Azerbaijan: Baku to the future

Azerbaijan’s once booming economy is shaky. It took a turn for the worse after the crash in global oil prices three years ago, leading to public spending cuts and exposing the weaknesses of the banking sector. In May, the International Bank of Azerbaijan, the country’s largest bank, filed for bankruptcy protection. Last year GDP contracted for the first time since 1995 and remains in negative territory, according to the World Bank.

There have been other problems for Azerbaijan’s reputation among international investors. The energy-rich state has been hit by alleged corruption scandals; allegations of secret payments, worth millions of dollars, to Malta’s senior political officials; and the ‘Azerbaijani Laundromat’, an alleged $2.9bn money laundering and lobbying scheme allegedly involving members of the country’s ruling elite, European politicians (including at the Council of Europe) and anonymous British companies. The scheme was disclosed last month through a joint investigation by a number of newspapers, including the Guardian.

In March Azerbaijan withdrew from the Extractive Industries Transparency Initiative (EITI). This came after the organisation, which monitors transparency and good governance in oil, gas and mining projects, suspended its membership over concerns about a continuing crackdown on government critics, lawyers and civil society. Azerbaijan’s decision to exit EITI has in turn put at risk loans from international banks, including EITI member EBRD, for the $46bn Southern Gas Corridor natural gas pipeline that will connect Azerbaijan’s gas fields in the Caspian Sea with Europe.

The small former Soviet state has effectively been ruled by the Aliyev family for almost five decades. Azerbaijan’s current president Ilham Aliyev, in office since 2003, is tightening his grip on the country. He was granted extra powers, including the right to choose his deputy, following a referendum to amend the constitution in September 2016. In February Aliyev named his wife Mehriban Aliyeva as vice-president.  

Yet, business lawyers are sanguine. ‘Despite the recent economic downturn due to the fall in oil prices, Azerbaijan has continued to track positively. Diversification of the economy is one of the main priorities [of the government],’ says Vugar Mammadov, managing partner of Baku-based Capital Legal Services (CLS), which launched in 2016 with two lawyers and now has five. ‘Significant steps have been taken to develop the non-oil industry and reduce Azerbaijan’s dependence on the production and export of oil and gas,’ says Mammadov, whose clients include Qatar Airways, Hyatt Regency and Holiday Inn.

‘The geographic location of Azerbaijan, at the heart of major trade routes and [as] an international transport corridor between Europe and Asia, has made the country a regional energy, trade and infrastructure hub,’ Mammadov adds. ‘Furthermore, Azerbaijan enjoys favourite trade status under the EU-Azerbaijan Partnership and Cooperation Agreement [in force since 1999].’

‘The government of Azerbaijan has responded to the crisis with various reforms and incentives designed to attract foreign investment, particularly in the non-oil sector,’ says James Hogan, managing partner of Dentons’ office in Baku. ‘It also has been promoting new projects, such as the new Baku International Sea Trade Port, the site of the country’s first free-trade zone, with the potential to become a major trade and logistics hub in the Caspian Region.’

Investment incentives such as tax and customs perks for investors in industrial or technological parks have been introduced. For qualifying projects outside these areas, the government now offers similar investment incentives – or Investment Promotion Certificates issued by the Ministry of the Economy, Hogan explains. Last year, the government streamlined the regime for obtaining licences or permits, and introduced an electronic licence and permit portal for online applications. ‘Various amendments to the banking and bankruptcy legislation of Azerbaijan have been adopted in the past year,’ Hogan notes.

Legal market

Most law firms active in Azerbaijan have ‘either downsized or maintained a stable headcount’ since the start of the downturn, Hogan says. Dentons’ Baku office employs nine full-time lawyers and Hogan believes the ‘current size is adequate for the market. We have the ability to draw lawyers from our other offices in the CIS or elsewhere if additional legal staff is needed’.

By UK standards the legal sector is tiny, reflecting in part the sophistication and size (ranked 88th in the world) of the economy. The largest law firm has about 20 lawyers, the Law Society says in its guide on doing legal business in Azerbaijan, and there are about 1,000 practising advocates and business lawyers.

There are few barriers to entry for foreign lawyers or law firms in Azerbaijan. Foreign lawyers can practise local law, but only Azerbaijani advocates may appear before the Supreme Court or represent a client on a criminal case.

Yet, only two international law firms have a presence in Azerbaijan – Baker McKenzie and Dentons. They provide full-service legal offerings alongside a handful of well-respected domestic firms such as CLS, MGB Law Offices, Omni Law Firm, and Michael Wilson & Partners; and the Big Four accounting firms.

‘Even when the Azerbaijani economy was booming, particularly between 2005 and 2014, magic circle and other large firms tended to work in conjunction with outside local counsel, instead of opening offices in Azerbaijan,’ Hogan notes.

That is because the main investments in the country were in the hydrocarbon sector, and these were made on the basis of production-sharing agreements (PSAs): ‘Once negotiated with detailed terms governing all aspects of a project, [PSAs] were approved by the national parliament and signed into law, superseding all past and future laws of general application. Thus, advice on the conformity of a PSA with local law was unnecessary because, by definition, the PSA was the law.

‘In addition, Azerbaijani legislation is fairly liberal in allowing for the application of English law, or the laws of other jurisdictions, to govern major financings and infrastructure development projects,’ Hogan adds, ‘meaning that the use of local counsel can be limited to advising on whether the terms of foreign law contracts were workable in the legal and economic environment of Azerbaijan.’

Picking up?

Despite the fall in oil prices since 2014, energy remains a staple sector for law firms in Azerbaijan, which is one of the world’s oldest oil producers. The Azeri-Chirag-Gunashli (ACG), offshore in the Caspian Sea, is Azerbaijan’s largest oil field, while Shah Deniz, in the South Caspian Sea, is one of the world’s largest gas and condensate fields. In 2016, Azerbaijan produced more than 41m tonnes of oil and nearly 30bn cubic metres of gas. BP is the largest foreign investor in Azerbaijan, and operates ACG and the Shah Deniz fields.

The British oil giant has been a regular client of Dentons since the law firm arrived in Azerbaijan more than 20 years ago. In Baku, Dentons advised Amoco (subsequently taken over by BP) on the country’s first PSA in 1994 (known as Contract of the Century), and at least three dozen subsequent exploration and production projects involving BP and other oil companies.

More recently, Dentons advised Malaysia’s state-owned Petronas on the $2.25bn acquisition of a 15.5% share from Statoil in the Shah Deniz PSA (the deal also included Statoil’s shares in the South Caucasus Pipeline Co); and it is acting for Total on the Absheron gas and condensate field, which the French oil giant operates, and discovered in 2011. In November last year, Total and SOCAR, the state-run oil and gas company, signed an agreement establishing the contractual and commercial terms for a first phase of production of the field.

‘Activity in the oil sector has picked up,’ observes Samir Hadjiyev, director and head of PwC Legal Practice, which launched in Baku in 2010, and now has 12 lawyers. Oil companies have adapted to the low oil prices and have ‘more confidence and clarity’ about how to forecast their business, Hadjiyev explains. PwC recently advised Caspian Sea Ventures International, a subsidiary of Eurasia Drilling Company Limited, on various matters.

Meanwhile, CLS advised MST, a group of local companies, on establishing ‘several’ joint ventures with international oil and gas companies in Azerbaijan, Mammadov says.

MGB Law Offices is a Baku-based firm with an international clientele that launched in 1995. It recently expanded its oil and gas practice with the hire of senior partner Kamil Valiyev from Baker McKenzie, a move that reflects increased corporate and M&A activity in the sector, managing partner Ismail Askerov says. MGB, which has a team of nine lawyers, recently advised Stork, a UK-based oil service company, and US Bredero Shaw International, on the formation of joint venture companies to provide services to BP.  

Michael Wilson & Partners (MWP), in Almaty and Baku since 1998 and 2003 respectively, is a full-service law practice and business consultancy, which covers Azerbaijan, Kazakhstan, the Central Asian Region and the Caucasus. Clients include ANZ Bank, Sanofi and the World Bank Group. Founder and director Michael Wilson (also founding partner of Baker McKenzie in Baku in 1997), says MWP has benefited from the ‘stabilisation and now recovery of commodity and oil prices, and demand from our clients, especially in corporate, banking, and IP’.  

MWP recently acted for UK-based energy services company Cape plc on its joint ventures with the Lancaster Group in Kazakhstan and SOCAR in Azerbaijan; and the China Development Bank on the Azeri-aspects of the One Belt, One Road Initiative. Another client is Credit Suisse, which MWP advises on private banking and other services, from Zurich, Geneva and Singapore, to clients who are Azerbaijani nationals and residents.

Data protection

Telecoms is the second largest industry in Azerbaijan: PwC, for example, is acting for Telia on plans to refocus its market strategy. Azertelecom is another client of PwC, which in Azerbaijan offers a wide range of tax and legal services, including indirect tax and customs, transfer pricing, corporate and M&A, employment and immigration, and intellectual property.

‘Clients are paying more and more attention to data protection,’ Hadjiyev adds. ‘That’s one area of practice that has been keeping us busy.’ This is the result of EU and national initiatives, including the European Union’s General Data Protection Regulation, coming into force in May next year, and Azerbaijan’s legislation on personal data, which was enhanced through constitutional amendments last September.

‘We continue to receive a steady flow of instructions concerning financings by IFIs [international financial institutions] and large European banks, usually backed by export credit agencies, as well as development projects involving the railway and aviation sectors,’ Hogan says. In recent years, Dentons has advised Goldman Sachs on its equity financing of SOCAR Turkey Enerji (a transaction valued at $1.3bn); and French construction and engineering company CNIM on its €346m project for the design, construction and operation of a ‘state-of-the-art’ waste-to-energy plant in Balakhani. In capital markets, Dentons advised on the first eurobond listing by a local bank in 2008 and is acting for a high-tech company on what is likely to be the first IPO on the Baku Stock Exchange.

‘However, large-scale financings and large industrial projects have slowed in the context of the current economic crisis. Not surprisingly, [it] has led to a burst of activity in areas such as bankruptcy and insolvency, debt restructuring and claims litigation,’ Hogan says.

In the past year, MGB has been busy on financing deals. These have included advising Azerbaijani state-run cargo operator Silk Way Airlines on three bridge financing projects to acquire Boeing, Airbus and Embraer cargo planes, having built an expertise in aircraft financing, Askerov says. It also is acting for Export Development Canada to finance the development, construction and operation of the ‘Azerspace programme’, the country’s first communication satellite.

With the worsening of the economy and the decline in foreign investment, the firm has also been ‘strengthening its debt restructuring and debt collection practices’, and is regularly instructed to act as the Azerbaijani counsel on behalf of EBRD in a number of debt financing deals and restructurings of loans, and related securities, in the non-energy sector.

The crash in oil prices and the double devaluation of the manat in 2015 exposed the weakness of the country’s banking system, leading to the closure of more than a dozen banks, and the default of state-owned IBA in May. Further casualties in the industry are expected. But for legal service providers, there is an upside.  

For example, PwC advised AtaBank, which earlier this year merged with Caspian Development Bank. Hadjiyev says the transaction generated a ‘significant’ amount of legal, tax and advisory work for the firm, adding: ‘For two decades, there had been no merger of banks in Azerbaijan.’

In the past year, Dentons has represented a group of IFIs in successful negotiations over the restructuring of loans to an ‘ailing Azerbaijan financial institution’ and advised on amendments to the Law On Banks of 16 January 2004. The amending legislation came into effect in April this year, allowing for the financial rehabilitation of distressed banks.

Another ‘notable development’ in the regulation of the banking and finance sector is the establishment (by presidential decree in February 2016) of the Chamber for Control of Financial Markets to ‘supervise the full spectrum of financial and banking activities in Azerbaijan’, Mammadov says. Assuming some of the functions of the Central Bank and other now extinct state bodies, the chamber is a public legal entity that licenses, regulates and supervises banks, investment funds, and insurance organisations, among other financial institutions. Furthermore, a Securities Market Law adopted in July 2015 has helped ‘bring life’ into sector, Askerov says. It regulates the public issues of stocks and bonds, among other securities, and participants in the market, including investment funds, stock exchanges and clearing houses.

Legislation tsunami

Not surprisingly, firms have been called on to advise clients on the tsunami of new legislation and regulations introduced over the past 24 months, not just to heal and reinvigorate the banking and finance sectors, but to promote tax transparency and foreign investments, particularly in the non-oil sector. For instance, amendments to the civil code were introduced in April to improve corporate governance practices in Azerbaijan, Askerov notes.

Significant changes to Azerbaijan’s tax code were introduced in January, including transfer pricing (in line with OECD guidelines), new rules on payments to residents in jurisdictions with a preferential tax regime and increased powers for tax authorities. Mandatory cashless settlements for taxpayers were also introduced at the start of the year, ‘contributing to the increase in transparency and the development of the banking system in Azerbaijan’, says Sarvar Hummatov, manager of Deloitte Legal practice in Baku. In March 2016, Azerbaijan also launched the Build-Operate-Transfer model, which is used for financing large-scale public work projects through private funding.

‘These developments have contributed to the expansion of Deloitte Legal in Azerbaijan,’ says Hummatov, emphasising the firm’s ‘multi-disciplinary expertise’ in banking and securities, energy and resources, manufacturing, consumer business, TMT and real estate.

CLS’s Mammadov adds: ‘Our tax, employment, banking and capital markets practices have expanded to meet our clients’ growing needs as a result of the recent changes.’

Another firm upbeat about the legislative reforms is MWP. Wilson, and partner Aygun Abbasova, also point to the ‘Strategic Roadmap for the development of the national economy and main sectors’, endorsed by presidential decree in December last year. ‘The decree aims to define the country’s development goals and priorities and ensure their implementation,’ in sectors such as oil and gas, consumer goods, and financial services, Wilson and Abossova say.  

Tougher economic conditions and foreign investors’ reluctance to use national courts have contributed to the rise of international arbitration in Azerbaijan. The country acceded to the New York Convention on the enforcement of foreign arbitral awards in 1999; it is a party to the Washington Convention on the Settlement of Investment Disputes between States and Nationals of Other States; and has passed domestic legislation on international arbitration. Foreign arbitral awards are recognised and enforced in Azerbaijan where the Supreme Court has exclusive jurisdiction on hearing such cases, the Law Society says.

‘The judicial system in Azerbaijan, though much improved since the time of independence, is very unpredictable and remains susceptible at times to political, nationalist or other influences,’ Hogan says. ‘The courts also have limited experience thus far in respect of complex transactions, especially in the financial sector.’ Consequently, most foreign investors provide in their contracts for dispute resolution by international arbitration. In recent years, Dentons has been involved in ‘major arbitration claims’ before the ICC, particularly in the construction and infrastructure sector.

MGB reflects a similar experience, reporting an uptick in commercial arbitrations. It recently represented French design and construction company Systra and Korean construction company Halla in their contractual disputes against state-owned water utility company Azersu.

Despite the glut of new laws and regulations, Hummatov argues, there are still challenges in their implementation and enforcement as well as regulatory gaps, which leads to ‘difficulties in effectively applying or addressing certain legal issues in practice’.

Lawyers find it challenging to advise on the ‘correct application of the many Azerbaijani laws and regulations that are lacking in detail or have unclear or ambiguous terms’, Hogan says, adding that ‘the interpretation of legislation sometimes changes from year to year, as government priorities change.’

The lack of transparency and the inconsistent application of regulations are reflected in Azerbaijan ranking 65 among 190 economies in the ease of doing business 2017 report by the World Bank. The country ranked 123rd of 176 countries in the 2016 corruption perception index of Transparency International.  

Some local lawyers face other more acute challenges. Azerbaijan’s human rights record has been repeatedly criticised. ‘The government of Azerbaijan continues to wage a vicious crackdown on critics and dissenting voices,’ says Human Rights Watch. ‘Numerous lawyers representing government critics in legal proceedings have been disbarred on questionable grounds, apparently to prevent them from carrying out their work.’

Askerov, for his part, is conscious of ensuring the neutrality of his firm and its autonomy. ‘One of the [main] challenges for us is to retain our independent status as the firm is not linked to any political or state organisations, nor has any exclusive network relationships,’ Askerov says. That has been ‘critical’ in allowing MGB to take part in major cross-border projects on behalf of international companies and financial institutions such as EBRD.

‘I would describe Azerbaijan as an emerging legal market,’ says Hadjiyev. That is not just in size terms, but also because of the ‘relatively underdeveloped culture of approaching legal advisers’, he says. ‘There is not much appreciation of the role of lawyers, particularly among small to medium-sized local businesses which prefer the old way of doing things by gentleman’s agreement,’ he says.

Nor is there the same degree of specialisation in the profession as in the UK. PwC, a ‘one-stop shop’ for tax and legal services, is seeking to change the perception among Azerbaijani businesses of lawyers, by providing expert legal advice, Hadjiyev adds.

Marialuisa Taddia is a freelance journalist