Research & Analytics

$3.5 bn from State Budget: What Ukraine Faces in the Dispute with New Motor Sich Investor

Asters fly

Recently, the Chinese company Beijing Skyrizon Aviation informed Ukraine about the possible investment arbitrage tribunal due to the Ukrainian government agencies’ actions, which make it impossible for the execution of control over JSC “Motor Sich.” The company claims that Ukraine is violating its international commitments under the bilateral Ukrainian-Chinese agreement.

The potential amount of damages the claimants demand to collect from Ukraine reaches an astronomical $ 3.5 billion.

In this article, we will analyse the extent to which Ukraine’s actions are in line with its international obligations. How real is the chance that our state will lose the case?

But will the international arbitration tribunal help a Chinese investor gain control over the company?

A long road to ownership

“European Truth” has already reported that the fate of the Ukrainian Motor Sich appeared at the centre of international negotiations after the company’s shares had become the property of Chinese owners. However, it is worth explaining more precisely what happened and why the Chinese believe that Ukraine is violating their rights.

JSC “Motor Sich” is a company of strategic importance for Ukraine and one of the world leaders in the production of aircraft engines for civil and military aviation. Since the early 1990s, the company’s shares have belonged to Vyacheslav Bohuslaev, directly and via controlled companies.

In 2015, Motor Sich and the Chinese company Beijing Skyrizon Aviation signed a memorandum to establish the production of aircraft engines in the Chinese city of Chongqing, at the construction and installation of which employees of Motor Sich were to participate. In 2016, Bohuslaev sold his shares to several offshore companies, according to media affiliated with the Chinese company.

Given the potential risks to Ukraine’s national security, including a possible technology leak to China, the Security Service of Ukraine said that the agreements between Bohuslaev and the Chinese investor have the signs of a “sabotage” preparation. And in 2017, SSU managed to achieve the seizure of Motor Sich shares within the criminal proceedings.

As a result, the Chinese investor lost the opportunity to assign his management to the company.

That is Skyrizon controlled the company on paper only since the seizure of shares made real control impossible.

In 2018, Ukraine’s authorities and the Chinese company seemed to have found a common language and agreed to jointly own the aviation production flagman shares.

According to media reports, Ukraine (represented by the state concern “Ukroboronprom”) and the group of companies Skyrizon and Xinwei (parent company of Skyrizon) signed a cooperation agreement under which the Chinese investor was to transfer 25% of the company’s shares to Ukroboronprom, giving the right to veto core decisions. Besides, Skyrizon had to provide the Ukrainian budget with $ 100 million for the aviation industry’s financial support.

A compromise seemed to be found. The parties even applied to the Anti-Monopoly Committee of Ukraine (AMCU) for a concentration permit, but later the Ukrainian side refused to continue cooperation. The official reason was the threat to national security. But based on political statements, there was another factor, namely opposition by the United States that persuaded Kyiv not to hand over Motor Sich to its geopolitical rival, China.

Washington did not hide the fact that this was the reason for the arrival of John Bolton, the US President’s ex-consultant on national security, in Kyiv in August 2019 and the call of Secretary of State Pompeo in August 2020.

However, in 2020, the Chinese company used another mechanism.

Maintaining the blockade

Skyrizon has found a Ukrainian partner, the DCH group of companies, owned by Ukrainian businessman Oleksandr Yaroslavsky.

According to the parties’ agreement, Mr. Yaroslavsky companies is to own 25% of the shares (as well as Ukroboronprom), and the Chinese investor will own more than 50% through the controlled companies. (The exact control share is unknown because it was unclear whether all the companies -current owners of Motor Sich shares – form a part of the Skyrizon group).

At the same time, the Chinese investor withdrew the joint application submitted to AMCU with Ukroboronprom and submitted a new one together with DCH.

In late August, the DCH reported that the AMCU had refused to consider their and Skyrizon’s application for technical and procedural reasons. (from the editors: by “strange coincidence,” it happened immediately after the conversation between Pompeo and Zelensky).

So, the new owners of Motor Sich shares do not dare to establish control without the prior permission of the AMCU. That can lead to significant fines up to 5% of the annual sales income of Skyrizon and DCH products (by the way, the Chinese group bought shares in Boguslaev without obtaining the permission of the AMCU, which now investigates the fact of potential violations of Ukrainian law for these reasons).

Besides, Motor Sich’s shares are still under arrest, despite lawyers’ constant attempts to get it overturned. Moreover, Oleksandr Yaroslavskyi has recently declared that after the announcement about the cooperation between DCH and a Chinese investor, the prosecutor’s office imposed another arrest on the shares and qualified an additional crime:  “treason.”

At the same time, neither the AMCU nor other state bodies have yet made a final decision to ban control over Motor Sich.

Thus, the question of buying an aircraft builder by Chinese companies remains open.

Is it possible to block the purchase?

It is a common practice in the world to check the impact on national interests and country security in the case of strategic enterprises purchase by foreign investors.

Such verification is usually executed according to special legislation. And under certain conditions (e.g. significant risks to national security) foreign investor’s entry into strategic enterprises can be blocked. Such laws are logical and justified, as a significant concentration of foreign capital in strategic areas can cause essential security risks.

However, there is no such legislation in Ukraine. And even its implementation, as a general rule, should not affect the sale that has already taken place. Thus, currently, Ukraine has in its “store”  shares seizures due to criminal proceedings and non-issuance of an AMCU permit to stop the Motor Sich sale.

At first glance, both paths are not reliable. Proving the elements of sabotage and treason is very difficult. And the AMCU must be impartial when considering applications for concentration and act only to protect economic competition.

And if these methods fail to block the transaction, the only option will be the Motor Sich nationalisation or actual expropriation. If so, the owners have reason to demand compensation.

However, as we can see, Chinese investors already see grounds for monetary claims against Kyiv. After all, Ukraine’s blocking of investors’ control over Motor Sich, despite the lack of special legislation, allows Chinese investors to declare international obligations violation by Ukraine.

Has Ukraine violated international agreements?

Unlike domestic business, international investors in Ukraine have numerous additional guarantees of protection arising from more than 65 bilateral and multilateral international investment agreements, under which Ukraine is obliged to provide complementary protection for foreign investments.

One of them is the 1992 Ukrainian-Chinese agreement on the promotion and mutual protection of investments. Under this agreement, the parties agreed to provide each other with certain rights and protection guarantees. In the case of the relevant obligations’ breach, foreign investors may bring an action in an international investment arbitration court to obtain compensation from a host country.

But this will come later.

What guarantees does the agreement provide to Chinese investors?

First, the agreement prohibits the expropriation of foreign investment (“nationalisation,” “requisition” and other measures having similar effects). The only exception from the rule is the of the following conditions’ fulfilment: (1) the expropriation is in the public interest; (2) the order established by the legislation is observed; (3) on a non-discriminatory basis; (4) and are accompanied by appropriate compensation repayment.

That is, the Motor Sich nationalsation for national security purposes is possible in principle, but with the compensation repayment.

Moreover, the same conditions should be applied in the case of so-called “indirect expropriation,” for example, if the state permanently prevents Skyrizon from having Motor Sich operating and the consequence of such actions for the investor is equivalent to a loss of investment or its part.

According to media, Skyrizon refers to Ukraine’s violation of this rule in its announcement about arbitration. Such a position could potentially be well-founded, as the Chinese-bought Motor Sich shares have been under arrest for a long time – more than three years – and the consequences could be tantamount to expropriation.

However, this is not the only argument in the Chinese investor “store”.

Chinese companies may also allege Ukraine’s violation of the standard of fair and equal investment treatment. This was not enshrined in the agreement. But its provisions provide that the investment regime cannot be less favourable than for third-country investors and potentially help to incorporate this standard from the international agreements concluded by Ukraine with other countries.

Moreover, Ukraine has signed many such agreements that guarantee “fair and equal” treatment.

What is the value of this “standard of protection”?

This standard prohibits measures that are disproportionate to a pursued objective, discriminatory, arbitrary, and violate an investor’s reasonable expectations.

And for this, such measures should not be equivalent to expropriation.

The Chinese investor may argue that the long-term blockade of his control over Motor Sich is arbitrary and disproportionate to the goal.

The fact that Ukraine (represented by Ukroboronprom) once agreed to share the shares and control over Motor Sich also plays in favour of the Chinese investor. Therefore, Chinese investors received grounds to say that Ukraine “encouraged” them with these agreements, and then, through the actions of state bodies, violated the reasonable expectations created by it.

Is Ukraine’s defeat guaranteed?

Notably, the described ways of appealing do not guarantee that international arbitration will protect Chinese buyers and not the Ukrainian state.

In particular, the possibility of using the standard of fair and equal treatment in arbitration court remains an open issue, as the provisions of the agreement provide for only expropriation disputes transfer to an arbitration court.

Besides, if the case goes to an arbitration court, Ukraine will probably have many counterarguments.

Here are some of them.

Firstly, only Chinese investors in Ukraine who meet the criteria set out in the agreement and have investments in Ukraine within the meaning of the agreement are the object of protection under the investment agreement.

For Skyrizon, to be qualified as an investor in Motor Sich, is necessary that its subsidiaries own its shares directly, not via some related parties.

As already mentioned, some of the purchased shares are in ownership of offshore companies. Meanwhile, the structure of control over them has not been disclosed yet. Therefore, depending on Skyrizon Holding’s corporate structure, Ukraine may note that not all the Motor Sich shares are the subject of investments within the agreement meaning.

Secondly, as it follows from Article 1 of it, only the investments made according to Ukrainian legislation are the object of protection.

That is, if the investments were made with a Ukrainian law violation, there is a chance to prove they are not an object of protection. As we noted earlier, Chinese investors did not receive approval by AMCU when buying shares from Boguslaev. So, Ukraine can potentially say that the investing violated the legislation, so these investments are not protected.

Thirdly, in the potential arbitration court, Ukraine will probably also refer to the fact that its state bodies’ actions regarding Motor Sich shares are justified by national security factors. In particular, the strategic enterprise sale to Chinese companies can cause a leak of technology or destroying it as a potential competitor, and so on.

However, this argument seems the least reliable, as the investment agreement between Ukraine and China does not contain any reservations about national security. Then, this argument will have to be proved based on customary international law rules.

If at the time of the purchase of shares by a Chinese investor Ukraine has the legislation on investment screening (verification of the impact) for compliance with national security, it would exclude investments from the agreement. But such norms did not exist in Ukrainian legislation then and do not exist still.

What is an international arbitration court capable of?

Usually, the first step in starting an investment dispute is to send Ukraine a notice of intent to initiate arbitration. But the 1992 agreement with China is a specific one. It allows the investor to go into arbitration without waiting for the so-called “cooling off” period for a peaceful settlement of the dispute.

However, according to media reports, the Chinese investor still decided to try to resolve the dispute peacefully first.

Now, the Ministry of Justice is to set up a working group on the investment dispute with Skyrizon with the participation of all interested Ukrainian authorities representatives. Practice shows that such negotiations can sometimes be efficient. But if the state strongly supports the intention to block the Motor Sich purchase, an agreement is unlikely to be concluded.

In this case, the Chinese investor reserves the right to apply to the international investment arbitration tribunal. The relevant arbitral tribunal is established on a case-by-case basis and shall consist of three arbitrators. One arbitrator will be appointed by the investor, another by Ukraine, and a third, presiding, will be appointed jointly by the two arbitrators.

If the Chinese investors’ arguments, described above, work, Skyrizon will be able to receive compensation for the losses it has suffered as a result of Ukraine’s violations.

The Chinese side estimates its losses at $ 3.5 billion

However, one cannot rule out that this amount is aimed at negotiations with Ukraine and may be greater than the losses which the Chinese can prove in arbitration.

If Ukraine refuses to fulfil the relevant arbitration decision, it can be applied further in more than 160 countries, including Ukraine, e.g. via the seizure of Ukrainian assets.

Therefore, this is a serious issue to which the state should pay maximum attention.

However, it is necessary to understand that the arbitral tribunal has no power to force Ukraine to regain control of Chinese investors over Motor Sich. Therefore, if official Kyiv intends to prevent the company from moving under the Chinese group control, it can achieve this. The only issue is the price.

Markiyan Klyuchkovsky, Partner at Asters Law Firm

Mykhailo Soldatenko, Lawyer, Asters Law Firm

Source: European Truth

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