I.         Introduction

Foreign companies face a variety of legal risks in the course of doing business in the Republic of Kazakhstan (RoK). Inadequate laws, corruption, lack of transparency of courts and regulatory authorities, unpredictability of judgments issued by state courts, in the author’s view, represent the greatest risks when doing business in the RoK.

In this article, the author aims to briefly analyze the main strategies available for mitigating  some of the legal risks mentioned above in the hope that readers will find them helpful. 

II.      Structuring Investments via a State Which Has Entered Into a Treaty with the RoK on the Mutual Promotion and Protection of Investments

2.1.The Significance of Treaties on the Mutual Promotion and Protection of Investments

Prior to entering a market, generally, foreign investors thoroughly examine double taxation treaties and relevant legal environment in order to evaluate tax implications of investing in the RoK from a particular jurisdiction and select a jurisdiction which has a tax treaty with the RoK, offering maximum tax efficient treatment. However, only a minority of potential investors pays sufficient attention to Treaties on the Mutual Promotion and Protection of Investments (BIT) entered into between the RoK and a foreign jurisdiction. In the author’s view, foreign investors should not underestimate the significance of BITs for the protection of their investments in the long run, as a tax treaty could become of little use, if there is no profit.

On several occasions, recognized legal practitioners of the RoK expressed views that domestic laws of the RoK and the judiciary can adequately protect foreign investors. They argued that BITs mostly contain declarations of signatory states. Other authors expressed the view that the scope of BITs is only limited to granting a foreign investor the right to submit to arbitration against the host state. It is difficult to fully agree with these views. As numerous awards of international arbitral tribunals reviewing investment disputes have shown, BITs offer effective protection which goes far beyond the protection available to foreign investors under domestic laws of the RoK.  

2.2.   Protection Available Under BITs

Since gaining independence, the RoK has ratified or acceded to more than 40 BITs and a few multilateral treaties on the protection of foreign investments. The analysis of BITs signed by the RoK shows that protection available under BITs varies substantially from treaty to treaty. Generally, BITs entered into with capital exporting states offer extended protections relative to BITs entered into with developing capital importing states.

BITs may offer the following categories of investment protection:

  • Most Favored Nation Treatment;
  • Fair and Equitable Treatment;
  • Observation of any obligation entered into by the host state with regard to the investments;
  • Full Protection and Security; compensation in the event of expropriation caused by actions or omissions of the host state, its subdivisions and other state authorities (e.g. municipal authorities).

Notions like “non discrimination”, “most favored nation treatment”, or “fair and equitable treatment”, at a first glance, may not seem to bear any special meaning, particularly to RoK trained lawyers. However, BITs are interpreted according to previous judgments of international courts and tribunals issued on similar matters. As this volume of authorities demonstrates, these notions can be interpreted with reasonably sufficient clarity. The norms contained in BITs, in fact, are not declarations, but turn out to be concrete obligations assumed by a host state towards a foreign investor.

For example, the standard of “fair and equitable treatment” obligates a host state to provide a stable environment for investments, ensure the availability of a fair and impartial judicial process, observation by the host state of its promises made to the foreign investor, and performance of contractual obligations to the foreign investor, etc. The obligation to “observe any obligation entered into with regard to the investments” implies a host state’s duty to observe the terms and conditions of investment contracts and other agreements entered into with a foreign investor. If this duty is breached, host state’s breach of contract would not only give rise to contractual remedies, but also result in violation of international law and thereby provide a foreign investor with remedies available under international law.

2.3.   International Arbitration

Courts of a host state are not always impartial when it comes to reviewing claims of a foreign investor against the government of a host state. Sometimes, even courts within states where the judicial system is considered to be independent demonstrate partiality. In order to avoid this, many foreign investors seek to resolve disputes in international arbitration.

The main rule governing conduct of international arbitration is the agreement of the parties to submit to arbitration in the event of a dispute (arbitration agreement). BITs generally contain a host state’s unilateral offer to resort to international arbitration, should an investor initiate international arbitration alleging violation of a BIT. By initiating international arbitration, a foreign investor accepts the host state’s offer to arbitrate a dispute and the arbitration agreement is deemed to have been constituted.

This option to access international arbitration is very effective in situations where the host state does not agree to incorporate an arbitration agreement into an investment contract or if, for example, the host state’s consent to international arbitration is contained in domestic laws. In the latter case, domestic laws can be amended or repealed. This was the case in the RoK when the 1994 RoK Law “On Foreign Investments”, containing the RoK Government’s consent to international arbitration, was repealed.

2.4.   Conclusion

The fact that the RoK is being named a respondent in a growing number of arbitration proceedings initiated by foreign investors seeking compensation of damages for the RoK’s breaches of BITs and other international treaties on the protection of investments (for example, the Energy Charter Treaty) demonstrates the effectiveness of BITs. There have been several examples where foreign investors have been able, fully or partially, to receive damages for their investments. Information on ongoing arbitral proceedings and the terms and conditions of agreements to settle the disputes (if any) are confidential and very rarely publicly available. Thus, it is difficult to fully evaluate the legal implications of breaches of BITs signed by the RoK.

In light of the above, where possible, foreign investors are advised to structure investments into the RoK through a holding company registered in a country which entered into a BIT with the RoK. It is important to select a jurisdiction with a BIT which provides adequate protection. Availability of BIT protection does not always ensure a favorable outcome, because the position of investor would depend on many different circumstances. Nevertheless, the availability of BIT protection serves as a reliable platform for protection of investments in the RoK.

III.   Investment Insurance

3.1.   General Overview

Multilateral Investment Guarantee Agency (MIGA) at the World Bank was established by the Convention signed in Seoul in 1985. MIGA was established with the objective to extend insurance coverage to investments of foreign individuals and companies from MIGA member states into developing MIGA member states. In order to be eligible for MIGA insurance a company investor must be registered and conduct its main business activities in a foreign state or be controlled by the majority of individuals, citizens of MIGA member states.

According to the Convention, MIGA insures, among other things, participation (shareholding) in legal entities, shareholder loans, investments in acquisition, modernization, and expansion of investment projects.

In order to obtain insurance coverage from MIGA, an investor should apply to MIGA. MIGA reviews an application and decides upon it. The Convention requires a host state’s consent prior to provision of insurance coverage, because in the event of insurance payment MIGA would be subrogated to an investor’s claim against the host state. Generally, MIGA serves a certain waiting period upon a host state and issues insurance, should the host state fail to respond.

3.2.   Coverage

MIGA insurance covers the following risks:

  1. Currency inconvertibility and transfer restrictions;
  2. Expropriation, including so-called indirect expropriation (loss of value of investments caused by a series of events having the effect of expropriation);
  3. War, terrorism, and civil disturbance;
  4. Breach of contract; and
  5. Non-honoring of sovereign financial obligations.

There have been practical examples where MIGA insurance allowed an investor to improve the credit rating of issued bonds which, in turn, helped the investor to lower borrowing costs. For more detailed information, please refer to the official website of MIGA at: www.miga.org.

3.3.   Cost, Duration, and Coverage

The annual cost of insuring risks at MIGA, generally, amounts to approximately one per cent of the value of investment. However, the cost of insurance significantly varies depending on the host state and sector into which the investment is intended.

MIGA provides insurance for up to 15 years and up to USD 220 million per project. Restrictions exist on the maximum volume of insured investments into one and the same state.

IV.   Resolution of Commercial Disputes

4.1.   Submission to Arbitration to the Extent Possible

Due to reasons described above, for the purposes of resolving not only investment related, but also commercial disputes, foreign investors should consider submitting disputes to international arbitration to the extent possible. Arbitration of disputes at recognized arbitration courts located on the territory of the RoK has proved to be effective in resolving medium or small disputes where arbitration outside of the RoK is too costly and time consuming. In considering arbitration of disputes in the RoK, one should bear in mind the restrictions established by the RoK laws. Arbitration courts located in the RoK may only review disputes arising out of commercial contracts. This means, all other categories of disputes are not capable of being resolved by arbitration.

The RoK laws distinguish two types of arbitration courts: international arbitration courts (IACs) and domestic arbitration courts (DACs). IACs and DACs differ only in the types of disputes which they can review: IACs review disputes where at least one foreign company or individual is involved, while DACs review disputes among RoK registered companies or citizens. Thus, for example a dispute between a foreign investor’s RoK incorporated subsidiary and a Kazakh company would fall within the jurisdiction of DACs. While dispute involving at least one foreign party, for example, a branch of a foreign investor in the RoK, could be submitted to IACs.

The RoK laws relevant to DACs envisage substantial restrictions: according to literal meaning of the law, awards of DACs can potentially be reconsidered on merits. However, the author is not aware of any cases where this has occurred in practice. DACs are substantially restricted in the types of contractual disputes which they can review compared to IACs. A number of legal practitioners have criticized laws governing the activities of DACs as effectively discriminating between local and international disputes.

In addition, while considering arbitration in the RoK one should bear in mind that, according to existing RoK laws, disputes involving rights to immovable property located in the RoK and several other categories of disputes fall within the exclusive competence of state courts of the RoK. Exclusive competence means that the dispute cannot be submitted to arbitration, and, if submitted, the resulting arbitral award is likely to be unenforceable in the RoK.

Notwithstanding the restrictions described above, in the author’s experience, submission of disputes to recognized arbitral institutions of the RoK ensures due process and prevents interference with decision making process of arbitral tribunals. Arbitration in the RoK is a good alternative to litigation in state courts of the RoK and costly and time consuming arbitration outside of the RoK.

4.2.   Structuring Shareholder Agreements at the Level of a Holding Company Registered in a Western Jurisdiction with Developed Legal System

Company laws of the RoK contain a number of uncertainties. In addition, there are many mandatory rules which foreign investors may find burdensome. For example, the RoK company laws contain a mandatory rule requiring a shareholder agreement for an entity registered in the RoK under foreign ownership, and among other things, for transfers of shares in such company to be governed by laws of the RoK. The RoK laws are not always flexible to reflect arrangements customary for shareholder agreements commonly signed in western jurisdictions.

In order to avoid these restrictions, sometimes, foreign investors choose to enter into a shareholder agreement at the level of a holding company registered in a western jurisdiction which has a developed legal system. The holding company then becomes sole shareholder of the subsidiary registered in RoK.

This type of arrangement, provided that all relevant procedures are observed, allows shareholders of the holding company to submit shareholders disputes to arbitration or courts of a foreign state depending on what is permitted by laws of the jurisdiction where the holding company is registered. This structure could help to avoid any possible pressure from powerful local shareholders, if applicable.