Subsoil Use Contracts: Issues of Legal Classification and Systematization
Professor Yuri G. Bassin, Senior Partner of Aequitas Law Firm
Professor Maidan K. Suleimenov, Member of the Academy of Sciences of the Republic of Kazakhstan, Director of the Research Institute of Private Law
Dr. Erlan B. Osipov, Research Assistant of the Research Institute of Private Law
Dr. Olga I. Chentsova, Managing Partner of Aequitas Law Firm
Identifying the Scope of Issue
Being a country with vast reserves of useful minerals, Kazakhstan in many respects shapes its domestic and foreign policy based on this circumstance. It is evident that the requirement for the efficient and reasonable use of natural resources is the adequate legal basis, including the system of relevant legislation. Kazakhstan has exerted every effort in this direction during a period over 10 years, and has achieved sizeable results.
Nevertheless, an atypical situation for the world practice has formed in the Republic as to the legislative definition of the legal regime of subsoil use contracts. The problem consists in that the legislation just names types of subsoil use contracts, but does not contain their legal definition, does not name the features of such contracts that would allow their differentiation. Numerous contracts executed during the years of independence have various names and differ in legal contents even when have similar names.
Meanwhile, the proper legal classification of subsoil use contracts, including their correct names, is of great practical significance as it means the determination of their kind and type, and, consequently, the establishment of their features and differences. Theoretically, the designation of a specific contract (for example, a concession contract, production sharing agreement, and others) should mean the automatic establishment for them of a specific legal regime, namely: material terms of the contract; basic rights and obligations of the parties, tax regime, etc.1. (At the same time a discretionary principle of the civil law allows appending the contents of a contract of any type (kind) with additional terms and conditions within the limits permitted by imperative rules of the current legislation). The establishment of the clear-cut and understandable legislative regime for subsoil use contracts considerably facilitates to subsoil users the entry to external market, specifically, the possibility of debt financing (providing for financing), and also the possibility of investment attraction, on the whole.
We know cases when in the absence of the proper legislative regulations the parties were mistaken as to their contractual rights and obligations; for example, they did not understand the difference between a service contract for subsoil use and an ordinary service contract for rendering certain services. In a service contract for subsoil use the state acts as the party-customer, and the other party is a subsoil user-contractor, which entered into a contract for subsoil use with the state. In an ordinary service contract for rendering services, any organizations (or even individuals) acting within the framework of their general or special legal capacity or, where so required by the law, on the basis of a license authorizing the performance of licensed activities, may act as a party-customer and also as the other party-performer.
Despite the fact that the above-mentioned service contracts are referred to contract services agreements, they will have different legal regime: in the first case a contract automatically falls under the regulations of the subsoil use legislation, including imperative rules (for example, mandatory application of Kazakhstan law to petroleum operations; mandatory use by the contractor of Kazakhstan goods, work, and services), while in the second case it will be governed by the rules of the Civil Code, not containing the terms regarding the Kazakhstan content, and permitting the application to service contracts encumbered by a foreign element of a foreign law at the discretion of the parties.
It would seem that if any difficulty arises in the determination of the legal status of subsoil use contracts, one may traditionally refer to the “world practice” since it is well known that agreements (contracts) on production sharing, concessions, etc. are for a long time and widely used in many countries. But the problem is that even prevailing contracts often have absolutely different contents stipulated both by the specific features of the legal systems of different countries (for example, the existence or absence of a right of ownership to subsoil) and peculiarities of the historic and national development of those countries, and also by the general state of their legal basis.
Being based on our experience and knowledge of the issue, we may say that the problem of proper classification of contracts in the subsoil use is a pressing issue not only for Kazakhstan, but for other CIS-member states as well, and theoretical (legislative) developments in this sphere are carried out rather actively, especially in Russia.
Types of Contracts for the Subsoil Use and their Place in the Legislation of the Republic of Kazakhstan
Kazakhstan legislation never provided a legal definition of types of subsoil use contracts with disclosing of their type-related and generic features and peculiarities. Different grounds served as the criteria for classification in 1995-1996 and in 19992. (There is meant a classification, provided in the Edict of the President of the Republic of Kazakhstan having the force of Law, On Petroleum, dated June 28, 1995 (hereinafter - the Petroleum Law) and the Edict of the President of the Republic of Kazakhstan having the force of Law, On the Subsoil and its Use, dated January 27, 1996 (hereinafter - the Subsoil Law), amended by the Law of the Republic of Kazakhstan, On Amending Certain Legislative Acts on the Issues of Subsoil Use and Performance of Petroleum Operations in the Republic of Kazakhstan, adopted on August 11, 1999 and introduced into effect from the moment of the official publication on September 1, 1999.). Initially, the contracts were classified by their legal contents; while the current classification of contracts is based on the division of contracts by the type of subsoil use operations (although the inclusion in this classification of a production sharing agreement is not based on this criterion).
The work on drafting the Law On the Subsoil and the Law On Petroleum, carried out at the present time, again reverts to the initial classification of contracts, that is, the classification by their legal contents, and names the following contracts: (1) a production sharing agreement; (2) a concession contract; (3) a contract services agreement and contract for rendering chargeable services (service contract). The draft law repeats the rule of permissibility of combined and other types of contracts, depending on the terms of the use (the Petroleum Law addresses not other types of contracts, but other forms of contracts which, probably, is one of the technical shortcomings of this Law).
Legal Nature of Subsoil Use Contracts
It is generally recognized that subsoil use contracts reflect dissimilar public relations, first of all, of civil-law and tax nature, and also of ecological, and financial nature, etc. Recognizing this fact, we, however, have no doubts in the civil-law nature of the subsoil use contract due to the following basic features:
1. Property relations is the subject of a contract. This means that the civil law is the basic legal regulator of the considered relations.
2. The state acts on equal terms with the subsoil user in subsoil use contracts. This means that the regime of a legal entity is applicable to the state in such relations.
One may identify the distinctive features of the contracts for subsoil use, including such stated feature as the state’s participation in it as a party to the contract. The fact that the state, being a party to the contract, performs the supervisory functions through the authorized agencies in the implementation of the contract, not as a party to the contract, but as the subject of public power, may be referred to the peculiarity of this contract.
Determination of Types and Kinds of Subsoil Use Contracts
As noted, the world practice does not know the single approach to the classification of the subsoil use contracts. Using one and the same terms, the lawmakers of various countries very often fill them with different contents or use different criteria as the basis of contracts’ classification. As a result, referring to the “world experience” very often allows finding arguments in confirmation of different approaches and views in the classification of the subsoil use contracts3. (For example, the Russian Law On Production Sharing Agreements (adopted in 1995 and amended in 1999) defines a production sharing agreement as a collective legal construction for the contract for the subsoil use and includes in it a concession and production sharing agreement. Thus, the PSA under the RF legislation does not fully comply with the similar concept applied in many other states (Indonesia, Malaysia, etc.)
However, with all this diversity, there are seen quite concrete directions for the base classification of the subsoil use contracts, which should be reasonably and carefully adapted to the Kazakhstan legal system. We believe that the following two basic types of subsoil use contracts may be identified in Kazakhstan:
I. lease-type contracts which include:
1) concession contracts; and
2) contracts for the construction and/or operation of underground installations.
II. contract services agreement type, which include:
1) contract services agreement for geological study of the subsoil;
2) production sharing agreement; and
3) service contract.
At the present moment the most actual for Kazakhstan from a practical perspective are concession contracts and production sharing agreements.
Legal Nature of Concession Contracts
From the beginning of the XXth century the concession contracts in the subsoil use is the most known form of contracts that have been modified during these decades4. (4Within the framework of this paper we do not address the issues of concession in the broadest sense, which, in addition to natural resources, may encompass the objects of economic infrastructure, the objects in the sphere of public services, etc. Furthermore, in accordance with our suggested classification, we are based on the fact that the concession is referred to one of the two types of subsoil use contracts, and is not generic with respect to other types of contracts.). In our view, the concession contracts belong to contracts of a lease-type, however, the concession in the subsoil use should not be identified with the lease even if the concession includes the obligation of the subsoil user, fixed in its work program, to attain a certain result on the exploration and/or production of useful minerals.
The term “concession” is mentioned but not disclosed in the Kazakhstan legislation. However, from the viewpoint of legal essence, the concession is the basic type of contracts in the subsoil use contracts system in Kazakhstan (exploration and/or production of useful minerals).
Under a concession contract, the subsoil user obtains an area of the subsoil for a certain period with the right to extract useful minerals. The right of ownership to the produced useful mineral from the moment of their extraction to the surface belongs to the contractor. The state receives the part of income due to it from the use by the subsoil user of the subsoil area mainly in the form of royalty, and also in the form of various bonuses. Taxes on the income of the subsoil user also represent indirect income of the state in the case of concession.
Legal Nature of Production Sharing Agreements (PSAs)
The urgent need for the research of the legal nature of PSA is stipulated both by the increasing number of concluded contracts for the performance of petroleum operations in the form of a production sharing agreement and the strategic plans of Kazakhstan related to a wider application of this type of contract in the development of oil fields on the Caspy.
The analysis shows that the main features of a production sharing agreement is the obligation of the subsoil user (contractor) at its own commercial risk to carry out the production of useful minerals from the subsoil which is in the state ownership (operations on the production or combined exploration and production of oil) subject to the compensation of costs incurred at the expense of produced oil and the receipt of part of produced oil as the remuneration.
The condition for the compensation is not a decisive factor for the production sharing agreement since the fundamental rule is the receipt by the state (the owner of subsoil) of the so-called “economic rent” in the form of a part of produced oil, and not only in the form of taxes from the contractor as in the concession. The right of ownership to all produced oil initially belongs to the state, but the contractor obtains the right of ownership to part of produced useful minerals (oil) in production sharing, and also to useful minerals (oil) transferred to it for the compensation of costs (if the agreement provides for the receipt of compensation).
A production sharing agreement may objectively be evaluated as a sort of a civil-law contract services agreement. In most cases this is confirmed by the international practice of the application of a given type of a contract. It shall be necessary in the legislation of Kazakhstan in the determination of the PSA terms to be based on the fact that it is a type of the contract services agreement and to confirm the subsidiarity of the application to it of the rules of the contract services agreement contained in the Civil Code. This would put in order the resolution of many issues related to the procedure for entering into, implementation, termination, and cancellation of production sharing agreements.
PSAs are divided into two types according to the criterion of the production sharing principle: (i) production sharing after deduction of the contractor’s costs; and (ii) direct sharing of production without preliminary deduction of the contractor’s costs.
In our view, as to the legal content, the obligation, which is the basis of the PSA with the term of direct sharing, does not differ greatly from the first type of PSA. The legal basis of such agreement also includes contractual relations: the contractor at its own risk performs the production of useful minerals for the payment in the form of part of the produced products. The specific features of this type of PSA primarily consist in the tax regime and terms of taxation.
In accordance with the general world practice, under a service contract (contract for service rendering) the contractor performs the work on exploration and production at its own risk, but for the established payment in monetary form (as distinct from PSA where the remuneration and the compensation are paid by oil) and receives, as a rule, cash compensation for the costs incurred. Under service contracts the contractor does not obtain a right of ownership to the produced oil; the owner of the produced oil is the state. On the whole, PSAs and service contracts are very close to each other, and their principal difference lies just in the form of payment to the contractor.
Service contracts are subdivided into the two following types: (1) contracts with risk, and (2) contracts without risk, depending on whether the state assumes all or part of the costs of exploration (or whether the remuneration is related to income).
We believe that service contracts in their essence are a type of a contract services agreement; therefore, from a perspective of the Kazakhstan legislation it would be more correct to speak in this case not of service contracts (contracts for service rendering), but of one of the varieties of the contract services agreement. However, according to the tradition based on the world practice, one may agree with the accepted name and retain it for the Kazakhstan legislation with the understanding of the actual legal nature of this contract.
Contract Services Agreements for Geological Study of Subsoil
Contract Services Agreements for Geological Study of Subsoil have a various character since they may mean both the entire complex of such study (up to the exploration of useful minerals) and just separate types of geological study (for example, monitoring of the subsoil state). We would like to additionally note that in contrast to exploration (as a separate operation related to the search for fields of useful minerals performed by the subsoil user at its own commercial risk), the exploration within the framework of geological study of the subsoil shall be subject to payment as established in the contract services agreement, in this case the contractor does not have further rights to the development of the explored field.
Contacts for Construction and/or Operation of Underground Installations
The Subsoil Law, among the contracts named by it, mentions a contract for construction and/or operation of underground installations not related to exploration and/or production, while the Petroleum Law mentions a contract for construction and/operation of underground storages and oil tanks.
The situation with obtaining (granting) a right to construction and operation of oil and gas pipelines on the land and at sea, underground storages and oil tanks is unclear in the current legislation. The right to perform such operations should be granted by entering into a contract between the competent agency and the contractor. However, some wordings of the legislation and also the system interpretation of all applicable rules in aggregate allow doubting the need of entering into the contract.
Other Contracts for the Subsoil Use
As noted, the Kazakhstan legislation consistently adheres to the position of the possibility of entering into subsoil use contracts different from those listed in the Laws On Subsoil and On Petroleum.
We believe that this is possible within the framework of the two basic types of contracts for the subsoil use - lease contracts and contract services agreements. As to the possibility of entering into contracts of other types or combined contracts, this issue needs an additional consideration. Of course, from the positions of the civil law methods of discretion and permissibility the answer should be unambiguous - everything is allowed. But practically (and it may be substantiated from the legal positions, including the permissibility of introduction of restrictions to the contractual regulation of contracts), allowing in the subsoil use of any contracts without special substantiation is hardly possible and justified. Kazakhstan, as some other countries, has a practice of the establishment of joint ventures and entering into contracts of joint activities (with the participation of foreign investors) for the subsoil use purpose (contract for joint activities with the formation or without formation of a legal entity). However, such form of a contract may only serve the purposes of cooperation (including corporate) between the partners, but is not sufficient for the performance of the subsoil use operations. The practice showed that combining in the foundation documents of joint ventures the corporate provisions with the issues of the subsoil use, and relations with state agencies is technically cumbersome and legally doubtful.
In conclusion we would like to note that the further legal research of the legal nature of the subsoil use contracts, their classification and systematization should be continued, and the relevant work within the framework of legislative activities should be referred to the category of priority work.
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