Thursday, 4 November 2021

Pandora Papers: How A U.S. Law Firm Attemped To Sell A Ukrainian Defence Giant To China

By Stijn Mitzer and Joost Oliemans
Over the past decades Ukraine has garnered a questionable reputation for supplying just about any interested nation with every type of armament you could possibly imagine. Whether a country was in the market for 2500km-ranged cruise missiles (Iran), S-300 SAM systems (United States), Tu-95 and Tu-160 strategic bombers (Russia), or even a complete aircraft carrier and the blueprints to build more of them (China), Ukraine had you covered. In some cases these deals were carried out at government level and according to international law, while others were concluded in nightclubs involving bribery and a lot of alcohol. [1]
In other cases Ukraine's attempts at selling off the vast quantities of armament it inherited from the Soviet Union led to the peculiar situation where Ukraine became the supplier of both sides in a conflict. In one such specific incidence, Ukrainian-delivered T-72AVs with South Sudanese crews that were trained by Ukrainian instructors were pitted against Ukrainian-delivered T-72AVs with Sudanese crews that similarly were trained by Ukrainian instructors. The battle for the contested region of Abyei in which both sides took part ultimately saw just one winner: The Ukrainian arms industry.

But in recent years Ukraine has undergone a gradual transformation from solely being an affordable source of secondhand weaponry to a producer of high-quality armament that meanwhile found its way to many militaries around the globe. Ukrainian armoured fighting vehicles (AFVs) have attained commercial success in Africa and Asia while Ukraine's Grom-2 short-range ballistic missile (SRBM) project has seen significant investments from Saudi Arabia. Another major client of Ukrainian military technology is Turkey, which uses the Ivchenko-Progress AI-450S engine for its Akıncı UCAVs and is also set to make use of Ukrainian engines for its MİUS unmanned jet fighter project and ATAK-II attack helicopters.

While recent orders like these have been a significant boost to the Ukrainian arms industry, it has seen very different times also. As already covered in several articles on this website, many Ukrainian arms projects trace their origin to an attempt borne from sheer desperation to conclude a deal rather than meeting customer demand, with upgrade projects failing again and again to find an international buyer. To give just one example, despite offering a large assortment of frigates, corvettes and missile boats to foreign clients, the Ukraine naval industry's sole export success was the sale of two Gurza-class patrol boats to Uzbekistan to guard its water border with Afghanistan, and only because the 5.6 million USD deal was paid for by the United States. [2]

The lack of sufficient orders to sustain commercial operations led some companies to take more drastic measures to ensure their financial survival. In one such instance, Motor Sich JSC – one of the largest manufacturers of aircraft and helicopter engines in the world secretly sold more than half of the company to a Chinese investor. [3] The sale to Beijing Skyrizon Aviation Industry Investment Co. (which has ties to both the Chinese government and its military) raised fears in the United States that China was attempting to acquire intellectual property and arms technology to advance key military capabilities that could one day threaten the United States. [3]

Motor Sich, located in Zaporozhye, Ukraine, designs and manufactures several types of aircraft and helicopter engines. As an engine is arguably one of the most complex parts of an aircraft, engine technologies are highly sought after by countries that seek to advance their indigenous aircraft industry, and that includes China. In 2017, Motor Sich was awarded an 800 million USD contract from the same country for the delivery of AI-322 jet engines to power the People's Liberation Army Air Force and Navy's new Hongdu JL-10 advanced jet trainers with the possibility of co-producing these and other engines in China in the future. [4]
The deal with China was a welcome break for Motor Sich, which lost the Russian aviation industry as its most important customer after the 2014 split with Ukraine. In addition to developing and producing various engines, engine-related technologies and even helicopters, Motor Sich also operates its own airline that flies around a dozen passenger and cargo aircraft to destinations in Ukraine and further abroad. While likely earning the company some profit, money earned from the airline business could in no way replace revenues lost after the severance of ties with Russia.

Motor Sich was thus on the lookout for a new major customer to sell its engines to. As Motor Sich mainly focuses on engine types used in a variety of Soviet-era designs such as the An-124 strategic airlifter, Mi-8 helicopters and some of the latter's more modern derivates, it was unlikely to find a market for its products in the U.S. or Western Europe. China on the other hand showed significant interest in the AI-222/AI-322 series of jet engines for its JL-10 jet trainer and several other engine designs, including the Mi-26's Progress AI-136T engine that could help it power its future heavy lift helicopter. [5]

In May 2017 it was disclosed by First Vice Prime Minister of Ukraine Stepan Kubiv that Motor Sich and Beijing Skyrizon would build an engine factory in Chongqing, China. Furthermore, Beijing Skyrizon would acquire a controlling stake in Motor Sich, promising to invest 250 million USD in return for a majority stake in the company. While the original reports stated that the controlling stake was directly acquired by Beijing Skyrizon, an investigation by the Organized Crime and Corruption Reporting Project (OCCRP) into the Pandora Papers reveals that there were a number of offshore firms behind the deal, and a draft agreement for the takeover by Beijing Skyrizon shows that it may actually have been facilitated by the Ukrainian offices of major U.S. law firm DLA Piper. [6]
The plan entailed a takeover in which three offshore firms British Virgin Islands-registered Skyrizon Aircraft Holdings, and Cyprus-registered Reckoner Investment and Argio Investment would acquire six offshores that together owned a controlling stake in Motor Sich. [6] The cunning plan appears to have been specifically designed to circumvent investigations by the Ukrainian government in light of Ukraine's antitrust laws. In the construction proposed by DLA Piper, no company would have more than the 25 percent needed to trigger an anti-monopoly review by Ukrainian authorities. [6]

China's JL-10 advanced jet trainer that uses two AI-222 jet engines manufactured by Motor Sich.

While the agreement may have sought to keep the Ukrainian government unaware of what was essentially a Chinese takeover of the country's most important manufacturer of engines, the U.S. government appears to have been fully aware of what was going on. Determined not to let China acquire a majority stake through which it could direct Motor Sich's designs and expertise to its own military projects, in the process potentially advancing Chinese engine designs by a decade or more, pressure by the Trump administration on the Ukrainian government is ultimately believed to have been a key motivator in the latter's decision to freeze the deal for national security reasons.
Motor Sich had already managed to get on the Ukraine government's bad side for crimes related to facilitating Russia, and Ukraine's patience with the company appears to have run out completely in March 2021, when a Kyiv court ruled to seize all property and shares of Motor Sich, and the company was transferred to a government body responsible for managing assets obtained through corruption and other crimes. [7] Two weeks later, Ukrainian President Volodymyr Zelenskiy signed a decree imposing sanctions on four Chinese companies including Skyrizon that were seeking to gain control of the aerospace firm. [7] As a result China's extensive efforts at highjacking the firm for its own purposes were completely sidelined.
Of course, China was not in the slightest amused by this turn of events, and in December 2020, the Chinese investors behind Beijing Skyrizon filed a 3.5 billion USD arbitration case against the Ukrainian government, accusing it of confiscating its investment in Motor Sich after Kyiv froze its shares in the company in 2018. [7] The arbitration case also saw a familiar face as press accounts have indicated that DLA Piper is one of three international law firms representing Beijing Skyrizon Aviation as it makes a bid to recover the assets frozen by the Ukrainian government. Thus the strange tale of the United States pressuring Ukraine to stop a U.S. law firm helping China to take over an Ukrainian engine manufacturer continues.

Although the sale of Motor Sich to China and thus access to key technologies related to modern aircraft and helicopter engines was ultimately prevented, the threat (to the U.S. at least) of other companies selling their technologies to adversaries or so called rogue nations is ever present. In another instance, China attemped to buy the unfinished An-225 strategic airlifter from Ukraine and acquire the blueprints to produce more aircraft. [8] Eventually Turkey offered itself as a more interesting candidate to cooperate on aviation projects with Ukraine's Antonov, the designer and manufacturer of the An-225. In fact, further orders of Ukrainian engines from Turkey for its Akıncı UCAV and ATAK-II attack helicopters might ultimately be the decisive factor keeping Motor Sich and other Ukrainian defence companies alive and running. [9]

Oleh Liashko, the former leader of Ukraine's Radical Party said that if the USA does not want Motor Sich to be closer with the Chinese, then they would need to buy enough aircraft engines. [10] While U.S. pressure might have been sufficient to stop Motor Sich's Chinese takeover, Turkey's much more constructive interest in the company might ultimately be what keeps Motor Sich and other companies from falling into foreign hands, preventing such events from occurring in the future.

[1] Mission impossible: How one man bought China its first aircraft carrier 
[3] ‘Predatory’ Chinese Takeover of Ukraine Defense Firm Was Facilitated by a U.S. Law Firm 
[4] Ukraine’s Motor Sich Awarded $800 Million Contract to Support Chinese Hongdu JL-10 Trainer Aircraft
[5] In China, "Motor Sich": "We managed to intercept the United States and Russia gem of engine"  
[6] ‘Predatory’ Chinese Takeover of Ukraine Defense Firm Was Facilitated by a U.S. Law Firm
[7] Ukrainian Court Seizes Aerospace Company Motor Sich From Chinese Investors
[9] Turkish Aerospace, Motor Sich ink deal for heavy-class helicopter engines

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