For readers’ convenience, this article divides subsoil users’ court disputes into 4 groups: tax, customs, ecological, and contractual. The vast majority of these cases involve investment disputes between investors and government agencies in the course of investment activity. The following article analyzes court practice in recent years to identify trends in resolving disputes over contractual obligations.
Contractual Disputes: When and Where?
According to the Civil Procedure Code1, the Nur-Sultan Court shall have exclusive competence over investment disputes as a court of the first instance, and the Supreme Court shall have exclusive competence over disputes with major investors. A major investment is determined to exceed 2 million times the monthly index (roughly 14 million USD). This figure is based on the planned investment as opposed to the actual investment. The judgments of the Nur-Sultan Court enter into force according to the general rule and may be appealed to the Specialized Division of the Supreme Court. Supreme Court judgments enter into force on the day they are issued and can be appealed to the Court’s Special Civil Cases Division.
Contractual Disputes: Parties and Claims
The parties to contractual disputes are typically the Ministry of Energy (the Competent Authority) and subsoil users. Review of cases over the last three years show that most were initiated by the Ministry of Energy. In stark contrast, claims initiated by subsoil users against the Competent Authority are virtually non-existent.
Most claims are based on violations of contractual obligations and the resulting penalties. These obligations include:
Local content requirements in procurement;
Local content requirements in human resources;
Training, professional development, and re-training of Kazakh employees;
Contributions to local social and economic development projects;
Contributions to research and development projects;
Contributions to the Liquidation Fund.
Ministry of Energy: Friend or Foe?
In relationships with subsoil users, the Ministry of Energy performs a dual role as the Competent Authority and as a party to the contract and as the plaintiff in court. This dual function causes a disparity in the position of the parties. According to the legal and contractual requirements, the subsoil user must submit quarterly reports (LKU) on fulfillment of contractual obligations to the Competent Authority. In this instance, the Ministry of Energy is the Competent Authority.
However, further down the road, the Ministry of Energy can use this information in court to support its claims against the subsoil users. The subsoil users thus submit important evidence later used against them in court, therefore alleviating the burden of proof for their opponent. This infringes on fundamental principles of civil procedure like the adversarial system and equality of parties. The explicit alliance and support of the Ministry’s claims by the prosecution cannot come as a surprise.
Contract Performance: Financial or Physical?
The work program attached to the contract specifies the subsoil user’s obligations on volume and type of work, as well financial obligations for each year. The Ministry of Energy has the exclusive competence to not only check on the investments, but to verify the physical performance of the contractual obligations. The Ministry sometimes files complaints against the subsoil user demanding fulfillment of its financial obligations plus penalties for contractual violations without checking on physical performance, ignoring the fact that the scope of work was in fact performed with financial savings. In these cases, the claims should not be resolved in the Ministry’s favor.
Support of Local Content at Investors’ Expense
In cases concerning local content requirements in procurement contracts, the courts exclude costs they regard as violating procedures for purchasing goods, works and services (such as no registration number in the registry) or for purchases made outside Kazakhstan from the calculation of expenses required to meet financial obligations. Once these expenses are excluded, the courts conclude that the subsoil user has failed to meet its contractual obligations, entailing a penalty of 30% of the ‘non-performance’ amount. This shows that the government agencies and state courts care more about formalities than substance.
Calculating Penalties: A Fair Rate or For-Profit?
Violating contractual obligations entails penalties as high as 30% of the ‘non-performance’ amount for subsoil user. Although the 2015 Ministry of Energy Order2 reduced the rate to 1% in favor of the investors, this is ignored by judges who claim it does not apply retroactively.
Pretrial Procedures: Last Minute Claims
The courts reject subsoil users’ arguments related to failure to observe pretrial procedures under the contract and rules of civil procedure. In most cases, the Ministry of Energy sends a notice about violations within a year following the violation. After the Competent Authority receives the subsoil user’s response, the violation and response are “forgotten” for a couple of years. Then the Competent Authority suddenly remembers the violation and jumps into action a few weeks before the statute of limitations expires, leaving the subsoil users without enough time to settle the issue before trial.
The Ministry of Energy is also exempt from paying the fee for filing a claim, but if the court decides in favor of the plaintiff, the fee is collected from the subsoil users. Thus, the subsoil users carry the burden for expenses that could have been easily avoided.
Statute of Limitations: The Main Obligation and Additional Obligations
Subsoil users question the statute of limitations because most cases are based on claims from 2014-2015, after expiry of the three-year statute of limitations. However, even then, the courts rule against the subsoil users. The courts rule that the penalty is a new additional obligation with an indefinite due term. They hold that the penalty dates from the moment the subsoil user receives the notice from the Competent Authority, not from the moment of the contractual violation. On this basis, the courts hold that the three-year statute of limitations for imposing penalties through the court should be calculated from the expiry date of the term for its voluntary execution.
According to the Civil Code3, expiry of the statute of limitations for the main claim means expiry of the statute of limitations for additional claims such as collecting penalties. At dispute is the main claim by the plaintiff (Ministry of Energy) against the subsoil user regarding its contractual obligations. Therefore, the penalty is an additional claim arising from the contractual obligations. Expiry of the statute of limitations for contractual obligations thus means expiry of the statute of limitations for penalties.
It is the general rule that the statute of limitations begins on the day when a person learns or should have learned about the violation of his rights4. We therefore believe that the statute of limitations begins on the day the Ministry of Energy receives the subsoil users’ annual report (normally January of the following year). The courts, however, take the date of the notice as a starting point, and this is a mistake.
This brief analysis of recent court practice for disputes about subsoil users’ contractual obligations leads us to the following conclusion. In the vast majority of cases, the dual role of the Ministry of Energy as a controlling government agency (the competent authority), as well as party to the contract predetermines the courts’ outcomes in favor of the state. Unfortunately, investor interests and a favorable investment climate remain only declarations.
Creating a balance of interests is essential. Regulation of an important industry such as the oil industry should not be repressive. Subsoil users have an interest in conducting a project successfully and the state has an interest in managing its natural resources with maximum profitability. It is crucial to find a common meeting ground for these interests and channel Kazakhstan’s natural resources in a way that will stimulate development of this industry and the national economy.
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