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23 February, 2021
NAKO’s Position on Draft Law 3822
On December 16, Members of Parliament (MPs) introduced updated draft law No. 3822 on defence industry reform, prepared jointly with Cabinet of Ministers representatives and the state defence conglomerate Ukroboronprom (UOP). It should become the basis for transforming and reforming UOP into transparent companies that implement the principles of corporate governance. Of course, adoption of this draft law is a key condition for reforming the defense industry. However, changes must be made in accordance with the principles of the Organization for Economic Cooperation and Development (OECD), which are the best standards for corporate governance of state-owned enterprises (SOEs). Therefore, NAKO analyzed the revised draft law’s main provisions for compliance with these recommendations.
Article 2 of the updated draft law enshrines a corporate model for SOEs in the defence industry that is in line with OECD recommendations, which is a very positive signal. However, it does not correspond to the best practices as defined in the draft law when it comes to the state's powers to manage UOP within the process of corporatization. Thus, the Cabinet of Ministers of Ukraine and the central executive body authorized by it, the Ministry for Strategic Industries (MinStrategProm), are simultaneously defined as a “subject of management”, which will lead to legal conflicts and blurring of responsibility. Both governmental entities will have the same powers to corporatize UOP, but there is no clear division as to the Cabinet of Ministers’ competencies and MinStrategProm’s powers. For example, this may include deciding about UOP corporatization, representation in the commission to corporatize UOP, approval of the UOP corporatization plan, functions in a general meeting, appointment and approval of members for the Supervisory Board, etc. This vague definition of “management entity” goes against the provisions of Section II paragraphs D and E of the OECD Guidelines on Corporate Governance of State-Owned Enterprises. These clauses stipulate that the state’s authority as the owner should be the only one and it should be clearly defined. In addition, there will be a conflict of interest if there is a decision to transfer “subject of management” functions to MinStrategProm, as the ministry will simultaneously formulate policy for the military and defence industry and perform “owner-entity” functions within the military and defence industry. At the same time, MinStrategProm is in the process of building its capacity as a state body, while according to the OECD Guidelines, the owner-entity needs the necessary capacity and competency to perform its powers effectively. NAKO recommends defining the Cabinet of Ministers of Ukraine as the “subject of management” as this will clearly define the owner-entity, eliminate conflicts of interest, and ensure an appropriate level of coherence and balance of interests in making strategic decisions.
Another risk is the lack of a clear description of the powers of the joint-stock company’s (JSC) governing bodies that will be transformed after UOP corporatization. Currently, the draft law only stipulates that the powers will be enshrined in the JSC Charter. This uncertainty may create a situation where the approved statute may provide significantly fewer guarantees of independence and authority than according to the Law of Ukraine “On Joint Stock Companies” and the OECD Guidelines. Arguments for “deviation” can be made via the possibility provided by the draft law and the Law “On Joint Stock Companies” to establish special conditions for the defence industry. This creates a risk of maintaining “manual control” and delaying the implementation of corporate governance in defence enterprises. It is especially worth noting the need to clearly define the exclusive competency of the JSC’s Supervisory Board, the procedure for forming it, and guarantees of its independent members’ work. NAKO’s risk assessment in this part of the draft law was supported by independent experts from Dentons Law Firm, as part of the International Lawyers Project. NAKO proposes supplementing Article 6 of this draft law with a provision for the JSC governing body to exercise its powers as defined by the Law of Ukraine “On Joint Stock Companies.” It is also necessary to consolidate the exclusive competency for the company’s Supervisory Board and provide that at least half of the Supervisory Board members are independent and are appointed in accordance with the law.
The draft law also stipulates a special regime for UOP and its subordinate legal entities during the process of corporatization, including a procedure for optimizing the property and resources of UOP enterprises. The draft law proposes a number of additional benefits and guarantees, which creates a special legal regime for defence SOEs. It also provides for a significant simplification of the procedure for transferring property from one enterprise to another, replacing encumbered property (not even registered in the prescribed manner) by a UOP decision (or by decision of the JSC that was formed instead of UOP) without obtaining the consent of the State Property Fund of Ukraine. In such circumstances, it is necessary to provide additional guarantees of proper control over the decisions taken, particularly by making them public. NAKO proposes obliging UOP and the JSC to publish their decisions on replacing the encumbered property or free transfer of property on the official website in compliance with legislative requirements on the protection of state secrets.
NAKO reaffirms its readiness to continue working on the constructive improvement of Draft Law No. 3822 for the effective implementation of OECD standards in the management of state-owned enterprises in the defence industry.