1. Introduction

As is known, contracts for subsoil use have a special status.This is because they concern the natural resources of the Republic of Kazakhstan and thus the country's vital interests. The subsoil of Kazakhstan is the exclusive property of the State. Despite the fact that the State grants the right of subsoil use to the possession of individuals, it nevertheless endeavours to retain substantial control over the rational use of mineral resources. 

The priority right of the State was first introduced in December 2004, as part of the amendment to the Law of the Republic of Kazakhstan on 'Subsoil and Subsoil Use' of January 27, 1996. Before the adoption of this legal amendment, in general the notion of the State's priority right had not been clearly established.

One of the reasons for introducing the concept of the priority right may have been the situation in 2003, when one of the participants in the development of the Kashagan field had announced the sale of shares belonging to it (16.67%) in the North Caspian Production-Sharing Agreement ('NPS') to two Chinese companies. The other NPS subsoil users who held the priority right to acquire the share of the outgoing subsoil user, expressed a desire to exercise their priority right of first refusal to acquire the said shares, though at that time in the Republic of Kazakhstan such a right had not been expressly agreed. In connection with this, Kazakhstan declared its right to purchase shares of alienated right of subsoil use, which took precedence over the priority rights of other parties.

Over time, the State widened the scope of application of its priority right. In particular, the priority right was extended to cover participatory shares in a subsoil user or its direct and indirect owners. 

2. The concept of the priority right and how it is exercised

Currently, the State's priority right is understood to be the priority right of the State to acquire the alienated right of subsoil use (parts thereof) and/or objects associated with the right of subsoil use. The objects related to the right of subsoil use are defined as: 1) a share/shares in a legal entity which has the right of subsoil use or 2) shares in a legal entity which has the ability to directly or indirectly determine the decisions and/or influence the decision making process of such a user, if the legal entity's main activity is connected with subsoil use in the Republic of Kazakhstan (the 'Objects')[1]. In other words, the State, typically represented by a national company, has the right to redeem alienated the subsoil use right and objects, not allowing them to be transferred to third parties.

The issue of whether to refuse or exercise the priority right of the State is the duty of the Ministry of Oil and Gas of the Republic of Kazakhstan (for hydrocarbon projects) and the Ministry of Industry and New Technologies of the Republic of Kazakhstan (for solid minerals). These bodies act as the so-called competent authorities within their respective spheres. 

Among the national companies involved in the implementation of the State's priority right in the mining sector are JSC NGK Tau-Ken Samruk ('Tau-Ken'), and in the area of hydrocarbons – JSC National Company KazMunaiGas ('KMG').

To date, the Law on 'Subsoil and Subsoil Use' of June 24, 2010 year (hereinafter – 'the Subsoil Law') stipulates the need to obtain permits for the transfer of subsoil use rights or objects. For this the alienator must submit an application to the competent authority in accordance with the requirements of the Subsoil Law. This statement should include a request to consider whether the priority right of state applies, and, if the appropriate decision is made, to consider issuing the waiver of the priority right.

After receiving the application, the competent authority verifies the package of documents. Further materials are forwarded to the national welfare fund Samruk-Kazyna JSC, which, in turn, forwards them to appropriate national company (KMG or Tau-Ken). In response, the national company sends a conclusion regarding its interest/disinterest in acquiring the alienated right of subsoil use and (or) objects. 

At this time KMG also provides documents for review to its subsidiary JSC KazMunaiGas Exploration Production to obtain the appropriate conclusion.

The consideration of abovementioned applications by the national company is not expressly stated in the Law. Rather, it follows from the provisions of the law on mineral resources that the State has a priority right to purchase alienated right of subsoil use objects through the national managing holding company, national or an authorized State body. 

Subsequently, the conclusion of the national company together with materials submitted to the competent authority are put before Inter-Ministerial Commission for exercising the priority right of the State (the 'IMC'). As a result, taking into account the opinion of the IMC, the competent authority makes the decision to either exercise or not exercise the priority right. 

Next, the application is considered by an expert commission which advises on whether to allow the alienation of the subsoil use right or objects. Then, based on the recommendations, the competent authority makes the appropriate decision.

The final response of the competent authority is like a letter and contains a waiver of the priority right (or decision to exercise it), and permission for the transfer of subsoil use right or objects (or a refusal to grant such permission). The letter also contains links to relevant protocols of the appropriate meetings of IAC  and of the expert commission. 

At this time the Subsoil Law lists a number of cases in which permission to transfer the right of subsoil use, or objects, or a waiver of the right of priority, are not required.

If the transaction is not completed within the prescribed period, the applicant must again apply to the competent authority for an extension of the authorization for a period not exceeding 6 months or obtain a new authorization to complete the transaction.

Transactions and other acts carried out without the approval of the competent authority or upon expiration of the authorization shall be deemed null and void from the moment of their conclusion.

Moreover, failing to notify the competent authority of the completed transaction within 5 business days of its being made is a basis for deeming the agreement invalid.

3. Time periods for exercising the priority right

The approximate period for considering an application relating to the Subsoil Law is about 70 days (about 3.5 months), but this period is often not respected and may be up to 4-7 months for a number of reasons:

  • the competent authority and national company, as a rule, request further information from the applicant. The law does not contain explicit restrictions on the number of additional requests authorities can make;
  • a clear period has not been established for when the national company must complete its consideration ;
  • IMC meetings do not take place regularly.

If the competent authority decides to exercise the priority right, the national company or relevant state body will initiate negotiations with the alienator. In such case the subsoil use right or facility should be sold to the State within 6 months.

4. Difficulties with the State's priority right

The lack of a precise definition of objects associated with the right of subsoil use

According to point 23 Article 1 of the Subsoil Law, objects related to the right of subsoil use are defined as a share/shares in a legal entity which has the right of subsoil use, as well as a legal entity who has the ability to directly or indirectly determine the decisions and/or influence decisions taken by such user, if the legal person's main activity is connected with subsoil use in the Republic of Kazakhstan.

Objects also include securities confirming the right of ownership of shares or which are convertible into shares of a legal entity which has the right of subsoil use, as well as a legal entity that has the ability to directly or indirectly determine decisions and/or influence decisions taken by such user, if the legal entity's main activity is connected with subsoil use in the Republic of Kazakhstan. 

The legislation does not explicitly state when the principal activity of the entity shall be deemed to be associated with the right of subsoil use in Kazakhstan. It often occurs that in deals involving shares in major holding company, where the share of the Kazakhstani subsoil user is 5-7 per cent, the permission of the competent authority and the renunciation of the right of priority are required. To resolve this problem, it is necessary to insert in the Law a method for determining whether the principal activity of a legal entity is associated with the right of subsoil use in Kazakhstan.

No clearly defined cases where authorization of the sale of subsoil use right or objects are not required

As indicated above, the Subsoil Law provides for a number of cases in which the permission to transfer rights of subsoil use or objects is not needed. As a rule, this is for when there is a transfer within a group of persons, when an actual change in the control of objects does not occur. 

For example, under point 5 of Article 36 of the Subsoil Law, permission is not required for the transfer of all or part of the subsoil use right or objects in favour of a subsidiary, in which at least 99% participatory share (shares) is directly or indirectly owned by the subsoil user, if such a subsidiary is not registered in a country which has preferential tax treatment. This provision contains a technical error, since objects (which are, for example, shares in a subsoil user) cannot be transferred by a subsoil user. The current version allows the transfer of the right of subsoil use only to the daughter company of the subsoil user (with its associated object), and not, for example, to the company which owns the subsoil user.

To resolve this error, it is enough to correct the provision in the following way: for the word 'alienator' read any entity, and not just a subsoil user. 

The absence of regulation regarding the transfer of the right of subsoil use and objects in a pledge, as well as under bankruptcy proceedings

The law does not establish detailed regulation rules related to the transfer of subsoil use rights and (or) objects under a pledge, or during bankruptcy proceedings. Please further note that in practice the above procedure is different from the normal authorization procedure, and as such increases the likelihood of an incorrect interpretation of the Subsoil Law.

5. Current problems

In our view, the idea of the priority right is to enable the government to establish permanent control over the distribution rights of subsoil use in Kazakhstan. When the priority right was first introduced, its scope was broad enough and included both the right of subsoil use and participatory interests/shares in subsoil users and their direct and indirect participants. With the introduction of the current Law on Subsoil, the scope of the priority right was extended to convertible securities.

This situation generally does not improve the investment climate in the country, as it reduces the guarantee of preserving your business in Kazakhstan.

The situation is worsened by the fact that the procedure for exercising the State's priority right takes a significant period of time, and the Subsoil Law contains a number of ambiguities regarding exceptions for obtaining approval for a deal.

***

Currently, the Ministry of Industry and New Technologies and the Ministry of Oil and Gas are working on improving the Subsoil Law. In particular, it is planned to limit the scope of the priority right to strategic deposits, as well as related Objects.