Outside looking in: Foreign investors welcome as the reform process continues

Two issues facing any prospective investor in a developing nation are what is permitted and whether the laws of that country will protect their investment. For several years it has been recognised that Mongolia has tremendous potential, not just in terms of mineral resources, but also in agriculture and renewable power generation. The country treasures its independence, but as a functioning democracy, it recognises the need to respect the rights of its citizens and foreigners alike. Significant strides have been made in the past 20 years to produce a body of Mongolian Law which achieves this aim.

ON BALANCE: At times the courts have struggled to keep up, particularly with some older judges trained under the Soviet system. It would be naive to assume that bribery and corruption do not exist, but successive governments have made it their priority to crack down on such practices. On balance, Mongolia is a far more transparent country in which to do business than many other developing nations. The broad thrust of commercial law will be recognisable to Western investors, as Mongolia has drawn from the West, rather than from Asia, in developing its laws. In broad terms, the concept of the rule of law is recognised in Mongolia. This chapter seeks to give a brief summary of some of the more important legal topics for prospective foreign investors. In particular, we shall review the new Law of Mongolia on Regulation of Foreign Investment in Business Entities Operating in Sectors of Strategic Importance, as it significantly affects the legal landscape of foreign investment.

ELEMENTS OF MONGOLIAN LAW: The constitution – enacted by the national parliament, the State Great Khural, in 1992 – is the primary source of Mongolian law. Questions regarding the legitimacy of laws and regulations are tested before the Constitutional Court regularly. The judiciary is fairly active and independent, though there have been repeated concerns about corruption and a lack of experience in commercial matters. In 2012 the parliament passed a series of laws designed to further the reform of the national judicial system. For instance, according to the new Law on Judiciary, from July 2013 Mongolian courts will be reorganised into specialist courts in three major areas of law – administrative, civil and criminal. Until now there have been no specialist courts; Mongolian courts have administered justice as regular (or “generalist”) courts (except for the Administrative Court of Ulaanbaatar). The specialisation will now affect all first instance and appeal courts in Ulaanbaatar, as well as in regional administrative subdivisions (aimags).

Another development of note in 2012 was the adoption of the Law on Status of Legal Professionals, which introduces, for the first time, a bar association for all Mongolian lawyers and judges. The association will be responsible for the self-regulation of the legal profession and serving its members. Membership in the bar association is mandatory.

CIVIL CODE: 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 that is not prohibited is allowed. This is codified in Article 13.2 of the Civil Code, which states that “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 a real property or shareholder rights and obligations, 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.

Contract parties may agree to submit disputes for final resolution to an arbitral tribunal either in Mongolia or overseas, with London and Singapore 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. In addition, the country is party to the Hague Convention on Civil Procedure, making it legally possible to recognise and enforce requests and decisions of courts in a foreign country which is also party to the convention.

FOREIGN INVESTMENT: In accordance with Article 6 of the 1993 Law of Mongolia on Foreign Investment (the Foreign Investment Law), as amended, a foreign investor can establish a presence in Mongolia through the following methods: establishing a wholly foreign-owned Mongolian partner; 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 productionsharing 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. LAW OF MONGOLIA ON REGULATION OF FOREIGN INVESTMENT IN BUSINESS ENTITIES OPERATING IN SECTORS OF STRATEGIC IMPORTANCE: The biggest event on the Mongolian legal scene in 2012 was the introduction of the Law of Mongolia on Regulation of Foreign Investment in Business Entities Operating in Sectors of Strategic Importance (The Foreign Investment Law in Sectors of Strategic Importance). It was passed by the State Great Khural and came into effect on May 17, 2012. Investment approval requirements of the Law do not apply retroactively to foreign investments made prior to that date. The impulse for adoption of the law came in 2012, when the state-owned Aluminium Corporation of China announced its intention to acquire 56% equity shares belonging to Ivanhoe Mines in Mongolia-based South Gobi Sands.

SCOPE OF THE LAW: The law introduces a number of approvals necessary for foreign investment – whether state or private – via acquisitions of shares or otherwise involving Mongolian businesses. It classifies foreign investment into two categories: that into sectors of strategic importance and that by foreign state-owned entities. FOREIGN INVESTMENT IN SECTORS OF STRATEGIC IMPORTANCE: Sectors of strategic importance are mineral resources, banking and finance, and media and telecoms. According to the law, these are “strategically important for meeting the basic needs of the population, maintaining the independence and normal functioning of the economy, generating national revenue and ensuring national security.” TRANSACTIONS WHICH REQUIRE CABINET APPROVAL: Most transactions by foreign investors in Mongolia which are subject to government approval require the consent of the cabinet. One transaction requires parliamentary authorisation. Transactions which require cabinet approval are:

• Acquisition of, or the right to acquire, 33.33% or more of the shares in a strategic entity by a foreign investor;

• Obtaining control of a strategic entity as a result of a proposed acquisition in that entity, regardless of the percentage of equity interest; e.g. the foreign investor has the right to solely appoint the executive management or a majority of the board; veto decisions of the executive management or board; or determine or implement management decisions and/or operations; and

• Where, as a result of a proposed acquisition involving a foreign investor, regardless of the percentage of equity interest, the transaction may: lead to a monopoly (of seller or supplier) in the international and Mongolian mining, raw material and commodities markets; affect the market or the price of exported mineral products; or result in a potential dilution in the shareholding of a foreign investor in that entity. TRANSACTION WHICH REQUIRES PARLIAMENTARY APPROVAL: The one transaction which requires the approval of the parliament is an acquisition by a foreign investor of an interest in a strategic entity if such acquisition is of more than 49% of shares in that entity and the value of the acquisition exceeds MNT100bn ($70m).

TRANSACTIONS WHICH REQUIRE NOTICE: Foreign investors in the three strategic sectors are required to give notice of certain transactions under which they would acquire 5-33.32% of the shares in a strategic entity. The requirement is to give a post notice, not to obtain a prior approval. Notice must be submitted within 30 days of the acquisition of shares.

REVIEW PRIOR TO APPROVAL: The criteria for granting approval centre on the national security interests commonly applied in other jurisdictions. The government will review the following factors:

• How the investor and its proposed investment would affect Mongolia’s national security interests;

• How the investment would affect the national budget or other state policies;

• How the investment would affect the relevant sector;

• How the investor would comply with Mongolia’s legislation and established business practices; and

• How the investment would impact competition and how likely it would be to lead to a monopoly.

TRANSACTIONS OUTSIDE MONGOLIA: The requirement of government approval for the above transactions also applies to offshore transactions.

IMPLEMENTING REGULATIONS: Pursuant to the law, the Cabinet of Mongolia is required to issue two separate regulations designed to implement some aspects. One is the regulation on review and approval of investment applications. The other is the regulation on “local content”, i.e., on priority procurement of goods and services by Mongolia’s strategic entities from Mongolian suppliers.

APPROVAL OF INVESTMENT APPLICATIONS: The procedure for approval of an investment application is prescribed in the Law as follows. The foreign investor is required to submit its application for approval to the Ministry of Economic Development (MED) within 30 days of agreeing to the transaction. The MED must then submit its recommendations on acceptance of the investment application to the cabinet within 45 days of receipt of such application. The cabinet has to make a decision within 45 days of receiving the recommendation. Finally, the decision must be communicated by the ministry to the applicant within five days of its making.

In its latest draft (November 16, 2012), the Regulation on Procedure for Approval of Investment Applications lists the detailed documentation which the applicant would need to present to the MED together with the application for approval of the transaction. These would include, among other things, a certificate of registration of the strategic entity, an investment plan, a draft agreement of the proposed transaction and a list of shareholders of the applicant as well as of the target strategic entity. In addition, the draft regulation names Mongolian government agencies whose formal opinion is required in the application review. For instance,

• Opinion of the Ministry of Finance is required on “how the investment would impact the national budget or other state policies”;

• Opinion of the Ministry of Justice on “how the investor would comply with Mongolia’s legislation and established business practices”;

• Opinion of the Fair Trade Agency on “how the investment would impact competition and how likely it is to lead to a monopoly”; and

• Opinion from input of the Ministry in charge of that sector on “how the proposed investment would impact the relevant strategic sector”. From our review of the draft regulation, it seems that the MED would have no ability to refuse to make a recommendation to the cabinet, but the cabinet itself would not be bound to agree with any proposal made to it by the MED. Once again, this regulation is a work in progress. It is possible the draft of the regulation will undergo further changes before it is passed by the cabinet in a final form. According to a senior official at the MED, it is likely to be issued by the cabinet in the near future.

In whatever form the regulation is passed, it remains to be seen to what extent it will answer the question being asked by many foreign investors: could it help administer the law efficiently and in a transparent manner so as to provide investors with certainty and clarity before making an investment decision in relation to Mongolia? PROCEDURE FOR PRIORITY PROCUREMENT OF LOCAL CONTENT: When procuring goods and services, a strategic entity must give a preferential right to Mongolian national businesses. A procedure is required to be approved by the cabinet detailing such preferential procurement procedure. According to the MED, the regulation will be developed at a later date once the approval regulation is passed. FOREIGN INVESTMENT BY STATE-OWNED FOREIGN INVESTOR OR INTERNATIONAL ORGANISATION: An acquisition or operations by a state-owned foreign investor or international organisation requires the approval of the cabinet. It appears that this requirement applies regardless of (i) whether the acquisition or operations are in a strategic sector or otherwise and (ii) the size of shareholding.

AVAILABLE INVESTMENT VEHICLES: In terms of available investment vehicles, Article 33 of the Civil Code provides that for-profit legal persons may be established as limited liability companies or joint stock companies, which are discussed below. In the past, foreign entities were also entitled to establish branches in Mongolia, but this 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, and this makes it an attractive vehicle for foreign entities that are in the initial stages of their operations in the country. On the other hand, a representative office is not an independent or a separate legal entity, but is 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, since a representative office is not an independent legal entity, it 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 as a result of their unclear drafting. Clarifications of the amendments will continue to be a work in progress for some time.

COMPANIES: 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). Except in certain specific sectors such as strategic mineral deposits and other areas covered by the Foreign Investment Law in Sectors of Strategic Importance, 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. There is no legal, regulatory or administrative requirement to form a joint venture with a Mongolian partner. 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 tugrik. Industry-specific rules may require a higher minimum paid-in capital as a precondition 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 is governed primarily by the Civil Code, the Company Law, the 1993 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 principle under the Company Law is to uphold the concept of limited liability, subject to a few specific exceptions.

In terms of corporate governance, limited liability companies are not required to have a board of directors. Investors often take advantage of the flexibility afforded by Mongolian law to establish a BEFI with a light management structure. This could mean a firm with authority being exercised by the shareholder, and day-to-day management undertaken by a so-called executive director who is not a member of the board of directors, but the rough equivalent of the CEO or general manager in other jurisdictions. It is also permissible for a limited liability company to have a board of directors.

JOINT STOCK COMPANIES: Under the new amendments to the Company Law, there are two types of joint stock company. Open joint stock companies 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 concept of closed joint stock companies was possibly intended to cover companies which might have to be delisted 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, of which one third 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. 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: 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 and to provide an explanation on how a decision was obtained. Further, the chairman may now bind the company only upon the issue of power of attorney.

LAND RIGHTS: The issue of land tenure is entirely different from the issue of real estate ownership. However, the Land Law of Mongolia, 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 permitted to own buildings and other physical structures constructed on land but 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 dispose of, land. 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 of. The general constitutional principle is that all land in Mongolia is owned by the state. The state may, however, allocate certain types of land to Mongolian families and citizens for private ownership. Mongolian citizens are prohibited from transferring the plots of land they own to foreign citizens.

LAND POSSESSION RIGHTS: 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 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 60 years with the right to extend, to lease, to transfer (with the approval of the land authority) or to pledge as security the whole or part of the land held under its possession.

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 or pledge his 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.

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 set terms and conditions, and that the government will determine tenure of such land use by companies with foreign investment.

The right of land use is defined as the right to utilise one of the useful characteristics of land in accordance with the contract made with the landowner (i.e. the state or Mongolian citizens) or the holder of land possession right. The key difference between land “possession” and “use” rights, from a business perspective, is that land in “possession” land can be pledged to a third party, whereas land in “use” cannot be pledged to a third party.

Under the Foreign Investment Law, the initial tenure of land use right cannot exceed 60 years and can be extended only once for up to 40 years. However, the land authorities often grant land use rights for five years, and in rare cases, for 15 years.

MINING LAW: Mining is the centrepiece of foreign investment in Mongolia. The 2006 Minerals Law of Mongolia (the Minerals Law), as amended, sets out a licensing regime whereby foreign investors and Mongolian companies can obtain operating permits as a precondition to the commencement of exploration and mining activities.

STRATEGICALLY IMPORTANT DEPOSITS: The Minerals Law designates certain reserves as “strategically important deposits”. This classification means the government has the right to purchase up to a 50% interest in a company engaged in mining activities 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.

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 said fees is a mandatory precondition to preserve the effectiveness of the underlying licence.

Even minor non-compliance, such as missing the payment deadline by as little as 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 amount 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.

The new government has made known its plans to amend the 2006 Minerals Law. According to the government’s 2012-16 Action Platform, the amendments will consist, among others, of the following:

• Allow more say to local residents in decision-making of issuing a mining licence;

• Issue exploitation licences upon the cabinet’s decision only;

• Introduce quotas (limitations) on a number of mining licences a single company may hold;

• Determine areas open to exploration based on the local residents’ opinion;

• Require extracting companies to sell their output to Mongolian-based processing buyers on a priority basis at market prices;

• Require Mongolian ownership of no less than 51% in a company to mine strategic deposits which were explored under state funding in the past;

• Restrict/prohibit mining where technical and economic feasibility is projected as unprofitable or where its impact is excessively harmful to the environment;

• Grant exploitation licences to those applicants who prove financial capacity to implement a rehabilitation programme; and

• Redefine the definition of strategic deposits in the Minerals Law, consider drawing up a category of “strategic minerals” consisting of thermal and coking coal, copper, iron ore, rare earth elements and others. The government has also reiterated its commitment to implementation of the Law on Prohibition of Minerals Exploration in Water Basins and Forested Areas.

LABOUR LAW: The basis legislation in the field of labour is the 1999 Law of Mongolia on Labour (the Labour Law), 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 the minimum wage, social insurance and occupational health and safety.

The Labour Law applies to all foreign entities operating in the territory of Mongolia. It 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 though negotiations with the employer. The law sets the minimum age for employment at 16 but there is an exception for those who reach 14 years of age with the consent of the parents or guardian and related authority. There are also protective measures for those under the age of 18.

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 out the 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 prior approval from the relevant government authorities.

The government 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 the general ratio of foreign workers-to-Mongolian employees, which is 5% in 2012.

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 the parliament’s enactment of the 2010 Concession Law of Mongolia (the Concession Law), the government has got to grips with its implementation. Concessions take the form of a long-term agreement under which the private company provides or contributes to the provision of a public service. The state property committee has expanded its list of concession items, or projects, from 86 to over 120 in sectors ranging from construction, roads, power, railways, communications, education and health. The Concession Law identifies seven types of concession agreements, such as build-operate-transfer, build-own-operate, build-own-operate-transfer and build-lease-transfer. Concessions may be granted a tender process, through direct contracting or sometimes through unsolicited bids. The state property committee has produced a standard form of concession agreement drafted with the input of international lawyers and the Asian Development Bank. The Concession Law also permits the government to provide financial support, including loan guarantees, partial concession financing, tax credits and exemptions, and guarantees for minimum profits for the concessionaire.