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Supreme Court Rules on Termination of Contracts for Subsurface Use - International Law Office

International Law Office

Litigation - Kazakhstan

Supreme Court Rules on Termination of Contracts for Subsurface Use

December 11 2007

Given Kazakhstan's economic reliance on its natural resources, court practice on questions of subsurface use is of particular significance. However, until recently the courts’ position on when the state may terminate subsurface use contracts has been uncertain.

The uncertainty arises because contracts for subsurface use are governed both by the Law on the Subsurface and Subsurface Use and by the Civil Code, and the legislative provisions are not entirely consistent.

Article 401 of the code provides that a court may confirm the termination of a contract at the request of a party only if the other party is in material breach of the contract. However, Article 45(2) of the law sets out eight further grounds on which the state may enforce early termination of a contract. For example, the state may terminate a subsurface use contract if a contractor refuses or fails to remedy within a reasonable period a factor which has caused its contract to be suspended by the state.

Articles 4 and 6 of the Law on Normative Legal Acts provide that, in the event of a conflict between a code and a law, the provisions of the code apply; the respective conflicting terms of the law may apply only after the code has been amended accordingly. This suggests that the code will always prevail over the law. However, Article 1 of the code stipulates that it applies to "relations for subsurface use" only to the extent that such relations are not regulated by specific legislation on subsurface use.

The courts have not applied a uniform reading of Article 1 of the code and have failed to agree on the question of whether termination of a subsurface use contract falls within the scope of the term 'subsurface use relations' - if it does not, the code should prevail over the law on termination issues and the courts should apply it accordingly.

In a string of recent appellate reviews of cases in which contractors sued the Ministry of Energy and Mineral Resources for the unlawful termination of their subsurface use contracts, the Supreme Court has ruled that the law prevails.

In one case the contractor claimed that the ministry had incorrectly suspended the contract and had subsequently unlawfully terminated it in breach of Article 401 of the code. The court upheld the lower courts' findings that the ministry had: (i) validly suspended the contract on the grounds of the contractor’s failure to invest $2 million and to finance professional training for Kazakh personnel, as it was contractually required to do; and (ii) rightfully terminated the contract after the contractor had failed to remedy its non-compliance within the set term. The court also unequivocally stated that law regulates the termination of subsurface use contracts, and that therefore the code does not apply when such contracts are terminated.

In light of amendments to the law in October 2007, which extend the state’s ability unilaterally to rescind subsurface use contracts for reasons of national security, the recent developments in court practice may indicate a new risk for foreign investors - and signal a need for such investors to comply closely with their obligations under contracts for subsurface use.

For further information on this topic please contact Vladimir Furman or Dinara Jarmukhanova at McGuireWoods Kazakhstan LLP by telephone (+7 3272 596 100) or by fax (+7 3272 596 116) or by email (vfurman@mcguirewoods.com or djarmukhanova@mcguirewoods.com).

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