Embed Size (px)
Citation preview
1
European Bank for Reconstruction and Development Legal Technical Assistance Project
MONGOLIA <<ASSESSMENT OF THE CURRENT LEGAL FRAMEWORK OF MONGOLIA
REGARDING CORPORATE GOVERNANCE AND SECURED TRANSACTIONS>>
Assessment Report
Funded by The EBRD-Mongolia Co-operation Fund
February 2002
2
CONTENTS CONTENTS .............................................................................................................................. 2 SECTION A - INTRODUCTION AND OVERVIEW............................................................. 4
Other initiatives ..................................................................................................................... 5 International Finance Corporation (IFC)........................................................................... 5 World Bank ....................................................................................................................... 5 USAID............................................................................................................................... 6 GTZ (German Technical Assistance) ................................................................................ 6 JICA (Japanese)................................................................................................................. 6 Asian Development Bank.................................................................................................. 6
SECTION B: CORPORATE GOVERNANCE ........................................................................ 7 Definition of Corporate Governance ..................................................................................... 7 Market data............................................................................................................................ 7 Overview of legal and regulatory institutions ....................................................................... 8 Assessment of institutional framework supporting corporate governance............................ 9
Legal assessment of the Company Law framework.......................................................... 9 Company Law of Mongolia in light of corporate governance standards ........................ 10
General ........................................................................................................................ 10 General provisions....................................................................................................... 11 Intra shareholder relations, and shareholder - board relations..................................... 12
1) Shareholders’ rights ............................................................................................ 12 2) Shareholder protection ........................................................................................ 15
Board-Management relationship ................................................................................. 16 1) Division of responsibility .................................................................................... 16 2) Appointment and removal of directors................................................................ 19 3) Directors’ duties and their enforcement .............................................................. 20 4) Supervisory Board............................................................................................... 23 5) Management of the company .............................................................................. 23
Disclosure .................................................................................................................... 25 SECTION C: SECURED TRANSACTIONS......................................................................... 27
Overview of legal and regulatory institutions ..................................................................... 27 Assessment of legal and regulatory institutions .................................................................. 28
General provisions........................................................................................................... 28 Creation of a charge......................................................................................................... 29 Involvement of third parties ............................................................................................ 31 Enforcement and termination .......................................................................................... 31 Registration ..................................................................................................................... 33
Summary ............................................................................................................................. 35 SECTION D: CONCLUSIONS AND KEY RECOMMENDATIONS.................................. 36
Conclusions ......................................................................................................................... 36 Corporate Governance..................................................................................................... 36
Recommendation 1 - Corporate Governance: strategy study to prioritise needs ................ 37
3
Key factors driving this recommendation ................................................................... 38 Recommendation 2 – Corporate Governance: work with key stakeholders to establish a clear legal governance framework....................................................................................... 38
Key factors driving this recommendation ................................................................... 39 Secured Transactions: Conclusion ...................................................................................... 39 Recommendation 3 – Secured Transactions: develop a register for charges on moveable property ............................................................................................................................... 41
Key factors driving this recommendation ................................................................... 41 APPENDICES......................................................................................................................... 44 Appendix A: Draft terms of reference..................................................................................... 45 Appendix B: List of persons met............................................................................................. 54 Appendix C: List of materials collected .................................................................................. 56 Appendix D: Meetings ............................................................................................................ 59
Munkh Orgil (MO), Vice Minister of Justice and Home Affairs .................................... 59 William Mako, World Bank ............................................................................................ 60 Professor Davaasuren Naranchimeg, Otgontenger University........................................ 61 Dolgormaa Dagvadorj, ‘State Immovable Property Registration Office’ ....................... 62 D Bayarsaikhan, Head of Department of Legal Policy, Ministry of Justice and Home Affairs.............................................................................................................................. 63 Doug McGay, Ivanhoe Mines ......................................................................................... 64 GTZ, Lkhagvagiin Zaya .................................................................................................. 65 Civil Chamber of Supreme Court, R Jamiyanchoijil....................................................... 66 Securities Commission, Bazar Ayush ............................................................................. 68 MCS Holding, J Od ......................................................................................................... 69 Mongolian Bankers Association , Jigjid Unenbat ........................................................... 70 Loropiana, Ayush Buyandelger....................................................................................... 71 J Ganbaatar, Mongol Bank (Central Bank) ..................................................................... 72 USAID, Charles Ferrell ................................................................................................... 73 Asian Development Bank, Darius Tetler......................................................................... 74 State Property Committee, Chairman Damdinjaviin Batsukh......................................... 75 Adviser to State Property Committee, D Bailikhuu ........................................................ 76 IMF, Michael Martin (telephone call) ............................................................................. 77 Mongolian Stock Exchange, D Dorligsuren.................................................................... 77 Gonchigiin Seseer, Ministry of Foreign Affairs and Trade............................................. 79 Tserengavaa Jigden, Dalai Van-Audit............................................................................. 80 Wagner Asia Equipment, Ts. Togtokhdalai .................................................................... 81 American – Mongolian Business Group, Maurice Lynch............................................... 83 Gobi Cashmere, Otgontsetseg (secretary to board) ......................................................... 84 AG Bank, Debra Boyer ................................................................................................... 86 Golomt Bank, D Munkhtur.............................................................................................. 87
4
SECTION A - INTRODUCTION AND OVERVIEW This report was commissioned in order to make an assessment of Mongolia’s legal framework for corporate governance and secured transactions, with the specific aim of developing proposals to help the Mongolian government improve legal and regulatory institutions applicable to corporate governance and the implementation of Mongolia’s secured transactions regulatory framework.
In order to best follow these terms of reference, the report has been structured into two main
sections focusing on corporate governance and secured transactions respectively.
Section B examines corporate governance in Mongolia under the following topics:
• Definitions
• Overview of current legal and regulatory institutions
• Assessment of institutional framework supporting corporate governance.
Section C then considers secured transactions in Mongolia using the same framework1:
• Definitions
• Overview of current legal and regulatory institutions
• Assessment of institutional framework supporting secured transactions.
Section D contains conclusions and key recommendations. (Draft terms of reference for
possible next stages of work, a list of all materials gathered during the mission, a list of all
meetings, and a record of such meetings are incorporated in appendices A to D respectively).
In Sections B and C the report first clearly adopts a working definition of the topic under
investigation. In the overview of current legal and regulatory institutions, comparison is made
with commonly accepted international standards. In the assessment of the institutional
framework on corporate governance and secured transactions experiences, examples and
comments elicited from persons met in Mongolia are cited. More detailed comments are set
out in appendix D.
1 No adequate aggregate data on secured transactions is available to support this section of the report.
5
Other initiatives
One specific requirement of this study is to identify and comprehend the current legal
technical assistance projects in the field of corporate governance and secured transactions.
Identifying these projects will help ensure that where specific needs have been identified, and
initiatives started to address these needs, co-ordination can take place to ensure the best
possible outcome. A summary of current or proposed activities of other donor agencies is set
out below –
International Finance Corporation (IFC) The IFC has recently proposed a two year Corporate Governance Technical
Assistance Project in Mongolia.2 It is understood that this proposal has not yet been
accepted by the Mongolian authorities nor has funding been secured. The proposed
work is similar to programmes carried out by the IFC in Russia, Armenia and
Ukraine. The proposal has the following elements: training at enterprise level in
corporate governance practices, professional education at the business and law
schools, direct assistance to regulatory agencies in implementing proposals,
legislative reform by a review of corporate governance laws and regulations
(including assessment against OECD guidelines), and information and public
education.
It was reported that the IFC is seeking to undertake a project on financial leasing but
no further information was available so this cannot be confirmed.
World Bank The World Bank completed a mission on corporate governance in late January 2002.
The mission was carried out for the regional private sector development team and
focused on a) assessing corporate governance and securities market regulation
relative to OECD principles of corporate governance, b) advising the Government /
Parliament Corporate Governance Taskforce on amending Mongolia’s company law,
and c) providing a commentary to the Taskforce and World Bank on appropriate
configuration for the capital market.3
It is understood that no work on secured transactions is currently being undertaken by
the World Bank.
2 Memorandum ‘Corporate Governance Project Proposal’ of Darrin Hartzler, undated. 3 Memo from William Mako (EASPS) to Cliff Kennedy dated 29 January 2002, and distributed to IFC and MIGA.
6
USAID USAID is supporting the training of court officials and lawyers across Mongolia in
implementation of the new Civil Code (to become effective on 1 September 2002).
The training will cover administration of provisions on secured transactions because
they are in the Code, but will not go to substantive aspects of the Law. GTZ is
accompanying USAID and is undertaking the substantive aspect of this programme.
It is understood that USAID is not working in corporate governance.
GTZ (German Technical Assistance) GTZ is the donor agency responsible for the reform of the Civil Code’s provisions on
secured transactions. It is currently working with USAID on raising awareness
among, and training, court officials and lawyers prior to the amended law becoming
effective. GTZ will work this year on certain detailed regulations affecting property
interests in immoveable property.
GTZ is not working on legal or regulatory aspects of corporate governance.
JICA (Japanese) An internal memorandum of EBRD indicated that JICA was to begin corporate
governance and secured transactions reform work in 2003, following a recent
mission. However, in discussions with the deputy Minister and the local EBRD
representative nothing of detail could be confirmed. It was not possible to meet the
JICA representative in Ulaan Baatar.
Asian Development Bank The ADB currently has no technical assistance in corporate governance or secured
transactions. Its technical assistance is focused on the public sector. However, over
2000 and 2001, it sponsored a large study by Arthur Anderson on a range of
corporate governance and secured transactions institutions. Specifically, consultants
produced studies on the law and practice of secured transactions in Mongolia, and on
aspects of company law and securities market regulation that applied to corporate
governance. Discussions with the ADB representative indicate that due to changes in
ADB’s personnel in head office that affects oversight of Mongolia projects it is very
unclear as to how these studies will be accepted and developed. Therefore there is no
imminent or planned technical assistance in the relevant areas to be sponsored by the
ADB.
7
SECTION B: CORPORATE GOVERNANCE
Definition of Corporate Governance
For the purposes of this report corporate governance is defined as:
The system which regulates the structures and processes by which business organizations are formed and pursue the purpose for which they were formed, and avoid pursuing other purposes.4
This definition is deliberately wide, and thereby encompasses not only legal rules but also practices that exist in the operation of corporations. It is also wide enough to embrace a wide range of rules and institutions. In other words, the study of corporate governance concerns not just company law and securities law but extends beyond capital market institutions. Although all corporations are subject to governance, a key limit of this study is limited to those (either open joint stock companies, or limited liability companies) where enterprises are owned by persons or interests that are separate from the persons who direct and manage the corporations.
Market data
Economic activity that underpins corporate governance practices in Mongolia is best characterized by reference to aggregate data on the number and type of business entities, and data on the capital stock and flows. Figure 1 sets out data on business entities registered in Ulaanbaatar: the capital city which accounts for the over half of the population of Mongolia. Use of the limited liability company for organizing business activity has increased steadily, while there has been a dramatic decrease in persons doing business by way of sole proprietorship. Joint stock companies were established for the purposes of privatization by way of stock exchange auction between 1992 and 1995 and the reduction in that number is consistent with the finding that a large number of the enterprises underlying joint stock companies are not suited to that form or organization.
From the data available, it is not possible to assess the number of persons that are involved in companies whether as shareholders, directors or employees of joint stock or limited liability companies, nor is it possible to assess the scale of the aggregate involvement by way of contribution to the registered capital, the assets under control of the corporate entities, nor the sectors in which they operate.
4 See Chen and Bates, Introduction to Focus on Corporate Governance Law in Transition Autumn 1999 (ed. Sanders and Bernstein); see also Prowse, Corporate Governance in an International Perspective BIS Economic Papers no. 31 (1994).
8
Figure 1 - Structure of taxpayers By type of entity 1994 1995 1996 1997 1998 1999 2000 2001
Sole proprietorship 22,367 27,816 22,375 19,087 8,843 4,931 4,395 4,148
Cooperative 2,115 3,599 2,111 2,711 2,626 2,033 1,872 2,022
Partnership 1,187 133 1,339 2,069 2,741 3,449 3,692 3,819
Joint stock company 534 498 423 447 443 398 396 398
LL company 6,013 5,598 5,955 7,516 8,652 9,935 12,047 13,643
SOE 994 1,236 1,153 1,006 904 617 474 473
Total 33,210 38,880 33,356 32,836 24,209 21,363 22,876 24,503
(Source: from the Register of Business Entities of the National Taxation Administration)
Overview of legal and regulatory institutions
The legal and regulatory institutions that apply to corporate governance practices cover a
broad range, from laws on state property to regulations issued by the National Taxation
Administration. This report does not ignore important laws and regulations that affect where
the focal point of corporate governance practice lies.
Each year the Mongolian Parliament approves the state budget. This is relevant for corporate
governance because it provides one of very few catalysts for corporate governance practices.
The majority of enterprises in the Mongolian economy (measured by asset value, turnover,
number of employees) remain under total or partial state ownership. The state budget sets
down the state’s projected income including by way of privatisation during the stated period,
and indicates which assets under state control will be the source of that income.
As the Mongolian government retains significant control of enterprise, the core corporate
governance law is the Law on State and Local Property. All wholly or partially state-owned
enterprises have legal personality either in the form of a joint stock company or a limited
liability company governed by the Company Law 1997. However, the Law on State and
Local Property supersedes the Company Law because it is the primary source of authority and
regulation triggering governance processes of the very significant state owned sector of the
Mongolian economy.
Specifically, the finding of this study cited above that the Law on State and Local Property
supersedes the Company Law concerns the power over key decisions and the procedures by
which those decisions are taken. Chapter 3 of the Law on State and Local Property regulates
the relations between State Property Committee and the board of directors in ‘self financing
enterprises’, i.e. those privatised companies with state ownership that maintain commercial
relations with the private sector. The rules that establish the powers of the State Property
Committee and its representatives, and which govern the procedures for decision making, are
9
more detailed than what is found in the Company Law, and supplant what would otherwise be
regulated under a company’s charter.
Evidence of the governance practices of the State Property Committee in such firms (in
comparison with firms having no state ownership)5 confirm that the actual governance
practices of such firms do not conform to the practices of firms regulated only by the
Company Law. A conclusion of this section of the report is that the fact of state ownership
combined with the Law on State and Local Property superseding the application of the
Company Law leads to different governance practices. Examples are provided in relevant
sections below.
There is some doubt (even among officials of both the State Property Committee and the
employees of enterprises with significant government ownership) over whether, and the
extent to which, the Law on State and Local Property regulates relations between the
shareholders and the board in excess or in place of the Company Law. Evidence gathered for
this study demonstrated that regardless of the precise legal analysis (over which there is a
range of views and very little specification) the practices between the State Property
Committee and the boards are similar in each case. The fact of state ownership and benefits
and costs associated with varying states of relations between the board, management and
governmental officials appear to have considerable influence on governance practices.
Assessment of institutional framework supporting corporate governance
Legal assessment of the Company Law framework
The Civil Code of Mongolia provides the general legal framework for ‘natural’ and ‘legal
persons’ by establishing general institutions of property and contract.
The Civil Code defines ‘legal persons’ as entities created for certain purposes, stated in their
founding documents, which can acquire legal rights and incur legal obligations through their
own acts6. There are three forms of ownership of legal entities: state ownership, private
ownership and mixed ownership7.
5 See the notes of meetings with Batsukh, and Bailikhuu of the State Property Committee and Gobi Cashmere for state ownership, and J Od and the representative of Loropiana for private ownership. 6 Article 24.1 7 Article 24.3
10
The Civil Code contains only general principles relating to activity of the companies. More
specific regulation can be found in the Company Law of Mongolia. Specifically, basic
economic rights and obligations, name, company seat, registration, mergers and acquisitions,
as well as liquidation are generally outlined in the Civil Code, whilst the company legislation
provides more detailed rules deriving from the principles of the Code.
It is crucial in the Mongolian context to note that the largest and most influential corporate
enterprises are those wholly or partially owned by the state. Key corporate governance
relationships in these companies – such as relations between the board and the state
shareholder agency, and between the management and the state shareholder agency – are
regulated in detail by the Law on State and Local Property, along with regulations made
under that Law. For example, interviews with representatives of the State Property
Committee (which exercises the right of the government shareholder), and with officers of
companies with the government as shareholders, illustrated a close, dynamic governance
relationship between this shareholder and the company officials. This, more than anything,
characterizes corporate governance practice in Mongolia given the large state participation in
commercial enterprises.
This report does not seek to go into detailed discussion of the Mongolian company law, nor
its comparison with other jurisdictions. Its purpose is to consider selected provisions of the
company law against well-established principles of corporate governance.
The analysis which follows considers provisions that 1) regulate intra-shareholder relations
and relationship with the board of the company, 2) regulate the structure of directors
relationships with shareholders (e.g. board composition and duties) and which regulate the
conduct of management toward to the board and also of the board and management to the
shareholding community. Most analysis focuses on the core Company Law and the Law on
State and Local Property– because they form the foundation of these relationships in
Mongolian system. Toward the end of the section, provisions in other laws which take
account of specific aspects of these relationships for specific circumstances (e.g. disclosure
required where company shares are listed and traded on public securities market).
Company Law of Mongolia in light of corporate governance standards General
This report approaches corporate governance as a system that, for any given enterprise,
combines voluntarily structures and processes along with external forces composed of legal
11
and market forces. Company law in Mongolia, as elsewhere, is for business organization the
core external instrument for both enabling and constraining business activity.
General provisions
As a separate branch of law, company law requires a number of general provisions which
form solid basis for more advanced and sophisticated rules relating, for example, to the
management of the company, raising of capital, internal organization, etc.
First, there has to be clear distinction between different types of the companies. This is very
important because making a decision as to the choice of a company form involves a number
of considerations relating to the size of a future company, the way it finances operations,
distributes profits etc. This in turn would have an impact on scrutiny of the rules with which
the company has to comply. There are two main forms that a company may take in the
commercial context: open (public) companies and closed (private) companies. In practice,
there can also be a situation where either company seeks to change its form for various
reasons.
Company Law of Mongolia recognises two forms that a company may take: an open or joint
stock company and a closed or limited liability company.8 The distinction currently drawn
between these types of companies in the Mongolian law is vague and unsatisfactory. By way
of illustration, there is neither an upper limit on a number of members for a limited liability
company, nor a minimum required number of members for a joint stock company9.
The Mongolian Stock Exchange, as in many post-communist states, has listed the securities of
many joint stock companies that are of small scale and for which the costs of joint stock
company status and Stock Exchange listing are a burden. There are no procedures in place
for companies planning to convert into a limited liability company10. The closing of open
joint stock companies is, as in many other post-communist states, a sensitive and current issue
as assets privatized by way of stock exchange auction are of insufficient scale and potential to
derive any investor interest through trading on the stock exchange. Typically, these
companies have one or more block owners and the prospect of closure (by formal or informal
means) raises issues of fair treatment of minority owners that, in other markets, has attracted
regulation11.
8 Article 3.4 9 Article 4, 5 10 Chapter 2 11 For example, in Bulgaria.
12
Finally, there is a general shortage of definitions both in the Company Law itself and other
sources of regulation such as Civil Code of Mongolia, Law of State and Local Property, etc.
A general recommendation in this connection may be to remove certain uncertainties by
coordinating amendments of relevant laws.
Intra shareholder relations, and shareholder - board relations
1) Shareholders’ rights
Shareholders are the contributors of capital and retain ultimate ownership of the company’s
assets through the ability to control those who represent them on the board of directors in
companies where ownership and management is not fused. Shareholders rights should be
evaluated as to their clarity and protective elements across two dimensions – in their
relationship with other shareholders (who may, for instance, hold significantly more shares
than them; or, for example, with whom they must co-operate to impose their will on the
board) and in their relationship with the board.
Under the law, fundamental decisions concerning the company’s activities and future are
decided, insofar as the power of decision has not been devolved on the directors, in general
meetings of the shareholders. In short, shareholders should generally be authorised to:
• elect directors to sit on the company’s board;
• approve the company’s accounts;
• appoint the auditors;
• make decisions relating to secondary issues of securities, e.g. rights issues;
• approve related party transactions falling within a threshold of the relevant regulation;
• approve changes to the charter and major decisions involving a reorganisation in the
company or a change in its activities; and
• approve the payment of dividends (although interim payments can often be approved
by the board only) 12.
The Law on its face appears to protect principal rights of a shareholder. These include but are
not limited to a right to receive dividends, to participate in meetings of shareholders, to vote
on issues proposed at such meetings, to receive a share of the proceeds from the sale of assets
13
of the company remaining after satisfaction of claims of creditors following the company’s
liquidation13. Moreover, distinction is made between the rights attached to different classes of
shares. For example, holders of preferred shares have the right to vote at a shareholders
meeting with respect to decisions limiting or changing their rights14.
It is encouraging that recognition of the positive rights of shareholders are clearly indicated in
the Company Law of Mongolia. On the whole the Company Law follows the general
framework set out above. By way of illustration, shareholders exercise power to elect
directors to sit on the company’s board, approve various forms of reorganisation of the
company, authorise amendments to the company’s charter (articles), etc15.
However, there are a number of provisions in the present version of the Company Law that
still raise concern as to whether an adequate balance of power has been struck between
shareholders and the board. Some examples best illustrate this issue:
First, shareholders are left outside the decision making process as to the issuance of securities,
for it is the board which is solely responsible for taking a decision concerning the type and
number of such securities, as well as terms and conditions of their issuance16. Given a
potential conflict of interest at the board level (where directors may hold substantial interest
in the company) which is further aggravated by a total exclusion of shareholders, legal owners
of the company, from the issuance decision making process, the rule appears to provide
excessive powers to the board at expense of the shareholders because it excludes the
shareholders. For example, terms and conditions of issuance set out by the board should be
made subject to approval by 75% of shareholders participating in a meeting.
Secondly, the company legislation seeks to introduce stricter liability for those shareholders
who hold more than ten percent and exercise unlawful influence over the company affairs and
thus cause certain loss to the company. In this case they shall be liable to the extent of their
contribution to the company17. Though formally this rule is more relevant in the context of
shareholders’ liability, and even more so in liquidation proceedings, it also has a corporate
governance dimension too because at least, at face level, it runs counter to the right of all
shareholders to be treated equally by the company. In its present form the rule can be
criticised for being too vague and lacking sufficient justification for its existence as provided
in the Company Law.
12 EBRD Sound Business Standards and Corporate Practices 1997. 13 Article 3.3, the main catalogue of rights is provided in Articles 35, 36 14 Article 36.6 15 Article 63.1.7 16 Article 43
14
A procedural weakness of the legislation is that there are few procedures supporting general
powers of shareholders. The provisions in question are included in the chapter regulating
management of the company, though rules concerning shareholders are a topic of their own
right. In practice, there is an imbalance of shareholder rights and influence in favour of the
state over other shareholders. Under the Law on State and Local Property, general rules over
the role of the State (and its nominee on board of state owned companies) is set down. It is
understood these rules are elaborated in a series of more detailed regulations.18 The general
principles make clear that the State Property Committee as shareholder can exercise rights in
excess of those granted to ordinary shareholders under company law rights.19 The company
law, for instance, provides that shareholders have the right only to approve the accounts.20
Fieldwork established that the legal position supports disparities in treatment between
government and non-government shareholders. For example, the State Property Committee
receives detailed financial and operating information every 6 months for all companies in
which the state has an interest. In addition, it receives in advance of board meetings draft
papers on decisions to be taken, especially financial and operating decisions, and annual
plans. Where the state controls the majority of shares, the State Property Committee amends
and approves the papers. Where it is in the minority, it provides comments for board’s
information: these comments are reported to be influential.21
Effective corporate governance requires equal treatment of shareholders, and for shareholders
to act collectively towards the board of directors. While the transfer of ownership from the
state to the private sector involves transition of authority and decision making influence from
governmental sources to company organs it is important to establish rules and encourage
processes that respect the different and unique role of shareholders and the common rights
they share. At present the rules and practices effectively create separate class of shareholders
rights, for governmental shareholding. While there may well be strategic needs to prevent
certain activities occurring by entrenching certain rights with a state shareholder, many
systems around the world have ensured that processes between state and private shareholders
reflect the company law position and do not amount to a preferential and unique situation.22
Negative impacts include the attractiveness of minority shareholdings, and the incentive for,
17 Article 9(4) 18 These cover a range of activities, e.g. payment to state employees for board services, but the consultant does not have copies of such specific regulations. 19 Article 21 Law on State and Local Property. 20 Articles 35 and 36. 21 See notes of meeting with Chairman of State Property Committee in appendix D. 22 Consider for example the case of the Commonwealth of Australia and its stake in the fixed line telecoms company Telstra (www.telstra.com.au).
15
and the resulting efficiency of, board and management systems to interact with shareholders
at an arm’s length basis. Mongolia’s institutional framework needs to develop in this respect.
2) Shareholder protection
Protection of shareholders from abuse by the company’s management, or by their peers,
requires separate discussion. A general rule is that the majority of shareholders can undertake
any course of action regarded by them as necessary in the circumstances. However, a modern
company law does not interpret this as allowing enrichment of the majority at the expense of
a minority. In order to protect minority shareholders from exploitation there are various
remedies available in jurisdictions with an advanced company law. These include, but are not
limited to, the right to bring a derivative action, to start proceedings against unfair prejudice,
to apply for a voluntary dissolution of the company through a court order, etc. Increasingly,
mediation and arbitration in shareholder disputes are becoming an attractive alternative to
court action.
In addition there are various schemes designed to protect shareholders from misuse of powers
by directors and officers of the company23.
There are two remedies available in Mongolian law to shareholders who want to assert their
rights either against an individual director or against a majority shareholder. The first is the
right to bring a derivative action24 and the second is the right to redeem shares (a right to buy-
out) 25.
Provisions of the Mongolian law concerning derivative litigation are vague. Any loss caused
to the company or its shareholders is actionable, and a holder or holder of at least one percent
of the company’s common shares can bring an action.26 It is likely that a court faced with
such action would not be able to proceed because of the lack of relevant criteria to guide it in
such cases. In order to avoid this, consideration should be given to extending the provisions
concerning derivative actions. They should cover breach of duty only by a director.
Shareholders should therefore be excluded as possible defendants in such cases. Ratifications
and decisions not to sue should block a derivative action if lawful. This would provide
adequate protection of a company from extortionate litigation.
23 These schemes are considered later in this report. 24 Article 83 25 Chapter 7 26 Article 83
16
Redemption is generally well defined in the relevant provisions of the Company Law27. It
provides assurance to shareholders that in certain situations they may have their shares
redeemed and exit the company. Selective buy-backs raise certain doubts. In the present form
the Company Law does not oblige the board to ask shareholders for any consent on such
transactions28. Another area of concern is the amount of securities the company is entitled to
buy back, which is 25% of its outstanding common shares in any year. This is a high
threshold that may have an adverse impact on the maintenance of capital requirements.
One of the possible decisions would be to impose an obligation on shareholders in closely
held companies to buy out the interest of a shareholder who wants to leave the company. This
would ensure maintenance of the capital and prevent shareholders from deadlocks.
The Government should also consider introducing voluntary winding up by a court order
following a petition from shareholders. Currently no provision is made for any possible court
order on voluntary winding up29.
Finally, there must be a procedure that would enable the court, with reference to the
circumstances of a case, to make an order facilitating justice for a shareholder or group of
shareholders. This could be analogous to the rule against unfair prejudice typical of common
law jurisdictions. Criteria of potentially prejudicial conduct should be set out in law, and the
courts should be given discretion to make an order according to the circumstances of the case
to remedy a shareholder position. This may have a particular benefit for shareholders, as
derivative litigation serves the company’s interest and not that of shareholders. As for
redemption, this is limited to specific situations and may not be able to take into account all
circumstances of a particular case. Unfair prejudice, on the other hand, could serve the
individual needs of particular shareholders and be more efficient than other remedies.
Board-Management relationship
Here the report considers the second dimension of core governance relationships in the
company – between the shareholders and the board.
1) Division of responsibility
Whilst executives exercise a day-to-day control over the company’s activity to maximise its
profits, board of directors is typically responsible for:
27 Chapter 7 28 Article 50 29 Article 26
17
• the selection of the Chief Executive and the monitoring of his or her performance;
• directing the strategy and assessing the general conduct of the business;
• approving major transactions;
• endorsing the financial statements prior to submission to shareholder meetings;
• providing recommendations on issues on which they shareholders vote; and
• monitoring the financial resources of the company to ensure that the company does
not continue to trade if it is becoming insolvent.30
Decisions of the directors must be taken either at a board meeting at which a quorum is
present or by unanimous agreement. This is, however subject to the directors’ power to
delegate (e.g. to a managing director, committee of directors or appointed agent). It has
become a common practice among the boards seeking to maintain high level of corporate
governance to establish committees required to deal with the issues sensitive for corporate
governance such as audit of the company, remuneration and nomination of directors. It is
important to note that this practice was strongly encouraged by industries and stock
exchanges; however, there was no element of the government compulsion involved. This
shows that company law is really flexible and can accommodate not only matters prescribed
by a regulator but also those necessary to enhance corporate governance standards adhered to
by a company.
The Company Law of Mongolia generally follows the principles outlined above as far as the
division of responsibility between different bodies of the company is concerned. It outlines
the role of the board, its powers and obligations, etc. However, a number of critical points
should be made without prejudice to the generally good structure of the provisions concerning
the board.
First, it is international practice for an independent valuer to determine the market value of
property and property right given in consideration for securities31. Therefore this provision
should be amended so as to make it the duty of a valuer in addition to the board to assess the
fair market value of the consideration provided for the company’s securities.
30 EBRD Sound Business Standards and Corporate Practices 1997. 31 Article 76.1.6
18
Second, the board is entitled to decide on the terms and conditions of the service contracts
with the executives32. Whilst this is still an acceptable practice in many jurisdictions,
shareholders increasingly receive more disclosure over executive contracts and benefits. The
Company Law could improve in this respect.
Third, the company’s auditor is elected by the board, which also determines contract terms33.
The company’s auditor has to prepare a report stating whether in the auditor’s opinion the
annual accounts have been prepared properly. The auditor has also to consider if the
information given in the directors’ report is consistent with those accounts. Hence the auditor
has to be independent from the board in the exercise of these functions, otherwise his
statement would not be credible. Doubts can be expressed that the auditor, who from the
outset owes his appointment to the board and to the board alone, can be independent. A better
arrangement is where it is members of the company who at every annual meeting elect an
auditor. The latter is accountable to the shareholder assembly and it is quite logical that it
should elect the auditor of the company.
Finally, the board solely determines the amount of dividends to be paid and the procedures for
payment34. This provision is flawed for it excluded the company’s members, its owners, from
a decision making process. The directors are the managers of the company’s business, and so
are in a better position than the members to assess the economic ability of the company to pay
dividends. However, principles of the corporate democracy require that the board’s
recommendation concerning dividends should be discussed by the members in general
meeting. Discussion of the dividend policy is important, for it shows whether and to what
extent board is supported by the members of the company.
It is important to illustrate that in Mongolia the Law on State and Local Property and the
practices which have developed under the application of this instrument result in the board’s
authority over many of these issues being usurped. The negative impact of the interaction of
this law and practice is that incentives for board members and managers to use their expertise
and knowledge in furtherance of the firm’s objectives are destroyed. This means that benefits
of board and management having unique, discreet roles, are not realized.
It has been illustrated above in relation to intra-shareholder relationships how the general
principles and detailed regulations of the Law on State and Local Property lay a foundation
for unequal treatment of shareholders. In relation to board management relations, for
32 Article 76.1.9 33 Article 76.1.10 34 Article 76.1.12
19
instance, the processes for selecting and incentivising management – which should be a board
function – are effectively usurped by the State Property Committee. The Committee is
heavily involved in the appointment of the General Director, and the setting of the
management contract, including remuneration. This is a board function and the State
Property Committee has nominees on the board. By removing the responsibility from the
board in practice, the shareholders (or a significant representative of them) is not utilizing the
resources of the board. It is releasing the board from accountability over the decision, and it
is creating a dependency on the state which may negatively impact the medium value of the
equity capital, i.e. through frustrating the development of robust, discreet functions inside the
company.
2) Appointment and removal of directors
It is an internationally accepted practice to provide a minimum number of directors in a
company. This is usually fixed at a level of two or three.
The main power to appoint directors is given to shareholders. It is usually exercised by way of
an ordinary resolution. Appointments to fill vacancies on the board and appointments of
additional directors (up to the maximum, if any, fixed by shareholders) may be made by the
board itself. A person co-opted in this way holds office until the following annual general
meeting.
The most straightforward way in which a director may vacate office is to retire by giving
notice to the company. Usually this takes the form of a letter to the board.
Director can be removed by ordinary resolution (i.e., by a majority vote of the shareholders in
general meeting). This power overrides anything in the company’s charter (even, for example,
an article naming a life director) or in an agreement with the director. It is the most effective
means by which majority shareholders who object to the way in which their company is being
run can keep control of the company. Where the directors themselves are the majority
shareholders, as they very frequently will be in the case of a limited liability company, the
other (minority) shareholders have limited rights to object to the way the board is running the
company.
Companies’ legislation also contains a number of provisions under which directors are
disqualified either automatically or by court order. This is usually based on the grounds of
dishonesty, fraud or commission of specific offences in connection with the management of a
company.
20
The company’s charter may, of course, make provisions for disqualification or automatic
retirement in circumstances other than those specified in the legislation. This can include, for
example, bankruptcy of a director, mental disorder, regular absence at directors’ meetings,
etc.
The Company Law of Mongolia generally follows rules relating to appointment and removal
of directors as described above. Directors are regularly elected by shareholders through
cumulative voting at shareholder meetings.35
However, criticism can be raised with regard to the provision of Mongolian law requiring a
company to have at least nine members on its board.36 This seems to be excessive and
significantly reduces discretion of the company. The size of the board should be exclusively a
matter for the company to decide upon having regard to all relevant circumstances such as its
size, nature and scale of business it operates, etc. A minimum size of the board is usually set
at the level of two-three directors regardless of the form of the company.
In addition it is generally unsatisfactory situation that an individual director cannot be
removed if he has been elected by cumulative voting.37 This effectively deprives members of
the company to express their disagreement with the conduct of individual members of the
board by voting against them.
3) Directors’ duties and their enforcement
Directors do not hold the property of their company since the company is a separate legal
entity and therefore is able to own property directly. However, directors do owe fiduciary
duties to their company, that is, they are in the same position in respect of their powers as
trustees or agents with respect to the company; they have a duty to serve in the best interest of
the company and not for a collateral purpose. Absent special circumstances directors do not
owe duties to investors, shareholders etc.
Because of their fiduciary duties directors must not make any secret profit out of their
position. The concept of secret profit is a rather intangible one; it does not, of course, prevent
directors from receiving remuneration for their service. A profit is a secret profit if it comes to
the director because of his position as a director. Secrecy in this context means failure to
35 Article 77 36 Article 75.3 37 Article 77.4
21
obtain permission rather than actual secrecy. A secret profit must be paid over to the company
even if the company itself could not have made the profit.
The second requirement of directors’ fiduciary duties is that the directors must exercise their
powers given to them bona fide for the benefit of the company as a whole. This involves two
separate restrictions on directors’ powers:
a) directors must not exercise their powers other than for the purpose for which they
were given; if they exercise their powers for some other reason, their decisions may
be challenged;
b) directors must not exercise their powers for motives of personal gain (this often
overlaps with the rule against directors making secret profits).
Directors may be liable to their company for their negligence as well as for breach of
fiduciary duty. It is always difficult to assess and then interfere with business decisions,
however foolish they may seem with the benefit of hindsight. The duty of care and skill
required from a director is, therefore, a low one. In particular, the test applied is a subjective
one, that is, a director need not exhibit in the performance of his duties a greater degree of
skill than may reasonably be expected from a person of his knowledge and experience.
Directors’ duties can be enforced by the company itself or members of the company, who
may bring a derivative (representative) action on behalf of the company. If a director is held
to be in breach of his duties, he may be liable to fines, imprisonment or summary dismissal.
The director will personally be liable to account for benefits received. He may also have to
pay compensation or damages. For using company property for his own purposes in breach of
his fiduciary duties, a director may also have to pay compound interest on sums he has to pay.
Third parties who have participated in the breach may also be liable to damages or an action
for money had and received.
Directors may escape liability if the general meeting validly ratifies the breach (unless this
amounts to fraud on minority) or if they can claim an indemnity from the company (or if they
are insured). But directors with all the issued shares who commit misfeasance by an act of
gross negligence inflicting loss on the creditors may not be able to ratify that gross
negligence.
22
‘Directors’ duties’ is the weakest area of the Company Law of Mongolia. Provisions
concerning directors’ duties are random and lack policy rationale behind them38. The
provision in question seeks to cover under the term ‘governing persons of a company’ not
only directors but also other senior executive officers of the company who shall be deemed to
be such persons. This contradicts the division of responsibility within the company because
non-directors are not elected by the company’s members and therefore owe no fiduciary
duties to the company. Directors retain accountability and therefore specific responsibilities
for the company’s activities, even where they delegate their powers to senior executives, for
example, there is a residuary duty on them to maintain effective internal control over
employees of the company. Failure to do this amounts to the breach of the fiduciary duties.
Unfortunately the Company Law does not make this distinction and insteads adopts the
approach of imposing duties on a wider range of persons within the company appearing to
dilute the accountability of the board.
The Company Law suggests that liability of a governing person should be based on the duties
as stated in the contract between this person and the board of directors. There are several
possible points of criticism here. First, there must be general principles of liability provided
for in the company law. In fact any division of the company law in Mongolia may be barred
for the want of these principles and supporting terminology. If liability is to be determined on
specific terms of the contract, there will be no general standard of the directors’ duties in the
company law. Taking into account that one can hardly find two identical companies using
similar formulas to define such duties, this could make the issue of fiduciary duties
impossible to reconcile for Mongolian courts. There has to be a statutory definition and list of
fiduciary duties of directors.
The Company Law also imposes liability on a shareholder of a limited company that alone or
in conjunction with an affiliated person holds twenty or more percent of the company’s
common shares.39 This provision appears excessive because a shareholder holding a specified
amount of the share capital can be a passive institutional investor and still be liable according
to this provision. It would be more just if the Company Law adopted a concept of a ‘shadow
director’ (see below). This concept is wide enough to cover different situations and not only
that of a majority shareholder using its voting power in his own interest.
One final point is that the Company Law does not provide any means by which directors can
escape liability, e.g. by resolution, indemnification, court’s order. This is indeed necessary
where the company wishes to whitewash its directors of any liability.
38 Article 81
23
4) Supervisory Board
In a number of jurisdictions, especially in continental Europe, joint stock companies are
required to have supervisory boards. Their main duty is to ensure compliance of the
company’s bodies with internal processes and decisions. Supervisory board is usually only
accountable to the company’s shareholders.
There are few concerns connected with the existence of such boards. First, they often
duplicate monitoring functions of the board; hence they are a waste of the company’s
resources. Second, their independence can often be questioned, for they heavily depend on the
board and management of the company from whom they receive information about the
company. Unless a reliable supply of credible information is in place, supervisory board is
helpless to change anything in practice. Arguably, the supervisory board often does the same
job as the audit committee of the board of directors. Provided the board’s committee is staffed
with independent directors, a two-tier board in these circumstances is simply obsolete.
The Company Law makes it obligatory for joint stock companies to have a supervisory
board.40 It has a wide remit and is responsible for monitoring the company’s management,
presenting a relevant report to shareholders at every annual meeting, reviewing financial
statements of the company, etc.41 It is elected by the company’s shareholders.42
All considerations discussed above are also relevant in the Mongolian context. Provided that
an efficient system of supply of the information exists within the company, an independent
supervisory board would be able to carry out its functions for the benefit of shareholders.
5) Management of the company
Executive directors carry out a day-to-day management of the company. It is very common
for one of the directors of a company to be appointed managing director. The functions
actually performed by the managing director vary from company to company but in practice
he will usually be either the most senior director in the company’s hierarchy or second in
command to the chairman.
39 Article 81.6 40 Article 92 41 Article 92.2 42 Article 92.4
24
Board of directors may delegate to any managing director such of their powers as they
consider desirable to be exercised by him. The board are also given the power to specify what
his powers are to be and to impose conditions. The powers granted may even be to the
exclusion of the powers of the board but can be revoked or altered at any time by the board.
The managing director will usually have a service contract. The terms of the contract will be
negotiated by the managing director and the board;43 the members’ approval will be required
if he is given security of tenure for longer than a specified period in the legislation, for
example five years, and cannot be removed by notice. The managing director is both a
director and an employee of the company; like other employees he has certain statutory rights
against the company if he is unfairly dismissed or made redundant. Since he automatically
ceases to be managing director if he ceases to be a director, the members can remove him
from both offices by passing an ordinary resolution but this may result in heavy damages
being payable by the company for breach of the service contract
In modern company law the term ‘director’ is wide enough to include ‘any person in
accordance with whose directions or instructions the directors of a company are accustomed
to act’. Such persons are ‘shadow directors’ of the company and may incur personal liability
for the debts of an insolvent company. They may also be disqualified from holding office or
being concerned in the management of a company, as if they were directors.
Provisions for management in the Company Law of Mongolia are adequate and generally fit
well with the similar principles in other jurisdictions. An element of delegation from the
board level to the company’s executives is stressed by the rule that the former may terminate
the powers of the executive at any time.44 The rules for establishing internal procedures,
electing chairman of the collegial executive body, etc. seem clear and easy to understand.
There are only a limited number of objections to the current version of the Company Law
relating to the company’s management.
First, executives conclude their contract with the board of directors.45 It would be correct to
say that a contract is concluded with the company and the board merely acts on behalf of the
company. One should bear in mind that it is a company to which directors owe their duties
and not the board.
43 However, this is not the case is a significant number of enterprises in Mongolia which are economically important because the state property committee has effective control over these matters. 44 Article 80.10 45 Article 80.4
25
Second, only managers who are at the same time directors should owe directors’ duties.
Liability of those managers who are not directors of the company should be determined
according to their contracts. But all this is subject to the necessary clarifications and
amendments in the area of directors’ duties as outlined above.
A final point of criticism relates to the way the Company Law deals with major and conflict-
of-interest transactions. It imposes a statutory duty on potentially interested person to disclose
their interest in a transaction to the board46. The test itself employed to determine
independence of a member of the board of directors seems artificial. It is based on the
previous record of a person in the company, i.e. whether a person or one the specified persons
affiliated with him has been an officer or member of the governing body of the company47. It
would be more effective to impose a general duty on every individual director to disclose his
interest in every individual transaction by way of notice to the board. This would give a better
picture of the directors’ interests involved rather than to rely on unsubstantiated presumptions.
Disclosure
Company law judged by high corporate governance standards persistently requires disclosure
of certain details, whether to the public or to particular individuals or groups of individuals, so
that persons have sufficient information to enable them to decide whether to act or refrain
from acting in a particular way. For example, prospectuses inducing persons to become
shareholders must apprise potential subscribers of certain facts.
Information may be made available in different ways to different individuals. A company
could publicise as many as details about its affairs as it wished to, but like most natural
persons, it will prefer to keep them private. If it wishes its shares to be listed on a stock
exchange, it will have to undertake to provide the exchange with information, which can be
made generally available.
In practice minimal standards are laid down by the law, which requires specifies matters to be
registered and made open to public inspection, e.g. the memorandum, the articles, special
resolutions, names of officers, and details of share capital and notifiable interests in shares.
Much stricter disclosure requirements are usually set out in corporate governance codes and/
or listing rules of stock exchanges.
46 Article 88 47 Article 89.2
26
Despite potential benefits for the investor community stemming from extensive disclosure
bare information alone may be of little use except to those with professional advisers able to
assess and explain its significance. In such cases, another source of publicity, the financial
press, may play a useful role in exposing facets of a company’s dealings.
The Company Law imposes requirement on companies with respect to the maintenance of
financial records and, in the case of joint stock companies, their audit48. These requirements
are in addition to requirements set by the Accounting Laws of Mongolia49.
The Company Law does not meet minimum international practice requirements outlined
above. In particular, it does not clearly require all joint stock companies to have their annual
account audited by an independent auditor. It would also be desirable for such a requirement
to be repeated in the Listing Rules of the Mongolian Stock Exchange, so that MSE may take
enforcement action if a listed joint stock company fails to prepare and lodge for release to the
market audited annual accounts.
In the case of financial record keeping, the Company Law should impose a general
requirement on all companies to maintain financial records that correctly record and explain
its transactions, financial position and performance. Such a general obligation would give the
Securities Commission a more general power to prosecute companies for non-compliance
with specific requirements already reflected in the Company Law.
Accounts filed with SEC should be made available for inspection by any member of the
public. In the case of listed issuers, the accounts should also be required to be lodged with the
stock exchange and released to the market.
The Company Law provides unequal opportunities to shareholders with different stakes in the
company’s share capital. Those holding ten percent or more may demand that the company
provides them with information about all current shareholders of the company.50 This
provision should be changed, for all shareholders must have the equal right to receive
information about their company and make informed investment decisions.
48 Article 91 49 Article 91 50 Article 96.3
27
SECTION C: SECURED TRANSACTIONS
Overview of legal and regulatory institutions51
The Mongolian legal system is generally close in its main features to the legal family of Civil
Law. It consists of a system of codes containing general principles and definitions which are
further supplemented by specific laws.
The issue of property rights is generally dealt with in the Civil Code.52 There are two forms of
ownership: state and private. In addition legislation recognises that in certain instances both
private and state property may be mixed, thus giving effect to the concept of mixed
ownership. Chapter 12 of the Civil Code provides a comprehensive framework for regulation
of property rights and obligations in Mongolia.
The specific provisions relating to the creation of a charge over the property can be found in
Chapter 13 of the Code. It establishes general principles, definitions and procedures for the
law of secured transactions. The Chapter is divided into four subchapters: general provisions;
special regulation for charges over movable property, mortgages and charges over
immoveable property, and public registers of charges. Mortgages and charges over
immovable property are allocated the most detailed provisions. This is due to emerging
secured lending practice in Mongolia where immovable property is the most widespread form
of security.
The Code is not the only source of regulation of secured transactions. There is, for example, a
reference in the Civil Code itself that the administration of an immovable property register
will be made through a special law53, which has to comply with the relevant provisions of the
Code. In the case where there is a conflict between these two laws, the latter prevails. Since
no English translation of the current draft Civil Code provisions were available to the
51 No English language version of the new Civil Code was available to the consultant. The following analysis is therefore subject to the following caveats. The analysis is based on a draft of the amended Civil Code dated October 2001 that was provided to the EBRD by GTZ’s resident office, along with a short form summary of the amendments to the Civil Code provided by the EBRD’s resident mission. The GTZ draft is in German and the comments below are based on a number of conversations between the consultant and his German speaking colleagues. A draft Asian Development Bank report ‘Strengthening Secured Collateral’ was of additional assistance, and it is drawn on to give context to certain matters below. However, this undated draft report is understood to have been written in 2000 and, given the legislative drafting over the 2000 – 2001 period prior to enactment of the amended Civil Code in late 2000, the content is likely to be out of date. 52 Chapter 12 53 Article 174.3; this reference is made to the Immovable Property Registration Law, 1997
28
consultant, the analysis below is subject to review and must necessarily be seen as possibly
incomplete and inaccurate.
Assessment of legal and regulatory institutions General provisions ‘Charge’ is defined in the Civil Code as a means of securing the creditor’s claims as well as
other rights connected with it54. Moreover, rights relating to a charge are seen as a way of
ensuring that the creditor’s claim in case of the debtor’s default will be satisfied through the
auction-sale of the charged property or otherwise.
Both tangible and intangible property may be a subject matter of a charge.55 The same item of
property can be made subject to several charges. Ranking of the charges would depend in
these circumstances on the point in time when they were created.
The Immovable Property Registration Law inter alia specifically deals with the issues of
registering a charge on immovable property. However, it introduces certain restrictions as to
what property can be made subject to a charge. For example, it does not contemplate use of
immovable property that is still under construction as security. A broader understanding and
application of the principle of securing property to be created or acquired would assist in
developing construction finance in this area.
Recent developments in the ‘Minerals Law’ of Mongolia have further broadened the scope of
property that can be used as security in secured transactions, by enabling licence holders to
pledge their licences in order to finance their investments and operations in Mongolia.56 The
‘pledgor’ shall submit a copy of the pledge agreement, together with the licence certificate, to
the Minerals Authority which is responsible for verifying compliance with relevant rules and
procedures and registration of the pledge. The licence certificate properly recorded by the
Minerals Authority is deposited with a ‘pledgee’ until after the termination of the pledge
agreement. Unless there has been a breach by a ‘pledgor’ of the terms under the pledge
agreement, the pledged licence certificate should be returned to the licence holder through the
Minerals Authority.57
If, however, the ‘pledgor’ fails to fulfill its obligations, the ‘pledgee’ is entitled to submit an
application to the Minerals Authority to transfer the pledged licence to a person eligible to
54 Article 145.1 55 Article 146 56 Article 42 57 Article 42(5)
29
hold such a licence. It is understood from a local practitioner that the enforcement procedure
has not yet been tested.
Creation of a charge
The draft Civil Code removes some uncertainty relating to creation of a charge over the
debtor’s property. Specifically uncertainty is eliminated by clarity over the following matters.
It imposes a number of requirements58 as to the form of the agreement creating a charge:
regardless of the nature of property charged all agreements have to be in writing; certain
information must be disclosed in the agreement itself, e.g., names and place of residence of
the parties, description of the secured debt, the security right, the description of the charged
property, the value of the property charged and its location. Agreements concerning charges
over immovable property must be witnessed by a notary. As to the other types of property the
parties are at liberty to choose if the agreement should be so notarised.
The Civil Code makes provisions for the main rights and obligations of both parties to the
agreement.59 Under these provisions a chargee is entitled to:
• use the charged property;
• have a priority over the claims of other creditors in case of default on the part of the
debtor;
• acquire ownership and dispose of secured property
• select an item of charged property to be sold in case where there is a choice of property.
At the same time the chargor is obliged to:
• preserve the charged property if it is under the chargor’s control according to the
agreement;
• inform the chargee if charged property has been damaged or destroyed;
• keep the proceeds of sale until the end of the agreement.
58 Article 148 59 Article 149
30
A chargee also has the right to use the charged property. It will therefore depend on whether
or not the charge is a possessory or non-possesory charge.
It is the chargor’s obligations which are more important in the context of secured transactions.
Their general purpose is, on the one hand, to protect a chargee from default on the secured
debt and, on the other hand, to ensure that the chargor’s interest in the property is sufficiently
protected. Hence, a chargor is obliged to:
• preserve the charged property;
• inform the third parties about the existence of the charge where the property in
question is burdened with the interest of a third party;
• have regard to the rights and interest of third parties where they act as guarantors of
his debt, i.e. where they provide charged property.
Though the draft Civil Code removes some uncertainty relating to the creation of a charge,
there are still a number of gaps which, absence long standing commercial practice, may well
lead to uncertainty. For example, in terms of the application of general provisions to different
types of charge, no distinction is drawn between possessory and non-possessory charges.
Furthermore, while it is a positive development that at a general level the principle that
moveable property could be the subject of the charge is clarified, this is specified for ‘cattle’
for instance, but not generally for movable things. Similarly, there is no general provision
that rights may be charged though it is specified that receivables may be the subject of a
charge.60 It may be that practical, interpretation challenges remain. for instance, the
establishment of detailed rules and practices for charges of receivables and securities61.
Now that certain principles of secured transactions (including over moveable property) are
more clearly defined in the law, further careful analysis and assessment is required to ensure
that practice will develop in line with the expectation of the law and the reformers. One such
initiative will be a source of feedback on whether the definition of the Law is sufficiently
clear: a programme of training and awareness raising being conducted by GTZ and USAID
across Mongolia. It is expected that this will illustrate where there are i) gaps in the Law as a
matter of principle, and ii) uncertainties over implementation of, and practice under, the new
provisions.
60 Comment of Professor Narinchimeg, Member of Civil Code Revision Expert Group. 61 with the view of Professor Naranchimeg.
31
Involvement of third parties
It was not possible to identify any specific provisions in the Civil Code dealing with priority
of claims against charged property amongst other charges and against unsecured claims. It
was not possible to identify any provision dealing specifically with the rights of a transferee
of charged property.
Enforcement and termination The draft Civil Code contains two provisions relating to the sale of security and termination
of rights under the agreement creating a charge. In case of default on the part of a debtor
charged assets can only be sold through a public auction of which a sufficient notice has to be
made.62 It is a chargee who has to bear the costs of the auction.63 The bidder of the highest
price at the auction, who is obliged to pay the price immediately, acquires absolute property
rights over the assets.64
The charge is deemed to be terminated where at least one of the following happens65:
• discharge of the secured claim;
• declaration by a chargor of the transfer of charged property to a chargee or owner of
charged property;
• passage of title to chargee;
• reversion of title to a chargor;
• destruction of charged property;
• operation of law.
Amendments to the Civil Code in 1998 allowing creditors to seize charged property and sell it
without involvement of the court and without using a bailiff’s office to sell the charged
property, have been maintained in the revised Civil Code with modifications to protect the
62 Article 151.1 63 Article 151.2 64 Article 151.5 65 Article 152.1
32
interests of the borrowers, the other creditors of the owner of the charged property, and the
rights of any other claimants to the charged property.
The 1998 amendments favour the creditor and do not really balance the rights of the
borrower, other creditors of the borrower and other claimants to the same charged property.
Specific issues which do not yet appear to have been specifically addressed in the new Civil
Code provisions are set out below.
Normally court procedures are important to the protection of the rights of these parties and,
when procedures are allowed that avoid these court protections, the procedures must provide
acceptable methods to protect those parties. In practice, the courts have been asked to hear
complaints of debtors, and have generally enforced contracts though at a cost in terms of time
and effort.66
Specific procedures to enhance the current regime could include the right of the borrower to a
reasonable notice and opportunity to cure its non-performance, and the right of the borrower
and borrower’s creditors to adequate notice and opportunity to participate in a sale (whether
by auction or alternative means) of the property, before the charged property can be treated as
belonging to the lender.
It is critical to the secured lending programme that procedures be maintained for seizing the
charged property and selling it without undue court interference or unacceptable bailiff’s
auction procedures. However, new requirements need to be added to the non-judicial
procedures that protect: the rights of other creditors with claims against the charged property;
unsecured creditors of the borrower; and the rights of the owner of the charged property who
is usually the borrower.
A balanced approach that accomplishes the desired result while respecting the rights of all
parties is needed. While court proceedings and bailiff’s auctions may not be the correct
answer, procedures should be adopted to at least require the minimum steps to be taken before
a sale of immovable property outside of court procedures would be valid. A specific solution
to the problem of balancing competing interests of the parties following default could be the
creation of an institution of charge manager who may be charged with general responsibility
for dealing with the charged property should the default or any other key event occur.
Although the reference procedures may be reasonable for sales of immovable property, they
would need to be modified to use in the case of sales of movable property. Due to the variable
66 See comment of representatives of Wagener Asia, Inc. and Golomt Bank in appendix D.
33
nature of movable charged property and the fluctuations of its value (sometimes on a daily or
hourly basis) requiring an auction of the property and notice of the sale to be published for a
month before the sale would be unlikely to assure a sale at a reasonable value. Much more
expeditious procedures must be available for sales of movable charged property, and a
standard that such sales must be ‘reasonable, in light of the existing conditions’ should be
taken into account.
Also, a procedure to protect the proceeds of the sale and assure its proper distribution among
the parties is needed. As one of the solutions, a proceeds manager may be used to provide this
protection. In order to achieve fairness while acting for the parties the manager should be
made to comply with extensive disclosure obligations. A special proceeds depositary must be
set up to reduce opportunities for the abuse of powers by the manager.
Consideration of some of all of these possible refinements of the new framework for secured
transactions would go some way to meeting current concerns of the creditor and legal
community.67
Registration
General provisions relating to registration can be found in the draft Civil Code, Chapter 13,
Subchapter 4. They include a right to have an entry about the charge made in the registry;
criteria as to the ranking of the creditors’ interest in charged property; and effect of the
registration. The Civil Code is supplemented by other laws in this area: the Immovable
Property Registration Law, Minerals Law, and the procedures of the Stock Exchange where
charges on securities are currently registered.
The laws currently provide a system to register pledges of immovable property. However,
there is some inefficiency in this system:
• the involvement of the Registration Office in determining the value of the property
registered and the amount of debt for which the property is pledged;
67 See notes of meetings with Golomt Bank, Wagener Asia Limited and Ag Bank in appendix D where the time and cost of enforcement was cited as an obstacle for their business. In the meeting with the representative of the Supreme Court, it was felt that the law and application of it by financial institutions is biased in favour of the creditor, and that the judicial process seeks to redress this perceived imbalance.
34
• the involvement of the Registration Office in reviewing documents to determine whether
they are in compliance with the substantive law and not merely the procedural laws
governing registration process;
• and the dependency of all offices except for the Central Office on hand written records
with little or no automation.
Generally, the function of registering charges on property should be considered as an
administrative function and should not incorporate legal analysis of the documentation.
However, the SIPRO has been given responsibilities for legal review, archival of records, and
valuation of the immovable property, which may result in impeding the efficient use of the
agency for registration of charges. However, statements made in a meeting with officials of
SIPRO suggested that actual work process is of an administrative nature and no substantive
legal review takes place.
The responsibility of the SIPRO to conduct a legal review of the documents should be limited
to certain procedural issues such as the proper execution of the documents before a notary,
and should not involve a legal review of the substantive legal issues involved in the legality of
the documents.
At present, the data held by SIPRO is not considered to be public information. SIPRO
officials are very clear that the agency does not have a function of publicizing information.
For immoveable property, information is only made available to interested parties (e.g. a
prospective lender) on the basis of a specific authorization by a prospective chargor. As a
matter of principle and policy, this should be reconsidered in light of the new Civil Code, and
any feasibility analysis of whether the SIPRO can take on a role of registering charges on
moveable property. One approach would be for SIPRO records to be made public and, if
certain records should not be made public, they should not be filed with the agency in the
registrar’s records but in other records of the government agency independent of the register
of the ownership and claims against the property.
The duties of the SIPRO as established by the law leave significant openings for debate as to
the actual functions of registering charges on property. This is perhaps largely due to SIPRO
being established for registering ownership and changes thereto. (Data on precise charging
structure for charges on immoveable property was requested but was not received by the
consultant).
Should SIPRO take on a role in relation to charges on moveable property and should its role
in registering charges on immoveable property continue to develop, then the issue of publicity
35
of data held at the agency will raise specific issues that should be considered. In particular, a
balance will need to be struck between the level of detail over private contractual
arrangements between artificial and natural persons that are required for registration, and are
made available for inspection. For example, standard templates should confirm the core
information but valuation of the charged property and covenants applicable to the underlying
debt do not need to be part of such a template. This issue must be directly addressed in any
further analysis of development of register on moveable property, and the principles and
recommendations will be relevant to current charges on immoveable property.
Summary
Perhaps the most noticeable problem that impedes the use of collateral for loans is the lack of
understanding of the existing and proposed laws and processes that are available to lenders. A
gap exists in the understanding of how the systems are designed to function and how to make
them operate effectively for the benefit of borrowers and lenders. Future workshops and
educational programmes will be needed to raise the level of awareness of the principles of
ownership of property rights, and use of those rights as charged property.
• Establishing a regime for secured lending in Mongolia involves far more than enacting a Law on Secured Transactions that appears to provide an infrastructure for secured lending including a registration facility for pledges of movable and immovable property.
36
SECTION D: CONCLUSIONS AND KEY RECOMMENDATIONS
Conclusions
This is a high level study, conducted over a week’s field trip, and including preparatory review of materials and followed by further analysis and write up. The main conclusions of the report are set out below in sections appropriate to the topic. Recommendations on the most pressing needs identified by the consultant then follow.
Corporate Governance
The most significant institutions for corporate governance in Mongolia are the Company Law and Law on State and Local Property. This conclusion is based on the premise that analysis of significant corporate governance issues should focus on circumstances where enterprises are characterised by separation of ownership and control, and significant economic activities and economic value underlie those enterprises. In Mongolia, in common with other post-communist economies, we find these circumstances in companies which have been privatised and in which the state retains some ownership. We do not find a significant overlap between these enterprises and those companies whose securities are traded on the Mongolian Stock Exchange.
Consistent with this finding, the most significant significant laws and regulations are the Company Law and the Law on State and Local Property. This study concludes that these instruments have the greatest effect on the practices of corporate governance, and lead to the presence of observable obstacles to achieving best practice in Mongolia. Given the high level, brief nature of the field trip, and the purpose of this report to guide more in depth investigation, the obstacles fall into two categories – rules and practices governing relationships among shareholders, and between shareholders and boards of enterprises of significant size.
In particular, the matters to be covered are –
• Processes for communication between shareholders
• Processes for accounting by boards to shareholders
• Processes for transparency by significant shareholders and boards on significant decisions
• Annual general meeting procedures
• Procedures for selection of board members and disclosure of their appointment terms
• Board and committee structures and meeting processes
37
• Procedures for engagement by board of management, and management conflict of interest
• Procedures for setting standards on operational and financial risk, and for monitoring management performance
This study concludes that practices of these large, state-owned enterprises resulting from the Company Law and Law on State and Local Property have demonstration effect. This is important for two reasons – ineffective rules and practices at this level operate as significant barriers, but reform focused at this level promises spillover effects.
The field trip and background research covered the institutional framework for the securities market. This study concludes that obstacles in the securities market laws and regulations could well have However, this study concludes that work on securities market rules and instituitions is not a priority for improving corporate governance practices. This is largely due to the relatively small amount of economic activity underpinned by the public equity and debt securities market, and the illiquidity of those markets. It is also due to a prediction that direct, private investment must be of a critical mass and carried out under robust governance systems before scarce resources are allocated to public securities markets. Nevertheless, the public securities market is likely to receive significant assistance from other donor agencies.
Recommendation 1 - Corporate Governance: strategy study to
prioritise needs
The EBRD should consider working with the Corporate Governance Task Force to fund and
coordinate a focused strategy study of the needs and priorities for corporate governance
institutional reform in the financial and private sectors. As a response to the letter from N.
Ganbyamba (dated in early February by a standing committee member), the EBRD should
respond by pointing out that it is aware of a range of proposed activities falling within the
corporate governance area (e.g. the current study of company law and capital markets for the
World Bank and the recent IFC proposal). EBRD should therefore offer to work closely with
the Ministry of Justice and Home Affairs and Economic Standing Committee of the
Parliament to articulate for the Corporate Governance Task Force the rationale and
components of their work. To fall within the scope of legal reform, such a study could focus
on the legal dimension for institutions. The deliverable would be to identify whether (and if
so what type of) institutional reform would enhance the corporate governance performance of
financial and industrial firms (e.g. regulation of internal control systems).
38
Key factors driving this recommendation There is a critical mass of support at the highest levels of the Mongolian political economy
for enhancement of existing corporate governance systems. However, such support is not
matched by a clear sense of direction as to what steps need to be undertaken, and how to
improve the Mongolian system in an integrated fashion (as opposed to responding in an ad
hoc fashion). Other donor agencies (for good reasons) are targeting corporate governance
issues in isolation, often based on home-country specific approaches, techniques and
recommendations, rather than in a systemic fashion specifically designed for the existing
realities facing Mongolia.68 Some specific initiatives, such as work by the Mongol Bank
considering corporate governance in the financial sector, offer a positive baseline that could
be used as an integral part of a wider feasibility study.
Recommendation 2 – Corporate Governance: work with key
stakeholders to establish a clear legal governance framework
The EBRD should consider working with the Ministry of Justice and Home Affairs to fund
and direct drafting of regulations under the Company Law and Law on State Property and
other associated legislation. Such actions would be undertaken in order, first, to agree suitable
parameters for the internal organisation of financial and industrial entities, and secondly to
establish these parameters in a clear legal framework. Careful consideration should be given
to the form of regulation (e.g. ‘hard law’ or ‘soft law’). It should also cover induction /
implementation training for state and private sector officials and professional advisers. Such
an initiative should deliver:
• draft regulations covering the interactions between shareholders and the board
• draft regulations covering the interactions between the board and executive
management,
• draft regulations covering board process.
Crucially, the scope of any investigation into legal reform must cover both state-controlled
and private firms, and draft regulations may therefore need to extend beyond the Company
Law to associated laws and regulations. There may also be a need for a specific investigation
68 The IFC proposal (see page 8 above) articulates an integrated approach in many respects, mostly in training and practices at the grass roots level. Even if this is implemented to its fullest potential, there remain gaps at the level of interaction between the state-owned enterprises, and the legal and regulatory regime that has institutionalized governance practices to date.
39
into the securities, depending on the current size and liquidity of the Mongolian securities
capital market. Careful consideration should be given to the range of enterprises to be subject
to any draft regime: in particular, Small and Medium sized Enterprises [SMEs] should not be
ignored. The State Property Committee and Ministry of Justice and Home Affairs should
both be project sponsors. Ideally, a representative body of Mongolian Corporations could also
be used in an advisory capacity, thus making it more likely that any recommendations can be
adopted.
Key factors driving this recommendation
Both the state-controlled and fully private sectors face transitional problems adjusting
company organisational conduct to the rules of limited liability and open joint-stock
ownership, especially where such ownership is separated from control. We observed
potential costs arising in privately held business, and state controlled firms, both in terms of
process and an interesting current, high profile dispute over procedure for calling a
shareholders meeting. Such costs result from the fact that practices for rational risk bearing
are slow to develop while enterprises are closely controlled. This in turn results in poor
incentives for professional managers and thus a small pool of professional managers available
to drive and support reform and value creation. This recommendation would aim to reduce
these structural costs to economic activity by initiating a process to set clear benchmarks for
process and control. To enhance the prospects for success of such an initiative, state-
controlled corporations should be included in discussions and encouraged to lead
implementation of recommendations.
Secured Transactions: Conclusion
The report concludes that there are very specific, incremental needs to develop secured
transactions rules and practices in Mongolia. Timing is critical because of significant
institutional reform in the area, culminating in the enactment of a heavily revised Civil Code
in October 2001. This revision included specific provisions on secured transactions laying
the foundations for a modern legal basis to support secured lending.
The report concludes that there are a number of obstacles before the goals of the policy
makers, law makers, and creditors and debtors are achieved. These fall into the following
categories –
a. Legal uncertainty – While the new law appears to cover all the principles, there is
insufficient detail, and certain inconsistencies, which may well frustrate the smooth
development of business and legal practice. This issue pervades the creation,
40
enforcement, priority of and termination of a charge. For example, many business
people comment that there is not much more immoveable property that can be
charged and that the law should enable the charging of moveable property. While the
law clarifies the principle, it supplies too little detail on different types of valuable
moveable property, e.g. receivables, and the procedures by which those charges are
created and enforced. A key conclusion is that charges on moveable property should
be made on basis of an electronic registration system. The current initiative of the
GTZ and USAID will build up a list of issues on perceived gaps of principle and
uncertainty as to implementation It is hoped this leads to a detailed commentary and,
if necessary, a list of issues for consideration by the Ministry of Justice and Home
Affairs. It may be that many points of detail were envisaged by law makers but were
not considered appropriate for incorporation in the Code.
b. Institutional support for charges – The State Immoveable Property Office has
successfully participated in a rapid institutionalisation of charges over immoveable
property. Nevertheless, it is unclear whether in fact the current practice of
registration of charges is a pure administrative act, or contains substantive aspects. In
addition, it could be an obstacle to effective future practice if the data held by the
office is not make more freely available. This issues goes to the inherent role of the
office. However, the new Civil Code envisages changes to the procedures of that
office for immoveable property, and more significantly the creation of charges over
moveable property without specifiying whether this will take place by registration.
The introduction of the new Code (to be effective 1 September 2002) marks an
opportunity to revise and extend the institutional support for secured transactions
throughout Mongolia. This is essential if charges on moveable property
c. Training and awareness raising – There is a very small community of users of the
secured transactions infrastructure, including banks and non-bank financial
institutions.69 While there have been significant advances in practice in connection
with a growing level of secured credit, the new Civil Code marks an ideal time to
ensure that debtors as well as creditors have the means to use a modern system with a
view to getting maximum benefits. Again, the GTZ and USAID study will help
identify where specific emphasis should occur. However, this programme itself is not
of a detailed and substantive nature in certain technical areas. Creation of charges on
moveable property by registration is an area where specific training and awareness
raising should be focused.
69 See notes of meeting with AG Bank, Golomt Bank and Wagener Asis Equipment.
41
Recommendation 3 – Secured Transactions: develop a register for
charges on moveable property
EBRD should conduct a feasibility study on the merits of developing a register for charges on
moveable property. The objectives of such a study would be to establish whether and if so on
what basis (legal, technical and resource bases) should a register be established. The Ministry
of Justice and Home Affairs should sponsor the study, but work should take place in close co-
operation with the central and regional offices of the State Immoveable Property Registration
Office, and the National Statistics Office (to which data on pledges on immovables is
currently reported). The study should build logically on a draft unpublished report
commissioned by the Asian Development Bank mapping out a plan for the development of a
secured transactions registry.
The study should cover – the adequacy of the amendment to the Civil Code for the
administration and practice of charges on moveable property, the level of demand by creditors
for charges on movable property, the level of willingness of debtors to supplement charges on
immoveable property with charges on movables, the need for detailed rules to guide
administration and practice, the computerisation of a register for charges on moveable
property and the publicity of information concerning charges on moveable property.70
Key factors driving this recommendation
Considerable work has already been done to effect legal changes in Mongolia’s Civil Code.
Moreover, the concepts of ‘pledge over immovables’ and ‘enterprise assets’ have already
become reasonably well institutionalised in practice. However, much doubt remains over
whether (and if so how) a register of charges on movables should be established, both
amongst Mongolian stakeholders and donor agencies.
It was reported to the consultant that a World Bank macro-level study some years ago
concluded that (absent adequate laws on secured lending and no register for charges on
immoveable property) no register of charges on moveable property was necessary. Since that
time the law and practice of charges on immoveable property has developed considerably,
e.g. 25% of SIPRO’s work is the registration of charges, and enforcement of charges by banks
is commonplace, if not perfect. The amended Civil Code clarifies that charges on moveable
70 Further elaborated in the draft terms of reference set out in appendix A.
42
property are permissible, but there is little guidance on the legal and institutional framework
for this to develop in practice.
A feasibility study is considered the most appropriate way forward for the following reasons.
First, no systematic, empirical approach to the proposition of establishing a register has ever
been carried out. Previous studies have been theoretical, and in any event have preceded the
introduction of the amended law. A feasibility study incorporating an empirical component
should redress this gap in institutional development. The consultant discovered that the
banking and non-bank financial community strongly support the introduction of such a
register, and data to support empirical study should be available. In particular, the US
managed Ag Bank, Golomt Bank, and Wagener Asia Inc. expressed strong support for a
register and data could be requested from these organisations.
Second, the consultant observed uncertainty and debate amongst key opinion shapers (e.g.
governmental, technical assistance missions and academic persons) on whether a registry was
necessary for effective operation of non-possessory charges on moveable property. A
feasibility study should specifically engage a range of opinion shapers to remove uncertainty,
and sharpen debate on the function of a register for non-possessory charges.
There is an important timing issue for feasibility study. The main sponsor of the amendments
to the Civil Code (GTZ) is currently undertaking a countrywide tour training court officials
and lawyers on the new Civil Code which becomes effective on 1 September. The proposed
feasibility study should liaise closely with GTZ and USAID to ensure that feedback from
participants in this programme on the implementation of the new law is taken into account for
the study.
The study may well conclude that a register is not feasible. Deliverables of the feasibility
study should include –
• proof of demand for, and statement of predicted economic benefits of, a registry
• problems identified in the Civil Code, and draft text to clarify (this work would
investigate charges over receivables and securities, timing of creation of charges,
priority of competing charges)
• Organizational features of a registry system – e.g. which state body is accountable,
recommended relationships between aimag offices and UB office, and draft
instruments for authority and regulation of the apparatus to run the register
43
• technical specification if registry to be computerised
Consideration should be given to whether sponsoring ministry should benefit from details of
potential capital and operating costs being set out in the study.
44
APPENDICES
45
Appendix A: Draft terms of reference
TERMS OF REFERENCE
IMPROVING CORPORATE GOVERNANCE FRAMEWORK AND PRACTICES
1. BACKGROUND The Government of Mongolia has requested the European Bank for Reconstruction and Development (the “EBRD”) to [state the request] Corporate Governance Task Force established by the Economic Standing Committee of Mongolian Parliamnet. The EBRD has agreed to utilise the resources made available under the EBRD-Mongolia Co-operation Fund to conduct this [state request received] The EBRD, as an international institution with the mandate to assist the transition process in its countries of operations, views the promotion of sound standards of business conduct as central to its work. In a set of guidelines published in September 199771, the EBRD seeks to help companies understand some of the broader concerns that lenders and investors have when considering a potential loan or investment opportunity in the region. The guidelines cover not only the fundamental interests of shareholders, but also the relationship between companies and their clients, suppliers, local communities and governments. Sound and stable relationships depend on fair, transparent and responsible practices, behaviour and standards. Thus the long-term success of a company and its ability to attract capital depends on establishing and meeting these standards. Sound principles of corporate governance include the existence of a transparent shareholding structure, respect for the rights of minority shareholders and a well-functioning board of directors. Given that good corporate governance depends on the broader legal and regulatory environment prevailing in the country of domicile of a given company, it is very important to raise awareness of policy makers and other interested parties about the legal, regulatory and market environment underpinning good corporate governance in the relevant country in order to stimulate reform. The EBRD conducted a legal due diligence assessment covering corporate governance in January of 2002. That study concluded that an obstacle to the development of effective corporate governance practices is current practice under the Law on State and Local Property, and the Company Law. Much of Mongolia’s significant industrial enterprise has been corporatised yet remains in the total or partial control of the state. This means that control over such corporations is exercised by the State Property Committee with reference to both the Law on State and Local Property, and Company Law. In practice, actions taken under the Law on State and Local Property are dominant (e.g. the preparation of shareholder and board meetings). This means that indepedendent practices by individual corporations in line with
71 EBRD, Sound Business Standards and Corporate Practices: A Set of Guidelines (September 1997), available at the EBRD website at http://www.ebrd.com.
46
the objectives of the Company Law are slow to develop. Discussions with local market participants showed that practices in these corporations (of comprising the largest economic group in Mongolia) have large demonstration effect both for managers and employees within the enterprises, and for other corporations. 2. OBJECTIVES The primary goal of this Project is to assist the Corporate Governance Taskforce of the Economic Standing Committee improve the Mongolia’s corporate governance framework and practices. More specifically, the objectives of the Project are:
o To evaluate the adequacy of the framework of the Law on State and Local Property, and the Company Law, and all relevant regulations made under those laws, for encouraging the development of independent corporate governance practices in Mongolian companies.
o To develop proposals to the Mongolian Corporate Governance Taskforce on
specific revisions to such Laws and Regulations in order to bring corporate governance framework and practices in line with international best practice.
3. SCOPE OF WORK In order to attain the objectives set forth in Section 2 above, the Consultant shall perform all relevant legal and regulatory studies, analyses and investigation as needed, and, specifically, undertake the tasks set forth below: 3.1 Field trip With reference to the objectives set out in section 2 above, the Consultant shall make a field trip to Mongolia to meet and work the Ministry of Justice and Home Affairs of Mongolia (“the MmoJ”), the Administration Departmnet of the State Property Committee (“SPC”), and the secretariat to the Economic Standing Committee (the “secretariat”), and relevant institutions in the private sector to:
o Establish a taxonomy of legislative and regulatory rules under the Law on State and Local Property and the Company Law72 which regulate –
o Conduct amongst shareholders in corporations with total or partial state ownership
o Conduct between the SPC on one hand, and all shareholders on another, and the boards of such corporations
47
o Conduct between boards and management of such corporations • Investigate the practices of a representative sample of corporations with partial or
total state ownership specifying o Conduct amongst shareholders o Conduct between the SPC as shareholder, and through its board
representative, and the board as a whole o Conduct between management and the board of directors
• Conduct a similar investigation of practices of a limited number of corporations with private sector ownership
• Identify all relevant issues that need to be addressed in order to achieve the primary goal of this Project
• Collect other relevant information pertaining to the subject matter of the Project In particular, the taxonomy of porovisions in legislation and regulationsm, and the corresponding investigation of conduct, should include –
o Processes for communication between shareholders o Processes for accounting by boards to shareholders o Processes for transparency by significant shareholders and boards on significant
decisions o Annual general meeting procedures o Procedures for selection of board members and disclosure of their appointment terms o Board and committee structures and meeting processes o Procedures for engagement by board of management, and management conflict of
interest o Procedures for setting standards on operational and financial risk, and for monitoring
management performance 3.2.1 Preparation of a legal recommendations report (the “Report”) 73. 3.2.2 Immediately after the trip mentioned in Section 3.1 above, the Consultant shall
proceed to review and organise all the information collected during the trip. 3.2.3 The Consultant shall then prepare and submit the Legal Assessment Report before the
deadline set forth in Section 5.1 below. The Legal Assessment Report shall contain, at a minimum, the following components:
o A summary of the Consultant’s trip to Mongolia, which shall include descriptions
of:
72 While a small proportion of the relevant corporations have securities admitted for trading on the Mongolian Stock Exchange, the taxonomy should include in an appendix rules of a similar nature that are contained the Law on Securities and the Stock Exchange Regulations. 73 Please note that the copyright of the Legal Due Diligence Report will reside with the EBRD, while the authorship will remain with the Consultant.
48
o The itinerary of the trip; o The meetings that the Consultant had with Mongolian officials and other
relevant persons and the relevant issues discussed; and o The information collected during the trip, in particular, those mentioned
in Section 3.1 above74;
o A taxonomy of the legal institutions established under 3.1 above; o The Consultant’s assessment and significance of the specific areas of conduct
investigated under section 3.1 above which lead to ineffective corporate governance practices that do not confirm with best practice;
o The Consultant’s assessment of the specific provisions of the Law on State and Local Property and Company Law which in terms of fostering sound corporate governance practice;
o The Consultant’s recommendations on specific revisions of the current legislative and regulatory framework (under the Law on State and Local Property and Company Law) to improve the conditions for corporate governance practices.
4. IMPLEMENTATION ARRANGEMENTS 4.1 The MmoJ, the SPC and the Economic Standing Committee are the joint beneficiaries
of this Project and will each designate a senior official to meet with and assist the Consultant with the Assessment Visit. The Consultant is required to collaborate closely with the MMoJ official so designated.
4.2 The MMoJ will assist the Consultant with the Assessment Visit by providing:
Access to necessary information within the context of the Project; Assistance in arranging meetings with or otherwise gaining access to key officials
within the Government of Mongolia and other people relevant to the subject matter of this Project; and
Other logistical support as appropriate and if available. 5. TIMETABLE AND DELIVERABLES 5.1 The timetable for the Consultant to produce relevant deliverables of this Project is set
forth below: Week Description of Work Deliverable Deadline for
74 In an annex to the Report, the Consultant shall attach copies of all relevant written information collected during the trip.
49
Submission of Deliverable
0 Inception75. (none) The tasks set forth in Sections 3.1. (none)
The tasks set forth in Sections 3.2. Legal Assessment
Report
5.2 Language and Format: Each deliverable described above shall be prepared in
English, and shall be produced in hardcopy by using Word for Windows. On request, the electronic version of the relevant deliverable shall be made available to the MMoJ and the EBRD.
5.3 Number of Copies: For each deliverable, the Consultant shall send the EBRD two
copies of the Legal Assessment Report.
TERMS OF REFERENCE
LEGAL TECHNICAL ASSISTANCE PROJECT
IMPROVING SECURED TRANSACTIONS FRAMEWORK AND PRACTICES
1. BACKGROUND The Government of Mongolia has requested the European Bank for Reconstruction and Development (the “EBRD”) to [conduct a feasibility study of establishing a system for registering charges on moveable property under the Civil Code]. The EBRD has agreed to utilise the resources made available under the EBRD-Mongolia Co-operation Fund to conduct this [state request received] The EBRD, as an international institution with the mandate to assist the transition process in its countries of operations, views the promotion of effective rules and practices for secured transactions. Based on the EBRD’s model law on secured transactions published in 1994, the EBRD seeks to help companies understand some of the broader concerns that lenders and investors have when considering a potential loan or investment opportunity in the region. Specifically, for money loaned or credit extended, a lender or creditor usually will take a mortgage or a pledge as security in order to reduce the risk of loss. Therefore, the inability to obtain valuable security over the debtor's assets is likely to discourage potential providers of credit. If the law or the way in which it is applied do not give creditors confidence that they
75 Inception is deemed to take place on the date when the relevant consultancy contract with the Consultant becomes effective.
50
can recover real value from mortgaged or pledged assets it will have little economic effect. On the other hand, security that effectively reduces the risk of giving credit can increase the availability of credit and improve the terms on which it is available. In other words, the availability and cost of credit as well as the efficiency of the market for secured credit is directly influenced by the laws affecting secured transactions and their implementation. The EBRD conducted a legal due diligence assessment covering secured transactions in January of 2002. That study concluded that a potential obstacle to the development of more effective secured transactions practices is the absence of legal uncertainty on the basis and the procedures for creating, enforcing and terminating charges on rights and moveable property. The Mongolian Parliament enacted a revised Civil Code in October 2001 in which the principles for establishment of charges on rights and moveable property were confirmed. The new law will become effective in September 2002. The January study concluded that the development of secured transactions over rights and movables (for which there is demand) has been hampered by lack of enabling legal framework. While the introduction of the new law should improve the situation, there remain uncertainties over whether and how charges on rights and moveable property can effected. In addition, there is a divergence of views on whether or not a register for charges on moveable property should be established. 2. OBJECTIVES The primary goal of this Project is to assist the Mongolian Ministry of Justice and Home Affairs (MmoJ) improve Mongolia’s secured transactions framework and practices. More specifically, the objectives of the Project are:
o To evaluate the adequacy of the legal framework contained in the Mongolian Civil Code and associated regulations for establishing, enforcing and terminating charges on moveable property and rights.
o To deliver a feasibility study on development of a register on moveable
property (including rights) containing proposals to the MMoJ on the development of registration system relating to charges on moveable property.
3. SCOPE OF WORK In order to attain the objectives set forth in Section 2 above, the Consultant shall perform all relevant legal and regulatory studies, analyses and investigation as needed, and, specifically, undertake the tasks set forth below: 3.1 Field trip With reference to the objectives set out in section 2 above, the Consultant shall make a field trip to Mongolia to meet and work with the Ministry of the Justice and Home Affairs of
51
Mongolia (“the MmoJ”), the State Immoveable Property Registration Office (“SIPRO”) and relevant institutions in the private sector to:
• Establish a taxonomy of legislative and regulatory provisions contained in the Mongolian Civil Code and relevant laws and regulations that prescribe the establishment, enforcement and termination of charges on moveable property and rights.
• Evaluate the extent of divergence and convergence between the Mongolian system and rules considered to demonstrate international best practice for secured transactions, and in particular best practice rules derived from the EBRD’s model law on secured transactions
• Investigate and illustrate the practices of a sample of creditors in structuring transactions in which credit is provided for the purchase or use of moveable property
• Investigate and record the needs and obstacles of the creditor and commercial debtor community in relation to providing credit and giving security over moveable property
• Investigate the technical and administrative capacity of existing institutions (i.e. the Court system and SIPRO) to effect charges on moveable property
• Identify all relevant issues that need to be addressed in order to achieve the primary goal of this Project
• Collect other relevant information pertaining to the subject matter of the Project 3.2.1 Preparation of a legal recommendations report (the “Report”) 76. Immediately after the trip mentioned in Section 3.1 above, the Consultant shall proceed to review and organise all the information collected during the trip. 3.2.2 The Consultant shall then prepare and submit the Feasibility Study before the
deadline set forth in Section 5.1 below. The Legal Assessment Report shall contain, at a minimum, the following components:
o A summary of the Consultant’s trip to Mongolia, which shall include descriptions
of - o The itinerary of the trip; o The meetings that the Consultant had with Mongolian officials and other
relevant persons and the relevant issues discussed; and o The information collected during the trip, in particular, those mentioned
in Section 3.1 above77;
76 Please note that the copyright of the Legal Due Diligence Report will reside with the EBRD, while the authorship will remain with the Consultant. 77 In an annex to the Report, the Consultant shall attach copies of all relevant written information collected during the trip.
52
o A feasibility analysis on developing a registration system for charges on moveable property is to be produced addressing the following issues -
o Adequacy of current legal and regulatory provisions, and recommendations for clarification and enhancement to those provisions
o Evaluation of the needs of creditors and commercial debtors and overall level of demand for charges on moveable property and rights, and whether likely to be met under operation of provisions of Civil Code
o Evaluation of whether registration system for charges on moveable property and rights is necessary to meet the needs of the creditor and debtor communities, and the standards of international best practices
o Evaluation of the adequacy of administrative capacity to create and administer system for charges on moveable property
o Specification of the legal, administrative and technical features necessary for a registration system
4. IMPLEMENTATION ARRANGEMENTS 4.3 The MmoJ is the beneficiary of this Project and will each designate a senior official
to meet with and assist the Consultant with the Assessment Visit. The Consultant is required to collaborate closely with the MMoJ official so designated.
4.4 The MMoJ will assist the Consultant with the Assessment Visit by providing:
Access to necessary information within the context of the Project; Assistance in arranging meetings with or otherwise gaining access to key officials
within the Government of Mongolia and other people relevant to the subject matter of this Project; and
Other logistical support as appropriate and if available. 6. TIMETABLE AND DELIVERABLES 5.4 The timetable for the Consultant to produce relevant deliverables of this Project is set
forth below:
Week Description of Work Deliverable Deadline for
Submission of Deliverable
53
0 Inception78. (none) The tasks set forth in Sections 3.1. (none)
The tasks set forth in Sections 3.2. Legal Assessment
Report
5.5 Language and Format: Each deliverable described above shall be prepared in
English, and shall be produced in hardcopy by using Word for Windows. On request, the electronic version of the relevant deliverable shall be made available to the MMoJ and the EBRD.
5.6 Number of Copies: For each deliverable, the Consultant shall send the EBRD two
copies of the Legal Assessment Report.
78 Inception is deemed to take place on the date when the relevant consultancy contract with the Consultant becomes effective.
54
Appendix B: List of persons met
Time
Person to meet
Venue
Contact
telephone
January 19, Saturday
7:00 Arrival, hotel accommodation Bayangol hotel 312255
12:00 O.Gerel, EBRD Office Manager Bayangol hotel lobby 99117987
19:00 Dinner hosted by Ts. Munkh-Orgil, Deputy Minister of
Justice and Home Affairs
Restaurant
99192389
Gerelchuluun
January 21, Monday
9:00 W. Mako, WB expert on legal reform WB Office 312647
10:00 D.Naranchimeg, Deputy Director of Otgontenger Private
University (expert on commercial laws)
Otgontenger
University
99157631
453944
11:30 D.Dolgormaa, Head of Agency for Registration of
Immovable Property
Agency for
Registration of
Immovable Property
3133576
99113954
14:00 D.Bayarsaihan, Head of Legal Policy Department,
Ministry of Justice and Home Affairs
MJHA 311951
15:00 Doug McGay, Ivanhoe mining company (Canada) Ivanhoe office 99112308
16:00 L.Zaya, Project Coordinator, GTZ Judicial Reform
Program
MJHA, 2nd floor
January 22, Tuesday
10:00 Jamyanchoijil, Judge of Civil Chamber, Supreme Court Supreme Court 320622
12:00 Od, Vice President, MCS Corporation MCS Plaza 91116283
14:30 Unenbat, President of Mongolian Bankers’ Association Mongol Shuudan
Bank bldg, 5th floor
99118745
323581
16:00 A.Buyandelger, Director of Loro-Piana Mongolia Co.Ltd.
(cashmere processing plant)
Company building
near Gobi cashmere
99115458
January 23, Wednesday
10:00 L.Mandal, Head of Administration Department, Mongol
Bank
Mongol Bank, 3rd
floor
322166
11:00 R.Lamont, Chief of Party, USAID “Mongolia Judicial
Reform Program”
MJHA, 2nd floor
14:30 Darius Teter, Program Coordinator, ADB Resident Office MCS Plaza 328936
15:00 Batsukh, Head of State Assets Representation & SPC 312574
55
Management, State Property Committee
16:00 Bayasgalan, General Director of Golomt Bank Golomt Bank 99116607
assistant
17:00 Bailykhuu, Advisor to SPC, member of the Parliament
Task Force on Corporate Governance
99156239
January 24, Thursday
10:00 D.Dorligsuren, Chairman of Mongolian Stock Exchange MSE 310501
12:00 Seseer, Head of Legal Department, Ministry of Foreign
Affairs
311311
14:30 Jigden, “Dalai Van Audit” Accounting Firm Dalai Van Office 99115430
325218 328749
17:00 Maurice Lynch, Head of US-Mongolian Business Group
and partner of “Munkh-Orgil, Idesh & Lynch” Law Firm
Int Trade Center, 5th
floor
99115298
January 25, Friday
9:30 Otgontsetseg, Secretary of the Governing Board, Gobi
Corporation
Gobi Plant 342872
11:00 Debra Boyer, Chief Operating Officer, Agricultural Bank Ag Bank 99113729
1600 Munkhtur, Head of Credit, Golomt Bank
January 26, Saturday
Departure
56
Appendix C: List of materials collected
Arthur Andersen, TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Executive Summary, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 2 – Strengthening Supervision, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 2 – Appendix Draft Regulation on Corporate Governance, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 4 – Capital Markets, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 5 – Capital Markets Legal, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 5 – Capital Markets Legal, Attachment 1 – Comments on Draft Security Law, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 5 – Capital Markets Legal, Attachment 2 – Review of Draft Investment Funds Law, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 5 – Capital Markets Legal, Attachment 4 – Comments on Company Law of Mongolia 1999, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 5 – Capital Markets Legal, Attachment 6 – Summary of best practices for managing credit risk of settlement banks by clearance and settlement/depository organizations, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 5 – Capital Markets Legal, Attachment 7 - Regulation of Securities Exchanges and Securities Dealers’ Trading Associations under the Mongolian Securities Law, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 7 –Pensions Legal and Regulatory, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 8 –Report of Insurance Industry Expert, Asian Development Bank.
57
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Section 8 –Insurance Industry, Asian Development Bank.
TA 3459 MON - Strengthening Financial Sector Development, DRAFT Final Report, Strengthening Secured Collateral, Asian Development Bank.
Administration of Immovable Property Registration, http://www.monjustice.url.mn/immov/etanil.html (downloaded 1/23/02).
Banking Law of Mongolia, http://www.mongolbank.mn/public/en/Rule/laws/index.html (downloaded 1/18/02).
Securities Law of Mongolia (Ulaanbaatar: 13 October 1994).
Law on State and Local Property.
Minerals Law of Mongolia.
Brief Overview of Amendments to the Civil Code of Mongolia.
Company Law of Mongolia.
International Finance Corporation, Corporate Governance Project Proposal (2002)
International Monetary Fund, Mongolia: Statistical Annex, IMF Staff Country Report No. 00/26 (International Monitory Fund: March 2000).
J. Enkhchuluun et alii., General Council of Courts. The Mongolian Benchbook: A Practical Manual for Judges (Interpress: 1998).
Morris Rossabi, Mongolia in the 1990s: from Commissars to Capitalists?
Daniel Kaufmann, Aart Kraay, Pablo Zoido-Lobaton, Governance Matters (World Bank: Washington DC)
Mongolia: Assessment of Current Legal Framework on Corporate Governance and Secured Transactions.
Resolution of the Economic Standing Committee of the State Great Hural No. 19 (January 10, 2002).
Bankruptcy Law of Mongolia.
Law of Mongolia Prohibiting Unfair Competition (Ulaanbaatar, May 12, 2000).
Civil Code of Mongolia
Government of Mongolia, State Property Committee, Tender Announcement, http://www.spc.gov.mn/offerings/announcement.html (downloaded 1/23/02).
58
USAID, Mongolia Judicial Reform Program, Quarterly Report, Cooperative Agreement #492-A-00-01-00001 (USAID: Washington DC, September-November, 2001).
Asian Development Bank, Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance Grant to Mongolia for the Second Financial Sector Program, RRP: MON 30101 (June 2000).
Memorandum of Understanding Between Government of Mongolia and Asian Development Bank Second Financial Sector Program Loan (FSPL II) (8 June, 2001), (received at MNRM on June 12, 2001).
OECD, Investment Guide for Mongolia, 2000
Policy Matrix for the Second Financial Sector Program Mongolia.
Mongolia: Legal Needs Assessment Report (Ulaanbaatar, June 1999-May 2000), (Published April 27, 2000).
59
Appendix D: Meetings
Note the abbreviations CG and ST are used for corporate governance and secured transactions
respectively.
Munkh Orgil (MO), Vice Minister of Justice and Home Affairs
The purpose of this meeting with the key counterpart individual was to understand his
perspective of the current status and likely future features of CG or ST reformMO was very
clear about the relevant emphasis and direction to be allocated to ST and CG. Following
recent amendment to Civil Code (approved by Parliament but not to have effect until 1
September 2003) the needs are very specific. GTZ has provided extensive drafting assistance
over the last 6 years, and World Bank has developed an approach to registration of charges
over moveable property: a software package has been viewed by some Mongolian authorities
and is available for development with the relevant authority when implementation plan has
been adopted. USAID has and continues to provide assistance on judges training and any
assistance dedicated to secured transactions should be co-ordinated with that agency. MO
specifically stated that JICA and IFC do not provide technical assistance in either ST or CG.
MO believes there are specific implementation tasks that are needed and are not yet covered
by the donors. Essentially, this covers training for practitioners of ST – bankers and lawyers
– on one hand, and a public awareness initiative on the other hand. A key initiative that MO
would like to draw on is an agreement between MO and his counterpart at the Central Bank.
They plan to co-ordinate their staff and resources to work with the banking sector to ensure
recent reform is institutionalized properly.79
CG is at a much higher level and is only respected as a complex mix of policy and regulatory
initiatives by very few people. MO sees a need for a strategic perspective to be taken at this
stage. Together with key ST issues, the key contact person handing the Ministry of Justice
and Home Affairs contribution to this area is Chief of Legal Policy. In terms of the scope of
this policy, MO emphasized the development of the capital market which he associated
closely with public trust in the public securities market, i.e. as developed through the stock
exchange.
JB communicated the umbrella nature of the EBRD study. He emphasized that the terms of
reference required understanding of practices which meant that the experience of users of the
79 The Deputy Minister stated that Mr Stanton J Singleton recently completed a study on ‘Strengthening Secured Collateral’ sponsored by the ADB (email [email protected])..
60
ST and CG institutional framework had to be taken into account. This would provide at least
some anecdotal evidence supporting any proposals, and their priority, that arise from the
study.
William Mako, World Bank
Mr Mako has responsibility for private sector development in a region covering China,
Mongolia and some other parts of Asia. He is based in Washington but was in UB on mission
connected to his project. His project in Mongolia is to administer a 10 million USD
programme of assistance to Golomt Bank and Trade and Development Bank. He believes
that decline in non-performing loans is due at least in part to the effectiveness of security on
immoveable property. However, the working capital rates at terms of between 3 and 9
months for enterprises remained at TGD1.9%-3% and USD1.5%-2.5% per month.
Mr Mako confirmed that to his knowledge there were no specific World Bank initiatives on
developing a registry for charges on moveable property. On corporate governance, he
confirmed he held meetings with a representative of a newly established parliamentary
standing committee on Corporate Governance. This committee had declared 2002 a ‘Year of
Corporate Governance’ and had created a taskforce. In support of one of a company law
component of this initiative, a World Bank consultant in collaboration with Mr Mako’s
department will undertake a 2 week mission to UB on February 18 2002. This consultant
would focus on areas including –
• Appointment of directors.
• Procedures for AGM.
Mr Mako stated that this Committee believed that the configuration of capital markets
required work. In particular, the infrastructure for clearing and settlement of securities and
market monitoring by the SEC equivalent. We then discussed areas of governance which had
not been addressed, and agreed that procedures and processes of corporate governance of
state owned enterprises had not been specifically covered by the initiatives of which Mr Mako
was aware. Significant restructuring and possible ownership changes in transport, copper,
tourism, power and telephone enterprises is planned.
The IFC recently had a mission focusing on issues which included financial leasing and
governance issues. Mr Mako suggested we make direct contact with them but believed that
their governance work would focus on practices and accounting issues.
61
Professor Davaasuren Naranchimeg, Otgontenger University
This professor (DN) was a member of the expert group that supported the recent reform of the
Civil Code. The purpose of the meeting was to ascertain the scope of reform of secured
transactions law, and the current status of practices.
The Civil Code contains the provisions on secured transactions. The current effective law
includes modern provisions on secured transactions. For example, it permits charges on pools
of assets (e.g. inventory of a business) and permits private enforcement by a financial
institution of a charge pursuant to a debt provided that the relevant provisions are included in
the charging instrument. Important recent changes (to be effective on 1 September 2002)
contained certain clarifications and further modernization of the regime for pledging assets.
There are no specific restrictions on property which can be pledged, and the recent change
clarified that moveable property is also able to be pledged. For example, the amendments
clarified that cattle can be the subject of a pledge. There are only general limitations on the
type of property to be subject to a pledge, e.g. property which is co-owned. DN was clear that
the principle that future property could be the subject of pledge without more has been
contained in the Civil Code since changes in 1996.
The new amendments clarify that receivables can be pledged, and that private enforcement is
available to all creditors through the appropriate provisions in the charging instrument. The
most controversial aspects of the passage of the new provisions into law concerned privileges
of banks and enforcement by them. In addition, there was considerable debate promoted by
association of apartment owners over penalty interest charges and bank pledges. Specifically,
the debate concerned whether the associations of apartment owners be legal persons or not.
The economic relevance is the impact that status has on the ability of associations to procure
services.
The discussion then turned to the major challenges for implementing secured transactions,
and current practical. DN agreed that pledge on moveable property was not practised and
would require institutional development. In particular, pledge of receivables or other rights
required work. While the institutional framework had been clarified at the general level, there
was interpretation and practical challenges over – a) what should be considered to be
moveable property, and b) how should the rights over newly pledged property be
administered from creation stage through to enforcement stage, including the procedures of
the bailiffs. There are also specific issues over real property. Land is not privatized and each
apartment owner and business owners has a right of use over the land. This is 99 years for
communal property.
62
We turned to typical disputes concerning enforcement of secured transactions. The main
issues are – a) co-ownership, b) pledges being given over property not owned (including both
apartments and moveable), and c) priorities and claims on output of pledged property in the
commercial context. There was an interesting and high profile case involving a Mongolia-
Chinese joint venture under which the bailiffs sought to claim both equipment and the product
of the equipment.
DN confirmed the extensive assistance of GTZ in drafting of the Civil Code reform, but did
not believe there were any plans to develop a registration system for charges on moveable
property arising from secured transactions.
Dolgormaa Dagvadorj, ‘State Immovable Property Registration Office’
The purpose of the meeting was to establish the scope of the agency’s current role in secured
transactions, and plans for future development. The agency was established in 1997 to
coincide with the privatization of apartments. It has been in operation for five years. In the
absence of private ownership of land and a cadastral system for property rights in land, the
agency provides the basic real property registration function. It derives its competency and
authority from the ‘Law on registration of property’.
In 1999, the agency accepted registration of pledges on immovable property. It began the
practice of receiving loan agreements containing pledging clauses where there were
certificates from the owner of the property giving the pledge as to ownership. There is no
practice of a separate charging instrument. The loan document must be notarized. The
process carried out by the agency is administrative. There is no verification of the contents.
The process carried out by the officers of the agency is to check the following items are
completed –
• Title of parties
• Ensure no previous pledges, but do accept multiple pledges and just check for
consent.80
• Check with tax authorities and police on whether property under dispute.
The main drivers for the increase in pledges in 1999 – this was possible from 1996 – were
increased construction of apartments and houses, and a growth in loans to manufacturing
80 From this and other meetings, there does not seem to be clear understanding of a concept of priority of pledges and how that is effected and enforced.
63
industries. Historic data was requested that broke down the number of pledges registered by
sector (commercial), by amount of secured debt, and by value of secured property over the
last three years. The agency was not willing to provide data. DD commented that the number
of pledges rises from year to year. In 2001, 25% of services by number of users was for
pledges (including both private and commercial pledges).
Discussion then turned to the infrastructure of the agency. The records and the methods of
operating are not computerized. The charges are set at levels according to amount of the
pledge. Pledges are effected in 3 to 4 working days, but can be rushed through in 1 day for an
additional fee of USD3 – 5. The agency is not a public information agency. The only public
information is the certificate. Aggregate data is delivered by the agency to their monitoring
agencies – the statistical agency, the Mongol Bank, the Tax Office, and the Ministry of
Justice and Home Affairs.
The agency participates in the mandatory auction on basis of a court order but has no other
involvement in private enforcement.
In terms of culture towards pledge, the agency believes there is a need to improve public
awareness of the pledge system, and for enforcement as a process to be more effective. The
two issues are linked. In turn, this means the regime should be clarified but the agency was
not open to suggesting in what specific ways clarification was required. Banks should also
improve their approach to receiving pledges over assets located outside UB. At the moment,
pledges are only accepted if the bank has a local branch in the aimag.
D Bayarsaikhan, Head of Department of Legal Policy, Ministry of Justice and Home Affairs
The purpose of the meeting was to establish the current initiatives in secured transactions
legal policy and implementation, and legal policy affecting corporate governance.
In terms of corporate governance, the Ministry sees the central instrument as the Company
Law. A law on economic activities of 1991 saw Mongolia through initial stages of transition
but this was updated in 1996 specifically to take account of companies. In 1997, a new
Company Law was enacted, based on the consulting work of Professor Black who had
assisted the Russian Federation with its Law on Joint Stock Companies. The Ministry
characterized this as a universal law, in other words applicable to all types of companies.
Despite there being periodic reviews, the original law of 1991 still applies to certain economic
activities, e.g. power of citizens to conduct business.
64
DB reported that implementation of the 1997 law remains poor. The by-laws and company
statutes of many joint stock companies have not been updated in accordance with that law. A
requirement of the task force recently established by the standing committee is to investigate
why this is the case. More generally, there is a lack of understanding of the change in law for
certain decisions to have a 75% majority decision from the 66% majority previously.
Another issue is the procedure for closing a joint stock company. In common with many
post-communist economies where privatization took place via the stock exchange, many open
joint stock companies that are essentially closely held and of small asset size remain. The
company law does not clearly deal with desirable change of status of these companies
including procedures to protect the interests of minority.
In terms of broader issues, some state controlled enterprises do not fall under the Company
Law. For instance, MIAT has a governing board but this is at the shareholder level. It is not
possible to use the Company Law, and indeed this applies to 18 enterprises transferred to
shareholding companies. The government ownership is typically split according to the
following ratios:
• Ministry of Finance – 20%
• Infrastructure Ministry – 41%
• State Property Department – 39%
Discussion turned to securities law. Again this is subject to work by the task force. The
Ministry of Finance has supported the development of a draft securities law, however the
Ministry of Justice and Home Affairs made clear it has yet to be fully debated by relevant
departments before being presented to Parliament. There have been no donor agencies
involved in this draft.
The meeting concluded before turning to secured transactions.
Doug McGay, Ivanhoe Mines
The purpose of this meeting was to gauge the experience of a foreign direct investor with the
administrative agencies for companies in Mongolia, and with the management practices of
Mongolian staff.
Ivanhoe acquired the right to continue the gold exploration business of BHP Billiton in the
Gobi desert under an earn-in agreement. The contractual arrangements are off shore. Ivanhoe
65
has no joint venture partner in Mongolia, and does not raise any finance locally. Major
expenditure is about to start, but through third party contracting with drilling experts and
equipment suppliers capital remains off shore. Security of their operations dervives from the
clarity of the minerals law and the competence of the minerals authority staff. (Note this
agency also registers pledges on licences). Opinion is that Mongolian minerals law in best in
Asia.
Ivanhoe hire Mongolian managers. Level of education is high, workers are intelligent, and
adaptable. Noticeable difference in generation gap between under and over 40s in attitude to
work. The knowledge gap and legacy of old management practices is considered to be the
primary cause.
GTZ, Lkhagvagiin Zaya
The purposes of the meeting were to ascertain the scope and stage of the reform of secured
transactions laws in the Civil Code, and to establish current and planned technical co-
operation projects by GTZ in the fields of corporate governance and secured transactions.
LZ advised that GTZ’s mission focused on legal drafting, and in the case of the Civil Code
had been on going for 6 years. The lead technical consultant was Prof Dr Rolf Klipper. The
work on the Civil Code touching secured transactions extended beyond the language of the
Code itself to include a law on baillifs and a law on civil procedure. To supplement drafting,
GTZ was about to conduct training of judges, prosecutors and defence attorneys on the
application of the new law in conjunction with USAID. This would clearly include aspects of
secured transactions. As a necessary complement to the drafting effort, a legal interpretation
is being produced by the commission which oversaw the drafting of the Code. A 9 person
mission to Germany commenced on 28 January 2002.
GTZ does support other initiatives (e.g. management training at Agribank, and institution
building at Mongol Bank) but this does not cover secured transactions nor corporate
governance.
In terms of implementation of secured transactions reform contained in the Code, there is
considerable debate over whether a system for registration of charges over moveable property
is necessary. Apparently, an earlier high level review of banking system by World Bank
concluded that a registry system would not be valuable.
GTZ plan each year’s work using a survey and then presenting the results to the Ministry of
Justice and Home Affairs. For 2002, four areas have been approved for work by GTZ
66
following this process: interpretation of the Civil Code, advice on law on securities, reform of
land law, and further amendments to the law on registration of immoveable property. (Note
that both the law on registration of immoveable property together with the Civil Code permit
the pledge of an apartment).
Current work is focusing on amendment to the law on registration of immoveable property.
GTZ claims that there will be no changes of principle. Detail will be clarified in the interests
of protecting the interests of the buyer of apartment including:
• Definition of ownership
• Definition of tenancy
• Definition of pledge rights
• Specification of physical location and dimension of property
• Impact of inheritance regulations
• Impact of co-ownership
• Standards for assessment of value (note this is probably tax driven in support
of levying of stamp duty because at present there is a large gap between
declared and actual price)
Discussion concluded by rounding up the activities of various donor agencies in the area of
corporate governance and secured transactions: GTZ concentrates on economic law drafting,
ADB focuses on judicial training (but has some plans for accounting and auditing work),
USAID focuses on judicial system (including court administration), Soros focuses on legal
profession, and the World Bank has not been active to date but looks as if it will enter the area
in a manner that is connected to its lending (e.g. FESAL loans) commencing in 2003. No
information on IFC.
Civil Chamber of Supreme Court, R Jamiyanchoijil
The purposes of the meeting were to ascertain the nature of demands on court system of
secured transactions and corporate governance issues, and to establish the problems in
applying judicial system to such issues.
A clear explanation of secured transactions and corporate governance issues was provided.
RJ confirmed that both secured transactions and corporate governance cases were increasing.
67
In the case of corporate governance, the most common disputes concerned actions by
shareholders and board against executive director over his duties and responsibilities. The
underlying problem concerned dealing with company property and therefore raised the legal
issue of authority of the executive director. In addition, disputes between shareholders over
rights of ownership are common. Recent case indicates common in purchase of state owned
enterprise where several parties contribute to the purchase process. Underlying both of these
issues lie issues of conceptual understanding of the separate legal personality of the company,
the division of authority between different organs, and decision procedures.
In response to these issues, the Supreme Court will undertake this year completion of an
official commentary on the company law in order to unify understanding amongst legal
practitioners and company leaders.
A high profile case promises to raise corporate governance debate in Mongolia. APU (drinks
company) was a state owned company sold to a consortia of Mongolians / Russians and state
retained control. Under the state ownership, the management owners could impose its will
because state agreed with its proposals. Further sell down under which the non-management
owners acquired greater interest than management owners and now there is a dispute on who
can call, and in what way, a shareholders meeting. The dispute was brought before the court.
The court referred the matter back to the parties – stating that this is not for court but subject
to interpretation and implementation of the charter and by-laws and the Company Law. RN
did not believe court had a role in interpreting the law for the parties in this case, although
official interpretation of the Company Law would help.
In terms of secured transactions, the most frequent disputes concern pledges that are not
notarized or not registered. The court sees a range of financings before it; including bank,
non-bank, and pawn shops. RN commented that the banks were the major players in the
pledge transactions. RN aware of the new law and believes that the law could be better
balanced between creditor and debtor rights if more clarity on procedures. At present, the
private enforcement by banks under the pledge agreements has led to balance heavily in
favour of banks.
RN was asked to comment on the effectiveness of interaction between the courts and the
Agency for registration of pledges over enforcement. RN commented that in general the
Agency followed the provisions of law, but more could be done to improve co-ordination
between the court system and the registry over disputed cases.
68
Securities Commission, Bazar Ayush
The objectives of the meeting were to ascertain current practices in securities market by
issuers and intermediaries that concerned the operation of the corporate governance system, to
establish current problems that are related to the legal environment, and to be aware of current
and planned initiatives to develop the institutional environment.
Currently the securities market operates under the Law on Securities. In1997 a secondary
market was established to facilitate trading in shares that were acquired by way of
privatization. There has been virtually no new issue activity of any type for three years. In
late 2001, a Japanese – Mongolian joint venture ‘Mirakon’ issued bonds. BA noted that a
number of companies have recently requested information on issuing bonds but none have yet
done so. Commercial banks are active in buying government bonds and the argument is that
corporate bonds will be attractive. The joint venture issue is interesting because it is linked to
the construction boom, the high costs of commercial loans and the lack of housing. The
company built an apartment building largely for employees and financed a stage of
construction through bonds with security over the building. Terms of bonds were between 3
and 6 months. The pattern of equity trading remains thin, and characterized by occasional
block trades reported through the exchange.
In terms of systemic issues, BA emphasized that the control of clearing and settlement had
not been separated from the Stock Exchange. When pressed, it was not clear what problem
this was causing: there is an argument this might be the most efficient solution given current
and likely use of securities market. There is the counter argument that this creates a
disincentive for securities market activity because of increased clearing and settlement risk
due to no separate agency carrying out this function. BA believes Mongol Bank should have
required it.
In terms of micro-issues where governance improvements are needed, BA believes there
should be better disclosure on directors and financial interests in the company because none is
required at the moment (latest regulation in August 2000) The Commission decided not to
issue specific regulation on this because it considered it personal and not company specific
data: there was an issue of competency to do so.
In terms of current developments, BA stressed that the Securities Commission had
competency under the Company Law 1997 in relation to joint stock company disclosure. The
priorities now are in relation to infrastructure of the securities market, and on disclosure. BA
specifically noted that the regulations on disclosure that the have been issued are –
69
• Ministry of Finance reg 2001
• Securities Commission summary financial report regulation – 1996
The Commission has been working on a draft Securities Law for the last three years and this
will be made one of the subjects of the Corporate Governance Task Force on which BA sits.
MCS Holding, J Od
The purpose of the meeting was to gather case study evidence of the corporate governance
structure and processes of a large scale Mongolian privately held company, and to discover
issues and problems on operating that problem in the current regulatory system.
MCS Holding controls a group of operating companies. The company is private (a LLC), is
controlled by a family and has grown from origins as a consulting firm in the early 1990s. Its
initial success was derived from close links to government. (The brother interviewed was in
government when the company began operations.) It has developed through three stages of
growth. The first stage was in consulting where it developed expertise and experience in
energy, privatization, education and healthcare sectors. The second stage is when it acquired
companies by purchasing shares under the development of the secondary market on the Stock
Exchange subsequent to privatization. For instance, it acquired control of greenhouse
business and spirits business in this way. In many cases, it has subsequently acquired the
government’s remaining share in the company. The third and current stage has been to
continue its growth by participating in joint ventures with foreign companies. It has
developed its spirits business to bottling and is building a factory for Coca-Cola bottlers, and
is participating in telecoms alongside Skytel (a foreign telecoms company).
All financing is done from cashflow. While they evaluate financing decisions by receiving
proposals from banks, to date they have not considered the standing nor the terms offered by
the bank’s as attractive. Foreign currency loans sourced off-shore are more attractive, and
they note the arrival of Chinese banks now offering RMB loans direct to Mongolian business
through local offices. Equipment financing is typical in this respect.
The corporate structure is dictated by history, which is characterized by diversification. A
large influence on the holding structure with operating subsidiaries is the company reporting
taxation system. There is no system for consolidation of accounting in group structure and no
70
group tax system. Incentive by way of organization is to ringfence each business and to keep
them small and unprofitable for tax reporting purposes.
Discussion then turned from structural issues to management culture and processes. Like
many Mongolian business, the family ties were very important in MCS. MCS identified there
were costs in this system of building employee base, despite benefits of familiarity and trust,
and consciously avoid family connections in employee and business relations because it
hinders growth. The change in culture has been facilitated in part by reward schemes which
include bonuses and shares. Salary levels for qualified staff are as high if not higher than top
administrative jobs in embassies. Benefits are also an important part of the package – MCS
provides access to grants and / or cheap finance for home purchase and has constructed an
apartment building for employees.
In terms of problems with operating under the company law, there are no significant business
costs that are direct result of the law – good advisers find a way through for a reasonable cost.
However, generally there are logic problems and gaps which lead to inconsistency and lack of
predictability. JO attributes this to instability in the mechanism (i.e. bureaucracy) of
government (as opposed to political stability at the executive level). Laws are amended very
easily.
Mongolian Bankers Association , Jigjid Unenbat
The purposes of the meeting were to establish the patterns and obstacles to secured lending in
Mongolia, and to establish issues of corporate governance in the industrial sector where a
relationship with commercial lending practices. (JU was Governor of Central Bank from
1996 – 2000). The volume and range of secured lending has increased markedly since
February 2001 when banks were enabled to enforce pledges privately. There is an argument
now, however, that banks rely too much on security – using it as a substitute for good credit
analysis to be supplemented by security.
Discussion turned to the basis for credit analysis. Analysts do not find useful nor trust
accounts produced in accordance with Mongolia accounting standards. The standards of
accounting and reporting are not enforced by the Central Bank, Ministry of Finance, nor is
there pressure from the professional community. Particular problems are no agreed and
reliable measures of return on assets and return on equity. A significant cause of this is
understood to be the tax reporting regime which distorts the incentives and therefore the form
of accounting and disclosure.
71
In terms of market-based credit information systems, the Central Bank sponsors and manages
a system. The ADB provided some financial support to the development of this system. The
system is used pursuant to confidentiality obligations on the users. The system is reported to
be reliable but slow and a current initiative at the Central Bank is upgrading the software.
Banks therefore seek specific information from prospective and existing customers to support
their credit analysis and request for security. The lack of transparency of ownership of the
enterprise is a significant issue. Other big issues are transfer pricing within a group, and the
extent and nature of related party transactions.
There is reported to be a large increase in lending and volume has increased as well. But
growth is spread across sectors, according to JU. JU believe the most important factor
supporting this pattern is the pledge system. However, the terms of such credits remain short
term though some with the support of credit lines from off-shore (multi-lateral support) have
extended their terms (e.g. Trade Development Bank and Golomt Bank). It is clear to JU that
with the liquidity and reserves being maintained by banks in off-shore markets, the risk
premium in the loan rate is still extensive.
It was not clear to JU that the Stock Exchange system should be the priority for development
of the capital market given that there was still much to do in basic commercial lending. The
main priorities must be improvement of disclosure and transparency.
Loropiana, Ayush Buyandelger The purpose of the meeting was to establish, in the case of a foreign direct investor, the
adequacy of the legal and regulatory environment for corporate governance. Loropiana is an
Italian fashion brand which owns and operates businesses through the production and sales of
high quality garments. The Mongolian business represents vertical integration at the level of
dehairing cashmere for use in its products. Loropiana started sourcing cashmere from
Mongolia in 1981 when Gobi-Cashmere Factory was first set up (under a UNIDO
programme with financial support from Japan in part reparation for WWII issues). Loropiana
entered into long term contracts with Gobi-Cashmere and procured about 150 tons per year.
This system ended in the early 1990s when the whole system of procurement collapsed. This
caused an increase in the number of traders and in response Loropiana set up its own trading
company. This was not ideal (the costs of procuring from multiple sellers was relatively
high) and Loropiana took the opportunity to purchase a dehairing plant that came up for sale.
In order to purchase this, the registered capital of the trading company was doubled to USD 2
million and the plant was purchased. The company is wholly owned by Loropiana (family
business) and the board is composed of Mr Loropiana (Chairman), a CFO (Mongolian) and
72
the CEO (AB). The firm operates under a five year licence issued by the Board of Foreign
Investment and Trade: this required an amendment of its original trading licence.
To operate, Loropiana maintains a series of relationships with local and state authorities. It is
required under the licence to produce audited accounts (which is undertaken by Arthur
Anderson in accordance with international standards set by Loropiana group). Financial
audits along with a letter of audit are required by the board of foreign investment to be
submitted to the City tax authorities.
The firm is regulated at the local municipality level too. It is required to submit statistical
data on its production and output, labour protection standards, and social protection standards
including data on medical position of staff, and number and nature of factory incidents.
Sanitary checks are made regularly.
In terms of financing, working capital is provided by a Swiss Bank as guaranteed by the
parent company. There is only one buyer for the output (i.e. the spinning subsidiary based in
Italy to which all the output is shipped) and therefore payment on the date of dispatch is made
by the buyer to the firm and a simultaneous credit is made to the working capital facility
provided by the Swiss Bank. The firm experiences some problem with withholding tax
regime because it is not clear that credit for tax withheld in Mongolia can be enjoyed by the
Group’s Italian or Swiss companies.
In terms of staff, the firm has a total of between 27 and 30 staff. In addition to 2 executive
directors, there are three persons in the administration function taking care of general
management function, accounting, and financial administration. The plant operates 4 shifts
per day – and three employees (a manager and two operatives) for each shift, i.e. a total of 12.
In addition, there are 15 sorting staff. AB procures most of the staff from the large Gobi-
Cashmere (indeed where she worked for 16 years before joining Loropiana). Formally, staff
have a one year employment contract and are paid a bonus depending on the firm
performance and their own. There is very small amount out of turnover, and high degree of
longevity of employment.
J Ganbaatar, Mongol Bank (Central Bank) The purposes of the meeting were to establish the role of the central bank in institutional
development (particularly of secured transactions practice and corporate governance of
banks), to gather data on secured lending, and to ascertain what donor funded initiatives are
being planned or underway.
73
The Mongol Bank has a strong role in institutional development through training and
developing certain services for financial institutions. For example, over the last two years
Swedish government-sponsored consultants have advised on the development of strong
banking structures, and foreign and domestic payment systems. Mongol Bank administered
the creation of a credit information system with the assistance of the ADB and is now
operated by the Mongol Bank. The Swedish assistance will end at end of 2002.
On corporate governance, the Bank has been aware of a need to support the
institutionalization of corporate governance practices in the banking sector for some time.
The OECD Principles were translated, and banks were invited to two seminars: they were also
asked to amend their own regulations to meet the standards in the principles. More
specifically, the Bank has operated seminars on internal control and internal audit. All of
these seminars are apparently operated on a commercial (i.e. fee paying) basis. To serve this
function, the policy department has a staff of four full time people and is able to target
seminars at various levels of banking firms – from management to junior credit evaluation
staff. At he beginning of each year, the Bank’s policy division surveys the commercial banks
to assess their training needs. They also inform those banks of the monetary policy plan for
the year to enable the banks to take suitable action. Those needs are then prioritized in view
of monetary policy developments. A curriculum for training is developed then presented to
the Mongol Bank Governor for approval.
In terms of current and future developments, non-bank financial institutions are rising up in a
largely unregulated environment in response to demand for micro-finance. There is a draft
law covering credit unions, investment companies, and finance companies. This has been
drafted by a member of Parliament but requires more work. In addition, a new co-operatives
law contains provisions focusing on financial companies. The Mongol Bank remains cautious
about both of these recent developments.
USAID, Charles Ferrell
The purpose of the meeting was to establish the nature of USAID assistance, and to establish
whether there was any overlap or symmetry with EBRD proposals. USAID began a five year
USD 10 million programme in 2001. The programme focuses on court administration – it
focuses on training of judges, retraining of lawyers and procedures of court staff for
administering the court system. At the general level, as the court system would hear disputes
over secured transactions and corporate governance issues, and in the case of secured
transactions could play a role in enforcement, this represents a parallel development.
74
However, the USAID treatment is likely to be at the general level only because of the theme
of judicial system development. It is more likely that partner organizations would deal with
specific technical aspects. By way of example, a Mongolian wide tour is about to commence
in which the new civil code system is presented in a series of seminars to both judges and the
lawyer communities in non-UB aimags. This is in advance of the new Civil Code becoming
effective in September 2002. CF would like to see this extended to setting benchmarks in up
to five other law areas.
USAID is also supporting a project delivering legal information (laws and regulations) by
internet to five courts. The take up of information technology is low and though there are
many courts with computer systems many of them are never switched on. USAID (along
with GTZ) has offices in the Ministry of Justice and Home Affairs: therefore the activities are
closely co-ordinated with the Ministry.
Asian Development Bank, Darius Tetler
(This was an abbreviated meeting due to overbooking of meetings. Local EBRD
representative advised that very little being done by ADB). The purpose of the meeting was
to establish whether, and if so what, activities the ADB was undertaking in secured
transactions and corporate governance. DT stated that they were undertaking nothing in
secured transactions, and had no immediate plans to do so. In terms of corporate governance,
there is broad relevance in their capital markets development work. Specifically, they have a
financial sector program loan and a budget sector program loan. There are conditions and
criteria in place which impact on the overall corporate governance system but this is largely
concentrated on the national bank and financial institutions.
ADB has, however, sponsored a large study by Andersons on a range of private sector
development institutions including company law and secured transactions. (Copy of some of
this material has been received in confidence). Due to a change of personnel in ADB head
office with responsibility for private sector development in Mongolia, nothing has been done
to drive this draft report forward to get approval from the government and conduct follow up
projects. DT believes this position is unlikely to change soon.
It is more likely that the ADB continues to undertake work in the governance of the public
sector in line with themes of work connected to current financing.
75
State Property Committee, Chairman Damdinjaviin Batsukh
The purposes of the meeting were to establish the current practice of corporate governance in
state-controlled or partially state-owned enterprises, particularly the structure and processes of
relations between the State Property Committee and the board; to establish whether the
operation of the legal and regulatory regime created any problems to operating those
relationships; and to establish whether any donor sponsored initiatives were underway or
planned to develop corporate governance in this sector.
The State Property Department is comprised of four departments: State Property Registration,
Privatisation, State Representation of Assets, and Chancellory (Administration). DB is
Chairman of the ‘Representation’ Division. This department gains competence and guidance
from the Law on State Property (1995 and 1996) and the Law on Local Property, now
combined in the Law on State and Local Property. There are two types of enterprises that fall
within state enterprise – a private company with state ownership, and a private company with
state property.
In terms of process, DB’s committee collects financial and operating reports every 6 months
from both private companies which have state as controlling shareholder and where the state’s
interest is in the minority. The annual plans for each type of entity are submitted to the
Department in advance of the board meeting for approval, in the case of the state controlled
companies, and for information in the case of the non-controlled enterprises. Typically, the
Committee will review estimates of expenses and revenues, suggest ways to improve
efficiencies, and scrutinize particular expenses. Where the state has control, that plan is
amended and becomes part of the agreement between the board and the CEO. Where state
does not have control, the board normally takes into account the view of the Committee and is
often affects the contract between the board and CEO. In DB’s experience, the State
Committee is harder on expenses than the board. CAPEX is never supported financially by
the State Property Committee either directly or indirectly by any government agency,
according to DB.
In terms of board nomination policy, the State Committee takes recommendations from the
line ministry, the industry ministry and consults officers in the State Property Department
before nominating director to the board. Criteria focus very much on skills and experience.
Where the State controls ownership, a state nominee is Chairman.
In terms of board processes, DB’s department receives a preliminary agenda before the board
gets its own. DB always receives the papers for the meeting. As a matter of course, he writes
76
comments and signs and then all state nominees must support this action in meetings. If not
followed, they are dismissed from the board. In terms of monitoring information that is of
most interest to this Committee, accounts payable and receivable, profit and loss,
incentivisation, salaries, and apartments and benefits receive normal scrutiny. The
Committee has no special view on layoffs and in any event they rarely have any significant
financial impact which is the touchstone of the Committee’s role. Recently at Erdonent
(copper mining company) reduction in staff numbers was a clear action in view of world
copper prices falling and profits being reduced.
In terms of incentivisation of CEOs, it must be borne in mind that the General Director
remains a political appointee. The standard package would include one variable item (i.e. the
level of profit target). If profits are reached a payment of up to 20% of excess of target is
paid.
There is no specific assistance being given to this governance system of state owned
enterprises. The issue is likely to become greater as privatization proceeds, and even so there
is still scope for further improvement.
Adviser to State Property Committee, D Bailikhuu
DB is an adviser to the State Property Committee, and a member of the newly formed
Corporate Governance Taskforce. The purposes of the meeting were to establish why the
Corporate Governance Taskforce was established, the projects that are in place and the likely
co-operation with international agencies.
No specific institution is in charge. The economic standing committee pressed for this, and
has co-opted heads of a number of key governmental and non-governmental organizations to
the task force. (See list and mandate attached). The mandate was adopted by formal
resolution of the taskforce.
Composition of the taskforce was driven by perception that foreign investment, accounting
and auditing standards, and taxation were very important drivers. A member of Parliament is
the Chairman. As the taskforce has only just been established, it is very early days. The IFC
has, however, already met with the Chairman of this taskforce and has offered some financial
and technical support to possible initiatives. DB stated that they were now in the process of
soliciting funds, and that the likely focus of the IFC work would be micro-level: in companies
at the board level.
77
DB believed that the World Bank would be supporting capital market design projects. For
example, Stock Exchange and SEC rules and processes, and in particular the multi-
functionality of the Stock Exchange, i.e. over clearing, settlement an deposits and listing.
At the state property level, the major scope for improvement is on regulations and procedures
under which state owned enterprises and the SPC interact. This could be solved by
amendment or introduction of regulations to be issued by the SPC. A major problem which
such change could help to address is the depoliticisation of the appointment of the CEO. (To
protect against this, the US funders of the Ag Bank adopted a management contract
approach). Whether the situation would improve depends on the pool of available
professional managers which DB believes is also an issue, i.e. there needs to be both
structural measure but also capacity building in the actual governance processes and
performance of state-controlled enterprises.
DB then proceeded to make a number of suggestions / requests of the EBRD and other
agencies – in particular, to enable governance leaders in Mongolia to attend workshops, make
study trips and undertake internships abroad.
IMF, Michael Martin (telephone call)
The purpose of the telephone call was to inform Mr Martin of the EBRD’s mission, and to
establish any overlap or parallel with the IMF’s initiatives. MM appreciated the call, and
introduced the programme of the IMF in Mongolia. The IMF’s government counterparts are
the Ministry of Finance and Mongol Bank. Institutional development in the area of corporate
governance and secured transactions is only in relation to the development of prudential rules
and practices, and conduct of business rules and practices in the financial sector. In that
respect, however, the emphasis is at the level of Mongol Bank and Ministry of Finance
practices. MM fully supported the initiatives of the EBRD, and noted that he observed a
boom in the construction industry at this time, and believed that the banking system had
significant exposure to these developments. He recommended this as a fruitful area of
analysis for private sector institutional analysis and reform.
Mongolian Stock Exchange, D Dorligsuren
The purposes of the meeting were to establish the current patterns of stock market activity and
the determinants of them in so far as corporate governance is relevant, and to establish current
and planned initiatives to develop the stock exchange infrastructure.
78
The MSE was established in 1991 in order to facilitate privatization. Blue vouchers were
distributed to 1.1 million people and 476 enterprises were privatized by way of the MSE.
This process continued until 1995. In 1995, the MSE established a secondary market for
trading in the equity securities of these privatized firms. As in other post-communist
countries, a massive concentration of ownership occurred. About 350 companies remained
listed at that time and through the concentration process, 80% of the aggregate amount of
shares in issue were held by 1,500 people. In 1999, privatization via the MSE ended, and
liquidity and prices fell in line with global falls.
In terms of the impact of the institutional framework on the concentration process, DD
believes that the Company Law facilitated concentration (without protecting interests of the
minority, i.e. through no fair pricing provisions nor mandatory take-over). One negative
result was that insider companies through concentration meant the pressure on and therefore
quality of the CEO fell. The process for doing so was management would acquire large
blocks from small minority owners. No notice provided to these small shareholders, and the
buy-out price was the average trading price over 6 months which was in most cases
artificially depressed. When pressed DD did not believe this was a securities law problem but
was generally a problem of vague and general laws and regulations.
DD feels the MSE regulations on registration and listing criteria are institutionally weak, and
serve no regulatory role in practice. Their purpose is to assist in marketing the company.
There are no MSE rules on transparency: this is in Securities Law. Of 400 listed companies,
only 75 companies send in financial reports. This is mostly due to lack of resources. Annual
listing fees range from TGD 100,000 to TGD 400,000 depending on market valuation. Of
400 companies, only 150-160 paid their fees in 2001. Following a survey, more started to
pay.
DD believes, given the market activity and the general perception of the MSE and securities
markets, separating clearing and settlement is a non-issue. The MSE could not survive if it
was forced to incur costs of separation and lose some revenue it has now. Does not believe
the current combination creates a problem of legitimacy.
Main income is derived from –
• Government bonds – significant
• Clearing and trading – small
• Depositary services – moderate
79
Total income is USD700,000. Of 42 broker members, only 20 pay.
Stepping back, there is no clear understanding that the purpose of the MSE has to evolve from
an instrument of privatization to a proper market place. Two main hurdles to move this. First,
a recent large scale survey of the public showed 70-80% having no confidence in shares.
Second, deposit rates are high (1.2-1.8% per month) meaning it is hard for equities to
compete with deposits.
A market development is the role of MSE in relation to government bonds. These yield
1.15% per month and the banks are happy to buy and hold these. DD argues that the proof of
the MSE’s role in the capital markets is proven by the banks wiling to take increasingly lower
return which in part is due to transparent and fair distribution and allocation system operated
by the MSE. Note that are no investment banks in UB which DD believes is an institutional
weakness. (In many ways, MSE acts as sales and distribution function for the State
Treasury). For an issue, of TGD 3 billion, MSE takes an income of TGD 3 million. As
budget revenue is very low for the first half of the year, and costs are high (particularly on
heating and electricity) this means of financing is necessary and increasingly used.
Accountability of the MSE is to both the Ministry of Finance and the Securities Commission.
Private company bond issues are infrequent. Last one sought 2.1 billion but only raised 1.2
billion. Used as short term financing for stage of construction – deposit of flat buyers used to
get property started and then next stage tap bond markets as alternative to commercial
lending. Bonds sell well when buyers can see a building. DD is optimistic: more companies
will go bankrupt thereby clearing his books, and prospect of more government bonds and
some corporate bonds give MSE legitimacy. ADB has, apparently, recommended
privatization of the MSE and separation of the clearing and settlement functions. DD
skeptical of privatization because only asset is really the building they occupy – an ornate
former cinema.
Gonchigiin Seseer, Ministry of Foreign Affairs and Trade
This visit was a courtesy call due to assistance of the Sodnom Ganhuyag of the Ministry
during the visit of the consultant. The Ministry’s involvement in secured transactions and
corporate governance is at the inter-governmental level either in bi-lateral or multi-lateral
agreements. Mongolia’s membership of the World Trade Organisation requires the
government to be transparent on all treaties and the impact of them on Mongolian citizens and
businesses. GS reported that this was significant challenge in terms of logistics and cost, and
sought assistance in effecting this duty.
80
Tserengavaa Jigden, Dalai Van-Audit
The purpose of the meeting was to establish the current range of accounting and auditing
rules, and the perceived weaknesses in them and the associated practices. TJ is Chairman of
National Association of Auditors and also a member of the Corporate Governance Taskforce.
This firm has 200 commercial clients, among whom are 30 open joint stock companies
including Erdonet (copper), NIC (oil), and MIAT (airline). The firm delivers accounting,
audit and consulting services, and for the larges companies more than 50% of fee income is
on the audit.
The firm is licensed by the Finance Ministry and must be a member of the Institute of
Professional Accountants. The process for membership is the grant of a licence on the basis
of recommendation of executive staff. The authorities under which audit and accounting
services are provided are the Law on Audit (1997) and the Law on accounting (1993 –
amended with effect from April 2002). All professional accounting and auditing regulations
are issued under the Law on Audit.
According to TJ significant step was taken in 1998 to align Mongolian accounting standards
with IAS. In a survey last year by the Ministry of Finance of large companies, 27% had
transformed their accounts to the new format, 33% had introduced some changes, and 40%
had undertaken no change. As a general comment, TJ feels that all large enterprises have
taken some steps, e.g. MIAT and Erdonet are consolidating their accounting systems and
reports.
In terms of experience of undertaking audit, TJ’s firm has never refused to sign the audit letter
but many challenges remain. It is very difficult to obtain information, and company officials
do not yet understand the process. Key issues which cause TJ concern and should be
addressed both in terms of accounting and audit rules and processes, and understanding and
practice of company officers are –
• Long lists of debts and receivables – most receivables listed are hopeless and not
recoverable yet this is not reconciled
• Depreciation of assets – there is no objective assessment
• Intellectual property – there is no process for treating IP and no recognition, for
instance, of R and D expenditure
81
• Related party transactions – government procurement contracts often involve highly
inflated prices, although this problem is reducing
• Internal control – this process is institutionally weak
• Government partial or wholly owned – the process between the auditor and the state
property committee is not open and searching
• State revision commission (the government’s internal auditor) – the process between
the external auditor and this body is stronger because the state commission is high
profile and is removed from the executive branch of government
TJ believes that the key issue is the lack of human resource in the profession and in industry.
There is a scarcity of people who can audit to professional standards. Professional education
is weak, requiring inter alia significant retraining of auditors into accountants. Mongolia has
40,000 persons with accounting diplomas from university but only 600 professional
accountants – of which only 200 have licences. There are 200 licensed auditors. Institutional
change (for instance recent amendment to the Law on Accounting) driven by coalition of
Financial College, Ministry of Finance, Auditors Union and the Accounting Profession.
Wagner Asia Equipment, Ts. Togtokhdalai The purpose of the meeting was to establish current secured transactions practice by an
equipment leasing firm. The company is owned by a Denver based US company. It has
operated for five years in Mongolia. Total sales of USD 100 million in that time. Its business
involves leasing equipment necessary for large scale earth moving and construction, parts and
other vehicles. It effectively distributes brand US products in these areas. Its 2001 sales were
USD 13 million broken down as follows –
• CAT equipment – 6-7 mill
• Ford – 2 million
• Goodyear – 1.1 million
• Parts – 3 million
Bad debts currently running at estimate of USD6 – 7 million. For both equipment and cars,
the risk is shared as part of the deal between the offshore financing company
Basic structure of CAT equipment financing
82
• Rates
o Up to one year 12% of price
o Up to 2 years 14% - 16%
o Up to 3 years 16-18%
• Wagner owns equipment under one of 2 methods
o Wagner own till buyer pays full amount
o Buyer own and pledge of asset on payment of price
CAT financeco (offshore)
Dealer
CAT factory End user Sale
Finance and profit / risk sharing on end user Pay for
equipment Financial lease
83
In terms of pledge on transfer of equipment, the typical assets pledged and the charges for
establishing them are –
• Gold / mineral licence – issued by mineral authority – USD 500
• Buildings – issued by immoveable property agency – 0.1% of loan
• Vehicles (treated as immoveable) – 0.1% of loan
• Shares – stock exchange registers pledge – 0.1 % of loan
• Legal and notary fees – 0.02%
The weaknesses in the current institutional framework are
• No single register of pledges on moveable property
• Priority provisions for number of pledges on assets – there are no valuation of assets
provisions in pledges that are currently taken, so whole of debt is charged on all
assets pledged
Last year spent USD 500,000 on legal fees. This credit manager spends many days in court.
Car sales are effected by 30% payment in cash, and 70% provision of finance. Two structures
are used – seller retains ownership, or ownership transferred and car is pledged along with
other assets. Under the first model, two insurance companies become involved and share
Wagener’s risk of default. Repossession of cars is a common activity for this credit manager
and works well. However, under the second model, the transfer of pledged property to the
creditor is problematic because enforcement is difficult – courts are reluctant to effect transfer
of property to the creditor under the pledge agreements.
American – Mongolian Business Group, Maurice Lynch
The purpose of this meeting was to establish critical issues of corporate governance and
secured transaction practices in Mongolia, particularly from the legal perspective, and other
institutional initiatives in this area. ML is a US attorney who has been resident in UB for
about 5 years. He is also the Chairman of a networking group for US business interests in
Mongolia.
In terms of company law, ML is currently 1/3 through a practical commentary on the
company law funded by Soros Foundation. He retains contact with Bernard Black of
Stanford who drafted the 1997 Company Law. ML sees a number of problems with the
current application of the Law, and the commentary is aimed at solving some of them. For
example, the capital maintenance philosophy of the law is derived from US standards,
especially Delaware, but the Law itself has maintained the legacy of German law concept of
registered capital. The US concept of beneficial ownership is a key corollary of a meaningful
application of affiliate persons definitions and therefore the related party transactions.
84
However, in common with many post-communist states there is no concept of beneficial
ownership and legal ownership is the focus point for analysis thereby rendering the related
party transaction terms of limited effect.
ML provided his understanding of other donor funded projects. He confirmed the IFC
initiative on corporate governance and also work on financial leasing. He believed IFC had
established a working plan for Ochahoo, the chief protagonist of the Corporate Governance
Task Force. He confirmed the role of GTZ in the secured transactions.
Commenting on institutional capacity, ML believes the Stock Exchange has a useful role in
registration of ownership and distribution of securities, and also in the registration of
notification of pledges on securities. The Minerals Authority has established a sound
competency in issuing licences and administering the transfer of licences, as well as
administering the creation of pledges in mining licences. To the best of ML’s knowledge,
however, enforceability under the Minerals Law remains to be tested.
In terms of governance and management practices, the key issues for ML are that there is a
dearth of professionally managed companies, shareholders are considered as those who pay
and will get paid in due course – there is no overriding concept of loyalty or duty to
shareholders, and the concept in law and in debate about corporate democracy is in no way
entrenched. Making all of these issues a theme of upcoming privatizations would have
demonstration effect.
Gobi Cashmere, Otgontsetseg (secretary to board)
The purpose of this meeting was to establish corporate governance practices from the
perspective of the partially state controlled, strategic industry, and to further support the
details on process set out by the representatives of the State Property Committee (SPC).
Gobi Cashmere was established in 1981 and is now 75% owned by the government. The
remaining 25% was sold through Stock Exchange privatisation. The original number of
78,000 shareholders has shrunk to 22,000 and about 80% of the 25% is concentrated amongst
4 people, of whom 3 are members of the board. The board has 11 members of which 8 are
appointed by the government and 3 are appointed by the shareholders meeting.
The board meeting agenda is regulated by a bylaw. In practice, the relationship with the SPC
is very close. Of 8 government members, 2 are part of the SPC while the remaining 6 are
members of various line ministries. O confirmed the SPC statement of process that the SPC
receives a preliminary board meeting agenda and comments on specific items, including
85
financial information and business plans. There are currently 4 other individuals appointed to
the board in preparation for a proposed sell down of 5%. These persons derive their authority
from the Law on State and Local Property and a resolution of the SPC, and currently maintain
a direct relationship with the SPC on specific business matters which are seen as key to the
sell down effectively by-passing the General Director. . For example, in late 2001 this Group
carried out a one month review of Gobi Cashmere’s business for the SPC – most contact is
with the finance and accounting division.
The General Director is not on the board and in normal circumstances he has a detailed and
formal relationship with the board (effectively the SPC). The only variable factor is the bonus
available to the General Director because his commission is determined according to a
percentage of profit achieved over certain levels of targets. The contract and targets do not
contain any non-financial criteria – it is formally regulated by the by-laws. The position of
GD is essentially a political appointment with changes mapping precisely to the changes in
government. Succession planning is ensured by ensuring that a senior manager allied with the
political party currently not in political control is available to step in should the government
change.
The board provides assistance to the management in securing finance, and there is some
indication of subsidisation of the firm by government shareholders in this respect.
Turning to relations between the General Director and other interest groups, there is an annual
agreement between the General Director and trade union representing workers. (Gobi has
2,000 employees on the payroll). Last year’s agreement was for TGD 300 million and it was
approved by the board. This amount has remained constant for the last three years and so in
real terms has fallen, although employee numbers have fallen too. Payments cover all staff
benefits.
Senior managers procure their authority via internal rules. The executive board provides
management co-ordination and the four functions represented are – marketing, processing,
production and finance. The executive director council (including the general director plus
the head of each of these divisions) meets twice per week. It takes decisions which are
formalised by way of resolution and then distributed to mid-level managers. Reward that is
related strictly to the performance of the enterprise is payable only to the General Director.
The GD has agreements with each department head derived out of his contract with the board,
for example the production department has a target on pricing. Performance related reward is
therefore related to individual performance, not related to firm performance at all.
86
In terms of information flows from management to the board, there is no direct link between
individual departments and the SPC. Communication of financial performance data is
distributed monthly to the SPC but this is always via the executive directors council.
O has no problems with the current operation of the Company Law as it applies to Gobi
Cashmere.
AG Bank, Debra Boyer
The purposes of the meeting were to establish the effect of a unique corporate governance
model in the Mongolian context, to establish knowledge of managerial practices at local level
in a country-wide firm, and to assess needs on secured transactions law reform.
It has been established in the meeting with the SPC Chairman Batsukh that the relationship
between the government and AG Bank’s management was very different from all other
corporate governance structures in Mongolia. The reason for this structure was an agreement
between the Ministry of Finance, the World Bank, USAID and Ag Bank that it was a
condition of financing that this structure was in place. The board has 6 members – 1 each
from the Ministry of Finance, and the SPC, and three sponsored / nominated by USAID
(including DB) plus an independent Chairman (the head of the Financial College who strictly
speaking fits the criteria of a SPC nominee because he is an employee of the state in his
capacity at the Financial College).
Current assessment is that the model is hard to effect because government and staff alike are
only starting to appreciate the rationale and consequences of the separation of ownership and
control. For example, the USAID board / management coalition had to work very hard to
refuse and prevent random inspection by the SPC of the list of assets of AG Bank. Another
example is a controversial dismissal where the employee has made independent approach to
the Chairman to the SPC on his grievance. However, certain members of the SPC realise the
cost savings and efficiency increases in maintaining an arm’s length relationship.
Having established a degree of separation at the shareholder board level, governance practices
are promulgated by the management in a manner suitable for a financial institution in the
Mongolian context. Management has an overriding strategy to raise awareness of roles and
responsibilities, flowing from the system by which the CEO and COO operate: not atypical of
an American management system. Specifically, there is a strong delegation and control
process in place. All matters of policy are retained by the COO, and major procedures are
approved by the COO. Financial authorities start with the CFO who is delegated authority
87
subject to certain limits. Each regional office manager has delegated financial authority over
loans, and credit procedures are set in place by which the credits are assessed and granted.
This credit line is matched by authority over budgets and expenses. Monitoring of use of
delegated authority was carried out centrally but now is supported locally by regional control
functions.
Turnover of regional managers has been high – 50% in 17 months. Main reason has been
fraud related activities, whereby the conflict of interest and related party transactions
characterise many of the loans in the regions. Incentives are performance based pay whereby
each region has performance target and bonus is based on management objectives: each
regional manager has authority to make bonus payments and set criteria for those as well. In
other words, a fairly devolved structure.
The statutory revision commission does not really have a role given the internal control
structure put in place by management.
Enforcement of defaulting loans on secured property works well in practice. AG Bank uses
private agreements, and believes that banks are well protected. Though there are no specific
rules governing all aspects of the disclosure process by creditor to debtor, AG Bank has
established internal standards to ensure that debtors are fully aware of the potential that they
might lose their pledged assets. DB felt strongly that a registry for charges on moveable
property should be established.
Golomt Bank, D Munkhtur
This is one of UB’s largest commercial banks. The purpose of the meeting was to establish
the practice of secured transactions carried out by the bank, and issues for improvement. The
pledge is currently working well, but there is not enough property for pledging. Currently,
typical property pledged in immovables, installed equipment, shares, and inventory (but only
if quickly sellable). The bank wishes to take pledge on moveable property but the law is not
clear and there is no register for pledges on moveable property.
The bank currently provides finance on 50-70% of the valuation of the assets. For equipment,
for instance, the valuation is calculated by reference to the productivity of the equipment and
also the liquidity of transfer. Total loans for 2000 were USD 25 million and for 2001 USD 50
million. Average credit is USD 100,000 and average length of credit one year. Backed by a
credit line from multilateral bank, credits have been extended for 7 years in the flour,
cashmere, and construction materials sectors. Loan portfolio broadly represented as follows –
88
• Cashmere – 20 %
• Construction materials – 10-15%
• Meat – 10%
• Gold – 15%
Balance of non-performing loans is reported to be about USD 25 million, or about 10%. The
biggest problem with secured transactions is the uncertainty and cost of enforcement. About
10-15% of the bank’s credits are unsecured – these are with large, credible customers who
can repay. In their loan book, he believes total stock of secured property is about USD 30
million. Most common enforcement uncertainty and source of dispute in the commercial
setting is where a holding receives the credit and pledges its assets and so does the subsidiary
– but the bank cannot monitor the independent financing of the subsidiary (which often has
the assets).
To improve the process of pledges, M argues in favour of an auction system for the
enforcement of pledge via sale of property. This should be government sponsored.
