On 24 October 2007 the president of Kazakhstan signed into law an amendment to the Subsoil and Subsoil Use Law (the Subsoil Use Law) purporting to allow the government to cancel oil and gas contracts with foreign investors if foreign investors do not agree to renegotiate those contracts. The amendment has been seen as an attempt principally to bring pressure to bear on the contracting companies at the Kashagan field to renegotiate their production sharing agreement (PSA). Its effect could, however, reach far further.
The law and its effect on foreign investors
Kazakhstan’s Subsoil Use Law regulates the use of Kazakhstan’s underground resources, including oil, natural gas, metals and minerals.
The amending law adds new grounds on which the government of Kazakhstan may terminate contracts for subsoil use (including PSAs).
The new article 45-2(1) allows the government of Kazakhstan to propose amendments to existing contracts if a subsoil user’s actions with respect to deposits of strategic importance materially alter Kazakhstan’s economic interests, creating a threat to its national security.
The Subsoil Use Law as amended includes additional grounds upon which the government of Kazakhstan may terminate a subsoil use contract: if the subsoil user refuses to enter into negotiations with respect to changes proposed under article 45-2(1) within two months, or if changes to the contract are not agreed within four months of the subsoil user’s agreement to negotiate. The contract can also be terminated if changes are not implemented within six months of the parties’ agreement to the changes.
In addition, new article 45-3 allows the government of Kazakhstan to stop performing the contract if the subsoil user’s actions with respect to deposits of strategic importance materially alter Kazakhstan’s economic interests, creating a threat to its national security.
Three points should be noted about the amendments to the Subsoil Use Law:
- they grant the government of Kazakhstan the discretion to define deposits that are of ‘strategic importance’;
- neither the amending law nor the existing Subsoil Use Law defines what would constitute a ‘material alteration’ to Kazakhstan’s economic interests or a threat to Kazakhstan’s ‘national security’, the nebulous concepts that form the basis for the government’s purported right to renegotiate and/or terminate contracts; and
- the Subsoil Use Law before the amendment already contained certain grounds on which the government of Kazakhstan was entitled to suspend a contract (eg in the event of breach of contract by the subsoil user) or terminate a contract (eg in the event of material breach of a contract or work programme, or failure to remedy a problem that has led to the suspension of the contract).
Investors’ potential contractual rights
Any attempt by the government to exercise its renegotiation or cancellation rights under the amended Subsoil Use Law could trigger potential rights contained in an investment contract, particularly if it contains a stabilisation clause.
Such a clause will usually state that the contract is governed by the laws in force at the effective date of the contract and will provide for compensation if, as a result of later-passed laws, the investor’s economic position deteriorates.
However, in addition to any such contractual rights, investors are likely to have significant and actionable rights under relevant bilateral and multilateral investment treaties.
Investors’ rights under bilateral investment treaties
A bilateral investment treaty (BIT) is an instrument of international law that provides investors with certain protections for their investments in a foreign state and, in most cases, a right to seek direct redress against governmental action that causes them loss. This redress is available in the form of international arbitration against the host state, often under the auspices of the International Centre for Settlement of Investment Disputes (ICSID), an arm of the World Bank in Washington, DC.
Kazakhstan is a party to some 35 BITs, most of which are in force. It has treaties that have entered into force with the following states, among others:
- the United Kingdom;
- the United States of America;
- the Netherlands;
- Spain; and
Although the guarantees can vary depending on the treaty, the following investor protections are common to many BITs:
- fair and equitable treatment – the basic minimum standard regardless of the host state’s domestic law;
- mandatory compliance with obligations entered into with investors in connection with investments;
- national treatment and ‘most favoured nation’ treatment, prohibiting discrimination on the basis of nationality;
- ‘full protection and security’ for investments;
- free transfer of investments and returns; and
- no expropriation, or measures equivalent to expropriation, without prompt, adequate and effective compensation.
The concept of expropriation extends to an indirect taking (also referred to as ‘creeping’ or de facto expropriation) in the form of interference with the use and enjoyment of property. Whether a particular governmental measure amounts to indirect expropriation is often controversial and will be decided on a case-by-case basis. The test, however, is generally accepted as the following: whether the host state’s measures have resulted in a substantial diminution in the value of the investment (or deprived the investor of the substantial benefit of the investment) even though the actual title to the asset remains with the investor.
Fair and equitable treatment is one of the most valuable guarantees contained in modern investment protection treaties. The precise content of the fair and equitable treatment standard is the subject of some debate, but it is acknowledged that failure to provide a stable and predictable investment environment, for example by suddenly altering the legal framework within which an investment was made, can in certain circumstances constitute a breach of the standard.
Many BITs contain a clause imposing a requirement on the contracting states to observe obligations entered into with private parties. There are differing views as to the type of obligation a state must breach to found an action for breach of such a clause, but recent decisions suggest that breach of a contractual stabilisation clause may constitute such a breach.
Rights under the Energy Charter Treaty
The Energy Charter Treaty (ECT) is a multilateral treaty among most of the countries of the former Soviet Union and the countries of western Europe (among others). It has been ratified by 46 states, including:
- the United Kingdom;
- Belgium; and
- the Netherlands.
The ECT covers a range of issues not included in most BITs (in particular, trade in energy products and transit of energy across the territory of member states), but the section of the ECT dealing with the promotion and protection of energy sector investments is an adapted version of the Organisation for Economic Co-operation and Development (OECD) model BIT and therefore contains many of the protections contained in the BITs signed by most western European countries. BIT and ECT protection in practice
Even if they are not considering arbitration, it is vital for foreign investors to know their rights and the protection available to them under investment protection treaties. This will enable them to enter into any eventual negotiations with the government of Kazakhstan from the strongest possible position: safe in the knowledge that any stance can be backed with the real possibility of legal action.
In addition to considering these potential rights, investors will now wish to ensure that, in communicating with the government in the immediate aftermath of the law, they consider the steps necessary to preserve any international law-based arguments that they may wish to rely on in the future.