**FOREIGN INVESTORS AND PRIVATIZATION IN AZERBAIJAN**

 

By Kenan Najafov, Ulviya Bayramova, and Jonathan Hale –Baker Botts LLP

 

            UnderAzerbaijani law, foreign natural and legal persons[i]("foreign investors") may take part in the privatization of stateproperty.[ii]The government privatizes state-owned property by selling it to currentlessees, by offering shares in state-owned companies to employees, by holdingprivatization voucher[iii]auctions and tenders, and by establishing closed and open joint stock companies.[iv]Both domestic and foreign banks may provide financing for privatizationtransactions.[v]

 

            Themethod the Azerbaijani government uses to privatize companies depends on thesize of the company. State-owned companies are classified as small, medium, orlarge according to their sector and number of employees.[vi]  The State Property Committee may allowmedium-size companies to be privatized under the rules established for smallcompanies.  The Committee considersthe medium-size company’s technology and valuation in making this decision.[vii]

 

            Atleast 15% of the shares in small companies are offered to employees. Theremaining 85% are sold at cash auctions. A Trustee is appointed to representthe interests of small companies' employees and to take any actions necessaryto help prepare for privatization. Foreign investors are never allowed to serveas the Trustee.[viii] Allmedium and large companies are transformed into joint stock companies beforethey are privatized.[ix] The StateProperty Committee offers 15% of the shares to workers and managers from thesecompanies at closed voucher auctions. If some of these shares are notpurchased, they are usually sold along with other shares at a public voucherauction.[x]At least 50% of a company's shares must be sold at public voucher auctions. Theremaining shares are sold at cash auctions or investment tenders.[xi]Whereas cash auctions involve the immediate sale of shares for cash, ininvestment tenders bidders commit to making investments in the company that isbeing privatized. Depending on the terms of the investment tender, the biddermay be required to pay cash or provide privatization vouchers before receivingtitle or possession of the privatized company's shares.  In practice, investment tenders havebeen used to sell 55% or more of state owned shares in large companies such asthe Garadag Cement Plant, the Baku Steel Plant, and others.

 

            Theinitial offering price of shares in state-owned companies is determined by thecompanies themselves. The companies must follow State Property Committeeinstructions to set this price.[xii]The valuation is based on the book value of the company's assets.  When fixed assets under constructionare sold to foreign investors, the initial price of these assets is determinedon the basis of their international market value.[xiii]

 

**How Foreign Investors Acquire PrivatizedProperty**

            Foreigninvestors may purchase privatized property either during its initialprivatization or after it is privatized, i.e. on a secondary market. Only theState Property Committee has authority to sell state-owned property to foreigninvestors.[xiv] ThePresident of Azerbaijan must authorize the sale of property in certain sectors,including: oil, gas, mining, chemical, telecommunications, broadcast, transportcompanies, commercial banks, airlines, port facilities, certain urbaninfrastructure, hotels, and state-owned property located outside Azerbaijan.[xv]The President must also approve foreign investors' participation in theprivatization of these types of property.[xvi]

 

            Generally,foreign investors must acquire State Privatization Options in order to purchaseprivatized property. Options are purchased in Manat, the Azerbaijani currency,and as of August 16, 1999, one Option cost approximately 60,000 Manat, or $14.Options are bearer securities that can remain in circulation for three years.[xvii]Privatization Options can be used to acquire shares in any company and aredistinct from “Options” as normally defined by securities laws in the UnitedStates or in other countries. Options are used when foreign investors register shares with theNational Depository Center in Baku. Once they are surrendered to the Center, the Options are voided.

 

            BeforeJuly 26, 1999, the State Property Committee was in charge of issuing Options toforeign investors. Since July 26, the State Securities Committee[xviii]has had the authority to issue Options.[xix]  The State Securities Committee now setsthe rules for determining the price of the Options, publishes prices eachmonth, and sells Options at these prices.[xx]The State Property Committee previously had authority to perform thesefunctions. 

 

            Foreigninvestors can sell Options to other foreign investors on a secondary market. Inthis case, the purchaser must register the Options.[xxi]While the State Property Committee had the power to register secondary tradingof Options, the State Securities Committee may now have this authority byimplication, because it has been authorized to issue Options and by virtue ofits broad regulatory power over securities.

 

            LikeAzerbaijani citizens, foreign investors may use vouchers to bid for shares instate-owned companies that are made available at voucher auctions. To do so,foreigners must surrender one Option for each voucher that is used in suchauctions.[xxii]

 

            Foreigninvestors also need Options to place bids at cash auctions.  The number of Options that are requiredcorresponds to the voucher-to-share ratio that is determined in a voucherauction for shares of the same company.[xxiii]

 

            Whenplacing bids at investment tenders, foreign investors may acquire shares withor without using Options. The State Property Committee establishes the terms ofinvestment tenders.[xxiv]According to State Property Committee officials, these terms pre-determinewhether or not Options will be required. If the terms require the winner to submit a certain number of vouchers,then the winner, if foreign, must also provide an equal number of Options.

 

            Foreigninvestors are also generally free to purchase formerly state-owned property,including shares that are offered on secondary markets.  However, until August 15, 2000, foreigninvestors must also surrender Options to the National Depository Center inorder to register such shares.  Thenumber of Options per share that are required is equivalent to the number ofOptions fixed during the original privatization of those companies.[xxv]

 

 

**Initial market(Privatization)**
| ***Form  of Sales*** | ***Options  required? How many?***                                                             |
|----------------------|------------------------------------------------------------------------------------------------|
| Voucher Auctions     | Yes; one Option per one Voucher                                                                |
| Cash Auctions        | Yes; as per Voucher-Share ratio                                                                |
| Investment Tenders   | Only if required to submit Vouchers under the terms of the  tender; one Option per one Voucher |

** **

**Secondary Market(Post-Privatization)***
| ***Form  of Sales*** | ***Options  required? How many?***                                             |
|----------------------|--------------------------------------------------------------------------------|
| Any form             | Yes; equal to number of Options fixed during the initial  sale (privatization) |

**Requirement imposeduntil August 15, 2000*

 

**Formalization of Foreign Investors' Rightsin Privatized Property**

            Afterforeign investors purchase shares in medium and large companies at voucherauctions, cash auctions or investment tenders, they must notify the Ministry ofFinance and the State Property Committee within fifteen days.[xxvi]  Title passes to buyers upon the shares'registration with the National Depository Center or with another depository orshare registry.[xxvii]  After registration, the State PropertyCommittee provides every winner of a voucher auction with written notificationof ownership of shares and the address of the place of registration.  Upon the conclusion of investmenttenders, a purchase and sale agreement must be signed within fifteen businessdays.  It must include:

 

�                the name of the seller and buyer;

�                the name of company and its legal address;

�                the number and price of shares sold;

�                the conditions of the sale and any obligations of thebuyer including future investments             andpayment of outstanding debts of the company;

�                provisions on the seller’s supervision of the buyer’sperformance of investment terms;

�                penalties for breach of the agreement; and

�                provisions listing any basis for making the agreementvoid.[xxviii]

 

            Inorder to formalize property rights in small companies, buyers and sellers mustsign a protocol and conclude a purchase and sale agreement that must be signedand include:

 

�          adescription of the property; 

�          theprice; 

�          theform and date of payment;

�          thename and legal address of the seller and buyer and their agents (if any);

�          anyobligations regarding the use of the property and penalties for their breach;and

�          anyrules for the use of the land on which the privatized property is located.[xxix]

 

The agreement can also contain other provisions with theconsent of both the buyer and seller. If the buyer does not pay the selleraccording to the terms of the agreement, the agreement will be terminated andany earnest money is forfeited.[xxx]If all the conditions in the agreement are met, the seller provides the buyerwith a Certificate of Sale that conforms to strict standards set out inAzerbaijani law. Both the purchase and sale agreement and the Certificate ofSale are registered with the State Property Committee. Property rights pass tothe buyer when these documents are properly executed and registered.[xxxi]

 

**Limitations on What Foreign Investors MayBuy**

            Thereare a number of limitations on foreign investors' participation inprivatization in Azerbaijan. For example, foreign investors can only take partin the privatization of small companies with the consent of the employees orTrustee of that company.[xxxii]  Although Azerbaijani natural and legalpersons, including foreign-owned enterprises organized under the laws ofAzerbaijan, can buy land plots on which privatized companies are located,foreign persons are not allowed to make such a purchase. They may only begranted right of use or a lease for this land.[xxxiii]Azerbaijani law prohibits the sale of other strategic state property to bothforeign investors and Azerbaijani citizens.[xxxiv]

** **

**1999-2000 STATEPRIVATIZATION PROGRAM**

            TheState Property Committee has prepared the 1999-2000 State Privatization Programand it  is currently under reviewwithin the Azerbaijani Government. In order to become law, it must be approvedby the Parliament, which is called the Milli Mejlis, and must be signed by thePresident. If enacted, the 1999-2000 Privatization Program will govern theprivatization of medium and large companies, including energy companies.

* *

***This article is intended to be informational. Its contents should notbe construed as legal advice and readers should not act upon information inthis article without consulting legal counsel. Baker Botts LLP maintains anactive practice with respect to investment in the Caspian/Caucasus Region. Inorder to better serve clients' needs in the region, the firm opened an officein Baku, Azerbaijan in 1998. It is located at 6-10 Vagif Mustafa-zadeh Street,Third floor, Baku 370004, Azerbaijan. The authors of this article are in thefirm's Washington and Baku offices. They can be contacted at: (202) 639 7700 or011 994 12 97 63 88.***

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               [i]               Therules for foreign investors also apply to joint ventures if foreign ownershipexceeds 25% of the venture's equity. 1995-98 State Privatization Program, Art.4(3), July 21, 1995.

               [ii]               Lawon Privatization, Art. 5, Jan. 7, 1993.

               [iii]               Underthe State Privatization Program, Azerbaijani citizens, who registered with thegovernment, were each given four vouchers that they could use to acquire sharesin privatized companies at voucher auctions. Azerbaijanis can also use thevouchers to obtain shares in privatization investment funds.  The vouchers, which are valid for threeyears, are fully alienable and devisable. 1995-98 State Privatization Program,Art. 3 (2-4).

               [iv]               Lawon Privatization, Art. 14. 

               [v]               1995-98State Privatization Program, Art. 11.

               [vi]               Id.at Appendix 2.

               [vii]               Id.at Art. 8.3.

               [viii]               1995-98State Privatization Program, Art. 7.

               [ix]               Id.at Art. 2. 

               [x]               In1999, the government of Azerbaijan suspended voucher auctions.  They cite the expiration of the firstprivatization program as well as the need to review the results of voucherprivatizations in 1996-1998 as the reasons for the suspension, which may betemporary.

               [xi]               Id.at Art. 8(3).

               [xii]               StateProperty Committee Methodic Instructions on Valuation of Privatized State-OwnedProperty, Art. 3.

               [xiii]               Regulationson Privatization of Temporarily Closed Property, Suspended Construction, andFixed Assets Under Construction, Art. 13, Mar. 25, 1996.

               [xiv]               Id.at Appendix 10(5). 

               [xv]               1995-98State Privatization Program, Appendix 10(7).

               [xvi]               Id.

               [xvii]               1995-98State Privatization Program, Art. 4.

               [xviii]               TheState Securities Committee (“SSC”) under the President of Azerbaijan is a newlyestablished government agency with broad powers in  securities regulation. Regulations on the SSC were approved by  Presidential Decree 161 on July 26, 1999.  In practice, the SSC has yet to befully formed.

               [xix]               PresidentialDecree 161 on Providing for the Activities of the State Securities Committeeunder the President of Azerbaijan Republic, 14 May 1997, paragraph 9

               [xx]               Id.

               [xxi]               Cabinetof Ministers Decree 94, Apr. 28, 1998.

[xxii]           1995-98State Privatization Program, Art. 4.

               [xxiii]               Id.

               [xxiv]               Regulationson Investment Tenders approved by the Presidential Decree 771, September 28,1998

               [xxv]               Cabinetof Ministers Decree 94, Apr. 28, 1998.

               [xxvi]               1995-98State Privatization Program, Appendix 10(1).

               [xxvii]               NationalDepository System Regulations, 14 May 1997,  Art.4.1.  Notethat currently the National Depository Center is the only depository/shareregistry licensed in Azerbaijan.

               [xxviii]               PresidentialDecree on Investment Competition, Sept. 28, 1998, Art. 6.

[xxix]               PresidentialDecree on State Property Committee Rules on Formalization of Property Rights inPrivatized Property, Mar. 25, 1996, Art. 2.

               [xxx]               Id.at Art. 4.

               [xxxi]               Id.at Art. 6

               [xxxii]               1995-98State Privatization Program, Appendix 10(6).

               [xxxiii]               PresidentialDecree on Procedures for Sale of Land Plots on which Companies Being Privatizedare Located, Art. 3.

               [xxxiv]               Stateproperty that can not be privatized includes: subsoil and natural resources,national historic sites and objects, the National Bank of Azerbaijan, militaryand security facilities and equipment, companies that develop weapons andexplosives, transportation infrastructure, waste disposal companies, prisons,cemeteries, and certain medical facilities and orphanages. Id. at Appendix1(5).