Oil & Gas Sector Investment Kazakhstan Mitigating Risks In M&A Transactions.
Main steps of the M&A transactions
Mergers and acquisitions (M&A) in the subsoil sector require careful planning and certain steps to ensure the legality and success of the transaction. The main steps to be followed:
Due Diligence
In the first stage, the target company will undergo due diligence, which includes legal, tax, and financial analysis. This stage aims to identify the risks associated with the company’s activities and assess its current state.
- Legal due diligence: Verifying the legality of the company’s establishment, constituent documents and property rights, and identification of encumbrances and risks.
- Tax due diligence: Assessment of tax liabilities and possible tax risks associated with the transaction.
- Financial due diligence: Analysis of financial statements, liabilities, = and company assets to assess its financial condition.
Structuring
The transaction shall be structured based on the results of the due diligence. This includes determining the terms and conditions, the objectives of the transaction, and the specifics of the company’s business. It is important to consider the company’s status and the results of preliminary agreements between the parties.
Approvals
Once the transaction is structured, all necessary governmental and corporate approvals must be obtained (e.g., authorisation of the competent authority in subsoil use for the transfer of rights, authorisation of the antimonopoly authority for economic concentration).
Draft contract
Drafting, negotiating and concluding the purchase and sale agreement and other documents related to the transaction.
Completion
Transfer of the participation interest, registration of the transfer of the participation interest with state authorities, notification of the competent authority, etc.
The success of a subsoil-use M&A transaction depends on the fulfilment of all of the above steps.
Due Diligence of the company/asset
The objective of Due Diligence is to examine the most critical aspects of a company or asset. The analysis identifies the foremost legal risks associated with the company’s activities and special conditions to be observed by the parties.
As a result, Due Diligence allows the buyer to negotiate price reductions, determine the transaction’s structure, develop tax optimisation schemes and effectively integrate the acquired asset into the buyer’s group.
Main aspects of Due Diligence:
- Due Diligence: Legal, Tax, Financial
- Buy-side Due Diligence
- Sell-side Due Diligence
Legal Due Diligence
Legal Due Diligence includes activities to verify a company or asset’s legality and legal cleanliness.
Main aspects of legal audit:
- Examination of the legitimacy of the company’s establishment: Analysing the constituting documents and charter capital formation.
- Assessment of the powers of management bodies: Checking the legitimacy of appointment and scope of powers of the company’s management bodies.
- Verification of legal validity: Assessment of the legal cleanliness of the company’s property rights, real estate title registration and identification of existing encumbrances.
- Contractual work analysis: Evaluation of the legal integrity of the contractual system and agreements with partners, along with identifying vital legal risks.
- Transaction dispute risk assessment: Assessment of risks related to the potential dispute of property rights and the validity of concluded transactions, including major and related-party transactions and authorisation issues.
- Licence Due Diligence: Due diligence of essential licences and their revocation or suspension risks.
- Prospects for transaction approval: Estimating prospects for transaction approval by regulators, other participants, and third parties.
- Litigation analysis: assessment of the status and prospects of current and potential future litigations.
Specifics of due diligence for subsoil users
Subsoil users’ due diligence includes specific aspects intended to verify compliance with the requirements of subsoil use legislation.
Main aspects of due diligence of subsoil users:
- Verification of contract history: Analysing prior approvals and the terms on which the contract was concluded.
- Verification of Competent Authority Consents: Validation of the Competent Authority’s consent to transfer subsoil use rights.
- Verification of compliance with licence and contract conditions (ЛКУ): Assessment of compliance with the conditions set out in subsoil use licences and contracts.
- Verification of compliance with local content requirements: Analysis of compliance with local content requirements established by legislation.
- Availability of approved project documents: Verify the presence of approved exploration/mining project documents required for exploration and production.
- Procurement Compliance Check: Assessment of compliance with procurement rules and regulations.
Main authorisations for M&A transactions in the subsoil use industry
Due to specific legal requirements, M&A transactions in the subsoil use sector require several authorisations.
Major authorisations:
- Authorisation of the Ministry of Energy: Required for the authorisation of transfer of subsoil use rights and/or objects related to subsoil use rights, as well as a waiver of the state’s priority right to acquire them.
- Decision of the Government of the Republic of Kazakhstan: Authorisation must encumber strategic objects with third-party rights or their alienation.
- Consent of the antimonopoly authority: Required to obtain approval for economic concentration, which may affect competition in the industry.
- Registration of the currency agreement: A foreign currency contract related to capital movements with the National Bank of the Republic of Kazakhstan.
Authorisation for transfer of subsoil use rights and objects related to subsoil use rights
The relevant authorisation must be obtained in transactions involving the transfer of subsoil use rights and objects related to subsoil use rights. Main provisions include:
- Nullity of transactions without authorisation: Transactions involving the transfer of subsoil use rights and objects related to subsoil use rights without authorisation or after the expiration of its term are invalid.
- Obligation to obtain authorisation: The acquirer’s responsibility is to obtain a permit.
- Electronic submission of application: The application for a hydrocarbons and uranium permit shall be submitted only online.
- Notification of Competent Authority: After completing the transaction, the competent authority must be notified of the subsoil user’s change in control.
Authorisation of encumbrance or alienation of strategic objects to third parties
Encumbrance or alienation of strategic objects is possible only with the authorisation of the Government of the Republic of Kazakhstan. This provision is regulated by Article 193-1 of the Civil Code of the Republic of Kazakhstan.
Main provisions:
- RoK Government authorisation: Encumbrance or alienation of strategic objects requires government permission (Article 193-1, Civil Code of Kazakhstan).
- ‘Grey zone’ in share transactions: There is a ‘grey zone’ in current legislation regarding transactions involving shares of companies that indirectly own a strategic object, which requires special attention.
- Obligation to obtain authorisation: The seller of a strategic object is responsible for obtaining authorisation for encumbrances or disposals.
- Nullity of transactions: Transactions involving the alienation of strategic objects that violate the law are recognised as null and void under Article 193-1 of the Civil Code.
Consent of the antimonopoly authority on economic concentration
The antimonopoly authority’s consent must be obtained for transactions that may lead to economic concentration. Main provisions: Application by the buyer: The buyer must apply for economic concentration consent. Conditions and exceptions: The law sets out specific conditions and exceptions under which the antimonopoly authority requires permission. Cancellation of transactions: Economic concentration carried out without consent and resulting in a monopoly or restriction of competition may be cancelled by a court in the antimonopoly authority’s suit.
Registration of a foreign currency contract related to capital movements with the National Bank of the Republic of Kazakhstan
Transactions involving capital movements require accounting registration of the currency agreement with the National Bank of the Republic of Kazakhstan. Main provisions for registration:
- Definition of capital flows: Transactions with securities, shares and derivative instruments are considered capital movement transactions.
- Registration of transactions over USD 500.000: Transactions over USD 500 thousand are subject to registration with the National Bank of the Republic of Kazakhstan.
- Registration obligation: The obligation to register lies with the resident of the Republic of Kazakhstan.
Corporate Procedures
Notice to third parties
In M&A transactions, it is important to notify third parties of significant changes related to a change in company control.
Key aspects of third-party notification:
- Spousal consent: Spousal consent should be considered where required by law or internal company rules.
- Change of control: Notify contractors, suppliers and other counterparties of a change of control in the company. This may affect the terms of existing agreements.
- Financial arrangements: Notifying third parties under financial arrangements of changes in control that may affect the terms of loans, borrowings and other financial commitments.
Main documents of M&A transactions
When conducting M&A transactions, an important stage is the preparation and execution of the necessary documents. Below are the main documents that may be required during the transaction process:
1. Preliminary Contract or Protocol of Intentions: A document in which the parties record the upcoming transaction’s main terms and intentions.
2. Confidentiality Agreement: An agreement that protects the information disclosed by the parties during the negotiation and conclusion of the transaction.
3. The Share Sale and Purchase Agreement is the document that governs the terms and conditions of the transfer of shares from the seller to the buyer.
4. Option Agreement: An agreement that gives one party the right (but not the obligation) to buy or sell assets in the future at a predetermined price.
5. Disclosure Letter: A document in which the party selling an asset discloses the risks and liabilities associated with the asset.
6. Shareholders Agreement or Foundation Agreement: Documents that define the rights and obligations of shareholders, how the company is managed, and other aspects.
7. Completion protocol: A formal document that records the actual completion of a transaction and the transfer of rights and obligations.
Factors hindering the process of M&A transactions
The M&A transaction process can face several factors that make it difficult to complete successfully. The main ones are:
1. Conflicting legal systems: The application of English law (the standard for cross-border transactions) may conflict with the national law where the asset is located, creating additional complexity in negotiating the terms of the transaction.
2. Complex Approach to Reconciliation: The need for a complex approach to reconciliation in different jurisdictions requires considering the specifics of each law, which complicates the process.
3. Impact of governmental approvals: Different governmental approvals can significantly impact the overall structure of the transaction, creating additional hurdles.
4. Timing: Synchronising the closing timing is critical, and any delays can cause problems.
5. Practical difficulties in closing the transaction due to mandatory legal provisions:
5.1: Lack of a unified approach of state authorities: simultaneous requirement of permits under the Subsoil Code and for alienation of a strategic object.
5.2: Term of validity of authorisations of competent and antimonopoly authorities – 1 year.
5.3: A visa or residence permit is required for foreign business immigrants.
