Our experience with foreign investors doing business in Kazakhstan demonstrates that foreign businesses operating in Kazakhstan may face a variety legal challenges and risks: from uncertainties in law and sometimes unreasonably bureaucratic procedures to a judicial system which is not transparent and not always predictable.
Disputes with local and national state authorities are common in the course
of obtaining permits, construction, and operation of investment in Kazakhstan. Disputes with state authorities also frequently arise in connection with regulatory actions taken by various government agencies, e.g. over taxation, sanitary and epidemic regulation, foreign work permits, state audits, etc. Apart from political risks, disputes with a local partner or local third parties may arise in the course of implementation or operation of investment.
Disputes with State Authorities:
The vast majority of disputes with state authorities in the course of implementing an investment project arise out of regulatory actions of the state. This category of disputes, under Kazakh law, cannot be submitted to arbitration (whether foreign or domestic), because disputes would arise out of public actions of the state.
These disputes are reviewed by state courts of Kazakhstan. As our experience shows, state courts of Kazakhstan are not transparent. Sometimes, judgments are unpredictable and illegitimate. The courts are prone to administrative pressure and bias. In our practice, we notice the trend that state courts tend to support state authorities in a dispute where the substance of the dispute concerns payments to the state budget, e.g. tax payments, payments for emissions into environment, administrative fines, etc. or interests of the state.
There is no readily available solution to avoid the risks listed above. However, we would like to share with you some ideas which other foreign businesses have applied in order to mitigate the risks described above.
Entering into Memorandum of Understanding with the Government
Few large investment projects in Kazakhstan have been supported by the central or municipal government. For example, the Abu Dhabi Plaza project in Astana has been actively promoted by the municipal government of Astana and the central government. Kazakhstan and United Arab Emirates have signed and ratified an international treaty in respect to this project to set out a regulatory regime distinct from that existing under Kazakh law.
Some investors try to seek support from local municipalities by entering into certain memoranda of understanding (MoU) where the local municipality takes obligations to assist in regulatory matters which may arise in the course of operation of the investment project. Although the MoUs generally do not have a binding effect under Kazakh law, they could be used in potential disputes to obtain support from relevant state authorities or to demonstrate the court that the dispute has political implication and that it needs to be properly reviewed.
Establishing a Holding Company via a BIT Jurisdiction
Kazakhstan has ratified or acceded to over 40 bilateral treaties on the mutual protection and promotion of foreign investment (BIT). The BITs generally provide for protections to foreign investments originating from the BIT signatory state (the home state of the investor) ranging from guarantees of non-discrimination, most favored nation treatment, fair and equitable treatment to full protection, security, and compensation in the event of expropriation (taking of the investment) caused by actions or inactions of the Government of Kazakhstan or subdivisions or agents thereof. The BITs generally provide a foreign investor an opportunity to bring a claim against the government to an international arbitral tribunal, if the investment is expropriated or its value is diminished considerably due to actions of local or central government, its subdivisions, or agents. In this connection, it is generally advisable that a foreign investment in Kazakhstan is structured via a holding structure incorporated in jurisdiction which has entered into a respective BIT with Kazakhstan subject to certain circumstances. BIT protection may not always be available, however.
By way of information, the Government of Kazakhstan has been named a respondent in a growing number of arbitrations where foreign investors sought compensation for violations by the Government of relevant BITs, other international treaties, or breaches of guarantees extended by contract to a foreign investor. There are several examples where foreign investors have been able fully or partially to recover their investment. However, largely, information on these proceedings is not publicly available and the terms of settlements (relatively frequent) are not always open to public scrutiny.
Although this type of investment protection is used by foreign investors relatively seldom, still few large projects in Kazakhstan have been insured at the Multilateral Investment Guarantee Agency of the World Bank (MIGA). For example, Raiffeisen Bank’s leasing arm and the acquisition of ATF Bank by Unicredit Group and few other large acquisitions in Kazakhstan have been insured at the MIGA.
MIGA can offer insurance against: (i) currency inconvertibility and transfer restriction; (ii) expropriation; (iii) war, terrorism, and civil disturbance; (iv) breach of contract; and (v) non-honoring of sovereign financial obligations.
More information on the types of insurance and conditions thereof could be obtained at the official website of MIGA at: www.miga.org.
We note that the option to arbitrate a dispute may not always be available for businesses operating in Kazakhstan for the following reasons:
Domestic vs. Foreign Arbitration
According to conservative interpretation of Kazakh law, arbitration outside of Kazakhstan is available only if at least one of the parties to a commercial dispute is a foreign entity (entity incorporated outside of Kazakhstan) or individual. That means, if a dispute arises with a Kazakh company, arbitration outside of Kazakhstan would be available only if the other party to the dispute (your legal entity) is incorporated outside of Kazakhstan. This circumstance should be borne in mind when entering into a transaction which contains an arbitration agreement.
This complication arises out of interpretation of Kazakh arbitration law such that commercial disputes between companies incorporated in Kazakhstan, if submitted to arbitration, must be arbitrated solely within the territory of Kazakhstan. Arbitration of disputes in Kazakhstan where both parties to the dispute are residents of Kazakhstan has a considerable downside: arbitral awards issued by domestic arbitrations in disputes between residents of Kazakhstan are more prone to annulment rather than the awards issued by foreign arbitrations. In fact, theoretically, an arbitral award issued by a domestic tribunal may be reviewed on merits. Arbitration within Kazakhstan is also considerably restricted in terms of arbitrability of disputes.
Arbitrability of Disputes over Rights to Real Estate in Kazakhstan
Under Kazakh law, disputes, among others, over rights to real property located in Kazakhstan fall within the exclusive jurisdiction of Kazakh courts. Exclusive jurisdiction means that disputes could not be submitted to arbitration, and if submitted to arbitration, a subsequently issued arbitral award would most likely be unenforceable in Kazakhstan. As a matter of Kazakh law, a finished construction (an aggregation of construction materials) becomes a real estate, within the meaning of Kazakh law, at the time of state registration of the finished construction in the state legal cadastre (register of real estate). In light of the above, considerable legal uncertainties may arise over arbitrability of a dispute arising out of construction contract, if an object of finished construction is registered in the state legal cadastre (becomes an object of immovable property) after an arbitration is initiated, provided one of the parties in dispute claims rights over the immovable property. Seeking a judicial injunction (stay order) in this case would be vital to save the arbitral award.
We note, however, that the legal risk discussed in the preceding paragraph may not affect enforcement of an arbitral award outside of Kazakhstan.
Kazakh company laws contain a number of uncertainties and mandatory provisions which one may view as burdensome or risky. For example, under Kazakh law, a shareholders’ agreement in relation to a legal entity incorporated in Kazakhstan, including transfers of interest in a Kazakhstani entity, and other arrangements between shareholders of a Kazakhstani entity must be governed by Kazakh law. This mandatory rule requires shareholders to apply Kazakh law, which is not always flexible to reach shareholders’ arrangements commonly accepted in western jurisdictions.
In order to avoid the legal uncertainties arising out of application of Kazakh law, many foreign investors enter into shareholder arrangements at the level of a holding company incorporated in a western jurisdiction with a more shareholder friendly legal system. As a result, a holding company becomes the sole shareholder of the local entity, while the main shareholders’ activities are taken at the level of the holding company. This arrangement may allow shareholders to arbitrate their dispute or have it reviewed by courts of foreign jurisdiction, depending on the laws of relevant jurisdiction. This structure helps also to avoid the risk of undue pressure from a powerful local shareholder, if applicable.
The vast majority of businesses in Kazakhstan choose the form of a business vehicle named a limited liability partnership (LLP). This structure is similar to an LLC or a private company existing in many western jurisdictions. This vehicle is easier to manage and incorporate, it requires no public disclosures. However, in few examples, we have seen foreign investors using a business vehicle in the form of a joint stock company (JSC) (analogous to a public limited company). JSC may or may not publicly trade its shares or subject to public disclosures and reporting. According to some of the foreign investors, JSC law offers greater certainty as compared to laws governing LLPs.