Merger and Acquisitions in Kazakhstan and Legal Impediments

Merger and Acquisitions in Kazakhstan and Legal Impediments

    The growth of M&A deals in Kazakhstan reveals one of the crucial problems in M&A activity: the governing law of share purchase agreement or other agreements related to transfer of title to shares or participating interests. There are differences between these agreements governed by Kazakhstan’s law and agreements under common law. The major ones will be discussed below in this article.
    The essential issue for any M&A deal is to select the governing law for agreements on transfer of title. For the purpose of this article let us consider a share purchase agreement (hereinafter referred to as the SPA) as an agreement on transfer of title to the participating interest in a limited liability partnership. A Limited Liability Partnership or LLP is a legal entity founded by one or several persons either individuals or legal entities. The charter capital of LLP is subdivided into shares or so called participating interest. The size of 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. An LLP is very similar to Limited Liability Company. The word partnership shall not be confusing and shall not be understood as a partnership in common law countries.
    The SPA related to purchase of participating interest in LLP established with foreign participation in Kazakhstan shall be governed by Kazakhstan’s law.  We have clause 1114 of the Civil Code of the Republic of Kazakhstan (hereinafter referred to as the Civil Code) on applicable law to establishment and transfer of participating interest in legal entities with the foreign capital. I think it is better to provide this clause in full:
   
    Clause 1114 Law Applicable to an Agreement on 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 establishment of a legal entity with foreign participation.
    2. Relations being regulated by this Clause shall comprise relations associated with establishment and termination of a legal entity, 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 case of establishing mutual rights and obligations of participants of a legal entity with foreign participation by other foundation documents.

    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 direct wording of clause 1114, then it is clear that this clause shall apply only to legal entities with foreign participation. For example, LLP is established by two participants: a local company and a foreign company. In case of sale of its participating interest by any of the participants of LLP, the transfer of title to participating interest and, I assume, the whole SPA shall be governed by Kazakhstan’s law. However, if LLP is established by two Kazakhstan’s companies and one of them is selling its interest to a foreign entity, then the SPA may be governed by other law, for example law of the buyer. I believe that for application of foreign law there is shall be involvement of foreign element. In our example, the buyer is such foreign element.
    In many cases I have seen simple coping of SPA provisions governed by common law into the SPA governed by Kazakhstan law. In some cases I have seen certain modifications of the SPA provisions, but still major common law provisions may not work properly under Kazakhstan law. Here are the main parts of any SPA which may not work properly in Kazakhstan: (i) Conditions precedent and (ii) Representations and Warranties.

Conditions precedent

    The main purpose of conditions precedent is to make closing of the SPA subject to satisfaction or waiver of conditions precedent. In other words, the main obligation of purchaser to pay for the participating interest and the main obligation of seller to transfer title shall not be performed by the parties unless conditions precedent are satisfied or waived. The conditions precedent may include receipt of relevant authorizations from state or corporate bodies, absence of adverse changes, correctness of representations and warranties and many other conditions.
    Kazakhstan has similar mechanism: suspensive (delaying) condition or otlagatelnoe uslovie. A transaction shall be considered to be entered into under a delaying condition, where the parties conditioned the emergence of their rights and obligations upon a circumstance, with regard to which it is not known whether it will occur or not. The main concern is whether it means that all rights and obligations are put under condition or just part of them, like payment of purchase price and transfer of title. There are court decisions recognizing the whole transactions as invalid because otlagatelnoe uslovie has not taken place. It is not clear whether the parties to SPA are obliged to perform conditions precedent and abide by pre-closing covenant, if the whole SPA may be recognized as invalid based on the fact the conditions precedent were not met.

Representations and Warranties

    In general, representations and warranties are not enforceable under Kazakhstan law. In fact we have clause 159 of the Civil Code which provides that a deal which is entered into as a result of a misunderstanding which has material importance may be recognized by the court as invalid upon an action by the party which acted under the influence of misunderstanding.  The misunderstanding is material when it relates to the nature of a transaction, or its identity, or to any other qualities of its subject which significantly reduce the possibility of its intended use.  Taking into account that most of the representations and warranties are given in respect of the target LLP, but the subject matter of SPA are participating interest in LLP, then it would be difficult to prove in our courts, that breach of the representations and warranties in respect of LLP as opposed to those given in respect of the parties of SPA shall be the ground for recognition of SPA as invalid.
    Kazakhstan’s law provides legal remedies for breach of obligations, including reimbursement of direct damages and/or indirect damages (lost profit), penalties and in certain cases specific performance. However, representations and warranties can not be classified as obligations of the seller under SPA and, therefore, breach of representations and warranties by the seller shall not give the buyer a right to these legal remedies.
    In conclusion I would like to say, that SPA under common law gives more protection and provides more confidence to the parties. Therefore, SPAs which are to be governed by Kazakhstan’ law require a lot of modifications and introduction of new mechanisms in order to work properly under our law. It requires a lot of input from local counsels and not just checking representations and warranties and closing procedure under SPA.

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