Open for business: The government is looking to increase levels of foreign investment

Mongolia has begun to attract the attention of the global business media as the next success story to come out of Asia. While it may still be early days, such optimism does not seem to be unfounded. Since October 2006, there has been a veritable “gold rush” of investment banks, hedge funds, private equity funds, construction firms, major and junior mining companies, mining support businesses, accounting firms and even law firms entering a market that has heretofore been regarded as the “back of beyond”.

The initial reason for this is, of course, the investment agreement signed by the government of Mongolia and the mining companies Ivanhoe Mines and Rio Tinto. It has long been known that Mongolia literally sits on mountains of gold, silver, copper, coal, iron, uranium, rare earths and molybdenum, among other minerals and metals. However, such untapped wealth was no more than just dirt in the ground until global prices for such commodities rose to their current levels. China's voracious appetite for these materials has changed the image of the country from a remote outpost to a modern El Dorado.

The legal and business environment of Mongolia poses many challenges for foreign investors, as is the case with any developing jurisdiction. However, these challenges are not insurmountable compared with other more bureaucratic jurisdictions.

BACKGROUND: Mongolians often say that their country is the “most eastern extension of Europe”, which is not as curious an assertion as it first sounds. Certainly, Mongolia had been under the tutorship of the Soviet Union and Eastern Europe since its declaration of independence from China in 1921, and this created a tendency to look at matters through a Western lens – albeit one shaped by communist practice. However, there are other reasons for this assertion since Mongolia represents a paradigm for a different way of operating in Asia.

Mongolians have always had a spirit of independence that derives from their nomadic heritage. The ability to retain livestock wealth and move to “greener pastures” precluded the rise of the tyranny of the rice paddy, whereas other Asians had no choice but to cling to their landholdings and submit to the exactions of petty civil servants. Furthermore, Confucian thought arrived only in the 19th century and made an impact in the form of aphorisms that are still used today.

There was no exultation of a civil servant class who stood above the law in exercising its powers. As the Mongolian language is alphabetic, acute powers of memorisation were not required to master thousands of Chinese characters in order to be literate, which, in turn, formed the basis for a more European method of education in the early 20th century.

An interesting aspect of traditional Mongolian culture is the acceptance of a code of behaviour applicable to all members of society. This tendency is engrained in the local psyche and possibly traces its origins back to the yasa, or code of laws compiled by Chinggis Khan in the early 13th century. For this reason, it is not surprising that Mongolian legal jurisprudence follows the Roman-German civil law tradition. As of November 25, 2011, the Mongolian parliament has enacted 468 laws (with two that are about to take effect), while Mongolian court decisions have persuasive – yet not binding – authority on subsequent disputes.

ELEMENTS OF MONGOLIAN LAW: The constitution, enacted by parliament in 1992, is the primary source of Mongolian law. Questions regarding the legitimacy of laws and regulations are tested before the Mongolian Constitutional Court on a regular basis. Mongolia's judiciary tends to be fairly active and independent, though there have been repeated concerns about corruption and lack of experience in commercial matters.

The Civil Code of Mongolia (the “Civil Code”), enacted on January 10, 2002, as amended recognises the freedom to contract, stipulating that parties to a contract are entitled, within the applicable legal framework, to conclude contracts freely and to define the contents of their contracts. Mongolian law is based on an overarching principle reminiscent of the English legal constitutional concept that everything which is not prohibited is allowed. This is codified in Article 13.2 of the Civil Code: “Participants to civil legal relationship may, at their own will, exercise any rights and duties that are not prohibited or directly stated in the law.”

The Civil Code's recognition of the freedom to contract injects an element of liberality. For example, aside from certain agreements relating to real property or shareholder’s rights and obligations, the parties to a contract are free to accept the laws of any state to govern the interpretation of the contract’s terms in the event of a dispute. If the parties agree, a foreign language version of the contract may prevail over the Mongolian language version. Furthermore, contract parties may agree to submit disputes for final resolution to an arbitral tribunal in Mongolia or overseas, with London and Singapore being frequently selected forums. As a signatory to the New York Convention for the Mutual Recognition and Enforcement of Foreign Commercial Arbitral Awards, Mongolian courts are obliged to recognise and enforce foreign arbitral awards.

FOREIGN INVESTMENT: In accordance with Article 6 of the Law of Mongolia on Foreign Investment (the Foreign Investment Law), adopted on May 10, 1993, as amended, a foreign investor can establish a presence in Mongolia through any of the following methods:

• Establishing a wholly foreign-owned business entity;

• Establishing a joint venture with a local Mongolian partner;

• Making direct foreign investment by acquiring stock, shares or other securities in a Mongolian domestic entity;

• Acquiring (by law, concession or product sharing contract) the rights to exploit and process natural resources;

• Entering into a contract for marketing or management; or

• Making an investment through finance leasing or franchise. The forms of foreign investment which are outlined in the Foreign Investment Law are a reflection of the relatively nascent state of development of the Mongolian economy in 1993.

AVAILABLE INVESTMENT VEHICLES: In terms of available investment vehicles, Article 33 of the Civil Code provides that for-profit legal persons in Mongolia may be established as limited liability companies or joint stock companies, which are discussed further below. In the past, foreign entities were also entitled to establish branches in Mongolia, but this possibility has been abolished by a series of amendments to the Foreign Investment Law made on May 29, 2008.

A foreign legal entity can also establish a representative office in Mongolia. Unlike other forms of foreign investment vehicles, there is no minimum capital requirement for setting up a foreign representative office, which makes it an attractive vehicle for foreign entities in the initial stage of their operations in Mongolia. On the other hand, a representative office is not an independent or a separate legal entity, but rather a liaison office for its parent company; the parent company is entirely responsible for the obligations of its representative office, and the actions of the representative office are deemed to be the actions of the parent company. The statutory functions of a representative office are therefore to protect the legal interests of its parent company and to conclude transactions on its behalf in accordance with its charter.

However, as a representative office is not an independent legal entity, a representative office generally does not have the legal capacity to enter into revenue-generating contracts with other entities and is not eligible to obtain an administrative licence. Given these limitations, most foreign investors elect to incorporate a company under the Company Law of Mongolia (the "Company Law"), enacted on July 2, 1999, as amended from time to time. On November 21, 2011, a round of new amendments to the Company Law entered into effect, causing uncertainty because of unclear drafting. Clarification of the amendments will continue to be a work in progress for some time.

COMPANIES: As noted above, companies in Mongolia may either take the form of limited liability companies (whose shares are subject to certain restrictions on transfer) or joint stock companies (whose shares may be freely traded). There is no general restriction on the maximum foreign shareholding percentage in Mongolian companies, and wholly foreign-owned Mongolian subsidiaries are permitted both in law and practice, i.e. there is no legal, regulatory or administrative requirement to form a joint venture with a Mongolian partner (except in certain specific sectors such as with strategic mineral deposits). If a foreign investor contributes 25% or more of the capital in a company in Mongolia, such a company is classified as a business entity with foreign investment (BEFI).

The minimum equity contribution of the foreign investor in a BEFI is $100,000 or an equivalent amount in Mongolian togrogs. Industry-specific rules may require a higher minimum paid-in capital as a pre-condition for obtaining a special licence, e.g. a construction licence. With respect to the financing of the company, the Business Entities Tax Law of Mongolia, enacted on June 29, 2006, as amended, imposes limits on the deductibility by a Mongolian corporate borrower, which the company would be, of interests paid to its investor(s) if the equity-to-debt ratio exceeds 1:3.

LIMITED LIABILITY COMPANIES: The creation of a limited liability company with foreign investment in Mongolia is governed primarily by the Civil Code, the Company Law, the Foreign Investment Law and the Law of Mongolia on the State Registration of Legal Entities (the "Legal Entities Registration Law"), adopted on May 23, 2003, as amended. The general principle under the Company Law is that “shareholders shall not be liable for the obligations of the company and shall only bear risk of loss to the extent of the shares they hold [in the company]”. However, in Mongolia as in other jurisdictions, limited liability is not an absolute protection, and the Company Law permits corporate veil piercing in three situations.

In terms of corporate governance, limited liability companies are not required to have a board of directors. Foreign investors take advantage of the relative flexibility afforded under Mongolian law to establish a BEFI with a relatively "light" management structure. In this respect, the lightest structure would be a company with no board of directors, where the highest authority is the shareholder, and the day-to-day management of the company is exercised by a so-called executive director (who is not a member of the board of directors, but rather the rough equivalent of the chief executive officer or general manager in other jurisdictions).

Alternatively, it is possible to entrust the day-to-day management of the company to a collegiate executive body (with a chairman and other members). It is also possible, although not required, for a limited liability company to have a board of directors, an auditor and so forth. The amendments to the Company Law now provide a shareholder of a limited liability company with the right to receive information related to the company and to have access to financial and other documents of the company.

JOINT STOCK COMPANIES: The new amendments to the Company Law have injected an element of uncertainty regarding joint stock companies. Under the amendments, there are two types of joint stock company. Open joint stock companies are those that are registered with the Mongolian Stock Exchange (MSE) where their shares are publicly traded. Closed joint stock companies are registered with the undefined securities depository organisation with their shares being traded outside the MSE. The amendments do not explain where the shares of such closed joint stock companies are to be traded or why investors would wish to select such an entity for their investment.

According to people close to the working group for the draft amendments, closed joint stock companies are envisaged as a default category for previously listed joint stock companies that do not fulfil the criteria of the amended laws to continue to be publicly traded. The shares of this new classification of joint stock companies are likely to be traded at the Mongolia Securities Clearing House and Central Depository at some point in the near future. The Central Depository is a state-owned enterprise that is responsible for the settlement of payments resulted from securities trading on a contractual basis, the registration of ownership rights of securities and changes in such ownership rights. While it is still very early days in terms of the legal professions’ understanding of the amendments, it appears that the creation of closed joint stock companies was a compromise or an intermediate step short of delisting certain joint stock companies from the MSE. All joint stock companies are obliged to adhere to a more detailed corporate governance regime than limited liability companies. A joint stock company must have a board consisting of no less than nine members. Under the new amendments, one-third of the members must be independent directors. If a board of directors does not have the correct percentage of independent members, it will be deemed as having no authority to exercise its powers (in contrast, a limited liability company does not need to have independent directors unless its charter expressly calls for this).

IMPACT OF AMENDMENTS TO THE COMPANY LAW: undefined Under the amendments to the Company Law, all Mongolian companies must call and hold regular shareholder meetings within four months of the end of the fiscal year. Failure to hold such meetings nullifies the authority of the board of directors or the executive management and all contracts and transactions entered into after such date will be void. The amendments also obligate the board of directors to make a declaration of dividends within 50 days after the end of each financial year and to provide an explanation on how a decision was obtained.

The amendments to the Company Law have overturned some long-standing practices. For example, in the past, the chairman of the board of directors could represent the company or enter into binding agreements on behalf of the company without procuring power of attorney. The amendments have removed this power. Accordingly, the chairman may bind the company only upon the issue of power of attorney.

The Company Law sets out various legal concepts that are unique to Mongolia, such as governing persons, affiliated persons, conflict-of-interest transactions and major transactions. Each of the definitions and scope of liabilities of such terms has been revised under the amendments. The Company Law mandates that the shareholders of an existing company must amend the companies charter and complete re-registration procedures by July 1, 2012 if the charters’ terms are not in compliance with the amendments.

LAND RIGHTS: At the outset, the issue of land tenure is entirely different from the issue of real estate ownership. Foreign investors are permitted, both in law and in practice, to own buildings and other physical structures constructed on land. However, the Land Law of Mongolia (the "Land Law"), adopted on June 7 2002, as amended recognises three types of rights with respect to land: ownership, possession and use. Foreign investors and BEFIs are only permitted to acquire land use rights, as explained in more detail below.

LAND OWNERSHIP: Land ownership is defined as the right to exercise legitimate control over, and to dispose of land. More generally, the right of ownership in Mongolia is composed of three elements: the right to freely possess, the right to use and the right to dispose. The general constitutional principle is that all land in Mongolia is owned by the state.

The only exception to this principle is that the state may allocate certain types of land for private ownership to Mongolian families and citizens only. Moreover, Mongolian citizens are prohibited from transferring the plots of land they own to foreign citizens.

LAND POSSESSION: The land possession right is defined as the right of the possessor to exercise legitimate control over the land in accordance with its purpose of use, under the terms and conditions specified in the relevant land possession contract entered into with the state. Pursuant to the Land Law, Mongolian citizens and entities can have the right to possess land initially for up to sixty (60) years with the right to extend, to lease the whole or part of the land held under its possession, to transfer with the approval of the land authority or to pledge as security. The state, as the owner of the land, may grant possession rights over plots of land only to Mongolian citizens and domestic capital companies and organisations. The land possessor may, in turn, only transfer and pledge his/her/its Land Possession Certificate to another Mongolian citizen, company or organisation. The cumulative effect of these provisions is that foreign entities and foreign-invested entities cannot obtain possession rights over land in Mongolia.

LAND USE: The right to land use is defined as the right to utilise one of the useful characteristics of land in accordance with the contract made with the land owner (i.e. the state or Mongolian citizens) or the holder of land possession right. Pursuant to the Land Law, parliament has the power to decide the use of land by foreign countries and foreign legal entities as well as international organisations under lease or concession agreements, and the government determines the boundary of such land and the procedure for such use of land. Moreover, foreign citizens and stateless persons who are residing in Mongolia above 183 days can hold land use rights for the purpose of common family use upon the decision of the municipal governor through a land auction procedure.

FOREIGN INVESTMENT LAND USE RIGHT: The Land Law stipulates that land may be used by Mongolian companies with foreign investment for specific purposes and on specific terms and conditions, and that the government will determine tenure of such land use by companies with foreign investment. The Foreign Investment Law provides the principal terms and conditions of land use by companies with foreign investment. Under the Foreign Investment Law, the initial tenure of land use right cannot be more than 60 years and can be extended only once for up to 40 years. However, in practice, the land authorities often grant land use rights for 5 years, and in rare cases, for 15 years.

Moreover, the land authorities permit extensions more than once so long as the maximum tenure of 100 years has expired. The land authorities claim that, by granting short-term tenure, they will have more control over land use right holders and have more flexibility on their side to invalidate land use right, reject the tenure extension or terminate land use agreements if holders of land use rights do not pay their land fees or violate the terms of land use agreements.

MINING LAW: Mining is, of course, the centrepiece of foreign investor interest in Mongolia. The Minerals Law of Mongolia (the "Minerals Law"), enacted on 8 July 2006, as amended sets out a licensing regime whereby foreign invested and domestic Mongolian companies can obtain operating permits as a precondition to the commence of exploration and mining activities.

STRATEGICALLY IMPORTANT DEPOSITS: The Minerals Law designates certain reserves as "strategically important deposits". This classification means that the government of Mongolia has the right to purchase up to a 50% interest in a company engaged in mining activities in such reserves if the state has allocated funding for the exploration of the deposits. If the state has not allocated such funding, then it has the right to purchase up to a 34% interest of such company. It is important to note that the state must procure funding to provide its percentage of the registered capital of the company; it does not have any rights of expropriation regarding the mining company. Moreover, it has been suggested in the Mongolian media that the government of Mongolia is not inclined to exercise its rights regarding strategically important deposits in the future.

MINERALS EXPLORATION: A minerals exploration company is obliged to pay an annual fee calculated on the number of hectares under exploration and the year of the term of the exploration licence. Payment of such annual fees are a mandatory precondition to preserve the effectiveness of the underlying licence. Even minor noncompliance with paying fees, such as missing the payment deadline by a few days, can render the exploration licence subject to revocation.

A holder of a minerals exploration licence must also undertake exploration work set as certain statutory requirements based upon the size of the reserve as well as the year of the licence term.

MINERALS MINING: A key element of the Mongolian mining regime is that an exploration licence holder has an absolute right to convert its exploration licence into a mining licence should it conclude that the deposits in the reserve are commercially viable. Approval must be obtained from the state commission under the Ministry of Mineral Resources and Energy for the commencement of mining activities.

An annual licensing fee is levied at the rate of around $15 per ha, while this fee is reduced to $5 per ha for coal and other common minerals. Moreover, royalties are levied at the rate of 2.5% of the domestic sales of coal and common mineral resources. For other extracted products, the royalty rate rises from 5% to 10% depending upon the market price of the minerals in question and the level of processing. In addition, the holder of a mining licence must deposit an amount equal to 50% of its state-approved environmental protection budget in a local bank account.

LABOUR LAW: The basic legislation in the field of labour law is the Law of Mongolia on Labour (the "Labour Law"), dated May 14 1999, as amended, which defines the respective statutory rights of employees and employers, basic conditions of labour, employment contracts, procedures for dismissal, collective bargaining rules and the resolution of labour disputes, among other matters. There are also detailed laws and regulations affecting minimum wage, social insurance and occupational safety and health. The Labour Law applies to all foreign entities that are operating in the territory of Mongolia. The Labour Law allows employees to form unions, and an employee's rights and legal interests more favourable than those guaranteed by the Labour Law are to be agreed in a collective agreement or through negotiations with the employer. The Labour Law sets the minimum age for employment at 16 but there is an exception for persons who reach 14 years of age with the consent of the parents or guardian and related authority. There are also certain protective measures for persons under age 18.

BASIC CONDITIONS OF LABOUR: The minimum working week consists of 40 hours, with Saturday and Sunday as days of rest unless otherwise agreed. A total of nine public holidays are also designated in the Labour Law. An employee is entitled to have annual paid leave of 15 to 32 working days, depending on the length of years in employment and labour conditions. In addition to the weekly rest days, employees are entitled to statutory public holidays and maternity leave up to 120 days under the Labour Law. Overtime is to be paid at 1.5 times the employee's standard hourly rate. Work on a public holiday is by agreement and paid at double the rate. The current minimum monthly wage is MNT140,400 ($106) as increased by the National Three Parties Committee on Labour and Social Concurrence in April 2011. An employer has a legal obligation to provide social and health insurance for employees and compensate employees in the event of an industrial accident, poisoning or work-related disease.

Furthermore, the Labour Law prevents discrimination against people with disabilities and requires entities with more than 25 employees to hire handicapped persons at the rate of at least 4% of such employees, or make a monthly payment to the government.

The concept of at-will employment does not exist in Mongolian law. An employer may terminate an employment contract only upon existence of certain specific grounds provided for in the Labour Law. Collective labour disputes are settled by utilising intermediaries, or through the labour arbitration court. Individual labour disputes between an employer and an employee is resolved by the labour dispute settlement commission and/or the courts.

EMPLOYMENT OF FOREIGN INDIVIDUALS: The Law of Mongolia on Dispatching Workforce Abroad and Bringing Workforce and Specialists from Abroad (the “Labour Export and Import Law”), dated April 12, 2001, as amended, sets forth the principal procedures for bringing foreign workers for employment in Mongolia.

Article 7.1 of the Labour Export and Import Law permits a Mongolian legal or natural person to employ foreign workers and specialists in positions that require professional skills for the purpose of introducing science, education and advanced technology: carrying out novel manufacturing or services: assembling or repairing equipment: or implementing a project in Mongolia upon obtaining a prior approval of the relevant government authorities. The government of Mongolia sets an annual quota for foreign workers based on the following three major factors: (a) industrial sectors or sub-sectors, (b) total number of employees, and (c) total paid-in capital. Entities which conduct business activities but are not listed in the foreign workforce quota are subject to a general ratio of foreign workers to Mongolian employees, which is 5% in 2011.

Furthermore, Article 7.3 of the Labour Export and Import Law stipulates that foreign workers can be imported upon the government’s deciding in the event where necessary workers are not able to be hired domestically in the following two cases: (i) implementing projects and programmes or constructing buildings that are national in scale; or (ii) dealing with the consequences of natural disasters.

CONCESSION LAW: Following parliament’s enactment of the Concession Law of Mongolia on January 28, 2010 (the "Concession Law"), the government has got to grips with its implementation. Commonly called public-private partnerships in the West, concessions take the form of a long-term agreement between the government and a private company, under which the private company provides or contributes to the provision of a public service. The state property committee has announced 86 concession items, or projects, in sectors ranging from construction, roads, power, railways, communications, education and health. The first concession agreement is the build-operate-transfer (BOT) contract for the Mogoi River Thermal and Heating Power Plant between the state property committee and a Mongolian company, New Asia Mining.

The Concession Law identifies seven types of concession agreements such as BOT, build-own-operate, build-own-operate-transfer, build-lease-transfer and the like. Concessions may be granted by way of a tender process, through direct contracting in special circumstance, and through unsolicited bids. After some initial false starts, the state property committee has produced a standard form concession agreement drafted with the input of international lawyers and the Asian Development Bank. The Concession Law also permits the government of Mongolia to provide financial support, including loan guarantees, partial concession financing, tax credits/exemptions and guarantees for minimum profits for the concessionaire. Presently, international and domestic bidders are considering the Combined Heat and Power Plant 5 project in Ulaanbaatar, which is due to be awarded in March 2012.

DEVELOPMENTS IN THE BANKING SECTOR: In the past two years, there has been increased interest on the part of international commercial banks in Mongolia. Currently ING and Standard Chartered Bank have established representative offices. In anticipation of further development, the central bank of Mongolia (Mongolbank) has considered implementing new regulations to clarify the procedures whereby a foreign bank or financial institution may establish a business presence that allows for wider scope of business activities than that permitted for representative offices. The Banking Law of Mongolia, enacted by parliament on January 28, 2010 (the “Banking Law”) permits foreign legal entities, banks and financial institutions to establish a foreign invested bank subsidiary, a branch or a representative office, and authorises Mongolbank to determine additional requirements applicable for operations of a foreign invested bank, foreign bank branches or foreign bank representative offices. However, to date, regulations promulgated by Mongolbank and the Financial Regulatory Commission have treated the concepts of a subsidiary and a branch as inter-changeable. While both the Company Law and the Banking Law in theory permit foreign entities to establish branches in Mongolia, the Foreign Investment Law does not contemplate a process for the registration of a branch. Accordingly, there is no registration process to set up a Mongolian branch of a foreign company.

Furthermore, under the Licensing Law of Mongolia, enacted on February 1, 2001 (“Licensing Law”), an entity engaged in banking services must procure the requisite licences. Licences are issued only to companies incorporated under Mongolian law and registered with the Legal Enterprise Registration Office of Mongolia. In other words, only legal entities incorporated in Mongolia can apply for and hold licences. Branches of Mongolian and foreign entities cannot independently apply for licences under the Licensing Law. Draft banking regulations address this dilemma by treating a branch of a foreign bank as a subsidiary. Such draft regulations call for a Mongolian branch to have legal personality that is separate from the foreign bank and to meet the same statutory minimum paid-in capital requirement that is imposed on Mongolian-incorporated banks. This poses a dilemma for foreign banks. On the one hand, representative offices are not able to engage in revenue-generating activities or may only perform a liaison function. Such restrictions are not appealing to those banks wishing to participate more fully in the Mongolian market. On the other hand, the establishment of a branch that is indistinguishable from a subsidiary poses the risk that a Mongolian branch would create pools of "trapped" liquidity, resulting in an inefficient use of funds.

Appeals have been made to Mongolbank to consider revising the current foreign investment regime so as to permit the registration of true branches of foreign banks. This issue will continue to be under review as Mongolia moves into the new year.

CONCLUDING COMMENTS: Mongolia is commonly described as a single market given the country's dependence upon China. Nevertheless, the government of Mongolia realises that its economic development is acutely dependent upon close economic ties with China and now pursues a policy of encouraging direct investment by Chinese companies. Nevertheless, Mongolia still seeks support from other nations in accordance with its third neighbour policy in its foreign affairs. Investment from other nations is keenly sought in order to provide leverage against the geopolitical influence of its two gigantic neighbours. The government of Mongolia cultivates a foreign investment policy that seeks to bring in all of the G20 countries so that the country becomes fully integrated into the global economy. There will be prime mover advantages for those foreign companies that invest in the country now.