History of Liquidation of Chernomorsky Shipbuilding Yard (ChSY)

On 25 June 2021, the Economic Court of Mykolaiv region confirmed the liquidation of Chernomorsky Shipbuilding Yard PJSC (hereinafter referred to as ChSY).

The main reasons that led to the bankruptcy and further winding up of ChSY include the following:

• the crisis in the Ukrainian shipbuilding sector that was a result of the global economic recession of 2008 and the tragic events in Ukraine in 2014
• cessation of state financing for corvette-class shipbuilding program
• unfriendly actions of Poroshenko’s authorities in order to take the company under their control and exert influence on the opposition politician Vadym Novynskyi through pressure on business.

It is important to note that we are talking particularly about the liquidation of a legal entity, not a business. Even during the bankruptcy process, ChSY continued to seek orders, performed its economic activities, paid salaries on time, and made all mandatory payments to the budget in due time. After the liquidation of the legal entity, the shipbuilding facilities of ChSY were concentrated within a separate cluster that occupies no more than 5% of the former Soviet behemoth ChSY with an area of 200 hectares. Such concentration/clustering is a worldwide practice. Mykolaiv Shipyard of Smart Maritime Group LLC now carries out shipbuilding and ship repairing activities.

In what follows, we will dwell in more detail on each of the components of ChSY’s involuntary bankruptcy.

1. Strategic sector’s crisis

Since 2007, when companies of Smart-Holding Group became ChSY’s shareholders, the shipyard began to restore its activities, which it had practically not carried out since 2004. Long-term wage debts were paid off, debts to contractors and budgets of all levels were cleared, and the main production facilities, which were previously in a deplorable condition, were restored.

It was not easy to breathe a new life into the shipyard, especially since in 2005 a special investment regime for the shipbuilding industry was cancelled in Ukraine, which entailed the withdrawal of foreign investors from the country (in particular, Damen Shipyard (the Netherlands)). After that, Ukrainian shipyards began to operate at a loss and cut jobs. The cancellation of the special regime was the first major blow to the domestic nautical architecture and shipbuilding industry.

In 2008, the global economy was shaken by the economic recession and it took some time for Ukrainian shipbuilders to feel it. The shipbuilding industry is inert to crisis-related political or economic situations since the execution of shipbuilding orders takes more than one and a half to two years.

The holding company understood what challenges Ukrainian shipbuilders would face in the near future. In 2009, Smart-Holding established an operating company Smart Maritime Group LLC (hereinafter referred to as SMG). The Group singled out a shipbuilding cluster in its business portfolio for the efficient management of core assets and their development in Kherson and Mykolaiv.

After the global economic downfall, the Ukrainian shipbuilding sector began to slip into the crisis in 2010, when foreign partners almost ceased placing orders in our country.

Importantly, in those countries where the shipbuilding industry is a strategic one, it is supported by the state, and amid crises, national governments ensure the competitiveness of their shipbuilders in international markets. In addition, in such periods the state becomes the key customer of the industry, mainly in military shipbuilding, to strengthen and maintain the country’s defence capability. When negative consequences of the 2008 global recession began to affect the Ukrainian shipbuilding industry, the country did not have a national strategy to support the sector. Smart-Holding took the blow. The work of shipbuilders, including those from ChSY, was subsidized, and the main task was to retain the team of professionals. Smart-Holding took active steps to find domestic and international orders. From 2008 to 2013, nine vessels with a total displacement of 26,300 tons were built for customers from the Netherlands, the UK and Russia, and more than 200 civilian vessels were upgraded and repaired. Tanker RST27 SVL Liberty, built by SMG, entered the TOP 50 significant ships of 2013 according to the British Royal Institution of Naval Architects.

The shipyard also implemented some projects for the needs of the Ukrainian Naval Forces: in 2009, ChSY signed a contract for the construction of a series of corvette-class naval ships, which we will cover in detail below; in 2012 and 2013, six warships were repaired.

The tragic events of 2014 in the country completely cut off Ukraine from external markets, dramatically worsened the economic situation in the country and called into question further existence of the shipbuilding sector since the state did not endorse any feasible programs to support its strategic industry.

The year 2014 was also an unfavourable year for the global shipbuilding sector. According to CLARKSON consulting company, this period saw the largest decline in the volume of orders in all market segments since 2004, including the segment in which SMG shipyards specialize – construction of ships with a deadweight of up to 50,000 tons. Moreover, the forecasts for the medium term, unfortunately, were not encouraging.

The key factor that led to ChSY’s bankruptcy was the termination of state financing for the military order in 2014. There were no prospects for restoring the payment schedule, and this led to disastrous consequences.

ChSY, like most companies facing crisis, needed a turnaround plan – a rehabilitation procedure – in order to save jobs and be able to continue the implementation of the military order as soon as state financing would be resumed. We will dwell upon the main reason why it was not possible to rehabilitate ChSY in the third part, and now we will tell the readers in greater detail how the project on the construction of the first corvette of independent Ukraine developed.

2. Legendary Ukrainian corvette

In December 2009, ChSY won a tender for the implementation of a project to build a series of corvette-class naval ships for the Naval Forces of the Ministry of Defence of Ukraine. Historically, the shipyard was a military shipbuilding base. It had a unique design and development centre and was the only enterprise in the former USSR that had respective production capabilities and built various types of aircraft-carrying strike ships with a length of over 300 metres. Cruisers built under 1143 design project became the hallmark of ChSY. The shipyard also used to build destroyers, battleships, submarines, missile floating bases, submarine floating bases, anti-submarine cruisers, etc.

The availability of specialized production facilities and expertise in the field of military shipbuilding played a key role in choosing ChSY as a contractor for the construction of the first Ukrainian corvette.

According to the results of the tender, on 17 December 2009, contract No. 247/1/09/45 was concluded for the implementation of project No. 58250 of the Ministry of Defence of Ukraine (hereinafter referred to as the MDU) to build four naval ships. However, only two years later, the government was able to approve the target program that kicked off the construction of the lead ship.

Resolution of the Cabinet of Ministers of Ukraine No. 1150 of 9 November 2011 approved the government’s targeted defence program for the construction of a series of corvette-class vessels. This program earmarked the planned amounts of financing for the state defence order broken down by years. The total amount for the entire set of ships was UAH 11.69 billion, of which UAH 2,090.6 million were to be allocated for the construction of the lead ship.

According to the updated terms and conditions (for which the corresponding supplementary agreements were signed with ChSY), the financing for the construction of the lead ship was to be as follows: UAH 55 million in 2011; UAH 157.47 million in 2012; UAH 175.02 million in 2013; UAH 456.99 million in 2014; UAH 474.48 million in 2015; and UAH 771.64 million in 2016.

The deadline for the delivery of the lead ship, namely, 15 December 2016, was tied to this financing schedule.

During the period of 2009-2013, within the framework of the contract, the company received UAH 215.3 million out of UAH 387.5 million envisaged by the program. It should be noted that major amounts were received only in 2013, of which UAH 98 million were received in December 2013. This was the last tranche under the contract, after which the funding was stopped.

More than half of the amount of UAH 215.3 million was spent on advance payments to purchase equipment and armament. Within the framework of contracts with foreign suppliers, advance payments were made in foreign currency in an amount equivalent to UAH 123.6 million.

As can be seen, the actual financing schedule went with significant deviations from that stipulated in the contract, which obviously influenced the construction time frame. At the same time, ChSY did not suspend its work and continued the construction, spending its own funds and thus advancing money to the government.

At the beginning of 2014, as mentioned above, the state froze the financing of the project “due to the military and political situation in the country”, about which the MDU officially notified ChSY only in July 2014.

ChSY was holding negotiations and did not halt the construction process until October 2014. The shipyard had to stop the work on the project when the amount of company’s own funds spent on the construction exceeded the amount allocated by the state by UAH 30 million, and there was no feedback regarding the resumption of financing.

As at the end of September 2014, 80% of the corvette hull work was completed. The blocks of the hull and superstructures of the lead ship were built. In general, the lead ship was 17% complete technically. The shipyard concluded contracts with foreign suppliers (ABS HYDROMARINE B.V., FINCANTIERI CANTIERI NAVALI, OTO MELARA, RHEINMETALL AIR DEFENCE, ZEPPELIN INTERNATIONAL AG). ChSY performed all the works under the supervision of the MDU. The choice of suppliers was solely the prerogative of the Ministry.

The MDU signed and accepted work completion certificates to the amount of more than UAH 60 million. At the same time, the State Financial Inspectorate, which was the predecessor of the State Audit Service, repeatedly audited the economic and financial activity of the company within the framework of the corvette construction program. Such audits were made in 2013 and in 2015. According to the results of the audits, no violations or irregularities by the main contractor – ChSY – were found.

The main challenge for the shipyard was the fact that, based on its internal regulations, the MDU could sign the certificates on advance payments to foreign suppliers only after the delivery of equipment and its installation. Since the financing was stopped, the delivery of the equipment could not take place as foreign suppliers did not receive full payment. Because of this collision, the MDU could not attribute the advance payments to the targeted use of funds.

Further on, the situation for ChSY began to deteriorate exponentially. Making advance payments abroad is subject to the currency regulation procedure. In particular, late receipt of goods (more than 90 days after the advance payment) leads to an additional 0.3% forfeit on the default/non-refund amount for each day of delay, as well as to the suspension of the company’s foreign economic activity in general. This is exactly what happened to ChSY. The amount of penalties accrued for unmeant violation of the currency legislation was more than UAH 100 million. The tax authority began to file claims against the shipyard, the prosecutor’s office filed lawsuits due to the missing certificates on the targeted use of advance payment funds. For the same reasons, the company was subject to sanctions by the Ministry of Economic Development, which significantly complicated its foreign economic activity. The company received claims from foreign suppliers in connection with default on the terms of financing under the contracts. Penalties went up above one million dollars.

Thus, ChSY got into a trap due to the cessation of the state funding and was squeezed by claims and lawsuits from all sides. De facto, the company became insolvent through the fault of the state, which led to the bankruptcy procedure. For ChSY, this became a chance to stop the breaking-up of the company, to win some time to be heard, and to make the state sit down at the negotiating table. Through the turnaround procedure, it was possible to rehabilitate the company and continue the execution of the state order.

During 2014-2018, ChSY, SMG and Smart-Holding took an active position. Representatives of ChSY and SMG held some meetings with representatives of foreign suppliers trying to agree on changes to contracts that would make it possible not to lose advance payments. The ChSY management sent a number of official letters to the Ministry of Defence describing the situation and asking to join the negotiations with foreign partners.

There were numerous appeals from ChSY to the MDU and the SFS (the State Fiscal Service) regarding possible exclusion of advance payments for purchasing armament under the corvette program from the sphere of foreign economic activity regulation, and regarding the settlement of the situation with reporting on the use of budgetary funds by the MDU. They all remained unanswered.

In 2017-2018, the state finally decided to pay attention to the situation around the military order. Under the MDU, represented by the Department of Armaments and Ukroboronservice, and joined by representatives of Smart-Holding, a working group was established to search for options to resolve this situation and preserve the project. Meetings were held every two weeks, and the parties worked out some options for solving the accumulated problems. As a result of negotiations, which with varying intensity lasted for almost a year, proposals on further work, as well as proposed changes to the contract, were agreed upon and reflected in the minutes of meetings.

In particular, an option that was considered and assessed as a promising one was spin-off of a new company from ChSY PJSC as part of the turnaround plan implementation where such new company would be a successor of all the rights and obligations under the project. The relevant measures were included in the ChSY rehabilitation plan and approved by the court decision. The general meeting of ChSY PJSC shareholders in December 2017 approved the spin-off of a new Shipbuilding Company Corvette PJSC from the company.

However, all the proposals that were adopted at the working group level did not find support from the then President since they did not align with his economic and political interests. Having not received political support, all the decisions of the working group remained “ink on paper”, and ChSY went for the winding up process.

The liquidator of ChSY found a legal solution in order to have all the hull elements and equipment of the lead ship separated from the general pool of assets subject to liquidation and transferred to the Ministry of Defence of Ukraine. But even after that, for several years the officials of the Ministry of Defence could not find a possibility to make an inventory of the transferred structures, despite regular official requests from the company, in whose warehouses the unfinished corvette is stored.

The further fate of the project today is entirely in the hands of the Ministry, which, as far as we know, has not yet decided on the contractor that would be ready to complete it. We would only note that the mothballing and subsequent storage of the unfinished ship to this day is financed by the businesses of Smart-Holding.

3. Political arbitrariness of those in power and fatal influence on the ChSY liquidation process

The economic and political interests of Petro Poroshenko, the former President of Ukraine, coalesced in the best way in the fight against the opposition member Vadym Novynskyi. Both ChSY itself and the state order “Corvette” were put at stake.

The then Prosecutor General Yuriy Lutsenko, as the media wrote, often acted as an instrument in Petro Poroshenko’s political struggle. And in the case of ChSY, as evidenced by the facts set out below, the situation repeated itself.

In May 2017, based on a statement by Andriy Vadaturskyi, MP from the Petro Poroshenko Bloc, the Prosecutor General’s Office opened a criminal case, and in July 2017, at the motion of investigators of the Prosecutor General’s Office, all property of ChSY and shares issued by it were attached in the framework of this case.

It should be noted that ChSY was privatized in 2003. Smart-Holding became a shareholder in 2007, having acquired shares in the secondary market, and not in the course of the privatization. The company continued to fulfil its investment obligations, like the previous owners, strictly observing the requirements of the law and reporting to the State Property Fund (SPF), about which it received respective confirmations from the SPF.

It is obvious that the “case” was contrived and trumped up by a political order.

From 2014 to 2018, investigators of the Prosecutor General’s Office made dozens of searches at the shipyards and other enterprises of Smart-Holding, as well as in the central office in Kyiv, during which the financial and economic activities of these enterprises were blocked for a long time. Documents and office equipment were seized, and unfounded suspicions were brought up against ChSY’s officials. Subsequently, representatives of ChSY proved the inconsistency of the prosecutors’ charges in the courts of various instances, but sweeping administrative pressure already played its role in the destruction of ChSY.

ChSY, SMG and Smart-Holding took an active public position in relation to the illegal actions of the Prosecutor’s Office.

On 25 July 2016, Smart-Holding addressed an open letter to Vasyl Grytsak, the then Head of the Security Service of Ukraine, and to Yuriy Lutsenko, the then Prosecutor General of Ukraine, https://smart-holding.com/en/press-centre/news/2194/, publicly declaring its readiness to cooperate with the pre-trial investigation authorities and provide all the necessary documents and information that were available, as well as to facilitate a comprehensive investigation of any crime case within the framework of the current legislation.

However, the pressure kept growing up.

On 17 August 2017, Smart-Holding made another statement about the government’s pressure on business https://www.smart-holding.com/en/press-centre/news/2271/.

Despite the open position of Smart-Holding, the company’s business continued to feel biased attitude from the authorities and law enforcement agencies. Thus, on 26 June 2018, at a meeting in Pecherskyi District Court of Kyiv, representatives of the Prosecutor General’s Office insisted on leaving the attachment of ChSY’s property and shares unchanged, and the court agreed with their dubious reasoning. It is noteworthy that during that court session the investigator and the prosecutor openly stated that their main task was to launch the process of the company’s re-privatization with the help of criminal prosecution.

During more than two years, law enforcement agencies failed to conduct a full and impartial pre-trial investigation. In the meantime, due to the imposed property attachment, the rehabilitation of the company was completely blocked. The rehabilitation manager sent numerous appeals to the Prosecutor General where he described disastrous consequences for the fulfilment of the military state order if the shipbuilding company does not go through the financial recovery procedure. They all went unanswered. Thus, the conclusion suggests itself that the interests of the state were secondary in comparison with the economic and political interests of the former President.

The economic rationale for the President’s purposeful actions was trivial. Poroshenko was the owner of Leninska Kuznya shipbuilding enterprise (hereinafter referred to as Kuznya), for which he began to collect major state orders.

However, Leninska Kuznya could not implement large shipbuilding and naval building projects without direct access to the sea. In addition, a large real estate development project was planned on the territory of Kuznya. It becomes obvious that the shareholder of Kuznya and the then President of Ukraine needed to have his own shipyard with the appropriate equipment, which would implement the contracts of the Ministry of Defence. Thus, the aim behind the actions of law enforcement officers of the Poroshenko-Lutsenko era was, at least, to eliminate the competitor, and, as a maximum, to take over the shipyard and change its owner.

Clearly this process also helped keep Vadym Novynskyi’s entire business in a state of tension or stress and exert constant pressure from law enforcement agencies. This was precisely the political pressure on the opponent who was out of the authorities’ favour.

Outcomes

The deconstructive position of the Prosecutor General’s Office made it impossible to implement the ChSY rehabilitation plan. The only legally possible way to resolve the above-described situation was to discontinue the legal entity through liquidation. The creditors’ committee, including representatives of government agencies and institutions, whose claims are included in the register of creditors, supported the liquidation of ChSY.

Today, Mykolaiv shipyard of SMG performs shipbuilding and ship repair activities on the territory of former ChSY. It does not occupy the entire area of 200 hectares used by the former Soviet behemoth shipyard. In the unused territory, Smart-Holding is implementing an Industrial Park logistics project, which provides for the development of railway and port infrastructure, attracting of new residents to form various industrial clusters, including small and medium-sized businesses. International investors are invited to join the project. It is designed to develop the industrial area, give it a new life, create up to 5,000 jobs, and increase the country’s export potential. To that end, support at the local and national level is essential. We hope that the current government authorities of Ukraine, acting in the true interests of residents of Mykolaiv city and the entire region, as well as the country as a whole, will be taking active part in creating a new page in the life of the legendary company.