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Editorial

Transfer of the subsoil use right in Kazakhstan: risks and recommendations overview

This article is prepared by Yessen Massalin, Head of Corporate practice. For further information please email to yessen@olympex.kz 

The article analyses the main requirements established by the Subsoil Use Law 2010 in regard to transfer of the subsoil use rights in Kazakhstan. At the same time, a comparison analysis has been done with respect to the previous law that reveals some advantages and complications of the new law while transferring of the subsoil use tights. The article also focuses on exemptions available under Subsoil Use Law that allow for subsoil users to sell the subsoil use right in Kazakhstan without state consent and obtaining waiver of the state priority right.

The Law of the Republic of Kazakhstan ("RoK") "On Subsurface and Subsurface Use" signed on 24 June 2010 (the "2010 Law")  compared with the RoK Law "On Subsurface and Subsurface Use" dated 27 January 1996 (the "1996 Law"), regulates the procedure for transferring the subsurface use rights (shares, participatory interests) thoroughly.

However, a large number of detailed additions and amendments explains the need to study their essence and how they will impact the circulation of subsurface use rights and all related risks for subsurface users.

1. Objects Related to the Subsurface Use Right.

 
Before we start analyzing the changes made in the legal regulation of the procedure for the transfer of the subsurface use right, let's review what "objects related to the subsurface use right" (the "Objects") are.
 
Pursuant to the 2010 Law, Objects include:
 
1)                 participatory interest (blocks of shares) in:
 
-                     a legal entity which is a subsurface user;
 
-                     a legal entity which is able to determine, directly and/or indirectly, decisions and/or influence on decisions made by such subsurface user, provided that the principal activity of such legal entity is associated with the subsurface use in the Republic of Kazakhstan.
 
2)                 securities confirming the right of ownership of shares or convertible into shares of:
 
- a legal entity which is a subsurface user;
-  
- a legal entity which is able to determine, directly and/or indirectly, decisions and/or influence on decisions made by such subsurface user, provided that the principal activity of such legal entity is associated with the subsurface use in the Republic of Kazakhstan.
-  
It should be noted that the novelty introduced by the 2010 Law defining "Objects" is technical as the 1996 Law without developing terminology, in essence, uses participatory interest (shares) for the purposes similar to those pursued by the 2010 Law.  
 
2. Detailed regulation of the transfer of the subsurface use right and Objects.
 
While identifying Objects related to the subsurface use right, the 2010 Law, if compared to the 1996 Law, attempts to give a clearer structure to the concept of the transfer of the subsurface use right and Objects.
 
The scope of the ways by which the transfer of the subsurface use right and Objects can take place, which under the 1996 Law included:
 
-                     alienation on the basis of civil legal transactions;
 
-                     transfer to the charter capital;
 
-                     alienation in the course of privatization, bankruptcy proceedings;
 
-                     enforced execution, including in case of a pledge;
 
-                     creation of pledge;
 
was expanded to include under Article 36 of the 2010 Law the following:
 
-                     acquisition of the right to an interest in a subsurface user (a legal entity controlling the subsurface user) as a result of the increase in the charter capital by means of additional contributions made by participants as well as upon admission of a new participant to the legal entity;
 
-                     initial public offering of securities in a subsurface user (a legal entity controlling the subsurface user) through listing on a regulated market.
 
The logic behind these additions is clear as these ways may lead to the transfer of Objects.  For example, an additional issue of shares under IPO may lead either to changes of shareholders of a subsurface user or to the change in the structure of the share capital of the subsurface user, which, based on the concept of the 2010 Law, requires prior consent.  

3. In which cases the consent is not required for the transfer?

 
 Section 5 of Article 36 of the 2010 Law presents a positive change for subsurface users - consent of the authorized bodies is not required for the transfer of the subsurface use right in the following cases:
 
a)                  execution of transactions concerning alienation of securities, which are traded on a regulated securities market, in a legal entity being a subsurface user, a legal entity which is bale to determine, directly and/or indirectly, decisions and/or influence on decisions made by such subsurface user provided that the principal activities of this legal entity are associated with the subsurface use in the Republic of Kazakhstan;
 
b)                 transfer, in full or in part, of a subsurface use right, Objects between legal entities in which not less than 99% of participatory interest (blocks of shares) is owned, directly or indirectly, by one person, provided that the transferee is not registered in a tax haven country;
 
c)                  transfer to a subsidiary in which not less than 99% of participatory interest (block of shares) is owned, directly or indirectly, by a subsurface user, provided that such subsidiary is not registered in a tax haven country;
 
d)                 transfer of shares (participatory interest) in a legal entity being a subsurface user if as a result of such transfer a person acquires the right directly or indirectly (through third persons) to dispose of less than 0.1% of participatory interest (blocks of shares) in the charter capital of the legal entity being a subsurface user and/or a legal entity which  is able to determine, directly and/or indirectly, decisions and/or influence on decisions made by such subsurface user provided that the principal activity of such legal entity is associated with the subsurface use in the Republic of Kazakhstan.
 
In this connection a question arises whether consent is required for the entry into stock exchange, i.e., for the initial public offering (IPO) of securities at the stock exchange.[1]
 
Historically, there were some cases when the competent body issued consent to companies to carry out an IPO specifying that the consent is also given to all subsequent sales of the placed securities on that stock exchange.
 
We believe that a similar understanding is also present in the 2010 Law since it exempts from control any "transactions in relation to the alienation of securities that are traded on a regulated securities market."  Here, the key word "traded" implies that exemption applies only to transactions with the shares that are already listed, but not transactions relating to the initial offering (as part of an IPO).  
 
This conclusion is supported by section 3 of Article 36 of the 2010 Law and by the fact that issue of consents for initial offering of securities for listing on a regulated market falls within in the scope of authorities of the Expert Commission for Subsurface Use.[2]
 
In other words, the 2010 Law provides a liberal regulation only for transactions in which a subsurface use right or Objects go "down" the chain of closely affiliated persons (ownership interest is not less than 99%).
 
And these limitations should be taken into account when planning transactions in the area of subsurface use.
 
4. Legislative legalization of the Interdepartmental Commission for Exercising the State's Priority Right.  Introduction of a new entity (the Expert Commission for Subsurface Use).

 
As discussed above, the 2010 Law[3] introduced some additions that legislatively formalize the existing practice of the state regulation of the circulation of subsurface use rights and related objects.
 
Thus, the new old entities[4] have been introduced in this area:
 
- the Interdepartmental Commission for Exercising the State's Priority Right ("IAC")
 
- the Subsurface Use Expert Commission ("EC").
 
Pursuant to the 2010 Law's definition:
 
-                     IDC is an advisory body established by the RoK Government with a view of reviewing issues and developing recommendations concerning acquisition (refusal to acquire) by the state of an alienated subsurface use right (part thereof) and/or of objects related to a subsurface use right in the RoK;
 
-                     EC is an advisory body established by the competent body for developing proposals for the competent body on the issues defined in Article 24 of the 2010 Law (issuance of consents for selling subsurface use rights and related objects, and other functions).
 
5. Correlation of the procedures: waiver of the state's priority right and consent for transfer.
 
Upon review of the provisions concerning the state's priority right for alienated subsurface use rights and Objects and consent for the alienation that have been expanded, when compared with the 1996 Law, certain changes in the procedural regulation should be noted.  The difference lies in that the procedure for issuing consent for the alienation essentially incorporates the procedure for exercising the priority right.
 
Before, when consummating transactions the subsurface user submitted a comprehensive application to the competent body requesting the following:
 
-                     waiver of the state's priority right, and
 
-                     consent for the transaction.
 
A single package of documents was enclosed and it was implied that those issues would be reviewed simultaneously.
 
Under the 2010 Law, these procedures now will not be parallel (simultaneous), but rather sequential, which seems to be logical based on the objectives of these procedures:
 
-                     initial review of the applicability of the priority right;
 
-                     if the state decides not to exercise its right, then the matter relating to issue of the consent for the transaction will be considered.
 
These changes will, in our view, increase the time period for reviewing applications as we will have two independent procedures with specific rules.
 
6. Conditions for issuing consents.

 
A special emphasis should be given to the introduction of conditions for issuing consent for the alienation of a subsurface use right and Objects.
 
Previously the 1996 Law provided for a somewhat different mechanism:  there were no mandatory conditions for issuance, but rather grounds on which the competent body had the right to refuse consent; this gives grounds to believe that the a stricter approach to reviewing applications has been enacted into law.
 
Moreover, not only another angle of looking has been introduced, but the conditions have been also modified:

 

No.

 

The 1996 Law

 

(refusal if any of the condition is present)

 

The 2010 Law

 

(consent on condition that)

 

1

 

If a potential transferee of the subsurface use right is not capable of performing obligations or part thereof (in case of a partial transfer of the subsurface use right) imposed on the subsurface user under a contract.

 

If the acquirer of a subsurface use right (part thereof) fully meets the requirements set by this Law for subsurface users and persons seeking to obtain a subsurface use right. 

 

 

 

2

 

The subsurface user has knowingly submitted false information to the competent body.

 

 

If the application for issuing consent to transfer subsurface use right, objects related to the subsurface use right corresponds to the requirements of the Law.

 

 

3

 

If the transfer of a subsurface use right entails failure to observe the requirements on ensuring the national security of the country, including in case of concentration of rights within the framework of a contract and/or concentration of rights to conduct operations in the area of subsurface use.  

 

 

 

If such transfer does not lead to the failure to comply with the requirements of the RoK law, including the requirements on ensuring the national security of the country, concentration of rights within the framework of a contract and/or concentration of rights to conduct operations in the area of subsurface use, as well as international treaties concluded by the RoK.

 

 

 

7. Effective term of consent
 
For the first time the law now stats an effective term of consent for the transfer of a subsurface use right, which is 6 months.
 
The logic behind this novelty is evident as it imposes a certain limit on the period of time for parties to a transaction to avoid incentivising the parties by giving an unlimited term of consent for the transaction to delay the transaction since the conditions under which the consent was issued can change over time (market conditions, the buyer's potential, etc.).
 
As a matter of practice, by the time of filing an application for consent to sell a subsurface use right or Object the parties have already reached an agreement on all fundamental terms of sale (moreover, their agreement has been already initialled) and obtaining consent is just one of the conditions for closing the transaction.   
 
In some cases this time period could be insufficient, therefore it is recommended that the potential parties should be ready to close the transaction as soon as possible after they obtain consent.
If this time period is insufficient, the 2010 Law[5] gives the applicant two options - it can apply to the competent body for:
 
-                    an extension of the term of consent, or
 
-                    a new consent for the transaction.
 
8. Cancellation (suspension, withdrawal) of consent.
 
It is surprising that the 2010 Law, while setting out detailed provisions concerning the procedure for issuing consent to transfer a subsurface use right, does not contain any provisions whatsoever that would regulate the cancellation (suspension, withdrawal) of the previously issued consent.
 
This situation can lead to a free interpretation of the grounds, conditions, the procedure for cancelling the permit in practice, but most importantly - of the consequences of such step.  We have no doubts that in the future similar cases will not be unusual.  Let's, for example, take a recent withdrawal of the consent issued by the state with regard to the IPO of one famous Kazakhstani brand in the mining sector.  That is why it is important to clearly understand the mechanism of actions to be taken by both the state and other interested parties.[6]
 
What grounds can be used for cancelling the consent?  In our experience, we can predict the following:
 
-                    If it is ascertained that at filing an application for consent inaccurate information was submitted;
 
-                    If it is ascertained that the conditions for issuing the consent have been violated - for example, the transaction lead to the failure to comply with the requirements of the RoK Law, etc.
 
We should point out that we conditionally call the analyzed action as "cancellation."  In reality, to ensure legal clarity one should make distinction between such actions as withdrawal, suspension, cancellation.
 
A distinguishing feature is the outcome of an action:
 
-                    In case of cancellation: the consent itself is deemed invalid from the moment of its issue;
 
-                    In case of withdrawal: the consent is deemed as ineffective from the date of the relevant decision to withdraw (though this interpretation can be synonymous with cancellation);
 
-                    In case of suspension: the consent will not be deemed invalid, but it will not be in effect pending the subsequent decision to cancel, withdraw or restore it.
 
The most severe is cancellation which gives rise to the following questions concerning its consequences:
 
- whether the transaction for which consent was issued should be automatically deemed invalid ab initio;
 
- what parties to the transaction must do: perform restitution (return what they receive to each other);
 
- who will compensate losses and many other things.
 
Based on the logic of law, one may assume that restitution would probably take place.  In case the former seller does not want to take the asset back, it can be claimed by the state with a subsequent exercise of its priority right or putting it for a tender.
 
The losses will be compensated by the party guilty of causing the cancellation of the consent, and the investments made by the buyer since the acquisition of the asset could be offset in its favour by a future acquirer.
 
All the above is, of course, just hypothetical, and it would be better if the Law[7] itself regulate the procedure for, and consequences of, cancelling the consent in detail.  This would be useful, first of all, for government officials so that they have a clear understanding how to resolve problematic issues.
 
9. What effect will the 2010 Law have on consents issued prior to its coming into force?

 
Pursuant to Article 129 of the 2010 Law (Transitional Provisions), the Law applies to the relations arising after its coming into force (July 2010).
 
This means that the 2010 Law must not apply to the earlier issued consents.  However, the subtlety here is that the Law contains provisions regarding only the procedure for reviewing documents submitted for issuing consent and the issuance itself.
 
Accordingly, the adoption of the 2010 Law has no significant effect on the status of the earlier issued consents.
 
As we have seen, the discussed issues as, for example, cancellation of an earlier issued consent is not regulated by either the 1996 Law or the 2010 Law.  Therefore, the competent body could take an initiative on this issue.[8]
 
10. Conclusions and overall recommendations

 
To sum up our analysis of the legislative novelties with regard to the regulation of selling subsurface use rights and Objects, we should repeat the above-mentioned idea that the 2010 Law significantly supplemented and changed the previously existed mechanism for authorizing transactions in the area of subsurface use by the state.
 
It is recommended that when planning transactions subsurface users (their parent companies) should:
 
-                    thoroughly analyze the structure of shareholding in order to clearly determine entities whose shares (participatory interest) can be subject to regulation by the 2010 Law.  Such analysis would allow controlling the risk of illegality of transactions.
 
-                    prepare all necessary documents in advance to be able to perform all the required actions on time because any issued consent now has an effective term during which a transaction should be effected.
-                    take into account that there are now certain conditions for issuing consent which legislative wording presents some risks that could be reduced by a thorough examination of the structure of a transaction and assessment of its consequences.
 
-                    take into account that there are cases when certain transactions do not require any consent.


[1] IPO stands for ‘initial public offering.'  The RoK Law "On Securities Market" contains a Kazakhstani analog - a primary securities market (offering of authorized equity securities by the issuer (underwriter or issuing consortium) except for any subsequent placement by the issuer of the treasury equity securities that were bought out on the secondary securities market).
[2] This commission is formed by the competent body as an advisory body for various purposes, including for the review of issues relating to issuing consents by the state for transactions with Objects.  More detailed information about this body is discussed further on in this article.  

[3] We remind the reader that in this Article a new Law "On Subsoil and Subsoil Use" dated June 24, 2010, is called the 2010 Law whereas the previous RoK Law "On Subsoil and Subsoil Use" dated January 27, 1996, is called the 1996 Law.

[4] By calling these bodies "new old" we emphasize that the 1996 Law did not mention them; however, the Interdepartmental Commission was established by Resolution No. 789 of the RoK Government dated July 29, 2005 while EC used to exist on the basis of internal orders already at the RoK Ministry of Energy and Mineral Resources.

[5] We also remind the reader that in this article a new Law "On Subsoil and Subsoil Use" dated 24 June 2010, is referred to as the 2010 Law whereas the previous RoK Law "On Subsoil and Subsoil Use" dated 27 January 1996, is referred to as the 1996 Law.

[6] We believe that this is one of the cases (together with those analyzed above, for example with regard to section 9 of Article 37 of the 2010 Law) when it would be quite useful and timely, including, first of all, for the state itself, to modify the provisions of the 2010 Law.

[7] For example, a similar issue is partially regulated by the RoK Law "On Competition" as to the revision of the earlier issued consent for economic concentration.

[8] The authors came across prior cases when the competent body initiated withdrawal of the earlier issued consents for the transfer of participatory interest in a legal entity controlling the subsoil user, though that was not expressly stipulated in the 1996 Law.


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