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 KAZAKHSTAN International Business Magazine №3, 2002
 Kazakhstan and International Law Implications of the Proposed Law “On State Regulatory of Production and Turnover of Certain Types of Oil Products”
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Kazakhstan and International Law Implications of the Proposed Law “On State Regulatory of Production and Turnover of Certain Types of Oil Products”
 
Thomas C. O’Brien, Partner in the Almaty Office of Coudert Brothers
Alyia M. Suleimenova, Associate in the Almaty Office of Coudert Brothers
1. Introduction
 
The Kazakhstan Government recently submitted a draft law on State Regulation of Production And Turnover of Certain Types of Oil Products (“Draft Law”) and a draft law on Amendments To Some Legislative Acts on State Regulation Of Production And Turnover of Certain Types of Oil Products (the “Draft Amendments”) for consideration in Kazakhstan Parliament.
 
Oil companies have expressed concern over the overall trend of both the Draft Law and Draft Amendments (collectively – the “Proposed Legislation”) to re-impose Soviet-era style state controls on the oil economy. The proposed legislation would definitely impact the operations of many foreign investors involved in import, production, storage, transportation, sale and export of oil and oil products.
 
In many respects the Proposed Legislation does not break new ground, but rather adds some sharp and specific teeth to the broader contours of pre-existing legislation. Moreover, the Draft Amendments are more in the nature of an authorizing statute, granting regulatory power to the Government without specifying details.
 
The Draft Law directly imposes specific controls and requirements on the import and export (Article 12), production (Article 9), storage (Article 11), transportation (Article 13), and sale (Article 11) of oil and oil products. Other provisions of the Proposed Legislation detail the contours of the authority of the Kazakhstan Government (and the bodies it designates as “competent bodies”).
 
Article 2 of the Draft Amendments and much of the Draft Law propose only to give the Kazakhstan Government the authority to regulate certain aspects of the production and sale of oil and oil products. To the extent that the Proposed Legislation grants new authority to the Kazakhstan Government, the stage is set for the promulgation of further regulations. Thus the Proposed Legislation might be viewed as the beginning of a “rollout” of regulations with the potential to create future regulatory friction with the investor community.According to modern international law theory of expropriation, a loss of the investment as a result of acts by the host government may constitute an act of regulatory expropriation. If the Proposed Legislation results in significant losses by foreign investors, the Proposed Legislation could be viewed as an act of regulatory expropriation, which would give rise to foreign investors’ claims.
 
Often, governments enact unfavorable legislation or request unfavorable modifications of long-term contracts with foreign investors, so as to adjust the terms in light of changed circumstances or policies. Certainly, this presents the investor with a Hobson’s Choice between fighting the changes and enforcing the contract, or preserving its relationship with the government. Foreign investors often choose the latter. However, choosing the latter can ultimately hamper the ability of the foreign investor to challenge more severe changes. In 1982, in a landmark arbitration involving the nationalization of Aminoil’s assets by Kuwait, (see Kuwait v. Aminoil, 21 I.L.M. 976 (1982)), the arbitration tribunal found that by acquiescing to modifications of agreements and allowing the Kuwaiti Government to chip away at the investor’s rights, the later claim of ultimate expropriation was critically weakened.
 
2. Statutory Stabilization Protections
 
Article 6 of the Parliamentary Law No. 244 On Foreign Investments (adopted on December 27, 1994) (the “Foreign Investment Law”) broadly protects oil companies that made investments prior to July 16, 1997, against adverse changes in legislation. An amendment to Article 6(4) of the Foreign Investment Law excludes protection for investments made after July 16, 1997, excepting, among other items, “sales of excisable goods” from stabilization protection. The term “excisable goods” would include those products listed in Article 257 of the Code On Taxes And Other Obligatory Payments To The Budget (adopted on June 12, 2001) (the “Tax Code”), such as petrol, diesel, crude, and other hydrocarbon products. Statutory stabilization provisions are also found in other Kazakhstan laws.
 
Foreign Investment Law. Article 6(1) of the Foreign Investment Law provides for stabilization protection for both upstream and downstream products:
 
“If a Foreign Investor’s position is deteriorated due to change of law and/or enforcement of international treaties, and/or amendments to the terms and conditions of international treaties, the legislation in force at the moment of making those Investments shall apply to the foreign Investments in the course of 10 years. If Investments have been made under long-term investment contracts (exceeding 10 years) signed between a Foreign Investor and a state authorized body, such legislation shall apply till the expiration of the contract term unless otherwise stipulated in the contract.”
 
Therefore, according to the Foreign Investment Law, foreign investors that made investments prior to July 16, 1997 would be exempted from any application of the Proposed Legislation that deteriorates their position.
 
Civil Code. The Proposed Legislation would not have a retroactive effect on the investments that were made prior the enactment of the Proposed Legislation. According to Article 4(1) of the Civil Code, newly adopted legislation may not have retroactive effect:
 
“The time effect of civil legislation. (1) The acts of civil legislation shall not have retroactive force and they shall apply to the relations that arise after their entering into force. The legal force of an act of civil legislation shall extend to the relations that arose prior to its enactment in the cases where it is directly stipulated therein.”
 
Article 37 of the Law On Normative Acts reinforces Article 4 of the Civil Code, by stating an anti-retroactivity principle. New legislation has no retroactive effect unless explicitly retroactive. Similar stabilization provisions are contained in Article 71 of the Subsurface Law applicable to subsoil users, and Article 57 of the Petroleum Law.
 
3. Sources of Investor Rights Under International Law
 
The rights of foreign investors used to be protected by customary international law. International law was difficult to prove and lacked an effective enforcement mechanism. The rules of customary international law were also challenged by a number of nationalizations and expropriations of foreign investments after the Soviet revolution and in developing countries. Over the last thirty years, this has led to foreign investors’ reliance on multi-lateral and bilateral investment treaties (“MITs” and “BITs”) for definition and protection of investor rights.
 
Under Article 4.3 of the Kazakhstan Constitution (adopted on August 30, 1995), a ratified treaty has priority over all other laws of Kazakhstan.
 
In general, BITs ensure fair and equitable treatment, full protection and security of investments, national treatment (investors are entitled to the same treatment afforded to local investors), and most favored nation treatment (investors have the most favorable treatment accorded by the host state to investors from another state with which it has signed a BIT). BITS also typically provide specific rights concerning favorable conditions for expatriation of funds and the attraction and use of foreign managers. More importantly BITs provide protection against expropriation, and provide recourse to dispute resolution settlement procedures through international arbitration. Kazakhstan has signed and ratified more than 30 BITs including with countries such as the US, UK, Germany, Spain, Turkey and China.
 
There are two important MITs for foreign investors in Kazakhstan, the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the “ICSID Convention”) (Kazakhstan became a member on October 21, 2000) and the Energy Charter Treaty (the “ECT”) (Kazakhstan acceded to the ECT on October 18, 1995).
 
ICSID. Kazakhstan is a party to the International Center for the Settlement of Investment Disputes (ICSID) Most investment treaties and laws include dispute provisions that utilize ICSID arbitration. ICSID has helped resolve a number of cases between investors and host countries related to expropriation of investments.
 
Energy Charter Treaty. The Proposed Legislation appears to run counter to the Energy Charter Treaty, to which Kazakhstan, and European Union member countries are signatories. Articles 1(6) and 13 of the ECT define expropriation to include any taking of an “Investment” as well as define an “Investment” to include “any right conferred by law or contract or by virtue of any licenses or permits granted pursuant to law to undertake any Economic Activity in the Energy Sector.”Under Article 10 of the ECT each Party is “to accord at all times to the investments of investors of other Contracting Parties fair and equitable treatment”. Investments “shall also enjoy the most constant protection and security and no Contracting Party shall in any way impair by unreasonable or discriminatory measures their management, maintenance, use, enjoyment or disposal”. Also “in no case shall such investment be accorded treatment less favourable than that required by international law, including treaty obligations”. Finally each Contracting Party shall endeavour to accord investors of the other parties treatment not less favourable to that accorded to its own investors or to those of any other Contracting Party or third state, whichever is the most favourable.
 
4. Expropriation
 
Under general international law a state is free to adopt measures of expropriation or nationalization of a foreign investment in its territory. Investment treaties do not contest this right but aim at subjecting expropriation to substantive and procedural requirements including compensation and to afford effective means of redress in case of violation. The concept of regulatory expropriation is finding widespread acceptance under international law. Regulatory expropriation refers to claims also termed as “creeping expropriation,” “constructive expropriation,” “indirect expropriation,” “tantamount to expropriation,” “de facto taking,” and others.
 
4.1. Regulatory Expropriation under International Law
 
Historically, expropriation under national and international law has referred to the actual deprivation of possession of tangible property, and its subsequent transfer to the host state. The essential point to emphasize is that unless a physical dispossession occurred, or a contractually agreed benefit was deprived, the classic theory of expropriation was simply inapplicable.
 
Current trends recognize not simply dispossession but also the deprivation of the fruits of ownership, and also view property more broadly to include contractual and other intangible rights. Following this trend, the more modern view has expanded the classic claim of expropriation to include a broad range of claims, which are broadly referred to as “regulatory expropriation.” As noted in a recent law review article tracing the transition from the historical view to today’s more modern view:
 
“In the past, it was not difficult to decipher what would constitute an expropriation since the laws of the host country would transfer title to the investment from the foreign investor to the government or another public agency, which was clearly an exercise of eminent domain. Today, most countries engage in more subtle forms of “expropriation.” They exercise arbitrary or discriminatory police power, or impose “onerous regulations” and taxation. Under these subtle methods, an investor might be forced to abandon his investment. This approach is known as a “creeping expropriation” because it gradually achieves the same result that a formal “expropriation” would have achieved immediately.”1
1 See “Chapter 11: The Efforts to Define Expropriation,” by Ana Tschen, 8 Current Int’l Trade Law Journal, 50 (1999).
 
The form of state action that constitutes regulatory expropriation has gained sufficient recognition as a country (political) risk that it is now embedded in OPIC and MIGA insurance coverage as a form of expropriation. Both the Multilateral Investment Guarantee Agency (MIGA) and the Overseas Private Investment Corporation (OPIC) explicitly underwrite the risk of “creeping” expropriation. MIGA’s Investment Guarantee Guide (2001), categorizes “expropriation” as an insurable political risk, and explicitly includes reference to creeping expropriation:
 
“Loss of the insured investment as a result of acts by the host government that may reduce or eliminate ownership of, control over, or rights to the insured investment. In addition to outright nationalization and confiscation, “creeping” expropriation – a series of acts that, over time, have an expropriatory effect – is also covered.”
 
The OPIC definition (as summarized in its published text on Insurance, Products and Coverage Types (2001)) of creeping expropriation is likewise instructive: “an unlawful government action depriving the investor of fundamental rights in a project.”
 
Depending on how the Proposed Legislations are actually imposed on foreign investors as a regulatory matter, a prima facie case of regulatory expropriation might be asserted by foreign investors. Investors may raise a claim of regulatory expropriation under Kazakhstan law, under the governing law of the affected contract, under an applicable treaty, under the domestic laws of the investor’s home country, or under general principles of international law.
 
4.2. Regulatory Expropriation Under Kazakhstan Law
 
Foreign investors may raise a claim of regulatory expropriation on the basis of the following sources of Kazakhstan law: (i) the Constitution, (ii) the Civil Code, and (iii) the Foreign Investment Law.
Constitution. Article 26(3) of the Kazakhstan Constitution provides that absent a court order, “no one may be deprived of his/her property …forcible alienation of property for the public use in extraordinary cases stipulated by law may be exercised on condition of its equivalent compensation.”
 
Thus, a foreign investor has a constitutional right to protection of its property and may claim payment of adequate compensation as a result of the forcible alienation of its property. There is no precedent of which we are aware, however, as to any regulatory expropriation deemed compensable under the Kazakhstan Constitution.
 
Civil Code. Article 188(1) establishes a private right to property, the violation of which may be compensable:
 
“The right to own shall be recognized and protected by the legislative acts, the right of a person [natural or legal] of its discretion to possess, use and dispose of the assets which belong to it.”
 
What is important here is that the property right granted includes the rights to “use and dispose” of property which are the rights infringed in most regulatory expropriation cases. Restrictions of this statutorily recognized property right, pursuant to Article 188(5) of the Civil Code, are permitted only in cases specified in the Civil Code:
 
“The right to own shall be for an indefinite term. The right to own assets may be compulsory terminated on any of the grounds which are provided in the present Code.”
 
Such specified cases are set forth in Article 249 of the Civil Code which provides an inclusive list of grounds where ownership may be terminated. In the context of the Proposed Legislation, the only permitted impositions on ownership would occur in the case of “requisition,” but Article 249 goes on to require that “the conversion of property privately owned by individuals and legal entities into state property (nationalization) . . . shall be compensated . . . in the procedure established by Article 266 of this Code.”
 
Article 266 of the Civil Code provides full compensation where the state has terminated protected rights:
 
“In the event legislative acts are adopted by the Republic of Kazakhstan, which terminate the right of ownership, the losses brought upon the owner as a result of the adoption of these acts shall be reimbursed in full by the Republic of Kazakhstan.”
 
There has been no precedent in Kazakhstan applying these provisions in the context of a regulatory expropriation. Note however that under the Civil Code, the definition of “losses” subject to reimbursement includes lost profits.
 
Foreign Investment Law. Article 7(1) of the Foreign Investment Law provides that foreign investment shall not be subject to “expropriation, nationalization and other measures having the same consequences, except for the cases when such expropriation is done in the public interest, within the proper order and without discrimination” (emphasis added). In those cases falling within the public interest exception, compensation is required. Specifically, Article 7(2) stipulates “indemnification shall be equal to the fair market value of the expropriated investments at the moment when the investor becomes aware of the expropriation.”
 
Claims of expropriation under the Foreign Investment Law may be adjudicated in Kazakhstan courts or may be submitted, in accordance with Article 27.2 (2) of the Foreign Investment Law, to international arbitration with ICSID, the Alternative Facility of ICSID, arbitration bodies organized according to UNCITRAL, and the Arbitration Institute of the Stockholm Chamber of Commerce.
 
5. Conclusion
 
The Proposed Legislation will potentially disrupt the operations of foreign investors involved into import, production, storage, transportation, sale and export of oil and oil products. Some of the provisions of the Proposed Legislation that might be interpreted as “mandatory norms” or the proper exercise of the “police powers” authority of the state to maintain order might be exempt from legal attack. Such exercise of “police powers” would have negative influence on Kazakhstan’s efforts to attract new foreign investors.
 
However, the provisions of the Proposed Legislation that are disruptive to foreign investors as an economic matter would be subject to statutory stabilization protection under Kazakhstan law including: Article 6 of the Foreign Investment Law, Articles 4 and 383 of the Civil Code, Article 71 of the Subsurface Law, Article 57 of the Petroleum Law, Article 37 of the Law On Normative Acts, and Articles 1(6), 13 of the Energy Charter Treaty. In this case, the Proposed Legislation might serve as a basis for foreign investors to claim regulatory expropriation under international and Kazakhstan law. The Proposed Legislation may also result in the increase of international arbitration cases by foreign investors and a chilling effect on Kazakhstan’s investment climate.
 


Table of contents
Invest in Astana!  Adilbek Dzhaksybekov 
Helios Means First!  Shukhrat Danbai 
Certain Environmental Aspects of the Activities of Subsoil Users  Aigul Kenjebayeva, Yuliya Mitrofanskaya 
Issiue Deductibility of Interest on Foreign Currency Loans  Bill J. Page, Gaukhar Iskakbayeva 
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