Legal Analysis in the Mechanism of Shares Divestment in Indonesian

Mining Law

Widhayani Dian Pawestri and Iman Prihandono

Faculty of Law, Universitas Airlangga

Keywords: Investment, Mining, Law, Shares, Divestment.

Abstract: This paper is based on shares divestment issues which are still problematic and caused some negative

impacts. First, Indonesian government is always late in making purchases or executing divestment. Second,

although the divestment is conducted by Indonesian government, it is often difficult to obtain funding for

the purchase of divestment shares. Third, even if the divestment fund is successfully obtained, the

divestment is conducted through a syndicated process which uses loan money from foreign party. This study

shows that the dispute on divestment share pricing and potential losses between countries and foreign

investors is not unusual to be happened. In some cases, governments and foreign investors often disagree on

how to calculate the share price or the value of the company upon expropriation, or when the business

license is revoked. The Indonesian government can learn the approaches from previous awards of the

ICSID. In this research, there are 2 alternatives for divestment mechanism in the mining sector, namely:

determining a clearer mechanism of the price of shares divestment and the divestment without the purchase

of shares. This article is a legal research and the approaches used are conceptual approach, statute approach,

case approach, comparative approach, and economic analysis of law.

1 INTRODUCTION

The mining industry for the economies of countries

in the world including in Indonesia has a very

important role. In fact, Indonesia has limited funding

in the exploration and exploitation activities of the

mineral and coal mining sector. In the management

of natural resources, it is required a very large share,

advanced equipment, experts and high risk, so it is

necessary to cooperate with foreign parties in the

management of natural resources by doing

investment activities using the Contract of Work/

Kontrak Karya (KK).

Government policy related to investment in

mining sector is the issuance of Government

Regulation Number 1 of 2017.In that regulation, all

foreign mining companies in Indonesia, both KK

holders and Mining Business Licenses/ Izin Usaha

Pertambangan (IUP) and Special Mining Business

Licenses/ Izin Usaha Pertambangan Khusus (IUPK)

shall be subject to Law Number 4 of 2009

concerning Mineral and Coal Mining are required to

divest the 51% of shares. The obligation of Shares

Divestment is also reinforced by the issuance of

Regulation of the Minister of Energy and Mineral

Resources Number 9 of 2017 on Procedures of

Shares Divestment and the Mechanism of

Determining Shares of Divestment on Mineral and

Coal Mining Business Activities.

This divestment offer is conducted in stages to:

Government, Provincial Government, or

Regency/City Government, State-Owned Enterprises

(BUMN), Regional Government Enterprises

(BUMD), or National Private Enterprise. If the

divestment is not preferred by the Central

Government to BUMN, the implementation of the

divestment must be carried out under a public

offering scheme in the Indonesian stock exchange

through Initial Public Offering (IPO).

The divestment policy in the process has never

conducted smoothly. This can be seen from several

cases at the International Center for the Settlement

of Investment Disputes (ICSID) or the International

Arbitration Body related to Shares Divestment cases

(Prihandono, 2014), including as well as the very

recent case, the Freeport divestment case (2016).In

the Freeport case, the Government of Indonesia

currently has 9.36% shares of PT Freeport Indonesia

(Indonesia). Based on the previous policy (as

stipulated in Government Regulation Number 77 of

Pawestri, W. and Prihandono, I.

Legal Analysis in the Mechanism of Shares Divestment in Indonesian Mining Law.

DOI: 10.5220/0010050903550361

In Proceedings of the International Law Conference (iN-LAC 2018) - Law, Technology and the Imperative of Change in the 21st Century, pages 355-361

ISBN: 978-989-758-482-4

355

2014), Freeport which has underground mining

activities is obliged to divest 30%.

In early January 2016, Freeport offered

divestment of 10.64% of shares or USD 1.7 billion

of 100% total valuation of USD 16.2 billion. This

figure also includes the assumption that the

company's investment is poured if the government

extends Freeport operations until 2041. Freeport's

obligation to release 51% of its shares-is up to this

year. If it refers to a contract of work, the Freeport

contract expires in 2021. However, the government

has never approved the extension of the Freeport

contract. This means that the company's copper and

gold reserves since the contract expires in 2021 to

2041 are owned by the Government of Indonesia. In

the Permen ESDM No.9 of 2017, the determination

of the price of the divestment shares, it must be a

fair market value. In addition, share pricing

mechanism also do not take into account the mineral

reserves contained therein, so that the offer of share

price by entering the next investment value as done

by Freeport cannot be done anymore because fair

market value does not include the existing reserves

beneath.

From the above cases, there is one major issue in

the process of divesting shares in Indonesia the

problem is the share pricing mechanism that will be

divested. This resulted in the objective of divestment

arrangement not being achieved due to unequal price

fixing issues between the government and Freeport.

This article will discuss how the divestment

mechanism in Indonesia and the obstacles that

hinder the divestment process.

2 MATERIAL AND METHODS

This article is a legal research. It will be a reference

in policy making process and as a foundation in the

development and establishment of law. The

approaches which are used are conceptual approach,

statute approach, case approach, comparative

approach, and economic analysis of law. The

primary legal materials which are used in this

research are all applicable legislation, international

conventions and court decisions related to

investment and mining in Indonesia. The

international conventions include the GATT, the

Agreement Establishing the WTO in particular on

TRIMs, and the decision of ICSID decisions.

Meanwhile, the secondary legal materials are in the

form of literature and related materials regarding

investment law and mining law, as well as previous

research related to this issue.

3 PROVISIONS OF SHARES

DIVESTMENT IN THE

CONTRACT OF WORKS

BETWEEN THE

GOVERNMENT OF

INDONESIA AND FREEPORT

The existence of Law No. 1 of 1967 initiated a

Contract of Work between Freeport Indonesia

Incorporations and the government of Indonesia or

better known as Generation I of Contract of Work

(KK Generation I) signed on April 7, 1967 (Putra,

Mencermati Posisi Freeport dari UU Minerba,

Kontrak Karya, serta MoU, 2017). The

establishment of the Contract of Work is motivated

by the circumstances at that time, in which there is

no standard form of contract in the mining sector.

The provisions on compulsory divestment of shares

are stipulated in the Contract of Work between PT

Freeport Indonesia and the Indonesian government

effective on 30 December 1991, also known as the

Generation II of Contract of Work (KK Generation

II).After Government Regulation No. 77 of 2014

issued, PT Freeport Indonesia renegotiates with the

Indonesian government regarding the extension of

the contract of work (Putra, Mencermati Posisi

Freeport dari UU Minerba, Kontrak Karya, serta

MoU, 2017). In this case, PT Freeport Indonesia

attaches a Memorandum of Understanding (MoU)

which was agreed with the Indonesian government

on July 25, 2014.

The provisions for PT Freeport Indonesia to

extend contracts with the Indonesian government

where one of the six required points before signing a

contract is a divestment, but this divestment

obligation is not regulated specifically about the

stages and the amount of shares to be divested.The

government subsequently renegotiated the KK

Generation II with PT Freeport Indonesia resulting

in an amendment to the divestment provisions from

51% to 30% (Putra, Mencermati Posisi Freeport dari

UU Minerba, Kontrak Karya, serta MoU, 2017). Not

only there, PT Freeport Indonesia's contract of work

with the Indonesian government was extended to

KK Generation V. Based on Article 24 of KK

Generation V, PT Freeport Indonesia is required to

divest the shares in two stages: The first phase, PT

Freeport Indonesia sold shares to Indonesian

participants of 9.36% in the first ten years since

1991; and The second stage, PT Freeport Indonesia

is required to sell its shares at 2% per annum from

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356

2001 until the ownership of Indonesian participants

to 51%.

The liability for the first stage of Shares

Divestment has been successfully performed, in

which 9.36% of PT Freeport Indonesia's shares are

owned by PT Indo Copper. However, the obligation

of the second stage of Shares Divestment was

delayed due to the issuance of Government

Regulation No. 20/1994 concerning Share

Ownership in Companies Established in Foreign

Investment Framework. This means that the

government currently has only 9.36% shares of PT

Freeport Indonesia and there are still 41.64% more

shares that need to be acquired.

4 OBSTACLES OF SHARES

DIVESTMENT IN MINING

SECTOR

The provisions concerning the obligation of Shares

Divestment in the mining sector is an effort of the

Indonesian government to realize the state control

over the resources it has, as stated in Article 33

paragraph (3) of the 1945 Constitution. The share

ownership of the divestment proceeds is expected

that the Indonesian government can provide benefits

for Indonesian participants in two ways (Manley &

Bria, 2017). First, Indonesian participants can

benefit directly through share ownership in mining

companies rather than indirect benefits through tax

revenues. Secondly, through this provision, mining

companies can acquire new technology and develop

new businesses, open jobs, as well as larger business

opportunities at domestic level. In other words, the

implementation of the Shares Divestment

obligations for foreign investment companies in the

mining sector is expected to bring benefits to

Indonesian participants. However, in practice this is

not easy to implement.

4.1 The Government Expectations on

the Policy of Shares Divestment

Will be Difficult to Achieve

Based on an analysis report from the Natural

Resource Governance Institute (NRGI), the terms of

the Shares Divestment have little chance of

achieving the initial target intended by the

Indonesian government. In addition, the government

also has other obligations such as improving

infrastructure and increasing overall economic

productivity. It should be considered that domestic

capital will be difficult to meet both of the above

objectives, to purchase shares of foreign mining

divestment and build infrastructure. If the

Indonesian government still chooses to use the

existing budget to purchase the shares of foreign

mining divestment, the benefits gained by society

will not be felt.

The NRGI in its analytical report addresses

several factors that would be an obstacle for the

Indonesian government to achieve the objectives of

a mandatory stock divestment policy in the mining

sector for foreign companies. First, the purchase of

divestment shares by Indonesian participants will

require an increase in foreign debt or divert large

amounts of domestic investment from other sectors.

It is worth noting that during the last five years the

extractive sector, which also includes mineral and

coal mining activities, attracted US $

21,000,000,000 from foreign investors. This amount

is worth almost half of all investment from

Indonesian participants in all other sectors of the

economy. In accordance with the provisions of our

laws that must be divested by foreign investment

companies at least 51% of the total number of

shares. If an Indonesian participant buys more than

51% of all foreign direct investment stocks, the

required amount will likely require significant

engagement from Indonesian investors from other

industrial sectors.

Indonesian participants who purchase the shares

of the divestment will then take on the role of

replacing foreign investors. Then the question arises,

whether the Indonesian participants in this case able

to maintain its role just like with foreign investors

before? Based on data collected by NRGI, the

answer is no. We can conclude that each option has

significant consequences and certainly less useful

for the benefit of the people of Indonesia. The NRGI

concludes that buying the shares of the foreign

companies’ divestment in the mining sector is a

hollow victory.

One of the risks to be faced by the Indonesian

government in achieving the main objective of a

mandatory stock divestment policy for foreign direct

investment in the mining sector is the acquisition of

dividends from investments made by Indonesian

participants may be below expectations. This can be

explained by two reasons. First, the number of

shares of Indonesian participants will not be enough

to buy the divestment share price offered by the

foreign investment companies, so that Indonesian

participants must owe to other parties. Permen

ESDM No.9 of 2017 has stipulated that holders of

IUP of Production Operation IUP and IUPK of

Legal Analysis in the Mechanism of Shares Divestment in Indonesian Mining Law

357

Production Operation and its affiliates are prohibited

from lending funds to Indonesian participants who

will purchase their divestment shares. As a result we

can see in the case of Newmont, where Multicapital

as an Indonesian participant purchasing NNT BV

divestment shares borrowed US $ 300,000,000 to a

foreign party, Credit Suisse Singapore. This case

reflects that the Indonesian participants will seek

loans to other parties to be able to purchase the

divestment shares offered by the foreign investment

companies.

Article 2 Paragraph (7) of Permen ESDM No. 9

of 2017 provides a loophole for majority

shareholders, in the case of Newmont above is NNT

BV, to reduce the dividend income for Indonesian

participants as minority shareholders which may

result in payment of dividends that do not meet the

expectations of Indonesian investors. As in the case

of Newmont, the DMB did not gain any profit

because the dividends received were used to pay its

debts to Credit Suisse Singapore. NNT BV as the

majority shareholder in this case can ensure that the

company owes funds from related shareholders or

similar entities and may transfer income from other

shareholders, such as the Indonesian shareholders to

affiliated companies (Manley & Bria, 2017).

The second factor that can be a barrier to the

government in achieving the main objective of the

mandatory Shares Divestment policy in the mining

sector is the ownership of shares by Indonesian

participants can actually reduce the number of

Indonesian workers and business opportunities for

the people of Indonesia (Manley & Bria, 2017).

Acquisition of shares affecting control holders in

mining companies may create opportunities for

Indonesian participants to open new businesses and

create jobs in the mining sector for Indonesians.

Networks owned by foreign companies previously

may develop domestic connections following the

transfer of ownership and control of the company to

Indonesian participants. However, this is likely to be

difficult because foreign investment companies will

not release the connections they previously had for

free. Foreign companies have spent most of the cost

of mining projects during the development process

and the first 10 years of production. During the two

processes, foreign companies have established a

network of suppliers that foreign firms can keep in

order to maintain maximum dividends from their

remaining shares and continuous supply can

generate new business for foreign companies. The

possibility of achieving the goal of increasing the

number of Indonesian workers in the mining sector

will also be difficult to achieve, since a change of

ownership does not always guarantee an increasing

number of domestic workers. Logically, if this

divestment provision causes investment activity in

the mining sector to decline significantly, then

employment for the people of Indonesia also

decreased.

4.2 Requiring Divestment Will Charge

Large Expenses for Indonesia

The provisions on divestment for foreign investment

companies in the mining sector will not be far from

the possibility that there will be a significant share

price discount, given the ability of Indonesian

participants in the mining sector will not be able to

meet the divestment share price offered by the

foreign companies. In other words, the divestment

rules can hinder foreign investment and thus the

overall development in the mining sector.

Analogously, foreign investors will find it hard to

expect anything to receive sufficient returns to pay

their costs and creditors to satisfy their shareholders,

if at the end of their shares should be divested by

possibly lower than they expect.

This can be attributed to several factors, such as

the enormous cost and potential decline in foreign

investment activities in the mining sector

significantly in the future. This enormous cost will

collide with the interests of the government also in

terms of building infrastructure in the country. The

reduction of the state budget for the purchase of

shares of divestment has far less benefits for the

Indonesian people in general. It is also written by

Michael Agustinus, the Indonesian government has

reached a divestment agreement with 51%

(Agustinus, 2017) of PT Freeport Indonesia. The

Indonesian participant who will purchase the

divestment is a holding of state-owned mines

consisting of PT Inalum, PT Aneka Tambang Tbk,

PT Timah Tbk and PT Bukit Asam Tbk. The

problem arising from this agreement is the

insufficient amount of assets from the holding of the

BUMN to meet the divestment price of shares

offered by PT Freeport Indonesia.

Through the debt, the holding assets of BUMN

will not be able to buy Freeport shares divestment

(Agustinus, Berapa Harga 51% Saham Freeport? Ini

Hitung-hitungannya, 2017). It was not feasible

because it would violate the rules of debt to equity

ratio. Based on an article written by Amy Gallo, the

debt to equity ratio in general must be balanced

(Gallo, 2015). Based on the calculation formula of

debt to equity ratio, if the value of a company's debt

is higher than the value of assets owned, it will be

iN-LAC 2018 - International Law Conference 2018

358

higher the debt to equity ratio of the company. The

higher debt to equity ratio of a company will

indicate that the company is experiencing financial

difficulties or distress, where there is a possibility

that the company will not be able to pay its debts

(Gallo, 2015). Therefore, if the holding of a state-

owned mine proposes a debt whose value is higher

than its asset value in order to fulfill the Freeport

divestment share price, then the debt to equity ratio

will be of high value and affect the financial state of

the holding of the BUMN.

On the other hand, the difficulties in

implementing Shares Divestment obligations

occurred in Newmont's case. Based on the contract

of work between the Government of Indonesia and

Newmont Nusa Tenggara BV (NNT BV) in 1986,

NNT BV is required to divest shares to Indonesian

participants at least one third of the total shares

(Manley & Bria, 2017). The implementation of this

divestment obligation is conducted after the

arbitration of the United Nations Commission on

International Trade Law (UNCITRAL) decision on

March 31

2009.

5 RECOMMENDATION OF

SHARES DIVESTMENT IN

INDONESIAN MINING LAW

5.1 Determining a Clearer Mechanism

of the Price of Divestment Shares

There are various methods of pricing divestment

shares, so the government of Indonesia and PT

Freeport Indonesia should not be fixated on the

method that has been debated. Here are the various

methods of divestment share pricing that can be

adopted. The NRGI in its analytical report argues

that the approach used by the Indonesian

government to determine the divestment share price

is likely to hamper future foreign investment

activities in the mining sector. Therefore, NRGI

provides two main suggestions in its report with the

following details (Manley & Bria, 2017): (a)

Determination of divestment share price should

include component of capital cost of equity of

foreign investment company. Without this change,

the effective divestment rule would be a

considerable fiscal burden for investors which would

impact the decline in future foreign investment; and

(b) The need to consider several other methods of

determining the price of a divestment share, such as

a method based on income (discounted cash flow) or

replacement cost. This is in accordance with the

practice in the mining industry in general and

reflects that the Indonesian government does not

only refer to one particular method.

The Indonesian government may follow different

international appraisal rules in each of the cases.

Some mineral-producing countries have detailed and

detailed rules regarding the valuation of mining

assets such as VALMIN (the Australian Institute of

Mining and Metallurgy), CIMVAL (Canadian

Institute of Mining, Metallurgy and Petroleum), and

SAMVAL (South African Mining Associations).

Implementing one of these international rules will

likely reduce the potential for conflict between

various stakeholders and reduce uncertainty in

determining the price of divestment shares in the

mining sector.

5.2 The Divestment without the

Purchase of Shares

The determination of the price of the Shares

Divestment to be offered by foreign investment

company in the mining sector to Indonesian

participants is a crucial factor in the success of

achieving a Shares Divestment agreement. It has

been briefly discussed above that Minister of Energy

and Mineral Resources Regulation No. 9 of 2017

regulates the shares divestment, where the

divestment share price of the holders of IUP of

Production Operation or IUPK of Production

Operations offered to Indonesian participants is

determined based on fair market value by not taking

into account mineral or coal reserves at the time of

implementation of the offer Shares Divestment.

However, according to Yustinus Prastowo, the use

of fair market value method in determining the share

price of divestment is considered unsuitable to be

applied especially to Freeport shares divestment case

(Energi, 2017). This is because the fair market value

method is applied only to assets with comparative

value, while underground mining assets conducted

by Freeport have no comparative value with other

assets in general (Energi, 2017).

In addition, Michael Agustinus also said that the

use of fair market value method in determining the

price of PT Freeport Indonesia divestment shares

would not make it possible for Indonesian state-

owned holding companies to be able to buy 51% of

the divestment shares. When calculated using the

fair market value method, the divestment price will

also cover mineral reserves until the end of the

Freeport Contract of Work, which is 2041. Until

then, the value of 100% PT Freeport Indonesia

Legal Analysis in the Mechanism of Shares Divestment in Indonesian Mining Law

359

shares is US $ 15.9 billion or approximately Rp 211

trillion, then the value of 51% of its shares about Rp

107 trillion. Yustinus Prastowo said that assets

owned by holding state-owned mining only reached

Rp 58 trillion, in other words that the assets of

Indonesian participants do not undertake the price of

51% shares of PT Freeport Indonesia divestment.

On the other hand, addressing the NRGI's

analysis report, the use of the fair market value term

poured by the Indonesian government in Permen

ESDM No. 9 of 2017 has an interpretation that is not

different from the method of replacement cost ever

Indonesia pour in the previous regulation (Manley &

Bria, 2017). In theory, the value of shares that

brokers expect to trade on the market includes the

value the firm derives from selling its future yields

minus taxes (taxes equivalent to reserves less minus

expenses and taxes) (Manley & Bria, 2017).

However, Article 14 paragraph (1) of Permen ESDM

No. 9 of 2017 excludes the possibility of future

production, where the allowed assessment is to

calculate the assets on the land owned by the current

mining company (such as infrastructure and capital

developed, less depreciation of the assets). The

result of the calculation expected by the Indonesian

government is equivalent to the implementation of

the replacement cost method defined in the previous

rule (Manley & Bria, 2017).

Yustinus Prastowo also stated that the use of

replacement cost method in determining the price of

Freeport divestment shares is not fair, because the

divestment share price will only be based on the cost

incurred by Freeport alone in doing mineral mining

in Indonesia without covering the expectations of

shareholders of PT Freeport Indonesia itself as an

investor. The NRGI adds that even if investors do

not have to fully receive net tax revenues from

future production to invest, they will usually expect

returns that are comparable to their capital use

(Manley & Bria, 2017). In this case, the intended

return does not have a certain amount, but according

to the results of analysis conducted in the mining

sector investors tend to use the benchmark close to

the yield of 12.5% of the capital used (Manley &

Bria, 2017).

PT Freeport Indonesia's refusal to use the

replacement cost method in determining the share

price of divestment by the Indonesian government

seems to be true. On September 29

2017, a letter

from Richard Adkerson as Director of PT Freeport

Indonesia refused the Government of Indonesia's

proposal regarding the divestment of 51% shares

(Henricus & Aron, 2017). This is because the

Indonesian government only gives divestment price

valuation valued at 51% based on the benefits of

mining activities acquired up to 2021, when PT

Freeport Indonesia Contract of Work will come to

an end. PT Freeport Indonesia believes that the

divestment of shares should reflect the fair market

value of the business run by them until 2041, which

they say conforms to international standards in

assessing the mining business and is consistent with

their rights contained in the Contract of Work

(Henricus & Aron, 2017).

In essence, the implementation of the stock

divestment will be very difficult to implement

considering that neither the Indonesian government

nor the foreign investment companies in the mining

sector have reached an agreement in determining the

share price of the divestment in accordance with the

interests of each party. Therefore, the divestment

without the purchase of shares by the government

should be regulated at the beginning of the granting

of the Business License. This obligation is direct

without any financial compensation. Mining

business actors may conduct business feasibility

assessments under the terms of this 'direct

divestment'. Business actors may consider whether

the investments made will be profitable at the

beginning of the operating plan of the mining

business activities, including by calculating the costs

incurred by 'direct divestment' obligations without

this purchase.

6 CONCLUSION

This paper is based on shares divestment issues

which are still problematic and caused some

negative impacts. First, Indonesian government is

always late in making purchases or executing

divestment. Second, although the divestment is

conducted by Indonesian government, it is often

difficult to obtain funding for the purchase of

divestment shares. Third, even if the divestment

fund is successfully obtained, the divestment is

conducted through a syndicated process which uses

loan money from foreign party. Therefore, there is

an urgency to reform or make legal changes in the

mechanism of Shares Divestment in this mining

sector.

This study shows that the dispute on divestment

share pricing and potential losses between countries

and foreign investors is not something unusual to be

happened. In some cases, governments and foreign

investors often disagree on how to calculate the

share price or the value of the company upon

expropriation, or when the business license is

iN-LAC 2018 - International Law Conference 2018

360

revoked. Unfortunately practices and decisions on

investor-state dispute settlement (ICSID) disputes

have not shown uniformity. At least, the Indonesian

government can take lessons from previous cases. In

this research, there are 2 alternatives for divestment

mechanism in the mining sector, namely:

determining a clearer mechanism of the price of

shares divestment and the divestment without the

purchase of shares.

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