The Set Up

These are only but a few of the issues that potential or current investors face while conducting business activities in Kazakhstan. Therefore, in The Business Year: Kazakhstan 2012, we have decided to outline additional, highly significant legal issues that may affect the current business environment in Kazakhstan.

Kazakhstani or Local Content

The break up of the USSR resulted in the collapse of existing supply chains, and subsequently in the collapse of almost all sectors of industry in the former Soviet republics, including Kazakhstan. Currently, the vast amount of investments attracted into Kazakhstan are in the oil and gas and mining industries. Given the absence of the required goods and services on the local market, foreign investors involved mainly in the oil and gas and mining industries procured such goods, works, and services required for the performance of their obligations under subsoil-use contracts abroad. Of course, such a situation did not add to the development of Kazakhstan’s industry in general or increase the competitiveness of locally manufactured goods.

The initial edition of the Law on Subsoil and Subsoil Use dated January 27, 1996 (the “Old Subsoil Law”) provided that a subsoil user shall give preference to (1) equipment, materials, and finished products manufactured in Kazakhstan, on the condition that such equipment, materials, and finished products have competitive ecological and technical qualities, price, operation parameters, and terms of supply; (2) Kazakhstani service companies while conducting subsoil use operations, on the condition that such services are price, efficiency, and quality competitive; and (3) Kazakhstani personnel when conducting subsoil use operations.

However, the percentage of equipment, materials, and finished products manufactured in Kazakhstan to be used was not specified in subsoil-use contracts.

The concept of Kazakhstani content was first introduced in the Old Subsoil Law by December 1, 2004 amendments and was defined as a percentage of annual volumes of both Kazakhstani personnel involved in the performance of a subsoil-use contract and the cost of Kazakhstani goods, works, and services acquired. However, amendments in 2004 remained of a declarative character until approval by the government of Kazakhstan under the Concept for the Further Development of Kazakhstani Content in September 2009 (the “Concept”). The Concept identified goals aimed at stimulating the production of goods and services by national manufacturers, creating conditions for local manufacturers to achieve import substitution.

For the implementation of the Concept, a number of normative and legislative acts were adopted, including the “Law on the Introduction of Amendments to Some Legislative Acts of the Republic of Kazakhstan on Issues Related to Kazakhstani Content” dated December 29, 2009. The said law introduced the following concepts, which were subsequently incorporated with slight changes into the new Law on Subsoil and Subsoil Use dated June 24, 2012 (the “New Subsoil Law”):

•Kazakhstani content in goods;

•Kazakhstani content in works and services;

•Kazakhstani content in personnel;

•Kazakhstani manufacturers of goods;

•Kazakhstani performers ofworks and services;

•goods of Kazakhstani origin; and

•a registry of goods, works, and ser- vices used while conducting subsoil use operations.

Later, as a result of amendments to certain normative and legislative acts dated January 9, 2012, the phrase “Kazakhstani content” was substituted with “local content.” The New Subsoil Law regulates the issues on local content in respect of subsoil users and contains the following terms and definitions in respect of local content:

•Local content in goods means a share (in percent) of the cost of local materials and the expenses of the manufacturer on the processing of goods in Kazakhstan in the final cost of goods.

•Local content in works (services) means an aggregate cumulative share of local content in the cost of goods used for the performance of works, in the aggregate value and/or payments to Kazakhstani employees, and in the salary fund of the entity performing works or rendering services under an agreement after deduction of the cost of goods used for the performance of work and subcontract values.

•Local content in personnel means the percentage of Kazakhstani employees engaged in the implementation of a contract with a breakdown by each category of workers and employees.

•A Kazakhstani performer of works and services means Kazakhstani citizens and/or legal entities established and located in Kazakhstan where employees that are Kazakhstani citizens constitute at least 95% of the total number of employees.

•Goods of Kazakhstani origin means goods having a certificate of origin for internal circulation certifying their production in the territory of Kazakhstan.

•Kazakhstani manufacturers of goods include citizens and/or legal entities of Kazakhstan that manufacture goods of Kazakhstani origin.

The requirements of the New Subsoil Law on local content are applicable to all stages of granting subsoil use rights: from tendering or direct negotiations, including tender application and identification of the winner, to the execution of the subsoil use contract.

So, for obtaining subsoil use rights granted through a tender procedure, potential bidders shall undertake, among other things, the obligations on local content. In accordance with Clause 3 of Article 50 of the New Subsoil Law, a bid shall contain, among other things, the following articles: (1) the obligations on local content in personnel, which should increase along with the implementation of mandatory training programs and the professional development of Kazakhstani personnel; (2) the obligations on training Kazakhstani personnel; and (3) the obligations with respect to local content in goods, works, and services required to implement the contract.

During the period of transition from exploration to production, the competent body and a subsoil user shall jointly set forth the following terms of the production contract:

1) the size of the local content in goods, works, and services; and

2) the size of expenditures on the social and economic development of the region and its infrastructure.

In accordance with Clause 2 of Article 61 of the New Subsoil Law, a contract shall contain the obligations on local content in personnel and local content in goods, works, and services. Additionally, the contract shall contain the size of penalties for non-performance, and improper performance by the subsoil user of the obligations, including the obligations on local content in goods, works, services, and personnel set forth by the contract.

Based on the above, we can summarize that:

1) the term on local content and the size of penalties for non-performance by a subsoil user of the obligations undertaken on local content are considered to be material terms of a contract; and

2) the absence of the above material terms may become grounds for the recognition of a contract as not concluded, and, subsequently, the grounds for refusal in its registration with the competent body, and in respect of a registered contract, the grounds for the recognition of the contract as invalid.

Local content is calculated in accordance with the Unified Methodic of Calculation of Kazakhstani Content by Organizations when Procuring Goods, Works, and Services, approved by Decree No. 964 of the government of Kazakhstan dated September 20, 2010 (the “Unified Methodic”).

The Unified Methodic is applicable, among others, to subsoil users and/or companies authorized by subsoil users to carry out the procurement of goods, works, and services in accordance with the New Subsoil Law.

For the calculation of the share of local content in goods, the government of Kazakhstan, through Decree No. 1647 dated October 22, 2009, approved the Rules for Determining the Origin of Goods, the Execution and Issue of Expert Act on the Origin of Goods, and the Issue of Certificate of the Origin of Goods (the “Rules on Origin of Goods”).

According to the Rules on the Origin of Goods, the Committee on Technological Regulation and Metrology of Kazakhstan is the authorized body for the issue of CT-KZ certificates on the origin of goods. A CT-KZ form certificate is issued in respect of goods for internal circulation, and it specifies the share of local content in goods.

The analysis of the development of norms on Kazakhstani or local content during the last two decades reveals that the legislative regulation of such norms has tightened considerably and became of a mandatory character.

Public & Private Partnerships in Kazakhstan

Currently, in many countries the development of the economy is characterized by the consolidation of the input of the public and private sectors. Public-private partnerships (PPP) in Kazakhstan are one of the developing institutions of the economy. As world practice shows, the use of PPP mechanisms allows for increased efficiency in mutually advantageous cooperation of the state and the public sectors, ensuring the necessary financing, improving the quality of services provided, and speeding up the modernization of infrastructure to diversify the economy. PPP provides a number of advantages both for the state and the development of business. The private sector acquires new investment opportunities and subsequently new sources of income, and the chance to participate in new projects. PPP presupposes the use of resources and the intellectual potential of the private sector in spheres that are traditionally under the responsibility of the state.

In Kazakhstani practice, as well as in international practice, there is no generally accepted and statutory fixed definition of PPP. In general, PPP is a mutually advantageous cooperation of the state and private sector in areas traditionally referred to as the sphere of responsibility of the state, on the terms of a balanced spread of risk, advantage, and cost, in conjunction with the rights and obligations set forth in relevant agreements.

Kazakhstan has the legislative basis and experience in the application of one of the contractual forms of PPP based on a concession agreement.

The legislative basis for the use of PPP mechanisms is Law No. 167-III, “On Concession,” dated July 7, 2006 (the “Concession Law”), which provides for the transfer of the right of the creation of the objects of state property to foreign and national investors. In accordance with the Concession Law, the object of concession is an existing object owned by the state, or an object that will be created in future as a result of the performance of the obligations undertaken under the concession agreement. The PPP model currently used in Kazakhstan is that of Build-Operate-Transfer (BOT).

Under the Concession Law, the concession holder is granted the right of temporary possession and use of an object owned by the state under the terms and conditions set forth in relevant concession agreements, without the right to dispose of the object.

In addition, in accordance with the Concession Law, to support the activity of the concession holder, it may be granted one or a number of measures of state support.

The legislation on concessions also includes a number of sub-statutory and normative acts, which detail the legislative regulation of the planning and implementation of concession projects.

It is worthy to note that apart from a concession, the legislation of Kazakhstan provides for and presupposes other forms of cooperation between the state and private sector.

As a result, it is possible to formalize contractual relations in the form of a trust management agreement, which has the features of PPP based on a contract for operation and maintenance. In case of the use of PPP and execution of the operation and maintenance contract, it is obligatory to hold a tender for the selection of a private company for the operation of state property.

The legislation also allows for the setting up and implementation of joint projects with national companies (companies in which the state holds a controlling stake of shares). In that regard, the Law on Subsoil and Subsoil Use in force provides for the partnership of a national company with strategic partners—Kazakhstani or foreign legal entities—for the implementation of subsoil-use contracts executed as a result of direct negotiations with a national company and the competent body.

Another option is the establishment of social and business corporations (SBCs). SBCs are holding companies that operate state property at the local level. SBCs are meant jointly with the private sector to develop the mineral resources of the area, assist in the development of local business by way of providing land plots and funds, and construct and develop infrastructure. The target of SBCs is the use of resources of the state and the private sector for forming the business environment and encouraging competition in spheres that are socially important but not attractive for business at the current moment. Such spheres include education, health care, culture, and sport. With the financial support of the state and private sectors, SBCs should implement highly technological investment projects.

For further extension of the legislative practice for the implementation of socially important projects using PPP mechanisms, Kazakhstan needs to improve the legislative basis in this sphere.

The development of PPP as one of the efficient devices for the realization of infrastructure projects by way of attracting non-budget funds, and the high-quality operation of infrastructure objects by the private sector is considered by the government as one of the priority tasks of state policy. In that regard, the Program on the Development of Public and Private Partnership in Kazakhstan for 2011—2015 was approved by the government of Kazakhstan under Decree No. 731 dated June 29, 2011 (the “Program”). The aim of the Program is the formation of the legislative and institutional basis for the realization of investment projects using PPP mechanisms. The Program provides for measures aimed at the creation of the necessary conditions for the improvement of investment attractiveness of the projects to be implemented using PPP mechanisms.

The creation of the required legislative basis will widen the spheres of application of PPP mechanisms in various sectors of the economy, including utilities systems, education, science, health care, and the penitentiary system.

According to international practice, the development of PPP in a country presupposes three stages: preparation, implementation, and improvement. At the current moment, it is possible to state that Kazakhstan has completed the preparation stage and is at the stage of the intensive development and implementation of PPP, which is one of many interesting and attractive forms and areas of activity for local and foreign investors.

Applicable Law for Contracts

One of the main issues that foreign investors and businessmen may face during their business activity in Kazakhstan is the applicable law for their commercial transactions.

According to Article 1 of the constitution, the current law requires conforming to the laws, normative legal acts, international treaties, and other obligations, as well as the normative rulings of the Constitutional Council and the Supreme Court.

Due to the fact that Kazakhstan belongs to a continental legal system, Article 3 of the Civil Code provides the hierarchy of the laws and legislative acts that form the civil legislation of Kazakhstan. Additionally, Article 3 of the Civil Code provides that civil relations may be regulated by the customs (and business usages) if they do not conflict with civil legislation.

Pursuant to Article 1084 of the Civil Code, the applicable law to civil (including commercial) relations with the participation of foreign individuals and legal entities or complicated with foreign elements can be determined based on the Civil Code, other legislative acts, international treaties, and ratified by Kazakhstan and admitted international customs.

In other words, the provisions of international law and doctrine of private international law of Kazakhstan provide three sources of law: 1) international treaties; 2) local (national) legislation; and 3) international customs.

According to Article 1112 of the Civil Code of Kazakhstan, the parties may choose the applicable law to their contract, if otherwise not stipulated by the legislative acts of Kazakhstan.

The agreement on the applicable law should be very clear or directly follow from conditions of the contract of matters of the case. The applicable law shall cover, in particular: i) interpretation of the contract; ii) rights and obligations of the parties; iii) performance of the contract; iv) consequences of the non-performance or undue performance of the contract; v) termination of the contract; vi) grounds and consequences for the invalidity of the contract; and vii) assignment of the demand and transfer of debt.

The Civil Code of Kazakhstan (conflict of law rules) also allows for the determination of the applicable law if the parties did not choose the applicable law in the contract. For example, if the parties fail to choose the applicable law in the contract, the applicable law shall be the law of the area where the activity is registered, or where the main place of activity of the party is, and which is:

i) a seller in a sale and purchase agreement;

ii) a grantor in a gift agreement;

iii) a lessor in a lease agreement;

iv) a lender in an agreement of free usage of property;

v) a contractor in a construction contract;

vi) a carrier in a carriage agreement;

vii) a shipping agent in a freight forwarding agreement;

viii) a creditor in a loan agreement;

ix) an agent in an agency agreement;

x) a commissioner in an agreement for a commission agent;

xi) a keeper in a custodial services agreement;

xii) an underwriter in an insurance agreement;

xiii) a principal in an agency agreement;

xiv) a pledger in a pledge agreement; and

xv) a grantor of a license in a licensing agreement for using intellectual property rights.

In certain very limited cases provided in the law, only Kazakhstani law can be applicable to a contract despite any law chosen by the parties to the contract, for example: a contract for subsoil use; a foundation agreement for establishing a legal entity, and so on. In other cases, if it is contrary to the public order of Kazakhstan, legislation may also forbid the use of foreign law as the applicable law for a contract.

Therefore, before entering into a commercial contract, foreign investors must know the conflict of law rules of Kazakhstani private law.

Arbitration

In accordance with the laws of Kazakhstan, participants of civil law relations may refer legal disputes between them for resolution by international commercial arbitration.

Over recent years, the resolution of disputes at arbitration courts has become widespread in Kazakhstan. The explanation for it is the promptness and efficiency of dispute resolution, the independence and fairness of arbitrators, and also the simplicity and straightforwardness of arbitration procedures.

Currently, in Kazakhstan there is a developed legislative basis both for the functioning of national commercial arbitrations and recognition and enforcement on the territory of Kazakhstan of the awards of foreign arbitration bodies.

In Kazakhstan the disputes with participation of foreign entities may be considered by national (local) international commercial arbitrations.

To refer a dispute for resolution to international commercial arbitration the participants are required to enter into an arbitration agreement (arbitration clause).

An international commercial arbitration court is guided by its approved regulations when conducting its activity and considering disputes.

When applying for international commercial arbitration, participants are entitled to independently select the arbitrators who will consider the dispute, choose the language of proceedings, and determine the terms on applicable material law.

Arbitration proceedings in international commercial arbitrations may be held both with the attendance of the participants, i.e. in the form of holding oral hearings, as well as on the basis of materials provided in writing when the participants do not attend the hearings.

Kazakhstan is a party to all main arbitration conventions, including the New York Convention of 1958 on the Recognition and Enforcement of Foreign Arbitral Awards, which allows for the recognition and enforcement of the awards of foreign arbitration on the territory of Kazakhstan.

The recognition and enforcement of foreign arbitral awards is carried out in accordance with the national civil procedural legislation and the laws on the enforcement of judicial acts by way of applying to state courts.

Thus, the operation of Kazakhstani commercial arbitration and the possibility of the recognition and enforcement of foreign arbitral awards creates a favorable environment for investors in Kazakhstan.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

TBY would like to thank Integrites International Law Firm for compiling this analysis.