Setting Up Production Facilities in Ukraine: Options for Foreign Defense Companies

To help Ukraine win the war, many foreign defense companies are beginning to set up their production facilities in Ukraine, instead of sending military equipment from abroad.  It makes business sense for them, too: Ukraine offers lower wages and cheaper production costs than the European Union or the Scandinavian countries.  Plus, you can re-export your local products to other volatile markets such as Africa or Asia.

For all those reasons, foreign defense companies are establishing their operations in Ukraine.  For example, in March 2024, the German defense conglomerate Rheinmetall announced its plans to construct at least four plants in Ukraine for weapons manufacturing, producing Ukraine ammunition, military equipment, and air defense systems.  Last year, the Ukrainian Defense Industry JSC and Rheinmetall entered into a joint venture, Rheinmetall Ukrainian Defense Industry LLC.

More recently, on Oct. 1, the French-German defense company KNDS announced that it registered its 100% foreign-owned company in Kyiv (KNDS Ukraine LLC) to carry out the domestic maintenance and repair of Ukrainian land systems and produce artillery ammunition. 

Today, foreign investors have two basic options in setting up defense production facilities in Ukraine:

• Create a 100% foreign-owned company (usually as a limited liability company); or,
• Enter into a joint venture with a compatible Ukrainian company (registered as a limited liability company or a joint stock company).

When setting up Ukrainian production facilities, these two options can be used in different ways, depending on whether an investor wants to work independently or if the investor needs a Ukrainian partner for any reason (e.g., compatible production facilities, assistance with product sales, procurement of necessary licenses, etc.)  In this regard, the following alternatives exist for establishing local production facilities:

• Acquiring a Ukrainian company with compatible production facilities (in its entirety or certain parts thereof)
• Establishing a joint venture with a Ukrainian partner that has compatible production facilities or other valuable contributions (such as unique dual application intellectual property rights, local contacts, IT specialists, etc.)
• Leasing local factory space to establish production facilities (either as a joint venture or a 100% foreign-owned subsidiary)
• Investing in a greenfield project (building new production facilities on industrial land, either as a joint venture or 100% foreign-owned subsidiary)

Immediately below we review each of the above options, as well as due diligence options:

• Acquiring a Ukrainian Company

An investor has two fundamental options: acquire either (a) an existing Ukrainian company via stock or equity buyout, or (b) assets (buildings, land, intellectual property, critical employees, etc.).

The most common way to set up local production is by purchasing shares in the target company, either by directly buying the target company’s shares or by purchasing shares in a special-purpose vehicle that controls the Ukrainian target company (usually a non-resident company).  Alternatively, the investor may acquire the target company’s assets, including “cherry-picking” (breaking out a special asset from the target company’s integrated property complex) or purchasing the entire business complex, including administrative buildings, production facilities, equipment, etc.

The acquisition procedures for limited liability companies (LLC) and joint-stock companies (JSC) are different, but they all have the same basic approach: (a) signing a non-binding letter of intent, (b) performing due diligence; (c) negotiating and executing all underlying agreements; (d) obtaining the necessary regulatory approvals and licenses.

The Ukrainian Antimonopoly Committee’s formal approval may be required if the transaction meets the financial thresholds described in the Law “On Protection of Economic Competition” (worldwide sales or assets of all parties exceed €30 million and sales or assets in Ukraine of at least two parties exceed €4 million, or the sales or assets in Ukraine, taking into account control relations, of at least one party exceed €8 million and the sales of at least one party exceed €150 million worldwide).

Last, but not least, setting up production in the defense area requires various licenses, depending on the production line (drones, ammunition, armored vehicles, etc.).  All such licenses must be procured before production can commence.

• Joint Venture and Joint Production Agreements

On May 6, Dmytro Klimenkov (Deputy Minister of Defense) stated the following during the Ukrainian Defense-Industrial Forum in Brussels:

“Ukraine is interested in creating joint ventures with European defense companies.  Armaments, which we most urgently require, can serve as the foundation for such cooperation between the Ukrainian and European defense industries. These are air defense systems, artillery systems and ammunition, EW equipment, as well as reconnaissance and attack drones.”

In fact, the most common way to establish production facilities in Ukraine is to enter into a joint venture with a Ukrainian company that has compatible production facilities or other valuable contributions (such as unique dual application intellectual property rights, extensive product distribution network, know-how and market experience, effective and efficient workforce, etc.).

Conveniently, Ukrainian legislation offers foreign investors two types of joint ventures: (a) a registered legal entity (usually a limited liability company or a joint stock company), and (b) a joint cooperation agreement without the creation of a legal entity (e.g., production sharing agreement).  In an unincorporated joint venture, the parties simply enter into an agreement to cooperate (joint production) without creating a separate legal entity, where they will together work to achieve specific business goals.

Most foreign investors prefer to enter into joint ventures with well-matched Ukrainian partners by registering a legal entity (usually LLC), especially in cases where the local assets and experience are indispensable (including industrial or intellectual property).  In this arrangement, each of the founders contributes ownership of its assets to the company’s authorized capital, either in cash or in-kind (industrial assets, land rights, registered intellectual property, etc.)  The parties’ contributions are subject to valuations, which will determine each party’s respective percentage of ownership in the company (unless the parties agree otherwise in a separate shareholders’ agreement).

If the joint venture is a legal entity, it may need to obtain Ukrainian Antimonopoly Committee approvals depending on the financial thresholds described in the Law “On Protection of Economic Competition.”  There are also licensing requirements, depending on the joint venture’s production profile.

• Leasing Industrial Space for Production Purposes

In certain cases, it is faster and less expensive to lease industrial space, factories and warehouses, to set up production, especially in cases of simple product assembly (e.g., drone components).  Without a large up-front investment, leasing industrial space can be an excellent option for joint ventures as well as 100% foreign-owned subsidiaries.

Most industrial spaces can be leased through a commercial lease agreement, which contains a detailed description of the leased property and other standard provisions including term, amount of rent and currency, utilities and service charges, sub-lease (if any), lease term extensions and early termination provisions, liabilities of the parties, conditions for return of the leased property to the landlord, etc.

With reference to lease term, two types of commercial leases exist: fixed-term or for an indefinite period.  Short-term leases (less than three years) do not need to be notarized, but if the lease term exceeds three years, the agreement must be notarized and the lease has to be registered with the State Register of Proprietary Rights to Real Estate.  In order to avoid additional expense and hassle associated with notarization and state registration of lease rights, commercial leases are often concluded for a period of less than three years with the right of automatic extension.

• Investing in a Greenfield Project

Long-term foreign investors sometimes choose to participate in a greenfield project, which consists of building new production facilities on industrial land in Ukraine to their exact specifications.  This can be implemented via joint venture as well as a 100% foreign-owned subsidiary.

While this theoretical option exists, it is not particularly useful for foreign defense companies due to the urgent need for munitions and drones during the times of war.  Historically, greenfield projects are notoriously complicated and usually needed substantial time to implement.  Extensive negotiations, followed by the land allocation/transfer process with subsequent registrations, the procurement of various licenses (including construction permits), and the actual construction of the facilities and utilities (electricity, sewage), combined with government bureaucracy, all caused delays that are simply unacceptable in today’s dynamic environment.

In all cases foreign investors must conduct extensive due diligence regarding the Ukrainian target company, its assets (real property, intellectual property, specialist employees, etc.) and liabilities.  The following areas are subject to diligence, depending on the transaction:

• Corporate documents: review all statutory documents in state registers, all ownership/title documents, any encumbrances on alienation of shares or equity (corporate rights) in the target company, including absence of insolvency proceedings

• Assets: review all ownership/title documents to the core assets (buildings, land, IT rights) and uncover any liabilities (asset liens, arrests, pending litigation)

• Intellectual property ownership: review all intellectual property rights, including all non-disclosure and confidentiality agreements concluded with personnel and contractors, review all information about the full transfer of intellectual property from employees and contractors, and compliance with personal data protection rules

• Financial records: review all accounting and reporting filings with the local authorities, including primary accounting documents, employee payroll lists, internal work regulations and recent audits from local fiscal authorities

• Regulatory compliance: review the compliance of the target’s operational activities in light of updated statutory requirements (martial law requirements, labor and fire safety, waste management)

• Employment records: review all labor contracts and the target company’s compliance with Ukrainian labor laws, including their recent history in withholding and paying social insurance contributions to the state budget on behalf of employees

• Litigation: review of all material disputes involving the target company, including any pending litigation

In cases of real property transfers (industrial property and land), we strongly recommend to retain independently certified specialists to assess the condition of the transferred assets, because all sales are “as is” condition.  In case of land transfers, we recommend hiring licensed specialists to assess potential land contamination (if any) to avoid clean-up costs at a later date upon taking possession.

See the previous two articles in this series by Maksym Koval and Scott Brown here.

The views expressed in this opinion article are the author’s and not necessarily those of Kyiv Post.