More clarity: A look at recent revisions to laws affecting foreign investors

As may be expected in a fast-growing emerging market, Mongolia’s legal framework – like many other aspects of Mongolian society – is in a constant state of flux. At first blush, since foreign investors tend to crave legal certainty, this would appear to be a weakness of the country’s legal system. However, investors should take comfort in the fact that over the long term the changes to Mongolia’s legal system tend to be in the “right” direction; i.e. towards more stability, predictability and openness in order to attract a greater amount of foreign direct investment (FDI).

Lawmakers struggle to balance the competing interests of Mongolian citizens. The traditional paradigm between those who favour more openness to foreign investment as opposed to the “resource nationalists” is nuanced by additional policy objectives, such as the protection of human rights, redistribution of the wealth being generated from the country’s vast natural resources and appropriate methods to preserve Mongolia’s environment. These policy goals often come into conflict with one another and thus shape the laws which the country’s parliament, the State Great Khural, enacts.

OVERVIEW: Mongolia’s constitution was enacted in 1992 and is the primary source of Mongolian law. Mongolia’s private law is largely based on the Germanic civil law model, and those familiar with the German Bürgerliches Gesetzbuch (or the civil codes of other jurisdictions which are based on the German model) will find numerous similarities in both style and substance to Mongolia’s Civil Code. The Civil Code of Mongolia, enacted on January 10, 2002 (as amended from time to time), is the cornerstone of Mongolian private law. The Civil Code is the primary source of private law norms and contains the rules on property, obligations (including contract law), inheritance and private international law.

Much of Mongolia’s Civil Code contains principles which will be familiar to jurists elsewhere. The concept of freedom of contract is enshrined in Article 189 of the Civil Code, and specific rules governing nominate contracts, such as the sale of goods, services for hire, loans and leases, are covered therein.

As Mongolia’s legal system is based on the Civil Law tradition, strictly speaking, case law does not form a primary source of law.

However, decisions from Mongolian courts ( particularly the Supreme Court) are being used more frequently to explain and elaborate on specific provisions of the Civil Code and other statutes. In this way, rulings from judges are becoming more predictable, thus increasing legal certainty.

COMPANIES & INVESTMENT VEHICLES: The Company Law of Mongolia, enacted on October 6, 2011, outlines two forms of companies which have full legal capacity: the limited liability company (LLC) and the joint-stock company (JSC). Shares in an LLC tend to be privately held whereas those in a JSC are either listed publicly on the Mongolian Stock Exchange (an open JSC) or deposited for private trading at a securities depositing organisation (a closed JSC). The LLC has far fewer requirements mandated by law in terms of the corporate structure or governance, and as such, tends to be the preferred vehicle for foreign investors.

A foreign company that wishes to have a full-time presence in Mongolia may also establish a representative office. The key distinction between an LLC and a representative office is that the former has a distinct legal personality (meaning, among other things, that it may enter into contracts in its own name), whereas the latter is simply the representative of the parent company. Representative offices work well in certain industries, such as insurance and banking, but are more limited for other sectors since they cannot generate revenue in their own name.

PECULIARITIES OF THE LEGAL SYSTEM Land: Ownership of land is restricted to citizens of Mongolia and the state. Foreign citizens or foreign invested companies can own immovable property (other than land), so long as the land on which it sits is subject to a valid land possession or land use certificate. Business entities with foreign investment can obtain land use certificates which outline the purposes and conditions of the land use.

Furthermore, each Mongolian citizen is entitled to ownership of a plot of land for family usage, the size of which depends on its location, which is to be granted by the state. Currency Controls: The Law of Mongolia on Conducting Settlements in the National Currency (the National Currency Law) requires all domestic transactions to be expressed and settled in Mongolian tugriks (MNT). Transactions in which one of the parties is located abroad are not affected by this law, and there are certain additional transactions carried out by banks and non-banking financial institutions which are also exempt from this requirement.

In addition to settlement being made in MNT, purely domestic contracts must also express figures in MNT. The biggest impact the National Currency Law tends to have on foreign investors occurs when employing expatriate staff, as salaries must lawfully be expressed and paid in MNT. Mongol Bank, the central bank of Mongolia, as well as the Financial Regulatory Commission (FRC) are charged with enforcing the National Currency Law.

ADOPTION OF THE INVESTMENT LAW: In November 2013 the Mongolian parliament adopted the long-anticipated Investment Law, which replaced the former regime in place for foreign investors operating in Mongolia.

In the same act of parliament, the former Foreign Investment Law and Strategic Entities Foreign Investment Law (SEFIL) were both repealed. The SEFIL in particular had been widely blamed for the drop in FDI since its inception in May 2012. The SEFIL called for governmental or parliamentary approval in the event that a proposed transaction affected what the law deemed to be the strategic sectors of mining, banking and finance, and communications and media. This requirement of obtaining approval prior to a transaction taking place paralysed a number of foreign investors who were keen to put their money into Mongolia but were nervous about the uncertainty which accompanied the SEFIL. The new Investment Law does not maintain the governmental approval requirement, with the exception of cases where a foreign state-owned entity (which is defined as an entity which has at least 50% of its shares owned by a foreign state) attempts to acquire 33% or more of the shares of a Mongolian legal entity operating in mining, banking and finance, or communications and media.

A number of the changes brought about by the Investment Law concern the stabilisation of the tax environment for investors through the issuance of stabilisation certificates. The Investment Law stipulates that corporate income tax, Customs duties, value-added tax and mineral royalties are all potential forms of taxation which can be fixed pursuant to a tax stabilisation certificate.

The issuance and terms of the stabilisation certificate are determined by the amount of the investment, the completion of an environmental impact assessment (if required by law), the creation of a sustainable workplace, as well as the sector in which the investor will operate.

The Investment Law is a departure from the previous regime in place for foreign investors, as the law applies to both domestic investors and those from abroad. However, it would not be accurate to say that the Investment Law treats foreign and domestic investors “equally”; the Investment Law continues to include a distinct concept of “business entities with foreign investment” as being those in which a foreign investor holds 25% or more of the issued shares.

Business entities with foreign investment are required to have paid-in capital of at least $100,000 per foreign investor. This requirement is actually an increase from the regime under the old Foreign Investment Law, whereby foreign investment companies were only required to have paid-in capital of $100,000 for the entire company regardless of the number of foreign investors. ADOPTION OF REFORMS TO THE PRACTICE OF LAW: In 2012 parliament adopted the Law on the Legal Status of Lawyers, paving the way for the professionalisation of the practice of law in Mongolia. The inaugural meeting of the Lawyers’ Association was held in September 2013. The meeting was attended by nearly 500 delegates representing the interests of the legal community.

A code of ethics has been drafted which all Mongolian lawyers and advocates, as well as foreign registered lawyers, are required to adhere to.

The structure of the courts throughout the country has also been recently updated and become more organised. A law was passed by parliament in 2013 which establishes the General Council of Judges, a body whose work comprises of, among other things, providing professional assistance and administrative support to Mongolia’s judges.

Working teams under the General Council are in charge of monitoring and evaluating the performance of judges, as well as devising a code of ethics for judges.

MINING: The most significant piece of Mongolian legislation in the mining sector is the Minerals Law of 2006 (as amended from time to time). The Minerals Law lays out the framework whereby companies, both domestic and foreign invested, can obtain exploration and mining licences.

Pursuant to the Minerals Law, a holder of an exploration licence is granted the exclusive right to obtain a mining licence if the holder deems the mineral deposit to be commercially viable. Exploration licences are granted for an initial term of three years, with the possibility of extending the term for an additional three years twice.

Mining licences are valid for an initial term of 30 years, with the possibility of extending the term for an additional 20 years twice.

The Minerals Law outlines rules concerning what are deemed “strategically important deposits”, and allows the state the ability to acquire certain ownership interests in companies which are exploiting such deposits. If state funding was used during the exploration phase, the state may purchase up to 50% of the shares in a company exploiting the deposit. If no state funding was used, the government still has the right to acquire up to a 34% interest in the company conducting the mining activities.

Since 2010 the government of Mongolia has had a moratorium on the issuance of new exploration licences as well as the transfer of existing exploration licences. Parliament is scheduled to address these issues during the spring session of 2014, and it is widely expected that the moratoriums will either be lifted or eased slightly to promote economic activity in the mining sector.

In January 2014 parliament passed the State Minerals Policy in the hopes of outlining a strategic overview of the direction amendments should take to laws affecting the mining sector from 2014 to 2025. The State Minerals Policy includes the following specific examples of how laws and regulations in the mining sector will be affected:

• Concrete examples of how the legal framework within the minerals sector can be improved (e.g. adopting the Law on Common Minerals);

• Specific regulations to be passed dealing with the monitoring of gold mining activities;

• Defining specific terms in order to develop the legal framework in the minerals sector;

• Specific policy statements on: 1) Minerals;

2) The geological sector; and 3) Mining activities (e.g. production and refining);

• Outlining how to improve local development, citizens’ rights, environmental protection and other significant policy objectives;

• Methods for implementing the State Minerals Policy in the minerals sector (e.g. organising events, passing regulations, etc); and

• A timeframe for implementation of the State Minerals Policy and how to incorporate it into the legal framework.

BANKING & FINANCE: Since LLCs tend to be the preferred form of business entity, for both foreign and domestic investors, raising funds through the sale of a company’s equity has been quite limited in practice. In order to obtain financing, firms often resort to more traditional forms of raising funds such as asset-based secured debt financing. This is obviously more time-consuming and costly, meaning it raises barriers to entry for organisations that wish to operate in Mongolia.

The only security interest over physical assets under Mongolian law is the pledge. Currently, there are only three forms of pledge which can be registered and therefore perfected: pledges over mining licences, immovable property and shares in a JSC. For other pledges (e.g. over movable assets), the timing of when the contract was concluded will determine priority ranking.

The need for a developed legal framework for secured transactions involving security interests over movable property has been present in the country for some time, though legal reforms have yet to materialise. In 2013 the Ministry of Justice formed a working group comprised of academics, judges and other professionals to examine how to implement changes in this area and propose a draft law to be considered by parliament in 2014.

Though new developments in the legal framework of securities markets will hopefully encourage new methods of investment, for the immediate to short term, conventional debt financing remains the lone option for many businesses. The adoption of a law on the registration of movable property pledges would have a significant positive impact on the ability of Mongolian firms to obtain financing.

SECURITIES MARKET REFORM: In May 2013 parliament adopted a number of amendments to Mongolia’s Securities Law which came into force at the beginning of 2014. To date, Mongolia’s securities market has been limited by the legal framework necessary to monitor and regulate the trading of securities. The revised Securities Law introduces a legal regime which will provide greater transparency for investors, as well as granting greater authority to the FRC to enact regulations and oversee the securities market. Although the Securities Law is generally a positive development, additional rules, regulations and legal concepts need to be adopted and developed in order to make further improvements to the securities markets.

In addition to the revisions to the Securities Law, parliament adopted the Investment Fund Law in October 2013 which also came into force at the beginning of 2014. The Investment Fund Law lays out the obligations on professional investors operating investment funds within Mongolia.

As with the amended Securities Law, the purpose of the Investment Fund Law is to provide more transparency and predictability for investors in the hope of establishing an improved regulatory framework for Mongolia’s capital markets.

DISPUTE RESOLUTION: Although Mongolia’s rules on private international law specifically indicate that Mongolian courts can and will interpret foreign law, in practice, Mongolian judges are often quite reluctant to apply foreign law to disputes. Moreover, given that cross-border disputes are a relatively recent development in Mongolia, many judges lack the experience necessary to rule on complex international commercial transactions. Courts in Mongolia will generally not recognise judgments rendered in foreign jurisdictions unless a treaty has been concluded with the state where the judgment was rendered. While parties to trans-border contracts may wish to select the courts of their home state to have the exclusive jurisdiction over any dispute, if that state does not have a treaty with Mongolia on the mutual recognition of judgments, any judgment rendered in that state would be difficult if not impossible to enforce in Mongolia.

For the above reasons, parties to international transactions tend to favour arbitration as a method of dispute resolution. Although Mongolia’s current arbitration law is somewhat rudimentary, it does include the competence-competence principle, meaning Mongolian courts will generally decline jurisdiction in disputes where the parties have an agreement to arbitrate.

Furthermore, Mongolia is a party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958, meaning arbitral awards rendered abroad will generally be recognised and enforced in Mongolia unless one of the grounds for non-recognition as laid out in the treaty is met.

Presently Mongolia’s Ministry of Justice is in the process of developing revisions to Mongolia’s arbitration law and the Code of Civil Procedure in order to incorporate international best practices.

OBG would like to thank Lehman, Lee & Xu Mongolia for their contribution to THE REPORT Mongolia 2014