Legal Environment

Legal Environment and
Legislation Update

Daniel Matthews
Partner, Baker & McKenzie


Introduction

As an independent nation for only ten years, Azerbaijan is still in political and economic transition. The Constitution of the Republic of Azerbaijan (the "Constitution"), ratified by popular referendum six years ago in November 1995, contains a western system of checks and balances aimed at securing separation of powers among the legislative, executive and judiciary branches of the government. The Constitution provides for a unicameral parliament (the National Assembly or Milli Majlis), a president and a prime minister.

Azeri Folk Dancers

The President is the head of the executive branch of the government and, with the consent of the National Assembly, appoints the Prime Minister. In contrast, the President appoints members of the Cabinet of Ministers without the consent of the legislature.

Judicial power in Azerbaijan is exercised by a court system whose independence is guaranteed by the Constitution. The Constitutional Court decides issues relating to the form and substance of laws and other acts of authorized agencies, international treaties concluded on behalf of the Republic of Azerbaijan, court decisions and the banning of political parties. It also resolves disputes among the branches of government. The Supreme Court, in contrast, is the court of last resort for all civil, criminal, administrative and other matters.

Foreign Investment in Azerbaijan

Since independence in 1991, Azerbaijan’s economic policy has focused on attracting foreign capital into Azerbaijan. To this end, Azerbaijan has been implementing a legal regime to encourage foreign investment in various industrial sectors. Azerbaijan has already succeeded in attracting major international oil companies to explore and develop its natural resources1. With the development of the oil industry, Azerbaijan has been able to attract additional foreign capital into the development of transportation2, communications3 and information technology services.

To ensure adequate financing technology transfer and management, foreign participation will be required for investment in most large- and medium-scale projects. Ultimately, these projects must operate within the domestic foreign investment regime. All foreign investors in Azerbaijan are entitled to rely on the most favorable legal regime available under Azerbaijani law and, in many cases, actually receive preferential treatment.

Foreign investment in Azerbaijan is regulated by a number of legislative acts, including the Law On Protection of Foreign Investments dated January 15, 1992 (“Foreign Investment Law”), the Law On Investment Activity dated January 13, 1995 (the “Investment Activity Law”), the Law On Privatization of State Property and the Second Program for Privatization of State Property in the Republic of Azerbaijan, adopted on August 10, 2000 (the “Second Privatization Program”), as well as laws that regulate separate sectors of the Azerbaijani economy.

Under Azerbaijani law, foreign investors may engage in any investment activity not prohibited by law. Pursuant to the Foreign Investment Law, foreign investment may be through:

  • joint ventures with Azerbaijani entities or citizens;

  • wholly foreign-owned subsidiaries;

  • the purchase of enterprises, buildings, structures, shares of enterprises and other securities and any other property, which may be owned by foreign investors;

  • the acquisition of rights to use land and other natural resources and other proprietary rights; and

  • agreements with Azerbaijani entities and citizens providing for other methods of realizing foreign investments.
  • Under the Foreign Investment Law, foreign investments are guaranteed:

  • a “not-less-favored” regime under which foreign investors have at least the same rights as local investors and may be granted certain preferential rights;


  • the right to repatriate profits, revenues and other amounts received in connection with investments, provided that all applicable Azerbaijani taxes have been paid;


  • a ten-year moratorium on the application of any subsequent law adversely affecting an investment. The moratorium has the force of law, automatically enforceable and binding upon all Azerbaijani state agencies. Laws, which govern the general investment climate, defense, national security, public order, morality, public health and environmental protection and legislation affecting credits and finances, however, fall outside the scope of the moratorium. Under the later-enacted Investment Activity Law, however, subsequent legislation (including laws on defense, national security, public order and tax) adversely affecting investment terms do not apply to an investor for the term of an investment contract;


  • that property may only be nationalized by a resolution of the National Assembly under exceptional circumstances to prevent harm to the people and damage to the state interests. Requisition of property is possible only under circumstances of natural disaster, epidemics, and other extraordinary situations by a decision of the Cabinet of Ministers. In both cases, foreign investors are entitled to compensation which shall be “prompt, effective and adequate”; and


  • free access to international arbitration upon the agreement of the parties where arbitration is not otherwise prohibited by law. Rulings of foreign courts are generally unenforceable in Azerbaijan.

  • In certain sectors of the Azerbaijani economy, such as energy, incentives are available to foreign investors and enterprises with foreign investment. These incentives may be granted by law or by agreements with the government.

    Bilateral investment treaties may establish a more favorable investment climate for certain investors and provide additional guarantees. Under Azerbaijani law, international treaties prevail over local legislation except for the Constitution and acts adopted by referendum. Azerbaijan has so far concluded 17 bilateral investment treaties with countries, such as the U.S., the U.K., Germany, France, Austria, Italy, and Turkey, as well as a number of multilateral foreign investment treaties.


    Business Organizations

    Azerbaijani law authorizes both foreign and domestic individuals and entities to participate in Azerbaijani legal entities. An Azerbaijani legal entity may be established in the following legal forms provided in the Civil Code and the Law On Enterprises:

  • general partnership;

  • limited partnership;

  • joint stock company;

  • limited liability company;

  • additional liability company


  • TA general partnership is a legal entity comprised of at least two individuals and/or legal entities. An Azerbaijani citizen may participate in a general partnership only if registered as an entrepreneur. Additionally, Azerbaijani citizens and legal entities may participate in only one general partnership. As in most jurisdictions, general partners are jointly and severally liable for the partnership’s liabilities. To the extent that the partnership does not have sufficient assets to cover its obligations, the partners are then personally liable for its obligations.

    Old Soviet ad for insurance company

    A limited partnership has one or more general partners and one or more limited partners. The general partners are personally liable for the partnership’s obligations. A limited partner’s liability is limited to the extent of its contribution. An individual may be a general partner in only one limited partnership. Similarly, a partner of the general partnership may not participate as a general partner in a limited partnership.

    To secure a limited liability structure, i.e., without recourse to the founders, an Azerbaijani legal entity must be created as a either a joint stock company (JSC) or a limited liability company (LLC). These entities that provide their shareholders/members with liability limited to the extent of their shares. An LLC established by a physical person, however, may not participate as the only founder in another LLC. A JSC may be created by a single shareholder provided that shareholder has purchased all outstanding shares of the company.

    A JSC may be either “open” or “closed”. Closed JSCs with more than 50 shareholders must be reorganized into open JSCs. Shares of a closed JSC and participatory interests of an LLC are distributed only among the founders and transferred to third parties only upon failure of shareholders/members to exercise their right of first refusal and upon failure of the company to purchase its shares for fair market value. Shares of an open JSC are publicly traded and may be alienated by shareholders to third parties without restriction. Shares in a JSC are securities, which must be registered with the State Securities Committee before issuance. Shares may be either common or preferred shares. Preferred shares may not exceed 25% of the charter capital.

    The charter capital of a JSC is divided into a fixed number of shares of a stated par value. For a closed JSC, the minimum amount of the charter capital is 10 million AZ manats (approximately US $2,200 calculated at 4,600 AZ manats to US $1). The minimum capitalization for an open JSC is 20 million AZ manats.

    An additional liability company (ALC) is an entity established by one or more individuals or legal entities contributing their shares to the charter capital. The legal structure of an ALC is similar to an LLC, except that the participants of an ALC may assume liability for the company in excess of their contributions as regulated by the charter

    The charter capital of any Azerbaijani legal entity, irrespective of its business form, must be fully paid on or before the date of its state registration. If the value of the net assets of an Azerbaijani legal entity is less than the amount of the charter capital at the end of the Azerbaijani legal entity’s second fiscal year, the charter capital must be decreased with the decrease registered with the Ministry of Justice.

    All Azerbaijan legal entities are subject to state registration with several state authorities including the Ministry of Justice, the tax authorities and the social insurance, employment and other special purpose mandatory funds

    A foreign legal entity may establish a representative office or branch in Azerbaijan. Representative offices and branches are not considered legal entities under Azerbaijani law but, rather, are considered an extension of a foreign legal entity. Both a representative office and a branch may carry out all or some of the functions of the entity and may engage in revenue-generating activities. They both operate on the basis of regulations (similar to a charter) approved by their parent legal entities.

    Real Estate

    Azerbaijani law recognizes private land ownership as well as non-possessory interests in land. Legal title to land and structures may be held by any legal entity without regard to its business form4. Azerbaijani law does, however, impose certain restrictions on land ownership by foreign individuals and entities, which may not directly hold title to land. As a general rule, land may only be leased to foreign entities5. Foreigners may own land only if it was transferred to them by bequest, gift or enterprise mortgage and must be disposed of within one year of such transfer. If a foreigner has not voluntarily disposed of an interest in land and structures, the executive and municipal authorities may order a forced sale6.

    Azerbaijani law, however, does not prohibit foreign investors from acquiring ownership interests in land and structures through creation of joint ventures with local capital or the establishment of wholly foreign-owned companies in Azerbaijan, as these are viewed as Azerbaijani legal entities.

    An ownership interest in land exclusive of buildings and other structures not acquired through privatization must be registered with the State Land Committee (SLC), which is responsible for issuing title certificates and recording information in the State Land Registrars. If land is owned by the municipality, the SLC may issue an ownership/lease certificate pursuant to a decision of the municipality to grant an ownership or a possessory interest in the land7. An ownership interest in land acquired through privatization, as well as any interest in immovable property, is subject to registration with the Ministry of Economic Development.

    Overview of the Old Town

    Banking and Finance

    Banking in Azerbaijan is regulated by the Law On Banks and Banking8 and the Law On the National Bank9. Banks and credit organizations are covered by the general notion “credit organization.” While banks are allowed to carry out all types of banking operations, credit organizations are still subject to the NBA’s regulations and may conduct only certain types of banking operations. Azerbaijan has a two-tiered banking system, with the NBA comprising the first tier and the remaining banks comprising the second tier. Currently, there are approximately 60 second-tier banks registered in Azerbaijan, including about a dozen banks with foreign participation. The number of registered second-tier banks is expected to decrease as banks consolidate in order to meet the minimum capitalization requirements imposed by the NBA.

    All banking activities, including the acceptance of deposits, maintenance of correspondent accounts, cash operations, money transfers, and lending are subject to licensing. Only the NBA has the right to grant licenses for banking activity. The NBA establishes the prudential requirements (including minimum capital and the ratio between monetary and non-monetary portions of a bank’s capital) and reserve fund requirements.

    Under the 1996 Lawi On Banks and Banking Activities in Azerbaijan, the NBA is also authorized to establish a cap on foreign participation in Azerbaijan’s banking industry. Pursuant to this law, the NBA limited the aggregate amount of foreign participation in the banking sector at 30%10. This was a considerable liberalization compared with prior banking law, which had limited foreign participation in any Azerbaijani bank to 49%.

    With further liberalization in mind, Azerbaijan created a regulatory framework for the activities of credit unions and other types of credit organizations as envisioned by Law On Banks and Banking. A non-banking credit organization is an entity licensed by the NBA to conduct only certain types of banking operations.

    On Amendments to Rule No. 1 “On Licensing of Credit Institutions” (the “Rules”): (1) non-banking credit organizations created in Azerbaijan by international or foreign credit institutions and sponsored by such international or foreign institutions or their respective governments to finance small and medium businesses in the developing countries; and (2) non-banking credit organizations created in Azerbaijan by international financial institutions such as IFC and EBRD are qualified to hold a limited banking license. Banks and non-banking organizations are restricted from engaging directly in insurance, commercial and manufacturing activities.


    Currency Control

    Under the existing foreign currency regulatory regime, residents11 and non-residents12 are entitled to open bank accounts both in manats, the national currency, and in foreign currency with the authorized banks of Azerbaijan. The 1994 Law On Currency Regulation subjects residents’ capital operations13 to a licensing requirement. To conduct such capital operations, residents must first obtain a license from the National Bank of Azerbaijan

    Both residents and non-residents may open current foreign currency account with any authorized bank of Azerbaijan. Non-residents, however, may open manat accounts only if such non-residents operate in Azerbaijan through established representative offices, branches and affiliates. Under banking rules, both residents and non-residents may receive payments in foreign currency, except when: (1) such payments are made for goods sold and services rendered in Azerbaijan; or (2) such payments are made in cash for exported goods and services.

    Both residents and non-residents are allowed to make payments in foreign currency within the country in many instances, such as for payments to representative offices, branches, and affiliates of both residents and non-residents for imported goods and services, for the creation of joint ventures and other legal entities in Azerbaijan; for the purchase of foreign currencies, for the repayment of loans issued in foreign currency, and for the payment of dividends. Although offshore payments made under various import contracts and loan repayments non-residents are not automatically deemed to be capital operations, such payments in certain cases may require the prior consent of the National Bank.

    Payment System

    Prior to enactment of the new Civil Code of Azerbaijan, the paper-based Azerbaijani payment system was a major contributing factor to the slowness and complexity of inter-bank transfers. The demand for electronic banking services has grown continuously since the establishment of a commercial banking system in Azerbaijan. This demand was first recognized in the law, however, only upon the adoption of Azerbaijan’s new Civil Code which for the first time authorized electronic banking and electronic signatures. That initial legislative step has set the stage for electronic banking, which previously had been limited to the introduction of automated teller machines. Fortunately, the NBA has utilized this new legislative basis to bring innovative technologies to Azerbaijan’s banking sector.

    NBA's first public step was to adopt the Rules On the Inter-bank Transfers by Banking Institutions in Azerbaijan (the “Rule”) on February 2, 2001. Under the Rules, bank account holders are authorized to issue payment instructions to their banks either physically on paper or electronically. For electronic fund transfer, the National Bank of Azerbaijan has now established:

  • the National Inter-bank Settlement System (AZIPS); and


  • the AZIPS National Settlement Center


  • Each commercial bank in Azerbaijan may now offer electronic banking services to its customers only if it is a member of AZIPS. AZIPS-based electronic payments in Azerbaijan are made through the nearly universally used SWIFT system and processed through the AZIPS National Settlement Center. This center processes electronic inter-bank fund transfers by debiting the corresponding account of the issuing bank and crediting the account of the beneficiary bank in the amount of the electronic inter-bank fund transfers.

    Conclusion

    As Azerbaijan seeks to attract much needed foreign investment, it has made progress in addressing issues arising from the legal regime. Recently adopted laws and the pending regulations will help to improve the investment climate and help to promote the country’s long-standing foreign investment policy.



    FOOTNOTES

    1. Azerbaijan has ratified about 20 production sharing agreements ("PSAs") operated by major international oil companies such as BP, ExxonMobil, Chevron, Agip, Shell, Conoco, Devon, TotalFinaElf and others.
    2. For example, construction of the Baku International Airport, the purchase of two Boeing 757-200 aircraft for the national airline and the pending reconstruction and modernization of the 44 kilometer Alyat-Gazi Magomed highway.
    3. Reconstruction of local telephone operation stations and the expansion of the GSM networks in Azerbaijan by Azercell and Bakcell.
    4. Law On Ownership effective on November 9, 1991, with the 1997 amendments; Land Code of August 8, 1999, Articles 5 and 48; Civil Code effective on September 1, 2000.
    5. Land Code, Articles 14, 15 and 49.
    6. Land Code, Article 49.
    7. Land Code, Articles 66 and 67; 1996 Presidential Decree, On the Application of the Land Reform Law; Presidential Decree of March 6, 2000, On the Application of the Land Code of Azerbaijan adopted on June 25, 1999.
    8. Law of the Republic of Azerbaijan No. 123-IQ, On Banks and Banking, dated July 14, 1996, as amended.
    9. Law of the Republic of Azerbaijan No. 118-IQ, On the National Bank of the Republic of Azerbaijan, dated June 10, 1996.
    10. A bank with more than 50% of the paid-up capital owned by or attributed to foreign entities is deemed to be a bank with foreign participation.
    11. Residents are defined as citizens and other persons with a permanent residence in Azerbaijan; legal entities incorporated or otherwise established pursuant to the Azerbaijani law; representative offices, branches and affiliates of the Azerbaijani legal entities located both within and outside Azerbaijan; and embassies and other diplomatic missions of Azerbaijan.
    12. Non-residents are defined as foreign citizens and other persons with a permanent residence outside Azerbaijan; legal entities incorporated under the laws of the foreign jurisdictions; representative offices, branches and affiliates of non-residents in Azerbaijan.
    13. Capital operations are defined as direct investment in the form of creation or acquisition of foreign legal entities abroad; purchase of securities; purchase of real estates, lands or mineral resources abroad; payments under export and import contacts made over 180-day period; etc.
    14. AZIPS was a US $3 million project financed primarily by the World Bank.
    15. SWIFT is an acronym for the Society of Worldwide Inter-bank Financial Telecommunication.