A Good Governing Law Makes a Good Ending - Kazakhstan
A choice of the governing law of any agreement is the most important element. In Kazakhstan, sometimes the parties are not free to select any governing law.
In general, Kazakhstan’s legislation respects the choice of law made by parties. Clause 1112 of the Civil Code (General and Special Parts) of the Republic of Kazakhstan (hereinafter ‘the Civil Code’) states that a contract shall be regulated by the law chosen by the parties, unless otherwise provided for by the legislative acts of the Republic of Kazakhstan. However, as per usual, there are certain exceptions to this general rule. One of the major exceptions is provided in clause 1114 of the Civil Code, namely:
Clause 1114 Law Applicable to an Agreement on the Establishment of a Legal Entity with Foreign Participation
1. The law of the country where a legal entity is to be established or has been established shall apply to the agreement on the establishment of a legal entity with foreign participation.
2. Relations being regulated by this Clause shall comprise of relations associated with the establishment and termination of a legal entity, the transfer of share of participation in it and other relations between participants of a legal entity connected with their mutual rights and obligations (including those determined by subsequent agreements).
3. Provisions of this Clause shall apply also in the case of establishing mutual rights and obligations of the participants of a legal entity with foreign participation by other foundation documents.
This clause has not been amended or changed from the beginning and has been in effect since the Civil Code came into force. Generally speaking, we have had this clause since 1 July 1999 and it is only now, with the growth of M&A deals in Kazakhstan, this crucial problem has been revealed: share purchase agreements or other agreements related to the transfer of title to shares or participating interests shall be governed by Kazakhstan law.
The essential issue for any M&A deal is the decision over which governing law should be chosen for the agreement on the transfer of title. For the purpose of this article, let us consider a share purchase agreement (hereinafter ‘the SPA’) as an agreement on the transfer of title to a participating interest in a Limited Liability Partnership. A Limited Liability Partnership or LLP is a legal entity founded by one or several persons, either as individuals or legal entities. The charter capital of the LLP is subdivided into shares or so called participating interests. The size of the participating interest is defined in the foundation documents. Please note that the participants shall not be liable for their obligations and, in general, they shall bear the risk of losses within the limits of their contributions. The word “partnership” should not be confused with, nor understood to be, a partnership in common law countries.
Clause 6 of the Civil Code provides that the norms of civil legislation shall be construed in accordance with their direct wording. If we consider the direct wording of clause 1114, then it is clear that this clause shall apply only to legal entities with foreign participation. For example, an LLP is established by two participants: a local company and a foreign company. In the case of the sale of its participating interest by any of the participants of the LLP, the transfer of title of the participating interest, and I assume the whole SPA, shall be governed by Kazakhstan’s law. However, if the LLP is established by two Kazakhstani companies and one of them is selling its interest to a foreign entity, then the SPA may be governed by another law, for example the law of the buyer. I believe that for foreign law to be applicable there should be a foreign element to the transaction. In our example, the buyer is the specified foreign element.
In the ten years since this clause came into play, I have seen very few SPAs that were governed by Kazakhstan law. In fact, many of the special provisions of the common law SPA, such as conditions precedent, indemnities, representations and warranties, may not work properly under Kazakhstan law. More often parties simply ignore it and choose another governing law. In this article, I would like to discuss the potentials problems with choosing another governing law.
The issue of governing law arises when the parties are very close to the settlement of a dispute through arbitration. Let us assume that the parties to a SPA chose English law as the governing law of the SPA. There are two instances where such a choice may be challenged by any of the parties. First of all, during the arbitration process, the party may prove that the choice of English law was not correct and that it contradicts the imperative norms of the Kazakhstan legislation. In accordance with clause 1088 of the Civil Code, any agreement or any action aimed at the avoidance of the mandatory application of the choice of law prescribed by the Civil Code is invalid. Should this take place, the law of the Republic of Kazakhstan shall be the governing law. Thus, in spite of choosing English law to be the governing law for the SPA, in the case of dispute, Kazakhstan law shall be the governing law. In other words, the choice of law made by the parties in the SPA shall be invalidated and the arbitration shall be made under the condition that Kazakhstan law is the governing law of the SPA.
Second, if the dispute in the arbitration is solved in accordance with English law in spite of a party’s claim regarding the applicability of Kazakhstan law, there may be a problem with the recognition and enforcement of the arbitral award.
The foreign arbitral award shall be recognized and enforced by the court of the Republic of Kazakhstan. The Republic of Kazakhstan is a party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Article V of the Convention provides five grounds on which the party against whom the enforcement is invoked can oppose recognition and enforcement and two grounds on which the court can, of its own initiative, refuse recognition and enforcement: arbitrability and public policy.
The public policy exception rule provides that if the court finds that the recognition or enforcement of the award would be contrary to the public order of the Republic of Kazakhstan, then the court shall refuse to recognize and enforce the foreign arbitral award.
The law of the Republic of Kazakhstan on International Commercial Arbitration defines public order as the foundation of the state and public system fixed in the legislation of the Republic of Kazakhstan. There is no definite concept or scope of the public order and there is no case law development on this point; therefore, the public order may be subject to broad interpretation by the courts of the Republic of Kazakhstan.
The choice of English law as a governing law for the SPA may be considered by a Kazakhstan court to be contrary to the public order of the Republic of Kazakhstan, because such a choice contradicts Clause 1114. Consequently, in accordance with Clause 1088 of the Civil Code, the choice shall be recognized as being invalid.
Please note that international commercial arbitral awards may be cancelled by the Kazakhstan courts. The public policy exception rule is one of the grounds for cancellation. Thus, in addition to refusing the enforcement of a foreign arbitral award, a Kazakhstan court has the ability to cancel the award in Kazakhstan.
In conclusion, I would like to reiterate that selecting the governing law for your agreement is the most crucial and important step. A SPA, which is to be governed by Kazakhstan law, requires a lot of input from local councils and not simply checking representations and warranties and closing procedures under the SPA. A good beginning makes a good ending indeed.
ABOUT THE AUTHOR: Arlan Yerzhanov
Arlan is a partner and representative in the United States of Grata law firm. Grata is the leading independent law firm based in Central Asia and the Caspian region with more than 80 lawyers across branches in Kazakhstan, Uzbekistan, Azerbaijan and Kyrgyzstan, and representative offices in Turkmenistan, Tajikistan, London, New York and Istanbul. Arlan has more than 14 years of in-house and law firm experience. He has advised international and local companies on a broad spectrum of matters, including mergers, acquisitions, joint ventures, corporate governance, restructurings and employment issues.
Before joining GRATA Arlan worked as head of legal department in Kazakhstan’s oil & gas construction company and had law firm experience. Acting as an in-house lawyer, Arlan participated in successful negotiation of a $300 million Engineering Procurement & Construction (EPC) oil pipeline contract to China and a $500 million gas pipeline construction contract to Russia.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.