The main statute governing international arbitration in the Republic of Kazakhstan (hereinafter "RoK") was introduced in 2004. However, the growing interest in the resolution of disputes by means of international arbitration is only a recent development. In addition to those who would traditionally pursue this route, such as foreign companies or subsidiaries located in the RoK, an increasing number of Kazakhstani companies are considering international arbitration.
In light of this we would like to highlight the most significant areas of uncertainty in the law which should be borne in mind by parties contemplating arbitration.
- Risks Associated With Clauses Stipulating Arbitration as the Means of Dispute Resolution or Courts of General Jurisdiction, which are at the Discretion of One of the Parties or So-Called “Split Arbitration Clauses”
We frequently encounter arbitration agreements which permit one of the parties to submit a dispute not only to international arbitration, but also to courts of general jurisdiction (state courts). This category of arbitration agreement is also referred to as a "split arbitration clause". Split arbitration clauses are common in loan agreements entered into with western financial organizations. They could also be found in other types of commercial contracts. In these contracts, the right to select the forum (means of dispute settlement) generally rests with the creditor or pledgee. Below, for your reference, is an example of a split arbitration clause:
"The Parties agree that all disputes, controversies or claims arising out of or in connection with this Agreement, or its breach, termination or invalidity (the "Disputes") shall be subject to final resolution by arbitration in accordance with [indicate arbitral institution] Rules.
Section above is for the benefit of the Pledgeholder only. As a result and notwithstanding Section above, it does not prevent the Pledgeholder from taking proceedings relating to a Dispute in any other court having general jurisdiction in any country."
As you may see from the provision referred to above, the pledgeholder has the discretion to resort to either international arbitration or courts of general jurisdiction. In connection with this category of arbitration agreement, we are frequently requested to assess whether a split arbitration agreement would be valid, and whether Kazakh courts would recognize and enforce arbitral awards issued by tribunals formed on the basis of a split arbitration agreement.
Although, in light of the principle of freedom of contract, RoK law does not prohibit entering into split arbitration agreements, in our view, there are risks regarding the validity of such arbitration agreements. For example, the fact that the arbitration agreement allows only one of the parties to submit to courts of general jurisdiction, while simultaneously preventing the other party from doing the same, may be viewed as a violation of the principle of equality of parties.
Recently, in June 2012, the High Arbitrazh Court of the Russian Federation applied this specific rationale (hereinafter "HAC RF") in "Sony Ericsson Mobile Communications" vs. ZAO "Russkaya Telefonnaya Kompaniya". The Resolution of the HAC RF is interesting in that it analyzed the validity of the following arbitration agreement:
"Any dispute arising in connection with this Agreement, if not resolved by negotiations, shall be subject to final resolution in accordance with Rules of Conciliation and Arbitration of the International Chamber of Commerce by three (3) arbitrators appointed in accordance with the said Rules. The place of arbitration shall be London. The language of arbitration shall be English... The arbitration agreement does not prevent Sony Ericsson from initiating proceedings to recover the value of supplied Goods in a competent court having the jurisdiction."
Although the courts of lower levels have affirmed the validity of the arbitration agreements, sometimes referring to the principle of the freedom of contract, the HAC RF has held as follows:
"In light of the general principles of protection of rights, an agreement to resolve disputes may not vest in only one party (supplier) to the contract the right to resort to a competent state court and deprive the second party (customer) from such right. If such an agreement is concluded, it shall be invalid, as violating the balance of rights of the parties. Therefore, a party whose right has been violated may also resort to a competent state court and exercise the right for judicial protection on terms equal to those of its counter party."
The HAC RF concluded that the arbitration agreement was also invalid on the grounds that it violates the adversarial principle and the principle of equality of the parties.
It is difficult to agree with this rationale, because when entering into the arbitration agreement both parties were equal, and no one has been forced to limit one’s right to resort to courts of general jurisdiction. One could also argue that a creditor bears greater risks associated with the failure to repay the debt or return the value of the goods supplied. This explains why one party should have a priority in protecting his/her rights.
Having said that, notwithstanding broad criticism of the resolution issued by HAC RF, there is at least some certainty in the Russian Federation when it comes to the validity of split arbitration clauses. In Kazakhstan, due to lack of consistent judicial practice, the validity of split arbitration clauses remains questionable. This raises a number of questions and creates uncertainty in entering into contracts.
It is also unclear as to whether an arbitration agreement which allows both parties to resort to arbitration or courts of general jurisdiction, depending on the size of the claim, would be upheld.
- Risks Associated with Arbitration of Disputes Arising Out of Construction Contracts
In our experience, we come across situations where foreign contractors hired by local customers for construction in Kazakhstan require international arbitration to be selected as a means of dispute resolution. A number of clients have heard about the corruption in the judicial system, while others seek to avoid a dispute from being reviewed by a prejudiced local judge. This may be the reason why international arbitration is so popular among foreign businessmen doing business in Kazakhstan.
Developers entering into a construction contract in RoK should appreciate the risks inherent in submitting disputes arising out of construction works to international arbitration. According to Article 6(4) of the Law of the RoK dated December 28, 2004 "On International Commercial Arbitration":
"Based on the agreement of parties, disputes between individuals and commercial and other organizations, arising out of commercial contracts, can be submitted to arbitration, provided at least one of the parties is not a resident of the Republic of Kazakhstan."
At first glance, this seems to present no serious issues. However, uncertainties arise when a construction is completed and its status changes from movable to immovable property. According to Article 68(13) of the Law of the RoK dated July 16, 2001 "On Architecture, Town Planning, and Construction in the Republic of Kazakhstan":
"13. An object of finished construction is subject to commissioning in accordance with chapter 11 of this Law. The Commissioning Act for an object of finished construction, as approved in the established order, serves as a basis for registration of the object with the state authority charged with registration of rights to immovable property."
A finished construction, comprising an aggregate of construction materials, is deemed immovable property at the time of its state registration. According to Article 417(1) of the Code of Civil Procedure of the RoK dated July 13, 1999:
"1. Courts of the Republic of Kazakhstan have exclusive competence to review: 1) cases relating to rights for immovable property located in the Republic of Kazakhstan..."
In light of the above, uncertainties may arise in practice, as discussed in more detail below: Example: if a dispute arises, can a foreign contractor resort to international arbitration, if the object of finished construction has already been registered, and it enjoys the status of immovable property? It is not clear whether an arbitral award issued in this dispute would be set aside or refused enforcement in the RoK on the grounds that the arbitral tribunal has exceeded its powers.
Disputes arising out of construction contracts may vary. The question as to whether an arbitral tribunal would have the jurisdiction to review a dispute arising out of a construction contract needs to be analyzed in each specific case.
For example, in the event that a customer fails to pay, according to Article 624 of the Civil Code of the RoK, a contractor may withhold the object of completed construction. In this case, in our view, there would be a dispute over rights to property located in the RoK, which is subject to exclusive jurisdiction of RoK courts. If, however, the dispute arises out of the quality of the construction, a claim to recover damages may not necessarily fall within the exclusive competence of the RoK courts. Having said that, sometimes, a party unwilling to submit the dispute to arbitration may formulate his/her claims in a way that the claims would appear as if they related to immovable property located in the RoK.
The risks described above should be thoroughly assessed when making a decision to incorporate an arbitration agreement into a construction contract, because, even if an object of completed construction has not been registered as immovable property at the time of submission of a claim to arbitration, it may be registered later during the arbitration proceedings. This circumstance may significantly jeopardize the chances of enforcing a subsequently issued arbitral award in the RoK.
In light of the above, in our view, it would be appropriate to issue guidance, by means of a Normative Resolution of the Supreme Court, explaining the application of Article 417(1) of the Code of Civil Procedure of the RoK to disputes arising out of construction contracts.
- Kazakhstan Residents Submitting to International Arbitration Located Outside of the Republic of Kazakhstan
Quite frequently we are approached by citizens of the RoK and businesses with the following question: can residents of the RoK resort to international arbitration located outside of the RoK? This situation frequently occurs among local subsidiaries of foreign multinationals operating in Kazakhstan.
On the one hand, it is not prohibited by law for companies registered in the RoK (or Kazakh citizens) to submit to arbitration located outside of the RoK. According to Article 41(1) of the law of the RoK “On Normative Legal Acts” dated March 24, 1998:
"Normative legal acts of the Republic of Kazakhstan adopted by the President of the Republic of Kazakhstan, the Parliament of the Republic of Kazakhstan, the Government of the Republic of Kazakhstan, central executive and other central authorized agencies, shall apply to the entire territory of the Republic of Kazakhstan, except to the extent that the normative legal act or acts on the entry of such act into force provide otherwise."
The Law of the RoK “On Arbitration Courts” dated December 28, 2004 applies to the resolution of disputes between residents of the RoK on the territory of the RoK. The law does not extend geographically to territories outside of the RoK. As a result, in our view, the law applies to the resolution of disputes between residents only within the borders of RoK. Thus, the question of whether or not residents of the RoK may resort to arbitrations located outside of the RoK needs to be analyzed under the laws of the foreign state where residents of the RoK seek to resolve their dispute. Generally, the laws of European countries and the United States do not prohibit foreign residents from resorting to arbitration located within those countries. As such, in our view, the law does not expressly prohibit residents of the RoK from submitting disputes to arbitrations located outside of Kazakhstan.
On the other hand, even if residents of the RoK submit their dispute to arbitration outside of RoK, uncertainties would exist over the enforcement prospects of a foreign arbitral award subsequently issued in a dispute between residents of the RoK. It is difficult to say whether submission by residents of the RoK to arbitration outside of the RoK may constitute a violation of the public order of the RoK. According Article 2(10) of the law of the RoK "On International Commercial Arbitration" dated December 28, 2004, "public order" means "the fundamentals of state and public structure as established by laws of the Republic of Kazakhstan". Let us assume that submission by residents of RoK to foreign arbitrations violates the public order of the RoK. Such a conclusion, however, would constitute discrimination against residents of the RoK in favour of non-residents, because the latter category of entities is not prevented from arbitrating disputes abroad. This in turn would violate the principle of equality of rights, which could be considered the violation of "the fundamentals of state and public structure, as established by laws of the Republic of Kazakhstan".
In light of this uncertainty, residents of RoK considering the option of submitting a dispute to arbitration outside of RoK should thoroughly evaluate the risks discussed above. It is worth mentioning, however, that in a situation where a foreign arbitral award does not entail enforcement on the territory of RoK (e.g. if the property of the respondent is located outside of RoK), risks concerning the recognition and enforcement of an arbitral award should be analyzed under the laws of the state where enforcement is sought. In this case, in the course of enforcing a foreign arbitral award issued in a dispute between residents of RoK, the risks described above may not be present.