Rules vs. Regulations
Petroleum Industry Procurement Requirements
Joel Benjamin, Partner, Denton Wilde Sapte, Almaty, Kazakhstan
Raushan? Chaltabayeva, Junior Attorney, Denton Wilde Sapte, Almaty, Kazakhstan
The adoption in June 2002 by Government Decree No. 612 of the Rules for the Procurement of Goods, Works and Services when Carrying Out Petroleum Operations (the "Rules") caused a lot of debate among oil companies operating in Kazakhstan. As follows from the expressed opinions, contractors carrying out petroleum operations are extremely dissatisfied with the provisions of the Rules. In particular, there was concern about the strengthening of state controls over the activities of contractors, as well as the fact that a number of the basic provisions of the Rules differ from existing legislation of the Republic of Kazakhstan. Other problems stem from lack of clarity of many provisions of the Rules, including the absence of both a clear definition of the range of goods, works and services which must be procured in accordance with the Rules and a price threshold for application of the Rules.
Furthermore, the authorised body (initially the Ministry of Energy and Mineral Resources was given this role by Decree 612 but subsequently on 14 November 2002, Government Decree No. 1204 "On Measures for Promoting State Support to Local Producers" was adopted and the Ministry of Industry and Trade was designated) was required to adopt certain clarifying instructions. Unfortunately, the instructions were not adopted and the Rules were not immediately implemented by the authorised body.
Though the Rules were never fully implemented, they remain the legislation applicable to procurement of goods, works and services when carrying out petroleum operations. Most companies are obligated to comply with the Rules. Recently, however, draft Procurement Regulations (the "Regulations") that are intended to replace the Rules have been prepared by the Ministry of Energy and Mineral Resources. A version of the draft Regulations may be adopted sometime in the not too distant future.
Below is a brief overview of the existing Rules and the proposed Regulations. In preparing such overview, we primarily concentrated on the arguments that are raised by contractors regarding the Rules and on whether the draft Regulations address such arguments.
Both the Rules and the Regulations apply to all contractors carrying out Petroleum Operations as well as to third parties making purchases on their behalf (i.e. subcontractors) and were adopted to help promote opportunities for domestic suppliers of goods, works and services to the Petroleum industry.
Under the Rules there is no clear definition of goods, work and services. For example, in accordance with the Rules, the terms "goods", "works", and "services" are defined as follows:
· goods - equipment, finished goods and other materials necessary for carrying out Petroleum Operations;
· works - performance of work pursuant to the instructions of the customer, for a fee, for the creation (manufacture) of goods, installation of equipment, construction of installations and other operations which are needed for carrying out Petroleum Operations;
· services - commission, pursuant to the instructions of the customer, for a fee, of certain efforts or performance of certain activities, not resulting in manufacture of goods, or of which material items are not the objective, but which are needed for carrying out Petroleum Operations.
From such definitions it seems that the Rules apply to all purchases connected with "carrying out Petroleum Operations." Taking a strict interpretation it would appear that the Rules apply to purchases of ordinary office supplies as well as purchases of drilling equipment.
Proceeding from the absurdity of the requirement to apply the Rules for the purchase of ordinary office supplies, it was assumed that for the period of adoption of the current Rules the range of goods, work and services to which the Rules would apply would be established in the Instruction on the procedure for consideration of customer's applications and issuance of permits for purchases without tenders, procedure of approval of tender conditions, which Instruction was to be prepared by the authorized body in accordance with Section 6 of the Rules. Such Instruction was never been prepared.
Under the draft of the Regulations, no definitions of goods, works or services were provided at all. This will mean that time consuming and burdensome procurement tenders generally required under the Regulations (and now required under the Rules) likely will need to be followed even when purchasing toilet paper or office stationery.
Apart from the fact that the draft Regulations do not establish the range of goods, works and services, the Regulations do not provide for the adoption of any clarifying instructions similar to those envisaged by the current Rules. Ideally such clarifications would be embodied in the Regulations themselves.
Besides the absence of clear definitions of goods, work and services, the current Rules have no thresholds for the amount of goods, work and services (by value) to be acquired by a tender. This means that any purchases made by contractors in the process of their business, even the most negligible, would fall under tender requirements.
The Regulations, however, contain such a threshold. They provide for the possibility to make purchases on a competition free (i.e. tender free) basis when the amount of any homogenous goods, work or services being procured does not exceed fourteen thousand times the monthly calculation index (a figure established by Kazakhstan's budget law), currently 14,420,000 tenge or approximately $115,000.
However, it shall be noted that in accordance with the most recent draft Regulations, companies may also undertake procurement on a competition free basis where procurement is "conducted with the attraction of potential suppliers exclusively from the Uniform State Register of the Kazakhstani manufacturers…." Thus, it is also permitted to undertake procurement without holding a tender if only Kazakhstan providers are considered even where the amount of the purchase involved is above the threshold of 14,420,000 tenge.
While the Rules prioritise procurement by Kazakhstan suppliers, they define "production within the territory of Kazakhstan" as production by Kazakhstan enterprises. However, this indicates a company registered in Kazakhstan without reference to the content of materials or workers.
The initial draft of the Regulations provided that Kazakhstan origin of work and services rendered by legal entities depended on whether such entities are owned by Kazakhstan citizens. Such provision contradicted the Subsurface Law, which provided that Kazakhstan origin is the direct performance of work and services in Kazakhstan. More importantly, tying Kazakhstan origin (and consequently, Kazakhstan content) to the ownership right will not contribute to the development of Kazakhstan suppliers. The issue should depend, first of all, on who provides services (i.e. on the number of Kazakhstan citizens), and also on the place of the provision of services (within or outside the territory of Kazakhstan) as well as the place of origin of the raw materials and parts which make up the final product.
The most recent draft Regulations eliminated ownership as a criteria but do not address the issue clearly. Now the draft Regulations provide that Kazakhstan origin works/services shall be the rendering of services by Kazakhstan producers personally. However, the Regulations do not address the question of what is a Kazakhstan producer.
In order to ensure that local companies are given the opportunity to compete for business in the petroleum industry and that petroleum contractors are meeting their obligations to use local goods and services the Rules require that purchases of goods, works, or services are to be carried out via tenders that are to be closely monitored by the authorised state body. This includes requiring approval of the authorised body for both the tender terms and procedures for every purchase and the results of every tender. Also, a representative of the authorised state body will participate in a company’s tender commission.
The exceptions for procurement without holding a tender are limited. Purchases may be undertaken without a tender in only three cases:
· when a specific company is the only one offering the goods, works or services in question;
· when it is necessary to purchase goods, works or services from a particular seller to maintain compatibility with items already purchased (e.g. spare parts);
· when the tender fails (e.g., where there are not 2 or more bidders).
The Regulations provide a bit more flexibility. There are similar exceptions when goods may be purchased directly from a single source. However it also permits procurement without holding a tender in certain circumstances. Specifically, as noted above, procurement on competition-free basis shall be permitted in the following cases:
· the amount of the procurement of any homogenous goods, work and services, in terms of the value thereof, does not exceed fourteen thousand times the monthly calculation index (a figure established by Kazakhstan's budget law) or currently 14,420,000 tenge; or
· when only potential suppliers included in the Unified State Register of Kazakhstan Producers are considered.
Under the competition-free method it will, nonetheless, be necessary to obtain price bids from several suppliers.
The Rules require that the procedures (terms) for each tender must be approved by the authorised state body on an individual basis; it is not possible to obtain approval of a set of general tender procedures or terms to be used for all or several tenders. In order to obtain approval from the authorised state body of the tender terms, a company is required to submit detailed information including:
· information about the tender procedure, which shall be addressed to potential tender participants;
· the contents of tender documentation;
· regulations of the tender commission.
The Rules are quite specific about the information that must be provided; the list is quite extensive. To provide such information for each and every purchase that a company makes would involve a significant amount of work on the part of the purchaser.
Fortunately, in practice, apparently due to the fact that the Ministry of Industry and Trade has limited resources to monitor procurement, it is enough to inform the Ministry of the details of a tender and not wait to receive approval.
Under the Regulations there is no such requirement that tender terms be approved by the authorised body. Nor is there a requirement to obtain the approval of the authorised body for the results of a tender.
However, the Regulations require that the tender documents shall be prepared on the basis of standard tender documents that should be developed by the authorised organization. We believe that this may interfere with generally accepted business practices and the individual policies of particular contractors. In addition, this may be inconsistent with the procedures already established under stabilized subsurface use contracts. Simply put, standard documents may not work efficiently as different companies and different situations may have or require different procedures and documents.
Moreover, the Regulations require companies to submit annual procurement plans to the authorised body as well as to the competent authority, i.e. the Ministry of Energy and Mineral Resources. This is ostensibly to allow the authorities the ability to publicise to domestic suppliers opportunities to supply goods, works and services. In addition, the plan will also enable the bodies to monitor the procurement activities of companies to ensure compliance with the Regulations and the obligations of contractors to use local content.
State Representative on Tender Commission
The Rules require the authorised state body to appoint a representative to each Tender Commission. In practice, however, we understand that the Ministry simply does not have sufficient numbers of trained staff and, thus, this aspect of the Rules has not been followed. However, in theory the Ministry could appoint a representative to sit on a tender commission, which is a troublesome prospect for companies concerned with confidentiality. The Regulations will do away with this requirement - they appear to be more about ensuring procurement can be monitored rather than controlled. This will eliminate the concern companies have about maintaining confidentiality of the procurement process when an outside party has access to its tender documentation.
Approval of Tender Results and Execution of Agreement
Under the Rules, once a tender has been held and a winner selected, the decision must be submitted to the authorised state body for its approval. The authorised state body must give its approval or notified refusal to approve the results within 10 days. The tender organiser is also obliged to notify each of the non-winning participants of the results with an explanation of the reasons its bid did not win.
Importantly, a contract may not be executed with the winning bidder until the Protocol of the tender results has been approved.
The Regulations approach this differently. While the Regulations eliminate the requirement to have the results of Tenders approved they require tender commission decisions to be put in the form of detailed minutes setting forth the basic terms of each bid and other information. This must be submitted to the authorised organisation. Each participant of the tender must be notified of the decision and with losing bidders being given a reason why their bid did not win.
Under both the Rules and the Regulations, any interested party including participants of a tender may challenge the results of a tender.
Period Needed to Conduct Tenders
The Rules require notice of tenders, which may be published only upon approval of tender conditions, to be published at least 30 days prior to holding a tender. The Regulations establish a similar requirement. However under the Rules the ability to undertake procurement quickly is hampered by the requirement to obtain approval of tender terms and further of tender results, each of which added another 10 days to the time required to complete a tender. In overall, as the matter of practice, under the Rules the procedure of conducting a tender takes two months and more; that said the following factors are not taken into account: the working program authorized by the parties of the contract, the necessity of conducting urgent purchase, the right of subsoil users for independent signing of contracts on goods and services delivery. In this respect, the Regulations may help to somewhat speed up procurement.
While the Rules were adopted to help promote the opportunities for domestic suppliers of goods, works and services to the Petroleum industry they did little more than dictate procedures for procurement and give the authorised body some control over the process. In this respect, the Regulations are quite different. Although the Regulations still require most procurement to be conducted through tenders, the positive development is that there is less involvement of the authorised body required. The negative factor is that the Regulations (in their most recent version) contain a heavier bias in favour of local suppliers, which may be in contravention of existing and future obligations (to be) undertaken by Kazakhstan in respect of bilateral and multilateral treaties, as well as stabilized subsurface use contracts. The fact that the Regulations will be clearly favourable to Kazakhstan companies, while understandable from Kazakhstan's point of view is also somewhat incompatible with Kazakhstan's interest in obtaining WTO membership.
The Regulations are currently being worked on by the Ministry of Energy and Mineral Resources. It is not clear when they will be adopted. However, it is likely to be before the end of the current year or early in the next.
Joel is a partner and head of Denton Wilde Sapte's Banking and Finance practice in Central Asia. Joel has extensive experience in trade finance, project finance, capital markets and mergers & acquisitions. Joel is cited in Chambers Global Guide 2006 as a ranked specialist in Corporate/Commercial matters.
Raushana is a junior attorney at Denton Wilde Sapte and assists with advices to the clients on a wide variety of Kazakhstan and international law issues, including banking and finance, energy, corporate, construction, subsoil use law.
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