Thought leadership from our experts

A new law “On Arbitration”: Key issues undermining the investment attractiveness of Kazakhstan

On 8 April 2016 the new Arbitration Law was enacted in Kazakhstan. This law was adopted in response to the request of President Nazarbayev, who–in his speech at the opening of the fourth session of the Kazakh Parliament of the fifth convocation–noted that "comprehensive development of arbitration is necessary for effective investment activity" and in this connection instructed that a uniform law on arbitration be developed. It is commonly known that, until recently, domestic (treteyskie sudy) and international arbitrations were regulated by two different laws, and a legal status of domestic arbitrations was largely inferior to a legal status of the latter. Therefore, the idea of enacting a single law for all arbitrations was accepted with enthusiasm.

However, the new Arbitration Law in fact turned out to be inconsistent with the President's abovementioned instruction, because it is unlikely to facilitate a comprehensive development of arbitration and effective investment activity. Such "problematic" provisions of the new law include, among others, the following.

Unilateral withdrawal from an arbitration agreement

The possibility of settling contractual disputes through arbitration is one of the most sensitive issues for foreign investors when deciding whether to invest in a given country. Foreign investors normally agree to enter into a contract only if it contains an arbitration agreement and if there are specific contractual instruments protecting such arbitration agreement.

Unfortunately, the new Arbitration Law establishes such a regulation under which any effort to protect the arbitration agreement becomes meaningless. The Arbitration Law entitles any party to withdraw unilaterally from the arbitration agreement. In particular, Article 9.5 provides that "prior to emergence of a dispute the parties shall have the right to unilaterally repudiate, in accordance with Article 404 of the Civil Code of the Republic of Kazakhstan, an arbitration agreement by giving notice to the other party within a reasonable time." Article 404 of the Civil Code entitles a party to repudiate a contract unilaterally in cases stipulated by the legislation and the parties' agreement.

For example, even if a loan agreement between a foreign bank and a Kazakhstan borrower contains an arbitration agreement referring any potential disputes to foreign arbitration, once the borrower receives the loan it appears it may without any explanation unilaterally withdraw from the arbitration agreement. Obviously, this approach entails at least the following negative consequences:

  • Investors (both foreign and domestic) will not invest in Kazakhstan, realizing that their business partners may at any time unilaterally withdraw from the arbitration agreement.
  • Foreign banks and financial institutions will not provide loans to Kazakhstan entities, or such loans will become extremely expensive so that banks can cover the corresponding risks. From this perspective, if Russia suffers from a lack of foreign borrowing due to the sanctions, Kazakhstan itself creates the conditions for the same situation.
  • Such a regulation will lead to the destruction of arbitration in Kazakhstan, which will definitely worsen the investment climate in the country.

According to the Government's explanatory note to the draft law "On Arbitration," the purposes of its enactment are to improve the legislative framework applicable to arbitration and to develop the system of alternative dispute resolution as a whole. Obviously the possibility of a unilateral withdrawal from the initially agreed mechanism of dispute settlement is in direct contradiction to these stated purposes. Moreover, such a possibility contradicts Article 8.7 of the same Arbitration Law, according to which the arbitration agreement may be terminated by agreement of the parties in the same order in which it was concluded.

The law of obligations in Kazakhstan provides for the inadmissibility of unilateral refusal to perform an obligation assumed or unilaterally change of its terms and conditions (Article 273 of the RoK Civil Code). The unilateral refusal is allowed only in limited cases, including the circumstances which are independent of the parties (bankruptcy of a party, inability to fulfill obligations, abolition of the state body's act on the basis of which the contract was concluded (Article 404.2 of the RoK Civil Code). The possibility of unilateral withdrawal from the arbitration agreement in the absence of similar circumstances contradicts the system of laws of obligations and contracts.

It is questionable whether the Arbitration Law applies to recognition and enforcement of foreign arbitral awards in Kazakhstan. There is a risk of Kazakh courts taking extensive interpretation and subordinating disputes arbitrated abroad to the Arbitration Law. Therefore, it is recommended to abolish Article 9.5 of the Arbitration Law as soon as possible, and until such abolishment–at least to clarify officially that this provision must be interpreted in a way that the unilateral withdrawal is allowed only in limited cases established by the RoK Civil Code.

Applicable law

It is a general rule of Kazakhstan law that disputes shall be resolved in accordance with the law applicable to underlying relationships. Where at least one of the contracting parties is a non-resident, the RoK Civil Code clearly provides them with the choice of law freedom.

Article 44 of the Arbitration Law, on the contrary, contemplates that Kazakhstan substantive law must apply to the merits of the following disputes:

  • Disputes arising between physical and/or legal entities of Kazakhstan
  • Disputes with participation of state bodies (shall be understood as the state itself), state enterprises and state-owned (50% or more of direct or indirect shareholding)

The above requirement is detrimental to the investment climate since it directly applies to, among others, joint ventures that are often created between foreign investors and state enterprises/state-owned companies. Under the Arbitration Law, arbitrators in Kazakhstan will have to ignore "governing law" clauses contained in, for example, shareholders agreements concluded with respect to such joint ventures. Consequently, this requirement even makes arbitration less attractive compared to a judicial process, because state courts are still obliged to honor the parties' choice of law agreement in cases allowed under the RoK Civil Code (if a party, property, place of conclusion or implementation is located abroad).

One could try to avoid the above requirement by referring any potential disputes to foreign arbitration. This is because there are certain arguments that the Arbitration Law shall not apply to arbitrations held outside of Kazakhstan. This approach would reduce the risk of invalidity of a choice of law clause, unless Kazakh courts choose to take extensive interpretation and subordinate disputes arbitrated abroad to the Arbitration Law. Such an extensive interpretation would be erroneous but still practically possible, as the Arbitration law does not draw a line between domestic and foreign arbitrations.

Consent Requirement

Prior to April 2016, domestic arbitration as opposed to foreign arbitration was unavailable to disputes involving state interests. This prohibition has evolved in the Arbitration Law in order to eliminate its discriminating nature to domestic arbitration.

Pursuant to Article 8.10 of the Arbitration Law, disputes between physical and/or legal persons of Kazakhstan, on one side, and state bodies, state enterprises and state-owned companies (i.e. 50% or more of voting shares of which directly or indirectly are controlled by the state), on the other side, cannot be arbitrated without consent of the authorized body of the respective branch of industry (with respect to republican property) or a local executive body (with respect to communal property).

Moreover, the state bodies, state enterprises and state-owned companies, as described above, which intend to conclude an arbitration agreement, shall send a request to the same authorized body or to a local executive body on granting a consent to execution of such an agreement with an indication of expected sums of money that would be required to cover arbitration expenses. When considering the request, the authorized body shall take into consideration economic security and interests of the state. The request shall be considered within 15 calendar days.

As noted above, the Arbitration Law provides that the consent requirement is needed only in cases where the other party to the arbitration agreement is a physical or legal person of Kazakhstan. However, the next paragraph of the same law does not have this exemption for arbitrations with foreign persons; therefore, a certain risk exists that this requirement could be applicable to arbitrations with foreign persons as well. If courts adhere to this position, enforcement of foreign arbitration awards by Kazakh courts may not be possible if corresponding arbitration agreements had not complied with the consent requirement. Literal meaning of the Arbitration Law suggests that such risk is remote.

In the past state enterprises and state-owned companies enjoyed the right to enter into arbitration agreements freely if the place of arbitration was outside of Kazakhstan, while now such entities are deprived of this right and must obtain consent of the state in order to conclude an arbitration agreement.

Conclusion

Unfortunately, the Law on Arbitration does not correspond to its declared purposes. Although the Law on Arbitration contains several positive novelties, overall it could be considered as a serious attack on arbitration in Kazakhstan. In our view, the above discussed provisions of the Arbitration Law make the investment climate in Kazakhstan less attractive, in particular for investors implementing or planning to implement various projects jointly with state enterprises and state-owned companies. Currently arbitration agreements are less stable, and enforceability of foreign arbitration awards in Kazakhstan is less certain than they were prior to the enactment of the Arbitration Law. We hope that future judicial practice, resolutions of the Supreme Court and the Constitutional Council as well as possible amendments to the legislation would change this situation.