citizens and Armenian organizations (i.e., those formed and registered under
Armenian law) may own land in Armenia, branches and representative offices of foreign organizations
would only pay land taxes if they were "users of state-owned land." According to D. Sargsian, there is no
Armenian citizen ownership requirement with respect to Armenian organizations that own land.
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        9. Other

        A bank may reorganize through being merged with another bank58 or may
restructure itself through a change in its legal organizational status. The LoB spells out
the procedure for merging and refers to the Civil Code regarding restructuring.

            A bank may establish branches and representative offices in Armenia and abroad.

IV. Financial Sector Laws and Regulations

 A. General

        The financial sector laws and regulations relevant to the microfinance sector are
limited to the LoB, the Law on the Central Bank of Armenia (LoCB) and the regulations
adopted by the CBA.

 B. Law on Banks and Banking

        1. Scope of Application

        The main objectives of the Law on Banks and Banking are "to develop the
banking system, promote safety and regular operation of the banks and the establishment
of grounds for free economic competition between banks." (LoB, Art. 3) In connection
with this, the Law on Banks and Banking sets forth "the procedure and provisions for
registration, licensing, regulation and suspension of activities and supervision of the
banks registered in Armenia, branches of foreign banks, representative and operation
offices of the banks." (LoB, Art. 1.)

        The LoB prohibits anyone from performing "banking transactions" without a
banking license from the CBA. Although the term "banking transactions" is not defined,
it appears to mean those activities listed in Article 34.1 of the LoB (entitled "Financial
transactions") other than the activities that can be undertaken by non-banks pursuant to
the Civil Code (e.g., giving financial advice).59

        2. Licensing

        To be licensed as a bank, an applicant must register with the State Registrar/MoF,
submit to the CBA the required documents for "prior approval" (including, among other
things, a business plan for the bank), pay in the minimum capital amount, and
demonstrate the acceptability of the individuals or legal entities who would own
"significant equity interests." If the CBA determines that a license was issued based on
fraudulent information (and the CBA would not have issued a license had the information


58
   The authors were advised by various people that banks in Armenia are generally averse to the idea of a
merger for cultural reasons.
59
   The list set forth in Article 34.1 of the LoB is also set forth above in Section III.D.3.
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been true and accurate), then the CBA may revoke the license.60 In addition, the license
may be withdrawn if: (i) the provisions of the LoB or the other banking laws have been
violated; (ii) a bank does not eliminate violations according to the terms set by the CBA;
(iii) a bank does not commence operations within one year after obtaining a license; or
(iv) a bank ceases to function. If a license is revoked or withdrawn, then the bank shall
be liquidated.

        Currently, there is no provision under Armenian law for a "limited license" bank.
However, the MoF and the CBA have each drafted legislation which would permit the
existing banks to transform into "limited license" non-depository banks. The general
purpose of both pieces of draft legislation is to enable banks which are not be able to
meet the new $5 million minimum capital requirement to continue to operate. The new
requirement must be complied with as of January 1, 2005. As currently contemplated by
both the MoF and the CBA, these limited license banks would not participate in the
payment system.

        3. Regulation and Supervision

            See Section III.D.7 above.

 C. Law on the Central Bank of Armenia

        As stated in the LoCB, among the objectives of the CBA are the "stability of the
banking system, ensuring the necessary environment for solvency, … liquidity and
normal activities, as well as the creation of effective settlement and payment system, and
smooth activities." (LoCB, Art. 5.1) In order to fulfill its objectives, the CBA is
authorized to engage in the following activities (among others): licensing banks and, in
cases described in separate legislation, also licensing "other financial and crediting
organizations," as well as regulating and supervising their activities.61 (LoCB, Art. 5.2)
Thus, although currently the CBA does not regulate and supervise non-depository
financial institutions (because there is no separate legislation calling for it to do so), it
does, in fact, have explicit authority to do so. The CBA also is the "lender of last resort"
to the banks.

       Mr. Wayne Fralin, Senior Advisor for the USAID CBA Bank Supervision project,
advised the authors that the CBA would be focusing on three areas in the near future:
deposit insurance (which will be mandatory for all banks),62 the establishment of a credit


60
   Although the LoB is worded in the permissive ("may"), it is unlikely that the CBA could act otherwise
than to revoke the license.
61
   Mr. Wayne Fralin, Senior Advisor for the USAID CBA Bank Supervision project, advised the authors
that the CBA Board had just approved a new method of supervision – viz., risk-based supervision. (The
new amendments to the Law on the CBA include the provision that the CBA shall regulate mandatory
credit risk assessment by the banks.) This will, as Mr. Fralin underscored, lead to a risk-based management
approach for the banks.
62
   The most recent amendments to the LoCB include provisions for the establishment of a deposit insurance
fund to be established and maintained by the CBA. According to the LoCB, payments of insurance
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rating agency and development of a new legal form for non-bank financial institutions.63
Mr. Vache Gabrielyan, a Council member of the CBA, discussing the new minimum
capital requirements that banks must comply with by January 1, 2005, underscored the
importance of averting the liquidation of banks (some of which are solvent and financial
stable) that will not be able to meet the new requirements. While he seemed to believe
that this could be accomplished through the establishment of a new form of non-bank
financial institution, he expressed a firm belief that the CBA would and should only
regulate and supervise depository institutions.

V. Lending Activities and Collateral

 A. Lending Activities

        1. Who may Lend

       The Civil Code does not restrict who may be a party to a loan contract. Thus, any
form of legal entity may make loans and borrow funds (unless an institution's constitutive
documents contain restrictions on such activities).

        2. Sources of Funds for Lending

        There is clearly no limitation on the ability of any individual or legal entity to
make loans from his, her or its own funds and there is no explicit prohibition on
borrowing funds and onlending such funds. According to Mr. Vache Gabrielyan, a
Council Member of the CBA, there are no provisions prohibiting an individual or legal
entity that is not a bank from lending while attracting funds from other sources. However,
Mr. Zorik Kostanyan, Head of the MoF's Department of Financial Market Development
and Foreign Currency Regulation, stated that a lending organization that both borrows
and lends may only borrow from companies, and not from individuals. According to Mr.
Kostanyan, borrowing from individuals (if such funds were on-lent) would be deemed
deposit-taking, which requires a banking license.64




premiums (to be specified by the CBA) are to commence on July 1, 2003; reimbursement of insured
amounts (in accordance with the law and regulations adopted by the CBA) shall commence July 1, 2005.
63
   The recent amendments to the LoCB specify that the CBA is to establish such a credit rating agency ("an
information system on the client creditworthiness") in which all the banks operating in Armenia must
participate. Mr. Gabrielyan confirmed that an on-line system should be operational by the end of 2002.
64
   Mr. Fralin also expressed the view that a non-bank legal entity which both borrowed and lent funds
would be viewed as taking deposits. Mr. Fralin, however, did not distinguish between institutional
borrowing for onlending purposes and borrowing from individuals for onlending purposes, suggesting
instead that either might be considered deposit-taking, which would require a banking license.
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        3. Loan Agreement

        There are no explicit requirements regarding what a loan agreement must contain
other than that it be in writing. (An oral loan agreement is invalid and void.) However,
unless otherwise provided, interest shall be paid monthly.65

        4. "Credit" vs. "Loan"

        The current position of Mr. Artur Ossikyan, the Head of the Legal Department of
the Government, as well as Mr. Gabrielyan of the CBA66 is that only banks and credit
organizations are permitted to issue "credits" under the LoCB,67 whereas any individual
or legal entity may make "loans" under the Civil Code. 68 The one apparent substantive
distinction between credits and loans appears to be the provision in the Civil Code that
specifies that under a credit contract, a bank or other credit institution is lending money
(as opposed to property) to the borrower. As the Civil Code explicitly states that the
rules relating to a loan contract also apply to credit contracts (unless otherwise provided
under the Civil Code or pursuant to the terms of the credit contract), the significance of
the recent deletion of the term "bank loans" from banking activities (see footnote 68
below) is unclear.

      Other than this seemingly circular distinction, it appears that there is no difference
between the two terms.

 B. Interest Rates

        The Civil Code provides that the interest rate on a loan may not exceed two times
the accounting rate of bank interest established by the CBA. While this did not appear to
present a problem for the MFIs currently operating in Armenia (i.e., they can achieve
sustainability given the current maximum rate), it is possible that a maximum may
present a problem in the future.

 C. Collateral

       The Civil Code provides that any property rights (except property excluded from
commerce, such as claims for support payments) may be the subject of a pledge. There
are possessory and non-possessory pledges.


65
   Unless the loan agreement provides otherwise, a loan will be deemed to be without interest (i) if made
between individuals for an amount not exceeding 50 times the minimum monthly wage and not connected
with the conduct of entrepreneurial activity by at least one of the parties or (ii) in the case of loans of
property (as opposed to money).
66
   The authors were not able to meet with the Head of the Legal Department of the CBA and thus cannot
express her opinion regarding this matter.
67
   Currently, there is no definition of "credit organization."
68
   ACC, Art. 887.1. While officials at the Central Bank and the Ministry of Finance confirmed that the use
of the term "credits" does not prohibit non-banks from extending "loans," the recent amendments to the
LoB deleted the words "bank loans" from the banking activities listed in Article 34.1.
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        A pledge may take the form of (among other things) a deposit, a mortgage, a
pledge of monetary assets, goods in commerce, alienable rights or goods in a pawnshop.69
Pledged monetary assets must be kept in a deposit account in a bank or at a notarial
office.

        While there is considerable experience in Armenia regarding judicial enforcement
of pledges in the microfinance context, the process has not been simple. According to Mr.
John Sax, Managing Director of SEF International's Small Enterprise Fund in Armenia,
SEF has been extremely active in going after collateral on defaulted loans, including
several cases that have been taken as far as the Supreme Court. However, according to
Mr. Sax, judicial corruption is a significant barrier to the enforcement of collateral rights
in Armenia and SEF has become accustomed to losing cases at the 1st and 2nd levels (even
though in most cases SEF is ultimately successful on appeal).

VI. Taxation

 A. VAT

        Only those individuals and legal entities carrying out "business activity" must
register as subjects of value added taxation (VAT) (meaning that they must, in general,
charge and remit VAT). "Business activity" is defined by the Law on VAT as "economic
activity implemented regularly for the purpose of deriving income (profit)." (Law on
VAT, Art. 2) Although MFIs do engage in economic activity, MFIs formed as
foundations have the explicit purpose of pursuing "social, charitable … and other
socially-useful purposes," (ACC, Art. 123.1) and therefore are not obliged to charge and
remit VAT.

        While commercial companies, including banks, are generally obliged to charge
and remit VAT,70 the provisions of loans and other financial services – for example, the
provision of credits, loans and guarantees, the receipt of deposits, and the sale of
collateral by a bank71 – are exempt from VAT. This means that borrowers (and other
recipients of financial services) are not charged VAT by their lenders or other financial
service providers.

 B. Profits Tax and Deductions

       Under the Law on Profits Tax, both residents and non-residents pay profits tax in
Armenia.72 Residents are taxed on profit derived both in Armenia and abroad; non-
residents are taxed only on income from Armenian sources.73

69
   The authors note that a new law on pawnshops was recently adopted, which was not reviewed for
purposes of this Survey.
70
   With respect to small MFIs, however, only companies with total revenues in excess of AMD 10 million
during the relevant quarter and the previous twelve-month period are obliged to charge and remit VAT.
71
   The sale of collateral by a non-bank is not exempt from VAT.
72
   Legal entities are deemed to be (i) residents if they are registered in Armenia and (ii) non-residents if
they are formed in foreign countries (even if they have branches and representative offices recorded at the
State Registrar in Armenia) or are international organizations.
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        Income received by non-residents from other Armenian sources (e.g., dividends)
is subject to a withholding tax paid by the payer of the Armenian source income. Thus,
to the extent that an Armenian MFI borrows funds from abroad – whether from its parent
organization or a foreign bank – the MFI will be required to pay withholding tax on
interest payments on the loan. Withholdings may be reduced or eliminated under double
taxation treaties. The tax year is the calendar year.

        As stated above in Section III.A.7, the Law on Profits Tax provides that a
foundation, as a non-commercial organization, need not file profits tax forms, provided
that none of its revenues are considered to be taxable income under Article 8 of that Law.
The Armenian text appears to make it possible to interpret the relevant provision as
exempting all revenues of a non-commercial organization (such as a foundation) that are
used to carry out the organization's charter purposes, including revenue derived from the
provision of services.74 This is also apparently the interpretation currently given to this
provision by the Legal Department of the Ministry of State Revenue.

        Today, the MFIs operating as foundations do not pay profits tax according to the
interpretation of the Ministry of State Revenue. However, the Chief of Party of the
USAID Tax, Fiscal & Customs Project, Mr. Terry Murdoch, expressed the view to the
authors that this interpretation is influenced by the existence of bilateral agreements that
provide tax exemption for projects financed with foreign assistance. Mr. Murdoch
further advised that after the bilateral agreements are no longer in force,75 it should be
expected that the tax officials will start looking into the activities of the MFIs more
closely (even those operating as foundations) and that they may attempt to assess profits
tax against such institutions. It is important to note, however, that in the authors’
discussions of profits tax exemption for MFIs operating as Armenian foundations with
officials of the Legal Department of the Ministry of State Revenues, bilateral agreements
were never mentioned as a basis for the interpretation currently exempting their revenues
from profits tax.

        In determining taxable profits for those legal entities that are subject to profits
tax, deductible expenses include interest on loans and other borrowings. Items that are
not considered a deductible expense include losses from the revaluation of foreign
currency or assets and liabilities held in foreign currency. For non-residents, permitted
expenses include the management and general administrative expenses incurred in and
outside Armenia.




73
   Thus non-residents operating through subdivisions or places of business in Armenia are taxed on profits
earned from the activities of the subdivision or location.
74
    Under the English translation supplied to authors, income of non-commercial organizations excludes all
revenues (including membership fees) received gratuitously, but appears not to exclude income earned on
the provision of services.
75
   It is noted that the bilateral agreement with the U.S. government is observed today even though it has not
been ratified by the Armenian Government. See footnote 7 above for further discussion.
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         For residents only, losses may be carried forward. Banks may carry forward such
losses for an indefinite period of time; non-bank companies and foundations (if subject to
profits tax) may carry forward their losses for five years.

        Deductions make be taken (i) for contributions made to religious, public and other
non-profit organizations (up to 0.25% of gross income); (ii) for write-offs of bad debts (in
the amount of allocations to the reserve fund); and (iii) when such accounts are fully
written-off, for the amount exceeding the reserve allocation. Banks may take additional
deductions for (among other things) payments to a reserve fund for doubtful and bad
debts; interest accrued on clients' deposits; and interest accrued on other bank liabilities.

        Non-bank companies and foundations (if subject to profits tax) can benefit from
the significant tax privileges accorded to Armenian entities in which at least AMD 500
million in foreign investment has been received cumulatively since January 1, 1998. The
foreign investment can be made in one or many installments by one or more investors.
However, if the organization is liquidated in the period during which it receives the tax
privileges, then it must pay profits taxes on its activities during such period at the full
rate.

 C. Property Taxes

        The operations of an MFI (whether a foundation, cooperative, company or bank)
will also be subject to property taxes on real estate, automobiles and boats.




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                                                       Appendix A
                                             Assessment and Recommendations
I.          Introduction

        The current legal and regulatory environment for microfinance in Armenia is,
comparatively speaking,76 quite benign as are the current attitudes and interpretations of
the relevant laws and regulations (as expressed by the public officials with whom the
authors met). However, the financial sector in Armenia is entering a period of flux
during which many of the relevant laws are being or will be amended and new draft laws
are under consideration. By being involved in the process of change, the MFIs may be
able to preserve the benign operating environment they currently enjoy.77

        The microfinance sector in Armenia currently appears to equivocate regarding
whether it should be seen as part of the broader financial sector. Consequently, those
MFIs represented by the Credit Forum have articulated a desire for a separate legal
regime that will distinguish MFIs from other sorts of financial service providers, even
though MFIs currently have few legal or regulatory complaints. Such an approach – of
separating MFIs out for "special" legal status – is likely to be short-sighted. The pending
legal reforms affecting the financial sector – specifically, the creation of one or more
forms of non-depository financial institution that will allow existing banks to reorganize
and operate in a limited fashion (with lower minimum capital than what is required for
banks) – will proceed in any event. As there exists a significant risk that the microfinance
sector, which is still relatively small and lacking in clearly sustainable MFIs, will find
that these changes in the broader financial sector legal and regulatory environment affect
them adversely, the MFIs would do best to focus on ensuring that the reforms are
favorable (or neutral, at least) to microfinance operations.

        The recommendations made below are grouped very roughly according to
proposed timetable and relative urgency of the reforms and other activities recommended.
This ordering is based upon the situation existing in December 2001, including pending
or planned legislative changes. The prioritization suggested may require reordering if the
situation changes.




76
   This observation holds especially true when the Armenian environment is compared with most other
republics of the former Soviet Union.
77
   In fact, MFIs in Armenia are in a good position to influence future developments in the legal and
regulatory environment. The establishment of the Credit Forum – and the preparation of a draft law on
microcredit organizations (see Appendix F for the authors' comments on this draft) – indicates the sector's
ability to organize in furtherance of its legal and regulatory interests. It has also assisted in putting together
an ad hoc coalition of microfinance practitioners and relevant public officials that participated in the First
NIS Policy Forum on Microfinance Law and Regulation, held in Krakow, Poland in June of this year. The
policy makers who participated in the NIS Policy Forum have continued in the ensuing months to be
extremely active, opening the door to constructive engagement between microfinance practitioners and
government officials that is lamentably rare in the region.
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II.         Necessary Short-Term Actions

           As suggested above, the first, and most important, short-term action would be for
            the microfinance sector to recognize its interest in monitoring and participating in
            the legal reforms that are progressing in the broader financial sector. The
            environment is dynamic and fast changing. While the Credit Forum is working
            on its vision of the ideal separate legal regime applicable only to MFIs, it is
            possible, if not likely, that new, broader financial sector legislation will be
            adopted that will at least create ambiguities as to the ongoing legal legitimacy of
            the existing MFIs. Such new legislation may also subject MFIs to a regulatory
            regime applicable to all non-bank financial institutions but inappropriate for
            MFIs. (Of course, this risk is greater if the MFIs are not involved in the
            legislative process.)

           One immediately relevant issue of concern is the legal treatment of solvent and
            stable commercial banks that most likely will not meet the new minimum capital
            requirements that become effective in 2005. While there will be a new law
            governing such financial institutions – whether the CBA draft law or the parallel
            proposal from the MoF – it most probably will affect existing MFIs. Even if the
            new legislation only creates a new type of non-depository institution that is
            organized as a commercial company and that agrees to be subject to regulatory
            requirements which exceed the negligible requirements currently applicable to the
            (mostly nonprofit) existing MFIs, it is likely that this type of institution will
            constitute a possible option for at least some existing MFIs that may wish to
            transform in order to access new sources of capital.

           A second front on which it will be important for the microfinance sector to remain
            engaged is the future of mutual benefit financial service organizations. At
            present, there is a movement (supported by the agricultural sector and those with
            interest in that sector) to adopt legislation to legitimize the existing "savings
            clubs" initiated by the USDA project. (As noted in the Survey, the authors were
            unable to gain information regarding how such savings clubs have operated
            without a banking license.) This movement exists notwithstanding the reports –
            according to interviews the authors had with various governmental and non-
            governmental officials – that (i) the currently existing legislative proposals
            contains many technical flaws and (ii) the MoF has expressed a lack of interest in
            this type of legal form. As with the new legislation referred to in the paragraph
            above, the microfinance sector can better protect its position if it supports the
            creation of a well-crafted legal and regulatory option for savings and credit
            cooperatives or similar mutual benefit organizations rather than risk the adoption
            of an ill-conceived and poorly defined regulatory option that could open a
            potentially significant loophole, thereby damaging the public image of all
            financial service institutions aimed at serving low-income clients.

           At the present time, it is unclear whether it would be preferable (strategically) for
            the microfinance sector to support (i) a consolidated legislative proposal on non-

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            depository financial institutions that would include a separate category for NGO
            MFIs or (ii) two separate pieces of legislation, one defining NGO MFIs (the
            predominant legal form presently used for organizing MFIs in Armenia) and the
            second dealing with other types of non-depository financial institutions but
            containing language explicitly excluding NGO MFIs from coverage under such
            legislation. Either approach would assure the sector’s most important objective:
            to make sure that at end of the reform process, a clear (and appropriately lightly
            regulated) "legal space" for NGO MFIs continues to exist.

           As with the laws of many NIS countries, Armenian law distinguishes between the
            term "credit" and "loan." As with many other NIS countries, there appears to be
            no substantive difference between a credit and a loan other than the type of
            institution which is the "creditor" or "lender." However, the existence of two
            terms which appear to be identical in substance can lead to confusion.
            Specifically, under Armenian law, only banks and other credit organizations
            licensed by the CBA are permitted to extend credits. This exclusive right of
            licensed organizations to conduct an activity which is identical to an activity that
            does not require a license renders all lenders not licensed by the CBA vulnerable
            to baseless charges of violating the law (i.e., extending credits without a proper
            license). We would, therefore, recommend legislative clarification of the
            situation (such as by a clear affirmation that a "credit" is merely a "loan" made
            by a CBA-licensed lender).

           As noted in the Survey, the profits tax treatment for NGO MFIs is potentially
            open to varying interpretations, even though the Ministry of State Revenues
            currently interprets the relevant provisions to exempt NGO MFIs from profits tax.
            According to David Sargsian, the relevant text of the Law on Profits Tax in the
            Armenian language version (as well the Russian language translation) appears to
            provide a basis for the Ministry’s favorable interpretation. (This interpretation
            excludes NGO MFI "profits" (excess revenues over expenses) from taxation if
            such excess income is used in accordance with the organization's permitted
            purposes.) The relevant provision, however, is nonetheless open to a contrary
            interpretation (as underscored by the fact that the English language version
            supplied to the authors appears to subject to profits tax all NGO MFI net revenues
            other than those received in the form of grants). This language should therefore
            be revised to clarify that an NGO's net income from the performance of its
            permitted activities (i.e., any net surplus revenues over expenses) should not be
            subject to profits tax, provided that it is used to carry out further permitted
            activities.

           Several government officials expressed interest in learning about microfinance
            "success stories" from other countries, as well as the attributes of the legal and
            regulatory environments in which microfinance has flourished. Policy awareness
            seminars and workshops should be scheduled for members of Parliament, the
            Central Bank and the Ministries of Finance and Justice. Such seminars and
            workshops can be an effective forum for explaining to policy makers not only the

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            benefits that a robust microfinance sector may offer their country, but also the
            need for a "safe legal space" for microfinance in order to ensure that a robust
            sector develops. Given that the government is already in the midst of grappling
            with the creation of legal options for new forms of non-bank financial institutions,
            it is advisable that such events be organized in the near future.

           Microfinance in Armenia has already made a strong start through two quite
            different types of institutional approach: independent MFIs (mostly formed as
            foundations) and commercial banks engaged in onlending programs targeting a
            small business clientele. Based on the authors’ interviews with persons involved
            in onlending programs, it appears that there is some hostility towards the NGO
            MFIs and their "favorable" (i.e., non-regulated) position. To avoid a situation in
            which the commercial banks engaged in microlending attempt to subject NGO
            MFIs to inappropriate types of regulation under the guise of creating a level
            playing field, it would be advisable to organize a meeting or series of meetings to
            bring the two groups together. Ideally, such meeting(s) would be organized by a
            third party who would legitimize the meetings and who could function as a
            mediator (if necessary).

III.        Desirable Mid-Term Actions

           As noted in the Survey, there are no provisions in the Civil Code (or in any other
            law) setting forth the mechanism for transforming a foundation into another type
            of legal entity. Nonetheless, in meetings with the authors, various NGO MFIs
            discussed plans to transform into some form of commercial financial institution.
            Although these appear to be longer-term plans, there may well be an appropriate
            opportunity to address this issue in developing legislation for the new forms of
            non-depository, non-bank financial institutions discussed above.

           Governance is a significant issue in any newly developing microfinance sector,
            and Armenia is no exception. It is generally inadvisable to limit unduly an MFI's
            flexibility regarding its governance structure in the laws defining possible forms
            of MFIs. However, model charter provisions for the various possible legal forms
            can be of significant assistance to organizations in designing a sound governance
            structure. Naturally, such model provisions may only be drafted once the basic
            enabling legislation is in place.

IV.         Long-Term Actions

           Various MFIs complained about corruption in the judiciary and the difficulties
            this creates for loan and collateral enforcement. As the entire financial sector
            faces these problems, it may make sense for the microfinance sector to attempt to
            integrate any efforts it devotes to this issue into a broader-based initiative. It is
            possible the USAID Rule of Law project or the World Bank may be interested in
            pursuing this issue.


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           As previously noted, several NGO MFIs mentioned to the authors that they hope
            eventually to transform into a form of commercial financial institution. While
            none of them discussed the possibility of transforming into a depository
            institution, this institutional option – which represents both an additional means of
            raising capital and an additional range of services to offer clients – warrants
            consideration in the longer term. Typically, a microfinance depository institution
            (or "microfinance bank") offers both depository and other limited banking
            services. Due to its smaller size and limited license, a microfinance bank could be
            expected to be subject to different (and in some cases, less demanding) prudential
            requirements from those applicable to banks.

           Currently, the CBA is authorized to establish a maximum rate of interest for all
            lenders. Thus far, MFIs in Armenia have been able to set interest rates that are
            high enough for them to work towards both operational and financial
            sustainability. However, as the interest rates for microlending are typically higher
            than the rates for conventional commercial lending (due to higher administrative
            costs as well as other factors), it is possible that the CBA might in the future
            establish a maximum rate that would be above the market rate for commercial
            loans but below the rate necessary for MFIs to achieve and maintain
            sustainability. It may therefore be advisable to consider amending the law to
            eliminate the maximum rate.




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                                                      Appendix B
                                            Comparison Matrix of Legal Forms


 Existing legal               Registration             Regulation                 Level of             Taxes applied and
 form of                      authority                authority                  regulation           specific exemptions
 operation
 Foundation                   State Registrar          None                       None                  Interpretation of
                                                                                                       Ministry of State
                                                                                                       Revenues generally
                                                                                                       exempts MFIs formed
                                                                                                       as foundations from
                                                                                                       profits tax


                                                                                                       Financial services are
                                                                                                       generally not
                                                                                                       considered VATable


                                                                                                       Various less
                                                                                                       significant taxes may
                                                                                                       apply, depending on
                                                                                                       individual MFI’s
                                                                                                       situation
 Branch/Represen              State Registrar          None, unless               None                 "
 tative Office of                                      deposits are taken
 foreign entity
 JSC and LLC                  State Registrar          None, unless (i)           None except in       Generally subject to
                                                       deposits are taken         exceptions           profits tax
                                                       (regulator: CBA)           referred to in
                                                       or (ii) it is a            "Regulation
                                                       reporting issuer           authority" box. If   Financial services are
                                                       under the                  exceptions apply,    generally not
                                                       Securities Market          then level of        considered VATable
                                                       Regulation Law             regulation is
                                                       (regulator:                prudential
                                                       Securities                                      Various less
                                                       Commission)                                     significant taxes may
                                                                                                       apply, depending on
                                                                                                       individual MFI’s
                                                                                                       situation
 Cooperative                  State Registrar          None, unless               None                  Profits tax treatment
 (non-                                                 deposits are taken                              of MFI formed as a
 commercial)                                                                                           non-commercial
                                                                                                       cooperative is unclear
                                                                                                       Financial services are
                                                                                                       generally not
                                                                                                       considered VATable



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                                                                            B-1
                                                                                               Various less
                                                                                               significant taxes may
                                                                                               apply, depending on
                                                                                               individual MFI’s
                                                                                               situation


 Cooperative                  State Registrar          None, unless               None         MFI formed as a
 (commercial)                                          deposits are taken                      commercial
                                                                                               cooperative is subject
                                                                                               to profits tax


                                                                                               Financial services are
                                                                                               generally not
                                                                                               considered VATable


                                                                                               Various less
                                                                                               significant taxes may
                                                                                               apply, depending on
                                                                                               individual MFI’s
                                                                                               situation


 Bank (JSC, LLC               State Registrar          CBA                        prudential   Subject to profits tax
 or cooperative)

                                                                                               Financial services are
                                                                                               generally not
                                                                                               considered VATable


                                                                                               Various less
                                                                                               significant taxes may
                                                                                               apply, depending on
                                                                                               individual MFI’s
                                                                                               situation




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                                                            Appendix C
                                                       Legislation Consulted


Civil Code of Armenia (signed by the President July 28, 1998; effective January 1, 1999)

Law on Bankruptcy (effective March 1, 1997)

Law on Bankruptcy of Banks (passed by the NA on June 10, 1996)

Law on Banks and Banking (passed by the National Assembly on June 30, 1996), with
amendments through October 23, 2001

Law on the Central Bank of Armenia (signed by the President on June 30, 1996), with
amendments through October 23, 2001

Law on Foreign Investments (signed by the President July 31, 1994)

Law on Joint Stock Companies (to be effective December 6, 2001)

Law on Land Tax (signed by the President April 27, 1994)

Law on Licensing (adopted by the NA on May 30, 2001)

Law on Profit Tax (adopted by the NA on September 30, 1997; effective January 1,
1998) with amendments through December 26, 2000

Law on Property Tax (effective January 1, 1998)

Law on Simplified Tax (effective July 1, 2000)

Law on VAT (adopted by the National Assembly on May 14, 1997; effective July 1,
1997) with amendments through December 26, 2000

Law on Tax, Customs and other Compulsory Payment Privileges related to the 12/15/92
Bilateral Agreement between Armenia and the U.S.A. (adopted July 6, 2000)

Law on Taxes (adopted by the NA on April 14, 1997) with amendments through
November 13, 1997




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                                                          Appendix D
                                                       Persons Consulted

Ashot Abrahamyan, Senior Bank Advisor, Credit Expert, German-Armenian Fund Micro
Finance Programme, Internationale Projekt Consult GmbH

David Akopyan, Assistant Resident Representative, UNDP

Artur Avezyan, Head of Legal Department, Ministry of State Revenues

Samvel Avetisyan, Member of Parliament

Armen Berberian, Head of Department on Issuers, Central Depository Agency of
Armenia

Deborah Berns, Program Management Specialist, USAID

Zachar Boyajyan, Country Director, Small Business Loan Program, Eurasia Foundation

Maria Elaina Cortez, Operations Manager, FINCA Armenia

Charles Crye, Country Director, FINCA Armenia

Craig Feinberg, Microfinance Technical Advisor, Save/Microenterprise Development
Fund (MDF) Kamurj

Wayne Fralin, Chief of Party, Senior Advisor, Bank Supervision Project, KPMG
Consulting

Vache Gabrielyan, Board Member, Central Bank of Armenia

Stepan Geshyan, General Manager, Agricultural Cooperative Bank of Armenia

Zohrabyan Gevorg - Ministry of Finance, Leading Specialist, Department of Financial
Market Development and Foreign Currency Regulation

Khachatur Kazazyan, Project Coodinator, Micro-Enterprise Development Project,
International Organization for Migration

Zorik Kostanyan - Ministry of Finance, Head, Department of Financial Market
Development and Foreign Currency Regulation

Khoren Malkayan, Legal Specialist, Ministry of State Revenues Souren Mamikonyan,
Head of Legal Department, National Assembly


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                                                                  D-1
Gahmk Markarian, Chemonics International Inc., USAID Armenia Rule of Law &
Commercial Law Project

Lilit Martirosyan, Chemonics International Inc., USAID Armenia Rule of Law &
Commercial Law Project

Lusine Meliksetian, Investment Officer, Shorebank Advisory Services

Stepan Melikyan, Collection Manager, Small Enterprise Fund (SEF) International/ World
Vision Armenia

Merujan Mikaelyan, Deputy Minister, Ministry of Finance and Economy

Terry Murdoch, Chief of Party, Barents Group, KPMG Consulting, USAID Tax, Fiscal &
Customs Project

Brian Murphy, Chief of Party, Chemonics International Inc., USAID Armenia Rule of
Law & Commercial Law Project

Artur Ossikyan, Head of Legal Department of Government

Grigoryan Nane - Ministry of Finance, Leading Specialist, Department of Financial
Market Development and Foreign Currency RegulationThomas Samuelian, lawyer

John Sax, Managing Director, Small Enterprise Fund (SEF) International/ World Vision
Armenia

Mr. Simonyan, Head of Legal Department, Ministry of State Revenues

Marie Florence Stock, Caucasus SME Finance Program, Country Director, Shorebank
Advisory Services

Bagrat Tunyan, Public Sector Management Specialist, World Bank

Gagik Vardanyan, Executive Director, Save/Microenterprise Development Fund (MDF)
Kamurj

Bagrat Yengibaryan, World Bank PIU seated within Ministry of Finance and Economy

Mariam Yessayan, UMCOR




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                                                              Appendix E
                                                       Existing Draft Legislation


The five draft laws are:

Draft credit club law. The draft "credit club" law was prepared by USDA and Parliament
last year. Although the authors were informed by various people that the draft had been
shelved, it appears to be gaining momentum once again and is currently undergoing
parliamentary review, according to reports of the Head of the Legal Department of the
NA and an active parliamentarian, Mr. Samvel Avetisyan.

Draft Law on Microfinance Organizations prepared by the Credit Forum. The Credit
Forum, comprised of most of the MFIs in Armenia (not including banks engaged in
microlending), drafted this document in response to the draft credit club law prepared by
Parliament. Comments to the draft are set forth in Appendix F.

Draft Law on Regulation of Activity of Non-Banking Financial Organizations and
Reorganization of Banks into Non-Banking Financial Organizations prepared by the
MoF. The MoF is working on a draft law that will enable existing banks unable to meet
the new $5 million minimum capital requirement (which is to be complied with by
January 1, 2005) to continue to operate as "limited license" non-depository financial
institutions. The draft does not specify the body that would authorize the activities of
these institutions.

Draft Law on Reorganization of Banks and Alteration of their Activities prepared by
the CBA. Based on what the authors were told, the CBA prepared this draft law –
consideration of which is currently suspended – in order to address the problem that
certain existing banks will face in 2005 when they will be required to meet the new $5
million minimum capital requirement.

Draft prepared by Mr. Arman Berberian. Mr. Berberian, an Armenian delegate to the
NIS Policy Forum on Microfinance Law and Regulation, held in Krakow, Poland in June
2001, who now is the head of the Central Depositary in the MoF, is the former MoF
Deputy Minister in charge of financial markets development and foreign currency
regulation. He has prepared a draft law that would cover non-banking institutions and
NGO MFIs. Different regulations and different regulators would apply to each. The
NGO MFIs would be self-regulated; regulations would be non-prudential (e.g., reporting
requirements).




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                                                       Appendix F

                 Comments on the Credit Forum Draft Law Entitled
       "The Law of the Republic of Armenia on ‘Micro-Financing Organizations’"


I.          Introduction

       Set forth below are the authors' comments on the draft law produced by the Credit
Forum. The comments include text-specific observations78 as well as some general
observations concerning topics not addressed in the draft law.

II.         Text-Specific Comments

         Title. The term "micro-financing organization" is generally used to cover both
depository and non-depository legal forms. As this draft deals only with non-depository
institutions, the name given to organizations covered by the draft should be
"microlending organization" rather than "micro-financing organization. "79

        Article 1. Subject of Regulation of Law. The draft does not in fact set forth the
procedure for establishing microlending organizations. Presumably, the subject of
establishment can be left to the Civil Code and to other laws; this draft law would address
only the process by which the organizations formed under such other laws will be
approved to carry out microlending activities.

        Article 2. Micro-Financing Activity. The wording of this Article should be
carefully tailored and not too restrictive, leaving the specific restrictions regarding what
will constitute microlending activity (e.g., definition of permitted borrowers) to be
defined by the relevant regulatory body in its normative acts.

        Article 3. Micro-Financing Organizations. Generally, we would recommend that
the draft law list the legal forms that may be used to conduct microlending activities.

        Article 3, Paragraph 1. This paragraph should be worded to harmonize with (and
explicitly refer to) the relevant provisions of the Civil Code and any other laws under
which microlending organizations are to be formed. We note that the current draft does
not permit a JSC or LLC to engage in microlending activities, even if these activities
were identical to those carried out by, for example, funds formed under the Civil Code.
This issue should be thought through extremely carefully. We note that passage of a law
on microlending organizations that does not include commercial companies could have
the effect of making the activities of at least one Credit Forum member illegal.

78
   With respect to several provisions, the recommendation is that they be deleted from the draft and
addressed either (i) in normative acts adopted by the "relevant regulatory body" (i.e., the public body that
would have jurisdiction over the approval of microlending organizations) or (ii) by the microlending
organizations themselves (as specified in the charter or other internal document).
79
   This comment applies throughout the draft.
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       Article 3, Paragraph 2. As noted above with respect to paragraph 1, this
provision should reference the provisions of the Civil Code or other laws that allow for
the formation of the relevant legal entities. As drafted, it is not clear whether the
provision intends to include cooperatives as a possible legal form of microlending
organization.

         Article 3, Paragraph 3. As noted above, we would recommend that the draft law
list the types of legal entities that may be used to form microlending organizations.

       Article 3, Paragraph 4. As noted above, the term "microlending" would be more
appropriate than "microfinancing."

        Article 3, Paragraph 6. The topic of transformation – particularly transformation
from a nonprofit legal form into a commercial legal form – requires clear and explicit
treatment. If this topic is addressed ambiguously or only very generally, then presumably
conflicts between this draft and other existing laws would be resolved by giving legal
effect to the more explicit and potentially restrictive provisions.

       Article 4. Legislation on Micro-Financing Organizations. It is not clear to the
authors what this Article adds to the draft, substantively speaking.

        Article 5. Own funds of Micro-Financing Organizations Established Based on
Membership. This Article seems to indicate an intention to permit microlending
organizations to be created as a form of "mutual benefit organization. " It is not
necessarily inappropriate that a piece of legislation cover mutual benefit organizations
together with organizations formed as nonprofits; however, each of these legal forms has
different legal attributes and these differences require careful and detailed treatment. In
particular, any provision which includes mutual benefit organizations under the concept
of "microlending organization" must be worded carefully to harmonize with the relevant
existing provisions of law regarding cooperatives.

         Article 6. Activity of Micro-Financing Organizations. Paragraph 1. The first
sentence provides "Micro-financing organizations provide loans for any targeted
entrepreneurial activity." The authors would recommend that the relevant regulatory
body be responsible for adopting normative acts which would define the permissible
activities of microlending organizations.

        Article 6, Paragraph 2. All of the issues addressed in this paragraph would be
more appropriately provided for in normative acts of the relevant regulatory body in
order to facilitate future amendments. Similarly, care should be taken not to require
microlending organizations to include in their charter an unreasonable level of detail,
given that charter amendments can be administratively difficult and the legal
consequences of an organization inadvertently violating its charter can be drastic.



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       Article 6, Paragraph 3. It is not clear why the law should distinguish between
lending to existing businesses and lending to start-ups. If the distinction is necessary, it
would seem more appropriate to address this either in normative acts of the relevant
regulatory body or in the individual organizations' internal documents covering lending
and operating procedures.

        Article 7. Regulation of Legal Relations between Micro-Financing Organizations
and Clients. The text of the first paragraph in this Article does not appear to add
anything beyond what existing law would require. Furthermore, the matters covered by
the second paragraph are not appropriate for inclusion in the draft law. Ideally, these
matters would be addressed by the individual organizations in the manner they viewed
appropriate. If there is a reason for such matters to be regulated, then they should be
addressed in the normative acts of the regulatory body in charge.

        Article 8. Regulation and Supervision of Micro-Financing Organizations. While
the intent of this Article – to leave microlending organizations and their sponsors as well
as professional organizations with the task of providing for financial operating norms for
the sector – is sound, the wording is confusing. It would be simpler and less likely to be
misinterpreted if there were a provision setting forth the limited regulatory powers of the
public body that will have jurisdiction over the approval of microlending organizations
(referred to in this commentary as the "relevant regulatory body").

        Article 9. Responsibilities of Micro-Financing Organizations. Paragraph 1. This
provision raises at least two issues. First, unless there is some standardization required,
the information published will not be very useful from a consumer protection perspective.
Second, a publication requirement may not be the most effective way of ensuring that this
information is publicly available. See our comments in Section III below concerning the
usefulness of centralized reporting by microlending organizations. We would
recommend that any requirements regarding publishing of information be left to
specification in normative acts adopted by the regulatory body in charge.

       Article 9, Paragraph 2. This commercial secrecy provision (including the
language regarding potential liability for violations) should be harmonized with the
standards applicable to other types of lenders (such as banks).

        Article 9, Paragraphs 3-5. These paragraphs cover matters in the nature of "best
practices" which should in most (if not all) cases be left to the discretion of microlending
organizations. As a general matter, best practices should not be legally mandated unless
there is a specific policy goal to be served, such as consumer protection.

        Article 9, Paragraph 6. The obligations of a lender with respect to pledged
property are set forth in the Civil Code. Microlending organizations should not be
subject to standards different from other lenders on this issue. The authors would
therefore recommend deletion of this provision.



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        Article 10. Rights of Micro-Financing Organizations. Paragraphs 1-4. As with
several of the provisions already discussed, it is not clear why the matters covered by
these provisions should be covered by a legislative enactment. Moreover, the listing of
certain normal microlending practices as "rights" in the draft law raises the question
whether other practices typically followed by microlending organizations would be
considered illegal. A list such as this could easily inhibit innovation and restrict
flexibility, both of which are important in a developing microfinance sector.

        Article 10, Paragraph 5. The rights of a lender/pledgee are spelled out in the
Civil Code. As stated above, microlending organizations should be treated the same as
other types of lenders. The authors would therefore recommend deletion of this
provision.

       Article 11. Subsidiary Responsibility of Micro-Financing Organizations
Established based on Membership. See comments above with respect to Article 5.

        Article 12. Grounds for Termination of Activity of Micro-Financing
Organizations. The termination of microlending organizations would presumably be
covered by the Civil Code provisions applicable to the types of underlying legal entities
involved (foundations, LLCs, JSCs, cooperatives, etc.). The draft law could
appropriately cover termination of a special approval to engage in microlending activity,
as discussed further in point 2 of Section III below.

        Article 13. Reports and Auditing of Micro-Financing Organizations. The issues
covered in the first paragraph of this Article might appropriately be left to the charters of
the organizations. The idea of a required external audit is sound, provided that there are
clear standards to be followed (presumably described elsewhere in Armenian law or
regulation). We question, for example, whether there is a clear standard for determining
what constitutes "non-commercial activity" under Armenian law at present.

        Article 14. Liquidation of Micro-Financing Organizations. The subject of
liquidation is dealt with in the Civil Code provisions defining the different types of legal
entities that will serve as microlending organizations (funds, joint stock companies,
cooperatives, etc.).

III.        Topics Not Adequately Addressed in the Draft

       The following topics (which are relevant to the activities of microlending
organizations) are either not covered in the draft or are ambiguous.

        1. Tax Treatment of Microlending Activity by NGO Microlending Organizations.
The draft law will not be an appropriate place to cover the tax treatment of microlending
activity unless, under Armenian law, the law is given the status lex specialis. However,
it may be feasible to maximize the possibility of favorable tax treatment of NGO
microlending organizations under existing tax laws by distinguishing among the different
types of legal entities that may engage in microlending.

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        2. Approval Process and Termination of Approval. The draft does not
contemplate a public body playing a role with respect to microlending organizations.
While it is a legitimate concern of microlending organizations that they not be subjected
to the type of prudential regulation and supervision that applies (and should apply) to
depository financial institutions, there is justification for requiring some modest non-
prudential regulation of microcredit organizations. This type of regulation is
transparency-driven, and does not require the regulatory body to intervene or monitor
microlending organizations. It does, however, offer the organizations an opportunity to
police each other. In addition, it offers the government a means of gathering data on the
sector, which may be useful in monitoring and achieving monetary policy objectives.
This transparency-related regulation can be achieved by creating an approval process that
requires the regulatory body in charge to accept documents filed with it by an
organization seeking recognition and approval as a microlending organization. The
regulatory body in charge may also be given the power to revoke approval if an
organization engages in activities prohibited by the draft law.

        3. Centralized Reporting by Microlending Organizations. In addition to the type
of centralized approval process suggested above, the draft law also might include a
requirement that microlending organizations file annual audited financial statements in a
central location that is open to the public. This furthers the transparency-related
objectives discussed above.

        4. Transformation and Treatment of Assets Upon Termination. This important
topic is difficult to cover comprehensively without examination and possible amendment
of each of the laws and Civil Code provisions describing the types of legal entities that
will engage in microlending activities, as well as the provisions governing their tax
treatment. However, as with taxation, it may be possible to clarify in the draft law the
ambiguities in the existing laws to the extent that they would be applicable to a
microlending organization seeking to transform into a different form of legal entity or
terminate its activities.




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