Kazakhstan - Choice Of Law In Contracts: English Law Benefits.
Legal News & Analysis - Asia Pacific - Kazakhstan - FDI
30 August, 2019
Today, the choice of English law is one of the most popular in international investment and corporate transactions. M&A transaction, direct investments in capital and other similar transactions are often concluded under English law. Nowadays, English law is also applied in other industries such as construction, trade and other international contracts and cross-border transactions.
Kazakh legal system today, cannot ensure the full implementation of the legal structures of English law for the lack of relevant legal norms, and because of the unwillingness of the judicial system to apply the legal structures which are not prohibited by Kazakh law, but yet not familiar to Kazakh courts. In addition, the imperative nature of certain rules of Kazakh law reduces the ability of the parties to formalize their agreements, including possibility to apply English law to certain types of contracts.
Thus, one of such imperative restrictions of Kazakh legislation is the prohibition to use foreign law about agreements on establishment of a Kazakh legal entity with foreign participation, and the agreements on transfer of interest in the charter capital of such legal entity. This makes it impossible to make the agreement on transfer of interest in the charter capital of a Kazakh limited liability partnership to be governed by a foreign (i.e. English) law, even if both parties to the transaction are foreign entities. As for transferring shares of a Kazakh joint stock company a common opinion among the lawyers and relevant judicial practice on whether the abovementioned restriction of law shall apply to the contracts on transfer of shares of a Kazakhstan joint stock company have not been established yet.
This factor forces foreign investors to structure the possession of Kazakh companies through foreign jurisdictions, where most merger and acquisition deals take place and where English law can be applied.
However, apart from above restriction, according to the general principle of freedom of contract enshrined in the Civil code of the Republic of Kazakhstan (the ‘Civil code’), the parties have the right by mutual agreement to choose the applicable law to the contract concluded between them. Thus, according to Article 1112 of the Civil code, the contract shall be governed by the law of the country chosen by the agreement of the parties, unless otherwise provided by the legislative acts of the Republic of Kazakhstan. However, it shall be noted that Article 1112 of the Civil code belongs to the Section 7 of the Civil code (’Private international law’) and, therefore, shall only apply to civil relations that include a foreign element.
Foreign governing law may apply to a contract only if the contract includes a foreign element i.e. foreign party to the contract. Thus, foreign governing law may apply to the contract if at least one party to the contract is a foreign individual or a company.
The intention of foreign investors to choose a well-known, well-developed and reputable English law as one of the preferred neutral laws seems justified and reasonable. We believe that English law may be beneficial for both the foreign and Kazakh parties, in particular because:
- English law is based on the fundamental principle of freedom of contract, which is more flexible than the Kazakh law system, applying a more prescriptive civil code. Parties to an English law contract are bound to their agreement unless the terms of the contract are contrary to the public interests or have an illegal purpose.
- The principles and fundamental concepts of English law are world-wide clear and well-known, which increases the predictability of the outcome of any contractual conflict based on contract interpretation.
- There is an established practice of using English law for construction projects in developing economies where foreign contractors are engaged. The reason is that the construction documents governed by English law are well developed and the interpretation and practice of this area of law is clear and well established. If the EPC contract is regulated by Kazakh law, the bankability of the construction project could be decreased. The reason is that, contrary to a contract regulated by Kazakh law, the banks are less likely to ask completion guarantees for the EPC contract regulated by English law. If Kazakh law is selected as governing law, financial institutions may request a completion guarantee and a direct agreement regulated by English law. In this situation, the customer cannot avoid using English law, and this may generate a potential inconsistency between separate project and financing documents.
- Interpretation of a contract regulated by Kazakh law in international arbitration would be much more difficult (and costly) than a contract governed by English law. Foreign partners are unlikely to recognize Kazakh courts as a dispute resolution forum, and most may request international arbitration in a neutral jurisdiction. Although international arbitration in Kazakhstan is workable, it would be an added risk for contractors for which they could increase the overall contract price.
Below, we provide a list of the main shortcomings of Kazakh contract law compared to English law, which makes it more favourable:
Representations and warranties.
Representations under English law are statements by one party that induce another party to enter a contract. If the statement is incorrect, the other party may be entitled to ‘rescind’ the contract unwinding it and/or to claim damages. The aim of the damages is to put the innocent party in the position it would have been if the false statement had not been made as if it had not entered the contract.
Warranties are terms of a contract which, if breached, will entitle the innocent party to claim damages (but not to rescind or end the contract). Here the aim of a claim of damages is different to those that may be awarded for misrepresentation: the contractual measure of damages in this case aims to put the innocent party in the position it would have been if the breach had not occurred.
English law offers much more flexibility in agreeing on representations and warranties. Remedies for breach of warranties under English law differ from remedies available under Kazakh law. Fundamental issues such as the allocation of liability for breach of representations or warranties cannot be addressed under Kazakh law.
Indemnities are agreements to compensate for loss arising from a particular liability and be used where there is a known or potential identifiable liability, such as a tax liability, a potential environmental claim, or a specific issue arising from due diligence. Kazakhstan law does not recognize indemnities as a legal concept to the same extent as English law recognizes them.
Calculation of damages
English law has some well-established rules for determining damages for breach of contract. Particularly, for breach of warranty the courts will try to put the innocent party into the position it would have been in if the contract had been performed without the breach occurring. This will involve payment of damages by the breaching party, as financial compensation for the loss suffered from the breach.
Kazakh legislation has less flexibility in the calculation of damages. Loss of profits or consequential damages may be claimed under Kazakh law, but are difficult to prove in court.
Under English law, the parties may agree on a liquidated damages provision, which will provide that if of a breach, the breaching party must pay an agreed sum which makes up a genuine pre-estimate of their loss from such breach. The pre-estimate must be genuine at the time the contract is made. Kazakh legislation does not stipulate the concept of liquidated damages, and the court may reduce the amount of any so-called penalty damages.
Conditions precedent are clauses that provide that certain parts of the contract will only come into force if agreed conditions are met. On an M&A deal these conditions might include getting anti-monopoly merger approvals, bank consent or change of control approvals from key customers and suppliers. On a finance deal, these will include implementing agreed security packages and providing legal opinion letters.
Under English law, the parties can agree to whatever conditions they like for the contract to complete. These conditions need not be within the control of the parties and do not even need to be realistic, provided they are clear and can be assessed. The only conditional agreements the Kazakh legislation will recognize that are those whose terms are beyond the control of the parties.
Often on private equity investments, the parties will step-in rights or swamping rights. These are a contractual mechanism (also contained in the foundation documents of the company) which allows one party to step-in and take voting control of the board of directors and/or general meetings of shareholders. These are essential rights for creditors. However, Kazakh legislation does not address such rights, and their enforcement under Kazakh law is doubtable.
Even if English law governs the EPC contracts, it shall still follow Kazakh law's mandatory requirements, given that the project is being implemented in Kazakhstan. In case of EPC contract these mandatory requirements are linked to regulatory issues such as licensing, relevant technical norms, staff employment, health and security requirements, environmental issues, building commissioning and completion, building warranty periods.
Mentioned above selecting English law as the governing law may be beneficial for both sides to the contract if at least one party to the contract is a foreign entity. We see that Kazakh legislation develops and improves together with growing trust in the legal system, and courts’ accumulation of relevant experience and development of the practice. We hope that clever and prompt reforms of Kazakh legislation, including the effective incorporation of certain structures of English law, soon will make Kazakh law more competitive and reliable in the eyes of foreign investors.
For further information, please contact:
Saniya Perzadayeva, Managing Partner, Unicase Law Firm