Petroleum Legislation: Analysis of Amendments 2005
Saule Akhmetova, Partner, Law firm GRATA, Almat Daumov, Lawyer, Law firm GRATA
Creation of legislation which is very favorable to investors became the most important factor which has allowed Kazakhstan to attract the foreign capital to the national economy at the beginning of independence. Subsoil users also received State support. At the same time, recently a stiffening tendency, an increasing severity is evident in the national petroleum legislation. In addition to the changes to the legislation made in December 2004, which are being discussed by investors, scientists and lawyers as on 14 October 2005 the Law which has introduced the amendments to subsoil-use and oil-development operation legislation was signed by President of country.1 Below we shall try to make the comparative analysis of innovations and to give comments on this occasion.
1. The Law of the Republic of Kazakhstan On Introduction of Changes and Amendments into some Legislative Acts of the Republic of Kazakhstan on Subsoil Use and Oil Development Operations ???. dated 14 October 2005, #79-III
CHANGES AND AMENDMENTS TO THE LAW ON OIL
Comment. Reference in legislation to the special State Authority for subsoil exploration and use is considered a solution to a problem that has existed from September 2004. It has turned to the practical flatness following the entry into force and effect of the December 2004 amendments to petroleum legislation.
The point is that, due to the prohibition on gas flaring, Article 30-5 of the Law On Oil contained a reference to approval and authorisation to be provided by the Authorised Agency for subsoil use and mineral resource conservation. In September 2004, this function was split between the Ministry of Environment Protection and Control (MEPC) and the Ministry of Energy and Mineral Resources (or rather its Geology Committee). In that way, as from September 2004, a single body/authority responsible for both the conservation of subsoil resources and their efficient use ceased to exist. This contradiction in the legislation has been used and continues to be used by oil companies as an argument against the Geology Committee Territorial Departments' decisions in connection with the prohibition on gas flaring. Moreover, judicial authorities have accepted such arguments, meaning that the law does not operate in favour of the State.
Comment. The amendments introduced to the Law On Oil on 1 December 2004 provided for a prohibition on flaring associated/natural gas during oil development operations. Subsoil users had fixed projects of field development, work programme, process flow charts, programme for natural gas utilisation, permits and licences for environmental pollution and for emissions etc., all approved by the State Authorities. The technical specifications as well as the terms and conditions of many contracts refer to the unprofitable nature of full or even partial utilisation. In the course of negotiations surrounding subsoil use contracts, obligatory environmental impact assessments, economic reviews and tax audits are carried out and a feasibility study conducted in relation to each project, all taking into account the technical and economic conditions and parameters. The whole set of project documentation is examined by the State authorities themselves, and with respect to the many contracts providing for full or partial gas flaring a great many positive expert opinions have been issued. In other words, the State once having agreed contract terms and conditions, now introduces amendments to legislation and simply requires subsoil users to comply with the altered legislation without proper alteration of the contracts in question.
Immediate fulfilment of the State authorities' requirement to utilise in full any associated gases in January–March proved to be unrealisable. It was technically impossible to suspend all operations in frosty weather conditions, and with respect to many projects it was necessary to take special measures and actions in order to ensure operating safety. Each project of course presents individual challenges and requires an individual approach (some fields are characterised by issues of very high pressure, others require specialised equipment, the weather conditions in some regions are very severe etc.). The full utilisation can only be introduced in steps. Before making any investment into a project, subsurface users will demand a technical appraisal and an economic review or feasibility study, will consider several alternatives of utilisation, will make selection of equipment (and here the subsoil users are also restricted by the necessity to organise tenders for purchase of goods, works and services, creating additional delays), will provide certification, and will obtain the required permits, licences and authorisations (for example, for use of foreign equipment, construction of mini-plants etc.). Realisation of the whole package of measures and actions takes a great deal of time, but it would appear that this has not been taken into account in the preparation and adoption of the December amendments to the petroleum legislation.
As a result, many problems have arisen in practice for solving which the provisions of the considered Law have been called. According to them the prohibition of the flaring of gas shall not apply to contractors carrying out oil development operations under subsoil use contracts until implementation of such utilisation programs has been completed, if these programs were approved by the Authorised Agency before 1 December 2004. To the same contractors who had no programme on associated gas utilisation on 1 December 2004 the prohibition of the flaring of gas shall not apply provided that any programme is developed and approved by the competent authority and by the Authorised Agency for Environmental Protection before 1 July 2006.
However, it is not clear whether it means that the flaring of gas can be conducted under a utilisation program. As mentioned above, extraction conditions and project economy are individual activities and that is why the full utilisation of gas will not be profitable and safe in all projects. Moreover, it follows from the last part of new Article 30-5.2-1 of the Law On Oil that it is necessary to get authorisation for flaring of gas from the Authorised Agency for Subsoil Exploration and Use. Legally speaking the rules mean that (i) from 8 December 2004 till 18October 2005 companies carrying out oil development operations could flare gas, as the new Article 30-5.2-1 of the Law On Oil can be considered a provision that alleviates/eliminates the prohibition, i.e. has retroactive effect; and (ii) after 18 October 2005 oil-producing companies are obliged to get authorisation for flaring of gas that will endure until the development and approval of a utilisation programme (before 1 July 2006), and perhaps even before implementation of the approved utilisation program is started (terms can be approved with the State Authorities).
Comment. It should be noted that the first part of Sub-Article 1 provides for additional authorisation procedures in case of alienation by the founders of a subsoil-using legal entity of their equity interests (shareholdings). It may be assumed that this innovation has been adopted for the purpose of implementation of and in addition to the law which provides for the preferential right of the State to purchase an alienated interest in any oil development project.
According to Article 71 of the Law On Subsoil Resources the State has the preferential right as against the other Party of a Contract, against other participants of the legal entity having the right to subsoil use, or against any other persons to purchase/ acquire of assigned or otherwise alienated subsoil use rights (or their parts) and/or any equity interest (shareholding) in the legal entity having the right to subsoil use, on conditions not worse than those as offered to other purchasers.
On 29 July 2005 the Government issued Decree #789 On Establishment of an Inter-Departmental Commission for the Acquisition by the State of Assigned or Alienated Subsoil Use Rights (or their Part) and/or any Equity Interest (Shareholding) in the Legal Entity having the Right to Subsoil Use (below, the 'Decree'). The Commission's composition and regulations have been outlined and approved by the above Decree.
According to Paragraph 4 of the Commission Regulations the major tasks and objectives of the Commission are as follows:
1)Consideration of applications by subsoil users for assignment or alienation of subsoil use rights (or their part) under Subsoil Use Contracts;
2)Consideration of applications for assignment or alienation of an equity interest (shareholding) in legal entities having the right to subsoil use;
3)Preparation of offers for acquisition by the State of the assigned or alienated subsoil use rights (or their part) and/or any equity interests (shareholdings) in a legal entity having the right to subsoil use;
4)Submission, for consideration, to the Government of the Republic of Kazakhstan of proposals for acquisition by the State of assigned or alienated subsoil use rights (or their part) and/or any equity interests (shareholdings) in a legal entity having the right to subsoil use.
A special role shall be played by the Competent Authority (MEMR) in the Commission's activities. According to Paragraph 7 of the Decree, the MEMR is the Commission's labour body, providing technical and organisational support for the Commission's work.
So, the State now has the legal and regulatory framework or basis for monitoring and controlling of the process of assignment or alienation of an equity interest (shareholding) in subsoil-using legal entities.
In addition the Law requires the competent Authority (MEMR)'s consent for any assignment or alienation of an equity interest (shareholding) in a subsoil-using legal entity, which considerably bureaucratises this process and restricts the right of the legal entity's founder to dispose of its private property. The MEMR, being a member and the labour body of the above Commission, may take into consideration the State's interests and adopt a resolution on the exercise by the State of its preferential right to purchase or acquire an equity interest (shareholding) in a subsoil-using legal entity.
Part II of the new wording of Article 53.1 of the Law On Oil requires the Competent Authority's authorisation for transactions with affiliated persons. Firstly, according to the Article wording it is not clear what transactions are affected, and so this may become grounds for differing interpretations or constructions of this rule. For example, this Article may apply to any transaction as concluded between a subsoil user and its subsidiary companies and/or founders. It may be assumed that the Law authors have provided for and meant (by the definition of "transactions") all transactions connected with assignment or alienation of an equity interest (shareholding) in a subsoil-using legal entity.
Secondly, as already mentioned above, this rule does not introduce any essentially innovative legislative instruments for protection of the interests of the Republic of Kazakhstan – the legal and regulatory framework in this respect already exists.
Thirdly, this rule may also apply to both daughter and parent companies whose activities are not connected with subsoil use. It may therefore turn out that the State can have the interests in enterprises not directly involved in the oil sector.
CHANGES AND AMENDMENTS TO THE LAW ON SUBSOIL RESOURCES
Comment. The above definitions have been introduced with the purpose of complementing the provisions of the new wording of Part II, Article 14.9-1 of the Law On Subsoil Resources, according to which the competent Authority shall be entitled to refuse to grant its authorisation of transfer of subsoil use rights, if such transfer of subsoil use rights results in violation of the country's national security, including cases of concentration of rights.
Firstly, it is possible that the abstraction and vagueness of the definitions "concentration of rights within the framework of a Contract","concentration of rights for carrying out operations in the field of subsoil use", "threat to the economic interests of the Republic of Kazakhstan" and "the country's national security" can serve as a basis for abuse of its power by the Competent Authority and for groundless or unreasonable refusals to grant authorisations for transfers of subsoil use rights.
Secondly, as mentioned above, the State has real opportunities to regulate and control the process of assignment of alienation of the subsoil use right and to exercise the preferential right to acquire/purchase the assigned or alienated subsoil use right. In other words, if a subsoil user makes a decision to transfer its subsoil use right to any "non-desirable" investor, which will constitute (or rather can constitute) any conceivable threat to the country's economic interests and national security, the State in accordance with the current legislation will be entitled to exercise its preferential right to purchase or acquire the assigned/alienated subsoil use right.
Comment. It should be noted that the legislation of Kazakhstan contains a provision according to which a parent organisation may provide a guarantee for full performance of obligations under a contract, jointly and severally with one of its subsidiaries. In this light these amendments are inexpedient since transfer will be made not to any third party but to a subsidiary organisation. No "interests substitution" occurs during such transfers of subsoil use rights.
In addition to the above, under the new wording of Article 14 of the Law On Subsoil Resources it will be necessary to obtain authorisation from the Competent Authority for transfers of subsoil use rights by operation of law.
According to Article 116 of the Civil Code of the Republic of Kazakhstan (General Part) of 27.12.1994 (hereinafter referred to as the "RoK Civil Code") succession by operation of law means inheritance and reorganisation of a heritable legal entity. In accordance with Article 45 of the RoK Civil Code, reorganisation may be achieved by merger, amalgamation, consolidation, affiliation, separation or transformation.
The following example can be used to illustrate how unreasonable this amendment is:
Many subsoil users possess the legal-organisational form of Closed Joint-Stock Company or Open Joint-Stock Company. According to recent changes and amendments to the 13.05.2003 Law of the Republic of Kazakhstan On Joint-Stock Companies, companies registered before the amendments of 8 May 2005 entered into force are obliged to introduce all changes necessary for conformity into their constituent documents (i.e. to increase their equity capital size or provide for reorganisation) within 3 years.
In practice many subsoil-using companies (OJSCs and CJSCs) have avoided the need to take such steps by transforming themselves into Limited Liability Partnerships. For example, Munai CJSC has become Munai LLP. In this case only the legal-organisational form has changed, with the subsoil-use right being transferred from Munai CJSC to Munai LLP by universal legal succession.
The Law would make it necessary in such cases to obtain authorisation from the competent Authority.
Comment. It should be noted that any legal entity holding shares in a subsoil user (irrespective the size of its interest) may be said to have an influence upon the decisions taken and resolutions adopted by that subsoil user, merely as a result of holding the shares. For example, according to the legislation on Limited Liability Partnerships some decisions or resolutions may only be taken or adopted with the unanimous consent of all members. In such cases, any person that has even only a 1% share in the subsoil-using LLP's equity capital would be capable of influencing the decision or resolution made or adopted by the LLP. Moreover, the definition of "principle activities" is liable to be interpreted and constructed in different ways by the State Authorities and investors.
At the same time the Law does not eliminate contradiction between provisions of the Law On Subsoil Resources and those of the RoK Civil Code, which have been appeared with the changes and amendments to the petroleum legislation from 1.12.04. So, under Article 80.2 of the RoK Civil Code, an LLP's members hold a preferential right against any third party to purchase or acquire any share interest (or any part of one) in their LLP. The same provision is to be found in the Law On Limited and Additional Liability Partnerships. In other words, the provisions of the Law On Subsoil Resources concerning the preferential right of the State to purchase or acquire any share interest (or any part of one) in an LLP, over and above the LLP's members, is in conflict with the RoK Civil Code. According to Article 6.1 of the law On Regulatory Legal Acts (24.03.98), in case of any contradiction between regulatory legal acts of different levels, the higher-level regulatory legal act shall prevail (in our case the Civil Code), unless the State introduces appropriate changes and amendments into the Civil Code. It would therefore seem logical that if a company co-founder of a subsoil-using LLP wishes to sell its share in the equity capital of the LLP, the preferential right to purchase the shares would belong to the other members of the LLP, and not to the State.
Moreover, Article 111.1 of the RoK Civil Code, according to which the State must participate in civil law relations on equal terms with other participants in such relations, is also violated.
Where a Subsoil Use Contract is concluded with a Consortium (an association of legal entities), the sale by any member of the Consortium of its share in the Subsoil Use Contract (that is, of its part of the subsoil use right) is subject to the following basic rules:
1) The Subsoil Use Contract is co-owned by all the Consortium's members (Article 230.2 of the RoK Civil Code);
2) The provisions of the RoK Civil Code relating to co-ownership shall apply to the Contract (Article 230.4 of the RoK Civil Code);
3) Each member of the Consortium shall be entitled at their own discretion to sell, grant or pledge their share in the Subsoil Use Contract, or to otherwise dispose of it subject to compliance with the provisions of Article 216 (and Article 212.2) of the RoK Civil Code; and
4) In case of a sale (or other disposal) by any member of the Consortium of its share in the Subsoil Use Contract, the other members have a preferential right to purchase or acquire that share in the Contract (Article 216.1 of the RoK Civil Code).
So, the provisions of the Law On Subsoil Resources concerning the preferential right of the State, as against the other members of a Consortium, to purchase or acquire a Consortium member's share in a Subsoil Use Contract will be in conflict with the above-mentioned provisions of the RoK Civil Code. Hence in this case the State's preferential right may not be applied either, since the Civil Code is a regulatory legal act of a higher level than the Law On Subsoil Resources.
* The English text of the article was provided by the author.
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