The Importance Of Conducting A Legal Audit (Due Diligence) When Acquiring A RES Facility In Kazakhstan.

 

1 April 2021

 

 

Acquisitions typically require the buyer to exercise a substantial amount of prior due diligence.  Before committing to a transaction, the buyer will want to obtain an understanding of, amongst other things:  the nature of the business, obligations that come with it, the nature and extent of the target company’s contingent liabilities, the existence of any problematic contracts, and litigation risks.  This is particularly true in private company acquisitions, where the target company has not been subject to the scrutiny of the public markets, since the buyer has little (if any) ability to obtain the information it requires from public sources.
 

Renewable Energy (RE) facilities currently represent a fast-growing sector in Kazakhstan. They are regulated by Kazakhstan Law “On supporting the use of renewable energy sources” dated July 4, 2009 (hereinafter the “RE law”), as well as the Order of the Minister of Energy of the Republic of Kazakhstan dated March 2, 2015 No. 164 “On approval of the Rules for the centralized purchase and sale by the Financial Settlement Center of Electrical Energy produced by facilities for the use of renewable energy sources” (hereinafter the “Rules”).
 

This article aims at providing the summary of the most significant legal and business due diligence activities that are connected with a typical RE sector specific M&A transaction. Careful planning and proper anticipation of the related issues that may arise, will allow the target company to be well equipped with particulars to successfully execute the transaction.
 

The key contractual components of the Legal Due Diligence (DD) of a target company are:
 

• Corporate structure;

• Land plots;

• Grid Connection Arrangements;

• Power Purchase Agreement (PPA);

• Permits and Licenses;

• Finance and Loans; and

• Litigation.
   

Corporate structure
 

Corporate structure research covers the history of the legal entity, from its initial registration until the DD date, including the identities of the participants, charter capital, participatory interest disposal, tax indebtedness, etc.  In examining the corporate structure of a company, one must pay attention to the previous participatory interest transfers, as well as the documents confirming such transfers (i.e. Sale-Purchase Agreement).
 

It is worth mentioning that the charter capital payment is essential, as non-payment of charter capital may lead to the compulsory winding-up of the company by the court.
 

Another possible risk during the DD exercise is the absence of the antimonopoly authority consent for the previous transactions if any.  Under Kazakhstan law, transactions constituting economic concentration require prior consent or notification of the antimonopoly authority when certain thresholds are met.
 

This requirement is equally applicable to transactions made outside of Kazakhstan when, as a result, one of the following conditions is satisfied:

 

• the main asset, intangible assets located in Kazakhstan or shares (participating interest in the  charter capital) of market participants (including Kazakhstan and foreign legal entities, their branches and representative offices, and non-profit organizations), property or non-property rights in relation to Kazakhstan legal entities are affected; or

• competition in Kazakhstan is restricted.
   

Power Purchase Agreement 
 

Under the RE law, an energy-producing organization that uses renewable energy sources has the right to sell its produced electric energy at its discretion using one of the following options:
 

• to the Financial Settlement Center for the Support of Renewable Energy Sources LLP (hereinafter – FSC) at rate of the feed-in tariff that is valid at the PPA execution date , or at an auction price determined based on the auction results, considering indexation;

• to consumers through signed bilateral agreements in accordance with the power industry regulations of the Republic of Kazakhstan.
   

The potential buyer must therefore ensure that the legal entity is a winner of the auction and that the Ministry of Energy has accordingly included it into the RE facilities siting plan within five working days from the date of receipt of the register of the auction winners from the organizer.
 

It is advised to make sure that the developer (energy producing company) follows the project development schedule as agreed in the PPA with the FSC.  In particular, one must ensure timely submission of the following documents to the FSC:
 

• a copy of the notice on the commencement of construction and installation works of the RE facility, in respect of which the PPA is concluded, sent to the state authorities responsible for national architectural and construction control – within 18 months from the PPA execution date.  The developer is entitled to request the FSC a 6-month deadline extension;

• a copy of the commissioning act of acceptance of the RE facility, approved in accordance with the architectural, urban planning and construction regulations of the Republic of Kazakhstan, in respect of which the PPA is concluded – within 36 months from the PPA execution date.  The developer is entitled to request a 6-month extension.
   

Financial guarantees play an important role in securing the obligations of the energy producing company under the PPA:
 

• Bid Bond, at the initial stage, when submitting an application for participation in the RE auction is to ensure that the winner will conclude the PPA with RFC on the terms and conditions stipulated by the Rules for organizing and conducting auction trading, and will provide a Performance Bond for the PPA execution.  The Bid Bond (more often regarded as financial support of the application for participation in the auction) is issued in favor of the RFC and is provided no later than two business days before the date of the start of the auction;

• Performance Bond for the fulfillment of the terms of the PPA. In accordance with the auction and PPA conditions, the Seller shall provide the Buyer with a Performance Bond (often regarded as financial security for the fulfillment of the terms of the Agreement) within 30 calendar days from the date of signing such an agreement.  If the Seller violates this deadline, the PPA shall be terminated.
   

Subject to the Order of the Minister of Energy of the Republic of Kazakhstan dated May 19, 2020 No. 197 On amendments to the Rules, the energy producing companies are entitled, due to force majeure arising in connection with the pandemic caused by the spread of the COVID-19 virus, to ask the RFC to extend the deadlines for provision of the copies of the notice of the commencement of construction and installation works of the RES facility, in relation to which the PPA is concluded and a copy of the commissioning acts of acceptance for 1 year.  In its turn, in practice, RFC signs an Addendum to the PPA.

 

Land plot permits
 

In accordance with the RE Law and the Auction Rules approved by the Order of the Minister of Energy of the Republic of Kazakhstan as of December 21, 2017, No. 466, the local executive authorities of regions (Akimat) shall reserve land plots for the construction of RE facilities until the auction winners are given the land title, according to the Land Code of the Republic of Kazakhstan dated June 20, 2003, and shall send the relevant information to the Ministry of Energy of the Republic of Kazakhstan.
 

The procedure for reserving land is determined by the Rules for the Reservation of Land approved by the Order of the Minister of National Economy of the RK dated February 28, 2015, No. 178.  It is worth noting however, that if land plot reserved for the RE facility construction not used within 3 years, it may be subject to expropriation; such procedure is regulated under Article 94 of the Land Code.
 

Generally, the procedure of obtaining a land plot consists of 4 stages:
 

• Land selection;

• Obtaining of a permit from Akimat to use the land plot for design and survey work;

• Design and survey work; and

• Obtaining the land plot right.
   

Moreover, it is recommended to ensure the presence or absence of any property located on the land plot belonging to the legal entity in order to reduce possible risks, such as a pledge on such property. A violation may lead to the termination of PPA.
 

Note that the RE facilities should conclude a standard grid connection agreement with the energy transmission organization that directly connects RE facilities to its power grids.  This usually happens after receipt of technical specifications for connection to the grid from the regional energy transmission organization.
 

Grid Connection Arrangements
 

The RE law commits transmission companies to provide unimpeded and non-discriminatory grid connection point with a commensurate voltage class and to ensure connection of RE facilities.

 

Grid Connection arrangements include the availability of 3 documents: the Power Delivery Scheme, the Technical conditions and the Agreement on connection of the RE facilities.

 

• Power Generation scheme shall be approved by the system operator (KEGOC JSC) with the relevant organization (transmission and/or generation) to the planned connection grids within.

• Technical specifications (TS) are based on the approved power dispatch scheme. It is issued by the connecting grid company and contains technical specifications (TS) for the connection to the network. Note that the investor finances all activities required to obtain the TS. Its validity period is no less than the time needed for preliminary project studies, design and construction of the renewable energy facilities, as identified by current design and construction norms, and should not exceed 3 years.

• Agreement on connection of the RE facility stipulates that the transmission company shall provide the RE facility with access to the network by providing the connection point specified in the TS.  This agreement is valid between the date of the technical specifications and the signing of the grid connection act.  However, it will have a deadline for the latter, linked to the commissioning deadlines agreed in the PPA.
   

Finance and Loans
 

Prior to concluding the transaction, it is also recommended to check for all debt obligations of the legal entity, as there may be penalties for late repayments.  The bank statements can serve as confirmations of timely payments.
 

Litigation
 

The legal entity must be examined for any involvement in court proceedings on the date of the report preparation. The verification takes place in public searches and open databases.  However, the public searches in the database of the Supreme Court may not contain the entire list of the judicial proceedings involving the target company, since it does not always contain the exhaustive information.

 

In the course of the Legal Due Diligence exercise, we examine the legal basis of company’s activities, describe its main business processes (internal and external) from the legal perspective, verify the legal “cleanliness” of the property title, identify any existing encumbrances, assess legal risks, and find ways to mitigate them. We recommend carrying out the Legal Due Diligence in any major transactions involving purchases of businesses or assets, including real estate, and business restructuring in the presence of negative development trends.
 

Comprehensive due diligence will protect the acquirer from hostile takeovers.  The due diligence exercise will also be beneficial when planning to expand your business by selling shares of your company.  Due diligence is also required in cooperation with a foreign company or change of the management system of contracts/agreements conclusion with contractors.  In the course of the legal due diligence, the risks related to the transaction are identified, thereby reducing the probability of further disputes and disagreements between the parties of the transaction.
 

 

For further information, please contact:

 

Saniya Perzadayeva, Managing Partner, Unicase Law Firm

saniya.p@unicaselaw.com