Audit: How KQ bought two planes at Sh2b — only to sell them at a throw-away Sh210m

KQ Boeing 777 take off. PHOTO: FILE
NAIROBI: Kenya Airways (KQ) bought two planes at Sh2 billion from KLM Dutch Airlines, its largest shareholder, and later sold them off at Sh210 million.

A forensic audit done by Deloitte Consulting Ltd shows the national carrier bought the two planes, Boeing B737-300 aircraft from Koninklijke Luchtvaart Maatschappij (KLM), under a conditional sales agreement.

The first sales agreement was executed on July 2, 2010 for the first aircraft registered as 5Y-KYM.

A similar sales agreement dated September 14, 2010 was executed for the second aircraft registered as 5Y-KYN. The purchase price of each aircraft was stated at $10,260,000 (Sh1 billion at current exchange rates).

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Auditors say the planes could have fetched at least Sh600 million, but the airline instead went ahead and disposed them for a song,

The auditors describe the move to sell off the two aircraft “as a costly strategic decision made by the Board”.

“We determined that the two aircraft had been purchased at USD20.52 million in 2010 from KLM and later sold at a combined price of USD2.1 million in 2015 to Engage Aviation LLC. Prior to the sale in 2015, an independent review of the potential value of the two aircraft was stated at USD6 million,” Deloitte says in its Draft Factual Findings Report, dated August 2016.

To finalise the sale of the two aircraft in 2015, KQ made a lump-sum payment of Sh900 million ($9 million) to KLM in compliance with the agreed terms at the time of purchase.

The purchase from KLM was also rushed, the audit says, despite not being in line with the fleet development strategy.

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“It is possible that the decision made to purchase these aircraft was a result of undue pressure by the KQ management,” the report reads.

The first aircraft was delivered prior to inspection by the Kenya Civil Aviation Authority.

The fleet director told the auditors that in his opinion, the purchase process was a rushed decision.

According to the report, the airline lost Sh1.8 billion in the sales process, which is the difference between the total purchase price and the total sales price.

Further, before the aircraft were sold, KQ had paid hundreds of millions of shillings in expenses on the aircraft.

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According to the report, the airlines legal officer had drafted two letters addressed to the then managing director, Titus Naikuni, specifying the terms of the conditional sale per aircraft.

KQ had to make 48 instalments of Sh12 million ($120,000) per month. This translated to Sh576 million in two years. The airline was also to pay an engine compensation fee of Sh180 million (Sh90 million per engine) on the scheduled delivery date. The firm was to pay Sh450 million at the end of the 48th month. 

“Our review of the letter dated 2 July 2010 revealed that Mr Naikuni, Ms Kiboi, Mr Mbugua, Francis Musila, Ground Services Director, Ms Felicita Kagwanja, Insurance Services Manager, and Mr Allan Fullilove, former KQ Technical Director, had endorsed and confirmed the suitability of the terms and conditions of the agreement,” the report notes.

Controversial plan

Messrs Fullilove and Naikuni executed the agreement on behalf of KQ, while Jan Witsenboer and Barbara van Koppen signed on behalf of KLM.

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The discussions on disposing the planes started as soon as the airline mooted the controversial development plan dubbed Project Mawingu.

The 10-year strategic plan was developed to grow the KQ fleet and help it retain a tangible presence in the market. The plan, which was launched on May 27, 2011, was to grow the fleet from 31 aircraft at the time, to 120 aircraft by the end of the 10-year period.

But the board had indicated it needed more convincing that the plan was achievable, and said it should be based on “controlled growth”, with detailed plans for each three to five-year period.

However, they approved a medium scenario that projected 115 aircraft, including freighters, by the 2020-21 financial year.

This is what laid the ground for the disposal of the planes.

On June 24, 2014, the airline’s board discussed the disposal of the two Boeing B737-300 aircraft.

“This disposal was in line with the Project Mawingu III Strategic Plan that had been approved on 16 April 2014. A review of the plan established that the fleet strategy was to retire the Boeing B737-300 fleet by the year 2013/2014,” the report notes.

A brief from Rick Sine, the airline’s former fleet development director, revealed that the book values of the two aircraft were Sh470 million and Sh530 million, respectively.

But on September 10, 2015, KQ negotiated a sale price for both aircraft at Sh250 million. A commitment deposit of Sh20 million was paid by August 10, 2015.

And then the airline made the dangerous decision to switch engines after the vendor, Engage Aviation LLC, viewed the aircraft.

“This decision was made by management, who thought it was in the best interest of the company to save money. We confirmed that the engines were switched. The Board was concerned that the switching of the engines posed a reputational risk for the company given that Engage Aviation LLC (Engage), the prospective buyers, were not notified of the change,” the Deloitte report notes.

It was then that the board resolved that it was “in the best interest of the company” to sell the two aircraft at a combined price of Sh210 million.

Aircraft procurement and disposal is managed by KQ’s fleet development department. Andrew Mudachi, the head of fleet development, told the auditors that the fleet acquisition and disposal policy manual is still in the draft stage and has not been approved.

Mr Mudachi further explained that aircraft acquisition and lease processes and decisions are effected on a transactional basis. A strategy team is convened to conduct fleet studies and analyses to determine projected destinations, passenger numbers, cargo capacity and route profitability.

FINANCIAL LOSS

The Deloitte report was based on investigations conducted between February and August 2016, which were aimed at establishing if there had been any irregular activities that resulted in a financial loss for KQ in the processes of acquiring new aircraft.

The airline confirmed last week that it had received the forensic report from Deloitte, and it is studying it before taking action.

“The report is more than 1,000 pages and we cannot name the individuals before we have enough evidence. But we shall take the necessary action, be it disciplinary or otherwise. Action has already began,” Dennis Awori, the airline’s chairman, said on the sidelines of an annual general meeting.

The report also found that the appointment of Afrexim Bank to finance the purchase 20 other aircraft valued at Sh200 billion for the airline’s Project Mawingu had been done irregularly.

“Our review of the aircraft financing for the aircraft acquired in the period under review informed us that the appointment of Afrexim Bank may have been irregular,” the report notes.

The auditors found that discussions to appoint Afrexim Bank as the lead mandate arranger had already been under way prior to the issue of the tender in March 2012.

“Our relativity searches on aircraft financing email correspondences confirmed that on 21 July 2011, Ms Flora Talam and Mr Timothy Tiampati from IDB Capital Limited (IDB) had requested Ms Kiboi for a mandate letter to facilitate the financing of the nine (9) Boeing B787 aircraft,” the report reads.

Deloitte found an email where on August 16, 2011, Kiboi informed Naikuni that they obtained invaluable information during Mr Tiampati’s visit to KQ headquarters.

On January 17, 2012, a meeting was held at the Afrexim Bank offices in Cairo.

In attendance from Afrexim Bank were BO Oramah, James Mwangi, Ismail Kamara, Humphrey Nwugo and Samuel Mugoya. The individuals representing IDB were James Karanja and Tiampati, while Kiboi and Sophia Costa Hendy represented KQ.

Kiboi informed auditors that she presented the funding proposal.

At the close of the meeting, it was decided that Afrexim Bank would forward a draft mandate letter and term sheet for KQ’s consideration by close of business on Friday, January 20, 2012.

On its part, the airline was asked to forward all the relevant project documents, including the detailed business plan and cash flow projections, by January 21, 2012.

Afrexim Bank’s senior management was to arrange a meeting with the KQ senior executive team to finalise the financing discussions and to execute the financing mandate by mid February 2012.

But while this was being done, auditors established that a draft mandate letter between KQ and Afrexim Bank had already been under discussion.

“The document dated 6 February 2012 displayed KQ’s comments on the draft mandate made on 14 February 2012. The document log confirms that Afrexim Bank was the originator of the document,” the report reads.

At a board meeting held on March 30, 2012, the board approved an aircraft financing offer from Afrexim Bank of $2.049 billion (Sh200 billion) to acquire 20 aircraft.

Financing offer

The deal would see the bank finance nine Boeing B787-800, one Boeing B777-300ER and 10 Embraer E190. These planes were being touted as the first phase in the actualisation of the airline’s growth strategy.

Of the Sh200 billion, Sh173 billion ($1.738 billion) was to be allocated to the acquisition of delivery financing and Sh31 billion ($310.96 million) towards pre-delivery financing.

However, after subsequent discussions with Afrexim Bank, the facility amount was increased to $1.924 billion, and a mandate letter was signed on May 22, 2012 between the two parties.

According to the tender evaluation process in the Purchasing Procedures Manual (PPM) of the airline, evaluation and ranking of supplier bids precedes the tender award process.

“Based on our review, we did not obtain any evidence of the responses from the financial institutions except for the summary of responses provided in the Board minutes,” Deloitte found.

In addition, interviews with the airline’s staff did not reveal any of them formed part of the evaluation team.

“We cannot confirm which KQ employees or former employees, if any, participated in the selection process. Consequently, we cannot establish whether desktop or technical evaluation criteria was used to select Afrexim Bank as the winner of the bid,” the report notes.

“Though the terms offered by Afrexim Bank in the summary provided were the most favourable, it is possible that the bank may have had a competitive advantage over the other bidders.”

There were 16 institutions interested in the deal.

Procurement policy

KQ’s procurement policy indicates goods and services valued at more than Sh50,000 shall undergo a competitive bidding process. It further states that for purchases worth Sh5 million to Sh10 million, a selective tendering process will be used; for purchases worth more than Sh10 million, an open tendering process will be used.

However, despite the deal to source for funds for aircraft purchases being worth more than Sh10 million, a selective process was used to source and evaluate bidders.

The auditors also cleared the airline’s controversial use of special purpose vehicles (SPV) that had been set up to facilitate the acquisition process.

Deloitte says it consulted relevant current and former KQ staff members, reviewed documents and performed digital forensic analyses of the computer hard drives of key players involved in the decisions to procure aircraft.

The firm also conducted business intelligence background searches to establish the ownership, shareholding structures and beneficiaries of KQ’s SPVs incorporated in Delaware, Bermuda and the Cayman Islands.

“Our searches revealed that no potential conflicts of interest existed between the owners and managers of the SPVs and any current or former KQ staff. Our discussions with Exim Bank officials confirmed that the SPVs had been specifically created to support the aircraft financing transactions,” the report notes.

THE RECOMMENDATIONS

Deloitte concludes by recommending that all tenders to source for aircraft financing that are above Sh10 million be subjected to an open tender process.

“The aircraft purchase decision strategies should be also be in line with the KQ corporate strategy,” the report reads.

“We recommend the completion and implementation of the Fleet Acquisition and Disposal Policy manual. The manual should incorporate internal control procedures to be followed during the purchase or lease of aircraft. The importance of such a manual is to ensure any internal control weaknesses during procurement of aircraft are addressed effectively.” 

The auditors also want the airline to consider further investigating charitable credits relating to transactions in 2004 and 2005.

“Consider further investigation into the charitable credits paid to KQ by an aircraft manufacturer and how this was utilized by KQ.”

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